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Understanding Transfer Pricing Regulations and Mechanisms in India

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The rising popularity of multinational companies in India has encouraged the tax authorities to enforce stricter transfer pricing regulations. Check out this post for a brief overview of the applicable transfer pricing mechanisms and regulations in India.

In 2020, India received more than $60 billion in Foreign Direct Investment (FDI). On the global scale, it makes India the 5th largest recipient of foreign investments.

As one of the fastest-growing economies globally, India has attracted the interest of several global entities. But the rising popularity of MNCs (Multi-National Companies) in the country has encouraged the tax authorities to enforce stricter transfer pricing regulations.

As a result, it is essential for global entities involved in the transfer of goods or services between related parties to and from India to understand the applicable regulations in the country clearly. Here’s a quick overview of the transfer pricing mechanisms and regulations in India-

Basics of Transfer Pricing Regulations in India

The Transfer Pricing (TP) regulations were inserted into the Income Tax Act, 1961, through the Finance Bill (2001). Section 92A to 92F was added to the IT Act for defining all the provisions and regulations related to transfer pricing, including the Arm’s Length Principle.

As per the regulations, entities involved in transfer pricing practices should maintain and document transaction details prescribed under Section 10(D). The entities should maintain these documents to comply with TP regulations-

  • Price related
  • Entity related
  • Economic analysis records
  • Financial estimates, forecasts, and budget records
  • Any analysis record for comparing transactions (if required)
  • Detailed information about the TP mechanism used and reasons for rejecting the other methods

What is the Arm’s Length Principle?

It is a common practice among MNCs to shift the profits generated from a high tax country to one where the tax rates are low. The OECD (Organization for Economic Co-operation and Development) has introduced the Arm’s Length Principle (ALP) to avoid illegitimate use of such practices.

As per the principle, related entities should conduct transactions as if they were unrelated. If the transaction between two related entities fulfils this criterion, it can be considered that the transaction was conducted ‘at arm’s length.’

What are the Transfer Pricing Mechanisms in India?

The transfer pricing regulations in the country have prescribed six mechanisms that entities can use for determining ALP. Most businesses rely on professional transfer pricing services to help them choose the correct method. Take a look-

  1. Resale Price Method (RPM)- In this method, the price of transactions conducted between unrelated entities are used for determining ALP.
  2. Comparable Uncontrolled Price (CUP)- In CUP, the ALP is determined by comparing uncontrolled transactions with the price and conditions of comparable controlled transactions.
  3. Profit Split Method (PSM)- For PSM, the profits generated by entities that conduct similar uncontrolled transactions are used for determining ALP.
  4. Cost Plus Method (CPM)- The CPM method focuses on the costs borne by the goods or service supplier. A gross profit mark-up is added to the cost for calculating ALP.
  5. Transactional Net Margin Method (TNMM)- The ALP is determined through TNMM by considering the net profit margin generated by a 3rd party with a similar transaction to the net profit margin of a controlled transaction.
  6. Other Method- The new introduction to TP mechanisms allows entities to determine ALP by considering hypothetical 3rd party transactions. 

Complying with Transfer Pricing Regulations in India

When used correctly, the transfer pricing provisions can unlock a host of valuable benefits for a multinational company. But the complex financial structure of such companies and the regularly changing TP regulations often make compliance very challenging for most MNCs.

The expert assistance of transfer pricing professionals can help businesses comply with the regulations and take maximum advantage of a TP mechanism that best meets their needs and expectations.

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