Transfer Pricing Rules in India
What is Transfer Pricing?
Transfer pricing, in simple terms, can be defined as the price charged by one unit of the enterprise from another unit of the same enterprise. For example, X Inc. has two units, Unit A and Unit B. Unit A of the X Inc. manufactures speedometers for automobiles and Unit B manufactures automobiles which include the speedometers produced by Unit A of the X Inc. Now, the price paid by Unit B for the speedometers produced by Unit A is the transfer pricing, and the method is known as Transfer Price.
While, this may not appear significant in small enterprise. It is of immense significance when the scale of an industry is raised. Another question can be that why would corporation employ transfer pricing, why not charge another unit the same price as they charge other companies, or why not give to their own unit for free?
It can be explained through and an example, let us assume that Unit A is in a high tax rate country, and Unit B is in a low tax rate country. Unit B can charge a rate, lower than the market rate for the speedometers produced by Unit A, which would give a loss to Unit A as far as the sale is concerned. But Unit B would make profits out of the sale. Since Unit A is in a high tax rate country, eventually, X Inc. will reduce the tax burden by making Unit B profitable and Unit A unprofitable as companies in loss are not taxed.
So, while this is profitable to the company it is the overall loss for the country where Unit A is located as they are not able to collect taxes while Unit A’s parent company is reaping the profit. So, naturally, countries will have some regulations for transfer pricing.
Transfer Pricing Rules in India
For any businessman knowledge of transfer pricing laws becomes important as their default carries huge penalties. Each country has its own transfer pricing laws. In India, Sections 92 to 92F of Income Tax Act govern transfer pricing.
When does the Transfer Pricing Rule Apply?
Transfer pricing rules apply only to ‘Associated Enterprises’ involved in trading with each other. So, in order to determine whether an enterprise is an “Associated Enterprise” or not depends on the relationship between the enterprises. The relationship between the enterprises is determined by the participation in management, control of one enterprise by another enterprise, etc. One important thing that is to be noted here is that the association can be direct or indirect or through one or more intermediaries. For example, enterprise A owns or controls enterprise B either directly or through an intermediary, then enterprise A and B are Associated Enterprises and transfer pricing rule applies to them. And if Mr. X is controlling both Enterprise A and Enterprise B then enterprises A and B are Associated Enterprises.
In case of cross-border transactions, the transfer pricing rules apply, where at least one of the associated enterprises to the transaction is a non-resident enterprise. For example, Enterprise A is located in India and its associated enterprise, B is located in South Africa. The transfer pricing rules will apply to the transaction between Enterprise A and Enterprise B. But Suppose, Enterprise A is the resident enterprise which imports goods from an unassociated foreign enterprise B. But they have an agreement which states that the import prices would be fixed by an associated enterprise of A say C. Now the transfer pricing rules will apply to this transaction with the unassociated foreign enterprise B also. The transfer pricing rules also apply to specified domestic transactions (which are not international transactions) if the aggregate value exceeds ‘Rs.5 crore’.
How Should the Income be Calculated?
The income arising out of the international transactions between the associated enterprises should be determined by using the Arm’s Length Price (ALP). Arm’s Length Price is a price that is fixed by the associated enterprises as if they had fixed the price between unassociated enterprises entering into the transaction. There are prescribed methods for determining the Arm’s Length Price. They are:Transactional Net Margin Method, Profit Split Method, Comparable Uncontrolled Price Method, Cost plus method and Resale Price Method. The taxpayers should use the most appropriate method.
Importance of Documentation
If the aggregate value of the international transaction is above INR 10 million, then all the information regarding the international transaction should be documented. An analysis of the most appropriate method used should also be documented. An accountant should also certify that the method used to determine the ALP was in accordance with the transfer pricing rules. And this documentation is a mandatory annual requirement, and it should be maintained for a minimum period of 8 years. If the value is less than INR 10 million then the analysis on the determination of ALP would be sufficient. The documentation should be submitted within 30 days of request. The documentation is important because the burden of proof is always on the taxpayers and they have to prove their claim that the method used was in accordance with the rules.
Adjustments to Reported Income
The taxpayer might have followed all the procedures in accordance with the rules, but sometimes there may be a difference between transfer prices as per the financial statement and the arm’s length price. In such cases, the Transfer Pricing Officer can propose an amount that can be adjusted to the reported income of the taxpayers. The additional assessment amount should be paid within 30 days of notice.
What are the Penalties?
Generally, the penalties are imposed when the taxpayer has failed to comply with the rules and the procedural requirements. If the taxpayer has failed to furnish or maintain the documents regarding the information of the transaction or if the taxpayer furnishes incorrect information then the penalty is 2 percent of the value of the international transaction. If the taxpayer evades tax by concealing the income, then the penalty ranges from 100–300 percent on the tax that was evaded. If the taxpayer has failed to obtain a report from an accountant, then there is fixed penalty of Rs.1 lakh. Interests are chargeable on penalties if the penalties are not paid on due time. However, if the taxpayers feel that there is no reasonable cause for the penalties imposed, then the taxpayer can contest on appeal either to Commissioner of Income Tax (Appeals) or before the Tax Tribunal.