SECTION - B

INTERNATIONAL TAXATION

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Agreements (DTAA)
This Module includes:

12.1 Types of DTAA

12.2 Models of DTAAs (OECD and UN)

12.3 Interlink of DTAAs with Section 90 of Income Tax Act. 1961

12.4 Overview of Articles in DTAAs

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Agreements (DTAA)
SLOB Mapped against the Module:
1. To develop understanding about various provisions of direct taxation laws and rules
including international taxation laws, and inherent issues that are subject to interpretation
with reference to case laws, etc.
2. To attain abilities to apply the acquired understanding for solving complex taxation problems
and taking tax efficient business decision and execution thereof.

Module Learning Objectives:

After studying this module, the students will be able to -
 Identify the income which are subject to double taxation
 Analyse the various articles of the treaty or convention
 Apply the provision of income tax to provide relief

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 Introduction 12

In home country, tax is an obligation, while in the host country, tax is a cost.
Every nation has a sovereign right to tax its residents/nationals on their global incomes. As a result, the income of
a person can get taxed in both countries i.e. in the home country (country of his residence) as well the host country
(country where income is generated) due to conflict of jurisdictions to tax. In such an environment, the benefits
of international trade and competitive cost advantages would be lost. Double taxation is harmful for movement
of capital, technology transfer, commerce, trade, and of course, people. In order to prevent the injury caused to
international trade and commerce, Article 51 of the Indian Constitution has inter-alia provides that:
“The State shall endeavour to -
a. promote international peace and security;
b. maintain just and equitable relations between nations;
c. foster respect for international law and treaty obligations in the dealings of organised people with one another;
d. encourage settlement of international disputes by arbitration.
It is pertinent to note that entries 10 and 14 of list I of the seventh schedule confer the power on Parliament to
legislate the treaties with foreign countries. Further, this power of Parliament has been delegated to the Central
Government vide sec. 90 and 90A of the Income-tax Act, 1961.

Economic Double Taxation Juridical Double Taxation

� Same income taxed in two or more country but � Two or more states levy taxes on same entity
in the hands of different taxpayers on same income for identical periods
� e.g. business profits and dividend in different � Arises due to overlapping claims of tax
countries jurisdictions
� Tax treaties largely prevent / mitigate juridical
double taxation
Generally, income is taxable on two basis viz. i) Source of income basis and ii) Residential Status basis, which
results into double taxation of the same income of the person. Firstly, such income is taxed in the country in which
such income is generated and again, the same income may be taxed on the basis of residential status of the person
in another country. For instance, Mr. X, an ordinarily resident in India, earned bank interest of ` 1,00,000 on his
money deposited into a bank located in US. In that case, such income is taxable in US on Source of income basis
and again in India as he is an ordinarily resident India. In times when economies are going global and borders
fading, double taxation is still one of the major obstacles to the development of inter-country economic relations.
In order to prevent this hardship or to avoid double taxation, relief is provided to the tax-payer.

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Such relief is provided by two ways:

� Bilateral Relief
� Unilateral Relief

Relief

Bilateral Relief through Unilateral Relief

Agreement [Sec. 91]
[Sec. 90 or Sec. 90A]

Examption Method Tax Credit Method

Exemption with
Full Exemption Direct Credit Indirect Credit Special Credit
tax progression

Ordinary Undertaking Tax

Full Credit Tax Sparing
Credit Credit

Bilateral Relief
In this, the government of two countries enters into an agreement (known as ‘treaties’) to provide relief against
double taxation of the same income. As per Article 2 of the Vienna Convention on Laws of Treaties, 1969, “Treaty”1
means an international agreement concluded between States in written form and governed by international
law, whether embodied in a single instrument or in two or more related instruments and whatever its particular
designation. The relief is granted on the basis of the terms of such agreement. Generally, such an agreement
provides relief through the following methods:
Exemption Method: In this method, one country provides an exemption to such type of income. Generally, the
residence country gave up its right and the country of source is then given the exclusive right to tax such incomes.
a. Full Exemption Method
Under this method, income earned in the State of Source is fully exempt in the State of Residence.
b. Exemption with Progression
Under this method, income from the State of Source is considered by the State of Residence only for the rate
purpose.
E.g., an Indian Company has earned income from Indian sources of ` 75 Lacs. Income from foreign sources (relief
available as per exemption with progression method) is ` 35 Lacs. As per the provisions of the Act, in India, an
additional surcharge of 7% is levied in addition to normal income-tax liability if the total income exceeds ` 1
crore and at the rate of 12% if income exceeds ` 10 crores. Therefore, in the present case, total income for rate
purpose only will exceed ` 1 crore and accordingly, effective rate for tax would be after considering the additional
surcharge of 7%. However, the income on which the effective rate (inclusive of surcharge) would apply will be `
75 Lacs only.

1 Tax Treaties attempt to eliminate double taxation and try to achieve balance and equity. They aim at sharing of tax revenues by the concerned
states on a rational basis. Tax treaties do not always succeed in eliminating Double Taxation, but contain the incidence to a tolerable level. Tax
Treaties or DTAAs are also known as AADT (Agreements for Avoidance of Double Taxation), or DTCs (Double Tax Conventions). These
terms are used interchangeably.

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Mathematically, it would work in this way:

Particulars Amount (`)

Income from India 75,00,000
Income from a foreign county 35,00,000
Total Income 1,10,00,000
Tax on above @ 30% 33,00,000
Add: Surcharge @ 7% 2,31,000
Tax and surcharge 35,31,000
Add: HEC @ 4% 1,41,240
Tax, Surcharge and Cess [A] 36,72,240
Average rate of tax [` 36,72,240 / ` 1,10,00,000 × 100] 33.38%
Relief [` 35,00,000 × 33.38%] [B] 11,68,440
Tax, Surcharge and Cess [A - B] 25,03,800
Which effectively [` 75,00,000 × 30% × 107% × 104%]. If foreign income is not considered then tax on `
75,00,000 would be calculated without considering surcharge, in that case, total income would not exceed the
threshold limit applicable for charging surcharge.

Credit Method: In this method, the resident remains liable in the country of residence on its global income,
however as far as the quantum of tax liabilities is concerned credit or deduction for tax paid in the source country is
given by the residence country against its domestic tax as if the foreign tax were paid to the country of the residence
itself.
Taxpoint: In this type of relief, the mechanism for granting relief is provided in the agreement itself.
a. Full Credit
Total tax paid in the State of Source is allowed as credit against tax payable in the State of Residence.
b. Ordinary Credit
State of Residence allows credit of tax paid in the state of Source restricted to that part of income tax which is
attributable to the income taxable in the state of Residence.
Example
� Mr. A is a resident of country X, went on 3 months assignment to Country Y
� Salary income of Mr. A is ` 24,00,000
� Of the above, Country Y taxed 3 months income of ` 6,00,000 @ 28%
Compute tax liability of Mr. A considering full credit method and ordinary credit method.

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Solution:
Computation of tax liability of Mr. A

Particulars Country X Country Y

Total Income 24,00,000 6,00,000
Tax rate Slab 28%
Tax on above before relief 4,36,800 1,68,000
Relief:
Full Credit 1,68,000
Ordinary Credit [Lower of the following] 1,38,450
- Tax paid in country Y 1,68,000
- Tax paid in country X [` 4,36,800 x ` 6,00,000 / ` 24,00,000] 1,09,200
c. Tax Sparing
State of Residence allows credit for deemed tax paid on income which is otherwise exempt from tax in the
State of Source.
Example
� A Ltd, the parent company, being located in Country X has a branch in Country Y
� Branch earns a profit of ` 10,00,000
� Country X taxes residents on global income @ 30%
� Tax rate in country Y is 25%. However, as a measure to promote economic development therein (like
special economic zones), country Y is not levying any tax.
� DTAA between Country X-Y has tax sparing provisions.
Compute tax sparing if branch operates in a specified area and is not taxed in Y
Solution:
Computation of tax liability of A Ltd

Particulars Country X Country Y

Total Income 10,00,000 10,00,000
Tax on above before relief 3,00,000 0
Relief as per tax sparing provision
Relief [` 10,00,000 x rate of tax in foreign country i.e., 25%] 2,50,000
Tax Payable 50,000 0
Relief is available in country X deeming that tax has been paid in the country Y @ 25% though no tax has been
paid in the country Y.
d. Underlying Tax Credit
Underlying tax credit method attempts to mitigate the economic double taxation. Economic double taxation
occurs where the same income is taxed more than once in the hands of different person in the same tax
jurisdiction. E.g., The profits earned by the corporates are taxed at their hand and the same is again taxed when

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it is distributed to shareholders as dividend. Under underlying credit method, credit is allowed to resident not
only for the taxes withheld against the dividend income but also for the taxes paid on the underlying profits out
of which the said dividend is paid by a company in the overseas jurisdiction. However, underlying credit may
only apply if satisfaction of substantial shareholding requirement is met.
Example
� A Ltd, the parent company, being located in Country X has a subsidiary B Ltd in Country Y
� B Ltd out of its profits of ` 10,00,000 paid dividend to A Ltd ` 1,00,000
� Other income of A Ltd is ` 11,00,000
� Dividend withholding tax rates in Country Y – 15%
� Tax rate in country Y is 25 % and in Country X it is 30%
� DTAA between Country X-Y has an underlying tax credit (UTC) provision
Solution
Computation of tax liability

Particulars A Ltd B Ltd

Total Income 12,00,000 10,00,000
Tax on above before relief 3,60,000 2,50,000
Less: Tax credit for withholding tax 15,000 0
Tax Liability without relief 3,45,000
Relief as per underlying tax credit
Relief [` 10,00,000 x rate of tax in foreign country i.e., 25%] 2,50,000
Tax Payable after relief 95,000 0
Unilateral Relief
The aforesaid method depends on the bilateral activity of both the countries. However, no country will have
such an agreement with every country in the world. To avoid double taxation in such cases, the country of the
residence itself may provide relief on a unilateral basis.

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 Types of DTAA 12.1

2
DTAA can be of two types, limited or comprehensive. Limited DTAA are those which are limited to certain types
of incomes only e.g. DTAA between India and Pakistan is limited to shipping and aircraft profits only.
Comprehensive DTAAs are those which cover almost all types of incomes covered by any model convention.

2 Presently India have DTAA with more than 90 countries

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 Models of DTAAs (OECD and UN) 12.2

G
lobal trade and commerce have made the world a single integrated market. In today’s scenario, no
country can claim that it is self-sufficient. This gives rise to import and export of goods and services.
As and when the global trade started expanding its operations, economic transactions triggered tax
provisions of various jurisdictions. In the absence of any agreement for avoidance of double taxation,
the global business environment was affected. Therefore, a need was felt that there must be formulated a convention
which would enable avoidance of double taxation. This led to series of model tax conventions by various bodies
in different years.
Model tax treaties serve as the starting point (or can be termed as standard format) for negotiations between two
countries. Although model treaties are not legally binding, their language often is incorporated verbatim (or
with only minor alterations) in the text of bilateral treaties. However, sometimes they make changes as per their
requirement and relationship with the other country.
Presently, the following are the model tax conventions which are in vogue –
a. Organisation for Economic Co-operation and Development (OECD) Model
The emergence of present form of OECD Between developed
Model Convention can be traced back to countries
Model Conventions

1927, when the Fiscal Committee of the OECD Model

League of Nations prepared the first draft Advocating Residence
of Model Form applicable to all countries. Principle
Since then, it has been revised several times
Between developed and
and the latest being in the year 2017. OECD developing countries
Model is essentially a model treaty between UN Model
two developed nations. This model advocates Advocating source
residence principle, that is to say, it lays principle
emphasis on the right of state of residence to
tax the income. US Model Treaty with US

b. United Nations (UN) Model

In 1968, the United Nations set up an Adhoc Group of Experts from various developed and developing
countries to prepare a draft model convention between developed and developing countries. In 1980, this
Group finalized the UN Model Convention in its present form. It has further been revised a number of times,
the recent ones being in the year 2021. It gives more weight to the source principle as against the residence
principle of the OECD Model. UN Model is designed to encourage flow of investments from the developed
countries to developing countries. It takes into account sharing of tax-revenue with the country providing
capital. Most of India’s tax treaties are based on the UN Model.

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c. US Model
The US Model convention was first published in 1976 and revised several times. US motel is used by the
United States while entering into tax treaties with various country.
Articles in OECD Model and UN Model
In UN model, there are VII chapters which contains 31 articles whereas VII chapters of the OECD model contains
32 articles. List of articles are as under:

Article OECD Model UN Model

1 Person covered Person covered
2 Taxes covered Taxes covered
3 General definitions General definitions
4 Resident Resident
5 Permanent establishment Permanent establishment
6 Income from immovable property Income from immovable property
7 Business profits Business profits
8 Shipping, inland waterways transport and Shipping, inland waterways transport and air transport
air transport (Alternative A & B)
9 Associated enterprise Associated enterprise
10 Dividends Dividends
11 Interest Interest
12 Royalties Royalties
12A Fee for Technical Services Fee for Technical Services
12B -- Income from automated digital services
13 Capital Gains Capital Gains
14 Deleted Independent personal services
15 Income from employment Dependent personal services
16 Directors’ fees Directors’ fees and remuneration of top-level
managerial officials
17 Entertainers and sportspersons Artistes and sportspersons
18 Pensions Pensions and Social Security Payments (Alternative A
& B)
19 Government service Government service
20 Students Students
21 Other Income Other Income
22 Capital Capital
23A Exemption method Exemption method
23B Credit method Credit method
24 Non discrimination Non discrimination
25 Mutual agreement procedure Mutual agreement procedure (Alternative A & B)

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Article OECD Model UN Model

26 Exchange of information Exchange of information
27 Assistance in the collection of taxes Assistance in the collection of taxes
28 Members of diplomatic missions and Members of diplomatic missions and consular posts
consular posts
29 Entitlement of benefits Entitlement of benefits
30 Territorial extension Entry in force
31 Entry in force Termination
32 Termination
In India, relief for the avoidance of double taxation is provided in both ways. Provisions relating thereto are
enumerated here-in-below:

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Interlink of DTAAs with Section 90 of

12.3
Income Tax Act, 1961
Agreement with foreign countries [Sec. 90] [Bilateral Relief]
The Central Government may enter into an agree­ment with the Government of any country outside India or speci­
fied territory outside India:
a. for the granting of relief in respect of—
(i) income on which have been paid both income-tax under this Act and income-tax in that country or specified
territory, as the case may be, or
(ii) income-tax chargeable under this Act and under the corresponding law in force in that country or specified
territo­ry, as the case may be, to promote mutual economic relations, trade and investment, or
b. for the avoidance of double taxation of income under this Act and under the corresponding law in force in that
country or specified territory, as the case may be, without creating opportunities for non-taxation or reduced
taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining
reliefs provided in the said agreement for the indirect benefit to residents of any other country or territory); or
c. for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this
Act or under the corresponding law in force in that country or specified territory, as the case may be, or
investigation of cases of such evasion or avoidance, or
d. for recovery of income-tax under this Act and under the corresponding law in force in that country or specified
territo­ry, as the case may be,
and may make such provisions as may be necessary for implementing the agreement.
Taxpoint
� Applicability of DTAA
� Where the Central Government has entered into an agreement with the Government of any country or
specified territory outside India for granting relief of tax or avoidance of double taxation, then, in relation
to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they
are more beneficial to that assessee. However, the provisions of Chapter X-A of the Act (i.e., GAAR) shall
apply to the assessee even if such provisions are not beneficial to him.
� Example: If as per DTAA with a foreign country, fee for technical services is to be taxed at the rate of
15% whereas it is taxable u/s 115A of the Act @ 10%, then it will be beneficial to apply sec. 115A. On
the other hand, if as per the provision of DTAA, it is either not taxable or taxable at a rate lower than 10%,
then DTAA is applicable.
� Sections 4 and 5 of the Income-tax Act provide for taxation of global income of an assessee but this is
subject to the provisions of an agreement entered into between the Central Government and the Government
of a foreign country for avoidance of double taxation. In case of any conflict between the provisions of

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the agreement and the Act, the provisions of the agreement would prevail over the Act in view of the
provisions of sec. 90(2) [CIT v Kulandagan Chettiar (P V A L) (2004) (SC)] If any matter or income is not
covered by the agreement, the Income-tax Act shall be applicable.
� When tax rate is determined under DTAA then tax rate prescribed therein shall have to be followed strictly
without any additional taxes thereon in form of surcharge or education cess [DCIT -vs.- BOC Group Ltd.
(2016) 156 ITD 402 (Mum) (Trib)]
� The charge of tax in respect of a foreign company at a rate higher than the rate at which a domestic
company is chargeable, shall not be regarded as less favourable charge or levy of tax in respect of such
foreign company.
� In case of a remittance to a country with which a Double Taxation Avoidance Agreement is in force, the
tax should be deducted at the rate provided in the Finance Act of the relevant year or at the rate provided
in the Double Taxation Avoidance Agreement, whichever is more beneficial to the assessee.
� If no tax liability is imposed under this Act, the question of relief does not arise [UOI vs Azadi Bachao
Andolan (2003) (SC)]
� Relief cannot be granted unless the income which has been taxed in one of the contracting countries has
also suffered tax in the other contracting country. Proof has to be provided of the income having suffered
double taxation.
� Tax Residency Certificate: An assessee, not being a resident, to whom DTAA applies, shall not be entitled to
claim any relief under such agreement unless a certificate of his being a resident in any country outside India
or specified territory outside India, as the case may be, is obtained by him from the Government of that country
or specified territory. Further, the assessee shall also provide such other documents and information, as may be
prescribed.
� Where the Government of the State certified that a person is a resident of that state or has a permanent
establishment in the State, the certificate is binding on the other Government [UOI vs Azadi Bachao
Andolan (2003) (SC)]
� “Specified territory” means any area outside India which may be notified3 as such by the Central Government.
� Meaning of the terms
� Where any term used in an agreement is defined under the said agreement, the said term shall have the
same meaning as assigned to it in the agreement; and where the term is not defined in the said agreement,
but defined in the Act, it shall have the same meaning as assigned to it in the Act and explanation, if any,
given to it by the Central Government.
� Further, any term used but not defined in the Act or in the agreement shall, unless the context other­wise
requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning
as assigned to it in the notification issued by the Central Government.
� Further, where any term is used in any agreement and not defined under the said agreement or the Act,
but is assigned a meaning to it in the notification issued, then, the meaning assigned to such term shall be
deemed to have effect from the date on which the said agreement came into force.

3 Bermuda, British Virgin Islands, Cayman Islands, Gibraltar, Guernsey, Isle of Man, Netherlands Antilles, Macau, Hongkong and Sint Maarten

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Illustration 1.
Mr. Ramesh, a resident Indian, has derived the following incomes for the previous year relevant to the A.Y. 2024-
25:

a. Income from profession in India ` 12,44,000

b. Income from profession in country A (Tax paid in foreign country @ 5%) ` 4,50,000
Compute Indian tax liability of the assessee assuming that as per treaty between India and Country A, ` 4,50,000
is taxable in India. However foreign tax can be set off against Indian tax liability.

Solution:
Computation of total income and tax liability of Mr. Ramesh for the A.Y. 2024-25

Particulars Amount
Income from profession in India 12,44,000
Income from profession in Country A 4,50,000
Gross Total Income 16,94,000
Less: Deduction u/ch. VIA NA
Total income 16,94,000
Tax on above 2,08,200
Add: Health & Education cess 8,328
Tax and cess payable 2,16,528
Less: Relief u/s 90 [` 4,50,000 × 5%] 22,500
Tax payable in India (Rounded off u/s 288B) 1,94,030

Illustration 2.
Shri Anuj, an ordinarily resident in India, provides following details of his income for the previous year relevant
to the A.Y. 2024-25
- Income from India ` 13,40,000
- Income from Country Z ` 12,00,000
- Investment in PPF ` 1,00,000
Further, it is to be noted that:
a) India has avoidance of double taxation agreement with Country Z. According to the said agreement, income is
taxable in the country in which it is earned and not in the other country. However, in the other country, such
income can be included for the purpose of computation of tax rate.
b) Foreign income has been taxed in Country Z @ 20%.
Compute Indian tax payable.
Solution:
Computation of total income and tax liability of Shri Anuj for the A.Y. 2024-25

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Particulars Amount
Income from India 13,40,000
Income from Country Z 12,00,000
Gross Total Income 25,40,000
Less: Deduction u/s 80C [Investment in PPF] NA
Total income 25,40,000
Tax on above 4,62,000
Add: Health & Education cess 18,480
Tax and cess payable 4,80,480
Less: Relief u/s 90 [` 12,00,000 x 18.92%1] 2,27,040
Tax payable in India (Rounded off u/s 288B) 2,53,440
1.
Average rate of Indian tax = ` 4,80,480 / ` 25,40,000 x 100 = 18.92%
Adoption by Central Government of agreements between specified associations for double taxation relief
[Sec. 90A]
Any specified association in India may enter into an agreement with any specified association in the specified
territory outside India and the Central Government may, by notification in the Official Gazette, make such
provisions as may be necessary for adopting and implementing such agreement—
a) for granting of relief in respect of—
(i) income on which have been paid both income-tax under this Act and income-tax in any specified territory
outside India; or
(ii) income-tax chargeable under this Act and under the corresponding law in force in that specified territory
outside India to promote mutual economic relations, trade and investment, or
b) for the avoidance of double taxation of income under this Act and under the corresponding law in force in that
specified territory outside India, without creating opportunities for non-taxation or reduced taxation through
tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided
in the said agreement for the indirect benefit to residents of any other country or territory); or
c) for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this
Act or under the corresponding law in force in that specified territory outside India, or investigation of cases
of such evasion or avoidance, or
d) for recovery of income-tax under this Act and under the corresponding law in force in that specified territory
outside India.
Notes
� Specified association means any institution, association or body, whether incorporated or not, functioning
under any law for the time being in force in India or the laws of the specified territory outside India and which
may be notified as such by the Central Government for the purposes of this section.
� Specified territory means any area outside India which may be notified as such by the Central Government for
the purposes of this section.
� Tax Residency Certificate: An assessee, not being a resident, to whom DTA applies, shall not be entitled to
claim any relief under such agreement unless a certificate of his being a resident in any country outside India

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or specified territory outside India, as the case may be, is obtained by him from the Government of that country
or specified territory. Further, the assessee shall also provide such other documents and information, as may be
prescribed.
� Meaning of the terms
� Where any term used in an agreement entered into is defined under the said agreement, the said term
shall have the same meaning as assigned to it in the agreement; and where the term is not defined in the
said agreement, but defined in the Act, it shall have the same meaning as assigned to it in the Act and
explanation, if any, given to it by the Central Government.
� Where any term is used in any agreement and not defined under the said agreement or the Act, but is
assigned a meaning to it in the notification issued, then, the meaning assigned to such term shall be deemed
to have effect from the date on which the said agreement came into force.
� GAAR: Where a specified association in India has entered into an agreement with a specified association of
any specified territory outside India and such agreement has been notified, for granting relief of tax, or as the
case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies,
the provisions of this Act shall apply to the extent they are more beneficial to that assessee. However, the
provisions of Chapter X-A of the Act (i.e., GAAR) shall apply to the assessee even if such provisions are not
beneficial to him.
Certificate for claiming relief u/s 90 / 90A [Rule 21AB]
� For the purposes certificate discussed in sec. 90 and 90A, the following information shall be provided by an
assessee in Form No. 10F:
i. Status (individual, company, firm etc.) of the assessee;
ii. Nationality (in case of an individual) or country or specified territory of incorporation or registration (in
case of others);
iii. Assessee’s tax identification number in the country or specified territory of residence and in case there is
no such number, then, a unique number on the basis of which the person is identified by the Government
of the country or the specified territory of which the asseessee claims to be a resident;
iv. Period for which the residential status, as mentioned in the certificate, is applicable; and
v. Address of the assessee in the country or specified territory outside India, during the period for which the
certificate, as mentioned above, is applicable.
� The assessee may not be required to provide the information or any part thereof referred above, if the
information is contained in the certificate.
� The assessee shall keep and maintain such documents as are necessary to substantiate the information and an
income-tax authority may require the assessee to provide the said documents in relation to a claim by the said
assessee of any relief under an agreement
� An assessee, being a resident in India, shall, for obtaining a certificate of residence for the purposes of an
agreement referred to in sec. 90 and 90A, make an application in Form No. 10FA to the Assessing Officer.
� The Assessing Officer on receipt of an application and being satisfied in this behalf, shall issue a certificate of
residence in respect of the assessee in Form No. 10FB.

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Countries with which no agreement exists [Sec. 91] [Unilateral Relief]

If any person who is resident in India in any previous year proves that:
a) The income has accrued or arose during the previous year outside India (and which is not deemed to accrue or
arise in India),
b) He has paid in any country income-tax on such income, by deduction or otherwise, under the law in force in
that country
c) India does not have any agreement u/s 90 for the relief or avoidance of double taxation with that country
- then he shall be entitled to the deduction from the Indian income-tax payable by him
(i) of a sum calculated on such doubly taxed income at the average of Indian rate of tax or
(ii) of a sum calculated on such doubly taxed income at the average rate of tax of the said country,
- whichever is the lower, or at the Indian rate of tax if both the rates are equal.
Notes
a) The expression ‘such doubly taxed income’ really purports to indicate that it is only that portion of the income
on which tax has been imposed and been paid by the assessee that is eligible for the double tax relief. Thus,
where the foreign income which suffered tax in the foreign country was ` 88,535, and the income actually
taxed in India after allowances and set off of losses (or deduction under chapter VIA) was ` 63,141, relief
admissible would be calculated on ` 63,141 [CIT v. O.VR.SV.VR. Arunachalam Chettiar]
b) Relief u/s 91 is to be calculated on income country-wise and not on basis of aggregation or amalgamation of
income of all foreign countries [CIT v. Bombay Burmah Trading Corpn. Ltd. (2003)]
c) No benefit is available on income which is deemed to accrue or arise in India, even though such income is
doubly taxed.
Illustration 3.
Mr. Saha, a resident Indian, has derived the following incomes for the previous year relevant to the A.Y. 2024-25:

a. Income from profession ` 3,74,000

b. Royalty on books from foreign country Y (` 3,00,000 is eligible for deduction u/s 80QQB) ` 5,00,000
(Tax paid in foreign country @ 20%)
Compute Indian tax liability, if he has opted for old regime, assuming that India does not have any agreement with
country Y.
Solution:
Computation of total income and tax liability of Mr. Saha for the A.Y. 2024-25

Particulars Amount
Income from profession 3,74,000
Royalty earned in country Y 5,00,000
Gross Total Income 8,74,000
Less: Deduction u/s 80QQB 3,00,000
Total income 5,74,000

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Particulars Amount
Tax on above 27,300
Add: Health & Education cess 1,092
Tax and cess payable 28,392
Average rate of tax [` 28,392 / ` 5,74,000 x 100] 4.95%
Rate of tax in country Y 20%
Relief u/s 91 [4.95%1 of ` 2,00,000] 9,900
Tax payable (Rounded off u/s 288B) 18,490
1.
Indian average tax rate: 04.95% Foreign average tax rate: 20.00%
Relief u/s 91 is available at lower of aforesaid rate. i.e., 4.95%

Illustration 4.
Arvind, a textile merchant and resident Indian is doing business in India and abroad. During the previous year
2023-24, he disclosed the following information:

`
Income from business in India 27,00,000
Income from business in Country- A with which
India does not have agreement for avoidance of double taxation 15,00,000
Income-tax levied by government in Country-A 5,00,000
Loss from business in Country-B with which also
India does not have agreement for avoidance of double taxation (4,00,000)
Contribution to public provident fund 1,50,000
Payment of life insurance premium on the life of his Father and mother 20,000
Compute the tax liability of Arvind for the assessment year 2024-25.

Solution:
Computation of total income and tax liability for the A.Y. 2024-25

Particulars Amount
Income from business in India 27,00,000
Income from business in Country A 15,00,000
Income from business in Country B (-) 4,00,000
Gross Total Income 38,00,000
Less: Deduction u/s 80C NA
Total income 38,00,000
Tax on above 8,40,000
Add: Health & Education cess 33,600
Tax and cess payable 8,73,600

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Particulars Amount
Average rate of tax [` 8,73,600 / ` 38,00,000 x 100] 22.99%
Rate of tax in country A 33.33%
Relief u/s 91 [22.99% of ` 15,00,000]
1 3,44,850
Tax payable (Rounded off u/s 288B) 5,28,750
1.
Indian average tax rate: 22.99% Foreign average tax rate: 33.33%
Relief u/s 91 is available at lower of the aforesaid rates i.e., 22.99%
Illustration 5.
Amar, an individual, resident of India, receives the following payments after TDS during the previous year 2023-
24:
(i) Professional fees on 17.08.2023 2,40,000
(ii) Professional fees on 04.03.2024 1,60,000
Both the above services were rendered in country X on which TDS of ` 50,000 and ` 30,000 respectively has been
deducted. He had incurred an expenditure of ` 2,40,000 for earning both these receipts / income. His income from
other sources in India is ` 5,00,000 and he has made payment of ` 70,000 towards LIC. Compute the tax liability
of Amar and also the relief u/s 91, if any, for A.Y.2024-25.
Solution:
Computation of total income and tax liability of Mr. Amar for the A.Y. 2024-25
Particulars Amount Amount
Income from profession from foreign 4,80,000
Less: Expenses 2,40,000 2,40,000
Income from profession in India 5,00,000
Gross Total Income 7,40,000
Less: Deduction u/s 80C NA
Total income 7,40,000
Tax on above 29,000
Add: Health & Education cess 1,160
Tax and cess payable 30,160
Average rate of tax [` 30,160 / ` 7,40,000 x 100] 4.08%
Rate of tax in Country X 16.67%
Relief u/s 91 [4.08% of ` 2,40,000]
^ 9,792
Tax payable (Rounded off u/s 288B) 20,370
^
Relief u/s 91 is available at a lower rate i.e., 4.08%
Foreign Tax Credit [Rule 128]
An assessee, being a resident shall be allowed a credit for the amount of any foreign tax paid by him in a country or
specified territory outside India, by way of deduction or otherwise, in the year in which the income corresponding
to such tax has been offered to tax or assessed to tax in India, in the manner and to the extent as specified in this

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rule.
Taxpoint:
� More than one year: In a case, where such foreign income is offered to tax in more than one year, credit of
foreign tax shall be allowed across those years in the same proportion in which the income is offered to tax or
assessed to tax in India.
� No credit for interest, etc.: The credit shall be available against the amount of tax, surcharge and cess payable
under the Act but not in respect of any sum payable by way of interest, fee or penalty.
� No credit for disputed tax: No credit shall be available in respect of any amount of foreign tax or part thereof
which is disputed in any manner by the assessee. However, the credit of such disputed tax shall be allowed
for the year in which such income is offered to tax or assessed to tax in India if the assessee within 6 months
from the end of the month in which the dispute is finally settled, furnishes evidence of settlement of dispute
and an evidence to the effect that the liability for payment of such foreign tax has been discharged by him and
furnishes an undertaking that no refund in respect of such amount has directly or indirectly been claimed or
shall be claimed.
Meaning of Foreign Tax

In respect of Foreign Tax

A country or specified territory with Tax covered under the said agreement
which India has entered into an
agreement u/s 90 or 90A
Any other country or specified territory Tax payable under the law of that country or specified territory in the
nature of income-tax referred to in the Explanation to sec. 91 (i.e.,
“income-tax” in relation to any country includes any excess profits tax
or business profits tax charged on the profits by the Government of
any part of that country or a local authority in that country)
Taxpoint
The credit of foreign tax shall be the aggregate of the amounts of credit computed separately for each source of
income arising from a particular country or specified territory outside India and shall be given effect to in the
following manner:
� The credit shall be the lower of the tax payable under the Act on such income and the foreign tax paid on such
income.
� However, where the foreign tax paid exceeds the amount of tax payable in accordance with the provisions
of the agreement for relief or avoidance of double taxation, such excess shall be ignored.
� The credit shall be determined by conversion of the currency of payment of foreign tax at the telegraphic
transfer buying rate on the last day of the month immediately preceding the month in which such tax has been
paid or deducted.
Tax Payable under MAT or AMT
� In a case where any tax is payable u/s 115JB or 115JC, the credit of foreign tax shall be allowed against such
tax in the same manner as is allowable against any tax payable under the provisions of the Act other than the
provisions of the said sections (hereafter referred to as the “normal provisions”).
� Where the amount of foreign tax credit available against the tax payable u/s 115JB or 115JC exceeds the
amount of tax credit available against the normal provisions, then while computing the amount of credit u/s

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115JAA or 115JD in respect of the taxes paid u/s 115JB or 115JC, as the case may be, such excess shall be
ignored.
Documents Required for Credit
Credit of any foreign tax shall be allowed on furnishing the following documents by the assessee within due date
of furnishing return of income:
� a statement of income from the country or specified territory outside India offered for tax for the previous year
and of foreign tax deducted or paid on such income in Form No.67 and verified in the manner specified therein;
� certificate or statement specifying the nature of income and the amount of tax deducted therefrom or paid by
the assessee:
a) from the tax authority of the country or the specified territory outside India; or
b) from the person responsible for deduction of such tax; or
c) signed by the assessee:
● The statement furnished and signed by the assessee shall be valid if it is accompanied by:
A. an acknowledgement of online payment or bank counter foil or challan for payment of tax where
the payment has been made by the assessee;
B. proof of deduction where the tax has been deducted.
Taxpoint: Form No.67 shall also be furnished in a case where the carry backward of loss of the current year results
in refund of foreign tax for which credit has been claimed in any earlier previous year or years.
Permanent Establishment (PE)
One of the important terms that occurs in all the Double Taxation Avoidance Agreements is the term ‘Permanent
Establishment’ (PE) which has not been defined in the Income Tax Act. However as per the Double Taxation
Avoidance Agreements, PE includes, a wide variety of arrangements i.e. a place of management, a branch, an
office, a factory, a workshop or a warehouse, a mine, a quarry, an oilfield etc. Imposition of tax on a foreign
enterprise is done only if it has a PE in the contracting state. Tax is computed by treating the PE as a distinct and
independent enterprise.
Generally, in Indian context, the term permanent establishment” means a fixed place of business through which
the business of an enterprise is wholly or partly carried on. The term “permanent establishment” shall also include:
a. a place of management;
b. a branch;
c. an office;
d. a factory;
e. a workshop;
f. a mine, an oil or gas well, a quarry or any other place of extraction of natural resources;
g. a warehouse in relation to a person providing storage facilities for others;
h. a farm, plantation or other place where agricultural, pastoral, forestry or plantation activities are carried on;
i. premises used as a sales outlet or for receiving or soliciting orders;

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j. an installation or structure, or plant or equipment, used for the exploration for or exploitation of natural
resources;
k. a building site or construction, installation or assembly project, or supervisory activities in connection with
such a site or project, where that site or project exists or those activities are carried on (whether separately or
together with other sites, projects or activities) for more than specified months (generally 6 months).
Exclusion
An enterprise shall not be deemed to have a permanent establishment merely by reason of :
a. the use of facilities solely for the purpose of storage or display of goods or merchandise belonging to the
enterprise;
b. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of
storage or display;
c. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of
processing by another enterprise;
d. the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of
collecting information, for the enterprise; or
e. the maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information,
for scientific research, or for similar activities which have a preparatory or auxiliary character, for the enterprise.
An enterprise of one of the Contracting States shall not be deemed to have a permanent establishment in the other
Contracting State merely because it carries on business in that other State through a broker, a general commission
agent or any other agent of an independent status, where that person is acting in the ordinary course of the person’s
business as such a broker or agent. However, when the activities of such a broker or agent are carried on wholly
or principally on behalf of that enterprise itself or on behalf of that enterprise and other enterprises controlling, or
controlled by or subject to the same common control as, that enterprise, the person will not be considered a broker
or agent of an independent status within the meaning of this paragraph.
Taxation of Business Process Outsourcing Units in India
Taxation of IT-enabled Business Process Outsourcing Units in India as provided in the Circular 05/2004 dated
28-9-2004 are as under:
1. A non-resident entity may outsource certain services to a resident Indian entity. If there is no business
connection between the two, the resident entity may not be a Permanent Establishment of the non-resident
entity, and the resident entity would have to be assessed to income-tax as a separate entity. In such a case, the
non-resident entity will not be liable under the Income-tax Act, 1961.
2. However, it is possible that the non-resident entity may have a business connection with the resident Indian
entity. In such a case, the resident Indian entity could be treated as the Permanent Establishment of the non-
resident entity. The tax treatment of the Permanent Establishment in such a case is under consideration in this
circular.
3. During the last decade or so, India has seen a steady growth of outsourcing of business processes by non-
residents or foreign companies to IT-enabled entities in India. Such entities are either branches or associated
enterprises of the foreign enterprise or an independent Indian enterprise. Their activities range from mere
procurement of orders for sale of goods or provision of services and answering sales related queries to the
provision of services itself like software maintenance service, debt collection service, software development
service, credit card/mobile telephone related service, etc. The non-resident entity or the foreign company will

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be liable to tax in India only if the IT-enabled BPO unit in India constitutes its Permanent Establishment. The
extent to which the profits of the non-resident enterprise is to be attributed to the activities of such Permanent
Establishment in India has been under consideration of the Board.
4. A non-resident or a foreign company is treated as having a Permanent Establishment in India under Article
5 of the Double Taxation Avoidance Agreements entered into by India with different countries if the said
non-resident or foreign company carries on business in India through a branch, sales office etc. or through
an agent (other than an independent agent) who habitually exercises an authority to conclude contracts or
regularly delivers goods or merchandise or habitually secures orders on behalf of the non-resident principal.
In such a case, the profits of the non-resident or foreign company attributable to the business activities carried
out in India by the Permanent Establishment becomes taxable in India under Article 7 of the Double Taxation
Avoidance Agreements.
5. Paragraph 1 of Article 7 of Double Taxation Avoidance Agreements provides that if a foreign enterprise carries
on business in another country through a Permanent Establishment situated therein, the profits of the enterprise
may be taxed in the other country but only so much of them as is attributable to the Permanent Establishment.
Paragraph 2 of the same Article provides that subject to the provisions of Paragraph 3, there shall in each
contracting state be attributed to that Permanent Establishment the profits which it might be expected to make
if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar
conditions and dealing wholly independently with the enterprise of which it is a Permanent Establishment.
Paragraph 3 of the Article provides that in determining the profits of a Permanent Establishment there shall be
allowed as deductions expenses which are incurred for the purposes of the Permanent Establishment including
executive and general administrative expenses so incurred, whether in the State in which the Permanent
Establishment is situated or elsewhere. What are the expenses that are deductible would have to be determined
in accordance with the accepted principles of accountancy and the provisions of the Income-tax Act, 1961.
6. Paragraph 2 contains the central directive on which the allocation of profits to a Permanent Establishment
is intended to be based. The paragraph incorporates the view that the profits to be attributed to a Permanent
Establishment are those which that Permanent Establishment would have made if, instead of dealing with its
Head Office, it had been dealing with an entirely separate enterprise under conditions and at prices prevailing
in the ordinary market. This corresponds to the “arm’s length principle”. Paragraph 3 only provides a rule
applicable for the determination of the profits of the Permanent Establishment, while paragraph 2 requires that
the profits so determined correspond to the profit that a separate and independent enterprise would have made.
Hence, in determining the profits attributable to an IT-enabled BPO unit constituting a Permanent Establishment,
it will be necessary to determine the price of the services rendered by the Permanent Establishment to the Head
office or by the Head office to the Permanent Establishment on the basis of “arm’s length principle”.
7. “Arm’s length price” would have the same meaning as in the definition in sec. 92F(iii) of the Income-tax Act.
The arm’s length price would have to be determined in accordance with the provisions of sec. 92 to 92F of the
Act.

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Overview of Articles in DTAAs 12.4

M
ost of the world’s income tax systems impose tax on the world-wide income of their residents and on
profits with a source in the country where the income is derived by a non-resident. In the event of cross-
border investments or business activities, two jurisdictions may wish to tax the same profits – the source
country because the income is attributable to factors within that country and the residence country because all
residents are taxed on their world-wide incomes. In the absence of any agreement between the source country
and the residence country from which a cross-border investor or business is carried out, the source country would
have primary taxing rights if only because it is in a position to extract the tax before the profits are repatriated to
the residence country. Unless the residence country wished to double tax the income and in effect discourage any
outward investment or business activities by its residents, it will have no choice but to forgo its claimed taxing
rights and limit its tax to the difference, if any, between the tax rate imposed in the source country and that imposed
in the residence country.
Wealthier countries, particularly OECD nations, very often enter into treaties with each other to divide taxing
rights flowing from their competing claims to tax the same income. Treaties limit the source country’s taxing
rights, leaving more room for the country in which the investor or business is resident to tax the profits. Where
two capital exporting nations enter into a tax treaty, the limitation of the source country’s taxing rights has little
overall impact as each jurisdiction will sacrifice to the other taxing rights of profits from cross-border investment
and business. If one party to a treaty is a capital importing nation, the treaty will shift overall taxing rights (and tax
revenue) from the poorer country to the richer country.
Country representatives commonly draw on two model treaties prepared by the OECD and UN respectively when
negotiating tax treaties. The OECD treaty shifts more taxing powers to capital exporting countries while the UN
treaty reserves more for capital importing countries.
Article-wise comparison of these two models are as under:

Para OECD Model Tax Convention UN Model Convention

Article 1
“Persons
Covered” This Convention shall apply to persons who are residents of one or both of the Contracting States.
1 Taxpoint: Person is defined in article 3
2 For the purposes of this Convention, income derived by or through an entity or arrangement that is
treated as wholly or partly fiscally transparent under the tax law of either Contracting State shall be
considered to be income of a resident of a Contracting State but only to the extent that the income
is treated, for purposes of taxation by that State, as the income of a resident of that State.
3 This Convention shall not affect the taxation, by This Convention shall not affect the taxation,
a Contracting State, of its residents except with by a Contracting State, of its residents except
respect to the benefits granted under paragraph 3 with respect to the benefits granted under 8

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Para OECD Model Tax Convention UN Model Convention

of Article 7, paragraph 2 of Article 9 and Articles paragraph 2 of Article 9, [paragraph 2 of Article
19, 20, 23 [A] [B], 24, 25 and 28. 18 (Alternative A) or paragraph 3 of Article 18
(Alternative B)] and Articles 19, 20, [23 A or 23
B], 24, [25 (Alternative A) or 25 (Alternative
B)] and 2
Article 2 “Taxes Covered”
1 This Convention shall apply to taxes on income and on capital imposed on behalf of a Contracting
State or of its political subdivisions or local authorities, irrespective of the manner in which they
are levied.
2 There shall be regarded as taxes on income and on capital all taxes imposed on total income, on
total capital, or on elements of income or of capital, including taxes on gains from the alienation
of movable or immovable property, taxes on the total amounts of wages or salaries paid by
enterprises, as well as taxes on capital appreciation.
Taxpoint
Tax imposed on the following are covered:
� Total income,
� Total capital,
� Elements of income or of capital,
� Gains from the alienation of movable or immovable property,
� Total amounts of wages or salaries paid by enterprises,
� Capital appreciation.
3 The existing taxes to which the Convention shall apply are in particular:
(a) (in State A): ............................................
(b) (in State B): ............................................
4 The Convention shall apply also to any identical or substantially similar taxes which are imposed
after the date of signature of the Convention in addition to, or in place of, the existing taxes. The
competent authorities of the Contracting States shall notify each other of significant changes
made to their tax law.
Article 3 “General Definitions”
1 For the purposes of this Convention, unless the context otherwise requires:
1(a) The term “person” includes an individual, a company and any other body of persons;
1(b) The term “company” means any body corporate or any entity that is treated as a body corporate
for tax purposes;
Taxpoint: It includes unincorporated entity like partnership firm, trust, etc.
1(c) The term “enterprise” applies to the carrying on --
of any business
Taxpoint: Enterprise generally means a profit making entity including carrying on any professional
activity.

