International taxation and transfer pricing are complex yet critical areas in the world of corporate finance and tax compliance. With the rise of global business operations and cross-border transactions, companies face various tax challenges. For professionals preparing for interviews in this domain, a strong grasp of key concepts, rules, and recent developments is essential. This article covers frequently asked interview questions on international taxation and transfer pricing, providing clear, easy-to-understand explanations.

What is Transfer Pricing and Why is it Used?

Transfer pricing refers to the pricing of goods, services, or intangible property transferred between associated enterprises (AEs), typically within a multinational group. Since these transactions occur between related parties, there is a risk that prices could be manipulated to shift profits from high-tax jurisdictions to low-tax jurisdictions, reducing overall tax liability.

India introduced transfer pricing regulations to prevent such tax avoidance. By ensuring that related-party transactions are priced on an arm’s length basis—meaning at prices comparable to those between unrelated parties—tax authorities aim to protect the country’s tax base.

Why Did India Introduce Transfer Pricing Regulations?

India introduced transfer pricing rules in 2001, aligning with international practices set by the OECD. Before these rules, multinational corporations could shift profits easily, reducing taxable income in India. With India becoming a major player in the global economy and increasing cross-border transactions, transfer pricing became vital to ensure fair taxation and curb base erosion.

Examples of International Transactions Subject to Transfer Pricing

Transfer pricing applies to a wide range of international transactions between associated enterprises, such as:

• Sale or purchase of goods
• Provision or receipt of services (e.g., technical support, consultancy)
• Transfer or use of tangible or intangible property (e.g., patents, trademarks)
• Financing transactions, including loans and guarantees
• Business restructuring or cost-sharing agreements

Who are Considered Associated Enterprises?

Two enterprises are considered associated if one directly or indirectly controls the other, or both are under common control. Control can arise from ownership of shares, voting power, or the ability to influence management decisions.

Indian transfer pricing laws define associated enterprises broadly to include:

• Holding and subsidiary companies
• Enterprises with shareholding of 26% or more in each other
• Enterprises under common control through a third party

What Documents Are Required for International Transactions?

Under Indian transfer pricing regulations, companies must maintain detailed documentation to support the arm’s length nature of their international transactions. These documents include:

• Nature and terms of the international transaction
• Details of associated enterprises involved
• Functional and risk analysis of the entities
• Industry and economic conditions affecting pricing
• Transfer pricing method applied and justification
• Comparable uncontrolled transactions or companies
• Financial statements and reconciliation statements
• Master file and local file (where applicable)

The documentation must be ready before filing income tax returns and furnished to the tax authorities on demand.

What is the Arm’s Length Principle and How is it Determined?

The arm’s length principle is the cornerstone of transfer pricing. It requires that transactions between associated enterprises be priced as if they were between unrelated parties dealing independently under comparable conditions.

Section 92F of the Indian Income Tax Act defines arm’s length price (ALP) as the price applied or proposed to be applied in a transaction between two unrelated persons under uncontrolled conditions.

To determine ALP, the law considers:

• Persons are unrelated if they are not associated enterprises (Section 92A).
• Conditions are uncontrolled if they are not manipulated or suppressed to achieve predetermined results.

Methods to Compute Arm’s Length Price (Section 92C)

Indian law specifies several methods for calculating ALP, broadly aligned with OECD guidelines. The taxpayer can choose the most appropriate method based on facts and circumstances:

1. Comparable Uncontrolled Price (CUP) Method
   Compares price charged in a controlled transaction to price charged in comparable uncontrolled transactions for identical or similar goods/services.
2. Resale Price Method (RPM)
   Starts with the resale price to an unrelated party and subtracts an appropriate gross margin to arrive at the transfer price for the related party transaction.
3. Cost Plus Method
   Adds an appropriate markup to the cost incurred by the supplier of goods or services in related-party transactions.
4. Profit Split Method
   Splits combined profits from controlled transactions according to the relative value of contributions by the parties, often used for transactions involving unique intangibles.
5. Transactional Net Margin Method (TNMM)
   Examines net profit margin relative to an appropriate base (cost, sales, assets) and compares it with that of comparable uncontrolled transactions.
6. Other Methods Prescribed by the Board
   The Indian tax authorities may prescribe additional methods as required.

Do Transfer Pricing Rules Apply to Domestic Transactions?

Yes, transfer pricing rules apply to certain specified domestic transactions between associated enterprises in India. This was introduced to prevent tax avoidance through manipulation of prices within India itself. Such domestic transactions are treated similarly to international transactions for transfer pricing purposes.

Does Transfer Pricing Apply When an Indian Company Becomes Associated with a Non-Resident in the Last Quarter of the Previous Year?

Yes, the transfer pricing rules apply for the entire previous year, not just the last quarter. Even if association arises late in the year, the income from related-party transactions throughout the year is subject to transfer pricing regulations.

Do Transfer Pricing Rules Apply Between Head Office and Branch?

Yes, transactions between a head office and its branch are subject to transfer pricing regulations, as they are treated as associated enterprises. The branch is often considered a dependent agent or permanent establishment for tax purposes.

What Are the Sources of International Tax Law?

International tax law draws from multiple sources, including:

• Domestic tax statutes and regulations of countries
• Bilateral or multilateral tax treaties (Double Taxation Avoidance Agreements – DTAAs)
• OECD Transfer Pricing Guidelines and BEPS Actions
• United Nations Model Tax Convention
• Case laws and rulings from courts and tax authorities

These sources work together to address cross-border taxation issues.

