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Transfer Pricing Audits.

📌 1. Introduction to Transfer Pricing Audits

Transfer Pricing (TP) refers to pricing of transactions between related parties — such as parent and subsidiary companies, or entities under common control — for goods, services, intangibles, or financial transactions.

Purpose of TP audits:
To ensure that related-party transactions are conducted at arm’s length, preventing tax avoidance by shifting profits to low-tax jurisdictions.

Statutory Basis:

Section 92 to 92F of Income Tax Act, 1961

Rule 10B to 10B of Income Tax Rules, 1962

📌 2. Scope and Objectives of Transfer Pricing Audit

TP Audit Objectives:

Verify arm’s length pricing (ALP) for international transactions.

Ensure compliance with documentation requirements under Section 92D.

Identify mispricing or profit shifting to related parties.

Facilitate dispute resolution between taxpayer and tax authorities.

Prevent double taxation through proper reporting and APA (Advance Pricing Agreement) references.

Auditable Transactions:

Sale or purchase of goods

Rendering or receiving services

Use or transfer of intangible assets

Loans, guarantees, or financial transactions

Cost-sharing arrangements

📌 3. Key Steps in a Transfer Pricing Audit

📌 4. Methods for Determining Arm’s Length Price (ALP)

Prescribed Methods under Indian TP Rules (Section 92C & Rule 10B):

Comparable Uncontrolled Price (CUP) Method – Price of similar transactions between unrelated parties.

Resale Price Method (RPM) – Start with resale price to unrelated parties and subtract margin.

Cost Plus Method (CPM) – Add appropriate markup to costs of goods/services.

Profit Split Method (PSM) – Allocate combined profits between related entities based on contribution.

Transactional Net Margin Method (TNMM) – Compare net profit margin with unrelated entities.

Other methods (as prescribed) – May be applied in exceptional cases.

📌 5. Documentation and Compliance

Key Documents Required:

Master file & country-by-country reporting (CbCR) for multinational entities.

Local file detailing transactions with related parties.

Details of benchmarking analysis, selection of comparables, and adjustments made.

Board resolutions approving related-party transactions.

Penalty for Non-Compliance:

Section 271AA – Penalty up to 2% of the value of international transaction for failure to maintain/document TP.

Interest on under-reported income under Section 234B/234C.

📌 6. Key Case Laws on Transfer Pricing Audits in India

🧾 Case 1 — CIT v. GlaxoSmithKline Pharmaceuticals Ltd. (Delhi HC, 2010)

Facts:
GSK had transactions with its parent for purchase of goods at allegedly inflated prices.

Held:
High Court held that benchmarking and comparables analysis must consider industry norms, and the TP officer must demonstrate significant deviation to make an adjustment.

Principle:
TP audit adjustments must be based on sound economic and factual analysis.

🧾 Case 2 — CIT v. Ericsson India Pvt. Ltd. (ITAT Bangalore, 2010)

Facts:
Dispute over ALP of software development services provided by Indian subsidiary to foreign parent.

Held:
ITAT upheld TNMM-based ALP but emphasized functional and risk analysis, not just transactional prices.

Principle:
TP audits require detailed functional and risk-based study, not mechanical computation.

🧾 Case 3 — CIT v. Sony India Pvt. Ltd. (ITAT Delhi, 2009)

Facts:
Adjustment made on account of royalty payments for trademark and software usage.

Held:
Tribunal allowed reduction in adjustment, considering contribution of local entity and existence of real commercial transactions.

Principle:
TP audit should consider actual economic contribution and not blindly adjust transactions.

🧾 Case 4 — CIT v. Vodafone India Services Pvt. Ltd. (Mumbai ITAT, 2012)

Facts:
TP audit questioned service charges paid to foreign parent for management and technical services.

Held:
Tribunal ruled arm’s length price determined using CUP/TNMM must reflect risk-bearing and assets employed.

Principle:
Audit must incorporate function, asset, and risk (FAR) analysis.

🧾 Case 5 — CIT v. Dell International Services Ltd. (ITAT Pune, 2014)

Facts:
Dell’s payments for software services and technical support were challenged in TP audit.

Held:
Tribunal upheld ALP based on TNMM but reduced adjustments because comparables were not perfectly matched.

Principle:
Selection of comparables is critical; TP audit adjustments can be contested if benchmarking is inappropriate.

🧾 Case 6 — CIT v. Microsoft Corporation India Pvt. Ltd. (ITAT Bangalore, 2015)

Facts:
Royalty payments to foreign parent questioned for TP compliance.

Held:
Tribunal allowed partial adjustments, taking into account economic substance, contractual obligations, and contribution of Indian entity.

Principle:
TP audits must respect substance over form; audit officers cannot make arbitrary adjustments without analysis.

📌 7. Key Learnings from Case Law

TP audits are heavily fact-based; mere difference from international price does not justify adjustment.

Functional and risk analysis (FAR) is critical to determine ALP.

Comparables must be relevant; improper selection can invalidate adjustment.

Penalties apply only if documentation is inadequate or non-compliant.

Economic substance matters — Indian entity’s contribution and market realities are considered.

TP audits are guided by Section 92C, 92D, 92CA, but judicial scrutiny ensures fairness.

📌 8. Practical Guidance for Transfer Pricing Audits

Maintain robust TP documentation (master and local files).

Perform functional and risk analysis for all related-party transactions.

Use appropriate benchmarking methods (CUP, TNMM, PSM).

Ensure board approvals and evidence of commercial rationale.

Respond to TP audits with supporting economic analysis.

Consider APA or MAP to reduce disputes with tax authorities.

📌 9. Conclusion

Transfer pricing audits ensure compliance with ALP rules and prevent profit shifting.

Judicial precedents highlight importance of FAR analysis, benchmarking, and economic substance.

Companies must maintain complete documentation and follow a methodical approach to withstand audit scrutiny.

Penalties are significant if non-compliance or poor documentation is found, but can be mitigated with careful planning.

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