Transfer Pricing Concept:

DEFINITION:
Transfer pricing refers to the pricing of contributions (assets, tangible and
intangible, services, and funds) transferred within an organization (a corporation or
similar entity). For example, goods from the production division may be sold to the
marketing division, or goods from a parent company may be sold to a foreign
subsidiary. Since the prices are set within an organization (i.e. controlled), the typical
market mechanisms that establish prices for such transactions between third parties
may not apply. The choice of the transfer price will affect the allocation of the total
profit among the parts of the company. This is a major concern for fiscal authorities
who worry that multi-national entities may set transfer prices on cross-border
transactions to reduce taxable profits in their jurisdiction. This has led to the rise of
transfer pricing regulations and enforcement, making transfer pricing a major tax
compliance issue for multi-national companies.

The Concept

TP relates to the pricing of transactions (such as transfer of goods, services,

intangibles and funds) that take place within affiliate segments of a group company in
different tax jurisdictions. To illustrate this, let us suppose a subsidiary company,
resident in country A (which has a tax rate of, say, 40%) manufactures goods and
transfers them to its parent company in country B (which has a tax rate of 20%) for
trading. In order to increase the overall profits of the group company, it will seek to
supply the goods at prices which are lower than the market price. So, in effect, the
subsidiary company in country A will have lower profits and [therefore,] a lower tax
incidence whereas the parent company in country B is affected in the opposite
manner higher profits due to low costs, but lower taxes because of the tax rate - which
illustrates the importance of TP from a taxation perspective. However, TP
transactions can be much more complex than the example above and usually involve
deliberations on inter related variables and the weighing of regulatory and other
constraints.

1
Nowadays, tax revenue authorities have become more vigilant about TP issues as TP
transactions form a considerable part of the tax base of all countries. Compared to
other countries, India is a late entrant in the field of regulating TP. The Finance Act,
2001 introduced provisions regulating TP in the Income Tax Act, 1961 with effect
from 1 April, 2001. Prior to this amendment, a limited provision regulating transfer
pricing did exist in section 92 of the Act. However, this was very often not strictly
complied with by businesses as there were no rules or guidance available regarding
its implementation. However, the 2001 amendment, which defined associated
enterprise and international transaction for the first time, has brought much needed
clarity to the law. There is greater respect among businesses (including MNEs) for the
expertise of the Indian tax authorities in handling the complexities involved in TP
transactions.
MNEs have to keep in mind multiple factors in deciding their TP strategies. Some of
them are:
Tax jurisdiction: Profit is a function of price. As a result, charging higher prices in a
higher tax jurisdiction results in a low tax base and relatively higher profits in a lower
tax jurisdiction.
Import duties: Usually, low prices of commodities attract low import duties in
countries where custom duties form a major part of tax revenues.
Thin Capitalization: MNEs also have the option of thinly capitalizing some of its
constituent entities by making investments as loans instead of equity to avail tax
benefits. This mechanism would usually involve a foreign affiliate of a group
company making an investment in a domestic affiliate of the company in the form of
loans. As a result, the companies debt-equity ratio increases, i.e. it becomes thinly
capitalized. Thin capitalization can be part of a larger TP strategy. MNEs make
iniquitous use of this method to avail of tax benefits since interest on loans is
deductible while calculating taxable income. In India, there is no formalized
provision regulating thin capitalization under the law, but there are some related
provisions regarding permissible debt in the Foreign Exchange Management Act,
1999 (FEMA), which act as alternative mechanisms to reduce such practices.

Others: Other methods include the exploitation of fluctuations in foreign exchange

rates to derive maximum benefit. For instance, a company can reduce the expected

2
currency devaluation risk by transferring funds to its affiliates in other countries and
varying the cash flow requirements of the companies within MNEs. The MNE group
may be pressurised by shareholders to show high profitability at the parent company
level, particularly if financial reporting is not carried out on a consolidated basis.

Transfer pricing services include:

• Planning and analysis related to intangible property, including cost sharing and
licensing of patents, trademarks, trade names and other intangibles.

• Creating optimal tax structures through operational planning, including the

realignment of manufacturing, sourcing, distribution and other service operations.

• Negotiating Advance Pricing Agreements to mitigate risks by agreeing in advance

to transfer pricing policy terms with one or multiple tax authorities.

• Creating financial models that support operational efforts to monitor transfer pricing
compliance and assist in the preparation of documentation for Sarbanes-Oxley
internal control reviews.

• Performing transfer pricing due diligence for mergers and acquisitions.

• Recommending post-merger transfer pricing integration plans, including the

consolidation of intellectual property ownership.

