Transfer Pricing – Secondary Adjustments in the Indian Context

Piyush Baid, FCCA MCSI

1) General Considerations

  1. A secondary adjustment refers to the modification made in the financial records of a related entity (RE) in order to ensure that the actual distribution of profits between the RE and the taxpayer aligns with the transfer price established through a primary adjustment. The principal modification pertains to the transfer price adjustment, which is implemented to ensure that it aligns with the arm’s length principle. The secondary adjustment is a requisite measure to achieve the reconciliation of the taxpayer’s cash accounts and tax accounts.
  2. The taxpayer’s and the AE’s books of account are where secondary adjustments are recorded. Difference between taxpayer’s actual earnings and profits that would have been made if the transfer price had been arm’s length is the amount of the secondary adjustment. Both the primary and the secondary adjustments are supposed to be made the same accounting/ financial year.
  3. In the absence of secondary adjustments, the taxpayer has the potential to derive advantages from the primary adjustment, wherein its taxable profits can be augmented without a corresponding increase in its cash profits. This is due to the fact that the principal adjustment alone affects the taxpayer’s tax liability, without impacting its cash flow. The secondary adjustment mechanism serves to ensure that the cash profits of the taxpayer are correspondingly augmented, so preventing the taxpayer from unduly benefiting from the initial adjustment in an inequitable manner.
  4. Many countries’ transfer pricing legislation include provisions for secondary adjustment because it is a widely accepted global notion in the current scenario. To bring the economic benefit of the transactions in line with the arm’s length principle1, secondary adjustment provisions are put in place. The primary purpose of the secondary adjustment provisions is to approximate the tax position that would have been reached if the relevant transactions had been entered into at arm’s length.

2) Treaty Law Aspects

  1. Secondary adjustments have an interesting perspective as far as transfer pricing rules are concerned. From this perspective, it is interesting to note that commentary on article 9(2) of the OECD Model Convention in this aspect is materially different from the UN Model Convention, although the Technical Explanation to the US Model Convention is more or less in sync with the OECD Model, with some riders with regard to the IRS Code2. However, curiously enough the Technical Explanation to the US Model Convention refers to the adjustments as correlative adjustment3.
  2. The OECD Transfer Pricing Guidelines4 glossary makes a reference to Secondary adjustment5 as “An adjustment that arises from imposing tax on a secondary transaction”, and a Secondary Transaction as “A constructive transaction that some countries will assert under their domestic legislation after having proposed a primary adjustment in order to make the actual allocation of profits consistent with the primary adjustment. Secondary transactions may take the form of constructive dividends, constructive equity contributions or constructive loans”.
  3. The author is of the opinion for the ordinary meaning of the word constructive, in absence of an express definition in the OECD TP guidelines, recourse might be made in accordance with VCLT6, as since, although the OECD TP guidelines do not effectively take the form of a treaty, but nonetheless, they form part of persuasive soft law7. Thus, the ordinary meaning of constructive would be which can be declared by interpretation, but usually not by fact8.
  4. The US Model Convention Article 9(2)9, is para materia with the OECD Model Convention Article 9(2), and the technical explanation also refers to the commentary on the OECD Model Convention Article 9(2).
  5. However, there is a difference when considering the definition in the United Nations Practical Manual on Transfer Pricing for Developing Countries10. Under the UN Manual the glossary defines Secondary Adjustment as “An adjustment that arises from imposing tax on a secondary transaction. A secondary transaction is a constructive transaction that may be asserted in some countries after making a primary adjustment, in order to make the actual allocation of profits consistent with the primary adjustment. Secondary transactions may take the form of constructive dividends, constructive equity contributions or constructive loans”. It might be noted that both the 2017 and 2021 versions correspond to similar definitions.
  6. Following from the above, it becomes manifest that secondary adjustments take the form of either
    1. Constructive Dividends
    2. Constructive Equity Contributions
    3. Constructive Loans
  7. The OECD TP Guidelines give instances of such transactions
    1. For constructive dividends11 the OECD TP guidelines mentionFor example, a country making a primary adjustment to the income of a subsidiary of a foreign parent may treat the excess profits in the hands of the foreign parent as having been transferred as a dividend, in which case withholding tax may apply. It may be that the subsidiary paid an excessive transfer price to the foreign parent as a means of avoiding that withholding tax. Thus, secondary adjustments attempt to account for the difference between the re- determined taxable profits and the originally booked profits. This subjecting to tax of a secondary transaction gives rise to a secondary transfer pricing adjustment (a secondary adjustment). Thus, secondary adjustments may serve to prevent tax avoidance. The exact form that a secondary transaction takes and of the consequent secondary adjustment will depend on the facts of the case and on the tax laws of the country that asserts the secondary adjustment”. As is apparent this is the case of constructive dividend approach.
    2. With respect to the constructive loan approach12 the OECD TP Guidelines say “Another example of a tax administration seeking to assert a secondary transaction may be where the ta administration making a primary adjustment treats the excess profits as being a constructive loan from one associated enterprise to the other associated enterprise. In this case, an obligation to repay the loan would b deemed to arise. The tax administration making the primary adjustment may then seek to apply the arm’s length principle to this secondary transaction to impute an arm’s length rate of interest. The interest rate to I applied, the timing to be attached to the making of interest payments, if any, and whether interest is to be capitalized would generally need to be addressed. The constructive loan approach may have an effect not only for the year to which a primary adjustment relates but to subsequent years until such time as the constructive loan is considered by the tax administration asserting the secondary adjustment to have been repaid.
    3. Although the OECD TP Guidelines do not cater to a specific example of constructive equity contribution, but a simple example might be repatriation of profits in the form of investments in an associated enterprise.
  8. The OECD has also accepted the fact that any excess allocations made ,can be called upon by a jurisdiction to be repatriated back, considering the practical difficulties faced by some countries. Such practices if availed of, would also be acceptable13. The OECD has accepted the validity of such practices by mentioning14 “Some countries that have adopted secondary adjustments also give the taxpayer receiving the primary adjustment another option that allows the taxpayer to avoid the secondary adjustment by having the taxpayer arrange for the MNE group of which it is a member to repatriate the excess profits to enable the taxpayer to conform its accounts to the primary adjustment. The repatriation could be effected either by setting up an account receivable or by reclassifying other transfers, such as dividend payments where the adjustment is between parent and subsidiary, as a payment of additional transfer price (where the original price was too low) or as a refund of transfer price (where the original price was too high).”

