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Meaning of International Transaction in Transfer Pricing

Ruchi Gandhi

| Updated: Feb 04, 2022 | Category: Transfer Pricing in India

International Transaction in Transfer Pricing

Transfer pricing pertains to the pricing policy used when goods or services are transferred between affiliated businesses. The goal of transfer pricing law is to make sure that transactions between associated enterprises do not occur at an unreasonably favourable and controlled price.

The primary goal of transfer pricing legislation in international transactions is to help make sure that transactions between related enterprises are carried out at the same price as if they were carried out between unrelated parties.

To be subject to transfer pricing rules and regulations, a transaction must be classified as either an international transaction, a presumed international transaction, or a specified domestic transaction (or SDT) that is conducted between associated enterprises.

Meaning of Transaction

It is critical to first comprehend how the term “transaction” is defined in the Income Tax Act of 1961. The transaction is defined in Section 92F(v) of the Act as follows:

A “transaction” is defined as an agreement, understanding, or action taken in concert, but whether or not the agreement, understanding, or activity is formal or in writing, and also whether or not such agreement, understanding, or action is intended to be legally enforceable.

According to the preceding definition given under law, a transaction includes any agreement, understanding, or activity, whether formal or informal, oral or written, and whether it is entered into with the aim of being legally enforceable or not. This term, as an inclusive definition, is much broader in scope and encompasses all types of agreements under its purview.

What is an International Transaction in Transfer Pricing?

Section 92B of the Income Tax Act has defined the meaning of an international transaction. In the context of transfer pricing law, an “international transaction” is defined as a transaction between two or more associated enterprises, one or both of which are non-residents, in which tangible or intangible property is purchased, sold, or leased, services are provided, or money is lent or borrowed.

The concept of international transactions is broad, with each transaction that is entered between Related Enterprises being classified as an international transaction. The main requirement for such transactions to be classified as “international transactions” is that at least one of the participants to the transaction be a non-resident. For example, XYZ Ltd. is a Japanese corporation with a subsidiary in India called ABC Ltd. ABC Ltd. produces industrial goods for its Japanese parent company. In this scenario, the sale of industrial goods by ABC Ltd. to XYZ Ltd. constitutes an international transaction under section 92B because both Company XYZ and Company ABC are connected parties, and one of the two is a non-resident.

The definition of the international transaction was expanded in the Finance Act 2012, with retrospective effect from April 1, 2002. Through the addition of an Explanation to Section 92B, certain overseas transactions that were previously outside the purview of transfer pricing regulations have been brought into the purview of Indian Transfer Pricing regulations.

The following transactions will be defined as international transactions under the extended definition:

  • Transactions involving the acquisition, sale, or lease of real estate, whether the property is tangible or intangible in nature.

Tangible property is one that has a physical form, whereas an intangible property is one that lacks physical features. Section 92B states that transactions between related enterprises involving the acquisition, sale, or lease of tangible or intangible property are regarded as international transactions for the purposes of transfer pricing requirements. Section 92B’s explanation has also incorporated several things in the definition of tangible and intangible property, thereby broadening its reach.

  • Transactions in which one party renders services to another

The transaction of provision of services between two or more related firms is included in the definition of International Transaction as indicated in Section 92B. Explanation to Section 92B has particularly expanded the scope by incorporating the provision of market analysis, marketing strategy, marketing management, administration, technical services, repairs, designing, consulting, agency, scientific research, legal or accounting service within the purview of ‘provision of services’ with retrospective effect from April 1, 2002.

  • Transactions in capital financing that entail/cover both lending and borrowing money for both short-term and long-term goals.

It is typical for enterprises in a group to engage in financial transactions such as lending or borrowing money, offering guarantees, and so on. Because such transactions have an impact on the enterprise’s revenues and losses, they are classified as international transactions. Explanation to Section 92B significantly broadened the definition of the international transaction to expressly embrace a variety of capital financing activities, such as guarantee, acquisition, or sale of marketable securities, or any sort of advance, payment, or deferred payment or receivable, and any other debt.