• Conducting FIN 48 analyses from a transfer pricing perspective.

• Preparing transfer pricing documentation to support global compliance

requirements.

TRANSFER PRICING MANIPULATION:

INTRODUCTION:

3
 Governments and MNEs have both been putting pressure from either side to
get Transfer Pricing policies in their favour just like any other Tax law, Governments
want to earn more tax (or save outflow of justified tax) and MNEs want the flexibility
to save taxes.
Transfer pricing is simply the act of pricing of goods and services or
intangibles when the same is given for use or consumption to a related party (e.g.
Subsidiary). There can be either Market-based, i.e. equivalent to what is being
charged in the outside market for similar goods, or it can be non-market based.
Importantly, two-thirds of the managers say their transfer pricing is non-market
based.
There can be internal and external reasons for transfer pricing. Internal include
motivating managers and monitoring performance, e.g. by putting a cost to imported
inputs. External would be taxes and tariffs. This leads us to the point of Transfer
Pricing Manipulation (TPM). It is TPM that is discouraged by Governments as
against Transfer Pricing which is the act of pricing. However, in common parlance, it
is Transfer Pricing which is generally used to mean TPM.
TPM is fixing transfer price on non-market basis which generally results in
saving the total quantum of organization’s tax by shifting accounting profits from
high tax to low tax jurisdictions. The implication is moving of one nation’s tax
revenue to another.
A similar phenomenon exists in domestic markets where different states attract
investment by under cutting Sales tax rates, leading to outflow from one state to
another, something the Government is trying to curb by way of implementation of
VAT.

MOTIVATIONS FOR TPM:

4
It is not just the Corporate Tax differential that induces organizations to
manipulations in Transfer Pricing. Some of the other reasons are:
• High Customs Duty – leading to under-invoicing of goods.
• Restriction on Profit Repatriation – leading to over-invoicing of raw materials, etc
transferred from parent country, hence compensating for locked forex.
• Ownership Restrictions ( E.g. Insurance Sector – 26%) – since this leads to less than
justified returns on the technology or knowledge invested in the JV, MNEs
circumvent it through over charging on royalties for technology, etc.

There can be various other similar motivations for TPM. The transactions
most likely disputed by Governments are Administration & Management Fees,
Royalties for intangibles and transfer of finished goods for resale.

EFFECTS OF TPM ON NATIONS:

1. One primary and well appreciated effect is the loss of Government Tax and
Custom Duty revenues. Loss of tax revenues in this form leads to a burden on the rest
of the population through over taxation and/or borrowings by the Government, which
becomes essential to meet expenditure requirements.
2. TPM also leads to distortions in Balance of Payments between the host and home
country, something that has the potential to challenge the sovereignty of nations given
the mega size of some of these firms.
3. Another implication is on the location of international production and employment.
Given the objective of maximization of global profits, MNEs will open subsidiaries
where production is most profitable, which is where tax burden is less and therefore
effect the level of FDI a country gets. This linkage is so strong that some like Hong
Kong and Singapore have no Transfer Pricing controls, making themselves attractive
destinations for FDI.

Transfer Pricing has been existing in domestic and importantly international

transactions over decades now and there is nothing novel about the concept. What is,
however, is the extent of this practice which has now acquired critical mass to be
given due consideration by various tax authorities.

5
TPM GAINING IMPORTANCE:
The issue has gained importance in the recent past due to organizations
acquiring huge economic power (in some cases more than nations themselves - Of the
100 biggest economies, 51 are companies and 49 are countries) operating in scores of
nations, making their sales, production and distribution structure more and more
complex to come under the purview of one tax regime.
The other phenomenon is increasing liberalization due to which a larger
number of countries are allowing entry of these MNEs and a further larger number
making their environment conducive for foreign investment. This has led to
establishment of truly global corporations resulting in a higher proportion of intra
organization trade in international trade. To substantiate the idea further, one-thirds of
total world trade Is intra-firm.
A third phenomenon, particularly in countries like India, is one of
Government moving away from control of productive resources (by way of
divestment, etc.) which has put all the more emphasis on tax revenues in meeting
Govt.’s revenue requirements.

Arms Length Price:

DEFINITION:
A deal between two interrelated or enterprise associates parties. That is
behavior as if they were not related, so that there is no query of a disagreement of
attention. In simple way we can describe this as “a deal between two unconnected or
associate parties”.
The concept of an arm's length deal is to make sure that both associates in the
transaction are behave in their self attention and are not issue to any force or pressure
from the other associate.
Provided that in exceptional cases, the company may decide to use a non-arm’s
length transfer price if the Board of Directors as well as the audit committee of the
Board are satisfied for reasons to be recorded in writing that it is in the interest of the
company to do so. In all such cases, the use of a non-arms length transfer price, the
reasons therefore, and the profit impact thereof shall be disclosed in the annual report.

