Year: 2025

The article analyses the correct accounting treatment for disputed foreign-currency trade payables under Ind AS 37 and Ind AS 21. When a quality dispute makes the final settlement uncertain, the liability is no longer a standard trade payable but becomes a provision, since the obligation exists, an outflow is probable, and a reliable estimate—such as a 30–40% settlement—is available (paras in full text). Only this best-estimated amount represents the carrying value under Ind AS 37. The remaining portion becomes a contingent liability, disclosed but not recognised. This estimated foreign-currency liability is a monetary item, which must then be re-translated at the closing rate under Ind AS 21, with resulting exchange differences recorded in profit or loss. The article contrasts this correct method with the incorrect practice of translating the full invoiced amount, and explains auditor expectations under SA 540, disclosure requirements, and the financial-statement impact.

Consider a common yet challenging scenario: a company procures goods from a foreign supplier, and a liability is recorded in a foreign currency. Subsequently, a significant dispute emerges over the quality of the supplies, leading to negotiations. Management, supported by robust evidence and ongoing communication, concludes that the final settlement will be a fraction of the amount originally invoiced.

This situation presents a critical accounting dilemma that strikes at the heart of the “true and fair view” principle. At the reporting date, the auditor come across with the common question: should the period-end foreign exchange (forex) impact be calculated on the full, legally invoiced liability, or on management’s best estimate of the probable settlement amount?

This article provides a definitive analysis of this issue, navigating the intricate interplay between Indian Accounting Standard (Ind AS) 37, Provisions, Contingent Liabilities and Contingent Assets, and Ind AS 21, The Effects of Changes in Foreign Exchange Rates.

The core thesis is that the correct accounting treatment is not a matter of choice between two alternative bases for forex calculation. Instead, it demands a sequential application of these two standards. First, the principles of Ind AS 37 must be applied to determine the appropriate carrying amount of the liability, based on the best estimate of the expected outflow. It is only this adjusted carrying amount that constitutes the monetary item to be subsequently re-translated under the mandatory requirements of Ind AS 21.

Using the Ind AS 37 Framework:

ESTABLISHING THE OBLIGATION:

While the obligation originated as a standard trade payable, the introduction of significant uncertainty regarding the final settlement amount transforms its accounting character, bringing it firmly within the purview of Ind AS 37. Ind AS 37 defines a provision as “a liability of uncertain timing or amount”. This uncertainty is the key feature that distinguishes provisions from other liabilities such as trade payables or accruals, where the amount and timing of the settlement are largely known.

In the scenario under review, the company has a clear liability to its foreign creditor. However, the dispute over quality has rendered the final settlement amount uncertain. The original invoice value no longer represents a certain future outflow. This transformation of a certain liability into an uncertain one is the critical event that triggers the application of Ind AS 37’s recognition and measurement rules.

For a provision to be recognized, Ind AS 37 stipulates that three cumulative criteria must be met which are as follows:

1. A present obligation (legal or constructive) as a result of a past event:

The “past event” or “obligating event” is the initial receipt of goods under a commercial contract. This event created a legal obligation to pay the supplier. The subsequent dispute does not extinguish this present obligation; rather, it introduces uncertainty about the quantum of resources required to settle it. The obligation to the creditor continues to exist at the reporting date.

2. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation:

The term “probable” in the context of Ind AS 37 means “more likely than not”. In the given situation, settlement negotiations are underway, and management anticipates, based on ongoing negotiations, a payment of 30-40% of the outstanding balance. This clearly indicates that an outflow of resources is not merely possible but probable.

3. A reliable estimate can be made of the amount of the obligation:

The management’s estimate of a 30-40% settlement is not a speculative guess. It is substantiated by ongoing communications with the creditor and an assessment of the merits of the quality dispute. This demonstrates that a sufficiently reliable estimate can be made, even if it is a range rather than a single point figure.

Provision vs. Contingent Liability

It is crucial to distinguish this situation from a contingent liability. A contingent liability is defined as either a possible obligation whose existence is yet to be confirmed, or a present obligation that is not recognized because an outflow of resources is not probable or the amount cannot be measured with sufficient reliability.

