In taxation and accounting, Transfer Pricing refers to the methods of transaction pricing for two associated entities, primarily when they are situated in different provinces. And in order to avoid companies from gaining any sort of tax advantage in all such deals, they are obliged to produce an extensive transfer pricing report. Let us delve further into it by visiting some of the key terms first.
Arm’s Length Price (ALP)
Section 92F of the 1961 Income Tax Act states that Arm’s Length Price is the price imposed or proposed to be imposed in case of transactions between parties apart from Associated Enterprises in uncontrolled circumstances.
In transfer pricing, all incomes are evaluated using this ALP principle.
Associated Enterprises (AE)
Under section 92A of the Act, an enterprise engaged in direct or indirect involvement in management, control, or assets of another enterprise is an Associated Enterprise (AE).
Participation in AEs may also occur via one or more intermediaries, whereby the same individual engages in the management, control, and capital of each of the involved enterprises.
Transfer Pricing in Domestic Transactions
TP guidelines came into effect in India from 2001. “Specified domestic transactions” were incorporated into it from the financial year 2012-13. Only if the combined value of the transaction surpasses INR 200 million, it will qualify for transfer pricing. In such expenditures, a deduction has to be asserted during the estimation of profits for a business or profession. Else, it has to be related to businesses qualified for profit-linked tax incentives (for example infrastructure facilities, SEZ units, etc.) as specified in the 1961 Income Tax Act.
Calculation of ALP
The Income Tax Act of 1961 recommends the following methods to compute Arm’s Length Price:
Price Based Methods
· Comparable Uncontrolled Price (CUP) Method
· Resale Price Method (RPM)
· Cost Plus Method (CPM)
Profit Based Methods
· Transactional Net Margin Method (TNMM)
· Profit Split Method (PSM)
The Transfer Pricing regulations also allow the employment of other methods for determining ALPs for a price that has been charged or already paid for the same or similar transactions.
The nature and class of the deal, associated parties, their actions, and other relevant features decide the most appropriate method for ALP calculations.
Documenting Transfer Pricing
The law mandates that every taxpayer involved in any transaction with AEs has to conduct a comprehensive Transfer Pricing study annually. It should also include information on the calculation of ALP.
The OECD (Organization for Economic Co-operation and Development) suggests three-tier documentation that involves a master file, a local file, and a country-by-country report (CbCR). The master file documents information about MNC groups, intangibles, financial ventures, etc. The local file is specific to a country and includes particulars about intercompany transactions within the group. The CbCR holds details of economic activities like income, taxes, etc.As globalization continues to bring about dynamic changes in the business world, maintaining a Transfer Pricing report with every substantial detail has become even more significant than before. Currently, in India, companies are required to produce a report on or before November 20, i.e. at the end of the relevant fiscal year.
