1. Frequently Asked
Questions on
Transfer Pricing
Prepared By – Rashi Pilaniwala and Nandita Naruka

2. FAQ on Transfer Pricing
Introduction of The history of transfer pricing is as old as that of international transaction or cross-border
Transfer Pricing? transactions. International transaction, to start with, was limited to production in one
location and sale to independent parties in another or there were simple cases of import
and export of raw materials and of finished goods traded between independent parties.
Transfer Pricing came into existence in year 2001,a separate code on Transfer Pricing
st
under section 92 to 92F of the Income Tax Act 1961 came into existence from 1 April
2001.Since introduction of code, transfer Pricing has become the most important
international tax issues affecting multinational enterprise operating in India. The
regulations are broadly based on the OECD guidelines and describe the various transfer
Pricing methods, impose extensive transfer pricing documentation requirements and
contain harsh penal provisions for non-compliance.
What is transfer Transfer prices are the price at which an enterprise transfers physical goods and
pricing? intangibles or providing services to associated enterprises. It is an internationally
accepted principle that transactions between related parties should be based upon the
same terms as between unrelated parties. Thus both tax treaties entered into between
countries and domestic tax legislation of various countries have adopted the arm's length
principle.
How is transfer With globalization, transfer pricing became an unwanted reality. Price charged by one
pricing abused? company in Country A to another company in Country B is reflected in the profit and loss
account of both companies, either as an income or an expenditure. Thus prices charged
impact the tax paid by the two related companies.
By resorting to transfer pricing, related entities can reduce the global incidence of tax by
transferring higher income to low-tax jurisdictions or greater expenditure to those
jurisdictions where the tax rate is very high.
For example, the current tax rate on domestic companies in India is 35 per cent.
Company A is located in India and Company B in Country XYZ. Both belong to the same
group. If tax rate in Country XYZ is 15 per cent, then Company B will transfer raw
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3. material to Company A at slightly higher prices. This will enable Company A to show a
higher expenditure and reduce its taxable profits. On the other hand, slightly higher
income will not harm Company B much as the tax rate in its country is very low. Thus the
global group as a whole will benefit from tax savings.
What are the The most important provisions in the tax laws is section 92. Here, if owing to a close
regulations in India connection between an Indian entity and a foreign party, the Indian tax authorities feel
that tackle transfer that the prices charged in a transaction were not at an arm's length they can adjust the
pricing? taxable income of the Indian party. In other words, taxable income can be enhanced if
the transaction has led to a lower profits for the Indian party.
Section 92(1) provides that:
• There must be income arising;
• Such income must arise from an international transaction;
• Such income shall be computed having regard to the arm's length price.
Allowance for any expenses or interest arising from an international transaction is also to
be determined having regard to arm’s length price. Further, the application of arm’s
length price results in reducing the chargeable income or increasing the loss from an
Indian Income-tax perspective, then the income, expense, interest or other allocation or
apportionment of expenses need not be calculated at such arm’s length price.
Section 92(2) provides that cost sharing arrangements between associated
enterprises (AEs) will also be subject to the arm’s length rule.
The term enterprise is defined in section 92F(iii) to mean a person including a
permanent establishment of a person who is, or has been or is proposed to be
engaged in certain specified activities. These activities are in relation to :
• production storage, supply, distribution, acquisition or control of:
• articles or goods; or
• know-how, patents, copyrights, trademarks, 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:
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4. • of which the other enterprise is the owner; or
• in respect of which the other enterprise has exclusive rights;
OR
• provision of services of any kind;
OR
• carrying out any work in pursuance of a contract;
OR
• investment;
OR
• providing loan;
OR
• business of acquiring, holding, underwriting or dealing with shares, debentures
or other securities of any other body corporate.
• Such activity or business may be carried on directly or through one or more of
the units or divisions or subsidiaries, which may be located at the same place
where the enterprise is located or at a different place(s).
What do we mean by • The term arm’s length price is defined in section 92F(ii) to mean—
Arm’s Length price? • The price which is applied; or
• Is proposed to be applied;
• In a transaction between persons other than AEs;
• In uncontrolled conditions.
What are the The various methods as prescribed by section 92C, to calculate the arm’s length prices
different methods/ with respect to an international transaction are the following:
pricing • Transactional net margin method (TNMM);
methodologies to
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5. calculate the arm’s • Resale price method (RPM);
length price?
