Transfer Pricing (TP) is a key concept in international taxation, particularly for multinational corporations (MNCs) operating across countries. It refers to the pricing of goods, services, and intangible assets exchanged between related entities within a corporate group. TP ensures fair allocation of profits and tax liabilities across jurisdictions, reflecting the value created in each country. To prevent tax avoidance, regulatory frameworks enforce that prices between related parties adhere to market based conditions.

As per the Income Tax Act, 1961 (India), Transfer Pricing refers to the pricing of transactions between associated enterprises (AE), which may involve the purchase or sale of goods, services, or intangible assets. Section 92 of the Act mandates that such transactions between related parties must be conducted at an arm’s length price, meaning the price should be the same as what would be charged between unrelated parties in similar conditions (arm’s-length principle). The aim is to prevent related entities from manipulating prices to shift profits to low-tax jurisdictions.

Applicability of Transfer Pricing

The Indian TP Regulations apply to an Indian taxpayer (or Indian entity), if such an entity has entered into an International Transaction with its non-resident AE, which eventually gives rise to the taxable income or it gives rise to an expenditure claim for such entity during a relevant financial year (“FY”) (i.e. a period of 1st April to 31st March). It is important to note that the TP Regulations apply to a taxpayer even if the total value of such transactions is negligible like say just Indian Rupees (“INR”) 1 or even if there are any free-of-cost transactions between such taxpayer and its AEs.

The Indian TP Regulations also apply to a non-resident AE, in a situation where a particular International Trans-action entered into with an Indian resident AE, gives rise to a taxable income in India in the hands of such non-resident AE. In addition to the above, the TP Regulations in India are also applicable to transactions between two non-resident AEs, however again the precondition is the same, to evaluate whether such a particular international transaction gives rise to a taxable income for such non-resident AE in India.

Hence, transfer pricing rules are applicable to:

• Multinational Corporations: Companies engaged in cross-border transactions must comply with TP rules to avoid tax evasion allegations.
• Domestic Enterprises: Any Indian company engaging in specified domestic transactions that exceed INR 20 crores is also subject to these regulations.
• Associated Enterprises: Defined under Section 92A of the Income Tax Act, associated enterprises are those that have a direct or indirect relationship affecting their management or capital.
• Taxpayers Claiming Deductions: Entities claiming deductions on expenses related to specified domestic transactions must adhere to TP rules.

Laws Governing TP and Related Sections

The primary laws governing TP in India are:

• Income Tax Act, 1961: This Act contains various provisions related to TP, including Section 92, which deals with TP adjustments.
• Income Tax Act, 1962: Transfer Pricing was introduced through inserting Section(s) 92A-F and relevant Rule(s) 10A-E of the Income Tax Rules 1962. It ensures that the transaction between ‘related’ parties is at a price that would be comparable if the transaction was occurring between unrelated parties.
• Transfer Pricing Rules, 2017: Further, in the year 2017, India also updated its Regulations to incorporate the recommendations of the OECD Base Erosion and Profit Shifting (“BEPS”) project, and accordingly, it implemented the “Three Tier Documentation” structure for maintaining Transfer Pricing documents as recommended by the OECD
• Notifications and Circulars: The Central Board of Direct Taxes (CBDT) issues notifications and circulars to clarify TP provisions and provide guidance to taxpayers.

Common Terminologies

Associated Enterprise (as per Section 92A)
These are companies that are related to each other, meaning they are controlled by the same people or group of people. These companies might share owners, directors, or have significant financial ties.

International Transactions
Section 92B of the Income Tax Act, 1961 defines an international transaction as one between two or more associated enterprises, where at least one of the enterprises is a non-resident. The transactions can involve the purchase, sale, or lease of tangible or intangible assets, provision of services, lending or borrowing of funds, or any other transactions that impact the profits, income, losses, or assets of the enterprises involved.

Specified Domestic Transactions
Transfer pricing regulations in India also apply to specified domestic transactions with related parties, as defined under Section 92BA, when they exceed a prescribed threshold limit during the financial year. Since 2012, this threshold has been set at INR 20 crores (approximately USD 2.7 million), including those involving deductions for business expenses or profit linked tax incentives.

Arms’-Length principle
It is crucial for the company to ensure that pricing for such transactions is at fair market value. In transfer pricing terms “it has to be at Arms-length”. This is to show the tax authorities that the price determined for the particular transaction by the company would have been the same under an uncontrolled situation.

Method to determine Arms’ Length

The margin calculation is a key aspect of TP analysis. It involves determining the profit margin earned by the related parties on the transactions. There are different methods to calculate margins, including:

Comparable Uncontrolled Price (CUP) Method: The CUP Method compares the “price” for a product or service in a controlled transaction to the price in a comparable uncontrolled transaction in comparable circumstances. If there are any differences in the controlled and uncontrolled transactions, the price of the uncontrolled transaction is adjusted to account for the differences.

