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- The Transfer Pricing (TP) Regulations were introduced in India in the year 2001, in order to prevent erosion of Indian tax base. The Indian TP Regulations are contained in Chapter X of the Income-tax Act, 1961 (the Act) under the title 'Special Provisions relating to avoidance of tax'.
- Over the past two decades, the regulations have evolved in order to catch up with both global and local developments. Introduction of the domestic transfer pricing regime and the Advance Pricing Agreement programme in 2012, the Safe Harbour rules in 2013, the framework for use of multiple year data and range concept in benchmarking analysis, three-tier TP documentation structure as per BEPS (Base Erosion and Profit Shifting) Action Plan 13 in 2016, Secondary adjustment provisions and limiting interest deduction for thinly capitalized companies in 2017 are examples of evolution in the Indian TP Regime.
- The Indian TP Regulations recognize the 'arm’s length principle' and require income from an international transaction to be computed having regard to the arm’s length price.
- India is not a member of the OECD. As of now, India is only a member of approximately 30 committees of the OECD. The OECD and India have enhanced their co-operation in dealing with issues related to transfer pricing and to promote better tax compliance in order to improve the prevention of cross border disputes. As part of the G-20 group, India has played an active role in the OECD’s project for the prevention of Base Erosion and Profit Shifting (BEPS) and is committed to the outcomes of the BEPS project.
- Indian TP Regulations do not make mention of the OECD TP Guidelines (updated in July 2017). However, the TP legislation in India is broadly based on the OECD TP Guidelines including the contents of the three-tier TP documentation structure, transfer pricing methods etc. Both the taxpayers and the Revenue authorities have placed reliance on the OECD TP guidelines especially in cases where guidance is not available under the domestic legislation. Similarly, the principles laid down in the OECD TP guidelines have been relied upon in several judicial rulings in India.
The Indian TP Regulations prescribe the following six methods for determination of the arm’s length price:
- Comparable uncontrolled price method;
- Resale price method;
- Cost-plus method;
- Profit Split Method;
- Transactional net margin method; and
- Other method
The sixth method (other method) has been prescribed by the Central Board of Direct Taxes (the CBDT) as any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transactions, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.
There is no hierarchy in the selection of methods and the most appropriate method can be any of the six prescribed methods.
The Indian TP regulations do not have a self-assessment regime. The Taxpayers who have entered into international transactions with their Associated Entities have to obtain a report, certified from an Accountant (being an independent Chartered Accountant), in prescribed Form no. 3CEB. The Independent Chartered Accountant has to certify inter alia the nature of international transactions entered into by the Taxpayer, quantum of such international transactions as per the books of accounts, arm’s length value of such international transactions, and the method considered to be the most appropriate method.
Taxpayers have to electronically file the Form no. 3CEB certified by an Accountant. The due date for electronic filing of Form no. 3CEB is 31 October 2020 for the financial year ended 31 March 2020 (FY 2019-20). The statutory due dates may be revised by the Central Board of Direct Taxes (CBDT*) in case COVID-related disruptions continue.
* The CBDT is the apex body of the Indian Revenue department, charged with the administration of direct taxes. The functions of CBDT include setting up the structure of the revenue department, laying down policies and procedures of work, administering and laying down policies and framework for all matter of tax policy, legislation and implementation by revenue authorities, issuing directions, notifications, guidance etc.
- Mandatory TP documentation is required to be maintained by the Taxpayers where the aggregate value of international transactions with their Associated Entities exceeds INR.10 million. The documentation to be maintained is prescribed in Rule 10D of the Income-tax, Rules 1962. The prescribed documentation includes ownership structure, the profile of the multinational group, business description, nature and terms of international transactions, functional asset & risk analysis, TP methods considered and analysis under those methods, budgets, forecasts & estimates, industry analysis and reports, any other information relevant for demonstrating the arm’s length standard of international transactions.
- The TP documentation is to be maintained every year by the due date of filing the Accountant’s Report in Form no. 3CEB, which is 31 October 2020 for FY 2019-20. The TP documentation is required to be submitted before the revenue authorities when information for the same is called for during the TP audits.