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Para OECD Model Tax Convention UN Model Convention

1(d) of The terms “enterprise of a Contracting State” and “enterprise of the other Contracting State” mean
OECD respectively an enterprise carried on by a resident of a Contracting State and an enterprise carried
Model and on by a resident of the other Contracting State;
1(c) of UN
model
1(e) of The term “international traffic” means any transport by a ship or aircraft except when the ship or
OECD aircraft is operated solely between places in a Contracting State and the enterprise that operates the
Model and ship or aircraft is not an enterprise of that State;
1(d) of UN
Taxpoint: Further refer article 8
model
1(f) of The term “competent authority” means:
OECD (i) (in State A): ................................
Model and
(ii) (in State B): ................................
1(e) of UN
model Taxpoint: This definition enables each contracting States, to nominate one or more authorities as
being competent authorities to handle issue relating to the convention.
1(g) of The term “national”, in relation to a Contracting The term “national” means:
OECD State, means:
(i) any individual possessing the nationality
Model and
(i) any individual possessing the nationality of a Contracting State
1(f) of UN
or citizenship of that Contracting State; and
model (ii) any legal person, partnership or association
(ii) any legal person, partnership or association deriving its status as such from the laws in
deriving its status as such from the laws in force in a Contracting State.
force in that Contracting State
Taxpoint: In UN Model, the word “citizenship” was excluded.
1(h) The term “business” includes the performance --
of professional services and of other activities of
an independent character.
1(i) of The term “recognised pension fund” of a State means an entity or arrangement established in that
OECD State that is treated as a separate person under the taxation laws of that State and:
Model and
(i) that is established and operated exclusively or almost exclusively to administer or provide
1(g) of UN
retirement benefits and ancillary or incidental benefits to individuals and that is regulated as
Model
such by that State or one of its political subdivisions or local authorities; or
(ii) that is established and operated exclusively or almost exclusively to invest funds for the
benefit of entities or arrangements referred to in subdivision (i).
2 As regards the application of the Convention at any time by a Contracting State, any term not
defined therein shall, unless the context otherwise requires or the competent authorities agree to
a different meaning pursuant to the provisions of Article 25, have the meaning that it has at that
time under the law of that State for the purposes of the taxes to which the Convention applies, any
meaning under the applicable tax laws of that State prevailing over a meaning given to the term
under other laws of that State.

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Para OECD Model Tax Convention UN Model Convention

Taxpoint: If any term used under tax treaty is not defined there in then the meaning of that term
can be adopted from tax laws of the relevant contracting states. However, where more than one
meaning is given in the tax laws of a contracting State, the meaning which is provided for a
particular provision for an issue, should be considered.
Article 4 “Resident”
1 For the purposes of this Convention, the term For the purposes of this Convention, the term
“resident of a Contracting State” means any “resident of a Contracting State” means any
person who, under the laws of that State, is person who, under the laws of that State, is
liable to tax therein by reason of his domicile, liable to tax therein by reason of that person’s
residence, place of management or any other domicile, residence, place of incorporation,
criterion of a similar nature, and also includes place of management or any other criterion
that State and any political subdivision or local of a similar nature, and also includes that State
authority thereof as well as a recognised pension and any political subdivision or local authority
fund of that State. This term, however, does not thereof as well as a recognized pension fund
include any person who is liable to tax in that of that State. This term, however, does not
State in respect only of income from sources in include any person who is liable to tax in that
that State or capital situated therein. State in respect only of income from sources in
that State or capital situated therein.
2 Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting
States, then his status shall be determined as follows:
a. He shall be deemed to be a resident only of the State in which he has a permanent home
available to him; if he has a permanent home available to him in both States, he shall be
deemed to be a resident only of the State with which his personal and economic relations are
closer (centre of vital interests);
b. If the State in which he has his centre of vital interests cannot be determined, or if he has not
a permanent home available to him in either State, he shall be deemed to be a resident only of
the State in which he has an habitual abode;
c. If he has an habitual abode in both States or in neither of them, he shall be deemed to be a
resident only of the State of which he is a national;
d. If he is a national of both States or of neither of them, the competent authorities of the
Contracting States shall settle the question by mutual agreement.
Taxpoint:
Tie-breaker rules, as the name suggests, serve to determine which of two countries should tax
an individual as his/her country of residence, in case there is a “tie” on the matter between two
countries.
WHICH COUNTRY’S PRESIDENT AM I?

� In which country do you have a permanent home (Owned or

Rented) available to you?
PERMANENT HOSE
� If you have permanent home in more than one country, move to
the next question

� In which country are your personal and economic relations

CENTER OF VITAL closer?
INTEREST � If the center of vital interest cannot be determined, move to the
text questions

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Para OECD Model Tax Convention UN Model Convention

WHICH COUNTRY’S PRESIDENT AM I?

� In which country do you have an habitual abode?

HABITUAL ABODE � If you have an habitual abode in neither of the countries, move
to the next question

� In which country are you a national?

NATIONALITY � If you are a national of both countries or of neither of them,
move to the next question

COMPETENT � The residency will be determined by mutual agreement between

AUTHORITY both the countries ‘competent authority’

3 Where by reason of the provisions of paragraph 1 a person other than an individual is a resident
of both Contracting States, the competent authorities of the Contracting States shall endeavour to
determine by mutual agreement the Contracting State of which such person shall be deemed to be
a resident for the purposes of the Convention, having regard to its place of effective management,
the place where it is incorporated or otherwise constituted and any other relevant factors. In the
absence of such agreement, such person shall not be entitled to any relief or exemption from tax
provided by this Convention except to the extent and in such manner as may be agreed upon by
the competent authorities of the Contracting States.
Taxpoint: This is tie-breaker rule for a person other than an individual.
Article 5 “Permanent Establishment”
1 For the purposes of this Convention, the term “permanent establishment” means a fixed place of
business through which the business of an enterprise is wholly or partly carried on.
2 The term “permanent establishment” includes especially:
a) a place of management;
b) a branch;
c) an office;
d) a factory;
e) a workshop, and
f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
3 A building site or construction or installation The term “permanent establishment” also
project constitutes a permanent establishment encompasses:
only if it lasts more than 12 months.
a. A building site, a construction, assembly
or installation project or supervisory
activities in connection therewith, but only
if such site, project or activities last more
than 6 months;

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Para OECD Model Tax Convention UN Model Convention

b. The furnishing of services, including
consultancy services, by an enterprise
through employees or other personnel
engaged by the enterprise for such purpose,
but only if activities of that nature continue
within a Contracting State for a period or
periods aggregating more than 183 days
in any 12-month period commencing or
ending in the fiscal year concerned.
4 Notwithstanding the preceding provisions of Notwithstanding the preceding provisions of
this Article, the term “permanent establishment” this Article, the term “permanent establishment”
shall be deemed not to include: shall be deemed not to include:
a) the use of facilities solely for the purpose (a) The use of facilities solely for the purpose
of storage, display or delivery of goods or of storage or display of goods or
merchandise belonging to the enterprise; merchandise belonging to the enterprise;
b) the maintenance of a stock of goods or (b) The maintenance of a stock of goods or
merchandise belonging to the enterprise merchandise belonging to the enterprise
solely for the purpose of storage, display solely for the purpose of storage or
or delivery; display;
c) the maintenance of a stock of goods or (c) The maintenance of a stock of goods or
merchandise belonging to the enterprise merchandise belonging to the enterprise
solely for the purpose of processing by solely for the purpose of processing by
another enterprise; another enterprise;
d) the maintenance of a fixed place of business (d) The maintenance of a fixed place of
solely for the purpose of purchasing goods business solely for the purpose of
or merchandise or of collecting information, purchasing goods or merchandise or of
for the enterprise; collecting information, for the enterprise;
e) the maintenance of a fixed place of business (e) The maintenance of a fixed place of
solely for the purpose of carrying on, for the business solely for the purpose of carrying
enterprise, any other activity; on, for the enterprise, any other activity;
f) the maintenance of a fixed place of business (f) The maintenance of a fixed place of
solely for any combination of activities business solely for any combination of
mentioned in subparagraphs a) to e), activities mentioned in subparagraphs (a)
to (e),
provided that such activity or, in the case of
subparagraph f), the overall activity of the fixed provided that such activity or, in the case of
place of business, is of a preparatory or auxiliary subparagraph (f), the overall activity of the
character. fixed place of business, is of a preparatory or
auxiliary character.
Taxpoint: Para 4(a) and 4(b) of the UN model does not include the word “delivery”

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4.1 Paragraph 4 shall not apply to a fixed place Paragraph 4 shall not apply to a fixed place
of business that is used or maintained by an of business that is used or maintained by an
enterprise if the same enterprise or a closely enterprise if the same enterprise or a closely
related enterprise carries on business activities related enterprise carries on business activities
at the same place or at another place in the same at the same place or at another place in the same
Contracting State and Contracting State and:
a. that place or other place constitutes a a. that place or other place constitutes a
permanent establishment for the enterprise permanent establishment for the enterprise
or the closely related enterprise under the or the closely related enterprise under the
provisions of this Article, or provisions of this Article, or
b. the overall activity resulting from the b. the overall activity resulting from the
combination of the activities carried on by combination of the activities carried on by
the two enterprises at the same place, or the two enterprises at the same place, or
by the same enterprise or closely related by the same enterprise or closely related
enterprises at the two places, is not of a enterprises at the two places, is not of a
preparatory or auxiliary character, preparatory or auxiliary character,
provided that the business activities carried on provided that the business activities carried on
by the two enterprises at the same place, or by by the two enterprises at the same place, or by
the same enterprise or closely related enterprises the same enterprise or closely related enterprises
at the two places, constitute complementary at the two places, constitute complementary
functions that are part of a cohesive business functions that are part of a cohesive business
operation. operation
5 Notwithstanding the provisions of paragraphs 1 Notwithstanding the provisions of paragraphs 1
and 2 but subject to the provisions of paragraph and 2 but subject to the provisions of paragraph
6, where a person is acting in a Contracting 7, where a person is acting in a Contracting State
State on behalf of an enterprise and, in doing on behalf of an enterprise, that enterprise shall
so, habitually concludes contracts, or habitually be deemed to have a permanent establishment
plays the principal role leading to the conclusion in that State in respect of any activities which
of contracts that are routinely concluded without that person undertakes for the enterprise, if such
material modification by the enterprise, and a person:
these contracts are a. habitually concludes contracts, or habitually
a. in the name of the enterprise, or plays the principal role leading to the
b. for the transfer of the ownership of, or for the conclusion of contracts that are routinely
granting of the right to use, property owned concluded without material modification
by that enterprise or that the enterprise has by the enterprise, and these contracts are
the right to use, or i. in the name of the enterprise, or
c. for the provision of services by that ii. for the transfer of the ownership of,
enterprise, that enterprise shall be deemed or for the granting of the right to use,
to have a permanent establishment in that property owned by that enterprise or
State in respect of any activities which that that the enterprise has the right to use,
person undertakes for the enterprise, unless or
the activities of such person are limited to iii. for the provision of services by that
those mentioned in paragraph 4 which, if enterprise,

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exercised through a fixed place of business unless the activities of such person are
(other than a fixed place of business to which limited to those mentioned in paragraph 4
paragraph 4.1 would apply), would not make which, if exercised through a fixed place
this fixed place of business a permanent of business (other than a fixed place of
establishment under the provisions of that business to which paragraph 4.1 would
paragraph. apply), would not make this fixed place of
business a permanent establishment under
the provisions of that paragraph; or
b. the person does not habitually conclude
contracts nor plays the principal role
leading to the conclusion of such contracts,
but habitually maintains in that State a
stock of goods or merchandise from which
that person regularly delivers goods or
merchandise on behalf of the enterprise.
6 -- Notwithstanding the preceding provisions
of this Article but subject to the provisions
of paragraph 7, an insurance enterprise of a
Contracting State shall, except in regard to
re-insurance, be deemed to have a permanent
establishment in the other Contracting State if it
collects premiums in the territory of that other
State or insures risks situated therein through a
person.
6 of OECD Paragraph 5 shall not apply where the person Paragraphs 5 and 6 shall not apply where the
Model and acting in a Contracting State on behalf of an person acting in a Contracting State on behalf
7 of UN enterprise of the other Contracting State carries of an enterprise of the other Contracting State
Model on business in the first-mentioned State as an carries on business in the first-mentioned
independent agent and acts for the enterprise State as an independent agent and acts for
in the ordinary course of that business. Where, the enterprise in the ordinary course of that
however, a person acts exclusively or almost business. Where, however, a person acts
exclusively on behalf of one or more enterprises exclusively or almost exclusively on behalf of
to which it is closely related, that person shall one or more enterprises to which it is closely
not be considered to be an independent agent related, that person shall not be considered to be
within the meaning of this paragraph with an independent agent within the meaning of this
respect to any such enterprise. paragraph with respect to any such enterprise.
Taxpoint: In UN Model, provisions for both dependent agent and independent agent is discussed.
7 of OECD The fact that a company which is a resident of a Contracting State controls or is controlled by a
Model and company which is a resident of the other Contracting State, or which carries on business in that
8 of UN other State (whether through a permanent establishment or otherwise), shall not of itself constitute
Model either company a permanent establishment of the other.

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8 of OECD For the purposes of this Article, a person or enterprise is closely related to an enterprise if, based
Model and on all the relevant facts and circumstances, one has control of the other or both are under the
9 of UN control of the same persons or enterprises. In any case, a person or enterprise shall be considered
Model to be closely related to an enterprise if one possesses directly or indirectly more than 50 per cent
of the beneficial interest in the other (or, in the case of a company, more than 50 per cent of
the aggregate vote and value of the company’s shares or of the beneficial equity interest in the
company) or if another person or enterprise possesses directly or indirectly more than 50 per cent
of the beneficial interest (or, in the case of a company, more than 50 per cent of the aggregate vote
and value of the company’s shares or of the beneficial equity interest in the company) in the person
and the enterprise or in the two enterprises.
Article 6 “Income from Immovable Property”
1 to 4 1. Income derived by a resident of a 1. Income derived by a resident of a
Contracting State from immovable property Contracting State from immovable property
(including income from agriculture or (including income from agriculture or
forestry) situated in the other Contracting forestry) situated in the other Contracting
State may be taxed in that other State. State may be taxed in that other State.
2. The term “immovable property” shall 2. The term “immovable property” shall have
have the meaning which it has under the the meaning which it has under the law of
law of the Contracting State in which the the Contracting State in which the property
property in question is situated. The term in question is situated. The term shall
shall in any case include property accessory in any case include property accessory
to immovable property, livestock and to immovable property, livestock and
equipment used in agriculture and forestry, equipment used in agriculture and forestry,
rights to which the provisions of general law rights to which the provisions of general law
respecting landed property apply, usufruct respecting landed property apply, usufruct
of immovable property and rights to of immovable property and rights to
variable or fixed payments as consideration variable or fixed payments as consideration
for the working of, or the right to work, for the working of, or the right to work,
mineral deposits, sources and other natural mineral deposits, sources and other natural
resources; ships and aircraft shall not be resources; ships and aircraft shall not be
regarded as immovable property. regarded as immovable property.
3. The provisions of paragraph 1 shall apply to 3. The provisions of paragraph 1 shall also
income derived from the direct use, letting, apply to income derived from the direct
or use in any other form of immovable use, letting, or use in any other form of
property. immovable property.
4. The provisions of paragraphs 1 and 3 shall 4. The provisions of paragraphs 1 and 3 shall
also apply to the income from immovable also apply to the income from immovable
property of an enterprise. property of an enterprise and to income
from immovable property used for the
performance of independent personal
services

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Article 7 “Business Profits”
1 Profits of an enterprise of a Contracting State The profits of an enterprise of a Contracting
shall be taxable only in that State unless the State shall be taxable only in that State unless
enterprise carries on business in the other the enterprise carries on business in the
Contracting State through a permanent other Contracting State through a permanent
establishment situated therein. If the enterprise establishment situated therein. If the enterprise
carries on business as aforesaid, the profits that carries on business as aforesaid, the profits of
are attributable to the permanent establishment the enterprise may be taxed in the other State
in accordance with the provisions of paragraph but only so much of them as is attributable to
2 may be taxed in that other State. a. that permanent establishment;
b. sales in that other State of goods or
merchandise of the same or similar kind
as those sold through that permanent
establishment; or
c. other business activities carried on in that
other State of the same or similar kind as
those effected through that permanent
establishment.
Taxpoint: Principle of Force of Attraction (FOA) Rule
The basic principle underlying the principle of FOA rule is that when an enterprise establishes a
PE in another country, it brings itself within the jurisdiction of that country to such an extent that
such another country acquires right to tax all profits that enterprise derives from their country,
whether through the involvement of that PE or otherwise. Therefore, under the FOA rule, mere
existence of PE in another country leads to all the profits, that can be said to be derived from that
another country, being treated as taxable in that another country. In substance, such extended scope
empowers the source country to tax profits of the enterprise also from the direct sale of similar
goods/services in the source country, without involvement of the PE. Force of Attraction (FOA) in
a way expands the rights of the source country to tax such business income of an enterprise. UN
model, includes this rule.
2 For the purposes of this Article and Article Subject to the provisions of paragraph 3, where
[23 A] [23 B], the profits that are attributable an enterprise of a Contracting State carries on
in each Contracting State to the permanent business in the other Contracting State through a
establishment referred to in paragraph 1 are the permanent establishment situated therein, there
profits it might be expected to make, in particular shall in each Contracting State be attributed to
in its dealings with other parts of the enterprise, that permanent establishment the profits which
if it were a separate and independent enterprise it might be expected to make if it were a distinct
engaged in the same or similar activities under and separate enterprise engaged in the same
the same or similar conditions, taking into or similar activities under the same or similar
account the functions performed, assets used conditions and dealing wholly independently
and risks assumed by the enterprise through the with the enterprise of which it is a permanent
permanent establishment and through the other establishment.
parts of the enterprise.
Taxpoint: In order to allocate profits, OECD Model uses the term like functions performed, asset
used and risk assumed. However, these terms are not used in the UN model.

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3 In the determination of the profits of a
permanent establishment, there shall be allowed
as deductions expenses which are incurred for
the purposes of the business of the permanent
establishment including executive and general
administrative expenses so incurred, whether in
the State in which the permanent establishment
is situated or elsewhere.
However, no such deduction shall be allowed in
respect of amounts, if any, paid (otherwise than
towards reimbursement of actual expenses) by
the permanent establishment to the head office
of the enterprise or any of its other offices, by
way of royalties, fees or other similar payments
in return for the use of patents or other rights,
or by way of commission, for specific services
performed or for management, or, except in the
case of a banking enterprise, by way of interest
on moneys lent to the permanent establishment.
Likewise, no account shall be taken, in the
determination of the profits of a permanent
establishment, for amounts charged (otherwise
than towards reimbursement of actual
expenses), by the permanent establishment to
the head office of the enterprise or any of its
other offices, by way of royalties, fees or other
similar payments in return for the use of patents
or other rights, or by way of commission for
specific services performed or for management,
or, except in the case of a banking enterprise, by
way of interest on moneys lent to the head office
of the enterprise or any of its other offices.
3 Where, in accordance with paragraph 2, a --
Contracting State adjusts the profits that are
attributable to a permanent establishment of an
enterprise of one of the Contracting States and
taxes accordingly profits of the enterprise that
have been charged to tax in the other State,
the other State shall, to the extent necessary to
eliminate double taxation on these profits, make
an appropriate adjustment to the amount of the
tax charged on those profits. In determining such
adjustment, the competent authorities of the
Contracting States shall, if necessary, consult
each other.

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4 -- In so far as it has been customary in a
Contracting State to determine the profits to
be attributed to a permanent establishment
on the basis of an apportionment of the total
profits of the enterprise to its various parts,
nothing in paragraph 2 shall preclude that
Contracting State from determining the profits
to be taxed by such an apportionment as may
be customary; the method of apportionment
adopted shall, however, be such that the result
shall be in accordance with the principles
contained in this Article.
5 -- For the purposes of the preceding paragraphs,
the profits to be attributed to the permanent
establishment shall be determined by the same
method year by year unless there is good and
sufficient reason to the contrary
4 of OECD Where profits include items of income which are dealt with separately in other Articles of this
Model & Convention, then the provisions of those Articles shall not be affected by the provisions of this
6 of UN Article.
Model
Article 8 “International Shipping and Air Transport”
1 Profits of an enterprise of a Contracting State Alternative A
from the operation of ships or aircraft in
Profits of an enterprise of a Contracting State
international traffic shall be taxable only in that
from the operation of ships or aircraft in
State.
international traffic shall be taxable only in that
State.
2 The provisions of paragraph 1 shall also apply The provisions of paragraph 1 shall also apply
to profits from the participation in a pool, a joint to profits from the participation in a pool, a joint
business or an international operating agency. business or an international operating agency
Alternative B
1. Profits of an enterprise of a Contracting
State from the operation of aircraft in
international traffic shall be taxable only in
that State.

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2. Profits of an enterprise of a Contracting
State from the operation of ships in
international traffic shall be taxable only
in that State unless the shipping activities
arising from such operation in the other
Contracting State are more than casual. If
such activities are more than casual, such
profits may be taxed in that other State.
The profits to be taxed in that other State
shall be determined on the basis of an
appropriate allocation of the overall net
profits derived by the enterprise from its
shipping operations. The tax computed
in accordance with such allocation shall
then be reduced by ___ per cent. (The
percentage is to be established through
bilateral negotiations.)
3. The provisions of paragraphs 1 and 2 shall
also apply to profits from the participation
in a pool, a joint business or an international
operating agency.
Article 9 “Associated Enterprises”
1 Where:
a. an enterprise of a Contracting State participates directly or indirectly in the management,
control or capital of an enterprise of the other Contracting State, or
b. the same persons participate directly or indirectly in the management, control or capital of an
enterprise of a Contracting State and an enterprise of the other Contracting State,
and in either case conditions are made or imposed between the two enterprises in their commercial
or financial relations which differ from those which would be made between independent
enterprises, then any profits which would, but for those conditions, have accrued to one of the
enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits
of that enterprise and taxed accordingly
2 Where a Contracting State includes in the profits of an enterprise of that State—and taxes
accordingly—profits on which an enterprise of the other Contracting State has been charged to
tax in that other State and the profits so included are profits which would have accrued to the
enterprise of the first-mentioned State if the conditions made between the two enterprises had
been those which would have been made between independent enterprises, then that other State
shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In
determining such adjustment, due regard shall be had to the other provisions of the Convention
and the competent authorities of the Contracting States shall, if necessary, consult each other.

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3 -- The provisions of paragraph 2 shall not apply
where judicial, administrative or other legal
proceedings have resulted in a final ruling
that by actions giving rise to an adjustment of
profits under paragraph 1, one of the enterprises
concerned is liable to penalty with respect to
fraud, gross negligence or wilful default.
Article 10 “Dividends”
1 Dividends paid by a company which is a resident
of a Contracting State to a resident of the other
Contracting State may be taxed in that other
State.
2 However, dividends paid by a company which However, dividends paid by a company which
is a resident of a Contracting State may also be is a resident of a Contracting State may also be
taxed in that State according to the laws of that taxed in that State and according to the laws
State, but if the beneficial owner of the dividends of that State, but if the beneficial owner of the
is a resident of the other Contracting State, the dividends is a resident of the other Contracting
tax so charged shall not exceed: State, the tax so charged shall not exceed:
a. 5% of the gross amount of the dividends if a. ___ % (the percentage is to be established
the beneficial owner is a company which through bilateral negotiations) of the gross
holds directly at least 25% of the capital amount of the dividends if the beneficial
of the company paying the dividends owner is a company which holds directly
throughout a 365 day period that includes at least 25% of the capital of the company
the day of the payment of the dividend paying the dividends throughout a 365
(for the purpose of computing that period, day period that includes the day of the
no account shall be taken of changes of payment of the dividend (for the purpose
ownership that would directly result from a of computing that period, no account shall
corporate reorganisation, such as a merger be taken of changes of ownership that
or divisive reorganisation, of the company would directly result from a corporate
that holds the shares or that pays the reorganisation, such as a merger or divisive
dividend); reorganisation, of the company that holds
the shares or that pays the dividend);
b. 15 per cent of the gross amount of the
dividends in all other cases. b. ___ % (the percentage is to be established
through bilateral negotiations) of the gross
The competent authorities of the Contracting
amount of the dividends in all other cases.
States shall by mutual agreement settle the
mode of application of these limitations. This The competent authorities of the Contracting
paragraph shall not affect the taxation of the States shall by mutual agreement settle the
company in respect of the profits out of which mode of application of these limitations. This
the dividends are paid. paragraph shall not affect the taxation of the
company in respect of the profits out of which
the dividends are paid.

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3 The term “dividends” as used in this Article The term “dividends” as used in this Article
means income from shares, “jouissance” shares means income from shares, “jouissance” shares
or “jouissance” rights, mining shares, founders’ or “jouissance” rights, mining shares, founders’
shares or other rights, not being debt-claims, shares or other rights, not being debt claims,
participating in profits, as well as income from participating in profits, as well as income from
other corporate rights which is subjected to the other corporate rights which is subjected to the
same taxation treatment as income from shares same taxation treatment as income from shares
by the laws of the State of which the company by the laws of the State of which the company
making the distribution is a resident. making the distribution is a resident.
4 The provisions of paragraphs 1 and 2 shall not The provisions of paragraphs 1 and 2 shall not
apply if the beneficial owner of the dividends, apply if the beneficial owner of the dividends,
being a resident of a Contracting State, carries on being a resident of a Contracting State, carries
business in the other Contracting State of which on business in the other Contracting State of
the company paying the dividends is a resident which the company paying the dividends is a
through a permanent establishment situated resident, through a permanent establishment
therein and the holding in respect of which the situated therein, or performs in that other State
dividends are paid is effectively connected with independent personal services from a fixed
such permanent establishment. In such case the base situated therein, and the holding in respect
provisions of Article 7 shall apply. of which the dividends are paid is effectively
connected with such permanent establishment
or fixed base. In such case the provisions of
Article 7 or Article 14, as the case may be, shall
apply
5 Where a company which is a resident of a Where a company which is a resident of a
Contracting State derives profits or income from Contracting State derives profits or income
the other Contracting State, that other State may from the other Contracting State, that other
not impose any tax on the dividends paid by the State may not impose any tax on the dividends
company, except insofar as such dividends are paid by the company, except in so far as such
paid to a resident of that other State or insofar as dividends are paid to a resident of that other
the holding in respect of which the dividends are State or in so far as the holding in respect of
paid is effectively connected with a permanent which the dividends are paid is effectively
establishment situated in that other State, nor connected with a permanent establishment or
subject the company’s undistributed profits to a a fixed base situated in that other State, nor
tax on the company’s undistributed profits, even subject the company’s undistributed profits to
if the dividends paid or the undistributed profits a tax on the company’s undistributed profits,
consist wholly or partly of profits or income even if the dividends paid or the undistributed
arising in such other State. profits consist wholly or partly of profits or
income arising in such other State.
Article 11 “Interest”
1 Interest arising in a Contracting State and paid to a resident of the other Contracting State may be
taxed in that other State.
2 However, interest arising in a Contracting State However, interest arising in a Contracting State
may also be taxed in that State according to the may also be taxed in that State and according
laws of that State, but if the beneficial owner of to the laws of that State, but if the beneficial
the interest is a resident of the other Contracting owner of the interest is a resident of the other
State, the tax so charged shall not exceed 10% of Contracting State, the tax so charged shall
the gross amount of the interest. The competent not exceed ___ % [the percentage is to be
authorities of the Contracting States shall by established through bilateral negotiations] of

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mutual agreement settle the mode of application the gross amount of the interest. The competent
of this limitation. authorities of the Contracting States shall by
mutual agreement settle the mode of application
of this limitation
3 The term “interest” as used in this Article means income from debt claims of every kind, whether
or not secured by mortgage and whether or not carrying a right to participate in the debtor’s profits,
and in particular, income from government securities and income from bonds or debentures,
including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges
for late payment shall not be regarded as interest for the purpose of this Article.
4 The provisions of paragraphs 1 and 2 shall not The provisions of paragraphs 1 and 2 shall not
apply if the beneficial owner of the interest, apply if the beneficial owner of the interest,
being a resident of a Contracting State, carries being a resident of a Contracting State, carries
on business in the other Contracting State in on business in the other Contracting State in
which the interest arises through a permanent which the interest arises, through a permanent
establishment situated therein and the debt- establishment situated therein, or performs in
claim in respect of which the interest is paid that other State independent personal services
is effectively connected with such permanent from a fixed base situated therein, and the debt
establishment. In such case the provisions of claim in respect of which the interest is paid is
Article 7 shall apply. effectively connected with
a. such permanent establishment or fixed
base, or with
b. business activities referred to in (c) of
paragraph 1 of Article 7. In such cases the
provisions of Article 7 or Article 14, as the
case may be, shall apply.
5 Interest shall be deemed to arise in a Contracting Interest shall be deemed to arise in a Contracting
State when the payer is a resident of that State. State when the payer is a resident of that State.
Where, however, the person paying the interest, Where, however, the person paying the interest,
whether he is a resident of a Contracting State whether he is a resident of a Contracting State
or not, has in a Contracting State a permanent or not, has in a Contracting State a permanent
establishment in connection with which the establishment or a fixed base in connection with
indebtedness on which the interest is paid was which the indebtedness on which the interest is
incurred, and such interest is borne by such paid was incurred, and such interest is borne
permanent establishment, then such interest by such permanent establishment or fixed base,
shall be deemed to arise in the State in which the then such interest shall be deemed to arise in the
permanent establishment is situated. State in which the permanent establishment or
fixed base is situated.
6 Where, by reason of a special relationship between the payer and the beneficial owner or between
both of them and some other person, the amount of the interest, having regard to the debt claim
for which it is paid, exceeds the amount which would have been agreed upon by the payer and the
beneficial owner in the absence of such relationship, the provisions of this Article shall apply only
to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable
according to the laws of each Contracting State, due regard being had to the other provisions of
this Convention.

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Taxpoint: Special relationship means
a. direct or indirect participation in the management, control and capital
b. relatives
Article 12 “Royalties”
1 Royalties arising in a Contracting State and Royalties arising in a Contracting State and
beneficially owned by a resident of the other paid to a resident of the other Contracting State
Contracting State shall be taxable only in that may be taxed in that other State
other State.
2 -- However, royalties arising in a Contracting
State may also be taxed in that State and
according to the laws of that State, but if the
beneficial owner of the royalties is a resident of
the other Contracting State, the tax so charged
shall not exceed ___% [the percentage is to
be established through bilateral negotiations]
of the gross amount of the royalties. The
competent authorities of the Contracting States
shall by mutual agreement settle the mode of
application of this limitation.
2 of OECD The term “royalties” as used in this Article The term “royalties” as used in this Article
Model and means payments of any kind received as a means payments of any kind received as a
3 of UN consideration for the use of, or the right to use, consideration for the use of, or the right to use,
Model any copyright of literary, artistic or scientific any copyright of literary, artistic or scientific
work including cinematograph films, any patent, work including cinematograph films, or
trade mark, design or model, plan, secret formula films or tapes used for radio or television
or process, or for information concerning broadcasting, any patent, trademark, design
industrial, commercial or scientific experience. or model, plan, secret formula or process, or
for the use of, or the right to use, industrial,
commercial or scientific equipment or for
information concerning industrial, commercial
or scientific experience.
3 of OECD The provisions of paragraph 1 shall not apply The provisions of paragraphs 1 and 2 shall not
Model and if the beneficial owner of the royalties, being apply if the beneficial owner of the royalties,
4 of UN a resident of a Contracting State, carries on being a resident of a Contracting State, carries
Model business in the other Contracting State in on business in the other Contracting State in
which the royalties arise through a permanent which the royalties arise, through a permanent
establishment situated therein and the right or establishment situated therein, or performs in
property in respect of which the royalties are paid that other State independent personal services
is effectively connected with such permanent from a fixed base situated therein, and the right
establishment. In such case the provisions of or property in respect of which the royalties
Article 7 shall apply. are paid is effectively connected with (a)
such permanent establishment or fixed base,
or with (b) business activities referred to in

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(c) of paragraph 1 of Article 7. In such cases the
provisions of Article 7 or Article 14, as the case
may be, shall apply.
5 -- Royalties shall be deemed to arise in a
Contracting State when the payer is a resident
of that State. Where, however, the person
paying the royalties, whether he is a resident of
a Contracting State or not, has in a Contracting
State a permanent establishment or a fixed base
in connection with which the liability to pay
the royalties was incurred, and such royalties
are borne by such permanent establishment or
fixed base, then such royalties shall be deemed
to arise in the State in which the permanent
establishment or fixed base is situated.
4 of OECD Where by reason of a special relationship between the payer and the beneficial owner or between
Model and both of them and some other person, the amount of the royalties, having regard to the use, right or
6 of UN information for which they are paid, exceeds the amount which would have been agreed upon by
Model the payer and the beneficial owner in the absence of such relationship, the provisions of this Article
shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall
remain taxable according to the laws of each Contracting State, due regard being had to the other
provisions of this Convention.
Article 12A “Fees for Technical Services”
1 to 7 -- 1. Fees for technical services arising in a
Contracting State and paid to a resident of
the other Contracting State may be taxed in
that other State.
2. However, notwithstanding the provisions
of Article 14 and subject to the provisions
of Articles 8, 16 and 17, fees for technical
services arising in a Contracting State
may also be taxed in the Contracting State
in which they arise and according to the
laws of that State, but if the beneficial
owner of the fees is a resident of the other
Contracting State, the tax so charged shall
not exceed ___ % of the gross amount of
the fees [the percentage to be established
through bilateral negotiations].
3. The term “fees for technical services” as
used in this Article means any payment
in consideration for any service of a

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managerial, technical or consultancy
nature, unless the payment is made:
(a) to an employee of the person making
the payment;
(b) for teaching in an educational
institution or for teaching by an
educational institution; or
(c) by an individual for services for the
personal use of an individual.
4. The provisions of paragraphs 1 and 2 shall
not apply if the beneficial owner of fees
for technical services, being a resident of
a Contracting State, carries on business in
the other Contracting State in which the
fees for technical services arise through
a permanent establishment situated in
that other State, or performs in the other
Contracting State independent personal
services from a fixed base situated in that
other State, and the fees for technical
services are effectively connected with:
(a) such permanent establishment or fixed
base, or
(b) business activities referred to in (c) of
paragraph 1 of Article 7.
In such cases the provisions of Article 7 or
Article 14, as the case may be, shall apply.
5. For the purposes of this Article, subject
to paragraph 6, fees for technical services
shall be deemed to arise in a Contracting
State if the payer is a resident of that State
or if the person paying the fees, whether
that person is a resident of a Contracting
State or not, has in a Contracting State a
permanent establishment or a fixed base
in connection with which the obligation to
pay the fees was incurred, and such fees are
borne by the permanent establishment or
fixed base.

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6. For the purposes of this Article, fees for
technical services shall be deemed not to
arise in a Contracting State if the payer
is a resident of that State and carries on
business in the other Contracting State
through a permanent establishment situated
in that other State or performs independent
personal services through a fixed base
situated in that other State and such fees
are borne by that permanent establishment
or fixed base.
7. Where, by reason of a special relationship
between the payer and the beneficial owner
of the fees for technical services or between
both of them and some other person, the
amount of the fees, having regard to the
services for which they are paid, exceeds
the amount which would have been agreed
upon by the payer and the beneficial owner
in the absence of such relationship, the
provisions of this Article shall apply only
to the last-mentioned amount. In such case,
the excess part of the fees shall remain
taxable according to the laws of each
Contracting State, due regard being had to
the other provisions of this Convention.
Article 12B “Income from Automated Digital Services”
1 -- Income from automated digital services arising
in a Contracting State, underlying payments
for which are made to a resident of the other
Contracting State, may be taxed in that other
State.
2 -- However, subject to the provisions of Article 8
and notwithstanding the provisions of Article
14, income from automated digital services
arising in a Contracting State may also be taxed
in the Contracting State in which it arises and
according to the laws of that State, but if the
beneficial owner of the income is a resident of
the other Contracting State, the tax so charged
shall not exceed ___ % [the percentage is to be
established through bilateral negotiations] of
the gross amount of the payments underlying
the income from automated digital services.

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3 --
The provisions of paragraph 2 shall not apply
if the beneficial owner of the income from
automated digital services, being a resident
of a Contracting State, requests the other
Contracting State where such income arises,
to subject its qualified profits from automated
digital services for the fiscal year concerned
to taxation at the tax rate provided for in the
domestic laws of that State. If the beneficial
owner so requests, subject to the provisions of
Article 8 and notwithstanding the provisions
of Article 14, the taxation by that Contracting
State shall be carried out accordingly. For
the purposes of this paragraph, the qualified
profits shall be 30% of the amount resulting
from applying the profitability ratio of that
beneficial owner’s automated digital services
business segment to the gross annual revenue
from automated digital services derived from
the Contracting State where such income arises.
Where segmental accounts are not maintained
by the beneficial owner, the overall profitability
ratio of the beneficial owner will be applied to
determine qualified profits. However, where
the beneficial owner belongs to a multinational
enterprise group, the profitability ratio to be
applied shall be that of the business segment
of the group relating to the income covered by
this Article, or of the group as a whole in case
segmental accounts are not maintained by the
group, provided such profitability ratio of the
multinational enterprise group is higher than
the aforesaid profitability ratio of the beneficial
owner. Where the segmental profitability ratio
or, as the case may be, the overall profitability
ratio of the multinational enterprise group
to which the beneficial owner belongs is not
available to the Contracting State in which the
income from automated digital services arises,
the provisions of this paragraph shall not apply;
in such a case, the provisions of paragraph 2
shall apply.

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4 -- For the purposes of paragraph 3, “multinational
enterprise group” means any “group” that
includes two or more enterprises, the tax
residence for which is in different jurisdictions.
Further, for the purposes of paragraph 3, the
term “group” means a collection of enterprises
related through ownership or control such that
it is either required to prepare Consolidated
Financial Statements for financial reporting
purposes under applicable accounting principles
or would be so required if equity interests in
any of the enterprises were traded on a public
stock exchange.
5 -- The term “automated digital services” as used in
this Article means any service provided on the
Internet or another electronic network, in either
case requiring minimal human involvement
from the service provider.
6 -- The term “automated digital services” includes
especially:
(a) online advertising services;
(b) supply of user data;
(c) online search engines;
(d) online intermediation platform services;
(e) social media platforms;
(f) digital content services;
(g) online gaming;
(h) cloud computing services; and
(i) standardized online teaching services
7 -- The provisions of this Article shall not apply
if the payments underlying the income from
automated digital services qualify as “royalties”
or “fees for technical services” under Article 12
or Article 12A as the case may be
8 -- The provisions of paragraphs 1, 2 and 3 shall
not apply if the beneficial owner of the income
from automated digital services, being a resident
of a Contracting State, carries on business in
the other Contracting State in which the income
from automated digital services arises through
a permanent establishment situated in that other
State, or performs in the other Contracting State

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independent personal services from a fixed
base situated in that other State, and the income
from automated digital services is effectively
connected with:
a. such permanent establishment or fixed
base, or
b. business activities referred to in para 1(c)
of Article 7.
In such cases the provisions of Article 7 or
Article 14, as the case may be, shall apply
9 -- For the purposes of this Article and subject
to paragraph 10, income from automated
digital services shall be deemed to arise in a
Contracting State if the underlying payments
for the income from automated digital services
are made by a resident of that State or if the
person making the underlying payments for the
automated digital services, whether that person
is a resident of a Contracting State or not, has in
a Contracting State a permanent establishment
or a fixed base in connection with which the
obligation to make the payments was incurred,
and such payments are borne by the permanent
establishment or fixed base.
10 -- For the purposes of this Article, income from
automated digital services shall be deemed not
to arise in a Contracting State if the underlying
payments for the income from automated
digital services are made by a resident of
that State which carries on business in the
other Contracting State through a permanent
establishment situated in that other State or
performs independent personal services through
a fixed base situated in that other State and
such underlying payments towards automated
digital services are borne by that permanent
establishment or fixed base.
11 -- Where, by reason of a special relationship
between the payer and the beneficial owner of
the income from automated digital services or
between both of them and some other person,
the amount of the payments underlying such
income, having regard to the services for

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which they are paid, exceeds the amount which
would have been agreed upon by the payer
and the beneficial owner in the absence of
such relationship, the provisions of this Article
shall apply only to the last-mentioned amount.
In such case, the excess part of the payments
underlying such income from automated digital
services shall remain taxable according to the
laws of each Contracting State, due regard being
had to the other provisions of this Convention.
Article 13 “Capital Gains”
1 Gains derived by a resident of a Contracting State from the alienation of immovable property
referred to in Article 6 and situated in the other Contracting State may be taxed in that other State.
2 Gains from the alienation of movable property Gains from the alienation of movable property
forming part of the business property of a forming part of the business property of a
permanent establishment which an enterprise of permanent establishment which an enterprise of
a Contracting State has in the other Contracting a Contracting State has in the other Contracting
State, including such gains from the alienation State or of movable property pertaining
of such a permanent establishment (alone or to a fixed base available to a resident of a
with the whole enterprise), may be taxed in that Contracting State in the other Contracting State
other State. for the purpose of performing independent
personal services, including such gains from the
alienation of such a permanent establishment
(alone or with the whole enterprise) or of such
fixed base, may be taxed in that other State.
3 Gains that an enterprise of a Contracting State that operates ships or aircraft in international traffic
derives from the alienation of such ships or aircraft, or of movable property pertaining to the
operation of such ships or aircraft, shall be taxable only in that State
4 Gains derived by a resident of a Contracting Gains derived by a resident of a Contracting
State from the alienation of shares or comparable State from the alienation of shares or
interests, such as interests in a partnership or comparable interests, such as interests in a
trust, may be taxed in the other Contracting State partnership or trust, may be taxed in the other
if, at any time during the 365 days preceding the Contracting State if, at any time during the
alienation, these shares or comparable interests 365 days preceding the alienation, these shares
derived more than 50% of their value directly or or comparable interests derived more than
indirectly from immovable property, as defined 50% of their value directly or indirectly from
in Article 6, situated in that other State. immovable property, as defined in Article 6,
situated in that other State.
5 -- Gains, other than those to which paragraph 4
applies, derived by a resident of a Contracting
State from the alienation of shares of a company,
or comparable interests, such as interests in
a partnership or trust, which is a resident of
the other Contracting State, may be taxed in

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that other State if the alienator, at any time
during the 365 days preceding such alienation,
held directly or indirectly at least ___ % (the
percentage is to be established through bilateral
negotiations) of the capital of that company or
entity.
5 of OECD Gains from the alienation of any property, other Gains derived by a resident of a Contracting
Model and than that referred to in aforesaid paragraphs State from the alienation of a right granted
6 of UN shall be taxable only in the Contracting State of under the law of the other Contracting State
Model which the alienator is a resident. which allows the use of resources that are
naturally present in that other State and that are
under the jurisdiction of that other State, may
be taxed in that other State.
7 -- Subject to paragraphs 4 and 5, gains derived
by a resident of a Contracting State from
the alienation of shares of a company, or
comparable interests of an entity, such as
interests in a partnership or trust, may be taxed
in the other Contracting State if
a. the alienator, at any time during the 365
days preceding such alienation, held
directly or indirectly at least ___% [the
percentage is to be established through
bilateral negotiations] of the capital of that
company or entity; and
b. at any time during the 365 days preceding
the alienation, these shares or comparable
interests derived more than 50% of their
value directly or indirectly from
i. a property any gain from which would
have been taxable in that other State
in accordance with the preceding
provisions of this Article if that gain
had been derived by a resident of
the first-mentioned State from the
alienation of that property at that time,
or
ii. any combination of property referred
to in subdivision (i).
8 -- Gains from the alienation of any property other
than that referred to in paragraphs 1 to 7 shall be
taxable only in the Contracting State of which
the alienator is a resident.

