Transfer pricing means
the value or price at which transactions take place amongst related parties.
Transfer prices are the prices at which an enterprise transfers physical goods
and intangible property and provides services to Associated Enterprises.
POSITION IN INDIAA need was felt for a detailed and separate
regulation for administering transfer pricing with globalisation of Indian
economy. Absence of such Regulations not only results in litigation but loss of
revenue to the exchequer. In absence of Transfer Pricing Regulations, India was
losing its legitimate share of revenue.
Section 92 of the Income Tax Act, 1962 states that:
·
Any income arising
from an international transaction shall be computed having regard to arm’s
length price.[Section 92(1)]
·
The allowance for any
expense or interest shall be determined having regard to the arm’s length price
while determining income under sub-section (1) above [Section 92(2)].
·
The cost or expense
allocated or apportioned between two or more associated enterprises shall be at
arm’s length price.
The relationship of Associated
Enterprises emerges if any of the following criteria is met at any time
during the previous year.
The basic criterion
to determine Associated Enterprise is the participation in management,
control or capital (ownership) of one enterprise by another enterprise. The
participation may be by:
a.
Direct control
b.
Through intermediary
There are also additional
criterion to determine an Associated Enterprise based upon the following:
a.
holding of 26% of
voting power;
b.
advance of loan not
less than 51%of the book value of the total assets of the borrowing company;
c.
guarantees not less
than 10% of the total borrowings on behalf of borrower;
d.
appointment of more
than 50% of the Board of Directors or members of the Governing Board;
e.
Dependence wholly on
the enterprise possessing exclusive rights for manufacturing or pricing of
goods or articles by using knowhow, patents etc. This however refers to only
technology transfer and not financial participation. Technology could be by way
of transfer for use of knowhow, patents, copyrights, trademarks, licenses,
franchises, any other business or commercial right of similar nature. However technology
for services e.g. software is not included in this definition;
f.
dependence up to 90%
or more for the raw materials and consumables on another enterprise, coupled
with influence over price and other terms of supply.
g.
The goods or articles
manufactured or processed by one enterprise, are sold to the other enterprises
or to persons specified by the other enterprise, and the prices and other
conditions relating thereto are influenced by such other enterprises;
h.
Where one enterprise
is controlled by an individual, the other enterprise is also controlled by such
individual or his relative or joinly by such individual and relative of such
individual;
i.
Where one enterprise
is controlled by a Hindu undivided family, the other enterprises 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;
j.
Where one enterprise
is a firm, association of persons or body of individuals, the other enterprise
holds not less than 10% interest in such firm, association of persons or body
of individuals;
k.
there exists between
the two enterprises, any relationship of mutual interest, as may be prescribed.
The term "Enterprise"
is widely defined to include any person carrying out commercial activities of
various types specified in the relevant section.
"International
Transaction" (S. 92 B) is defined
to mean a transaction between two or more Associated Enterprises of which
either both or anyone is a non resident in the nature of :
·
Purchase, sale or
lease of tangible property or intangible property; or
·
Provision of services:
or
·
Lending or borrowing
of money: or
·
Any transaction having
a bearing on the profits, income, losses or assets.
·
Mutual agreement or
arrangement between two or more Associated Enterprises for the allocation or
apportionment of any contribution, cost or expense.
Hence:
·
Transactions between
Indian company and its overseas branch would be outside the purview of Transfer
pricing regulations as both the entities will be residents;
· Transactions between foreign entity and
its permanent establishment (Indian branch) would be covered;
·
Any transaction
between two permanent establishments in India would be covered as both will be
non-residents of India.
The term "Arm’s
Length Price" is defined to mean a price applied in uncontrolled
conditions. In other words it refers to the market value of a particular
transaction ignoring the impact on pricing due to existence of special
relationship between Associated Enterprises.
Arm’s Length Price is
the internationally accepted transfer pricing standard which must be applied
for tax purposes by multinational enterprises and tax administration. The
Transfer Pricing Regulations framed in India also recognises determination of
pricing between Associated Enterprises on an arm’s length basis. The major
reason for adoption of Arm’s Length Principle is to avoid the creation of tax
advantages or disadvantages that would otherwise distort the relative
competitive position of either type of entity. By separating tax considerations
from economic decisions the arm’s length principle promotes the growth of
international trade and investment.
