Transfer Pricing FAQs

Q1. When do the transfer pricing outline regulations apply to a business?

Transfer pricing outline regulations apply to a business when it engages in transactions with related parties, especially if these transactions are conducted across international borders. As a Chartered accountant, it is important to note that related parties can include subsidiaries, affiliates, or entities under common control. The regulations are put in place to ensure that the prices at which goods, services, or intellectual property are exchanged between related entities are conducted at arm’s length—that is, similar to what would have been agreed upon between unrelated parties in similar circumstances.

Q2.When can two companies be called as ‘associated enterprises?’

Two companies can be called as ‘associated enterprises’ when there exists a significant degree of influence or control between them, either directly or indirectly. As a Chartered accountant, it is essential to understand that the concept of associated enterprises is crucial in the context of transfer pricing regulations.

According to transfer pricing guidelines, two companies are considered associated enterprises if one of them participates, directly or indirectly, in the management, control, or capital of the other. This includes scenarios where one company holds a significant share in the other’s voting power, holds the power to appoint key management personnel, or exercises substantial influence over the financial and operating policies of the other entity.

Q3. What is meant by ‘International Transaction’ with regard to Transfer Pricing Outline?

International transactions can encompass a wide range of activities, including the sale or purchase of tangible goods, the provision of services, the transfer of intellectual property, the lending or borrowing of money, and the allocation of research and development expenses, among others.
It’s important to note that even if an international transaction takes place between associated enterprises but is not directly related to the purchase, sale, or transfer of goods or services, it can still be subject to transfer pricing regulations. This is because tax authorities want to prevent any attempt to shift profits between related parties through such transactions.

Q4. What are the different procedures to calculate the arm’s length price?

– Understanding and applying the Comparable Uncontrolled Price (CUP),

Resale Price Method (RPM),

Cost Plus Method (CPM),

Transactional Net Margin Method (TNMM),

Profit Split Method (PSM),

and Comparable Profits Method (CPM) for international transactions.

Q5. What documents are required to be maintained by a company while executing an international transaction?

Maintaining comprehensive documentation is crucial for a company while executing an international transaction to demonstrate compliance with transfer pricing regulations and support the arm’s length nature of the transaction. The specific documents required may vary depending on the nature and complexity of the transaction, as well as local tax regulations. Generally, the following documents are essential to be maintained:
1.Transfer Pricing Study Report: A detailed study report that justifies the transfer pricing method chosen, provides a functional analysis of the associated enterprises, and explains how the arm’s length price was determined.

2.Comparability Analysis: A thorough analysis of comparable uncontrolled transactions to support the selection of the most appropriate transfer pricing method.

3.Functional and Risk Analysis: A description of the functions performed, risks assumed, and assets employed by the associated enterprises involved in the transaction.

4.Intercompany Agreements: Any written agreements or contracts between associated enterprises, outlining the terms and conditions of the international transaction.

5.Financial Statements: Financial information of the associated enterprises involved in the transaction, including balance sheets, income statements, and cash flow statements.

6.Segmental Data: Segmented financial data of the associated enterprises, particularly for multinational groups with diverse business segments.

7.and Market Research: Relevant industry and market data to support the arm’s length nature of the transaction.

Q6. Who is the authorized person to furnish the report under section 92E of the Transfer Pricing Regulation Act?

“Transfer Pricing Report,” is required to be prepared by the Chartered Accountant in accordance with the provisions of the Act and any rules or guidelines issued by the relevant tax authorities. This report plays a crucial role in assessing and documenting the arm’s length pricing of international transactions between associated enterprises.

Q7.Does the expression “arithmetical mean” warrant the inference that there could be two prices where the most appropriate method is followed?

The expression “arithmetical mean” used in the context of transfer pricing does not necessarily warrant the inference that there could be two prices when the most appropriate method is followed. The term “arithmetical mean” refers to the average of two or more prices or profits under consideration, which is often used as a comparison point for determining the arm’s length price of a controlled transaction. However, the use of the arithmetical mean does not inherently imply the existence of multiple prices. Rather, it is a statistical tool employed to arrive at a fair and reasonable transfer price based on the data available. The most appropriate method, as prescribed by transfer pricing regulations, is used to identify the arm’s length price by considering comparable uncontrolled transactions and applying various transfer pricing methods to select the best-suited one for a particular case. It aims to ensure that multinational enterprises price their transactions with associated enterprises in a manner consistent with the principle of fairness and preventing any potential tax avoidance or manipulation of prices. Therefore, while the arithmetical mean may be used in the process, it does not necessarily signify the existence of multiple prices but rather serves as a technique to arrive at a justifiable and compliant transfer price.

