Computation of income arising from international transactions and specified domestic transactions : Clause 161 of the Income Tax Bill, 2025 vs. Section 92 of the Income-tax Act, 1961

Clause 161 Computation of income from international transaction and specified domestic transaction having regard to arm's length price.

Income Tax Bill, 2025

Introduction

Clause 161 of the Income Tax Bill, 2025, is a pivotal statutory provision designed to address the computation of income arising from international transactions and specified domestic transactions, with a particular focus on ensuring that such computations are made with reference to the arm's length price. This clause is situated within Chapter X of the Bill, which is dedicated to special provisions relating to the avoidance of tax-a theme that has been central to Indian transfer pricing law since the early 2000s. Section 92 of the Income-tax Act, 1961, as amended over the years, currently serves as the cornerstone for transfer pricing regulations in India. It provides a framework for the computation of income from international transactions, and, following subsequent amendments, from specified domestic transactions as well, with reference to the arm's length price. Both Clause 161 and Section 92 reflect India's commitment to aligning its tax laws with global standards, particularly the OECD Transfer Pricing Guidelines, and to curbing profit shifting and base erosion. The introduction of Clause 161 in the Income Tax Bill, 2025, signals a legislative intent to consolidate, clarify, and perhaps modernize the transfer pricing regime for the new tax code era. This commentary provides a detailed analysis of each provision within Clause 161, interprets its legislative intent, explores its practical implications, and undertakes a systematic comparison with the corresponding provisions of Section 92 of the Income-tax Act, 1961.

Objective and Purpose

The primary objective of Clause 161 is to ensure that the income and related allowances arising from international transactions and specified domestic transactions between associated enterprises are computed in a manner that reflects the true economic value of such transactions, as if they were carried out between unrelated parties. This is encapsulated in the requirement to use the "arm's length price" as the benchmark for such computations. The legislative purpose behind this provision is twofold:

• To prevent tax avoidance through transfer pricing manipulation, where profits may be shifted out of India or within group entities to exploit differential tax rates or benefits.
• To bring certainty and uniformity in the computation of taxable income arising from cross-border and specified domestic transactions, thereby aligning Indian law with international best practices and obligations under various tax treaties.

The historical background for such provisions can be traced to the increasing globalization of businesses, the proliferation of multinational enterprises, and the resultant challenges in ensuring fair taxation of profits attributable to Indian operations. The inclusion of specified domestic transactions in the ambit of transfer pricing rules reflects the recognition that profit shifting can occur not only across borders but also within domestic group entities, especially where tax incentives or exemptions are involved.

Detailed Analysis of Clause 161 of the Income Tax Bill, 2025

Computation of Income from International and Specified Domestic Transactions

Clause 161(4) mandates that the income arising from both international transactions and specified domestic transactions between associated enterprises must be computed with reference to the arm's length price. The inclusion of both "international transaction" and "specified domestic transaction" ensures a broad coverage, encompassing cross-border dealings as well as certain domestic transactions that may be susceptible to manipulation. The arm's length principle is a cornerstone of transfer pricing law globally, ensuring that related party transactions are priced as they would be between independent enterprises in comparable circumstances. This sub-clause thus operationalizes the principle of neutrality and fairness in tax computations.

 Allowance for Expenses or Interest

Clause 161(2) extends the arm's length requirement to the allowance of expenses or interest arising from the covered transactions. In practice, this means that not only the income side but also the deduction side is scrutinized to ensure that expenses (such as management fees, royalties, interest, etc.) claimed by the taxpayer are not inflated or manipulated to erode the Indian tax base. By subjecting the allowance of expenses and interest to the arm's length standard, the law seeks to prevent situations where profit is artificially reduced through excessive or non-arm's length payments to associated enterprises.

Allocation or Apportionment of Costs/Expenses

Clause 161(3) addresses situations where associated enterprises share costs or expenses under mutual agreements or arrangements, such as cost-sharing agreements (CSAs), cost contribution arrangements (CCAs), or shared services arrangements. The law mandates that the allocation, apportionment, or contribution to such costs or expenses must be at arm's length, i.e., reflective of what independent parties would have agreed to in similar circumstances. This is a significant provision as it covers a wide variety of intra-group arrangements, including shared R&D costs, group management services, and centralized procurement. It ensures that cost allocations are not used as a vehicle for profit shifting or base erosion.

Restriction on Application in Case of Reduction of Taxable Income or Increase in Loss

Clause 161(4) is an anti-abuse provision designed to ensure that the transfer pricing adjustments mandated by this section cannot be used by taxpayers to reduce their taxable income or increase their losses. In other words, if applying the arm's length price results in a lower taxable income or a higher loss than what is reflected in the books, such adjustment is not permitted. The rationale is to prevent taxpayers from using transfer pricing rules as a tool for tax planning to their advantage, rather than as a means to ensure fair taxation.

Practical Implications

Clause 161, if enacted as part of the Income Tax Bill, 2025, will have several practical implications for different stakeholders:

• Businesses and Multinational Enterprises: These entities will need to ensure robust transfer pricing documentation, benchmarking studies, and justifications for the arm's length nature of their international and specified domestic transactions. The scope includes not only income but also expenses, interest, and cost-sharing arrangements.
• Specified Domestic Transactions: The explicit inclusion of specified domestic transactions ensures that large domestic groups cannot exploit transfer pricing loopholes to shift profits between group entities, especially where tax incentives or differential rates exist.
• Tax Authorities: The provision empowers tax authorities to scrutinize and, where necessary, adjust the income, expenses, and cost allocations of taxpayers to ensure compliance with the arm's length standard.
• Compliance and Litigation: The breadth of the provision may lead to increased compliance burdens and potential litigation, especially in complex cases involving cost-sharing or intangible assets.
• Anti-abuse Safeguards: The restriction on using transfer pricing adjustments to reduce taxable income or increase losses is a clear anti-abuse safeguard, but may also give rise to disputes regarding the interpretation and application of this restriction.

