The Transfer Pricing Law Review: India
Transfer pricing law in India was introduced in April 2001 following an amendment to the Income-tax Act 1961 (ITA), which covered intra-group cross-border transactions, and, from April 2013, the provisions were extended to specified domestic transactions between related enterprises for a limited time until 2017. The law broadly aligns with the Organisation for Economic Co-operation and Development Guidelines on Transfer Pricing (the OECD Guidelines), and definitions of international transactions, documentation requirements, and associated enterprises are broad and expansive.
The law, broadly, provides methods to compute the arm's-length price, extensive annual requirements of transfer pricing documentation and penal provisions for non-compliance. 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.
Section 92B of the ITA defines the term 'international transaction' to mean a transaction between two or more associated enterprises involving:
- the sale, purchase or lease of tangible or intangible property;
- the provision of services;
- cost-sharing arrangements;
- lending or borrowing money; or
- any other transaction having a bearing on the profits, income, losses or assets of such enterprises.
A relationship between associated enterprises can involve:
- the direct or indirect holding of at least 26 per cent voting interests;
- controlling the board of directors;
- common control;
- a significant dependence on intangibles, raw materials or consumables;
- supplier lending or guaranteeing a loan for the substantial percentage of total assets from one enterprise; or
- any other relationship of mutual interest.
The above definition includes deemed international transactions in third-party situations, particularly when the terms of the contract are determinable.
The 2001 transfer pricing provisions remained largely unreformed until 2012, when substantial changes were introduced. In particular, the definition of international transaction was retrospectively expanded to cover an array of other transactions, such as the purchase or sale of tangible and intangible assets, and capital financing. The definition of 'intangible property' was given a broad scope at a time when the debate on intangibles at the global level was gathering momentum (see Section IV).
A wave of reforms gathered momentum from 2013 to 2015, and was followed up in 2017 and 2020 with the following material changes:
- introduction of safe harbours rules (SHR);
- an option to use a 'sixth methodology';
- eligibility to seek a five-year unilateral or bilateral advance pricing agreement (APA), which subsequently covered rollback of up to four years;
- use of multiple years of data for benchmarking purposes;
- an Indian version of an interquartile range between 35 and 65 percentile;
- thin capitalisation; and
- secondary adjustment.
A major development was carried out by the Finance Act 2020 with regard to profit attribution for permanent establishments (PE) and extension of SHR and APA to PE profit attribution.
Although the arm's-length principle applies if income charging provisions are triggered, the debate regarding its application to the issuance of shares or a capital transaction is now settled.2 However, the disclosure rules have been amended to disclose such capital transactions. Dividends are not subject to arm's-length pricing principles because they are an appropriation of profits and exempt from tax at the shareholder level.
Section 188 of the Companies Act 2013 prescribes the consent of the board of directors for specified related-party (domestic and international) transactions. This does not apply to transactions under the ordinary course of business. In November 2019, the capital markets regulator, namely the Securities and Exchange Board of India (SEBI), constituted a working group to review the policy pertaining to related-party transactions (RPTs) for listing entities. Consequently, in January 2020, SEBI announced policy proposals with respect to RPTs to protect the investor's interest and for ease of doing business.
There are no direct implications of not transacting at arm's length (such as deemed dividend implications), unlike in other jurisdictions. However, the ITA was amended to provide for secondary adjustments (see Section VIII).
Taxpayers are required to annually maintain extensive supporting information and documents relating to international transactions undertaken with their associated enterprises. Rule 10D of the Income Tax Rules 1962, which has been widely interpreted by the courts, prescribes that the documentation requirements may be broadly divided into two parts. The first part lists the following mandatory information that a taxpayer must maintain:
- information on the ownership structure (e.g., group profile and business overview);
- whether in writing, implied in action or acting in concert: the associated enterprises' contractual nature, terms, quantity, value, etc., of an international transaction; and
- relevant financial forecasts or estimates that form part of a comprehensive transfer pricing study.
The documentation includes information in relation to: functions performed; risks assumed; assets employed; details of relevant uncontrolled transactions; comparability analyses; benchmarking studies; assumptions; policies; details of economic adjustments; and 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, and courts have held that commercial wisdom cannot be questioned in this regard.