The arm’s length price
in relation to an international transaction shall be determined by any of the
following methods:
· Comparable uncontrolled price method: This method compares the price charged in a
controlled transaction to the price charged in a comparable uncontrolled
transaction in comparable circumstances. Where it is possible to locate
comparable uncontrolled transactions this method is the most reliable and
direct method.
· Resale price method: This is ordinarily used in cases involving
the purchase (from a related party) and resale (to an unrelated party) of
property in which the re-seller has not added substantial value to the goods.
Under this method, the Arms Length Price of the goods purchased from a related
party is determined by deducting an arm’s length gross profit from the resale
price of the goods resold to an unrelated party.
· Cost plus method: Under this method, an Arm’s Length Price is
determined by adding an arm’s length mark-up to the costs of the supplier
supplying goods to a related purchaser. This method is useful where
semi-finished products are sold between related parties, in case of joint
facilities arrangement or where services are provided between related parties.
· Profit split method: The net income from transactions is allocated
to the respective entities, based on the value of their contributions to the
net profit.
·
Transactional
net margin method: Reference to the net
profit level of similar business enterprises may help provide some guidance in
the determination of Arm’s Length Price to be applied on related entity
transactions. Profit may be assessed in different ways in relation to total
sales, operating expenses incurred or assets.
·
Such other method as
may be prescribed: Other method may be used provided the result is at arm’s
length.
Sub-section (2)
provides that where more than one price may be determined by the most appropriate
method, the arm’s length price shall be taken to be the arithmetical mean of
such prices. This is a unique concept in India.
Rule 10B explains in
detail methods prescribed above. The Rule also provides that the comparability
of one transaction with another shall be judged with reference to the
following, namely:-
a.
the specific
characteristics of the property or services transferred in either transaction;
b.
the functions
performed taking into account assets employed or to be employed and the risks
assumed by respective parties of the transactions;
c.
the contractual terms
(whether or not such terms are formal or in writing) of the transactions which
lay down explicitly or implicitly how the responsibilities, risks and benefits
are to be divided between the respective parties to the transactions;
d.
conditions prevailing
in the markets in which the respective parties to the transactions operate,
including the geographical location and size of the markets, costs of labour
and capital in the markets, overall economic development and level of
competition and whether the markets are wholesale or retail.
Rule 10C provides that
the most appropriate method shall be the method which is best suited to the
facts and circumstances of each particular international transaction, and which
provides the most reliable measure of an Arm’s Length Price in relation to the
International Transaction.
Rule 10C provides that
the most appropriate method shall be selected having regard to the following,
namely:-
1.
the nature and class of
the international transaction;
2.
the class or classes
of Associated Enterprises entering into the transaction and the functions
performed by them;
3.
the availability,
coverage and reliability of data necessary for application of the method;
4.
the degree of comparability
existing between the International Transaction and the uncontrolled transaction
and between the enterprises entering into such transactions;
5.
the extent to which
reliable and accurate adjustments can be made to account for differences, if
any, between the transactions being compared and the enterprises entering into
such transactions;
6.
the nature, extent and
reliability of assumptions required to be made in application of a method.
Determination of Arm’s
Length Price by Tax Authorities (Section 92 C)
If during assessment
proceedings, or appellate proceedings, the tax authorities on the basis of
material or information or documents in their possession, are of the opinion
that the Arm’s Length Price is not determined as provided under the Income-tax
Act, the total income may be recomputed accordingly after giving tax-payer the
opportunity of being heard. This will enable the assessing officer to make the
addition of income or disallowance of expenses, but only if the transfer price
arrived at by the assessee is more than 5% higher or lower than the transfer
price arrived at by the assessing officer.
·
No deduction under
section 10A/10B or under Chapter VI-A of the Income- tax Act will be allowed in
respect of income by which the total income of the tax-payer is so enhanced.
