Over the past decade, India has become a big opportunity for global entrepreneurs looking to grow a successful business. The liberalization, booming middle class, and growing jobs and salaries have made India an attractive destination. At the same time, setting up a business in India means navigating through the various tax and legal complexities. And one of the major tax lawsthat needs to be kept in mind is the one on transfer pricing.
"A lot of times, Non Resident Indians (NRIs) who have businesses in India as well as their home country do not realize the implications of transfer pricing rules," says Veena Parrikar, Principal - Transfer Pricing, BDO.
"For instance, take the case of a US parent company with a subsidiary in India. Both companies may make inter-company transfer of funds, often without a proper documentation and support for tax purposes. They tend to believe that transfer pricing is not an issue because the funds remain within the same commonly owned group, and the intercompany transfers are eliminated in consolidation anyway. While it is true that intercompany transactions are eliminated in consolidation, it is important to remember that the two companies are located in different tax jurisdictions and the tax authorities in each jurisdiction will want it's fair share of profits and taxes" she adds.
So in a series of articles, we will explore the various aspects of transfer pricing. Let us begin with understanding the transfer pricing rules in India.
The crux of Indian transfer pricing rules.
Transfer pricing refers to the pricing of intercompany transfers of goods or services. Most countries around the world have implemented transfer pricing regulations with the aim of preventing tax evasion.
The Indian Government tries to ensure that it does not face tax leakages on account of an Indian company overpaying or being underpaid respectively, for goods and services received or rendered, Both these situations will lead to lower profits in India and therefore lower taxes.
Transfer pricing rules can be found under Section 92 to 92F of the Indian Income Tax Act. To put it in a single sentence, the transfer pricing code states that income arising from international transactions between associated enterprises should be computed having regard to the arm's-length price. The three main aspects are 'international transaction.' 'associated enterprise' and 'arms length price.'
What is international transaction?
International transaction means a transaction between two or more associated enterprises involving:
- Sale, purchase or lease of tangible like machinery, equipment, tools, commodities, products etc
- Sale, purchase or lease of intangible property like copyrights, trademarks etc
- Provision of services like market research, design, consultation, administrative services etc
- Cost-sharing arrangements
- Lending/borrowing of money
- Any other transaction having a bearing on the profits, income, losses or assets of such enterprises.
Example: Company A is a US holding company with operations in India through subsidiary company B. Company A transfers $ 1 million to company B for vendor payments. At the end of the financial year, all such amounts must be accounted for as funds received for specific purposes, such as administrative services or consultancy services or any other appropriate transaction. If they are loans, then appropriate interest payments must be reported.
Who are associated enterprises?
Two companies are said to be ‘associated’ if one company participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise. The participation can also be through people.
The Act goes on to define participation. For instance, if one company holds 26% of voting power of the other, the former is said to be participating in the latter. Or if 90% or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, they are said to be associated.