Precision in practice

In recent years, domestic transfer pricing has emerged as a critical aspect of tax management for companies operating in India. With the aim of preventing tax evasion and ensuring a fair allocation of income, the Indian government has tightened its regulations pertaining to transfer pricing. Let us delve into the concept of domestic transfer pricing in India and discuss essential internal control measures that businesses should implement to comply with regulations and mitigate risks.

Domestic transfer pricing is the process of determining the transfer prices for intra-group transactions between related entities within the same country. These transactions include the exchange of goods, services, or use of any tangible/intangible assets. Domestic transfer pricing refers to the pricing of goods, services, or intangible assets transferred between related parties within the same country. The objective is to ensure that transactions between affiliated entities are conducted at an arm's length, meaning the prices are comparable to those between unrelated parties in similar circumstances.

Since 2001, India has been one of the early adopters of transfer pricing regulations. Initially, the focus was on international transactions, but in 2012, the Indian government extended its scope to cover domestic transactions as well. Now, any transaction exceeding a prescribed monetary threshold between related parties within India must abide by domestic transfer pricing regulations.

The methodology for domestic transfer pricing in India is primarily based on the arm's length principle. This principle ensures that transactions between related entities are conducted at a price that would be charged between unrelated entities operating under similar circumstances or market conditions. The following methods can be used for determining arm's length prices in domestic transfer pricing:

Comparable Uncontrolled Price Method (CUP): This method compares the price charged for a controlled transaction with prices charged for similar transactions between unrelated parties. The CUP method is favoured when reliable data on comparable uncontrolled transactions is available.

Resale Price Method (RPM): The RPM involves determining the price at which a product purchased from a related party is sold to an unrelated party. This resale price is then reduced by an appropriate gross margin to establish the arm's length price.

Cost Plus Method (CPM): In the CPM, the costs incurred by a related party in providing goods, services, or using assets are determined. An appropriate markup or profit margin is then added to these costs to establish the arm's length price.

Transactional Net Margin Method (TNMM): TNMM compares the net profit margin earned from a controlled transaction with the net profit margin earned by comparable uncontrolled transactions. This method is useful when reliable data on similar transactions is available.

To comply with domestic transfer pricing regulations in India and minimise the risk of disputes or penalties, companies should adopt the following internal control measures:

Documentation and maintenance: Maintaining robust documentation is crucial for defending the arm's length nature of transactions. Companies should prepare comprehensive transfer pricing documentation, including details of the analysed comparable transactions, methodologies used, and justifications for their selection.

Selection and application of transfer pricing methodologies: Companies are required to use appropriate transfer pricing methodologies to determine the arm's length price. They must carefully choose the most suitable method based on the nature of the transaction and industry standards.

Benchmarking and comparability analysis: Ensuring accurate benchmarking and comparability analysis is vital. It involves identifying comparable transactions or companies and justifying their relevance to the tested transaction. Companies should evaluate factors such as functions performed, assets employed, and risks assumed in the transaction.

Monitoring and maintenance of consistent transfer pricing policies:

Consistency in transfer pricing policies is crucial for internal control. Companies should establish clear guidelines regarding pricing policies and ensure their consistent application across all related-party transactions.

Regular review and adjustment: Companies should periodically review their transfer pricing policies and methodologies to ensure they remain aligned with any changes in business circumstances, industry practices, or tax regulations.

Transfer pricing audits and assessments:

o Tax authorities may conduct transfer pricing audits to ensure compliance.

o The Transfer Pricing Officer (TPO) is responsible for determining the arm's length price in case of any adjustments.

Advance Pricing Agreements (APAs):

o Taxpayers can proactively seek certainty in their transfer pricing arrangements by entering APAs with tax authorities.

o APAs provide a predetermined method for computing arm's length prices, reducing the risk of future disputes.

Penalties for non-compliance:

o Non-compliance with DTP regulations may result in penalties.

o It is crucial for businesses to adhere to the prescribed documentation requirements and maintain transparency in their related-party transactions.

Domestic transfer pricing regulations in India require companies to demonstrate compliance with arm's length pricing standards. Implementing and maintaining a robust internal control framework is vital for companies to meet these requirements effectively. By adopting the suggested control measures, businesses can not only mitigate any risks associated with non-compliance but also enhance their overall tax management strategies. The methodology and procedural aspects of domestic transfer pricing in India are crucial for businesses operating within the country. It is essential for taxpayers to understand and comply with the transfer pricing regulations to avoid penalties and ensure fair pricing within related entities. With the arm's length principle and various methods available, businesses can establish transfer prices that reflect market conditions and minimise the risk of transfer pricing disputes. Navigating the intricacies of Domestic Transfer Pricing in India requires a thorough understanding of the procedural aspects and methodology involved. Businesses should proactively engage in compliance measures, adopt appropriate transfer pricing methods, and stay informed about regulatory changes to ensure a seamless and transparent transfer pricing framework within the country.

Views expressed are personal