India: Transfer Pricing

Last Updated: 30 January 2004
Article by Rajkumar Dubey

Transfer pricing means the value or price at which transactions take place amongst related parties. Transfer prices are the prices at which an enterprise transfers physical goods and intangible property and provides services to Associated Enterprises.

POSITION IN INDIAA need was felt for a detailed and separate regulation for administering transfer pricing with globalisation of Indian economy. Absence of such Regulations not only results in litigation but loss of revenue to the exchequer. In absence of Transfer Pricing Regulations, India was losing its legitimate share of revenue.

The sections and rules under the Income Tax Act, 1961 which deal with Transfer Pricing Regulations are sections 92 to 92F and rules 10A to 10E and sections 271(1)(c) , 271AA ,271BA and 271G.

Section 92 of the Income Tax Act, 1962 states that:

  • Any income arising from an international transaction shall be computed having regard to armís length price.[Section 92(1)]
  • The allowance for any expense or interest shall be determined having regard to the armís length price while determining income under sub-section (1) above [Section 92(2)].
  • The cost or expense allocated or apportioned between two or more associated enterprises shall be at armís length price.

The relationship of Associated Enterprises emerges if any of the following criteria is met at any time during the previous year.

The basic criterion to determine Associated Enterprise is the participation in management, control or capital (ownership) of one enterprise by another enterprise. The participation may be by:

  1. Direct control
  2. Through intermediary

There are also additional criterion to determine an Associated Enterprise based upon the following:

  1. holding of 26% of voting power;
  2. advance of loan not less than 51%of the book value of the total assets of the borrowing company;
  3. guarantees not less than 10% of the total borrowings on behalf of borrower;
  4. appointment of more than 50% of the Board of Directors or members of the Governing Board;
  5. Dependence wholly on the enterprise possessing exclusive rights for manufacturing or pricing of goods or articles by using knowhow, patents etc. This however refers to only technology transfer and not financial participation. Technology could be by way of transfer for use of knowhow, patents, copyrights, trademarks, licenses, franchises, any other business or commercial right of similar nature. However technology for services e.g. software is not included in this definition;
  6. dependence up to 90% or more for the raw materials and consumables on another enterprise, coupled with influence over price and other terms of supply.
  7. The goods or articles manufactured or processed by one enterprise, are sold to the other enterprises or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprises;
  8. Where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or joinly by such individual and relative of such individual;
  9. Where one enterprise is controlled by a Hindu undivided family, the other enterprises is controlled by a member of such Hindu undivided family or by a relative of a member of such Hindu undivided family or jointly by such member and his relative;
  10. Where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than 10% interest in such firm, association of persons or body of individuals;
  11. there exists between the two enterprises, any relationship of mutual interest, as may be prescribed.

The term "Enterprise" is widely defined to include any person carrying out commercial activities of various types specified in the relevant section.

"International Transaction" (S. 92 B) is defined to mean a transaction between two or more Associated Enterprises of which either both or anyone is a non resident in the nature of :

  • Purchase, sale or lease of tangible property or intangible property; or
  • Provision of services: or
  • Lending or borrowing of money: or
  • Any transaction having a bearing on the profits, income, losses or assets.
  • Mutual agreement or arrangement between two or more Associated Enterprises for the allocation or apportionment of any contribution, cost or expense.


  • Transactions between Indian company and its overseas branch would be outside the purview of Transfer pricing regulations as both the entities will be residents;
  • Transactions between foreign entity and its permanent establishment (Indian branch) would be covered;
  • Any transaction between two permanent establishments in India would be covered as both will be non-residents of India.

The term "Armís Length Price" is defined to mean a price applied in uncontrolled conditions. In other words it refers to the market value of a particular transaction ignoring the impact on pricing due to existence of special relationship between Associated Enterprises.

Armís Length Price is the internationally accepted transfer pricing standard which must be applied for tax purposes by multinational enterprises and tax administration. The Transfer Pricing Regulations framed in India also recognises determination of pricing between Associated Enterprises on an armís length basis. The major reason for adoption of Armís Length Principle is to avoid the creation of tax advantages or disadvantages that would otherwise distort the relative competitive position of either type of entity. By separating tax considerations from economic decisions the armís length principle promotes the growth of international trade and investment.

