LAW OF TRANSFER PRICING IN INDIA 1.

INTRODUCTION Increasing participation of multi-national groups in economic activities in India has given rise to new an !o"#$e% iss&es e"erging 'ro" transa!tions entere into (etween two or "ore enter#rises (e$onging to the same group. )en!e* there was a nee to intro &!e a &ni'or" an internationa$$+ a!!e#te "e!hanis" o' eter"ining reasona($e* 'air an e,&ita($e #ro'its an ta% in In ia in the !ase o' s&!h "&$tinationa$ enter#rises. A!!or ing$+* the Finance Act, 2001 introduced law of transfer pricing in India through sections 92A to 92F of the Indian Income tax Act, 1961 whi!h g&i es !o"#&tation o' the trans'er #ri!e an s&ggests etai$e o!&"entation #ro!e &res. -. SCOPE . APPLICA/ILIT0 Trans'er Pri!ing Reg&$ations 12TPR23 are a##$i!a($e to the a$$ enter#rises that enter into an International !ransaction with an Associated "nterprise . There'ore* genera$$+ it applies to all cross #order transactions entere into (etween asso!iate enter#rises. It even a##$ies to transa!tions invo$ving a "ere (oo4 entr+ having no a##arent 'inan!ia$ i"#a!t. The ai" is to arrive at the compara#le price as availa#le to an$ unrelated part$ in open mar%et !on itions an is 4nown as the Arm s &ength 'rice ( A&' )* Fro" F0 1-516 onwar s* trans'er #ri!ing reg&$ations are a##$i!a($e even on !ertain s#e!i'ie o"esti! transa!tions a$so. 2*1* Associated "nterprises ( A"s ) - +ow Identified, !he #asic criterion to determine an A" is the participation in management, control or capital (ownership) of one enterprise #$ another enterprise. The #arti!i#ation "a+ (e direct or indirect or through one or more intermediaries. The !on!e#t o' !ontro$ a o#te in the $egis$ation e%ten s not on$+ to !ontro$ thro&gh ho$ ing shares or voting #ower or the #ower to a##oint the "anage"ent o' an enter#rise* #ut also through de#t, #lood relationships, and control over various components o' the (&siness a!tivit+ #er'or"e (+ the ta%#a+er s&!h as !ontro$ over raw "ateria$s* sa$es an intangi($es. The -overnment ma$ go to an$ la$er o' "anage"ent* !ontro$ or ownershi# in or er to 'in o&t asso!iation 1a3 Dire!t Contro$ 1(3 Thro&gh Inter"e iar+ For instan!e* i' enter#rise / is "anage * !ontro$$e or owne either ire!t$+ or thro&gh an inter"e iar+* then Enter#rise / is sai to (e an AE o' enter#rise A. F&rther* i' 7r A an 7r / !ontro$ (oth Enter#rise A an Enter#rise A an Enter#rise / AEs. Enter#rise / then (oth

2*2* .hat is an International !ransaction, An international transaction is essentiall$ a cross #order transaction (etween AEs in an+ sort o' propert$, whether tangi#le or intangi#le, or in the provision of services, lending of mone$ etc . At $east one o' the #arties to the transa!tion "&st (e a non5resi ent entering into one or "ore o' the 'o$$owing transa!tions 1a3 P&r!hase* sa$e or $ease o' Tangi($e or Intangi($e Pro#ert+ 1(3 Provision o' servi!es 1!3 Len ing or (orrowing o' "one+ 1 3 An+ transa!tion having a (earing on #ro'its* in!o"e* $osses or assets 1e3 7&t&a$ agree"ent (etween AEs 'or a$$o!ation8a##ortion"ent o' an+ !ost* !ontri(&tion or e%#ense. An i$$&stration o' a istant 9Internationa$ Transa!tion9 !o&$ (e: Resi ent enter#rise e%#orts goo s to an &nre$ate #erson a(roa * an there is a se#arate arrange"ent or agree"ent (etween the &nre$ate #erson an an AE whi!h in'$&en!es the #ri!e at whi!h the goo s are e%#orte . In s&!h a !ase the transa!tion with the &nre$ate enter#rise wi$$ a$so (e s&(;e!t to TPR. /* 0"!+123 1F 2"!"40I5I5- !+" A&' In a!!or an!e with internationa$$+ a!!e#te #rin!i#$es* the TPR have #rovi e that an+ in!o"e arising 'ro" an internationa$ transa!tion (etween AEs sha$$ (e !o"#&te having regar to the ALP* whi!h is the price that would #e charged in the transaction if it had #een entered into #$ unrelated parties in similar conditions. The ALP is to (e eter"ine (+ an+ one or "ore o' the #res!ri(e "etho s. The ta%#a+er !an se$e!t the "ost a##ro#riate "etho to (e a##$ie to an+ given transa!tion* (&t s&!h se$e!tion has to (e "a e ta4ing into a!!o&nt the 'a!tors #res!ri(e in the TPR. With a view to a$$ow a egree o' '$e%i(i$it+ in a o#ting the ALP* a variance allowance of 6 percent has #een provided under the !'4* The #res!ri(e "etho s have (een $iste (e$ow 1a3 Co"#ara($e Un!ontro$$e Pri!e 7etho 19CUP93 1(3 Resa$e Pri!e 7etho 1<RP793 1!3 Cost #$&s "etho 19CP793 1 3 Pro'it S#$it 7etho 19PS793 1e3 Transa!tiona$ Net 7argin 7etho 19TN7793 Severa$ (ases o' trans'er #ri!es are in vog&e:

