A transfer pricing audit is an examination carried out by tax authorities to verify whether transactions between related entities of a multinational enterprise (MNE) comply with the arm’s length principle. This principle requires intercompany transactions—such as the transfer of goods, services, or intellectual property—to be priced as if they were conducted between independent, unrelated parties under comparable conditions.
In India, the Income Tax Department conducts these audits to prevent profit shifting and ensure that taxable income is appropriately reported within the country. Given the scale and complexity of intercompany transactions, transfer pricing audits can be detailed, time-consuming, and financially impactful if not handled correctly.
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Points should be considered
Preparing for a transfer pricing audit requires a structured and well-documented approach. The following aspects are critical for audit readiness.
Comprehensive and reliable information
Accurate and detailed data forms the backbone of a strong transfer pricing defence. Businesses must clearly understand the economic substance of each intercompany transaction and ensure alignment with Indian and international regulations.
A robust functional analysis is essential, covering the functions performed, assets employed, and risks assumed by each related entity. This analysis helps establish comparability with independent transactions and strengthens audit preparedness. Reliable information significantly improves the ability to defend pricing policies during scrutiny.
Sound documentation paired with stable financial planning—such as allocating reserves to fixed deposits—helps organisations manage audit uncertainty more confidently.
Proper methodology
Choosing the right transfer pricing method and applying it consistently is critical. Commonly used methods include the Comparable Uncontrolled Price (CUP), Resale Price Method, Cost Plus Method, Transactional Net Margin Method (TNMM), and Profit Split Method.
The appropriateness of the method depends on transaction nature, industry practices, and availability of comparable data. Tax authorities closely evaluate whether the selected method reflects market realities. Incorrect methodology can lead to adjustments, penalties, and potential double taxation.
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Documentation and compliance
Maintaining detailed transfer pricing documentation is mandatory under Indian tax laws. This includes transaction details, method selection rationale, and economic analysis supporting arm’s length pricing.
Failure to maintain or submit proper documentation can attract penalties of 2% of the transaction value. Timely filing of mandatory forms such as Form 3CEB is equally important. Strong documentation demonstrates transparency, compliance, and audit readiness.
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