CHAPTER 1 TRANSFER PRICING- AN INTRODUCTION
Transfer pricing is very important in economic sense as it impacts foreign investment. These transactions are also not subject to the same set of circumstances worldwide and each transaction may be affected by different variables. This is essential due to the rise and the growth of the Multi National Enterprises (MNE
). These are enterprises that have the flexibility and the ability to place their enterprises anywhere in the globe. This is of importance as the role of MNE which have businesses all over the globe is increasing. The advancement in technology has contributed to the removal of barriers for trade and commerce. Significant amount of global trade has now being carried out with regard to the transfer of the goods and services as the entities cannot operate on a standalone basis. A large amount of trade and commerce is carried on between these MNEâ€™s and such transaction between the enterprises of an MNE is known as â€˜intra group transactionsâ€™. More than 60 (sixty) per cent of global trade is carried out between associated enterprises of MNE.
This however brings up new challenges and issues in the commercial sense as well as for the purpose of taxation. The issue of transfer pricing is one such issue as these corporations would like to change the shareholding patterns. To minimise the tax burdens the MNEâ€™s, the transactions between the parties is not governed by the market considerations but a single enterprise. There objective is to arrange the cash flow in such a method between them to minimise tax liability and this would be done by shifting the tax liability to a tax friendly jurisdiction where they would not be taxed as much as they would have been in the country from which they are making the transfer. To combat this provision the concept of transfer pricing was introduces to ensure that the profits that ought to have been earned in India are not shifted to other jurisdiction either by reducing the income or inflating the expenditure in transaction between various entities belonging to a multinational group.
The transfer prices aim to determine the income of the parties that are involved in the cross border transaction. Tax bases of the countries involved in the transaction are generally affected. This affects the countries as, if one country tries to make an adjustment it would indirectly affect the tax base of the other country. Therefore there are three main issues in transfer pricing and these are regarding jurisdiction, valuation and allocation of the income that is earned. This is very important as there may be common resources that are generally shared between the entities. The reason for the transfer pricing regulation is that most of the MNE try to avoid the payment of the taxes to increase their revenue. One of the other important reasons is that the developing counties in order to be more technologically advanced have liberalised transactions leading to the transfer of knowledge and technical know- how. These regulations are made use of by the MNE and try to circumvent the liability. The presence of certain political and economical uncertainties may also be the reason why the MNEâ€™s try to shift the capital or profit. One of the recourse that is available to the parties is to show that the particular transaction would not lead to an income to the corporation. Therefore the object is to determine the likely profits that would have been earned in India if the transaction was on the basis of the arms length price between the independent entities. However, the authorities in many instance have taken a very aggressive stance against the investment and such agreement that have been entered into by the parties which acts as a deterrent to the MNE who would like to establish their businesses in India.
- TRANSFER PRICING
One party transfers to another goods or services, for a price. That price is known asâ€œtransfer priceâ€ and this may be arbitrary or dictated.
The Organisation for Economic Co-operation and Development (hereinafter â€œOECD
â€) defines transfer pricing as â€˜a price, adopted for book- keeping purposes, which is used to value transactions between affiliated enterprises integrated under the same management at artificially high or low levels in order to effect an unspecified income payment or capital transfer between those enterprisesâ€™.
Transfer pricing is the mechanism adopted by MNE for valuing the goods and services traded with their subsidiaries or associate companies abroad so as to lower taxes and to maximize profits.
â€œTransfer Pricingâ€generally refers to prices of transactions between associated enterprises which may take place under conditions differing from those taking place between independent enterprises. 
The Blackâ€™s law dictionary defines it to â€œthe charge assigned to an exchange of goods or services between the corporationsâ€™s organised unitsâ€™.
The expression transfer pricing has of late acquired pejorative meaning as it evokes the idea of systematic manipulation of the prices to reduce the prices artificially to cause loss, avoid tax and duties in a specific country. 
- OECD Guidelines
The Transfer Pricing laws of countries are generally based on the OECD Guidelines on the subject and the current provisions in India have been moulded to a large extent by the OECD guidelines. The OECD was officially born on 30 September 1961 and has now 34(thirty four) member countries.
The OECD companies analyse the problems which the countries are facing and try to bring about a workable solution to deal with the problem by making policies among other things to address the issues. They have identified that this issue is important to both the tax authority as well as the tax payer and have tried through their various policies to maintain the balance of odds in both the parties favour. They have tried to bring and implement workable solutions so that both the parties are not disadvantaged. OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations
is the most important guideline on the matter regarding transfer pricing. This particular guidelines provides for the application of the "arm's length principle" for purposes of cross-border transactions between associated enterprises. Associated enterprise as per these guidelines is an enterprise which satisfies the conditions which have been set forth in Article 9 Sub Paragraphs 1a, 1b of the OECD Model Tax Convention on Income and on Capital (hereinafter as the â€œOECD Model Tax Convention
The principle report which dealt with the issue of transfer pricing is the transfer pricing and the Multinational Enterprises 1979 which was repealed by the OECD Council in the year 1995. The other reports which addressed this issue is the Transfer pricing and the Multinational Enterprises- the taxation issues in 1984
- Transfer pricing in India- a brief history
The Union Budget of India for the financial year 2001â€“2002 introduced comprehensive transfer pricing regulations to the Indian legal and tax laws. The Finance Act 2001 has replaced the earlier Section 92 of the Indian Income-tax Act, 1961 (hereinafter known as the â€œAct
â€) which was based on a restricted and a diminutive form of transfer pricing which was based on Section. 42(2) of the Income Tax Act, 1922. The provision stated above however does not define the term transfer pricing clearly and efficiently but merely dealt with the situation regarding transfer pricing. There were certain conditions which had to exist to invoke the transfer pricing regulation and they are as follows.
