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Transfer Pricing in India

Transfer Pricing Rules in India

The transfer pricing rules in India apply to both domestic and international transactions that fall above a threshold in terms of deal value.

According to the transfer pricing rules in India, income arising from international transactions or specified domestic transactions between Associated Enterprises (AE) should be computed using the arm’s-length price principle.

India’s transfer pricing rules provide a detailed statutory framework for the computation of reasonable, fair, and equitable profits.

Important Tip
‘International transactions’ refers to transactions between two (or more) AEs involving the sale, purchase, or lease of tangible or intangible property, the provision of services or cost-sharing agreements, the lending/borrowing of money, or any other transaction with a bearing on the profits, income, losses, or assets of such enterprises.

Relationships falling under the AE category include direct/indirect participation in the management, control, or capital of an enterprise by another enterprise. They also cover situations in which the same person participates in the management, control, or capital of both enterprises.

They also cover situations in which the same person participates in the management, control, or capital of both enterprises.

For tax purposes, companies are required to record the exchange of goods using the arm’s-length principle, which states that the prices charged by affiliated companies should be equivalent to the prices that would have been charged by an unrelated third party.

Transfer pricing provisions under India’s Income Tax Act

  • Two or more enterprises are associated enterprises if:
    • One of them participates in the management, control, or capital of another; or
    • There is common management, control, or capital exercised by some persons.

Conditions in Which Two Enterprises Will be Deemed Associated Enterprises

 

Detail

1

Shareholding having at least 26% voting power

2

Shareholding having at least 26% voting power by the same person

3

Advancement of the loan - a loan advanced by one enterprise to another enterprise constitutes not less than 51% of the book value of the total assets of the other enterprise

4

Guarantee of borrowings - one enterprise guarantees not less than 10% of the total borrowings of the other enterprise

5

Appointment of board of directors - at least 51% of the board of directors or members of the governing board are appointed by the other enterprise

6

Appointment of board of directors by the same person - at least 51% of the board of directors or members of the governing board are appointed by the same person

7

Commercial rights of manufacture/ processing

8

Supply of raw materials/ consumables - at least 90% of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise are supplied by the other enterprise

9

Sale of goods/articles

10

Control by the same person/relative

  • An international transaction is a transaction between two or more associated enterprises (AEs), and either or both of them are non-residents.
  • Arm-length price refers to a price that is applied to transactions between persons other than AEs in uncontrolled conditions.
  • Five methods prescribed for the computation of arm’s-length price are as follows:

Methods for Determining Arm’s Length Price

Comparable Uncontrolled Price (CUP) Method

The price charged or paid for property transferred or services provided in a comparable uncontrolled transaction + Adjustments

Re-sale Price Method (RPM)

Resale Price charged by the tested party for the goods or services obtained from the AE to the unrelated party minus the normal uncontrolled gross profit and the expenses incurred by the assessee + Adjustments

Cost Plus Method (CPM)

A sum of direct and indirect costs incurred and [normal uncontrolled gross profit + Adjustments]

Profit Split Method (PSM)

Employed in transactions involving the transfer of unique intangibles. The combined net profit of the AEs in a transaction is compared to their relative contribution to arrive at an apportioned transfer price profit

Transaction Net Margin Method (TNMM)

The net profit of the tested party is determined against costs incurred, sales affected assets employed or any other relevant base, and the same is compared against the net profit of comparable determined against the same base + Adjustment.

Other Method

The other method can be any method that considers the price that has been charged or paid or would have been charged or paid for the same or similar uncontrolled transaction with or between unrelated parties under similar circumstances, considering all the relevant facts.

  • Specified domestic transactions (SDT): Transfer pricing regulations are applicable to domestic transactions that fall under domestic pricing only if the aggregate value is more than the threshold limit of INR 200 million (US$2.7 million). Transactions with related domestic parties that qualify as SDT include: 
    • Two or more enterprises are associated enterprises if:

⇒ One of them participates in the management, control, or capital of another; or

⇒ There is common management, control, or capital exercised by some persons.