The armís length price in relation to an international transaction shall be determined by any of the following methods:

  • Comparable uncontrolled price method: This method compares the price charged in a controlled transaction to the price charged in a comparable uncontrolled transaction in comparable circumstances. Where it is possible to locate comparable uncontrolled transactions this method is the most reliable and direct method.
  • Resale price method: This is ordinarily used in cases involving the purchase (from a related party) and resale (to an unrelated party) of property in which the re-seller has not added substantial value to the goods. Under this method, the Arms Length Price of the goods purchased from a related party is determined by deducting an armís length gross profit from the resale price of the goods resold to an unrelated party.
  • Cost plus method: Under this method, an Armís Length Price is determined by adding an armís length mark-up to the costs of the supplier supplying goods to a related purchaser. This method is useful where semi-finished products are sold between related parties, in case of joint facilities arrangement or where services are provided between related parties.
  • Profit split method: The net income from transactions is allocated to the respective entities, based on the value of their contributions to the net profit.
  • Transactional net margin method: Reference to the net profit level of similar business enterprises may help provide some guidance in the determination of Armís Length Price to be applied on related entity transactions. Profit may be assessed in different ways in relation to total sales, operating expenses incurred or assets.
  • Such other method as may be prescribed: Other method may be used provided the result is at armís length.

Sub-section (2) provides that where more than one price may be determined by the most appropriate method, the armís length price shall be taken to be the arithmetical mean of such prices. This is a unique concept in India.

Rule 10B explains in detail methods prescribed above. The Rule also provides that the comparability of one transaction with another shall be judged with reference to the following, namely:-

  1. the specific characteristics of the property or services transferred in either transaction;
  2. the functions performed taking into account assets employed or to be employed and the risks assumed by respective parties of the transactions;
  3. the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions;
  4. conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.

Rule 10C provides that the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction, and which provides the most reliable measure of an Armís Length Price in relation to the International Transaction.

Rule 10C provides that the most appropriate method shall be selected having regard to the following, namely:-

  1. the nature and class of the international transaction;
  2. the class or classes of Associated Enterprises entering into the transaction and the functions performed by them;
  3. the availability, coverage and reliability of data necessary for application of the method;
  4. the degree of comparability existing between the International Transaction and the uncontrolled transaction and between the enterprises entering into such transactions;
  5. the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the transactions being compared and the enterprises entering into such transactions;
  6. the nature, extent and reliability of assumptions required to be made in application of a method.

Determination of Armís Length Price by Tax Authorities (Section 92 C)

If during assessment proceedings, or appellate proceedings, the tax authorities on the basis of material or information or documents in their possession, are of the opinion that the Armís Length Price is not determined as provided under the Income-tax Act, the total income may be recomputed accordingly after giving tax-payer the opportunity of being heard. This will enable the assessing officer to make the addition of income or disallowance of expenses, but only if the transfer price arrived at by the assessee is more than 5% higher or lower than the transfer price arrived at by the assessing officer.

  • No deduction under section 10A/10B or under Chapter VI-A of the Income- tax Act will be allowed in respect of income by which the total income of the tax-payer is so enhanced.
  • It is further provided that when the total income of the Associated Enterprise is computed on the basis of Armís Length Price paid to another enterprise from which tax has been deducted under the provisions of Chapter XVIIB, the income of the other enterprise shall not be recomputed by reason of such determination of Armís Length Price in case of first mentioned enterprise.

Transfer Pricing Officer (Section 92CA)

Where any person being the assessee, has entered into an International Transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may with the previous approval of the Commissioner refer the computation of the armís length price in relation to the said international transaction under section 92C to the Transfer Pricing Officer.

Maintenance of Documents (Section 92D)

Any person entering into an international transaction is required to keep and maintain the information and documents prescribed for a period of eight years from the end of relevant assessment year.

Further, the person is required to keep the specified information and documents ready by:-

  • in the case of a Company, October 31 of the relevant assessment year;
  • in any other case, July 31 of the relevant assessment year.