- The business should be transacted between a resident and a non resident
- There should be a close connection between the two
- On the account, the course of the business so arranged that the business produces either no profit or less than normal profit to the resident.
Therefore it is safe to conclude that this earlier provision was insufficient to deal with the issue of transfer pricing. In 2001 the compliance with the transfer pricing regulation has become mandatory.
The Circular No 14 December 12, 2001, gives the reasons for changing the provisions of Section 92 with SS. 92- 92 F via the Finance Act, 2001. It states that the earlier provisions regarding the transfer pricing were very vague and no proper guidelines were prescribed as to the maintenance of records by the assessee. It also stated that the increase of the multinational corporations has increased in economical activities and there can be manipulations in the prices charged and paid in the intra-group transactions which eventually lead to the erosion of tax revenues. There was another replacement of the Section 92 through the Circular No 8, August 27, 2002. Through this particular circular various other sections were also amended. Considering all these changes the tax authorities have gotten bolder and more experienced through the passage of the time. They have constantly updating the transfer pricing provisions to meet the global standards. The recent controversial adjustment is with regard to the share valuation and share subscription. The decisions given in Vodafone and Shell have been the reason as to why this has come to light and the corresponding retrospective amendment have been made by the government in this regard.
- Research question
The issues which is sought to be addressed at this stage is
- Whether Capital receipts by way of subscription of shares is covered under the transfer pricing regulation and under the jurisdiction of the Income Tax Act, under Chapter X?
- Whether a single transaction of issue of shares can be treated as two transactions â€“ viz. as that of issue of shares and of grant of a financial accommodation?
- Whether the income tax authorities can challenge the valuation of shares undertaken by the Indian subsidiary during the share subscription at the time of issue of shares?
The methodology used in this research is based on the doctrinal method. This issue in transfer pricing is a relatively new issue. The research will be based on the recent judicial trends, scholarly articles, reports and articles published by recognised organisations who deal with the issue of transfer pricing on a regular basis and are renowned for the services that they provide regarding the same. I would also look into the statistical data that is published by the survey conducting institutions. This will include both original and derivative work or jurist, economist and tax practitioners.
The area of transfer pricing as both a legal as well as an economic implication as it related to the transaction between two associated enterprises in an MNE. We have already established that the no of MNE participating in the market has increased in India since the opening of the market for the benefit of trade and commerce. As the transaction between the associated entities is inevitable, it becomes important as they would go to new avenues which are friendlier to the taxpayer and have a reasonable method of imposing the tax. On the other hand, since it is a taxing issue, we have the revenues interest at the other end. The revenue would not like to give a slightest margin to the tax payer if they feel that they have an authority to tax a particular transaction especially if they feel that the amount to tax is in huge. In light of the conflicting interest the study aims to look at the interpretation and the implication of the laws and regulations with this regard in light of the recent developments.
- Impact and Significance
Transfer pricing is a subject of relatively recent origin in the Indian tax regime. This law is evolving. It reflects the dynamism and which the global trade and commerce is taking place. This area of law due to its wide reaching implication has gained the attention of all the countries and they all are trying to arrive at a legislation which would effectively look into the interest of both the parties concerned. The law regarding transfer pricing has to move in tandem with the global developments in trade and commerce. As we are now aware of the importance of transfer pricing, this particular issue regarding the shares plays a significant role as it indirectly is dealing with the foreign direct investment into India. Through this study a clearer picture of the position of law, the impact of the position of law would be analysed in a way so that it would at a level look into the principle of law enshrined in these provision which may be beneficial for both the parties when there is a dispute. An attempt to resolve the dispute with this regard will be made which would complement the current regime.
Ministry of Finance Department of Revenue, Central Board of Direct Taxes, White paper on black money
, May 2012. See also, Christian, Death and Taxes: The Truth of Tax Dodging
, March 2009. 
See generally KAnga, Palkhiwala, Vyas, The Law and Practice of Income Tax 1736 (LexisNexis Butterworth 9ed.) 
Income Tax department, Transfer Pricing
, available at http://law.incometaxindia.gov.in/DIT/File_opener.aspx?fn=http://law.incometaxindia.gov.in/Directtaxlaws/act2005/tp1.htm
(Last accessed Feb 12, 2013) 
OECD, Glossary of statistical terms. 
Department of Valuation, Transfer pricing
, available at http://www.dov.gov.in/newsite3/tp_agenda.asp
(Last accessed Jan 31, 2013).  Supra
note 1 
Garner, Black Laws Dictionary 1536,( 7th
edn., 1999). 
D.P. Mittal, Law of Transfer pricing In India 9.(Taxmann, 3rd
ed. 2009) 
See, History of OECD available at http://www.oecd.org/about/history/
(Last accessed Jan 31, 2013). 
The OECD Transfer pricing Guidelines for Multinational Enterprises and Tax Administrations, 2010. 
As provided in the guidelines. 
The OECD Transfer pricing Guidelines for Multinational Enterprises and Tax Administrations, 2010. 
Section 42(2) of the Income Tax Act, 1922 has prescribed certain conditions to invoke the transfer pricing provision. 
The Finance Act, 2001, made the compliance with the transfer pricing regulation mandatory. The memorandum with the bill gave an explanation as to the growth of the MNE and the need for a tax legislation to prevent the tax erosion. See
Circular NO. 14 dated 20 November 2001.