Transfer Pricing 2024 Comparisons

Indian transfer pricing (TP) regulations are contained in Chapter X (Sections 92 to 92F) of the Income Tax Act, 1961, under the title “Special provisions relating to avoidance of tax”. These regulations are required to be read with Rules 10A to 10THD of the Indian Income Tax Rules, 1962. In addition to this, the Indian government regularly issues circulars, instructions and notifications in order to streamline, update, clarify and/or operationalise the TP provisions. 

The TP regulations were introduced in India in 2001 to prevent erosion of the country’s tax base. While the provisions were initially made applicable to “international transactions” only, in 2012 the scope of the provisions was expanded to also include a certain category of “specified domestic transactions”. Over the past two decades, the regulations have evolved in response to various global and local developments. This primarily includes the following key changes:

• the setting-up of the Dispute Resolution Panel (DRP) in 2009, with the intention to provide an alternative dispute resolution mechanism, which could facilitate expeditious resolution of TP disputes;
• the introduction of the Indian advance pricing agreement (APA) programme in 2012 and the safe harbour rules in 2013, with the intention of reducing TP litigation in India and providing certainty to taxpayers;
• the use of multiple years’ data and the range concept in benchmarking analysis permitted in 2014 to align Indian TP regulations with global practices;
• the introduction of a three-tier TP documentation structure in 2016 to align Indian TP documentation requirements with the OECD’s recommendation in BEPS Action Plan 13; and
• the introduction of secondary adjustment provisions and limiting interest deduction for thinly capitalised companies in 2017. 

The Indian TP regulations recognise the “arm’s length principle” and require income from an international transaction/specified domestic transaction between associated enterprises to be computed having regard to the arm’s length price. The Indian TP regulations lay down detailed definitions of the terms “associated enterprises”, “international transactions” and “specified domestic transactions”, respectively. Below is a high-level overview of these terms.

Associated Enterprises (AEs)

Broadly speaking, two enterprises are considered as AEs if either:

• one party (directly or indirectly) participates in the management, control or capital of the other party; or
• a common party (or parties) participates in the management, control or capital of both enterprises.

For the purpose of this definition, the law lays down 13 specific instances where the above-mentioned conditions are deemed to be satisfied. These include direct or indirect holding of shares carrying more than 26% of the voting power.

International Transaction

This primarily refers to a transaction between two (or more) AEs involving:

• purchase, sale or lease of tangible or intangible property;
• provision of services;
• lending/borrowing of money;
• cost-sharing arrangements; or
• any other transaction having a bearing on the profits, income, losses or assets of such AEs, provided one of the parties is a non-resident for tax purposes in India. 

However, the Indian TP regulations also extend to certain transactions undertaken by a taxpayer with domestic or overseas third parties, where there is a prior agreement in relation to said transaction between such third party and the taxpayer’s AE, or where the terms of said transaction are determined in substance between such third party and the taxpayer’s AE.

Specified Domestic Transactions

The following categories of domestic transactions are also covered within the ambit of Indian TP regulations, provided their aggregate value exceeds INR200 million:

• the transfer of goods or services between different sub-units of an entity claiming or eligible to claim a tax holiday under specified sections of the Indian Income Tax Act, 1961; or
• any business transacted between an entity claiming a tax holiday or concession under specified sections of the Indian Income Tax Act, 1961, and a closely connected person.

The term “closely connected person” has not been defined under the Indian TP regulations, and is therefore generally given a very wide interpretation by taxpayers and tax authorities alike.

The Indian TP regulations adopt the concept of “most appropriate method” for computation of the arm’s length price. For this purpose, a taxpayer may use any of the following six methods, according to which is the most appropriate:

• comparable uncontrolled price (CUP) method;
• resale price method (RPM);
• cost-plus method (CPM);
• profit split method (PSM);
• transactional net margin method (TNMM); and
• such other method as may be prescribed by the Central Board of Direct Taxes.

The “other method” or “sixth method” allows the use of any methodology that takes into account the price that has been charged or paid, or that would have been charged or paid, for the same or a similar uncontrolled transaction between third parties. This allows taxpayers to explore the use of various data points, such as quotations, valuation reports, standard rate cards, etc, for the purpose of an arm’s length analysis.

The Indian TP regulations require taxpayers to compute the arm’s length price using any of the six prescribed TP methods (see 3.1 Transfer Pricing Methods). However, generally speaking, the other method prescribed under the law acts as a “residuary method”, which allows taxpayers some flexibility for using data around prices that would have been charged between third parties under a comparable scenario for the arm’s length exercise. 

Indian TP law does not provide any preference or hierarchy within the prescribed methods. The “most appropriate method” acts as the general rule for computing the arm’s length price. However, taxpayers are required to document appropriate reasons for selecting a method as the most appropriate method, as well as their reasons for rejecting the other methods.

The arm’s length range concept was introduced in India in 2014. Indian TP law adopted the 35th to 65th percentile as the arm’s length range. Where the transaction price falls outside the prescribed range, the median of the data set is considered as the arm’s length price. However, a taxpayer can use the benefit of range only when:

• the arm’s length price is computed using the CUP method, the TNMM, the RPM or the CPM; and
• the data set comprises six or more comparable entries.

