Company Taxation

Transfer Pricing

Transfer pricing refers to the inter-company pricing arrangements between related business entities and commonly applies to intercompany transfers of services and tangible/intangible properties. In India, detailed transfer pricing provisions were introduced by the Finance Act, 2001 to facilitate the computation of fair, reasonable, and equitable profits and tax in India for businesses carried on by multinational companies. Essentially, transfer pricing is the process of determining the prices of cross-border transactions between related/associated parties. Section 92 of the ITA provides that the price of any transaction between Associated Enterprises (AE), either or both of whom are non-residents for tax purposes (international transaction), shall be computed with regard to the arm's length principle. Subsequently, the Finance Act, 2012 also brought 'Specified Domestic Transactions', (SDT) under the purview of transfer pricing, to mitigate tax arbitrages where transactions are carried out between two related Indian entities (and both of them enjoy tax holidays or preferential rates of taxes).

Associated Enterprises: Two enterprises are considered to be associated if there is direct/indirect participation in the control, management, or capital of one enterprise by another enterprise or by the same persons in both the enterprises. For the determination of participation in management or control, several factors are considered, including:

  • Direct/indirect shareholding with 26% or more of the voting power
  • Advancing of loans of 51% or more of the total assets
  • Appointment of more than 50% of the Board of Directors
  • Sale of manufactured goods, whereby the terms, conditions, and prices are influenced by the other party
  • Complete/absolute dependence of one entity’s business on intellectual property rights owned by another party, etc.

Transactions Covered

The regulations cover (i) all international transactions and (ii) certain specified domestic transactions (which may result in a tax arbitrage) in case the value exceeds INR 200 million.

International transactions would include routine transactions relating to the purchase and sale of goods and services, as well as transactions involving business restructuring, intangibles, goodwill, corporate guarantee, overdue debts, capital financing transactions, cost contribution arrangements, free of cost services, etc.

SDTs would include cases of inter-unit transfer of goods and services, which enjoy tax exemptions/deductions for carrying out eligible activities/businesses as well as transactions with new manufacturing companies having lower effective corporate tax rate (vide Section 115BAB). Initially, the threshold for the applicability of SDT was INR 50 million. That has been increased to INR 200 million.

Furthermore, in India there is also a concept of deemed international transactions which covers transactions with third parties (whether resident or not) under the ambit of transfer pricing if:

  • There exists a prior agreement in relation to such a transaction between the third party and the associated enterprise, or;
  • The terms of such transactions are determined in substance between the third party and the associated enterprise.

Reporting and Compliance

Obtaining an accountant’s certificate in the prescribed format is mandatory and would have to be filed on or before the prescribed due date4 of the relevant assessment year, along with the tax return. There is no threshold exemption limit provided for compliance. Strict penal provisions have been established for non- compliance with the prescribed requirements.

Determination of 'Arm's Length Price' (ALP)

A crucial aspect of transfer pricing is the process of determining the Arm's Length Price (ALP). The Central Board of Direct Taxes (CBDT) has prescribed six methods for determining the ALP:

  • Comparable Uncontrolled Price Method
  • Resale Price Method
  • Cost Plus Method
  • Profit Split Method
  • Transactional Net Margin Method
  • Other Method (via Notification No. 18/2012 dated 23 May 2012)

The 'other method' has been prescribed to potentially cover transactions involving intangibles and business restructuring for which the above methods may not be the most appropriate. The regulations do not give preference to any specific method or methods. The choice of the appropriate method is determined with respect to the nature and class of transaction, the classes of associated persons, the functions performed by them, and other relevant factors.

Usage of multiple year data and range

To enhance the reliability of the comparability analysis, taxpayers need to examine multiple year data as opposed to single year data in order to evaluate factors that influence transfer pricing, such as long-term arrangements, business/product life cycles, etc.

The adoption of the arm’s length range and allowing the usage of multiple year data and a range of comparable results (35th to 65th percentile) has aligned the transfer pricing rules to global practices, to a certain extent.

However, if the dataset contains less than six comparability data points, taxpayers need to use the arithmetical mean to ascertain the ALP, wherein a tolerance range of 1% for ‘wholesale trading’ and 3% for all other transactions is also allowed vis-a-vis the ALP. ‘Wholesale trading’ has also been defined to include:

  • Where the purchase cost of finished goods is at least 80% of the total cost of such trades; and
  • The average monthly closing inventory of such goods must be 10% or less of sales from such trading activities

Extensive Transfer Pricing Documentation (Three-tiered documentation approach)

The transfer pricing documentation requirements have been substantially revised to align with Action Plan 13 of the OECD BEPS Project, in which a three-tiered documentation (viz. Country by Country Report (CbCR), Master File, and Local File requirements) was introduced.