1. Cost /ase #ri!es a3 F&$$ !ost (ase #ri!es (3 7argina$ Cost #ri!es !3 Stan ar Cost #ri!es -. 7ar4et /ase #ri!es 6. Negotiate Pri!es =. D&a$ Pri!es >. Sha ow Pri!es A i''erent (asis 'or trans'er #ri!ing !an (e &n er whi!h the AEs o#erate. e#en ing &#on the !ir!&"stan!es

!ransfer 'rices .hen A"s have 3ourcing Freedom I' the AEs have !o"#$ete in e#en en!e on so&r!ing* #ri!ing e!isions !an (e reso$ve (+ the !on!erne AEs. The S&##$+ing AE 1SAE3 "eets the !o"#etition with res#e!t to the #ri!es an other !on itions o' sa$e or e$se it wi$$ not get the (&siness 'ro" the Re!eiving AE 1RAE3. Si"i$ar$+* &n$ess the RAE is #re#are to #a+ a #ri!e e,&iva$ent to the "ar4et #ri!e* the SAE wo&$ not s&##$+ to it (&t se$$ its #ro &!ts to !&sto"ers o&tsi e the !o"#an+. The o&tsi e #ri!e "e!hanis" wi$$ govern the 'i%ation o' trans'er #ri!es. )owever* this s+ste" oes not ens&re an o#ti"&" &ti$i?ation o' reso&r!es o' the !o"#an+ as there is a #ossi(i$it+ o' a RAE (&+ing 'ro" o&tsi e the !o"#an+ es#ite the e%isten!e o' i $e !a#a!it+ within the !o"#an+. On the other han * i' the SAE is !on'i ent o' '&$$ &ti$i?ation o' !a#a!it+ even in the a(sen!e o' an or er 'ro" the other ivision either (+ #ro!essing so"e other "ateria$s or !o"#onents or #ro &!ing an se$$ing the sa"e #ro &!t or !o"#onent to o&tsi e #arties* it nee not (other a(o&t RAE@s a!tions. !ransfer 'rices 7nder 3ourcing 4estrictions Ro(ert N Anthon+ has #res!ri(e a set o' r&$es (ase on the nat&re o' #ro &!ts trans'erre . )e !ategories the" into 'o&r !$asses an s&ggests a i''erent (asis 'or ea!h !$ass o' #ro &!t. 8lass 1 'roduct9 These are the #ro &!ts whi!h are never $i4e$+ to (e got #ro &!e o&tsi e the !o"#an+ 'or reasons o' ,&a$it+* se!re!+ o' esign* re$ative i"#ortan!e to the 'ina$ #ro &!t or the ris4 o' $oosing s#are #arts "ar4et. It is ver+ i''i!&$t to o(tain !o"#etitive #ri!es 'or these #ro &!ts. The "ost rationa$ (asis 'or #ri!ing !$ass 1 #ro &!ts is stan ar !ost #$&s stan ar "argin. 8lass 2 'roducts9 These in!$& e #ro &!ts "an&'a!t&re with s#e!ia$ e,&i#"ent an e%#ertise an the so&r!ing !annot (e !hange 're,&ent$+. I' the so&r!ing e!ision were to (e !hange in 'avo&r o' #&r!hasing the #ro &!t 'ro" an o&tsi e ven or* the #$ant an e,&i#"ent wi$$ have to (e s!ra##e . )en!e* the so&r!ing e!isions on!e "a e have to (e o#erative 'or a n&"(er o' +ears.