Resale Price Method: For the purpose of applicability of RPM, the resale price of the goods is reduced by the normal gross profit margin that would have been earned by an enterprise in a similar uncontrolled comparable transaction. Further, all direct expenses relating to purchase of the goods resold have to be reduced. The price so arrived is taken to be the Arm’s Length Price.

Cost-Plus Method: The CPM determines an arm’s length price by comparing the gross profit mark-up realized in controlled and uncontrolled transactions. CPM is the most appropriate method where related parties undertake transactions in respect of sale of semi finished goods, joint facility agreements, long term buy and supply arrangements and provisions of services.

Transaction Net Margin Method (TNMM): It involves comparing the net profit margin of the controlled transaction to the net profit margin of comparable uncontrolled transactions. This method is particularly useful when there is limited transaction data available or when it is difficult to find directly comparable uncontrolled transactions. By comparing profit margins, the TNMM can help identify potential transfer pricing issues and ensure that prices are set at a fair market value.

Profit Split Method (PSM): PSM is generally applicable in cases where international transactions involve transfer of intangibles or in multiple international transactions which are so interrelated that they cannot be evaluated separately.

Other Method: CBDT by Notification No. 18/2012 has prescribed a new method by inserting Rule 10AB in the Rules. This Rule provides that arm’s length price may be computed taking into account the price which has been charged or paid or would have been charged or paid for the same or similar uncontrolled transactions. Since the data on price charged or to be charged is not available in other uncontrolled transactions and also given the fact that TNMM is adopted as the most appropriate method, this notified method is accordingly not selected as the most appropriate method.

Transfer Pricing Compliance

Transfer pricing compliance requires adhering to prescribed documentation and reporting requirements. The key aspects of compliance include:

1. Transfer Pricing Audit and Filing Form 3CEB

Transfer pricing audits are mandatory for companies engaging in related-party transactions. Form 3CEB is an essential part of the Transfer Pricing (TP) audit. It is a report prepared by a Chartered Accountant that must be furnished by any entity engaged in international or specified domestic transactions, as required under Section 92E of the Income Tax Act. The due date for filing Form 3CEB is typically October 31st following the financial year-end (March 31st). The audit ensures that the company has adhered to the arm’s length principle and other transfer pricing regulations. Form 3CEB has to be reported even if the company has an international transaction of a single rupee!! Failure to furnish accountant’s report: INR 1,00,000.

2. Transfer Pricing Documentation (TP Study)

Companies must maintain comprehensive documentation (as per Section 92D r/w Rule 10D of the Income Tax Rules) justifying related-party transaction pricing, including details of the nature of the transaction, functions performed, risks assumed, assets employed, and comparable transactions with unrelated parties. This documentation must be contemporaneous, substantiating transfer pricing practices, and updated annually. This document is becomes applicable if the aggregate amount of international transactions during the year under consideration exceed the threshold limit of Rs. 1crore.

• Functional Analysis: This assesses the role of each party in a transaction, their responsibilities, and the risks they bear. It determines how value is created within the corporate group.

• Economic Analysis: This involves identifying and selecting comparable transactions between independent entities. The economic analysis also includes selecting the most appropriate method for determining the arm’s length price.

• Bench-marking Study: A key aspect of the TP study is bench-marking related-party transactions against similar transactions undertaken by unrelated parties to ensure that the pricing is comparable.

• Documentation: Preparing a comprehensive TP report documenting the findings and conclusions.

The outcome of this study helps businesses justify their transfer pricing practices during audits or disputes with tax authorities. Failure to maintain transfer pricing documentation, failure to report the transaction, maintenance or furnishing of incorrect information/document: 2% of the value of the international transactions.

3. Master file

The transfer pricing master file provides a comprehensive overview of a multinational group’s global business structure and activities. It’s a crucial part of transfer pricing compliance and is prepared at the group level. This file is essential for understanding the context of intercompany transactions and should be consistent with the local files prepared at the company or country level.

This is a mandatory compliance if the consolidated group revenue for the preceding accounting year exceeds Rs.500 crore or total value of the international transactions conducted has exceeded Rs.50 crore for the present accounting year or if there have been any international intangible property-related transactions, the value of such transactions exceeds Rs.10 crore. Failure to comply will have the company be fined a sum of 5,00,000 rupees.

4. CBCR

Country-by-Country Reporting (CbCR) is part of the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan 13. In essence, large multinationals have to provide an annual return, the CbC report, that breaks down key elements of the financial statements by jurisdiction. A CbC report provides local tax authorities visibility to revenue, income, tax paid and accrued, employment, capital, retained earnings, tangible assets and activities. This has to be reported if the groups consolidated revenue exceeds the threshold of 5,500 crores. Non-compliance will have the company levied with penalties of rupees 5,000- 50,000 per day after the due date, i.e., 31st December.