  • Transactions relating to the transfer of goods or services, such as profit-linked deductions for enterprises engaged in infrastructure development or industrial undertakings, producers and distributors of power, or telecommunication service providers.
  • Transactions between the entity located in a tax holiday area and the one which is situated in a non-tax holiday area in case both are under the same management structure.

Introduction of a master file and country-by-country reporting (CbCR)

The efforts by OECD’s BEPS project have led to the formulation of proposals to implement the “minimum standards,” including Country-by-Country Reporting (CbCR). Globally, CbCR applies to MNCs with a combined revenue of US$837 million at a maximum. Under the CbCR requirement, large MNCs have to provide local tax authorities visibility to revenue, income, tax paid and accrued, employment, capital, retained earnings, tangible assets and activities.  

Transfer pricing compliance

All income acquired by a company or associated enterprise by means of any international transaction is calculated at the arm’s-length price.

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The respective methods to calculate the arm’s-length price are applied depending on the nature and type of the transaction, the nature of the group or the association involved, or any other features of the transactions involved. If there are two or more appropriate prices assumed for a certain transaction, the arm’s-length price will be calculated as the average of the prices.

The group or person who does not adhere to these rules is liable to pay the penalties as imposed by the CBDT.

Maintaining TP documentation

Taxpayers are required to maintain information related to international transactions undertaken with AEs. The rules prescribe detailed information and documentation that must be maintained by the taxpayer.

Such requirements can broadly be divided into two parts:

  • Information on the ownership structure of the taxpayer, a group profile, and a business overview of the taxpayer and AEs, including prescribed details such as the nature, terms, quantity, and value of international transactions. The rules also require the taxpayer to document a comprehensive transfer pricing study.
  • Adequate documentation must be maintained to substantiate the information, analysis, and studies documented under the first part of the rule. It also contains a recommended list of such supporting documents, including:
    • Government publications;
    • Reports, studies, technical publications, and market research studies undertaken by reputable institutions;
    • Price publications;
    • Relevant agreements,
    • Contracts, and 
    • Correspondence.

Taxpayers having aggregate international transactions below the prescribed threshold of INR 10 million and specified domestic transactions below the threshold of INR 200 million are relieved from maintaining the prescribed documentation.

It is essential that the documentation maintained should be adequate to substantiate the arm’s-length price of the international transactions or specified domestic transactions.

Companies to which transfer pricing regulations are currently applicable are required to file their tax returns on or before November 30, following the close of the relevant tax year.

The prescribed documents must be maintained for a period of eight years from the end of the relevant tax year and must be updated annually on an ongoing basis. 

The categories of documentation required are:

  • Documentation regarding the ownership hierarchy and structure of the group.
  • Overview of the business activities and operations of the multinational group.
  • Details of international transactions, including their nature, terms, and pricing.
  • Explanation of the roles, assets, and risks involved in the transactions.
  • Documentation of any financial projections or estimates used in relation to the transactions.
  • Information on comparable transactions between the group and independent third parties.
  • Assessment comparing the international transaction with similar uncontrolled transactions.
  • Explanation of the various transfer pricing methods considered.
  • Justification for dismissing alternative transfer pricing methods.
  • Information on any adjustments made to align with the arm's-length principle.
  • Any additional data or documents related to the associated enterprise relevant to determining the arm’s-length price.
  • Certificate from a licensed Chartered Accountant (3CEB) confirming the maintenance of required documentation.

It is also imperative to obtain an independent accountant’s report with respect to all international transactions between AEs, and the same must be submitted by the due date of the tax return filing, on or before November 30.

Transfer Pricing Related Penalties

Nature of default and relevant sections under the Income Tax Act, 1961

Nature of penalty

Section 270A: Under-reporting or misreporting of income

  • A sum equivalent to 50% of the amount of tax payable on under-reported income.
  • A sum equal to 200% of the amount of tax payable on under-reported income where under-reported income is in consequence of any misreporting.
  • Underreporting of income does not include a transfer pricing adjustment where the taxpayer has declared the international transaction, maintained information and documents as prescribed, and disclosed all the material facts relating to the transaction

Section 271AA: Failure to maintain transfer pricing documentation, failure to report the transaction, maintenance or furnishing of incorrect information/document

  • 2% of the value of the international transactions

Section 271BA: Failure to furnish accountant’s report

  • INR 100,000 (US$1346.20)

Section 271G: Failure to furnish documents/report transaction

  • 2% of the value of the international transactions

271GB: Failure to furnish the documents prescribed under Section 286.