Methods of Computation of Arm’s Length Price:

6
The arm’s length price shall be determined by any of the following methods, being
the most appropriate method, having regard to the nature of transaction or class of
transaction, namely:
(1) Comparable Uncontrolled Price Method
(2) Resale Price Method
(3) Cost Plus Method
(4) Profit Split Method
(5) Transactional Net Margin Method
(6) Any other basis approved by the Central Government, which has the effect of
valuing such transaction at arm’s length price.

(1) Comparable Uncontrolled Price (CUP) Method :

The price charged or paid in a comparable uncontrolled transaction or a number of
such transactions shall be identified. Such price shall be adjusted to account for
differences, if any, between the related party transaction and the comparable
uncontrolled transactions or between the enterprises entering into such transactions,
which could materially affect the price in the open market. The adjusted price shall be
taken as arm’s length price.
The uncontrolled transaction means a transaction between independent enterprises
other than related parties and shall cover goods or services of a similar type, quality
and quantity as those between the related parties and relate to transactions taking
place at a similar time and stage in the production/distribution chain with similar
terms and conditions applying.

(2) Resale Price Method :

The price at which the goods purchased or services obtained from a related party is
resold or is provided to an unrelated entity shall be identified. Such resale price shall
be reduced by the amount of a normal gross profit margin accruing to the enterprise
or to an unrelated enterprise from the purchase and resale of the same or similar
goods or services in a comparable uncontrolled transaction or a number of such
transactions. The price so arrived at shall be further reduced by the expenses incurred
by the enterprise in connection with the purchase of goods or services. Such price
shall be further adjusted to take into account the functional and other differences

7
including differences in accounting practices, if any, between the related party
transaction and the comparable uncontrolled transactions or between the enterprises
entering into such transactions, which could materially affect the amount of gross
profit margin in the open market. The adjusted price shall be taken as arm’s length
price in respect of goods purchased or services obtained from the related party.
The resale price method would normally be adopted where the seller adds relatively
little or no value to the product or where there is little or no value addition by the
reseller prior to the resale of the finished products or other goods acquired from
related parties. This method is often used when goods are transferred between related
parties before sale to an independent party.

(3) Cost Plus Method :

The total cost of production incurred by the enterprise in respect of goods transferred
or services provided to a related party shall be determined. The amount of a normal
gross profit mark-up to such costs arising from the transfer of same or similar goods
or services by the enterprise or by an unrelated enterprise in a comparable
uncontrolled transaction or a number of such transactions, shall be determined. The
amount of a normal gross profit mark-up shall be adjusted to take into account the
functional and other differences, if any, between the related party transaction and the
comparable uncontrolled transactions or between the enterprises entering into such
transactions, which could materially affect such profit mark-up in the open market.
The total cost of production referred to above increased by the adjusted profit mark-
up shall be taken as arm’s length price. It is also important here to ensure that the cost
base to which mark-up is applied is comparable to the cost base of the third party
transaction which serve as comparable. For example, it may be necessary to make an
adjustment to cost where one person leases its business assets while other owns its
business assets.
The cost plus method would normally be adopted if CUP method or resale price
method cannot be applied to a specific transaction or where goods are sold between
associates at such stage where uncontrolled price is not available or where there are
long term buy and supply arrangements or in the case of provision of services or
contract manufacturing.

8
 (4) Profit Split Method :
The combined net profit of the related parties arising from a transaction in which they
are engaged shall be determined. This combined net profit shall be partially allocated
to each enterprise so as to provide it with a basic return appropriate for the type of
transaction in which it is engaged with reference to market returns achieved for
similar types transactions by independent enterprises. The residual net profit,
thereafter, shall be split amongst the related parties in proportion to their relative
contribution to the combined net profit. This relative contribution of the related
parties shall be evaluated on the basis of the function performed, assets employed or
to be employed and risks assumed by each enterprise and on the basis of reliable
market data which indicates how such contribution would be evaluated by unrelated
enterprises performing comparable functions in similar circumstances. The combined
net profit will then be split amongst the enterprises in proportion to their relative
contributions. The profit so apportioned shall be taken into account to arrive at an
arm’s length price.
This method would normally be adopted in those transactions where integrated
services are provided by more than one enterprise or in the case multiple inter-related
transactions which cannot be separately evaluated.

