Analysis of ‘Domestic Transfer Pricing’ In India

1. ANALYSIS OF ‘DOMESTICTRANSFER PRICING’ ININDIA https://taxguru.in/income-tax/analysis-domestic-transfer-pricing-india.html SameerSamal[1] Introduction: Multinational corporations are continuing to play an increasingly crucial role in international tradewhich directly affects taxation issues. Tax administrations as well as multinational corporations have felt the heat of such taxation issues and the global community has come to a consensus that such issues must be considered at a global scale instead of a narrow domestic context. Primarily, the practical issue that dwells, for both tax administrations and multinational corporations, is the determination of income and its attribution to a specific jurisdiction. With the ever-increasing difference between the taxation standards of various countries, it was pertinent to resolve such issues at a global scale. As taxation laws and regulations differ from country to country, it increases the burden of compliance on multinational corporations and also increases the uncertainty it has with respect to such jurisdiction. Transfer Pricing provisions were introduced at an international level withan intention to curb such issues and create certainty for multinational corporations as well as tax administrations. These provisions assist in ascertaining the income and expenses of a multinational corporation and attributing them to specific associated enterprises that are often present in different tax jurisdictions. Transfer pricing provisions of such nature we earlier constrained to international transactions carried out by multinational corporations. However, considering its efficiency in curbing the aforementioned issues, nations considered it imperative to introduce such provisions at a domestic level aswell. India, similar to various other nations, introduced transfer pricing provisions for domestic transactions under the Income Tax Act, 1961 w.e.f. 1st April 2013. The provisions of transfer pricing were extended to be applicable to certain “specified domestic transactions”. To better understand the foregoing notion, the paper explores the concept of transfer pricing, the origins of domestic transfer pricing provisions in India, and the concept of “arms- length price”. Additionally, this paper will also inspect the significant contributions of the judiciary in the introduction of domestic transfer pricing provisions under the Indian taxationregime. International TransferPricing: International transfer pricing provisions are triggered when goods or services are transferred between associated enterprises against a consideration. The objective of transfer pricing law, whether international or domestic, is to ensure that the transactions between associated enterprises take place at a fair and un-controlled price. Itvirtually ensures that the transactions between associated enterprises or related parties take place as if the transaction was taken place between unrelated enterprises. To supplement the understanding of international transfer pricing, an illustration is presentedbelow: A mobile phone manufacturer is based at a high corporate tax jurisdiction, the USA, and has established four subsidiary companies across various jurisdictions, theseare:

2. Manufacturing of mobile phone components and software-India • Trading company- British VirginIsland • Brand Holding-Bahamas • Insurance Company-Mauritius • The subsidiary company in India is set up to supply raw materials and provide labor for the manufacturing of mobile phones. This set-up is used as raw materials and labor in India is cheaper compared to labor and component prices in the USA. The trading company purchases these components and other raw materials from India and sells it to the USA at an exorbitant profit margin. Thus, increasing expenses for the USA company. The company then sells these mobile phones in the US market at an appropriate profit margin and has to pay tax at the rate of 30%. However, to reduce the net tax liability of the entity based in America, it takes loans and insurance from the insurance company established in Mauritius. Moreover, the US entity also has to pay royalties to the Bahamas entity as it holds the Brand and gives the same under license at a hefty royalty cost. Therefore, the overall profit of the US entity reduces to a significant extent and shows nil profit or even a loss. Using such similar mechanism, many multinational corporations reduce their tax base without affecting the overall financial health or share prices of their company. In light of such malicious practices, countries deemed it fit to introduce transfer pricing provisions that govern international transactions between associated enterprises. It is incorporated to ensure fair dealings between related parties at fairprices. • The role of Indian judiciary in the incorporation of Domestic TransferPricing: • In the case of Commissioner of Income Tax v. Glaxo Smith Kline Asia (P) Ltd.[2], Hon’ble Supreme Court of India recommended the Government of India to amend certain provisions, i.e., sections 40(2) and 80-IA (10) of the Income Tax Act 1961, to empower the Assessing Officer to extend transfer pricing regulations to certain domestictransactionsbetweenrelatedpartyenterprises.TheAssesseeinthecase,M/sGlaxoSmithKlineAsia • (P)Ltd.,didnothaveanyemployeeotherthanaCompanySecretary.Alladministrativeservices,suchas • marketing, human resources, finances, and other were provided by M/s Glaxo Smith Kline Consumer Healthcare Ltd. Such arrangement was made in pursuance of an agreement between the two related parties wherein the assessee agreed to reimburse the cost of such services plus5%. • During the assessment proceedings, the Assessing Officer disallowed partial charges on the grounds that they were excessive and not in furtherance of business purposes. The contention of the Assessing Officer was upheld in appeal by Ld. Commissioner of Income Tax (Appeals). Further, the Assessee approached Hon’ble Income Tax Appellate Tribunal that deleted the disallowance and upheld the Assessee’s contentions. The Income Tax Department filed a Special Leave Petition before the Supreme Court of India, but the same was dismissed. The Supreme Court noted that “transfer pricing provisions should be extended to domestic transactions to reduce litigation”. • Domestic TransferPricing: • Following the recommendations and suggestions of Hon’ble Supreme Court of India in the case of Commissioner of Income Tax v. Glaxo Smith Kline Asia (P) Ltd[3], the Central Government amended transfer pricing provisions to cover certain ‘specified domestic transactions’. Section 92 of the Income Tax Act, 1961has been amended to provide that allowance for interest, cost, income or expenditure relating to the specified domestic transactions are required to be computed following the arm’s-lengthprinciple.