In this case, the obligation is present (not possible), and the outflow is probable (not remote or merely possible). Therefore, the liability must be recognized as a provision, not merely disclosed as a contingent liability. The core issue is one of measurement uncertainty, not existence or probability.

By correctly identifying the disputed payable as a provision, we establish that its accounting is no longer governed by the face value of the original invoice. Instead, it must be measured according to the specific principles laid out in Ind AS 37.

The amount not classified as a provision i.e., balance 60-70% will fall under the category of contingent liability. As contingent liability is defined as a possible obligation whose existence is yet to be confirmed, or a present obligation that is not recognized because an outflow of resources is not probable or the amount cannot be measured with sufficient reliability. The difference between total invoice value and amount already classified as a provision may turn into possible obligations once the matter under consideration finalised and hence it is contingent upon the future events and classified as a contingent liability in the notes to the financial statements.

DETERMINING THE BEST ESTIMATE:

Having established that the disputed liability is a provision, the next critical step is to determine its carrying amount at the reporting date. This is the central element that directly informs the subsequent foreign currency translation. Ind AS 37 provides clear, albeit judgement-intensive, guidance on this measurement.

Paragraph 36 of Ind AS 37 is unequivocal: “The amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.” Now, this is a departure from the historical cost or invoice value, focusing instead on a realistic assessment of the future economic outflow.

For a single, one-off obligation, such as the settlement of a lawsuit or a disputed claim, Paragraph 40 of Ind AS 37 further clarifies that the best estimate of the liability may be the “individual most likely outcome”.

The facts of the scenario provide compelling evidence to support an estimate that is significantly lower than the full liability:

• Management’s Assessment: The management team, being closest to the negotiations, holds the view that the full amount is not payable.
• Corroborating Communications: This view is not merely an internal opinion; it is “backed by the communications taking place between the supplier and the company.” This documented correspondence is a key piece of audit evidence.
• Creditor’s Concession: Most significantly, the foreign creditor has expressed “a reluctance on their part to receive the full amount, citing concerns regarding the poor quality of supplies.” This is a powerful admission that corroborates the company’s position and strengthens the reliability of a lower settlement estimate.
• Specific Range: The estimate is not an arbitrary number but a specific range of 30-40%, indicating a degree of precision based on the negotiation status.

This body of evidence strongly suggests that the “most likely outcome” is a settlement within the 30-40% range. Recognizing a liability for the full 100% of the invoice value would ignore this evidence and would not represent the “best estimate” of the future economic outflow. It would, in fact, overstate the company’s liabilities and understate its equity, failing to present the economic substance of the situation. The principle of substance over form dictates that the financial statements must reflect the probable economic outflow, not merely the legal claim on the original invoice.

Therefore, the carrying amount of the liability must be adjusted at the reporting date to reflect this best estimate. For instance, if the range is 30-40%, management might use the mid-point of 35% as the best estimate, subject to further evidence. It is this adjusted amount in the foreign currency that represents the true liability for financial reporting purposes. It is also important to recognize that this estimate is not static; it must be reviewed at each subsequent reporting date and adjusted to reflect the current best estimate as negotiations evolve, or new information becomes available.

Using the Ind AS 21 Framework:

With the carrying amount of the liability determined under Ind AS 37, the focus shifts to Ind AS 21 to address the foreign currency translation. Ind AS 21 does not create provisions; it prescribes the methodology for translating existing assets and liabilities. The output of the Ind AS 37 measurement process becomes the direct input for the Ind AS 21 translation process.

DETERMINING MONETARY ITEM

Ind AS 21 applies different translation rules for monetary and non-monetary items. A monetary item is defined as “units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of units of currency”. The provision for the disputed liability, although an estimate, represents an obligation to pay a determinable amount of foreign currency units (e.g., 35% of the original invoice value). The uncertainty lies in the final quantum, but once estimated under Ind AS 37, it becomes a determinable amount for translation purposes. It is, therefore, a monetary item.

SUBSEQUENT MEASUREMENT:

Paragraph 23 of Ind AS 21 states that at the end of each reporting period, “foreign currency monetary items shall be translated using the closing rate”. The closing rate is the spot exchange rate at the end of the reporting period. There is no alternative treatment or policy choice available.

