Transfer Pricing and Its Implication

Sonal Pruthi

11 Dec, 2020

Transactions of related parties have always been looked at by the Income tax department with embowed view. The Income Tax Act, 1961^[1] contains provisions, which govern the transactions between related parties.

The Act further requires the Indian party to such cross border transactions to maintain proper documents and information in support of cross border transactions, so as to assist the Income Tax Department in ascertaining the Arm’s Length Price of such transaction.

• Where the actual price of such cross border transaction is not at arm’s length, the Act provides for Income Adjustment of the  taxpayer.
• However unlike the provisions relating to the cross border transactions, prior to 2012, the Act did not provide for the mechanism to compute the fair market value in case of such transaction nor were the taxpayers required to maintain proper documents in support of such transactions.
• Accordingly, the act was amended prospectively by the Finance Act 2012, with effect from the Assessment Year 2013-2014, to provide for a mechanism to determine the fair market value of such transactions. The amendment has been related to the applicability of the International Transfer Pricing provisions which has been extended to the certain Domestic transactions between the related termed as “specified dome”.

Introduction to The Indian Transfer Pricing Legislation

• Overview

An expert under the Chairmanship of Mr. Raj Narain, was set up by the Government in November 1999, to study global transfer pricing practices, and inspect the requirement for an extensive transfer pricing enactment in India. Due to these recommendations of the Group, the presented new move valuing arrangement in the Union Budget for the year 2001-02. The Indian enactment is extensively in accordance with the OECD Guidelines, and has consolidated certain facts of the legislation of different nations, for example, China and Korea.

•  Substantive Provisions- Section 92 To 92F

The objective behind the introduction of the new provisions was explained by the Finance Minister in his Budget Speech, and in the Memorandum explaining the provisions of the Finance Act,2001. The same are extracted below:

“The presence of Multinational enterprise in India and their ability to allocate profits in different jurisdictions by controlling prices in intragroup transactions has made the issue of transfer pricing a matter of serious concern.

Concepts Of Transfer Pricing

The Price Charged in a Transaction between Unrelated Parties

• Arm’s Length Price
• Transfer Price

The Price Charged In Transaction Between The Associated Enterprise

1. Uncontrolled Transaction
2. Controlled Transaction

• Uncontrolled Transaction- The Transaction between two unrelated parties.
• Controlled Transaction- The Transaction between two associated or related parties.

Concept of TP

• Taxpayer
• Associated Enterprise
• Independent Entity

Illustration To Understand The Concept Of TP

Transaction of sale and purchase between two domestic companies (Indian) which are subject to the same rate of marginal tax rate, would not lead to any tax advantage to either of them.

• However, if the companies are related to each other under Section 40A(2)(b) of the Act and the volume of transaction rises above 5 Crore in a given financial year, the transaction between two companies would still subject to the domestic transfer pricing regulations and companies would require to maintain the proper documents in respect of Arm’s Length Pricing of such transactions  and require to obtain the accountant’s report.

Need For The Amendment Of Transfer Pricing Provision

The case of GLAXO Smithline resulted in the need of amendment of transfer pricing provision in India.

Glaxo SmithKline Case

The Memorandum explaining the provisions of the Finance Bill, 2012 refereed to the decision of Supreme Court CIT-IV, Delhi v Glaxo SmithKline Asia (P) Ltd, where the Supreme Court made certain observations regarding the need for an amendment in the transfer pricing provisions in certain domestic transactions.

“the Supreme Court in the case of CIT v GlaxoSmithKline Asia (P) Ltd, in its order has, after examining the  issues arising where  related parties, suggested that Ministry of Finance should consider appropriate provisions in law to make transfer pricing regulations applicable to such related party domestic transactions”

It has been viewed by the Supreme Court

• The revenue filed a Special Leave Petition (SLP) before the Honorable supreme court and supreme court held that since the exercise is revenue neutral and both the parties are not related parties in terms of Section 40A(2) of Income tax act, no interference is called for and the SLP filled by the Revenue is dismissed. The honorable Supreme then stated that the larger issue is whether Transfer Pricing provisions
• It should be limited to cross-border transactions or whether the Transfer Pricing Regulations will cover transactions which occur in India . In domestic transactions, where invoicing  occurs will be revenue neutral in nature. However the following cases will not be covered   (i) loss making or (ii) Paying tax at lower rate and the profits are shifted to such entity;

• The Central Board of Direct taxes (CBDT) should examine whether Transfer Pricing provisions can be applied to domestic transactions between related parties. The AO can make adjustments to the income declared by the assessee having regard to the fair market value of the transactions between the related parties and can apply any of the generally accepted methods of determination of arm’s length price, including the methods provided under Transfer Pricing provisions
• It suggested that Act should make amendments such as maintenance of books of accounts, documentation, reflecting the transactions between the related entities at Arm’s Length Price and also getting specific transfer pricing audit done in respect of the domestic transactions between related parties.

