Transfer Pricing

Transfer Pricing The Finance Bill, 2001 introduced Transfer Pricing Regulations by amending the provisions of section 92 of The Income Tax Act, 1961. The reason for introducing the Transfer Pricing legislation has been explained by the Memorandum explaining the provisions of Finance Bill, 2001 introduced by the Finance Minister. “The increasing participation of multinational groups in economic activities in the country has given rise to new and complex issues emerging from transactions entered into between two or more enterprises belonging to the same multinational group. The profits derived from by such enterprises carrying on business in India can be controlled by the multinational group, by manipulating the prices charged and paid in such intra group transactions, thereby leading to erosion of tax revenues”. With a view to provide statutory framework which can lead to computation of fair, reasonable and equitable tax and profits in India new provisions were introduced in the Income Tax Act with effect from financial year 2001-2002 i.e. Assessment year 20022003. These provisions relate to the computation of income from international transactions having regard to arm’s length price, keeping and maintaining of information and documents by persons entering into international transactions, furnishing of report from an accountant by persons entering into such transactions and definitions of certain expressions occurring in the said sections”. However before we go into discussion of these new provision it is essential to understand the old section 92 which will highlight the importance of new provisions both from assessee and Tax administrator point of view . Section 92 as it existed till 31st March, 2001 provided that if in the opinion of the assessing officer if the transaction between resident and non resident is so arranged that produces no profit or less profits than otherwise it might produce owing to the close connection, the assessing officer has the power to determine the profits that may have been reasonably derived. Rule 10 of the Income Tax Rules, 1962 as it existed till 31st March, 2001 provided that in determination of income to non resident in respect of any transaction that has arisen to non resident due to connection between the resident and non – resident. The assessing officer may calculate the profits on the following basis : a) At such percentage of the turnover as the assessing officer may consider it reasonable. b) On any amount which bears the same proportion to the total profits and gains of the business of such person, as the receipts accruing or arising bear to the total receipts of the business. c) In such manner as the assessing officer may deem suitable.

It emerges from the analysis of the above Rule 10 that assessing officer had the arbitrary powers to calculate the profits in case of international transactions. Several judicial decisions also supported the above arbitrary powers of the assessing officer. In the case of CIT vs Mewar Textiles Mills Lts. (70 ITR 458) it was decided by the court that it will not interfere if the assessing officer has made a fair estimate. Further in the case of Blue Star Engg. Co. (P) Ltd. V. CIT (73 ITR 283) (Bom) it was decided that even if the estimate is based on guesswork, court might not interfere if assessee has not placed material before justifying a more definite and certain apportionment. So in order to overcome arbitraniness in the provisions for computation of profits in case of international transactions new provisions were introduced which were already in existence in many countries. Most of countries in drafting their transfer pricing provisions have followed the OECD guidelines on transfer pricing & India has also followed to a large extent OECD guidelines. The provisions relating to Transfer Pricing Regulations are as follows : Section 92 92A 92B 92C 92E 92F

Provision of the Section Computation of Income from international transaction Definition of Associated Enterprise Definition of International Transaction Computation of income under Arm’s length method Furnishing of report by a chartered Accountant Definitions of Transactions, Arm’s length price etc.

Section 92 Section 92 is split into three parts. -

Section 92(1) provides that the computation of income in respect of international transaction shall be computed on the basis of an “ arm’s length principle”. Section 92(2) provides that allowance for any expense or interest shall also be determined having regard to arm’s length price. Section 92(3) provides that where in an international transaction two or more associated enter into a mutual agreement or arrangement for sharing of any cost then such cost shall be allocated or apportioned having regard to arm’s length price.

Section 92A