  • INR 5,000 (US$59.71)  per day up to service of penalty order.
  • INR 50,000 (US$597.16)  per day for default beyond the date of service of the penalty order.

Industry-Specific Transfer Pricing Issues

Transfer pricing poses unique challenges and opportunities across different industries. In India, industries such as IT services, manufacturing, and pharmaceuticals encounter distinct transfer pricing issues that require tailored strategies for compliance and optimization.

IT Services

The IT services industry in India is characterized by significant cross-border transactions, especially with parent companies and subsidiaries in the United States and Europe. The primary transfer pricing challenge here is the valuation of software development and IT-enabled services. Key issues include, accurately valuing intangibles like software and proprietary algorithms, ensuring that service agreements between related entities are at arm's length, and properly allocating costs between different geographical locations and ensuring these allocations reflect the actual economic activity.

Manufacturing

The manufacturing sector in India faces transfer pricing issues related to the pricing of goods, raw materials, and intercompany services. This industry often deals with complex supply chains that span multiple countries. Key issues include, pricing transactions for raw materials and finished goods between related entities, conducting value chain analysis to allocate profits, and ensuring that the transfer of tangible goods complies with the arm's length principle.

Pharmaceuticals

The pharmaceutical industry is heavily regulated and involves significant R&D activities, making transfer pricing particularly complex. Key issues include, the valuation of intellectual property, the allocation of profits from drug sales, and allocating R&D costs among entities in different jurisdictions.

Impact of digital economy on transfer pricing

The rise of the digital economy has fundamentally altered traditional business models, bringing new challenges to the realm of transfer pricing. The proliferation of digital business models and intangible assets, such as software, patents, and trademarks, complicates the application of conventional transfer pricing methods.

Digital business models, characterized by high reliance on intangible assets and the ability to operate across borders with minimal physical presence, pose unique transfer pricing issues. These models often involve complex value chains where intangible assets play a pivotal role in value creation.

The OECD has acknowledged these issues and provided guidance through its Base Erosion and Profit Shifting (BEPS) project. The BEPS Action 1 report specifically addresses the tax challenges of the digital economy. Key recommendations include adopting new nexus rules based on significant economic presence and ensuring that profits are taxed where economic activities and value creation occur.

The OECD also emphasizes the importance of transparency and information sharing among tax authorities to combat base erosion and profit shifting.

India’s response to digital economy challenges

India has implemented several measures to ensure that digital businesses contribute their fair share of taxes.

Introduced in 2016, the Equalization Levy initially targeted online advertisement services and was later expanded to cover a broader range of digital services. This levy is designed to tax digital transactions involving foreign companies that derive significant income from Indian users but lack a physical presence in India.

The 2 percent equalization levy (EL) on non-resident digital companies was abolished in India as of August 1, 2024, as part of the Union Budget 2024. This change was made in recognition of the progress being made on the OECD Pillar 1 negotiations on how to tax foreign earnings from digital service providers.

In 2018, India introduced the concept of Significant Economic Presence as part of its domestic tax law. This concept expands the scope of taxable presence to include digital businesses that engage significantly with Indian users.

SEP criteria are based on factors such as revenue generated from Indian users and the number of users, aiming to capture value created through digital interactions.

Dispute resolution mechanisms

Transfer pricing disputes can arise due to the complex nature of cross-border transactions and differing interpretations of transfer pricing regulations. To address these challenges, India offers several dispute resolution mechanisms, including Advance Pricing Agreements (APAs), Mutual Agreement Procedures (MAP), and Safe Harbour Rules. This section provides a detailed explanation of these mechanisms and their effectiveness, supported by relevant case studies.

Advance Pricing Agreements (APAs)

An APA is a pre-emptive agreement between a taxpayer and the tax authority determining the transfer pricing methodology for transactions over a specified period. APAs aim to provide certainty and reduce disputes.

