Concept of Transfer Pricing and Foreign Direct Investment (FDI) in India | Best FDI Attorney in India | FDI Attorney in Delhi NCR | India Business Entry |
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“Foreign corporation are coming to India by way of foreign direct investments in India or FDI in India with the purpose to manufacture or trade good within India including their imports and exports. Transfer Pricing is closely related to Foreign Direct Investment (FDI) as its definition suggests- Transfer Pricing refers to the price that is paid by an entity for transferring of goods and services from one entity to its other entity/branch/office situated in another country. Transfer pricing is a complex process and requires proficient legal advice from the best FDI attorney in India. Further, the attorney should be well versed with business laws of India and the corporate laws of India including the practice and procedure for FDI in India respectively.”
Now the question is what are the transactions that are subjected to the Transfer Pricing?
So, to answer this question the transactions like sale of final goods, purchase of raw material to produce final goods, buying of fixed assets, buying or selling of machineries, support services rendered, IT enabled services, payment for technical services rendered, software development services, Management and Royalty fees and Loan received and paid etc. These are the transactions subject to the rule of Transfer Pricing.
Rationale behind Transfer Pricing and its Importance in India: Best FDI Attorney Legal Advice in india
The objective behind Transfer Pricing is to make sure avoidance of taxes under opportunities of tax arbitrage for domestic transactions and Equitable sharing revenues from tax between the nations where the concerned entities is situated and doing business. It’s also important to protect the tax bases. For this purpose, it is important for those entities that are having cross-border business to understand the concept of Transfer Pricing and be abide by the rules of Transfer Pricing.
Transfer Pricing and Foreign Direct Investment (FDI) in India: Best FDI Legal Solutions in india
Transfer pricing and Foreign Direct Investment are related and changes in Transfer pricing affect the Foreign Direct Investment. It can either adversely affect the foreign direct investment or attract the same resulting in inward flow of foreign currency. Heterogeneity in transfer pricing of home and host country do affect the foreign investment in the way as if the tax incentives and not there and tax in the both countries are same it would not encourage the foreign direct investment but in case there are tax incentives in the country where investment is made it would attract the foreign direct investment. Understanding the rules and regulations of Transfer Pricing in the country where the entity is trying to set-up business or invest helps in making decisions about whether it would be profitable to invest in that certain country or not. So, we can say that both are closely related concepts and that’s why understanding the concept of Transfer Pricing is important.
Indian Transfer Pricing Regulations: Best FDI Legal Services in india
Section 92 to 92F of Indian Income Tax Act, 1961 enumerates the provision for Transfer Pricing in India. Before understanding the compliances of Transfer Pricing, there is a need to get familiarised with certain terms.
The term ‘Associated Enterprise’ refers to the enterprise which has participation in the management or capital or control of another enterprise either directly or indirectly and it is defined in section 92A of the Indian Income Tax Act, 1961.
Section 92B of the Indian Income Tax Act, 1961 defines “International Transaction” as a transaction between the two or more than two Associated Enterprises. International transactions include purchase, sale, transfer, lease or use of tangible and intangible property, capital financing including lending or borrowing or guarantee or any other transaction having a bearing on the profits, income, losses or assets of such enterprises.
Section 92C of the Indian Income Tax Act, 1961 defines Arm’s Length Price which refers to the price which is charged on parties other than the Associated enterprise entering into similar transactions under the uncontrolled conditions.
Transfer Pricing Compliances
- Entity involved in international transaction have to maintain a proper record on each and every transaction as according to the law and;
- The income earned by the company by way of any international transaction have to be calculated at arm’s length price and;
- In case if there are two or more than two appropriate prices are assumed for a certain transaction then in that case the arm’s length price will be calculated as the average of the prices;
- The report in Form 3CEB has to be submitted under the guidance of a Chartered Accountant at the end of the financial year and this has to be done before the entity/individual files the Income Tax return of the same period.
