Transfer pricing rules in India
Commercial transactions between the different multinational groups may not take place through the same market forces existing between the two independent companies. One company often transfers to another their goods or services to the other for a consideration known as “transfer price”. This may be arbitrary having no relation with cost and is different from the existing market forces.
Transfer price is a price representing the value of goods or services between independently operating companies. However, the term “transfer pricing” normally refers to prices of transactions between enterprises associated with each other which may take place under different conditions unlike those occurring between independent companies.
Transfer price generally denotes the value attached to transfers of goods or services between related organizations. It also refers to the price of transfers taking place between unrelated parties though controlled by means of a common entity.
In other words, transfer pricing is the setting of the price for goods or services transferred between related concerns of an enterprise. For example, if a subsidiary concern sells products to a parent company, the cost of such products is the transfer price.
Entities under the control of a single concern include companies that are wholly or mostly owned by the parent company. Entities having the same members on their boards of directors are also considered to be under the common control.
Object of Transfer pricing:
Transfer pricing can be used as a profit allocation method to add to the net profit of a multinational company.
The effect of transfer pricing is that the parent company tends to make insufficient taxable income or loss on a deal. Profits accruing to the parent can be increased by setting high transfer prices and low transfer prices to remove profits to companies located in low tax jurisdiction.
A company A purchases goods for Rs. 1000 rupees and sells it to its sister concern B in another country for Rs. 2000, who in turn sells them to a company C for Rs. 5000. If A would have sold it directly to C, it would have made a profit of Rs.4000. But A permitted B to appropriate the balance profit by making a profit of merely Rs.1000. The transaction between A and B is arranged and the goods are transferred at a transfer price which is arbitrary but not on the market price.
Transfer Pricing Regulations are applicable to the all enterprises entering into an “International Transaction” with an associated concern. It normally applies to all international transactions entered into between associated companies and also to transactions involving only a book entry having no financial effect.
Section 92 of the Income tax Act, 1961:
Section 92 of the Act provides that any income arising from an international deal shall be computed having regard to the arm’s length price.
It further states that the allowance for any expense shall also be determined taking into account the arm’s length price.
“Associated enterprise” as per Section 92A of the Income tax Act, 1961:
As per the provisions of this section an “associated enterprise”, in relation to another enterprise, means an enterprise participating in the management or capital of the other enterprise, or in which one or more persons participating in its management or capital are the same persons who participate in the management or capital of the other enterprise.
Two enterprises are associated enterprises if one of them holds shares carrying not less than 26% of the voting power in the other enterprise or has any person holding shares carrying not less than 26% of the voting power in each of such enterprises. Two enterprises are associated enterprises if a loan has been given by one of such enterprises to the other amounting to not less than 50% of the total assets of the other enterprise or one of them guarantees not less than 10% of the total borrowings of the other one or more than half of the board of directors or members or the executive director(s) or executive member(s) of the governing board of one enterprise are appointed by the other one.
Two enterprises are associated enterprises if more than half of the directors or members or the executive directors or members of each of them are appointed by the same person(s) or the business carried out by one enterprise is fully dependent upon the other enterprise or 90% or more of the raw materials required for the manufacture of goods carried out by one enterprise are supplied by the other enterprise.
Two enterprises are also associated enterprises if the goods manufactured by one enterprise are sold to the other enterprise and the prices relating to such sale are influenced by the other enterprise or where one enterprise is controlled by a person controlling the other enterprise or where one enterprise is controlled by a HUF and the other one is controlled by a member of such HUF or by a relative of a member of such HUF.
Two enterprises are also associated enterprises if one is a firm or body of individuals and the other holds not less than 10% interest in such firm or body of individuals or if there is any mutual interest between the two enterprises.
Section 92B: Meaning of international transaction:
For the purposes of this section an “international transaction” means a transaction between two or more associated companies, either or both of whom are non-residents, in connection with the purchase, sale or lease of any property or services, or lending or borrowing any sum, or any other transaction relating to the profits, income, losses or assets of such enterprises and includes a mutual agreement or arrangement between the enterprises for the contribution to any cost incurred in connection with a service provided to any one or more of such enterprises.
A transaction entered into by an enterprise with someone except an associated enterprise shall be considered to be a transaction entered into between two associated enterprises, if there is a prior agreement relating to the relevant transaction between them.