Group taxation is not permitted under the Indian tax law.
Transfer pricing on international transactions
The Indian transfer pricing regulations (ITPR) stipulate that income arising from ‘international transactions’ between ‘associated enterprises’ should be computed having regard to the ‘arm’s-length price’. Furthermore, any allowance for expenses or interest arising from any international transaction is also to be determined having regard to the arm’s-length price. The expressions ‘international transactions’ and ‘associated enterprises’ have been defined in the ITPR.
The ITPR also contain the concept of ‘deemed international transaction’ whereby a transaction between an enterprise and a third party (whether based in India or overseas) would be subjected to transfer pricing regulations in case there exists a prior agreement in relation to such a transaction between the third party and the associated enterprise of the transacting enterprise or if the terms of such a transaction are determined in substance between the third party and the associated enterprise of the transacting enterprise.
The ITPR also define a certain class of transactions undertaken by a taxpayer with its domestic related parties and whose aggregate value exceeds INR 200 million as specified domestic transactions to which the transfer pricing provisions apply.
Initially, the ITPR prescribed five methods for computation of arm’s-length price. These are broadly in line with OECD Guidelines. A sixth method, termed as the ‘other method’, was notified in 2012. Taxpayers are required to adopt the most appropriate method for determining the arm’s-length price.
Taxpayers are also required to maintain a comprehensive set of prescribed information and documents relating to international transactions and specified domestic transactions that are undertaken between associated enterprises, on an annual basis, within the prescribed timelines. Taxpayers being a constituent entity of an international group shall also keep and maintain such information and documents (essentially master file and country-by-country [CbC] report) in respect of the international group. Further, taxpayers are required to obtain an Accountant’s Report (certificate) from an independent accountant certifying the nature and amount of international transactions. The certificate needs to be filed one month in advance of the income tax return. The burden of proving the arm’s-length character of the transaction is primarily on the taxpayer. On 1 October 2020, the CBDT notified certain changes in the form of the certificate, including expanding the coverage of specified domestic transactions in certain cases.
The taxpayer is required to comply with the above requirements on an annual basis.
The ITPR adopt an arithmetic mean of comparable prices as the arm's-length price, with a flexibility of deviation from the percentage that is notified by the Central Government as +/- 1% for wholesalers and +/- 3% for others. The CBDT has also prescribed rules for use of range for determining arm’s-length price, which is discussed subsequently. Where the transfer pricing officer is of the opinion that the arm’s-length price was not applied, the officer may re-compute the taxable income after giving the taxpayer an opportunity to be heard. Stringent penalties are prescribed in cases of failure to comply with the provisions of the ITPR.
Notified Jurisdictional Area (NJA)
The Indian government is empowered to declare a country/territory with which there does not exist an effective mechanism for exchange of information as an NJA.
Any transaction between a taxpayer and a person located in an NJA or a transaction entered into by a taxpayer wherein one of the parties is located in an NJA will be covered under the ITPR. However, the benefit of the +/- 3% range and the option to be covered under the Safe Harbour Rules would not be available in this case.
Safe Harbour Rules
Safe Harbour Rules were notified in 2013. These rules prescribe who the eligible taxpayers are, which are the eligible international transactions, the target operating margin, procedural aspects, timeline for audit, etc. Thereafter, these Safe Harbour Rules were also extended to certain domestic transactions. Safe Harbour Rules also cover attribution of profits to a PE.
The Safe Harbour Rules were initially applicable for a maximum of five tax years beginning with tax year 2013/14.
Thereafter, in June 2017, the CBDT made amendments to the Safe Harbour Rules reducing the target operating margins for most of the eligible international transactions. Further, the revised Safe Harbour Rules introduced receipt of low value-adding intra-group services to the list of eligible transactions subject to certain thresholds. Also, there were certain modifications made to the definitions of certain terms vis-à-vis in the original Safe Harbour Rules. The revised Safe Harbour Rules are applicable for a maximum of three tax years beginning with tax year 2016/17 with the taxpayers having an option to apply the original Safe Harbour Rules or the revised Safe Harbour Rules for the tax year 2016/17, whichever is more beneficial.