Furthermore, detailed provisions are prescribed for the manner of computing the above range, and such range should not be computed using simple Excel-based formulas. 

Where the above-mentioned conditions are not met, the arm’s length price is computed in the following manner:

• the arithmetic mean is considered as the arm’s length price (where there is more than one comparable data point); and
• where the arithmetic mean is used, a tolerance band of 3% (1% for wholesale traders) from the actual transaction price is available to the taxpayer. 

The Indian TP regulations require a suitable adjustment for any differences, including functional and other differences, between the related party transaction and the comparable uncontrolled transaction(s), or between the enterprises entering into such transactions, which could materially affect the price/margin in the open market.

The TP provisions applicable to other related party transactions in general are equally applicable to the transactions involving intangibles. There are no specific provisions under the Indian TP regulations in respect of intangibles. However, the definition of the term “international transaction” includes a specific reference to “intangible property”. 

Furthermore, an inclusive definition of the term “intangible property” has also been laid down under the Indian TP regulations, which is quite extensive and covers various types of assets/rights within its ambit, such as:

• marketing intangibles (eg, trade marks, logos, etc);
• technology intangibles (eg, patents, technical know-how, etc);
• artistic-related intangibles (eg, literary works and copyrights, musical compositions, etc); and
• customer-related intangibles (eg, customer lists/relationships, customer contracts, etc). 

The Indian TP regulations do not recognise the concept of hard-to-value intangibles. However, practically, Indian tax authorities may challenge the valuation of an intangible based on future forecasts, wherein the actual results vary from such forecasted values.

The Indian TP regulations are applicable to mutual agreements or arrangements between associated enterprises, including cost-sharing/cost-contribution arrangements. However, the Indian TP regulations do not contain any detailed provisions or lay down any specific guidance for analysing such arrangements.

Taxpayers have an option to offer suo moto adjustments in their return of income, where they believe their controlled (related party) transactions are not at arm’s length. Such adjustments should also be disclosed in the accountant’s report (Form No 3CEB) – ie, the certificate required to be furnished annually in respect of such related party transactions. It is also important to analyse the applicability of secondary adjustment provisions while offering such suo moto adjustments.

Taxpayers may still have an option to revise these documents after filing them. While legally there is no provision for revision of the accountant’s report (Form No 3CEB) in India, experience has shown that taxpayers are able to submit such revision request online. 

Furthermore, a return of income may be revised, should the taxpayer discover any omission or wrong statement therein, more than three months prior to the end of the relevant assessment year (“assessment year” refers to the 12-month period starting from April 1st after the close of the relevant financial year on March 31st) or before the completion of the audit by the tax authorities, whichever is earlier.

Further, a person may furnish an updated return of income with effect from 1 April 2022 for the relevant assessment year at any time within 24 months from the end of the relevant assessment year (subject to fulfilment of certain prescribed conditions).

India has entered into agreements with various jurisdictions to:

• avoid double taxation;
• grant relief from double taxation;
• exchange information to prevent tax evasion/avoidance (or investigation of such cases); and
• co-operate with each other in the recovery of taxes.

Thus, India has a strong tax treaty network that includes double-tax avoidance agreements (DTAAs) with around 104 countries (a comprehensive agreement with 96 countries/territories and a limited agreement with eight jurisdictions) and tax information exchange agreements with 23 countries/territories.

The advance pricing agreement (APA) programme was introduced in India in 2012. A taxpayer can opt for a unilateral, bilateral or multilateral APA, and this can provide TP certainty to taxpayers for five prospective years with a roll-back option for four previous years. Thus, an APA can provide certainty for a total of nine years using the roll-back option. 

The Indian APA programme is administered by the Central Board of Direct Taxes (CBDT) with the help of a specialised and designated team constituted for this purpose. This team consists of income tax authorities as identified by the CBDT and may include nominated experts in economics, statistics, law or any other field.

The Indian APA regime allows taxpayers to opt for a unilateral, bilateral or multilateral APA. In respect of a bilateral or multilateral APA, the competent authorities of the countries involved (including India) are required to first reach an arrangement through a mutual agreement procedure (MAP). This arrangement must be accepted by the taxpayer before a bilateral or multilateral APA can be entered into. 

Any taxpayer who has undertaken an international transaction or is contemplating undertaking an international transaction is eligible to file for an APA. An APA can be applied to any category of international transaction. While there is no limit on the value of international transactions that may be covered under an APA, the expected aggregate value of such international transactions can affect the total statutory fee payable to the Indian government for applying such an APA. However, an APA cannot be applied for specified domestic transactions. 

In the case of an international transaction that is of a continuing nature, the APA application must be filed before the beginning of the first financial year out of the future years proposed to be covered under the APA. For example – if the APA application seeks to cover five years starting from financial year (FY) 2024–25 to FY 2028–29, the application must be filed before 1 April 2024. 