Types of APAs:

  • Unilateral APA: Agreement between the taxpayer and the tax authority of one country.
  • Bilateral APA: Agreement involving the tax authorities of two countries.
  • Multilateral APA: Agreement involving the tax authorities of more than two countries.

Process:

  • An informal meeting to discuss the potential APA application.
  • Submission of a detailed application, including transaction descriptions, proposed transfer pricing methods, and supporting documentation.
  • Discussion between the taxpayer and tax authorities to finalize the terms of the APA.

Mutual Agreement Procedure (MAP)

MAP is a dispute resolution mechanism under tax treaties, allowing competent authorities of the involved countries to resolve issues related to double taxation and transfer pricing adjustments.

  • The taxpayer initiates the MAP by submitting a request to the competent authority in their home country.
  • Competent authorities from the involved countries negotiate to resolve the dispute, aiming to eliminate double taxation and ensure a consistent transfer pricing approach.
  • The agreed resolution is implemented, typically through corresponding adjustments in the tax assessments of the involved countries.

Safe harbour rules

The safe harbor provisions provide relief from compliance and litigation, as well as simplify the administrative process. They prescribe the eligibility criteria for taxpayers, eligible international transactions, the target operating margin, procedural aspects, timeline for audit, etc.

Safe harbor rules refer to those legal provisions that reduce or eliminate the liability of the taxpayers given certain conditions are fulfilled, as they provide for circumstances in which a certain category of taxpayers can follow a prescribed set of rules under which transfer prices are automatically accepted by the income tax authorities.

  • Specific categories of international transactions are covered under Safe Harbour Rules, such as software development services, IT-enabled services, and contract R&D services.
  • The Safe Harbour Rules specify the acceptable profit margins for eligible transactions. If the taxpayer’s margins fall within these predefined limits, the transactions are accepted without detailed scrutiny.
  • An Indian company providing IT-enabled services to its foreign parent company opted for Safe Harbour Rules. By ensuring its operating margins were within the specified range, the company avoided detailed transfer pricing audits and minimized compliance costs.

Frequently Asked Questions

What is the meaning of arm's length price?

The arm's length price refers to the price that would be charged in a transaction between unrelated parties under open market conditions. This principle ensures that transactions between associated enterprises (AEs) are conducted as if they were between independent entities, ensuring fairness and compliance with tax regulations.

What are Associated Enterprises (AEs)?

Associated Enterprises (AEs) are entities that are related to each other through control or significant influence. This relationship can be established through shareholding, voting power, or management control. Transactions between AEs are subject to transfer pricing regulations to prevent tax avoidance.

What are the different types of methods which can be applied for computing arm's length price?

The methods for computing the arm's length price include:

  • Comparable Uncontrolled Price (CUP) Method
  • Resale Price Method (RPM)
  • Cost Plus Method (CPM)
  • Profit Split Method (PSM)
  • Transactional Net Margin Method (TNMM)
  • Other methods prescribed by the Central Board of Direct Taxes (CBDT)

When are the taxpayers required to prepare Transfer Pricing (TP) Documentation as per Rule 10D of the Income-tax Rules, 1962?

Taxpayers must prepare Transfer Pricing (TP) Documentation if their aggregate value of international transactions exceeds INR 1 crore in a financial year. The documentation should be prepared contemporaneously and maintained to justify the arm's length nature of their transactions.

When are the taxpayers required to file an accountant's report specified in Section 92E of the Income-tax Act, 1961?

Taxpayers engaging in international or specified domestic transactions must file an accountant's report in Form 3CEB under Section 92E of the Income-tax Act, 1961. This report must be filed by the due date of filing the income tax return, which is generally on or before November 30th of the assessment year.

Which transaction is classified as “international transaction”?

An "international transaction" involves the transfer of goods, services, or intangible property between associated enterprises (AEs) located in different countries. This also includes capital financing, business restructuring, cost-sharing arrangements, and other intercompany transactions that may impact the taxable income of the entities involved.

When do the transfer pricing regulations apply to an enterprise?

Transfer pricing regulations apply to enterprises that engage in international transactions or specified domestic transactions with associated enterprises. The regulations ensure that these transactions are conducted at arm's length prices to prevent profit shifting and tax avoidance.

Is a Liaison Office (LO) in India of a foreign corporation subject to TP Provisions?