Paragraph 28 of Ind AS 21 further mandates that “Exchange differences arising on the settlement of monetary items or on translating monetary items at rates different from those at which they were translated on initial recognition shall be recognised in profit or loss in the period in which they arise”.

The accounting standards require an entity to first determine the correct carrying amount of the liability in the foreign currency using the “best estimate” principles of Ind AS 37. This amount is the monetary item. This monetary item must then be translated into the functional currency at the closing rate as required by Ind AS 21. The resulting exchange difference is recognised in the statement of profit and loss. There is no conceptual basis for applying the closing exchange rate to the original, full invoice amount, as that amount does not represent the entity’s probable future obligation and is not the liability’s carrying amount at the reporting date.

ILLUSTRATIVE EXAMPLE:

Assume Company A, whose functional currency is the Indian Rupee (INR), purchased goods from a foreign supplier for 100,000 units of a foreign currency (FC) when the exchange rate was 1 FC = INR 80. A dispute over quality arises before the year-end.

• Initial Transaction:

Liability recognized = FC 100,000

Liability in functional currency = 100,000 × 80 = INR 8,000,000

• Dispute and Re-estimation (Application of Ind AS 37):

Based on negotiations, management’s best estimate for settlement is 35% of the invoice value, i.e., FC 35,000.

The liability is written down by FC 65,000 (100,000 – 35,000).

A gain on remeasurement of the provision is recognized in P&L: 65,000 FC×80 INR/FC = 5,200,000 INR.

The new carrying amount of the provision is FC 35,000, which is carried in the books at 35,000 FC×80 INR/FC = 2,800,000 INR.

FC 65,000 is Contingent Liability that needs to be converted into INR at each reporting date and that amount will be disclosed in Notes to Accounts. No impact in the Profit & Loss Accounts to be given for conversion of FC 65,000 as the same is not recognised liability.

• Year-End Translation (Application of Ind AS 21):

The closing exchange rate at year-end is 1 FC = 83 INR.

The provision of FC 35,000 is re-translated at the closing rate: 35,000 FC×83 INR/FC = INR 2,905,000.

The exchange difference is calculated as the difference between the re-translated amount and the current carrying amount: 2,905,000 − 2,800,000 = INR 105,000.

An exchange loss of 105,000 INR is recognized in P&L.

The Auditor’s Lens

The measurement of a provision for a disputed liability is a significant accounting estimate, and as such, it will be subject to scrutiny under the Standards on Auditing (SAs), particularly SA 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures.

SA 540 requires the auditor to obtain sufficient appropriate audit evidence to evaluate whether accounting estimates are reasonable in the context of the financial reporting framework. A high degree of professional skepticism is required, especially for estimates that involve significant judgment, are complex, or are susceptible to management bias. A disputed liability, where management’s estimate directly impacts reported profit, is a prime example of an area requiring heightened skepticism. The auditor must challenge the assumptions and methodologies used by management rather than simply accepting them.

Given the inherent uncertainty in predicting the outcome of a negotiation or legal dispute, this type of provision is characterized by high estimation uncertainty. This elevates the matter to a “significant risk” in the auditor’s assessment, warranting a more robust and detailed audit response.

To gain assurance over the reasonableness of management’s “best estimate,” the auditor must perform a range of procedures to corroborate the assumptions and data used. These procedures would typically include:

• Review of Correspondence: Scrutinizing all written communication (emails, letters, meeting notes) between the company and the foreign creditor to find consistent evidence supporting the dispute’s validity and the estimated settlement range.
• External Confirmation: Requesting direct confirmation from the creditor regarding the outstanding balance and the status of the dispute. While a standard confirmation may not be fully effective, a carefully worded inquiry can provide valuable evidence.
• Legal Counsel Evaluation: Obtaining and critically evaluating the opinion of the company’s external or internal legal counsel regarding the legal merits of the dispute and the likely range of outcomes.
• Review of Board Minutes: Inspecting minutes of meetings of the Board of Directors or its audit committee to understand the governance and oversight of the dispute resolution strategy and to confirm consistency with management’s representations.
• Developing an Independent Estimate: The auditor may develop their own independent point estimate or range of reasonable outcomes to compare against management’s estimate. A significant divergence would require further investigation.