However, for an international transaction proposed to be entered for the first time, the application may be made at any time before actually undertaking such a transaction. For example – if the taxpayer is proposing to provide certain services for the first time to its foreign associated enterprise from 1 July 2024, the APA application in respect of such a transaction can be filed before 1 July 2024 and the time limit of 1 April 2024 will not apply here. 

Taxpayers are required to pay a statutory fee before making any APA application. Such fee varies from INR1 million to INR2 million, depending on the likely aggregate value of international transactions expected to be entered into during the period proposed to be covered under the APA.

Furthermore, an additional fee of INR500,000 is required to be paid by taxpayers opting for a roll-back.

The Indian APA programme seeks to provide certainty to taxpayers for five prospective years. The law also offers a roll-back option for the previous four years, subject to certain conditions. Thus, in India, an APA can give certainty for a total of nine years with roll-back, and five years without roll-back.

As discussed in 7.1 Programmes Allowing for Rulings Regarding Transfer Pricing, subject to a few conditions, the roll-back option is available in India to cover the previous four years under the APA.

Taxpayers in India are subject to the following key annual compliance requirements in respect of their related party transactions. 

• The accountant’s report in Form 3CEB is mandatorily required to be electronically filed by every person who has entered into international transactions (including deemed international transactions) or specified domestic transactions on or before 31 October 2024. Form 3CEB contains a brief summary of international transaction(s) and/or specified domestic transactions, along with the method used to justify the arm’s length nature of such transactions. This report is required to be certified by a chartered accountant.
• TP documentation or a local file is required to be prepared and kept ready on record on or before the above due date. For international transactions (including deemed international transactions), such documentation is required if the aggregate value of the transactions entered during a year exceeds INR10 million. 

TP documentation or a TP study is a detailed contemporaneous document maintained by the taxpayer to justify the arm’s length pricing of transactions, which should include various prescribed particulars such as:

• a business overview of the group, associated enterprises and the taxpayer;
• an overview of the industry/market in which the taxpayer operates;
• functional, asset and risk analysis;
• reasons for selection/rejection of a method;
• economic analysis; and
• other prescribed particulars/documents. 

Nevertheless, even if the value of international transactions is less than INR10 million, the taxpayer will have to maintain basic documentation to demonstrate the arm’s length nature of such transactions. 

Apart from the above, India also has provisions pertaining to master file and country-by-country reporting (CbCR). 

The Indian TP regulations lay down specific penalties to ensure adherence to the above compliance requirements. Failure to furnish Form 3CEB on or before the due date can attract a penalty of INR100,000. 

Furthermore, Indian TP law prescribes onerous penalties equivalent to 2% of the value of the transaction, which may be levied in the event of:

• failure to keep the TP documentation ready on or before the due date; 
• failure to report any international or specified domestic transaction;
• maintaining/furnishing incorrect information or an incorrect document; or
• failure to furnish the TP documentation on request to tax authorities within the permitted time period.

The law also provides for penalties in respect of non-compliances pertaining to the master file and CbCR. Failure to file the master file may attract a penalty of INR500,000. On the other hand, the law prescribes penalties in the range of INR5,000 to INR50,000 per day for non-compliances relating to CbCR, depending on the number of days over which such non-compliances continue. Providing inaccurate information pertaining to CbCR may attract an additional penalty of INR500,000.

Separately, other administrative penalties provided under Indian tax law, including penal interest, may also be levied in the event of TP scrutiny/adjustments.

Taxpayers may safeguard themselves from some penal provisions in the case of any failure to comply with the provisions of tax laws, provided they are able to demonstrate the existence of a “reasonable cause” for such failure. Completing timely and transparent tax filings, the availability of robust documentation to support their position and opinions, and co-operation with the tax authorities during the course of audits are a few factors that may help the taxpayer in establishing such reasonable cause when any penalties are assessed. Taxpayers may alternatively choose an appeal before the appellate authorities against an order imposing such penalty.

The Indian TP regulations are largely modelled on the TP principles laid down under the OECD TP Guidelines, including TP documentation requirements. Indian TP regulations have always required taxpayers to prepare TP documentation or perform a TP study annually to substantiate the arm’s length nature of their international/specified domestic transactions. However, in 2016, keeping up with the country’s commitment to the OECD’s BEPS action plans, the Indian government introduced the concept of three-tier TP documentation in India and re-aligned TP documentation requirements in India with the OECD’s recommended structure. As a result of this change, taxpayers who are part of a multinational group (MNE or “MNE Group”), are required to comply with the following requirements.

Local File

The local file refers to the annual TP documentation discussed earlier. The TP documentation is required to be contemporaneous and should be maintained on an annual basis. This is not a new reporting requirement and, conceptually, it has always been part of the Indian TP regulations.

Master File

The master file is a new reporting requirement, which was introduced in India in 2016 pursuant to the OECD’s BEPS action plans. It is required to be electronically filed in Form No 3CEAA (Part A and Part B) where the value of international transactions during the relevant accounting year exceeds INR500 million (INR100 million in the case of intangible related transactions) and where the consolidated group turnover exceeds INR5 billion. However, Part A of the master file (Form 3CEAA) is required to be filed even if the above thresholds are not met. Where there is more than one constituent entity that may or may not be resident in India, one of these entities may be designated to complete such filing.

