Taxing authority and tax law
Tax authority: Central Board of Direct Taxes (CBDT), Income Tax Department
Tax law: Sections 92-92F, 144C, 271, 271AA, 271BA and 271G of the Income Tax Act, 1961
Relevant regulations and rulings
Rules 10A to 10E of the Income Tax Rules, 1962
OECD guidelines treatment
The Indian legislation is broadly based on the OECD guidelines. In conformity with the OECD guidelines, the legislation prescribes the same five methods to compute the arm’s length price. Further, the tax authorities generally recognize the OECD guidelines and refer to them for guidance to the extent they are not inconsistent with the domestic law.
Priorities/pricing methods
The Indian legislation prescribes the following methods: CUP, Resale Price, Cost Plus, Profit Split and Transactional Net Margin Method. The legislation also grants the power to the CBDT to prescribe any other method; however, no other method has been prescribed by the CBDT to date. No hierarchy of methods exists. The most appropriate method should be applied.
Transfer pricing penalties
- For inadequate documentation, the taxpayer is fined 2% of the transaction value
- For not furnishing sufficient information or documents requested by the tax officer, the taxpayer is fined 2% of the transaction value
- If due diligence efforts to determine the arm’s length price have not been made by the taxpayer, then 100% to 300% of incremental tax on transfer pricing adjustments may be levied by the tax officer
- For not furnishing an Accountant’s Certificate (Form 3CEB) along with the return of income, the taxpayer is fined approximately INR100,000 (approximately US$2,200)
Penalty relief
Penalties may be avoided if the taxpayer can demonstrate that it exercised good faith and due diligence in determining the arm’s length price. This is also demonstrated through proper documentation and timely submission of documentation to the tax authorities during assessment proceedings.
Documentation requirements
A detailed list of mandatory documents are listed in Rule 10D(1). The categories of documentation required are:
- Ownership structure
- Profile of the multinational group
- Business description
- The nature and terms (including prices) of international transactions
- Description of functions performed, risks assumed and assets employed
- Record of any financial estimates
- Record of uncontrolled transaction with third parties and a comparability evaluation
- Description of methods considered
- Reasons for rejection of alternative methods
- Details of transfer pricing adjustments
- Any other information or data relating to the associated enterprise which may be relevant for determination of the arm’s length price
A list of additional optional documents is provided in Rule 10D(3). The taxpayer is required to obtain and furnish an Accountant’s Certificate (Form 3CEB) regarding adequacy of documentation maintained.
Documentation deadlines
The information and documentation specified should, as far as possible, be contemporaneous and exist by the specified date of the filing of the income tax return, which is 30 September following the end of the financial year.
Although an Accountant’s Report must be submitted along with the tax return, the taxpayer is not required to furnish the transfer pricing documentation with the Accountant’s Report at the time of filing the tax return. Transfer pricing documentation must be submitted to the tax officer within 30 days of the notice during assessment proceedings.
Statute of limitations on transfer pricing assessments
Tax assessments (where a matter has been referred to the transfer pricing officer) are to be completed within 45 months of the end of the financial year (1 April to 31 March). However, if the tax authorities determine that income has escaped assessment, an assessment may be re-opened within seven years of the end of the financial year.
Return disclosures/related-party disclosures
Under Section 92E, an Accountant’s Report is required to be provided along with the tax return. The accountant certifies whether proper documentation is maintained by the taxpayer.
In accordance with Indian Accounting Standard 18, the company is required to disclose related-party transactions in its financial statements.
Audit risk/transfer pricing scrutiny
Internal guidelines have been issued by the tax authorities, pursuant to which companies with related-party transactions in excess of US$1m are being scrutinized. In most cases, the tax authorities does not seem to have adopted a centralized or coordinated approach to audits, with officers in different locations taking divergent positions on similar taxpayer fact patterns. Substantial documentation is being requested in the course of audit proceedings.
The information technology, business process outsourcing, banking and pharmaceutical sectors have received particular attention. Additionally, the tax authorities are increasingly scrutinizing intra-group services received and royalty payments made by Indian taxpayers.
The tax authorities have sought an updated analysis using data that may not be available to the taxpayer at the time of the preparation of contemporaneous documentation. Furthermore, officers have insisted on unbundling transactions in cases where the taxpayer has adopted an aggregate or combined approach to its transfer pricing documentation. During recent audits, the approach adopted by the taxpayer in the selection of comparable data has received considerable attention from the tax authorities.
The Government has introduced an alternate dispute resolution process, by which the taxpayer, at his option, can approach a dispute resolution panel in case a transfer pricing adjustment is proposed by the tax officer. The panel should dispose of the matter within nine months, which shall be binding on the tax officer. This process is expected to significantly expedite the first level of the litigation process in India, which usually takes a much longer time.
APA opportunity
APAs are not available yet, but the Indian Government has proposed to introduce APA provisions as part of the new Direct Tax Code to be implemented from 1 April 2012 onwards.
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