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Article 14 “Independent Personal Services”
1&2 Deleted 1. Income derived by a resident of a
Contracting State in respect of professional
services or other activities of an independent
character shall be taxable only in that State
except in the following circumstances,
when such income may also be taxed in the
other Contracting State:
a. If he has a fixed base regularly available
to him in the other Contracting State
for the purpose of performing his
activities; in that case, only so much
of the income as is attributable to that
fixed base may be taxed in that other
Contracting State; or
b. If his stay in the other Contracting State
is for a period or periods amounting to
or exceeding in the aggregate 183 days
in any 12 months period commencing
or ending in the fiscal year concerned;
in that case, only so much of the
income as is derived from his activities
performed in that other State may be
taxed in that other State.
2. The term “professional services” includes
especially independent scientific, literary,
artistic, educational or teaching activities
as well as the independent activities of
physicians, lawyers, engineers, architects,
dentists and accountants.
Article 15 “Income from Employment” [OECD Model] / “Dependent Personal Services” [UN Model]
1 Subject to the provisions of Articles 16, 18 and 19, salaries, wages and other similar remuneration
derived by a resident of a Contracting State in respect of an employment shall be taxable only in
that State unless the employment is exercised in the other Contracting State. If the employment is
so exercised, such remuneration as is derived therefrom may be taxed in that other State.
2 Notwithstanding the provisions of paragraph Notwithstanding the provisions of paragraph
1, remuneration derived by a resident of a 1, remuneration derived by a resident of a
Contracting State in respect of an employment Contracting State in respect of an employment
exercised in the other Contracting State shall be exercised in the other Contracting State shall be
taxable only in the first-mentioned State if: taxable only in the first-mentioned State if:
a. The recipient is present in the other State a. The recipient is present in the other State
for a period or periods not exceeding in the for a period or periods not exceeding in the
aggregate 183 days in any twelve-month aggregate 183 days in any twelve-month
period commencing or ending in the fiscal period commencing or ending in the fiscal
year concerned; and year concerned; and

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b. The remuneration is paid by, or on behalf b. The remuneration is paid by, or on behalf
of, an employer who is not a resident of the of, an employer who is not a resident of the
other State; and other State; and
c. The remuneration is not borne by a c. The remuneration is not borne by a
permanent establishment which the permanent establishment or a fixed base
employer has in the other State. which the employer has in the other State.
3 Notwithstanding the preceding provisions of this Article, remuneration derived by a resident of a
Contracting State in respect of an employment, as a member of the regular complement of a ship
or aircraft, that is exercised aboard a ship or aircraft operated in international traffic, other than
aboard a ship or aircraft operated solely within the other Contracting State, shall be taxable only
in the first-mentioned State.
Article 16 “Directors’ Fees”
1 Directors’ fees and other similar payments derived by a resident of a Contracting State in his
capacity as a member of the board of directors of a company which is a resident of the other
Contracting State may be taxed in that other State.
2 -- Salaries, wages and other similar remuneration
derived by a resident of a Contracting State
in his capacity as an official in a top-level
managerial position of a company which is a
resident of the other Contracting State may be
taxed in that other State.
Article 17 “Entertainers and Sportspersons”
1 Notwithstanding the provisions of Article 15, Notwithstanding the provisions of Articles
income derived by a resident of a Contracting 14 and 15, income derived by a resident of a
State as an entertainer, such as a theatre, motion Contracting State as an entertainer, such as a
picture, radio or television artiste, or a musician, theatre, motion picture, radio or television
or as a sportsperson, from that resident’s artiste, or a musician, or as a sportsperson, from
personal activities as such exercised in the other his personal activities as such exercised in the
Contracting State, may be taxed in that other other Contracting State, may be taxed in that
State. other State.
2 Where income in respect of personal activities Where income in respect of personal activities
exercised by an entertainer or a sportsperson exercised by an entertainer or a sportsperson in
acting as such accrues not to the entertainer or his capacity as such accrues not to the entertainer
sportsperson but to another person, that income or sportsperson himself but to another
may, notwithstanding the provisions of Article person, that income may, notwithstanding the
15, be taxed in the Contracting State in which provisions of Articles 7, 14 and 15, be taxed in
the activities of the entertainer or sportsperson the Contracting State in which the activities of
are exercised. the entertainer or sportsperson are exercised.
Article 18 “Pensions” [OECD Model] / “Pensions and Social Security Payments” [UN Model]
Subject to the provisions of paragraph 2 Alternative A
of Article 19, pensions and other similar
1. Subject to the provisions of paragraph 2
remuneration paid to a resident of a Contracting
of Article 19, pensions and other similar
State in consideration of past employment shall
remuneration paid to a resident of a
be taxable only in that State.
Contracting State in consideration of past
employment shall be taxable only in that
State.

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2. Notwithstanding the provisions of
paragraph 1, pensions paid and other
payments made under a public scheme
which is part of the social security system
of a Contracting State or a political
subdivision or a local authority thereof
shall be taxable only in that State.
Alternative B
1. Subject to the provisions of paragraph 2
of Article 19, pensions and other similar
remuneration paid to a resident of a
Contracting State in consideration of past
employment may be taxed in that State.
2. However, such pensions and other similar
remuneration may also be taxed in the other
Contracting State if the payment is made by
a resident of that other State or a permanent
establishment situated therein.
3. Notwithstanding the provisions of
paragraphs 1 and 2, pensions paid and
other payments made under a public
scheme which is part of the social security
system of a Contracting State or a political
subdivision or a local authority thereof
shall be taxable only in that State.
Article 19 “Government Service”
1 a. Salaries, wages and other similar a. Salaries, wages and other similar
remuneration paid by a Contracting State or remuneration paid by a Contracting
a political subdivision or a local authority State or a political subdivision or a local
thereof to an individual in respect of services authority thereof to an individual in
rendered to that State or subdivision or respect of services rendered to that State
authority shall be taxable only in that State. or subdivision or authority shall be taxable
only in that State.
b. However, such salaries, wages and other
similar remuneration shall be taxable only b. However, such salaries, wages and other
in the other Contracting State if the services similar remuneration shall be taxable only
are rendered in that State and the individual in the other Contracting State if the services
is a resident of that State who: are rendered in that other State and the
individual is a resident of that State who:
i. is a national of that State; or
i. is a national of that State; or
ii. did not become a resident of that State
solely for the purpose of rendering the ii. did not become a resident of that State
services. solely for the purpose of rendering the
services.

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2 a. Notwithstanding the provisions of paragraph a. Notwithstanding the provisions of
1, pensions and other similar remuneration paragraph 1, pensions and other similar
paid by, or out of funds created by, a remuneration paid by, or out of funds
Contracting State or a political subdivision created by, a Contracting State or a political
or a local authority thereof to an individual subdivision or a local authority thereof to an
in respect of services rendered to that State individual in respect of services rendered to
or subdivision or authority shall be taxable that State or subdivision or authority shall
only in that State. be taxable only in that State.
b. However, such pensions and other similar b. However, such pensions and other similar
remuneration shall be taxable only in the remuneration shall be taxable only in the
other Contracting State if the individual is a other Contracting State if the individual is
resident of, and a national of, that State. a resident of, and a national of, that other
State.
3 The provisions of Articles 15, 16, 17 and 18 shall apply to salaries, wages, pensions, and other
similar remuneration in respect of services rendered in connection with a business carried on by a
Contracting State or a political subdivision or a local authority thereof.
Article 20 “Students”
Payments which a student or business apprentice Payments which a student or business trainee
who is or was immediately before visiting or apprentice who is or was immediately before
a Contracting State a resident of the other visiting a Contracting State a resident of the
Contracting State and who is present in the first- other Contracting State and who is present
mentioned State solely for the purpose of his in the first-mentioned State solely for the
education or training receives for the purpose purpose of his education or training receives
of his maintenance, education or training shall for the purpose of his maintenance, education
not be taxed in that State, provided that such or training shall not be taxed in that State,
payments arise from sources outside that State. provided that such payments arise from sources
outside that State.
Article 21 “Other Income”
1 Items of income of a resident of a Contracting State, wherever arising, not dealt with in the
foregoing Articles of this Convention shall be taxable only in that State.
2 The provisions of paragraph 1 shall not apply The provisions of paragraph 1 shall not apply
to income, other than income from immovable to income, other than income from immovable
property as defined in paragraph 2 of Article 6, property as defined in paragraph 2 of Article 6,
if the recipient of such income, being a resident if the recipient of such income, being a resident
of a Contracting State, carries on business in the of a Contracting State, carries on business in the
other Contracting State through a permanent other Contracting State through a permanent
establishment situated therein and the right or establishment situated therein, or performs in
property in respect of which the income is paid that other State independent personal services
is effectively connected with such permanent from a fixed base situated therein, and the right
establishment. In such case the provisions of or property in respect of which the income
Article 7 shall apply. is paid is effectively connected with such
permanent establishment or fixed base. In such
case the provisions of Article 7 or Article 14, as
the case may be, shall apply

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3 Notwithstanding the provisions of paragraphs
1 and 2, items of income of a resident of a
Contracting State not dealt with in the foregoing
Articles of this Convention and arising in the
other Contracting State may also be taxed in
that other State.
Taxation of Capital
Article 22 “Capital”
1 Capital represented by immovable property referred to in Article 6, owned by a resident of a
Contracting State and situated in the other Contracting State, may be taxed in that other State.
2 Capital represented by movable property Capital represented by movable property
forming part of the business property of a forming part of the business property of a
permanent establishment which an enterprise of permanent establishment which an enterprise of
a Contracting State has in the other Contracting a Contracting State has in the other Contracting
State may be taxed in that other State State or by movable property pertaining
to a fixed base available to a resident of a
Contracting State in the other Contracting State
for the purpose of performing independent
personal services may be taxed in that other
State.
3 Capital of an enterprise of a Contracting State that operates ships or aircraft in international traffic
represented by such ships or aircraft, and by movable property pertaining to the operation of such
ships or aircraft, shall be taxable only in that State
4 All other elements of capital of a resident of a Contracting State shall be taxable only in that State.
Taxpoint: In UN Model, it is also mentioned that the question of the taxation of all other elements
of capital of a resident of a Contracting State is left to bilateral negotiations. Should the negotiating
parties decide to include in the Convention an article on the taxation of capital, they will have to
determine whether to use the wording of paragraph 4 as shown or wording that leaves taxation to
the State in which the capital is located
Methods for the Elimination of Double Taxation
Article 23 A “Exemption Method”
1 Where a resident of a Contracting State derives income or owns capital which may be taxed in the
other Contracting State, in accordance with the provisions of this Convention (except to the extent
that these provisions allow taxation by that other State solely because the income is also income
derived by a resident of that State or because the capital is also capital owned by a resident of that
State), the first-mentioned State shall, subject to the provisions of paragraphs 2 and 3, exempt such
income or capital from tax.
Taxpoint: Where the exemption method is followed, doubly taxed income or capital shall be
exempted in the resident State and it will be taxable in the source State.
2 Where a resident of a Contracting State derives items of income which, in accordance with the
provisions of Articles 10, 11 (in UN Model 12, 12A and 12B also) may be taxed in the other
Contracting State, the first-mentioned State shall allow as a deduction from the tax on the income of
that resident an amount equal to the tax paid in that other State. Such deduction shall not, however,
exceed that part of the tax, as computed before the deduction is given, which is attributable to such
items of income which may be taxed in that other State.

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3 Where in accordance with any provision of the Convention income derived or capital owned by
a resident of a Contracting State is exempt from tax in that State, such State may nevertheless,
in calculating the amount of tax on the remaining income or capital of such resident, take into
account the exempted income or capital.
Taxpoint: The doubly taxed income may be considered for rate purpose in the resident State.
4 The provisions of paragraph 1 shall not apply to The provisions of paragraph 1 shall not apply
income derived or capital owned by a resident of to income derived or capital owned by a
a Contracting State where the other Contracting resident of a Contracting State where the other
State applies the provisions of this Convention Contracting State applies the provisions of this
to exempt such income or capital from tax or Convention to exempt such income or capital
applies the provisions of paragraph 2 of Article from tax or applies the provisions of paragraph
10 or 11 to such income. 2 of Article 10, 11, 12 or 12A, or the provisions
of Article 12B, to such income; in the case
where the other Contracting State does not
exempt the income, the first-mentioned State
shall allow the deduction of tax provided for by
paragraph 2
Article 23 B “Credit Method”
1 Where a resident of a Contracting State derives income or owns capital which may be taxed in the
other Contracting State, in accordance with the provisions of this Convention (except to the extent
that these provisions allow taxation by that other State solely because the income is also income
derived by a resident of that State or because the capital is also capital owned by a resident of that
State), the first-mentioned State shall allow:
a. as a deduction from the tax on the income of that resident an amount equal to the income tax
paid in that other State;
b. as a deduction from the tax on the capital of that resident, an amount equal to the capital tax
paid in that other State.
Such deduction in either case shall not, however, exceed that part of the income tax or capital tax,
as computed before the deduction is given, which is attributable, as the case may be, to the income
or the capital which may be taxed in that other State.
2 Where, in accordance with any provision of this Convention, income derived or capital owned
by a resident of a Contracting State is exempt from tax in that State, such State may nevertheless,
in calculating the amount of tax on the remaining income or capital of such resident, take into
account the exempted income or capital.
Article 24 “Non-Discrimination”
1 Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation
or any requirement connected therewith which is other or more burdensome than the taxation
and connected requirements to which nationals of that other State in the same circumstances, in
particular with respect to residence, are or may be subjected. This provision shall, notwithstanding
the provisions of Article 1, also apply to persons who are not residents of one or both of the
Contracting States.

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2 Stateless persons who are residents of a Contracting State shall not be subjected in either Contracting
State to any taxation or any requirement connected therewith which is other or more burdensome
than the taxation and connected requirements to which nationals of the State concerned in the same
circumstances, in particular with respect to residence, are or may be subjected.
3 The taxation on a permanent establishment which an enterprise of a Contracting State has in the
other Contracting State shall not be less favourably levied in that other State than the taxation
levied on enterprises of that other State carrying on the same activities. This provision shall not
be construed as obliging a Contracting State to grant to residents of the other Contracting State
any personal allowances, reliefs and reductions for taxation purposes on account of civil status or
family responsibilities which it grants to its own residents.
4 Except where the provisions of paragraph Except where the provisions of paragraph 1 of
1 of Article 9, paragraph 6 of Article 11, or Article 9, paragraph 6 of Article 11, paragraph
paragraph 4 of Article 12, apply, interest, 6 of Article 12, paragraph 7 of Article 12A or
royalties and other disbursements paid by an paragraph 11 of Article 12B apply, interest,
enterprise of a Contracting State to a resident royalties, fees for technical services, payments
of the other Contracting State shall, for the underlying income from automated digital
purpose of determining the taxable profits of services, and other disbursements paid by an
such enterprise, be deductible under the same enterprise of a Contracting State to a resident
conditions as if they had been paid to a resident of the other Contracting State shall, for the
of the first-mentioned State. Similarly, any purpose of determining the taxable profits of
debts of an enterprise of a Contracting State to a such enterprise, be deductible under the same
resident of the other Contracting State shall, for conditions as if they had been paid to a resident
the purpose of determining the taxable capital of the first-mentioned State. Similarly, any
of such enterprise, be deductible under the same debts of an enterprise of a Contracting State to a
conditions as if they had been contracted to a resident of the other Contracting State shall, for
resident of the first-mentioned State. the purpose of determining the taxable capital
of such enterprise, be deductible under the same
conditions as if they had been contracted to a
resident of the first-mentioned State
5 Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled,
directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected
in the first-mentioned State to any taxation or any requirement connected therewith which is
other or more burdensome than the taxation and connected requirements to which other similar
enterprises of the first-mentioned State are or may be subjected.
6 The provisions of this Article shall, notwithstanding the provisions of Article 2, apply to taxes of
every kind and description.
Article 25 “Mutual Agreement Procedure”
1 to 5 1. Where a person considers that the actions Alternative A
of one or both of the Contracting States
result or will result for him in taxation 1. Where a person considers that the actions
not in accordance with the provisions of of one or both of the Contracting States
this Convention, he may, irrespective of result or will result for him in taxation
the remedies provided by the domestic not in accordance with the provisions of
law of those States, present his case to the this Convention, he may, irrespective of
competent authority of either Contracting the remedies provided by the domestic
State. The case must be presented within law of those States, present his case to the
three years from the first notification of the competent authority of the Contracting

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action resulting in taxation not in accordance State of which he is a resident or, if his case
with the provisions of the Convention. comes under paragraph 1 of Article 24, to
2. The competent authority shall endeavour, if that of the Contracting State of which he
the objection appears to it to be justified and is a national. The case must be presented
if it is not itself able to arrive at a satisfactory within three years from the first notification
solution, to resolve the case by mutual of the action resulting in taxation not in
agreement with the competent authority of accordance with the provisions of the
the other Contracting State, with a view Convention.
to the avoidance of taxation which is not 2. The competent authority shall endeavour,
in accordance with the Convention. Any if the objection appears to it to be justified
agreement reached shall be implemented and if it is not itself able to arrive at a
notwithstanding any time limits in the satisfactory solution, to resolve the case
domestic law of the Contracting States. by mutual agreement with the competent
3. The competent authorities of the Contracting authority of the other Contracting State,
States shall endeavour to resolve by mutual with a view to the avoidance of taxation
agreement any difficulties or doubts arising which is not in accordance with this
as to the interpretation or application of the Convention. Any agreement reached
Convention. They may also consult together shall be implemented notwithstanding
for the elimination of double taxation in any time limits in the domestic law of the
cases not provided for in the Convention. Contracting States.
4. The competent authorities of the 3. The competent authorities of the Contracting
Contracting States may communicate with States shall endeavour to resolve by mutual
each other directly, including through a agreement any difficulties or doubts arising
joint commission consisting of themselves as to the interpretation or application of
or their representatives, for the purpose of the Convention. They may also consult
reaching an agreement in the sense of the together for the elimination of double
preceding paragraphs. taxation in cases not provided for in the
Convention.
5. Where,
4. The competent authorities of the
a. under paragraph 1, a person has
Contracting States may communicate with
presented a case to the competent
each other directly, including through a
authority of a Contracting State on the
joint commission consisting of themselves
basis that the actions of one or both of
or their representatives, for the purpose
the Contracting States have resulted for
of reaching an agreement in the sense of
that person in taxation not in accordance
the preceding paragraphs. The competent
with the provisions of this Convention,
authorities, through consultations, may
and
develop appropriate bilateral procedures,
b. the competent authorities are unable conditions, methods and techniques for the
to reach an agreement to resolve that implementation of the mutual agreement
case pursuant to paragraph 2 within procedure provided for in this Article.
two years from the date when all the
information required by the competent Alternative B
authorities in order to address the case 1. Where a person considers that the actions
has been provided to both competent of one or both of the Contracting States
authorities, result or will result for him in taxation
any unresolved issues arising from the case not in accordance with the provisions of
shall be submitted to arbitration if the person this Convention, he may, irrespective of
so requests in writing. These unresolved issues the remedies provided by the domestic
shall not, however, be submitted to arbitration law of those States, present his case to the
competent authority of the Contracting

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if a decision on these issues has already been State of which he is a resident or, if his case
rendered by a court or administrative tribunal of comes under paragraph 1 of Article 24, to
either State. Unless a person directly affected by that of the Contracting State of which he
the case does not accept the mutual agreement is a national. The case must be presented
that implements the arbitration decision, that within three years from the first notification
decision shall be binding on both Contracting of the action resulting in taxation not in
States and shall be implemented notwithstanding accordance with the provisions of the
any time limits in the domestic laws of these Convention.
States. The competent authorities of the 2. The competent authority shall endeavour, if
Contracting States shall by mutual agreement the objection appears to it to be justified and
settle the mode of application of this paragraph. if it is not itself able to arrive at a satisfactory
solution, to resolve the case by mutual
agreement with the competent authority
of the other Contracting State, with a view
to the avoidance of taxation which is not
in accordance with this Convention. Any
agreement reached shall be implemented
notwithstanding any time limits in the
domestic law of the Contracting States.
3. The competent authorities of the Contracting
States shall endeavour to resolve by mutual
agreement any difficulties or doubts arising
as to the interpretation or application of
the Convention. They may also consult
together for the elimination of double
taxation in cases not provided for in the
Convention.
4. The competent authorities of the
Contracting States may communicate with
each other directly, including through a
joint commission consisting of themselves
or their representatives, for the purpose
of reaching an agreement in the sense of
the preceding paragraphs. The competent
authorities, through consultations, may
develop appropriate bilateral procedures,
conditions, methods and techniques for the
implementation of the mutual agreement
procedure provided for in this Article.
5. Where,
a. under paragraph 1, a person has
presented a case to the competent
authority of a Contracting State on the
basis that the actions of one or both of
the Contracting States have resulted
for that person in taxation not in
accordance with the provisions of this
Convention, and

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b. the competent authorities are unable to
reach an agreement to resolve that case
pursuant to paragraph 2 within three
years from the presentation of the case
to the competent authority of the other
Contracting State,
any unresolved issues arising from the case
shall be submitted to arbitration if either
competent authority so requests. The person
who has presented the case shall be notified
of the request. These unresolved issues shall
not, however, be submitted to arbitration if
a decision on these issues has already been
rendered by a court or administrative tribunal
of either State. The arbitration decision
shall be binding on both States and shall be
implemented notwithstanding any time limits
in the domestic laws of these States unless
both competent authorities agree on a different
solution within six months after the decision has
been communicated to them or unless a person
directly affected by the case does not accept
the mutual agreement that implements the
arbitration decision. The competent authorities
of the Contracting States shall by mutual
agreement settle the mode of application of this
paragraph.
Article 26 “Exchange of Information”
1 The competent authorities of the Contracting The competent authorities of the Contracting
States shall exchange such information States shall exchange such information
as is foreseeably relevant for carrying out as is foreseeably relevant for carrying out
the provisions of this Convention or to the the provisions of this Convention or to the
administration or enforcement of the domestic administration or enforcement of the domestic
laws concerning taxes of every kind and laws of the Contracting States concerning
description imposed on behalf of the Contracting taxes of every kind and description imposed
States, or of their political subdivisions or local on behalf of the Contracting States, or of their
authorities, insofar as the taxation thereunder is political subdivisions or local authorities,
not contrary to the Convention. The exchange of insofar as the taxation thereunder is not contrary
information is not restricted by Articles 1 and 2. to the Convention. In particular, information
shall be exchanged that would be helpful to
a Contracting State in preventing avoidance
or evasion of such taxes. The exchange of
information is not restricted by Articles 1 and 2.

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2 Any information received under paragraph 1 Any information received under paragraph 1
by a Contracting State shall be treated as secret by a Contracting State shall be treated as secret
in the same manner as information obtained in the same manner as information obtained
under the domestic laws of that State and shall under the domestic laws of that State and it
be disclosed only to persons or authorities shall be disclosed only to persons or authorities
(including courts and administrative bodies) (including courts and administrative bodies)
concerned with the assessment or collection of, concerned with the assessment or collection of,
the enforcement or prosecution in respect of, the enforcement or prosecution in respect of, or
the determination of appeals in relation to the the determination of appeals in relation to, the
taxes referred to in paragraph 1, or the oversight taxes referred to in paragraph 1, or the oversight
of the above. Such persons or authorities shall of the above. Such persons or authorities shall
use the information only for such purposes. use the information only for such purposes.
They may disclose the information in public They may disclose the information in public
court proceedings or in judicial decisions. court proceedings or in judicial decisions.
Notwithstanding the foregoing, information Notwithstanding the foregoing, information
received by a Contracting State may be used for received by a Contracting State may be used for
other purposes when such information may be other purposes when such information may be
used for such other purposes under the laws of used for such other purposes under the laws of
both States and the competent authority of the both States and the competent authority of the
supplying State authorises such use. supplying State authorizes such use
3 In no case shall the provisions of paragraphs 1 and 2 be construed so as to impose on a Contracting
State the obligation:
a. To carry out administrative measures at variance with the laws and administrative practice of
that or of the other Contracting State;
b. To supply information which is not obtainable under the laws or in the normal course of the
administration of that or of the other Contracting State;
c. To supply information which would disclose any trade, business, industrial, commercial or
professional secret or trade process, or information, the disclosure of which would be contrary
to public policy (ordre public).
4 If information is requested by a Contracting State in accordance with this Article, the other
Contracting State shall use its information gathering measures to obtain the requested information,
even though that other State may not need such information for its own tax purposes. The obligation
contained in the preceding sentence is subject to the limitations of paragraph 3 but in no case shall
such limitations be construed to permit a Contracting State to decline to supply information solely
because it has no domestic interest in such information
5 In no case shall the provisions of paragraph 3 be construed to permit a Contracting State to decline
to supply information solely because the information is held by a bank, other financial institution,
nominee or person acting in an agency or a fiduciary capacity or because it relates to ownership
interests in a person.
6 -- The competent authorities shall, through
consultation, develop appropriate methods and
techniques concerning the matters in respect
of which exchanges of information under
paragraph 1 shall be made

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Article 27 “Assistance in the Collection of Taxes”
1 The Contracting States shall lend assistance to each other in the collection of revenue claims. This
assistance is not restricted by Articles 1 and 2. The competent authorities of the Contracting States
may by mutual agreement settle the mode of application of this Article.
2 The term “revenue claim” as used in this Article means an amount owed in respect of taxes of every
kind and description imposed on behalf of the Contracting States, or of their political subdivisions
or local authorities, insofar as the taxation thereunder is not contrary to this Convention or any
other instrument to which the Contracting States are parties, as well as interest, administrative
penalties and costs of collection or conservancy related to such amount
3 When a revenue claim of a Contracting State is enforceable under the laws of that State and is
owed by a person who, at that time, cannot, under the laws of that State, prevent its collection,
that revenue claim shall, at the request of the competent authority of that State, be accepted for
purposes of collection by the competent authority of the other Contracting State. That revenue
claim shall be collected by that other State in accordance with the provisions of its laws applicable
to the enforcement and collection of its own taxes as if the revenue claim were a revenue claim of
that other State.
4 When a revenue claim of a Contracting State is a claim in respect of which that State may, under its
law, take measures of conservancy with a view to ensure its collection, that revenue claim shall, at
the request of the competent authority of that State, be accepted for purposes of taking measures of
conservancy by the competent authority of the other Contracting State. That other State shall take
measures of conservancy in respect of that revenue claim in accordance with the provisions of its
laws as if the revenue claim were a revenue claim of that other State even if, at the time when such
measures are applied, the revenue claim is not enforceable in the first-mentioned State or is owed
by a person who has a right to prevent its collection.
5 Notwithstanding the provisions of paragraphs 3 and 4, a revenue claim accepted by a Contracting
State for purposes of paragraph 3 or 4 shall not, in that State, be subject to the time limits or
accorded any priority applicable to a revenue claim under the laws of that State by reason of its
nature as such. In addition, a revenue claim accepted by a Contracting State for the purposes of
paragraph 3 or 4 shall not, in that State, have any priority applicable to that revenue claim under
the laws of the other Contracting State.
6 Proceedings with respect to the existence, validity or the amount of a revenue claim of a Contracting
State shall not be brought before the courts or administrative bodies of the other Contracting State.
7 Where, at any time after a request has been made by a Contracting State under paragraph 3 or 4
and before the other Contracting State has collected and remitted the relevant revenue claim to the
first-mentioned State, the relevant revenue claim ceases to be
a. in the case of a request under paragraph 3, a revenue claim of the first-mentioned State that
is enforceable under the laws of that State and is owed by a person who, at that time, cannot,
under the laws of that State, prevent its collection, or
b. in the case of a request under paragraph 4, a revenue claim of the first-mentioned State in
respect of which that State may, under its laws, take measures of conservancy with a view to
ensure its collection
the competent authority of the first-mentioned State shall promptly notify the competent authority
of the other State of that fact and, at the option of the other State, the first-mentioned State shall
either suspend or withdraw its request.

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8 In no case shall the provisions of this Article be

construed so as to impose on a Contracting State
the obligation:
a. to carry out administrative measures at
variance with the laws and administrative
practice of that or of the other Contracting
State;
b. to carry out measures which would be
contrary to public policy (ordre public);
c. to provide assistance if the other Contracting
State has not pursued all reasonable
measures of collection or conservancy, as
the case may be, available under its laws or
administrative practice;
d. to provide assistance in those cases where
the administrative burden for that State is
clearly disproportionate to the benefit to be
derived by the other Contracting State.
Article 28 “Members of Diplomatic Missions and Consular Posts”
Nothing in this Convention shall affect the fiscal
privileges of members of diplomatic missions
or consular posts under the general rules of
international law or under the provisions of
special agreements.
Article 29 “Entitlement to Benefits”
Provision that, subject to paragraphs 3 to Except as otherwise provided in this Article,
5, restricts treaty benefits to a resident of a a resident of a Contracting State shall not be
Contracting State who is a “qualified person” as entitled to a benefit that would otherwise be
defined in paragraph 2 accorded by this Convention (other than a benefit
under paragraph 3 of Article 4, paragraph 2 of
Article 9 or Article 25) unless such resident is
a “qualified person”, as defined in paragraph 2,
at the time that the benefit would be accorded.
Article 30 “Territorial Extension”
1. This Convention may be extended, either
in its entirety or with any necessary
modifications [to any part of the territory
of (State A) or of (State B) which is
specifically excluded from the application of
the Convention or], to any State or territory
for whose international relations (State A)

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or (State B) is responsible, which imposes --
taxes substantially similar in character to
those to which the Convention applies.
Any such extension shall take effect from
such date and subject to such modifications
and conditions, including conditions as to
termination, as may be specified and agreed
between the Contracting States in notes to
be exchanged through diplomatic channels
or in any other manner in accordance with
their constitutional procedures.
2. Unless otherwise agreed by both Contracting
States, the termination of the Convention
by one of them under Article 32 shall also
terminate, in the manner provided for in that
Article, the application of the Convention
[to any part of the territory of (State A)
or of (State B) or] to any State or territory
to which it has been extended under this
Article.
Article 31 (OECD Model) / Article 30 (UN Model) “Entry into Force”
1. This Convention shall be ratified and the instruments of ratification shall be exchanged at
______________________ as soon as possible.
2. The Convention shall enter into force upon the exchange of instruments of ratification and its
provisions shall have effect:
(a) (In State A): ..........................................
(b) (In State B): ..........................................
Article 32 (OECD Model) / Article 31 (UN Model) “Termination”
This Convention shall remain in force until terminated by a Contracting State. Either Contracting
State may terminate the Convention, through diplomatic channels, by giving notice of termination
at least six months before the end of any calendar year after the year ...... In such event, the
Convention shall cease to have effect:
a) (in State A): .........................................
b) (in State B): .........................................

Solved Case 1:
Mr. Amin, a resident individual in India (age 42) furnishes you the following particulars of income for the previous
year 2023–24:

Particulars `
Income from business in India (computed) 11,00,000
Dividend received from Company incorporated in Country X (gross) 2,00,000
Royalty income from writing text book for schools in Country Y (gross) 6,00,000
Expenditure incurred for authoring text book 50,000

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Particulars `
Business loss in Country Y (gross) 2,50,000
Health insurance premium paid for his father (age 67) a resident in India (His father is not 30,000
dependent on Mr. Amin)
The business loss in Country Y is eligible for set off against other income as per the Income-tax law of that country.
There is no DTAA between India and Country “X” and Country “Y” given above. The rate of tax in Country “X”
and Country “Y” may be taken as 10% and 25% respectively (without any threshold exemption limit).
On the basis of aforesaid information, you are requested to choose correct options for the following:
1. What will be his tax liability, assuming he has opted for old regime) before any relief u/s 90 or 91?
2. What is his average rate of tax?
3. State the eligible amount of relief u/s 90 or 91

Solution:
Computation of Total Income of Mr. Amin for A.Y. 2024–25

Particulars ` ` `
Profits and gains of Business or profession
Income from business in India 11,00,000
Loss from business in Country “Y” 2,50,000
Less: Set off against royalty income 2,50,000 -
Income from other Sources
Dividend from companies in Country “X” 2,00,000
Royalty income from Country “Y” 6,00,000
Less: Expenditure thereon 50,000
5,50,000
Loss from business in Country “Y” 2,50,000 3,00,000 5,00,000
Gross Total Income 16,00,000
Less: Deduction under Chapter VI-A
Section 80D Health insurance premium for father, senior citizen is 30,000
deductible even though he is not dependent on the assessee.
Section 80QQB: As the assessee has authored text-book for - 30,000
schools in Country “Y‟ hence it is not eligible for deduction.
Total Income 15,70,000
Tax on above 2,83,500
Add: Cess 11,340
Tax and cess 2,94,840
Less: Relief u/s 91 [See Working] 76,339
Tax after relief 2,18,500

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Working:

Average rate of tax in India ` 2,94,840 x 100 / ` 15,70,000 18.78%

Average rate of tax in country X 10%
Doubly taxed income of country X 2,00,000
Relief u/s 91 would be 10% or average rate @ 18.78%, whichever is lower ` 20,000
[10% on ` 2 lakhs]
Doubly taxed income of country Y (after set-off of business loss) 3,00,000
Rate of tax country Y 25%
Relief u/s 91 would be @ 18.78% or 25% whichever is lower ` 56,339
[18.78% on ` 3 lakhs]
Relief under section 91 ` 76,339

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Exercise
A. Theoretical Questions
Multiple Choice Questions

1. In respect of DTAA, generally, India follows:

a. UN Model
b. UK Model
c. OECD Model
d. US Model
2. Sec. 91 deals with
a. Bilateral Relief
b. Unilateral Relief
c. Both (a) and (b)
d. None of the above

[ Answer - 1 - a; 2 - b]
Short Essay Type Questions
1. State the provisions of sec. 91.
2. Write a brief note on Model tax conventions.

B. Numerical Questions
Comprehensive Numerical Problems
Anupam Gulati, a resident in India, is a famous badminton player, who plays in several tournaments. For the
year ended 31-03-2024, he has derived income from playing in tournaments outside India and also share income
from a firm, from nations with which no DTAA exists.
The summarized results of the income earned during the year are as under:

`
Income from tournaments in India 32,50,000
Income from tournaments outside India (as converted into INR) 16,00,000
Share of loss from a partnership firm abroad (Set off permitted in that nation) 2,00,000
Residential house property purchased at Colombo (including registration and stamp duty for ` 4,00,00,000
1,80,000)
On the foreign income, he has paid tax of ` 3,50,000. Compute relief u/s 90 or 91, assuming that he has opted for
old regime?
[Ans: ` 3,50,000]

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References
https://www.incometaxindia.gov.in/
https://www.incometax.gov.in/
https://www.indiabudget.gov.in/

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 Transfer Pricing 13

This Module includes:

13.1 Transfer Pricing including Specified Domestic Transactions

13.2 Determination of Arm’s Length Price
13.3 Advance Pricing Agreement- Concept and Application
13.4 Safe Harbour Rules, Thin Capitalisation and Secondary Adjustment

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SLOB Mapped against the Module:

1. To develop understanding about various provisions of direct taxation laws and rules
including international taxation laws, and inherent issues that are subject to interpretation
with reference to case laws, etc.
2. To attain abilities to apply the acquired understanding for solving complex taxation problems
and taking tax efficient business decision and execution thereof.

Module Learning Objectives:

After studying this module, the students will be able to -
 Appreciate the meaning of various terms like international transaction, specified domestic transactions,
etc.
 Appreciate the provision of income tax in respect of international transactions
 Appreciate the method of computing arm’s length price
 Apply such method in computing arm’s length price
 Understand the provision of advance pricing agreement, thin capitalisation, etc.

506 The Institute of Cost Accountants of India

 Introduction 13

“Globalisation and new electronic technologies can permit a proliferation of tax regimes designed to attract
geographically mobile activities. Governments must take measures, in particular intensifying their international
cooperation, to avoid the world-wide reduction in welfare caused by tax-induced distortions in capital and financial
flows and to protect their tax bases.
International taxation is the study or determination of tax on a person or business subject to the tax laws of different
countries or the international aspects of an individual country’s tax laws. Governments usually limit the scope
of their income taxation in some manner territorially or provide for offsets to taxation relating to extraterritorial
income. The manner of limitation generally takes the form of a territorial, residency, or exclusionary system.
Some governments have attempted to mitigate the differing limitations of each of these three broad systems by
enacting a hybrid system with characteristics of two or more. Systems of taxation vary widely, and there are no
broad general rules. These variations create the potential for double taxation (where the same income is taxed by
different countries) and no taxation (where income is not taxed by any country). Income tax systems may impose
tax on local income only or on worldwide income. Generally, where worldwide income is taxed, reductions of
tax or foreign credits are provided for taxes paid to other jurisdictions. Limits are almost universally imposed on
such credits. With any system of taxation, it is possible to shift or recharacterize income in a manner that reduces
taxation. Jurisdictions often impose rules relating to shifting of income among commonly controlled parties, often
referred to as transfer pricing rules. Residency based systems are subject to taxpayer attempts to defer recognition
of income through use of related parties. A few jurisdictions impose rules limiting such deferral (“anti-deferral”
regimes). Deferral is also specifically authorized by some governments for particular social purposes or other
grounds. Agreements among governments (treaties) often attempt to determine who should be entitled to tax what.
Most tax treaties provide for at least a skeleton mechanism for resolution of disputes between the parties. Tax
laws in India are becoming more and more complex. Globalisation of economies, signing and review of free trade
agreements, increase in the number of cross border transactions, mergers, acquisitions, tax treaties, transfer pricing
etc. have added to these complexities.
Tax Heaven
Many fiscally sovereign territories and countries use tax and non-tax incentives to attract activities in the financial
and other services sectors. These territories and countries offer the foreign investor an environment with a no or
only nominal taxation which is usually coupled with a reduction in regulatory or administrative constraints. The
activity is usually not subject to information exchange because, for example, of strict bank secrecy provisions.
These jurisdictions are known as tax havens. In other words, any country which modifies its tax laws to attract
foreign capital could be considered a tax haven. The central feature of a haven is that its laws and other measures
can be used to evade or avoid the tax laws or regulations of other jurisdictions. A tax haven is a state or a country
or territory where income tax are levied at a low rate or no tax at all is levied. Individuals and/or corporate entities
can find it attractive to establish shell subsidiaries or move themselves to areas where reduced or nil tax is charged.
This creates a situation of tax competition among governments though tax heaven countries may not always be

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profitable. Some tax heavens have become failure like Beirut, Tangiers, Liberia, etc. Different jurisdictions tend to
be havens for different types of taxes, and for different categories of people and/or companies.
Geoffrey Colin Powell (former economic adviser to Jersey) has defined it as under:
“What ... identifies an area as a tax haven is the existence of a composite tax structure established deliberately to
take advantage of, and exploit, a worldwide demand for opportunities to engage in tax avoidance.”
Some important destinations of tax heavens are:

In USA Delaware, Nevada, Wyoming

In Europe Andorra, Canary, Netherlands, Cyprus
In Asia Mauritius, Singapore, Dubai
In Africa Capetown, Nairobi

Key Factors
Four key factors are used to determine whether a jurisdiction is a tax haven:  

� Imposes no or only nominal taxes: Tax havens

impose nil or only nominal taxes (generally or in
special circumstances) and offer themselves, or
are perceived to offer themselves, as a place to be
used by non-residents to escape high taxes in their
country of residence.
� Lack of transparency: Transparency ensures that there is an open and consistent application of tax laws among
similarly situated taxpayers and that information needed by tax authorities to determine a taxpayer’s correct
tax liability is available (e.g., accounting records and underlying documentation). A lack of transparency in
the operation of the legislative, legal or administrative provisions is another factor used to identify tax havens.
The OECD is concerned that laws should be applied openly and consistently, and that information needed by
foreign tax authorities to determine a taxpayer’s situation is available. Lack of transparency in one country can
make it difficult, if not impossible, for other tax authorities to apply their laws effectively. ‘Secret rulings’,
negotiated tax rates, or other practices that fail to apply the law openly and consistently are examples of a lack
of transparency. Limited regulatory supervision or a government’s lack of legal access to financial records are
contributing factors.
� Lack of effective exchange of tax information with foreign tax authorities: Whether there are laws
or administrative practices that prevent the effective exchange of information for tax purposes with other
governments on taxpayers benefiting from the no or nominal taxation. Tax havens typically have laws or
administrative practices under which businesses and individuals can benefit from strict rules and other
protections against scrutiny by foreign tax authorities. This prevents the transmittance of information about
taxpayers who are benefiting from the low tax jurisdiction.
� No requirement for a substantive local presence of the entity: The absence of a requirement that the activity
be substantial is important because it suggests that a jurisdiction may be attempting to attract investment
and transactions that are purely tax driven. It may also indicate that a country does not provide a legal or
commercial environment or offer any economic advantages that would attract substantive business activities in
the absence of the tax minimising opportunities it provides. The no substantial activities criterion was included
in the 1998 Report as a criterion for identifying tax havens because the lack of such activities suggests that a

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jurisdiction may be attempting to attract investment and transactions that are purely tax driven. In 2001, the
OECD’s Committee on Fiscal Affairs agreed that this criterion would not be used to determine whether a tax
haven was co-operative or unco-operative.
With regard to exchange of information in tax matters, the OECD encourages countries to adopt information
exchange on an “upon request” basis. Exchange of information upon request describes a situation where a
competent authority of one country asks the competent authority of another country for specific information in
connection with a specific tax inquiry, generally under the authority of a bilateral exchange arrangement between
the two countries. An essential element of exchange of information is the implementation of appropriate safeguards
to ensure adequate protection of taxpayers’ rights and the confidentiality of their tax affairs.  
Methodology
The methods followed in doing business through tax heavens, broadly, are as under:
Personal residency
Wealthy individuals from high-tax jurisdictions have sought to relocate themselves in low-tax jurisdictions. In
most countries in the world, residence is the primary basis of taxation. In some cases the low-tax jurisdictions levy
no, or only very low, income tax, capital gain tax and inheritance tax. Individuals who are unable to return to a
higher-tax country in which they used to reside for more than a few days a year are sometimes referred to as tax
exiles.
Asset holding
Asset holding involves utilizing a trust or a company, or a trust owning a company. The company or trust will be
formed in one tax haven, and will usually be administered and resident in another. The function is to hold assets,
which may consist of a portfolio of investments under management, trading companies or groups, physical assets
such as real estate or valuable chattels. The essence of such arrangements is that by changing the ownership of the
assets into an entity which is not resident in the high-tax jurisdiction, they cease to be taxable in that jurisdiction.
Often the mechanism is employed to avoid inheritance tax.
Trading and other business activity
Many businesses which do not require a specific geographical location or extensive labour are set up in tax havens,
to minimize tax exposure. Perhaps the best illustration of this is the number of reinsurance companies which have
migrated to Bermuda over the years. Other examples include internet based services and group finance companies.
In the 1970s and 1980s corporate groups were known to form offshore entities for the purposes of “reinvoicing”.
These reinvoicing companies simply made a margin without performing any economic function, but as the
margin arose in a tax free jurisdiction, it allowed the group to “skim” profits from the high-tax jurisdiction. Most
sophisticated tax codes now prevent transfer pricing schemes of this nature.
Financial intermediaries
Much of the economic activity in tax havens today consists of professional financial services such as mutual
funds, banking, life insurance and pensions. Generally, the funds are deposited with the intermediary in the low-
tax jurisdiction, and the intermediary then on-lends or invests the money (often back into a high-tax jurisdiction).
Although such systems do not normally avoid tax in the principal customer’s jurisdiction, it enables financial
service providers to provide multi-jurisdictional products without adding an additional layer of taxation. This has
proved particularly successful in the area of offshore funds.
Counteracting harmful tax practices
OECD has issued a report on Harmful Tax Competition and has made 19 specific recommendations, some of them
are as follows:

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a. Adopt Controlled Foreign Corporations (CFC) or equivalent rules

b. Consider foreign information reporting rules
c. Enter into Tax Information Exchange Agreement (TIEA)
d. Application of provision of withholding tax1 while making payment to offshore recipients
e. Curbing ‘treaty shopping nations’ of existing treaties with tax heaven
f. Mutual assistance of tax authorities in the recovery of cross boarder tax claims
g. More international co-operation by establishing Forum to avoid Harmful Tax Practices
h. Other measures
� Adopt foreign investment fund or equivalent rules
� Considering restrictions on participation exemption and other systems of exempting foreign income in the
context of harmful tax competition
� Formulation and adoption of transfer pricing rules
� Providing access to banking information for tax purposes
� Considering co-ordinated enforcement regimes (joint audits; co-ordinated training programmes, etc.)
� Guidelines to develop and actively promote Principles of Good Tax Administration

1
Tax deducted at source

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Specified Domestic Transactions

T
he increasing participation of multinational groups in economic activities in the country has given rise
to new and complex issues emerging from transactions entered into between two or more enterprises
belonging to the same multinational group. The profits derived by such enterprises carrying on business
in India can be controlled by the multinational group, by manipulating the prices charged and paid in
such intra-group transactions, thereby, leading to erosion of tax revenues. In other words, the course of business
between a resident person and an associated non-resident or not ordinarily resident person, is so arranged that the
resident makes either no profit or less than the ordinary profit in that business. Such an arrangement would deprive
that Indian revenue of the tax which would otherwise be payable by the resident.
With a view to provide a statutory framework which can lead to computation of reasonable, fair and equitable
profits and tax in India, in case of such multinational enterprise, new set of special provisions relating to avoidance
of tax have been introduced under chapter X
Associated Independent
Enterprise entity
in the Income tax Act. These provisions relate
International Transactions
to computation of income from international
- Goods transaction having regard to arm’s length price,
- Services meaning of associated enterprises, meaning
Transfer - Intangibles Arm’s Length of international transaction, determination of
Price - Loans Price arm’s length price, keeping and maintaining
- Guarantees
of information and documents by persons
entering into international transaction,
Taxpayer Taxpayer furnishing of a report from an accountant by
persons entering into such transactions.