The second part stipulates documentation authenticating the information and analyses provided in the first part. This documentation must be contemporaneous, maintained for a period of eight years from the end of the relevant assessment year (i.e., nine years from the end of the relevant financial year) and presented to the tax authorities on request, at the audit, assessment or dispute resolution stage.
An accountant's report for all international transactions between associated enterprises is mandatory; it is to be obtained from an independent accountant, who would certify the value of international transactions (in accordance with the books of accounts) and state the arm's-length price based on the documentation and supporting information maintained by the taxpayer. The report has to be furnished in Form 3CEB by the due date of the tax return filing (i.e., on or before 30 November, following the close of the relevant tax year on 31 March). The report requires the accountant to give an opinion on the proper maintenance of prescribed documents and information according to the rules, and to certify the correctness of an extensive list of transactions, including the methodology of the transactions. Failure to supply this report leads to a penalty of 100,000 rupees. A penalty of 2 per cent of the value of the international transaction may be levied for failure to maintain the prescribed documentary report.
India has committed to implementing the recommendations of Action 13 of the OECD Base Erosion and Profit Shifting (BEPS) Action Plan, and consequently the ITA was amended in 2016 to introduce a requirement to furnish a master-file country-by-country report (CbCR) together with the transfer pricing documentation for the year ending 31 March 2017. The master file has to be filed electronically in Form 3CEAA. The master file in Form 3CEAA has two parts: Part A specifies generic information about the constituent entities of a multinational enterprise (MNE) group operating in India; and Part B provides a high-level overview of the MNE group's business structure, operations, transfer pricing policies, etc. The key filing requirements are as follows:
- the filing of Part A of the master file in Form 3CEAA is applicable to every constituent entity operating in India, whether it has its parent entity resident in or outside India; and
- regarding the threshold for Part B of the master file in Form 3CEAA:
- the consolidated revenue of the international group according to the consolidated financial statements for one accounting period must exceed 5 billion rupees;
- the aggregate value of international transactions of the constituent entity during the accounting period must exceed 500 million rupees; or
- the aggregate value of international transactions in respect of purchase, sale, transfer, lease or use of intangible property during the accounting period, must exceed 100 million rupees.
Where an international group has multiple constituent entities operating in India, the group may designate one of its constituent entities as an alternate reporting entity to fulfil the requirement of filing Form 3CEAA on behalf of the group.
To support the documentation, tax authorities at the audit stage require a scientific analysis such as an independent report, particularly for intra-group charges, royalty, intangibles, etc. However, select tribunals have rejected the mechanical approach of the Revenue, namely undertaking mechanical adjustments on such transactions, and held that commercial wisdom cannot be questioned – instead the role of the auditor is to assess the arm's-length principle as per the statutory provisions.
Presenting the case
i Pricing methods
The term 'arm's-length price' is defined under Section 92F of the ITA and applies to transactions between persons other than associated enterprises in uncontrolled conditions. The following methods have been prescribed by Section 92C of the ITA for the determination of the arm's-length price:
- the comparable uncontrolled price (CUP) method;
- the resale price method (RPM);
- the cost-plus method;
- the profit split method;
- the transactional net margin method (TNMM); and
- an unspecified method.3
On the choice of methodology, the law prescribes the use of the 'most appropriate methodology'. The transfer pricing rules on this choice of methodology are in line with the OECD Guidelines, except that the methodologies are ranked in a hierarchical manner. Having said that, it is appropriate for taxpayers to choose the most appropriate methodology. If, however, the Department of Revenue believes that the choice of methodology deemed most appropriate by the taxpayer does not arrive at the correct arm's-length price, it may disagree and recalculate the arm's-length price using an alternative methodology. Choice of methodology is the most vexed issue, given the inconsistencies in interpretation and in the policy stance on transactions that involve use of intangibles. Lately, use of the residual profit split method has been gaining prominence.