Where a taxpayer has opted to be covered under the Safe Harbour Rules and the transfer price declared has been accepted by the tax authorities, then such a taxpayer cannot invoke proceedings under a Mutual Agreement Procedure (MAP).
In May 2020, the CBDT notified that the revised Safe Harbour Rules applicable for tax years 2016/17 to 2018/19 will continue to apply for tax year 2019/20. The CBDT, on 24 September 2021, notified to extend applicability of Safe Harbour Rules for tax year 2020/21 as well. On 17 June 2022, the CBDT further extended the applicability of Safe Harbour Rules to tax year 2021/22.
It is pertinent to note that no Safe Harbour Rules have yet been notified for the subsequent tax year. We will have to wait for any further notification from the Indian Revenue Department in this regard.
Advance pricing agreements (APAs)
An APA is an arrangement between the taxpayer and the tax authorities covering transactions, with a view to pre-empt potential transfer pricing disputes. The CBDT has notified detailed rules providing the procedures and necessary forms for application/administration of APAs.
The rules provide for constitution of an APA team, which shall consist of an income tax authority and experts from economics, statistics, law, and other necessary fields. APAs can be applied to existing, as well as proposed, transactions. Further, APAs entered into after 1 April 2020 can also cover attribution of profits to PEs.
The rules have provided for both unilateral and bilateral/multilateral APAs. In cases where a bilateral APA negotiated between competent authorities is not acceptable to the taxpayer, the taxpayer may, at its option, continue with the process of entering into a unilateral APA without benefit of an MAP.
The salient features of the procedure laid down for APAs are application for APA, withdrawal of APA, defective application, procedure, compliances post-APA, cancellations of APA, and revisions and renewal of APA.
The legislation has provisions of roll-back of APAs for four years prior to the first year covered under the APA.
Rules prescribing the use of ‘range’ and multiple year data
The CBDT has notified the rules prescribing the scheme for the usage of the ‘range’ concept and multiple year financial data for determining the arm’s-length price. These rules are applicable to international transactions and specified domestic transactions.
The rules envisage the applicability of the ‘range’ concept and multiple year data only where the arm’s-length price determination is done using either the transactional net margin method, resale price method, cost plus method, or comparable uncontrolled price method. Furthermore, the rules in connection with the applicability of the ‘range’ concept, inter alia, prescribe the adequate number of external comparables and the methodology for computing the upper and lower percentile. In case the number of external comparables identified is not adequate, the ‘range’ concept will not apply and the concept of arithmetic mean will continue to apply.
The multiple year data can only be used if the most appropriate method selected of benchmarking purposes is either transactional net margin method, resale price method, or cost plus method. Further, multiple year data entails use of data for the year under consideration (current year) and data for up to two preceding financial years. Data for the current year is compulsorily to be considered. If the data for the current year is available and is not comparable on account of either qualitative or quantile reasons, the comparable cannot be considered.
Master file and country-by-country (CbC) reporting documentation as per base erosion and profit shifting (BEPS)
The government has introduced three-layered transfer pricing documentation requirements in line with the international standard as per the BEPS Action Plan 13. Taxpayers are required to prepare a master file, local file, and CbC report from tax year 2016/17. The CBDT has notified the final rules for maintaining and furnishing of transfer pricing documentation in the master file and CbC report.
As per the rules, the master file shall be applicable to every Indian taxpayer (called as a constituent entity or CE) part of an international group (whether inbound or outbound) having an annual consolidated turnover of over INR 5 billion in the preceding accounting year of the parent company and meeting certain other thresholds of the quantum of aggregate value of international transactions. Again, the Indian taxpayer must furnish the master file with the prescribed authority (i.e. Director General of Income-tax [Risk Assessment]). For Indian CEs with parent companies resident outside India, the master file must be furnished even if it is filed by the parent entity in its home country or by a designated entity in its home country. In case there are more than one constituent entities of an international group that are required to file the Master File in India, the international group can designate any one of its constituent entities to file Master File on behalf of other constituent entities. Earlier, a designated entity could only file Master File on behalf of the Indian resident constituent entities and non-resident constituent entities were required to file separate Master Files for compliance in India. However, CBDT issued a notification on 5 April 2021 clarifying that the Master File is required to be filed by any one of the constituent entities, designated for the same, for both resident and non-resident entities.