- With India embracing the three-tier documentation standards, the taxpayers in India are also required to maintain and file master file and Country by Country reports (CbCR) (including related intimations) with the Indian Tax Authorities, if the conditions for maintenance of master file and CBC reports as prescribed under the Indian TP Regulations are met by the taxpayers.
In accordance with its commitment to the OECD’s BEPS Action Plan, the Indian Government introduced the concept of three-tier TP documentation in the year 2016.
An Indian entity which is part of a multinational enterprise (MNE) group is required to maintain the following group information by way of three files:
- Local file
- Master file (MF)
- Country by Country reporting or CbCR
Local file in India is currently the same as the annual TP documentation which is required to be maintained (as per Rule 10 D) if the aggregate value of international transactions with the Associated Entities exceeds INR.10 million during the relevant financial year.
Master File (MF) is required to be electronically filed where the value of international transactions of the enterprise with its Associated Entities (AEs) exceeds INR.500 million during the relevant accounting year (INR.100 million in case of intangible related transactions) and the consolidated global turnover of the MNE group exceeds INR 5,000 million.
The information required to be maintained and electronically filed as part of the master file in India includes names and addresses of the constituent entities in the MNE group, corporate legal chart, nature of the business, key drivers of profits, supply chain description of the five largest product or services, analysis of the functions performed, the assets utilised and the risks assumed (FAR analysis) of entities constituting at least 10% of the group revenues, profits or assets, group strategy for the intangibles, R&D functions, key financing arrangements, strategy for intangibles and details of transactions involving intangibles, business restructuring, copy of consolidated financial statements of the MNE group etc.
The prescribed form for the electronic filing of the master file is Form no. 3CEAA and it is filed by the taxpayers without any requirement of certification by an accountant. The due date for filing is 30 November 2020 for FY 2019-20.
The contents of Indian master file are mostly in line with the OECD’s MF format barring a few differences, for example: The OECD MF requires disclosure of principle contributions to value creating activities by individual group entities, whereas, Indian MF requires disclosure of Functions, Assets and Risk (FAR) analysis of constituent entities of international group that contribute at least 10% of the revenues or assets or profits of such group.
Country-by-Country Report (CbCR) is required to be electronically filed in India where the Ultimate Parent Entity (UPE) of the Multinational group (MNE) is resident in India or where the MNE has designated an alternate reporting entity for the purposes of filing CbCR in India. CbCR is required to be filed in India where the annual consolidated group revenue as per the consolidated financial statements of the MNE group in the immediately preceding accounting year relevant to the Indian financial year, is more than INR 55,000 million.
The due date for filing CbCR in the prescribed Form no. 3CEAD in India is 12 months from the end of reporting accounting year of the UPE preparing consolidated financial statements. The UPE can designate another group entity as an alternate reporting entity for the purposes of filing CbCR in India.
In view of the COVID -19 pandemic, the CBDT issued a notification dated 24 June 2020 providing extension in timelines for various compliances. As per the notification, wherever the due date for filing of CbCR in India falls in a period till December 2020, the due date has been extended to 31 March 2021. For example: If the reporting accounting year of the UPE is January 2019 to December 2019 and original due date for filing of CBCR report is 31 December 2020, the same stands extended to 31 March 2021.
CbCR filing requirements are also triggered in India if:
- the UPE of the MNE group is a resident of a country with whom India does not have an agreement for exchange of the CbCR
- the UPE of the MNE group is not obligated to file CbCR in its jurisdiction
- there has been a systematic failure on part of the UPEs jurisdiction to share information and such failure has been intimated to the Indian entity.
In India, the Assessing Officer (AO) has to refer the audit of international transactions to a designated Transfer Pricing Officer (TPO). Earlier such reference was based on revenue’s internal guidance on the monetary threshold for the value of international transactions. The CBDT issued an instruction in March 2016 to the revenue authorities with guidance on the factors (Risk criteria) to be considered in order to make a reference to the TPO. As per the guidance:
- the cases to be selected for scrutiny should be based on 'TP risk parameters' either under the Computer Aided Scrutiny Selection (CASS) or under compulsory manual selection process. CBDT’s instruction in this regard does not contain what exactly are the risk factors but the same may be available to the revenue authorities internally.
