The Transfer Pricing Law Review: India

Overview

Transfer pricing laws in India are codified in the Income-tax Act, 1961 (the Act).2 The law is applicable to all taxpayers: corporates and non-corporates, residents and non-residents, with income chargeable to tax in India. The law specifies situations in which transactions with third parties shall also be covered in the ambit of transfer pricing provisions.

The law broadly aligns with the Organisation for Economic Co-operation and Development Guidelines on Transfer Pricing (the OECD Guidelines). Methods to compute the arm's-length price, extensive annual requirements for transfer pricing documentation and penal provisions for non-compliance are also provided. Although the law covers both income and capital transactions with similar rules, it only covers capital transactions that have an incidence of income, such as business reorganisations and use of intangibles, that is enshrined in the charging provisions of the substantive law. Transactions are deemed to be arm's length, and while primary onus is on the taxpayer to support the arm's-length nature of its transactions, the tax authorities also need to arrive at the arm's-length price in the manner prescribed in the law, if they do not accept the taxpayer's price or the arm's-length price as arrived at by the taxpayer. However, there are stringent penalties on the taxpayer if it does not maintain the prescribed documentation. The term 'international transaction' covers:

  1. the sale, purchase, lease, transfer or use of tangible property;
  2. the sale, purchase, transfer, lease or use including transfer of ownership or the provision of use of rights of intangible property;
  3. capital financing transactions, including any type of lending, borrowing or guarantee, payments or deferred payment or receivable, any type of advance, purchase or sale of marketable securities, any debt arising during the course of business;
  4. the provision of services;
  5. transaction of business restructuring or reorganisation;
  6. cost-sharing arrangements;
  7. lending or borrowing money; or
  8. any other transaction having a bearing on the profits, income, losses or assets of such enterprises. Business restructuring or reorganisation transactions have to be covered irrespective of whether they have a bearing on the profits, income, losses or assets.

Notably, the law provides that transactions include an arrangement, understanding or action in concert, whether or not it is formal or in writing, and whether or not it is intended to be enforceable by legal proceeding. Additionally, the law provides that if a transaction is entered into with a third party, but the terms of the transaction are determined in substance by the third party with the person's associated enterprise, then such transaction shall be deemed to be an international transaction between two associated enterprises and shall need benchmarking.

Associated enterprises are also widely defined to mean association by direct or common management, capital or control. Some situations in which enterprises shall be deemed to be associated, are as under:

  1. direct or indirect holding of at least 26 per cent voting interests;
  2. controlling the appointment of more than half the board of directors or governing board;
  3. controlling the appointment of one or more of the Executive Directors;
  4. a significant dependence on intangibles, raw materials or sales consumables;
  5. supplier lending or guaranteeing a loan for the substantial percentage of total assets from one enterprise; or
  6. any other relationship of mutual interest as prescribed.

The law also provides avenues for obtaining certainty such as safe-harbour rules and advance pricing agreements (APAs). APAs are available for transfer pricing for a total of nine years, including rollback years, and from April 2020, were made available for profit attribution to permanent establishments (PEs).3

Additionally, the law also encompasses provisions for thin capitalisation (thin cap) and secondary adjustments. Thin cap provisions are applicable even where the debt is issued by a lender that is not associated if the debt is implicitly or explicitly guaranteed by an associated enterprise, or if the associated enterprise deposits a corresponding or matching amount of funds with the lender. Secondary adjustment provisions provide that beyond a threshold, in certain specified circumstances, such as voluntary adjustment made by taxpayer, addition made by tax officer and accepted by the taxpayer, adjustment resulting as a resolution of MAP proceedings, the excess money will need to be repatriated to India within a specified time frame. Failing this, the excess money is treated as advance and interest is computed on such advance.

Filing requirements

Taxpayers are required to annually maintain extensive supporting information and documents relating to international transactions undertaken with their associated enterprises. The first part includes:

  1. information on the ownership structure (e.g., group profile and business overview);
  2. the associated enterprises' contractual nature, terms, quantity and value of an international transaction or specified domestic transactions;4
  3. relevant financial forecasts or estimates that form part of a comprehensive transfer pricing study, an analysis of functions performed;
  4. risks assumed;
  5. assets employed;
  6. details of relevant uncontrolled transactions;
  7. comparability analysis;
  8. benchmarking studies;
  9. assumptions;
  10. policies;
  11. details of economic adjustments; and
  12. explanations as to the selection of the most appropriate transfer pricing method.

