Transfer pricing is when two companies or parties relate to each other enter (related parties) into a transaction. The “arm’s length principle” is the very foundation of such transactions. According to the arm’s length principle, the price at which a transaction occurs between two related parties must be similar to the price at which a comparable transaction may occur between unrelated parties in the open market. Transfer pricing in India is governed by the Income Tax Act 1961, wherein a Chartered Accountant is required to present a report on whether transactions between related parties are at an arm’s length or not.
Transfer pricing types
Transfer Pricing in India applies to domestic and international transactions, although the application rules are different. While international transfer pricing applies to all transactions between related parties regardless of the value, domestic transfer pricing is applicable only if the concerned party takes certain deductions under the law. The scope for international transfer pricing is quite broad, wherein the scope for domestic transfer pricing has been limited.
What transactions are covered under transfer pricing?
Transfer pricing in India covers all transactions between two related parties. Such transactions include transactions concerning intangibles, loans and guarantees, purchase or sale of goods and services, as well as research and development transactions.
Companies or firms must ensure that any transactions between related parties are at an arm’s length price to avoid or mitigate any risk concerning transfer pricing. Companies may enter into an advanced pricing agreement with the government to reduce any risk regarding transfer pricing or related transactions.
The tax laws allow for a minimum tolerance level for related party transactions, and the tax authorities generally accept any difference within such levels. Such tolerance level was at 1% for wholesale transactions and 3% for all others for the year ending 2020.
What are different methods for calculations of ALP?
Various methods are prescribed in India’s transfer pricing provisions and rules to calculate the arm’s length price. Such methods may be applied as per the transaction that the companies are undertaking. These include the following methods:
- Comparable Uncontrolled Price Method
- Resale Price Method
- Cost Plus Method
- Profit Split Method
- Transactional Net Margin Method
- Any other method as may be prescribed
The methods may be used as per the transaction undertaken between the two parties, and each method is suitable in different situations. The company’s consultant may calculate the arm’s length price between two parties on any transaction and issue a report wherein it is stated that such a transaction is as per the arm’s length price or not.
Transfer pricing report
A Chartered Accountant or a firm of Chartered Accountant may issue the transfer pricing report to any entity under the income tax law. Transfer pricing in India requires the chartered accountant to issue such reports u/s 92C of the act. Such reports are categorized under Form 3CEB and have to be digitally issued to the income tax department, including the consultant’s views regarding the party’s transactions.
Apart from the transfer pricing report, the consultant may also help the company prepare and submit the Master File & the country by country reporting as per the BEPS Action Plan 13. Companies have to ensure that documentation, as required by transfer pricing norms, is maintained. The same has to be certified by the Chartered Accountant in their form or report issued u/s 92C.
Transfer Pricing in India was made effective from the financial year, which ended in March 2002, to ensure no profit erosion and tax avoidance by related parties governed by different tax laws for various reasons. Transfer Pricing in India has constantly been evolving since the initial days. The government is looking to incorporate international laws and standardize the format as per the OECD’s requirements.
Transfer Pricing regulations require in-depth and technical analysis of all transactions subject to the arm’s length price between two parties. In such circumstances, consultants such as AKM Global, KPMG, PwC, etc., can help the companies properly analyze their transactions and mitigate transfer pricing risks concerning various transactions being undertaken by them.