The information and documents have to be submitted to the Assessing Officer/ Commissioner of Income-tax (Appeals) within 30 days of the receipt of notice from him.

The persons who are required to keep and maintain the information and documents can be divided into two categories:

  1. Those persons who have entered into international transactions the total value of which exceeds Rs. 1 Crore (Category 1).
  2. Those persons who have entered into international transactions the total value of which does not exceed Rs. 1 Crore (Category 2).

Primary Documents

Every person falling into Category 1 is required to keep and maintain the following information and documents, namely:-

Pertaining to the Assessee as a whole :

  1. A description of its ownership structure with details of shares or other ownership interest held therein by the enterprises with whom he has entered into an International transaction.
  2. A profile of the multinational group of which it is a part along with the name, address, legal status and country of tax residence of each of the enterprises comprised in the group with whom international transactions have been entered into by it, and ownership linkages with them.
  3. A broad description of the business of the assessee and the industry in which it operates and of the business of the Associated Enterprises with whom it has transacted.

Pertaining to the Transactions :

  1. The nature and terms (including prices) of International Transactions entered into with each Associated Enterprise, details of property transferred or services provided and the quantum and the value of each such transaction or class of such transactions.
  2. A description of the functions performed, risks assumed, and assets employed or to be employed by it and by the Associated Enterprises involved in the International Transaction.
  3. A record of the economic and market analysis, forecasts, budgets or any other financial estimates prepared by it for the business as a whole and for each division or product separately, which may have a bearing on the International Transactions entered into by it.
  4. A record of uncontrolled transactions taken into account for analysing their comparability with the International Transactions entered into, including a record of the nature, terms and conditions relating to any uncontrolled transactions with third parties which may be of relevance to the pricing of the International Transactions.
  5. A record of the analysis performed to evaluate comparability of uncontrolled transactions with the relevant International Transaction.
  6. A description of the methods considered for determining the Armís Length Price in relation to each International Transaction or class of transaction, the method selected as the most appropriate method along with explanations as to why such method was so selected, and how such method was applied in each case.
  7. A record of the actual working carried out for determining the Armís Length Price, including details of the comparable data and financial information used in applying the most appropriate method, and adjustments, if any which were made to account for differences between the international transactions and the comparable uncontrolled transactions, or between the enterprises entering into such transactions.
  8. The assumptions, policies and price negotiations, if any which have critically affected the determination of the Armís Length Price.
  9. Details of the adjustments, if any, made to transfer prices to align them with Armís Length Prices determined under these rules and consequent adjustment made to the total income for tax purposes.
  10. Any other information, data or document, including information or data relating to the Associated Enterprise which may be relevant for determination of the Armís Length Price.

Supporting Documents

The information specified above will have to be supported by authentic documents, which may include the following:

  1. Official publications, reports, studies and data bases from the government of the country of residence of the Associated Enterprise, or of any other country.
  2. Reports of market research studies carried out and technical publications brought out by institutions of national or international repute.
  3. Price publications including stock exchange and commodity market quotations.
  4. Published accounts and financial statements relating to the business affairs of the Associated Enterprises.
  5. Agreements and contracts entered into with Associated Enterprises or with unrelated enterprises in respect of transactions similar to the International Transactions.
  6. Letters and other correspondence documenting any terms negotiated between the assessee and the Associated Enterprise.
  7. Documents normally issued in connection with various transactions under the accounting practices followed.

Documentation by Every Person falling in Category 2.

No detailed information and documents, as stated above, have been prescribed for persons falling under Category 2. But they will be required to substantiate, on the basis of material available with them, that income arising from International Transactions entered into by him has been computed in accordance with the provisions of Section 92. It is advisable, therefore, to maintain as many records as possible as are prescribed for Category 1 as the burden of proof of justifying the Armís Length Price is on the assessee.

Separate Report from an Accountant (Section 92E)†

Every person who has entered into an International Transaction (as defined in the Section) in a previous year must submit a Report from the Accountant in the prescribed form. Rule 10E prescribes the Form No. 3CEB for the Report.

