Transfer Pricing Basics for an Indian Subsidiary

Once a foreign company owns an Indian subsidiary, almost every payment between the two is a transfer pricing transaction. Management fees, royalties for the brand or technology, cost-plus charges for development or support work, loans, guarantees and the sale of goods between the entities all have to be priced as if the parties were unrelated. This guide gives a foreign parent the core concepts of Indian transfer pricing so that the first year's intra-group arrangements are set up correctly rather than fixed later under audit.

Associated enterprises

Indian transfer pricing applies to international transactions between associated enterprises. Two enterprises are associated when one participates in the management, control or capital of the other, or when both are under common control. The Income-tax Act lists specific tests, including holding 26% or more of voting power, appointing more than half of the board, a loan of 51% or more of the book value of assets, and dependence on the other party for technology, raw materials or sales. A wholly owned subsidiary and its parent are always associated enterprises, and so are two sister companies under the same group.

The arm's length principle

Every international transaction between associated enterprises must be priced at an arm's length price: the price that would have been charged between unrelated parties in uncontrolled conditions. If the actual price results in lower income in India than the arm's length price would have, the tax officer can adjust the Indian company's income upward. Adjustments only go one way: the department will not reduce Indian income because the subsidiary was overcharged. The burden of showing that the price is at arm's length is on the taxpayer.

The five methods

Indian rules also allow any other method that takes into account the price that would be charged in similar uncontrolled circumstances, which is used for unusual transactions such as the sale of a business or a one-off asset. The law requires the most appropriate method for each transaction, chosen with regard to the nature of the transaction, the availability of reliable data and the degree of comparability.

Documentation and Form 3CEB

1. 1

   Identify every international transaction: List all payments, receipts, loans, guarantees, cost allocations and free-of-charge services between the subsidiary and any associated enterprise during the financial year.

2. 2

   Maintain the transfer pricing study: Under current rules, once the aggregate value of international transactions crosses the prescribed threshold, the subsidiary must keep contemporaneous documentation describing the group, the functions performed, assets used and risks assumed by each party, the method selected and the benchmarking analysis.

3. 3

   Obtain Form 3CEB: A chartered accountant must issue a report in Form 3CEB listing each international transaction, the method used and the arm's length price. It is filed electronically before the due date for the income tax return of a company with international transactions, which falls later in the year than the ordinary company deadline.

4. 4

   File the return consistently: The income tax return must report the same transactions as Form 3CEB. Mismatches between the two are a common trigger for scrutiny.

5. 5

   Check master file and country-by-country obligations: Larger groups have additional reporting in India once the group's consolidated revenue crosses the thresholds set under current rules.

Safe harbour

India offers safe harbour rules for certain categories of transactions, such as software development services, IT-enabled services, knowledge process outsourcing, contract research and development, and intra-group loans. If the Indian entity earns at least the prescribed operating margin or charges at least the prescribed rate, and opts into the safe harbour by filing the required form, the tax authorities accept the price without a detailed audit. The prescribed margins are generally higher than what a benchmarking study would support, so safe harbour trades a somewhat higher Indian tax bill for certainty and lower dispute cost. Eligibility limits and margins change from time to time, so check the current notification before relying on it.

Common intra-group transactions

• Management or head-office fees charged by the parent: deductible in India only if the subsidiary can show the services were needed, actually rendered and priced at arm's length. Shareholder activities, such as the parent's own board reporting, cannot be charged.
• Royalties for brand, software or know-how: benchmarked by CUP where licence data exists; the rate must reflect what the Indian entity actually uses. Withholding tax and, where applicable, GST under reverse charge also apply to the payment.
• Cost-plus development or support services provided by the subsidiary: the standard model for captive centres, usually priced under TNMM with a mark-up on total operating costs. The mark-up must be supported by a comparable search or by safe harbour.
• Reimbursement of expenses: pure pass-through costs without mark-up are accepted when the subsidiary adds no value and can show third-party invoices.
• Loans and guarantees from the parent: interest must be at an arm's length rate; even an interest-free loan from the parent is examined, and a guarantee given by the parent to an Indian lender can be treated as a service requiring a fee.
• Sale or purchase of goods: priced under CUP, RPM or TNMM depending on the role of the Indian entity.

What to do in the first year

Set the pricing model when the subsidiary is formed, document it in an intercompany agreement, book the transactions consistently throughout the year, and commission the benchmarking study and Form 3CEB well before the filing deadline. Fastlegal's transfer pricing service covers the agreement, the study, the accountant's report and the related withholding tax certificates such as Form 15CA and 15CB for each remittance.

This guide is general information under rules current at the date shown, not professional advice for your situation. Rules, due dates and fees change by notification.