Indian Transfer Pricing Laws
In an era of liberalization and globalization of trade and investment and the emergence of e-commerce, the perceptible results have been increase in the number of cross-border transactions, the complexity, speed and lack of transparency with which global business can be transacted. There is a general belief that multi-national corporations, in an effort to manage and minimize their global tax outflow, have employed creative transfer pricing approaches in the context of flow of goods, services, funds, intangibles etc.
When transactions are entered into between independent enterprises, the consideration therefore is determined by market forces. However, when associated enterprises deal with each other, it is possible that the commercial and financial aspects of transactions are not influenced by external market forces but are determined based on internal forces. In such a situation, when the transfer pricing agreed between the associated enterprises does not reflect market forces and arm’s length principle, the profit arising from the transactions, the consequent tax liabilities of the associated enterprises and the tax revenue of the host countries could be distorted.
The existence of different tax rates and rules in different countries offers a potential incentive to multinational enterprises to manipulate their transfer prices to recognize lower profit in countries with higher tax rate and vice versa. This can reduce the aggregate tax payable by multinational groups and increase the after tax returns available for distribution to shareholders.
In India, the Act had hitherto not dealt with this problem in a detailed manner. The erstwhile section 92 sought to determine the amount of profits which may reasonably be deemed to have been derived from a business carried on between a resident and a non-resident which, owing to the close connection between them is so arranged that it produced, to the resident, either no profits or less than the ordinary profits which might be expected to arise in that business.
The Finance Act ,2001 introduced transfer-pricing regulation (TPR) in India with effect from 1st April 2001 corresponding to the assessment year 2002-03.The section 92 to 92F and rule 10A to 10E and sections 271(1)(c),271 AA, 271 BA and 271 G. Certain amendments were made in Transfer Pricing regulations corresponding to assessment year 2003-04. The exercise of amendment is carried out to remove inconsistencies, administrative problem and inconvenience besides widening the tax base.
In line with the international income, the Finance Act, 2001 introduced transfer pricing provisions in the income Tax Act,1961 under chapter X and sections 92 to 92F. The new TP provisions deviate very little from the one by the Organization for Economic Co-operation and Development (OECD) in their report on Transfer pricing and Multinational Enterprises.
Section 92 of Finance Act,2002 provides that any income arising from an international transaction or where the international transaction comprise of only an outgoing, the allowance for such expenses or interest arising from the international transaction shall be determined having regard to the arm’s length price. The provisions, however, would not be applicable in a case where the application of arm’s length price results in decrease in the overall tax incidence in India in respect of the parties involved in the international transaction.
The term “associated enterprise” is defined in section 92A of the act. According to sub-section (1), an enterprise which participates directly or indirectly or through one or more intermediaries, in the management or control or capital of the other enterprise shall be regarded as an associated enterprise.
Similarly, an enterprise in respect of which one or more persons who participate in management or control or capital, directly or indirectly through one or more intermediaries are the same persons who participate in a similar manner in the management or control or capital of the other enterprise shall be regarded as an associated enterprise.
MANAGEMENT :- Appointment of more than half of the Board of directors/ Board of Members/ One or
more Executive Directors/ Executive Members by :
– The other enterprise
– The same person in both the enterprises.
CAPITAL :- Holding not less than 26% of the Voting power directly or indirectly
– In the other enterprise
– In each of such enterprises.
– Loan>= 51% of book value of total assets
– Guarantees>= 10% of total borrowings
– Use of know how, patents
– Purchase of >= 90% of Raw Materials under controlled conditions
– Control by same person
– Sale to or under instruction or direction of the controlling party
The term ‘transaction’ has been defined in clause (v) of section 92F as under:-
“(v) Transaction includes an arrangement, understanding or action in concert ;
(i) Whether or not such arrangement, understanding or action is formal or in writing; or
(ii) Whether or not such arrangement, understanding or action is intended to be enforceable by legal
The definition is an inclusive definition and therefore wider in its scope. As per this definition, a transaction includes any arrangement, understanding or action, whether formal or informal, whether oral or in writing, whether legally enforceable or not.
The definition of international transaction under the transfer pricing regulation is very wide and in its scope it includes transaction in the nature of :
i. Purchase, sale or lease of tangible or intangible property; or
ii. Provision of services; or
iii. Lending or borrowing of money; or
iv. Any other transaction having a bearing on the profits, income, losses or assets of such enterprises.
It shall also include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expenses incurred or to be incurred in connection with a benefit, service, facility provided or to be provided to any one or more such enterprises.
Any transaction between an enterprise and a person other than an associated enterprise will be deemed to be a transaction with an associated enterprise as per sub-section (2) of section 92B under certain situations. This deeming provision is intended to cover cases where an independent third party can be interpreted by two associated enterprises to remain out of the transfer pricing provisions of the Act.
According to sub-section (2) of section 92B, a transaction between an enterprise and an unrelated person shall be deemed to be a transaction between associated enterprises if in relation to that transaction-
i. There exists a prior agreement between such other person and the associated enterprise; or
ii. The terms of the relevant transaction are determined in substance between such unrelated person and the associated enterprise.