CbCR

CbCR is also a relatively new reporting requirement, introduced in India in 2016. CbCR is required to be electronically filed by the ultimate parent entity (UPE) of an MNE group that is resident in India, having an annual consolidated group revenue in the immediately preceding accounting year of more than INR64 billion. The statutory due date for e-filing is 12 months from the end of the reporting accounting year of the UPE. The UPE can designate another group entity as an alternative reporting entity for the purposes of filing CbCR. 

Where the UPE is outside India, in a country with which India has an agreement for the exchange of CbCR-related information, the Indian constituent entity is obliged to file a notification specifying the details of the group entity filing such CbCR. Such notification must be filed at least two months before the due date of the CbCR filing. 

Local filing of the entire CbCR may also be required if:

• the UPE is a resident of a country with whom India does not have an agreement for the exchange of CbCR;
• the UPE is not obliged to file CbCR in its jurisdiction; or
• there has been a systematic failure on the part of the UPE’s jurisdiction to share information and such failure has been intimated to the Indian entity.

India is not a member of the Organisation for Economic Co-operation and Development (OECD). The Indian TP regulations do not make any specific mention or reference to the OECD TP Guidelines. However, the TP legislation in India is in line with the OECD TP Guidelines (with certain modifications), including the broad structure of the three-tier TP documentation, comparability analysis, TP methods, etc.

Both taxpayers and the tax authorities have placed their reliance on the OECD TP Guidelines, especially in cases where guidance is not available under domestic legislation. Similarly, the OECD TP Guidelines are often referred to/relied upon in judicial rulings in India.

The Indian TP regulations require that income (or expense) resulting from a controlled transaction should be computed having regard to the arm’s length price. 

India is a key partner country that actively participates in various committees, workshops and working groups of the OECD. The OECD and India have enhanced their co-operation in dealing with issues related to TP and to promoting better tax compliance in order to help prevent cross-border disputes. As part of the G-20 Group, India has played an active role in the OECD’s project for prevention of Base Erosion and Profit Shifting (BEPS) and is committed to the outcomes of the BEPS project.

Pursuant to the BEPS action plans, India has introduced various changes in its domestic TP regulations, including:

• the introduction of three-tier TP documentation in 2016 in response to the BEPS Action Plan 13;
• publication of detailed guidance on MAPs in August 2020 (which was also updated in June 2022), in order to implement the recommendations of BEPS Action Plan 14 on “Making Dispute Resolution More Effective” (the guidance provides that the Indian competent authorities will endeavour to – note, not commit to – resolve disputes under the MAP route within 24 months); and
• the introduction of interest limitation rules in 2017 in order to deal with the thin capitalisation challenges highlighted in BEPS Action Plan 4. 

BEPS Action Plan 1 sought to address the tax challenges of a digital economy. It recommended some interim options that could be adopted until global consensus is reached. The options were:

• introducing a new nexus rule – significant economic presence (SEP);
• withholding tax on certain types of digital transactions; and
• an equalisation levy (EL). 

Thereafter, India introduced the EL vide Finance Act, 2016, and the SEP provisions vide Finance Act, 2018, as interim measures in response to various tax challenges posed by the digital economy.

The EL is 6% on consideration received for online advertising, provision of digital advertising space or facilities/service for the purposes of online advertisements. EL 2.0 was introduced in the Finance Act, 2020. EL 2.0 is 2% on non-resident e-commerce operators for the online supply of goods or provision of services.

SEP provisions are included in the definition of “business connection”, thereby providing taxing rights to India in respect of digital businesses that operate in India without creating any physical presence in India, which has historically been a key requirement for creating a “permanent establishment” in India. 

It is expected that once a consensus-based solution is reached at the global level on Pillar 1, India will withdraw its digital service tax and other similar measures. 

India is an active participant in the BEPS 2.0 initiative (Two-Pillar Solution) and is in favour of a consensus-based solution that would allocate appropriate revenue to market jurisdictions.

With respect to Pillar 2, India’s endeavour has been to phase out exemptions/deductions. It is expected that the effective tax rate (ETR) will be higher than the agreed global minimum tax rate of 15% since the corporate tax rate in India is generally higher than 15%.

The Indian TP regulations do not contain any specific provision permitting – or restricting – an entity in terms of bearing the risk of another entity’s operations by guaranteeing the other entity a return. Practically, limited-risk structures are quite prevalent in India and are often used by MNEs in their overall structure. For this, Indian taxpayers generally place reliance on the overall TP principles provided under the Indian regulations, as well as the OECD TP Guidelines, to determine a suitable business/pricing model for their intra-group transactions based on the detailed review of the functional, asset and risk profile of the parties involved. Furthermore, the arm’s length standard is to be followed while deciding remuneration for any entity, including for a limited risk entity. 