- cases selected for corporate tax audits can also be selected for TP audits based on the following Non-TP risk parameters:
- Non filing of Form no. 3CEB or non-reporting of transactions in Form no. 3CEB
- TP adjustment of INR 100 million or more in earlier years where such adjustment is upheld by judicial authorities or is pending in an appeal
- Search, seizure, or survey operations have findings relating to TP matters.
Various penalties under the Indian TP Regulations are as follows:
- Failure to maintain specified information/documents, failure to report transactions in Form no. 3CEB and TP documentation, maintenance of incorrect information, failure to submit information during TP audits – 2% of the value of the international transaction
- Failure for filing of Form no. 3CEB – INR 0.1 million
- Underreporting or misreporting of income – 50% of tax amount in case of underreporting and 200% of tax amount in case of misreporting
- Concealment of income or furnishing inadequate particulars of income in respect of Arm’s length price (ALP) adjustments – 100% to 300% of the tax sought to be evaded
- Failure to furnish master file – INR 0.5 million
- Failure to furnish CbCR by the statutory due date – INR.5000 per day for one month, INR.15,000 per day after one month, INR.50,000 per day after the date of service of penalty order
- Penalty for failure to produce information before the prescribed authority for the purposes of filing CBC report – INR.5000 per day for one month, INR.50,000 per day after the date of service of penalty order
Penalties can be condoned where the taxpayer is able to demonstrate reasonable cause to support its position or delay in filings. The taxpayers can also prefer an appeal before the appellate authorities against an order imposing the penalty.
- The TP documentation should be robust and be supported by information which includes invoices, inter-company agreements, credit period on inter-company receivables, etc. as such information is crucial during TP audits by the Revenue authorities.
- In relation to limited risk captive service providers, Indian Revenue authorities do not accept losses or low-profit mark-ups.
- It is important to provide reasons for the operating losses in the TP documentation and explain such losses not having any nexus to the pricing of international transactions.
- Indian Revenue authorities do not generally accept the use of foreign tested parties and foreign comparable companies for international transactions of an Indian Resident entity.
- In relation to intra-group services, cost contribution arrangements, use of intangibles, etc., commercial rationale test, actual receipt of service test, benefit test, no duplication test and shareholder activity cost test are to be demonstrated by the taxpayer
- Several judicial precedents uphold priority in the use of internal uncontrolled comparable data over external comparable data where relevant comparability criteria are met
- Indian Revenue authorities are increasingly focusing on understanding the entire value chain of the MNE Group, obtain clarity on roles played/contribution by taxpayers in such value chain of MNE Group and ascertain proper alignment of transfer pricing with value creation by taxpayers
- Transactions pertaining to intangibles (including transactions having a possibility of application of profit split method) and business restructuring are becoming the focus areas of Indian Revenue authorities
- In order to avoid the normal litigation route and have certainty on transfer prices, taxpayers can opt for alternate dispute management/avoidance mechanisms viz., Advance Pricing Agreements (APAs), and Safe Harbour (SH) provisions.
- Taxpayers can also opt for the Mutual Agreement Procedure (MAP) route for resolution of past disputes.
- Taxpayers can opt for either the Advance Pricing Agreements (APA) option or the Safe Harbour (SH) option as the alternate dispute management/resolution schemes under the Indian TP Regulations. A snapshot of both alternatives is as follows:
- Advance Pricing Agreement (APA):
The APA programme was introduced in India in the Finance Act, 2012 and ever since its utility as an alternative transfer pricing dispute prevention mechanism has increased among taxpayers. As per CBDT’s annual report for FY 2018-19 on Indian APAs, India received the most number of APA applications globally after USA in FY 2018-19.
The Indian APA programme which was introduced in the year 2012 seeks to provide certainty for 5 prospective years and has a rollback option for 4 previous years. Taxpayers can opt for unilateral, bilateral or a multilateral APA. Also, there are no thresholds on the value of international transactions for the Taxpayers to opt for APAs.
