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    A detailed overview of Transfer Pricing Regulations in India

    Published Tue, 01 Nov 2022 | Updated Tue, 01 Nov 2022

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    Introduction to transfer pricing regulation in India:

    Transfer pricing is the most important tax issue affecting multinational enterprises operating in different parts of the world or across the globe and multinational companies will make the investment decisions and make their Cross Border transactions, Policies and Transfer pricing documentation accordingly.

    The Government of India has introduced a separate code on transfer pricing in order to mitigate tax arbitrages in international transactions entered between associate enterprises under section 92 to 92F of  the Income Tax Act, 1961 (herein after referred as Act) to cover intra group cross border transactions  in the  1st April’2001 &   later on in the year  April 2012  domestic transaction between two associated enterprises  were also subject to Arm’s Length by insertion of new Section 92BA for specified domestic transactions.

    These regulations are broadly based on the Organization for Economic Co-operation and Development (OECD) Guidelines and describe the various transfer pricing methods, impose extensive annual transfer pricing documentation requirements, and contain penal provisions for non-compliance in order to match the international practices.

    Why Arm’s Length Pricing is necessary - Transfer Pricing:

    One party transfers goods or services to another party for a price. That price is known as "transfer price". This may be arbitrary and dictated, with no relation to cost and added value, diverge from the market forces.

    Thus transfer price is a price which represents the value of goods or services between independently operating units of an organization. It may also be noted that the transfer pricing within the group may not necessarily be driven by market forces and the group’s interest may precede over the market consideration, it is possible that the transfer pricing may differ from the prices that would have ordinarily fetched in similar transaction from an independent enterprise under similar circumstance.

    There is always a possibility that a commercial transaction between the two associate enterprises of multinational groups may not be subject to the same market forces or conditions as the transition it would happen in between two independent Enterprises. Therefore in order to cater to such situations the concept of Aram’s is being introduced.

    Applicability of transfer pricing regulations in India:

    The transfer pricing regulation is to determine arm’s length price in relation to any income arising from an international transaction between two Associate Enterprises. Where in an international transaction, two or more associated enterprises enter into mutual agreement  or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm's length price of such benefit, service or facility, as the case may be.

    Definitions under Transfer Pricing Regulations in India:

    International transactions under transfer pricing regulations in India:

    Section 92B of the Act defines the term ‘International transaction’ to mean a transaction between two (or more) associated enterprises, either or both are non-resident, involving the sale, purchase or lease of tangible or intangible property; provision of services; cost-sharing arrangements; lending/borrowing of money; or any other transaction having a bearing on the profits, income, losses or assets of such enterprises.

    An explanation having an inclusive list of transactions has been inserted in the definition of ‘international transaction’ to specifically cover certain transactions/ arrangements such as purchase, sale, transfer, lease or use of intangible property, provision of guarantees, deferred payments or receivables, business restructuring or reorganization etc.

    Specified Domestic Transaction under transfer pricing regulations in India:

    As per section 92BA of Act, specified domestic transactions for an assessee means any of following transaction, not being an international transaction, namely:

    • Any transaction referred in section 80A

    • Any transfer of goods/services referred in section 80 IA (10)

    • Any business transacted between assessee and person referred in section 80 IA (10) 

    • Any transaction referred to in any other section under Chapter VI or section 10AA, to which provision of 80 IA (10) (8) are applicable 

    • Any business transacted between the persons referred to in sub-section (6) of section 115BAB.

    • any other transaction as may be prescribed.

    Associated Enterprises under transfer pricing regulations in India:

    Relationship of associated enterprises (AEs) has been defined as per Section 92A of Income Tax Act to cover direct/indirect participation in the management, control or capital of an enterprise by another enterprise. It also covers situations in which the same person (directly or indirectly) participates in the management, control or capital of both the enterprises.

    For the purpose of above definition associated enterprise include an enterprise:

    • Direct/indirect holding of 26% or more voting power in an enterprise by the other enterprise or in both the enterprises by the same person.

    • Advancement of a loan, by an enterprise, that constitutes 51% or more of the total book value of the assets of the borrowing enterprise.

    • Guarantee by an enterprise for 10% or more of total borrowings of the other enterprise.

    • Appointment by an enterprise of more than 50% of the board of directors or one or more executive directors of the other enterprise or the appointment of specified directorships of both enterprises by the same person.