The documentation prescribed by the rules in respect of the master file is largely in line with OECD’s final BEPS Action Plan 13 report; however, there are certain additional information requirements, like the description of the functions, assets, and risks (FAR) analysis of all CEs within the group that contribute at least 10% of revenues or assets or profits of the group; detailed description of the financial arrangements of the group, including the names and address of the top ten unrelated lenders; and a list of all entities of the international group engaged in development and management of intangible property, along with their addresses. Further, every CE has certain master file related filing requirements even if such CE does not undertake any international transactions.
The CbC report is applicable only for taxpayers having an annual consolidated group turnover of over INR 64 billion (increased from INR 55 billion with effect from 1 April 2021 vide a notification issued by CBDT on 5 April 2021) in the preceding accounting year of the parent company. A parent entity of an outbound international group or an alternate reporting entity of an inbound international group, resident in India, must file the CbC report with the prescribed authority. For Indian CEs with parent companies resident outside India, the CbC report must ordinarily be filed by the parent entity in its home country or by an alternate reporting entity/a designated entity in its home country. The Indian tax authorities will access the CbC report through mutual exchange of information agreements with such country, failing which the Indian subsidiary will be required to furnish the report. However, if the parent entity is not obligated to file the CbC report in its home country or if there is no mutual exchange of information agreement signed between India and the parent entity’s country or territory, or there has been a systemic failure of the country or territory and such failure has been informed to the Indian CE by the prescribed authority, then the Indian CE will be required to furnish the report.
In case there are multiple entities of the same international group resident in India, one of the entities will have to be identified as the designated entity for filing the master file as well as for other communication in respect of the master file and the CbC report. Further, the rules have prescribed various forms for intimations to be filed with the prescribed authority and filing of the master file and CbC report with the prescribed authority at various dates. The due date for filing the master file is the specified due date for filing the annual tax returns. In case of CbC report, every parent entity or the alternate reporting entity, resident in India, will have to file the CbC report within a period of 12 months from the end of the said reporting accounting year of the parent entity. In case the Indian CE or the designated Indian CE is required to file the CbC report with the prescribed authority for reasons as discussed above, then the timeline is within a period of 12 months from the end of the international group’s reporting accounting year unless there has been a case of systemic failure, in which case the timeline is within six months from the end of the month in which said systemic failure was informed.
Significant penalty provisions will apply for non-compliance and furnishing of inaccurate information.
Further, on 27 June 2018, the CBDT issued an instruction relating to appropriate use of CbC report information. This instruction provides clarity on certain fundamental aspects of use of such information by the Indian tax authorities.
Restrictions on interest deduction
The BEPS Action Plan 4 recommends alternate approaches for countries to limit tax base erosion through interest deductions and other financial payments. Provisions have been introduced in the Income-tax Act that seek to limit the interest deduction of Indian companies or PEs of foreign companies in India. Taxpayers engaged in banking or insurance business are specifically excluded. Further, it is clarified that interest on loan extended by a PE of a non-resident bank is also excluded.
The provision will apply to interest or similar expenses paid (including those paid on existing debt) to (i) overseas associated enterprises or (ii) third-party lenders for whom the underlying debt is backed by an implicit or explicit guarantee or equivalent deposit from overseas associated enterprises.
Any interest paid for the year under consideration in excess of 30% of the EBITDA of the taxpayer will be treated as excess interest. Excess interest disallowed in a year will be eligible for carry forward up to eight consecutive years, subject to the above limits. The provision will, however, not apply to interest paid or payable up to INR 10 million.
The provisions that limit the interest deductions have largely adopted the ‘Fixed Ratio Rule’ proposed as a best practice approach under BEPS Action Plan 4, however, with some differences. It is relevant to note that the provisions do not correspondingly limit the WHT liability or taxability of the non-resident associated enterprise on the interest income. The provisions apply from tax year 2017/18 onwards.
