1. Income Tax under
International
Taxation
Transfer Pricing
Regulations
(Section 92-92F)
VARUN VAISH By:
Varun Vaish
NALSAR (2008-74)
2. Transfer Pricing Explained
Indian TP Regulations
Arm’s Length Principle
The Tax Treaty Aspect-Development of TPR
Meaning of Associated Enterprises
Meaning of International Transaction
Transfer Pricing Methods
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3. Introduction
What is Transfer Price ?
A Price at which one person transfers physical goods
and intangibles or provides services to another person.
What is Transfer Pricing ?
Transfer Pricing is the act of pricing physical goods and
intangibles or services when the same is transferred to
another person.
What is Transfer Price from tax perspective ?
A Price at which one person transfers physical goods and
intangibles or provides services to another associated
person.
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4. Introduction
What is Transfer Pricing from tax perspective ?
Pricing of the intercompany transactions that take place
between two associated enterprises.
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5. Transfer Pricing Explained
Suppose a company A purchases goods for 100 rupees
and sells it to its associated company B in another
country for 200 rupees, who in turn sells in the open
market for 400 rupees.
Had A sold it direct, it would have made a profit of 300
rupees. But by routing it through B, it restricted it to
100 rupees, permitting B to appropriate the balance.
The transaction between A and B is arranged and not
governed by market forces.
The profit of 200 rupees is, thereby, shifted to the
country of B. The goods is transferred on a price
(transfer price) which is arbitrary or dictated (200
hundred rupees), but not on the market price (400
rupees).
6. Introduction
Commercial transactions between the different parts of
the multinational groups may not be subject to the
same market forces shaping relations between the
two independent firms.
One party transfers to another goods or services, for a
price. That price is known as “transfer price”.
This may be arbitrary and dictated , with no relation
to cost and may diverge from the market forces.
Transfer price is, thus, a price which represents the
value of good; or services between independently
operating units of an organisation.
7. The expression “transfer pricing” generally
refers to prices of transactions between
associated enterprises which may take place
under conditions differing from those taking
place between independent enterprises.
It refers to the value attached to transfers of goods,
services and technology between related entities.
It also refers to the value attached to transfers between
unrelated parties which are controlled by a common
entity.
8. Effect of transfer pricing
The effect of transfer pricing is that the parent company or a
specific subsidiary tends to produce insufficient taxable
income or excessive loss on a transaction.
For instance, profits accruing to the parent can be increased
by setting high transfer prices to siphon profits from
subsidiaries domiciled in high tax countries, and low transfer
prices to move profits to subsidiaries located in low tax
jurisdiction.
As an example of this, a group which manufacture products
in a high tax countries may decide to sell them at a low profit
to its affiliate sales company based in a tax haven country.
That company would in turn sell the product at an arm's
length price and the resulting (inflated) profit would be
subject to little or no tax in that country.
The result is revenue loss and also a drain on foreign
exchange reserves
9. SCOPE & APPLICABILITY
Transfer Pricing Regulations ("TPR") are applicable to the
all enterprises that enter into an 'International
Transaction' with an 'Associated Enterprise'.
Therefore, generally it applies to all cross border
transactions entered into between associated
enterprises.
It even applies to transactions involving a mere book
entry having no apparent financial impact.
The aim is to arrive at the comparable price as
available to any unrelated party in open market
conditions and is known as the Arm's Length
Price ('ALP').
10. Provision Reference
Computation of income from international Section 92 of the
transaction having regard to arm’s length price Income tax Act, 1961
(‘the Act’)
Meaning of associated enterprises Section 92A of the Act
Meaning of international transaction Section 92B of the Act
Computation of arm’s length price Section 92C of the Act
Reference to transfer pricing officer Section 92CA of the
Act
Maintenance and keeping of information and Section 92D of the Act
document by person entering into an
international transaction
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11. Provision Reference
Report from an accountant to be furnished Section 92E of the Act
by person entering into international
transaction
Definitions of various terms Section 92F of the Act
Penalty consequent to re-determination of Explanation 7, Section
arm’s length price 271(1)(c) of the Act
Penalty for failure to keep and maintain Section 271AA of the Act
information and document in respect of
international transaction
Penalty for failure to furnish report under Section 271BA
section 92E
Penalty for failure to furnish information or Section 271G
document under section 92D
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12. Provision Reference
Meaning of certain expressions Rule 10A of the Income
tax Rules, 1962 (‘the
Rules’)
Determination of arm’s length price under Rule 10B of the Rules
section 92C
Most appropriate method Rule 10C of the Rules
Information and documents to be kept and Rule 10D of the Rules
maintained under section 92D
Report from an accountant to be furnished Rule 10E of the Rules
under section 92E
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13. Prices set for transactions between group entities
should, for tax purposes, be derived from prices which
would have been applied by unrelated parties in similar
transactions under similar conditions in the open
market.
Section 92 of the Act
“Any income arising from an international transaction shall be
computed having regard to the arms length price.
Explanation - For the removal of doubts, it is hereby clarified
that the allowance for any expense or interest arising from an
international transaction shall also be determined having
regard to the arms length price.”
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14. Section 92F (ii) of the Act
“arms 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”
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15. The arm’s length principle was included in treaties
concluded by France, the United Kingdom and the
United States as early as the twenties and thirties of this
century.
In a multilateral context the arm’s length principle was
formulated for the first time in Article 6 of the League
of Nations draft Convention on the Allocation of
Profits and Property of International Enterprises
in 1936.
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16. These articles are substantially similar to Article 9 of the
1963 OECD Draft Double Taxation Convention on
Income and Capital (1963) and Article 9, paragraph 1 of
the present OECD and UN Model tax treaties.
Articles 9 of the OECD and UN Models are identical.
