Transfer pricing regulations are increasingly becoming popular over the last few years due to the increasing tax controversies among multinational companies.
When two related entities enter into any transaction, they manipulate the price to their advantage so that the tax liability of the group company is minimum. To curb this, transfer pricing law came into existence.
As per the Indian Transfer Pricing law, income arising from international transactions or specified domestic transactions between associated enterprises should be computed based on the arm’s length price.
Earlier the applicability of transfer pricing provisions was restricted to International Transactions only. However, with subsequent ammendments, the scope of transfer pricing provisions is extended to specified domestic transactions also. With this ammendment, all the transfer pricing requirements relating to transfer pricing documentation, transfer pricing accounting, transfer pricing methods, etc. shall equally apply to specified domestic transactions.
Transfer price is the actual price charged for goods and services sold between two related entities within an enterprise. These entities are a part of a multinational or domestic group. Now, we know that the tax rates vary from country to country. Therefore it is possible that these entities may adjust the price of the transaction in a way so that the group company benefits from minimum tax liability. This is done by adjusting the price between two group entities. The country having high tax rate books less profit so that tax liability is minimum.
But with transfer pricing law in place, a transfer price for the transaction should match either with what the seller would normally charge an independent, arm’s length customer, or what the buyer would normally pay to an independent, arm’s length supplier.
Transfer pricing applies to every entity that enters into an international transaction or specified domestic transaction with any of its associated enterprise.
Arm’s length transaction is a deal in which the buyer and the seller act independently, unrelated, well-informed and have equal bargaining power. The buyer and seller both should act purely in their own self-interest to get the best price out of the deal and are not subject to any pressure or duress from the other party. Since both buyer and seller have an equal right, an arm’s length transaction is the one that ensures fair market value.
According to sections 92, 92A, 92B, 92C, 92D, 92E and 92F, a company can be termed as an associated enterprise with respect to the other if,
- It is involved directly or indirectly or with the help of one or more intermediaries in the management, control, or the capital of the other company.
- If any person/persons of the respective company who is/are involved directly or indirectly or with the help of one or more intermediaries in the management, control, or the capital of one company is/are involved directly or indirectly or with the help of one or more intermediaries in the management, control, or the capital of the other company
A set of extensive information and transfer pricing documentation relating to international transactions undertaken with Associate Enterprise is required to be maintained by the taxpayers on annual basis. The transfer pricing documentation also includes details of the international transactions and entities involved in the related party international transactions along with other requirements. Noncompliance of the rules leads to a heavy penalty.
Apart from that, every entity who enters into an international transaction or specified domestic transaction with any of its associated enterprise has to mandatorily get the Transfer Pricing Audit done. The audit has to be conducted by the specified person and he is responsible for uploading the Transfer Pricing report on the Income Tax website. The due date for uploading the report is 30th November of every Assessment Year. Noncompliance of the rules leads to a heavy penalty.
On account on non filing of the report, a penalty of Rs. 1 lakh is leviable.
On account of non-maintenance or non-preparation of the Transfer Pricing documentation, penalty leviable is 2% of the total international transaction value.
On account of non-filing of the Transfer Pricing documentation, a further penalty of 2% of the total international transaction value is leviable.