Experience has also shown that where an MNE group headquartered in India has a limited risk entity overseas, Indian tax authorities may question whether such foreign entity is, in fact, bearing its own risks, and therefore whether it should be entitled to an assured return for its activities. This issue gains more prominence in cases where an Indian entity is not deriving or earning a commensurate value from overseas operations, while continuing to bear the costs and risks of such overseas entity. Furthermore, in terms of comparability analysis for such limited risk structures, the Indian tax authorities may challenge the use of an overseas entity as the tested party, especially in the absence of reliable financial information for foreign comparable companies. 

The UN Practical Manual on Transfer Pricing is not specifically referred to in the Indian TP regulations. However, India is an active contributor to the UN Practical Manual and has contributed an entire chapter to the manual on TP practices and challenges in India. 

Furthermore, taxpayers and tax authorities in India often rely on the UN Practical Manual for guidance on relevant matters. Similarly, reference to the UN TP manual can also be found in judicial rulings in India.

Indian safe harbour provisions provide circumstances in which the income tax authorities will accept the transfer price declared by the taxpayer, in respect of its eligible international transactions, without conducting in-depth scrutiny of the declared transfer price. Safe harbour rules were first made applicable in India in FY 2012–13. These rules were then revamped and revised in 2017 to make the prescribed margins/prices more reasonable.

The CBDT recently notified changes to these rules (in December 2023) effective from FY 2023–24 onwards. These changes primarily pertain to:

• the international transaction of outbound intra-group loans, wherein amendments have been made to the definition of the term “intra-group loan”, resulting in expansion of the scope of the intra-group loans covered under safe harbour rules;
• introduction of different reference rates to be used for foreign currency denominated loans in view of the phasing out of LIBOR; and
• changes in credit ratings to be used for deciding interest spread along with the arm’s length interest rate to be used for intra-group loans.

Further, minor changes were also made to the definitions of the terms “operating expense” and “operating revenue” as used in the context of other international transactions.

The safe harbour rules were last notified (on 9 August 2023) for FY 2022–23 and are applicable to the following transactions: 

• the provision of software development and/or IT-enabled services;
• the provision of knowledge process outsourcing services;
• contract R&D services relating to software development and generic pharmaceutical drugs; 
• the manufacture and exportation of core auto components; 
• the manufacture and exportation of non-core auto components; 
• providing a corporate guarantee; 
• providing an intra-group loan (these have since undergone changes as described above); and 
• receipt of low-value adding intra-group services.

Safe harbour rules are yet to be notified for FY 2023–24 and subsequent years.

Apart from the above, India also introduced limited safe harbour provisions for certain categories of specified domestic transactions.

There are no specific rules in the Indian TP regulations governing allocation of the benefit of location savings/advantages between associated enterprises. However, India as a country offers various location-linked cost savings due to the availability of lower cost skilled and unskilled labour, lower rental costs, etc, and offers other advantages such as access to a large market and a wide customer base.

Therefore, the concept of “location savings” may be one of the aspects analysed by Indian tax authorities during the course of TP audits. Where good quality local comparable companies/transactions are available for the arm’s length analysis, which have access to similar location advantages, one may conclude that the benefits of such location savings/advantages are captured in the arm’s length price itself.

The following is a summary of some key trends, rules and practices witnessed in the Indian TP landscape since the inception of the TP regulations in India in 2001.

Annual TP Documentation Requirement

In India, taxpayers are required to prepare contemporaneous TP documentation or a local file on an annual basis. The underlying economic analysis (or benchmarking analysis) also needs to be performed every year. 

Domestic TP Provisions

Certain domestic transactions are also subject to TP provisions in India, provided their aggregate value exceeds INR200 million. This primarily includes:

• the transfer of goods or services between units of an entity claiming or eligible to claim a tax holiday under Indian tax laws; or
• any business transacted between an entity claiming a tax holiday or concession under specified sections of Indian tax laws and a closely connected person. 

Use of the Sixth Method or Residual Method for Arm’s Length Analysis

The Indian TP regulations prescribe a sixth method, namely “the other method”, for arm’s length analysis. This is a residual method that allows the use of any reasonable approach for computing the arm’s length price, provided it reflects the price that has been charged or paid, or that would have been charged or paid, for the same or a similar uncontrolled transaction between third parties. As a result, taxpayers can explore the use of various data points, such as quotations, valuation reports, standard rate cards, etc, for the purpose of the arm’s length analysis using this residual method.

Specialised Officers for TP Audits

TP audits in India are currently being performed only by specialised tax officers – ie, TP officers (TPOs). TPOs are solely responsible for performing TP audits, and regular tax assessing officers are no longer permitted to analyse the arm’s length nature of a taxpayer’s international or specified domestic transactions. 

Deemed International Transactions

Deemed international transactions are also included within the scope of the Indian TP regulations. A deemed international transaction in the context of a taxpayer means a transaction entered into by an enterprise with an unrelated enterprise, where a prior agreement exists between the unrelated enterprise and the AE of the taxpayer; or where the terms of such a transaction are, in substance, determined between such unrelated enterprise and the AE of the taxpayer (where the resident or non-resident status in India of such unrelated enterprise is irrelevant).

