Ashok Kumar Singh*
AK Singh & Co, New Delhi
aksingh@aksinghco.com

Saloni Singh
AK Singh & Co, New Delhi

Aparna Tripathi
AK Singh & Co, New Delhi

Overview of transfer pricing

Transfer pricing, in very basic terms, refers to stock transfers between multinational companies or enterprises. But as easy as it sounds, it is also complex.

Transfer pricing is an accounting and taxation practice that represents the price that one associate enterprise in a company charges another associate enterprise for goods and services provided. Transfer pricing allows for the establishment of prices for the goods and services exchanged between subsidiaries, affiliates or commonly controlled companies that are part of the same larger enterprise.^[1]

Transfer pricing is normally used by multinational corporations to shift profits out of the countries where they operate and into tax havens.^[2] Though it is a concept of international taxation and accounting principles, it is also used in certain specified categories of domestic transactions.

Organisation for Economic Cooperation and Development (OECD) on transfer pricing laws

With an objective to ensure, that in a global economy where multinational enterprises (MNEs) play a prominent role, the taxable profits of MNEs are not artificially shifted out of the respective jurisdiction, the OECD has laid down guidelines for transfer pricing^[3] by enacting the OECD’s Base Erosion and Profit Sharing (BEPS) Action Plan 8 to 10.^[4]

Transfer pricing laws in India

India is not an OECD member but is an OECD BEPS Plan complaint country. The Indian legal landscape in respect of transfer pricing is more or less guided by the OECD principles themselves.

The regulations in respect of transfer pricing were adopted by India in 2001. Gradually, with time and following the requirements, Indian law has been updated with the introduction of the domestic transfer pricing regime and the Advance Pricing Agreement programme in 2012, the Safe Harbour rules in 2013, the framework for use of multiple year data and range concepts in benchmarking analysis, the three tier transfer pricing documentation structure as per BEPS Action Plan 13 in 2016, secondary adjustment provisions and limiting interest deductions for thinly capitalised companies in 2017. These are all examples of the evolution in the Indian Transfer Pricing Regime.^[5]

The Indian Transfer Pricing Law prescribes that income arising from international transactions or specified domestic transactions between associated enterprises should be computed having regard to the arm’s-length price. Any allowance for an expenditure, interest or allocation of any cost or expense arising from an international transaction or specified domestic transaction shall also be determined by using the same principle.^[6]

Legal provisions on transfer pricing

The provisions have been made under the Indian Income Tax Act 1960 (the ‘Income Tax Act’) to deal with issues pertaining to transfer pricing.

Although India has tried to show a very extensive approach towards the adoption of the Transfer Pricing Regulations, the Income Tax Act misses the very definition of the same. Nowhere in the Act or in the Rules framed thereunder, is there a definition of transfer price or transfer pricing. Instead, the Act defines the terms ‘international transactions’, ‘specified domestic transactions’, ‘associated enterprises’ and ‘arm’s-length price’.^[7]

Let us take a glance on the applicable Transfer Pricing laws in India:

(I) INCOME TAX LAW VIZ-À-VIZ TRANSFER PRICING

As per the Income Tax Act and Rules therein, an assessee is required to comply with transfer pricing provisions when:

1. such assessee has entered into an international transaction with its associated enterprise; or
2. such assessee enters into a transaction where one of the parties to the transaction is a person located in a notified jurisdictional area (NJA); or
3. such assessee enters into a specified domestic transaction.^[8]

Section 92B of the Income Tax Act defines the term ‘international transaction’. It means a transaction between two (or more) associated enterprises involving the sale, purchase or lease of tangible or intangible property; the provision of services; cost-sharing arrangements; the lending/borrowing of money; or any other transaction having a bearing on the profits, income, losses or assets of such enterprises.^[9]

The associated enterprises could be either two non-residents or a resident and a non-resident; furthermore, a permanent establishment (PE) of a foreign enterprise also qualifies as an associated enterprise. Accordingly, transactions between a foreign enterprise and its Indian PE are within the ambit of the code.^[10]

An explanation having an inclusive list of transactions has been inserted in the definition of ‘international transaction’ by the Finance Act 2012, to specifically cover certain transactions or arrangements such as the purchase, sale, transfer, lease or use of intangible property, provision of guarantees, deferred payments or receivables, business restructuring or reorganisation etc. Intangible property has been explained to include marketing intangibles, customer-related intangibles, human capital intangibles and location-related intangibles etc. These clarifications have been inserted retrospectively, with effect from 1 April 2001.^[11]

Until the financial year (FY) 2011–2012, transfer pricing regulations were not applicable to domestic transactions. However, the Finance Act 2012 has extended the application of transfer pricing regulations to ‘specified domestic transactions’.

The following transactions with certain related domestic parties are brought within the purview of the Transfer Pricing Regulations, if the aggregate value of such transactions exceeds INR 5 crore:

• Any expenditure with respect to which a deduction is claimed while computing the profits and gains of a business or profession.
• Any transaction related to businesses eligible for profit-linked tax incentives, for example, infrastructure facilities (section 80-IA) and SEZ units (section 10AA).
• Any other transactions as may be specified.^[12]

The Income Tax Act also prescribes mandatory annual filing requirements as well as the maintenance of contemporaneous documentation by the taxpayer in cases where international transactions between associated enterprises cross a threshold and contain stringent penalty implications in cases of non-compliance. The primary burden of proving the arm’s length price of the transaction lies with the taxpayer.^[13]

(II) TRANSFER PRICING METHODS IN INDIA

The principle of arm’s length for determining the transfer price is followed in India.

