Transfer Pricing : Summary : Go through this 2-3 times.This will help you to answer all the specific questions on Transfer Pricing.
- Central Board of Direct Taxes (CBDT)
- Income Tax Department
- Sections 92–92F, 144C, 271, 271AA, 271BA and 271G of the Income Tax Act, 1961
- Rules 10A to 10TG and Rule 44GA of the Income Tax Rules, 1962
Relevant regulations and rulings:
The pricing of international transactions between associated enterprises should be determined with regard to the arm’s length principle, using methods prescribed under Indian transfer pricing regulations. Associated enterprises are enterprises for which 26% voting power in one is held by the other or a common parent holds at least 26% of voting power in both such enterprises. Transfer pricing provisions are applicable to the following types of transactions between associated enterprises:
- Purchase, sale or lease of tangible or intangible property
- Provision of services
- Lending or borrowing money or capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business
- A mutual agreement or arrangement for cost allocation/apportionment
- A transaction of business restructuring or reorganization
- Any other transaction having a bearing on the profits, income, losses or assets of such enterprises
Transactions with a third party will be deemed transactions between associated enterprises if the third party has a prior agreement with the associated enterprise, or if the terms of the relevant transaction are determined in substance between the third party and the associated enterprise.
Safe Harbor Provisions:
On 18 September 2013, the CBDT introduced safe harbor provisions. The provisions provide minimum operating profit margins in relation to operating expenses a taxpayer is expected to earn for certain categories of international transactions, such as provision of software development services, information technology enabled services, knowledge process outsourcing services, contract research and development services, manufacture and export of automotive components etc., that will be acceptable to the tax authority. Further, the provisions also cover transactions pertaining to lending of money and providing guarantee by an Indian entity to its wholly owned subsidiary.
The transfer price contained in the safe harbor rules shall be applicable for five years beginning from financial year 2012–13. The safe harbor rules, optional for a taxpayer, contain the conditions and circumstances under which the norms/margins would be accepted by the tax authority and the related compliance obligations. The taxpayer has flexibility in electing the years to be governed by the safe harbor rules within the five year period. Where a taxpayer’s transfer price is accepted by the tax authority under the safe harbor rules, the taxpayer shall not be entitled to invoke the mutual agreement procedure under an applicable tax treaty.
Specified domestic transactions:
With effect from the financial year 2012–13, the transfer pricing provisions are applicable to ”specified domestic transactions” if the aggregate value of such transactions exceeds US$0.8 million (approximately).
“Specified domestic transactions” include payments to related parties, inter-unit transfer of goods or services of profit-linked tax-eligible units, transactions of profit-linked tax holiday-eligible units with other parties and any other transaction that may be notified by the CBDT.
By extending transfer pricing provisions to specified domestic transactions, the pricing of these transactions will need to be determined with regard to the arm’s length principle, using methods prescribed under Indian transfer pricing regulations.
OECD guidelines Treatment:
Indian legislation is broadly based on the OECD Guidelines. Five of the six methods prescribed in the legislation to compute arm’s length prices are in conformity with the OECD Guidelines.
Further, the tax authorities generally recognize the OECD Guidelines and refer to them for guidance to the extent that they are not inconsistent with domestic law.
Pricing Methods :
Indian legislation prescribes the following methods: CUP, Resale Price, cost plus, Profit Split, and TNMM. In addition, with effect from financial year 2011–12, the legislation also provides a sixth method; namely, any other method that takes into account the price charged or paid for a similar uncontrolled transaction. No hierarchy of methods exists; rather, the most appropriate method should be applied.
Transfer Pricing Penalties:
- For inadequate documentation, failure to report the transaction or maintenance or furnishing of inaccurate particulars, the taxpayer is fined 2% of the transaction value
- For a failure to furnish sufficient information or documents requested by the tax officer, the taxpayer is fined 2% of the transaction value
- If due diligence efforts to determine the arm’s length price have not been made by the taxpayer, then 100% to 300% of incremental tax on transfer pricing adjustments may be levied by the tax officer
- For not furnishing an Accountant’s Certificate (Form 3CEB) along with the income tax return, the taxpayer is fined approximately INR100,000 (approximately US$1,600)
Penalties may be avoided if the taxpayer can demonstrate that it exercised good faith and due diligence in determining the arm’s length price. This is also demonstrated through proper documentation and timely submission of documentation to the tax authorities during assessment proceedings.