8lass / 'roducts9 These in!$& e #ro &!ts that !an (e #ro &!e o&tsi e the !o"#an+ witho&t an+ signi'i!ant isr&#tion to the #resent o#erations. The+ are #ro &!e on genera$ #&r#ose "a!hines eg.* Ao$tage Sta(i$i?ers* Ther"ostati! Contro$ Units. 8lass : 'roducts9 C$ass = #ro &!ts are a$so "an&'a!t&re with genera$ #&r#ose "a!hiner+ an "a4e or (&+ e!isions !an (e a$tere an+ti"e witho&t "&!h isr&#tion to the interna$ o#erations. These #ro &!ts are !&rrent$+ (eing so$ #art$+ to o&tsi e #arties an #art$+ trans'erre to RAE. Davi So$o"on in his (oo4 on ivisiona$ #er'or"an!e "eas&re"ent an !ontro$ #ro#ose a 'ra"ewor4 o' trans'er #ri!es (ase on the ,&ant&" o' the o&t#&t trans'erre 'ro" one AE to another. 1. Is there a !o"#etitive o&tsi e "ar4et 'or the trans'erre RAE "a+ 'ree$+ resort toB #ro &!t to whi!h

I' +es* the trans'er #ri!e sho&$ (e this #ri!e. Te"#orar+* a(nor"a$ !hanges in s&!h "ar4et #ri!es sho&$ (e ignore . I' no* then see the ne%t ,&estion -. Is the trans'erre the AEB ,&antit+ a##re!ia($e eno&gh to "ateria$$+ a''e!t an+ o'

I' no* $eave the trans'er #ri!e to (e negotiate (etween AEs. I' +es* see the ne%t ,&estion 6. Is the trans'erre ,&antit+* a #re o"inant #art o' the SAEB I' no* trans'er #ri!e sho&$ (e stan ar varia($e !ost #$&s a $&"# s&" !ontri(&tion to the SAE@s 'i%e !osts an #ro'it. This $&"# s&" to (e eter"ine (+ re'eren!e to the ann&a$ (& gete trans'er ,&antit+ an not (e !hange i' the a!t&a$ ,&antit+ were to (e i''erent. I' +es* see the ne%t ,&estion. =. Is the SAE a($e to "eet a$$ the #ro(a($e re,&ire"ents o' the RAEB I' +es* the trans'er #ri!e sho&$ (e the sa"e as in 163 a(ove e%!e#t that the $&"# s&" sho&$ (e !a$!&$ate so as to give the SAE its target nor"a$ ret&rn. I' not* it "eans the SAE is short o' the re,&ire !a#a!it+. This "ight (e on$+ a short ter" #heno"enon sin!e the enter#rise !an ta4e ste#s to re"ove this !a#a!it+ !onstraint. In the short r&n* the ,&estion (e!o"es one o' a$$o!ation o' the SAE@s s!ar!e #ro &!t 'or the "a%i"&" overa$$ ret&rn to the enter#rise. Un er the !ir!&"stan!es* the trans'er #ri!e sho&$ (e arrive at in s&!h a "anner as to re#resent a 'air sharing o' the

'ina$ #ri!e (etween the two AEs* so that the+ !o&$ $i4e an+ nor"a$ ea$.

earn the sa"e ret&rns

'ros and 8ons of 2ifferent ;asis of !ransfer 'ricing

!ransfer 'rice ;ased on 8ost 'rice9 Cost (ase trans'er #ri!es 'or inter !osts or stan ar !osts. The+ "a+ !osts or "argina$ !osts. The "ain is that the SAE is not en!o&rage !osts are a&to"ati!a$$+ re!overe #ri!es. AE transa!tions !an (e (ase on a!t&a$ (e (ase on the '&$$ re!over+ o' a!t&a$ $i"itation o' a!t&a$ !ost trans'er #ri!es to sear!h 'or e!ono"ies as the a!t&a$ 'ro" the RAE as #art o' the trans'er