Computation of income from international transaction or specified domestic transaction having regard to
arm’s length price [Sec. 92]
The provisions are as under:

Provisions Example Treatment Impact on

income
Any income arising from an international X Ltd., resident, sold goods While computing Income of X
transaction shall be computed having or services to its associated income of X Ltd., ₹ 9 Ltd. will be
regard to the arm’s length price. enterprises, XY Plc. (a lacs shall be considered increased by ₹
foreign company), for ₹ as sale value 4 lacs.
5 lacs whereas the arm’s
length price of such goods
or services is ₹ 9 lacs

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Provisions Example TreatmentImpact on

income
The allowance for any expense or R Ltd. takes a loan of `20 Interest @ 12% p.a. Income of R
interest arising from an international lacs from an associated shall be allowed as Ltd. will be
transaction or specified domestic enterprise in Ireland @ deduction to R Ltd. increased by ₹
transaction2 shall also be determined 20% p.a. whereas the arm’s 1,60,000/-
having regard to the arm’s length price. length rate of interest is
12% p.a.
Where in an international transaction or An enterprise in Germany While computing If no such
specified domestic transaction, makes research on a new income of Indian benefit is
� two or more associated enterprises product and incurred ₹ enterprise, it will available to
� enter into a mutual agreement or 50 lacs. Out of this, ₹ 40 be required to be the Indian
arrangement for the apportionment lacs has been allocated examined whether the e n t e r p r i s e ,
of, or any contribution to, any cost to its Indian associated Indian enterprise is total income
incurred enterprises dealing in the deriving proportionate of such
� in connection with a benefit, service same product. benefit to the research e n t e r p r i s e s
or facility provided to any such expenditure allocated is suitably
enterprises, increased by
disallowing
the cost apportioned to (contributed by), proportionate
any such enterprise shall be determined allocated cost.
having regard to the arm’s length price
of such benefit, service or facility.
The provisions (in any of aforesaid X Ltd., resident, sold goods The provision of No Impact
situation) shall not apply in a case or services to its associated transfer pricing is not
where the computation of income or the enterprises, XY Plc. (a applicable
determination of the allowance for any foreign company), for ₹
expense or interest or the determination 5 lacs whereas the arm’s
of any cost or expense allocated or length price of such goods
contributed has the effect of reducing or services is ₹ 3 lacs
the income chargeable to tax or
increasing the loss, as the case may be,
computed on the basis of entries made
in the books of account in respect of the
previous year in which the international
transaction or specified domestic
transaction was entered into.
Arm’s length price [Sec. 92F(ii)]
Arm’s length price means
(i) a price which is applied or proposed to be applied in a transaction
(ii) between persons other than associated enterprises (i.e., unrelated person, resident or non-resident),
(iii) in uncontrolled conditions.
Taxpoint: There may be more than one arm’s length price.
2 Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to the specified domestic transaction
shall be computed having regard to the arm’s length price.

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Process
The process to arrive at the appropriate arm’s length price typically involves the following processes or steps:
(a) Comparability analysis
The concept of establishing comparability is central to the application of the arm’s length principle. An analysis
under the arm’s length principle involves information on associated enterprises involved in the controlled
transactions, the transactions at issue between the associated enterprises, the functions performed and the
information derived from independent enterprises engaged in comparable transactions (i.e., uncontrolled
transactions). The objective of comparability analysis is always to seek the highest practicable degree
of comparability, recognising that there will be unique transactions and cases where any applied method
cannot be relied on. It is clear that the closest approximation of the arm’s length price will be dependent
on the availability and reliability of comparables. There are many factors determining the comparability of
transactions for transfer pricing analysis:
(i) Characteristics of the property or services
Property, tangible or intangible, as well as services, may have different characteristics which may lead
to a difference in their values in the open market. Therefore, these differences must be accounted for and
considered in any comparability analysis of controlled and uncontrolled transactions. Characteristics that
may be important to consider are:
● In case of tangible property, the physical features, quality, reliability and availability of volume and
supply;
● In the case of services, the nature and extent of such services; and
● In case of intangible property, the type and form of property, duration and degree of protection and
anticipated benefits from use of property.
(ii) Functional analysis (Functions, Assets and Risks)
● In dealings between two independent enterprises, the compensation usually reflects the functions
that each enterprise performs, taking into account assets used and risks assumed. Therefore, in
determining whether controlled and uncontrolled transactions are comparable, a proper study of all
specific characteristics of an international transaction or functional activity needs to be undertaken,
including comparison of the functions performed, assets used and risks assumed by the parties. Such
a comparison is based on a “functional analysis”.
● A functional analysis seeks to identify and compare the economically significant activities and
responsibilities undertaken by the independent and associated enterprises. An economically significant
activity is considered to be any activity which materially affects the price charged in a transaction and
the profits earned from that transaction.
● Functional analysis is thus a key element in a transfer pricing exercise. It is a starting point and lays
down the foundation of the arm’s length analysis. The purpose of functional analysis is to describe and
analyse the operations of an enterprise and its associated enterprises.
● Functional analysis typically involves identification of ‘functions performed’, ‘assets employed’ and
‘risks assumed’ (therefore named a “FAR analysis”) with respect to the international transactions of
an enterprise. Functions that may need to be accounted for in determining the comparability of two
transactions can include:
� Research and development

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� Product design and engineering;

� Manufacturing, production and process engineering;
� Product fabrication, extraction and assembly;
� Marketing and distribution functions, including inventory management and advertising activities;
� Transportation and warehousing; and
� Managerial, legal, accounting and finance, credit and collection, training and personnel
management services.
� Outsourcing nature of work
� Business process management
● Risks that need to be considered while determining the degree of comparability between controlled
and uncontrolled transactions include:
� Financial risks including method of funding, funding of losses, foreign exchange risk
� Product risk including design & development of product, after sales service, product liability risk,
intellectual property risk, risks associated with R&D, obsolescence / upgrading of product
� Market risks including fluctuations in prices and demand, business cycle risks, development of
market including advertisement and product promotion
� Credit and collection risks;
� Entrepreneurial risk including risk of loss associated with capital investment
� General business risks related to ownership of plant, property and equipment.
● Furthermore, it is not only necessary to identify the risks but to identify who bears such risks. The
allocation of risk is usually based on contractual terms between the parties; however these may not
always reflect the reality of a transaction or a relationship, and an allocation of risk between controlled
taxpayers after the outcome of such risk is known or reasonably knowable lacks economic substance.
● Consider an example where company S, situated in country A, is the wholly‐owned subsidiary of
company P, situated in country B but a foreign manufacturer. The subsidiary company S acts as the
distributor of goods manufactured by the parent company P and both parties execute an agreement
that any product liability costs will be borne by the parent company P. However, in practice when
product liability claims are raised, subsidiary company S always pays the resulting damages. In such
a case the tax authorities will generally disregard the contractual arrangement and treat the risk as
having been in reality assumed by subsidiary company S.
(iii) Contractual Terms
● The conduct of the contracting parties is a result of the terms of the contract between them and
the contractual relationship thus warrants careful analysis when arriving at the transfer price. Other
than a written contract, the terms of the transactions may be figured out from correspondence and
communication between the parties involved. In case the terms of the arrangement between the two
parties are not explicitly defined, then the terms have to be deduced from their economic relationship
and conduct.
● One important point to note in this regard is that associated enterprises may not hold each other to
the terms of the contract as they have common overarching interests, unlike independent enterprises,

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who are expected to hold each other to the terms of the contract. Thus, it is important to figure out
whether the contractual terms between the associated enterprises are a “sham” (something that appears
genuine, but when looked closer lacks reality, and is not valid under many legal systems) and/or have
not been followed in reality.
● Also, explicit contractual terms of a transaction involving members of a MNE may provide evidence as
to the form in which the responsibilities, risks and benefits have been assigned among those members.
For example, the contractual terms might include the form of consideration charged or paid, sales and
purchase volumes, the warranties provided, the rights to revisions and modifications, delivery terms,
credit and payment terms etc. This material may also indicate the substance of a transaction, but will
usually not be determinative on that point.
● It must be noted that contractual differences can influence prices as well as margins of transactions.
The party concerned should document contractual differences and evaluate them in the context of the
transfer pricing methods discussed in detail in a later chapter of this Manual, in order to judge whether
comparability criteria are met and whether any adjustments need to be made to account for such
differences.
(iv) Market Conditions
Market prices for the transfer of the same or similar property may vary across different markets owing
to cost differentials prevalent in the respective markets. Markets can be different for numerous reasons;
it is not possible to itemise exhaustively all the market conditions which may influence transfer pricing
analysis but some of the key market conditions which influence such an analysis are as follows:
Geographical location – In general, uncontrolled comparables ordinarily should be derived from the
geographic market in which the controlled taxpayer operates, because there may be significant relevant
differences in economic conditions between different markets. If information from the same market is not
available, an uncontrolled comparable derived from a different geographical market may be considered if
it can be determined that (i) there are no differences between the market relevant to the transaction or (ii)
adjustments can be made to account for the relevant differences between the two markets.
Another aspect of having different geographic markets is the concept of “location savings” which may
come into play during transfer pricing analysis. Location savings are the cost savings that a MNE realises
as a result of relocation of operations from a high cost jurisdiction to a low cost jurisdiction. Typically, cost
savings include costs of labour, raw materials and tax advantages offered by the new location. However,
there might be disadvantages in relocating also; the “dis-savings” on account of relocation might be high
costs for transportation, quality control, etc. The savings attributable to location into a low-cost jurisdiction
(offset by any “dis-savings”) are referred to collectively as the “location savings”. The important point,
where there are such location savings, is not just the amount of the savings, but also the issues of to whom
these savings belong (i.e. the captive service provider or the principal). In this respect, the allocation of
location savings depends especially on the relative bargaining positions of the parties. Relative bargaining
power of buyer, seller and end user is dependent on issues such as the beneficial ownership of intangible
property and the relative competitive position.
The computation of location savings might seem simple in theory; however its actual computation may
pose many difficulties. Moving to an offshore location might be accompanied by changes in technologies,
productions volumes or production processes. In such a circumstance, the additional profit derived cannot
be treated as only due to location savings as the profitability is due both to low costs and introduction of
new technology. A simple comparison before and after in such a scenario would give a distorted picture
of location savings.

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If the tax authorities were to administer transfer pricing principles to “shift” profits without any consideration
of market forces prevalent in the respective countries, then such reconfiguration of economic profile,
and consequently the financial statements in the host country, would be against the principles of transfer
pricing and may result in unrelieved double taxation if the tax authority in another country does not agree
to reduce the profits of an associated enterprise in its country.
Government rules and regulations – Generally, government interventions in the form of price controls,
interest rate controls, exchange controls, subsidies for certain sectors, anti‐ dumping duties etc, should be
treated as conditions of the market in the particular country and in the ordinary course they should be taken
into account in arriving at an appropriate transfer price in that market. The question becomes whether,
in light of these conditions, the transactions by controlled parties are consistent with “uncontrolled”
transactions between independent enterprises.
An example of where government rules affect the market are the Export Oriented Units (EOU’s) which
may be subject to beneficial provisions under the taxation laws of the country; ideally companies which
enjoy similar privileges should be used as the comparables, and if that is not possible, adjustments may
need to be made as part of the comparability analysis.
Level of Market – For example, the price at the wholesale level (sale to other sellers) and retail levels
(sale to consumers) would generally differ, and there may be many levels of wholesalers before a product
reaches the consumer.
Other market conditions – Some other market conditions which influence the transfer price include
costs of production (including costs of land, labour and capital), availability of substitutes (both goods and
services), level of demand/supply, transport costs, size of the market, the extent of competition.
(v) Business Strategies
● Business strategies relating to new product launches, innovations, market penetration or expansion
of market share may require selling products cheaper as part of such a strategy and thus earning
lower profit in the anticipation of increased profits in the coming years, once the product has become
more established in the market. Such strategies must be taken into account when determining the
comparability of controlled and uncontrolled transactions. E.g., “start-up” companies are prone to
incurring losses during their early life and it would not generally be appropriate to include such start-
ups when the tested party (i.e. the party in the controlled transaction to whom the transfer pricing
method is applied) is a company with a track record over many years.
● The evaluation of the claim that a business strategy was being followed which decreased profits in
the short-term but provided for higher long-term profits is one that has to be considered by the tax
authorities carefully after weighing several factors. One factor being - who bears the cost of the market
penetration strategy? Another factor to consider is whether the nature of relationship reflects the
taxpayer bearing the cost of the business strategy –for example, a sales agent with little responsibility
or risk typically cannot be said to bear costs for a market penetration strategy. Another factor is
whether the business strategy itself is prima- facie plausible or needs further investigation; an endless
“market penetration strategy” that has yielded no profits in many years might under examination have
no such real basis in practice.
(b) Transaction analysis
The arm’s length price must be established with regard to transactions actually undertaken; the tax authorities
should not substitute other transactions in the place of those that have actually happened and should not
disregard those transactions actually undertaken unless there are special circumstances - such as that the real

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economic substance of the transaction differs from its form or the transaction arrangements are not structured
in the commercially rational manner that would be expected between independent enterprises. In general,
restructuring of transactions should not be undertaken lightly as it may lead to double taxation due to divergent
views by the nation states on how the transactions are structured. Whether authorities are able to do so will
ultimately depend on their ability to do so under applicable local law, and even where it is possible, a good
understanding of business conditions and realities is necessary for a fair “reconstruction”. These issues are
relevant not only to the administration of transfer pricing, but also to developing the underlying legislation
at the beginning of a country’s transfer pricing “journey” to allow effective administration (and to assist, and
reduce the costs of, compliance by taxpayers) during the course of that journey.
(c) Evaluation of separate and combined transactions
● An important aspect of transfer pricing analysis is whether this analysis is required to be carried out
with respect to individual international transactions or a group of international transactions having close
economic nexus. In most cases, it has been observed that application of the arm’s length principle on a
transaction-by-transaction basis becomes cumbersome for all involved, and thus recourse is often had to
the “aggregation” principle.
● For example with transactions dealing with intangible property such as the licensing of “know-how”
(practical technical knowledge of how to do something, such as of an industrial process, that is not widely-
held) to associate enterprises it may prove difficult to separate out the transactions involved. Similarly
long-term service supply contracts and pricing of closely linked products are difficult to separate out
transaction-wise.
● Another important aspect of combined transactions is the increasing presence of composite contracts and
“package deals” in an MNE group; a composite contract and/or package deal may contain a number of
elements including royalties, leases, sale and licenses all packaged into one deal. The tax authorities
would generally consider the deal in its totality and arrive at the appropriate transfer price; in such a
case comparables need to be similar (deals between independent enterprises). In certain cases, the tax
authorities might find it appropriate for various reasons to allocate the price to the elements of the package
or composite contract. It must be noted that any application of the arm’s length principle, whether on a
transaction by transaction basis or on aggregation basis, needs to be evaluated on a case to case basis,
applying the relevant methodologies to the facts as they exist in that particular case.
(d) Use of an arm’s length range
● The arm’s length principle as applied in practice usually results in an arm’s length range (that is, a range of
acceptable/comparable prices) rather than a single transfer price for a controlled transaction. The range of
transfer prices exists because the transfer pricing methods attempt to reflect prices and conditions between
independent parties. However at times it is difficult to make highly precise adjustments due to differences
between controlled transactions and uncontrolled transactions. If only one transfer pricing method is
applied, the method may indicate a single acceptable price range. If more than one transfer pricing method
is being used, each method may indicate different ranges. If the range of prices that are common to the
methods is used, the range is more likely to be reliable in fairly reflecting business conditions.
● If the transfer prices used by a taxpayer are within the arm’s length range, adjustments should not be
required. If the transfer prices used by a taxpayer are outside the range of prices determined by a tax
authority, the taxpayer should be given an opportunity to explain the differences.
● If a taxpayer is able to explain the difference and provides its own transfer pricing documentation used in
setting its transfer prices which supports this, a tax authority will usually decide not to make adjustment.
On the other hand, if the taxpayer is unable to justify its transfer prices an adjustment may be required.

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(e) Use of multiple year data

● When economic and financial data is being tested, previous years’ data may truly represent the results
achieved by both the controlled and uncontrolled taxpayers. The use of multiple year data allows the data
to be better harmonised, as it tends to average the results over a period of time. Multiple year data can
also uncover relevant abnormal economic factors affecting the results, such as strikes or other adverse
conditions. Such an approach also tries to test the data thrown up in typical business cycles and thus
eliminates the risk of testing data of only a particularly bad or good year.
● Furthermore, in certain industries which are more cyclical in nature the multiple year data may give a
better standard of comparison than use of single year data; the automotive industry can be one example
of such a cyclical industry. That is not to say, however, that use of multiple year data prevents authorities
from challenging artificial attempts to take advantage of such an approach by, for example, wrongly
pricing in the last year of the data in the hope that such pricing will be “absorbed” into the wider data
set. Some countries consider that they are legally required to consider data on a year-by year basis; that
will be a matter for domestic law, but if the choice exists when setting up a transfer pricing regime, it
would generally be preferable to have a multi-year approach to deal with legitimate variations in business
conditions across years.
● While using multi-year data for comparability analysis, it is in any case necessary to adjust for factors such
as the occurrence of significant events in the preceding years and the role of inflation in changing prices of
commodities and services.
● Overall, multiple year data provides information about the relevant business and product life cycles of the
comparables; differences in business or product life cycles may have an effect on the conditions which
determine comparability. Data from previous years can show whether an independent enterprise engaged
in comparable transactions was affected by similar economic conditions so as to be used as a comparable
or not.
(f) Losses
● In an MNE group, one of the enterprises might be suffering a loss, even a recurring one, but the overall
group may be extremely profitable. The fact that there is an enterprise making losses that is doing business
with profitable members of its MNE group may warrant scrutiny by the tax authorities concerned. Such
a situation perhaps indicates that the loss-making enterprise is not receiving adequate compensation from
the MNE group of which it is a part in relation to the benefits derived from its activities.
● However there are many facets of these losses that have to be studied such as the nature of the loss (spread
across group, history of loss-making within entity and group etc), the reasons for the loss (economic
downtime, business cycle, start-up business, poor management, excessive risk etc), and the period of loss
(short-term, long-term) as all these factors play a significant role in determining how the loss should be
treated with respect to transfer pricing.
(g) Intentional set-offs
● A deliberate or intentional set-off occurs when an associated enterprise has provided a benefit to another
associated enterprise within the MNE group and is compensated in return by that other enterprise with
some other benefits. These enterprises may claim that the benefit that each has received should be set-
off against the benefit each provided and only the net gain or loss if any on the transactions needs to be
considered for tax assessment.

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● Set-offs can be quite complex; they might involve a series of transactions and not just a simple “one
transaction, two party” set-off. Ideally the parties disclose all set-offs accurately and have enough
documentation to substantiate their set-off claims so that after taking account of set-offs, the conditions
governing the transactions are consistent with the arm’s length principle.
● The tax authorities may evaluate the transactions separately to determine which of the transactions satisfy
the arm’s length principle. However, the tax authorities may also choose to evaluate the set-off transactions
together, in which case comparables have to be carefully selected; set-offs in international transactions and
in domestic transactions may not be easily comparable, such as due to the differences in the tax treatment
of the set-offs under the taxation systems of different countries.
(h) Use of custom valuations
● The General Agreement on Trades and Tariff (GATT, Article VII), now part of the World Trade
Organization (WTO) set of agreements, has laid down the general principles for an international system of
custom valuation. Customs valuation is the procedure applied to determine the customs value of imported
goods. Member countries of WTO typically harmonise their internal legislation dealing with the customs
valuation with the WTO Agreement on Customs Valuation.
● In appropriate circumstances, the documented custom valuation may be used for justifying the transfer
prices of imported goods in international transactions between associated enterprises. The arm’s length
principle is applied by many customs administrations as a principle of comparison between the value
attributable to goods imported by associated enterprises and the value of similar goods imported by
independent enterprises. However when there is no customs duty imposed and goods are valued only for
statistical purposes, and for items which have no rate of duty, this approach would not be useful. Even
when utilising the custom valuation for imports in a transfer pricing context, certain additional upward or
downward adjustments may be required to derive the arm’s length price for the purpose of taxation.
● Internationally, there is a great deal of focus on the interplay of transfer pricing methods on the one hand
and custom valuation methods on the other hand. Debates have centred on the feasibility and desirability
of the convergence of the systems surrounding the two sets of value determination. The issue is considered
in more detail in a later chapter.
(i) Use of transfer pricing methods
● It is important to note at the outset that there is no one transfer pricing method which is generally applicable
to every possible situation. The bottom line is that comparables play a critical role in arriving at arm’s
length prices; it is also abundantly clear that computing an arm’s length price using transfer pricing analysis
is a complex task; it requires a lot of effort and goodwill from both the taxpayer and the tax authorities in
terms of documentation, groundwork, analysis and research.

Enterprise [Sec. 92F(iii)]

Enterprise means a person (including a permanent establishment1 of such person) who is, or has been, or is proposed
to be, engaged:
� in any activity, relating to the production, storage, supply, distribution, acquisition or control of:
(a) articles or goods; or
(b) know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial
rights of similar nature; or

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(c) any data, documentation, drawing or specification relating to any patent, invention, model, design, secret
formula or process, of which the other enterprise is the owner or in respect of which the other enterprise
has exclusive rights; or
� in the provision of services of any kind; or
� in carrying out any work in pursuance of a contract; or
� in investment, or providing loan; or
� in the business of acquiring, holding, underwriting or dealing with shares, debentures or other securities of any
other body corporate,
whether such activity or business is carried on, directly or through one or more of its units or divisions or
subsidiaries; or
whether such unit or division or subsidiary is located at the same place where the enterprise is located or at a
different place or places.
Permanent establishment includes a fixed place of business through which the business of the enterprise is wholly
1.

or partly carried on [Sec. 92F(iiia)]

Meaning of international transaction [Sec. 92B]

� International transaction means a transaction between two or more associated enterprises, either or both of
whom are non-residents, in the nature of

(i) purchase, sale or lease of tangible or intangible property, or

(ii) provision of services, or

(iii) lending or borrowing money, or

(iv) any other transaction having a bearing on the profits, income, losses or assets of such enterprises; &

shall include a mutual agreement or arrangement between two or more associated enterprises

a. for the allocation or apportionment of, or

b. any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or
facility provided or to be provided to any one or more of such enterprises [Sec. 92B(1)]

� A transaction entered into by an enterprise with a person other than an associated enterprise shall, be deemed
to be an international transaction entered into between two associated enterprises,

(i) if there exists a prior agreement in relation to the relevant transaction between such other person and the
associated enterprise; or

(ii) the terms of the relevant transaction are determined in substance between such other person and the
associated enterprise

where the enterprise or the associated enterprise or both of them are non-residents irrespective of whether such
other person is a non-resident or not [Sec. 92B(2)]

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Prior agreement/terms are E.g. C Co., an Indian company, and A Co., a

determined in substance by A Co. Pior agreement/terms foreign company, are associated enterprise. Z Plc.,
A Co.
(Parent)
are determined in a foreign company, (not an associated enterprise
A Co. Unrelated substance by A Co.
third party
of C Co.) and A Co. enters into an agreement for
(Parent)
determining the terms of transactions between C
Outside India Outside India
India India
Co. and Z Plc. The transaction as may be entered
vic
es between C Co. and Z Plc., which is governed by
Ser
C Co. C Co.
(Subsidiary)
Unrelated such an agreement existing between A Co. and Z
(Subsidiary) third party
Services Plc. shall be deemed to be a transaction between
Transaction between C Co. and Third Party is subject to TP provisions two associated enterprises.
Taxpoint
� Non-resident means a person who is not a ‘resident’ including a person who is not ordinarily resident [Sec.
2(30)]
� Transaction includes an arrangement, understanding or action in concert,—
(A) whether or not such arrangement, understanding or action is formal or in writing; or
(B) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceeding.
[Sec. 92F(v)]
� For a transaction to be an international transaction, it should satisfy the following two conditions cumulatively:
a) It must be a transaction between two associated enterprises; and
b) At least one of the two enterprises must be a non-resident.

Deemed International Transaction

International transaction shall include:
a. the purchase, sale, transfer, lease or use of tangible property including building, transportation vehicle,
machinery, equipment, tools, plant, furniture, commodity or any other article, product or thing;
b. the purchase, sale, transfer, lease or use of intangible property3, including the transfer of ownership or the
provision of use of rights regarding land use, copyrights, patents, trademarks, licences, franchises, customer

3 Intangible property shall include:

a. marketing related intangible assets, such as, trademarks, trade names, brand names, logos;
b. technology related intangible assets, such as, process patents, patent applications, technical documentation such as laboratory notebooks, technical
know-how;
c. artistic related intangible assets, such as, literary works and copyrights, musical compositions, copyrights, maps, engravings;
d. data processing related intangible assets, such as, proprietary computer software, software copyrights, automated databases, and integrated circuit
masks and masters;
e. engineering related intangible assets, such as, industrial design, product patents, trade secrets, engineering drawing and schema-tics, blueprints,
proprietary documentation;
f. customer related intangible assets, such as, customer lists, customer contracts, customer relationship, open purchase orders;
g. contract related intangible assets, such as, favourable supplier, contracts, licence agreements, franchise agreements, non-compete agreements;
h. human capital related intangible assets, such as, trained and organised work force, employment agreements, union contracts;
i. location related intangible assets, such as, leasehold interest, mineral exploitation rights, easements, air rights, water rights;
j. goodwill related intangible assets, such as, institutional goodwill, professional practice goodwill, personal goodwill of professional, celebrity
goodwill, general business going concern value;
k. methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data;
l. any other similar item that derives its value from its intellectual content rather than its physical attributes.

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list, marketing channel, brand, commercial secret, know-how, industrial property right, exterior design or
practical and new design or any other business or commercial rights of similar nature;
c. capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or
sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other
debt arising during the course of business;
d. provision of services, including provision of market research, market development, marketing management,
administration, technical service, repairs, design, consultation, agency, scientific research, legal or accounting
service;
e. a transaction of business restructuring or reorganisation, entered into by an enterprise with an associated
enterprise, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises
at the time of the transaction or at any future date;

Meaning of Specified Domestic Transactions [Sec. 92BA]

“Specified Domestic Transaction” in case of an assessee means any of the following transactions, not being an
international transaction, namely:
i. any transaction referred to in sec. 80A;
ii. any transfer of goods or services referred to in sec. 80-IA(8);
iii. any business transacted between the assessee and other person as referred to in sec. 80-IA(10);
iv. any transaction, referred to in any other section under Chapter VI-A or sec. 10AA, to which provisions of sec.
80-IA(8) or (10) are applicable; or
v. any business transacted between the persons referred to in sec. 115BAB(4);
vi. any business transacted between the assessee and other person4 as referred to in sec. 115BAE(4);
vii. any other transaction as may be prescribed,
and where the aggregate of such transactions entered into by the assessee in the previous year exceeds a sum of
₹ 20 crore.

Example 1:
Sultan Ltd. took services of one of its group company, an associated enterprise enjoying tax holiday. The transaction
is a specified domestic transaction. Sultan Ltd. paid ₹ 28,40,00,000 for the said service to the group company.
The arms length price of such service is ₹ 17,00,00,000. The arms length price, i.e., the fair value of the service
is ₹ 17,00,00,000 but by paying higher charges, Sultan Ltd. claimed a higher deduction and reduced its profit by
₹ 11,40,00,000. In this case the provisions of sec. 92 will be applicable and the income of Sultan Ltd. will be
recomputed by taking into account the arms length price of the specified domestic transaction.
In other words, the taxable income of Sultan Ltd. will have to be computed by allowing deduction of only ₹
17,00,00,000 on account of service charges instead of the actually paid amount of ₹ 28,40,00,000.
If in the above example, the transaction is not a specified domestic transaction, then the provisions of sec. 92 will
not apply.

4 certain new manufacturing co-operative societies

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Meaning of associated enterprise [Sec. 92A]

Associated enterprise, in relation to another
A A
enterprise, means an enterprise:
Both A & B are D & E are (a) which participates, directly or indirectly,
AE’s of C also AE’s of
B B - Direct B D C Ultimate or through one or more intermediaries, in
A - Indirectly parent (A) the management or control or capital of the
other enterprise; or
C C E
(b) in respect of which one or more persons
who participate, directly or indirectly, or
through one or more intermediaries, in its management or control or capital, are the same persons who participate,
directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other
enterprise.

Deemed associated enterprise [Sec. 92A(2)]

For the above purpose, two enterprises shall be deemed to be associated enterprises if, at any time during the
previous year fulfill any of the following conditions (if one of following conditions are not satisfied, then mere
participation in management or control or capital of the other enterprise, etc. shall not make them associate):
(a) one enterprise holds (directly or indirectly) shares carrying not less than 26% of the voting power (i.e., equity
shares in case of company) in the other enterprise; or
(b) any person or enterprise holds (directly or indirectly) shares carrying not less than 26% of the voting power in
each of such enterprises; or
(c) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly (not
partially) dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any
other business or commercial rights of similar nature, or any data, documentation, drawing or specification
relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the
owner or in respect of which the other enterprise has exclusive rights; or
(d) 90% or more of the raw materials and consumables required for the manufacture or processing of goods or
articles carried out by one enterprise, are supplied by the other enterprise or by persons specified by the other
enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise; or
(e) the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons
specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such
other enterprise; or
(f) where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or
his relative or jointly by such individual and relative of such individual; or
(g) where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member
of such Hindu undivided family, or by a relative of a member of such Hindu undivided family, or jointly by
such member and his relative; or
(h) where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less
than 10% interest in such firm, association of persons or body of individuals; or
(i) a loan advanced by one enterprise to the other enterprise constitutes not less than 51% of the book value of the
total assets of the other enterprise; or

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Taxpoint: Revaluation of asset shall not be ignored.

(j) one enterprise guarantees not less than 10% of the total borrowings of the other enterprise; or
(k) more than ½ of the board of directors or members of the governing board, or one (not ½ of total number of
executive director) or more executive directors or executive members of the governing board of one enterprise,
are appointed by the other enterprise; or
Taxpoint: Mere power to appoint director is not sufficient, such power must be exercised.
(l) more than ½ of the directors or members of the governing board, or one or more of the executive directors or
members of the governing board, of each of the two enterprises are appointed by the same person or persons;
or
(m) there exists between the two enterprises, any relationship of mutual interest, as may be prescribed.

HOLDING MANAGEMENT ACTIVITIES CONTROL

● >= 26% Direct / ● Appointment ● 100% ● One enterprise
Indirect holding by > 50% of DEPENDENCE on controlled BY AN
enterprise DIRECTORS/ use of Intangibles INDIVIDUAL
(or) one or more for manufacture/ and the other by
Executive processing/business himself or his
● By SAME PERSON Director by an relative or jointly
in each enterprise enterprise ● Direct/Indirect Supply
of >= 90% RAW ● One enterprise
(or)
● LOAN >= 51% of MATERIALS under controlled BY
total assets ● Appointment by influenced prices and HUF and the other
same person in conditions by
● GUARANTEES >= each enterprise - a member of
10% of debt ● Sale under HUF his
INFLUENCED relative or
● > 10% INTEREST in prices and conditions Jointly by
Firm/AOP/BOI member and
relative

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 Determination of Arm’s Length Price 13.2

Computation of arm’s length price [Sec. 92C]

� The arm’s length price in relation to an international transaction or specified domestic transaction shall be
determined by any of the following methods, being the most appropriate method, having regard to the nature
of transaction or class of transaction or class of associated persons or functions performed by such persons or
such other relevant factors as the Board may prescribe, namely:
Transaction Based Methods
a. comparable uncontrolled price method;
b. resale price method;
c. cost plus method;
Profit Based Methods
d. profit split method;
e. transactional net margin method;
f. such other method as may be prescribed by the Board.
See Rule 10B & Rule 10AB as given in Annexure 1.
� The most appropriate method shall be applied, for determination of arm’s length price, in the manner as may
be prescribed.
More than one arm’s length price: Where more than one price is determined by the most appropriate method,
the arm’s length price shall be computed in such manner as may be prescribed.
� Computation by the Assessing Officer: As per sec. 92C(3), where during the course of any proceeding for
the assessment of income, the Assessing Officer is, on the basis of material or information or document in his
possession, of the opinion that:
(a) the price charged or paid in an international transaction or specified domestic transaction has not been
determined in accordance with above provision; or
(b) any information and document relating to an international transaction or specified domestic transaction
have not been kept and maintained by the assessee in accordance with the provisions contained in sec.
92D(1) and the rules made in this behalf; or
(c) the information or data used in computation of the arm’s length price is not reliable or correct; or
(d) the assessee has failed to furnish, within the specified time, any information or document which he was
required to furnish by a notice issued u/s 92D(3),

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Direct Tax Laws and International Taxation

the Assessing Officer may proceed to determine the arm’s length price (in accordance with above provisions)
in relation to the said international transaction or specified domestic transaction, on the basis of such material
or information or document available with him.
However, an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee
to show cause, on a date and time to be specified in the notice, why the arm’s length price should not be so
determined on the basis of material or information or document in the possession of the Assessing Officer.
� Where an arm’s length price is determined by the Assessing Officer, the Assessing Officer may compute the
total income of the assessee having regard to the arm’s length price so determined u/s 92C(4). However:
� No deduction u/s 10AA or under Chapter VIA shall be allowed in respect of the amount of income by
which the total income of the assessee is enhanced after computation of income by the assessing officer.
� Where the total income of an associated enterprise is computed by assessing officer on determination
of the arm’s length price paid to another associated enterprise from which tax has been deducted or
was deductible, the income of the other associated enterprise shall not be recomputed by reason of such
determination of arm’s length price in the case of the first mentioned enterprise.

Due to application of transfer pricing provisions, there should be no loss to the revenue.

Reference to Transfer Pricing Officer (TPO) [Sec. 92CA]

� Where any person, being the assessee, has entered into an international transaction or specified domestic
transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he
may, with the previous approval of the Commissioner, refer the computation of the arm’s length price in
relation to the said international transaction or specified domestic transaction u/s 92C to the Transfer Pricing
Officer.
� Where a reference is made, the Transfer Pricing Officer shall serve a notice on the assessee requiring him to
produce or cause to be produced on a date to be specified therein, any evidence on which the assessee may
rely in support of the computation made by him of the arm’s length price in relation to such international
transaction or specified domestic transaction.
� On the date specified in the notice or as soon thereafter as may be, after hearing such evidence as the assessee
may produce, including any information or documents referred to in sec. 92D and after considering such
evidence as the Transfer Pricing Officer may require on any specified points and after taking into account all
relevant materials which he has gathered, the Transfer Pricing Officer shall, by order in writing, determine the
arm’s length price in relation to the international transaction or specified domestic transaction [in accordance
with sec. 92C(3)] and send a copy of his order to the Assessing Officer and to the assessee.
� Where a reference was made, an order may be made at any time before 60 days prior to the date on which the
period of limitation referred to in sec. 153 for making the order of assessment or reassessment or recomputation
or fresh assessment, as the case may be, expires.
� In case assessment proceedings stayed in any circumstances referred to in Explanation (1) [clause (ii) or (x)]
to sec. 153 and the period of limitation available to the Transfer Pricing Officer for making an order is less
than 60 days, such remaining period shall be extended to 60 days and the aforesaid period of limitation shall
be deemed to have been extended accordingly.
� On receipt of the order, the Assessing Officer shall proceed to compute the total income of the assessee u/s
92C(4) in conformity with the arm’s length price as so determined by the Transfer Pricing Officer

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� With a view to rectifying any mistake apparent from the record, the Transfer Pricing Officer may amend any
order passed by him and the provisions of section 154 shall, so far as may be, apply accordingly.
� Where any amendment is made by the Transfer Pricing Officer, he shall send a copy of his order to the
Assessing Officer who shall thereafter proceed to amend the order of assessment in conformity with such order
of the Transfer Pricing Officer.
� Where any other international transaction, comes to the notice of the Transfer Pricing Officer during the
course of the proceedings before him, the provisions of this Chapter shall apply as if such other international
transaction is an international transaction referred to him.
� Where in respect of an international transaction, the assessee has not furnished the report u/s 92E and such
transaction comes to the notice of the Transfer Pricing Officer during the course of the proceeding before him,
the provisions of this Chapter shall apply as if such transaction is an international transaction referred to him.
� The Transfer Pricing Officer may, for the purposes of determining the arm’s length price under this section,
exercise all or any of the powers specified in sec. 131(1) or 133(6) or 133A.
� The Central Government may make a scheme, for the purposes of determination of the arm’s length price, so
as to impart greater efficiency, transparency and accountability by—
a. eliminating the interface between the Transfer Pricing Officer and the assessee or any other person to the
extent technologically feasible;
b. optimising utilisation of the resources through economies of scale and functional specialisation;
c. introducing a team-based determination of arm’s length price with dynamic jurisdiction.
The Central Government may, for the purpose of giving effect to the scheme, direct (within 31-03-2024)
that any of the provisions of this Act shall not apply or shall apply with such exceptions, modifications and
adaptations as may be specified.
� Transfer Pricing Officer means a Joint Commissioner or Deputy Commissioner or Assistant Commissioner
authorised by the Board to perform all or any of the functions of an Assessing Officer specified in sections 92C
and 92D in respect of any person or class of persons.

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Advance Pricing Agreement –
13.3
Concept and Application
Advance Pricing Agreement [Sec. 92CC]

Advance Pricing Agreement is an agreement between

■ APA is a contract a taxpayer and a taxing authority on an appropriate
■ Usually for multiple years transfer pricing methodology for a set of transactions
■ Between a taxpayer and at least one tax authority over a fixed period of time in future. The APAs offer
■ Mainly to prospectively resolve real or potential better assurance on transfer pricing methods and are
transfer pricing issues conducive in providing certainty and unanimity of
approach. A framework for advance pricing agreement
■ Involving transactions between related parties
are as under:
� The Board, with the approval of the Central Government, may enter into an advance pricing agreement with
any person, determining the—
a. arm’s length price or specifying the manner in which the arm’s length price is to be determined, in relation
to an international transaction to be entered into by that person;
b. income referred to in sec. 9(1)(i), or specifying the manner in which said income is to be determined, as is
reasonably attributable to the operations carried out in India by or on behalf of that person, being a non-
resident.
� The manner of determination of arm’s length price, may include the methods referred to in sec. 92C or any
other method, with such adjustments or variations, as may be necessary or expedient so to do.
� The arm’s length price of any international transaction, in respect of which the advance pricing agreement has
been entered into, shall be determined in accordance with the advance pricing agreement so entered.
� The agreement shall be valid for such period not exceeding 5 consecutive previous years as may be specified
in the agreement.
� The advance pricing agreement entered into shall be binding:
a. on the person in whose case, and in respect of the transaction in relation to which, the agreement has been
entered into; and
b. on the Commissioner, and the income-tax authorities subordinate to him, in respect of the said person and
the said transaction.
� The agreement shall not be binding if there is a change in law or facts having bearing on the agreement so
entered.
� The Board may, with the approval of the Central Government, by an order, declare an agreement to be void ab
initio, if it finds that the agreement has been obtained by the person by fraud or misrepresentation of facts.

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� Upon declaring the agreement void ab initio,:

a. all the provisions of the Act shall apply to the person as if such agreement had never been entered into; and
b. for the purpose of computing any period of limitation under this Act, the period beginning with the date of
such agreement and ending on the date of such order shall be excluded.
However, where immediately after the exclusion of the aforesaid period, the period of limitation, referred to
in any provision of this Act, is less than 60 days, such remaining period shall be extended to 60 days and the
aforesaid period of limitation shall be deemed to be extended accordingly.
� The agreement may, subject to such conditions, procedure and manner as may be prescribed, provide for
determining
a. the arm’s length price or specify the manner in which arm’s length price shall be determined in relation to
the international transaction entered into by the person
b. income referred to in sec. 9(1)(i), or specifying the manner in which the said income is to be determined,
as is reasonably attributable to the operations carried out in India by or on behalf of that person, being a
non-resident
during any period not exceeding four previous years preceding the first of the previous years referred to in sec.
92CC(4), and the arm’s length price of such international transaction or the income of such person shall be
determined in accordance with the said agreement
� Where an application is made by a person for entering into an agreement, the proceeding shall be deemed to
be pending in the case of the person for the purposes of the Act.
� The Board may prescribe a scheme specifying therein the manner, form, procedure and any other matter
generally in respect of the advance pricing agreement. Following scheme has been framed by the Board in
respect of Advance Pricing Agreement
Meaning of expressions used in matters in respect of advance pricing agreement [Rule 10F]
a) “agreement” means an advance pricing agreement entered into between the Board and the applicant, with the
approval of the Central Government, as referred to in sec. 92CC(1);
b) “application” means an application for advance pricing agreement made under rule 10-I;
c) “applicant” means a person who has made an application;
d) “bilateral agreement” means an agreement between the Board and the applicant, subsequent to, and based on,
any agreement referred to in rule 44GA between the competent authority in India with the competent authority
in the other country regarding the most appropriate transfer pricing method or the arms’ length price;
e) “competent authority in India” means an officer authorised by the Central Government for the purpose of
discharging the functions as such for matters in respect of any agreement entered into under section 90 or 90A
of the Act;
f) “covered transaction” means the international transaction or transactions for which agreement has been entered
into;
g) “critical assumptions” means the factors and assumptions that are so critical and significant that neither party
entering into an agreement will continue to be bound by the agreement, if any of the factors or assumptions is
changed;
h) “most appropriate transfer pricing method” means any of the transfer pricing method, referred to in sec. 92C(1)
of the Act, being the most appropriate method, having regard to the nature of transaction or class of transaction
or class of associated persons or function performed by such persons or such other relevant factors prescribed
by the Board under rules 10B and 10C;

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Direct Tax Laws and International Taxation

i) “multilateral agreement” means an agreement between the Board and the applicant, subsequent to, and based
on, any agreement referred to in rule 44GA between the competent authority in India with the competent
authorities in the other countries regarding the most appropriate transfer pricing method or the arms’ length
price;
j) “rollback year” means any previous year, falling within the period not exceeding four previous years, preceding
the first of the previous years referred to in sec. 92CC(4);
k) “tax treaty” means an agreement under section 90, or section 90A of the Act for the avoidance of double
taxation;
l) “team” means advance pricing agreement team consisting of income-tax authorities as constituted by the Board
and including such number of experts in economics, statistics, law or any other field as may be nominated by
the Director General of Income-tax (International Taxation);

Unilateral APA Bilateral APA Multilateral APA

● APA entered into between ● APA entered into between ● A PA e n t e r e d b e t w e e n
a taxpayer and the tax the taxpayers, the tax the taxpayers, the tax
administration of the administration of the host administration of the host
country where it is subject country and the foreign tax country and more than one
to taxation administration foreign tax administrations

Persons eligible to apply [Rule 10G]

Any person who –
(i) has undertaken an international transaction; or
(ii) is contemplating to undertake an international transaction,
shall be eligible to enter into an agreement under these rules.

Process of APA
Pre-filing Consultation [Rule 10H]
1. Any person proposing to enter into an agreement under these rules may, by an application in writing, make a
request for a pre-filing consultation.
2. The request for pre-filing consultation shall be made in Form No. 3CEC to the Director General of Income Tax
(International Taxation).
3. On receipt of the request in Form No. 3CEC, the team shall hold pre-filing consultation with the person
referred to in rule 10G.

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4. The competent authority in India or his representative shall be associated in pre-filing consultation involving
bilateral or multilateral agreement.
5. The pre-filing consultation shall, among other things,-
(i) determine the scope of the agreement;
(ii) identify transfer pricing issues;
(iii) determine the suitability of international transaction for the agreement;
(iv) discuss broad terms of the agreement.
6. The pre-filing consultation shall–
(i) not bind the Board or the person to enter into an agreement or initiate the agreement process;
(ii) not be deemed to mean that the person has applied for entering into an agreement.

Application for advance pricing agreement [Rule 10-I]

1. Any person, referred to in rule 10G may, if desires to enter into an agreement furnish an application in Form
No. 3CED alongwith the requisite fee.
2. The application shall be furnished to Director General of Income Tax (International Taxation) in case of
unilateral agreement and to the competent authority in India in case of bilateral or multilateral agreement.
3. Application in Form No. 3CED may be filed by the person referred to in rule 10G at any time–
i. before the first day of the previous year relevant to the first assessment year for which the application is
made, in respect of transactions which are of a continuing nature from dealings that are already occurring;
or
ii. before undertaking the transaction in respect of remaining transactions.
4. Every application in Form No. 3CED shall be accompanied by the proof of payment of specified fees.
5. The fees payable shall be in accordance with following table based on the amount of international transaction
entered into or proposed to be undertaken in respect of which the agreement is proposed:

Amount of international transaction entered into or proposed to be undertaken in respect of which Fee
agreement is proposed during the proposed period of agreement. ₹
Amount not exceeding ₹ 100 crores 10 lacs
Amount not exceeding ₹ 200 crores 15 lacs
Amount exceeding ₹ 200 crores 20 lacs

Withdrawal of application for agreement [Rule 10J]

1. The applicant may withdraw the application for agreement at any time before the finalisation of the terms of
the agreement.
2. The application for withdrawal shall be in Form No. 3CEE.
3. The fee paid shall not be refunded on withdrawal of application by the applicant.