To align the ITPR with the OECD Guidelines and international practices, provisions have been introduced in the ITPR for a secondary adjustment. The secondary adjustment is an adjustment in the books of account of the taxpayer and its associated enterprise to reflect that the actual allocation of profits between the Indian taxpayer and its associated enterprise are consistent with the transfer price determined as a result of primary adjustment. This is intended to remove the imbalance between the cash account and actual profit of the Indian taxpayer.
The secondary adjustment is required only where a primary adjustment to the transfer price occurs in one of the following circumstances:
- Where adjustment has been made on one’s own by the taxpayer in one’s income tax return.
- Adjustment made by the Assessing Officer has been accepted by the taxpayer.
- Arising due to the APA signed.
- Application of Safe Harbour Rules.
- Settlement arrived at under the MAP route.
However, an exception has been made according to which such secondary adjustments shall not be carried out by the taxpayer if the amount of the primary adjustment made in the case of a taxpayer does not exceed INR 10 million.
According to this provision, excess money arising from primary transfer pricing adjustments not repatriated into India within the prescribed time limit will be deemed as an advance made by the Indian taxpayer to its associated enterprise. Time limits have been prescribed having regard to the circumstance leading to the primary transfer pricing adjustment. The effect of the advance is given by way of an imputation of interest on such advance. The imputed per annum interest on such advance will be computed at the one-year marginal cost of fund lending rate of the State Bank of India as on 1 April of the relevant previous year plus a spread of 325 basis points in cases where the international transaction is denominated in Indian rupees. In cases where the international transaction is denominated in foreign currency, the interest will be computed at six-month London Interbank Offered Rate (LIBOR) as of 30 September of the relevant previous year plus a spread of 300 basis points. This interest will be imputed till such time as the excess money arising due to primary transfer pricing adjustments is repatriated into India.
The provisions relating to secondary transfer pricing adjustment are generally applicable for primary transfer pricing adjustments made from tax year 2016/17 onwards.
Further, it has been clarified that this interest will be computed on excess money or part thereof. Further, the excess money may be repatriated from any of the associated enterprises of the taxpayer that is not a resident of India. These amendments are effective retrospectively from 1 April 2018 (i.e. for tax year 2017/18 onwards).
Also, it has been clarified that the provisions of this section are applicable to APAs signed on or after 1 April 2017. Further, no refund of taxes paid till date under the pre-amended section will be allowed.
Moreover, to simplify the implementation of these provisions, an option has been introduced to taxpayers to either pay tax on the imputed interest every year until the excess money arising due to primary transfer pricing adjustments is repatriated into India or pay a one-time tax on the excess money or the part thereof at 18% plus surcharge of 12% and cess of 4%. Interest will have to be paid till the date of payment of the additional tax. Further, no credit will be given for this additional tax paid, neither will a deduction be allowed under any provision of the Act, in respect of such amount on which the tax has been paid. This has been effective from 1 September 2019 onwards. The aforesaid is in line with the internationally accepted best practices.
Minimum alternate tax provisions have been amended to provide for adjustment for increase in book profit of the previous year due to inclusion of income of past year/years pursuant to an APA or secondary adjustment. The Tax Officer shall make the aforesaid adjustment and recompute the book profit of past year/years and the tax payable, if any, for the previous year, provided an application in this regard is made by the taxpayer and having regard to other conditions/provisions prescribed.
Mutual Agreement Procedure (MAP)
India has the MAP process in place as a dispute resolution mechanism under the DTAAs. There are specific provisions within the Indian Tax Law for the same. With a view to align the MAP process with the OECD BEPS Action 14 Minimum Standard and provide more clarity around the MAP process, the Indian government amended the MAP rules in May 2020 with specific procedures for filing MAPs and notification to the foreign competent authority, along with an aim to resolve the MAP cases within an average timeline of 24 months. Further, in August 2020, the CBDT issued detailed guidance around procedural and technical aspects, acceptance/denial of MAPs, and the implementation of MAPs. On 10 June 2022, the CBDT released an updated version of the guidance on MAP wherein it clarified the interplay between MAP and the Direct Tax Vivad se Vishwas Act, 2020. It also elaborated on the MAP applicant’s responsibility to make true and complete disclosure during the MAP process.