The annual documentation must be updated to reflect the latest financial data adjustments on such transactions.

The second part stipulates supporting documentation authenticating the information and analysis provided in the first part, which includes official publications, reports, studies, and databases from the government, market research reports or technical publications by reputed institutes, published accounts and financial statements relating to the business affairs of associated enterprises, agreements and contracts entered into with associated enterprises or with unrelated enterprises, letters and other correspondence evidencing negotiations between associated enterprises and documents normally issued in connection with various transactions under the accounting practices followed.

This documentation must be contemporaneous, maintained for a period of nine years from the end of the relevant financial year (1 April 1 to 31 March) and presented to the tax authorities on request, at the audit, assessment or dispute resolution stage.

An independent accountant's report for all international transactions or specified domestic transactions between associated enterprises has to be mandatorily filed with the tax authorities.

India has implemented country-by-country reporting (CbCR) requirements in accordance with Action Plan 13 of the BEPS Inclusive Framework. Where an international group has multiple constituent entities, the group may designate one of its constituent entities as an alternate reporting entity to fulfil filing requirements on behalf of the group.

The law provides for an Indian parent company to file the CbC report if the total consolidated group revenue of the international group during the accounting period exceeds 64 billion rupees.

Presenting the case

i Pricing methods

The transfer pricing rules on this choice of methodology are in line with the OECD Guidelines. On the choice of methodology, the law prescribes the use of the 'most appropriate methodology', which are summarised as follows:5

  1. comparable uncontrolled price (CUP) method;
  2. resale price method (RPM);
  3. cost-plus method;
  4. profit split method;
  5. transactional net margin method (TNMM); and
  6. a sixth additionally prescribed method, which is any method that, inter alia, takes into account the price paid or charged, or payable or chargeable in the same or similar uncontrolled transactions.6

If there are six or more comparables, an interquartile range beginning with the 35th percentile and ending with the 65th percentile is considered as the arm's-length range. In other cases, a specified deviation (1 per cent or up to 3 per cent) from the mean or arm's-length price is available.

At the tax office level, there is a clear preference for internal comparables over external comparables, although in practice, at the audit stage, if a taxpayer has used an internal comparable, he or she is also expected to supplement their analysis with an entity level external TNMM. The law provides for making adjustments to eliminate any material effects of differences between either the transactions or the enterprises entering into the transaction. Routine adjustments such as working capital adjustment are largely accepted by courts. There is a plethora of disputes on the choice of most appropriate method, and courts have ruled that equal onus on choice of methods and comparability is on the revenue authorities if they seek to reject the taxpayer's analysis.

ii Authority scrutiny and evidence gathering

Cases are picked up for scrutiny based on risk assessment parameters, which are not made public. In practice, transfer pricing audits usually take place by having in-person meetings with the taxpayer or the taxpayer's authorised representatives. Transfer pricing officers (TPOs) often use their powers to obtain data not available in public domain. Courts have ruled that access to the data should be provided to the taxpayer and the taxpayer should be given an opportunity to rebut such data. The use of expert witnesses during the audit stage is unheard of. Audits are usually concluded based on documentary submissions made and in-person hearings. Notably, during the financial year ending March 2021, India moved to a faceless audit regime7 for domestic tax audits; this regime is expected to extend to transfer pricing audits in due course.8

The investigative powers9 of the tax authorities in general, including in relation to transfer pricing law, are discussed in Section VI.

Under the existing provisions, there was no mechanism to administratively review a transfer pricing order. A new provision has been inserted by the Finance Act, 2022, which provides that the tax department can administratively review and revise10 a transfer pricing order that is considered prejudicial to the tax department.

To facilitate the implementation of the exchange of CbCR among tax administrations, India signed the CbC Multilateral Competent Authority Agreement in May 2016. To restrict the use of CbCR data by the TPO, the Indian Board of Direct Taxes issued11 an Instruction12 providing guidance on the appropriate use of CbCR by stating that the CbCR data received by virtue of the automatic exchange of information would only be used for risk assessment procedures and cannot be the sole basis for transfer pricing adjustments.13 The instruction specifically provides that when the information is made available to a TPO, the information in the CbCR can be used only for the following:

  1. high-level transfer pricing risk assessment;
  2. assessment of other BEPS related risks;
  3. economic and statistical analysis;
  4. planning a tax audit; and
  5. as the basis for making further enquiries into the group's transfer pricing arrangements and tax matters in the course of an audit.