What is Double Taxation Relief and How is it Provided?

Double taxation occurs when the same income is taxed in two or more jurisdictions. To avoid this, countries provide relief through:

1. Exemption Method:
   Income taxed in one country is exempted from tax in the other.
2. Credit Method:
   Tax paid in one country is credited against tax payable in the other, subject to limits.
3. Deduction Method:
   Foreign tax paid is deducted from taxable income.

India generally follows the credit method as per its DTAAs.

What is the Role of Foreign Tax Credit and How is it Computed?

Foreign Tax Credit (FTC) allows a taxpayer to reduce Indian tax liability by the amount of tax paid abroad on the same income. The credit is limited to the lower of foreign tax paid or Indian tax payable on that income.

Computing FTC involves:

• Determining foreign income taxable in India
• Calculating foreign taxes paid
• Matching income to respective foreign taxes
• Applying limitations as per Indian tax law

What is Covered Under Undisclosed Foreign Income and Assets?

The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 targets undisclosed foreign income and assets held by residents. It imposes heavy penalties and tax on:

• Income from foreign assets not disclosed in tax returns
• Foreign bank accounts, financial interests, properties
• Trusts and financial instruments held abroad

This Act aims to curb tax evasion and promote transparency.

What is the Multilateral Instrument (MLI) and Its Role in BEPS?

The Multilateral Instrument is an international treaty developed under the OECD’s Base Erosion and Profit Shifting (BEPS) project. It modifies existing bilateral tax treaties to:

• Implement anti-abuse provisions
• Enhance dispute resolution mechanisms
• Address treaty shopping and hybrid mismatch arrangements

India has signed and adopted the MLI to strengthen its treaty network.

What are General Anti-Avoidance Rules (GAAR) and When Do They Apply?

GAAR provisions, effective in India from April 2017, are designed to counter aggressive tax avoidance. Under GAAR, tax authorities can deny tax benefits if an arrangement lacks commercial substance and is primarily aimed at obtaining tax benefits.

GAAR applies to:

• Arrangements entered into after April 1, 2017
• Transactions that meet specific criteria for impermissible avoidance
• Cases where primary purpose is tax avoidance

What is an Impermissible Avoidance Agreement (IAA)?

An IAA is an arrangement lacking commercial substance and entered to obtain tax benefits. It is tested through:

• Primary Condition: Tax benefit must be the main purpose of the arrangement.
• Tainted Element Test: Arrangement involves non-arm’s length conditions, misuse of tax provisions, or other tax avoidance features.

If both conditions are satisfied, GAAR provisions apply.

What is the Safe Harbour Rule?

Safe Harbour Rules provide certainty to taxpayers by specifying predefined margins or conditions under which transfer pricing adjustments will not be made by tax authorities.

These rules reduce compliance burden and litigation risk for eligible taxpayers.

What is an Advance Pricing Agreement (APA)?

An APA is an agreement between a taxpayer and tax authorities on the transfer pricing methodology for future transactions. It provides certainty and prevents disputes on transfer pricing.

Types of APAs include:

• Unilateral (between taxpayer and one tax authority)
• Bilateral (involving two countries)
• Multilateral (involving more than two countries)

Who is Authorized to Furnish Transfer Pricing Reports?

Section 92E requires transfer pricing reports to be furnished by a Chartered Accountant or any other person authorised by the Indian government. The report must accompany the income tax return.

Is There a Statutory Deadline for Submission of Transfer Pricing Documentation?

Yes. Transfer pricing documentation must be prepared and submitted along with the income tax return. Typically, the due date is 30th September following the end of the relevant financial year.

What is Meant by ‘International Transaction’ in Transfer Pricing?

An international transaction means any transaction between associated enterprises involving:

• Transfer or acquisition of goods, services, or intangible assets
• Lending or borrowing of funds
• Business restructuring or cost-sharing
• Any other transaction affecting profits or losses

The key criterion is that the transaction crosses international borders between related parties.

How are Business Process Outsourcing (BPO) Units Taxed in India?

BPO units are taxed based on the nature of their services and transactions. If the BPO is part of a multinational group, transfer pricing rules apply to ensure arm’s length pricing for services rendered to related enterprises abroad.

Income is subject to Indian income tax, and withholding tax provisions may apply on payments made to non-residents.

Can Residents Seek Advance Rulings from the Authority for Advance Ruling (AAR)?

Yes. Indian residents or non-residents with business operations in India can seek advance rulings on tax matters, including transfer pricing. The ruling is binding only on the applicant and tax authorities concerning the applicant’s case.

What Tax Can Be Charged by Indian Government from Foreign Companies like Facebook and at What Rate?

India taxes foreign companies earning income from digital services through provisions like the Equalisation Levy and applicable income tax provisions. The Equalisation Levy currently stands at 2% on specified digital transactions.

Additionally, India has introduced rules to tax income from significant economic presence, impacting companies like Facebook.

Conclusion

Interview preparation in international taxation and transfer pricing requires a deep understanding of core concepts, practical scenarios, and current regulatory frameworks. The questions outlined here cover foundational and advanced topics that are frequently tested in interviews.

Knowing how to explain these concepts clearly and relate them to India’s tax context will greatly enhance your chances of success. Keep abreast of updates in transfer pricing rules, BEPS actions, and case laws to remain relevant in this evolving domain.