A Liaison Office (LO) in India generally engages in limited activities such as communication and liaison, without earning income in India. As such, an LO is typically not subject to transfer pricing provisions. However, if the LO is found to be engaged in income-generating activities, it will be equivalent to the creation of a Permanent Establishment (PE) in India and thus, transfer pricing regulations will apply. 

Do the transfer pricing rules apply in respect of transactions between head office (HO) and a branch office/project office?

Yes, transfer pricing rules apply to transactions between a head office (HO) and its branch office or project office if they involve cross-border transactions. These transactions must comply with arm's length principles to ensure accurate reporting and taxation.

What are the documents required to be maintained by a company while executing an international transaction?

Companies must maintain comprehensive documentation for international transactions, including:

  • Description of the transaction and the entities involved
  • Pricing methodologies and economic analyses
  • Comparability analyses
  • Agreements and contracts
  • Financial data and relevant documentation supporting the arm's length nature of the transactions

Does transfer pricing documentation have to be prepared annually?

Yes, transfer pricing documentation must be prepared and maintained annually for each financial year in which the international or specified domestic transactions occur. This ensures that the documentation is current and reflects the actual business activities and financial conditions.

What is the materiality limit/threshold for preparing and maintaining transfer pricing (TP) documentation?

The materiality threshold for preparing and maintaining transfer pricing documentation in India is INR 1 crore of aggregate value of international transactions in a financial year. Transactions below this threshold may not require comprehensive documentation but must still comply with transfer pricing regulations.

What are the different methods to calculate arm’s length price?

The methods to calculate the arm's length price are:

  • Comparable Uncontrolled Price (CUP) Method
  • Resale Price Method (RPM)
  • Cost Plus Method (CPM)
  • Profit Split Method (PSM)
  • Transactional Net Margin Method (TNMM)
  • Other methods prescribed by the Central Board of Direct Taxes (CBDT)

Is there a requirement for a fresh benchmarking analysis every year vs roll-forward/update of the financials?

A fresh benchmarking search needs to be conducted every year. Rule 10D(4) says, “The information and documents specified under sub-rules (1), (2) and (2A) shall, as far as possible, be contemporaneous and existing latest by the specified date referred to in clause (iv) of section 92F.”

Is there a statutory deadline for submission of transfer pricing documentation?

There is no statutory deadline for the submission of transfer pricing documentation itself, but the documentation must be prepared and maintained contemporaneously. The accountant's report in Form 3CEB, which relies on this documentation, must be filed by the due date for filing the income tax return, typically November 30th of the assessment year.

What are safe harbor rules under the Indian transfer pricing regulations?

Safe harbor rules provide predefined margins or criteria for certain transactions, deeming them to be at arm's length if they meet these conditions. These rules simplify compliance and reduce the likelihood of transfer pricing disputes for eligible taxpayers.

Does Indian transfer pricing law have an Advance Pricing Agreement (APA) program?

Yes, India has an Advance Pricing Agreement (APA) program that allows taxpayers to enter into agreements with the tax authorities to determine the transfer pricing methodology for specified transactions over a period of time. This provides certainty and reduces litigation risks.

What are the scenarios under which Form FC-TRS is required to be filed?

Form FC-TRS must be filed in cases involving the transfer of shares or convertible debentures of an Indian company from a resident to a non-resident, or vice versa. This form ensures compliance with the Foreign Exchange Management Act (FEMA) regulations.

What are the penal consequences for under-reporting or misreporting of income?

Penalties for under-reporting or misreporting income can be substantial, including:

  • Penalty of 50 percent of the amount of tax payable on the under-reported income
  • Penalty of 200 percent of the tax payable in cases of misreporting

What are the penal consequences for non-compliance with the Indian Transfer Pricing regulations?

Non-compliance with transfer pricing regulations can result in:

  • Penalty of 2 percent of the value of each international transaction for failure to maintain documentation, furnish information, or comply with the accountant's report requirement
  • Penalty of up to 100 percent to 300 percent of the tax amount on transfer pricing adjustments if deemed to be concealment of income.
  • For failure to furnish an accountant’s report: INR 100,000 (US$1,194).

 

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