Is Transfer pricing applicable?

Hi Jayanth. Thanks for sharing your query with us.

At the outset, I would wish to tell you that every international transaction entered into by the taxpayer (in your case, the wholly-owned Indian subsidiary) with its associated enterprises (here, the foreign parent company) shall attract transfer pricing.

In this case, what I can make out is that there are two transactions which the Indian subsidiary is entering into with its parent. These are –

1.    Purchase of finished goods by the Indian subsidiary from its parent (for resale into the Indian markets); and

2.    Receipt of sales commission from the parent for assistance in marketing and distribution activities

Both these transactions shall have transfer pricing implications. Transfer pricing certification will apply to the Indian subsidiary in all circumstances; but maintenance of documentation will be mandatory only if the total value of these two transactions (and other transactions with its parent, if any) exceeds INR 1 crore.

If I have erred on any fact or if there is something more you would like to know in this regard, just let me know.

Thanks and regards

Ankit Bansal

Thank you Ankit.

Purchases during the year and commissions received will together exceed Rs 1 crore.

But the crux of the question is whether the provisions are applicable, when there is no repatriation of profits in any form. It is purely buying from parent at a discount and selling at a profit and paying tax on the profit in India.

As per chapter X section 92(2), only when there is an allocation or apportionment or contribution to any cost or expense incurred in connection with a benefit, arms length pricing provisions are stated to be applicable.We neither apportion nor allocate anything. Can you make an opinion based on this?

Jayanth

Dear Sir,

Ankit has explained the things very clearly...

Repatriation is not a condition before applicability of TP Provisions..NR associated enterprise can always stand at the side of spendings and not necessarily it should be making revenue/profit out of the international transaction.

Ur attention is invited to subsection(1) of sec 92 together with its explanation -

(1) Any income arising from an international transaction shall be computed having regard to the arm’s 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 arm’s length price.

Hi

In this reference, I’ll rush you through the intent of transfer pricing. Transfer pricing, as the name suggests, seeks to ensure that transfers (here, it means intra-group transfers/transactions) are appropriately priced. This appropriate pricing is ensured with the aid of arm’s length principle which brings transactions with related as well as unrelated parties to a parity.

The basic intent of transfer pricing is to ensure that taxpayers show true profits in related-party transactions (in the same way as they show in case of independent transactions).

As you mentioned that the Indian subsidiary is buying from its parent at a discount, what needs to be seen under transfer pricing is that this purchase price is not undue vis-a-vis the market price.

For example: The Indian subsidiary pays INR 90 per unit to its parent for purchase of goods (after adjusting discount). But, this product is available in the market for INR 80 only. Then, in effect, the Indian subsidiary has manipulated its profits and claimed excess purchase expense to the extent of INR 10. This checking of prices needs to be done under transfer pricing.

Further, as Amir has kindly pointed out, I’ll draw your reference to section 92 of the Income-tax Act, 1961 which forms the backbone of Indian transfer pricing provisions. This section covers incomes as well as expenses (which includes interest, apportionments and allocations), but nowhere mentions repatriation. Thus, it is irrelevant whether profits are being directly repatriated.

And regarding Section 92(2), you may note that it is just a part of the section 92 and not the entire section. Section 92(1), which Amir has shared with us, talks of income (commission in our case) and expense (purchase of goods in our case).

And why do you say that there is no repatriation of profits. I agree that there is no direct repatriation of profits, but when the Indian subsidiary is purchasing from its parent at a much higher price (INR 90 in the above case), then it is actually repatriating its profits to the extent of INR 10, though by indirect means. In fact, this is the basic factor that operates behind transfer pricing provisions. Isn’t it? What do you opine on that?

And I'll also thank Amir for his valuable inputs on this topic.

With regards to the above discussion, what is the best method to calculate arm's length price for aforesaid "Sales Commission receipt/income"? Kindly give your view.