·
It is further provided
that when the total income of the Associated Enterprise is computed on the
basis of Arm’s Length Price paid to another enterprise from which tax has been
deducted under the provisions of Chapter XVIIB, the income of the other
enterprise shall not be recomputed by reason of such determination of Arm’s
Length Price in case of first mentioned enterprise.
Transfer Pricing
Officer (Section 92CA)
Where any person being
the assessee, has entered into an International Transaction in any previous
year, and the Assessing Officer considers it necessary or expedient so to do,
he may with the previous approval of the Commissioner refer the computation of
the arm’s length price in relation to the said international transaction under
section 92C to the Transfer Pricing Officer.
Maintenance of
Documents (Section 92D)
Any person entering into an international transaction is
required to keep and maintain the information and documents prescribed for a
period of eight years from the end of relevant assessment year.
Further, the person is
required to keep the specified information and documents ready by:-
·
in the case of a
Company, October 31 of the relevant assessment year;
·
in any other case,
July 31 of the relevant assessment year.
The information and
documents have to be submitted to the Assessing Officer/ Commissioner of
Income-tax (Appeals) within 30 days of the receipt of notice from him.
The persons who are
required to keep and maintain the information and documents can be divided into
two categories:
1.
Those
persons who have entered into international transactions the total value of
which exceeds Rs. 1 Crore (Category 1).
2.
Those
persons who have entered into international transactions the total value of
which does not exceed Rs. 1 Crore (Category 2).
Primary Documents
Every person falling
into Category 1 is required to keep and maintain the following information and
documents, namely:-
Pertaining to the
Assessee as a whole :
a.
A description of its
ownership structure with details of shares or other ownership interest held
therein by the enterprises with whom he has entered into an International
transaction.
b.
A profile of the
multinational group of which it 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 it, and
ownership linkages with them.
c.
A broad description of
the business of the assessee and the industry in which it operates and of the
business of the Associated Enterprises with whom it has transacted.
Pertaining to the
Transactions :
a.
The nature and terms
(including prices) of International Transactions 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
transactions.
b.
A description of the
functions performed, risks assumed, and assets employed or to be employed by it
and by the Associated Enterprises involved in the International Transaction.
c.
A record of the
economic and market analysis, forecasts, budgets or any other financial
estimates prepared by it for the business as a whole and for each division or
product separately, which may have a bearing on the International Transactions
entered into by it.
d.
A record of
uncontrolled transactions taken into account for analysing their comparability
with the International Transactions entered into, including a record of the
nature, terms and conditions relating to any uncontrolled transactions with
third parties which may be of relevance to the pricing of the International
Transactions.
e.
A record of the
analysis performed to evaluate comparability of uncontrolled transactions with
the relevant International Transaction.
f.
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.
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 transactions and the comparable
uncontrolled transactions, or between the enterprises entering into such
transactions.
h.
The assumptions,
policies and price negotiations, if any which have critically affected the
determination of the Arm’s Length Price.
i.
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.
j.
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.
Supporting Documents
The information
specified above will have to be supported by authentic documents, which may
include the following:
a.
Official publications,
reports, studies and data bases from the government of the country of residence
of the Associated Enterprise, or of any other country.
b.
Reports of market
research studies carried out and technical publications brought out by
institutions of national or international repute.
c.
Price publications
including stock exchange and commodity market quotations.
d.
Published accounts and
financial statements relating to the business affairs of the Associated
Enterprises.
e.
Agreements and
contracts entered into with Associated Enterprises or with unrelated
enterprises in respect of transactions similar to the International
Transactions.
f.
Letters and other
correspondence documenting any terms negotiated between the assessee and the
Associated Enterprise.
g.
Documents normally
issued in connection with various transactions under the accounting practices
followed.
Documentation by Every
Person falling in Category 2.
No detailed
information and documents, as stated above, have been prescribed for persons
falling under Category 2. But they will be required to substantiate, on the
basis of material available with them, that income arising from International
Transactions entered into by him has been computed in accordance with the
provisions of Section 92. It is advisable, therefore, to maintain as many
records as possible as are prescribed for Category 1 as the burden of proof of
justifying the Arm’s Length Price is on the assessee.