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Preliminary processing of application [Rule 10K]

1. Every application filed in Form No. 3CED shall be complete in all respects and accompanied by requisite
documents.
2. If any defect is noticed in the application in Form No. 3CED or if any relevant document is not attached thereto
or the application is not in accordance with understanding reached in any pre-filing consultation referred
to in rule 10H, the Director General of Income-tax (International Taxation) (for unilateral agreement) and
competent authority in India (for bilateral or multilateral agreement) shall serve a deficiency letter on the
applicant before the expiry of 1 month from the date of receipt of the application.
3. The applicant shall remove the deficiency or modify the application within a period of 15 days from the date
of service of the deficiency letter or within such further period which, on an application made in this behalf,
may be extended, so however, that the total period of removal of deficiency or modification does not exceed
30 days.
4. The Director General of Income Tax (International Taxation) or the competent authority in India, as the case
may be, on being satisfied, may pass an order providing that application shall not be allowed to be proceeded
with if the application is defective and defect is not removed by applicant in accordance with aforesaid rule.
5. No such order shall be passed without providing an opportunity of being heard to the applicant and if an
application is not allowed to be proceeded with, the fee paid by the applicant shall be refunded.
Procedure [Rule 10L]
1. If the application referred to in rule 10K has been allowed to be proceeded with, the team or the competent
authority in India or his representative shall process the same in consultation and discussion with the applicant
in accordance with provisions of this rule.
2. For this purpose, it shall be competent for the team or the competent authority in India or its representative to:
i. hold meetings with the applicant on such time and date as it deem fit;
ii. call for additional document or information or material from the applicant;
iii. visit the applicant’s business premises; or
iv. make such inquiries as it deems fit in the circumstances of the case.
3. The applicant may, if he considers it necessary, provide further document and information for consideration of
the team or the competent authority in India or his representative.
4. For bilateral or multilateral agreement, the competent authority shall forward the application to Director
General of Income-tax (International Taxation) who shall assign it to one of the teams.
5. The team, to whom the application has been assigned, shall carry out the enquiry and prepare a draft report
which shall be forwarded by the Director General of Income-tax (International Taxation) to the competent
authority in India.
6. If the applicant makes a request for bilateral or multilateral agreement in its application, the competent authority
in India shall in addition to the procedure provided in this rule invoke the procedure provided in rule 44GA.
7. The Director General of Income-tax (International Taxation) (for unilateral agreement) or the competent
authority in India (for bilateral or multilateral agreement) and the applicant shall prepare a proposed mutually
agreed draft agreement enumerating the result of the process including the effect of the arrangement referred
to in rule 44GA(5) which has been accepted by the applicant in accordance with rule 44GA(8).

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8. The agreement shall be entered into by the Board with the applicant after its approval by the Central Government.
9. Once an agreement has been entered into the Director General of Income-tax (International Taxation) or
the competent authority in India, as the case may be, shall cause a copy of the agreement to be sent to the
Commissioner of Income-tax having jurisdiction over the assessee.

Terms of the agreement [Rule 10M]

1. An agreement may among other things, include –
i. the international transactions covered by the agreement;
ii. the agreed transfer pricing methodology, if any;
iii. determination of arm‟s length price, if any;
iv. definition of any relevant term to be used in items (ii) or (iii);
v. critical assumptions;
vi. rollback provision referred to in rule 10MA;
vii. the conditions if any other than provided in the Act or these rules.
2. The agreement shall not be binding on the Board or the assessee if there is a change in any of critical assumptions
or failure to meet conditions subject to which the agreement has been entered into.
3. The binding effect of agreement shall cease only if any party has given due notice of the concerned other party
or parties.
4. In case there is a change in any of the critical assumptions or failure to meet the conditions subject to which
the agreement has been entered into, the agreement can be revised or cancelled, as the case may be.
5. The assessee which has entered into an agreement shall give a notice in writing of such change in any of
the critical assumptions or failure to meet conditions to the Director General of Income Tax (International
Taxation) as soon as it is practicable to do so.
6. The Board shall give a notice in writing of such change in critical assumptions or failure to meet conditions to
the assessee, as soon as it comes to the knowledge of the Board.
7. The revision or the cancellation of the agreement shall be in accordance with rules 10Q and 10R respectively.

Roll Back of the Agreement [Rule 10MA]

Sec. 92CC of the Act provides for Advance Pricing Agreement (APA). It empowers the Central Board of Direct
Taxes, with the approval of the Central Government, to enter into an APA with any person for determining the
Arm’s Length Price (ALP) or specifying the manner in which ALP is to be determined in relation to an international
transaction which is to be entered into by the person. The agreement entered into is valid for a period, not exceeding
5 previous years, as may be mentioned in the agreement. Once the agreement is entered into, the ALP of the
international transaction, which is subject matter of the APA, would be determined in accordance with such an
APA.
In many countries the APA scheme provides for “roll back” mechanism for dealing with ALP issues relating to
transactions entered into during the period prior to APA. The “roll back” provisions refers to the applicability of
the methodology of determination of ALP, or the ALP, to be applied to the international transactions which had
already been entered into in a period prior to the period covered under an APA. However, the “roll back” relief is
provided on case to case basis subject to certain conditions. Providing of such a mechanism in Indian legislation

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would also lead to reduction in large scale litigation which is currently pending or may arise in future in respect of
the transfer pricing matters.
1. Subject to the provisions of this rule, the agreement may provide for determining the arm’s length price or
specify the manner in which arm’s length price shall be determined in relation to the international transaction
entered into by the person during the rollback year (hereinafter referred to as “rollback provision”).
2. The agreement shall contain rollback provision in respect of an international transaction subject to the
following:
i. the international transaction is same as the international transaction to which the agreement (other than the
rollback provision) applies;
ii. the return of income for the relevant rollback year has been or is furnished by the applicant before the due
date specified u/s 139;
iii. the report in respect of the international transaction had been furnished in accordance with sec. 92E;
iv. the applicability of rollback provision, in respect of an international transaction, has been requested by the
applicant for all the rollback years in which the said international transaction has been undertaken by the
applicant; and
v. the applicant has made an application seeking rollback in Form 3CEDA in accordance with sub-rule (5);
3. Rollback provision shall not be provided in respect of an international transaction for a rollback year, if:
i. the determination of arm’s length price of the said international transaction for the said year has been
subject matter of an appeal before the Appellate Tribunal and the Appellate Tribunal has passed an order
disposing of such appeal at any time before signing of the agreement; or
ii. the application of rollback provision has the effect of reducing the total income or increasing the loss, as
the case may be, of the applicant as declared in the return of income of the said year.
4. Where the rollback provision specifies the manner in which arm’s length price shall be determined in relation
to an international transaction undertaken in any rollback year then such manner shall be the same as the
manner which has been agreed to be provided for determination of arm’s length price of the same international
transaction to be undertaken in any previous year to which the agreement applies, not being a rollback year.
5. The applicant may, if he desires to enter into an agreement with rollback provision, furnish along with the
application, the request for the same in Form No. 3CEDA with proof of payment of an additional fee of ₹ 5
lakh.

Amendments to Application [Rule 10N]

1. An applicant may request in writing for an amendment to an application at any stage, before the finalisation of
the terms of the agreement.
2. The Director General of Income Tax (International Taxation) (for unilateral agreement) or the competent
authority in India (for bilateral or multilateral agreement) may, allow the amendment to the application, if such
an amendment does not have effect of altering the nature of the application as originally filed.
3. The amendment shall be given effect only if it is accompanied by the additional fee, if any, necessitated by
such amendment in accordance with fee as provided in rule 10-I.

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Furnishing of Annual Compliance Report [Rule 10-O]

1. The assessee shall furnish an annual compliance report to Director General of Income Tax (international
Taxation) for each year covered in the agreement.
2. The annual compliance report shall be in Form 3CEF.
3. The annual compliance report shall be furnished in quadruplicate, for each of the years covered in the agreement,
within 30 days of the due date of filing the income tax return for that year, or within 90 days of entering into
an agreement, whichever is later.
4. The Director General of Income Tax (International Taxation) shall send one copy of annual compliance report
to the competent authority in India, one copy to the Commissioner of Income Tax who has the jurisdiction over
the income-tax assessment of the assessee and one copy to the Transfer Pricing Officer having the jurisdiction
over the assessee.
Compliance Audit of the agreement [Rule 10P]
1. The Transfer Pricing Officer having the jurisdiction over the assessee shall carry out the compliance audit of
the agreement for each of the year covered in the agreement.
2. The Transfer Pricing Officer may require:
i. the assessee to substantiate compliance with the terms of the agreement, including satisfaction of the
critical assumptions, correctness of the supporting data or information and consistency of the application
of the transfer pricing method;
ii. the assessee to submit any information, or document, to establish that the terms of the agreement has been
complied with.
3. The Transfer Pricing Officer shall submit the compliance audit report, for each year covered in the agreement,
to the Director General of Income Tax (International Taxation) in case of unilateral agreement and to the
competent authority in India, in case of bilateral or multilateral agreement, mentioning therein his findings as
regards compliance by the assessee with terms of the agreement.
4. The Director General of Income Tax (International Taxation) shall forward the report to the Board in a case
where there is finding of failure on part of assessee to comply with terms of agreement and cancellation of the
agreement is required.
5. The compliance audit report shall be furnished by the Transfer Pricing Officer within 6 months from the end of
the month in which the Annual Compliance Report referred to in rule 10-O is received by the Transfer Pricing
Officer.
6. The regular audit of the covered transactions shall not be undertaken by the Transfer Pricing Officer if an
agreement has been entered into under rule 10L except where the agreement has been cancelled under rule
10R.
Revision of an agreement [Rule 10Q]
1. An agreement, subsequent to it having been entered into, may be revised by the Board, if.-
i. there is a change in critical assumptions or failure to meet a condition subject to which the agreement has
been entered into;
ii. there is a change in law that modifies any matter covered by the agreement but is not of the nature which
renders the agreement to be non binding ; or

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iii. there is a request from competent authority in the other country requesting revision of agreement, in case
of bilateral or multilateral agreement.
2. An agreement may be revised by the Board either suo-moto or on request of the assessee or the competent
authority in India or the Director General of Income Tax (International Taxation).
3. Except when the agreement is proposed to be revised on the request of the assessee, the agreement shall not be
revised unless an opportunity of being heard has been provided to the assessee and the assessee is in agreement
with the proposed revision.
4. In case the assessee is not in agreement with the proposed revision the agreement may be cancelled in
accordance with rule-10R.
5. In case the Board is not in agreement with the request of the assessee for revision of the agreement, the Board
shall reject the request in writing giving reason for such rejection.
6. For the purpose of arriving at the agreement for the proposed revision, the procedure provided in rule 10 L may
be followed so far as they apply.
7. The revised agreement shall include the date till which the original agreement is to apply and the date from
which the revised agreement is to apply.
Cancellation of an agreement [Rule 10R]
1. An agreement shall be cancelled by the Board for any of the following reasons:
i. the compliance audit referred to in rule 10P has resulted in the finding of failure on the part of the assessee
to comply with the terms of the agreement;
ii. the assessee has failed to file the annual compliance report in time;
iii. the annual compliance report furnished by the assessee contains material errors; or
iv. the agreement is to be cancelled under rule 10Q(4) or rule 10RA(7).
2. The Board shall give an opportunity of being heard to the assessee, before proceeding to cancel an application.
3. The competent authority in India shall communicate with the competent authority in the other country or
countries and provide reason for the proposed cancellation of the agreement in case of bilateral or multilateral
agreement.
4. The order of cancellation of the agreement shall be in writing and shall provide reasons for cancellation and
for non acceptance of assessee‟s submission, if any.
5. The order of cancellation shall also specify the effective date of cancellation of the agreement, where applicable.
6. The order under the Act, declaring the agreement as void ab initio, on account of fraud or misrepresentation
of facts, shall be in writing and shall provide reason for such declaration and for non acceptance of assessee‟s
submission, if any.
7. The order of cancellation shall be intimated to the Assessing Officer and the Transfer Pricing Officer, having
jurisdiction over the assessee.
Procedure for giving effect to rollback provision of an Agreement [Rule 10RA]
1. The effect to the rollback provisions of an agreement shall be given in accordance with this rule.
2. The applicant shall furnish modified return of income referred to in sec. 92CD in respect of a rollback year to
which the agreement applies along with the proof of payment of any additional tax arising as a consequence of
and computed in accordance with the rollback provision.

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3. The modified return referred above shall be furnished along with the modified return to be furnished in respect
of first of the previous years for which the agreement has been requested for in the application.
4. If any appeal filed by the applicant is pending before the Commissioner (Appeals), Appellate Tribunal or the
High Court for a rollback year, on the issue which is the subject matter of the rollback provision for that year,
the said appeal to the extent of the subject covered under the agreement shall be withdrawn by the applicant
before furnishing the modified return for the said year.
5. If any appeal filed by the Assessing Officer or the Principal Commissioner or Commissioner is pending before
the Appellate Tribunal or the High Court for a rollback year, on the issue which is subject matter of the
rollback provision for that year, the said appeal to the extent of the subject covered under the agreement shall
be withdrawn by the Assessing Officer or the Principal Commissioner or the Commissioner, as the case may
be, within 3 months of filing of modified return by the applicant.
6. The applicant, the Assessing Officer or the Principal Commissioner or the Commissioner, shall inform the
Dispute Resolution Panel or the Commissioner (Appeals) or the Appellate Tribunal or the High Court, as the
case may be, the fact of an agreement containing rollback provision having been entered into along with a copy
of the same as soon as it is practicable to do so.
7. In case effect cannot be given to the rollback provision of an agreement in accordance with this rule, for
any rollback year to which it applies, on account of failure on the part of applicant, the agreement shall be
cancelled.
Renewing an agreement [Rule 10S]
Request for renewal of an agreement may be made as a new application for agreement, using the same procedure
as outlined in these rules except pre filing consultation as referred to in rule 10H.
Miscellaneous [Rule 10T]
1. Mere filing of a application for an agreement under these rules shall not prevent the operation of Chapter X of
the Act for determination of arms‟ length price under that Chapter till the agreement is entered into.
2. The negotiation between the competent authority in India and the competent authority in the other country or
countries, in case of bilateral or multilateral agreement, shall be carried out in accordance with the provisions
of the tax treaty between India and the other country or countries.
Procedure to deal with requests for bilateral or multilateral advance pricing agreements [Rule 44GA]
1. Where a person has made request for a bilateral or multilateral advance pricing agreement in an application
filed in Form No. 3CED in accordance with rule 10-I, the request shall be dealt with subject to provisions of
this rule.
2. The process for bilateral or multilateral advance pricing agreement shall not be initiated unless the associated
enterprise situated outside India has initiated process of advance pricing agreement with the competent
authority in the other country.
3. The competent authority in India shall, on intimation of request of the applicant for a bilateral or multilateral
agreement, consult and ascertain willingness of the competent authority in other country or countries, as the
case may be, for initiation of negotiation for this purpose.
4. In case of willingness of the competent authority in other country or countries, as the case may be, the competent
authority in India shall enter into negotiation in this behalf and endeavour to reach a set of terms which are
acceptable to the competent authority in India and the competent authority in the other country or countries, as
the case may be.

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5. In case of an agreement after consultation, the competent authority in India shall formalise a mutual agreement
procedure arrangement with the competent authority in other country or countries, as the case may be, and
intimate the same to the applicant.
6. In case of failure to reach agreement on such terms as are mutually acceptable to parties mentioned in sub-rule
(4), the applicant shall be informed of the failure to reach an agreement with the competent authority in other
country or countries.
7. The applicant shall not be entitled to be part of discussion between competent authority in India and the
competent authority in the other country or countries, as the case may be; however the applicant can
communicate or meet the competent authority in India for the purpose of entering into an advance pricing
agreement.
8. The applicant shall convey acceptance or otherwise of the agreement within thirty days of it being communicated.
9. The applicant, in case the agreement is not acceptable may at its option continue with process of entering
into an advance pricing agreement without benefit of mutual agreement process or withdraw application in
accordance with rule 10J

Effect to Advance Pricing Agreement [Sec. 92CD]

� Where any person has entered into an agreement and prior to the date of entering into the agreement, any
return of income has been furnished u/s 139 for any assessment year relevant to a previous year to which such
agreement applies, such person shall furnish, within a period of 3 months from the end of the month in which
the said agreement was entered into, a modified return in accordance with and limited to the agreement.
� Save as otherwise provided in this section, all other provisions of this Act shall apply accordingly as if the
modified return is a return furnished u/s 139.
� If the assessment or reassessment proceedings for an assessment year relevant to a previous year to which the
agreement applies have been completed before the expiry of period allowed for furnishing of modified return,
the Assessing Officer shall, in a case where modified return is filed, pass an order modifying the total income of
the relevant assessment year determined in such assessment or reassessment, as the case may be having regard
to and in accordance with the agreement.
� Where the assessment or reassessment proceedings for an assessment year relevant to the previous year to
which the agreement applies are pending on the date of filing of modified return, the Assessing Officer shall
proceed to complete the assessment or reassessment proceedings in accordance with the agreement taking into
consideration the modified return so furnished.
� The order shall be passed within a period of 1 year from the end of the financial year in which the modified
return is furnished.
� The period of limitation as provided in sec. 153, 153B or 144C for completion of pending assessment or
reassessment proceedings shall be extended by a period of 12 months.
� The assessment or reassessment proceedings for an assessment year shall be deemed to have been completed
where:
(a) an assessment or reassessment order has been passed; or
(b) no notice has been issued u/s 143(2) till the expiry of the limitation period provided under that sub-
section.

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Maintenance, keeping of information and document by persons entering into an

international transaction or specified domestic transaction [Sec. 92D]
� Every person,—
a. who has entered into an international transaction or specified domestic transaction shall keep and maintain
such information and document in respect thereof as may be prescribed;
b. being a constituent entity4 of an international group, shall keep and maintain such information and
document in respect of an international group as may be prescribed.
� The Board may prescribe the period for which the information and document shall be kept and maintained5
under the said sub-section.
� The Assessing Officer or the Commissioner (Appeals) may, in the course of any proceeding under this Act,
require any person referred to in (a) to furnish any information or document referred therein, within a period of
10 days from the date of receipt of a notice issued in this regard. However, such period may, on an application
made by such person, extend the period of ten days by a further period not exceeding 30 days.
� The person referred to in (b) shall furnish the information and document referred therein to the authority
prescribed u/s 286(1), in such manner, on or before such date, as may be prescribed.
� If constituent entity fails to furnish the information and documents, penalty of ₹ 5,00,000 shall be levied
on that person u/s 271AA. In other case, a sum equal to 2% of the value of each international transaction or
specified domestic transaction entered into by such person shall be levied as penalty

Report from an accountant to be furnished by persons entering into international

transaction or specified domestic transaction [Sec. 92E]
Every person who has entered into an international transaction or specified domestic transaction during a previous
year shall obtain a report from an accountant and furnish such report on or before the specified date (i.e., 31st Oct,
being one month prior the due date of filing of return of income) in the prescribed form [Form 3CEB] duly signed
and verified in the prescribed manner by such accountant and setting forth such particulars as may be prescribed.

Special measures in respect of transactions with persons located in notified jurisdictional

area [Sec. 94A]
� The Central Government may, having regard to the lack of effective exchange of information with any country
or territory outside India, specify by notification in the Official Gazette such country or territory as a notified
jurisdictional area in relation to transactions entered into by any assessee.
� If an assessee enters into a transaction where one of the parties to the transaction is a person located in a
notified jurisdictional area, then—
i. all the parties to the transaction shall be deemed to be associated enterprises within the meaning of sec.
92A;
ii. any transaction in the nature of purchase, sale or lease of tangible or intangible property or provision
of service or lending or borrowing money or any other transaction having a bearing on the profits,

4 “constituent entity” and “international group” shall have the meaning assigned to it in sec. 286(9).
5 8 years from the end of the relevant assessment year

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income, losses or assets of the assessee including a mutual agreement or arrangement for allocation or
apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection
with a benefit, service or facility provided or to be provided by or to the assessee shall be deemed to be an
international transaction within the meaning of sec. 92B,
and the provisions of sec. 92, 92A, 92B, 92C [except the second proviso to sec. 92C(2)], 92CA, 92CB, 92D,
92E and 92F shall apply accordingly.
� Person located in a notified jurisdictional area shall include:
a. a person who is resident of the notified jurisdictional area;
b. a person, not being an individual, which is established in the notified jurisdictional area; or
c. a permanent establishment of a person not falling above, in the notified jurisdictional area;
� No deduction,—
i. in respect of any payment made to any financial institution located in a notified jurisdictional area shall be
allowed under this Act, unless the assessee furnishes an authorisation in the prescribed form authorising
the Board or any other income-tax authority acting on its behalf to seek relevant information from the
said financial institution on behalf of such assessee; and
ii. in respect of any other expenditure or allowance (including depreciation) arising from the transaction
with a person located in a notified jurisdictional area shall be allowed under any other provision of this
Act, unless the assessee maintains such other documents and furnishes such information as may be
prescribed [under rule 10FC], in this behalf.
� Where, in any previous year, the assessee has received or credited any sum from any person located in a
notified jurisdictional area and the assessee does not offer any explanation about the source of the said sum
in the hands of such person or in the hands of the beneficial owner (if such person is not the beneficial owner
of the said sum) or the explanation offered by the assessee, in the opinion of the Assessing Officer, is not
satisfactory, then, such sum shall be deemed to be the income of the assessee for that previous year.
� Where any person located in a notified jurisdictional area is entitled to receive any sum or income or amount on
which tax is deductible under Chapter XVII-B, the tax shall be deducted at the highest of the following rates:
a. 30%
b. at the rate or rates in force;
c. at the rate specified in the relevant provisions of this Act;

Penalty
Failure to keep and maintain information and document in respect of international transaction or specified domestic
transaction [Sec. 271AA]
If any person in respect of an international transaction or specified domestic transaction:
i. fails to keep and maintain any such information and document as required by sec. 92D;
ii. fails to report such transaction which he is required to do so; or

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iii. maintains or furnishes an incorrect information or document,

the Assessing Officer or Commissioner (Appeals) may direct that such person shall pay, by way of penalty, a
sum equal to 2% of the value of each international transaction or specified domestic transaction entered into
by such person.

Penalty for failure to furnish report under section 92E [Sec. 271BA]
If any person fails to furnish a report from an accountant as required by sec. 92E, the Assessing Officer may direct
that such person shall pay, by way of penalty, a sum of ₹ 1,00,000.

Penalty for failure to furnish information or document under section 92D [Sec. 271G]
If any person who has entered into an international transaction or specified domestic transaction fails to furnish any
such information or document as required by sec. 92D(3), the Transfer Pricing Officer or Assessing Officer or the
Commissioner (Appeals) may direct that such person shall pay, by way of penalty, a sum equal to 2% of the value
of the international transaction or specified domestic transaction for each such failure.

However, where assessee shows reasonable cause, then no penalty u/s 271AA or 271BA or 271G shall be levied
[Sec. 273B]

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 Safe Harbour Rules, Thin Capitalisation 13.4
and Secondary Adjustment
Power of Board to make safe harbour rules [Sec. 92CB]
The determination of—
a. income referred to in sec. 9(1)(i); or
b. arm’s length price u/s 92C or 92CA,
- shall be subject to safe harbour rules.
Taxpoint
� The Board may make rules for safe harbour6.
� “Safe harbour” means circumstances in which the income-tax authorities shall accept the transfer price or
income, deemed to accrue or arise u/s 9(1)(i), as the case may be, declared by the assessee.

Limitation on interest deduction in certain cases [Sec. 94B]

Thin Capitalization
A company is typically financed or capitalized through a mixture of debt and equity. The way a company is
capitalized often has a significant impact on the amount of profit it reports for tax purposes as the tax legislations
of countries typically allow a deduction for interest paid or payable in arriving at the profit for tax purposes while
the dividend paid on equity contribution is not deductible. Therefore, the higher the level of debt in a company,
and thus the amount of interest it pays, the lower will be its taxable profit. For this reason, debt is often a more tax
efficient method of finance than equity. Multinational groups are often able to structure their financing arrangements
to maximize these benefits. For this reason, country’s tax administrations often introduce rules that place a limit
on the amount of interest that can be deducted in computing a company’s profit for tax purposes. Such rules are
designed to counter cross-border shifting of profit through excessive interest payments, and thus aim to protect a
country’s tax base.
Under the initiative of the G-20 countries, the Organization for Economic Co-operation and Development (OECD)
in its Base Erosion and Profit Shifting (BEPS) project had taken up the issue of base erosion and profit shifting by
way of excess interest deductions by the MNEs in Action plan 4. The OECD has recommended several measures
in its final report to address this issue.
In view of the above, sec. 94B was inserted in line with the recommendations of OECD BEPS Action Plan 4, to
provide that interest expenses claimed by an entity to its associated enterprises shall be restricted to 30% of its
earnings before interest, taxes, depreciation and amortization (EBITDA) or interest paid or payable to associated
enterprise, whichever is less.
6 Rule 10TA to Rule 10THD

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The provisions are enumerated here-in-below:

Applicable to
Indian company, or a permanent establishment of a foreign company in India, being the borrower
� Permanent establishment includes a fixed place of business through which the business of the enterprise is
wholly or partly carried on.
Conditions
a) The borrower has debt issued by a non-resident, being an associated enterprise of such borrower.
� Debt means any loan, financial instrument, finance lease, financial derivative, or any arrangement that
gives rise to interest, discounts or other finance charges that are deductible in the computation of income
chargeable under the head “Profits and gains of business or profession”;
b) He incurs any expenditure by way of interest or of similar nature exceeding ` 1 crore;
c) Such expenditure is deductible in computing income chargeable under the head “Profits and gains of business
or profession”
Effect
If all the aforesaid conditions are satisfied then, excess interest shall not be deductible in computation of income
under the said head.
� Excess interest means lower of the following:
a) An amount of total interest paid or payable in excess of 30% of earnings before interest, taxes, depreciation
and amortisation (EBITDA) of the borrower in the previous year; or
b) Interest paid or payable to associated enterprises for that previous year
Taxpoint
� Guarantee: Where the debt is issued by a lender which is not associated but an associated enterprise either
provides an implicit or explicit guarantee to such lender or deposits a corresponding and matching amount of
funds with the lender, such debt shall be deemed to have been issued by an associated enterprise.
� Exception:
The provision of sec. 94B is not applicable:
a) to an Indian company or a permanent establishment of a foreign company which is engaged in the business
of banking or insurance or notified non-banking financial companies (NBFC)
b) to interest paid in respect of a debt issued by a lender which is a permanent establishment in India of a
non-resident, being a person engaged in the business of banking
� Carry forward: Where for any assessment year, the interest expenditure is not wholly deducted against income
under the head “Profits and gains of business or profession”, so much of the interest expenditure as has not
been so deducted, shall be carried forward to the following assessment year(s), and it shall be allowed as a
deduction against the profits and gains, if any, of any business or profession carried on by it and assessable for
that assessment year to the extent of maximum allowable interest expenditure.
� Maximum carried forward: No interest expenditure shall be carried forward for more than 8 assessment years
immediately succeeding the assessment year for which the excess interest expenditure was first computed.

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Example 2:
Computation of interest expenses disallowed u/s 94B:
` in crore

Particulars Case 1 Case 2 Case 3

EBIDTA of the Indian Borrower 100 100 100
30% of the above [A] 30 30 30
Interest payable to associated enterprise [B] 35 Nil 15
Interest payable to non-associated enterprise [C] Nil 35 20
Total Interest expense incurred [D = B + C] 35 35 35
Total interest expenses incurred in excess of 30% of EBITDA [E = D – A] 5 5 5
Interest payable to associated enterprise [B] 35 Nil 15
Excess interest [lower of (E) and (B)] being disallowed u/s 94B 5 Nil 5
Secondary adjustment in certain cases [Sec. 92CE]
“Secondary adjustment” means an adjustment in the books of account of the assessee and its associated enterprise
to reflect that the actual allocation of profits between the assessee and its associated enterprise are consistent with
the transfer price determined as a result of primary adjustment, thereby removing the imbalance between cash
account and actual profit of the assessee.
The provisions are enumerated here-in-below:
� Where a primary adjustment to transfer price,:
i. has been made suo motu by the assessee in his return of income;
ii. made by the Assessing Officer has been accepted by the assessee;
iii. is determined by an advance pricing agreement entered into by the assessee u/s 92CC on or after 01-04-
2017;
iv. is made as per the safe harbour rules framed u/s 92CB; or
v. is arising as a result of resolution of an assessment by way of the mutual agreement procedure under an
agreement entered into u/s 90 or 90A for avoidance of double taxation,
- the assessee shall make a secondary adjustment.
� Exception: Nothing contained in this section shall apply, if:
i. the amount of primary adjustment made in any previous year does not exceed ` 1 crore; or
ii. the primary adjustment is made in respect of an assessment year commencing on or before 01-04-2016.
� Where, as a result of primary adjustment to the transfer price, there is an increase in the total income or
reduction in the loss, as the case may be, of the assessee, the excess money (or part thereof) which is available
with its associated enterprise, if not repatriated to India within the time as may be prescribed, shall be deemed
to be an advance made by the assessee to such associated enterprise and the interest on such advance, shall be
computed in such manner as may be prescribed [Sec. 92CE(2)]
� Excess money means the difference between the arm’s length price determined in primary adjustment and
the price at which the international transaction has actually been undertaken;

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� Primary adjustment to a transfer price, means the determination of transfer price in accordance with the
arm’s length principle resulting in an increase in the total income or reduction in the loss, as the case may
be, of the assessee;
� Excess money (or part thereof) may be repatriated from any of the associated enterprises of the assessee
which is not a resident in India.

Example 3:
An Indian company sells certain products to its Associated Enterprise for INR 100 crores, whereas the Arm’s
Length Price (ALP) of such transaction is INR 150 crores. The TPO confirms an upward adjustment (Primary
adjustment) of INR 50 crores, the difference between the Selling price INR 100 crores and the ALP INR 150
crores, which is taxed in the hands of Indian company.
Subsequently, for the purpose of Secondary adjustment, it would be deemed that the AE owes INR 50 crores
to Indian company (the difference between ALP and actual transfer price), which will be deemed to be a Loan
or an Advance by Indian company to its AE. As a consequence, an interest would be imputed on such Loan or
Advance and an Adjustment (Secondary adjustment) would be carried out in the hands of the Indian company.
Optional Scheme
� Where the excess money (or part thereof) has not been repatriated within the prescribed time, the assessee may,
at his option, pay additional income-tax @ 18% (plus surcharge @ 12% + cess) on such excess money.
� The tax so paid by the assessee shall be treated as the final payment of tax in respect of such money not
repatriated and no further credit therefor shall be claimed by the assessee or by any other person in respect of
the amount of tax so paid.
� No deduction shall be allowed to the assessee in respect of the amount on which tax has been paid.
� Where the additional income-tax is paid by the assessee, he shall not be required to make secondary adjustment
and compute interest from the date of payment of such tax
Computation of interest income pursuant to secondary adjustments [Rule 10CB]
1. For the purposes of sec. 92CE(2), the time limit for repatriation of excess money or part thereof shall be on or
before 90 days,—
i. from the due date of filing of return u/s 139(1) where primary adjustments to transfer price has been made
suo-moto by the assessee in his return of income;
ii. from the date of the order of Assessing Officer or the appellate authority, as the case may be, if the
primary adjustments to transfer price as determined in the aforesaid order has been accepted by the
assessee;
iii. in a case where primary adjustment to transfer price is determined by an advance pricing agreement
entered into by the assessee u/s 92CC in respect of a previous year,-
a. from the date of filing of return u/s 139(1) if the advance pricing agreement has been entered into on
or before the due date of filing of return for the relevant previous year;
b. from the end of the month in which the advance pricing agreement has been entered into if the said
agreement has been entered into after the due date of filing of return for the relevant previous year
iv. from the due date of filing of return u/s 139(1) in the case of option exercised by the assessee as per the
safe harbour rules u/s 92CB; or

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v. from the date of giving effect by the Assessing Officer under rule 44H to the resolution arrived at under
mutual agreement procedure, where the primary adjustment to transfer price is determined by such
resolution under a Double Taxation Avoidance Agreement entered into u/s 90 or 90A.
2. The imputed per annum interest income on excess money or part thereof which is not repatriated within the
time limit as per sec. 92CE(1) shall be computed,—
i. at the 1 year marginal cost of fund lending rate of State Bank of India as on 1st of April of the relevant
previous year plus 325 basis points in the cases where the international transaction is denominated in
Indian rupee; or
ii. at 6 months London Interbank Offered Rate as on 30th September of the relevant previous year plus 300
basis points in the cases where the international transaction is denominated in foreign currency.
3. The aforesaid interest shall be chargeable on excess money or part thereof which is not repatriated—
a. in cases referred to in sub-rule (1)(i), (iii)(a) and (iv), from the due date of filing of return u/s 139(1);
b. in cases referred to in sub-rule (1)(ii), from the date of the order of Assessing Officer or the appellate
authority, as the case may be;
c. in cases referred to in sub-rule (1)(iii)(b), from the end of the month in which the advance pricing agreement
has been entered into by the assessee u/s 92CC;
d. in cases referred to in sub-rule (1)(v), from the date of giving effect by the Assessing Officer under rule
44H to the resolution arrived at under mutual agreement procedure.
Taxpoint
� “International transaction” shall have the same meaning as assigned to it in sec. 92B;
� The rate of exchange for the calculation of the value in rupees of the international transaction denominated in
foreign currency shall be the telegraphic transfer buying rate of such currency on the last day of the previous
year in which such international transaction was undertaken and the “telegraphic transfer buying rate” shall
have the same meaning as assigned in the Explanation to rule 26 [i.e., “telegraphic transfer buying rate”, in
relation to a foreign currency, means the rate or rates of exchange adopted by the State Bank of India, for
buying such currency, having regard to the guidelines specified from time to time by the Reserve Bank of India
for buying such currency, where such currency is made available to that bank through a telegraphic transfer.

Annexure 1
Determination of income in the case of non-residents [Rule 10]
In any case in which the Assessing Officer is of opinion that the actual amount of the income accruing or arising to
any non-resident person whether directly or indirectly, through or from any business connection in India or through
or from any property in India or through or from any asset or source of income in India or through or from any
money lent at interest and brought into India in cash or in kind cannot be definitely ascertained, the amount of such
income for the purposes of assessment to income-tax may be calculated:
i. at such percentage of the turnover so accruing or arising as the Assessing Officer may consider to be
reasonable, or
ii. on any amount which bears the same proportion to the total profits and gains of the business of such person
(such profits and gains being computed in accordance with the provisions of the Act), as the receipts so
accruing or arising bear to the total receipts of the business, or
iii. in such other manner as the Assessing Officer may deem suitable.

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Determination of arm’s length price under section 92C [Rule 10B]

� For the purposes of sec. 92C(2), the arm’s length price in relation to an international transaction or a specified
domestic transaction shall be determined by any of the following methods, being the most appropriate method,
in the following manner:

a. comparable uncontrolled price (CUP) method, by which,—

i. the price charged or paid for property transferred or services provided in a comparable uncontrolled
transaction, or a number of such transactions, is identified;

● Uncontrolled transaction means a transaction between enterprises other than associated

enterprises, whether resident or non-resident – Rule 10A

● Transaction includes a number of closely linked transactions

ii. such price is adjusted to account for differences, if any, between the international transaction or the
specified domestic transaction and the comparable uncontrolled transactions or between the enterprises
entering into such transactions, which could materially affect the price in the open market;

iii. the adjusted price arrived at under (ii) is taken to be an arm’s length price in respect of the property
transferred or services provided in the international transaction or the specified domestic transaction

 Property includes goods, articles or things, and intangible property;

 Services include financial services

Taxpoint:

● Typical transactions in respect of which the comparable uncontrolled price method may be adopted
are:

a. Transfer of goods;

b. Provision of services;

c. Intangibles;

d. Interest on loans.

● CUP can be either of the following:

1. Internal CUP: this would be available if the taxpayer (or one of its group entities) enters into a
comparable transaction with an unrelated party where the goods or services under consideration
are same or similar.

Situations where Internal CUP may be applicable:

a. The tax payer or any other member of the group sells similar goods in similar quantities and
under similar terms to an independent enterprise in a similar market.

b. The tax payer or another member of the group buys similar goods in similar quantities
and under similar terms from an independent enterprise in a similar market (an internal
comparable).

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2. External CUP: this would be applicable if a transaction between two independent enterprises
involves comparable goods or services under comparable conditions.
a. An independent enterprise sells the particular product in similar quantities and under similar
terms to another independent enterprise in a similar market;
b. An independent enterprise buys similar goods in similar quantities and under similar terms
from another independent enterprise in a similar market.

CUP Method

Internal CUP External CUP

Parent Co. ● Commodity / Stock Exchanges

Parent Co. Unrelated Co. Y
Int ● Customs Data
ern UP
alC C
al
TP

TP

UP ● Loan transactions database

ern
Int
● Royalty transactions database
Sub Co. Unrelated Co. X Sub Co.

� Compare the prices charged for property or services

� Price under ‘controlled transaction’ is compared with ‘uncontrolled transaction’
� It requires close similarity in products, property or services that are involved
� Where the prices of the product fluctuate regularly, timing of the transaction also relevant
Example 4:
AE1 Ltd., is an Indian company. The shareholding pattern of AE1 Ltd., is as follows:

Shareholder’s name Status % holding

AE2 Ltd. Foreign Company 30
AE3 Ltd. Indian Company 30
Financial Institutions Indian Company 10
Public 30
AE1 Ltd., is a manufacturer of compact disc (CD) writers and its customers, inter alia, include AE2 Ltd, and M Ltd.
AE1 Ltd., during the year has supplied 10,000 nos. of the product to AE2 Ltd. at a price of ` 2,000 per unit and
200 nos. of the same product to AE3 Ltd., at a price of ` 2,750 per unit. AE1 Ltd., has sold 100 units of the same
product to M Ltd. at ` 3,000 per unit.
Analysis of the international transaction with comparable uncontrolled transaction

International transaction Comparable uncontrolled

(with AE2 Ltd.) transaction (with M Ltd.)
Price FOB CIF Freight and insurance ` 550
Quantity Yes No One CD of ` 10 each for every CD
discount writer plus ` 20 per CD writer

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Credit One month Cash and carry Cost of credit 1.25% per month
Warranty No warranty Six months warranty Cost of warranty is ` 250 per unit

Factors to be considered while determining ALP:

a. In the CUP method, one has to start from the price charged in the case of the comparable uncontrolled
transaction.
b. In this illustration one has to start with the price charged by AE1 Ltd., to M Ltd.
c. The price charged to AE3 Ltd., cannot be considered as AE3 Ltd., is itself an associated enterprise of AE1 Ltd.
d. The price charged to M Ltd., will have to be increased by the value of credit which is at the rate at 1.25% p.m.
(i.e. 15% p.a.). If the similar credit were offered to M Ltd., the price charged to M Ltd. would have been higher,
after factoring this cost.
e. The price charged to M Ltd., will have to be reduced by the following;
i. ` 550 representing the freight and insurance –This is for the reason that if the price to M Ltd., had been
on FOB basis, it would have been less by ` 550.
ii. ` 250 per unit representing the estimated cost of warranty execution for a period of 6 months on the basis
of a technical analysis and past experience - This is for the reason that if the warranty was not given, the
price to M Ltd. would have been lower, without factoring this cost.
iii. ` 10 representing the cost of each CD – This is for the reason that if similar gift had been offered to M
Ltd., the effective price to M Ltd., would have been less.
iv. ` 20 representing a quantity discount - This is for the reason that if similar discount had been offered to
M Ltd., the effective price to M Ltd., would have been less.

The following points are to be noticed:

i. All adjustments in the course of applying this method are to be made to the price charged in the uncontrolled
transaction. The presence or absence of any specific features in the uncontrolled transaction as compared to the
international transaction is to be adjusted for. These Methods of Computation of Arm’s Length Price features
are to be evaluated in monetory terms. This is a subjective process based on objective facts.
ii. Only differences that would materially affect the price in the open market are required to be adjusted. Two
points may be noted. Firstly, materiality would have to be judged in the light of various circumstances. If
there are numerous adjustments, which are individually not material but collectively material, the necessary
adjustments are required to be made. Secondly, the term ‘open market’, though not defined, would mean a
transaction between a knowledgeable and a willing purchaser and a knowledgeable and willing seller where
neither of them is influenced or compelled to act in a particular manner.
a. resale price method, by which,—
i. the price at which property purchased or services obtained by the enterprise from an associated
enterprise is resold or are provided to an unrelated enterprise, is identified;
ii. such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise
or to an unrelated enterprise from the purchase and resale of the same or similar property or from
obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a
number of such transactions;

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iii. the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with
the purchase of property or obtaining of services;
iv. the price so arrived at is adjusted to take into account the functional and other differences, including
differences in accounting practices, if any, between the international transaction or the specified
domestic transaction and the comparable uncontrolled transactions, or between the enterprises
entering into such transactions, which could materially affect the amount of gross profit margin in the
open market;
v. the adjusted price arrived at under (iv) is taken to be an arm’s length price in respect of the purchase
of the property or obtaining of the services by the enterprise from the associated enterprise.
Taxpoint
� The steps involved in the application of this method are:
i. identify the international transaction of purchase of property or services;
ii. identify the price at which such property or services are resold or provided to an unrelated party (resale
price);
iii. identify the normal gross profit margin in a comparable uncontrolled transaction whether internal or
external. The normal gross profit margin is that margin which an enterprise would earn from purchase of
the similar product from an unrelated party and the resale of the same to another unrelated party.
iv. deduct the normal gross profit from the resale price.
v. deduct expenses incurred in connection with the purchase of goods;
vi. adjust the resultant amount for the differences between the uncontrolled transaction and the international
transaction. These differences could be functional and other differences including differences in
accounting practices. Further these differences should be such as would materially affect the amount of
gross profit margin in the open market;
vii. the price arrived at is the arm’s length price of the international transaction;

Associated Enterprise ‘A’ Sale Associated Enterprise ‘B’ Resale Unrelated Buyer ‘X’

� RPM is a method based on the price at which a product that has been purchased from a related party
is resold to an unrelated enterprise.
� The resale price is reduced by the resale price margin/ gross profit margin.
� This is further reduced by the expenses incurred in connection with the purchase of product or obtaining
of services.
� When goods are purchased from AE or Unrelated party and same are sold to AE, this method cannot
be applied, since it can be applied only in a situation where goods are purchased from AE and same
are sold to Unrelated party.

� The application of the resale price method can be understood with the following example:

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AE1 Ltd., is an Indian company. The shareholding pattern of AE1 Ltd., is as follows;

Shareholder’s name Status % holding

AE2 Ltd. Foreign Company 30
AE3 Ltd. Indian Company 30
Financial Institutions Indian Company 10
Public 30
AE1 Ltd., trades in compact disc (CD) writers. AE1 Ltd., procures CD writers both locally and in the international
market. Its imports consist of CD writers purchased from AE2 Ltd. as well as other manufacturers (Non AEs).
AE1 Ltd., during the year purchased 100 CD writers from AE2 Ltd. at ` 2,900 per unit. These are resold to A Ltd.,
at a price of ` 3,000 per unit.
AE1 Ltd., has also purchased similar products from an unrelated supplier, viz. K Ltd., and has resold the same to
M Ltd., who is also an unrelated party and has earned a gross profit of 15% on sales.
Analysis of the sales transactions

Sales to A Ltd. Sales to M Ltd.

Price Ex shop FOR Destination with cost Impact of Freight and insurance on GP is 2%
of freight and insurance as the sale price increases but corresponding
estimated at 2% of GP expenses are not debited to trading account
but to profit and loss account
Quantity Yes - the cost No Impact of quantity discount on GP is 1%
discount of the same is
estimated at 1%
of GP
Free gifts No One CD pack for every CD As cost of gift is not debited to trading
writer with no change in account but to P & L Account, there is no
sale price impact on GP
Warranty No 6 months warranty (without As cost of warranty is not debited to trading
change in sale price) - cost account but to P&L Account, there is no
of warranty is estimated at ` impact on GP
250 per unit

Analysis of the purchase transactions

Purchase from AE2 Ltd. Purchase from K Ltd.

(International transaction)
Customs duty ` 25 per unit ` 25 per unit No impact
Freight ` 10 per unit Nil Cost of purchase from K Ltd., is
inwards lower
Quantity ` 15 per unit Nil Cost of purchase from K Ltd., is
discount higher

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Warranty Nil 6 months warranty No impact

purchase price
remaining unchanged
Factors to be considered while determining ALP:
a. In the above example, the international transaction is the purchase transaction entered into by AE1 Ltd., with
AE2 Ltd. which should be determined on the basis of arm’s length price;

Purchase from AE2 Ltd. AE1 Sales to A Ltd.

b. The comparable uncontrolled transaction is the purchase transaction entered into by AE1 Ltd., with K Ltd.