• Comparable uncontrolled price method (CUP);
• Cost plus method (CPM);
• Profit split method (PSM).
Section 92C provides the mechanism of determining the arm’s length price by
any of the following five methods, being the most appropriate method taking into
consideration the nature or class of the transaction functions performed or such
other factors as laid down in rule 10B:
Comparable uncontrolled price method;
• Comparison of price charged or paid for property transferred or services
provided in a comparable uncontrolled transaction.
• Used mainly in respect of transfer of goods, provision of services,
intangibles, loans, provision of finance.
Resale-price method;
• Considers the price at which property purchased or services obtained by
the enterprise from an AE is resold or are provided to an unrelated
enterprise.
• Used mainly in case of distribution of finished goods or other goods
involving no or little value addition.
Cost-price method;
• Considers direct and indirect costs of production incurred by an enterprise
in respect of property transferred or services provided and an appropriate
mark-up.
• Used mainly in respect of provision of services, joint facility arrangements,
transfer of semi finished goods, long-term buying and selling
arrangements.
Profit-split method;
• Considers combined net profit of the AEs arising from the international
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6. transaction and its split amongst them.
• Used mainly in report of transactions involving integrated services
provided by more than one enterprise, transfer of unique intangibles,
multiple interrelated transactions, which cannot be separately evaluated.
Transactional net margin method.
• Considers net profit margin realised by the enterprise from an international
transaction entered into with an AE;
• Used in respect of transactions for provision of services, distribution of
finished products where resale price method cannot be adequately
applied, transfer of semi-finished goods;
Any other method as prescribed by the CBDT: The CBDT has not yet
prescribed any other method.
The most appropriate method from the above method shall be applied for
determination of the arm’s length price in the manner laid down in Rule 10C.
No particular method has been accorded a greater or lesser priority. The most
appropriate method for a particular transaction would need to be determined
having regard to the nature of the transaction , class of transaction or
associated persons and functions performed by such other persons as well as
other relevant factors.
The legislation requires a taxpayer to determine an arm’s length price for
international transactions. It further provides that where the variation between
the arm’s length price determined and the price at which the international
transaction has been undertaken (transfer price) does not exceed such
percentage as may be notified by the Central Government of the transfer price,
then the transfer price is deemed to be the arm’s length price.
What is meant by “International transaction” means a transaction between two or more associated
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7. ‘International enterprises, either or both of whom are non-residents, in the nature of purchase,
Transaction’ with sale or lease of tangible or intangible property, or provision of services, or lending
regard to Transfer or borrowing money, or any other transaction having a bearing on the profits,
Pricing? income, losses or assets of such enterprises, and shall include 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 a benefit, service or facility provided
or to be provided to any one or more of such enterprises.
A transaction entered into by an enterprise with a person other than an
associated enterprise shall, for the purposes of sub-section (1), be deemed to be
a transaction entered into between two associated enterprises, if there exists a
prior agreement in relation to the relevant transaction between such other person
and the associated enterprise, or the terms of the relevant transaction are
determined in substance between such other person and the associated
enterprise.
When can two An enterprise is an Associated Enterprise :-
companies be called
as ‘associated • Which participates directly or indirectly in the management or control or capital of
enterprises?’ the other enterprise. This can be explained as under:
utf
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8. Two enterprises shall be deemed to be associated enterprises if, at any time during the
previous year,--
a. one enterprise holds, directly or indirectly, shares carrying not less than twenty-
six per cent. of the voting power in the other enterprise ; or
b. 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
c. 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
d. one enterprise guarantees not less than ten per cent. of the total borrowings of
the other enterprise ; or
e. 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
f. 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
g. the manufacture or processing of goods or articles or business carried out by
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9. 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
h. 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
i. 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
j. 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
k. 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
l. 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
m. there exists between the two enterprises, any relationship of mutual interest, as
may be prescribed.
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10. What all The taxpayer is required to maintain, on annual basis, a set of extensive
documents are information and documents relating to international transactions undertaken with
required to be associated enterprises. Rule 10D of the Income Tax Rules prescribed detailed
maintained by a information and documentation that has to be maintained by taxpayer. The
company while following documents have to be maintained when a company is involved in an
executing an international transaction.
international
transaction? a) 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 which the assessee has transacted.
b) A profile of the multinational group of which the 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 description of the ownership structure of the assessee enterprise
with details of shares or other ownership interest held therein by
other enterprise.
d) 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.
e) The nature and terms (including 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.