Comparative Analysis with Section 92 of the Income-tax Act, 1961

Section 92 of the Income-tax Act, 1961, forms the existing legal framework for transfer pricing in India. It has evolved through various amendments to cover both international transactions and specified domestic transactions. A comparative analysis reveals both significant similarities and some nuanced differences between Clause 161 and Section 92:

1. Scope of Transactions Covered

• Section 92 (Prior to 2012): Originally applied only to international transactions.
• Section 92 (Post-2012): Amended to include specified domestic transactions, reflecting the recognition of domestic profit shifting risks.
• Clause 161 (2025 Bill): From the outset, covers both international transactions and specified domestic transactions, demonstrating legislative intent for comprehensive coverage.

2. Arm's Length Principle

Both Section 92 and Clause 161 require computation of income, and allowance of expenses or interest, to be made with reference to the arm's length price. The language of both provisions is substantially similar in this regard, reflecting continuity in the application of the arm's length standard.

3. Cost Sharing and Mutual Agreements

Section 92(2) and Clause 161(3) both address mutual agreements or arrangements between associated enterprises for cost allocation, apportionment, or contribution. The language is nearly identical, requiring such allocations to be made at arm's length. However, Clause 161(3) is more streamlined and integrated, while Section 92, due to its legislative history, contains cross-references and explanations that reflect its piecemeal evolution.

4. Allowance of Expenses and Interest

Section 92, through its Explanation and subsection (2A), and Clause 161(2), both extend the arm's length requirement to the allowance of expenses and interest. The approach is consistent, although Clause 161 integrates this requirement more seamlessly into the main text, possibly for greater clarity.

5. Anti-Abuse Provision (Restriction on Reduction of Income or Increase in Loss)

Section 92(3) and Clause 161(4) contain essentially the same restriction: transfer pricing adjustments cannot be used to reduce taxable income or increase losses. The language is functionally identical, preserving the anti-abuse intent.

6. Structural and Drafting Differences

Clause 161 is drafted in a more concise and integrated manner, likely reflecting lessons learned from the practical application and litigation u/s 92. It eliminates some of the cross-references and explanatory notes that are present in Section 92 due to its incremental amendments.

7. Policy Consistency and Legislative Evolution

Both provisions are part of a continuum of policy aimed at preventing tax avoidance through transfer pricing manipulation. Clause 161 can be seen as the next step in the evolution of Indian transfer pricing law, seeking to consolidate, clarify, and future-proof the regime for the new tax code.

Ambiguities and Potential Issues in Interpretation

While Clause 161 largely carries forward the substance of Section 92, certain ambiguities and issues may persist or arise:

• Definition of "Arm's Length Price": Both provisions rely on the definition of arm's length price, which is subject to detailed rules and methods. Disputes may arise regarding the appropriate method, comparables, and adjustments.
• Scope of "Specified Domestic Transactions": The precise scope and thresholds for specified domestic transactions are determined by rules and notifications, which may evolve over time.
• Application of Anti-Abuse Provision: The restriction on reducing income or increasing loss may give rise to interpretational disputes, especially in cases of genuine commercial losses or fluctuating market conditions.
• Cost-Sharing Arrangements: Determining the arm's length value of shared services or benefits can be complex, particularly where intangibles or synergies are involved.

Practical Impacts and Compliance Requirements

Clause 161, like Section 92, places significant compliance obligations on taxpayers:

• Transfer Pricing Documentation: Taxpayers must maintain contemporaneous documentation justifying the arm's length nature of their transactions, including benchmarking studies, inter-company agreements, and functional analyses.
• Reporting Requirements: Annual transfer pricing reports and disclosures must be made in the prescribed forms.
• Risk of Adjustments and Penalties: Non-compliance or inadequate documentation may result in transfer pricing adjustments, penalties, and protracted litigation.
• Advance Pricing Agreements (APAs): Taxpayers may seek APAs to obtain certainty on the arm's length price of complex or recurring transactions.
• Dispute Resolution: Specialized mechanisms such as the Dispute Resolution Panel (DRP) are available for resolving transfer pricing disputes.

Conclusion

Clause 161 of the Income Tax Bill, 2025, represents a deliberate and thoughtful continuation of India's transfer pricing regime, building upon the foundation laid by Section 92 of the Income-tax Act, 1961. It encapsulates the core principles of the arm's length standard, comprehensive coverage of both international and specified domestic transactions, and robust anti-abuse safeguards. While the substantive law remains largely unchanged, the drafting of Clause 161 offers greater clarity and integration, potentially reducing interpretational ambiguities and aligning the transfer pricing regime with the needs of a modern, globalized economy. As with Section 92, the practical success of Clause 161 will depend on effective implementation, taxpayer compliance, and the evolution of jurisprudence to address complex and emerging issues in transfer pricing. Potential areas for future reform include further guidance on the valuation of intangibles, treatment of digital transactions, and the continued refinement of the anti-abuse provisions to balance tax integrity with commercial realities.

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Full Text:

Clause 161 Computation of income from international transaction and specified domestic transaction having regard to arm's length price.

 

Dated: 23-4-2025