  • Local File: The requirement of maintaining prescribed documentation would be attracted only in cases wherever aggregate value of international transactions exceed INR 10 million for the year. Furthermore, there is no specific format prescribed for documentation, but an indicative list to be included has been prescribed. A taxpayer (falling within the thresholds above) is required to keep contemporaneous documentation (in the English language) for demonstrating the arm’s length nature of the international transactions and SDTs (collectively referred to as a related party transaction). The record-keeping (retention of documentation) should be for a period of 8 years from the end of the relevant year of assessment. For comparability analysis, the taxpayer can use publicly available databases (Indian and overseas as relevant for the analysis) to arrive at an ALP, and appropriate adjustments need to be made if necessary. The Indian databases widely used are maintained by private companies, while the corporate filings of companies are available on the public portal, namely, the Ministry of Company Affairs (MCA).
  • Additionally, in line with the international consensus on this topic, it is now proposed that companies need to maintain and furnish extensive, group-level details to the Indian tax authorities by way of a Master File (MF) and CbCR, in addition to the current transfer pricing documentation (local file) requirements in India.

Master File- Rule 10DA: The information to be captured in the Master File can be broadly classified in four categories, i.e., (i) Description of the business, (ii) Particulars of intangibles, (iii) Particulars of financing activities, (iv) General information. Additionally, the groups consolidated financial statement is also expected to be included.

The applicability and timelines required for the Master File are as follows:

Entity Applicability Form to be filed Due Date
Indian subsidiary / affiliate of the multinational group A constituent entity irrespective of:
  • Whether the entity has entered in international transactions
  • Threshold applicability
  • Whether the entity is resident or not
Part A of Form No. 3CEAA By due date of furnishing the return of Income (i.e., 30 November)
A constituent entity passing the prescribed thresholds Part B of Form No. 3CEAA By due date of furnishing the return of Income (i.e., 30 November)
The designated entity, where there are multiple constituent entities resident in India Form No. 3CEAB At least 30 days before the due date of filing Form No 3CEAA
  • CbC Report (CbCR) - Rule 10DB : The CbCR shall include economic information within the multinational group, such as the nature of main business activities, revenues, profit/loss, income taxes paid, stated capitals, accumulated earnings, number of employees, tangible assets, etc. for each country in which the group operates.
  • The CbC reporting requirements shall apply to Indian multinational groups having a consolidated revenue above a threshold to be prescribed. It was indicated that the revenue threshold will be INR 64 billion (which is meant to be equivalent to the globally adopted EUR 750 million per year).

The applicability and timelines required for CbCR are as follows:

Entity Applicability Form to be filed Due Date
Indian subsidiary/affiliate of the multinational group, wherein the parent entity is not a resident of India Intimation of details of parent entity/alternate reporting entity which will file the CbCR Form No. 3CEAC 2 months prior to furnishing the CbCR
Parent entity or alternate parent entity in India Every parent entity or the alternate reporting entity resident in India Form No. 3CEAD The due date for furnishing the CbCR is on or before the due date for filing of Return of Income for the relevant accounting year of the group.
Indian subsidiary/affiliate of the multinational group, wherein the parent entity is not a resident of India Intimation of multiple constituent group entities in India Form No. 3CEAE No timeline mentioned in the rules. This needs to be clarified by the CBDT.

Secondary Adjustment

The concept of 'secondary adjustment' was introduced in 2017 to align transfer pricing provisions with international best practices. As a concept, secondary adjustment arises when the taxpayer agrees to a transfer price, which is different from what is recorded in the books of accounts. The taxpayer can agree to this different transfer price, either suo moto at the time of filing a tax return, or once the transfer pricing adjustment is done by the tax officer and not further litigated, or during the APA or Mutual Agreement Procedure (MAP) proceedings. The provisions require Indian taxpayers to repatriate the difference in transfer price as per tax and as per books of accounts (excess money) from the overseas AE within 90 days. In case the repatriation is not made within 90 days, it would be deemed as a loan given by the taxpayer to the AE, and the interest shall be computed till the time the repatriation is made by the AE. However, Finance Bill (No. 2) of 2019 provided certain clarifications regarding the effective implementation of these provisions, which are given below:

  • These provisions shall not apply if the primary adjustment does not exceed INR 10 million or the same pertains to AY 2016-17 and earlier years. These two conditions are not cumulative.
  • The taxpayer may choose not to make a secondary adjustment by a one-time tax payment at 18% on the amount to be repatriated, plus a 12% surcharge on such tax. However, the taxpayer will continue to pay the due interest till the date of such one-time tax, as per the existing provisions.
  • The amount of primary adjustment may be repatriated from any of the AEs not resident in India, and not necessarily the transacting AEs.

