Transfer Pricing
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This article is written by Amay Bahri who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.


Transfer pricing refers to a method of accounting for prices at which related parties, such as large corporations or companies and their smaller entities, transact with each other. There is no separate statute dealing with transfer pricing in the Indian taxation regime. All the provisions relating to transfer pricing are covered within the Income Tax Act. The provisions regarding transfer pricing were introduced in the Income Tax Act by an Amendment in 2002, so it has merely been 20 years since the introduction of the concept. Apart from this, the whole concept of transfer pricing is dealt with within a few provisions within the Income Tax Act, thus there is not a lot of statutory backing or depth in statutes when it comes to deciding with questions of transfer pricing. 

What comes within the ambit of transfer pricing?

Transfer pricing essentially covers intra-group cross-border operations and specific domestic operations. Due to its cross-border implications, it is necessary to take into account the wider international objectives of the nation when interpreting and laying down the rules relating to transfer pricing. The impacts of transfer pricing rules have global repercussions because it projects the country as a favourable place of doing business. Transfer pricing provisions ensure that neither of the entities are transacting at a disadvantageous price as compared to other similarly situated unrelated parties. Transfer prices usually do not differ much from market prices of goods, however, if there is a disparity between transfer prices and market prices, then the transfer pricing regulations come into play.

Transfer pricing in itself is not illegal; however, companies do misuse transfer pricing to shift tax liability to subsidy or entity placed in low-cost tax jurisdiction, which is illegal. To avoid misuse and keep a check on the transfer prices amongst companies and their subsidies, transfer prices are evaluated based on “arm length price” which is essentially the price at which the transaction between related parties should have been carried out, which is the price at which unrelated parties transact. There are various methods mentioned in the Income Tax Act to determine the arm length price. The provisions of the Income Tax Act for regulating transfer pricing apply to international transactions between associate enterprise and its subsidiaries.

Why are international transactions regulated under the Income Tax Act?

As mentioned earlier, Section 92 of the Income Tax Act, any income that is earned by an Indian entity through an international transaction, has to be computed as per arm’s length price. The intention in introducing such a provision was to prevent tax evasion by companies by undertaking transactions at different rates so as to shift the tax burden in tax friendly jurisdictions. To understand how this happens, take an example where Company D is a multinational company, and it has a subsidiary in India by the name of T. T and D transact for exchange of product which is then sold in India by T.

Consider that the Indian taxation regime is not beneficial for D. To reduce its tax liability in India, D would sell to T at a higher price which would lead to less taxable income. Transfer Pricing provision in the IT Act will apply to such transactions to determine the Arm Length Price and ensure that the transactions are carried out in a fair manner. Now, the computation of Arm’s length price can be done in various manners and the permissible manner as provided under section __ of the IT Act, but what the arm’s length price does is that it looks for businesses having similar business to that of the assessee (formally called comparables) and then looks at what price these businesses transact at. After analysing these comparable companies, the arm’s length price is computed and it is then seen if the assessee’s transactions are within this arm’s length price. By enforcing the arm’s length price, the authorities ensure that the transaction/trade is happening as per market standards and that there is no tax evasion.  

Essentials of Transfer Pricing 

For transfer pricing provisions to apply, the transaction in question has to be an “international transaction”. So the first requirement for transfer pricing is the occurrence of an international transaction. For an international transaction to happen the transaction has to be between two or more associated enterprises, where at least one party is to be a non-resident and one party has to be a resident. The point that becomes the point of contention in most international taxation cases is the issue of there being a “transaction”. Transaction is not defined in any statute; however, it has been accorded different meanings. As per Merriam Webster dictionary, transaction refers to the exchange or transfer; while according to Investopedia, transaction is an agreement to buy or sell or transfer. This aspect of there being a prior agreement or not is something that makes a lot of difference in any taxation regime and through the course of this piece we will understand the same.

Due to the evolving nature of taxation as a field, there controversies keep arising, and one such issue attracting a lot of litigation is the issue of characterisation of AMP expenditure for transfer pricing. AMP Expenditure stands for expenditure made for advertisement, marketing and promotion. This litigation stems from the confusion in the characterisation of AMP expenditure as ‘international transaction’ in the Income Tax Act. This aspect of law is still not settled as the Supreme Court has not deliberated on the issue and has not given a final holding; however, the Delhi High Court has given various judgements on the topic and to a limited extent the issue is settled by the High Court.

Court’s Approach 

The Maruti Suzuki v. Additional Commissioner of Income Tax was the first case to discuss this issue. The Delhi High Court here held that AMP expenditure will be an international transaction, provided the expenses incurred for the same exceeds the expense incurred by comparable entities. Similar was the approach of the court in LG Electronics where again the expense was considered to be an international transaction. In this case, the excess amount led to assumption of an understanding of international transactions between the subsidiary and the Foreign Associate Entity.

This was followed by the Sony Ericsson case before the Delhi High Court. Here the court held that AMP expenditure is an international transaction, and while doing so the court overruled the application of Bright Line Test (used in LG Electronic) of computation arm’s length price as it did not have statutory backing. AMP expense is argued to be considered as international transaction because the amount spent on AMP will always lead to benefitting of the brand name of the Associated Entity, thus it cannot be said that the amount spent here is for the local subsidiary and not for the main company. The Sony Ericsson case caused uncertainty again and it was being used to argue for application of transfer pricing provisions to AMP expenses, but this case applied in a limited context where the characterisation of AMP expense was not disputed. 

In the case of Maruti Suzuki v CIT, the question of characterisation again came to be considered. The court also referred to Sony Ericsson and held that the case will not apply here as the question of law was not deliberated upon in that case due to the assessee not contending that AMP expense was not international transaction. The court analysed the meaning of the word transaction and understood that transaction requires there to be some kind of agreement or understanding between the foreign associate enterprise and its subsidiaries. This agreement need not be written, but there has to be agreement for characterisation of transaction. The court held that in order for there to be an international transaction, the revenue has to prove that there was an agreement or direction from a related entity to carry out such AMP. This decision has been followed in various cases by the tribunals.


The above analysis of cases point that the AMP expenditure ordinarily will not amount to international transaction, however, the issue is still pending final deliberation by the Supreme Court as a civil appeal has been filed for finality on issue of AMP expenses. It will be interesting to see how the Supreme Court deals with the issue, especially in the absence of any substantive provision in the Income Tax Act dealing with international transaction in context with AMP expenses, and in light of rulings by the Supreme Court where it has held that incidental benefits should not be the sole reason for holding a transaction to be international transaction.

In addition to this, the definition of ‘international transaction’, in section 92B, starts with the word ‘includes’. This adds on to the complexities that the Supreme Court will have to cover when deliberating on the issue. Further, due to the complexities associated with various businesses and each case being different, the court will have to decide what all aspects have to be considered in absence of specific agreement for AMP expenses so that there is clarity for assessments in the future. 

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