Tax Incidents Related to Transfer Pricing in India


Increasing participation of multi-national groups in economic activities in India has given rise to new and complex issues emerging from transactions entered into between two or more enterprises belonging to the same group. Hence, there was a need to introduce a uniform and internationally accepted mechanism of determining reasonable, fair and equitable profits and tax in India in the case of such multinational enterprises. Accordingly, the Finance Act, 2001 introduced law of transfer pricing in India through sections 92A to 92F of the Indian Income-tax Act, 1961 which guides computation of the transfer price and suggests detailed documentation procedures.

Transfer Pricing in India was introduced in 2001 for curbing tax avoidance by laying down norms for computation of income arising from international transactions or specified domestic transactions(“SDTs”) having regard to the “arm’s length price”. The Indian Transfer Pricing Regulations (TP Regulations) comprise Sections 92 to 92F of the Income-tax Act, 1961 (“the Act”) and Rules 10A to 10T of the Income Tax Rules, 1962 (‘the Rules’) which guides computation of the transfer price and suggests detailed documentation procedures.

The Finance Act, 2012 expanded the scope of TP regulations by insertion of a new section 92BA in the Indian Income tax Act, 1961 to include SDTs within its ambit. SDTs would include transactions entered into by domestic related parties, or by an undertaking with another undertaking of the same tax payer. In addition the Finance Act, 2012 also introduced Section 92CC and 92CD read with Rules 10F to 10T and 44GA to provide the Advance Pricing Agreement Regime in the Indian transfer pricing environment.




Commercial transactions between the different parts of the multinational groups may not be subject to the same market forces shaping relations between the two independent firms. One party transfers to another goods or services, for a price. That price is known as “transfer price”. This may be arbitrary and dictated, with no relation to cost and added value, diverge from the market forces. Transfer price is, thus, a price which represents the value of good; or services between independently operating units of an organisation. But, the expression “transfer pricing” generally refers to prices of transactions between associated enterprises which may take place under conditions differing from those taking place between independent enterprises. It refers to the value attached to transfers of goods, services and technology between related entities. It also refers to the value attached to transfers between unrelated parties which are controlled by a common entity.

Suppose a company A purchases goods for 100 rupees and sells it to its associated company B in another country for 200 rupees, who in turn sells in the open market for 400 rupees. Had A sold it direct, it would have made a profit of 300 rupees. But by routing it through B, it restricted it to 100 rupees, permitting B to appropriate the balance. The transaction between A and B is arranged and not governed by market forces. The profit of 200 rupees is, thereby, shifted to the country of B. The goods is transferred on a price (transfer price) which is arbitrary or dictated (200 hundred rupees), but not on the market price (400 rupees).

Thus, the effect of transfer pricing is that the parent company or a specific subsidiary tends to produce insufficient taxable income or excessive loss on a transaction. For instance, profits accruing to the parent can be increased by setting high transfer prices to siphon profits from subsidiaries domiciled in high tax countries, and low transfer prices to move profits to subsidiaries located in low tax jurisdiction. As an example of this, a group which manufacture products in a high tax countries may decide to sell them at a low profit to its affiliate sales company based in a tax haven country. That company would in turn sell the product at an arm’s length price and the resulting (inflated) profit would be subject to little or no tax in that country. The result is revenue loss and also a drain on foreign exchange reserves[1]

Transfer Pricing Regulations (“TPR”) are applicable to the all enterprises that enter into an

‘International Transaction’ with an ‘Associated Enterprise’. Therefore, generally it applies to all cross border transactions entered into between associated enterprises. It even applies to transactions involving a mere book entry having no apparent financial impact. The aim is to arrive at the comparable price as available to any unrelated party in open market conditions and is known as the Arm’s Length Price (‘ALP’).

The basic criterion to determine an AE is the participation in management, control or capital (ownership) of one enterprise by another enterprise. The participation may be direct or indirect or through one or more intermediaries. The concept of control adopted in the legislation extends not only to control through holding shares or voting power or the power to appoint the management of an enterprise, but also

through debt, blood relationships, and control over various components of the business

activity performed by the taxpayer such as control over raw materials, sales and intangibles. It appears that one may go to any layer of management, control or ownership in order to find out association

(a) Direct Control

(b) Through Intermediary

An international transaction is essentially a cross border transaction between AEs in any sort of property, whether tangible or intangible, or in the provision of services, lending of money etc. At least one of the parties to the transaction must be a non-resident entering into one or more of the following transactions

(a) Purchase, sale or lease of Tangible or Intangible Property

(b) Provision of services

(c) Lending or borrowing of money

(d) Any transaction having a bearing on profits, income, losses or assets

(e) Mutual agreement between AEs for allocation/apportionment of any cost, contribution or expense.[2]

Transfer Pricing and Taxation

Since tax rates and structure are not same for all countries the world over, hence, transfer prices are also set in line with the different tax structures of different countries. According to Kumar (2006, p.59) there are high tax countries like US and the low tax countries such as Cayman Island. As a result, MNCs may use transfer pricing to shift cost to high tax countries and shift revenue to low tax countries.