Purchase from K Ltd. AE1 Ltd Sales to M Ltd.

c. The starting point for arriving at the ALP of such purchase transaction is the resale price charged to A Ltd. viz.
` 3,000 [Rule 10B(1)(b)(i)].
d. From the said resale price, the normal gross profit margin which AE1 Ltd., would earn in a comparable
uncontrolled transaction should be reduced. In this example, the actual gross profit margin earned by AE1 Ltd.,
in respect of its purchase from K Ltd, and its resale to M Ltd, is 15%.
e. The following adjustments are made to arrive at the normal GP;

Actual gross profit margin with M Ltd. 15%

Less:
1. Difference between Ex-shop and FOR prices 2%
2. Difference due to quantity discount 1% 3%
Normal gross profit margin with M Ltd. 12%

Note: While arriving at normal gross profits from the actual gross profits, only the differences in the sale
transactions of AE1 Ltd., with A Ltd., and M Ltd., have been taken. The differences in the purchase transactions
of AE1 Ltd., with AE2 Ltd. and K Ltd., affecting the gross profits are taken separately as provided in sub rule
(iv).
f. The resale price of ` 3,000 to M Ltd., is reduced by the normal gross profit margin of 12%. The resultant cost
of sales is ` 2,640 (i.e. 3,000 - 360) [Rule 10B(1)(b)(ii)].
g. The cost of sales so arrived at is reduced by the expenses incurred inconnection with the purchase (international
transaction) i.e. freight of ` 10 and customs duty of ` 25. The resultant amount is ` 2,605 (i.e. 2640 – 25 - 10)
[Rule 10B(1)(b)(iii)].
h. The above amount is further adjusted to take into account functionaland accounting differences between the
international transaction and the comparable uncontrolled transaction with AE2 Ltd the purchase transaction
with K Ltd., which will affect the amount of gross profit margin as explained below.
i. The aforesaid amount of ` 2605 should be increased by ` 10 being the freight incurred by AE1 Ltd., in the case
of purchase from AE2 Ltd., but not incurred in case of purchase from K Ltd., This is for the reason that if a
similar freight had been paid in respect of transaction with K Ltd, the gross profit margin from K Ltd., would
have been lower and the resultant price would have been higher.
j. A decrease by ` 15 representing the quantity discount allowed by AE2 Ltd., is to be made. This is for the

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reason that if a similar discount had been allowed in respect of transaction with K Ltd, the gross profit margin
from K Ltd., would have been higher and the resultant price would have been lower.

Determination of arm’s length price under resale price method

1. Associated enterprises : AE1 Ltd. and AE2 Ltd.
2. Other enterprises : K Ltd. and M Ltd.
3. International transaction : AE1 Ltd. and AE2 Ltd.
4. Bought from AE2 Ltd. and resold to : A Ltd.
5. CUT is purchase from K Ltd. and sales to M Ltd.

Details ` / unit
Price paid to AE2 Ltd.(FOB) 2,900
Quantity 100
Purchases cost (actual) (A) 2,90,000
Actual GP Margin on sales to M Ltd.(%) 15
Normal GP Margin on sales to M Ltd.(%) 12
Price charged to A Ltd. 3,000
Less: Normal GP margin 360
Balance 2640
Less: Expenses connected with purchase (freight & customs duty paid) 35
Price before adjustment 2,605
Add:
Freight incurred in case of purchase from AE2 Ltd. 10
Sub total 10
Less:
Quantity discount allowed by AE2 Ltd. 15
Sub total 15
Arm’s length price 2,600
Adjusted purchase cost (B) 2,60, 000
Income increases by (A-B) 30,000
The following points are to be noticed:
i. The resale price method is to be adopted only when goods purchased from an associated enterprise are resold
to unrelated parties.
ii. As provided in Rule 10B(1)(b)(iii), the expenses incurred in connection with the purchase from AE are to be
reduced from cost of sales. In resale price method, the arm’s length purchase price is arrived at reducing the
normal gross profit margin from the resale price as the first step. If the computation is stopped at this step itself,
the derived purchase amount would be inclusive of the such expenses. It is therefore necessary to reduce such
expenses in arriving at the arm’s length purchase price.

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iii. Adjustments have to be made also for accounting practices apart from functional and other differences.
Differences in accounting practices may be because:
a. sales and purchases have been accounted for inclusive of taxes or exclusive of taxes;
(b) method of pricing the goods namely, FOB or CIF;
(c) fluctuations in foreign exchange.
iv. In actual practice, the resale in any financial year may be also out of opening stock. Similarly, the goods
purchased during the said year may remain in closing stock. Under the resale price method, the arm’s length
price of purchases from AE during the financial year should be determined. The process of determination
under Rule 10B(1)(b) culminates in the cost of sales rather than value of purchase during the year. This ‘cost
of sales’ should be converted into ‘value of purchase’. For this purpose, the closing stock of goods purchased
from AE should be added and the opening stock of purchases from AE should be deducted.
c. cost plus method, by which,—
i. the direct and indirect costs of production incurred by the enterprise in respect of property transferred or
services provided to an associated enterprise, are determined;
ii. the amount of a normal gross profit mark-up to such costs (computed according to the same accounting
norms) arising from the transfer or provision of the same or similar property or services by the enterprise,
or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions,
is determined;
iii. the normal gross profit mark-up referred to in (ii) is adjusted to take into account the functional and other
differences, if any, between the international transaction or the specified domestic transaction and the
comparable uncontrolled transactions, or between the enterprises entering into such transactions, which
could materially affect such profit mark-up in the open market;
iv. the costs referred to in (i) are increased by the adjusted profit mark-up arrived at under (iii);
v. the sum so arrived at is taken to be an arm’s length price in relation to the supply of the property or
provision of services by the enterprise;
Taxpoint
� Typical transactions where the cost plus method may be adopted are:
(a) provision of services;
(b) joint facility arrangements;
(c) transfer of semi finished goods;
(d) long term buying and selling arrangements.
� The steps involved in the application of this method are:
i. Determine the direct and indirect cost of production in respect of property transferred or service provided
to an associated enterprise.
ii. Identify one or more comparable uncontrolled transactions for same or similar property or service.
iii. Determine normal gross profit mark-up on costs in the comparable uncontrolled transaction. Such costs
should be computed according to the same accounting norms. In other words, the components of costs of
comparable uncontrolled transaction should be the same as those of international transaction.

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iv. Adjust the gross profit mark-up to account for functional and other differences between the international
transaction and the comparable uncontrolled transaction. Such adjustments should also be made for
enterprise level differences.
v. The direct and indirect cost of production in the international transaction is increased by such adjusted
gross profit mark-up.
vi. The resultant figure is the arm’s length price.

� CPM determines ALP by adding Gross Profit Margin (mark-up) earned in comparable transaction(s) /
by comparable companies to the cost incurred by Tested Party under controlled transaction
� CPM is useful when tested party is supplying made-to-order goods (e.g. engineering goods) to its related
party
� While RPM focuses on the control of profit margin at the distribution level, CPM focusses on the control
of profit mark-up at the manufacturing level.
� The application of the cost plus method can be understood with the following example:
AE1 Ltd., is an Indian company. The shareholding pattern of AE1 Ltd., is as follows:
Shareholder’s name Status % holding
AE2 Ltd. Foreign Company 30
AE3 Ltd. Indian Company 30
Financial Institutions Indian Company 10
Public 30
AE1 Ltd., develops software for various customers, who include AE2 Ltd. and M Ltd.
AE1 Ltd., during the year billed AE2 Ltd. ` 2,00,000. The total cost (direct and indirect) for executing this
work was ` 1,75,000.
AE1 Ltd., provided similar services to M Ltd., and earned a gross profit (GP) of 50% on costs.
Analysis of transactions

Transactions with AE2 Ltd. Transactions with M Ltd.

Technology support Yes No - value of technology support incurred by
AE1 Ltd., is ` 17,500
Discount Yes – Discount offered is ` 8,750 No
Business risks and Yes – Value of the same is estimated No
marketing at ` 13,125
Credit Yes – Cost of credit is estimated at No
` 2,625
Factors to be considered while determining ALP:
a. In the CPM, one has to start with the gross profit mark up which the enterprise earned in a comparable
uncontrolled transaction. In this example, the comparable uncontrolled transaction is between AE1 Ltd.,
and M Ltd.
b. Such gross profit (GP) mark up needs to be decreased by the following:

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● As AE1 Ltd., did not receive the technology support from M Ltd., it has priced its services higher resulting
in its earning a higher GP with M Ltd.. The value of technology support of ` 17,500 received from AE2
Ltd. is 10% of cost. Therefore, the GP with M Ltd., has to be reduced by 10%.
● AE1 Ltd. did not provide discount to M Ltd., as volume of business from M Ltd., was not as high as that
from AE2 Ltd. Had AE1 Ltd., offered similar discount to M Ltd., the GP with M Ltd., would have been
lower. The discount of ` 8,750 offered to AE2 Ltd. is 5% of cost. Therefore, the GP with M Ltd., has to
be decreased by 5%.
● AE1 Ltd., has incurred ` 15,000 towards marketing functions in respect of its transactions with M Ltd.,
which is 7.5% of its cost. However, in its transactions with AE2 Ltd. the said functions are assumed by
AE2 Ltd. Had AE1 Ltd., not incurred similar expenses with M Ltd., it would have settled for a lower GP.
Therefore, the GP with M Ltd., has to be reduced by 7.5%.
● The cost of credit of ` 2,625 provided by AE1 Ltd., to AE2 Ltd. is 1.5% of its cost. However, in its
transactions with M Ltd., such credit is not provided. Had AE1 Ltd., provided similar credit to M Ltd., it
would have increased its price resulting in a higher GP. Therefore, the GP with M Ltd., has to be increased
by 1.5%.
c. The resultant gross profit mark up is the arm’s length gross profit mark up.
d. The costs of AE1 Ltd., in its transactions with AE2 Ltd. should be increased by the arm’s length gross profit
mark up to arrive at the arm’s length income.
Determination of arm’s length price under costs plus method
1. Associated enterprise : AE1 Ltd. and AE2.
2. Other enterprise : AE1 Ltd. and M Ltd
3. International transaction : AE1 Ltd and AE2 Ltd
4. Comparable uncontrolled transaction : AE1 Ltd. and M Ltd
Determination of arm’s length gross profit mark up
Details
Gross profit mark up in case of M Ltd. 50.00%
Less:
1. Technology support from AE2 Ltd. 10.00%
2. Quantity discount to AE2 Ltd not to M Ltd. 5.00%
3. Marketing functions performed by AE1 Ltd., in respect of M Ltd. 7.50%
Sub total 22.50%
Add:
1. Cost of credit to AE2. Ltd. 1.50%
Sub total 1.50%
Arm’s length gross profit mark up 29.00%
Determination of arm’s length price
Details
Direct and indirect costs incurred by AE1 Ltd. in respect of transactions with AE2 Ltd. 1,75,000
Arm’s length gross profit mark up 29.00%

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Arm’s length income (A) 2,25,750

Actual price charged to AE2 Ltd. (B) 2,00,000
Income increases by (A-B) 25,750
The following points are to be noticed:
i. In this method, the direct and indirect costs of production are to be determined. The terms ‘direct’ or ‘indirect’
costs are however not defined. A reference may therefore be made to the industry practice as well as the
pronouncements of the ICAI
ii. In determining the direct and indirect cost, the following factors have to be borne in mind:
(a) if the plant has been under utilised the costs may have to be suitably adjusted;
(b) absorption costing method is normally to be preferred.
iii. This method is to be adopted only in cases of supply of property or services to an associated enterprise.
This method is not to be applied when the enterprise is in receipt of property or services from an associated
enterprise.
e. profit split method, which may be applicable mainly in international transactions or specified domestic
transactions involving transfer of unique intangibles or in multiple international transactions or specified
domestic transactions which are so interrelated that they cannot be evaluated separately for the purpose of
determining the arm’s length price of any one transaction, by which:
i. the combined net profit of the associated enterprises arising from the international transaction or the
specified domestic transaction in which they are engaged, is determined;
ii. the relative contribution made by each of the associated enterprises to the earning of such combined net
profit, is then evaluated on the basis of the functions performed, assets employed or to be employed and
risks assumed by each enterprise and on the basis of reliable external market data which indicates how
such contribution would be evaluated by unrelated enterprises performing comparable functions in similar
circumstances;
iii. the combined net profit is then split amongst the enterprises in proportion to their relative contributions, as
evaluated under (ii);
iv. the profit thus apportioned to the assessee is taken into account to arrive at an arm’s length price in relation
to the international transaction or the specified domestic transaction.
� The combined net profit referred to in (i) may, in the first instance, be partially allocated to each enterprise so
as to provide it with a basic return appropriate for the type of international transaction or specified domestic
transaction in which it is engaged, with reference to market returns achieved for similar types of transactions
by independent enterprises, and thereafter, the residual net profit remaining after such allocation may be split
amongst the enterprises in proportion to their relative contribution in the manner specified under (ii) and (iii),
and in such a case the aggregate of the net profit allocated to the enterprise in the first instance together with
the residual net profit apportioned to that enterprise on the basis of its relative contribution shall be taken to be
the net profit arising to that enterprise from the international transaction or the specified domestic transaction.
Taxpoint
� Typical transactions where the profit-split method may be used are transactions involving:
a. integrated services provided by more than one enterprise for e.g., in case of financial service sector, where
the activities performed by Indian company and foreign AEs in relation of a merger and acquisition

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transaction are so interrelated that it may not possible to segregate them;

b. transfer of unique intangibles, for e.g. two associated enterprises contribute their respective intangibles to
develop a new product or process and earn income from such product or process.
� There are two approaches to this method, namely, total profits split and residual profit split.
Total profits split: The steps involved are as follows:
i. Determine the combined net profit of the associated enterprises arising from the international transactions
in which they are engaged. Such profits represent the profits earned from third parties due to the combined
efforts of the associated enterprises. It may be noted that the ‘combined net profit’ referred to in the rule
is not the aggregate of entire profits earned by the associated enterprises. Example: AE1 may earn profits
from certain transactions wherein there is no contribution by AE2 and vice versa. Such profits do not enter
into the determination of combined net profit. Only those profits that are earned as a result of joint efforts
of AE1 and AE2 should be taken as combined net profit.
ii. Evaluate relative contribution made by each entity involved in the transaction on the basis of:
a. functions performed;
b. assets employed;
c. risks assumed;
d. the reliable external market data indicating how such contribution would be evaluated by unrelated
enterprises performing comparable functions in similar circumstances. It may be noted that reference
to ‘external market data’ indicates comparable uncontrolled transactions. The use of word ‘external’
does not preclude use of internal CUT. In the process of choosing CUTs, the function performed,
assets used and risks taken (FAR) of the uncontrolled transactions would have been compared with
the FAR of the international transactions. When the FAR of the international transaction and CUT are
similar, the relative contribution adopted in the CUT should be applied to the international transaction.
Any significant differences between the two should be suitably adjusted.
iii. Thereafter, split the combined net profit in proportion to the relative contribution determined as above.
iv. The profit so apportioned is taken to arrive at the arm’s length price in relation to the international
transaction. The profits so apportioned to the AE when added to the costs incurred by it in relation to
international transaction would result in arm’s length price.
Residual profit split approach
� In this approach, firstly, a basic return is determined for each of the enterprises and profits of each such
enterprise is ascertained. This amount is reduced from the combined net profits. Residual profits are allocated
on the basis of relative contribution.
� Steps involved in this approach are as follows:
i. Determine the combined net profit of the associated enterprises arising from the international transactions
in which they are engaged.
ii. At the first stage, depending on functions performed, assets employed and risks assumed, determine the
basic return appropriate to the respective activities. Allocate the combined net profit on the basis of above.
This step results in a partial allocation of the combined net profit to each enterprise. For this purpose, the
allocation is undertaken with reference to margins of comparable uncontrolled entities.
iii. the balance of the combined net profit is allocated on the basis of the evaluation of the relative contribution.

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iv. the total net profit from such two-tier allocation is taken to arrive at the arm’s length price. The profits so
apportioned to the AE when added to the costs incurred by it in relation to international transaction would
result in arm’s length price.

� PSM is used when transactions are inter-related and is not possible to evaluate separately.

� PSM first identifies the profit to be split for the AE. The profit so determined is split between the AE on
the basis of the functions performed

� Division of profit maybe done on Contribution analysis basis or Residual analysis basis.

� Under Contribution analysis, the assessee must use comparable uncontrolled transactions as well as
factors such as risks undertaken and assets employed, to determine the division of profit

� Under Residual analysis during division of profit, step 1 involves division of profits to each party upto
the extent of just covering the costs incurred in producing the good. Step 2 involves further proportionate
distribution of residual profits in accordance with each party’s contribution, after carrying out step 1.

� The application of the profit split-method can be understood with the following example:

AE1 Ltd., is an Indian company. The shareholding pattern of AE1 Ltd., is as follows;

Shareholder’s name Status % holding

AE2 Ltd. Foreign Company 30
AE3 Ltd. Foreign Company 30
Financial Institutions Indian Company 10
Public 30

AE1 Ltd., is an investment advisory company, which in association with AE2 Ltd. assists its clients with
foreign acquisitions.

AE3 Ltd., which is based in U.S.A., has worldwide presence. AE1 Ltd. is approached by M for identifying
potential target companies for acquisitions in the USA. In order to serve M, AE1 Ltd. and AE3 Ltd., have each
contributed integrally to identification of potential target and assisting M with the acquisition process. For the
above, AE1 Ltd., received consideration of US$ 50,000. The financials are as follows;

AE1 Ltd. AE3 Ltd.

Revenue 30,000 20,000
Cost 20,000 8,000
Profit 10,000 12,000

Factors to be considered:

a. The normal basic return is ordinarily calculated as a percentage of the costs incurred or gross revenues or
capital employed. In this example, it is assumed as a percentage of the cost.

b. Based on the FAR analysis, the basic return for AE1 Ltd., and AE3 Ltd., are determined to be 15% and
10% respectively. Accordingly, the normal basic return for AE1 Ltd. in India for the aforesaid operation
is US$ 3000. The similar returns for AE3 Ltd., US$ 800. The total basic return, thus, is US $ 3,800.

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c. On the basis of functions performed, risks assumed and assets employed, the relative contribution may be
taken at 70%, 30% for AE1 Ltd. and AE3 Ltd., respectively.
Determination of arm’s length price under profit split method:
First Approach: Total Profit Split Method
1. Associated enterprises : AE1 Ltd. and AE3 Ltd.
2. Ultimate delivery of product is : By AE3 Ltd. to M Ltd.
3. International transaction : AE1 Ltd. and AE3 Ltd.

Details US$
Price charged by AE3 Ltd from M Ltd 50,000
AE3 Ltd share of revenue 20,000
AE1 Ltd share of revenue 30,000
Combined total profits 22,000
Evaluation of relative contribution
AE1 Ltd : India return – 70% 15,400
AE3 Ltd : US return – 30% 6,600
Total 22,000
Total return for AE1 Ltd 15,400
Total cost of AE1 Ltd 20,000
Income of AE1 Ltd on arm’s length price (A) 35,400
Actual revenue (B) 30,000
Increased income (A-B) 5,400
Note: In this example, the basic return is not required to be taken into account.
Second Approach: Residual profit split method

Details US$
Price charged by AE3 Ltd from M Ltd 50,000
AE3 Ltd share of revenue 20,000
AE1 Ltd share of revenue 30,000
Combined total profits 22,000
1. Basic return
AE1 Ltd : India return 3,000
AE3 Ltd : US return 800
Total 3,800
2. Residual net profit 18,200
AE1 Ltd: India return – 70% 12,740
AE3 Ltd: US return – 30% 5,460
Total 18,200

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Details US$
Total return for AE1 Ltd (12740 + 3000) 15,740
Total cost of AE1 Ltd. 20,000
Income of AE1 Ltd. on arm’s length price (A) 35,740
Actual revenue (B) 30,000
Increased income (A-B) 5,740
The following points are to be noticed:
a. It is the profit from a transaction with the associated enterprise that needs to be ascertained. If there
are other transactions, which contribute to the profits, then the profits from transactions with associated
enterprise may have to be arrived at on some approximation.
b. The rule itself provides an alternative method to arrive at the arm’s length price being the two-tier profit
split-method;
c. If in either of the alternatives, a range of figures is available, the arithmetical mean of such figures may be
adopted as the arm’s length price. It may however not be possible to adopt the arithmetical mean of the two
alternatives.
d. Under the two-tier split-method, the basic rate of return may have to be adopted having regard to the profits
compared to the net worth of the enterprise. Such rate of return may not be uniform for all the associated
enterprises involved in the transaction.
e. This is the only method for which the Rule itself has prescribed the types of transaction to which it may be
applicable.
f. Even though the computation proceeds with the profits from a transaction, the purpose is only to arrive at
the arm’s length price of a transaction. It is only by substituting the arm’s length price for the price in the
international transaction that an adjustment may be made to the income returned.
e. transactional net margin method, by which,—
i. the net profit margin realised by the enterprise from an international transaction or a specified domestic
transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales
effected or assets employed or to be employed by the enterprise or having regard to any other relevant
base;
ii. the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled
transaction or a number of such transactions is computed having regard to the same base;
iii. the net profit margin referred to in (ii) arising in comparable uncontrolled transactions is adjusted to
take into account the differences, if any, between the international transaction or the specified domestic
transaction and the comparable uncontrolled transactions, or between the enterprises entering into such
transactions, which could materially affect the amount of net profit margin in the open market;
iv. the net profit margin realised by the enterprise and referred to in (i) is established to be the same as the net
profit margin referred to in (iii);
v. the net profit margin thus established is then taken into account to arrive at an arm’s length price in relation
to the international transaction or the specified domestic transaction;
Taxpoint

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� Typical transactions where the transactional net margin method may be adopted are:
(a) provision of services;
(b) distribution of finished products where resale price method cannot be applied;

(c) transfer of semi finished goods where cost plus method cannot be applied;

(d) transactions involving intangibles where profit split method cannot be applied.

� The steps involved in the application of this method are:

i. Identify the net profit margin realised by the enterprise from an international transaction. Where the
assessee also has transactions, segments or businesses where the international transactions with associated
enterprises are not relevant, then the net profit margin to be considered for the purposes of this TNMM
method should be such net profit margin as is derived only from the transactions, segments or businesses
related to the international transaction. The net profit margin may be computed in relation to costs incurred
or sales effected or assets employed or any other relevant base.

For example,

● In case where the assessee acts as a distributor and the transaction pertains to import, the revenue may
be used as base.

● In case the transaction involves export of services/goods, costs may be taken as base.

ii. Identify the net profit margin from a comparable uncontrolled transaction or a number of such transactions
having regard to the same base; In practice, net profit margin is ascertained at segment level where segment
data are available. The unallocated expenses are allocated on a reasonable basis and the segmental net
profit is determined. Where segment data are not available, net profit is normally determined at enterprise
level. Where internal CUT is available transaction level net profit may be determined.

iii. In case internal CUT is not available, external CUT is taken. In such case, as discussed above, net profit
margin should be taken at enterprise level (segmental or enterprise as a whole) of comparable companies.
A search should be carried out to identify comparable companies on the basis of information and data
available with the assessee. Where such information and data are not available, search may be carried out
with reference to database in public domain.

iv. The net profit margin so identified is adjusted to take into account the transaction level and enterprise level
differences if any. The Methods of Computation of Arm’s Length Price differences should be those that
could materially affect the net profit margin in the open market;

iv. The adjusted net profit margin is taken into account to arrive at the arm’s length price in relation to the
international transaction.

� The application of the transactional net margin method may be understood with the following example:

AE1 Ltd., is an Indian company

AE1 Ltd., manufactures compact disc (CD) writers and sells the same to AE2 Ltd., which is an associated
enterprise of AE1 Ltd.

As AE1 Ltd., does not have similar transaction with a non AE, no internal CUT is available. As AE1 Ltd., does

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not have information and data to identify a comparable company, it has used the databases in public domain
for carrying out the search. The result of the search may be summarised as follows:

No. of companies
Search on the basis of following keywords:
(a) Computer 800
(b) Computer hardware 250
(c) Computer peripherals 66
Sub total 1116
Elimination process :
Companies with different activities 800
Companies with duplication when multiple database are used 75
Companies with no financials 90
Companies having significant operations like sales or purchases with related party 100
Companies reporting no operations 50
Sub total 1115
Company/companies selected – Z Ltd. 1

Note: The search criteria and filters adopted above should be taken as illustrative only.
The comparison between AE1 Ltd., and Z Ltd., is carried out as follows:

AE1 Ltd. Z Ltd.

Financials
(` in crores) (` in crores)
Sales 130 200
Other income 5 10
Total Income 135 210
Operating expenses 85 120
Interest 5 7
Depreciation 10 12
Loss on sale of undertaking 5 0
Expenses relating to non operating income 1 3
Total expenditure 106 142
Net profits 24 58
Operating margin
Sales 130 200
Gross revenue 130 200
Operating expenses 85 120
Interest 5 7
Depreciation 10 12
Total operating cost 100 139
Operating profit 30.00 61.00

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AE1 Ltd. Z Ltd.

Financials
(` in crores) (` in crores)
Operating margin (before interest and depreciation) 52.94 66.67
Operating margin (after depreciation but before interest) 36.84 51.52
� Rule 10B(e)(iii) requires that transaction level and enterprise level differences should be adjusted if such
differences materially affect the amount of net profit margin.

In this example, following enterprise level differences could be visualised;

a. Working capital – There may be differences in stock holding, debtors and creditors. Appropriate adjustment
to eliminate the impact of above difference may be made by taking the prevailing interest rate. For this purpose,
useful reference may be made to the guidelines issued by Internal Revenue Service of USA. However, in this
example, it is assumed that the difference in the working capital is not significant requiring any adjustment.
b. Cost of capital – There may be difference in the manner of funding such as equity, preference, debenture,
inter corporate loans etc. In order that such difference does not impact the net profit, the operating margin on
operating cost before interest is taken as profit level indicator.
c. Assets employed – There may be difference in assets employed and the method of providing depreciation.
In order that such difference does not impact the net profit, the operating margin on operating cost before
depreciation is taken as profit level indicator.
d. Assured or risk bearing business – There may be a difference in the customer/ revenue model of the assessee
vis-à-vis the comparables. For example, the comparables identified may be entrepreneurs bearing the market
risks of business volume, customer continuity, etc and the assessee’s international transaction is in the nature
of captive service provider or contract manufacturer with assured volumes and/or assured compensation and/
or assured business period, etc. Such differences may be eliminated by making appropriate adjustment for low-
risk or risk free business.
In the above table, the transaction level differences cannot be noticed. However, some transaction level
differences may exist and the same may be adjusted if requisite information is available. Some of the common
transaction level differences may be as follows;
i. Free gifts
ii. Extended warranty (in addition to the normal one-year)
iii. Marketing risks
iv. Pricing - Ex-Shop or FOR-destination.
v. Quantity discount

Computation of arm’s length price under the transactional net margin method
1. Associated enterprise : AE1 Ltd. and AE2 Ltd.
2. International transaction : AE1 Ltd. and AE2 Ltd.
3. Comparable uncontrolled company : Z Ltd.

%
Net profit margin of Z Ltd. - i.e. operating margin on cost before interest and after depreciation 51.52

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%
Adjustments for transaction level differences 0.00
Arm’s length net profit margin 51.52
(` in crores)
Operating costs before interest and after depreciation 95.00
Arm’s length sale revenue 143.94
Actual sales 130.00
Income increases by 13.94

The following points are to be noticed:

a. Different bases of determining the net profit margin [i.e. profit level indicators (PLI)] are recognised. The
same basis of arriving at the net profit margin is to be adopted year after year, unless circumstances justify an
alternate base;
b. Whichever base is selected in determining the net profit margin in an international transaction, the same basis
is to be adopted for arriving at the net profit margin in the comparable uncontrolled transaction;
c. It is recommended that operating profit margin may be used instead of net profit margin. Operating profit
margin would eliminate the nonoperating items (the items of revenue and costs which do not result from
routine business operations such as profit on sale of assets, dividend etc.). Further, the operating profit margins
should be computed on the basis of financial statements of the assessee and the comparable company.
d. The accounting treatment of expenses and depreciation is also a critical factor in computing the arm’s length
price. Unlike the preceding methods, the rule does not explicitly provide for adjustment on account of differing
accounting practices. Nevertheless, such differing practices should also be factored in;
e. It is not uncommon to find purchase transaction being an international transaction where TNMM is used.
TNMM requires the determination of the net profit margin from an international transaction and purchase
transaction as such does not result in net profit. However, as purchase is inextricably linked to earning net
profit, TNMM may be used for establishing arm’s length purchase value. In such case, comparable operating
margin should be appropriately used to work back the arm’s length purchase cost. This may be illustrated as
follows:

Illustration 1:
1. Actual Profit and loss account of the assessee

` in lakhs ` in lakhs
Opening stock-AE purchases 100 Sales of AE purchases 800
Opening stock-Non AE purchases 150 Sales of Non AE purchases 1200
Purchases from AE 500 Closing stock-AE purchases 120
Purchases from Non AE 1000 Closing stock-Non AE purchases 160
Gross profit 530
2280 2280
Expenses 200 Gross profit 530
Net profit 330
530 530

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2. Comparable operating margin (PLI being operating profit on sale): 35%

3. Profit and loss account - recast to compute arm’s length price of purchase

(` in lakhs) (` in lakhs)
Opening stock-AE purchases 100 Sales of AE purchases 800
Purchases from AE (balancing figure) 460 Closing stock-AE purchases 120
Gross profit (brought back) 360
920 920
Expenses-allocated (in the ratio of sales) 80 Gross profit (worked back) 360
Net profits 280
(applying TNMM margin on AE sales)
360 360
4. Arm’s length value of purchase is ` 460 as against actual value of ` 500. Therefore, income increases by `40.
Illustration 2 :
1. Profit and loss account of the assessee – Actual

` in lakhs ` in lakhs
Opening stock of raw material (AE 100 Sale of finished goods 2500
purchases)
Opening stock of raw material (Non-AE 150 Closing stock of raw material (AE 120
purchases) purchases)
Purchases of raw material from AE 500 Closing stock of raw material 160
(Non-AE purchases)
Purchases of raw material from Non-AE 1000 Closing stock of finished goods 500
Manufacturing costs 400
Admin, selling and finance expenses 200
Net profit 930
3280 3280
2. Comparable operating margin (PLI being operating profit on sale): 45%
3. Profit and loss account - recast:

` in lakhs ` in lakhs
Opening stock of raw material 150 Sale of finished goods 2500
(Non-AE purchases)
Cost of purchase from AE (net of stock) 405 Closing stock of raw material 160
(balancing figure) (Non-AE purchases)
Purchases of raw material from Non AE 1000 Closing stock of finished goods 500
Manufacturing costs 400
Admin, selling and finance expenses 200

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` in lakhs ` in lakhs
Net profit 1125
(arrived on basis of TNMM margin)
3280 3280
Arm’s length Purchase value:
Cost of purchase from AE (net of stock) 405
Add : Closing stock of Raw Material 120
Add : Closing stock of Raw Material in finished goods 20
(see Note 1 below)
Less : Opening stock 100
Arm’s length Purchase value 445
Actual purchase 500
Excess price paid 55
Notes:

1. In the above illustration, the raw material cost (of purchases from AE) built into closing stock of finished
goods is assumed to be ` 20.

2. It is assumed that there is no opening stock of finished goods.

f. any other method as provided in rule 10AB.

Taxpoint
The application of the sixth method may be understood with the following examples:

Illustration 3:
AE1 Ltd. is an Indian Company.
AE1 Ltd. owns certain registered patents which it has developed by undertaking research and development.

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It is a subsidiary of AE2 Ltd., a foreign company.

AE1 Ltd. has sold its registered patents to AE2 Ltd., for ` 50 crores. The price has been determined based on a
valuation report obtained from an independent valuer.
The sale of patents is a unique transaction and AE1 Ltd or AE2 Ltd. has not entered into similar transactions with
third parties and hence no internal or external CUP is available.
AE1 Ltd. may select the Other Method as the most appropriate method and use the independent valuation report
for comparability purposes.

Illustration 4:
An Indian Company (I Co) buys back its equity shares issued to its foreign associated enterprise (AE Co). I Co
obtains a valuation report from an external firm identifying the fair market value of these shares. I Co purchases
the shares at the value determined in the valuation report. This value denotes a price that would have been charged
if a third party would have bought the same shares. Hence, I Co could use Rule 10AB and rely upon the valuation
report to demonstrate this transaction to be arm’s length.

Illustration 5:
Another example where this method could be used is in cases of cost allocation arrangements where a taxpayer
benefits from certain services provided by a central entity of the group and has to pay a portion of the total cost
incurred by the service provider. These costs are generally allocated on the basis of allocation keys like headcount,
time spent, revenues etc. and a third party outside the group may not have the capability to provide identical
services. Hence, in the absence of comparable prices or transactions, Rule 10AB may be applied and the cost
allocation arrangement could be justified appropriately.
� For the purposes of aforesaid rule, the comparability of an international transaction or a specified domestic
transaction with an uncontrolled transaction shall be judged with reference to the following:
a. the specific characteristics of the property transferred or services provided in either transaction;
b. the functions performed, taking into account assets employed or to be employed and the risks assumed, by
the respective parties to the transactions;
c. the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay
down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the
respective parties to the transactions;
d. conditions prevailing in the markets in which the respective parties to the transactions operate, including
the geographical location and size of the markets, the laws and Government orders in force, costs of
labour and capital in the markets, overall economic development and level of competition and whether the
markets are wholesale or retail.
� An uncontrolled transaction shall be comparable to an international transaction or a specified domestic
transaction if—
i. none of the differences, if any, between the transactions being compared, or between the enterprises
entering into such transactions are likely to materially affect the price or cost charged or paid in, or the
profit arising from, such transactions in the open market; or
ii. reasonably accurate adjustments can be made to eliminate the material effects of such differences.

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� The data to be used in analysing the comparability of an uncontrolled transaction with an international
transaction or a specified domestic transaction shall be the data relating to the financial year (hereafter in this
rule and in rule 10CA referred to as the ‘current year’) in which the international transaction or the specified
domestic transaction has been entered into.
� In a case where the most appropriate method for determination of the arm’s length price of an international
transaction or a specified domestic transaction, entered into on or after 01-04-2014, is the method specified
in sec. 92C(1)(b), (c) or (e), then, the data to be used for analysing the comparability of an uncontrolled
transaction with an international transaction or a specified domestic transaction shall be:
i. the data relating to the current year; or
ii. the data relating to the financial year immediately preceding the current, if the data relating to the current
year is not available at the time of furnishing the return of income by the assessee, for the assessment year
relevant to the current year.
Where the data relating to the current year is subsequently available at the time of determination of arm’s
length price of an international transaction or a specified domestic transaction during the course of any
assessment proceeding for the assessment year relevant to the current year, then, such data shall be used for
such determination irrespective of the fact that the data was not available at the time of furnishing the return of
income of the relevant assessment year.

Other method of determination of arm’s length price [Rule 10AB]

For the purposes of sec. 92C(1)(f), the other method for determination of the arm’s length price in relation to an
international transaction or a specified domestic transaction shall be any method which takes into account the
price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled
transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant
facts.

Most appropriate method [Rule 10C]

The most appropriate method shall be the method which is best suited to the facts and circumstances of each
particular international transaction or specified domestic transaction, and which provides the most reliable measure
of an arm’s length price in relation to the international transaction or specified domestic transaction. In selecting
the most appropriate method, the following factors shall be taken into account:
(a) the nature and class of the international transaction or specified domestic transaction;
(b) the class or classes of associated enterprises entering into the transaction and the functions performed by them
taking into account assets employed or to be employed and risks assumed by such enterprises;
(c) the availability, coverage and reliability of data necessary for application of the method;
(d) the degree of comparability existing between the international transaction or specified domestic transaction
and the uncontrolled transaction and between the enterprises entering into such transactions;
(e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between
the international transaction or specified domestic transaction and the comparable uncontrolled transaction or
between the enterprises entering into such transactions;
(f) the nature, extent and reliability of assumptions required to be made in application of a method.

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Comparison of Methods of computing Arm’s Length Price

Product Functional
Methods Approach Remarks
Comparability Comparability
Prices are Very difficult to apply as very high
CUP Very High Medium
benchmarked degree of comparability required
GPM (on sales) Difficult to apply as high degree of
RPM High Medium
benchmarked comparability required
GPM (on costs) Difficult to apply as high degree of
CPM High High
benchmarked comparability required
PSM Medium Very High Profit Margins Complex Method, sparingly used
TNMM Medium Very High Net Profit Margins Most commonly used Method

Some Important Ratios

Cost Cover Ratio
The cost coverage ratio measures the ability of a company to cover its operating expenses through operating
revenue. Given the limitation of financial information publicly available, the operating expenses of a selected
comparable company are the sum of its operating revenue less EBIT.
Return on Assets Ratio
The return on assets ratio measures the amount of EBIT per rupee of asset invested. This is a profitability ratio
measuring each company’s operational efficiency, that is, how efficiently the assets have been deployed by the
company.
Berry Ratio
Berry ratio is the ratio of gross profit to operating expenses. It measures the return on operating expenses. As
the functions performed by the tax-payers are often reflected in the operating expenses, this ratio determines
the relationship of the income earned in relation to the functions performed. This ratio helps in overcoming the
difficulties in applying the RPM, which does not explain the creation of gross profit. This ratio is used in conducting
an arm’s length analysis of service-oriented industry such as limited risk distributor, advertising, marketing and
engineering services. The Berry ratio may be used to test whether service providers have earned enough mark-up
on their operating expenses. In essence, the Berry ratio implicity assumes that there is a relationship between the
level of operating expenses and the level of gross profits earned by routine distributors and service providers.

Annexure 2
Information and documents to be kept and maintained under section 92D [Rule 10D]
1. Every person who has entered into an international transaction or a specified domestic transaction shall keep
and maintain the following information and documents:
a. a description of the ownership structure of the assessee enterprise with details of shares or other ownership
interest held therein by other enterprises;
b. a profile of the multinational group of which the assessee enterprise is a part along with the name, address,
legal status and country of tax residence of each of the enterprises comprised in the group with whom

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international transactions or specified domestic transactions, as the case may be, have been entered into by
the assessee, and ownership linkages among them;
c. a broad description of the business of the assessee and the industry in which the assessee operates, and of
the business of the associated enterprises with whom the assessee has transacted;
d. the nature and terms (including prices) of international transactions or specified domestic transactions entered
into with each associated enterprise, details of property transferred or services provided and the quantum
and the value of each such transaction or class of such transaction;
e. a description of the functions performed, risks assumed and assets employed or to be employed by the
assessee and by the associated enterprises involved in the international transaction or specified domestic
transactions;
f. a record of the economic and market analyses, forecasts, budgets or any other financial estimates prepared
by the assessee for the business as a whole and for each division or product separately, which may have a
bearing on the international transactions or specified domestic transactions entered into by the assessee;
g. a record of uncontrolled transactions taken into account for analysing their comparability with the
international transactions or specified domestic transactions entered into, including a record of the nature,
terms and conditions relating to any uncontrolled transaction with third parties which may be of relevance
to the pricing of the international transactions or specified domestic transactions, as the case may be;
h. a record of the analysis performed to evaluate comparability of uncontrolled transactions with the relevant
international transaction or specified domestic transactions;
i. a description of the methods considered for determining the arm’s length price in relation to each
international transaction or specified domestic transactions or class of transaction, the method selected as
the most appropriate method along with explanations as to why such method was so selected, and how
such method was applied in each case;
j. a record of the actual working carried out for determining the arm’s length price, including details of the
comparable data and financial information used in applying the most appropriate method, and adjustments,
if any, which were made to account for differences between the international transaction or specified
domestic transactions and the comparable uncontrolled transactions, or between the enterprises entering
into such transactions;
k. the assumptions, policies and price negotiations, if any, which have critically affected the determination of
the arm’s length price;
l. details of the adjustments, if any, made to transfer prices to align them with arm’s length prices determined
under these rules and consequent adjustment made to the total income for tax purposes;
m. any other information, data or document, including information or data relating to the associated enterprise,
which may be relevant for determination of the arm’s length price.
2. Threshold limit in case of international transaction: Nothing contained in sub-rule (1), in so far as it relates
to an international transaction, shall apply in a case where the aggregate value, as recorded in the books of
account, of international transactions entered into by the assessee does not exceed ` 1 crore
However, the assessee shall be required to substantiate, on the basis of material available with him, that income
arising from international transactions entered into by him has been computed in accordance with sec. 92.
3. Eligible assessee, on which safe harbour rule applies in respect of specified domestic transaction: Nothing
contained in sub-rule (1), in so far as it relates to an eligible specified domestic transaction referred to in rule

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10THB, shall apply in a case of an eligible assessee mentioned in rule 10THA and:
a. the eligible assessee, referred to in rule 10THA(i) [i.e., Government company engaged in the business
of generation, supply, transmission or distribution of electricity], shall keep and maintain the following
information and documents:
i. a description of the ownership structure of the assessee enterprise with details of shares or other
ownership interest held therein by other enterprises;
ii. a broad description of the business of the assessee and the industry in which the assessee operates, and
of the business of the associated enterprises with whom the assessee has transacted;
iii. the nature and terms (including prices) of specified domestic transactions entered into with each
associated enterprise and the quantum and value of each such transaction or class of such transaction;
iv. a record of proceedings, if any, before the regulatory commission and orders of such commission
relating to the specified domestic transaction;
v. a record of the actual working carried out for determining the transfer price of the specified domestic
transaction;
vi. the assumptions, policies and price negotiations, if any, which have critically affected the determination
of the transfer price; and
vii. any other information, data or document, including information or data relating to the associated
enterprise, which may be relevant for determination of the transfer price;
b. the eligible assessee, referred to in rule 10THA(ii) [i.e., co-operative society engaged in the business of
procuring and marketing milk and milk products], shall keep and maintain the following information and
documents:
i. a description of the ownership structure of the assessee co-operative society with details of shares or
other ownership interest held therein by the members;
ii. description of members including their addresses and period of membership;
iii. the nature and terms (including prices) of specified domestic transactions entered into with each
member and the quantum and value of each such transaction or class of such transaction;
iv. a record of the actual working carried out for determining the transfer price of the specified domestic
transaction;
v. the assumptions, policies and price negotiations, if any, which have critically affected the determination
of the transfer price;
vi. the documentation regarding price being routinely declared in transparent manner and being available
in public domain; and
vii. any other information, data or document which may be relevant for determination of the transfer price.
4. The information specified in aforesaid rules shall be supported by authentic documents, which may include the
following:
a. official publications, reports, studies and data bases from the Government of the country of residence of
the associated enterprise, or of any other country;

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b. reports of market research studies carried out and technical publications brought out by institutions of
national or international repute;
c. price publications including stock exchange and commodity market quotations;
d. published accounts and financial statements relating to the business affairs of the associated enterprises;
e. agreements and contracts entered into with associated enterprises or with unrelated enterprises in respect
of transactions similar to the international transactions 56e[or the specified domestic transactions, as the case
may be];
f. letters and other correspondence documenting any terms negotiated between the assessee and the associated
enterprise;
g. documents normally issued in connection with various transactions under the accounting practices
followed.
Taxpoint
� The information and documents specified under aforesaid rules, should, as far as possible, be
contemporaneous and should exist latest by the specified date [i.e., due date u/s 139(1)].
� Where an international transaction or specified domestic transaction continues to have effect over more
than one previous years, fresh documentation need not be maintained separately in respect of each previous
year, unless there is any significant change in the nature or terms of the international transaction or specified
domestic transaction, in the assumptions made, or in any other factor which could influence the transfer
price, and in the case of such significant change, fresh documentation shall be maintained bringing out the
impact of the change on the pricing of the international transaction or specified domestic transaction.
� Aforesaid information and documents shall be kept and maintained for a period of 8 years from the end of
the relevant assessment year.

Illustration 6:
Brain Inc. London has 35% equity in Salem Ltd. The company Salem Ltd. is engaged in development of software
and maintenance of customers across the globe, which includes Brain Inc.
During the year 2023-24, Salem Ltd. spent 2000 men hours for developing and maintaining a software for Brain
Inc. and billed at ` 1,000 per hour. The cost incurred for executing maintenance work to Brain Inc. for Salem Ltd.
amount to ` 15,00,000. Similar such work was done for unrelated party Try Ltd. in which the profit was at 50%.
Brain Inc. gives technical support to Salem Ltd. which can be valued at 8% of gross profit. There is no such
functional relationship with try Ltd.
Salem Ltd. gives credit period of 90 days the cost of which is 3% of the normal billing rate which is not given to
other parties.
Compute ALP under cost plus method in the hands of Salem Ltd. and the impact of the same on the total
income.

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Solution:
A. Computation of Arms Length Gross Profit Mark-up

Particulars %
Normal Gross Profit Mark up 50.00
Less: Adjustment for differences
Technical support from Brain Inc [ 8% of Normal GP = 8% of 50%] (4.00)
46.00
Add: Cost of Credit to Brain Inc 3% of Normal Bill [3% ×GP 50%] 1.50
Arm’s Length Gross Profit mark-up 47.50

B. Computation of Increase in Total Income of Brain Inc

Particulars Amount
Cost of services 15,00,000
Arm’s length Billed Value [Cost / [ (100 – Arm’s Length mark up)] [` 15,00,000 / (100% - 47.50%)] 28,57,143
Less: Billed amount [ 2,000 hours x ` 1,000 per hour] 20,00,000
Therefore, Increase in Total Income 8,57,143

Illustration 7:
A Co. Ltd. of Chennai and Sky Inc. of Singapore are associate enterprises. A Co. Ltd. imported 1000 television
sets at ` 16,000 per set without any warranty period. A Co. Ltd. also imports similar TV sets from unrelated party
Sign Inc. of Japan. It is imported at ` 15,000 per set with warranty time of 2 years. The cost of warranty in respect
of goods imported from Sky Inc. for a period of 2 years would cost ` 2,000.
Compute arm’s length price and the amount of increase in total income of A Co. Ltd. as per CUP method.

