Methods to determine the arm’s length price
For tax purposes, companies are required to record the exchange of goods using the arm’s-length principal. India’s Income-tax Act, 1961 prescribes the following methods to determine the arm’s length price between two affiliated companies:
- Comparable Uncontrolled Price (CUP) Method.
- Resale Price Method (RPM).
- Cost Plus Method (CPM).
- Profit Split Method (PSM).
- Transactional Net Margin Method (TNMM).
- Such other methods as may be prescribed.
As such, no method is accorded priority. However, the most appropriate method for the transaction is determined based on the nature and class of transaction or associated persons and functions performed.
Safe harbor rules:
Safe harbor rules mean, circumstances under which income-tax authorities shall accept the transfer price declared by the assessee, without any question.
Advance pricing agreement
An advance pricing agreement (APA) is an agreement between a taxpayer and at least one tax authority. The agreement is on the transfer pricing methodology to be used to determine taxpayer’s international transactions with its associated enterprises (AEs) for maximum of 5 consecutive years.
Transfer pricing documentation
- Taxpayers are required to maintain information related to international transactions undertaken with AEs. The rules prescribe detailed information and documentation that must be maintained by the taxpayer. Such requirements can broadly be divided into two parts:
- The first part includes:
- Information on the ownership structure of the taxpayer,
- Group profile
- Business overview of the taxpayer and AEs, including prescribed details such as the nature, terms, quantity, and value of international transactions.
- Comprehensive study on transfer pricing.
- The second part of the rules requires that adequate documentation is maintained to substantiate the information, analysis, and studies documented under the first part of the rule.
- Taxpayers having aggregate international transactions below the prescribed threshold of Rs 1 Crore and Specified Domestic Transactions below the threshold of Rs 20 Crore are relieved from maintaining the prescribed documentation.
- However, it is essential that the documentation maintained should be adequate to substantiate the arm’s length price of the international transactions or specified domestic transactions.
- Companies to which transfer pricing regulations are currently applicable are required to file their tax returns on or before October 31 [as per latest amendment], following the close of the relevant tax year.
The Indian government has proposed to introduce three-layered transfer pricing documentation requirements.Taxpayers will now be required to prepare a master file, local file, and country-by-country (CbC) reporting.
While the detailed contents of these documents is provided through rules, the reporting requirements are expected to align with the organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Action on transfer pricing documentation and CbC reporting.
Some of the important requirements are mentioned as follows:
- The reporting provisions shall apply to an international group (a group that operates in two or more jurisdictions) having consolidated revenues exceeding the prescribed threshold, that is Rs 500 crore in the current year. The threshold is required to be computed based on the exchange rates on the last day of the previous year.
- An Indian parent entity is required to furnish the CbC report in respect of the group by the due date of furnishing of return of income for the relevant financial year. That is November 30, following the financial year.
- An entity in India of an international group having an overseas resident parent is only required to provide the details of the country of residence of the parent — form, manner, and date to be prescribed.
- An Indian entity belonging to an international group with an overseas parent shall be required to furnish the CbC report to the prescribed authority if the parent entity of the group is resident:
- In a country with which India does not have an arrangement for exchange of the CbC report; or
- There is a systematic failure of the country in exchanging the said information with India even though there is an agreement, and this fact has been intimated to the entity.