Transfer pricing provision in India

Rajdeep Saini

19 Jan, 2021

A significant volume of the trade worldwide comprises of the transactions between different enterprises within the group of the multinational enterprise (MNEs). The transaction between the associated or the related enterprise may happen under different circumstances from those of taking place between the autonomous enterprises. The term transfer pricing is used for the intra group transaction, cross border transaction, intangible goods, or services that include financial services. The ranges of prices, however, for the reason of the tax purpose to be in compliance with those which are charged between the independent enterprises, generally referred to as arms’ length enterprises. This article describes the Transfer pricing provision in India.

 The Arm’s length pricing referred to as an international standard that further compares the transfer price charged between the prices of independent entities and the prices of the associated entities.

The object of Transfer Pricing Provision (TPP)

If we see in the term of India, the TP regulation can date back to the year 1939 which is implemented in the Income Tax 1961 Act^[1]. The purpose of these regulations was to increase the participation of the MNEs in the economic lifestyle of India, most specifically after the liberalisation of the Indian economy in the year 1991. There was a need felt for providing a detailed legislative framework which can help to move forward in the more fair, reasonable and equitable allocation of tax and profit in India. Section 92-92F were implemented with the effect from 1-4-2002 with the number of rules from 10A to 10E. These provisions cover up the meaning of the associated enterprise and international transaction and with that simultaneously providing the methods of computing of documentation requirement and the arms length price.

These provisions also constructed an authority named as the TP Officer who is specialised in the role of establishing arms length price only after the assessing officer has made in respect of an international transaction. The intention behind this transfer pricing regulation was to avoid shifting the profits out of India by influencing the price charged in the international transactions which leads to eroding the tax base of the country.

Transaction subject under transfer pricing provision

The following international transactions are governed by the rules of transfer pricing:

• Trade of the finished goods
• Buying of raw material
• Buying of fixed assets
• Purchase and sale of machinery
• Purchase and sale of Intangibles
• Compensation of the expense received/paid
• Services which are IT enabled
• Support services
• Development of software services
• Service fees (Technical)
• Management Fees
• Loan paid or received
• Royalty fees
• Corporate guarantee fees

Importance of the transfer pricing provision

For the purpose of effectively reporting and accounting, the multinational companies have some level of discretion regarding how to distribute the expense and the profit to all the subsidiaries located in different nations. Many times a subsidiary of the main organisation might be segregated into segments or can be accounted as a standalone business. In these cases, transfer pricing can help in distributing the profits and the losses such as subsidiaries in a correct manner.

The earnings of these subsidiaries solely depend on the price of the transaction that occurred between different companies. Nowadays, the transaction between the inter companies is facing an augmented enquiry by the government. So, in the cases where the transfer prices are applied, can impact the wealth of the shareholders as this will influence the company’s free flow of tax and the taxable income of the company.

Essentials of transfer pricing provision

The following are the essentials of the transfer pricing:

Associated enterprise under Transfer pricing provision

The concept of Associate Enterprise was majorly based on the participation either directly or indirectly or by the medium of one or more intermediaries, in the capital or control or management of some other enterprise.

International transaction under Transfer pricing provision

It means when a transaction occurs between two or more associated enterprises, either or both of whom are a non-resident by the way of transfer of intangible or tangible property or assets or advancing of loans.

Arm’s Length method under Transfer pricing provision

With the conformity of the OECD guidelines, the methods provided under arm’s method are either indirect or direct. The direct method is a more uncontrolled price method comparably, the method of price resale and the cost plus method. On the other hand, the indirect methods are also known as profit split method that splits the transactional net margin and the combined net profit that further compares the operating profit and the net profit margin to an appropriate base including assets sales and cost.

Problems associated with transfer pricing provision (TPP)

The following are the few issues associated with the TP:

• On some occasions there could be differences in opinions among the operational managers with an associate to how to transfer price required being set.
• Additional manpower, time and costs would be required to execute the designing the accounting system and the transfer prices to match the requirements
• It is also a probability that the arm’s length price may root dysfunctional behaviour among the managers of the organisation.
• For some of the departments and division, for example, a service department, arms length prices doesn’t work similarly well as such division doesn’t offer any considerable benefits
• The issue of transfer pricing is a multinational setup is very problematic.

Conclusion

Read our article:Overview of Transfer Pricing in India