The Indian Board of Direct Taxes has put into place a system to maintain confidentiality and monitor the activities of the TPO.

Intangible assets

Intangible property, which is understood to have a wider connotation than intangible assets, has been very broadly defined14 in the Act, and includes intangible assets related to marketing, technology, art, data processing, customers, engineering, human capital, location, goodwill methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, technical data or any item that derives its value from intellectual content rather than its physical attributes. Moreover, the definition of 'international transaction' practically covers every direct or indirect transaction in relation to intangible property.

India has not specified any formal policy in response to the principles on the development, enhancement, maintenance, protection and exploitation of intangibles15 articulated in the BEPS AP other than the 2017 disclosure requirements. The CbCR requirement16 now mandates listing all multinational enterprise group entities engaged in the development of intangibles and the description of a multinational enterprise's strategy (transfer pricing policy) for development, ownership and exploitation of intangible property.

Before the BEPS initiative was underway, given the growing disputes over intangibles generated by R&D captives, the Indian Board of Direct Taxes issued guidelines17 to TPOs about the characterisation of R&D units based on functions, assets and risk assumed. A set of qualitative criteria was laid out to drive decision-making on characterisation with an emphasis on the substance of an arrangement and not the contractual arrangement between the centre in India and its foreign associated enterprise. This guidance has classified R&D centres under the following three categories:

  1. entrepreneurial in nature;
  2. based on cost-sharing arrangements; and
  3. undertaking contract R&D.

On the basis of these categories, suitable methodology is prescribed as either the profit split method or cost-plus method, and the most appropriate methodology is applied.

The tax officer has extensively focused on the creation of marketing intangibles through advertising, marketing and promotion (AMP) spends, by subsidiaries of foreign multinationals. A batch of appeals in this regard is pending before the Supreme Court – the apex court of India. The principal debates around this focus on whether an AMP spend can be considered an international transaction for transfer pricing purposes under Indian law, what is the demarcated quantum that should be considered (tax officers usually rely on a bright line or intensity adjustment) and what should be adequate compensation for the creation of such intangibles, if any.18

Settlements

In contrast to other jurisdictions, there is no mechanism in India for the settlement of transfer pricing disputes with the tax authorities. For settlements, safe-harbour provisions and unilateral and bilateral APA mechanisms are viewed as means to mitigate risks in advance, and the mutual agreement procedure (MAP) under the treaty is considered, post-adjustment, to settle disputes. The rollback provision under an APA also enables settlement of past disputes given its binding nature.

In a move to reduce litigation and boost investor confidence, India introduced unilateral, bilateral and multilateral APAs with effect from 1 July 2012.19 During the 10 years since its introduction, India has received over 1,000 applications and has concluded over 420 APAs.

The MAP has often been viewed as a credible resort for settling transfer pricing-related disputes. Under the MAP process, the Indian competent authority allows the foreign-associated enterprise, a resident of the treaty country, to submit its MAP request via its country's competent authority. Under various administrative directions, tax demands arising out of adjustments with non-resident-associated enterprises that are residents of the United States, the United Kingdom, South Korea and Denmark are frozen until the MAP process is concluded, subject to the submission of suitable bank guarantees. Article 19 of the Multilateral Instrument provides for mandatory binding arbitration when competent authorities are unable to reach a decision under MAP within two years. India has not accepted such provision, taking a position that such binding arbitration would adversely impact its sovereignty.

In line with OECD BEPS Action 14 'Making Dispute Resolution More Effective', the Indian Board of Direct Taxes has released new guidance20 to MAP and enabling rules.21 This guidance provides that MAP can be availed simultaneously if the matter is before the Income tax Appellate Tribunal (ITAT), since it is an independent statutory appellate body. However, in cases of an ITAT order, the Indian CA should not deviate from that order. Furthermore, an MAP case shall be considered closed if resolved by the ITAT (domestic remedy). Importantly, the guidance provides that an MAP option cannot be exercised if the dispute arises due to an application of domestic tax laws or the taxpayer has obtained advance rulings for the same issue.

The government introduced a hugely successful Vivad se Vishwas scheme in early 2020, which offered taxpayers an opportunity to settle disputed tax demands with a waiver of interest and penalty. However, this was more of a monetary settlement scheme and did not lay down any principles with respect to the merits of the matter. The scheme resulted in settling over 125,000 tax disputes with the government netting over US$13.5 billion. Almost 25 per cent of India's outstanding tax disputes have been reportedly settled under the scheme.