Section 94B - Limitation of interest benefit (Deduction)

In conformance with OECD BEPS Action Plan 4, the Finance Act, 2017 introduced Section 94B “Limiting Base Erosion Involving Interest Deductions and Other Financial Payments” where an Indian company or PE of a foreign entity as a borrower pays interest exceeding INR 10 million in respect of a debt issued/guaranteed (implicit or explicit) by a non-resident AE. The provisions intend to disallow interest expense in ‘excess’ of 30% of the earnings before interest, tax, depreciation, and amortization, subject to actual interest expense. However, the same shall be available to be carried forward for a period of 8 years and will be allowed as a deduction in subsequent years. The above restriction is not applicable to banking and insurance companies.

Penalty

In case of any lapses/adverse inferences drawn by the transfer pricing officers, penalties linked to the value of transactions are attracted. The penalties, circumstances under which they shall be attracted, and their quantum are mentioned below:

Nature of penalty Penalty
Failure to maintain documentation; Failure to furnish documentation to tax authorities, when called for; and Failure to disclose a transaction in the Chartered Accountant’s report (Form 3CEB) 2% of value of the international transaction entered into between related parties
Failure to furnish Chartered Accountant’s report (Form 3CEB) INR 100,000
For under-reporting of income 50% of the amount of tax payable on the under-reported income
For misreporting of income including failure to report any international transaction or related material facts 200% of the amount of tax payable on the misreported income
Failure to furnish the Master File; and Inaccurate information filed under the CbCR INR 500,000
Failure to furnish the CbCR or further information as called for INR 5000-50,000 per day depending upon the period of delay

Safe Harbor provisions

In existence since 2013, Safe Harbor Provisions have undergone a conscious revision to rationalize the acceptable profit ranges for a series of transactions such as IT/ITES/KPO, guarantee, etc. Also, a new category of international transactions for ‘receipt of low value-adding intra-group services’ was added. Safe Harbor Provisions have been stated to be in force only for the specific tax year/financial year and currently. the latest provisions have been pronounced for FY 2020-21.It is yet to be prescribed whether the existing Safe Harbor Provisions would continue to be valid for FY 2021-22, or if there are any other prescribed rates.

Advance Pricing Agreements (APA)

The Finance Act, 2012, introduced Advance Pricing Agreements (APAs) which is an agreement between a taxpayer and the tax authorities that specifies the manner in which ALP will be determined with respect to an international transaction.

  • The ALP shall be determined on the basis of the prescribed methods or any other method.
  • An APA would be valid for a maximum of 5 consecutive years, unless there is a change in the provisions or the facts having a bearing on the international transaction.

In March 2015, the Central Board of Direct Taxes (CBDT) introduced roll-back provisions according to which, an APA would also be applicable to international transactions undertaken in the previous 4 financial years subject to certain conditions. On 19 December 2014, India signed its first Bilateral APA (BAPA) with Japan, which was to be valid for 5 years. The APA had been finalized within a time span of approximately 32 months, which is significantly shorter than the time normally taken to finalize APAs internationally.

Provisions to convert Unilateral APAs (UAPAs) to BAPAs (subject to the satisfaction of certain conditions) are also available, and, since FY 2012-13, 42 Unilateral APAs have been converted under the same.

It should be noted that the total number of applications since inception filed till 31 March 2019 stood at 1155, which consisted of 944 UAPAs and 211 BAPAs. Basis the latest press release published on 31 March 2022, the CBDT announced that the total APA count has increased to 421 since inception. Despite severe economic and social disruption caused by the COVID 19 pandemic, the number of APAs signed has increased from 57 APAs in FY 2019-20, to 31 APAs in FY 2020-21, and now 62 APAs in FY 2021-225.

Furthermore, attribution of profit to a Permanent Establishment (PE) has also been included under the purview of APAs entered into on or after 1 April 2020 with a similar option for roll-back.

Get in Touch
Maulik Doshi
Deputy Managing Director
Transfer Pricing and International Tax

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