  • Transactions affecting the Associated Enterprises’ cost allocation or apportionment

In a group organization, there are normally a few entities that provide support services to all of the group’s entities, and the costs paid by these entities are reimbursed by the other group companies who receive such services. A mutual agreement or layout between two or more related enterprises for the distribution or apportionment of, or any contribution to, any cost or expenditure incurred or to be incurred in relation with a benefit, service, or facility provided or to be provided to any 1 or more of these enterprises is included in the expanded definition of international transaction.

  • Business restructuring and reorganization transactions

The business restructuring may entail the cross-border transfers of valuable intangible assets or a significant renegotiation of current agreements. Restructuring can take the shape of organizational change (a change in the ownership structure or administration of group companies) or operational change (which is a change in the functional or risk profile of the group companies).

  • Any other transaction that has a bearing on the profits, earnings, income, losses, and assets of an enterprise.

The concept of the international transaction has been broadened by the addition of Explanation to include any other transaction affecting an enterprise’s earnings, income, losses, or assets. As a result of this connotation, the word is broad enough to embrace any other transaction that has any influence on the taxpayer’s profits, income, losses, or assets. These transactions could include reimbursement transactions or transactions that do not incur any charges (i.e., free-of-cost services or goods).

Deemed International Transaction in Transfer Pricing

Previously, affiliated firms would use an unrelated third party to operate as an intermediary, and transactions would be routed through such an unrelated company to avoid transfer pricing rules. In 2014, the Indian Transfer Pricing Regulations introduced a deeming fiction under which transactions between unrelated firms are treated as international transactions between connected enterprises.

It is crucial to note here that a transaction entered into by an entity with a person other than an associated enterprise is regarded to be an international transaction entered into between two related enterprises if and only if the following conditions are met:

  • There is a prior agreement in place between such other person and the related enterprise in connection to the relevant transaction, or
  • The conditions of the relevant transaction are established in essence between such other person and the related enterprise if the entity or the associated enterprise or both of them are non-residents, regardless of whether such other person is a non-resident or not.

It is important to remember that any transaction that meets the above two characteristics is considered an international transaction, regardless of whether the other party is a non-resident or not.

Other relevant provisions

Section 92 of the Income Tax Act of 1961, which deals with the calculation of income resulting from overseas transactions, states that any income coming from an international transaction must be computed using the arm’s length price. It may be noted that an ‘arm’s length price’ is one that is applied or planned to be applied in an uncontrolled transaction between persons or entities other than related enterprises.

The most relevant technique among the following shall be used to compute the arm’s length price, depending on the nature of the transaction:

  • Comparable uncontrolled price method
  • Resale price method
  • Cost-plus method
  • Profit split method
  • Transactional net margin method (TNMM)
  • Any other technique as may be prescribed by the CBDT

The most acceptable approach for determining arm’s length price shall be used in the manner stipulated by Income-tax Rules[1], 1962 in the rules 10A, 10AB, 10B, 10C, and 10CA.

Keeping of information and books of accounts

Every participant who has entered into an international transaction must keep and maintain specific information and papers in that regard. Such information and papers are required by Rule 10 D of the Income-tax Rules of 1962. It should be noted that failure to keep and maintain such documentation would result in a fine of 2% of the value of any such foreign or international transaction.

Further, if a person or entity enters into an international transaction and the Assessing Officer (i.e., AO) deems it necessary, he may refer the calculation of the arm’s length price in connection to the said international transaction to the Transfer Pricing Officer with the explicit permission of the Principal Commissioner or Commissioner. As a result, if necessary, the officer in charge will make an adjustment.

Conclusion

Associated firms that engage in international transactions must ensure that the transactions are conducted at arm’s length price as if they were taking place between unrelated & independent parties in an uncontrolled manner. If such an arm’s length pricing is not secured and appropriate documentation is not kept, in that case, modifications and fines may have to be enforced.

Read our Article:Transfer pricing provision in India

Ruchi Gandhi

A CA together with MBA (Fin) and M Com, she relishes taking interest in insightful writing in the domain of taxation and finance. She has gained experience as a full-time author and has also served an accounting role in industry.

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