Investigations

Transfer pricing audits in India are part of the routine audit process. There is currently no specific concept of a standalone 'transfer pricing investigation' in India, other than the audit or assessment process, as discussed in Section III.

The tax authorities, however, have broad powers for assessment (e.g., reopening of past-year assessments and investigations), under the following provisions of the ITA:

  1. Section 143 – for regular audit or assessment;
  2. Section 144 – best-judgement assessment, where a taxpayer does not file a tax return;
  3. Section 147 – reassessment of income escaping assessment; and
  4. Section 153A – assessment or reassessment in situations of search and seizure.

Litigation

Once the TPO proposes an adjustment, it directs the tax officer to issue a draft assessment within the time limit described above. It is mandatory for the tax officer to issue a draft assessment before issuing the final order, and at that point the taxpayer has the following options:

  1. accept the draft assessment and adjustment proposed;22
  2. file an objection before the dispute resolution panel (DRP) by communicating its decision to the AO within 30 days of the draft assessment; or
  3. not file an objection, and instead allow the TPO or tax officer to convert the draft assessment into a final order and, if so advised, thereafter file an appeal before the Commissioner of Income Tax (Appeals) (i.e., the Appeals Commissioner) within 30 days of the final order.

The DRP as an alternative dispute resolution mechanism was introduced in law by the Finance Act 2009 to expedite resolution of disputes in transfer pricing. Since the assessment is in a draft stage, no tax demand is raised. The salient features of the DRP mechanism are as follows:

  1. the DRP must decide the taxpayer's objections within nine months of the end of the month in which the objection is filed;
  2. these directions are binding on the tax officer;23
  3. the DRP has wide powers to examine additional evidence and inquire further into the case;
  4. the DRP can issue directions to confirm, enhance or reduce the adjustment; and
  5. the DRP cannot, however, compromise or settle a dispute and its powers to adjudicate are limited.

In summary, the tax demand is finalised only upon the AO's passing of the final order, which is appealable to the Appeals Commissioner and to the ITAT if it is passed pursuant to the DRP directions.

The taxpayer has the right to appeal to the ITAT within 60 days of the final order pursuant to DRP directions or the order of the Appeals Commissioner. As the ultimate fact-finding authority, the ITAT examines the dispute afresh and adjudicates on most transfer pricing disputes. It has broad powers to decide questions of law or facts, including setting aside an assessment or restoring the order of the TPO or tax officer for fresh examination, and including admitting additional evidence.

Select ITAT orders travel to the jurisdictional High Court and from there to the Supreme Court. Notably, before admitting appeal from the ITAT order, the High Court has to be satisfied that the issue involved is a 'substantial question of law'.

Landmark cases

There have been a number of judicial opinions wherein transfer pricing disputes have been examined and crucial legal principles have evolved.

The Bombay High Court in the Vodafone and Shell cases24 dealt with the issue related to whether Indian subsidiary entity of Vodafone and Shell issuing shares to its foreign associated enterprise should fall within the ambit of transfer pricing law. The TPO formed an opinion that the shares were issued at an undervalued price and therefore, shortfall in the premium on the issue of shares should be 'income chargeable to tax' in the hands of the Indian entity. As a result, the TPO made a transfer pricing adjustment and further held that the shortfall in the premium is to be considered a loan given by the Indian subsidiary to its foreign associated enterprise. Hence, notional interest on arm's-length pricing of the deemed loan was charged as interest income by way of a secondary adjustment. The issue before the court (under a writ jurisdiction) was whether the alleged shortfall in share valuation constituted income in the hands of the Indian entity and was hence chargeable to tax. The High Court held that transfer pricing provisions allow for recalculation of the arm's-length price to determine the real value of the transaction, but not recharacterisation of the transaction. Therefore, there was no question of the transaction resulting in income and there could be no transfer pricing adjustment.

In SG Asia Holdings (India) Pvt Ltd ,25 the Supreme Court held that by not making reference to the TPO, the tax officer had breached the mandatory instructions issued by the Indian Board of Direct Taxes. However, the Supreme Court allowed the Revenue's plea for making a fresh transfer pricing audit.