Management must be prepared to provide a comprehensive file of evidence that triangulates information from internal assessments, external communications, and specialist opinions. Without such evidence, the auditor may be unable to conclude that the estimate is reasonable, potentially leading to a qualification in the audit report.

FINANCIAL STATEMENTS PRESENTATION:

• Balance Sheet: The provision, measured at its best estimate and translated at the closing rate, should be presented as a liability. Its classification as current or non-current will depend on the expected timing of the settlement. If a settlement is anticipated within the next twelve months, it would be classified as a current liability.
• Statement of Profit and Loss: Two distinct impacts would be presented.

First, the gain arising from the remeasurement of the provision (the write-down from the full invoice value to the best estimate) should be recognized.

Second, the foreign exchange gain or loss arising from the re-translation of this best estimate at the closing rate should be presented. The nature of both items should be clearly explained in the notes.

● Disclosure in Notes to Accounts

A reconciliation (roll-forward) of the provision: This table would show the carrying amount at the beginning of the period, the effect of the remeasurement (the write-down), the foreign exchange adjustment for the period, and the closing balance.

A brief description of the nature of the obligation: This narrative would explain that the provision relates to a disputed payable with a foreign creditor arising from concerns over the quality of goods supplied.

The expected timing of any resulting outflows: For example, “Management expects the dispute to be settled and the resulting payment to be made in the second half of the next financial year.”

An indication of the uncertainties and major assumptions: This is a critical disclosure. The company must disclose the uncertainties surrounding the final settlement amount and timing. Crucially, it must also disclose the major assumptions made in arriving at the best estimate, such as the basis for the 30-40% settlement range.

CONCLUSION:

The accounting treatment for a disputed liability denominated in a foreign currency is a complex issue that requires a disciplined and sequential application of Ind AS principles.

The process begins with Ind AS 37, which dictates that once a dispute introduces uncertainty, the liability must be treated as a provision and measured at the “best estimate” of the expenditure required for settlement. This best estimate, supported by all available evidence, becomes the new carrying amount of the liability in its foreign currency.

Subsequently, Ind AS 21 mandates that this monetary item be translated into the functional currency using the closing exchange rate at the reporting date, with any resulting exchange difference recognized in profit or loss.

Therefore, the definitive answer to the core question is that the forex impact must be calculated on the proposed or best-estimated settlement amount, as this is the amount that faithfully represents the entity’s present obligation at the reporting date. Applying forex calculations to the full, undisputed liability i.e., an amount the entity has no probable expectation of paying would fundamentally misrepresent the entity’s financial position, its performance, and its true exposure to foreign currency risk. Such a treatment would contravene the core tenets of both Ind AS 37 and Ind AS 21 and would ultimately fail the overarching test of presenting a true and fair view.

The article analyses ownership of trust property under the Indian Trusts Act and its implications for FEMA. A trust is not a separate entity and cannot own property; instead, the trustee is the legal owner solely in a fiduciary capacity, holding the property for the benefit of beneficiaries. Beneficiaries do not own the trust property but possess a beneficial interest, which is transferable and treated as a distinct form of property. Supreme Court decisions confirm that a trustee’s ownership is limited to administration, while beneficiaries are the real owners in substance. For FEMA purposes, settlement of property into a trust is treated as a gift from settlor to beneficiaries, not trustees. Accordingly, FEMA applies wherever any party (settlor, trustee, beneficiary) or the property is outside India. Transfers must comply with LRS limits, overseas investment rules, and RBI permissions. RBI has clarified that whatever is permissible directly to a non-resident can also be done through a trust, subject to the same restrictions.

INTRODUCTION

Under FEMA, all current account transactions are permitted except where specifically prohibited or regulated. All capital account transactions are prima facie prohibited except where specifically permitted.