ii Authority scrutiny and evidence gathering
In accordance with prevailing internal administrative guidelines, taxpayers are subject to risk-assessment rules (which are not made public) before being referred to a transfer pricing officer (TPO) for assessment or audit. Cases are selected for detailed audit by the issue of a notice under Section 143(2) of the ITA to the taxpayer within six months of the end of the financial year of the compliance calendar. There is a statutory requirement for the assessing officer (AO) to refer relevant transactions under Section 92CA of the ITA to the TPO for an audit, with prior approval of the jurisdictional commissioner, such that only select cases or transactions are audited. Although the criteria are not defined, a history of audits that resulted in an adjustment comprised of low margins, intangibles, intra-group services, etc. form a basis for cases being picked out for assessment audit. Typically, the TPO specifies the records, documents and details required to be produced for an audit. The TPO has wide assessment powers requiring the production of necessary evidence and material information to support the computation of the arm's-length price of transactions. Audit cases are scrutinised in detail to ensure that all relevant factors, such as appropriateness of the transfer pricing method applied and correctness of data, are verified. After taking into consideration all the information available, the TPO is required to determine the arm's-length price. However, in a situation where the taxpayer has modified the arm's-length price (determined in an APA), the tax officer can merely accept the modification to determine the return of income and cannot do an assessment or reassessment.
TPOs are vested with powers of inspection, discovery, enforcing attendance, examining a person under oath and compelling the production of books of account and other relevant documents and information as part of the assessment function. These powers were further extended, from 1 June 2017, to include conducting surveys for spot inquiries, verification for subsequent investigations, and collation of data. 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. The investigative powers of the tax authorities in general, including in relation to transfer pricing law, are discussed in Section VI. A penalty of 2 per cent of the value of the international transaction has been provided in Section 271AA of the ITA, both for failure to report transactions and for furnishing incorrect documentation at the audit stage.
Enhanced approaches such as adoption of practices suggested under BEPS Action Plans, following a risk-based tax audit approach or a faceless assessment or appeal, have bolstered the transfer pricing mechanism. During the past few audit periods and outcomes from appeals before appellate forums, the Revenue has learnt innovative ways to view a particular transaction and experiences from APA as well as CbCR have also boosted the tax policy framework. Another mode of building capacity is the use of technology, artificial intelligence and data analytics to analyse the complex web of MNE structures and routing of transactions.
In 2017, the concept of thin capitalisation was introduced in line with the recommendations contained in BEPS Action Plan 4. Where an Indian company, or a PE of a foreign company in India, being the borrower, pays interest exceeding 10 million rupees in respect of any debt issued or guaranteed (implicitly or explicitly) by a non-resident associated enterprise (AE), then such excess interest (being above 30 per cent of earnings before interest, tax and depreciation) will not be deductible.
The definition of the term 'international transaction' was broadened retrospectively in 2012 to cover transactions for the purchase, sale, transfer, lease or use of intangible property. The definition expanded to practically cover every direct or indirect transaction in relation to intangible property. The disclosure requirements for international transactions relating to intangibles changed in 2017, when it was made mandatory for taxpayers to disclose details of such transactions with an aggregate value exceeding 100 million rupees in respect of the lease or use of intangible property. These details are to be filed by the taxpayer in Form 3CEAA and be furnished to the Director General of Income Tax (Risk Assessment) on or before the date on which the taxpayer is due to furnish its tax return.
India has not specified any formal policy in response to the principles on the development, enhancement, maintenance, protection and exploitation of intangibles4 articulated in the BEPS Action Plan other than the 2017 disclosure requirements. The CbCR requirement 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.
Well before the BEPS initiative was under way, given the growing disputes over R&D captives, the Central Board of Direct Taxation (CBDT) issued guidelines5 to TPOs about 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:
- entrepreneurial in nature;
- based on cost-sharing arrangements; and
- undertaking contract R&D.
Based on these categories, suitable methodology is prescribed as either the profit split method or cost-plus method, and the most appropriate methodology is forensically applied.
