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Transfer Pricing Audit and its Regulations in India

Ruchi Gandhi

| Updated: Jan 24, 2022 | Category: Transfer Pricing in India

Transfer Pricing Audit

With the liberalization of trade and foreign exchange policy beginning in the year 1991, India has begun to integrate its economy with the global economy. This has resulted in an increase in the cross-border movement of goods, facilities, finances, and now even intangibles. There was a great enhancement in Foreign Direct Investment (FDI). Monetary controls were eased, and quantitative import restrictions were removed.

Obviously, with the increasing number of multinational enterprises interested in India, it has now become critical for Indian tax authorities to be aware of transfer pricing issues. It is worth noting that many Indian companies have recently become huge global players through major acquisitions and the establishment of overseas subsidiaries in a variety of tax jurisdictions.

The Transfer Pricing Regulations were implemented through the Finance Act, 2001 in India, by substituting Section 92 and introducing new sections 92A to 92F in the Income Tax Act (‘Act’) and some important rules 10A to 10E in the Income Tax Rules of 1962. The regulations apply to relevant international transactions entered into on or after April 1, 2001.

Prior to the implementation of the above-mentioned detailed provisions, the principle of Transfer Pricing Regulations in India was practiced under the Act in some particular situations and in a limited sense. Previously, section 92 required that when the tax authorities did believe that an international transaction with a non-resident contributed in less than ordinary profits for the resident due to a “close connection” between the two, then they could recalculate the resident’s taxable income.

Transfer Pricing Laws were introduced with the goal of providing a detailed statutory framework that can lead to the computation of reasonable, unbiased, and fair profits and tax in India, in the instances of international firms, and also brought new sections 92A to 92F in the Act, pertaining to the calculation of income from an international transaction having due regard to the arm’s length price, the definition of associated enterprise, the definition of international transaction, calculation of arm’s length price, maintenance of data & information by persons entering into such international transactions and definitions of other terms used in the said sections.

The legislative intent influencing the transfer pricing laws is to prevent profit shifting by attempting to manipulate prices charged or paid in international transactions, thus stripping away India’s tax base. The transfer pricing regulations were introduced to curb transfer pricing abuse, according to the explanatory memorandum of the Finance Bill, 2001.

Transfer Pricing Audit in India

Having grown significantly over the last decade, India is now a significant opportunity for global businesspeople seeking to establish a successful presence in the country. India has become an appealing destination due to liberalization, a thriving middle class, and increased employment and wage growth. Concurrently, establishing a company in India necessitates navigating the various tax and legal complexities. The transfer pricing litigation is one of the most important tax laws to consider. To combat the practice of foreign companies avoiding the tax audits in India, the legislation known as the Transfer Pricing Regulation containing the provisions of transfer pricing audit was enacted for this purpose.

A transfer pricing audit investigates the pricing of transactions involving two or more related associates. It is determined whether the transactions are conducted under market conditions and will withstand the Income Tax Department and other tax authorities’ due diligence by applying and documenting various test methods.

All Indian companies are required to analyze their international transactions in light of the Transfer Pricing Regulations and to adhere to them by keeping proper transactional records and documents. A transfer pricing audit must justify why a particular method was chosen for the enterprises and transactions under review.

Under a transfer pricing audit, a fact-finding exercise is conducted in order to assess the organization’s numerous functions as well as the potential risks that each activity may confront. Thereafter, an appropriate mechanism/method of transfer pricing is chosen and the parties who have been tested with it are identified. Later a survey using data from various national and international sources is conducted to discover companies that may be benchmarked for the chosen company and detailed financial analysis using that data is executed. On the basis of the analysis, the assessee compiles a consolidated report and properly records it. The Indian Income Tax Act of 1961 requires that you submit a report on Form 3CEB.

Some of the important points of the law pertaining to transfer pricing audit are as follows:

  • Each individual or organization that has participated in an international transaction is required by law to keep an up-to-date record of each transaction.
  • All income earned by the business as a result of any international transaction must be determined at arm’s length price. There are numerous methods for calculating the arm’s length price, depending on the characteristics and type of transaction, the type of the group or association engaged, or any other attributes of the transactions involved. The Central Board of Direct Taxes, also known as the ‘Board,’ introduces these methods. Some of them are the resale price method, the cost-plus method, the comparable uncontrolled price method, and the transactional net margin method (TNMM).
  • If two or more reasonable prices are assumed for a particular transaction, then the arm’s length price is calculated by taking the average of the prices.
  • Under the supervision of a Chartered Accountant, the individual or group participating in an overseas transaction should file a report of transfer pricing audit in Form 3CEB at the conclusion of the financial year. This form must be completed and sent before he files his Income Tax Return for the same period.
  • The group or individual who does not follow these rules is liable to pay the penalties as may be imposed by the Board.

Section 92E

Under Section 92E of the Income Tax Act[1], persons entering into an international transaction or a specified domestic transaction are required to provide an accountant’s report. Any person who entered into an international transaction or a specified domestic transaction in the previous year must obtain a report from an accountant in the prescribed form, duly signed and verified by the accountant, before the specified date. The audit applies to both international and domestic transactions that satisfy some specified criteria. Form 3CEB must be completed and submitted.

In addition, the accountant must express a view on whether the Assessee has retained “appropriate information and documentation as are prescribed” in respect of overseas transactions or certain domestic transactions that are entered into by him.

The chartered accountant’s report needed to be furnished by Section 92E includes all of the information as is required by Form 3CEB. In order for the accountant to be able to answer any questions before the tax authorities that may emerge later, he must make precise notes regarding the evidence he relied on throughout the test, as well as all of his working papers. His notes on the following, among other things, should be included in such working papers:

(a) work performed while conducting the scrutiny and by whom

(b) any kind of explanations or information that are given to him during the period of the examination and by whom

(c) any decision taken on the various points

(d) the judicial/legal pronouncements relied upon by him while drafting the report

(e) certificates issued by the company or client

(f) any letter of representation issued by the management of the assessee

(g) annexure to Form No. 3CEB duly filled in and authorized by the company or client

The report of transfer pricing audit is divided into three paragraphs, each of which deals with a different topic, as summarised below:

The first paragraph includes a declaration and states that the Assessee’s accounts and records will be examined in order to review the international transactions and certain domestic transactions in question.

The second paragraph entails expressing an opinion on whether the Assessee has kept proper information and documents as required by Rule 10D in respect of the identified international transactions and the specified domestic transactions, based on the information provided in Annexure to Form No.3CEB.

The third and final paragraph requires the accountant to express his/her opinion on whether the information in the Annexure to Form No.3CEB is true and correct.

Penalty for failure to submit a report under section 92E

Section 271BA of the Income Tax Act states that if a person to whom transfer pricing provisions apply fails to give an accountant’s report as required by section 92E, the Assessing Officer may order that the person will pay a penalty of one hundred thousand rupees. This penalty is imposed if a person fails to provide an accountant’s report, and it can be enforced by the Assessing Officer. A fine of INR 1 lakh shall be leviable.

Conclusion

Section 92E requires the entity carrying out an international transaction or a specified domestic transaction to provide an audit report from the accountant in a prescribed format. This report must certify the nature and amount of the transaction and must be filed with the income tax return. Form 3CEB must be completed for this purpose.

Read our Article:A Guide to Transfer Pricing Regulations 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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