(5) Transactional Net Margin Method :

The net profit margin realised by the enterprise from a related party transaction shall
be computed in relation to costs incurred or sales effected or assets employed or to be
employed by the enterprise or having regard to any other relevant base. The net profit
margin realised by the enterprise or by an unrelated enterprise from a comparable
uncontrolled transaction or a number of such transactions, shall also be computed
having regard to the same base. This net profit margin shall be adjusted to take into
account the differences, if any, between the related party transaction and the
comparable uncontrolled transactions or between the enterprises entering into such
transactions, which could materially affect such net profit margin in the open market.
The cost of production referred to above increased by the adjusted profit mark-up
shall be taken as arm’s length price. The adjusted net profit margin shall be taken as
arm’s length price.

9
This method would normally be adopted in the case of transfer of semi finished
goods; distribution of finished products where resale price method cannot be
adequately applied; and transaction involving provision of services.

Documentation Requirement in Transfer Pricing:

Primary Documentation:

i. A description of the ownership structure of the enterprise and details of

shares or other ownership interest held therein by other enterprises;
ii. A profile of the multinational group of which the taxpayer is a part and 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 made by the taxpayer and the ownership linkages among them;
iii. A broad description of the business of the taxpayer and the industry in
which it operates and the business of the associated enterprises;
iv. The nature, terms and prices of international transaction entered into with
each associated enterprise, details of property transferred or services
provided and the quantum and the value of each such transaction or class
of such transaction;
v. A description of the functions performed, risks assumed and assets
employed or to be employed by the taxpayer and by the associated
enterprise involved in the international transaction;
vi. A record of the economic and market analyses, forecasts, budgets or any
other financial estimates prepared by the taxpayer for its business as a
whole or separately for each division or product which may have a bearing
on the international transaction entered into by the taxpayer;
vii. A record of uncontrolled transactions taken into account for analysing
their comparability with the international transaction entered into,
including a record of the nature, terms sand conditions relating to any
uncontrolled transaction with third parties which may be of relevant to the
pricing of the internationals transactions;
viii. A record of the analysis performed to evaluate comparability of
uncontrolled transactions with the relevant international transaction;

10
 ix. A description of the methods considered for determining the arm's length
price in relation to each international transaction or class of transaction,
the method selected as the most appropriate method along with
explanations as to why such method was so selected, and how such
method was applied in each case;
x. A record of the actual working carried out for determining the arm's length
price, including details of the comparable data and financial information
used in applying the most appropriate method and adjustments, if any,
which were made to account for differences between the international
transaction and the comparable uncontrolled transactions or between the
enterprises entering into such transaction;
xi. The assumptions, policies and price negotiations if any which have
critically affected the determination of the arm's length price ;
xii. Details of the adjustments, if any made to the transfer price to align it with
arm's length price determined under these rules and consequent adjustment
made to the total income for tax purposes;
xiii. Any other information data or document including information or data
relating to the associated enterprise which may be relevant for
determination of the arm's length price.

Secondary Documentation:

Rule 10D also prescribes that the above information is to be supported by authentic
documents which may include the following:

i. Official publications, reports, studies and data bases of the government of

the country of residence of the associated enterprise or of any other
country;

11
 ii. Reports of market research studies carried out and technical publications
of institutions of national or international repute;
iii. Publications relating to prices including stock exchange and commodity
market quotations;
iv. Published accounts and financial statements relating to the business of the
associated enterprises;
v. Agreements and contracts entered into with associated enterprises or with
unrelated enterprises in respect of transaction similar to the international
transactions;
vi. Letters and other correspondence documenting terms negotiated between
the taxpayer and associated enterprise;

Transfer Pricing Law in India:

Finance
Act, 2001 substituted section 92 with a new section and introduced new sections 92A
to 92F in the Income-tax Act, relating to computation of income from an international
transaction having regard to the arm's length price, meaning of associated enterprise,
meaning of information and documents by persons entering into international
transactions and definitions of certain expressions occurring in the said section.

92A. Meaning of Associated Enterprise.

(a)Which participates, directly or indirectly, or through one or more

intermediaries, in the management or control or capital of the other
enterprise; or

(b) in respect of which one or more persons who participate, directly or

indirectly, or through one or more intermediaries, in its management or
control or capital, are the same persons who participate, directly or indirectly,
or through one or more intermediaries, in the management or control or
capital of the other enterprise.