Therefore, it becomes important for taxpayers in India to evaluate whether any of their third-party transactions fall within the ambit of Indian TP, necessitating the determination of the arm’s length price.

Preference for Use of Indian TP Databases

Indian tax authorities prefer the use of specific Indian TP databases in cases where an Indian entity is selected as the tested party for the arm’s length analysis.

Free-of-Cost Transactions

Indian tax authorities generally tend to question free-of-cost transactions, especially any free-of-cost support received from overseas group companies by Indian entities that are remunerated by their counterparts on a cost-plus basis.

Notional Interest on Overdue Balances

Indian authorities generally challenge the credit period that is offered by a taxpayer to its overseas group companies and tend to compute the notional interest on any overdue receivables by treating such outstanding balances as a deemed loan or advance. 

Marketing Intangibles

Marketing intangibles have been a key focus area in Indian TP. The Indian tax authorities generally challenge any significant advertising, marketing and promotion (AMP) expenses incurred by an Indian entity, especially where such entity is using marketing intangibles legally owned by an overseas group company. Indian authorities generally expect an Indian entity to be compensated for any benefits accruing to an overseas group company as a result of expenses incurred by the Indian entity, as such expenses are often perceived as being incurred on behalf of the overseas group company. This matter has been highly litigated in India, and is now pending adjudication before the Supreme Court of India.

Intra-Group Services/Royalty Transactions

Indian tax authorities are more likely to question the need and benefit of any outbound payment for intra-group services or royalty transactions. While various rulings have held that the commercial expediency of the taxpayer cannot be challenged by tax authorities, the tax authorities in India still seek detailed documentation/evidence to satisfy the need and benefit tests, along with proof of actual receipt of such services, in respect of such outbound payments.

Evaluation of the Reliability and Correctness of Comparability Analysis

The Indian tax authorities generally perform a detailed review of the taxpayer’s arm’s length analysis, including the methodology followed for the selection of comparable companies/transactions. This may include an in-depth analysis of the various quantitative and qualitative criteria applied by the taxpayer as part of its economic analysis. Furthermore, the tax authorities often proceed to perform their own independent benchmarking analysis, especially where they are not satisfied with the various filters used by the taxpayer and/or the adequacy and reliability of the comparables used by the taxpayer. 

Treatment of Pass-Through Costs

The tax authorities in India generally analyse the cost structure of the taxpayers in detail, especially in the case of limited risk captive entities operating in India, to determine if any costs have been intentionally excluded from the “operating cost” or have been wrongly classified as “pass-through costs”, thereby reducing the overall remuneration of such limited risk entity. For example, Indian tax authorities may try to determine if there are any services or resources made available by overseas AEs to the Indian captive entity on a free-of-cost basis, which may have resulted in reduced “operating costs” in India. Similarly, the tax authorities generally tend to include any cost pertaining to the employee stock plans granted by the overseas parent to the employees of the Indian entity, either on a free-of-cost basis or based on subsidised rates. 

Financial Transactions

Indian TP regulations are applicable to financial transactions as well, including borrowing, lending, guarantees, etc. The Indian courts have held that loans and guarantees are subject to TP provisions, even when entered into without consideration. Furthermore, in respect of loans, the Indian courts have held that the arm’s length interest rate should ideally be determined based on the interest rate applicable to comparable uncontrolled transactions denominated in the same currency as the intercompany loan.

Reliance on Other Regulations

In India, taxpayers and tax authorities often rely on other regulatory provisions prevailing in the country in order to defend their TP analysis. For example, taxpayers often rely on the provisions of foreign exchange management regulations for the purpose of defending the credit period offered to the AEs.

Secondary Adjustment Provisions

The concept of secondary adjustment was introduced in India from FY 2016–17 onwards in cases where the value of the primary TP adjustment exceeds INR10 million. The primary TP adjustment can be made voluntarily by the taxpayer in its return of income, or it can be made by a tax officer during TP audits (if accepted by the taxpayer). Primary TP adjustments also arise on account of APAs or application of safe harbour rules, or from a MAP resolution.

Secondary adjustment is an accounting adjustment in the books of accounts of both the taxpayer and the AE aimed at reflecting the actual allocation of profits between the taxpayer and its AE, in accordance with the primary TP adjustments based on the arm’s length principle. The provisions also require time-bound repatriation of excess money lying with the AE as a result of primary TP adjustments into India. Such repatriation may be done by any of the AEs not resident in India. Failure to repatriate triggers a levy of interest on the amount not repatriated. There is an option available to the taxpayer to pay one-time additional tax of 18% (plus applicable surcharge and cess) on secondary adjustments where the taxpayer is not able to repatriate the excess money to India.

Rules Limiting the Deduction of Interest Paid

In line with the recommendations under Action Plan 4 of the OECD’s BEPS Action Plan, India introduced interest limitation rules in 2017. Accordingly, the interest expense of the borrower, being an Indian company or a permanent establishment of a foreign company in India, is deductible to the extent of 30% of EBITDA. Balance interest is allowed to be carried forward for a period of eight subsequent financial years.

