A transfer price is a price that is used to value transactions between affiliated enterprises. In other words, it is the price paid for goods or services by one company to a related party situated in a different country.
A higher price increases the seller’s income and decreases the buyer's income, and a lower price decreases the seller's income and increases the buyer's income. Therefore, the transfer price influences the tax base of both the seller country as well as the buyer country which are involved in cross-border transactions.
The concept of transfer pricing was introduced in the United States in 1921, wherein consolidated returns reflecting the actual tax liability were permitted to be prepared on behalf of controlled entities.
Though in India, these provisions were introduced years after the US, post-globalization, in 1991, the presence of Multi-National Enterprises (MNEs) in India and their ability to allocate profits in different jurisdictions by controlling prices in intragroup transactions made the issue of transfer pricing a matter of grave concern for the Indian policymakers.
Before introducing transfer pricing regulations, specific introductory provisions existed under the Income Tax, Customs, and Excise legislation. A separate code on transfer pricing was established through the Finance Act, 2001 by introducing Sections 92 to 92F under the Income Tax Act 1961. It covered intra-group, cross-border transactions. The regulations were broadly based on the Organisation for Economic Co-operation and Development (OECD) Guidelines.
The transfer pricing rules become applicable when two or more associated companies enter into a mutual contract during an international transaction for goods, services, or facilities offered by any one or all companies. In such case, the cost shall be calculated considering the Arm's length price of the particular service, or facility, or goods.
Let us now understand some technical aspects of the above explanation:
As per section 92a of income tax act 1961, associated enterprise refers to an enterprise that directly or indirectly or through one or more intermediaries participates in:
Apart from this, section 92a of income tax act lists the situation during which the AE relationship is established. For example, any person or enterprise that holds, directly or indirectly, shares carrying not less than twenty-six percent of the voting power shall be deemed an associated entity.
For a transaction to be an international transaction, it should satisfy the following two conditions cumulatively:
Having regard to various factors, the following can be used to calculate Arm’s Length Price in India:
It is mandatory to maintain documentation when the taxpayer's aggregate book value of international transactions exceeds INR one crore.
Section 92D under the Income Tax Act 1961, mandates a taxpayer to maintain transfer pricing documentation in the form of TP Study and Form No. 3CEB. This report through Form No. 3CEB must be obtained from an independent practicing Chartered Accountant which is required to be furnished to the Income Tax department on or before the specified due date. The specified date means the date one month prior to the due date for furnishing the return of income under Section 139 of the Act. This report is essential in validating the fairness of arm's length pricing of the international/specified domestic transactions. The key component of a TP Report is the economic analysis which forms a foundation to conclude that the international transactions with its overseas affiliates are at arm's length.
To be filed if the following two conditions are satisfied:
The aggregate value of the international transaction exceeds INR 50 crores, or the aggregate value of international transactions regarding the purchase, sale, transfer, lease, or use of the intangible property as per the books of accounts intangible property exceeds INR 10 crores.
For further queries and professional assistance about section 92A of income tax act 1961, feel free to contact ASC Group.