International trade transactions can be subject to manipulation in terms of the price at which they are undertaken. This can lead to a shifting of profits from one country to another. This can be understood with a simple example. Suppose, a company imports goods from one of its associate entities in a tax haven country. As India is a high-taxation country, the company decided to import goods at an elevated price. That company in India can claim a higher amount of expense for imported goods leading to reduced taxes. Whereas, as the other entity is in a tax haven country, even an increased sales price and consequently increased profits won’t result in any taxes. This has led to the shifting of profits from India to the tax haven, thereby causing tax losses to the Indian government. That’s where the transfer pricing regulations in India kick in.
What Transfer Pricing Regulations Encompass?
Transfer pricing is the value at which the transactions relating to goods or services are undertaken between associated enterprises. It is important that the transaction price between the related parties is unbiased and at arm's length price so that the accounts and taxes are not manipulated.
Transactions Covered Under Transfer Pricing Regulations
Most of the transactions undertaken between the Indian entity and its associated enterprise fall within the transfer pricing ambit. These basically include:
- Sale and purchase of the goods
- Providing or availing of any services
- Sale or purchase of any fixed asset
- Sale or purchase of intangible assets
- Royalty fees
- Loan paid or received and interest charged thereon
- Any other transaction as may be specified
Transfer Pricing Methods
The income tax law has specified certain methods to determine the transfer price in case of international transactions between related parties. The following are these transfer pricing methods:
- Comparable Uncontrolled Price Method
Under this method, the price charged or paid for the goods or services under any comparable and uncontrolled transaction should be identified. The international transaction between related parties and the uncontrolled transaction should be compared and appropriate adjustments should be made to arrive at the arm’s length price.
- Resale Price Method
Under this method, the price at which the goods and services obtained from an associated enterprise would be resold to an unrelated enterprise should be identified. Following this, adjustments should be made to such resale price for the margin, expenses in relation to the connection for purchase or sale and any other differences.
- Cost Plus Method
Under this method, the amount of direct and indirect costs of production incurred by the enterprise for the goods and services provided should be determined. An appropriate amount of gross profit markup should be made as if such goods or services are provided to an unrelated enterprise in a comparable uncontrolled transaction.
- Profit Split Method
Under this method, the combined net profits of the associated enterprises being generated from the international transaction should be determined. Following this, the relative contribution of each associated enterprise for generating such combined net profit shall be evaluated based on the functions performed, assets employed and risks assumed by such enterprises. The combined net profits should be allocated amongst such enterprises based on their relative contributions. This method is basically used in international transactions that involve unique intangibles or when there are multiple international transactions and they are so inter-related that they cannot be evaluated separately for determining the arm’s length price.
- Transactional Net Margin Method
Under this method, the net profit margins that are realised by an enterprise from international transactions entered into with an associated enterprise shall be computed considering the costs incurred, assets employed or sales effected. Secondly, the net profit margin generated from a comparable uncontrolled transaction by an unrelated enterprise shall be computed. The margin should be adjusted for concerned differences and then should be compared with the margins in the first case.
- Any Other Method
Income tax law also allows taxpayers to apply any other method for transfer pricing purposes if they are more appropriate for the concerned transaction.
Transfer Pricing Audit
As per Section 92E of the Income Tax Act, 1961, every person who enters into an international transaction during the previous year is required to furnish a report from a Chartered Accountant in the prescribed form and manner. The auditor’s report shall be submitted in Form No. 3CEB as per Rule 10E. The auditor is required to go through the accounts and records relating to the international transaction and give his opinion on whether all the prescribed documents and information have been maintained by the assessee.
In a Nutshell
The transfer pricing rules and regulations were introduced in order to curb tax evasion due to the manipulation of transaction prices in the case of international transactions. The entities that undertake international transactions with their associated enterprises need to ensure compliance with all the regulatory requirements in relation to the income tax laws. In case you need any assistance in relation to transfer pricing compliance, feel free to contact the Exim Advisory.
Must Check "Certificate of Origin"