COUNTRY CHAPTER EXCERPT India Mukesh Butani and Sanjiv Malhotra, Taxand India. The authors can be contacted at +91 124 339 5000, mukesh.butani@bmrlegal.in / sanjiv.malhotra@bmradvisors.com 1. Tax Authority and Law The tax administration agency in India is the Central Board of Direct Taxes (CBDT). Sec. 92 of the Income Tax Act 1961 (ITA) contains the transfer pricing provisions. Rule 10 of the Income Tax Rules (ITR) provides further guidance on application legislation. India has attained an observer status in the OECD with enhanced engagement. It therefore endorses the OECD Transfer Pricing Guidelines to the extent such guidelines are not inconsistent with the domestic regulations. 2. Regulations and Rulings 2.1. Regulations, rulings and guidelines The transfer pricing regulations that find expression in Chapter X of the ITA were introduced by the Finance Act 2001 and are an outcome of the findings of the Expert Group set up by the government of India in November 1999 to study global transfer pricing practices and examine the need for such legislation in India. Although the Indian transfer pricing regulations are largely based on the OECD Transfer Pricing Guidelines, they have also incorporated certain aspects of legislation in other countries, particularly China and Korea (Rep.). To provide a statutory framework empowering the tax authorities to determine reasonable, fair, and equitable profits and tax of international transactions, new Secs. 92, 92A, 92B, 92C, 92D, 92E and 92F were included in the ITA, providing for a mechanism based on computation of income from cross-border transactions. The law is effective from 1 April 2001, corresponding to the financial year ending on 31 March 2002. Subsequently, the CBDT issued draft ITR 10A, 10B, 10C, 10D and 10E which were made effective from 21 August 2001. Other relevant sections of the ITA include Secs. 271(1)(c), 271AA, 271BA and 271G. These provide guidance on the application of the arm s length principle, methodologies acceptable to the tax authorities, which can be used to determine the arm s length price, other administrative regulations such as the type of records and documentation which should be maintained by the taxpayer involved in transfer pricing arrangements. In addition, the following administrative guidance has been issued by the CBDT:
Direct Tax Circular 12/2001 of 23 August 2001, containing provisions governing transfer price in an international transaction; and Circular 14/2001 on the new legislation to curb tax avoidance by abuse of transfer pricing. 2.2. Arm s length principle Sec. 92 of the ITA relates to the computation of income from an international transaction and provides that any income arising from an international transaction shall be computed having regard to the arm s length price. Further, it clarifies that the allowance for any expense or interest arising from an international transaction is also required to be determined having regard to the arm s length price. 3. Methodologies 3.1. Prescribed methods Sec. 92C of the ITA, read with Rule 10C of the ITR, provides the following methods to be used in determining the arm s length price: comparable uncontrolled price method; resale price method; cost-plus method; profit split method; and transactional net margin method. This law gives power to the CBDT to prescribe any other methodology but to date no such notification has been made. 3.2. Priority of methods Proper application of the arm s length principle and the determination of the transfer price hinges on the appropriate choice of transfer pricing method. Unlike the OECD Transfer Pricing Guidelines, there is no prescribed hierarchy of methods by the ITA. Computation of the arm s length price should be based on the most appropriate method. The Indian regulations in this regard are in line with international guidelines and laws of various countries such as the United States which also provides for the use of the most appropriate method. Rule 10C of the ITR provides that the most appropriate method should be the method best suited to the facts and circumstances of each particular international transaction between associated enterprises and that provides the most reliable measure of an arm s length price in relation to such international transaction. The taxpayer is given the right to choose any of the above methods. However, the Transfer Pricing Officer (i.e. tax officer who specializes in transfer pricing matters) can examine the relevance of the methodology selected by the taxpayer to ensure that the selected method produces the most reliable measure of an arm s length result.
