faq on transfer pricing

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Prepared By – Rashi Pilaniwala and Nandita Naruka

Frequently Asked

Questions on

Transfer Pricing

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FAQ on Transfer Pricing

Introduction of

Transfer Pricing?

The history of transfer pricing is as old as that of international transaction or cross-border

transactions. International transaction, to start with, was limited to production in one

location and sale to independent parties in another or there were simple cases of import

and export of raw materials and of finished goods traded between independent parties.

Transfer Pricing came into existence in year 2001,a separate code on Transfer Pricing

under section 92 to 92F of the Income Tax Act 1961 came into existence from 1st April

2001.Since introduction of code, transfer Pricing has become the most important

international tax issues affecting multinational enterprise operating in India. The

regulations are broadly based on the OECD guidelines and describe the various transfer

Pricing methods, impose extensive transfer pricing documentation requirements and

contain harsh penal provisions for non-compliance.

What is transfer

pricing?

Transfer prices are the price at which an enterprise transfers physical goods and

intangibles or providing services to associated enterprises. It is an internationally

accepted principle that transactions between related parties should be based upon the

same terms as between unrelated parties. Thus both tax treaties entered into between

countries and domestic tax legislation of various countries have adopted the arm's length

principle.

How is transfer

pricing abused?

With globalization, transfer pricing became an unwanted reality. Price charged by one

company in Country A to another company in Country B is reflected in the profit and loss

account of both companies, either as an income or an expenditure. Thus prices charged

impact the tax paid by the two related companies.

By resorting to transfer pricing, related entities can reduce the global incidence of tax by

transferring higher income to low-tax jurisdictions or greater expenditure to those

jurisdictions where the tax rate is very high.

For example, the current tax rate on domestic companies in India is 35 per cent.

Company A is located in India and Company B in Country XYZ. Both belong to the same

group. If tax rate in Country XYZ is 15 per cent, then Company B will transfer raw

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material to Company A at slightly higher prices. This will enable Company A to show a

higher expenditure and reduce its taxable profits. On the other hand, slightly higher

income will not harm Company B much as the tax rate in its country is very low. Thus the

global group as a whole will benefit from tax savings.

What are the

regulations in India

that tackle transfer

pricing?

The most important provisions in the tax laws is section 92. Here, if owing to a close

connection between an Indian entity and a foreign party, the Indian tax authorities feel

that the prices charged in a transaction were not at an arm's length they can adjust the

taxable income of the Indian party. In other words, taxable income can be enhanced if

the transaction has led to a lower profits for the Indian party.

Section 92(1) provides that:

• There must be "income arising";

• Such income must arise "from" an "international transaction";

• Such income "shall" be computed having regard to the "arm's length price".

Allowance for any expenses or interest arising from an international transaction is also to

be determined having regard to arm’s length price. Further, the application of arm’s

length price results in reducing the chargeable income or increasing the loss from an

Indian Income-tax perspective, then the income, expense, interest or other allocation or

apportionment of expenses need not be calculated at such arm’s length price.

� Section 92(2) provides that cost sharing arrangements between "associated

enterprises" ("AEs") will also be subject to the arm’s length rule.

The term "enterprise" is defined in section 92F(iii) to mean a "person" including a

"permanent establishment" of a person who is, or has been or is proposed to be

"engaged in" certain specified activities. These activities are in relation to :

• production storage, supply, distribution, acquisition or control of:

• articles or goods; or

• know-how, patents, copyrights, trademarks, licences, franchises or any other

business or commercial rights of similar nature; or

• any data, documentation, drawing or specification relating to any patent,

invention, model, design, secret formula or process:

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• of which the other enterprise is the owner; or

• in respect of which the other enterprise has exclusive rights;

OR

• provision of services of any kind;

OR

• carrying out any work in pursuance of a contract;

OR

• investment;

OR

• providing loan;

OR

• business of acquiring, holding, underwriting or dealing with shares, debentures

or other securities of any other body corporate.