(2) For the purposes of sub-section (1), two enterprises shall be deemed to be
associated enterprises if, at any time during the previous year,

12
(a) One enterprise holds, directly or indirectly, shares carrying not less than twenty-
six percent of the voting power in the other enterprise; or

(b) Any person or enterprise holds, directly or indirectly, shares carrying not less than
twenty-six per cent. of the voting power in each of such enterprises; or

(c) A loan advanced by one enterprise to the other enterprise constitutes not less than
fifty-one per cent. of the book value of the total assets of the other enterprise; or

(d) One enterprise guarantees not less than ten per cent. of the total borrowings of the
other enterprise; or

(e) More than half of the board of directors or members of the governing board, or
one or more executive directors or executive members of the governing board of one
enterprise, are appointed by the other enterprise; or

(f) The manufacture or processing of goods or articles or business carried out by one
enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-
marks, licences, franchises or any other business or commercial rights of similar
nature, or any data, documentation, drawing or specification relating to any patent,
invention, model, design, secret formula or process, of which the other enterprise is
the owner or in respect of which the other enterprise has exclusive rights; or

(g) Ninety per cent. 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, or by persons specified by the other enterprise, and
the prices and other conditions relating to the supply are influenced by such other
enterprise; or

92B. Meaning of international transaction.

International transaction means a transaction between two or more associated

enterprises, either or both of whom are non-residents, in the nature of purchase, sale
or lease of tangible or intangible property, or provision of services, or lending or
borrowing money, or any other transaction having a bearing on the profits, income,
losses or assets of such enterprises and shall include a mutual agreement or

13
arrangement between two or more associated enterprises for the allocation or
apportionment of, or any contribution to, any cost or expense incurred or to be
incurred in connection with a benefit, service or facility provided or to be provided to
any one or more of such enterprises.

A transaction entered into by an enterprise with a person other than an associated

enterprise shall, for the purposes of sub-section (1), be deemed to be a transaction
entered into between two associated enterprises, if there exists a prior agreement in
relation to the relevant transaction between such other person and the associated
enterprise; or the terms of the relevant transaction are determined in substance
between such other person and the associated enterprise.

92C.Computation of arm’s length price.

(1) The arm’s length price in relation to an international transaction shall be

determined by any of the following methods, being the most appropriate method,
having regard to the nature of transaction or class of transaction or class of associated
persons or functions performed by such persons or such other relevant factors as the
Board may prescribe, namely:-

(a) Comparable uncontrolled price method;

(b) Resale price method;

(c) Cost plus method;

(d) Profit split method;

(e) Transactional net margin method;

(f) Such other method as may be prescribed by the Board.

(2) The most appropriate method referred to in sub-section (1) shall be applied, for
determination of arm’s length price, in the manner as may be prescribed:

Provided that where more than one price is determined by the most appropriate
method, the arm’s length price shall be taken to be the arithmetical mean of such

14
prices, or, at the option of the assessee, a price which may vary from the arithmetical
mean by an amount not exceeding five per cent of such arithmetical mean.

92CA. Reference to Transfer Pricing Officer.

Section 92CA provides that where an assessee has entered into an international
transaction in any previous year, the AO may, with the prior approval of the
Commissioner, refer the computation of arm's length price in relation to the said
international transaction to a Transfer Pricing Officer. The Transfer Pricing Officer,
after giving the assessee an opportunity of being heard and after making enquiries,
shall determine the arm's length price in relation to the international transaction in
accordance with sub-section (3) of section 92C. The AO shall then compute the total
income of the assessee under sub-section (4) of section 92C having regard to the
arm's length price determined by the Transfer Pricing Officer.

The Transfer Pricing Officer means a Joint Commissioner/Deputy

Commissioner/Assistant Commissioner authorized by the Board to perform functions
of an AO specified in section 92C & 92D.

The first proviso to section 92 C(4) recognizes the commercial reality that even when
a transfer pricing adjustment is made under that sub-section the amount represented
by the adjustment would not actually have been received in India or would have
actually gone out of the country. Therefore no deductions u/s 10A or 10B or under
chapter VI-A shall be allowed in respect of the amount of adjustment.

The second proviso to section 92C(4) provides that where the total income of an
enterprise is computed by the AO on the basis of the arm's length price as computed
by him, the income of the other associated enterprise shall not be recomputed by
reason of such determination of arm's length price in the case of the first mentioned
enterprise, where the tax has been deducted or such tax was deductible, even if not
actually deducted under the provision of chapter VIIB on the amount paid by the first
enterprise to the other associate enterprise.

92D.Maintenance, keeping of information and document by persons entering

into an international transaction.

15
(1) Every person who has entered into an international transaction shall keep and
maintain such information and document in respect thereof, as may be prescribed.