Moreover, with the growing number of international corporations for doing business globally, the pricing of tangible and intangibles for cross-border transactions among the associated parties is becoming more and more complex and critical. And here the tax avoidance has gained much prominence amongst the many foreign controlled firms. Evidences, even in the country like USA suggest that the foreign controlled domestic firms have reported lower profits than the US controlled counterpart firms (Crains and Stiff, 1994; Kim and Lyn, 1990). According to Karen and Shearon (1996, p.420) transfer pricing manipulation is not the only explanation for lower tax liabilities, it does present a compelling rationale. More importantly the potential to manipulate lower tax labiality suggest that the outcome of transfer pricing policy may indeed be more interesting than the mechanism. Implication of taxation thus now plays more important and detrimental role than ever before in deciding where to locate manufacturing, distribution or research facilities as also to hold the intellectual property. At the same time, taxation authorities, realizing the potential leakage of revenues to national exchequer through the transfer pricing mechanism, are becoming more vigilant in enforcing the transfer pricing regulations in today’s globally inter-linked economies. According to Ernst & Young’s biannual research survey (2005-06), tax authorities around the world have become better informed and prepared than ever before, and they are also under more pressure to deliver revenue ‘gains’ from their anti-tax-avoidance efforts.



In the case of international technology transfers, foreign investments by MNCs, joint ventures with foreign entities, etc. sale of tangibles, and intangibles and supplying of services amongst the related parties are the general modes for transfer pricing abuses. And for that most important provision in the Indian Tax Law is known as section 92 of the Income Tax Act, 1961. Effective from April 1, 2001 India introduced a comprehensive transfer pricing legislation under this Income Tax Act of 1961. The section 92 has been replaced by section 92 to section 92F through the Finance Act, 2001. Under the various provisions of this law, if owing to a close relation between an Indian party and foreign party, the taxation authority feels that the prices charged in a transaction are not at an arm’s length, then they can adjust the taxable income of Indian party. Though this section provides the provisions for preventing abuses of transfer pricing, they are not very effective and found to be insufficient for the purpose. However, the section 92 has now been substituted by new sections viz. 92, 92A, 92B, 92C, 92D, 92D, 92E, and 92F and the new provisions have become operative with effect from April 1, 2002 and they address the following issues:

  • Section 92 pertains to the computation of income arising out of international transactions by considering the arm’s length price.
  • Section 92 A defines the expression of “associated enterprise.”
  • Section 92 B defines the expression of “international transaction.”
  • Section 92 C explains the methods for determining the arm’s length prices pertaining to the international transactions.
  • Section 92 D is related to maintenance, preservation of information and documents by the parties entering into the international transactions.
  • Section 92 E deals with requirement for getting the concerned parties a report from an accountant and
  • Section 92 F defines various expressions which have been used in the aforesaid sections.

In addition, penalties have also been provided for abuse of transfer pricing or not complying with requirements as prescribed in the various sections and for that purpose Sections 271AA, 271BA and 271G have been included.

 The major improvement of the new regime over the earlier one is that the onus is now on the resident assessee to keep his record straight. He cannot now smugly go through with his transactions with a non-resident associated enterprise in the hope that he may not after all be caught. While the new regime is definite improvement over the earlier one, it has the potential of harassment for the Indian resident. If it enters into any transaction with an associate enterprise which happens to be a non-resident, he must ensure that the transaction is at arm’s length. The arm’s length price in relation to an international transaction is to be determined by using one of the six methods – comparable uncontrolled price method; resale price method; cost plus method; profit split method; transactional net margin method; (this is broadly aligned to the comparable profits method prescribed in the US transfer pricing regulations); and such other methods as may be prescribed by the (CBDT) Central Board of Direct Taxation (Mehta, 2001). Industry (CII, 2001), however, has suggested that the method to be adopted for determining the arm’s length price should be left to the assessee and recommended that the ideal method would be to allow the assessee a price band within which the international transaction should remain instead of a single price. Similarly, Institute of Chartered Accountants of India (ICAI) has also recommended that the world wide practice of allowing the tax payer to choose the appropriate transfer pricing method for determining the arm’s length price depending upon the facts and circumstances of the case be adopted by the tax authorities (Business Line, 2001).

As per the legislation the administrative framework for assessment of taxpayers has been constructed on the following lines (Ernst & Young, 2005):

  • Transfer Pricing Units have been set up in the principal jurisdictions of Mumbai, Delhi, Kolkata, Chennai and Bangalore.
  • Specialist Transfer Pricing Officers (TPOs) have been appointed. TPOs will serve as experts to the mainstream assessing officers on transfer pricing assessments.

To simplify the complex transfer pricing rules, and reduce administrative and compliance costs, recently it has been decided to lift the threshold limit to Rs. 15 crore (Rs 150 million) in aggregate for compulsory scrutiny of international transactions between associated enterprises. However, Indian regulations have not yet included the provisions for advance pricing arrangement mechanism.[3]

Key features of the TP Regulations

  • every person who has undertaken an international transaction with an associated enterprise shall maintain information and contemporaneous documentation as prescribed under the Rules
  • every person who has entered into an international transaction during a previous year shall obtain an Accountant’s Report and furnish such report on or before the filing of the income tax return which is 30th November following the end of the financial year.
  • stringent penalties have been prescribed for non-adherence to the TP Regulations[4]



While the decision dealt with a fact situation of investments made by an Indian company outside India, the essential arguments successfully employed by the taxpayer are more wide-ranging in application, and would also be relevant in the context of investments made into India.