And if these are not followed by the entities/ individual then the same is liable to pay penalties as imposed.
Transfer Pricing Methodologies
According to the compliances the income earned by the company by way of any international transaction have to be calculated at arm’s length price. There are a number of methods to calculate the arm’s length price depending on the basis of nature and types of transaction and the nature of associated enterprises involved in that said transaction. The most common methods are resale price method, cost plus method, comparable uncontrolled price method, and transactional net margin method.
Comparable Uncontrolled Price Method- This method is considered as the most reliable one and also a direct way of applying the principle of arm’s length price. In this method for determining the arm’s length price the price which is charged in an uncontrolled transaction between the comparable firms is evaluated and recognized.
Resale Price Method- Under this method the price which is charged by the associated enterprises to third parties is evaluated and referred to as resale price. Then the gross margin is reduced from this resale price which is determined by comparing the gross margins in a comparable uncontrolled transaction. After this, costs that are associated with the purchase of that concerned product for example customs duty are deducted. The remaining amount is called the arm’s length price.
Cost Plus Method- Under this method the arm’ length price is calculated by determining the costs of the supplier of goods or services in the controlled transaction and the next step is to add a markup and this markup must reflect the associated enterprise’s profit on the basis of risks and functions performed.
So, these are the most commonly used methodologies for Transfer Pricing to calculate the arm’s length price.
Documentation Requirement (Section 92D)
Rule 10D of Income Tax Act, 1961 enumerates the documents and information which are required but these specified documentation as mentioned in Rule 10D is not required in case aggregate transaction value is less than Rs. 1 Crore whereas in case the aggregate value of specified domestic transactions it is required. These are the following documents and information required by the entities-
a. Ownership interest, details of shares and ownership structure of assessee enterprises;
b. Background and profile of the multinational group of which the assessee enterprise is a part of;
c. Details of business operated by the assessee and the sector in which that business is and the business associates of that assessee;
d. Nature and terms of concerned international transaction or specified domestic transactions including price;
e. Details of assets used or to be used in business, risk assumed and functions performed;
f. Financial estimates/forecast or market analysis by the assessee;
g. Details of uncontrolled transactions taken into account for analysing them;
h. Details of all the method considered for calculating arm’s length price;
i. A report of the actual method for determining the arm’s length price;
j. If there are any assumptions, policies and price negotiations that have critically affected the evaluation of the arm’s length price.
There is also the period for which the information and document have to be kept and maintained under the section 92D(2). Period of 8 years from the end of the relevant tax year is prescribed for the information and documents to be kept and maintained and if failed to do so there is a penalty.
Penalties for Non-Compliances
The penalties prescribed for non-compliances of the regulations are following-
If there is default in case of post-inquiry adjustment, then the penalty prescribed for that is 100-300 percent of tax on the adjusted amount and if there is default in case of maintaining documents as enumerated in Rule 10D of Income Tax Act, 1961 there is penalty of 2 percent of the value of transaction. Default in the case of furnishing documents during Transfer Pricing audit would cost a penalty of 2 percent of the value of transaction. Default in case of maintaining or furnishing incorrect information or documents as prescribed it would cost a penalty of 2 percent of the value of transaction. Failure to furnish an accountant’s report has a penalty of INR 100,000 (One hundred thousand rupees) and lastly default in reporting a transaction in accountant’s report has a penalty of 2 percent of the value of transaction.
Conclusion
Transfer Pricing and Foreign Direct Investment are interrelated and there is a need to understand the concept of Transfer Pricing by the entities before entering into the foreign markets. Every country has its own transfer pricing regulations and before thinking of making an investment it is very significant to go through that country’s transfer pricing regulations or rules. So, that the entity has the idea of tax in both the countries-home and host countries and by comparing that the entities can make a decision whether to set-up business or invest in that country or not.
Authored By: Adv. Anant Sharma & Anjali Swami