Indian Transfer Pricing Regulations and FAQ's
23 November 2022
In this update, Aditi Mehra, Transfer Pricing Manager at AGA member firm in New Delhi, Coinmen Consultants, and a member of AGA’s Transfer Pricing Global Practice Group updates us on the Transfer Pricing (TP) regulations in India and addresses FAQ's.
All businesses across the world are familiar with the term ‘Transfer Pricing.’ Transfer pricing regulations and compliances were introduced to ensure that global related parties conduct their business in a manner that there is no base erosion or profit shifting. Just like across the world, transfer pricing in India, is one of the most important matters considered by MNCs as they attempt to fairly distribute their profits amongst the companies within the group.
In this article, we have tried to address the most frequently asked questions with respect to Indian Transfer Pricing regulations.
1. Indian Transfer Pricing Regulations vis-à-vis Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines
India is not a member of the OECD. However, India has been invited to participate as an observer in the OECD’s Committee on Fiscal Affairs, which contributes to setting international tax standards, particularly in areas such as tax treaties and transfer pricing. TP provisions in India are broadly in line with the TP guidelines for MNCs and tax administrators issued by the OECD, though with certain noteworthy differences. Indian Tax offices have also indicated their intent of broadly following the OECD Guidelines during audits, to the extent the OECD Guidelines are consistent with the Indian Transfer Pricing Regulations.
2. Associated Enterprises (AEs)
Section 92A of the Income - tax Act, 1961 (‘the Act’) specifies that two or more enterprises become associated enterprises when one of them participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprises.
Other factors which can make two entities “associated” are:
- Giving more than 26% voting power
- Dependence on source of raw materials or customers
- Influences on price
- Depending on borrowings, and
- Authority to appoint board of directors or executive directors beyond a certain threshold.
3. International Transactions
Indian Transfer pricing regulations define an international transaction as a transaction between two or more AEs, where either or both of which are non-residents and have a bearing on the profits, income, losses, or assets of such enterprises. A few examples of international transactions subject to TP are:
- Purchase, sale, lease of tangibles or intangibles;
- Capital financing such as loan, purchase/sale of equity;
- Provision/availing of services.
- Cost apportionments, allocations, contributions.
- Cost reimbursements.
- Transaction of business restructuring or re-organisation.
- Transactions having a bearing on profits, income, losses, or assets; and
- Transactions with unrelated parties because of prior arrangements with related parties.
4. Specified Domistic Transaction (SDT)
The Government of India in 2012, extended the application of existing TP regulations and brought certain domestic transactions i.e., transactions between two resident entities under the umbrella of TP regulations in India. Such domestic transactions include transactions with units eligible for tax holiday, and newly set up manufacturing companies covered u/s 115BAB of the Act. Specified domestic transactions exceeding INR 200 million are covered under such provisions.
5. Transfer Pricing Methods
As per Section 92C of the Act, the following methods can be used for computing arm's length price:
- Comparable Uncontrolled Price (CUP) Method
- Resale Price Method (RPM)
- Cost Plus Method (CPM)
- Profit Split Method (PSM)
- Transactional Net Margin Method (TNMM)
- Any Other Method
OECD primarily endorse five methods to benchmark intra-group transactions. Transfer Pricing analysis depends a lot on facts and circumstances of the case. Genuine hardships were being faced by taxpayers in justifying the compliance of the arm’s length principle using the five originally prescribed methods such as justifying the valuation methods adopted, quotations being used (where there was no actual third-party transaction to compare), use of standard rate cards in specific industries, etc.
Given the same, in 2012, India notified the “Other Method,” (Other method of determination of arm’s length price), as the sixth method for determination of arm’s length.
6. Transfer Pricing (TP) Documentation
Indian government in line with OECD’s BEPS Project (Action 13) has introduced a three-tier TP documentation process i.e., local file, master file and CbCR (Country-by-Country Report)., keeping in mind India’s commitment to implementing OECD/G20’s BEPS recommendations.