(2) Without prejudice to the provisions contained in sub-section (1), the Board may
prescribe the period for which the information and document shall be kept and
maintained under that sub-section.

(3) The Assessing Officer or the Commissioner (Appeals) may, in the course of any
proceeding under this Act, require any person who has entered into an international
transaction to furnish any information or document in respect thereof, as may be
prescribed under sub-section (1), within a period of thirty days from the date of
receipt of a notice issued in this regard:

Provided that the Assessing Officer or the Commissioner (Appeals) may, on an

application made by such person, extend the period of thirty days by a further period
not exceeding thirty days.

92E.Report from an accountant to be furnished by persons entering into

international transaction.

Section 92E provides that every person who has entered into an international
transaction during a previous year shall obtain a report from an accountant and
furnish such report on or before the specified date in the prescribed form and manner.
Rule 10E and form No. 3CEB have been notified in this regard. The accountants
report only requires furnishing of factual information relating to the international
transaction entered into, the arm's length price determined by the assessee and the
method applied in such determination. It also requires an opinion as to whether the
prescribed documentation has been maintained.

92F.Definitions of certain terms relevant to computation of arm’s length price,

etc.

(i) Accountant shall have the same meaning as in the Explanation below sub-section
(2) of section 288;

16
(ii) arm’s length price means a price which is applied or proposed to be applied in a
transaction between persons other than associated enterprises, in uncontrolled
conditions;

(iii) enterprise means a person who is, or has been, or is proposed to be, engaged in
any activity, relating to the production, storage, supply, distribution, acquisition or
control of articles or goods, or know-how, patents, copyrights, trade-marks, licences,
franchises or any other business or commercial rights of similar nature, or any data,
documentation, drawing or specification relating to any patent, invention, model,
design, secret formula or process, of which the other enterprise is the owner or in
respect of which the other enterprise has exclusive rights, or the provision of services
of any kind, or in carrying out any work in pursuance of a contract, or in investment,
or providing loan or in the business of acquiring, holding, underwriting or dealing
with shares, debentures or other securities of any other body corporate, whether such
activity or business is carried on, directly or through one or more of its units or
divisions or subsidiaries, or whether such unit or division or subsidiary is located at
the same place where the enterprise is located or at a different place or places;

(iiia) "Permanent establishment", referred to in clause (iii), includes a fixed place of

business through which the business of the enterprise is wholly or partly carried on;

(iv) "Specified date" shall have the same meaning as assigned to "due date" in
Explanation 2 below sub-section (1) of section 139;

(v) "Transaction" includes an arrangement, understanding or action in concert,-

(A) Whether or not such arrangement, understanding or action is formal or in writing;

or

(B) Whether or not such arrangement, understanding or action is intended to be

enforceable by legal proceeding.

Penalties:

Penalties have been provided as a disincentive for non-compliance with procedural

requirements.

17
Explanation 7 to sub-section (1) of section 271 provides that where in the case of an
assessee who has entered into an international transaction any amount is added or
disallowed in computing the total income under sub-sections (1) and (2) of section 92,
then, the amount so added or disallowed shall be deemed to represent income in
respect of which particulars have been concealed or inaccurate particulars have been
furnished. However, no penalty under this provision can be levied where the assessee
proves to the satisfaction of the Assessing Officer (AO) or the Commissioner of
Income Tax (Appeals) that the price charged or paid in such transaction has been
determined in accordance with section 92 in good faith and with due diligence.

Section 271AA: provides that if any person who has entered into an international
transaction fails to keep and maintain any such information and documents as
specified under section 92D, the AO or Commissioner of Income Tax (Appeals) may
levy a penalty of a sum equal to 2% of the value of international transaction entered
into by such person.

Section 271BA: provides that if any person fails to furnish a report from an
accountant as required by section 92E, the AO may levy a penalty of a sum of one
lakh rupees.

Section 271G: provides that if any person who has entered into an international
transaction fails to furnish any information or documents as required under section
92D (3), the AO or CIT(A) may levy a penalty equal to 2% of the value of the
international transaction.
Above mentioned penalties shall not be imposable if the assessee proves that there
was reasonable cause for such failures.