This principle implies a business deal in which buyers and sellers act independently without one party influencing the other. Arm’s length transactions assert that both parties act in their own self-interest and are not subject to pressure from the other party. They also assure others that there is no collusion between the buyer and the seller.^[14] There are multiple ways to determine what an arm’s length principle transaction can be. To determine the same, India has adopted the following methods:

1. Comparable uncontrolled price method:  this method compares the ‘price’ of products or services in a controlled transaction with those of an uncontrolled transaction between unrelated parties.
2. Resale price method: this method is applicable where the property or services are purchased from related parties and re-sold to an unrelated enterprise without significant value addition.
3. Cost-plus method: this method is employed in cases involving the manufacture, assembly or production of tangible products or the provision of services that are sold or provided to related parties.
4. Profit Split Method: under this method, out of the overall profitability at the combined group level, the transacting parties are accorded returns for routine functions, and the balance profitability (commonly referred to as non-routine profits), is distributed between the transacting parties, based on each party’s contribution in generating such non-routine profit. It is used in cases involving the use or transfer of unique intangibles or where there are complex transactions that are incapable of being evaluated separately.
5. Transactional net margin method: this method compares the net profit, computed using an appropriate base (eg sales, costs, assets etc), earned from controlled transactions with those from uncontrolled transactions.^[15]
6. Other method: this ‘other’ method has been prescribed by the Central Board of Direct Taxes as any method that takes into account the price that has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transactions, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.^[16] This other method has been applicable since FY 2011–2012 in India.^[17]

There is no hierarchy in the selection of methods, and the most appropriate method can be any of the six prescribed methods.^[18]

(III) DISPUTE RESOLUTION

India does not have a mechanism for self-assessment. Taxpayers who have entered into international transactions (or domestic transactions of more than INR 200m) with their Associated Entities^[19] have to file proper documentation in respect of transfer pricing.

From there, a certain percentage of tax returns are selected for a detailed audit.^[20]

While dealing with such audits and to foresee and avoid disputes, there are different resolution mechanisms provided such as:

1. Mutual Agreement Procedures (MAPs): A major risk that international business transactions face is the potential for double taxation by multiple tax authorities. Most tax treaties negotiated between countries provide a mechanism to avoid double taxation. Multinationals can file a MAP claim requesting the relevant revenue authorities to resolve disputes concerning double taxation.^[21]
2. Safe Harbour Rules (SH): SH is defined to mean circumstances in which the income tax authorities shall accept the transfer price declared by the taxpayer subject to the fulfilment of certain prescribed conditions. The Finance Act 2009 introduced SH provisions under the Transfer Pricing Regulations with a view to reducing litigation. The rules pertaining to it were notified in September 2013.^[22]
3. Advance Pricing Agreements (APAs): An APA is an agreement between the tax authorities and the taxpayer that determines in advance the most appropriate Transfer Pricing methodology or the Arm’s Length Price for the covered intercompany international transactions.^[23]

Imperfections in transfer pricing laws

The burden of proving the arm’s-length nature of a transaction primarily lies with the taxpayer. If the tax authorities, during audit proceedings on the basis of material, information or documents in their possession, are of the opinion that the arm’s-length price was not applied to the transaction or that the taxpayer did not maintain or produce adequate and correct documents, information or data, the total taxable income of the taxpayer may be recomputed after a hearing opportunity is granted to the taxpayer.^[24]

India believes that comparable analysis is the key to determining arm’s length price of international transactions. However, increased market volatility and increased complexity in international transactions have thrown serious challenges to comparable analysis and determination of arm’s length price.^[25]

Another issue with the implementation of transfer pricing rules is related to the risks of tax evasion and avoidance. The perception of the Indian revenue authority is that the risk of tax evasion by an MNE is a by-product of its performance of functions and ownership, exploitation or use of assets employed over a period of time. Accordingly, risk is not an independent element but is similar in nature to functions and assets. In this context, it is believed that it is unfair to give undue importance to risk in the determination of an arm’s length price in comparison to functions performed and assets employed.^[26] Identification of risk and the party who bears such risks are important steps in comparability analysis.^[27]

Transfer pricing – major disputes

The biggest and most recent transfer pricing controversy in India was the Indian Government appealing the Hague decision in the Vodafone case. The permanent Court of Arbitration in the Hague ruled in favour of Vodafone against the income-tax department.^[28] In this case, in an unanimous decision, the Permanent Court of Arbitration at the Hague ruled that India’s retrospective demand of Rs 22,100 crore as capital gains and withholding tax imposed on the British telecommunication company for a 2007 deal was ‘in breach of the guarantee of fair and equitable treatment’. The Court has also asked the Indian government not to pursue the tax demand against Vodafone Group.^[29]

Another big controversy was that the Permanent Court of Arbitration at the Hague ruled in favour of Cairn against the Indian Income-tax Department on 23 December 2020 in a $1.4bn transfer pricing dispute.^[30] The Cairn case revolves around capital gains tax on a restructured company sold a decade ago.^[31]

Conclusion

With the advancement of time, it becomes imperative for any revenue mechanism to refurbish or update itself so as to not fall prey to tax avoidance and evasion. Such becomes the case in the Indian context too. Even with all its might, the Indian transfer pricing system proves to be not redecorated in many aspects. The Cairn and Vodafone judgments among others, are just a glimpse of the loopholes in the Indian transfer pricing system which require the immediate attention of the legislature to become a more effective, just and full-proof transfer pricing legal system to avoid such setbacks as received in the past and to ensure no tax evasion and/or avoidance happens from any angle.

Certainly, for this, India needs to keep itself in consonance with its global footing, considering major multinational enterprises globally are opting for India as their next business destination.