Solution:
A. Computation of Arms Length Price

Particulars Amount
Cost of TV Set acquired from Sign Inc 15,000
Less: Cost of Warranty 2,000
Arm’s Length Gross Profit mark-up 13,000
B. Computation of Increase in Total Income

Particulars Amount
Cost of TV Set acquired from Sky Inc [` 16,000 * 1,000] 1,60,00,000
Less: Arm’s length Value [` 13,000 * 1,000] 1,30,00,000
Therefore, Increase in Total Income 30,00,000
Illustration 8:

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J Inc. of Korea and CD Ltd, an Indian Company are associated enterprises. CD Ltd manufactures Cell Phones and
sells them to J.K.& F Inc., a Company based in Nepal. During the year CD Ltd. supplied 2,50,000 Cellular Phones
to J Inc. Korea at a price of ` 3,000 per unit and 35,000 units to JK & F Inc. at a price of ` 5,800 per unit. The
transactions of CD Ltd with JK & F Inc. are comparable subject to the following considerations:
Sales to J Inc. are on FOB basis, sales to JK & F Inc. are CIF basis. The freight and insurance paid by J Inc. for each
unit @ ` 700. Sales to JK & F Inc. are under a free warranty for Two Years whereas sales to J Inc. are without any
such warranty. The estimated cost of executing such warranty is ` 500. Since J Inc.’s order was huge in volume,
quantity discount of ` 200 per unit was offered to it.
Compute the Arm’s Length Price and the subsequent amount of increase in the Total Income of CD Ltd, if any.
Solution:
Computation of Arm’s Length Price of Products sold to J Inc. Korea by CD Ltd

Particulars ` `
Price per Unit in a Comparable Uncontrolled Transaction 5,800
Less: Adjustment for Differences -
(a) Freight and Insurance Charges 700
(b) Estimated Warranty Costs 500
(c) Discount for Voluminous Purchase 200 (1,400)
Arms’s Length Price for Cellular Phone sold to J Inc. Korea 4,400
Computation of Increase in Total Income of CD Ltd

Particulars `
Arm’s Length Price per Unit 4,400
Less: Price at which actually sold to J Inc. Korea (3,000)
Increase in Price per Unit 1,400
No. of Units sold to J Inc. Korea 2,50,000
Increase in Total Income of CD Ltd (2,50,000 x ` 1,400) ` 35 Crores

Illustration 9: Comparable sales of same product

DSM, a manufacturer, sells the same product to both controlled and uncontrolled distributor. The circumstances
surrounding the controlled and uncontrolled transactions are substantially the same, except that the controlled sales
price is a delivered price to the buyer and the uncontrolled sales are made F.O.B. DSM’s factory. Differences in
the contractual terms of transportation and insurance generally have a definite and reasonably ascertainable effect
on price, and adjustments are made to the results of the uncontrolled transaction to account for such differences.
In this case the transactions are comparable and internal CUP can be applied by comparing the prices of both, the
controlled and uncontrolled transactions, albeit after subtracting the costs of transportation and insurance of the
controlled transaction.

Illustration 10: Effect of geographic differences

FM, a foreign specialty radio manufacturer, also exports its radios to a controlled U.S. distributor, AM, which
serves the United States. FM also exports its radios to uncontrolled distributors to serve in South America. The
product in the controlled and uncontrolled transactions is the same, and all other circumstances surrounding the

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controlled and uncontrolled transactions are substantially the same, other than the geographic differences. The
geographic differences e.g. differences in purchasing power, levels of economic development, etc, in two different
geographies, are likely to have a material effect on price, for which accurate adjustments cannot be made and hence
the transactions are not comparable. Thus, CUP method cannot be applied.

Illustration 11: External Commercial Borrowing

Pharma Ltd, an Indian company has borrowed funds from its parent company at LIBOR plus 150 basis points. The
LIBOR prevalent at the time of borrowing is 4% for US$, thus its cost of borrowings is 5.50%. The borrowings
allowed under the External Commercial Borrowings guidelines issued under FEMA, for example, say is LIBOR
plus 250 basis points, then it can be said that Pharma’s borrowing at 5.50% is less than 6.50% and thus at arm’s
length. In this connection, one may rely on Rule 10B (2) (d) which specifies that the comparability of an international
transaction with an uncontrolled transaction shall be judged with reference to the laws and government orders in
force.

Illustration 12:
Megabyte Inc. of France and R Ltd. of India are associated enterprises. R Ltd. imports 3,000 compressors for Air
Conditioners from Megabyte Inc. at ` 7,500 per unit and these are sold to Pleasure Cooling Solutions Ltd at a price
of ` 11,000 per unit. R Ltd. had also imported similar products from Cold Inc. Poland and sold outside at a Gross
Profit of 20% on Sales. Megabyte Inc. offered a quantity discount of ` 1,500 per unit. Cold Inc. could offer only `
500 per unit as Quantity Discount. The freight and customs duty paid for imports from Cold Inc. Poland had cost R
Ltd. ` 1,200 per piece. In respect of purchase from Terabyte Inc., R Ltd. had to pay ` 200 only as freight charges.
Determine the Arm’s Length Price and the amount of increase in Total Income of R Ltd.

Solution:
Computation of Arm’s Length Price

Particulars Amount
Resale Price of Goods Purchased from Megabyte Inc. 11,000
Less: Adjustment for Differences –
a) Normal Gross Profit Margin at 20% of Sale Price [20% x ` 11,000] 2,200
b) Incremental Quantity Discount by Megabyte Inc. [` 1,500 – ` 500] 1,000
c) Difference in Purchase related expenses [` 1,200 – ` 200] 1,000
Arms Length Price 6,800

Computation of Increase in Total Income of R Ltd

Particulars Amount
Price at which actually bought from Megabyte Inc. of France 7,500
Less: Arms Length Price per unit under Resale Price Method 6,800
Decrease in Purchase Price per unit 700
No. of units purchased from Megabyte Inc. 3,000 units
Increase in Total Income (3,000 units x ` 700) ` 21,00,000
Illustration 13:

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NBR Medical Equipments Inc. (NBR) of Canada has received an order from a leading UK based Hospital for
development of a hi-tech medical equipment which will integrate the best of software and latest medical examination
tool to meet varied requirements. The order was for 3,00,000 Euros. To execute the order, NBR joined hands with
its subsidiary Precision Components Inc. (PCI) of USA and Bioinformatics India Ltd (BIL), an Indian Company.
PCI holds 30% of BIL. NBR paid to PCI and BIL Euro 90,000 and Euro 1,00,000 respectively and kept the balance
for itself. In the entire transaction, a profit of Euro 1,00,000 is earned. Bioinformatics India Ltd incurred a Total
Cost of Euro 80,000 in execution of its work in the above contract. The relative contribution of NBR, PCI and
BIL may be taken at 30%, 30% and 40% respectively. Compute the Arm’s Length Price and the incremental Total
Income of Bioinformatics India Ltd, if any due to adopting Arms Length Price determined here under.

A Share of each of the Associates in the Value of the Order 3,00,000

Share of BIL [Given] 1,00,000
Share of PCI [Given] 90,000
Share of NBR [Amount Retained = 3,00,000 – 1,00,000 - 90,000] 1,10,000
B Share of each of the Associates in the Profit of the Order
Combined Total Profits 1,00,000
Share of BIL [Contribution of 40% x Total Profit € 1,00,000] 40,000
Share of PCI [Contribution of 30% x Total Profit € 1,00,000] 30,000
Share of NBR [Contribution of 30% x Total Profit € 1,00,000] 30,000
C Computation of Incremental Total Income of BIL
Total Cost to BIL Ltd 80,000
Add: Share in the Profit to BIL (from B above) 40,000
Revenue of BIL on the basis of Arm’s Length Price 1,20,000
Less: Revenue Actually received by BIL 1,00,000
Increase in Total Income of BIL 20,000

Illustration 14:
lndco, an Indian company, has developed and manufactures a robot to be used for multiple industrial applications.
The robot is considered to be an innovative technological advance. Chco, a Chinese subsidiary of Indco, has
developed and manufactures a software programme which incorporates the new programme in the robot and makes
it more effective. The success of the robot is attributable to both companies for the design of the robot and the
software programme.
Indco manufactures and supplies Chco with the robot for installing of the new software programme for assembly
and manufacture of the robot. Chco manufactures the robot and sells to an arm’s length distributor.
In light of the innovative nature of the robot and software, the group was unable to find comparables with similar
intangible assets. Because they were unable to establish a reliable degree of comparability, the group was unable
to apply the traditional transaction methods or the TNMM.
However, reliable data are available on robot and software manufacturers without innovative intangible property,
and they earn a return of 10% on their manufacturing costs.
The total profits attributable to manufacture of robots are calculated as follows:

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Particulars Amount Amount

Sales to the arm’s length distributor 1,000
Less:
Indco’s manufacturing costs 200
Chco’s manufacturing costs 300
Total manufacturing costs for the group 500
Gross Margin 500
Less:
Indco’s development costs 100
Chco’s development costs 50
Indco’s operating costs 50
Chco’s operating costs 100 300
Net profit 200
Indco’s return to manufacturing (200 x 10%) 20
Chco’s return to manufacturing (300 x 10%) 30 50
Residual profit attributable to development 150
The split of the residual profit has been considered on the basis of the development cost considering the significance
of technology in the manufacturing process.
Based on proportionate development costs

Particulars Amount
Indco’s share of residual profit [100/)100+50)] x 150 100
Chco’s share of residual profit [50/(100+50)] x 150 50
Indco’s transfer price is calculated as follows:

Particulars Amount
Manufacturing costs 200
Development costs 100
Operating costs 50
Routine 10% return on manufacturing costs 20
Share of residual profit 100
Transfer price 470

Illustration 15:
Fox Solutions Inc. a US Company, sells Laser Printer Cartridge Drums to its Indian Subsidiary Quality Printing
Ltd at S 20 per drum. Doc Solutions Inc. has other takers in India for its Cartridge Drums, for whom the price is $
30 per drum. During the year, Fox Solutions had supplied 12,000 Cartridge Drums to Quality Printing Ltd.
Determine the Arm’s Length Price and taxable income of Quality Printing Ltd if its income after considering the
above is ` 45,00,000. Compliance with TDS provisions may be assumed and Rate per USD is ` 45. Also determine
income of Doc Solutions Inc.

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Solution:
Computation of Total Income of Quality Printing Ltd.

Particulars Amount Amount

Total Income before adjusting for differences due to Arm’s Length Price 1,08,00,000
Add: Difference on Account of adopting Arm’s Length Price [12,000 x $20 x ` 45] 1,62,00,000
Less: Amount under Arm’s Length Price [12,000 x $ 30 x ` 45] (54,00,000) 45,00,000
Incremental Cost on adopting ALP u/s 92(3), Taxable Income cannot be reduced on
applying ALP. Therefore, difference on account of ALP is ignored.
Total Income of Quality Printing Ltd. 45,00,000
Computation of Total Income of Fox Solutions Inc.
The provisions relating to taxing income of Fox Solutions Inc., on applying Arm’s Length Price for transactions
entered into by a Foreign Company is given in Circular 23 dated 23.7.1969, which is as follows:
i Transactions Not Taxable in India: Transactions will not be subject tax in India if transactions are on principal-
to-principal basis and are entered into at ALP, and the subsidiary also carries on business on its own.
ii Transactions Taxable in India if the Indian Subsidiary does not carry on any business on its own. The following
are the other considerations in this regard:
a. Adopting ALP does not affect the computation of taxable income of Fox Solutions Inc. if tax has been
deducted at source or if tax is deductible.
b. Where ALP is adopted for taxing income of the Parent Company, income of the recipient Company (i.e.
Quality Printing Ltd) will not be recomputed.

Illustration 16:
Khazana Ltd is an Indian Company engaged in the business of developing and manufacturing Industrial
components. Its Canadian Subsidiary Techpro Inc. supplies technical information and offers technical support to
Khazana for manufacturing goods, for a consideration of Euro 1,00,000 per year. Income of Khazana Ltd is ` 90
Lakhs. Determine the Taxable Income of Khazana Ltd if Techpro charges Euro 1,30,000 per year to other entities
in India. What will be the answer if Techpro charges Euro 60,000 per year to other entities. (Rate per Euro may be
taken at ` 50.)
Solution:
Computation of Total Income of Khazana Ltd

Particulars Amount Amount

When price charged for Comparable Uncontrolled Transaction € 1,00,000 € 50,000
Price actually paid by Khazana Ltd [€1,00,000 x ` 50] 50,00,000 50,00,000
Less: Price charged in Rupees (under ALP)
[€1,30,000 x ` 50] 65,00,000
[€60,000 x ` 50] 30,00,000
Incremental Profit on adopting ALP (A) (15,00,000) 20,00,000

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Particulars Amount Amount

Total Income before adjusting for differences due to Arm’s Length Price 90,00,000 90,00,000
Add: Difference on account of adopting Arms Length Price [if (A) is positive] NIL 20,00,000
Total Income of Khazana Ltd. 90,00,000 1,10,00,000
Note: u/s 92(3), Taxable Income cannot be reduced on applying ALP. Therefore, difference on account of ALP
which reduces the Taxable Income is ignored.

Illustration 17:
Videsh Ltd., a US company has a subsidiary, Hind Ltd. in India. Videsh Ltd. sells mobile phones to Hind Ltd. for
resale in India. Videsh Ltd. also sells mobile phones to Bharat Ltd. another mobile phone reseller. It sold 48,000
mobile phones to Hind Ltd. at ` 12,000 per unit. The price fixed for Bharat Ltd. is ` 11,000 per unit. The warranty
in case of sale of mobile phones by Hind Ltd. is handled by itself, whereas, for sale of mobile phones by Bhart
Ltd., Videsh Ltd. is responsible for warranty for 6 months. Both Videsh Ltd. and Hind Ltd. extended warranty at
a standard rate of ` 500 per annum.
On the above facts, how is the assessment of Hind Ltd. going to be affected?
Solution:
Computation of Arms Length Price

Particulars Amount
Cost of Mobile Phone sold to Bharat Ltd. 11,000
Less: Cost of Warranty 250
Arm’s Length Price 10,750
Computation of Increase in Total Income

Particulars Amount (`)

(in lacs)
Cost of mobile phone acquired from Videsh Ltd. [` 12,000 * 48,000] 5,760
Less: Arm’s length Value [` 10,750 x 48,000] 5,160
Therefore, Increase in Total Income 600

Illustration 18:
ABC India Limited (‘the Company’) is engaged in the business of import and sales of computers, laptops &
printers. The company is a 100% subsidiary ABC Inc., USA. The company purchases laptops from ABC Inc., USA
at negotiated rates and sells to independent customers in India under its own terms and conditions.
The company also trades in computers and printers which it procures from independent vendors in USA and sell to
its own customers in India under its own terms and condition.
Below is the profit and loss account of the company.

Particulars ` Particulars `

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Particulars ` Particulars `
Opening stock Sales
- Computers 500 - Computers 8,000
- Printers 200 - Printers 2,000
- Laptops 800 - Laptops 11,000
Purchases (Imports) Closing Stock
- Computers 5,000 - Computers 800
- Printers 1,300 - Printers 250
- Laptops 6,000 - Laptops 1,200
Gross profit c/f 9,450
23,250 23,250
Gross profit c/f 9,450
Salary 2,000
Rent 1,000
Fright Outward 250
Travel and Conveyance 300
PBITD 5,900
9,450 9,450

Other relevant information:

1. Credit period of 2 months is allowed for customers of computers and printers and hence 2% extra margin
towards interest cost is factored in sale price.
2. Purchase of materials accounted at landed costs. It is estimated that around 20% of the purchase cost reported
in P&L is towards customs duty and clearing charges.
3. Delivery of computers and printers made at company’s cost. For laptop, the customers collect the goods for
company premises.
4. For laptop purchases, the company has incurred ocean freight (around `300) whereas for computer and printers
the terms of import are CIF, Chennai.

Question and Solution

1. Identify the Associated Enterprise in the scenario?
Ans: ABC Inc., USA by virtue of ownership criteria.
2. Identify the International transaction?
Ans: Purchase of the laptop during the year of `4,800 (`6,000 less 20%)
3. Which is the comparable uncontrolled transaction here?
Ans: Sale of computers and printers (since they are similar product to laptops), procured from, as well as sold
to independent parties.

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4. What is the normal gross profit margin on the comparable transactions? `

Ans: Gross profit as per trading account 4,050
[8,000 + 2,000 + 800 + 250 – 500 – 200 – 5,000 – 1,300]
Less: Interest elements factored in sale price [2% of [8,000 + 2,000] 200
Less: Fright outward costs 250
Normal gross profit 3,600
Normal gross profit percentage [3,600 / 10,000 x 100] 36%
At this stage, the difference in the terms of sales transactions of computers and printers vis-a-vis the sale
transactions of laptops are considered. The difference in terms of purchase will be adjusted in subsequent
stage.

5. What is the price of laptop being purchased from the AE, is resold to unrelated enterprise?
Ans: `11,000
6. What is the resultant cost of sales after deducting ‘Normal Gross Profit Margin’
Ans: `7,040 (i.e. `11,000 less 36% Normal Gross Profit Margin)

7. What are the expenses incurred in connection with purchase?

Ans: `1,200 (since it is mentioned that around 20% of the purchase cost reported in P&L is toward freight,
customs duty and clearance charges)

8. What are the functional difference, including accounting practices, between the international transaction
and the comparable uncontrolled transaction, which could materially affect the amount of gross profit
margin?
Ans: `300 on account of ocean freight

9. What is the cost of sale after adjustment made as per 7 & 8 above?
Ans: `5,540 (i.e. `7,040 less `1,200 less `300)

10. How is the arm’s length purchase price determined?

Ans: Price as arrived at 9 above `5,540
Add: Amount in closing stock (80% of `1200) ` 960
`6,500
Less: Amount in opening stock (80% of `800) `640
Arm’s length price of purchase `5,860

11. Is the purchase price at arm’s length?

Ans: Yes. Since the purchase price is `4,800 is less than arm’s length price determined at `5,860.

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Illustration 19:
Compute arm’s length price from following information

Particulars Related Party Unrelated Party

Price paid (inclusive of taxes) INR 25,000 INR 23,500
Delivery terms CIF FOB
Quantity 100 pcs 110 pcs
Availability of Input Tax Credit No Yes
Quantity 100 pcs 110 pcs
Freight cost - INR 1,200
Insurance cost - INR 700
Input Tax Credit - INR 2,000

Solution:
Computation of ALP

Particulars Amount
Price paid to unrelated party (inclusive of taxes) INR 23,500
Adjustments of differences -
Delivery terms – Freight cost INR 1,200
Delivery terms – Insurance cost INR 700
Quantity -
Input tax credit available (INR 2000)
Arm’s Length Price INR 23,400

Illustration 20:
Compute arm’s length price from following information

Particulars Related Party Unrelated Party

Price paid (inclusive of taxes) INR 25,000 INR 23,500
Delivery terms CIF FOB
Quantity 100 pcs 110 pcs
Availability of Input Tax Credit No Yes
Quantity 100 pcs 110 pcs
Freight cost - INR 1,200
Insurance cost - INR 700
Input Tax Credit - INR 2,000
Credit period 90 days Upon dispatch
Interest rate on working capital 12% p.a. -

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Solution:
Computation of ALP

Particulars Amount
Price paid (inclusive of taxes) INR 23,500
Adjustments of differences
Delivery terms – Freight cost INR 1,200
Delivery terms – Insurance cost INR 700
Input Tax Credit available (INR 2000)
Credit period (Interest on INR 23,500 for 3 months @ 12% p.a.) INR 705
Arm’s length price INR 24,105

Illustration 21:
Compute ALP through following information:
- A Ltd. is a distributor of IT products.
- A Ltd. purchases these products from its related party, P Ltd.
- A Ltd. also trades in laptops manufactured by X Ltd.
- P Ltd as well as X Ltd would supply the warranty replacements free of cost to A Ltd.
- Other details are as under:

Particulars P Ltd (AE) X Ltd

Purchase price of A Ltd. INR 15,000 INR 22,000
Sale price of A Ltd INR 18,000 INR 26,000
Other expenses incurred by A Ltd INR 500 INR 700
Solution:
Computation of gross profit margin on unrelated transaction

Particulars Amount (INR)

Sale price of laptop in India 26,000
Expenses incurred by A Ltd 700
Net Sale proceeds of laptop in India [A] 25,300
Purchase price [B] 22,000
Gross profit [A - B] 3,300
GP on sale (%) 12.69%
Computation of arm’s length price

Particulars Amount
Sales price of desktop in India 18,000
Less: Expenses incurred by A ltd 500

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Particulars Amount
Less: Arm’s length resale margin @ 12.69 % of sale 2,284
Arm’s length purchase price 15,216
Purchase price paid to AE 15,000
Thus, no adjustment is required.

Illustration 22:
A sold a machine to B (associated enterprise) and in turn B sold the same machinery to C (an independent party)
at sale margin of 30% for ` 4,00,000 but B has incurred ` 4,000 in sending the machine to C. From the above data,
determine arm’s length price.

Solution:
Computation of Arm’s Length Price

Particulars Details Amount

Sales price to B 4, 00,000
Less: Gross Margin 4,00,000 × 30% 1, 20,000
Balance 2, 80,000
Less: Expenses incurred by B 4,000
Arm’s length price 2,76,000

Emerging Transfer Pricing challenges in India

Transfer Pricing Regulations in India
The Indian TP regulations are based on arm’s length principle. The regulations came into effect from 1 April,
2001. The regulations provide that any income arising from an international transaction between associated
enterprises shall be computed having regard to the arm’s length price (ALP). The concept of associated enterprises
has been defined in detail in the regulations. The regulations do not provide any hierarchy of the Arm’s Length
Methods and support concept of “most appropriate method” which provide the most reliable measure of an arm’s
length result under a particular set of facts and circumstances. The regulation prescribes mandatory annual filing
requirements as well as maintenance of contemporaneous documentation by the taxpayer in case international
transactions between associated enterprises cross a threshold and contains stringent penalty implications in case of
non-compliance. The primary onus of proving arm’s length price of the transaction lies with the taxpayer. Indian
transfer pricing administration prefer Indian comparables in most of the cases and also accept foreign comparables
in cases where foreign associated enterprises is less or least complex entity and requisite information are available
about tested party and comparables. In order to provide uniformity in application of transfer pricing law there is a
specialized Directorate of transfer pricing to administer transfer pricing rule under supervision of Director General
of Income tax (International Taxation). Transfer Pricing officers (TPO) are vested with powers of inspection,
discovery, enforcing attendance, examining a person under oath, on-the-spot enquiry/verification and compelling
the production of books of account and other relevant documents during the course of a transfer pricing audit.
A dispute resolution panel (in short DRP) is available to taxpayer to resolve disputes relating to transfer pricing
before disputes of final order by Assessing Officer, (which incorporates the order of TPO).

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Key Current and Emerging TP Audit Issues in India

Indian transfer pricing administration over the past 10 years has witnessed several challenges in administration of
transfer pricing law. Following are some of the emerging transfer pricing issues and difficulties in implementation
of arm’s length principle:
1. Challenges in the comparability analysis
India believes that comparability analysis is key to determine arm’s length price of international transaction.
However, increased market volatility and increased complexity in international transaction have thrown open
serious challenges to comparability analysis and determination of arm’s length price. Some of these challenges
and responses of Indian transfer pricing administration in dealing with these challenges are as under:
a. Use of contemporaneous data: Commodity price volatility, debt, recession and worries have brought
volatility to world market. The volatility impede a stable business environment and result in fluctuation in
margins of MNEs and their subsidiaries. In this context, use of contemporaneous comparables provides a
more accurate arm’s length price in a particular year.
b. Application of data rules: The Indian transfer pricing regulation stipulates that data to be used in
analyzing the comparability of uncontrolled transaction with an international transaction should be the
data relating to the financial year in which international transactions have been entered into. However,
the rule also provides exception and permits use of data for the preceding two years if and only if, it is
proved that such data reveals a fact which could have an influence on the determination of arm’s length
price. Therefore, the exception comes into the play only when a proof that earlier year data could have an
influence on determination of arm’s length price is brought on the record.
c. Rationale: The mandatory requirement under the law to use contemporaneous document has a solid
economic sense in the way that contemporaneous transaction reflect similar economic condition. Therefore,
use of current year data is more relevant and appropriate for ensuring a higher degree of comparability of
uncontrolled transaction for arriving at arm’s length price in respect of international transaction. In India,
contemporaneous data which may be available to the taxpayer and tax administration at the time of filing
of the tax return or conducting ex post facto analysis of transfer pricing studies cannot be held as use of
hindsight.
2. Issue relating to risks
a. A comparison of functions performed, assets employed and risks assumed is basic to any comparability
analysis. India believes that the risk of a MNE is a by-product of performance of functions and ownership,
exploitation or use of assets employed over a period of time. Accordingly, risk is not an independent
element but is similar in nature to functions and assets. In this context, India believes that it is unfair to
give undue importance to risk in determination of arm’s length price in comparison to functions performed
and assets employed.
b. Identification of risk and the party who bears such risks are important steps in comparability analysis.
India believes that the conduct of the parties is key to determine whether the actual allocation of risk
conforms to contractual risk allocation. Allocation of risk depends upon ability of parties to transaction to
exercise control over risk. Core functions, key responsibilities, key decision making and level of individual
responsibility for the key decisions are important factors to identity party which has control over the risks.
c. In India, MNEs are making claims before the transfer pricing auditor that related parties engaged in
contract R&D or other contract services in India are risk free entities. Accordingly, these related parties are
entitled to only routine (low) cost plus remuneration. MNEs also contend that the risks of R&D activities
or services are being controlled by them and Indian entities being risk free entities are entitled to (low) cost
plus remuneration.

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d. The Indian transfer pricing administration does not agree with the notion that risk can be controlled
remotely by the parent company and that the Indian subsidiaries or related party engaged in core functions,
such as carrying out research and development activities or providing services are risk free entities. India
believes that core function of R&D or services are located in India which in turn require important strategic
decisions by management and employees of Indian subsidiaries or related party to design, direction of
R&D activities or providing services and monitoring of R&D activities etc. Accordingly, the Indian
subsidiary exercises control over the operational and other risks. In these circumstances, the ability of the
parent company to exercise control over the risk - remotely and from a place where core functions of R&D
and services are not located - is very limited. In these circumstances, allocation of risk to the parent MNE
is not only questionable but is devoid of logical conclusion.
e. India believes that the subsidiary carries out core functions and by taking strategic operational decisions
controls a substantial part of risk. India believes that the parent company should be entitled to appropriate
returns for provision of funds and overall direction to R&D activity or services. The Indian subsidiary
should also similarly be entitled to returns on their core function including strategic decisions and control
on risk related to operation of R&D activities. In this context, Indian tax administration is of the view
that allocation of routine cost plus return in these cases will not reflect a true arm’s length price of the
transaction.
3. Arm’s length range
Application of most appropriate method may set up comparable data which may result in computation of more than
one arm’s length price. Where there may be more than one arm’s length price, mean of such prices is considered.
Indian transfer pricing regulations provide that in such a case the arithmetic mean of the prices should be adopted
as arm’s length price. If the variation between the arithmetic mean of uncontrolled prices and price of international
transaction does not exceed 3% or notified percentage of such transfer pricing, then transfer price will be considered
to be at arm’s length. In case transfer price crosses the tolerance limit, the adjustment is made from the central point
determined on the basis of arithmetic mean. Indian transfer pricing regulation do not mandate use of inter quartile
range.
4. Comparability adjustment
a. Like many other countries, Indian transfer pricing regulations provide for “reasonably accurate
comparability adjustments”. The onus to prove “reasonably accurate comparability adjustment” is on
the taxpayer. The experience of Indian transfer pricing administration indicates that it is possible to
address the issue of accounting difference and difference in capacity utilization and intensities of working
capital by making comparability adjustments. However, Indian transfer pricing administration finds it
extremely difficult to make risk adjustments in absence of any reliable and robust and internationally
agreed methodology to provide risk adjustment. In some cases taxpayers have used Capital Asset Pricing
Method (CAPM). However, the methodology was found flawed for the reasons outlined in the following
paragraphs
b. The CAPM model assumes that most assets rate of return within a portfolio are normally distributed
(meaning rates of return do not deviate too much from the mean). However, historically speaking, equities
have been prone to large deviations from the mean much more frequently than it is generally assumed
under the CAPM model. So, if an asset is actually prone to large swings in either direction from its mean,
then it stands to reason that its risk aspect may not be correctly captured by the CAPM calculation.
c. Capital asset pricing model is not able to capture all variations in equity returns in same industry segment.
Past empirical studies have demonstrated that some stocks, although they had lower beta and implied
lower risk vs. return ratio, still managed to pull off higher returns than the CAPM model would have
assumed initially.

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d. On a more practical level, one of the shortfalls of CAPM is that the model assumes all investors have the
same ideas of what constitutes risk and required rates of return, as well as the fact that the model excludes
the impact of taxes and transaction costs which, in reality, have adverse impact on the expected rate of
return.
e. The CAPM assumes the application of the market portfolio, which is supposed to consist of all risky assets
in all markets. The CAPM also assumes that investors have no individual preference as to which risky
assets they wish to invest in and in which markets. Yet, investors have been known to depart from assets
‘risk vs. return profiles often and particularly at times when markets were not normally distributed.
f. The CAPM accepts the concepts of the market portfolio, which theorizes inclusion of literally all asset
classes, including real estate, art intellectual property etc. However, in reality such a market portfolio is
impossible to construct which is why it is often equated with various composites. However, limiting the
market portfolio in such a manner could and it indeed has created fallacies within the CAPM model, thus
rendering it at the very least empirically inconsistent.
g. An important flaw relating to the computation of risk adjustment by the taxpayer is use of the “Beta”
concept. It is important to remember that computation of beta is based on a presumption that high-beta
shares usually give the highest returns. Over a long period of time, however, high beta shares are the worst
performers during market declines (bear market) which are more common phenomena in Indian stock
exchange. While someone might receive high returns from high beta shares, there is no guarantee that the
CAPM return is realized. It is worthwhile to mention here that the computation of beta in this case is based
on seven year average price of comparables and tested party shares; the methodology of taking an average
of such a long period is highly questionable in existing volatile world market conditions.
h. The Indian tax administration has also experienced difficulties in getting reliable data for computation of
comparability adjustments like capacity and working capital adjustments, where methodology to provide
comparability adjustment is more or less internationally agreed.

5. Location Savings
a. It is view of the Indian transfer pricing administration that the concept of “location savings” - which refer
to cost savings in a low cost jurisdiction like India – should be one of the major aspects to be considered
while carrying out comparability analysis during transfer pricing audits. Location savings has a much
broader meaning; it goes beyond the issue of relocating a business from a ‘high cost’ location to a ‘low
cost’ location and relates to any cost advantage. MNEs continuously search options to lower their costs
in order to increase profits. India provides operational advantages to the MNEs such as labour or skill
employee cost, raw material cost, transaction costs, rent, training cost, infrastructure cost, tax incentive
etc. It has also been noticed that India also provides following Location Specific Advantages (LSAs) to
MNE in addition to location savings:
� Highly specialized skilled manpower and knowledge
� Access and proximity to growing local/regional market
� Large customer base with increased spending capacity
� Superior information network
� Superior distribution network
� Incentives
� Market premium

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b. The incremental profit from LSAs is known as “location rents”. The main issue in transfer pricing is
the quantification and allocation of location savings and location rents among the associated enterprises.
Under arm’s length pricing, allocation of location savings and rents between associated enterprises should
be made by reference to what independent parties would have agreed in comparable circumstances. The
Indian transfer pricing administration believes it is possible to use the profit split method to determine
arm’s length allocation of location savings and rents in cases where comparable uncontrolled transactions
are not available. In these circumstances, it is considered that the functional analysis of the parties to
the transaction (functions performed, assets owned and risks assumed), and the bargaining power of the
parties (which at arm’s length would be determined by the competitiveness of the market - availability of
substitutes, cost structure etc) should both be considered appropriate factors.
b. Comparability analysis and benchmarking by taking local comparables will determine the price of a
transaction with a related party in a low cost jurisdiction. However, it will not take into account the benefit
of location savings which can be computed by taking into account cost difference between cost of low cost
country and high cost country from where the business activity was relocated. In view of this, the price
determined on the basis of local comparables is not consistent with arm’s length price because any arm’s
length transaction between two unrelated parties would not be possible without benefiting both parties to
the transaction.
b. Hypothetically, if an unrelated third party had to compensate another party to the transaction in a low cost
jurisdiction that was equal to the cost savings and location rents attributable to the location, there would
be no incentive for the unrelated third party to relocate business to a low cost jurisdiction. Thus, arm’s
length compensation for cost savings and location rents should be such that both parties would benefit
from participating in the transaction. In other words, it should be not less than zero and not greater than the
value of cost savings and locations rents; it should also reflect an appropriate split of the cost savings and
location rents between the parties.
6. Intangibles
a. Transfer pricing of intangibles is well known as a difficult area of taxation practice. However, the pace of
growth of the intangible economy has opened new challenges to the arm’s length principle. The transactions
involving intangible assets are difficult to evaluate because of the following reasons:
� Intangibles are seldom traded in the external market and it is very difficult to find comparables’ in the
public domain.
� Intangibles are often transferred bundled along with tangible assets. They are difficult to be detected.
b. A number of difficulties arise while dealing with intangibles. Some of the key issues revolve around
determination of arm’s length price of rate of royalties, allocation of cost of development of market
and brand in a new country, remuneration for development of marketing, Research and Development
intangibles and their use, transfer pricing of co-branding etc. Some of the Indian experiences in this regard
are discussed below.
� With regard to payment of royalties, MNEs often enter into agreements allowing use of brands,
trademarks, know how, design, technology etc. by their subsidiaries or related parties in India. Such
payments can be in a lump sum, periodical payments or a combination of both types of payments. It
is an internationally agreed position that intellectual property which is owned by one entity and used
by another entity generally requires royalty payment. However, the important issue in this regard
is determination of the rate of royalty. The main challenge in determination of arm’s length price
of royalty rate is to find comparables in the public domain with sufficient information required for
comparability analysis. The Indian experience suggests that it is impossible to find comparable arm’s
length prices in most cases. The use of profit split method as an alternative is generally not a feasible
option due to lack of requisite information.

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� The Indian tax administration has noticed serious difficulties in determining the rate of royalty charged
for use of brand and trademark in certain cases. In some cases the user had borne significant costs on
promotion of the brand/trademark, and to promote and develop customer loyalty for brand/trademark
in a new market. In these cases, royalty rate charged by the MNE will depend upon the cost borne by
the subsidiary or related party to promote the brand and trademark and to develop customer loyalty for
brand and product. In many cases no royalty may be charged under uncontrolled environment and the
subsidiary would require arm’s length compensation for economic ownership of marketing intangible
developed by it and for enhancing the value of brand and trademark owned by parent MNEs in the
new emerging market like India.
� In many cases, Indian subsidiaries which use technical know-how of their parent company have
incurred significant expenditure to customize such know-how and to enhance its value by their R&D
efforts. Costs on activities, such as R&D activities which have contributed in enhancing the value of
know-how owned by parent company is generally considered by Indian transfer pricing officer while
determining arm’s length price of royalty for use of technical know-how.
� The Indian transfer pricing administration has also noted significant transfer pricing issues in cases of
co-branding of new foreign brand of parent MNE (which is unknown to new market like India) with
popular Indian brand name. Since the Indian subsidiary has developed valuable Indian brand in the
domestic market over a period of time, incurring huge expenditure on advertisement, marketing and
sales promotion, it should be entitled for arm’s length remuneration for contributing to the value of
foreign little known brand through market recognition by co-branding it with a popular Indian brand.

7. R&D activities
a. Several global MNEs have established subsidiaries in India for research and development activities on
contract basis to take advantage of the large pool of skilled manpower which are available at a lower cost.
These Indian subsidiaries are generally compensated on the basis of routine and low cost plus mark up.
The parent MNE of these R&D centres justify low cost plus markup on the ground that they control all the
risk and their subsidiaries or related parties are risk free or limited risk bearing entities. The claim of parent
MNEs that they control the risk and are entitled for major part of profit from R&D activities is based on
following contentions:
� Parent MNE designs and monitors all the research programmes of the subsidiary.
� Parent MNE provides fund needed for R&D activities.
� Parent MNE controls the annual budget of the subsidiary for R&D activities.
� Parent MNE controls and takes all the strategic decisions with regards to core functions of R&D
activities of the subsidiary.
� Parent MNE bears the risk of unsuccessful R&D activities.
b. The Indian transfer pricing administration always undertakes a detailed enquiry in cases of contract R&D
centres. Such an enquiry seeks to ascertain correctness of the functional profile of subsidiary and parent
MNE on the basis of transfer pricing report filed by the taxpayers, as well as information available in the
public domain and commercial databases. After conducting detailed enquiries, the Indian tax administration
often reaches the following conclusions:
� Most parent MNEs were not able to file relevant documents to justify their claim of controlling risk of
core functions of R&D activities and asset (including intangible assets) which are located in the country
of subsidiary or related party.

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� Contrary to the above, it was found that day to day strategic decisions and monitoring of R&D
activities were carried out by personnel of subsidiary who were engaged in actual R&D activities and
bore relevant operational risks.
� The management of Indian subsidiary also took decision of allocation of budget to different streams
of R&D activities and Indian management also monitored day to day performance of R&D activities.
� It was true that in most of the cases funds for R&D activities were transferred from the MNE parent
and they bore the risk of such fund. However, in addition to “capital” other important assets like
technically skilled manpower, know how for R&D activities etc were developed and owned by the
Indian subsidiary. Accordingly, control of risk of the asset lies both with the MNE parent and Indian
subsidiary but the Indian subsidiary controls more risks as compared to the MNE parent.
c. On the basis of above functional analysis, the Indian transfer pricing administration decided in most
of the cases that Indian subsidiaries were not risk free entities but bore significant risk. Accordingly
Indian subsidiaries were entitled to an appropriate return for their function including the strategic
decision, monitoring, use of their assets and control over the risk. In view of these facts, routine cost plus
compensation model was not held at arm’s length price.
d. Most of these R&D centres in India were actually found to be engaged in creation of unique intangibles,
legal ownership of which was transferred to their parent MNEs under agreement. Such transfer took place
without any appropriate compensation and patents for these intangibles were registered in the name of
parent MNE. In these cases the Indian transfer pricing administration allocated additional arm’s length
compensation for transfer of such intangibles in addition to arm’s length compensation for R&D activities.
8. Marketing Intangibles
a. Transfer pricing aspect of marketing intangibles has been a focus area for the Indian transfer pricing
administration. The issue is particularly relevant to India due to its unique market specific characteristics
such as location advantages, market accessibility, large customer base, market premium, spending power
of Indian customers etc. The Indian market has witnessed substantial marketing activities by the subsidiary/
related party of the MNE groups in recent past, that have resulted in creation of local marketing intangibles.
For Indian transfer pricing administration first important step is to identify marketing intangibles. The
marketing intangibles are generally identified on the basis of the efforts of Indian subsidiary/related party
on:
� Enhancing the value of foreign trade mark/brand unknown to Indian market by incurring huge
advertisement, marketing and sale promotion expenditure.
� Creation of brand and product loyalty in the minds of customers.
� Creation of efficient supply chain.
� Establishing distributor network in the country.
� After sale services support network in the country.
� Conducting customer and market researches.
� Establishing customer list etc.
b. Since Indian subsidiaries/related parties (which are claimed as no risk and limited risk bearing distributors
by parent MNE in order to justify low cost plus return) have incurred and borne huge expenditure on
development of marketing intangibles. These entities generally incur huge losses or disclose very nominal
profit as evident from their return of income. Determination of ALP in cases of marketing intangibles
generally involves following steps:

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� Functional analysis of profile of the Indian and parent MNE to ascertain whether the Indian taxpayer
is a risk free, limited risk bearing or risk bearing entity?
� Identification of nature, types and stages of development of marketing intangibles. The Indian entity
may be engaged in different stages of development of marketing intangibles. For example if an MNEs
is new entrant in Indian market, the related party in India will incur substantial expenditure:
− to create awareness about trade mark, brand and product or services of MNE group in India.
− customer loyalty for brand and products/services for dealer network.
− after sale services network.
− market and customer research for creation of customer list.
c. After some years of operation, the cost on developing and sustaining marketing intangible may be reduced.
� Identification of expenditure on launch of new products in India and to ascertain who had borne such
expenditure.
� to ascertain who had borne the cost of development of marketing intangibles.
� examination of remuneration model to Indian related party.
d. The Indian tax administration computes the ALP in the cases involving marketing intangibles following the
concept of bright line i.e., no risk or limited risk distributor will bear the cost of only routine expenditure on
advertisement, marketing and sale promotion. However, the tax administration faces following challenges
in determination of the ALP:
� Whether parent MNE should reimburse the cost incurred by the Indian related party on development
of marketing intangibles with or without mark-up.
� Lack of uniform accounting codes creates a significant challenge in identification of advertisement,
marketing and sales promotion (AMP) expenditure in comparable companies and tested party.
� The developer of marketing intangibles who has economic ownership in the intangibles is entitled to
additional returns. However, the difficult question is what should be the arm’s length price of such
returns.
e. The important issue in the determination of ALP in these cases is to examine who benefits from the
extraordinary AMP expenditure. Taxpayers generally claim that such extraordinary expenditure helps the
business of the Indian entity also in addition to parent MNE. However, the tax authorities in India have
found that Indian distributors are claimed to be no risk or low risk bearing entities and are getting fixed and
routine return on cost plus basis. They do not get a share in the excess profit relatable to local marketing
intangibles. Accordingly, extra-ordinary AMP expenditure does not enhance the profitability of Indian
subsidiary or related party. This conclusion of the tax authorities is further supported by the fact that these
so called risk-free or limited risk distributors have disclosed huge losses even when they are entitled for
fixed return on cost plus basis and should not have incurred losses.
f. In this context, the Transfer Pricing administration have taken a view that such Indian entities which
incur excessive AMP expenses, bear risks and perform functions beyond what an independent distributor
with similar profile would incur or perform for the benefit of its own distribution activities should be
compensated for return on intangibles. Such compensation would be in the form of reimbursement of the
excess AMP expenditure along with mark-up. Alternatively, the Indian entity should be allowed to share
profit related to marketing intangibles. If no reimbursement is made in these type of cases along with

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mark-up, or the related party does not get an arm’s length return for development of marketing intangibles
in the form of its entitlement to share profits, the Indian tax administration makes adjustment on account
of reimbursement of excess AMP expenditure along with a mark-up for the functions undertaken by the
subsidiary/related party.
9. Intragroup Services
a. Globalization and the drive to achieve efficiencies within MNE groups have encouraged sharing of
resources to provides support between one or more location by way of shared services. Since these intra
group services are the main component of “tax efficient supply chain management” within an MNE
group, the Indian transfer pricing authorities attach high priority to this aspect of transfer pricing. The tax
administration has noticed that some of the services are relatively straight forward in nature like marketing,
advertisement, trading, management consulting etc. However, other services may be more complex and
can often be provided on stand-alone basis or to be provided as part of the package and is linked one way
or another to supply of goods or intangible assets. An example can be agency sale technical support which
obligates the licensor to assist the licensee in setting up of manufacturing facilities, including training
of staff. The Indian transfer pricing administration generally considers following questions in order to
identify intra group services requiring arm’s length remuneration:
� Whether Indian subsidiaries have received any related party services i.e., intra group services? Nature
and detail of services including quantum of services received by the related party.
� Whether services have been provided in order to meet specific need of recipient of the services? What
are the economic and commercial benefits derived by the recipient of intra group services?
� Whether in comparable circumstances an independent enterprise would be willing to pay the price for
such services?
� Whether an independent third party would be willing and able to provide such services?
b. The answers to above questions enable the Indian tax administration to determine if the Indian subsidiary
has received or provided intra group services which requires arms’ length remuneration. Determination of
the arm’s length price of intra-group services normally involve following steps:
� Identification of the cost incurred by the group entity in providing intra group services to the related
party.
� Understanding the basis for allocation of cost to various related parties i.e., nature of allocation keys.
� Whether intra group services will require reimbursement of expenditure along with markup.
� Identification of arm’s length price of markup for rendering of services.
c. Identification of the services which require an arm’s length remuneration is one of the main challenges
before the Indian transfer pricing administration. India believes that shareholder services, duplicate
services and incidental benefit from group services do not give rise to intra group services requiring arm’s
length remuneration. However, such conclusion would need a great deal of analysis. The biggest challenge
in determination of the arm’s length price is allocation of cost by using allocation keys. The nature of
allocation keys generally varies with the nature of services. However, it is difficult to reach agreement
between the tax administration and taxpayer on the nature of allocation of keys.
d. The next challenge before the transfer pricing administration is a most commonly asked question whether
or not it is necessary for services provider to make a profit. Typical example of this would include treatment
of pass through cost. Another important question is how to determine a percentage of mark up and to fix

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the benchmark of markup are tedious processes. The fixing up of the cost base to compute the markup is
another complex issue and it is a difficult decision to include or not to include various types of overhead.
e. A brief review of cases where adjustments have been made by Indian transfer pricing administration has
revealed that most of MNE parents do not allow any profit markup on the services rendered by Indian
subsidiaries to them. However, in some exceptional cases a low markup of 5% to 10% is allowed on
some services with a restricted cost base. On the other hand, where Indian subsidiaries or related parties
receive intra group services, parent MNEs generally charge mark up on all the services provided to such
entities, including duplicate services, shareholding services and services which provide only incidental
benefits to the Indian entities. The rate of markup charged on such intra-group services is also mostly on
the higher side. The Indian transfer pricing administration has also noticed that in several cases, the claim
of rendering services was found to be incorrect or the services were found not to be intra-group services
which required arm’s length remuneration.
f. In view of the above facts, transfer pricing of intra-group services is a high risk area for the Indian transfer
pricing administration.
10. Financial Transactions
a. Intercompany loans and guarantees are becoming common international transactions between related
parties due to management of cross border funding within group entities of a MNE group. Transfer
pricing of inter-company loans and guarantees are increasingly being considered some of the most
complex transfer pricing issues in India. The Indian transfer pricing administration has followed a quite
sophisticated methodology for pricing inter-company loans which revolves around:
� comparison of terms and conditions of loan agreement.
� determination of credit rating of lender and borrower.
� Identification of comparables third party loan agreement.
� suitable adjustments to enhance comparability.
b. The Indian transfer pricing administration has come across cases of outbound loan transactions where
the Indian parent has advanced to its associated entities (AE) in a foreign jurisdiction either interest free
loans or loans at LIBOR/EURIBOR rates. The main issue before the transfer pricing administration is
benchmarking of these loan transactions to arrive at the ALP of the rates of interest applicable on these
loans. The Indian transfer pricing administration has determined that since the loans are advanced from
India and Indian currency has been subsequently converted into the currency of the geographic location of
the AE, the Prime Lending Rate (PLR) of the Indian banks should be applied as the external CUP and not
the LIBOR or EURIBOR rate.
c. A further issue in financial transactions is credit guarantee fees. With the increase in outbound investments,
the Indian transfer pricing administration has come across cases of corporate guarantees extended by Indian
parents to its associated entities (AEs) abroad, where the Indian parent as guarantor agrees to pay the entire
amount due on a loan instrument on default by the borrower. The guarantee helps an AE of the Indian
MNE to secure a loan from the bank. The Indian transfer pricing administration generally determines
the ALP of such guarantee under the comparable uncontrolled price method. In most cases, interest rates
quotes and guarantee rate quotes available from banking companies are taken as the benchmark rate to
arrive at the ALP. The Indian tax administration also uses the interest rate prevalent in the rupee bond
markets in India for bonds of different credit ratings. The difference in the credit ratings between the
parent in India and the foreign subsidiary is taken into account and the rate of interest specific to a credit
rating of Indian bond is also considered for determination of the arm’s length price of such guarantees.