A detailed list of mandatory documents is listed in Rule 10D (1). The categories of documentation required are:
- Ownership structure
- Profile of the multinational group
- Business descripttttion
- The nature and terms (including prices) of international transactions
- Descripttttion of functions performed, risks assumed and assets employed
- Record of any financial estimates
- Record of uncontrolled transaction with third parties and a comparability evaluation
- Descripttttion of methods considered
- Reasons for rejection of alternative methods
- Details of transfer pricing adjustments
- Any other information or data relating to the associated enterprise which may be relevant for determination of the arm’s length price
A list of additional optional documents is provided in Rule 10D(3). The taxpayer is required to obtain and furnish an Accountant’s Certificate (Form 3CEB) regarding adequacy of documentation maintained.
The information and documentation specified should, as far as possible, be contemporaneous, and should be in existence on the filing date of the income tax return, which is 30 November following the close of the financial year.
Although an accountant’s report must be submitted along with the tax return, the taxpayer is not required to furnish the transfer pricing documentation with the accountant’s report at the time of filing the tax return. Transfer pricing documentation must be submitted to the tax officer within 30 days of the notice during assessment proceedings.
Statute of limitations on Transfer Pricing assessments:
Tax assessments (where a matter has been referred to the transfer pricing officer) are to be completed within 48 months of the close of the financial year (1 April to 31 March). However, if the tax authorities determine that income has escaped assessment, an assessment may be reopened within seven years of the close of the financial year.
Return disclosures/related party disclosures:
The taxpayer needs to specify whether it is liable to file the accountant’s report as the due date for return filing depends on the same.
In accordance with Indian Accounting Standard 18, the company is required to disclose related party transactions in its financial statements.
Transfer pricing-specific returns:
Under Section 92E, an accountant’s report is required to be provided along with the tax return. The accountant certifies whether proper documentation is maintained by the taxpayer.
Frequency of tax audit and transfer pricing scrutiny by the tax authority:
Internal guidelines have been issued by the tax authorities, pursuant to which companies with related party transactions in excess of US$3 million are being compulsorily scrutinized. Cases with lesser transactional values are also often picked up for audit. Audits are carried out on an annual basis, and once a case is selected for transfer pricing audit, there is a high likelihood of recurring audit thereafter.
In most cases, the tax authorities do not seem to have adopted a centralized or coordinated approach to audits, with officers in different locations taking divergent positions on similar fact patterns. Substantial documentation is being requested in the course of audit proceedings.
The likelihood of a general tax audit is characterized as high. Further, the likelihood that transfer pricing will be reviewed as part of a general audit is also characterized as high, provided that the aggregate value of international transactions exceeds US$0.8 million. Finally, if transfer pricing is reviewed as part of the audit, the likelihood that the transfer pricing methodology will be challenged is also high.
The information technology, business process outsourcing, banking and pharmaceutical sectors have received particular attention. Additionally, the tax authorities are increasingly scrutinizing intra-group services received and royalty payments made by Indian taxpayers. The taxpayer is required to demonstrate that the intra-group services were actually rendered or the IP was actually provided, and that such rendering or provision resulted in a tangible benefit to the taxpayer. In recent audits, there has also been a significant focus on marketing intangibles. In many cases, brand promotion expenses incurred by Indian subsidiaries have been held as excessive when compared with industry standards, and thus disallowed.
The tax authorities have sought an updated analysis using data that may not be available to the taxpayer at the time of the preparation of contemporaneous documentation.
Furthermore, officers have insisted on disaggregating transactions where the taxpayer has adopted an aggregate or combined approach to its transfer pricing documentation. During recent audits, the approach adopted by the taxpayer in the selection of comparable data has received considerable attention from the tax authorities.
In India adjustments by the competent tax authorities with regards to transfer pricing follow the regular appellate proceedings. In many cases, the appeals were pending at the first appellate authority for 3–5 years. Hence, to fast-track transfer pricing issues, in 2009, the government introduced an alternative dispute resolution process. Under this process, the taxpayer may choose to approach a dispute resolution panel in case a transfer pricing adjustment is proposed by the tax officer. The panel should dispose of the matter within nine months. The panel’s decision which was binding on the tax officer till last year will now be appealable. This process is expected to significantly expedite the first stage of the litigation process in India, which usually takes much longer.
An APA regime has been introduced in India with effect from 1 July 2012. The APA rules provide an opportunity for taxpayers to opt for a unilateral, bilateral or multilateral APA. The APA can be valid for a maximum period of five years, with no roll-back provision and require payment of a specified fee. The APA filing process includes a pre-filing submission, filing the APA request itself, negotiating the APA, execution and monitoring. Taxpayers are required to prepare and file an annual compliance report for each year under the APA, which is subject to a compliance audit by the tax authorities.