Understanding International Transactions in the Context of Transfer Pricing

Transfer pricing refers to the pricing method used when goods or services are exchanged between associated enterprises. The purpose of transfer pricing laws is to ensure that such transactions are conducted at a fair and unbiased price, similar to what would be charged in a transaction between unrelated parties.

The objective of Transfer Pricing Laws

The primary goal of transfer pricing laws in international transactions is to ensure that prices for transactions between associated enterprises reflect those that would be set if the parties were independent and unrelated.

International Transactions Between Associated Enterprises

In transfer pricing, an “international transaction” refers to any transaction between two or more associated enterprises, where one or both parties are non-residents. This may involve the purchase, sale, or lease of tangible or intangible assets, the provision of services, or the lending or borrowing of funds.

A transaction with a third party (not an associated enterprise) can also be treated as an international transaction between associated enterprises if:

There is a prior agreement regarding the transaction between the third party and the associated enterprise, or

The transaction’s terms are substantially influenced by the associated enterprise, whether or not the third party is a non-resident.

This principle applies when one or both associated enterprises are non-residents.

Background for Transfer Pricing under International Transaction

Some various rulings and judgments consistently affirm that an entity can’t trade and transact with itself or derive profit from the transaction within its branches. However, these principles have largely been established in the context of domestic transactions, not in the context of International transactions.

A critical question arises regarding the applicability of these principles to cross-border transactions between the head office outside India and the branch office in India and vice versa, or international transactions.

If the Branch office and Head office are both in India, these transactions are tax neutral as Indian residents are taxed on their worldwide Income.

Foreign enterprises are taxed only on the income earned in India/source of income in India. To safeguard the interest of India Tax law, transfer pricing provisions as part of international transactions come into the picture.

In this article, we will do a detailed analysis of the decision of the Ahmedabad special bench of the Tribunal in the case of Aithent.

Facts of the case:

The taxpayer, a resident of China, was contracted to construct power substations in India. They have established a project office in India which qualifies as a permanent establishment P.E. in India to execute the onshore services. Some of these services are further outsourced to independent third parties.

However, while doing the scrutiny of books of account, the transfer pricing officer has provided the opinion that said transaction done by the India project office would fall under the category of International Transaction as defined under section 92B of the Income Tax Act. 1961. The project office has made an excess payment to subcontractors than the rate received from the Company in China.

The project office in India has made the submission that the transactions between the Head office and permanent establishment are only internal and no tax impact is there.

TaxPayer Submission:

The Indian tax office is not a distinct legal entity but an integral extension of a foreign head office. The transaction with self can not result in taxable income and Transfer pricing provisions are also not applicable. This transaction can’t be considered as International Transactions. Treaty provisions such as Article 9 of the treaty override the domestic TP provisions.

 Revenue Contentions:

The transaction between the India Project office and the foreign head office is treated as an international transaction. The inclusion of Permanent establishment in the definition of enterprise suggests that a PE is deemed as a separate enterprise for TP purposes even if it may not have a separate legal existence.

In the Aithent decision, the Tribunal held that a transaction between an Indian H.O. and a branch in foreign does not qualify as an international transaction under the transfer pricing provisions.

But in another decision of Aithent of a separate year, the tribunal considered the definition of “enterprise” and “international transaction”. The transaction between the business office and general enterprise would fall under the provisions of transfer pricing.  The Entity residents in India are taxed on their worldwide Income (including income from foreign branches), any under or invoicing does not have much impact from a tax perspective and it will be considered as international transactions.

For non-resident entities, only the income deemed to accrue or arise in India is taxable. In such cases over or under-invoicing between entity resident in India and entity non-resident in India may have reduced the tax burden in India.  

To safeguard the interest of revenue, transactions between foreign HO and Indian Branch should fall under transfer pricing provisions and be considered international transactions.

Also in the case of the Fujifilm decision, the Tribunal referred to the definition of “enterprise” and held that transactions between foreign enterprise and Indian enterprise should vice versa should be subject to TP provisions. These deals are not tax-neutral because the Taxable income of foreign enterprises and branches in India are not consolidated for Income Tax purposes in India.

The decision of Bench:

The Ahmedabad special bench of the Tribunal ruled in favor of the revenue, upholding the applicability of transfer pricing provisions to dealing with the Indian Branch office and Foreign Head office.

The below definition of Section 92A(1) of the Income Tax Act, 1961, talks about the general condition in which two enterprises are to be considered as Associated Enterprise.

For this section and sections 92, 92B, 92C, 92D, 92E, and 92F, “associated enterprise”, about another enterprise, means an enterprise—

 (a) which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise; or

 (b) in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.

Section 92A(2) and Section 92A(1) are to be read together both can not be read independently, As long as the provision of one of the clauses in Section 92A(2) is not satisfied in spite of the enterprise having the control, participation in capital or control over the other enterprise, two enterprises can’t be said to be associated enterprise.

The Division branch may further analyze whether, having regard to the facts and circumstances of the case, the HO’s control over the permanent establishment in India is based on the facts of each case.

Conclusion: 

The Ahmedabad Tribunal’s decision highlights the importance of applying transfer pricing provisions to transactions between Indian branch offices and foreign head offices, ensuring compliance with India’s tax laws and safeguarding revenue. By treating such dealings as international transactions, the ruling aligns with global best practices and addresses potential tax avoidance through over or under-invoicing. This landmark judgment reinforces the significance of assessing the control and relationship between associated enterprises on a case-by-case basis, contributing to the evolution of international taxation principles in India.