• Such activity or business may be carried on directly or through one or more of

the units or divisions or subsidiaries, which may be located at the same place

where the enterprise is located or at a different place(s).

What do we mean by

Arm’s Length price?

• The term "arm’s length price" is defined in section 92F(ii) to mean—

• The price which is applied; or

• Is proposed to be applied;

• In a transaction between persons other than AEs;

• In uncontrolled conditions.

What are the

different methods/

pricing

methodologies to

The various methods as prescribed by section 92C, to calculate the arm’s length prices

with respect to an international transaction are the following:

• Transactional net margin method (TNMM);

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calculate the arm’s

length price?

• Resale price method (RPM);

• Comparable uncontrolled price method (CUP);

• Cost plus method (CPM);

• Profit split method (PSM).

Section 92C provides the mechanism of determining the "arm’s length" price by

any of the following five methods, being the most appropriate method taking into

consideration the nature or class of the transaction functions performed or such

other factors as laid down in rule 10B:

Comparable uncontrolled price method;

• Comparison of price charged or paid for property transferred or services

provided in a comparable uncontrolled transaction.

• Used mainly in respect of transfer of goods, provision of services,

intangibles, loans, provision of finance.

Resale-price method;

• Considers the price at which property purchased or services obtained by

the enterprise from an AE is resold or are provided to an unrelated

enterprise.

• Used mainly in case of distribution of finished goods or other goods

involving no or little value addition.

Cost-price method;

• Considers direct and indirect costs of production incurred by an enterprise

in respect of property transferred or services provided and an appropriate

mark-up.

• Used mainly in respect of provision of services, joint facility arrangements,

transfer of semi finished goods, long-term buying and selling

arrangements.

Profit-split method;

• Considers combined net profit of the AEs arising from the international

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transaction and its split amongst them.

• Used mainly in report of transactions involving integrated services

provided by more than one enterprise, transfer of unique intangibles,

multiple interrelated transactions, which cannot be separately evaluated.

Transactional net margin method.

• Considers net profit margin realised by the enterprise from an international

transaction entered into with an AE;

• Used in respect of transactions for provision of services, distribution of

finished products where resale price method cannot be adequately

applied, transfer of semi-finished goods;

Any other method as prescribed by the CBDT: The CBDT has not yet

prescribed any other method.

The most appropriate method from the above method shall be applied for

determination of the arm’s length price in the manner laid down in Rule 10C.

No particular method has been accorded a greater or lesser priority. The most

appropriate method for a particular transaction would need to be determined

having regard to the nature of the transaction , class of transaction or

associated persons and functions performed by such other persons as well as

other relevant factors.

The legislation requires a taxpayer to determine an arm’s length price for

international transactions. It further provides that where the variation between

the arm’s length price determined and the price at which the international

transaction has been undertaken (transfer price) does not exceed such

percentage as may be notified by the Central Government of the transfer price,

then the transfer price is deemed to be the arm’s length price.

What is meant by “International transaction” means a transaction between two or more associated

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‘International

Transaction’ with

regard to Transfer

Pricing?

enterprises, either or both of whom are non-residents, in the nature of purchase,

sale or lease of tangible or intangible property, or provision of services, or lending

or borrowing money, or any other transaction having a bearing on the profits,

income, losses or assets of such enterprises, and shall include a mutual

agreement or arrangement between two or more associated enterprises 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.

A transaction entered into by an enterprise with a person other than an

associated enterprise shall, for the purposes of sub-section (1), be deemed to be

a transaction entered into between two associated enterprises, if there exists a

prior agreement in relation to the relevant transaction between such other person

and the associated enterprise, or the terms of the relevant transaction are

determined in substance between such other person and the associated

enterprise.

When can two

companies be called

as ‘associated

enterprises?’