Unlike in 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 as of 1 July 2012. In the past seven years since introduction, India has received over 1,000 applications and concluded over 300 APAs of which more than 240 are unilateral and more than 30 bilateral APAs. These APAs cover various transactions, such as software services, IT-enabled services, intra-group payments, business support services commission or indent. The bilateral APA process covers important jurisdictions, such as the United States, the United Kingdom, Japan, Germany, France, Italy and the Netherlands. In recent APA negotiations, the Revenue has been advocating expanding the scope of 'profit attribution' in the source jurisdiction, based not just on Functions, Assets and Risk (FAR) analysis but also considering 'market' analysis, also referred to as Functions, Assets, Risk and Market (FARM) analysis. Value creation is positioning centre-stage in APA negotiations, particularly for digital business models. Evaluation of intangibles using development, enhancement, maintenance, protection and exploitation (DEMPE) analysis and focus on significant people function are also important aspects in APA negotiations and transfer pricing audits.
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 foreign 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 (MLI) provides for mandatory binding arbitration when competent authorities are unable to reach a decision under MAP within two years. With the onset of MLI-based treaties from 1 April 2020, it is pertinent to note that India has not accepted such provision, taking a position that such binding arbitration would adversely impact its sovereignty.
India introduced safe harbour rules in 2009 for resolving disputes for specific industries or transactions, particularly in the area of IT-enabled services, software development, R&D, exports of goods in the auto-ancillaries industry, inbound offshore loan and debt transactions, etc. The 2009 safe harbour limits were set with a higher threshold, and as a result there were fewer takers in the initial years. The safe harbour limits were revised downwards and tweaked further in 2013 to encourage taxpayers to avail of safe harbour, particularly for inbound low value-added services. The tax authorities will accept the transfer price declared by taxpayers opting for a safe harbour within the limits set out without question or scrutiny. In 2020, the law on safe harbour has been expanded to cover non-residents for determining profit attributable to their PE in India.
There is currently no specific concept of a '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, investigations), under the following provisions of the ITA:
- Section 143 – for regular audit or assessment;
- Section 144 – best-judgement assessment, where a taxpayer does not file a tax return or fails to comply with requests from the tax authorities;
- Section 147 – reassessment of income escaping assessment, where the tax authorities have reason to believe income chargeable to tax has escaped assessment; and
- Section 153A – assessment or reassessment in situations of search and seizure, where the tax authorities have reason to believe that the taxpayer's accounts do not reflect the true picture or the taxpayer has failed to produce the accounts.
In the course of an assessment, audit or reassessment, the TPO is empowered to carry out an adjustment if it forms an opinion that:
- the price charged in an international transaction is not at arm's length;
- any information and documentation relating to an international transaction has not been maintained by the taxpayer;
- the information or data used in computation of the arm's-length price is not reliable or correct; or
- the taxpayer has failed to furnish requested information or documentation within the specified time.
The TPO can arrive at an arm's-length price on the basis of information or documentation gathered over the course of assessment or audit. A show-cause notice has to be issued to the taxpayer to explain the basis of the adjustment and then (revised) benchmarking has to be performed to justify the adjustment. The order of the TPO shall be binding on the AO, who shall incorporate it in the taxpayer's main assessment and issue a draft order.
The time limit for completing an assessment, which must include a reference by way of notice to the TPO, has been reduced to 24 months from May 2020 onwards as compared to the erstwhile limit of 33 months.
The primary onus is on the taxpayer to maintain documentation to demonstrate that the price charged in an international transaction complies with the arm's-length price, and the method followed to ascertain the price is the most appropriate method. The taxpayer discharges this onus by maintaining the documentation and thereafter the onus shifts to the tax authorities. In the event that the tax authorities disagree with the taxpayers' view and seek additional explanation, the burden of proof again shifts (to the taxpayer) to prove why the method applied by the taxpayer is correct.
After categorically stating reasons for such rejection, the TPO is required to compute the arm's-length price by undertaking a fresh benchmarking analysis. The powers of the TPO have been widened to cover even the transactions not disclosed in the accountant's report.
The Bombay High Court6 has held that where no such benchmarking exercise was undertaken to determine the value of intra-group services, such approach was not in accordance with the spirit of the law.
