When multinationals proceed through cross border transactions, tax authorities on both sides would like to make sure that they get their fair share of tax. Transfer Pricing regulations are only to achieve this goal. But does transfer pricing means pricing of goods? Well, here you need to have a clear understanding of Transfer Pricing. Hence, go through the article as we have mentioned everything you should know about Transfer Pricing and International taxation.
1. What is Transfer Pricing?
At the first place, let’s talk about what is transfer pricing,
Transfer pricing means price charges for goods or services provided. However, under the tax, in common parlance, Transfer Pricing is considered as the value attached to goods or services when the transaction proceeds between two related/associate parties whether international or domestic.
Example: Suppose company A processes and produces apples. Company B acts as the distributor and seller of the same product. Company C owns both companies A and B. As company C owns both companies A & B, therefore, for the purpose of Transfer pricing provisions under Income Tax Act, 1961, Company A and B is considered as related/associate entities due to common control. So now, transactions of sales of apple to Company B by Company A shall be subject to transfer pricing provisions of Income Tax Act, 1961.
2. Applicability Of Transfer Pricing On Cross Border Transaction
Indian Finance Ministry has implemented the Transfer Pricing provisions from the financial year 2001-02. The finance Act, 2001, was introduced to substitute section 92, along with section 92F and section 92A in the Income Tax act 1961. The purpose of the substitution was to offer a clear statutory framework that can give a fair and reasonable computation process with equitable profits and tax in India. The Central Board of Direct Taxes (CBDT) came out with the Transfer Pricing Rules (Rule 10A to Rule 10E) mentioning minute details in relation to Arm’s length price, associated enterprise, and the documents requirements to indulge in international transactions.
Transfer pricing provisions are applicable to international and specific domestic transactions that take place between related/associate enterprises.
However, in this article, we will have a detailed discussion about international transactions only.
Business entities in India need to fulfill two conditions to apply transfer pricing provisions. To comply with the transfer pricing provisions, the first thing required is an international transaction. Secondly, the transaction must have to happen between two or more associated business enterprises where at least one party is a non-resident.
3. Meaning Of International Transaction Or Cross Border Transaction
“International transaction” means a transaction between two or more associate enterprises, where either or both parties are non-resident.
Such transactions can be related to purchase, sales or lease of property, tangible or intangible assets, lending of money, provision of services or any other transaction. As said earlier, one of the parties involved in the transaction has to be a non-resident entering to one or more than one of the transactions mentioned below:
- Transactions related to providing with services
- Transactions involving buying, selling or offering a lease of tangible and intangible properties
- A mutual deed among associated enterprises for appointment or allocation of any cost, contribution or expense
- Capital Financing deals like borrowing, or lending, guarantees
4. Meaning Of Associated Enterprises
Managerial participation, ownership of one business entity by another is the two basic conditions of considering Associated Enterprises.
As per the definition mentioned in Section 92A(1) of the Income Tax Act, 1961, the participation of associated enterprises can be direct or indirect or through one or more than one intermediaries.
Section 92A(1) is further supplemented with 13 additional clauses that enlist different circumstances under which two business entities will be adjudged as Associated Enterprises.
4.1 Different Clauses Under Section 92A
As per section 92A, you must consider the following entities:
1. Where one party participates, directly or indirectly, in the management or control or capital of the other enterprise.
E.g. A Limited having a wholly-owned subsidiary B Limited. Therefore, A Limited and B Limited shall be considered as Associate enterprises and any transaction between them shall be subject to transfer pricing provisions; or
