Indian transfer pricing (TP) rules were first introduced in 2001, and they were drafted based on the statutory laws of other countries, and in alignment with the Organization for Economic Co-operation and Development (OECD), though India was not a member. Today, the domestic TP regulations are incorporated within the Income Tax Act, which aligns with the 2017 Guidelines of the OECD.
Arm’s Length Principle
Under Section 92C of the Income-tax Act, related companies (like parent and subsidiary) must set prices for their transactions as if they were unrelated, dealing independently and fairly, like in the open market. It applies to cross-border transactions involving non-residents, excluding domestic transactions.
Related Party Definition
Under Section 92A of the Income Tax Act related parties are considered two businesses that are connected when one controls or influences the other, directly or indirectly in terms of management, ownership, or financial dealings. Illustrations include equity holding, board control, loan advances, and mutual interest relationships. Also, includes transactions involving ownership of shares, giving huge loans, appointing directors, or having common control by the same person or group.
Transfer Pricing Methods
The methods that can be used to determine the arm’s length price in India are:
- Comparable uncontrolled price method
- Resale price method
- Cost plus method
- Transactional net margin method
- Profit split method
The selection of the method for determining the arm’s length principle is based on the most appropriate method, without prioritizing any method. Factors taken into consideration include the nature of the transaction, the class of associated enterprises (AEs), data availability, comparability, reliable adjustments, and assumptions required.
Also, the legislator has provided that in case the chosen method gives more than one possible price, the average of those prices is taken as the Arm’s Length Principle. If the difference between the Arm’s Length Principle and the actual price is very small (within 3%, or as notified), then the actual price can be accepted as the Arm’s Length Principle.
Comparability Analysis
Comparability analysis is used in transfer pricing to ensure that the price or margin of an international transaction between related parties of an Indian company and its foreign affiliate matches what would be charged between unrelated parties under similar conditions. Usually, the Indian taxpayer is selected as the tested party the entity used as the basis for comparison. However, if the foreign affiliate (Associated Enterprise or AE) is less complex and more reliable data is available about it, it can be chosen instead. Courts have supported this in various rulings, emphasizing that the simpler party with fewer risks, assets, and functions should be the tested party, provided reliable data is available. Comparability is determined by looking at factors such as functions performed, assets used, and risks taken (FAR analysis).
If there are significant differences between companies being compared, adjustments (like risk, working capital, or Research and Development expenses must be made. If adjustments aren’t possible, those companies can’t be considered comparables. Indian tax rules also allow multiple-year data (up to 3 years) and the range concept when six or more comparables are available. Although the use of foreign comparables is not prohibited, Indian tax authorities are cautious, and courts have required strong supporting data to accept them.
Documentation Requirements
Documentation requirements for transfer prices in India are based on the three-layer method of the OECD. That means multinationals have to report the following to the Indian tax authorities:
- Master file;
- Local file; and
- Country-by-Country (CbC) report.
In India, if a taxpayer has international or specified domestic transactions exceeding 200 million in a financial year, they must maintain transfer pricing documentation to prove that the transactions were at arm’s length. This includes:
- Local File: Contains detailed information about the specific international or domestic transactions of the Indian entity.
- Master File: Contains an overview of the multinational group’s global operations, transfer pricing policies, and allocation of income and activities. Entities of an International Group (IG) must file Part A of the Master File without any threshold. Part B is required if the IG’s consolidated group revenue exceeds INR 5,000 million the aggregate value of international transactions exceeds INR 500 million, or intangible property transactions exceed INR 100 million.
- This documentation must be prepared before filing the income tax return and kept ready to submit to the tax authority within 10 days of request during an audit. A Report from an Accountant (Form 3CEB) must also be filed online, one month before the tax return’s due date.
Country-by-Country Reporting
Country by Country reporting applies to international groups with total consolidated revenue of 64 billion or more. It requires the ultimate parent (or an alternate reporting entity) to file a report that gives a country-wise breakdown of revenues, profits, taxes paid employees, activities, and more.
If the parent company is not obligated to file a CbC report in its country, or there is no information exchange agreement with India, the Indian subsidiary must file it instead. The CbC report must be submitted within 12 months from the end of the reporting year. A shorter timeline of 6 months applies if there’s a systematic failure by the parent’s country and India has notified the subsidiary.
Advance Pricing Agreements (APA) and Mutual Agreement Program (MAP)
In India, taxpayers have the option of using Advance Pricing Agreements (APAs), which in turn may help them to avoid or resolve transfer pricing issues. There are three types of APAs used in India:
- Unilateral (between the taxpayer and Indian authorities),
- Bilateral (also involving a foreign tax authority), and
- Multilateral (involving more than one foreign tax authority).
APAs can last for up to five years and may include a rollback for up to four earlier years. This helps reduce tax uncertainty and litigation, especially in cross-border transactions. The process includes stages like pre-filing, formal application, negotiation, and finalization. After entering into an APA, the taxpayer must file an annual compliance report.
Mutual Agreement Program (MAP)
In India, the Mutual Agreement Procedure (MAP) is used to resolve disputes regarding tax treaty interpretation or application. This procedure plays a key role in resolving issues between countries. For each case, there are specific points of contact which depend on the involved country. In some cases, taxpayers may ask for changes or refunds as per the agreement that comes out of the MAP.
Approach to Transfer Pricing Audits
In India, the transfer pricing audit is conducted by the Directorate for Transfer Pricing which is a specialized unit. This unit is headed by the Director-General of Income Tax and supported by Transfer Pricing Officers (TPOs) in major cities. When an assessing officer identifies international transactions the case may be referred to the TPO if it meets risk criteria. The TPO reviews the evidence, determines the arm’s length price, and presents a report to the Assessing Officer and the taxpayer.
Penalties
In India, if prices between related parties (associated enterprises) are not set properly as per transfer pricing rules, the tax authorities can increase the taxable income, which leads to extra tax, interest, and even penalties that can be up to three times the extra tax. Also, there are specific penalties under the Income Tax Act. If a person doesn’t maintain the required transfer pricing documents, doesn’t report a transaction properly, or gives incorrect information, they can be fined 2% of the value of each international transaction. In addition, if someone doesn’t file the transfer pricing report at all, they can be fined 1,00,000 Indian Ruppe. These penalties can be imposed by the Transfer Pricing Officer.
Taxation at a Glance
India’s tax system is divided between the Central Government, State Governments, and local bodies. The Central Government takes care of taxes like income tax, customs duties, and Goods and Services Tax (GST) on interstate trade, while states levy taxes such as state GST, stamp duty, and excise. Local bodies impose taxes on properties and utilities.
The currency of India is the Indian Ruppe (INR). The official name of the Indian tax authority is the Income Tax Department.
The table below provides a summary of the main taxation rates related to businesses:
Tax Type | Tax Rate |
Corporate Tax | 25%-35% |
VAT | 5%-28% |
Withholding tax on dividends to non-residents | 21.84% |
Withholding tax on interest to non-residents | 21.84% |
Withholding tax on royalties to non-residents | 21.84% |
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