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 transaction entered
into by the assessee.
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 transaction and the comparable
uncontrolled transactions, or between the enterprises entering into
such transactions.
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11. h) 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.
i) A record of the analysis performed to evaluate comparability of
uncontrolled transaction with the relevant international transaction.
j) A record of uncontrolled transaction taken into account for
analyzing their comparability with the international transaction
entered into, including a record of the nature, terms and conditions
relating to any uncontrolled transaction with the third parties which
may be of relevance to the pricing of the international transaction.
k)
l) The assumptions, policies and price negotiations, if any, which
have critically affected the determination of the arm’s length price.
m) 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.
n) Any other information, data or document, including information or
data relating to the associated enterprise, which may be relevant for
determination of arm’s length price.
.
Who is the Any person who has involved in an international transaction in the previous year
authorized person to shall submit the report in Form 3CEB through a Chartered Accountant, duly verified
furnish the report by him, on or before the date prescribed by the authority, furnishing all the required
under section 92E of details. The form of the report has been prescribed. The report requires the
the Income Tax Act? accountant to give an opinion on the proper maintenance of prescribed documents
and information by the taxpayer. Furthermore, the accountant is required to certify
the correctness of an extensive list of prescribed particulars.
What are the Penal The following stringent penalties have been prescribed for non compliance with the
Provisions of Income transfer pricing regulations:
Tax which apply on
Section 271AA: If the assessee fails to keep and maintain the prescribed
Transfer Pricing?
information and documents, penalty equal to 2% of the value of each international
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12. transaction may be leviable.
Section 271BA: Failure to furnish the accountant’s report may attract penalty of Rs.
1,00,000/-.
Section 271G: Failure to furnish the required information and documents may
attract penalty of 2% of the value of the international transaction for each failure.
Section 273B: The penalties u/ss. 271AA, 271BA and 271G may not be levied if
the assessee establishes reasonable cause for the said failures.
Section 271(1)(c) : As per Explanation 7 to section 271(1)(c):
where in case of an assessee who has entered into an international transaction
any amount is added or disallowed in computing the total income under section
92C(4) then the amount so added or disallowed shall be deemed to represent the
income in respect of which particulars have been concealed or inaccurate
particulars have been furnished unless the assessee proves to the satisfaction of
the Assessing Officer or the Commissioner (Appeals) or the Commissioner that the
price charged or paid in such transaction was computed in accordance with the
provisions contained in section 92C and in the manner prescribed under that
section, in good faith and with due diligence.
The amount of penalty provided for is :
• not less than the amount of tax sought to be evaded; and,
• not more than three times the amount of tax sought to be evaded, by reason of
the concealment as aforesaid.
Further, taxable income enhanced as a result of transfer pricing adjustment does
not qualify for various concessions/holidays prescribed by Income Tax Act.
What is the time limit The time limit for passing orders by the Assessing Officer where a reference is made to
for passing orders the TPO for determining the arm’s length price in an international transaction has been
by the Assessing increased to 12 months as under
Officer?
In respect of normal From 21 months to 33 months from the end of the
assessment assessment year in which the income was
first assessable
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13. In case of reopened From 9 months to 21 months from the end of the
assessments financial year in which the notice under section 148
was served
In case of order under From 9 months to 21 months from end of the financial
section 254 or under year in which the order under section 254 is received
section 263 or section 264 by the Chief Commissioner or order under section 264
is passed by the Chief Commissioner or
Commissioner of Income Tax
In case of a search cases From 21 months to 33 months from the end of the
financial year in which the last authorization for search
under section 132 or requisition under section 132A
was executed
Amendment as per Finance Bill 2012 153/153B- Extension of time for completion of
assessments and reassessments by three months w.e.f. 01.07.2012
What is the time limit As per the existing statutory provisions, the Accountant’s Report is required to be
for submitting a submitted by the specified date which is the due date for filing the return of income
th
revised Form 3CEB – (currently 30 November following end of financial year). The statute also provides
Accountant’s Report for a mechanism for filing a revised return of income if it is done so before expiry of
on International one year from the end of the relevant assessment year (i.e. 31st March, two years
Transactions? from end of financial year) or before the completion of the assessment. However,
there is no corresponding mechanism or enablement in the statute for submitting a
revised Accountant’s Report in Form 3CEB. In case a tax payer or Chartered
Accountant notices any error or omissions in the Form 3CEB, it may consider
approaching the relevant tax officer with a request for accepting a revised Form
3CEB or a letter explaining the error/omission and correction. While a tax payer
should try and complete this before the due date for filing a revised return, there is
no prohibition (or enablement) in law for doing so at a later date.