!ransfer 'rices ;ased on 0ar%et 'rices9 The "ar4et #ri!e o''ers a so&n (asis 'or trans'er #ri!e. It in &!es the SAE to have an e''i!ient !ontro$ on #ro &!tion !osts* as e%!ess !osts !annot (e #asse on to the RAE. A$so* "ar4et #ri!e (ase trans'er #ri!es are easi$+ a!!e#te (+ the a$$. The "ain #ro($e" with "ar4et (ase trans'er #ri!es is that the "ar4ets 'or "ost o' the inter"e iate #ro &!ts are !hara!terise (+ i"#er'e!t !o"#etition. At a given #oint o' ti"e* a wi e range o' "ar4et #ri!es !an (e o(serve 'or a$"ost i enti!a$ #ro &!ts or !o"#onents. This in!reases the !on'$i!ts in trans'er #ri!e negotiations. So"eti"es istress #ri!es r&$e the "ar4et. Des#ite these $i"itations* "ar4et #ri!e o''ers a (etter trans'er #ri!ing "e!hanis" than !ost #ri!es. !ransfer 'rices ;ased on 3hadow 'rices9 The o#ti"&" #ri!es 'or the o&t#&t trans'erre or the servi!es #rovi e (+ one AE to another !an (e !a$!&$ate (+ &sing a $inear #rogra""ing "o e$ 'or the $ogisti!s '$ow to o#ti"i?e a given '&n!tion 1sa+* #ro &!tion or sa$es #attern3 within given !onstraints. !ransfer 'rices ;ased on 2ual 'rices9 So"eti"es two sets o' trans'er #ri!es are &se . The SAE@s reven&e an+ (ase on nor"a$ sa$es #ri!e $ess a #er!entage to ta4e !are o' the se$$ing an istri(&tion !osts. The RAE "a+ (e !harge the stan ar !osts 'or the #ro &!t. The i''eren!e (etween the res&$tant two sets o' #ri!es "a+ (e !harge to gro&# hea . This a##roa!h is #ossi($e i' the AEs are ivisions o' sa"e enter#rise. The SAE is en!o&rage to he$# "a%i"i?e its #ro'its. Re!ent$+ C/DT has noti'ie the si%th "etho to eter"ine ALP. The new "etho inserte (+ wa+ o' R&$e 1CA/ states that Dan+ "etho whi!h ta4es into a!!o&nt the #ri!e whi!h has (een !harge or #ai * or wo&$ have (een !harge or #ai * 'or the sa"e or si"i$ar &n!ontro$$e transa!tion* with or (etween non5asso!iate enter#rises* &n er si"i$ar !ir!&"stan!es* !onsi ering a$$ re$evant 'a!tsE* sha$$ (e

!onsi ere as one o' the "etho s 'or a##$i!a($e 'ro" F0 -C1151- onwar s. :* 21870"5!A!I15

eter"ination o' ALP. This R&$e is

The #rovisions !ontaine in the TPR are e%ha&stive as 'ar as the "aintenan!e o' o!&"entation is !on!erne . This in!$& es /a!4gro&n in'or"ation on the !o""er!ia$ environ"ent in whi!h the transa!tion has (een entere into* In'or"ation regar ing the internationa$ transa!tion entere into* Ana$+sis !arrie o&t to se$e!t the "ost a##ro#riate "etho an to i enti'+ !o"#ara($e transa!tions* an ALP o' the transa!tion. the a!t&a$ wor4ing o&t o' the

