Indian legislation on Transfer Pricing defines the norms regulating the application of the modalities of choices for transfer prices.
Through Transfer Pricing, associated firms belonging to the same group and residing in different countries determine the prices of commercial transactions amongst each other. This subject, covering several spheres such as fiscal and business norms, it’s always more and more under the close attention of both international or national fiscal authorities, and transnational groups.
India became a hub for several international subsidiaries in the last 10-15 years and, as side effect, controversies about Transfer Pricing arose proportionally.
The Finance Act, 2001 introduced the law on Transfer Pricing adding the sections 92A to 92F to the Indian Income Tax Act, 1961. These sections deal with the calculation of transfer prices and suggest detailed procedures.
Rules on transfer pricing are applicable on all thefirms taking part in an international transaction with an “associated company” (even if there is no financial impact of these transactions, but only changes in the balance of accounts). The objective is to calculate the comparable price that an unrelated party under free market condition would pay, also known as arm’s length price.
The fundamental criteria for determining whether a firm is deemed associated or not include the participation to the control managementor the equity ownership of a firm with respect to another. Participation could be either direct or indirect, or through one or more intermediaries.
By international transaction we essentially refer to a transaction not made within the country of the associated firms. At least one of the parties involved must be “not residing” and taking part to one or more of the following transaction:
• Purchase, sale or lease of tangible or intangible goods
• Supply of services
• Fund lending
• Any transaction which affects profits, income, losses or assets
• Agreements among the associated companies for the distribution of costs, duties and expenses.
Coherently with the international principles, the law prescribes that any income that derives from an international transaction within related companies must be calculated considering the market price (arm’s length price) that can be calculated with one of the following methods:
• comparable uncontrolled price method (CUPM)
• resale price method (RPM)
• cost plus method (CPM)
• profit split method (PSM)
• transactional net margin method (TNMM)
The taxpayer can choose the preferred method for each transaction, but the choice must consider the prescribed factors of the Transfer Pricing law.
The prescriptions of the new law concerning the conservation of the necessary documents are very thorough. Amongst them:
• general information on the commercial context in which the transaction took place
• information regarding the international transaction
• the analysis that was conducted to decide the most appropriate method
• the process with which the market price was calculated
• a report from an accounting expert that certifies that the market price was calculated in coherence with the law and that the necessary documentation is maintained
The documentation must be conserved for a minimum period of 8 years.
If the value of the international transactions is less than INR 10 million (€115.000 at current exchange), it is enough for the taxpayer to keep the documents and the information regarding the market price.
The burden of proof, both for the determination of the market price according to the law and for the proof of the latter with the documentation described above, is on the taxpayer.
When the taxpayer has fulfilled his duties and the data for the determination of the market price are deemed reliable and correct there can be no intervention by tax authorities. In the other cases:
• the tax authority believes that the market price ofthe international transaction has not been determined in a manner consistent withthe law
• information and documentation relating to the international transaction have not been retained by the taxpayer as prescribed by law
• the information or data used in the calculation of the market price is not reliable or correct
• the taxpayer has failed to provide documentations which were requested by the tax authorities
• the tax authority may reject the market price chosen by the taxpayer and it can provide another market price in accordance with law. In order to give the proper value, the tax authority will delegate the computing process to Transfer Pricing Officer (TPO) that will determine the market price after having listened to the taxpayer’s defense.
In the event that the Transfer Pricing Officer in respect of a misrepresentation and lower income determines the market price, the taxpayer will be subject to the amendment of declared income and / or fine.
The tax authority is obliged to modify the income declared by the taxpayer as a result of the adjustment proposed by the Transfer Pricing Officer. This will have the effect of increasing the income or alternatively decrease thelosses.
Penalties are levied for false or misleading statements:
• sanction for lower income declared: 100-300% of thetax evaded
• sanctions for failure to preserve the documentation required: 2% of the value of international transaction
• penalty for not having delivered the report of the expert accountant: INR 100.000 (about € 1.150 at current exchange rates).
These penalties can be avoided if the taxpayer is able to demonstrate that there was a reasonable cause for such failures.