Due date for submission of Report is 31st October of the relevant assessment year in case of a company and 31st July of the assessment year in the case of other assessees.

The Accountant is required to:-

  1. Express an opinion on whether proper information and documents as prescribed have been maintained by the assessee.
  2. Certify that the particulars given in the annexure to Form 3CEB are true and correct. This annexure requires the assessee to list:
  • The Associated Enterpriseís with whom international transactions have been entered into and give a description of such transactions.
  • Particulars in respect of the international transactions and the method used in determining the ALP, with the amount as per books of accounts and the amount computed at ALP.

Penalties [Sections 271, 271AA , 271BA and 271G]

Section 271 provides that owing to transfer pricing adjustment if any amount is added or disallowed in computing the total income of the assessee under sub-section (4) of section 92C then such addition or disallowance would be deemed to represent the income in respect of which particulars have been concealed or inaccurate particulars have been furnished and it would attract penalty upto 300% of the amount of tax sought to be evaded. However, no penalty will be levied if the tax-payer is able to establish that he has computed the price charged in good faith and with due diligence.

Additional Penalties

Following additional penalties are also prescribed for non-compliance of various provisions:

  • Failure to maintain the prescribed information / documents would attract penalty @ 2% of the value of each international transaction. (Section 271AA).
  • Failure to furnish a report from an accountant would attract penalty of Rs. 100,000/-. (Section 271BA).
  • Failure to furnish information or document as required by the assessing officer would attract penalty @ 2% of the value of the international transaction for each such failure. (Section 271G).

Section 273B provides that penalties mentioned above shall not be imposed if the assessee proves that there was reasonable cause for the said failure.

Difficulty In Applying Armís Length Principle†

The Armís Length Principle has been recognized globally by all tax administrations. By separating tax considerations from economic decisions it promotes the growth of international trade and investment. However, practically there are certain difficulties in applying Armís Length Principle due to the following reasons:

  • Multinational Enterprises groups are dealing in the integrated production of highly specialised goods, in unique intangibles, and/or in the provision of specialised services.
  • Associated Enterprises may engage in transactions that independent enterprises would not undertake, example sale or license of intangibles.
  • Armís Length Price may result in an administrative burden for both the tax administrations of evaluating significant numbers and types of cross-border transactions. Also verification of such transactions takes place for some years at the time of assessment and therefore, it becomes all the more difficult to arrive at conditions prevailing at the time the transactions took place.
  • Far placed geographical locations and confidentiality etc. may cause difficulty in obtaining comparable data.

Based on the present status of legislation following emerges as the ĎDoís and Donítsí as far as Transfer Pricing is concerned:


  • Every person entering into an International Transaction shall do necessary documentation for such relationship e.g. Service/Transfer Pricing Agreement.
  • Choose one of the six prescribed methods being the most appropriate method, to compute arm lengthís price
  • Maintain information and documents in support of the method so adopted and as prescribed under the Transfer Pricing Rules
  • Prescribed information and documents must be kept and maintained for a period of 8 years from the end of relevant assessment year.
  • Submission of an Accountantís Report in Form No. 3CEB by 31st October of the relevant assessment year in case of a Company and 31st July in the case of other assessees.
  • Obtain services of Professionals duly qualified and well informed about the laws and procedures relating to Transfer pricing.


  • Concealment of a transaction, which may qualify as International Transaction.
  • Concealment of income by not conforming to the prescribed methods of computing Armís Length Price.
  • Failure to maintain proper records/information pertaining to actual working carried out for determining the Armís Length Price.
  • Supply/Servicing on Oral understanding.
  • Any adjustments/settlements which may be in variance of the Understanding documented as Service/Transfer Pricing Agreement.
  • Assignment of work connected with Transfer Pricing to un-qualified professional.


Actual resolution of legal issues depends upon many factors, including variations of fact and laws of the land. Though we have taken utmost care in the preparation of this Article, the information contained herein is not intended to constitute any legal advice and we cannot accept any responsibility towards those who rely solely on the contents of this booklet without taking further specialist advice. The reader should always consult with legal counsel before taking action on matters covered by this article. The editor welcomes any comments or suggestions that the readers of this Article may have.

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