7. Threshold for Transfer Pricing Documentation
Local file – Taxpayers indulging in any international transactions are required to maintain a set of documents specified in Rule 10D of the Income - tax Rules, 1962. The transfer pricing documentation shall be required if the value of international transactions exceeds INR 10 million in a financial year.
Master file – Taxpayer indulging in international transactions exceeding INR 500 million (or purchase sale, transfer, lease, or use of intangible property exceeds INR 100 million) during the financial year and the consolidated group revenue exceed INR 5000 million during the financial year.
CbCR – Where consolidated revenue of the international group exceeds INR 64000 million.
As per Indian transfer pricing regulations, transfer pricing documentation is required to be maintained annually if it crosses the prescribed threshold.
8. Documents Required to be Maintained by a Company Under Local File
The Transfer Pricing documentation shall include following information:
- Group information
- Organisation structure
- Business profile
- Business activities and related party transactions
- Description - Nature and terms (including prices) of international transactions
- Functional, Asset and Risk analysis (‘FAR analysis’)
- Comparability analysis (benchmarking of related party transactions)
9. Secondary Adjustment
Secondary adjustment means an adjustment in the books of accounts of the taxpayer and its AE to reflect the actual allocation of profits between them. Such adjustment shall be consistent with the transfer price determined because of primary adjustment. It removes the imbalance between cash account and actual profit of the taxpayer. Secondary adjustment mechanism was introduced in the year 2017 for the following primary adjustments:
- Suo-moto adjustment offered by taxpayers.
- Adjustment made by Tax Officer and accepted by taxpayer.
- Adjustment determined by an Advance Pricing Agreement.
- Adjustment made according to India’s Safe Harbor Rules.
- Adjustment arising due to a Mutual Agreement Procedure resolution.
10. Thin Capitalisation
In line with recommendations from OECD’s BEPS project, Government of India introduced Thin Capitalisation Rules in the year 2017. These provisions restrict interest deduction up to 30% EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) under certain circumstances. Excess interest disallowed in a year will be eligible for carry-forward up to 8 consecutive years.
11. Safe Harbour Rules (SHR)
SHR is a mechanism under which in certain circumstances tax authorities accept the transfer prices declared by taxpayer without undertaking detailed audit.
The tax authorities have introduced regulations prescribing procedure for adopting SHR. The categories of international transactions covered under the SHR include:
- Provision of software development services
- Provision of IT enabled services
- Provision of knowledge process outsourcing services
- Advancing of intra-group loans
- Provision of corporate guarantee
- Provision of contract research and development services
- Manufacturing and export of auto components Receipt of low value adding intragroup services
Advance Pricing Agreement (APA)
APA is a binding agreement between the taxpayer and tax authority to determine in advance, a set of criteria that would govern the transfer prices for covered inter-company transactions for a fixed period. The APA regime has been introduced in India effective 01 July 2012. The APA rules provide an option for taxpayers to seek a unilateral, bilateral, or multilateral APA. It can be valid for up to five years and additionally for a period of four consecutive previous years.
The APA filing process includes an optional pre-filing submission, the filing of the APA request, negotiation of the APA, execution, and monitoring. Taxpayers are required to prepare and file an annual compliance report for each year under the APA. It helps that taxpayer in attaining certainty on the transfer price adopted and assists in mitigating the risks of litigation for the period covered under APA.
Read more about AGA's Global Transfer Pricing expertise
About Coinmen Consultants:
Coinmen is a financial and business consulting firm established by three visionary Partners Vikrant Suri, Mohit Aggarwal, and Nitin Garg, following their respected careers in the Big 4 accounting firms and successful individual paths. Eleven years later, they now have a team of 75 and 5 Partners. Based in Delhi and Gurugram, the firm has a strong consulting practice and international orientation, with Japanese, Italian, Korean, and Spanish desks. Coinmen is AGA's financial and business consulting member firm in New Delhi.