Transfer Pricing

India’s transfer pricing laws are enumerated under Sections 92 to 92F of the IT Act, 1961 and cover intra-group cross-border transactions. Rules and regulations prescribe that income arising from international transactions or specified domestic transactions between Associated Enterprises (AE) should be computed using the arm’s-length price principle, that is, the amount payable if the trading companies were unrelated.

‘International transactions’ refers to transactions between two (or more) AEs involving the sale, purchase, or lease of tangible or intangible property, the provision of services or cost-sharing agreements, the lending/borrowing of money, or any other transaction with a bearing on the profits, income, losses, or assets of such enterprises.

Relationships falling under the AE category include direct/indirect participation in the management, control, or

capital of an enterprise by another enterprise. They also cover situations in which the same person participates in the management, control, or capital of both the enterprises.

For tax purposes, companies are required to record the exchange of goods using the arm’s-length principal, which states that the prices charged by affiliated companies should be equivalent to the prices that would have been charged by a third-party. The following methods are prescribed under the IT Act for the determination of the arm’s-length price:

  • Comparable Uncontrolled Price (CUP) Method;
  • Resale Price Method (RPM);
  • Cost Plus Method (CPM);
  • Profit Split Method (PSM);
  • Transactional Net Margin Method (TNMM); and
  • Such other methods as may be prescribed.

It has been notified that the ‘other method’ for determination of the arm’s-length price in relation to an international transaction shall be any method that takes into account the price which has been charged for the same or similar transactions, with or between non-associated enterprises, under similar circumstances considering all the relevant facts. No particular method has been accorded priority and the most appropriate method for the transaction would need to be determined with regard to the nature and class of transaction or associated persons and functions performed.

Until the fiscal year 2011-12, transfer pricing regulations were not applicable to domestic transactions. The Finance Act, 2012 extended the application of transfer pricing regulations to domestic transactions, labeled specified domestic transactions (SDT). This amendment has been applicable from the assessment year 2013-14 onwards. Transactions will fall under domestic pricing only if the aggregate value is more than the threshold limit of INR 200 million (US$2.7 million) (from assessment year 2016-17).

Transactions with related domestic parties that qualify as SDT include:

  1. Expenditures where payment is made or will be made to:
    1. A director
    2. A relative of the director
    3. An entity where a director or the company has a voting interest that exceeds 20%
  2. Transactions relating to transfer of goods or services provided in Section 80-IA (8) and (10) (that is, profit-linked deductions for enterprises engaged in infrastructure development or industrial undertakings, producers and distributors of power, or telecommunication service providers).
  3. SDT is also applicable on the transactions between the entity located in a tax holiday area, and the one which is situated in a non-tax holiday area in case both are under same management structure. For example, transactions between undertakings established in special economic zones, free trade zones, or export-oriented units that involve transfer of goods and services to another unit under same management at non-market prices.

Audit under transfer pricing

Under transfer pricing regulations, companies in India are expected to file Form 3CEB if the entity has entered any international transaction with an associated enterprise or some specified domestic transaction (the latter with effect from assessment year 2013-14).

This is filed alongside Form 3CD under Section 92A to 92F of the Income Tax Act, 1961. Form 3CD is a detailed statement of particulars related to various aspects of the business and transactions undertaken.

Though sending company profits from India is much simpler than remitting personal income, the procedures to remit money to the parent company depend upon an entity’s investment model.

Remitting Profits from India: Procedures and Regulations

Remitting from Liaison Offices

Typically, foreign companies in India operate through either a liaison office, project office, branch office or wholly owned subsidiary (WOS).

Liaison Offices are only meant to promote the parent company’s business interests, spread awareness of the company’s products and/or explore further opportunities for business. They are not allowed to undertake any business activities and thus cannot earn any income in India. Expenses must be met entirely through inward remittance of foreign exchange from the head office outside India. Therefore, companies are not permitted to repatriate money from a liaison office.

