Increasing participation of multi-national groups in economic activities in the country has given rise to new and complex issues emerging from transactions entered into between two or more enterprises belonging to the same multi-national group. As these multinational groups may avoid tax by manipulating the prices charged and paid in such intra-group transactions. To check the tax avoidance by multinational groups the provisions regulating transfer pricing have been introduced in the Income Tax Act. The Finance Act, 2001 substituted section 92 with a new section and introduced new sections 92A to 92F in the Income-tax Act, relating to computation of income from an international transaction in order to facilitate the computation of reasonable, fair and equitable profits and tax in
in the case of businesses carried on by multinational companies. The transfer pricing provisions are in line with those stipulated by OECD. However there is a difference that the Indian legislation does not permit the use of unspecified method to compute arms length price as permitted in OECD guidelines. India
When two unrelated companies trade with each other, the price at which they undertake their transactions is simply known as the price. But when supply of goods, services or finance is made to another related company, the negotiated price is called transfer price.
Transfer pricing is the process of adjusting the prices of cross-border transactions between related associated parties.
An international transaction means a transaction of
i) purchase, sale or lease of tangible or intangible property or
ii) provisional services of lending or borrowing of money or
iii) any other transaction having a bearing on the profits, income, losses or assets of such enterprises or
iv) 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 the benefit, service or facility provided or to be provided to any one or more of such enterprises between two or more associated enterprises either or both of whom are non-residents.
v) Or any other transaction having a bearing on the profits, income, losses or assets of such enterprises
Associated enterprise, in relation to another enterprise, means an enterprise--
a. which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise ; or
b. in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.
Two enterprises shall be deemed to be associated enterprises if, at any time during the previous year,--
c. one enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent. of the voting power in the other enterprise ; or
d. 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
e. 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
f. one enterprise guarantees not less than ten per cent. of the total borrowings of the other enterprise ; or
g. 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
h. 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
i. the manufacture or processing of goods or articles or business carried out by 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
j. 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
k. 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
l. 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
m. 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
n. 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
o. there exists between the two enterprises, any relationship of mutual interest, as may be prescribed.
Arm’s Length Price
Arm’s Length price means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.
The main objective of Arm’s length principle is profit maximization. The arm’s length price shall be determined by any of the following methods, being the most appropriate method having regard to the nature of transactions or class of transactions or class of associated persons or functions performed by such persons or such other factors as the Board may prescribe in a given case:
- comparable uncontrolled rice method
- resale price method
- cost plus method
- profit split method
- transactional net margin method
Where more than one price is determined by the most appropriate method, the arms length price shall be the arithmetic mean of such prices or a price which may vary from the arithmetic mean by an amount not exceeding 5% of such arithmetic mean , at the option of the assessee.
The most appropriate method shall be the one which is best suited to the facts and circumstances of each particular international transaction and which provides the most reliable measure of an arms length price. The factors to be considered include:
- Nature and Class of International Transaction
- Class or classes of associated enterprises entering into the transaction and the functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprises.
- the availability, coverage and reliability of data necessary for application of the method
- degree of comparability existing between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions.
- the extent to which reliable and accurate adjustments can be made to account for differences between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions.
- nature, extent and reliability of assumptions required to be made in the application method
a) Maintenance and keeping of information (92D)
b) Obtaining Accountants Certificate (92E)
a) Maintenance and keeping of information and document by persons entering into international transaction
Every person who has entered into an international transaction shall keep and maintain such information and document in respect thereof, as may be prescribed
The information and document shall be kept and maintained for a period of eight years from the end of the relevant assessment year.
Information and documents to be kept and maintained under Section 92D as prescribed under Rule 10D are
a) a description of the ownership structure of the assessee enterprise with details of the shares or other ownership interest held therein by other enterprises.
b) a profile of the multinational group of which the assessee 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 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 whom the assessee has transacted.
d) the nature and terms (including prices) of international transactions entered into with each associated enterprise, details of the property transferred or services provided and the quantum and the value of each such transaction or class of such transaction.
e) 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.
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 transactions entered into by the assessee.
g) 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 transaction with third parties which may be of relevance to the pricing of the international transactions.
h) a record of the analysis performed to evaluate comparability of uncontrolled transactions with the relevant international transactions.
i) 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
j) 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.
k) the assumptions, policies and price negotiations, if any, which have critically affected the determination of the arm's length price.
l) details of the adjustments, if any, made to transfer prices to align them with arms's length prices determined under these rules and consequent adjustment made to the total income for fax purposes.
m) 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.
A person who has entered into an international transaction shall not be required to maintain the above mentioned documents if aggregate value of transaction entered into by the assessee does not exceed one crore rupees.
The tax authorities may require the tax payer to furnish this information and documentation within a period of 30 days, which may be extended to further 30 days at the discretion of tax authorities.
b) Obtaining Accountants Certificate
Every person who has entered into an international transaction during a previous year has to obtain a report from an accountant and furnish such report on or before the due date of furnishing return in Form 3CEB duly signed and verified in the prescribed manner by such accountant and setting forth such particulars as may be prescribed.
In order to ensure compliance of Arms Length principle following penalties have been imposed by Indian Legislation
Nature of Penalty
In case of a post inquiry- adjustment, there is deemed to be a concealment of income
100-30% of tax of adjusted amount
Failure to maintain documents
2% of the value of each international transaction
Failure to furnish documents
2% of the value of each international transaction
Failure to furnish Accountants Report