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d. However, the Indian transfer pricing administration is facing a challenge due to non-availability of
specialized database and transfer price of complex cases of inter-company loans in cases of mergers
and acquisitions which involve complex inter-company loan instruments as well as implicit element of
guarantee from parent company in securing debt.

Solved Case
Terabyte Inc. of France and R Ltd. of India are associated enterprises. R Ltd. imports 6,000 compressors for Air
Conditioners from Terabyte Inc. at ` 6,700 per unit and these are sold to Refresh Cooling Solutions Ltd at a price
of ` 10,000 per unit. R Ltd. had also imported similar products from Gold Inc. Poland and sold outside at a Gross
Profit of 20% on Sales. Terabyte Inc. offered a quantity discount of ` 1,000 per unit. Gold Inc. could offer only `
500 per unit as Quantity Discount. The freight and customs duty paid for imports from Gold Inc. Poland had cost R
Ltd. ` 1,200 per piece. In respect of purchase from Terabyte Inc., R Ltd. had to pay ` 200 only as freight charges.
On the basis of aforesaid information, you are requested to choose correct options for the following:
1. What will be considered as arm’s length price per unit?
2. State the amount of addition required to be made in the computation of R Ltd.?
Solution:
Computation of Arm’s Length Price

Particulars Amount (`)

Resale Price of Goods Purchased from Terabyte Inc. 10,000
Less: Adjustment for Differences –
a) Normal Gross Profit Margin at 20% of Sale Price [20% x ` 10,000] 2,000
b) Incremental Quantity Discount by Terabyte Inc. [` 1,000 – ` 500] 500
c) Difference in Purchase related expenses [` 1,200 – ` 200] 1,000
Arms Length Price 6,500
Computation of Increase in Total Income of R Ltd

Particulars Amount
Price at which actually bought from Terabyte Inc. of France 6,700
Less: Arms Length Price per unit under Resale Price Method 6,500
Decrease in Purchase Price per unit 200
No. of units purchased from Terabyte Inc. 3,000 units
Increase in Total Income (6,000 units x ` 200) ` 12,00,000

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Exercise
A. Theoretical Questions
Multiple Choice Questions
1. The provisions of sec. 92 will apply only if the aggregate value of specified domestic transactions entered
into by the taxpayer during the year exceeds a sum of ` _____.
a. 100 crore
b. 5 crore
c. 10 crore
d. 20 crore
2. As per section _____ when any specified domestic transaction is carried out between associated enterprises,
the said transaction should be carried out at arm’s length price.
a. 90
b. 91
c. 92
d. 90A
3. Section ________ deals with methods of computation of arm’s length price.
a. 94
b. 93
c. 92C
d. 91
4. Arm’s length price is to be determined by applying _______
a. Resale Price Method
b. Fair Market Value Method
c. Stamp Duty Value Method
d. Indexed Cost of Acquisition Method
5. Advance Pricing Agreement shall be valid for such period not exceeding _____ consecutive previous years
as may be specified in the agreement.
a. 5
b. 3
c. 10
d. 2
6. As per sec. 94B, interest expenses claimed by an entity to its associated enterprises shall be restricted to
_____ of its earnings before interest, taxes, depreciation and amortization (EBITDA) or interest paid or
payable to associated enterprise, whichever is less.
a. 30%
b. 25%
c. 20%
d. 50%

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7. If any person fails to keep and maintain any such information and document as required by sec. 92D
in respect of an international transaction or specified domestic transaction, the Assessing Officer or
Commissioner (Appeals) may direct that such person shall pay, by way of penalty, a sum equal to _____
a. ` 5,00,000
b. 2% of the value of each international transaction or specified domestic transaction entered into by such person
c. ` 1,00,000
d. 1% of the value of each international transaction or specified domestic transaction entered into by such person

8. Uncontrolled transaction means a transaction between ____________, whether resident or non-resident

a. enterprises other than associated enterprises
b. associated enterprises
c. any enterprises
d. none of the above

9. Information and documents required to maintained u/s 92D shall be kept and maintained for a period of
_______ from the end of the relevant assessment year.
a. 8 years
b. 5 years
c. 10 years
d. 16 years

10. When an assessee fails to furnish any information relating to a specified domestic transaction, the quantum
of penalty as a percentage of value of the transaction would be —
a. 2%
b. 1%
c. 5%
d. 3%
[Answer : 1-d; 2-c; 3-c; 4-a; 5-a; 6-a; 7-b; 8-a; 9-a; 10-a]

Short Essay Type Questions

1. What do you mean by advance pricing agreement?
2. What is thin capitalisation?
3. State the provisions relating to secondary adjustments.

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B. Numerical Questions
Comprehensive Numerical Problems
On the basis of following information, you are requested to compute disallowance u/s 94B

Particulars Case I Case II Case III

` in lakhs
Net Profit after deduction of the following items: 1,000 1,000 1,000
Interest to SBI 70 50 200
Interest to associated enterprise 200 110 320
Interest to unrelated parties 500 190 300
Depreciation 90 80 110
Provision for taxation 340 170 70
Proposed dividend 300 150 100
[Ans: Nil]

References
https://www.incometaxindia.gov.in/
https://www.incometax.gov.in/
https://www.indiabudget.gov.in/

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This Module includes:

14.1 Applicability of General Anti-Avoidance Rule [Sec. 95]

14.2 Impermissible Avoidance Arrangement [Sec. 96]

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SLOB Mapped against the Module:

1. To develop understanding about various provisions of direct taxation laws and rules
including international taxation laws, and inherent issues that are subject to interpretation
with reference to case laws, etc.
2. To attain abilities to apply the acquired understanding for solving complex taxation problems
and taking tax efficient business decision and execution thereof.

Module Learning Objectives:

After studying this module, the students will be able to -
 Understand the provision of income tax in respect of General Anti Avoidance Rules (GAAR)
 Appreciate the applicability of such rules
 Understand the impact of applicability.

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Chapter X-A: GENERAL ANTI-AVOIDANCE RULE (GAAR)

The question of substance over form has consistently arisen in the implementation of taxation laws. In the Indian
context, judicial decisions have varied. While some courts in certain circumstances had held that legal form of
transactions can be dispensed with and the real substance of transaction can be considered while applying the
taxation laws, others have held that the form is to be given sanctity. The existence of anti-avoidance principles
are based on various judicial pronouncements. There are some specific anti-avoidance provisions but general anti-
avoidance has been dealt only through judicial decisions in specific cases.
In an environment of moderate rates of tax, it is necessary that the correct tax base be subject to tax in the face of
aggressive tax planning and use of opaque low tax jurisdictions for residence as well as for sourcing capital. Most
countries have codified the “substance over form” doctrine in the form of General Anti Avoidance Rule (GAAR).
In the above background and keeping in view the aggressive tax planning with the use of sophisticated structures,
there is a need for statutory provisions so as to codify the doctrine of “substance over form” where the real intention
of the parties and effect of transactions and purpose of an arrangement is taken into account for determining the
tax consequences, irrespective of the legal structure that has been superimposed to camouflage the real intent and
purpose. Internationally several countries have introduced, and are administering statutory General Anti Avoidance
Provisions. It is, therefore, important that Indian taxation law also incorporate a statutory General Anti Avoidance
Provisions to deal with aggressive tax planning. The basic criticism of statutory GAAR which is raised worldwide
is that it provides a wide discretion and authority to the tax administration which at times is prone to be misused.
This vital aspect, therefore, needs to be kept in mind while formulating any GAAR regime.
In addition to GAAR there also exists SAAR- Specific Anti-Avoidance Rules which specifically aim at certain
arrangements of tax avoidance. SAAR have many points to its favour, since its specific there is no scope of
confusion, it doesn’t provide taxation authorities any discretion and from the point of view of tax payer it provides
certainty regarding the nature of his arrangement. Provisions of SAAR are there in Chapter X of the Income Tax
Act 1961 and some of the provisions pertaining to SAAR are in various other chapters of Income Tax Act.
It is accordingly provided in the Finance Act, 2013 to provide General Anti Avoidance Rule in the Income Tax Act
to deal with aggressive tax planning w.e.f. 01-04-2018.

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Rule [Sec. 95]

A
n arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement
and the consequence in relation to tax arising therefrom may be determined subject to the provisions of
this Chapter.
The provisions of this Chapter may be applied to any step in, or a part of, the arrangement as they are applicable
to the arrangement.
Taxpoint
1. “Arrangement” means any step in, or a part or whole of, any transaction, operation, scheme, agreement or
understanding, whether enforceable or not, and includes the alienation of any property in such transaction,
operation, scheme, agreement or understanding;
2. “Step” includes a measure or an action, particularly one of a series taken in order to deal with or achieve a
particular thing or object in the arrangement;

Non-Application of General Anti Avoidance Rule [Rule 10U]

1. The provisions of Chapter X-A (i.e., GAAR Provisions) shall not apply to:
a. an arrangement where the tax benefit in the relevant assessment year arising, in aggregate, to all the parties
to the arrangement does not exceed a sum of ` 3 crore;
b. a Foreign Institutional Investor:
i. who is an assessee under the Act;
ii. who has not taken benefit of an agreement referred to in sec. 90 or 90A; and
iii. who has invested in listed securities, or unlisted securities, with the prior permission of the competent
authority, in accordance with the Securities and Exchange Board of India (Foreign Institutional
Investor) Regulations, 1995 and such other regulations as may be applicable, in relation to such
investments;
c. a person, being a non-resident, in relation to investment made by him by way of offshore derivative
instruments or otherwise, directly or indirectly, in a Foreign Institutional Investor.
d. any income accruing or arising to, or deemed to accrue or arise to, or received or deemed to be received
by, any person from transfer of investments made before 01-4-2017 by such person.
● The provisions shall apply to any arrangement, irrespective of the date on which it has been entered
into, in respect of the tax benefit obtained from the arrangement on or after 01-04-2017.

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Taxpoint: “Tax benefit” includes,—

a. a reduction or avoidance or deferral of tax or other amount payable under this Act; or
b. an increase in a refund of tax or other amount under this Act; or
c. a reduction or avoidance or deferral of tax or other amount that would be payable under this Act, as a result of
a tax treaty; or
d. an increase in a refund of tax or other amount under this Act as a result of a tax treaty; or
e. a reduction in total income; or
f. an increase in loss,
in the relevant previous year or any other previous year;

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Impermissible Avoidance Arrangement

14.2
[Sec. 96]
1. An impermissible avoidance arrangement means an arrangement, the main purpose of which is to obtain a tax
benefit, and it—
(a) creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length;
(b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;
(c) lacks commercial substance or is deemed to lack commercial substance u/s 97, in whole or in part; or
(d) is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide
purposes.
2. An arrangement shall be presumed, unless it is proved to the contrary by the assessee, to have been entered
into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or a part
of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole
arrangement is not to obtain a tax benefit.
Taxpoint: “Tax treaty” means an agreement referred to in sec. 90(1) or 90A(1).

Arrangement to lack commercial substance [Sec. 97]

1. An arrangement shall be deemed to lack commercial substance, if—
a. the substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the
form of its individual steps or a part; or
b. it involves or includes—
i. round trip financing;
ii. an accommodating party;
iii. elements that have effect of offsetting or cancelling each other; or
iv. a transaction which is conducted through one or more persons and disguises the value, location,
source, ownership or control of funds which is the subject matter of such transaction; or
c. it involves the location of an asset or of a transaction or of the place of residence of any party which is
without any substantial commercial purpose other than obtaining a tax benefit (but for the provisions of
this Chapter) for a party; or
d. it does not have a significant effect upon the business risks or net cash flows of any party to the arrangement
apart from any effect attributable to the tax benefit that would be obtained (but for the provisions of this
Chapter).

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2. For the aforesaid purposes, round trip financing includes any arrangement in which, through a series of
transactions—
a. funds are transferred among the parties to the arrangement; and
b. such transactions do not have any substantial commercial purpose other than obtaining the tax benefit (but
for the provisions of this Chapter),
without having any regard to —
A. whether or not the funds involved in the round trip financing can be traced to any funds transferred to, or
received by, any party in connection with the arrangement;
B. the time, or sequence, in which the funds involved in the round trip financing are transferred or received;
or
C. the means by, or manner in, or mode through, which funds involved in the round trip financing are
transferred or received.
3. A party to an arrangement shall be an accommodating party, if the main purpose of the direct or indirect
participation of that party in the arrangement, in whole or in part, is to obtain, directly or indirectly, a tax
benefit (but for the provisions of this Chapter) for the assessee whether or not the party is a connected person
in relation to any party to the arrangement.
4. The following may be relevant but shall not be sufficient for determining whether an arrangement lacks
commercial substance or not, namely:—
i. the period or time for which the arrangement (including operations therein) exists;
ii. the fact of payment of taxes, directly or indirectly, under the arrangement;
iii. the fact that an exit route (including transfer of any activity or business or operations) is provided by the
arrangement.

Taxpoint
1. “Asset” includes property, or right, of any kind;
2. “Fund” includes—
(a) any cash;
(b) cash equivalents; and
(c) any right, or obligation, to receive or pay, the cash or cash equivalent;
3. “Party” includes a person or a permanent establishment which participates or takes part in an arrangement;
4. “Connected person” means any person who is connected directly or indirectly to another person and includes,—
a. any relative of the person, if such person is an individual;
b. any director of the company or any relative of such director, if the person is a company;
c. any partner or member of a firm or association of persons or body of individuals or any relative of such
partner or member, if the person is a firm or association of persons or body of individuals;
d. any member of the Hindu undivided family or any relative of such member, if the person is a Hindu
undivided family;

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e. any individual who has a substantial interest in the business of the person or any relative of such individual;
f. a company, firm or an association of persons or a body of individuals, whether incorporated or not, or a
Hindu undivided family having a substantial interest in the business of the person or any director, partner,
or member of the company, firm or association of persons or body of individuals or family, or any relative
of such director, partner or member;
g. a company, firm or association of persons or body of individuals, whether incorporated or not, or a Hindu
undivided family, whose director, partner, or member has a substantial interest in the business of the
person, or family or any relative of such director, partner or member;
h. any other person who carries on a business, if—
i. the person being an individual, or any relative of such person, has a substantial interest in the business
of that other person; or
ii. the person being a company, firm, association of persons, body of individuals, whether incorporated
or not, or a Hindu undivided family, or any director, partner or member of such company, firm or
association of persons or body of individuals or family, or any relative of such director, partner or
member, has a substantial interest in the business of that other person;
5. Relative shall have the meaning assigned to it in the Explanation to sec. 56(2)(vi).
6. A person shall be deemed to have a substantial interest in the business, if,—
a. in a case where the business is carried on by a company, such person is, at any time during the financial
year, the beneficial owner of equity shares carrying twenty per cent or more, of the voting power; or
b. in any other case, such person is, at any time during the financial year, beneficially entitled to twenty per
cent or more, of the profits of such business;

Consequences of impermissible avoidance arrangement [Sec. 98]

1. If an arrangement is declared to be an impermissible avoidance arrangement, then, the consequences, in relation
to tax, of the arrangement, including denial of tax benefit or a benefit under a tax treaty, shall be determined,
in such manner as is deemed appropriate, in the circumstances of the case, including by way of but not limited
to the following:
a. disregarding, combining or recharacterising any step in, or a part or whole of, the impermissible avoidance
arrangement;
b. treating the impermissible avoidance arrangement as if it had not been entered into or carried out;
c. disregarding any accommodating party or treating any accommodating party and any other party as one
and the same person;
d. deeming persons who are connected persons in relation to each other to be one and the same person for the
purposes of determining tax treatment of any amount;
e. reallocating amongst the parties to the arrangement—
i. any accrual, or receipt, of a capital nature or revenue nature; or
ii. any expenditure, deduction, relief or rebate;

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f. treating—
i. the place of residence of any party to the arrangement; or
ii. the situs of an asset or of a transaction,
at a place other than the place of residence, location of the asset or location of the transaction as
provided under the arrangement; or
g. considering or looking through any arrangement by disregarding any corporate structure.
2. For this purposes:
i. any equity may be treated as debt or vice versa;
ii. any accrual, or receipt, of a capital nature may be treated as of revenue nature or vice versa; or
iii. any expenditure, deduction, relief or rebate may be recharacterised.
Taxpoint: “Benefit” includes a payment of any kind whether in tangible or intangible form;

Treatment of connected person and accommodating party [Sec. 99]

For the purposes of this Chapter, in determining whether a tax benefit exists,—
i. the parties who are connected persons in relation to each other may be treated as one and the same person;
ii. any accommodating party may be disregarded;
iii. the accommodating party and any other party may be treated as one and the same person;
iv. the arrangement may be considered or looked through by disregarding any corporate structure.
Application of this Chapter [Sec. 100]
The provisions of this Chapter shall apply in addition to, or in lieu of, any other basis for determination of tax
liability.
Framing of guidelines [Sec. 101]
The provisions of this Chapter shall be applied in accordance with such guidelines and subject to such conditions,
as may be prescribed. The following scheme has been framed:
Determination of consequences of impermissible avoidance arrangement [Rule 10UA]
For the purposes of sec. 98(1), where a part of an arrangement is declared to be an impermissible avoidance
arrangement, the consequences in relation to tax shall be determined with reference to such part only.
Notice, Forms for reference under section 144BA [Rule 10UB]
1. For the purposes of sec. 144BA(1), the Assessing Officer shall, before making a reference to the Commissioner,
issue a notice in writing to the assessee seeking objections, if any, to the applicability of provisions of Chapter
X-A in his case.
2. The notice shall contain the following:
i. details of the arrangement to which the provisions of Chapter X-A are proposed to be applied;
ii. the tax benefit arising under the arrangement;

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iii. the basis and reason for considering that the main purpose of the identified arrangement is to obtain tax
benefit;
iv. the basis and the reasons why the arrangement satisfies the condition provided in sec. 96; and
v. the list of documents and evidence relied upon in respect of (iii) and (iv) above.
3. The reference by the Assessing Officer to the Commissioner u/s 144BA(1) shall be in Form No. 3CEG.
4. Where the Commissioner is satisfied that the provisions of Chapter X-A are not required to be invoked with
reference to an arrangement after considering:
i. the reference received from the Assessing Officer u/s 144BA(1); or
ii. the reply of the assessee in response to the notice issued u/s 144BA(2),
- he shall issue directions to the Assessing Officer in Form No. 3CEH.
5. Before a reference is made by the Commissioner to the Approving Panel u/s 144BA(4), he shall record his
satisfaction regarding the applicability of the provisions of Chapter X-A in Form No. 3CEI and enclose the
same with the reference.

Time limits [Rule 10UC]

For the purposes of sec. 144BA:
i. no directions u/s 144BA(3) shall be issued by the Commissioner after the expiry of 1 month from the end of
the month in which the date of compliance of the notice issued u/s 144BA(2) falls;
ii. no reference shall be made by the Commissioner to the Approving Panel u/s 144BA(4) after the expiry of 2
months from the end of the month in which the final submission of the assessee in response to the notice issued
u/s 144BA(2) is received;
iii. the Commissioner shall issue directions to the Assessing Officer in Form No.3CEH:
a. in the case referred to in rule 10UB(4)(i), within a period of 1 month from the end of month in which the
reference is received by him; and
b. in the case referred to in rule 10UB(4)(ii), within a period of 2 months from the end of month in which the
final submission of the assessee in response to the notice issued u/s 144BA(2) is received by him.

Example 11:
Facts

M/s India Chem Ltd. is a company incorporated in India. It sets up a unit in a Special Economic Zone (SEZ) in F.Y.
2017-18 for manufacturing of chemicals. It claims 100% deduction of profits earned from that unit in F.Y. 2018-19
and subsequent years. Is GAAR applicable in such a case?

Interpretation:

There is an arrangement of setting up of a unit in SEZ which results into a tax benefit. However, this is a case of
tax mitigation where the tax payer is taking advantage of a fiscal incentive offered to him by submitting to the
conditions and economic consequences of the provisions in the legislation e.g., setting up the business unit in SEZ
area. Hence, the Revenue would not invoke GAAR as regards this arrangement.

1 Indco = Indian Company; Subco = Subsidiary company; NTJ = No tax jurisdiction; LTJ = Low tax jurisdiction

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Example 1A:
Facts:
In the above example 1, let us presume M/s India Chem Ltd. has another unit for manufacturing chemicals in a
non-SEZ area. It then diverts its production from such manufacturing unit and shows the same as manufactured in
the tax exempt SEZ unit, while doing only process of packaging there. Is GAAR applicable in such a case?
Interpretation:
This is a case of misrepresentation of facts by showing production of non-SEZ unit as production of SEZ unit.
Hence, this is an arrangement of tax evasion and not tax avoidance. Tax evasion, being unlawful, can be dealt with
directly by establishing correct facts. GAAR provisions will not be invoked in such a case.
Example 1B:
Facts:
In the above example 1A, let us presume that M/s India Chem Ltd. does not show production of non-SEZ unit as
a production of SEZ unit but transfers the product of non-SEZ unit at a price lower than the fair market value and
does only some insignificant activity in SEZ unit. Thus, it is able to show higher profits in SEZ unit than in non-
SEZ unit, and consequently claims higher deduction in computation of income. Can GAAR be invoked to deny
the tax benefit?
Interpretation:
As there is no misrepresentation of facts or false submissions, it is not a case of tax evasion. The company has tried
to take advantage of tax provisions by diverting profits from non-SEZ unit to SEZ unit. This is not the intention of
the SEZ legislation. However, such tax avoidance is specifically dealt with through transfer pricing regulations that
deny tax benefits. Hence, the Revenue would not invoke GAAR in such a case.
Example 1C:
Facts:
In the above example 1B, let us presume, that both units in SEZ area (say A) and non-SEZ area (say B) work
independently. M/s India Chem Ltd. started taking new export orders from existing as well as new clients for unit
A and gradually, the export from unit B declined. There has not been any shifting of equipment from unit B to unit
A. The company offered lower profits from unit B in computation of income. Can GAAR be invoked on the ground
that there has been shifting or reconstruction of business from unit B to unit A for the main purpose of obtaining
tax benefit?
Interpretation:
The issue of tax avoidance through shifting / reconstruction of existing business from one unit to another has been
specifically dealt with in the relevant section of deduction of the Act. Hence, the Revenue would not invoke GAAR
in such a case.
Example 2:
Facts:
An Indian company (Indco) has set up a holding company (Holdco) in a no tax jurisdiction outside India (say
NTJ) which has set up further subsidiary companies (Subco A and Subco B) which pay dividends to Holdco. Such
dividends are not repatriated to Indco. Can GAAR be invoked to look through Holdco to tax dividends in the hands
of Indco?

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Subco A Subco B

NTJ Holdco

INDIA Indco
Interpretation:
Declaration / repatriation of dividend is a business choice of a company. India does not have anti-deferral provisions
in the form of Controlled Foreign Company (CFC) rules in the I.T. Act. Accordingly, GAAR would not be invoked
in such a case.
Example 2A:
Facts:
In the above example 2, dividend is accumulated in Holdco for a number of years and subsequently, Holdco is
merged into Indco through a cross–border merger. Can GAAR be invoked on the ground that the merger route has
been adopted to avoid payment of tax on dividend in India?
Interpretation:
It is true that if Holdco declares dividends to Indco before merger, then, such dividend would have been taxable in
India. But the timing or sequencing of an activity is a business choice available to the taxpayer. Moreover, sec. 47
of the Act specifically exempts capital gains on cross border merger of a foreign company into an Indian company.
Hence, GAAR cannot be invoked when taxpayer makes a choice about timing or sequencing of an activity to deny
a tax benefit granted by the statute.
Example 3:
Facts:
The merger of a loss-making company into a profit making one results in losses setting off profits, a lower net profit
and lower tax liability for the merged company. Would the losses be disallowed under GAAR?
Interpretation:
As regards setting off of losses, the provisions relating to merger and amalgamation already contain specific anti-
avoidance safeguards. Therefore, GAAR would not be invoked when SAAR is applicable.
Example 4:
Facts:
A choice is made by a company by acquiring an asset on lease over outright purchase. The company claims
deduction for lease rentals in case of acquisition through lease rather than depreciation as in the case of purchase
of the asset. Would the lease rent payment, being higher than the depreciation, be disallowed as expense under
GAAR?
Interpretation:
GAAR provisions, would not, prima facie, apply to a decision of leasing (as against purchase of an asset). However,
if it is a case of circular leasing, i.e. the taxpayer leases out an asset and through various sub-leases, takes it back
on lease, thus creating a tax benefit without any change in economic substance, Revenue would examine the matter
for invoking GAAR provisions.

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Example 5:
Facts:
1. X Ltd. is a banking institution in LTJ (low tax jurisdiction);
2. There is a closely held company Subco in LTJ which is a wholly owned subsidiary of another closely held
Indian company Indco;
3. Subco has reserves and, if it provides a loan to Indco, it may be treated as deemed dividend u/s 2(22)(e) of the
Act.
4. Subco makes a term deposit with X Bank Ltd. and X Bank Ltd. bank based on this security provides a back to
back loan to Indco.
Say, India-LTJ tax treaty provides that interest payment to a LTJ banking company is not taxable in India.
Can this be examined under GAAR?

Deposit
Bank X Ltd

INDIA
Debt

Interpretation:
This is an arrangement whose main purpose is to bring money out of reserves in Subco to India without payment
of due taxes. The tax benefit is saving of taxes on income to be received from Subco by way of dividend or deemed
dividend. The arrangement disguises the source of funds by routing it through X Bank Ltd. X Bank Ltd. may also
be treated as an accommodating party. Hence the arrangement shall be deemed to lack commercial substance.
Consequently, in the case of Indco, the loan amount would be treated as dividend income received from Subco to
the extent reserves are available in Subco; and no expense by way of interest would be allowed.
In the case of X Bank Ltd, exemption from tax on interest under the DTAA may not be allowed as X Ltd is not
a beneficial owner of the interest, provided the DTAA has anti-avoidance rule of beneficial ownership. If such
anti-avoidance rule is absent in DTAA, then GAAR may be invoked to deny treaty benefit as arrangement will be
perceived as an attempt to hide the source of funds of Subco.
Example 6:
Facts:
Indco incorporates a Subco in a NTJ with equity of US$100. Subco has no reserves; it gives a loan of US$100 to
Indco at the rate of 10% p.a. which is utilized for business purposes. Indco claims deduction of interest payable
to Subco from the profit of business. There is no other activity in Subco. Can GAAR be invoked in such a case?
Interpretation:
The main purpose of the arrangement is to obtain interest deduction in the hands of Indco and thereby tax benefit.
There is no commercial substance in establishing Subco since without it there is no effect on the business risk of
Indco or any change in the cash flow (apart from the tax benefit). Moreover, it is a case of round tripping which

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means a case of deemed lack of commercial substance. Hence, it would be treated as an impermissible avoidance
arrangement.
Consequently, in the case of Indco, interest payment would be disallowed by disregarding Subco. No corresponding
relief would be allowed in the case of Subco by way of refund of taxes withheld, if any.
Example 7
Facts:
A large corporate group has created a service company to manage all its non core activities. The service company
then charges each company for the services rendered on a cost plus basis. Can the mark up in the cost of services
be questioned using GAAR.
Interpretation:
There are specific anti avoidance provisions through transfer pricing regulations as regards transactions among
related parties. GAAR will not be invoked in this case.
Example 8:
Country F1 LTJ

Y Ltd. 100%
A Ltd.

Country C1
Debt
49%

INDIA
Z Ltd. X Ltd.
51%

Facts:
1. Y Ltd. is a company incorporated in country C1. It is a non-resident in India.
2. Z Ltd. is a company resident in India.
3. A Ltd. is a company incorporated in country F1 and it is a 100% subsidiary of Y Ltd.
4. A Ltd. and Z Ltd. form a joint venture company X Ltd. in India after the date of commencement of GAAR
provisions. There is no other activity in A Ltd.
5. The India-F1 tax treaty provides for non-taxation of capital gains in the source country and country F1 charges
no capital gains tax in its domestic law.
6. A Ltd. is also designated as a ―permitted transferee of Y Ltd. ―Permitted transferee means that though
shares are held by A Ltd, all rights of voting, management, right to sell etc., are vested in Y Ltd.
7. As per the joint venture agreement, 49% of X Ltd‘s equity is allotted to A Ltd. and 51% is allotted to Z Ltd..
8. Thereafter, the shares of X Ltd. held by A Ltd. are sold to C Ltd., a company connected to the Z Ltd. group.
As per the tax treaty with country F1, capital gains arising to A Ltd. are not taxable in India. Can GAAR be invoked
to deny the treaty benefit?

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Interpretation
The arrangement of routing investment through country F1 results into a tax benefit. Since there is no business
purpose in incorporating company A Ltd. in country F1 which is a LTJ, it can be said that the main purpose of
the arrangement is to obtain a tax benefit. The alternate course available in this case is direct investment in X Ltd.
joint venture by Y Ltd. The tax benefit would be the difference in tax liabilities between the two available courses.
The next question is, does the arrangement have any tainted element? It is evident that there is no commercial
substance in incorporating A Ltd. as it does not have any effect on the business risk of Y Ltd. or cash flow of Y Ltd.
As the twin conditions of main purpose being tax benefit and existence of a tainted element are satisfied, GAAR
may be invoked.
Additionally, as all rights of shareholders of X Ltd. are being exercised by Y Ltd instead of A Ltd, it again shows
that A Ltd lacks commercial substance.
Hence, unless it is a case where Circular 789 relating Tax Residence Certificate in the case of Mauritius, or
Limitation of Benefits clause in India-Singapore treaty is applicable, GAAR can be invoked.
Example 9:
Facts:
A Ltd. is incorporated in country F1 as a wholly owned subsidiary of company Y Ltd. which is not a resident of
F1 or of India. The India-F1 tax treaty provides for non-taxation of capital gains in India (the source country) and
country F1 charges no capital gains tax in its domestic law. Some shares of X Ltd., an Indian company, are acquired
by A Ltd in the year after date of coming into force of GAAR provisions. The entire funding for investment by A
Ltd. in X Ltd. was done by Y Ltd. These shares are subsequently disposed of by A Ltd after 5 years. This results in
capital gains which A Ltd. claims as not being taxable in India by virtue of the India-F1 tax treaty. A Ltd. has not
made any other transaction during this period. Can GAAR be invoked?
Interpretation:
This is an arrangement which has been created with the main purpose of avoiding capital gains tax in India by
routing investments through a favourable jurisdiction. There is neither a commercial purpose nor commercial
substance in terms of business risks or cash flow to Y Ltd in setting up A Ltd. It should be immaterial here whether
A Ltd has office, employee etc in country F1. Both the purpose test and tainted element tests are satisfied for the
purpose of invoking GAAR. Unless it is a case where Circular 789 relating Tax Residence Certificate in the case of
Mauritius, or Limitation of Benefits clause in India-Singapore treaty is applicable, the Revenue may invoke GAAR
and consequently deny treaty benefit.
Example 10:
Facts:
The shares of V Ltd., an asset owning Indian company, was held by another Indian company X Ltd. X Ltd. was in
turn held by two companies G Ltd. and H Ltd., incorporated in country F2, a NTJ. The India-F2 tax treaty provides
for non-taxation of capital gains in the source country and country F2 charges no capital gains tax in its domestic
law. X Ltd. was liquidated by consent and without any Court Decree. This resulted in transfer of the asset/shares
from X Ltd., to G Ltd. and H Ltd. Subsequently, companies G Ltd and H Ltd sold the shares of V Ltd to A Ltd.
which was incorporated in F2. The companies G Ltd and H Ltd claimed benefit of tax treaty and the resultant gains
from the transaction are claimed to be not taxable. Can GAAR be invoked to deny treaty benefit?

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Interpretation:
The alternative courses available to taxpayer to achieve the same result (with or without the tax benefit) are:
i. Option 1: (as mentioned in facts): X Ltd. liquidated, G Ltd. and H Ltd. become shareholders of V Ltd.; A Ltd.
acquires shares from G Ltd. and H Ltd.; and becomes shareholder of V Ltd.
ii. Option 2: A Ltd. acquires shares of X Ltd. from G Ltd. and H Ltd.; X Ltd. is liquidated; and A Ltd. becomes
shareholder of V Ltd.
iii. Option 3: X Ltd. sells its entire shareholding in V Ltd. to A Ltd. and subsequently, X Ltd is liquidated.
In Options 1 & 2, there is no tax liability in India except the deemed dividend taxation to the extent reserves are
available in X Ltd. This is because of the treaty between India and country F1. In option 3, tax liability arises to X
Ltd., an Indian company, on sale of shares of V Ltd. Subsequently, when X Ltd. is liquidated, tax liability arises on
account of deemed dividend to the extent reserves are available in X Ltd.
The taxpayer exercises the most tax efficient manner in disposal of its assets through proper sequencing of
transactions. The Revenue cannot invoke GAAR as regards this arrangement.

Clarifications on implementation of GAAR [Circular 07/2017 dated 27/01/2017]

1. Will GAAR be invoked if SAAR (Specific Anti-Avoidance Rules) applies?
Ans. It is internationally accepted that specific anti avoidance provisions may not address all situations of abuse
and there is need for general anti-abuse provisions in the domestic legislation. The provisions of GAAR and
SAAR can coexist and are applicable, as may be necessary, in the facts and circumstances of the case.
2. Will GAAR be applied to deny treaty eligibility in a case where there is compliance with Limitation
of Benefits (LOB) test of the treaty?
Ans. Adoption of anti-abuse rules in tax treaties may not be sufficient to address all tax avoidance strategies
and the same are required to be tackled through domestic anti-avoidance rules. If a case of avoidance is
sufficiently addressed by LOB in the treaty, there shall not be an occasion to invoke GAAR.
3. Will GAAR interplay with the right of the taxpayer to select or choose method of implementing a
transaction?
Ans. GAAR will not interplay with the right of the taxpayer to select or choose method of implementing a
transaction.

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4. Will GAAR provisions apply where the jurisdiction of the FPI is finalised based on non-tax commercial
considerations and such FPI has issued P-notes referencing Indian securities? Further, will GAAR
be invoked with a view to denying treaty eligibility to a Special Purpose Vehicle (SPV), either on the
ground that it is located in a tax friendly jurisdiction or on the ground that it does not have its own
premises or skilled professional on its own roll as employees.
Ans. For GAAR application, the issue, as may be arising regarding the choice of entity, location etc., has to be
resolved on the basis of the main purpose and other conditions provided u/s 96 of the Act. GAAR shall not
be invoked merely on the ground that the entity is located in a tax efficient jurisdiction. If the jurisdiction
of FPI is finalized based on non-tax commercial considerations and the main purpose of the arrangement is
not to obtain tax benefit, GAAR will not apply.
5. Will GAAR provisions apply to (i) any securities issued by way of bonus issuances so long as the
original securities are acquired prior to 01 April, 2017 (ii) shares issued post 31 March, 2017, on
conversion of Compulsorily Convertible Debentures, Compulsorily Convertible Preference Shares
(CCPS), Foreign Currency Convertible Bonds (FCCBs), Global Depository Receipts (GDRs),
acquired prior to 01 April, 2017; (iii) shares which are issued consequent to split up or consolidation
of such grandfathered shareholding?
Ans. Grandfathering under Rule 10U(1)(d) will be available to investments made before 1st April 2017 in respect
of instruments compulsorily convertible from one form to another, at terms finalized at the time of issue of
such instruments. Shares brought into existence by way of split or consolidation of holdings, or by bonus
issuances in respect of shares acquired prior to 1st April 2017 in the hands of the same investor would also
be eligible for grandfathering under Rule 10U(1)(d) of the Income Tax Rules.
6. The expression “investments” can cover investment in all forms of instrument — whether in an
Indian Company or in a foreign company, so long as the disposal thereof may give rise to income
chargeable to tax. Grandfathering should extend to all forms of investments including lease contracts
(say, air craft leases) and loan arrangements, etc.
Ans. Grandfathering is available in respect of income from transfer of investments made before 1st April, 2017.
As per Accounting Standards, ‘investments’ are assets held by an enterprise for earning income by way
of dividends, interest, rentals and for capital appreciation. Lease contracts and loan arrangements are, by
themselves, not ‘investments’ and hence grandfathering is not available.
7. Will GAAR apply if arrangement held as permissible by Authority for Advance Ruling?
Ans. No. The AAR ruling is binding on the PCIT / CIT and the Income Tax Authorities subordinate to him in
respect of the applicant.
8. Will GAAR be invoked if arrangement is sanctioned by an authority such as the Court, National
Company Law Tribunal or is in accordance with judicial precedents etc.?
Ans. Where the Court has explicitly and adequately considered the tax implication while sanctioning an
arrangement, GAAR will not apply to such arrangement.
9. Will a Fund claiming tax treaty benefits in one year and opting to be governed by the provisions of
the Act in another year attract GAAR provisions? An example would be where a Fund claims treaty
benefits in respect of gains from derivatives in one year and in another year sets-off losses from
derivatives transactions against gains from shares under the Act.

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Ans. GAAR provisions are applicable to impermissible avoidance arrangements as under section 96. In so far as
the admissibility of claim under treaty or domestic law in different years is concerned, it is not a matter to
be decided through GAAR provisions.

10. How will it be ensured that GAAR will be invoked in rare cases to deal with highly aggressive and artificially
pre-ordained schemes and based on cogent evidence and not on the basis of interpretation difference?

Ans. The proposal to declare an arrangement as an impermissible avoidance arrangement under GAAR will be
vetted first by the Principal Commissioner / Commissioner and at the second stage by an Approving Panel,
headed by judge of a High Court. Thus, adequate safeguards are in place to ensure that GAAR is invoked
only in deserving cases.

11. Can GAAR lead to assessment of notional income or disallowance of real expenditure? Will GAAR
provisions expand the scope of charging provisions or scope of taxable base and/or disallow the
expenditure which is actually incurred and which otherwise is admissible having regard to diverse
provisions of the Act?

Ans. If the arrangement is covered under section 96, then the arrangement will be disregarded by application of
GAAR and necessary consequences will follow.

12. A definite timeline may be provided such as 5 to 10 years of existence of the arrangement where
GAAR provisions will not apply in terms of the provisions in this regard in section 97(4) of the IT Act.

Ans. Period of time for which an arrangement exists is only a relevant factor and not a sufficient factor under
section 97(4) to determine whether an arrangement lacks commercial substance.

13. It may be ensured that in practice, the consequences of a transaction being treated as an ‘impermissible
avoidance arrangement’ are determined in a uniform, fair and rational basis. Compensating
adjustments u/s 98 of the Act should be done in a consistent and fair manner. It should be clarified
that if a particular consequence is applied in the hands of one of the participants, there would be
corresponding adjustment in the hands of another participant.

Ans. Adequate procedural safeguards are in place to ensure that GAAR is invoked in a uniform, fair and rational
manner. In the event of a particular consequence being applied in the hands of one of the participants as a
result of GAAR, corresponding adjustment in the hands of another participant will not be made. GAAR is an
anti-avoidance provision with deterrent consequences and corresponding tax adjustments across different
taxpayers could militate against deterrence.

14. Tax benefit of INR 3 crores as defined in section 102(10) may be calculated in respect of each
arrangement and each taxpayer and for each relevant assessment year separately. For evaluating
the main purpose to be obtaining of tax benefit, the review should extend to tax consequences across
territories. The tax impact of INR 3 crores should be considered after taking into account impact to
all the parties to the arrangement i.e. on a net basis and not on a gross basis (i.e. impact in the hands
of one or few parties selectively).

Ans. The application of the tax laws is jurisdiction specific and hence what can be seen and examined is the
‘Tax Benefit’ enjoyed in Indian jurisdiction due to the ‘arrangement or part of the arrangement’. Further,
such benefit is assessment year specific. Further, GAAR is with respect to an arrangement or part. of the
arrangement and therefore limit of ` 3 crores cannot be read in respect of a single taxpayer only.

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15. Will a contrary view be taken in subsequent years if arrangement held to be permissible in an earlier
year?
Ans. If the PCIT/Approving Panel has held the arrangement to be permissible in one year and facts and
circumstances remain the same, as per the principle of consistency, GAAR will not be invoked for that
arrangement in a subsequent year.
16. No penalty proceedings should be initiated pursuant to additions made under GAAR at least for the
initial 5 years.
Ans. Levy of penalty depends on facts and circumstances of the case and is not automatic. No blanket exemption
for a period of five years from penalty provisions is available under law. The assessee, may at his option,
apply for benefit u/s 273A if he satisfies conditions prescribed therein.

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Exercise
A. Theoretical Questions
Multiple Choice Questions

1. General Anti Avoidance Rule (GAAR) is applicable from

a. 01-04-2018
b. 01-04-2017
c. 01-07-2017
d. 01-07-2018

2. GAAR provisions shall not apply to

a. an arrangement where the tax benefit in the relevant assessment year arising, in aggregate, to all the
parties to the arrangement does not exceed a sum of ` 3 crore
b. an arrangement where the tax benefit in the relevant assessment year arising, in aggregate, to all the
parties to the arrangement does not exceed a sum of ` 5 crore
c. an arrangement where the tax benefit in the relevant assessment year arising, in aggregate, to all the
parties to the arrangement does not exceed a sum of ` 1 crore
d. None of the above

[Answer : 1-a; 2-a]

Short Essay Type Questions

1. State the cases when provisions relating to GAAR are not applicable
2. Define impermissible avoidance arrangement.

References
https://www.incometaxindia.gov.in/
https://www.incometax.gov.in/
https://www.indiabudget.gov.in/

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NOTES
NOTES