The interest limitation rule is not applicable where the amount of interest is INR10 million or less. Borrowers who are in the business of banking or insurance, and borrowings from a permanent establishment of a foreign bank in India, are exempted from the interest limitation rules. The Finance Act 2023 has extended this exemption to non-banking finance companies as well.

In India, customs-related matters are administered by the Central Board of Indirect Taxes and Customs (CBIC), while TP matters fall under the purview of the Central Board of Direct Taxes (CBDT).

There is a fundamental difference between the customs valuation and TP regulations. The customs authorities seek to increase the value of imported goods, resulting in higher customs duty liability. The income tax authorities focus on reducing the value of imported goods, as a lower transfer price will result in higher taxable profits in India. However, practically, the customs authorities have been seen take reference from the values adopted under the TP documentation while assessing the valuation under the customs law.

At present, there are no provisions under any law which mandate synchronisation between the valuation adopted by both authorities (ie, the customs authorities and the income tax authorities). 

Since both laws are controlled by the central government, the government is aiming to arrive at a consensus between the authorities on the valuation aspect. 

To formulate the above synchronisation, in 2007 a joint working group (comprised of senior officers from the income tax and customs departments) recommended certain steps for achieving co-operation between the customs and TP laws/departments. The field officers from both departments were asked to make their respective databases regarding related party/associated enterprises available to each other on a “need to know” basis. Practically, not much traction was seen in this area.

Furthermore, in 2020, to begin a new era of co-operation and synergy between the CBDT and CBIC, a memorandum of understanding (MoU) was signed to facilitate a smoother bilateral exchange of data. This MoU makes it easier to share data and information on both an automatic and regular basis, as well as on request. 

In India, the first level tax officer or assessing officer (AO) has to refer the audit of international/ specified domestic transactions to a designated TP officer (TPO). Previously, such cases were picked up for TP scrutiny based on certain monetary thresholds. However, the Indian government later moved to a risk-based approach. 

Dispute Channels

A taxpayer required to make a TP adjustment as an outcome of an audit has two channels available for disputing such TP adjustments. The taxpayer may either approach the Dispute Resolution Panel (DRP) or file an appeal before the Commissioner of Income Tax (Appeals), known as CIT(A). 

While disputed tax is not required to be paid while approaching the DRP, a partial payment is generally required when an appeal is filed before the CIT(A). However, such payment may be waived by tax authorities depending on the facts of the case.

The Income Tax Appellate Tribunal

Where the taxpayer is not satisfied with the outcome of an appeal, a further appeal may be preferred before the Income Tax Appellate Tribunal (ITAT). While both taxpayers and the revenue authorities may file an appeal before the ITAT against an order passed by the CIT(A), only the taxpayer has the option to appeal against an assessment order passed pursuant to the directions of the DRP. 

The ITAT has the power to grant stay to taxpayers from payment of disputed tax for a certain time period. The ITAT is the final fact-finding authority in India, and generally only matters involving a question of law travel to higher courts, namely the jurisdictional high courts and then (if required) the Supreme Court of India. 

Constitutional Rights

Taxpayers, in certain cases, can also access their constitutional rights and directly approach either the jurisdictional high courts or the Supreme Court of India in the case of any violation of their rights or against any action taken by the tax authorities which is bad in law.

The TP regulations were introduced in India in 2001. Since then, the country has witnessed litigation on multiple TP issues. As a result, the country has developed a very rich repository of judicial precedents on TP issues. Various TP matters have been analysed by the Indian tax tribunals and courts, providing guidance and precedence on issues such as:

• the interpretation of TP provisions;
• the powers of the tax authorities;
• the scope of various terms, such as international transactions and associated enterprise;
• comparability factors, including quantitative and qualitative aspects;
• selection of the tested party; and
• penalties, etc.

India has witnessed extensive TP litigation over the past two decades. As a result, the country has seen various judicial pronouncements on multiple TP issues. The following is a quick snapshot of some important court rulings on TP controversies in India.