Once the TPO proposes an adjustment, it directs the AO to issue a draft assessment within the time limit described above. It is mandatory for the AO to issue a draft assessment before issuing the final order, and at that point the taxpayer has the following options:
- accept the draft assessment and adjustment proposed;
- file an objection before the dispute resolution panel (DRP) by communicating its decision to the AO within 30 days of the draft assessment; or
- not file an objection, and instead allow the TPO or AO 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. Once the taxpayer chooses to opt for the DRP process, no tax demand can be raised, given that the assessment is in a draft form at that stage. The salient features of the DRP mechanism are as follows:
- the DRP objections have to be filed within 30 days of the date of the draft assessment;
- the DRP, comprising three commissioners, must decide the taxpayer's objections within nine months of the date of reference by issuing written directions to the AO;
- these directions are binding on the AO, and it is expected that they shall be incorporated in the final order;
- the DRP has wide powers to examine additional evidence, inquire further into the case and, by a majority, issue directions to confirm, enhance or reduce the adjustment;
- the DRP cannot, however, compromise or settle a dispute and its powers to adjudicate are limited.
In 2016, the law was amended whereby the Revenue was barred from filing an appeal against the DRP directions. Alternatively, 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. In summary, the tax demand is finalised only upon the AO's passing of the final order, which is appealable to the Appeals Commissioner (if the taxpayer does not file an objection) and to the Income Tax Appellate Tribunal (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 AO for fresh examination, and including admitting additional evidence.
Select ITAT orders travel to the jurisdictional High Court and from there to the Supreme Court. The High Court has to be satisfied that a 'substantial question of law' arises from the ITAT order before admitting an appeal.
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 case:7 An Indian subsidiary entity of Vodafone and Shell issued shares to its foreign associated enterprise. The TPO formed an opinion that the shares were issued at an undervalued price. Hence, they treated the shortfall in the premium on the issue of shares as 'income chargeable to tax' in the hands of the Indian entity, and made a transfer pricing adjustment. The TPO held the shortfall in the premium to be 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. Hence, there was no question of the transaction resulting in income and there could be no transfer pricing adjustment.
In SG Asia Holdings (India) Pvt Ltd8 the Supreme Court has held that the ITAT was right in observing that by not making reference to the TPO, the AO had breached the mandatory instructions issued by the CBDT. 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,9 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.10
The Revenue has been appealing against such decisions of the ITAT to the High Court. In 2018, the Karnataka High Court delivered a landmark judgment in the case of Softbrands India Pvt Ltd,11 holding that adjustments on the basis of the comparables are a matter of estimate and cannot be challenged in the High Court unless the findings are ex-facie perverse and exhibit total non-application of mind. Subsequently, over 500 appeals were decided following this judgment, the correctness of which is currently being heard by the Supreme Court.
In another case,12 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 done between like companies and controlled and uncontrolled transactions'.
In the case of Mitsui,13 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 ground that no substantial question of law arose, though the Revenue has appealed to the Supreme Court, which is currently pending.
In another case,14 the ITAT has held that a Foreign AE can be taken as the tested party if it has a simpler FAR profile for analysing international transactions.
It is also held15 that 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,16 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.
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. For APAs concluded before the law's effective date, the secondary adjustment law does not apply. Secondary transfer pricing adjustments are applicable for primary adjustments if made in one of the following situations:
- a voluntarily adjustment by the taxpayer.
- an adjustment made by the TPO and accepted by the taxpayer;
- an adjustment determined by an APA;
- an adjustment determined pursuant to the safe-harbour rules; and
- an adjustment resulting from a MAP;
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.
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 fiscal years 2015 to 2016 onwards. The adjustment shall also apply in situations where the taxpayer is seeking rollback under the APA process. In 2019, the law was amended to prescribe a tax payment of 18 per cent of the adjustment amount plus surcharge and cess in lieu of the requirement to repatriate the quantum of a secondary adjustment.
For adjustments, the penalty is either 50 per cent of the adjustment (for under-reporting) or 200 per cent of the adjustment (for misreporting).
Broader taxation issues
i Diverted profits tax and other supplementary measures
India amended the ITA in 2012 to counter offshore indirect transfers of shares with underlying assets in India. Section 9(1)(i) provides that if any entity registered outside India derives its value from an entity situated in India in the form of shares or interest, then the former entity is deemed to be situated in India and liable for capital gains tax. Accordingly, transfers of interest in the foreign entity would attract capital gains, subject to exceptions and valuation rules.