High-pitched transfer pricing adjustments on intra-group services payments to AEs: the Mumbai ITAT in the landmark decision in the case of CLSA has held that ad hoc TP adjustments without following the due process of law should be deleted and no second opportunity should be given to the TPO,26 though a contrary decision has been taken by the Bangalore ITAT. There are other decisions where the ITAT has restored the case back to the tax officer, only for the limited purpose of verification of margins.27 The Revenue has been appealing against such decisions of the ITAT to the High Court.

In another case,28 the High Court, while rejecting the appeal of the Revenue, concluded that 'a party is not barred in law from withdrawing from its list of comparables, a company, if the same is found to have been included on account of mistake as on facts, it is not comparable. The Transfer Pricing Mechanism requires comparability analysis to be carried out between like companies and controlled and uncontrolled transactions'.

The Madras High Court ruled29 that foreign associated enterprises can be treated as a tested party under Indian transfer pricing regulations and also permitted change of tested party during the course of audit proceedings.

The Karnataka High Court of India ruled30 that in the absence of management or control, no AE relationship can be established, even if the enterprises were deemed AEs under India's transfer pricing laws; thus, transfer pricing provisions would not be applicable.

The Madras High Court ruled31 that a transfer of shares by parent to subsidiary, contributed as a gift (without consideration) was not a gift in the circumstances of the taxpayer, and ruled that the income would be chargeable to tax as capital gains, and hence transfer pricing provisions would be applicable to such transfers.

In the Mitsui case,32 the ITAT upheld the taxpayer's international transactions using TNMM as the most appropriate method and use of the Berry ratio as the profit level indicator (PLI). The Revenue's appeal was rejected by the High Court on the grounds that no substantial question of law arose, though the Revenue has appealed to the Supreme Court, which is currently pending.

It is also held33 that the choice of method available to a taxpayer is not an unfettered choice. The CUP method, if found appropriate in a given situation for determination of arm's-length price, should be preferred over the other methods.

There is also a precedent,34 whereby the adjustment to a taxpayer's arm's-length price on account of 'location saving' without carrying out a comparability analysis with an uncontrolled transaction to show that location factor materially affected price and profit margin, was rejected.

Notably, there are two critical matters that are pending before the Supreme Court, the first being whether transfer pricing issues amount to substantial questions of law and can be the subject of an appeal before the High Courts and Supreme Court;35 the second being whether adjustments based on the comparables cannot be challenged in the High Court unless the findings are ex facie perverse and exhibit total non-application of mind.36

Secondary adjustment and penalties

To align with the BEPS, India has amended the ITA to provide for secondary adjustments. India's secondary adjustment law came into effect on 1 April 2017 prospectively. Secondary transfer pricing adjustments are applicable for primary adjustments if made in one of the following situations:

  1. a voluntary adjustment by the taxpayer;
  2. an adjustment made by the TPO and accepted by the taxpayer;
  3. an adjustment determined by an APA;
  4. an adjustment determined pursuant to the safe-harbour rules; and
  5. an adjustment resulting from a MAP.

A secondary adjustment has to be applied where the primary adjustment is above 10 million rupees and it relates to a primary adjustment for the financial year 2016–17 onwards. The adjustment shall also apply in situations where the taxpayer is seeking rollback under the APA process.

If the sums arising as a consequence of a primary adjustment are not repatriated to India within the prescribed period, the amount would be deemed an advance by the Indian associated enterprise and imputed interest would be payable on the advance, according to the arm's-length price standard. Furthermore, the law provides that the excess money may be repatriated from any of the associated enterprises that are non-resident in India.

Alternatively, the law prescribes a final and one-time tax payment of 18 per cent37 of the adjustment amount in lieu of the requirement to repatriate the quantum of a secondary adjustment.38 However, no credit shall be allowed and no deduction shall be allowed under any other provision of the Act in respect in respect of the amount of the tax. If the tax is paid, the taxpayer is not required to make secondary adjustment.