    • Complete dependence of an enterprise (in carrying on its business) on the intellectual property licensed to it by the other enterprise.

    • Substantial purchase of raw material/sale of manufactured goods by an enterprise from/to the other enterprise at prices and conditions influenced by the latter.

    • The existence of any prescribed relationship of mutual interest. 

    Furthermore, in certain cases, a transaction between an enterprise and a third party may be deemed to be a transaction between AEs if there exists a prior agreement in relation to such transaction between the third party and an AE or if the terms of such transaction are determined in substance between the third party and an AE. Accordingly, this rule aims to counter any move by taxpayers to avoid the transfer pricing regulations by interposing third parties between group entities. 

    Computation of Arm’s Length Price (ALP) under transfer pricing regulations in India:

    For the purpose of computation of Arm’s Length Price, the following methods have been prescribed under section 92C of Act

    1. Comparable Uncontrolled Price (CUP) method:

    2. Resale Price Method (RPM):

    3. Cost plus method (CPM):

    4. Profit split method (PSM):

    5. Transactional net margin method (TNMM):

    6. Such other methods

    Read our article on transfer pricing methods for more details 

    Selecting Most Appropriate Method (MAM) under transfer pricing regulations in India:

    The Income Tax Act, 1961 does not provide any specific hierarchy of methods for transfer pricing. It insists on applying the ‘Most Appropriate Method’ (MAM) along with Rule 10C of the Income Tax Rules 1962 which specify factors for determining the Most Appropriate Method.

    The regulations require a taxpayer to determine an arm’s-length price of international transactions or specified domestic transactions. It further provides that where more than one arm’s-length price is determined by applying the most appropriate transfer pricing method, the arithmetic mean (average) of such prices shall be the arm’s-length price of the international transaction or specified domestic transactions. Accordingly, the Indian regulations do not recognize the concept of arm’s-length range but require the determination of a single arm’s-length price.

    However, some flexibility has been extended to taxpayers by allowing a range benefit which would be notified by the Government, not exceeding 3%. Accordingly, if the variation between the arm’s-length price and the price at which the transaction has actually been undertaken does not exceed the specified range of the latter, the price at which the transaction has actually been undertaken shall be deemed to be the arm’s-length price.

    Concept of Secondary Adjustments under transfer pricing regulations in India:

    Where, as a result of primary adjustment to the transfer price of an International Transaction and there is an increase in the total income or reduction in the loss of an Indian Entity then, then excess money which is available with its foreign associated enterprise (AE), if not repatriated to India within the time as prescribed, will be deemed to be an advance made by the Indian Entity to such AE and the interest on that advance will be computed as the income of the Indian Entity, in the manner prescribed. 

    An Indian entity is required to make a secondary adjustment, under the following situations:

    • Suo motu by the Indian Entity  in their  return of income;

    • An Adjustment  by the assessing officer (AO) during assessment proceedings, and has been accepted by the Indian Entity  

    • An adjustment determined by an Advance Pricing Agreement (APA) entered into by the taxpayer;

    • An adjustment made as per the safe harbour rules (SHR); or

    • An adjustment arising as a result of the resolution of an assessment by way of mutual agreement procedure (MAP).

      A secondary adjustment would not be applicable, if the amount of a primary adjustment made did not exceed INR 10 million.

    Reporting Requirements under transfer pricing regulations in India

    The Central Board of Direct Taxes (CBDT) has issued the final rules pertaining to Master File (MF) and Country by Country reporting (CbCR) on 31st October 2017.

    Master files – Forms and formalities: The MF should provide an overview of the MNE business, and the nature of its global operations, overall TP policies, allocation of income and economic activity. MF is not intended to provide exhaustive details. It will basically contain the group structure, description of the business, intangibles, intercompany financial activity between members of the group, and MNE financial and tax positions.

    Form

    Particulars

    Timelines

    3CEAA

    (Part A)

    Every constituent entity of an International Group irrespective of threshold applicability, whether entity is resident or not.

    *Constituent Entity of the International Group in India means any entity of the International Group in India whose accounts is included in Consolidated Financial Statement.