As per CBDT’s Annual Report on Indian APA Programme released in December 2019, a total of 1,155 APA applications have been filed till FY 2018-19 which included 944 unilateral APA applications and 211 bilateral APA applications. Out of 1,155 APA applications filed 271 have been signed till FY 2018-19 (240 unilateral and 31 bilateral). Based on information available in the public domain, the total number of signed APAs have increased to 300 by 30th September 2019.
- Safe Harbour provisions:
The Indian Safe harbour rules are an optional dispute avoidance mechanism that prescribes the minimum cost plus mark – up / transfer price that an eligible taxpayer has to maintain in relation to eligible categories of international transactions for a specified block of financial years (FYs). The previous block of covered years was FY 2016-17, 2017-18 and 2018-19. The CBDT vide its notification dated 20 May 2020 has extended the applicability of safe harbour rules to FY 2019-20 as well.
At present, safe harbour rules have been prescribed for the following international transactions:
- Provision of software development services*
- Provision of IT-enabled services*
- Contract R&D services relating to software development*
- Contract Research and Development services relating to generic pharmaceutical drugs*
- Granting intragroup loans denominated in Indian currency and Foreign currency
- Providing corporate guarantee
- Manufacture and export of core auto components
- Manufacture and export of non-core auto components
- Availing of low value-adding intra-group services+
* SH option is not available if the value of international transactions exceeds INR 2,000 million.
+ SH option is not available if the value of the international transaction exceeds INR 100 million.
- Mutual Agreement Procedure (MAP)
India has an extensive treaty network with other countries and access to MAP route for resolution of transfer pricing disputes is available to taxpayers under the treaty. India has published detailed guidance on MAP in August 2020 in order to implement the recommendations of BEPS Action 14 on 'Making Dispute Resolution More Effective'. The guidance provides that the Indian competent authorities would endeavour to resolve disputes under MAP route within 24 months (endeavour and not a commitment).
- The Indian TP Regulations prescribe applicability criteria for various categories of documentation which are as follows:
- TP documentation/Local file is to be maintained if the aggregate value of international transactions with the Associated Entities exceeds INR.10 million
- Master file is to be prepared and electronically filed if the aggregate value of international transactions of the enterprise with its Associated Entities exceeds INR.500 million during the relevant accounting year (INR.100 million in case of intangible related transactions) and the consolidated global turnover of the MNE group exceeds INR 5,000 million
- CbCR is required to be electronically filed by the ultimate parent entity of an MNE group with annual consolidated group revenue in the immediately preceding accounting year of more than INR 55,000 million.
Taxpayers who do not breach the applicability thresholds are not required to maintain and file the prescribed documentation.
- Accountant’s Report in Form no. 3CEB is to be filed irrespective of the value of international transactions and turnover. There is no exemption for filing of Form no. 3CEB.
The India Finance Act, 2020 has widened the scope of APAs and SHs by including within their ambit, the determination of attribution of income of a non-resident to the Permanent Establishments (PE) in India. Thus, the PE in India can now obtain certainty with respect to profit attributions.
The Secondary adjustment provisions were introduced in India in the year 2017 requiring an adjustment in the books of accounts of both the Indian taxpayer and its Associated Enterprise to reflect that the actual allocation of profits is based on the arm’s length principle. The provisions also require repatriation of excess money in the hands of the taxpayers into India within a prescribed time-limit, failing which the amount not repatriated is treated as a deemed advance on which interest is charged. In 2019, the Indian Government made amendments allowing the taxpayer to repatriate secondary adjustment from any of its Associated Enterprises and also gave an option to pay an additional tax @18% (plus 12% surcharge on tax) in case the taxpayer is not able to repatriate the money into India.
In accordance with the recommendations of Action 14 of the BEPS Action Plan – 'Making Dispute Resolution More Effective', the CBDT issued detailed guidance on Mutual Agreement Procedure (MAP) in August 2020 for the benefit of taxpayers, tax authorities, and competent authorities of treaty partners. The guidance covers aspects of access to and denial of MAP route, technical issues, and implementation of MAP outcomes. Among other things, it has been stated in the guidance that India is committed to endeavor to resolve MAP cases within an average timeframe of 24 months.
