Startup Transfer Pricing in India

Emerging Transfer Pricing Issues and Challenges in India

Introduction

The Arm’s length concept is followed by the Indian transfer pricing guidelines, which went into force on April 1, 2001. According to these laws, all profits from cross-border deals between affiliated businesses must be computed using the Arm’s length principle’s definition of a fair market price. Regarding taxation, transfer pricing deals with the value of transactions between affiliated entities. This process determines the earnings attributable to each party to the transaction. If overseas transactions between linked firms exceed a certain level, the rules require taxpayers to maintain contemporaneous records and to make required yearly submissions. They also describe the consequences of non-compliance.

Transfer Pricing Issues in Comparability Analysis

Conducting a comparability study is the first step in establishing a suitable arm’s length pricing for international transactions. But difficulties from volatile markets and complex transactions have made this research more challenging. In order to overcome these difficulties, the Indian transfer pricing administration has strongly emphasized using recent data from comparable businesses to determine an arm’s more precise length price. At first, Indian rules mandated utilizing information from the foreign transaction’s fiscal year, with an exemption for the prior two years, if applicable. This exception resulted in arguments and drawn-out disagreements. For transactions after April 1, 2014, the Indian government now allows multiple-year data to give clarity and flexibility, enabling comparison of international commerce with comparable enterprises.

Transfer Pricing Issues Related to Risks

In India, comparative comparison is essential in evaluating functions, assets, and risks. While processes and assets have historically been assessed with hazards, India avoids over-emphasizing risks while calculating Arm’s length pricing. In this study, determining and allocating risks is crucial, where parties’ behaviour and control over threats impact risk distribution. Core tasks, responsibility, decision-making, and financial capacity determine risk control. Some MNEs assert remote risk control and declare their Indian companies risk-free in exchange for inexpensive remuneration, but India disputes this. India has several crucial R&D and service tasks that need strategic choices, making remote risk control unfeasible.

Transfer Pricing Issues in Arm’s Length Range

Recent changes to the legislation aim to bring Indian transfer pricing restrictions into line with international best practices. These revisions include the notion of “Range” to calculate the Arm’s Length Price, which applies to international transactions concluded on or after April 1, 2014 (as of the assessment year 2015–16).

This method involves arranging data sets in ascending order, including the earnings margins or outcomes of at least six comparable companies. The thirty-fifth percentile of this dataset and the sixty-fifth percentile are established as the Arm’s length range. A foreign transaction is deemed at Arm’s length if the cost is within this range.

On the other hand, the Arm’s length price is calculated as the median value of all the numbers in the dataset (i.e., the 50th percentile) if the transaction price is outside of this range. The Arm’s Length Price will be determined using the arithmetic mean when the content cannot be applied since there aren’t at least six comparable entities.

Transfer Pricing Issues in Comparability Adjustment

As in numerous other countries, India’s transfer pricing regulations provide for the use of “reasonably accurate comparability adjustments.” The taxpayer is responsible for validating and presenting such modifications. Modifications to working capital and capacity utilization are implementable from the perspective of Indian transfer pricing¹ authorities. However, the Indian transfer pricing system has trouble accounting for risks since there isn’t a trustworthy, strong, and universally recognized method.

Transfer Pricing Issues in Location Savings

In transfer pricing audits, “location savings”—cost benefits in low-cost places like India—are critical. This idea encompasses all the cost advantages a particular location provides besides plain cost reduction. Indian advantages, including cheap labour, resources, and low transaction costs, are taken advantage of by Multinational Enterprises (MNEs) in order to lower costs and boost profits. Location rentals are the extra revenue these Location Specific Advantages (LSAs) generate.

Transfer pricing presents a great difficulty when dividing location savings and rents across associated businesses. According to agreements that independent parties would reach in comparable circumstances, the Arm’s length pricing technique seeks to disperse these profits. The Profit Split Method equally distributes these gains without similar transactions.

The Arm’s length pricing for a related-party transaction in a low-cost location can be calculated when comparable unregulated transactions are present by benchmarking against the performance of nearby, similar enterprises. The advantages of location savings are considered in the set Arm’s Length Price if pertinent local data is available. However, difficulties emerge if adequate local data is unavailable or if the tested party is an overseas-related organization, which makes it challenging to include location savings benefits when estimating the Arm’s Length Price.

Transfer Pricing Issues in Intra-Group Services

Globalization promotes resource sharing through standard services to serve organizations in several places, which increases efficiency in international organizations. These include readily apparent functions, such as management consulting, marketing, and trading. Some are more complicated and can be purchased separately, as a bundle, or with other intangible or tangible assets.

It is critical to assess whether the Indian subsidiary has delivered or received intra-group services in need of just remuneration. Regarding transfer pricing regulation, it might be challenging to pinpoint the services that call for appropriate compensation. India does not need fair pay for shareholder services, duplicate services, or incidental advantages from group services. However, this conclusion deserves careful consideration. Allocating expenses using allocation keys, which change depending on the type of service, makes it particularly challenging to determine fair pricing.

Conclusion

The primary objective of the Indian transfer pricing regulations is to provide fair market pricing for international commercial transactions between related companies. Despite its importance, transfer pricing creates several practical difficulties due to its complexity. Comparability analysis is one of the crucial processes where recent data from comparable companies is highlighted for correct pricing. While disagreements over remote risk control develop for businesses involved in strategic activities, risk assessment is essential, concentrating on roles, assets, and risk distribution. In accordance with international standards, recent changes add the “Arm’s Length Range” concept. Determining adequate compensation for intra-group services and adjustments for comparability and location savings are difficult tasks. Transfer pricing in India promotes honest and open international corporate transactions by incorporating comparability, risk assessment, geographical advantages, and intra-group services.

Frequently Asked Questions

Read our Article: Transfer Pricing Documentation and compliances

1. https://incometaxindia.gov.in/pages/international-taxation/transfer-pricing.aspx