Whether the arm’s
Both transfer pricing and customs have the common aim of arriving at arm’s length
length price
price in case of cross-border import transactions. Even though the underlying
determined for
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14. transfer pricing is concept of arriving at arm’s length price is similar under the two regulations, yet the
acceptable for objectives of the regulations are altogether divergent and diagrammatically
customs valuation opposite. While transfer pricing seeks to prevent excessive payment for imports,
purposes, and vice customs valuation seeks to prevent the short payment for imports. Though the
versa? specific methods prescribed in the legislation have several similarities, yet they also
vary in many ways. Consequently, arm’s length price computed under one
regulation may not suffice the justification of arm’s length price under the other
regulation. However, there needs to be some co-relation and co-ordination between
the two. As an example, ideally, where a tax-payer has been found to be guilty of
under-invoicing by Customs authorities, it should not be subjected to scrutiny by the
transfer pricing authorities for over-invoicing, and vice versa. In certain
circumstances, comparable data used for transfer pricing purposes can be used for
customs valuation purposes as well, for example, where Comparable Uncontrolled
Price (CUP) method is adopted. Profit evaluation based methods too have some
similarity and scope for cross-leverage.
Are there any Yes, there are certain deeming provisions under the Indian tax legislation wherein
circumstances transactions amongst unrelated entities are also subjected to transfer pricing
wherein transactions provisions.
between two
Firstly, on satisfaction of certain criteria, two entities would be deemed to be
unrelated entities
associated enterprises, and hence the transfer pricing provisions shall be applicable
can be subjected to
on all transactions amongst them. The said criteria – shareholding, voting power,
transfer pricing
loans, guarantees, appointment of board members, dependence on intellectual
provisions?
property, purchase of raw material, sale of goods, mutual interest relationships, etc.
Secondly, a transaction amongst two entities which are not associated enterprises,
would be deemed to be an international transaction in certain circumstances and
transfer pricing provisions shall become applicable on the said transaction. The said
circumstances are – where there is a prior agreement for the said transaction
between the other party and an associated enterprise of the taxpayer; and where
terms of the transaction are determined in substance between the other party and
an associated enterprise of the taxpayer.
Can the Transfer Section 92CA(7) expressly endows the Transfer Pricing Officer with powers under
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15. Pricing Officer use section 133(6), and, hence, generally speaking the Transfer Pricing Officer can use
comparable data the comparable data so gathered. However, it would be pertinent to note that
gathered from one applying the principles of natural justice, the Transfer Pricing Officer should provide
company using his the assessee an opportunity of being heard after having allowed it to examine the
powers under data so collected. Also, it is important to note that if the said data was not available
section 133(6) to with the Assessee or in public domain as on date when it prepared its transfer
frame an adverse pricing documentation, the principle of impossibility of performance would become
assessment for relevant. Where the assessee has itself undertaken an ‘objective’ exercise to
another company? evaluate and collate the potential comparables, and the data now collected by the
Transfer Pricing Officer was not available to the assessee at that time, the assessee
could consider contesting the matter.
Whether a Liaison Under the FEMA, the liaison officer cannot engage in any commercial activity so as
office is to comply to earn any income in India. In view of this, one could take a position that there is no
with the TPR income arising from the operation conducted by liaison officer and, hence TPR
would not apply. However the tax authorities in some cases held that the liaison
office constitutes the PE of the foreign company and is earing income based on
facts of the cases. Hence, the facts remains that there can be an “international
transaction” as provided in section 92B. Based on the facts of each case,one would
take a position on the compliance of TPR requirement.
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16. Delhi Office
A-380, Defence Colony, New Delhi –24 In case you require any
Tel: +91-11-4980 0000
Telefax: 91-11-4980 0029
Email: spn@spnagrath.com
clarifications, you can
Bangalore Office
contact
616, Oxford Towers, Bangalore
Tel: +91-80-25705494
Telefax: +91-80-32908917
rashi@spnagrath.com /
Email: spnblr@spnagrath.com
www.spnagrath.com
nandita@spnagtah.com
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