Vivaad se Vishwas (VSV) scheme: The Government of India introduced VSV scheme in 2020, for resolving disputes pending as on 31 January 2020, before various Appellate forums as well as the High Court and the Supreme Court. The English translation of VSV scheme is 'Dispute to Trust' scheme. Taxpayers get the benefit of immunity from prosecution and waiver of interest and penalties under the scheme where the taxpayer withdraws all its appeals and settles the tax liabilities. The due date for availing VSV scheme is 31 December 2020.
Addressing the challenges related to thin capitalization, the provision to limit interest deduction to 30% of EBIDTA was introduced in India in 2017 with a carry forward period of 8 years for the balance interest amount. This provision applies for interest payments to the Associated Entities or any lender (to whom the AEs have provided an explicit or implicit guarantee) exceeding INR 10 million. In 2020, interest payments on loans taken from an Indian branch of a foreign bank have been excluded from the purview of the provision for limitation of the interest deduction.
Expansion of Equalisation levy (EL) coverage: From 01 April 2020, transactions of online supply of goods or provision of services by a non-resident e-commerce operator to Indian customers also attract EL @ 2%, where the value of the provision of goods or services is INR.20 million or more during the relevant year.
Faceless assessment (ie audits by tax authorities): The Government of India launched 'Transparent Taxation – Honoring the Honest platform' in August 2020, aimed at easing tax compliance and rewarding honest taxpayers. This includes faceless assessments and appeals and the Taxpayer’s Charter.
CBDT draft on PE attribution: In April 2019, the CBDT introduced a draft report on amendments to PE attribution rules. The report recommends the use of the fractional apportionment method for attribution of profits to a PE in India. The fractional apportionment proposes to take into account inter alia the demand factor (sales in India) for determining the apportionment ratio.
- Equalization Levy (EL) is an interim measure discussed in BEPS Action Plan 1 to tax the digital economy. India introduced EL in Finance Act, 2016. Currently, EL is applicable in the following scenarios:
- A 6% equalization levy is to be withheld by the service recipient at the time of payment to a non-resident service provider where the value of the payment to such service provider exceeds INR.0.1 million in a financial year. Online advertisements and provision of digital advertising space or facilities/service for the purposes of online advertisements are covered services for the purposes of equalization levy in India.
- From 01 April 2020, transactions of online supply of goods or provision of services by a non-resident e-commerce operator to Indian customers also attract EL @ 2%, where the value of the provision of goods or services is INR.20 million or more during the relevant year.
CBDT has recently placed its focus on digitising the process of revenue audits and introduced the faceless assessment scheme in August 2020.
CBDT is embracing various measures suggested under the BEPS Action Plan which is manifested by the implementation of three-tier TP documentation structure, issuance of detailed guidance on the Mutual Agreement Procedure, Equalisation levy, limitation of interest deduction rules etc.
Taxpayers have responded very positively to CBDT’s Advance Pricing Agreement (APA) programme resulting in India having the second-highest number of APAs signed after the USA.
The COVID-19 pandemic has posed several challenges before the economy at large. Concerns surrounding health and disease control, lockdowns, social distancing norms, and disruptions in global economic systems have led to a slowdown in the economic activity and it is uncertain how the pandemic will pan out in the near future.
Keeping in view the challenges faced due to the COVID-19 pandemic, the Government of India has given relaxation from the trigger of the residency rules for FY 2019-20. As per the relaxation given, the period from 22 March 2020 till 31 March 2020 will not be considered for determining residential status in India. Similar relaxation for FY 2020-21 may be announced going forward.
- The due dates for various compliances including those under the Indian TP regulations have been extended. The extended due dates are as follows:
- The due date for filing of APA application for the APA period beginning from FY 2020-21 has been extended from 31 March 2020 to 31 March 2021
- The due date for filing of CbCR for FY ended 31 March 2019 by a parent entity or alternate reporting entity resident in India is extended from 31 March 2020 to 31 March 2021
- The time limit for completion of transfer pricing audits for FY 2016-17 by the revenue authorities is extended from 31 October 2020 to 30 January 2020.