Firstly, there is the issue of transfer pricing provisions being attracted only when the transaction results in chargeable income, a position that the Tribunal appears to have accepted although the reasoning has not been elaborately discussed in the order. Support for this position can be found in the language of section 92B, which defines an “international transaction” to mean “a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises…”.

Under section 92 which specifies arm’s length price requirements, transfer pricing provisions are only applicable to international transactions falling within the definition under section 92B. In its ruling in Dana, the Authority for Advance Rulings had stated that section 92 is not an independent charging provision, and that transfer pricing provisions do not bring about a charge of tax where none otherwise existed[5]. However, advance rulings are only binding on the parties involved and therefore we may place limited reliance on Dana. Further, there are conflicting decisions[6] on this issue which imply that chargeable income is not in fact a pre-requisite for transfer pricing to apply. Such a position may be on the basis that the “bearing on the profits” under the residuary part of section 92B is not specifically applied to the previous transactions such as purchase, sale, lease etc. However, such an interpretation ignores the fact that the term “any other” transaction would imply that all of the previous arrangements would have to have an impact on the profits in order to be considered “international transactions”. This approach is also contrary to the spirit of transfer pricing provisions as a protection against base erosion.

This brings us to the second and related issue: where capital investments could be said to fall within the framework contained in section 92B, if they do not fall within the residuary catchall provision. Under section 92B, an “international transaction” is defined to mean “a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises…”. Further, the Explanation introduced to section 92B in 2012 (with retrospective effect from 2002) contains an inclusive definition of “international transaction” which includes “capital financing… including … purchase or sale of marketable securities…”.

An “issuance” of shares is distinct from the “purchase” of shares. The conceptual distinction between the two was noted by the English Court of Appeal when it said “[T]he word ‘purchase’ cannot with propriety be applied to the legal transaction under which a person by the machinery of application and allotment, becomes a share holder in the company. He does not purchase anything when he does that… the difference between the issue of a share to a subscriber and the purchase of a share from an existing shareholder is the difference between the creation and the transfer of a chose in action. The two legal transactions of the creation of a chose in action and the purchase of a chose in action are quite different in conception and in result…”[7] This principle has been applied by the Supreme Court of India also.[8] A “purchase” requires an asset to first be in existence. In the case of an allotment, as held by the Supreme Court in Jalan’s case, there shares do not exist at all until they are allotted. Therefore, a share subscription may not be considered a “purchase”.

Although the term “capital financing” is wide enough to include share subscription as well, the transactions contemplated in the provision, including borrowing, lending, guarantee, purchase, sale, or any type of advance, payment or deferred payment or debt arising during the course of business, appear to be applicable to funding transactions capable of having a “bearing on profits” as required by section 92B rather than a capital subscription. We would also need to consider the impact of clause (e) of the Explanation which states that: an ‘international transaction’ includes”… a transaction of business restructuring… irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date…”. In the absence of a specific carve-out relating to the bearing on profits, it may be stated that a capital financing transaction would need to have a bearing on profits to be considered an international transaction within section 92B(1).

Therefore, it is unclear how a subscription to shares could be brought within the purview of the transfer pricing provisions under the current regime of the Act.


Laws relating to transfer pricing are relatively new in India. In fact inclusion of such laws in income tax Act reveals maturity of Indian economy and is another step towards the integration process of globalization. It is, however, necessary that the implementation of such provisions is done fairly and if penalties are to be levied these should be directed to reduce the abuse of transfer pricing rather than the revenues generating sources. In the past, due to the lack of these laws there have been many cases of abuse of transfer pricing and in many cases prices were exorbitant or very high. The new rules that have now come into existence in 2001 are definitely a welcome step in this direction and will check the abuse of transfer pricing by MNCs.

[1] (Last accessed on 23rd August,2013)

[2] (Last accessed on 23rd August,2013)

[3] (Last accessed on 23rd August,2013)

[4] (Last accessed on 23rd August,2013)

[5] However, contrary views have also been taken. For example, notional interest on interest-free loans has been held to be chargeable in India, by using transfer pricing provisions: see Perot Systems v. DCIT ITA 2320/De/2008. It could be argued that taxing of interest-free loans is only a matter of quantification of the appropriate price of the loan, and not a new charge of tax as such, and these decisions do not affect the general principle that transfer pricing provisions do not create a new charge where none existed before.

[6] For example, see the Ruling of the Authority for Advance Rulings in Re Castleton Investment, AAR 999 of 2010. This can be contrasted with the Ruling in Re Praxair, 326 ITR 276 (AAR).

[7] I Re V.G.M. Holdings [1942] 1 All ER 224.

[8] Sri Gopal Jalan v. Calcutta Stock Exchange AIR 1964 SC 250


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