APPLICABILITY OF FEMA:

Where the settlor, trustees, beneficiaries are all Indian residents, and trust property is situated in India; FEMA is not applicable. However, if any of the three categories of persons is a non-resident or if the property is a foreign property, FEMA is applicable. For example, if the settlor, trustees and the beneficiaries are Indian residents, but the property is a foreign property; it is a capital account transaction. One has to examine overseas investment rules to ascertain whether the transaction is permissible or not. Similarly, if the settlor and trustees are Indian residents, property is situated in India, but one or more beneficiaries are non-residents; FEMA is applicable. Again, one will have to examine the applicable provisions of FEMA.

TRANSACTIONS THROUGH TRUST:

Can one say that whatever is permitted to individuals; a similar transaction is permissible through a trust? In this matter, the Reserve Bank of India has responded to a query sent to it. Full texts are reproduced in this article. In short, the answer says whatever is permissible for the individual can be transacted through a trust. As a corollary, whatever is not permissible to an individual, cannot be done through a trust. Thus, consider an illustration; Indian resident father wants to settle a trust where the beneficiaries will be his non-resident son and his family. Under LRS, the Indian resident can make a gift to the non-resident relatives upto $ 250,000 per year. If he settles a trust and contributes upto $ 250,000 per year, it is permissible. However, if the Indian resident settles in a trust an amount exceeding $ 250,000; it would be a violation of FEMA. If shares in an Indian company are to be settled in a trust then nothing can be done without prior permission of Reserve Bank of India. If one or more house property / properties is/are to be settled, any number of properties can be settled without RBI permission. can be done irrespective of the value of the property and without specific permission from RBI. If shares of a foreign company are to be gifted, the same can be gifted irrespective of the value involved.  This subject has attracted different opinions. Hence the author is elaborating his view. The readers may study & take an informed independent decision.

Under FEMA, it is an unwritten cardinal principle: whatever is transacted, should be bonafide in substance.

The query raised under Indian Trust Act is: When a property is settled in a private family trust, who becomes the owner of the Trust Property: Trust, Trustees or Beneficiaries?  In other words, the settlor is gifting the property to the trustee or to the beneficiary? Based on the answer to this query, FEMA applicability may be determined. This is a specific query on the subject covered above. We therefore need to examine the Indian Trust Act and FEMA.

Ownership Rights over Trust Property.

Indian Trust Act (ITA). Let us take the issue in the summary above. Answer to this issue will determine answers about applicability of FEMA.

1. “Trust” is only a Relationship. It is not an entity. Hence a Trust cannot hold property.
2. Trustee is the legal owner of trust property in a fiduciary capacity. Section 3 of Indian Trust Act (ITA). A “trust” is an obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the trustee” So trustee is the Legal Owner of the trust property.

While trustee is the owner of the trust property, the ownership is not absolute. It has annexed “Obligation” to use & manage the property for the benefit of the beneficiaries as specified by the settlor. He has NO personal right, title or interest in trust property. Trustee cannot use trust property for personal benefit – Section 51. If a trustee uses a trust property or income for his personal benefit, it will amount to a “Breach of Trust”. Trustee’s “Ownership” of trust property is NOT transferable.

Objective of the Indian Trust Act (ITA) in making the trustee as “Legal Owner” is to facilitate his management of Trust property. One has to look at a law and its purpose. A decision on one issue under one law may not be applicable for a similar issue under another law. (See S.C. decision in State Bank of India vs. West Bengal secretary. Civil Appeals Nos. 3573-74 of 1988. D/d. 24.2.1994.)  Beneficiaries may be minor or otherwise unable to manage and preserve trust property. Hence Trustee is given “Legal Ownership”. But this is only for management & not for personal enjoyment.

Trustee has a “fiduciary” relationship with beneficiaries. It is trustee’s duty to manage the trust property for the benefit of the beneficiaries. When the settlor settles a trust, he is not making any gift to the trustees. He is gifting the property to the beneficiaries subject to management by trustees. He appoints trustees and the trustees accept an obligation to preserve and protect the property for the benefit of the beneficiaries. Beneficiaries enjoy the benefits of the trust.

3. Beneficiary: Under Indian Trust Act, a beneficiary does not have any ownership rights over trust property – neither legal nor beneficial. But he has a Beneficial Interest in trust property. This interest is transferable – section 58; and its value depends on trust property & trust income. Hence beneficial interest is valuable. Any financial interest that is valuable & transferable is a “property” and is subject to the applicable laws.