4. Comparability Analysis 4.1. Comparable data The Indian regulations replicate the conditions and procedures of the OECD Transfer Pricing Guidelines in respect of application of the arm s length principle and determination of the arm s length price. Rule 10B of the ITR provides that the comparability of one transaction with another should be judged with reference to: the specific characteristics of the property or services transferred in either transaction; the functions performed, taking into account assets employed or to be employed and the risks assumed by respective parties of the transactions; the contractual terms (whether or not those terms are informal or in writing) of the transactions that lay down explicitly or implicitly how the responsibilities, risks and benefits are divided between the parties to the transactions; and conditions prevailing in the markets in which the parties to the transactions operate, including the geographical location and size of the markets, costs of labour and capital in the markets, overall economic development and level of competition, and whether the markets are wholesale or retail. However, there are no specific guidelines on how to search for comparable data. Taxpayers are increasingly relying on the OECD s draft notes for comparability in this regard. 4.2. Foreign comparables The ITA has not provided guidelines on the use of foreign comparables. The trend, however, suggests preference to Indian comparables. 4.3. Secret comparables The ITR empowers the CBDT to use any information that it may possess to determine the arm s length price. Such information may not be in the public domain or available with the taxpayer while preparation of the transfer pricing documentation. The CBDT also has the power to cause other companies to furnish data as may be required for determination of the arm s length price for the taxpayer. Thus, the power of the authorities to collate documentation is open and wide. continued 4.4. Use of ranges Where more than one price is determined by the most appropriate method, the arm s length price is calculated as the arithmetical mean of such prices or, at the option of the assessed, a price which may vary from the arithmetical mean by an amount not exceeding 5% of such arithmetical mean. A recent amendment in the 2009 Budget has proposed to change the base of computing the 5% range from the arithmetical mean to the transfer price.
The use of the arithmetical mean as opposed to an interquartile range is unique in India and has been criticized on many occasions. Further, the language for usage of the 5% range is ambiguous and a subject matter of litigation. Indian tax tribunals have differing views on the same and the final position is not settled. In view of the long-standing controversy on the application of the 5% range, the 2009 Budget proposed that no adjustment would be made only if the taxpayer s price is within the prescribed range. However, if the price is outside the 5% range, adjustments can be made to the price without providing the benefit of the 5% range. To illustrate, where the transaction price is INR 80 and the arm s length price is determined to be INR 100, the arm s length range is INR 95 to INR 105. Previously, taxpayers contended that the price ought to be adjusted for INR 15 (i.e. INR 95 minus INR 80). Under the amendment proposed in the 2009 Budget, the adjustment will be for INR 20 (i.e. INR 100 minus INR 80). 5. Disclosure/Documentation Requirements 5.1. Tax return disclosures/accountant s certificate A report from an accountant is required to be furnished under Sec. 92E of the ITA by every person who has entered into an international transaction during a previous year in Form 3CEB (accountant s certificate). The same is required to be filed with the tax return of the taxpayer. The accountant s report only requires furnishing of factual information relating to the international transaction, the arm s length price determined by the taxpayer and the method applied in such determination. It also requires an opinion by the accountant as to whether the prescribed documentation has been maintained. However, Indian regulations do not require the furnishing of transfer pricing documentation in connection with tax returns. Documentation is normally provided during the transfer pricing audits. 5.2. Transfer pricing documentation requirements Sec. 92D of the ITA and Rule 10D of the ITR requires every person who has entered into an international transaction to maintain such information and documentation as may be prescribed. Functional analysis The general information and documentation requirements laid down under Rule l0d of the ITR primarily deal with the profile of the taxpayer s organization and business activities. The taxpayer is required to maintain information and documentation covering: a description of the ownership structure of the taxpayer enterprise, with details of shares or other ownership interests held therein by other enterprises; a profile of the multinational group of which the taxpayer enterprise is a part, along with the name, address, legal status and country of tax residence of each of the enterprises comprised in the group with whom international transactions have been entered into by the taxpayer, and ownership linkages among them; and