    By due date of Furnishing Return of Income,

    3CEAA

    (Part B)

    Single Constituent entity (as designated by the Group) of the International Group in India meeting the prescribed threshold limit mentioned below:

     

    Consolidated revenue of international group for the accounting year exceeds INR 500 Crore, 

    And

    Aggregate value of international transaction exceeds INR 50 Crore

    OR

    Aggregate value of international transaction pertaining to intangible property equals to INR 10 Crore

    By due date of Furnishing Return of Income,

    3CEAB (Intimation)

    In case of multiple Constituent Indian Entities in India, International Group shall designate one Indian Entity that will file form 3CEAA and such designation will be given in Form 3CEAB.

    30 days prior to the date of filing of Master File (3CEAA)

     

    Country By Country Reporting (CbCR)-Forms & Timelines:

    Rule 10DB provides the guidance for the information to be furnished as part of CbCR, threshold and the procedure of furnishing the information. The CbCR reporting requirements apply to an IG for an accounting year, if total consolidated group revenue, as per its consolidated financial statements for the preceding accounting year exceeds INR 5,500 Cr (Approx. Eur 720 million), it is marginally lower than the threshold as per OECD guidelines of Eur 750 million.

    Form

    Particulars

    Timelines

    3CEAC

    Intimation of details of Parent Entity/alternate reporting entity which will file the CbCR.

     

    Form 3CEAC is to be filed by all the Constituent Indian Entities of International Group whose Parent Entity is not resident in India

    At least 2 months before due date of Furnishing of form 3CEAD

    3CEAD

    Filing CbCR – Every parent entity or the alternate reporting entity resident in India

    Within 12 months following the end of reporting accounting year.

    3CEAE

    In case the IG has presence through more than one CEs resident in India, the group may designate one of the CE to furnish CbC report in India and notify DGIT (Risk Assessment) in Form 3CEAE.

    No timeline prescribed 

     

    Furnishing of Chartered Accountant Report:

    It is mandatory for all taxpayers, without exception, to obtain an independent accountant’s report (Form 3CEB) in respect of all international transactions between associated enterprises or specified domestic transactions. The report has to be furnished by the due date of the tax return filing on or before 31st October. The report requires the accountant to give an opinion on the proper maintenance of prescribed documents and information by the taxpayer. Furthermore, the accountant is required to certify the correctness of an extensive list of prescribed particulars.

    Documentation Requirements under transfer pricing regulations in India:

    Taxpayers are required to maintain, on an annual basis, a set of extensive information and documents relating to international transactions undertaken with AEs or specified domestic transactions. Rule 10D of the Income Tax Rules, 1962 prescribes detailed information and documentation that has to be maintained by the taxpayer. Such requirements can broadly be divided into two parts. 

    The first part of the rule lists mandatory documents/ information that a taxpayer must maintain. The extensive list under this part includes information on ownership structure of the taxpayer, group profile, business overview of the taxpayer and AEs, prescribed details (nature, terms, quantity, value, etc.) of international transactions or specified domestic transactions and relevant financial forecasts/estimates of the taxpayer. documentation  includes  the  functions performed, risks assumed, assets employed, details (nature, terms and conditions) of relevant uncontrolled transactions, comparability analysis, benchmarking studies, assumptions, policies, details of adjustments and explanations as to the selection of the most appropriate transfer pricing method. 

    The second part of the rule requires that adequate documentation be maintained that substantiates the information/ analysis/ 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/ 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 are relieved from maintaining the prescribed documentation. However, even in these cases, it is imperative that the documentation maintained should be adequate to substantiate the arm’s-length price of the international transactions or specified domestic transactions.

    All prescribed documents and information have to be contemporaneously maintained (to the extent possible) and must be in place by the due date of the tax return filing. Companies to whom Indian transfer pricing regulations are applicable are currently required to file their tax returns on or before 30 November following the close of the relevant tax year.

    Tax & Penalties under transfer pricing regulation in India:

    The following penalties have been prescribed for non-compliance with the provisions of the transfer pricing code:    

    S. No.

    Non Compliance

    Penalty

    1.

    For failure to maintain the prescribed information/document

    2% of transaction value

    2.

    For failure to furnish information/documents during audit

    2% of transaction value

    3.

    For failure to disclose any transaction in Accountant’s report

    2% of transaction value

    4.

    For adjustment to taxpayer’s income

    100% to 300% of the total tax on the adjustment amount

    5.

    For failure to furnish an accountant’s report

    INR 100,000

    Further, taxable income enhanced as a result of transfer pricing adjustments does not qualify for various tax concessions/holidays prescribed by the Act.

    Advance Pricing Agreements   Transfer Pricing   International Taxation   Arms length price