Q8. Is the transfer pricing to be certified even when the assesses are not liable to income tax?

Transfer pricing regulations and compliance are not solely dependent on the tax liability of the assessee. The focus of transfer pricing regulations is to ensure that transactions between associated enterprises are conducted at arm’s length, regardless of whether the assessee has taxable income or not.

Q9. An Indian company becomes an associate of a non -resident in the last quarter of the previous year. Do the transfer pricing rules apply for the year? If it does, does it apply for the quarter or whole of the year?

Q10. Indian Accounting Standard 24 issued by the Institute of Chartered Accountant of India relates to related party transactions. What is its relevance to the concept of associated enterprise under transfer pricing rules? How does it affect gifts?

Indian Accounting Standard (Ind AS) 24, issued by the Institute of Chartered Accountants of India (ICAI), pertains to “Related Party Disclosures” in financial statements. While Ind AS 24 primarily focuses on disclosure requirements for related party transactions in financial reporting, its relevance to the concept of associated enterprises under transfer pricing rules lies in its definition and identification of related parties.
In the context of transfer pricing rules, the concept of “associated enterprise” is crucial. Transfer pricing regulations require transactions between associated enterprises to be conducted at arm’s length prices to ensure fairness and prevent profit shifting between related parties. The definition of related parties provided in Ind AS 24 can be useful in identifying associated enterprises for transfer pricing purposes. Transactions with such associated enterprises must be carefully examined and benchmarked to determine if they comply with arm’s length standards.

Regarding the impact on gifts, Ind AS 24 does not specifically deal with the treatment of gifts. However, for transfer pricing purposes, if a gift is given or received by an Indian entity from/to an associated enterprise (i.e., an entity with which it has a relationship as defined by transfer pricing regulations), it would be considered a related party transaction. Therefore, the value of the gift must be carefully assessed to ensure it is consistent with arm’s length pricing. If the gift’s value is not at arm’s length, it may be adjusted to reflect the fair market value, and any income or expense arising from such a transaction could be subject to transfer pricing adjustments. It is essential to maintain proper documentation to support the valuation of the gift and demonstrate compliance with transfer pricing rules during tax assessments.

Q11. International transactions largely require confidentiality more than in any domestic transaction. Is it open to the auditor to insist upon such information? Can the assessing officer expect such information which is likely to be useful to the competitors?

In international business transactions, confidentiality often becomes a critical concern, more so than in domestic transactions, due to the involvement of multiple jurisdictions, sensitive commercial data, and potential risks of competitive advantage exposure. While auditors play a crucial role in verifying and validating financial information, they must respect the confidentiality requirements imposed by the parties involved. Generally, auditors are bound by professional ethics and legal obligations to maintain the confidentiality of the information they come across during the course of their audit work.

Q12 . There are a number of statutory audit reports, tax audit reports , reports of audit committees relating to corporate governance etc. It may be that the accounts or the transactions may be found to be in order with reference to the price without any adverse comment, while transfer pricing rules if applied to the accounts would indicate the accounts and the audit to be different. What are the consequences for the persons, who have reported and certified the accounts in such cases?

In situations where there are various statutory audit reports, tax audit reports, and reports of audit committees relating to corporate governance, it is possible that these reports may not raise any adverse comments or issues regarding the pricing of transactions. However, if transfer pricing rules are applied to the accounts separately, they may reveal discrepancies or differences in the pricing of certain transactions.

The consequences for the persons who have reported and certified the accounts in such cases can be significant. If the transfer pricing analysis shows that the transactions were not conducted at arm’s length prices as required by transfer pricing regulations, it could lead to several implications:

Transfer Pricing Adjustments: Tax authorities may make adjustments to the income or expenses of the entities involved in the related-party transactions to reflect arm’s length prices. This can result in additional tax liabilities for the taxpayers.

Penalties and Interest: Non-compliance with transfer pricing rules may attract penalties and interest charges, which can further increase the financial burden on the taxpayers.

Reputational Damage: Incorrect transfer pricing practices can harm the reputation of the entities and individuals involved, leading to loss of trust among stakeholders.

Increased Scrutiny: Tax authorities may subject the taxpayers to heightened scrutiny and audits in subsequent years, leading to further investigations and potential adjustments.

Legal Consequences: In severe cases of intentional tax evasion or misreporting, there may be legal repercussions, including criminal prosecution and fines.

