When different divisions of a multi-national, multi-entity company are required to transact with each other, by way of trade of supplies, or providing services, a ‘Transfer Price’ is used to transact such business. This may be arbitrary and dictated, and may not have any relation to cost and added value.
The expression ‘Transfer Pricing’ generally refers to the prices of transactions between two or more associated enterprises. The effect of Transfer Pricing is that the parent company or a specific subsidiary tends to produce insufficient taxable income or excessive loss on a transaction, thereby resulting in a revenue loss and also a drain on the foreign exchange reserves of the country.
To combat this trend, the Finance Act 2001 introduced various provisions on Transfer Pricing. These provisions lay down that the income arising from an international transaction between Associated Enterprises shall be computed having regard to the Arm’s Length price.
‘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.
While the primary responsibility of determining the Arm’s length price is on the Assessee, the Act also empowers the Assessing officer to determine the Arm’s Length price and compute the total income of the assesse accordingly. However, the Assessing Officer shall not make any adjustment to the arm’s length price determined by the taxpayer, if such price is up to 5 per cent less or up to 5 per cent more than the price determined by the Assessing Officer. In such cases the price declared by the taxpayer may be accepted.
The businesses entering into international transactions with Associated Enterprises are required to maintain certain specific documents and provide certain information to the Department.
Such businesses are also required to obtain a report from a Chartered Accountant in the prescribed format and furnish the same along with the return of income to the Department
The aforesaid provisions have been enacted with a view to provide a statutory framework which can lead to computation of reasonable, fair and equitable profit and tax in India so that the profits chargeable to tax in India do not get diverted elsewhere by altering the prices charged and paid in intra-group transactions leading to erosion of our tax revenues
The Finance Act has also provided penal clauses for non-compliance with the various provisions related to Transfer Pricing.
The failure to maintain certain specific documents and to provide the required information to the Department can attract a fine up to 2% of the value of the international transaction for each such failure.
The non-submission of the report from a Chartered Accountant can result in a fine of One hundred Thousand (100,000) rupees