OECD Transfer Pricing Guidelines And Comparison With Indian Regulations

• This section highlights certain key differences between OECD Guidelines and Indian Guidelines in respect of the Transfer Pricing methods.
• These Guidelines and the regulations broadly refers to the same set of methods, namely CUP, CPM, RPM, PSM, and TNMN. Though OECD guidelines do not categorically say so, it appears that they give sanction to any other method so long as it is in conformity with the arm’s length principle. On the other hand, the guidelines unequivocally reject the methods that do not conform to the arm’s length principle. The only leverage Indian Guidelines provide that in the use of other methods is that section 92C (1)(f) of the Act allows use of such other method as may be prescribed by the Board. However, no far such other has been prescribed.
• The OECD Guidelines divide the various methods into two categories- ‘traditional transaction methods (PSM and TNMM). The OECD Guidelines express a clear preference for traditional transaction methods over traditional profit methods. However, no such preference has been given under Indian Transfer Pricing Guidelines which requires the use of ‘the most appropriate method’.
• The OECD Guidelines are in exceptional situations permits the use of more than one transfer pricing method to demonstrate the arm’s length nature of the related party transaction. The Indian Regulations permits the use of only Transfer Pricing Method- ‘the most appropriate method’.
• The OECD Guidelines express preference for the use of multiple year data while applying the transfer pricing method. On the other hand, as a matter of general rules the regulations requires the use of single year data and permits the use of data relating to prior two years only in exceptional circumstances.
• The OECD Guidelines provide guidance with respect to cost sharing agreements and treatments of intangibles. An inconsistency plaguing the Indian regulations is the lack of guidance with respect to the cost sharing agreements.
• Again even for treatments of intangibles, the regulation provide no express guidance. One of the five have been prescribed for demonstrating arm’s length nature of transactions involving intangibles.
• With OECD Guidelines approve, the concept of Arm’s Length Range in principle, they do not express preference for any mathematical tool for deriving the range. The Indian tools are very specific for providing the for the concept of arm’s length range as the (+/-3%) range from the mean of prices (where more than one of the price is determined using the arm’s length price using the most appropriate method.)

Transfer Pricing Practice and Challenges Faced by India

In India, transfer pricing is turned out to be fruitful ground for several controversies. The early phase of regulations and absence of clarity on different interpretational issues combined with lack of legal reasonability have regularly left the taxpayers and Revenue experts at odds. The intent of this part is to basically assess the existing regulations, and highlights the key controversies that have developed few years of the transfer pricing audits.

Controversies-

• Use Of Single Year Data

The utilization of single year information and arithmetic mean intend to process ALP had made the TP Controls characteristically unbending. Further, it was unimaginable for taxpayers to discover equivalent companies announcing information of the present year to perform out a significant comparability examination inside the prescribed courses of time limit.

• Advance Pricing Agreement

An advance Pricing Agreement is a binding written agreement between company and the tax authority. Most countries have the facility for a group to obtain an advance ruling that pricing policies will be regarded as being arm’s length. This gives greater certainty than waiting for the tax authority to object to prices charged at a later date.

• Administrative Changes

In recent years, ȾP has been a major cause of dispute between the Indian tax authorities and MNEs. ȾP audits in India have consistently resulted in large tax demands and protracted litigation. CBDT issued different guidelines to work out ȾP provisions and to give procedural consistency to Indian Tax Authorities. Further, the Indian Government formed an alternative dispute mechanism called as Dispute Resolution Panel under the current arrangements of the IT Act to resolve the disputes identifying with TP international transaction.

Flow Chart Discussing The Adjustment Of Tp With Global Standards:

ADOPTION OF COMPUTING METHODS LIKE:

Landmark Judgments

Challenges Under Transfer Pricing Before 2012

1. TP provisions are intended to apply to transactions that give rise to income or expenditure. However, revenue authorities have extended  their applicability to investments made in subsidiaries as ‘international transactions’ subject  to transfer pricing.
2. TP regulations are not applicable on investment transactions, a robust valuation report justifying the issue price can be more effective a tool to steer clear of the controversy.
3. Transfer pricing of intangibles has been difficult area of work for tax administration across the world. The situation has been same for the Indian tax administration. The pace of growth of the intangible economy has opened up new challenges to the arm’s length principle.

How 2012 Changed This Position

1. However the position changed after 2011 – In the Union Budget for 2012, an inclusive definition of intangibles was inserted with retrospective effect from April 1, 2002 to include, inter alia, ‘marketing related intangible assets’, such as, trademarks, trade names, brand names, logos. An explanatory amendment in the definition of ‘international transaction ‘was also brought in with retrospective effect from April 1, 2002 to include.
2. As an administrative measure, the TP officers were bestowed with the right to test transactions not specifically referred by the tax officer. This was done to overturn one of the judicial pronouncements that questioned the authority of TP officers to assess such ÁMP spends in cases where the same were not reported as International transactions

Conclusion

Read our article:Transfer pricing provision in India