Transfer Pricing Audit

A Transfer Pricing Audit ensures that transactions between related entities, such as parent companies, subsidiaries, or affiliates, follow fair market pricing as required by the arm’s length principle. This audit is essential to prevent profit shifting to low-tax jurisdictions and ensure accurate tax payments in India. It applies to international transactions between related enterprises with at least one non-resident entity and specified domestic transactions.  The Transfer Pricing Audit report (Form 3CEB), certified by a Chartered Accountant (CA), must be submitted by 31st October of the following financial year, and the Income Tax Return (ITR) incorporating these transactions must be filed by 30th November to avoid penalties and ensure compliance.

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Transfer Pricing  

To make sure that multinational companies pay the right amount of tax in India, the government introduced Transfer Pricing Regulations. These rules ensure that when businesses within the same group (like a parent company and its subsidiary) trade with each other, they do so at fair prices. This prevents companies from shifting profits to other countries with lower tax rates. When two or more affiliated companies (those with shared ownership) exchange goods, services, or loans, it is important that the prices set for these transactions match what independent businesses would charge each other.

Transfer Pricing Audit

A Transfer Pricing audit is an examination conducted by tax authorities to verify that transactions between related entities or subsidiaries within a multinational enterprise (MNE), often operating across different countries, comply with the arm’s length principle. This principle ensures that the pricing of goods, services, or intellectual property exchanged between related parties aligns with what independent, unrelated parties would agree upon under similar market conditions.

A transfer pricing audit ensures these transactions are:

• Fairly priced (aligned with market rates).
• Properly documented for tax authorities.
• Transparent to prevent manipulation for tax avoidance.

In other words, this audit ensures that businesses are not underpricing or overpricing their internal transactions to reduce taxes. 

Applicability of Transfer Pricing Audit

The Transfer Pricing Audit applies when businesses engage in international or specified domestic transactions that meet certain conditions outlined under the Income Tax Act of 1961. Here’s when the audit becomes applicable:

International Transactions (Section 92B)

These are transactions between two or more associated enterprises, with at least one entity being a non-resident. Examples include:

• Purchase, sale, or lease of tangible or intangible property.
• Provision of services between associated entities.
• Lending or borrowing of money.
• Any other transaction that affects the enterprises' profits, income, losses, or assets.

The audit ensures these transactions adhere to the arm’s length principle to prevent profit shifting or tax manipulation.

Deemed International Transactions (Section 92B(2)):

• Even if a transaction is with a third party, it can be treated as an international transaction if:
• There is a prior agreement between the third party and an associated enterprise.

• The terms of the transaction are influenced or controlled by the associated enterprise.

Specified Domestic Transactions (Section 92BA):

Transfer pricing rules also apply to domestic transactions between related entities if:

• The transaction value exceeds ?20 crore (?200 million) during the financial year.
• These transactions include payments like management fees or royalty payments between Indian entities.

Exemption from Transfer Pricing Rules (Section 92(3)):

• Transfer pricing provisions do not apply if their effect reduces taxable income or increases losses in India. The regulations are intended only to prevent tax evasion, not to provide tax benefits.

In summary, the Transfer Pricing Audit applies to cross-border and certain domestic transactions that could impact profits or tax liabilities.

Why is a Transfer Pricing Audit Important?

A transfer pricing audit helps:

• Ensures Fair Market Pricing: Verifies that transactions between related entities are priced the same as those between independent companies.
• Prevents Tax Evasion and Profit Shifting: Ensures companies do not manipulate prices to shift profits to low-tax countries.
• Promotes Transparency: Provides clarity to tax authorities through detailed records of internal transactions.
• Ensures Compliance with Tax Regulations: Helps businesses meet transfer pricing laws and avoid legal complications.
• Reduces Penalty Risks: Minimizes the likelihood of fines or penalties from the Income Tax Department for non-compliance.
• Prepares for Regulatory Scrutiny: Ensures businesses have proper documentation to withstand tax audits.
• Facilitates Smooth Cross-Border Operations: Builds trust with regulators, allowing companies to operate confidently across jurisdictions.