3) Domestic Law Aspects

  1. Under the domestic law framework, the primary guidance in this aspect is provided under section 92CE15. This seems to have been made to ensure conformity with the OECD transfer pricing recommendations and global best practices, a new provision, namely section 92CE, has been incorporated into the Act. This provision pertains to the regulation of secondary adjustments and incorporates the idea of constructive interpretation in Indian Transfer Pricing. The main adjustment can arise from either a voluntary adjustment made by the taxpayer in their income tax return, an adjustment made by the Assessing Officer that has been accepted by the taxpayer, an adjustment determined under an Advance Pricing Agreement (APA), an adjustment made in accordance with the safe harbor rules, or an adjustment resulting from a resolution under the Mutual Agreement Procedure (MAP). Furthermore, this provision will be relevant for primary modifications surpassing INR 1 crore in instances of fiscal year (FY) 2016-17 and subsequent periods.
  2. Secondary adjustment under the Income Tax Act 1961 has been defined under section 92CE(3)(v) as “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.”16
  3. Section 92CE(1) provides primary conditions to exist for a secondary adjustment to come
    1. Where a primary adjustment to transfer price,—
      1. has been made suo motu by the assessee in his return of income;
      2. made by the Assessing Officer has been accepted by the assessee;
      3. is determined by an advance pricing agreement entered into by the assessee under section 92CC, on or after the 1st day of April, 2017;
      4. is made as per the safe harbour rules framed under section 92CB; or
      5. is arising as a result of resolution of an assessment by way of the mutual agreement procedure under an agreement entered into under section 90 or section 90A for avoidance of double taxation.What is interesting to note here is that, the assessee should have either made a suo-moto adjustment in the return, or has accepted the proposition made by the Assessing Officer in original proceedings. The outcome in case the original proceeding is appealed by the assessee is still ambiguous. It also is silent on the revisionary jurisdiction of the Principal Commissioner or the Chief Commissioner of Income Tax, as regards to the order by the Assessing Officer.
  4. Under section 90CE(2) of the Income Tax Act 1961, “ 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 money17 [or part thereof, as the case may be,] 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”. Here, the concept of “extra money” has been constructed in accordance with the constructed loans principle enunciated by the model treaties. Accordingly, it is assumed that extra money is made available to the Associated Enterprise, on a “constructed loan” basis and the same if not repatriated, shall be a deemed loan made by the assessee to its AE and the assessee shall be taxed on a notional interest income on such a loan/advance.
  5. Rule 10 CB(1) specified a maximum time limit of 90 days for such repatriation as envisaged by the scheme of things u/s 90CE. The determination of starting period u/s 92CE(1) is to be done in accordance with Rule 10CB and is in the following scenarios
    1. In case of a suo moto acceptance the due dates as mandated u/s 139(1)
    2. In case of assessment proceedings accepted, the date of order by the Assessing Officer
    3. In case of an APA, due dates specified u/s 139(1)
    4. If safe harbours availed then due dates u/s 139(1)
    5. In case of MAP being availed, then the date of the order under rule 44H by the AO.
  6. The interest money shall be computed in a similar manner.
  7. The rates of interest shall be either
    1. 1 year marginal cost of funds on the 1st day of April of the previous year + 3.25% in case the denomination is in INR
    2. LIBOR + 3% in case of any other denomination as standing on the 30th September of the previous year.
  8. The other approach used by the Income Tax Act 196119 seems to confirm to the constructive dividend approach, wherein in case, the extra money so deemed under 92(2) has not been repatriated, then the assessee may so choose to pay a net impost of 18%20. It is also clarified that the said tax on the constructive dividend shall be final, and neither any credit nor any deduction shall be allowed against such taxes paid21.