India has strict penalties for non-compliance with transfer pricing provisions, which are summarised in the table below:

SectionNature of default in respect of international transaction or specified domestic transaction (hereinafter collectively referred to as transactions)Quantum of Penalty
Section 271AA(1)
  • failure to keep and maintain information and documents prescribed under the Indian transfer pricing regulations
  • maintain or furnish incorrect information or document
  • failure to report the transaction in the accountant's report (Form 3CEB)
2 per cent of the value of each international transaction or specified domestic transaction
Section 271AA(2)Failure to furnish information and document by the constituent entity of an international group0.5 million rupees
Section 271BAFailure to furnish an accountant's report (i.e., Form 3CEB) either on or before the due date of filing the return of income0.1 million rupees
Section 271GFailure to furnish information or documents during the course of transfer pricing audit2 per cent of the value of the international transaction or specified domestic transaction, as the case may be
Section 270A(1)Penalty for under-reporting of income50 per cent of the amount of tax payable on under-reported income
Section 270A(8)Penalty for misreporting of income200 per cent of the amount of tax payable on misreported income
Section 271JFurnishing incorrect information in reports and certificates issued under any provisions of the Act10,000 rupees for each such report or certificate
Section 271GBFailure to furnish report or for furnishing inaccurate report (master file, CbCR)500,000 rupees

i Under-reporting of income

The concerned tax authority has been empowered to levy a penalty of 50 per cent of the amount of tax payable on under-reported income.39

In terms of transfer pricing, under-reporting of income could mean the following cases:

  1. where the income assessed is greater than income determined;
  2. if no return is filed, where the income assessed is greater than maximum amount not chargeable to tax;
  3. where the income reassessed is greater than income assessed; and
  4. in cases of loss return, where the income assessed or reassessed has the effect of reducing the loss or converting such loss into income.

Such under-reported income does not, however, include the amount represented by any addition made in conformity with the arm's-length price determined by the TPO if the taxpayer:

  1. maintained information and documents; or
  2. declared the international transaction, including the disclosure of all the material facts.

While the Act safeguards the taxpayer against the penalty of under-reporting through disclosure of all 'material information', the meaning of the term is very subjective. The term may carry different meanings for different stakeholders; hence, it is imperative for the taxpayer to demonstrate that the position taken by it is purely bona fide.

ii Misreporting of income

The law further provides penalty of 200 per cent of the amount of tax payable on misreported income in the following cases:

  1. misrepresentation or suppression of facts; and
  2. failure to report any international transaction or deemed international transaction or specified domestic transaction to which provisions of Chapter X shall apply.

The law further provides immunity from the imposition of penalties relating to under-reporting of income provided that due tax and interest have been paid within the specified time; and no appeal has been filed against the tax officer.40

Broader taxation issues

i Diverted profits tax, digital sales taxes and other supplementary measures

In 2016, India introduced a digital tax, known as 'equalisation levy', to provide for a charge of 6 per cent in the form of tax from amounts paid to a non-resident for business-to-business online and digital advertising services.

The scope of the equalisation levy was substantially expanded in 2020 to cover potentially all kinds of digital transactions of sale of goods or provision of services supplied to Indian residents and includes non-residents using an Indian internet protocol (IP) address. It imposes a 2 per cent levy on the gross considerations received or receivable by non-resident e-commerce operators from providing or facilitating e-commerce supply of services. It specifically covers transactions between non-residents and e-commerce operators where advertisements are targeted at Indian residents or customers using an Indian IP address; and sale of data collected from Indian residents or customers using an Indian IP address. Equalisation Levy 2020 must be paid by the e-commerce operator, unlike Equalisation Levy 2016.

In 2018, India introduced the concept of the 'significant economic presence' test to tax non-residents on profits under the domestic tax laws that are applicable from 1 April 2021.41

The law specifically states that only the income attributable to the business connection shall be deemed to accrue and arise in India42 and categorically lists certain income that will be attributable to operations carried out in India. The list is as follows:

  1. such advertisement that targets a customer who resides in India or a customer who accesses the advertisement through an internet protocol address located in India;
  2. sale of data collected from a person who resides in India or from a person who uses an internet protocol address located in India; and
  3. sale of goods or services using data collected from a person who resides in India or from a person who uses an internet protocol address located in India.43

In terms of Pillar Two, India is likely to adopt the subject to tax rule (STTR). For the income inclusion rule (IIR) and the undertaxed payment rule (UTPR), India is yet to notify enabling legislation because India does not have CFC legislation and there is no provision in the law to consolidate group company accounts and pay taxes on the consolidated P&L of a company.

ii Double taxation

The Indian Board of Direct Taxes has clarified that MAP and bilateral APA applications can be applied by any taxpayer operating in India (regardless of residence) with which India has a double-taxation avoidance agreement even though the agreement does not contain provisions for corresponding adjustment in matters of transfer pricing. Furthermore, Indian tax laws provide for condonation of delay for appeals filed; however, it remains to be seen whether non-acceptance of MAP resolution constitutes a valid ground for the delay.

iii Transfer pricing implications of covid-19

There is no administrative guidance issued by Indian tax authorities due to the covid-19 pandemic. Therefore, taxpayers depending upon the facts and circumstances can renegotiate the terms of the APA.

iv Consequential impact for other taxes

Indirect tax implications with regard to transfer pricing adjustments are independent of the ITA and are governed by distinct laws.