Burden of Proof:

The primary onus is on the taxpayer to determine an arm's length price in accordance
with the rules, and to substantiate the same with the prescribed documentation: where
such onus is discharged by the assessee and the data used for determining the arm's
length price is reliable and correct there can be no intervention by the Assessing
Officer (AO). This is made clear in sub-section (3) of section 92C which provides
that the AO may intervene only if he is, on the basis of material or information or

18
document in his possession of the opinion that the price charged in the international
transaction has not been determined in accordance with the methods prescribed, or
information and documents relating to the international transaction have not been
kept and maintained by the assessee in accordance with the provisions of section 92D
and the rules made there under, or the information or data used in computation of the
arm's length price is not reliable or correct ; or the assessee has failed to furnish,
within the specified time; any information or document which he was required to
furnish by a notice issued under sub-section (3) of section 92D. If any one of such
circumstances exists, the AO may reject the price adopted by the assessee and
determine the arm's length price in accordance with the same rules. However, an
opportunity has to be given to the assessee before determining such price. Thereafter,
the AO may compute the total income on the basis of the arm's length price so
determined by him under sub-section (4) of section 92C.

Tax treaty:

Many countries have entered into bilateral agreements with respect to taxes (tax
treaties). Tax treaties may cover income taxes, inheritance taxes; value added taxes,
or other taxes. Countries of the European Union (EU) have also entered into a
multilateral agreement with respect to value added taxes under auspices of the EU.
Tax treaties tend to reduce taxes of one contracting country for residents of the other
contracting country, thus tending to reduce double taxation of the same income. The
provisions and goals vary highly; very few tax treaties are alike. Commonly
appearing provisions:

19
 • define which taxes are covered and who is a resident and eligible for benefits,
• reduce the amounts of tax withheld from interest, dividends, and royalties paid
by a resident of one country to residents of the other country,
• limit tax of one country on business income of a resident of the other country
to that income from a permanent establishment in the first country,
• define circumstances in which income of individuals resident in one country
will be taxed in the other country, including salary, self employment, pension,
and other income,
• provide for exemption of certain types of organizations or individuals, and
• provide procedural frameworks for enforcement and dispute resolution.

The stated goals for entering into a treaty often include reduction of double taxation,
eliminating tax evasion, and encouraging cross-border trade efficiency. It is generally
accepted that tax treaties improve certainty for taxpayers and tax authorities in their
international dealings.

Economics of Treaties:

Fiscal (Tax) Residency

Generally, individuals are considered resident under a tax treaty and subject to
taxation where they maintain their primary place of abode. This definition is often
somewhat modified or expanded. The United States includes citizens, wherever
living, as subject to taxation. Most treaties recognize that a person could meet the
definition of residence in more than one jurisdiction (i.e., "dual residence") and
provide a “tie breaker” clause. Such clauses typically have a hierarchy of three to five
tests for resolving multiple residency, typically including permanent abode as a major
factor. Tax residency rarely impacts citizenship or permanent resident status, though
certain residency statuses under a country's immigration law may influence tax
residency.

Entities may be considered resident based on their country of seat of management,

their country of organization, or other factors The criteria are often specified in a
treaty, which may enhance or override local law. It is possible under some treaties for
an entity to be resident in both countries. Some treaties provide “tie breaker” rules for

20
entity residency some do not Residency is irrelevant in the case of some entities
and/or types of income, as members of the entity rather than the entity are subject to
tax.

Permanent Establishment
Most treaties provide that business profits (sometimes defined in the treaty) of a
resident of one country are subject to tax in the other country only if the profits arise
through a permanent establishment in the other country. Such treaties also define
what constitutes a permanent establishment (PE). Most but not all tax treaties follow
the definition of PE in the OECD Model Treaty. Under the OECD definition, a PE is
a fixed place of business from which the activities are conducted giving rise to the
particular profits. Specific things are included in PE, including an office, warehouse,
construction site, and others. Specific exceptions from the definition of PE are also
provided, such as a site where only preliminary or ancillary activities (like market
research or administration) are conducted. Some treaties contain provisions which
deem a PE to exist if certain activities (such as services) are conducted for certain
periods of time, even where a PE would not otherwise exist.

Withholding Taxes
Many tax systems provide for collection of tax from nonresidents by requiring payers
of certain types of income to withhold tax from the payment and remit it to the
government. Such income often includes interest, dividends, royalties, and payments
for technical assistance. Most tax treaties reduce or eliminate the amount of tax
required to be withheld with respect to residents of a treaty country.

Income from Employment

Most treaties provide mechanisms eliminating taxation of residents of one country by
the other country where the amount or duration of performance of services is minimal
but also taxing the income in the country performed where it is not minimal. Most
treaties also provide special provisions for entertainers and athletes of one country
having income in the other country, though such provisions vary highly. Also most
treaties provide for limits to taxation of pension or other retirement income.

