In this blogpost, Saurodeep Dutta, Student of University of Calcutta and the Diploma in Entrepreneurship Administration and Business Laws by NUJS, writes about what is transfer pricing, it’s applicability and computation.

Introduction

Transfer Pricing is one of the grey areas of International Taxation, and in practise is applicable mostly to divisions between multinational companies, who have various units working in tandem in various jurisdictions around the world. Transfer pricing provides optimal results for these enterprises, allowing them to stretch their profits across various jurisdictions, aiming for better use of their own resources by the use of other arms of their own enterprise, ultimately being better for the overall finances of the enterprise.

Definition

A definition is required here.

Investopedia says ” A transfer price is a price at which divisions of a company transacts with each other. Transactions may include the trade of supplies or labour between departments. Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as separately run entities.”[1]

Looking at this definition, we can conclude a few distinctive points about transfer pricing :-

• Transfer pricing normally involves the divisions of a company or at least units that are somehow related to each other.
• These are in the form of transaction
• These transactions may involve anything from supplies or labour, between the departments of the group companies
• This entire scenario comes into being especially when the involved parties to the transaction are regarded as being two separately run and administered units, under the umbrella of a larger,multi-entity firm.

Prices for goods and/or services is generally slightly lower than the market price of the product or the good being transferred, and it is specifically because the transaction is basically a ‘transfer’ between two related companies, instead of a ‘sale’ or a ‘purchase’ between the two companies.

An important point to note here, is that a very important feature of Transfer Pricing is the relation between the companies. The relation between the companies must be that one of the companies is an Associated Enterprise(AE), in relation to the other company. The Income Tax Act specifies 13 different relations between companies that will be regarded as being Associated Enterprises.

Transfer Pricing was initially a concept applied only to International Transactions between the units of multinational companies. The concept was enshrined in Section 92 of the Income Tax Act in 2001, dealing with the requirements of International Transactions. However, this concept was applied to domestic transactions with effect from 01/04/2013, bringing into its purview domestic transactions as well. It is thus important to now specify the Arm’s length nature of the transaction in domestic cases. This also provides a method of standardization of expenditure or fair market value for transactions between group companies.

Domestic Transfer Pricing had come about as a result of the case of CIT vs. GlaxoSmithKline Asia (P) Ltd. The Finance Ministry had been recommended to bring about a deterrent for complications that brought complications in relation to Fair Pricing rules. Thus, the Finance Bill had also stated a method which defines the applicability of the Domestic Transfer Pricing Rules on certain transactions.

Applicability

According to the now codified Section 92BA of the Income Tax Act, the provisions would apply to the following, referred to as Domestic transactions (the value of which,originally, would have to exceed Rs. 5 crore): –

1. any expenditure incurred between related parties referred to in section 40A(2)(b);
2. any transaction referred to in section 80A;
3. any transfer of goods or services referred to in section 80-IA(8);
4. any business transacted between the assessee and other person as referred to in section 80-IA(10);
5. any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which section 80-IA(8) or section 80-IA(10) are applicable; or
6. any other transaction as may be prescribed,

Note that any transaction of International variety nullifies the provisions’ applicability.

For the 2016-17 year, the value of the transaction has been increased to 20 crore rupees. This effectively ensures that a huge number of transactions will no longer come under the umbrella of Domestic Transactions, and it would not be applicable to them anymore.

Computation of Arm’s Length Price

Here, an important consideration is what the Arm’s Length Price[2] of the product would normally be. This can be calculated in the following manner

1. a) Comparable uncontrolled price method: Method is done by comparing the price charged for good/services in a controlled environment, versus the price charged in an uncontrolled environment
2. b) Resale price method: Determined by comparing the gross margin that the reseller earns from the controlled transaction with the gross margin from comparable uncontrolled transactions.
3. c) Cost plus method: Determined by comparing the cost that the manufacturer earns in a closed environment, an open environment.
4. d) Profit split method: Determined by evaluating the allocation of the combined profit or loss attributable to one or more controlled transactions with reference to the relative value of each controlled taxpayer’s contribution to that combined profit or loss.
5. e) Transaction net margin method: Determined by comparing the net profit on costs or sale that the manufacturer or service provider earns from the controlled transaction with net profit on costs or sale from comparable uncontrolled transactions.

Compliance Requirements

Like any other form of corporate taxation, there are certain compliance requirements that must be met for Transfer Pricing. This also has been specified in Section 92D of the Income Tax Act

1. Every assessee has to obtain and produce a Chartered Accountant-prescribed report in Form 3CEB
2. Every person who has entered into Specified Domestic Transaction shall keep and maintain such information and documents in respect thereof, as prescribed in Rule 10D of the Income Tax Rules.
3. Filing has to be done electronically on or before the due date of Income Tax returns, i.e., on or before the 30^th of November of the financial year.

Penalty Provisions

• Adjustment being treated as concealment : Penalty will be 100% to 300% of the tax on adjustment
• Maintenance of required documents not done : 2% of value of transactions
• Transaction in form (3CEB) from Chartered Accountant is not reported: 2% of value of transaction
• Documentation not furnished: 2% of value of transactions
• Failure to furnish report (3CEB) by the due date: Rs. 1,00,000

[1]http://www.investopedia.com/terms/t/transferprice.asp

[2] Arm’s Length Price: – Price that would normally be on the table if the parties to a particular transaction were at ‘arm’s length’, that is acting independently of any relation to each other, and with concern only for each other’s self-interest. Normally is a good indicator of market price.