a broad description of the business of the taxpayer and the industry in which the taxpayer operates, and of the business of the associated enterprises with whom the taxpayer has transacted. continued 6. Mutual Agreement Procedures (MAPs) Most of the tax treaties concluded by India provide for transfer pricing adjustments in relation to transactions between associated enterprises if such transactions are not priced at arm s length. This is typically captured in Art. 9(1) of the tax treaties. Art. 9(2) of the tax treaties provides for a mechanism to resolve economic double taxation which would arise pursuant to a transfer pricing adjustment in one country. However, in certain cases (such as Germany, Korea (Rep.), Singapore, etc.), Art. 9(2) is absent. This is increasingly becoming a big issue in resolution of transfer pricing disputes with these countries. The Indian competent authority has been taking a strict view on applicability of MAP relief for residents of such countries. Given that transfer pricing is relatively new to India and not many MAP cases have been resolved, there is no finality on the view taken by the Indian competent authority. 7. Advance Pricing Agreements (APAs) Currently APAs are not available in India. However, the government has recently released the draft of a new direct tax code for public comment. This new tax code, which is expected to take effect on 1 April 2011, provides for an APA mechanism in India. Under the proposed APA mechanism, a taxpayer may approach the tax authorities and agree on an arm s length price for its international transactions upfront. Such agreements will be binding on both parties and can be entered into for a maximum period of 5 years. continued 9.3. Desk and field audits Transfer pricing audits in India have generated tremendous controversy partly due to an exponential increase in audit activity and partly due to the resulting transfer pricing adjustments. There has been an increase in the number of government personnel exclusively dealing with transfer pricing matters. During the audits, Transfer Pricing Officers broadly follow the approach stipulated by the OECD Transfer Pricing Guidelines while applying Indian transfer pricing regulations, but only to the extent that such guidelines are not in conflict with domestic transfer pricing provisions. Further, no unified approach is followed by various Transfer Pricing Officers across the country. In a variety of cases, Transfer Pricing Officers adopt contradictory views over similar facts.
Sec. 92CA of the ITA in the scheme of the regulations enables the tax officer in charge, where he or she considers it necessary or expedient to do so, to refer the computation of the arm s length price in respect of an international transaction to the Transfer Pricing Officer. This section provides that previous approval of the jurisdictional Commissioner is mandatory before such a reference is made. The CBDT has issued notifications wherein it has prescribed value based criteria (transactions above INR 150 million) for the tax officers in charge to refer cases to the Transfer Pricing Officer. Such notifications are binding on the tax officers. 10. Penalties With an objective to ensure compliance with the arm s length principle, the Indian legislation has prescribed civil penalties for various non-compliances. Sec. 271(1)(c) of the ITA: Concealment of income As a general principle, if the tax officer in charge or the Commissioner of Income Tax (Appeals) is satisfied that any person has concealed the particulars of income or furnished inaccurate particulars of income, he may direct to pay (by way of penalty), a sum ranging from 100% to 300% of tax payable on such adjusted amount. Specifically in relation to transfer pricing adjustments, Explanation 7 to Sec. 271(1)(c) of the ITA states that the amount so added or disallowed (adjustment) shall be deemed to represent the income in respect of which particulars have been concealed or inaccurate particulars have been furnished, unless the taxpayer proves that the price charged or paid in such transaction was computed in accordance with the provisions contained in Sec. 92C of the ITA and in the manner prescribed under that Sec. 92C, in good faith and with due diligence. Sec. 271AA of the ITA: Penalty for failure to keep and maintain information and documents in respect of international transactions If any person fails to maintain such information and document as required by Sec. 92D of the ITA, the tax officer in charge or the Commissioner of Income Tax (Appeals) may direct such person to pay, by way of penalty, a sum equal to 2% of the value of each international transaction entered into by such person.