Article 9 confirms in a treaty situation
◦ the (domestic) right of a contracting state
◦ to adjust the profits of an enterprise located on its
territory, which is managed, held or controlled directly or
indirectly by an enterprise of the other contracting state
◦ if the conditions in their relationship differ from the
conditions which would have been stipulated between
independent enterprises
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17. Section 92A (1) (a)
“an enterprise which participates directly or indirectly or
through one or more intermediaries, in the management
or control or capital of the other enterprise shall be
regarded as an associated enterprise.”
A Ltd. B Ltd.
Inter Ltd. C Ltd.
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18. Section 92A (1) (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.”
A Ltd.
B Ltd. C Ltd.
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19. Section 92A (2) (a)
“One enterprise holds, directly or indirectly, shares
carrying not less than twenty-six per cent of the voting
power in the other enterprise.”
A Ltd.
75%
75%
B Ltd. C Ltd.
◦ only to those cases where the investee enterprise is a
company
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20. Section 92A (2) (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 the such enterprise.”
A Ltd.
75%
75%
B Ltd. C Ltd.
◦ only to those cases where the investee enterprise is a
company
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21. Section 92A (2) (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.”
A Ltd.
• B’s book value of asset Rs.10cr
• Loan from A Ltd. Rs.6cr
B Ltd.
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22. Section 92A (2) (d)
“One enterprise guarantees not less than ten per cent of
the total borrowings of the other enterprise.”
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23. Section 92A (2) (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.”
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24. Section 92A (2) (f)
“More than half of the directors or members of the
governing board, or one or more executive directors or
executive members of the governing board of each of the
two enterprises, are appointed by the same person or
persons.”
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25. Section 92A (2) (g)
“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.
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26. Section 92A (2) (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.”
JGarg Economic Advisors Pvt. Ltd. 26
27. Section 92A (2) (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.”
A Ltd B Ltd
A Ltd. Is a mfr.
Prices are influenced by B Ltd. C Ltd
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28. Section 92A (2) (j)
“The 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”
Section 92A (2) (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.”
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29. Section 92A (2) (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 or body
of individuals”
Section 92A (2) (m)
“There exists between the two enterprises, any
relationship of mutual interest, as may be prescribed.”
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30. Section 92B (1)
For the purpose of this section and section 92, 92C, 92D and
92E, “international transaction” means
◦ a transaction between two or more associated enterprises
◦ either or both of whom are non-residents
◦ in the nature of purchase, sale or lease of tangible
property…………..
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31. Section 92B (2)
A transaction entered into by an enterprise with a person
other than an associated enterprises shall for the purpose
of sub section (1),
◦ be deemed to be a transaction entered between
two associated enterprises
◦ if there exists a prior agreement
◦ in relation to the relevant transaction between such other
person and the associated enterprises, or
◦ the terms of the relevant transaction are determined in
substance between such other person and the associated
enterprise.
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32. TP Methods
OECD Guidelines Indian Regulations
CUP Methods CUP Methods
Resale Price Method Resale Price Method
Cost Plus Method Cost Plus Method
Profit Split Method Profit Split Method
Transactional Net Margin Method Transactional Net Margin Method
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33. METHODS OF DETERMINING
THE ALP
In accordance with internationally accepted principles,
the TPR have provided that any income arising from an
international transaction between AEs shall be
computed having regard to the ALP, which is the price
that would be charged in the transaction if it had been
entered into by unrelated parties in similar conditions.
The ALP is to be determined by any one or more of the
prescribed methods.
The taxpayer can select the most appropriate method to
be applied to any given transaction, but such selection
has to be made taking into account the factors
prescribed in the TPR.
34. In general
◦ CUP Method compare prices
◦ Resale Price Method compares gross margins
◦ Cost Plus Method compares profit mark-ups on costs
◦ Profit Split Method refers to the (total) profits from
transactions and splits them among the parties based on
the level of contribution
◦ Transactional Net Margin Method analyses net profit in
relation to an appropriate base, such as costs, sales or
assets
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35. Applicability
◦ Not every method can be applied to each taxpayer and
business transaction
◦ Applicability depends on
the characteristics of property or services
functions performed (including asset and risk assumed)
contractual terms
economic circumstances
business strategies
also depends upon the availability of information and reliability
of assumptions
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36. Priority among methods
◦ Indian Regulations does not prescribe any priority
◦ As per OECD Guidelines issues in 1995 “traditional
transaction methods” are given priority over “residuary
method”
◦ However, draft OECD guideline on related issue d for
comments has done away with preferential status of
traditional transactional methods remove
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37. DOCUMENTATION exhaustive
The provisions contained in the TPR are as far as the
maintenance of documentation is concerned.
This includes background information on the commercial environment in
which the transaction has been entered into, information regarding the
international transaction entered into, the analysis carried out to select
the most appropriate method and to identify comparable transactions,
and the actual working out of the ALP of the transaction.
This also includes report of an accountant certifying that the ALP has been
determined in accordance with the TPR and that prescribed
documentation has been maintained.
This documentation should be retained for a minimum period of 8 years.
However, it may be noted that in case the value of the international
transaction is below INR 10 million, it would be sufficient for the taxpayer
to maintain documentation and information which substantiates his claim
for the ALP adopted by him. In effect, they need not maintain the
prescribed documentation.
38. Penalties
Penalties have been provided as a disincentive for non-
compliance with procedural
requirements are as follows.
(a) Penalty for Concealment of Income - 100 to
300 percent on tax evaded
(b) Failure to Maintain/Furnish Prescribed
Documentation - 2 percent of the value of the
international transaction
(c) Penalty for non-furnishing of accountants
report - INR 100,000 (fixed)
The above penalties can be avoided if the taxpayer
proves that there was reasonable cause
for such failures.
