Documentation requirements under the Indian Transfer Pricing law

In India a new transfer pricing regime has been introduced this year by the Finance Act 2001. Earlier a limited provision (Section 92) existed in the Income tax Act, which provided for making adjustment to the income of a resident taxpayer from a transaction with a non resident if the Assessing Officer was of the view that the income from such a transaction was understated in the hands of the resident due to the close connection between the two. No other rules or obligations about maintenance of documents about such transaction existed under the old Section 92 which remained in the statute for a number of years though it was almost never invoked in practice. The Finance Act 2001 has substituted a new section 92 and inserted sections 92A to 92F and certain other provisions in the Income tax Act which provide the statutory backbone of the new transfer pricing law. The procedural rules under these sections have been inserted in the Income tax Rules, by Notification S.O 808 (E) dated 21 August, 2001. This article touches very briefly on the main substantive provisions and then provides a summary of the requirements relating to documentation under the Indian transfer pricing regulation.
The new transfer pricing regime requires compliance with the principle of arm's length price in cases i
nvolving an 'international transaction' between associated enterprises (Section 92). The term 'associated enterprise' is defined in Section 92A which provides 13 parameters to determine if the enterprises concerned would constitute 'associated enterprises'. Section 92B defines the term 'international transaction' as a transaction between two or more associated enterprises when either or both them are non resident. The transactions covered are transfer of tangibles, intangibles, services, lending and borrowing of capital and cost contribution agreements. Section 92 C lays down five methods for the determination of arm's length price. These are same as the transaction methods prescribed in the OECD guidelines viz. comparable uncontrolled price method, resale price method, cost plus method, profit split method and transaction net margin method. Section 92C also lays down the provisions relating to transfer pricing audit which may be triggered if the administration is of the opinion that the transfer price adopted does not reflect arm's length price, or if proper information or documents are not maintained. Provisions have also been made in respect of penalties for concealment of income by adopting non arm's length price, defaults relating to maintenance of prescribed information and documents and failure to furnish required information or documents during an audit or appellate proceedings.
The legal framework for maintenance of information and documentation by a taxpayer is provided in Section 92D which lays down that every person who enters into an international transaction with an associated enterprise shall maintain prescribed information and documents. The various types of information to be maintained in respect of an international transaction, the associated enterprise and the transfer pricing method used are prescribed in Rule 10D of the Income tax Rules, as under:
i. A description of the ownership structure of the enterprise and details of shares or other ownership interest held therein by other enterprises;
ii. A profile of the multinational group of which the taxpayer is a part and 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 made by the taxpayer and the ownership linkages among them;
iii. A broad description of the business of the taxpayer and the industry in which it operates and the business of the associated enterprises;
iv. The nature, terms and 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;
v. A description of the functions performed, risks assumed and assets employed or to be employed by the taxpayer and by the associated enterprise involved in the international transaction;
vi. A record of the economic and market analyses, forecasts, budgets or any other financial estimates prepared by the taxpayer for its business as a whole or separately for each division or product which may have a bearing on the international transaction entered into by the taxpayer;
vii. A record of uncontrolled transactions taken into account for analysing their comparability with the international transaction entered into, including a record of the nature, terms sand conditions relating to any uncontrolled transaction with third parties which may be of relevant to the pricing of the internationals transactions;
viii. A record of the analysis performed to evaluate comparability of uncontrolled transactions with the relevant international transaction;
ix. 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;
x. 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 transaction;
xi. The assumptions, policies and price negotiations if any which have critically affected the determination of the arm's length price ;
xii. Details of the adjustments, if any made to the transfer price to align it with arm's length price determined under these rules and consequent adjustment made to the total income for tax purposes;
xiii. Any other information data or document including information or data relating to the associated enterprise which may be relevant for determination of the arm's length price.
Rule 10D also prescribes that the above information is to be supported by authentic documents which may include the following:
i. Official publications, reports, studies and data bases of the government of the country of residence of the associated enterprise or of any other country;
ii. Reports of market research studies carried out and technical publications of institutions of national or international repute;
iii. Publications relating to prices including stock exchange and commodity market quotations;
iv. Published accounts and financial statements relating to the business of the associated enterprises;
v. Agreements and contracts entered into with associated enterprises or with unrelated enterprises in respect of transaction similar to the international transactions;
vi. Letters and other correspondence documenting terms negotiated between the taxpayer and associated enterprise;
vi. Documents normally issued in connection with various transaction under the accounting practices followed.
It is noteworthy that the information and documentation requirements referred to above are linked to the burden of proof laid on the taxpayer to prove that the transfer price adopted is in accordance with the arm's length principle. One of the conditions to be fulfilled for discharging this burden by the taxpayer is maintenance of prescribed information and documents in respect of an international transaction entered into with a associated enterprise. A default in maintaining information and documents in accordance with the rules is one of the conditions which may trigger a transfer pricing audit under Section 92C(3). Any default in respect of the documentation requirement may also attract penalty of a sum equal to two percent of the value of the international transaction (Sec 271AA).
There is no reference in the provisions included either in the Income tax Act or the Income tax Rules about any requirement to submit the prescribed information and documents at the stage of initial compliance in the form of submission of report under section 92E. All that Section 92E requires is that the concerned taxpayer shall obtain a report from an Accountant in the prescribed form (Form 3CEB) and submit the report by the specified date. Form 3CEB contains a certificate from the Accountant that in his opinion proper information and documents as prescribed have been maintained by the taxpayer. It does not require their submission along with the report.
While there is no requirement for their submission along with the report, Rule 10D requires that the information and document maintained should be contemporaneous as far as possible and should exist latest by the specified date for filing the report under section 92E. Section 92D also provides that information and documentation may be requisitioned by the Assessing Officer or the Appellate Commissioner on a notice of thirty days which period may be extended by another period of 30 days.
Although the law has prescribed no monetary limit in respect of international transaction covered by the transfer pricing requirements, an exception is provided in para 2 of Rule 10D in respect of the information and document requirement in respect of transactions not exceeding INR 10 million. It is provided that the above requirement will not apply to such transactions. However the concerned taxpayer may be required to substantiate on the basis of available material that the income arising from the international transaction is computed in accordance with the arm's length rule.
The prescribed information and documents are required to be maintained for a period of eight years. Rule 10D absolves a taxpayer entering into a international transaction which continues to have effect over more than one year from maintaining separate set of documents for each year. However separate documents are required for each year if there is any significant change in the terms and conditions of the international transaction which have a bearing on the transfer price.
As the transfer pricing provisions introduced by the Finance Act are effective from 1 April 2001, the above requirements will be applicable to all international transactions entered into by associated enterprises in India after that date. The first compliance date in respect of the new transfer pricing regulation would be 31 July 2002 for non-corporate and 31 October 2002 for corporate taxpayers in respect of international transactions entered into by them during the period 1 April 2001 to 31st March 2002. Taxpayers who are affected by the new transfer pricing regulation would thus have time till the above-mentioned dates to be ready with the required information and documents in respect of covered transactions.