Transfer Pricing Taxation

Transfer pricing ensures that transactions between related entities of multinational companies are priced fairly, following the arm’s length principle. In India, the Income Tax Act, 1961, regulates transfer pricing to prevent profit shifting and tax avoidance. Businesses engaged in international and specified domestic transactions must comply with strict documentation and reporting requirements, including Form 3CEB and country-by-country reporting. Non-compliance can result in penalties and tax adjustments. To stay compliant, companies should maintain transparent records, choose the right pricing method, and stay updated on regulatory changes. Filing Buddy helps businesses navigate transfer pricing compliance efficiently.

Transfer pricing refers to the pricing of goods, services, and intellectual property exchanged between related entities within a multinational company. The aim is to ensure that these transactions are conducted at arm’s length, meaning the price should be similar to what unrelated parties would agree upon in a free market.

Governments worldwide, including India, use transfer pricing regulations to prevent companies from shifting profits to low-tax jurisdictions and evading taxes. If a company charges an artificially low or high price in inter-company transactions, it could impact the tax revenue of the country.

India’s Income Tax Act, 1961, mandates that all transactions between related parties be conducted at arm’s length. The rules primarily apply to:

• International transactions between associated enterprises.
• Specified domestic transactions (SDTs) if the value exceeds INR 20 crore in a financial year.
• Transactions involving intangible assets, management services, loans, cost-sharing agreements, and other cross-border dealings.

To ensure fair pricing, the Indian tax authorities recognize six methods under Rule 10B of the Income Tax Rules:

1. Comparable Uncontrolled Price (CUP) Method – Comparing prices of similar transactions between unrelated entities.
2. Resale Price Method (RPM) – Comparing the resale price of a product purchased from a related entity with similar transactions in the open market.
3. Cost Plus Method (CPM) – Adding a reasonable markup to the cost incurred by the supplier in related transactions.
4. Profit Split Method (PSM) – Splitting profits fairly based on the relative contribution of each entity.
5. Transactional Net Margin Method (TNMM) – Comparing the net profit margin of related transactions with those of similar transactions by unrelated companies.
6. Other Methods – Any other reasonable approach accepted by tax authorities.

Companies must document their chosen method and justify why it is the most appropriate.

Businesses engaging in transfer pricing transactions must maintain proper documentation to justify their pricing. The key compliance requirements include:

• Master File: Provides a high-level overview of the group’s global operations, including revenue, profit, and business structure.
• Local File: Contains detailed information on the Indian entity’s transactions, functional analysis, and pricing methods used.
• Country-by-Country Report (CbCR): Required for multinational enterprises (MNEs) with consolidated group revenue exceeding INR 6400 crore.
• Form 3CEB: A mandatory disclosure form filed by companies engaged in transfer pricing transactions, certified by a Chartered Accountant.

Failure to comply with these documentation requirements can result in penalties ranging from 1% to 2% of the transaction value or even adjustments by the tax authorities.

Indian tax authorities take transfer pricing violations seriously. Some of the penalties include:

• 2% of the transaction value for failure to maintain required documents.
• 50% to 200% of the tax due if transfer pricing adjustments result in additional tax liabilities.
• Additional scrutiny, audits, and potential legal disputes.

1. Keep Transparent Documentation: Maintain proper records of all inter-company transactions and pricing decisions.
2. Conduct Regular Transfer Pricing Audits: Review pricing policies annually to ensure compliance.
3. Seek Professional Guidance: Engage experts to navigate the complexities of transfer pricing laws.
4. Stay Updated on Regulatory Changes: Indian transfer pricing rules evolve, and businesses must stay informed.
5. Use the Right Pricing Method: Select the most appropriate pricing method based on transaction type.

Transfer pricing regulations ensure fair taxation and prevent profit shifting. Businesses operating in India must comply with these rules to avoid legal and financial consequences. By following the prescribed methods, maintaining proper documentation, and staying updated on regulations, companies can ensure smooth operations while remaining tax-compliant.

At Filing Buddy, we help businesses navigate complex tax laws, including transfer pricing compliance. If you need assistance with documentation, tax planning, or regulatory compliance, our experts are here to guide you. Contact us today to ensure your business stays compliant and avoids penalties!

1. What is Transfer Pricing?

Transfer pricing refers to the pricing of goods, services, and intellectual property exchanged between related companies (like subsidiaries, parent companies, or sister companies) located in different countries. The aim is to ensure these transactions are fair and at market price to prevent tax evasion.

2. What is the Arm’s Length Principle?

The Arm’s Length Principle means that transactions between related parties (such as a parent company and its subsidiary) should be priced as if they were between two unrelated companies in an open market.

3. Who needs to follow Transfer Pricing rules in India?

Businesses engaged in international transactions or certain domestic transactions with related companies must comply with Transfer Pricing rules. This applies to multinational companies (MNCs), Indian businesses with foreign subsidiaries, and companies with related party dealings.

4. What are Associated Enterprises (AEs)?

Associated Enterprises (AEs) are companies that have a direct or indirect ownership, management, or control relationship. For example, if Company A owns more than 26% of Company B, they are considered Associated Enterprises under Indian tax laws.

5. How is the Arm’s Length Price determined?

The Income Tax Act, 1961, provides five methods for calculating the Arm’s Length Price:

1. Comparable Uncontrolled Price (CUP) Method
2. Resale Price Method (RPM)
3. Cost Plus Method (CPM)
4. Profit Split Method (PSM)
5. Transactional Net Margin Method (TNMM)

Companies must choose the most appropriate method based on their transaction type.

6. What is Form 3CEB, and who needs to file it?

Form 3CEB is a mandatory report filed by companies engaged in international transactions with Associated Enterprises. It must be certified by a Chartered Accountant (CA) and submitted before the due date of filing the Income Tax Return (ITR).

7. What happens if a company does not comply with Transfer Pricing rules?

Non-compliance can lead to penalties and tax adjustments. Some key penalties include:

• ₹1,00,000 for failing to maintain proper records.
• 2% of the transaction value for missing Form 3CEB submission.
• Additional tax liabilities due to adjustments made by tax authorities.

8. What is the purpose of Safe Harbor Rules?

Safe Harbor Rules provide predefined profit margins for certain industries, ensuring that if companies follow these margins, they won't face Transfer Pricing scrutiny. It offers certainty and helps businesses avoid long tax disputes.

9. What is an Advance Pricing Agreement (APA)?

An APA is an agreement between a company and the Indian tax authorities that predetermines the pricing method for future transactions. This helps businesses avoid disputes and ensures smooth tax compliance.

10. When should a company prepare Transfer Pricing Documentation?

Companies must prepare Transfer Pricing Documentation if:

• Their international transactions exceed ₹1 crore in a financial year.
• Their specified domestic transactions exceed ₹20 crore.
• They are required to submit Form 3CEB as part of tax compliance.

This documentation should be ready before the income tax return filing deadline and must be maintained for eight years.