An "enterprise" is an Associated Enterprise :-

• Which participates directly or indirectly in the management or control or capital of

the other enterprise. This can be explained as under:

utf

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Two enterprises shall be deemed to be associated enterprises if, at any time during the

previous year,--

a. one enterprise holds, directly or indirectly, shares carrying not less than twenty-

six per cent. of the voting power in the other enterprise ; or

b. any person or enterprise holds, directly or indirectly, shares carrying not less

than twenty-six per cent. of the voting power in each of such enterprises ; or

c. a loan advanced by one enterprise to the other enterprise constitutes not less

than fifty-one per cent. of the book value of the total assets of the other

enterprise ; or

d. one enterprise guarantees not less than ten per cent. of the total borrowings of

the other enterprise ; or

e. more than half of the board of directors or members of the governing board, or

one or more executive directors or executive members of the governing board of

one enterprise, are appointed by the other enterprise ; or

f. more than half of the directors or members of the governing board, or one or

more of the executive directors or members of the governing board, of each of

the two enterprises are appointed by the same person or persons ; or

g. the manufacture or processing of goods or articles or business carried out by

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one enterprise is wholly dependent on the use of know-how, patents, copyrights,

trade-marks, licences, franchises or any other business or commercial rights of

similar nature, or any data, documentation, drawing or specification relating to

any patent, invention, model, design, secret formula or process, of which the

other enterprise is the owner or in respect of which the other enterprise has

exclusive rights ; or

h. ninety per cent. or more 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, or by persons specified by the other enterprise,

and the prices and other conditions relating to the supply are influenced by such

other enterprise ; or

i. the goods or articles manufactured or processed by one enterprise, are sold to

the other enterprise or to persons specified by the other enterprise, and the

prices and other conditions relating thereto are influenced by such other

enterprise ; or

j. where one enterprise is controlled by an individual, the other enterprise is also

controlled by such individual or his relative or jointly by such individual and

relative of such individual ; or

k. where one enterprise is controlled by a Hindu undivided family, the other

enterprise is controlled by a member of such Hindu undivided family, or by a

relative of a member of such Hindu undivided family, or jointly by such member

and his relative ; or

l. where one enterprise is a firm, association of persons or body of individuals, the

other enterprise holds not less than ten per cent. interest in such firm,

association of persons or body of individuals ; or

m. there exists between the two enterprises, any relationship of mutual interest, as

may be prescribed.

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What all

documents are

required to be

maintained by a

company while

executing an

international

transaction?

The taxpayer is required to maintain, on annual basis, a set of extensive

information and documents relating to international transactions undertaken with

associated enterprises. Rule 10D of the Income Tax Rules prescribed detailed

information and documentation that has to be maintained by taxpayer. The

following documents have to be maintained when a company is involved in an

international transaction.

a) A broad description of the business of the assessee and the

industry in which the assessee operates, and of the business of the

associated enterprises with which the assessee has transacted.

b) A profile of the multinational group of which the enterprise is a part

along with the name, address, legal status and country of tax

residence of each of the enterprises comprised in the group with

whom international transactions have been entered into by the

assessee, and ownership linkages among them.

c) A description of the ownership structure of the assessee enterprise

with details of shares or other ownership interest held therein by

other enterprise.

d) A description of the functions performed, risks assumed and assets

employed or to be employed by the assessee and by the

associated enterprises involved in the international transaction.

e) The nature and terms (including prices) of international transaction

entered into with each associated enterprise, details of property

transferred or services provided and the quantum and the value of

each such transaction or class of such transaction.

f) A record of the economic and market analyses, forecasts, budgets

or any other financial estimates prepared by the assessee for the

business as a whole and for each division or product separately,

which may have a bearing on the international transaction entered

into by the assessee.

g) A record of the actual working carried out for determining the arm’s

length price, including details of the comparable data and financial

information used in applying the most appropriate method, and

adjustments, if any, which were made to account for differences

between the international transaction and the comparable

uncontrolled transactions, or between the enterprises entering into

such transactions.

