Transfer Pricing

The Finance Bill, 2001 introduced Transfer Pricing Regulations by amending the
provisions of section 92 of The Income Tax Act, 1961. The reason for introducing the
Transfer Pricing legislation has been explained by the Memorandum explaining the
provisions of Finance Bill, 2001 introduced by the Finance Minister.

“The increasing participation of multinational groups in economic activities in the

country has given rise to new and complex issues emerging from transactions entered into
between two or more enterprises belonging to the same multinational group. The profits
derived from by such enterprises carrying on business in India can be controlled by the
multinational group, by manipulating the prices charged and paid in such intra group
transactions, thereby leading to erosion of tax revenues”.

With a view to provide statutory framework which can lead to computation of fair,
reasonable and equitable tax and profits in India new provisions were introduced in the
Income Tax Act with effect from financial year 2001-2002 i.e. Assessment year 2002-
2003. These provisions relate to the computation of income from international
transactions having regard to arm’s length price, keeping and maintaining of information
and documents by persons entering into international transactions, furnishing of report
from an accountant by persons entering into such transactions and definitions of certain
expressions occurring in the said sections”.

However before we go into discussion of these new provision it is essential to understand

the old section 92 which will highlight the importance of new provisions both from
assessee and Tax administrator point of view .

Section 92 as it existed till 31st March, 2001 provided that if in the opinion of the
assessing officer if the transaction between resident and non resident is so arranged that
produces no profit or less profits than otherwise it might produce owing to the close
connection, the assessing officer has the power to determine the profits that may have
been reasonably derived.

Rule 10 of the Income Tax Rules, 1962 as it existed till 31st March, 2001 provided that in
determination of income to non resident in respect of any transaction that has arisen to
non resident due to connection between the resident and non – resident. The assessing
officer may calculate the profits on the following basis :

a) At such percentage of the turnover as the assessing officer may consider it

reasonable.
b) On any amount which bears the same proportion to the total profits and gains of
the business of such person, as the receipts accruing or arising bear to the total
receipts of the business.
c) In such manner as the assessing officer may deem suitable.
It emerges from the analysis of the above Rule 10 that assessing officer had the arbitrary
powers to calculate the profits in case of international transactions.

Several judicial decisions also supported the above arbitrary powers of the assessing
officer.

In the case of CIT vs Mewar Textiles Mills Lts. (70 ITR 458) it was decided by the court
that it will not interfere if the assessing officer has made a fair estimate.

Further in the case of Blue Star Engg. Co. (P) Ltd. V. CIT (73 ITR 283) (Bom) it was
decided that even if the estimate is based on guesswork, court might not interfere if
assessee has not placed material before justifying a more definite and certain
apportionment.

So in order to overcome arbitraniness in the provisions for computation of profits in case

of international transactions new provisions were introduced which were already in
existence in many countries. Most of countries in drafting their transfer pricing
provisions have followed the OECD guidelines on transfer pricing & India has also
followed to a large extent OECD guidelines.

The provisions relating to Transfer Pricing Regulations are as follows :

Section Provision of the Section

92 Computation of Income from international transaction
92A Definition of Associated Enterprise
92B Definition of International Transaction
92C Computation of income under Arm’s length method
92E Furnishing of report by a chartered Accountant
92F Definitions of Transactions, Arm’s length price etc.

Section 92

Section 92 is split into three parts.

- Section 92(1) provides that the computation of income in respect of international

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