Under the Goods and Service Tax (GST) laws, which apply to all supplies of goods and services in India (including imports), the transaction value between the parties is the primary basis of valuation for the purposes of determining the GST liability. In the case of a related-party transaction, however, the transaction value is not accepted. Consequently, a related-party transaction must be benchmarked based on the stipulated rules, among which is the open market value (OMV) of identical goods or services supplied to an unrelated party. If such OMV is not available, the taxable value is to be ascertained based on the value of similar supplies, the cost construction method or the resale price of goods to independent parties, in that order.

Indian customs law, which provides for levy of import and export duties on goods imported into and exported from India, is based on the World Trade Organisation's Customs Valuation Agreement in so far as determining taxable value for duty purposes is concerned. In case of any related-party transaction, the declared import price is not accepted unless it is established that the relationship between the buyer and the seller has not 'influenced the price' of the imported goods. Upon failure to establish this, the transaction value is rejected, and the valuation of the imports is administratively referred to the Special Valuation Branch (SVB). The SVB sequentially applies valuation rules prescribed under Customs Valuation Rules to determine the arm's-length transaction value. As per the Rules, this value is determined based on import value of identical goods or similar goods (with necessary adjustments), the deductive value method or computed value method, and thereafter the residual method.

Outlook and conclusions

In the past two decades since transfer pricing laws were introduced, the law has consistently evolved and is largely aligned with international best practices. Litigation has, however, seen no respite despite the introduction of safe harbours. India's APA programme has been successful in lending certainty; however, obtaining an APA is a time-consuming process and, on average, takes four to six years. The law will mature as safe harbour limits are rationalised and disputes pertaining to margin computations and selection of comparable are laid to rest.

Taxpayers would be well advised to maintain robust transfer pricing documentation as courts give cognisance to documentation maintained by taxpayers; most transfer pricing disputes are eventually settled in the taxpayer's favour.

The tax administration has reiterated its intent to operate in the multilateral framework laid out by the OECD under the BEPS Inclusive Framework. It will be interesting to see how much transfer pricing controversy is settled by adoption of the two-pillar solution.

Footnotes

1 Mukesh Butani and Seema Kejriwal are partners at BMR Legal Advocates.

2 The law is applicable to all taxpayers: corporates and non-corporates, and residents and non-residents, with income chargeable to tax in India.

3 It is widely debated that this amendment signifies that the profit attribution of PEs is different from FAR analysis and indicative of the Indian Revenue authorities' shift from a FAR to a FARM analysis.

4 The definition of Specified Domestic Transactions was inserted in the ITA by the Finance Act 2012, wherein certain transactions between domestic companies were considered as specified domestic transactions subject to conditions. The aggregate of such transactions entered into by the taxpayer should exceed the threshold limit of 200 million rupees from assessment year 2016–17.

5 Section 92F (v) of the Act.

6 The unspecified methodology was introduced as from the financial year 2011–2012.

7 Under the faceless scheme, all correspondence will take place electronically and the taxpayer will not have in-person hearings with the tax officer.

8 The Finance Act, 2022 has extended the timeline for its inclusion by 31 March 2024.

9 These powers are enshrined in Sections 133A and 133B of the ITA, which empower the TPO to enter any premises to inspect such books of accounts, cash, valuables or any information as the TPO may require that may be useful or relevant for the proceedings.

10 Such revision can only be carried out by a senior tax officer.

11 This instruction is aligned with the OECD recommendation on appropriate use of information contained in the CbCR.

12 Instruction No. 2 of 2018.

13 The notification specifically provides that use of information contained in CbC reports shall be considered as inappropriate under the following circumstances: (1) if the information is used as a substitute for a detailed transfer pricing analysis of international transactions and determination of arm's-length price based on a detailed functional and comparability analysis; and (2) if the information is used as the only material to propose a transfer pricing adjustment.