4) Conclusion

It is clear from the above discussion, that while the CBDT has shown a very forward looking approach towards resolution, of issues of secondary adjustment, and more so in tandem with internationally accepted soft law, there are some issues of concurrency which need to be addressed immediately

  1. Address of rate of interest issues in case of foreign currency transactions
  2. Address of revisionary jurisdiction issues
  3. Address of issue of in case of appeal by the assessee, which should ideally be dealt with in a time bound manner, so that the clarion call of the PM regarding fairness in tax matters gets impetus
  4. In case of international transactions
    ₹ 1 crore threshold is a nominal amount in concurrent days, especially on capital accounts, where the USD is ranging on the north of 80Rs. There should be a consideration of this threshold to at least of $250,000.00
  1. The OECD TP guidelines glossary available at OECD (2022), OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022, OECD Publishing, Paris, defines the Arm’s length principle as “The international standard that OECD member countries have agreed should be used for determining transfer prices for tax purposes. It is set forth in Article 9 of the OECD Model Tax convention as follows: where “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. For the sake of this discussion, we would be using the 2017 version of the OECD MC, 2021 version of the UN MC, and the 2006 version of the US MC. Although the author is aware of the fact that many treaties might be following the earlier versions.
  3. Page 31 of the Technical Explanation to the US model as at
  4. Available at 3 ibid supra
  5. The OECD TP guidelines glossary available at OECD (2022), OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022, OECD Publishing, Paris,
  6. Vienna Convention on the Law of Treaties 1969 available at conventions/1_1_1969.pdf
  7. Vega, Alberto, International Governance Through Soft Law: The Case of the OECD Transfer Pricing Guidelines (July 4, 2012). Working Paper of the Max Planck Institute for Tax Law and Public Finance No. 2012-05, Available at SSRN: or
  8. Black’s Law Dictionary defines constructive on page 355 as “That which is established by the mind of the law in its act of construing facts, conduct, circumstances, or instruments; that which has not the character assigned to it in its own essential nature, but acquires such character in consequence of the way in which it is regarded by a rule or policy of law; hence, inferred, implied, made out by legal interpretation”
  9. Available at pdf
  10. Ibid 9 (supra)
  11. Para 4.68 of the OECD TP Guidelines
  12. Para 4.69 of the OECD TP Guidelines
  13. Para 4.70-4.74 of the OECD Transfer Pricing Guidelines OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022, OECD Publishing, Paris,
  14. Para 4.74 of the OECD Transfer Pricing Guidelines OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022, OECD Publishing, Paris,
  15. Inserted by the Finance Act, 2017, w.e.f. 1-4-2018.
  16. Inserted by the Finance Act, 2017, w.e.f. 1-4-2018.
  17. Inserted by the Finance (No. 2) Act, 2019, w.r.e.f. 1-4-2018
  18. It is imperative that the CBDT provide a clarification by way of notification, as the LIBOR is now not in operation anymore, in the matter of determination of interest rates, for denomination in foreign currency
  19. Sections 92CE(2A) – 92CE(2D) of the Income Tax Act 1961, Inserted by the Finance (No. 2) Act, 2019, w.e.f. 1-9-2019
  20. Section 92CE(2A) of the Income Tax Act 1961
  21. Section 92CE(2B) – 92CE(2D) of the Income Tax Act 1961