4. Beneficial Interest: Different laws in India have created different kinds of rights over any property. Let us compare & contrast a few kinds of rights.

5. Types of Ownership

Personal Ownership. When a person has absolute, personal ownership of any property, he can use the same and deal with the same as he likes it. He does not need any one’s permission for sale or gift of the property. Compared to this personal ownership, the beneficiary has no ownership over trust property. He cannot sell or mortgage the property. He can enjoy the benefits of the property as directed in the trust deed.

Company: A company incorporated under Companies Act of India, is a separate legal entity. All the properties of the company are owned by the company. Shareholder does not have an ownership of company’s property. Shareholder, in his capacity of the shareholder cannot sell, mortgage or even use the company’s property. Shareholder owns shares in the company. Shares are a new kind of property created by the Companies Act. They are different from “Personal Ownership of property” and different from titles of partners, trustees etc. Shareholder can sell his shares in a company. But even if he holds 100% shares in a company, he, in his capacity as a shareholder, cannot sell company’s property. Shares in a company are a different property as compared to the properties owned by the company.

Beneficial Interest in a Trust: Beneficial interest is a separate property compared to the trust property. The beneficiary has no Ownership of trust property. He, in his capacity as a beneficiary, cannot sell or deal with the trust property. And yet, entire trust property and trust income are meant for beneficiaries as a group. Beneficiary can transfer his beneficial interest (Section 58) and no one can prevent beneficiary’s right to transfer his interest.

Company provides separation between ownership & management. Indian Trust Act provides a different kind of “Separation between Ownership and Management.” Both are quite different structures. Company is a commercial structure. Trust is generally, a family matter. Trust is created for a different objective – generally, a property is entrusted to a reliable person (trustee) to take care of persons who may not be able to take care of themselves (beneficiaries.) Under Trust Act, Beneficial Interest in a Trust is a valuable, transferable property. Settlement of a trust creates beneficial rights for the beneficiaries.

Who owns Trust Property? An analysis of Supreme Court Decisions.

H. O. W.O. Holdsworth vs. State of U.P. CIVIL APPEAL NO. 389 OF 1956 Year. 1957

In this case, a trust was settled for certain beneficiaries. Trust property consisted of agricultural land yielding agricultural income. The income was subject to U.P. Agricultural Income-tax. If the income was to be assessed in the hands of the trustees as one assessee; it would be subject to some tax. But if the same income were to be divided in the hands of all the beneficiaries; and then taxed as separate smaller incomes; then the aggregate income-tax would be smaller. This is what can happen in the normal income-tax under Income-tax Act, 2025. Hon’ble Supreme Court held that the Trustees owned the property and beneficiaries had no ownership rights. Hence the agricultural income had to be assessed in the hands of the trustees as one income. This is a decision under U.P. Agricultural Income-tax. The Supreme Court has, however, observed that the Trustee holds the property for the benefit of beneficiaries.

SBI vs. WB secretary S. C. Civil Appeals Nos. 3573-74 of 1988. (Year1994)

In this case, State Bank of India (SBI) was the trustee for a private family trust settled by an individual. Trust property was vacant land. UP government applied “Urban Land Ceiling Act” and started proceedings to acquire the surplus land. Under Section 19 of the Urban Land (Ceiling and Regulation) Act, 1976, land owned by SBI is exempt from land ceiling regulations. For the legal ground that SBI is the “Owner” of land and not its beneficiaries; support was taken from the S. C. decision in W.O. Holdsworth vs. State of U.P. in which case, S.C. has held that the Trustees owned the property and beneficiaries had no ownership rights. In the present case, Hon. S. C. observed that “The trustee, …. would, no doubt, become trust property’s owner for the purpose of effectively executing or administering the trust for the benefit of the beneficiaries and for due administration thereof but not for any other purpose.” Thus, the State Bank even though regarded under Trusts Act as the owner of trust property-vacant land for the purpose of executing or administering a trust, it (SBI) cannot hold a trust property as its owner …… as could make that land eligible for the benefit of exemption envisaged under Section 19 of the Act. Beneficiaries are the owners in substance and ULC Act will apply as if the beneficiaries are the owners.