Separate Report from
an Accountant (Section 92E)
Every person who has
entered into an International Transaction (as defined in the Section) in a
previous year must submit a Report
from the Accountant in the prescribed form. Rule 10E prescribes the Form No.
3CEB for the Report.
Due date for
submission of Report is 31st October of the relevant
assessment year in case of a company and 31st July of the assessment
year in the case of other assessees.
The Accountant
is required to:-
a.
Express an opinion on
whether proper information and documents as prescribed have been maintained by
the assessee.
b.
Certify that the
particulars given in the annexure to Form 3CEB are true and correct. This
annexure requires the assessee to list:
·
The Associated
Enterprise’s with whom international transactions have been entered into and
give a description of such transactions.
·
Particulars in respect
of the international transactions and the method used in determining the ALP,
with the amount as per books of accounts and the amount computed at ALP.
Penalties [Sections
271, 271AA , 271BA and 271G]
Section 271 provides
that owing to transfer pricing adjustment if any amount is added or disallowed
in computing the total income of the assessee under sub-section (4) of section
92C then such addition or disallowance would be deemed to represent the income
in respect of which particulars have been concealed or inaccurate particulars
have been furnished and it would attract penalty upto 300% of the amount of tax
sought to be evaded. However, no penalty will be levied if the tax-payer is
able to establish that he has computed the price charged in good faith and with
due diligence.
Additional Penalties
Following additional
penalties are also prescribed for non-compliance of various provisions:
·
Failure to maintain
the prescribed information / documents would attract penalty @ 2% of the value
of each international transaction. (Section 271AA).
·
Failure to furnish a
report from an accountant would attract penalty of Rs. 100,000/-. (Section
271BA).
·
Failure to furnish
information or document as required by the assessing officer would attract
penalty @ 2% of the value of the international transaction for each such
failure. (Section 271G).
Section 273B provides
that penalties mentioned above shall not be imposed if the assessee proves that
there was reasonable cause for the said failure.
Difficulty In Applying
Arm’s Length Principle
The Arm’s Length
Principle has been recognized globally by all tax administrations. By
separating tax considerations from economic decisions it promotes the growth of
international trade and investment. However, practically there are certain
difficulties in applying Arm’s Length Principle due to the following reasons:
·
Multinational
Enterprises groups are dealing in the integrated production of highly
specialised goods, in unique intangibles, and/or in the provision of
specialised services.
·
Associated Enterprises
may engage in transactions that independent enterprises would not undertake,
example sale or license of intangibles.
·
Arm’s Length Price may
result in an administrative burden for both the tax administrations of
evaluating significant numbers and types of cross-border transactions. Also
verification of such transactions takes place for some years at the time of
assessment and therefore, it becomes all the more difficult to arrive at
conditions prevailing at the time the transactions took place.
·
Far placed
geographical locations and confidentiality etc. may cause difficulty in
obtaining comparable data.
Based on the present
status of legislation following emerges as the ‘Do’s and Don’ts’ as far as
Transfer Pricing is concerned:
Do’s
·
Every person entering
into an International Transaction shall do necessary documentation for such
relationship e.g. Service/Transfer Pricing Agreement.
·
Choose one of the six
prescribed methods being the most appropriate method, to compute arm length’s
price
·
Maintain information
and documents in support of the method so adopted and as prescribed under the
Transfer Pricing Rules
·
Prescribed information
and documents must be kept and maintained for a period of 8 years from the end
of relevant assessment year.
·
Submission of an
Accountant’s Report in Form No. 3CEB by 31st October of the
relevant assessment year in case of a Company and 31st July in the
case of other assessees.
·
Obtain services of
Professionals duly qualified and well informed about the laws and procedures
relating to Transfer pricing.
Don’ts
·
Concealment of a
transaction, which may qualify as International Transaction.
·
Concealment of income
by not conforming to the prescribed methods of computing Arm’s Length Price.
·
Failure to maintain
proper records/information pertaining to actual working carried out for
determining the Arm’s Length Price.
·
Supply/Servicing on
Oral understanding.
·
Any
adjustments/settlements which may be in variance of the Understanding
documented as Service/Transfer Pricing Agreement.
·
Assignment of work
connected with Transfer Pricing to un-qualified professional.
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