In line with the OECD's BEPS Action Plan on taxing e-commerce transactions, India in 2016 introduced an 'equalisation levy' to provide for a charge of 6 per cent in the form of tax from amounts paid to a non-resident not having any permanent establishment in India, for specified services, which include business-to-business services such as online advertising and provisions for digital advertising space. In 2018, India introduced the concept of the 'significant economic presence' test to tax non-residents on profits generated through non-PE traditional rules under applicable double-tax treaties, although its implementation has been deferred following treaty amendments resulting from the OECD BEPS multilateral process. This provision was earlier proposed to be effective from tax year 2020–2021; however, in February 2020 it was deferred to 2021–2022.
In April 2019, India issued a public consultation document on profit attribution to PEs, introducing the concept of the 'fractional formulary approach' to attributing profits to PEs. OECD guidance focuses on the supply-side factors for attribution of profits and ignores factors related to markets and demand, which could have significant adverse consequences for developing economies like India.
ii Double taxation
CBDT 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.
iii 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 of supplies 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. In case such OMV is not available, then the taxable value is to be ascertained on the basis of 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 Organization's Customs Valuation Agreement in so far as determining taxable value for customs duties purposes is concerned. Basis the same, 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 such, the transaction value is rejected, and the valuation of the imports is referred, administratively, to the Special Valuation Branch (SVB) of Customs. The SVB sequentially applies valuation rules prescribed under Customs Valuation Rules to determine the arm's-length transaction value. As per the Customs Valuation 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
As an active member of the G20, India has signed multilateral instruments, is a key contributor to the OECD's BEPS initiative and has actively pursued changes in its domestic law policy. A significant step has already been taken to adopt the OECD's recommendations of mandatory filing of a master file and a CbCR.
Further, India has expressed views supporting a consensus-based solution for profit allocation for PEs. A CBDT committee has proposed a fractional apportionment methodology which adopts the entire profit for allocation, as compared to the residual profit approach adopted under the formulary apportionment methodology proposed by the OECD under the Unified Approach.
In addition, India has taken various steps to target anti-avoidance. It introduced General Anti-Avoidance Rule (GAAR) provisions effective from 1 April 2017 which are broad based and counter any 'impermissible avoidance arrangement'. India has also concluded revised tax treaties with Mauritius, Singapore and Cyprus, with the 'limitation of benefits' clause to address the potential of abuse of these treaties. Simultaneously, India has ratified the Multilateral Instrument (MLI) and aligned the ITA to incorporate the 'principal purpose' test and other elements of the MLI in its tax treaties which are part of its 'covered agreements'. India is also presently seeking to overhaul the ITA. The Government is reviewing an expert committee report on the Direct Tax Code, submitted by the committee in September 2019. The report has not been made public, and it is yet to be seen when it will be translated into law.
Impact of covid-19 pandemic
Businesses will have to factor in disruption due to covid-19 and realign transfer pricing policies. Inter-company agreements which impact pricing policies will need to be amended. For limited risk distributors, contract manufacturers and contract R&D service providers, taxpayers will assess the profit margin impact. There is no administrative guidance available in relation thereto, however taxpayers can renegotiate the terms of their APA.
1 Mukesh Butani is a managing partner at BMR Legal Advocates. The author would like to thank Surekha Debata and Shreyash Shah, managing associates, for their assistance in writing this chapter.
2 Vodafone India Services Pvt Ltd v. Union of India (2014) 369 ITR 511 (Bombay). This decision was accepted by the Government and no appeal was filed against it.
3 The unspecified methodology was introduced as from financial year 2011–2012.
4 Known as DEMPE functions.
5 Circular 06/2013, available at www.incometaxindia.gov.in/pages/communications/circulars.aspx.
6 CIT v. Merck Ltd  389 ITR 70; CIT v. Lever India Exports Ltd  78 taxmann.com 88 (Bombay); CIT v. Johnson & Johnson Ltd  80 taxmann.com 337 (Bombay); CIT v. Kodak India Pvt Ltd  79 taxmann.com 362 (Bombay).
7  368 ITR 1 (Bombay).
13 Mitsui and India Pvt Ltd [TS-602-SC-2017-TP].