• Aspects related to the arm’s length price determination, such as choice of comparable companies, choice of filters used, correctness of application of filters, etc, can fall under the purview of “substantial question of law” and hence can be appealed before the high courts under u/s 260A of the Act. See Hon’ble Supreme Court of India in the case of SAP Labs India Private Limited (CA 8463/2022 ETC).
• Provision of a corporate guarantee to an overseas group company, even without consideration, constitutes an international transaction, and therefore warrants computation of the arm’s length price. See the Madras High Court in the case of Redington (India) Limited (TCA Nos 590 and 591 of 2019).
• The arm’s length interest rate in respect of intra-group loans denominated in foreign currency should be computed based on the interest rate applicable on comparable uncontrolled transactions denominated in the same currency. See the Delhi High Court in the case of Cotton Naturals (I) Pvt Ltd (ITA No 233/2014).
• TP adjustments on account of excessive advertising, marketing and promotion (AMP) expenses incurred by the Indian taxpayer cannot be made in the absence of any international transaction between such taxpayer and its overseas AE by simply alleging that such expenses were incurred for the benefit of marketing intangibles legally owned by the foreign AE. See the Delhi High Court in the case of Maruti Suzuki India Ltd (ITA No 110/2014 and ITA No 710/2015) and Whirlpool of India Ltd (ITA No 610/2014 and ITA No 228/2015).
• Tax authorities cannot recharacterise a taxpayer’s international transaction barring a few exceptional cases. Furthermore, they cannot question a taxpayer’s commercial expediency while analysing the arm’s length nature of intra-group services availed from an overseas AE. See the Delhi High Court in the case of EKL Appliances Ltd (ITA No 1068/2011 & ITA No 1070/2011).
• Working capital adjustment performed by a taxpayer appropriately takes into account the impact of any delayed realisation of intercompany receivables. Therefore, a separate TP adjustment in the form of interest for an overdue receivable is unwarranted where the principal international transaction has already been demonstrated to be at arm’s length after such working capital adjustment. See the Delhi High Court in the case of Kusum Health Care Pvt Ltd (ITA 765/2016). 
• No separate adjustment for interest on overdue intercompany receivables is warranted where a uniform credit policy is adopted with AEs and non-AEs. See the Bombay High Court in the case of Indo American Jewellery Ltd (ITA No 1053 of 2012). 
• Use of a foreign AE as the tested party is permissible under the Indian TP regulations, where such entity meets the relevant criteria for selection as the tested party. See the Calcutta High Court in the case of Almatis Alumina Pvt Ltd (ITA No GA/2/2020).

Any outbound payment to unrelated parties needs to be made in accordance with the provisions of the Foreign Exchange Management Act, 1999 (FEMA) and the rules and regulations thereunder.

The provisions with respect to cross-border business expenses are governed by the Foreign Exchange Management (Current Account Transactions) Rules, 2000 rw FED Master Direction No 8/2015-16 (RBI/FED/2016-16/4) dated 1 January 2016, as amended from time-to-time (the “Regulations”). 

Current account transactions for business purposes are generally permitted under these regulations without any restrictions. However, certain types of transactions may have restrictions and require the prior approval of the central government and/or the Reserve Bank of India (RBI), as the case may be, in accordance with the Regulations.

It may be noted here that remittances exceeding USD10 million per project for any consultancy services in respect of infrastructure projects, and USD1 million per project for other consultancy services, will require the RBI’s prior approval. Royalty payments, on the other hand, are freely permitted.

Similarly, for outbound payments with respect to capital account transactions, specific regulations are to be referenced. Under indirect tax laws, the importation of goods/services attracts tax as per respective statutes – ie, the Indian goods and services tax (GST) law and customs laws. However, when making payment towards such imports, no specific restriction has been prescribed.

Any outbound payment to related parties needs to adhere to the arm’s length principle. Furthermore, such payments need to be made in accordance with the provisions of the FEMA regulations in India, as mentioned in 15.1 Restrictions on Outbound Payments Relating to Uncontrolled Transactions. 

Under indirect taxes, the importation of goods/services attracts tax as per the respective statutes – ie, Indian GST law and customs laws. However, when making payment towards such imports, no specific restriction has been prescribed.

Indian tax law does not have any specific rules regarding the effects of other countries’ legal restrictions. Furthermore, there are no provisions under Indian TP regulations allowing the benefit of a corresponding adjustment to taxpayers. However, India has a very strong tax treaty network with multiple countries. Taxpayers may access the MAP route via such tax treaties to get the benefit of such corresponding adjustments, if any, for obtaining necessary dispute resolution. Furthermore, bilateral advance pricing agreements may also be considered to avoid any double taxation issues in future. 

The Indian government regularly issues press releases to provide statistical updates and details of any landmark developments (such as the signing of bilateral APAs, the signing of APAs for new or complex transactions, the number of APAs signed in a financial year, updates on any extensive audits/search and seizure operations without sharing any confidential details, etc). The Indian government has also started publishing an annual report card, capturing various statistical data highlighting the overall progress and key achievements of the Indian APA programme. The last APA annual report was published for FY 2022–23 in September 2023.   

However, the Indian government does not publish the final outcomes of any APAs or TP audits, in view of their confidential nature and to protect taxpayers’ information.

At the same time, judicial pronouncements made by income tax appellate tribunals, the high courts and the Supreme Court in respect of any TP matters in India are available in the public domain. Such judicial pronouncements generally capture the key details of the overall approach adopted by the taxpayer as well as the lower tax authorities (including the key TP issues involved), resulting in TP adjustments.

Indian tax laws grant tax authorities/TPOs the power to seek information from any person in relation to such points or matters that may help them in computing the arm’s length price. Tax authorities often use these powers to access non-public financial or other key information (such as the financial data of companies not available in the public domain) in order to support their arm’s length conclusions. Furthermore, tax officers are also in a position to use their knowledge of industry practices acquired during the course of audits of other taxpayers operating in a similar industry, while performing the TP audit for a specific taxpayer. 

In the past, such information was not shared with taxpayers. However, over the years various tribunals/courts have upheld that such information, if used, should also be shared with taxpayers. The latter can generally seek such details from tax officers during the course of audits.