S.C. decision in the SBI case is a later decision and after considering its decision in the Holdsworth case; S.C. has held that the trustee is the legal owner only to administer the trust property and not for its own (trustee’s) benefit. A Comparison of both the SC decisions on the subject of “Ownership of Trust Property” is very important. It is abundantly clear as held by Honourable Supreme Court that “Trustee’s Ownership of Trust Property” is for the limited purpose of administration. The concept of “Trustees are the Legal Owners” has to be applied with reference to context. Not blindly, not universally.

Conclusion on Ownership: Trustee is Legal Owner but only in a fiduciary capacity. His right is only for the purpose of managing trust property for the benefit of beneficiaries. Trustee has no beneficial ownership in trust property. A trust is created for the beneficiaries and not for the trustees. When one considers applicability of FEMA provisions, one has to consider as if the settlor is making a gift to the beneficiaries. For example, if the settlor is settling a trust where the trustees are Indian residents and beneficiaries are non-residents; the settlor must consider whether “he can make a gift to a non-resident beneficiaries.” He cannot make the gift considering that the trustees are Indian residents, ignoring the beneficiaries’ residential status.

Beneficiary is not an owner of trust property. But he is the owner of Beneficial Interest, and he is entitled to transfer his beneficial interest. This is a valuable property and subject to applicable law. Trustee cannot transfer a beneficiary’s beneficial interest. Therefore, when an Indian Resident Individual settles the shares in a foreign company for the benefit of Individual Relatives under the Trust Act, one can consider it as a gift to the beneficiaries and not to the trustees. (The query on 2nd page does not refer to foreign shares. It is only on – who is the owner of property – trustee or beneficiary).

Foreign Exchange Management Act (FEMA)

Under FEMA – Settlement of any property in a trust is considered a gift. Gift amounts to transfer of assets from one person to another person.

Definition of a Capital Account Transaction:

“Section 2(e) – “capital account transaction” means a transaction which alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India or assets or liabilities in India of persons resident outside India, and includes transactions referred to in sub-section (3) of section 6;”
………………………………….

“6.(1) Subject to the provisions of sub-section (2), any person may sell or draw foreign exchange to or from an authorised person for a capital account transaction.

(For laws other than FEMA, “gift” and “transfer” are considered different kinds of transactions.) In a settlement, four factors are involved: Donor (settlor of trust), trustees, beneficiaries (donee) and the property being settled / gifted. If all the four factors are located within India, then FEMA does not apply. If all the four factors are located outside India, then also FEMA does not apply. If any one factor is in India and any other factor is outside India, then FEMA is applicable and it is a capital account transaction. We may call such transactions as “Cross Border” transactions.

Under FEMA, for a capital account transaction one has to check whether it is permitted by the Reserve Bank under any notification, rule or circular. In case, the transaction is not permitted by such notification etc., then the parties concerned must obtain an RBI permission before making the settlement. Please see section 6; Notification: FEMA 1 / 2000-RB dated 3rd May 2000 / GSR 384(E). Rule 4(a). Indian Resident gifting shares in foreign company is also subject to Overseas Investment Rules. One may refer to OI Rules. Schedule III, Rules: 1(2)(iii)(d) and Rule 2(2). These rules permit gift of shares in a foreign company by one Indian resident individual to another resident individual – who is a relative.

One may then refer to Schedule III, Rule 1. This investment is subject to the overall ceiling under LRS.  Hence, if a gift is to be made where FEMA is applicable, the gift has to be limited to LRS limit. In other words, if the settlement is proposed to exceed LRS limit; even before settlement of a trust, the settlor needs to obtain RBI permission.

However, gift by an Indian resident to another Indian resident of shares in a foreign company is permitted by Overseas Investment Rules Schedule III, Rule No. (2)(2). This transaction of gift between two residents is permitted without limit.

Can one say that “What is directly permitted is also permitted indirectly?” Well under FEMA, one has to examine the applicable rules. When an Indian resident acquires or holds shares in a foreign company, OI rules apply. Said OI Schedule III, Rule (2) permits inheritance and gifts. But there is no mention of “Settlement of a Trust”. For getting a clarity on this subject, CA Naresh Ajwani wrote a query to RBI and RBI has responded. Both letters are reproduced below.