Transfer Pricing Documentation Requirements

To comply with transfer pricing regulations and successfully complete a Transfer Pricing Audit, companies must prepare and maintain specific documentation. These documents ensure transparency, proper reporting, and alignment with the arm’s length principle. Here are the key documents required:

Transfer Pricing Certification (Form 3CEB)

This is a mandatory certificate that must be signed by a Chartered Accountant (CA).  Form 3CEB consists of three parts:

• Part A: General information about the company.
• Part B: Details of international transactions.
• Part C: Information on specified domestic transactions.

 This certification confirms that all related-party transactions comply with transfer pricing rules.

Country-by-Country (CbC) Report:

As per the BEPS (Base Erosion and Profit Shifting) Action Plan 13, the OECD mandates multinational companies to submit a Country-by-Country Report. This report provides financial details for each jurisdiction where the company operates, including:

• Income tax paid
• Revenue and capital
• Main financial data

It ensures local tax authorities can assess whether profits are appropriately allocated and taxed.

Master File

• The Master File provides a comprehensive overview of a company’s global operations and transfer pricing policies.
• It includes key information about the company’s structure, operations, and the methodology used for pricing transactions.

Transaction Documentation:

• Companies must also maintain detailed records of all international and specified domestic transactions.
• These documents include agreements, invoices, pricing methodologies, and any other supporting material related to the transfer pricing audit.

Importance of Maintaining Proper Documentation: Failure to maintain and submit the required documentation can result in severe penalties for non-compliance. Proper records ensure alignment with regulations and protect companies from tax disputes. It is essential to complete and submit Form 3CEB and other required reports before the relevant deadlines to avoid financial and legal consequences.

Key Legislative Provisions Governing Transfer Pricing Audits

Several important legislative provisions guide the transfer pricing audit process to ensure transparency, compliance, and adherence to fair pricing principles. These provisions include:

• Accurate Record-Keeping: All entities involved in international or cross-border transactions must maintain accurate and up-to-date records of their dealings to ensure compliance with transfer pricing regulations.
• Use of Market Values: Profits from overseas transactions must be calculated using market values. The arm’s length price is determined by considering factors such as the type of transaction, the nature of the business, and other relevant conditions.
• The Central Board of Direct Taxes (CBDT) provides multiple methods to calculate arm's length prices, including:
  • Comparable Uncontrolled Price (CUP) Method
  • Resale Price Method (RPM)
  • Cost Plus Method (CPM)
  • Transactional Net Margin Method (TNMM)
  • Profit Split Method (PSM)

• Determining the Arm’s Length Price: If multiple fair prices are found for a transaction, the arm’s length price is determined by calculating the average of those prices.
• Form 3CEB and Audit Report Submission: Entities involved in international or specified domestic transactions must submit a transfer pricing audit report certified by a Chartered Accountant (CA) at the end of the fiscal year. This report must be submitted using Form 3CEB before filing the company’s Income Tax Return.

Procedure for Transfer Pricing Audit 

Transfer Pricing (TP) Audit must be conducted and completed by a Chartered Accountant (CA), as mandated by Indian tax regulations. The CA is crucial in ensuring that all related-party transactions comply with the arm’s length principle and meet the documentation standards set by the Income Tax Act of 1961.

Engage a Chartered Accountant (CA)

The first step is to appoint a qualified Chartered Accountant (CA) who will oversee the entire audit process and certify Form 3CEB.

Identify Related Parties and Transactions

The CA reviews the company’s operations to identify all related-party transactions, including sales, loans, services, royalties, or asset transfers, involving domestic and international entities.

Select the Appropriate Transfer Pricing Method

Based on the nature of the transactions, the CA selects the most suitable pricing method.

Collect and Verify Documentation:

• The CA helps the company gather all necessary agreements, invoices, and financial records.
• Benchmarking data is collected to compare the company’s prices with those of similar independent companies.

Analyse and Benchmark Transactions:

The CA conducts a benchmark analysis to ensure the transactions comply with the arm’s length principle, meaning they reflect fair market value.