14 The expression 'intangible property' shall include: (1) marketing-related intangible assets, such as trademarks, trade names, brand names and logos; (2) technology-related intangible assets, such as process patents, patent applications, technical documentation including laboratory notebooks and technical know-how; (3) artistic-related intangible assets, such as literary works and copyrights, musical compositions, copyrights, maps and engravings; (4) data processing-related intangible assets, such as proprietary computer software, software copyrights, automated databases, and integrated circuit masks and masters; (5) engineering-related intangible assets, such as industrial design, product patents, trade secrets, engineering drawing and schematics, blueprints, proprietary documentation; (6) customer-related intangible assets, such as customer lists, customer contracts, customer relationship and open purchase orders; (7) contract-related intangible assets, such as favourable supplier, contracts, licence agreements, franchise agreements and non-compete agreements; (8) human capital-related intangible assets, such as trained and organised work force, employment agreements and union contracts; (9) location-related intangible assets, such as leasehold interest, mineral exploitation rights, easements, air rights and water rights; (10) goodwill-related intangible assets, such as institutional goodwill, professional practice goodwill, personal goodwill of professional, celebrity goodwill and general business going concern value; (11) methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists or technical data; and (12) any other similar item that derives its value from its intellectual content rather than its physical attributes.

15 Known as DEMPE functions.

18 High courts have given conflicting rulings in this regard. [2015] 374 ITR 118 (Delhi), [2016] 381 ITR 117 (Del).

19 These APAs cover various transactions, such as software services, IT-enabled services, intra-group payments or business support services commission.

22 If the taxpayer does not communicate its decision to refer the draft assessment to the DRP within 30 days, the AO shall finalise the assessment without modification of the draft.

23 In 2016, the law was amended whereby the tax authorities have been barred from filing an appeal against the DRP directions.

24 Vodafone [2014] 368 ITR 1 (Bombay); Shell [2015] 64 taxmann.com 262 (Bombay).

25 TS-775-SC-2019-TP.

26 CLSA India Pvt Ltd v. DCIT, Circle 4(1)(1), Mumbai [2019] 101 taxmann.com 388 (Mumbai – Trib).

27 CWT India Pvt Ltd [2019] 109 taxmann.com 182 (Mumbai – Trib).

28 Tata Power Solar Systems Ltd [2019] 77 taxmann.com 326 and Lionbridge Technologies Pvt Ltd [TS-176-HC-2019(BOM)-TP].

29 Virtusa Consulting Services (P) Ltd v. Deputy Commissioner of Income Tax, Company Circle 5(2), Chennai (T.C.A.No. 997 of 2018) [2021] 124 taxmann.com 309 (Madras).

30 Principal Commissioner of Income-tax v. Page Industries Ltd [2021] 431 ITR 409 (Karnataka).

31 Principal Commissioner of Income-tax-5, Chennai v. Redington (India) Ltd (T.C.A. NOS.590 & 591 OF 2019) [2020] 122 taxmann.com 122 (Madras).

32 Mitsui and India Pvt Ltd [TS-602-SC-2017-TP].

33 Serdia Pharmaceuticals (India) Pvt Ltd [2011] 9 taxmann.com 13 (Mumbai).

34 Syngenta India Ltd [2017] 77 taxmann.com 220 (Mumbai).

35 M/S Finastra Solutions (SLP-C 9066/2019).

36 Softbrands India Pvt Ltd (TS-475-HC-2018(KAR)-TP). Subsequently, over 500 appeals were decided following the Karnataka High Court judgment, the correctness of which is currently being heard by the Supreme Court.

37 Increased by applicable surcharge and cess.

38 The Finance Act, 2019 inserted clause (2A) to Section 92CE applicable from 1 September 2019.

39 Section 270A of the Act. Penalty for under-reporting or misreporting of income: following the course on 'graded penalty' structure curated in the Union Budget 2016, Section 270A was introduced with effect from 1 April 2017, dividing penalties into two.

40 Section 270AA of the Act. However, CBDT circular dated 16 August 2018 clarified that the tax authority shall not take an adverse view in respect of penalty proceeding under Section 271(1)(c) from earlier assessment years merely because the taxpayer has applied for immunity under Section 270AA.

41 Vide notification dated 3 May 2021. For it to apply, the turnover should be 20 million rupees or the user's base of 0.3 million has been notified.

42 Explanation 3 to Section 9 of the Act.

43 The Finance Act, 2020 has inserted new Explanation 3A to Section 9 of the Act.

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