3. Section 92 of the Act deals with the computation of income from international transactions having regard to arm’s length price, and section 92BA of the Act defines ‘specified domestic transaction’ for thispurpose. Arm’s LengthPrice: Section 92C of the Income Tax Act, 1961 states that the arm’s length price in relation to an international transaction or a specified domestic transaction shall be determined by way of the below mentioned methods, being the most appropriate method[4]. The prescribed arm’s length price methods are asfollows: Comparable Uncontrolled Price (CUP) method- Under this method of computation, the price chargedin an uncontrolled transaction between comparable enterprises is compared with an associated enterprise transaction price to determine the arm’s lengthprice. Resale Price Method- Under this method of computation, the gross margin in a comparable uncontrolled transaction is used to determine the arm’s length. The transaction must be a re-sale and such transaction must be compared with the transaction price of unrelatedparties. Cost Plus Method- the gross margin of a company selling manufactured products or services to unrelated parties is compared with the transaction price between associatedenterprises. Profit Split Method- the profits are split between associated enterprises according to the transaction based on economicparameters. Transactional Net Margin Method- the net profit margin of the enterprise in question is used as a comparabilityfactor. Other Methods- such other methods as may be prescribed by the Central Board of Direct Taxes.[5] In furtherance of Rule 10C of the Income Tax Rules, the most appropriate method must be adopted based on the facts and circumstances of each transaction. The factors that play a vital role in deciding the most appropriate method in a given transactionare: Nature of thetransaction; The class of associatedenterprises; Availability and reliability of the necessary data to choose the most appropriatemethod; The degree of comparability existing between the enterprises and the uncontrolledtransaction; The extent to which accurate adjustments can beexercised; The reliability of the assumptions that are required to be made in the most appropriatemethod. The Government of India has also prescribed certain compliance requirements and documentation requirements under section 92D of the Income Tax Act, 1961. The enterprise entering into specified domestic transactionmust maintain such records and information in respect to the transaction as may be prescribed under the Act and Rules. Moreover, the Assessing Officer (AO) or the Commissioner (Appeals) may in the course of proceedings require such persons to furnish information andrecords.

4. The Income Tax Act, 1961 has also prescribed for certain penalty provisions with respect to domestic transfer pricing regulations. Some of these penalty provisionsare: • Failure to maintain documents, failure to report a transaction in the accountant’s report, or furnishing incorrect information will attract 2% of the value of transaction aspenalty. • Failure to furnish the master file will attract Rs. 5,00,000/- aspenalty. • Furnishing incorrect information will attract Rs. 10,000/- penalty for each of such incorrectreport. • Conclusion: • Countries all over the world are currently witnessing economic developments that challenge the purview of corporate taxation. Although, tax planning has always been an integral part of corporate finances, the tax-paying morale of these corporations, whether domestic or multi-national, has consistently been in question. With the advent of the digital economy the task of tax administrators to effectively govern this transition has posed certain challenges. Taxing digital companies along with traditional brick-and-mortar companies following similar tax planning strategies is one such challenge. Countries were privy to the losses that their domestic economies were facing due to such aggressive tax planning by corporations. Therefore, it was felt necessary by these countries, from economic as well as legal perspective, to govern and benefit from such developments. One such governance and taxing measure is the introduction of transfer pricing laws. Observing the success of international transfer pricing laws, India, along with a significant number of other countries, deemed it necessary to introduce domestic transfer pricing laws. India has incorporated domestic transfer pricing provisions under the Indian Income Tax Act, 1961 whereby, these transactions are covered under the umbrella of “specified domestic transactions”. Therefore, on the overview of the abovementioned law and regulations prescribed with respect to domestic transfer pricing, it can be safely concluded that India has successfully implemented transfer pricing provisions in its domestic law to effectively curb instances of taxavoidance. • Sameer Samal is an LL.M. Candidate at Jindal Global Law School, OP Jindal Global University specializing in TaxationLaw. • Special Leave to Appeal (Civil ) No. 18121/2007 dated 26th October 2010 (SupremeCourt). • Supra Note1. • Section 92C of the Income Tax Act,1961. • Central Board of Direct Taxes (CBDT), Ministry of Finance, Government ofIndia.