Remitting from Project Offices

Project offices are set up to execute specific projects in India. They can only undertake activities related to the execution of the specified project. These offices can remit outside India a surplus, only upon completion of the project.

Remitting from Branch Offices

Branch offices are often used by foreign companies engaged in manufacturing and trading activities in India. They can represent the parent company but have limited operational capacity. Notable operations not allowed by branch offices include retail trading activities and manufacturing or processing activities.

All investments and profits earned by branches of a foreign company are repatriable after taxes are paid. There are, however, two uncommon exceptions to this; first, certain sectors such as defense are subject to special conditions. For these sectors, there is a lock-in period where companies have to wait for permission to be granted by the Indian government. The second exception is only when non-resident Indians (NRIs) specifically choose to invest under non-repatriable schemes.

According to sections 11C.1 and 11C.2 of the Reserve Bank of India’s (RBI) Exchange Control Manual, branch office of foreign companies must file the application for remittance of profits along with the following documents:

  • Certified copies of audited balance sheet and profit and loss account statement for the year to which the profit relates;
  • Certificate from auditors covering how the remittable amount was calculated;
  • Confirmation that the entire income of the branch office was accrued from sources in India;
  • Confirmation that the requirements of the Companies Act, 1956, have all been met;
  • Certificate from auditors citing RBI’s approval number and date, to the effect that the branch office has carried on business in compliance with approval granted by the RBI;
  • Certificate from auditors that shows sufficient funds have been set aside to meet all Indian tax liabilities, or that these liabilities have already been met; and
  • Declaration from the applicant that profits sought for remittance are purely earned in the normal course of business and do not include profits from any other source.

Companies must note that authorized dealers scrutinize the documents to make sure that the income is derived from RBI-approved activities and that calculations of the amount sought to be remitted are correct.

An authorized dealer is essentially a bank, specifically authorized by the RBI under Section 10(1) of FEMA to deal in foreign exchange. Most large international banks are authorized dealers.

Besides profits, remittances of winding-up proceeds of a branch office are also permitted under the Indian law. They are subject to prescribed procedures and require submission of the following documents:  

  • Tax clearance certificate from the Income Tax Department for the remittance;
  • An auditor’s certificate confirming that all liabilities in India have been either fully paid or adequately provided for;
  • An auditor’s certificate to the effect that the winding up is in accordance with provisions of the Companies Act, 1956; and
  • An auditor’s certificate stating that there are no legal proceedings pending against the applicant or the company under liquidation and that there is no legal impediment in permitting the remittance.

Remitting from Wholly Owned Subsidiaries

Wholly owned subsidiaries in India have independent legal status distinct from the parent foreign company. Foreign entities with long-term business objectives often choose to establish their presence with a WOS because it provides longevity, flexibility, and a stronger legal foundation for doing business in India.

  • The two ways of sending profits from a WOS in India are:        
  • Pay out of profits as dividends; and
  • Buyback of shares by the company.

Dividends are freely repatriable without any restrictions if taxes are paid, notably the Dividend Distribution Tax (DDT). Tax credit and/or tax relief is not applicable for the DDT or for repatriation of dividends. Companies do not require permission from the RBI, but the remittance must be made through an authorized dealer.

Further, there is a limited list of 22 consumer goods industries where repatriation of dividends is subject to certain requirements. The list includes the manufacturing of food products, coffee, and soft drinks among others.

Among specific requirements, the most notable one is that dividends must balance against export earnings for a period of seven years from the commencement of production.

Secondly, profits can be repatriated in the middle of the year with interim dividends after the DDT is paid. However, if using interim dividends, the company must have enough book profits to pay the dividend and enough money to pay taxes in India. If at the end of the year that turns out not to be possible, the directors may be made personally liable and be penalized, as a mistake on their part to declare interim dividends on the wrong judgment.

Profit can also be repatriated along with capital through buyback of shares if a buyback tax of 20 percent is paid on profits distributed by companies to shareholders.

The tax is not applicable if the company concerned is a publicly listed company or a subsidiary of a publicly listed company.

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