Q13. Many of the international transactions are covered by agreements, which fix terms of remuneration consistent with industrial policy statements and often specially approved by the Central Bank (Reserve bank of India in India) or the Central government. In such a case, can there be a different transfer pricing other than what is covered by other agreements?

In general, transfer pricing rules require transactions between associated enterprises to be conducted at arm’s length prices, which means prices that would have been applicable if the parties were unrelated. While agreements approved by regulatory authorities play a significant role in determining the pricing for certain transactions, they may not always align perfectly with the arm’s length principle.

Q14. The law has fixed the maximum retail price for certain businesses like pharmaceutical trade. Administrative prices are also fixed for most essential commodities known as civil supplies. In such a case, is it possible to infer a transfer price different from such a fixed price?

In cases where the law has fixed a maximum retail price (MRP) for certain businesses, such as in the pharmaceutical trade, and administrative prices are set for essential commodities like civil supplies, it becomes important to consider whether it is possible to infer a transfer price different from such fixed prices.
In the context of transfer pricing regulations, the arm’s length principle is paramount, which requires that transactions between associated enterprises be conducted at prices that would have been agreed upon between unrelated parties. When the government or regulatory authorities fix maximum retail prices or administrative prices for certain goods and services, it can create a challenge for transfer pricing analysis.

Q15. Do the transfer pricing rules apply in respect of transactions between head office and branch?

Yes, transfer pricing rules do apply in respect of transactions between a head office and its branch or subsidiary. Even though the head office and branch are part of the same legal entity, they are considered separate accounting units for transfer pricing purposes, as they may be situated in different tax jurisdictions. The transactions between the head office and branch are treated as related-party transactions, and it is essential to determine whether these transactions are conducted at arm’s length prices as per the transfer pricing regulations.
The arm’s length principle requires that the prices or terms of such transactions should be similar to what would have been agreed upon between unrelated parties in similar circumstances. This ensures that the allocation of profits and expenses between the head office and branch reflects fair market values, avoiding any potential transfer of profits solely for tax optimization purposes.

Q16. Is the absence of a motive for adoption of transaction price at a lower or higher rate, a good defense against application of transfer pricing rules?

The absence of a motive for adopting a transaction price at a lower or higher rate can be a relevant factor in defending against the application of transfer pricing rules to a certain extent. However, it is not necessarily a foolproof defense on its own. Transfer pricing regulations primarily focus on whether the pricing of related-party transactions complies with the arm’s length principle, which requires that prices or terms be comparable to those in transactions between unrelated parties under similar circumstances.
While a lack of motive for setting prices in a particular way may indicate that there was no deliberate intention to manipulate profits or taxes, it does not automatically guarantee that the transaction price is at arm’s length. The absence of a motive alone might not be sufficient to convince tax authorities that the pricing is truly at arm’s length.

Q17. Since the transfer pricing rules are targeted for determination of taxable income, could they have any relevance for determination of capital gains? Where shares in unlisted companies become the subject matter of a transaction as between associated enterprises, is it open to revenue to adopt transfer pricing rules for determination of capital gains?

Transfer pricing rules primarily aim to ensure that related-party transactions are conducted at arm’s length prices for the determination of taxable income. While they are primarily focused on income tax implications, they can also have relevance for the determination of capital gains in certain cases, especially when shares in unlisted companies become the subject matter of a transaction between associated enterprises.

Q18. Is there any requirement for certification of transfer price in Form 3CEB, when there is no liability arising out of an international transaction between associated enterprises?

Yes, there is a requirement for certification of transfer price in Form 3CEB, even if there is no tax liability arising out of an international transaction between associated enterprises. Form 3CEB is a report that needs to be submitted by taxpayers in India under Section 92E of the Income Tax Act, 1961, if they have undertaken any international transactions with associated enterprises.
The main purpose of Form 3CEB is to provide information about the related-party transactions and the transfer pricing documentation maintained by the taxpayer. This form acts as a statement to demonstrate that the taxpayer has complied with the transfer pricing regulations and has conducted the international transactions at arm’s length prices.

Even if there is no tax liability due to losses or other deductions, or if the taxpayer has applied the arm’s length principle correctly, the requirement to submit Form 3CEB with transfer pricing certification still applies. Proper documentation and certification are essential to ensure transparency and demonstrate adherence to the transfer pricing rules in the event of any tax scrutiny or audit.

Failure to submit Form 3CEB or provide adequate transfer pricing documentation can lead to penalties and other consequences, even if no tax liability arises from the international transactions. Therefore, taxpayers are advised to comply with the reporting and certification requirements prescribed under the Indian transfer pricing regulations to avoid potential issues with tax authorities.