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Transfer Pricing under the Income Tax Act 1961

A transfer price is a price that is used to value transactions between affiliated enterprises. In other words, it is the price paid for goods or services by one company to a related party situated in a different country.

A higher price increases the seller’s income and decreases the buyer's income, and a lower price decreases the seller's income and increases the buyer's income. Therefore, the transfer price influences the tax base of both the seller country as well as the buyer country which are involved in cross-border transactions.

Why was transfer pricing introduced in India?

The concept of transfer pricing was introduced in the United States in 1921, wherein consolidated returns reflecting the actual tax liability were permitted to be prepared on behalf of controlled entities.

Though in India, these provisions were introduced years after the US, post-globalization, in 1991, the presence of Multi-National Enterprises (MNEs) in India and their ability to allocate profits in different jurisdictions by controlling prices in intragroup transactions made the issue of transfer pricing a matter of grave concern for the Indian policymakers. 

Before introducing transfer pricing regulations, specific introductory provisions existed under the Income Tax, Customs, and Excise legislation. A separate code on transfer pricing was established through the Finance Act, 2001 by introducing Sections 92 to 92F under the Income Tax Act, 1961. It covered intra-group, cross-border transactions. The regulations were broadly based on the Organisation for Economic Co-operation and Development (OECD) Guidelines.

Applicability of Transfer Pricing Provisions 

The transfer pricing rules become applicable when two or more associated companies enter into a mutual contract during an international transaction for goods, services, or facilities offered by any one or all companies. In such case, the cost shall be calculated considering the Arm's length price of the particular service, or facility, or goods.

Let us now understand some technical aspects of the above explanation:

Meaning of Associated Enterprises

As per Section 92A (1) of the Act, associated enterprise refers to an enterprise that directly or indirectly or through one or more intermediaries participates in:

  • Management of the other enterprise
  • Control of the other enterprise
  • Capital of the other enterprise

Apart from this, Section 92A (2) of the Act lists the situation during which the AE relationship is established. For example, any person or enterprise holds, directly or indirectly, shares carrying not less than twenty-six percent of the voting power shall be deemed an associated entity.

Meaning of International Transaction

For a transaction to be an international transaction, it should satisfy the following two conditions cumulatively:

  • It must be a transaction between two associated enterprises and
  • At least one of the two enterprises must be a non-resident.

Method of calculating Arm’s length Price (Section 92C of the Act)

Having regard to various factors, the following can be used to calculate Arm’s Length Price in India:

  • Comparable Uncontrolled Price Method (CUP)
  • Profit Split Method (PSM)
  • Transactional Net Margin Method (TNMM)
  • Cost Plus Method
  • Resale Price Method (RPM)

What are the compliance requirements?

It is mandatory to maintain documentation when the taxpayer's aggregate book value of international transactions exceeds INR one crore.

Section 92D under the Income Tax Act, 1961, mandates a taxpayer to maintain transfer pricing documentation in the form of TP Study and Form No. 3CEB. This report though Form No. 3CEB must be obtained from an independent practising Chartered Accountant which is required to be furnished to the Income Tax department on or before the specified due date. The specified date means the date one month prior to the due date for furnishing the return of income under Section 139 of the Act. This report is essential in validating the fairness of arm's length pricing of the international/specified domestic transactions. The key component of a TP Report is the economic analysis which forms a foundation to conclude that the international transactions with its overseas affiliates are at arm's length. 

Other compliances and documentation

Form Name Particulars Applicability Timelines
Local File
3CEB Report from an accountant to be furnished under section 92E relating to the international transaction(s) along with Transfer Pricing Study. Companies engaged in international transactions with any associated enterprise. By October 31 of the AY.
Master File
3CEAA (Part A) Basic details of the group- consists of name, address, the tax identification number To be filed by every person, being a constituent entity of an international group. By November 30 of the AY.
3CEAA (Part B) Provides an overview of the international group's business operations and transfers pricing policies by a constituent entity To be filed if the following two conditions are satisfied:
  1. consolidated revenue of the international group exceeds INR 500 crores and
  1. Either of the following:
The aggregate value of the international transaction exceeds INR 50 crores, or the aggregate value of international transactions regarding purchase, sale, transfer, lease or use of an intangible property as per the books of accounts intangible property exceeds INR 10 crores.
By November 30 of the AY.
3CEAB (Intimation) Intimation for filing Form 3CEAA by a constituent entity In case multiple constituent entities are resident in India. By October 31 of the AY.
Country by Country reporting
3CEAC To intimate Alternate Reporting Entity or Parent Entity. Consolidated revenue of international group exceeds INR 5,500 crores By January 31 of the AY.
3CEAD CBCR Reporting- Report by a parent entity or an alternate reporting entity or any other constituent entity, resident in India, Consolidated revenue of international group exceeds INR 5,500 crores Within 12 months following the end of reporting accounting year.
3CEAE Intimation on behalf of the international group – no agreement for the exchange of CbCR by Constituent entity Consolidated revenue of international group exceeds INR 5,500 crores By January 31 of the AY.

 

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