In an earlier article, we looked at how transfer pricing rules can impact Non Resident Indians (NRIs) setting up businesses in India. In a nutshell, two commonly owned companies located in different countries also fall in two distinct tax jurisdictions, and the tax authorities in each jurisdiction will want their fair share of profits and taxes. The Indian transfer pricing code states that income arising from international transactions between associated enterprises should be computed having regard to arm's-length principles. We saw these rules in the earlier article.

Today we look at the ideal process for setting up a transfer pricing policy.

Step 1: Transfer pricing planning study
Transfer pricing consultants perform a planning study to assist you in formulating a practical and commercially viable transfer pricing policy. The various prescribed transfer pricing methods are evaluated and the best one is chosen depending on the facts and circumstances of your business. These studies also review the nature of inter-company transactions and help to understand the functional and risk profiles of the parties to the transactions.

"While this step is not mandatory, it is highly recommended to prepare a transfer pricing planning analysis at the outset, before you begin your cross-border operations. It helps in setting up proper intercompany agreements and to manage the profitability of the related parties in a manner consistent with their functions and risks", explains Veena Parrikar, a transfer pricing partner at BDO.

Step 2: Documentation

Documentation is a very critical aspect of transfer pricing policy. Transfer pricing documentation is mandatory in India for all international transactions above Rs 10 million.

According to E&Y's Transfer Pricing Global Reference Guide 2013, failure to have sufficient documentation can attract penalties. For instance, for inadequate documentation, a company can be fined up to 2% of the transaction value. For not furnishing an Accountant's Certificate (Form 3CEB) along with the income tax return, the company is fined approximately Rs 100,000 (around US$2,000).

If your company is selected for an audit, having a transfer pricing documentation study in hand makes it easier for the tax authority to understand your business. Moreover, it is evidence that your company established the pricing policy after due diligence and that the intercompany transactions were undertaken in good faith rather than intended to evade taxes.
E&Y's guide also outlines the categories of documents required:

> Ownership structure

> Profile of the multinational group

> Business description

> The nature and terms (including prices) of international transactions

> Description of functions performed, risks assumed and assets employed

> Record of any financial estimates

> Record of uncontrolled transaction with third parties and a comparability evaluation

> Description of methods considered

> Reasons for rejection of alternative methods

> Details of transfer pricing adjustments

> Any other information or data relating to the associated enterprise which may be relevant for determination of the arm's length price

A list of additional optional documents is provided in Rule 10D(3). The taxpayer is required to obtain and furnish an Accountant's Certificate (Form 3CEB) regarding adequacy of documentation maintained.

Documents vary from industry to industry and company to company.

Step 3: Execution and compliance

Once the transfer pricing policy is in place, companies must ensure that the policy is properly implemented by reviewing profitability of the entities at least quarterly. The company must also be able to manage price changes as well as impact of changes in taxes, duties etc.

Step 4: Preparing for audits "The Indian Government is very active in auditing multinational companies for compliance with transfer pricing regulations," Parrikar cautions. "In fact, international transactions above Rs 150 million are compulsorily required to undergo audit," she adds.

E&Y's report further goes on to state that the information technology, business process outsourcing, banking and pharmaceutical sectors have received particular attention for audits.

"Audits are carried out on annual basis, and once a case is selected for transfer pricing audit, there is a high likelihood of recurring audit thereafter. In most cases, the tax authorities do not seem to have adopted a centralized or coordinated approach to audits, with officers in different locations taking divergent positions on similar fact patterns. Substantial documentation is being requested in the course of audit proceedings," the report says.