Income Tax 2025

Appearance

CHAPTER X

SPECIAL PROVISIONS RELATING TO AVOIDANCE OF TAX

Computation of income from international transaction and specified domestic transaction having regard to arm’s length price. ​

161(1) ​

Any income arising from an international transaction or a specified domestic transaction shall be determined having regard to the arm’s length price.

161(2) ​

Any allowance for any expense or interest arising from an international transaction or a specified domestic transaction shall also be determined having regard to the arm’s length price.

161(3) ​

If in an international transaction or specified domestic transaction, two or more associated enterprises enter into a mutual agreement or arrangement for––

  • (a) allocation or apportionment of 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; 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, the cost or expense allocated or apportioned to, or, contributed by, any such enterprise shall be determined having regard to the arm’s length price of such benefit, service or facility.

161(4) ​

The provisions of this section shall not apply if the determination under sub-section (1) or (2) or (3) has the effect of reducing the income chargeable to tax or increasing the loss, computed on the basis of entries made in the books of account in respect of the tax year in which the international transaction or specified domestic transaction was entered.

Explanation

Section Summary: ​

This section of the Income Tax Act deals with the computation of income from international transactions and specified domestic transactions using the arm’s length price (ALP) principle. The ALP ensures that transactions between associated enterprises (e.g., subsidiaries, parent companies, or related parties) are conducted as if they were between independent entities, preventing tax avoidance through manipulation of prices or expenses.

Key Changes: ​

  1. Scope of Application: The section now explicitly includes specified domestic transactions (transactions between related parties within India) alongside international transactions.
  2. Expense Allocation: Sub-section (3) clarifies that costs or expenses allocated or apportioned between associated enterprises must also adhere to the ALP principle.
  3. Non-Applicability Clause: Sub-section (4) states that the ALP provisions do not apply if their application would reduce taxable income or increase losses compared to the amounts recorded in the books of account.

Practical Implications: ​

  1. For Businesses:
    • Companies engaged in international or specified domestic transactions must ensure that their pricing and expense allocations comply with the ALP principle.
    • Failure to comply may lead to adjustments by tax authorities, resulting in higher taxable income or penalties.
  2. For Taxpayers:
    • Taxpayers must maintain detailed documentation to justify the ALP of their transactions, including transfer pricing reports and supporting evidence.
  3. For Compliance:
    • Businesses must regularly review their intercompany agreements and pricing policies to ensure alignment with ALP requirements.

Critical Concepts: ​

  1. Arm’s Length Price (ALP): The price that would be charged in a transaction between independent, unrelated parties under similar circumstances. It ensures fairness and prevents tax evasion.
  2. International Transaction: Transactions between associated enterprises across borders, such as cross-border sales, services, or loans.
  3. Specified Domestic Transaction: Transactions between related parties within India, such as intercompany loans, services, or asset transfers.
  4. Associated Enterprises: Entities that are related through ownership, control, or management, such as parent companies, subsidiaries, or sister concerns.

Compliance Steps: ​

  1. Documentation:
    • Maintain detailed records of all international and specified domestic transactions.
    • Prepare transfer pricing documentation, including a master file, local file, and country-by-country report (if applicable).
  2. ALP Determination:
    • Use one of the prescribed methods (e.g., Comparable Uncontrolled Price, Resale Price, Cost Plus, Profit Split, or Transactional Net Margin Method) to determine the ALP.
  3. Reporting:
    • Disclose international and specified domestic transactions in the tax return, along with the ALP computation.
  4. Review Agreements:
    • Ensure that intercompany agreements reflect the ALP and are updated regularly to reflect market conditions.

Examples: ​

  1. International Transaction:
    • An Indian subsidiary sells goods to its foreign parent company. The price charged must be the same as what an independent buyer would pay (ALP). If the subsidiary sells at a lower price, the tax authority may adjust the income to reflect the ALP, increasing taxable income.
  2. Specified Domestic Transaction:
    • Two sister companies in India share the cost of a common service (e.g., IT support). The cost allocation must reflect the ALP. If one company bears a disproportionate share, the tax authority may adjust the expense allocation.
  3. Non-Applicability:
    • If applying the ALP reduces taxable income (e.g., by increasing expenses), the ALP provisions will not apply, and the income will be computed based on the books of account.

This section ensures that related-party transactions are conducted fairly, preventing tax avoidance while maintaining consistency with global transfer pricing standards.