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Domestic transfer pricing and financing transactions between related entities

Sometimes, companies enter into financing transactions with entities or individuals which are connected with them. These entities may be investors, investees and hence may be connected through shareholding, or through common directors. For example, obtaining and providing loans from directors is extremely common during different stages of a company’s operation. Since 1 April 2012, a ‘domestic transfer pricing’ regime has been introduced, which entitles tax officers to disregard the actual price of a transaction if it appears to be ‘excessive’ or ‘unreasonable’ keeping in mind the fair market value of the products or services that have been transacted. This is done with a view to prevent tax arbitrage by related entities. For example, an interest-free loan to a director from a company, or alternately, an extremely high interest rate loan from a director to a company, can be ways to channelize actual income from one source to another to save tax - these are sought to be prevented by the domestic transfer pricing regime.
Broadly, the following kinds of transactions must be undertaken on an arms-length basis under the act:
  • Transactions between a business vehicle and its directors / partners or their relatives
  • The company and those who have a ‘substantial interest’ in the company.
  • Transactions between another business-owner whose business has substantial interest in the current business.
(Refer to Section 40A(2) of the Income Tax Act for more details)

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