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Company Formation & FDI

Transfer Pricing

The price paid for goods or services (including those linked with intellectual property like research, patents and royalties) that are exchanged among the subsidiary, affiliate or commonly controlled companies or legal entities that are part of the same larger enterprise. Value attached to goods or services transferred amongst such related parties is termed as transfer pricing. In other words, transfer pricing is referred as the price concerning intercompany transactions. Provisions of Indian transfer pricing are regulated by section 92 of Income Tax Act, 1961 ("Act")

Transactions subject to transfer pricing

As per section 92B, below mentioned are international transactions which are subject to transfer pricing:

  • Purchase, sale, lease, use or transfer of tangible property. Tangible property includes transportation vehicle, building, furniture, machinery, tools, equipment, plant, commodity, thing, product or any other article
  • Purchase, sale, lease, use, transfer of ownership or provision of use of rights of intangible property. Intangible property includes copyrights, land use, patents, licences, trademarks, franchises, marketing channel, customer list, brand, know-how, commercial secret, industrial property right, any other commercial or business rights of related type
  • Capital financing transactions inclusive of any kind of long-term or short-term borrowing, lending, guarantee, purchase of marketable securities, sale of marketable securities, any kind of payments, deferred payment, receivable, advance or any other liability arising as a result of business activities
  • Provision of services covering provision of market research, marketing management, market development, technical services, administration services, repairs, consultation, design, agency, legal services, scientific research or accounting service
  • Transactions related to business reorganization or restructuring entered between associated enterprises. These transactions are considered irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date

As defined under section 92BA, specified domestic transactions means any below mentioned transaction, not being an international transaction, including:

  • Any transaction as prescribed in section 80A
  • Any transfer of goods or services mentioned in section 80-IA (8)
  • Any business transacted between the assessee and other person as included in section 80-IA (10)
  • Any transaction, explicitly mentioned in any other section under Chapter VI-A or section 10AA, to which provisions of section 80-IA (8) or 80-IA (10) are applicable
  • Any other transaction as may be prescribed

And where the sum of any such transactions entered into by the assessee in the preceding year exceeds an aggregate of INR 20 crores.

Methodologies of transfer pricing

In accordance with the provisions of section 92C, arm's length price in relation to an international transaction or specified domestic transaction shall be determined by any of the following methods:

  • Comparable uncontrolled price (CUP) method
    Price of goods or services charged in an uncontrolled transaction between comparable entities is apprehended and assessed with the price of a substantiated entity for evaluating the arm's length price. Arm's length principle might not be realized in financial and commercial conditions of the associated enterprises in case two transactions elicit in varied prices. Subsequently, the price in the controlled transactions may need to be substituted in the price of the transaction between unrelated parties. Such method is suitable where comparable data is accessible.
  • Resale price method / Resale minus method (RPM)
    With resale price method, the price at which one associated enterprise sells its product or renders any service to a third party is termed as the resale price. Gross margin determined by comparing the margins in a comparable uncontrolled transaction is then deducted from this resale price. Subsequently, costs associated with the purchase of such product like customs duties, etc. are subtracted. Remaining value is considered as arm's length price for a controlled transaction between the associated enterprises.
  • Cost plus method
    Under this method, one emphasizes on costs of the supplier of goods or services in the controlled transaction and adds a markup. The markup must exhibit the profit of the associated enterprise on the basis of risks involved and functions performed. The resulting figure is the arm's length price. Often, the markup in the cost plus method is computed after considering the direct and indirect cost related to production or supply. But, operating expenses of an enterprise such as overhead expenses aren't part of this markup.
  • Transactional net margin method (TNMM)
    Method in which profits are assessed from particular controlled transactions is referred as TNMM. It includes evaluating net profit against some "appropriate base" that results from a controlled transaction. Taxpayers are required to carry out functional analysis of their transactions to determine their comparability.
  • Transactional profit split method
    Its focus lies on highlighting how profits or losses would have been distributed among independent enterprises in comparable transactions. Consequently, it detaches any influence from "special conditions made or imposed in a controlled transaction" by directing the profits from the controlled transactions that are required to be split. The profits are then divided between the associated enterprises according to how they would have been bifurcated between independent enterprises in a comparable uncontrolled transaction resulting in an appropriate arm's length price of controlled transactions.
  • In case none of the above methods are used, any other method as may be prescribed by the Board can be used to evaluate arm's length price.

Transfer pricing documentation

Section 92D requires every person who has entered into an international transaction or specified international transaction to keep and maintain such information and document in respect thereof, as may be prescribed. The information and documents are required to be retained for a period of 8 years. Rule 10D of the Income Tax Rules prescribes the information and document which is required to be maintained.

Company's financial reporting requires close monitoring of transfer pricing. Such review often requires stern documentation which is maintained for preparation of documents of financial reporting for regulators as well as auditors. Such documentation is subject to scrutiny in certain cases. Inappropriately documented it often leads to additional expenses for the company resulting in added restatement fees or taxation. Such values are closely monitored for accuracy to secure those profits booked are appropriate, within arm's length pricing methods and in accordance with associated taxes paid.