Transfer Pricing Audit Report – Form 3CEB

Once the transfer pricing audit is completed, businesses must prepare a comprehensive report detailing the findings, pricing methods, and supporting documentation for all related-party transactions. This report must be presented in Form 3CEB, as mandated by the Income Tax Act, 1961. Form 3CEB includes the specifics of international and specified domestic transactions, ensuring they comply with the arm’s length principle. A chartered accountant (CA) must certify this form to confirm that the transfer prices are documented correctly and align with the market standards. Timely submission of Form 3CEB is essential to avoid penalties and demonstrate compliance with tax regulations.

Prerequisites for Filing Form 3CEB

To successfully file Form 3CEB, the following prerequisites must be fulfilled:

• Both the taxpayer and Chartered Accountant (CA) must be registered on the e-filing portal with valid user IDs and passwords.
• The PAN status of both the taxpayer and CA must be active.
• The taxpayer must assign the CA to prepare and file Form 3CEB.
•  Both the CA and taxpayer must have a valid and active Digital Signature Certificate (DSC) for authentication.

Process to Submit Form 3CEB

Follow these steps to complete and submit Form 3CEB on the e-filing portal:

Add the Chartered Accountant (CA):

The taxpayer must assign the CA by navigating to:

• Authorised Partners - My Chartered Accountant - Add CA.
• Alternatively, go to e-File - Income Tax Forms - File Income Tax Forms - Form 3CEB.

Assign Form 3CEB to the CA:

• After adding the CA, navigate to e-File - Income Tax Forms - File Income Tax Forms and select Form 3CEB.
• Assign the form by selecting the CA’s name, assessment year (AY), and filing type.

CA Reviews the Form Assignment:

• Once assigned, the form will appear in the CA’s worklist - For Your Action.
• The CA can accept or reject the assignment. If rejected, the taxpayer must reassign the form.

CA Fills and Submits Form 3CEB:

• Online Submission: The CA navigates to Worklist - For Your Action - Pending for Upload, fills in the details, and submits the form using the DSC.
• Offline Submission: The CA prepares the form using JSON/XML utility, compresses the file into a .zip folder, and uploads it via the same worklist section. Verification is done using the DSC.

Taxpayer Approves the Form:

• The submitted form will appear in the Taxpayer’s worklist ? For Your Action ? Pending for Acceptance.
• The taxpayer must review and approve the form to complete the submission.

Following these steps ensures Form 3CEB is correctly filed and submitted, fulfilling the compliance requirements for transfer pricing audits.

Transfer Pricing Audit Due Date

The due date for filing the Transfer Pricing Audit report using Form 3CEB is 31st October, following the end of the relevant financial year.

Additionally, businesses subject to transfer pricing regulations must file their income tax returns under Section 139 by 30th November. It is essential to complete the transfer pricing audit and submit Form 3CEB on time, as missing the deadline can result in penalties. 

Penalties for Non-Compliance with Transfer Pricing Regulations

Failure to comply with transfer pricing regulations in India can result in severe penalties and negative consequences for businesses. Below are the potential penalties for non-compliance:

• Penalty for Under-Reported Income: If the transfer pricing adjustment leads to additional taxable income, the penalty can range from 100% to 300% of the under-reported income.
• Penalty for Late Filing or Non-Filing of Form 3CEB: A fine of ?100,000 (approximately $1,200) may be imposed for failure to submit Form 3CEB by the due date.
• Consequences of Insufficient Documentation:  Inadequate or improper documentation can result in additional penalties, making it essential to maintain detailed transfer pricing records.

To avoid penalties, businesses must comply with transfer pricing rules and complete all necessary filings on time, including the filing of Form 3CEB by 31st October 2024 (for the financial year 2023-2024). 

Transfer Pricing Audit and Compliance Support by IndiaFilings

IndiaFilings offers end-to-end assistance for businesses navigating the complexities of Transfer Pricing Audits. Our team of experienced Chartered Accountants (CAs) provides full support, from preparing essential documentation to certifying and filing Form 3CEB. We ensure compliance with transfer pricing regulations by maintaining accurate records. Additionally, IndiaFilings handles the filing of Income Tax Returns (ITR), ensuring that all reporting obligations are met seamlessly. With our comprehensive services, businesses can stay compliant and avoid penalties.

We've got you covered, from audits and documentation to Form 3CEB preparation and ITR filings. Let our expert CAs handle everything so you can focus on growing your business. Contact us today to get started!