This a$so in!$& es re#ort o' an a!!o&ntant !erti'+ing that the ALP has (een eter"ine in a!!or an!e with the TPR an that #res!ri(e o!&"entation has (een "aintaine . This o!&"entation sho&$ (e retaine 'or a "ini"&" #erio o' F +ears. )owever* it "a+ (e note that in !ase the va$&e o' the internationa$ transa!tion is (e$ow INR 1C "i$$ion* it wo&$ (e s&''i!ient 'or the ta%#a+er to "aintain o!&"entation an in'or"ation whi!h s&(stantiates his !$ai" 'or the ALP a o#te (+ hi". In e''e!t* the+ nee not "aintain the #res!ri(e o!&"entation. 6* ;742"5 1F '411F - !A<'A="4 14 !A< 1FFI8"4, The #ri"ar+ on&s is on the ta%#a+er to eter"ine an ALP in a!!or an!e with the TPR an to s&(stantiate the sa"e with the #res!ri(e o!&"entation. Where s&!h on&s is is!harge (+ the ta%#a+er an the ata &se 'or eter"ining the ALP is re$ia($e an !orre!t there !an (e no intervention (+ the ta% o''i!er. In other !ases* where the ta% o''i!er is o' the view that the 1a3 #ri!e !harge in the internationa$ transa!tion has not (een eter"ine in a!!or an!e with the "etho s #res!ri(e * 1(3 or in'or"ation an o!&"ents re$ating to the internationa$ transa!tion have not (een 4e#t an "aintaine (+ the assessee in a!!or an!e with the TPR* 1!3 or the in'or"ation or re$ia($e or !orre!t* ata &se in !o"#&tation o' the ALP is not o!&"ent

1 3 or the assessee has 'ai$e to '&rnish an+ in'or"ation or whi!h he was re,&ire to '&rnish &n er the TPR

the ta% o''i!er "a+ re;e!t the ALP a o#te (+ the assessee an eter"ine the ALP in a!!or an!e with the TPR. For this #&r#ose* he wo&$ then re'er the "atter

to a Trans'er Pri!ing O''i!er 19TPO93 1a s#e!ia$ #ost !reate 'or va$&ation o' ALP3 who wo&$ eter"ine the ALP a'ter hearing the arg&"ents o' the ta%#a+er. 6* "FF"8!3 1F A2>73!0"5! !1 !+" A&' In !ase the ALP eter"ine (+ the TPO in i!ates &n erstate"ent o' in!o"e (+ the ta%#a+er it !o&$ res&$t into the 'o$$owing 1a3 A ;&st"ent to re#orte in!o"e o' the ta%#a+er 1(3 Lev+ o' #ena$t+ G.1. A ;&st"ent to the Re#orte In!o"e The ta% o''i!er is (o&n to a ;&st the re#orte in!o"e o' the ta%#a+er with the a"o&nt o' a ;&st"ent #ro#ose (+ the TPO. This wo&$ have an e''e!t o' in!reasing the assesse in!o"e or a$ternative$+ e!reasing the assesse $oss. F&rther"ore* the e$igi($e e &!tions avai$a($e to the ta%#a+er &n er se!tion FC !o&$ not (e avai$e on the enhan!e in!o"e. )owever* those ta%#a+ers who are e$igi($e 'or e &!tions &n er se!tion 1CA an 1C/ re"ain &na''e!te as these e &!tions re"ain avai$a($e on the enhan!e in!o"e. 6*2* 'enalties Pena$ties have (een #rovi e as a #ro!e &ra$ re,&ire"ents is as 'o$$ows: isin!entive 'or non5!o"#$ian!e with

1a3 Pena$t+ 'or Con!ea$"ent o' In!o"e 5 1CC to 6CC #er!ent on ta% eva e 1(3 Fai$&re to 7aintain8 F&rnish Pres!ri(e the va$&e o' the internationa$ transa!tion Do!&"entation 5 - #er!ent o'

1!3 Pena$t+ 'or non5'&rnishing o' a!!o&ntant@s re#ort* 'ai$&re to re#ort internationa$ transa!tions* 'ai$&re to "aintain or '&rnish in!orre!t o!&"ents8 in'or"ation5 -H o' va$&e o' internationa$ transa!tion. The a(ove #ena$ties !an (e avoi e reasona($e !a&se 'or s&!h 'ai$&res. i' the ta%#a+er #roves that there was

Another i"#ortant a"en "ent "a e to In ian trans'er #ri!ing reg&$ation is the intro &!tion o' A van!e Pri!ing Agree"ents 1APA3. Un er the APA ta%#a+ers !an a##roa!h the /oar 'or eter"ination o' the ar"@s $ength #ri!e in re$ation to an internationa$ transa!tion that "a+ (e entere into (+ the ta%#a+er.