Overview:

Foreign Direct Investments in India are also governed by the Income tax act of 1961, and one of such concepts under such FDI is Transfer pricing and the transactions relating to the same. This article will be looking into the concept of Transfer pricing under the Income tax act of 1961.

What is Transfer Pricing?

Let us first have an understanding of what transfer pricing is. As the term itself says, it is nothing but the price which is levied for any transfer of either the goods or the services between two units in a single larger company or firm or organization. These two entities need not be entities within a domestic country. Rather, they are multinational groups and are generally form part of associates of other companies. The price which they fix for the transfer shall be arbitrary and represents the value of the goods and services in any transaction.Secondly, an External audit which is contrary to the internal audit, is done by the auditors who are not parties to the respective auditors of the concerned company. The purpose of this kind of external audits is to make sure there are no biases in the process of reviewing or analyzing the company’s financials or the misstatements in the financial statements. Thirdly, an Internal Revenue Service audit is an audit where their purpose is to analyze the accuracy or the certainty of any taxpayer’s return individually or in any corporate organization.
It is also important to understand that these companies fix the price based on the market environment and also on the taxation system in the respective country. Their transfer prices shall be completely different from that of what has been priced by the two independent enterprises, which are not associated with each other, and because of this fact, the prices tend to be arbitrary in nature and shall be dictated due to market forces.
Let us look into an example to further understand how transfer pricing works in India as per the Income tax department. Company A buys a good for Rs. 50 and sells the same good to its associate company B, for Rs. 150, which is located in another country where Company A is not located. Now, Company B sells in the market for a price of Rs. 250. This is exactly how transfer pricing works. The reason for this pricing would include the tax system that two countries of A and B levies. Tax is one of the reasons for this transfer price. The profit would have been received by company A itself if it sells directly for such price of 250. But, it allowed company B to appropriate the remaining amount and sell accordingly. This price is Arm’s length price where there is inflation from the normal price. There might be taxes levied on this price, or there might not be at all.Thirdly, an Internal Revenue Service audit is an audit where their purpose is to analyze the accuracy or the certainty of any taxpayer’s return individually or in any corporate organization.
  • Transfer Pricing under Income Tax act, 1961:
Section 92 of the Income tax act, 1961 speaks about the computation of income from the international transaction. Subsection 2 of section 92 states that in case of international transactions, two or more associated enterprises enter into a mutual agreement or into an arrangement for the allocation or the appointment of any cost or the expense incurred or the expenses allotted or apportioned to or contributed by any of such enterprises shall be determined as per the Arm’s length price of such benefit received, as the case may be. What does this Arm’s length price mean? As per section 92F of the Income tax act of 1961, it means the price which shall be applied or proposed to be applied in any transaction between persons other than the persons who are associated with each other in an uncontrolled condition. 43.112 Section 92C of the Income tax act provides for the computation of transfer pricing as per Arm’s length price.

 It states that the Arm’s length price shall be determined through specific methods which would be appropriate as per the nature of the transaction or the class of transaction between the class of associated persons. The methods may be proscribed by the board, which includes 1. Comparable controlled price method, 2. Resale price method, 3. Cost plus method, 4. Profit split method or lastly, transactional net margin method. The method of determination other than the above shall also be fixed by the board.

  • Transfer pricing audit:
The reason for knowing what transfer pricing is under the Income tax act is to understand the meaning of the Transfer pricing audit under section 92E of the act. In general words, the auditing done for the transactions that have taken place as part of transfer pricing shall be reported in the name of the Transfer pricing audit. Section 92E of the Income act, 1961 requires the report from an accountant to be furnished by the persons who entered the international or even the domestic transaction. The companies or the organization should furnish a report from an accountant, and such report should be furnished within the specified date and duly signed by the accountant. The report should contain the required particulars as prescribed.
  • Domestic Transfer pricing:
Having seen what International transactions are, let us conclude with the domestic transfer pricing or the domestic transaction. Section 92BA of the act gives the definition of the specified domestic transaction as the one which is not the one that has been defined as International transactions and would include (ii) to (vi) of section 92BA. Those transactions are reiterated as follows.
  • i. Any transaction which has been referred to under section 80A
  • ii. Transfer of the goods or the services that took place under subsection (8) of section 80 IA
  • iii. Any of the businesses between the assessee and another person as mentioned under section 80 IA (10), and the one referred under chapter VI A or under section 10AA to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable
  • iv. Any other transactions as prescribed under the act.
And also, those transactions where the aggregate of a transaction entered by the assessee exceeds the sum of twenty crore rupees. This is to mean that any transaction under specified domestic transactions shall not be defined as international transactions under section 92B of the act, and the aggregate value of the transaction shall exceed the sum of 20 crores in the respective year.