Transfer pricing is governed under Income Tax Act, 1961 (“IT Act”) which generally refers to prices of transactions between associated enterprises that may take place under conditions differing from those taking place between independent enterprises. It refers to the value attached to transfers of goods, services, and technology between related entities. The transfer pricing is also known as transfer costing
Provisions of Transfer Pricing
- Associated enterprise ( Section 92 of Income Tax Act, 1961)
Two enterprises shall be deemed to be associated enterprises if hold, directly or indirectly any time during the previous year is as follows:
- shares carrying not less than twenty-six percent of the voting power in the other enterprise
- shares carrying not less than twenty-six percent of the voting power in each of such enterprises
- Loan advanced by one enterprise to the other enterprise constitutes not less than fifty-one percent of the book value of the total assets of the other enterprise
- one enterprise guarantees not less than ten percent of the total borrowings of the other enterprise
- more than half of the board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of one enterprise, are appointed by the other enterprise
- more than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board, of each of the two enterprises, are appointed by the same person or persons
- the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licenses, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights
- ninety percent or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise
- the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise
- where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual
- where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family or by a relative of a member of such Hindu undivided family or jointly by such member and his relative
- where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than ten percent interest in such firm, the association of persons or body of individuals
- there exists between two enterprises, a relationship of mutual interest between the entities.
- International Transaction
Under section 92B of Income Tax Act, 1961 international transaction means a transaction between two or more associated enterprises, either or both of whom are non-residents in the nature of:
- Purchase, sale or lease of tangible or intangible property, or
- Provision of services, or
- Lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and
- Shall include mutual agreement or contract between two or more associated entities for the allocation or any contribution in the form of cost or expense incurred or to be incurred in the future related to business.
A prior agreement exists between an entity with another entity that is not an associated entity in relation to the relevant transaction irrespective of whether such another person is a non-resident or not.
- Specified domestic transaction
Those transactions under section 92BA in case of an assesses having transaction other than international transaction such as any transaction under section 80A, transfer of goods or services or any transaction in subsection (8) or (10) of section 80-IA, any transaction with the person under section 115BAB or any other transaction as may be prescribed where the aggregate of a transaction entered into by a person in the previous year exceeds by Rs. 20 crores.
- Computation of arm’s length price
A price which is applied in a transaction between unassociated entities to an uncontrolled situation, Under section 92C of IT Act, 1961 computation of arm’s length price are on the basis of nature of transaction or class of transaction or class of associated person or functions performed by such person by the following methods:
- Comparable uncontrolled price method
- Resale price method
- Cost-plus method;
- Profit split method;
- Transactional net margin method;
- Such other methods as may be appropriate by the Board.
Where more than one price is calculated by different appropriate methods, the arm’s length price shall be taken as the arithmetic mean of the prices.
Arm’s length price is not applicable
Section 92 is not applicable to a non-resident who is not taxable under section 9 (income which is deemed to accrue or arise in India) and section 5 (non- resident is chargeable to tax in respect of income which is received or deemed to be received or accruing or deemed to accrue or arise in India) of the IT Act, 1961.
- Maintenance and keeping records
Under section 92D of IT Act, 1961 every person who has entered into an international transaction or specified domestic transaction or being a constituent entity of an international group shall keep and maintain such information and documents related with this transaction or international group as may be prescribed for a period of 8 years from the relevant Assessment Year.
- Report on the international transaction or specified domestic transaction
Under section 92E every person who has entered into an international transaction or specified domestic transaction during a previous year shall obtain a report from a Chartered Accountant and furnish such report before the specified date in the prescribed form duly signed and verified by the accountant in Form 3CEB on or before 30th November of the relevant assessment year.
Benefits of Transfer Pricing
Following benefits of transfer pricing which are as follows:-
- Transfer pricing helps to reduce the duty costs when goods sell to a high tariff country by shipping at minimal transfer price.
- It helps in reducing income and corporate taxes in high tax countries by overpricing goods that are transferred to those countries with lower tax rates.
Limitations of Transfer Pricing
Following limitations are as follows:-
- There lots of additional costs incurred to execute transfer pricing and maintaining a proper accounting system to support them.
- Transfer pricing is a very complicated and time-consuming methodology.
- It gets difficult to find prices of intangible items such as services.
- Product obsolescence, credit risk warranty of the products and market-related risks are involved and creates problems for both buyer and seller.
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Also Read: GST on Third-Party Exports