21
Tax Exemptions for Persons or Entities
Most treaties eliminate from taxation income of certain diplomatic personnel. Most
tax treaties also provide that certain entities exempt from tax in one country are also
exempt from tax in the other. Entities typically exempt include charities, pension
trusts, and government owned entities. Many treaties provide for other exemptions
from taxation that one or both countries as considered relevant under their
governmental or economic system.

Harmonization of Tax Rates

Tax treaties usually specify the same maximum rate of tax that may be imposed on
some types of income. As an example, a treaty may provide that interest earned by a
nonresident eligible for benefits under the treaty is taxed at no more than five percent
(5%). However, local law in some cases may provide a lower rate of tax irrespective
of the treaty. In such cases, the lower local law rate prevails.

Provisions Unique to Inheritance Taxes

Generally, income taxes and inheritance taxes are addressed in separate treaties.
Inheritance tax treaties often cover estate and gift taxes. Generally fiscal domicile
under such treaties is defined by reference to domicile as opposed to tax residence.
Such treaties specify what persons and property are subject to tax by each country
upon transfer of the property by inheritance or gift. Some treaties specify which party
bears the burden of such tax, but often such determination relies on local law (which
may differ from country to country).

Most inheritance tax treaties permit each county to tax domiciliaries of the other
country on real property situated in the taxing country, property forming a part of a
trade or business in the taxing country, tangible movable property situated in the
taxing country at the time of transfer (often excluding ships and aircraft operated
internationally), and certain other items. Most treaties permit the estate or donor to
claim certain deductions, exemptions, or credits in calculating the tax that might not
otherwise be allowed to non-domiciliaries.

22
Double Tax Relief
Nearly all tax treaties provide a specific mechanism for eliminating double taxation
still potentially present. This mechanism usually requires that each country grant a
credit for the taxes of the other country to reduce the taxes of a resident of the
country. The treaty may or may not provide mechanisms for limiting this credit, and
may or may not limit the application of local law mechanisms to do the same.

Mutual Enforcement
Taxpayers may relocate themselves and their assets to avoid paying taxes. Some
treaties thus require each treaty country to assist the other in collection of taxes and
other enforcement of their tax rules. Most tax treaties include, at a minimum, a
requirement that the countries exchange of information needed to foster enforcement.

Dispute Resolution
Nearly all tax treaties provide some mechanism under which taxpayers and the
countries can resolve disputes arising under the treaty. Generally, the government
agency responsible for conducting dispute resolution procedures under the treaty is
referred to as the “Competent Authority” of the country. Competent Authorities
generally have the power to bind their government in specific cases. The treaty
mechanism often calls for the Competent Authorities to attempt to agree in resolving
disputes.

Limitations on Benefits
Recent treaties of certain countries have contained an article preventing reduced tax
under the treaty unless the party seeking benefits meets additional tests. These
Limitation of Benefits articles vary widely from treaty to treaty, and are often quite
complex. Generally, individuals and publicly traded companies and their subsidiaries
are not adversely impacted by the provisions. The provisions tend to limit benefits
where an entity seeking benefits is not sufficiently owned by residents of one of the
treaty countries or "equivalent beneficiaries" of other treaty countries.

Priority of Law
Treaties are considered the supreme law of many countries. In those countries, treaty
provisions fully override conflicting domestic law provisions. For example, many EU

23
countries could not enforce their group relief schemes under the EU directives. In
some countries, treaties are considered of equal weight to domestic law. In those
countries, a conflict between domestic law and the treaty must be resolved under the
dispute resolution mechanisms of either domestic law or the treaty.
CONCLUSION:
Transfer pricing is inherent in the way the global economy is structured with
sourcing and consuming destinations being different, with numerous organizations
operating in multiple countries and most importantly due to varying tax and other
laws in different nations.

Also nations have to achieve a fine balance between loss of revenues in the
form of outflow of tax and making their country an attractive investment destination
by giving flexibility in Transfer Pricing. One can choose to go to extremes like
Singapore would be doing especially when it is the low tax country. Given that
countries are not integrated into a global system, each of them want increase in total
inflow through tax or FDI and something like VAT is not expected to remove this
non-competitive method of attracting investment, countries will need to enact
legislations on their own. Thus, achieving the mentioned balance, suiting their
conditions and pattern of international transactions, according to the stage of
economic development they are in, are some of the challenges companies are facing
as they become a global economic community.

Bibliography:
• Coopers & Lybrand. International Transfer Pricing.

24
• Transfer pricing Guidelines
• www.transferpricing-india.com
• www.tpweek.com
• www.transferpricing.com
• www.google.com

25