2. Where parties who have common participation in management or control or capital.
E.g. A limited and B Limited are a subsidiary of C Limited. As both the companies have common control, A Limited and B Limited shall be considered as associate enterprises; or
3. Where an enterprise holds shares, directly or indirectly, representing voting power of not less than 26%; or
4. Enterprises under common control through a shareholding of more than 26% of voting power; or
5. Where an enterprise has advanced a loan to another which 51% or more of the book value of the total assets of the other enterprise; or
6. Where one enterprise guarantees not less than 10% of the total borrowings of the other enterprise; or
7. Where 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;
8. Where 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
9. 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, licenses, etc. which is owned by other enterprises; or
10. 90% or more of raw materials and consumables is procured by one enterprise from 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
11. Goods or articles manufactured by one enterprise are sold to other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise;
12. Enterprises under common control of an individual or his relative or jointly by such individual and relative of such individual; or
13. Enterprises under common control of Hindu undivided family or member of such Hindu undivided family or jointly by such member and his relative; or
14. where one enterprise is a firm, an association of persons or body of individuals and other enterprise holds not less than 10% interest in such firm, the association of persons or body of individuals; or
The transfer pricing regulations have a wide scope. As per the rule even in the following case, you must consider a transaction as an international transaction.
If a resident business entity offers goods or services to an unrelated person abroad and there is a separate agreement between the person unrelated and an Associated Enterprise that can influence the price of the product also.
5. Arm’s Length Price
The transactions between two unrelated parties proceed by following the open market price. But as per the Arm’s Length Principle, if there is a transaction between two related parties, the price should be the same as the price would have been if those parties were not related.
6. Meaning Of Arm’s Length Price(ALP)
Arm’s Length Price is the price decided in case of a transaction between Associated Enterprises following the Arm’s length principle.
According to the Organisation for Economic Co-operation and Development (OECD), the ALP can be defined as the price at which transactions between two entities other than Associated Enterprises are carried out in uncontrolled situations.
7. Computation Of ALP
Depending on the type of transaction or class of transaction, the best possible method of calculating Arm’s length price will be implemented. According to the provisions of section 92C, the Arm’s length price in relation to an international transaction needs to determined through any of the following rules,
- Cost Plus method
- Profit split method
- Comparable Uncontrolled Price Method
- Transactional Net Margin Method
- Resale Price Method
However, we have provided detailed information on methods of computation of ALP in a separate article. To read the same click here
8. Documents To Be Maintained For International Transactions
As per the Transfer Pricing Regulations, detailed maintenance of documentation is required if the value of the international transaction with related parties exceeds Rs 10 million in a fiscal year. But there are absolute relaxation in the maintenance of documentation as well. Associated
8.1 Enterprises need to maintain thirteen types of documents.
The list includes,
- Enterprise related documents:
- Detail of the business entities,
- relations with associates,
- nature of business
8.2 Transaction Specific Documents:
- Details of each transaction,
- description of all the businesses performed,
- details of the employed assets,
- risks each party involved in the transaction has assumed,
- Economic and market analysis.
8.3 Documents Related to Computation
- Description regarding method considered,
- assumptions of actual work, policies, if any
- amendments made to the transfer price, information, and
- documents relied on the determination of the Arm’s length price.
9. Return Filing Requirement
Under the act of indulging in any international or specified domestic transaction, all the Indian taxpayers have a legal obligation to report compliance. Henceforth, a report from an authorized tax practitioner or Chartered Accountant in the prescribed format offering the details related to the transactions is essential. The accountant needs to clarify the below points:
- The Arm’s length computed tax price is correct, and done maintaining all the regulations
- The taxpayer has maintained the right documentation needs according to the regulatory requirements
However, the businesses need to furnish the report through form 3CEB for each financial year.
10. Penalty For Non-Compliance
There are rigorous penal provisions because of non-compliance under the transfer pricing regulations. However, here in this table, we have mentioned all the details of the penalties for non-compliance with several provisions,
|Nature of non-compliance||Penalty|
|Under section 271(1)(c) hiding actual income or furnishing improper details||100% to 300% tax on the additional income|
|Section 271G, unable to maintain required documents||2% of the value of the international transaction mentioned between related parties|
|Unable to furnish the Accountants’ certificate under section 271BA||Fixed penalty of INR 100,000/-|
|Failed to maintain transfer pricing documentation under section 271AA||2% of the value of the international transaction mentioned between related parties|
Associated Enterprises proceeding through an international transaction or cross border transactions have to ensure that all the transactions are maintained with Arm’s Length Principle. Hence, if you fail to maintain proper documents, a heavy penalty will have to pay.