Question 1

What is the "One Rupee Trap" in Indian tax compliance?

Accepted Answer

The "One Rupee Trap" refers to the fact that Indian transfer pricing rules are triggered by any international transaction with a foreign parent or associated enterprise, regardless of how small the amount is. Even a single rupee in a cross-border deal puts a company under the radar of tax authorities. While mandatory documentation like the Local File only kicks in once transactions exceed one crore rupees, the underlying requirement to maintain arm's length pricing applies to every transaction from the very first rupee.

Question 2

What is the "Stranger Test" and how does it relate to the arm's length principle?

Accepted Answer

The "Stranger Test" is a practical way to understand the arm's length principle. It asks: "What would you charge a random company or a stranger for this same service or product?" To comply with Indian tax laws, companies must prove they aren't giving global relatives a "family discount" that artificially reduces the tax base in India. This is documented through a FAR analysis, which examines the Functions performed, Assets used, and Risks assumed by each entity to ensure the price reflects economic reality.

Question 3

What are the three layers of documentation required for international tax compliance?

Accepted Answer

Following global BEPS standards, India uses a three-tier documentation structure. The first tier is the Local File, which provides a deep dive into the specific Indian entity and its local transactions. The second tier is the Master File, required for larger groups, which offers a global blueprint of the multinational’s IP, financing, and value drivers. The third tier is the Country-by-Country Report (CbCR), a high-level spreadsheet for very large corporations showing revenue, taxes paid, and employee counts across every country of operation to identify potential profit shifting.

Question 4

Does transfer pricing only apply to international deals?

Accepted Answer

No, transfer pricing also applies to "Specified Domestic Transactions" (SDT) within India if they exceed twenty crore rupees. This rule prevents companies from shifting profits between domestic units to take advantage of tax holidays, such as those offered to entities in Special Economic Zones (SEZs). Even if both companies are in India, they must prove their dealings—including shared services, inter-unit transfers, or interest on loans—are conducted at market rates.

Question 5

What are Safe Harbours and Advance Pricing Agreements (APAs)?

Accepted Answer

These are methods for companies to gain tax certainty and avoid future audits. A Safe Harbour is a "standard menu" where the government agrees not to audit a company if it declares a pre-defined minimum profit margin, such as 17% for software developers. An Advance Pricing Agreement (APA) is a customized, negotiated deal with the Central Board of Direct Taxes (CBDT) that fixes a pricing formula for up to five future years. APAs can also include a "rollback" provision to cover the four previous years, potentially securing nine years of tax certainty.

Transfer pricing rules for Indian companies

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