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h) A description of the methods considered for determining the arm’s

length price in relation to each international transaction or class of

transaction, the method selected as the most appropriate method

along with explanations as to why such method was so selected,

and how such method was applied in each case.

i) A record of the analysis performed to evaluate comparability of

uncontrolled transaction with the relevant international transaction.

j) A record of uncontrolled transaction taken into account for

analyzing their comparability with the international transaction

entered into, including a record of the nature, terms and conditions

relating to any uncontrolled transaction with the third parties which

may be of relevance to the pricing of the international transaction.

k)

l) The assumptions, policies and price negotiations, if any, which

have critically affected the determination of the arm’s length price.

m) Details of the adjustments, if any, made to transfer prices to align

them with arm’s length prices determined under these rules and

consequent adjustment made to the total income for tax purposes.

n) Any other information, data or document, including information or

data relating to the associated enterprise, which may be relevant for

determination of arm’s length price.

.

Who is the

authorized person to

furnish the report

under section 92E of

the Income Tax Act?

Any person who has involved in an international transaction in the previous year

shall submit the report in Form 3CEB through a Chartered Accountant, duly verified

by him, on or before the date prescribed by the authority, furnishing all the required

details. The form of the report has been prescribed. 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.

What are the Penal

Provisions of Income

Tax which apply on

Transfer Pricing?

The following stringent penalties have been prescribed for non compliance with the

transfer pricing regulations:

Section 271AA: If the assessee fails to keep and maintain the prescribed

information and documents, penalty equal to 2% of the value of each international

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transaction may be leviable.

Section 271BA: Failure to furnish the accountant’s report may attract penalty of Rs.

1,00,000/-.

Section 271G: Failure to furnish the required information and documents may

attract penalty of 2% of the value of the international transaction for each failure.

Section 273B: The penalties u/ss. 271AA, 271BA and 271G may not be levied if

the assessee establishes reasonable cause for the said failures.

Section 271(1)(c) : As per Explanation 7 to section 271(1)(c):

where in case of an assessee who has entered into an international transaction

any amount is added or disallowed in computing the total income under section

92C(4) then the amount so added or disallowed shall be deemed to represent the

income in respect of which particulars have been concealed or inaccurate

particulars have been furnished unless the assessee proves to the satisfaction of

the Assessing Officer or the Commissioner (Appeals) or the Commissioner that the

price charged or paid in such transaction was computed in accordance with the

provisions contained in section 92C and in the manner prescribed under that

section, in good faith and with due diligence.

The amount of penalty provided for is :

• not less than the amount of tax sought to be evaded; and,

• not more than three times the amount of tax sought to be evaded, by reason of

the concealment as aforesaid.

Further, taxable income enhanced as a result of transfer pricing adjustment does

not qualify for various concessions/holidays prescribed by Income Tax Act.

What is the time limit

for passing orders

by the Assessing

Officer?

The time limit for passing orders by the Assessing Officer where a reference is made to

the TPO for determining the arm’s length price in an international transaction has been

increased to 12 months as under

In respect of normal

assessment

From 21 months to 33 months from the end of the

assessment year in which the income was

first assessable

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In case of reopened

assessments

From 9 months to 21 months from the end of the

financial year in which the notice under section 148

was served

In case of order under

section 254 or under

section 263 or section 264

From 9 months to 21 months from end of the financial

year in which the order under section 254 is received

by the Chief Commissioner or order under section 264

is passed by the Chief Commissioner or

Commissioner of Income Tax

In case of a search cases From 21 months to 33 months from the end of the

financial year in which the last authorization for search

under section 132 or requisition under section 132A

was executed

Amendment as per Finance Bill 2012 153/153B- Extension of time for completion of

assessments and reassessments by three months w.e.f. 01.07.2012

What is the time limit

for submitting a

revised Form 3CEB –

Accountant’s Report

on International

Transactions?

