Transfer Pricing Basics for Small Exporters: Are You Compliant?

Published by: CA Atul Kapur, Senior Partner, Atul Kapur & Associates

Transfer pricing is often thought of as a concern only for large multinational corporations. In reality, any Indian business that transacts with a related party outside India, even a small exporter dealing with a foreign subsidiary or a family member's business abroad, is subject to India's transfer pricing regulations.

With over 38 years of experience working with exporters, travel trade businesses, and export consultants, I have seen how many small and mid-sized exporters unknowingly remain non-compliant. Here is what you need to know.

What Is Transfer Pricing?

Transfer pricing refers to the prices charged for goods, services, intellectual property, or loans between related parties in different countries. India's tax authorities, under Sections 92 to 92F of the Income Tax Act, require that all such transactions be conducted at an arm's length price, meaning the same price that unrelated parties would agree on in a free market.

The objective is to prevent profit shifting: artificially setting prices low when selling to a related party in a low-tax jurisdiction, thereby moving profit out of India and reducing tax liability here.

Who Does Transfer Pricing Apply To?

You are subject to transfer pricing regulations if:

•       You have an international transaction with a related party (associated enterprise)

•       The aggregate value of all such transactions exceeds Rs. 1 crore in a financial year

Related parties include: subsidiaries and holding companies, joint ventures, entities where you own more than 26% equity, and in some cases, businesses controlled by the same family or group.

Common International Transactions for Exporters

•       Selling goods to a foreign subsidiary at a price different from the market rate

•       Receiving commission from a foreign buying agent who is a related party

•       Paying management fees or royalties to a foreign parent or affiliate

•       Receiving loans from or giving loans to a foreign related party

•       Sharing marketing or distribution costs with an overseas related entity

Transfer Pricing Methods Accepted by Indian Tax Authorities

The Income Tax Act prescribes six methods for determining the arm's length price:

•       Comparable Uncontrolled Price (CUP): Most reliable when comparable independent transactions exist

•       Resale Price Method (RPM): Used when goods are resold to an unrelated party without significant value addition

•       Cost Plus Method (CPM): Common in manufacturing and services with identifiable costs

•       Profit Split Method (PSM): For highly integrated transactions where individual contributions cannot be easily separated

•       Transactional Net Margin Method (TNMM): Most widely used in India for services and distribution

•       Other methods: Allowed when none of the above are applicable

Compliance Requirements

•       Form 3CEB: A report from a Chartered Accountant certifying that all international transactions are at arm's length price. Must be filed by October 31 of each year.

•       Master File and Country-by-Country Report (CbCR): Applicable to large multinationals with turnover above Rs. 500 crore (consolidated group revenue above Rs. 5,500 crore for CbCR).

•       Transfer Pricing documentation: Maintain a contemporaneous documentation file demonstrating arm's length pricing. This is critical for audit defence.

Penalties for Non-Compliance

The penalties for transfer pricing violations are severe:

•       200% to 300% of tax evaded if the reported price differs from the arm's length price without reasonable cause

•       2% of the value of the international transaction for failure to maintain documentation

•       2% of the transaction value for failure to furnish Form 3CEB

The good news for small exporters is that the Indian tax authorities have introduced an Advance Pricing Agreement (APA) mechanism, allowing you to agree on a transfer pricing method with the tax department upfront for 5 years, providing certainty and eliminating audit risk.

Our Senior Partner CA Atul Kapur has specialized in transfer pricing and export-related tax matters since 1985. For a transfer pricing review, Form 3CEB filing, or APA guidance, contact us at office@akaca.org or call 011-4134-5501.