What is International Transaction for Transfer Pricing
Transfer pricing is the value that is attached to the goods and services that are transferred between related parties. Say,it is the price which is paid by one unit of an organization to another unit of the same organization located in different countries (with exceptions), for the goods and services which are transferred between them. The transfer pricing law helps in ensuring that transactions between associated enterprises do not happen at an unreasonably favourable or any controlled price.
Hence, we can say that the major objective of transfer pricing in international transactions would be to ensure that the transactions between any related parties or associated enterprises are taking place as if the same is happening between two unrelated parties.
Say, company A is manufacturing clothing while company B is the distributor of the clothing manufactured by A in Dubai. But C is the parent company of both these companies, which makes company A and B related parties as they are having common control. Hence, the transaction of clothing between companies A and B shall now be subject to provisions of transfer pricing under Income Tax Act.
International or Cross Border Transactions
The Finance Act, 2001 was brought in by the Ministry of Finance, India for the purpose of replacing section 92 along with section 92F and 92A of the Income Tax Act. With this, the major purpose or intention was to provide clarity with regard to the statutory framework so as to provide a fair and reasonable computation with equitable profits and tax in the country. There were also certain rules brought in by the CBDT (Central Board of Direct Taxes) for transfer pricing (Rule 10A to Rule 10E) which mentioned even the minute details in relation to the Arm’s Length Price, associated enterprise, and the documents which were required for involving in the international transactions.
For applying transfer pricing provisions two conditions are to be satisfied by the business entities in India, amongst which the first one is to have an international transaction while the second one is that it must have happened between two or more associated business enterprises where at least one party is a non-resident.
Thus, an international transaction is nothing but anactivity or the transaction between two or more associated entities where either one or both the parties to the transaction are non-resident. This can include the following;
- transaction related with providing of services,
- transactions involving buying, selling, or offering a lease of tangible and intangible properties,
- capital financing deals like borrowing, or lending, providing of guarantees,
- a mutual deed among associated enterprises for appointment or allocation of any cost, contribution, or expense for that matter.
For being considered as an associated enterprise the conditions which need to be satisfied are managerial participation or ownership of one business by another. As per the section 92A of the Income Tax Act, the following can be considered as associated enterprises;
- One of the parties participates in a direct or indirect manner in the management or control of the capital of other entities, or
- Parties who have common control in the management or control or capital of the other, or
- An enterprise holds shares directly or indirectly with voting power of not less than 26%, or
- Enterprises are under common control through shareholding and voting power of more than 26%, or
- An enterprise has an advanced loan to another enterprise which is 51% or more of the value of total assets of the other enterprise, or
- One enterprise has guaranteed not less than 10% of the total borrowings of the other enterprise, or
- One enterprise appoints 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 the other enterprise, or
- Same person or persons appointed, 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 entities that are involved, or
- The production or further processing of goods or articles or business carried out by one entity is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licenses, etc. which is owned by the other entity, or
- At least 90% or a higher of the raw materials and consumables are manufactured by one entity from the other entity or by those persons who are specified by the other entity, and the prices and also the other conditions relating to the supply of the same are influenced by such other entity, or
- Products or Articles which are produced by one entity are sold to the other entity or such persons specified by the other entity, and the prices or costs and the other conditions relating to the same are influenced by such other entity, or
- Enterprises under the common control of an individual or his relative or jointly by such individual and the relative, or
- Enterprise under the common control of HUF or Hindu Undivided Family or member of such HUF or jointly by such member and his relative, or
- Where an enterprise holds not less than 10% interest in another enterprise which is a firm, association of persons, or body of individuals.
Arm’s Length Price
When a transaction is entered into by unrelated parties i.e., a buyer and a seller in a common marketplace, they will be adopting the open market price for the completion of such transaction. But if the same is entered into between two related parties, then as per the Arm’s Length Principle, the price should be the same as the price, which they would have adopted if such parties were not related to each other.
It can be defined as the price at which transactions between two entities other than the associated enterprises or related parties would take place in an uncontrolled situation.
Computation of Arm’s Length Price (ALP)
As per the provisions of section 92C, the ALP with respect to an international transaction can be determined through any of the following rules;
– Cost Plus method
– Profit split method
– Comparable Uncontrolled Price Method
– Transactional Net Margin Method
– Resale Price Method
The best possible methods of computing ALP shall be adopted on the basis of the type and class of transaction.
Documents to be maintained for International Transactions
In case the value of international transactions between related parties exceeds INR 10,00,000 in a financial year, then detailed maintenance of documentation is required or mandated as per the Income Tax Act.
Enterprises would need to maintain certain documents with respect to such transactions and some of these are;
- Enterprise-related documents,
- Details of the business entities,
- Relations with associates,
- Nature of the associates,
- A profile of the multinational group of which the assessee entity is question is a part,
- A description of the ownership structure of the assessee enterprise.
Certain transaction-specific documents like;
- Details of each transaction,
- Description of all the businesses performed,
- Details of the employed assets,
- Risks each party involved in the transaction has assumed,
- Economic and market analysis.
Other documents which are related to the computation namely;
- Description regarding methods considered while computing,
- Assumptions of actual work, policies, if any,
- Amendments made to the transfer price or any information, and
- Documents relied on the determination of the Arm’s length price.
Return Filing and Penalty for Non-Compliance
All the enterprises involved in such international transactions are required to report compliance as per the Income Tax Act. Hence, they should obtain a report from Chartered Accountant or Authorized Tax Practitioners in the prescribed format including all the necessary details pertaining to such transactions. The following points are to be considered by the accountant or tax practitioner;
- The computation of ALP and the maintenance of all regulations with regard to the same,
- All the necessary documents according to the regulatory requirements are maintained by the assessee or not.
The reports regarding the same are to be furnished using Form 3CEB for each financial year.
The penal provisions with regard to this are rigorous under the transfer pricing provisions. And this is detailed below:
- Under section 271(1)(c) hiding actual income or furnishing improper details, the penalty will be 100% to 300% tax on the additional income.
- As per Section 271G, not able to maintain documents as per the requirement, 2% of the value of the international transaction entered into between related parties.
- Not able to furnish the accountants’ certificate pertaining to section 271BA, a levy of fixed penalty of INR 100,000/-.
- Failed to maintain transfer pricing documentation under section 271AA, 2% of the value of the international transaction mentioned between the related parties.
Thus, we can now conclude that international transactions between associated enterprises or related parties should be maintained or transacted at the ALP, along with proper documentation and furnishing of details. The failure of this will result in rigorous Income Tax Proceedings and the attraction of penalties.