As per the existing statutory provisions, the Accountant’s Report is required to be

submitted by the specified date which is the due date for filing the return of income

(currently 30th November following end of financial year). The statute also provides

for a mechanism for filing a revised return of income if it is done so before expiry of

one year from the end of the relevant assessment year (i.e. 31st March, two years

from end of financial year) or before the completion of the assessment. However,

there is no corresponding mechanism or enablement in the statute for submitting a

revised Accountant’s Report in Form 3CEB. In case a tax payer or Chartered

Accountant notices any error or omissions in the Form 3CEB, it may consider

approaching the relevant tax officer with a request for accepting a revised Form

3CEB or a letter explaining the error/omission and correction. While a tax payer

should try and complete this before the due date for filing a revised return, there is

no prohibition (or enablement) in law for doing so at a later date.

Whether the arm’s

length price

determined for

Both transfer pricing and customs have the common aim of arriving at arm’s length

price in case of cross-border import transactions. Even though the underlying

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transfer pricing is

acceptable for

customs valuation

purposes, and vice

versa?

concept of arriving at arm’s length price is similar under the two regulations, yet the

objectives of the regulations are altogether divergent and diagrammatically

opposite. While transfer pricing seeks to prevent excessive payment for imports,

customs valuation seeks to prevent the short payment for imports. Though the

specific methods prescribed in the legislation have several similarities, yet they also

vary in many ways. Consequently, arm’s length price computed under one

regulation may not suffice the justification of arm’s length price under the other

regulation. However, there needs to be some co-relation and co-ordination between

the two. As an example, ideally, where a tax-payer has been found to be guilty of

under-invoicing by Customs authorities, it should not be subjected to scrutiny by the

transfer pricing authorities for over-invoicing, and vice versa. In certain

circumstances, comparable data used for transfer pricing purposes can be used for

customs valuation purposes as well, for example, where Comparable Uncontrolled

Price (CUP) method is adopted. Profit evaluation based methods too have some

similarity and scope for cross-leverage.

Are there any

circumstances

wherein transactions

between two

unrelated entities

can be subjected to

transfer pricing

provisions?

Yes, there are certain deeming provisions under the Indian tax legislation wherein

transactions amongst unrelated entities are also subjected to transfer pricing

provisions.

Firstly, on satisfaction of certain criteria, two entities would be deemed to be

associated enterprises, and hence the transfer pricing provisions shall be applicable

on all transactions amongst them. The said criteria – shareholding, voting power,

loans, guarantees, appointment of board members, dependence on intellectual

property, purchase of raw material, sale of goods, mutual interest relationships, etc.

Secondly, a transaction amongst two entities which are not associated enterprises,

would be deemed to be an international transaction in certain circumstances and

transfer pricing provisions shall become applicable on the said transaction. The said

circumstances are – where there is a prior agreement for the said transaction

between the other party and an associated enterprise of the taxpayer; and where

terms of the transaction are determined in substance between the other party and

an associated enterprise of the taxpayer.

Can the Transfer Section 92CA(7) expressly endows the Transfer Pricing Officer with powers under

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Pricing Officer use

comparable data

gathered from one

company using his

powers under

section 133(6) to

frame an adverse

assessment for

another company?

section 133(6), and, hence, generally speaking the Transfer Pricing Officer can use

the comparable data so gathered. However, it would be pertinent to note that

applying the principles of natural justice, the Transfer Pricing Officer should provide

the assessee an opportunity of being heard after having allowed it to examine the

data so collected. Also, it is important to note that if the said data was not available

with the Assessee or in public domain as on date when it prepared its transfer

pricing documentation, the principle of impossibility of performance would become

relevant. Where the assessee has itself undertaken an ‘objective’ exercise to

evaluate and collate the potential comparables, and the data now collected by the

Transfer Pricing Officer was not available to the assessee at that time, the assessee

could consider contesting the matter.

Whether a Liaison

office is to comply

with the TPR

Under the FEMA, the liaison officer cannot engage in any commercial activity so as

to earn any income in India. In view of this, one could take a position that there is no

income arising from the operation conducted by liaison officer and, hence TPR

would not apply. However the tax authorities in some cases held that the liaison

office constitutes the PE of the foreign company and is earing income based on

facts of the cases. Hence, the facts remains that there can be an “international

transaction” as provided in section 92B. Based on the facts of each case,one would

take a position on the compliance of TPR requirement.

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