Conclusion: Applicability of FEMA provisions to Settlement of a trust.

RBI has clarified that what can be done directly by an Indian resident individual; can also be done by him through a trust. However, in both cases, applicable limits and restrictions will be applicable. Thus, for example:

(i) An Indian resident can gift an amount to a non-resident upto the LRS limit of US $ 2,50,000 per year. He can also settle a trust in favour of a non-resident within the LRS limit of US $ 2,50,000. Any settlement in excess of the limit will amount to a violation of FEMA. (For gift to NRI in rupees in India, it is necessary that persons should be relatives. For remittance abroad, there is no condition of relative.)

(ii) An immovable property situated in India can be gifted to a Non-resident relative without any limit as far as value of the property is concerned. Hence, the Indian resident can transfer an immovable property situated in India to a trust where a non-resident is a beneficiary irrespective of the value of the property.

(iii) Shares in an Indian company cannot be transferred to a non-resident without a prior permission from RBI. Hence shares in an Indian company cannot be settled in a trust where a non-resident is a beneficiary without a prior permission from RBI.

(iv) Shares in a foreign company can be gifted by an Indian resident to another Indian resident without any limit (both donor and done should be relatives). Hence an Indian resident can settle into a trust shares in a foreign company where all beneficiaries are Indian residents (settlor and beneficiaries are relatives). However, if any beneficiary is a non-resident, no such shares can be settled.

India’s Information Technology (IT) and IT-Enabled Services (ITES) sector, particularly the captive service provider segment operating within Multinational Enterprises (MNEs), stands as a cornerstone of the nation’s economy. These captives engage in extensive cross-border transactions with their associated enterprises (AEs), making transfer pricing (TP) a paramount area of focus for both taxpayers and the Indian tax administration. This article provides an analysis of the TP landscape for captive IT/ITES providers in India, focusing on practical challenges, dispute resolution mechanisms, and policy considerations.

INTRODUCTION: CAPTIVE IT & ITES PROVIDERS IN INDIA¹

The Indian IT/ITeS sector holds a prominent global position and has significantly driven export growth. Within this dynamic landscape, captive service providers, commonly structured as Global Capability Centres (GCCs), play an essential role. GCCs, subsidiaries of Multinational Enterprises (MNEs), are primarily established to deliver specialised services to other entities within their global groups. India hosts over 1,700 GCCs employing more than 1.9 million professionals. These GCCs typically offer diverse services such as software development (SWD), IT-enabled services (ITES)—including back-office support—Knowledge Process Outsourcing (KPO), engineering design, and contract Research & Development (R&D).

In contrast to third-party outsourcing, the captive model integrates these operations within the MNE group, enabling parent companies to maintain comprehensive control over operations, quality assurance, data security, intellectual property management, and strategic alignment. Moreover, the scope and complexity of roles within GCCs are rapidly expanding. Global roles based in Indian GCCs are projected to grow dramatically from approximately 6,500 currently to over 30,000 by 2030, driven by robust leadership and professional training initiatives.

While many captives are established as wholly-owned operations, alternative structures like the Build-Operate-Transfer (BOT) model exist, where third-party providers set up and manage operations temporarily before transferring control back to the parent company. Additionally, some captive centres evolve into hybrid models through strategic collaborations with external service providers.

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1. Economic Survey 2025

TYPICAL FUNCTIONAL, ASSET, AND RISK (FAR) PROFILES

A robust FAR analysis is fundamental in accurately characterising entities involved in controlled transactions, facilitating the selection of both the tested party and the most appropriate transfer pricing method. It goes beyond contractual terms, emphasising the economic substance and reality of the transaction. For Indian IT/ITES captives servicing their Associated Enterprises (AEs), a typical FAR profile commonly looks as follows² (though variations exist based on the complexity and maturity of the captive):

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2. The CBDT Circular No.06 /2013 (amending Circular No.03/2013 dated 26th March,2013) provides conditions relevant to identify development centres engaged in contract R&D services with insignificant risk. The criteria laid out are also reflected in the eligibility conditions for availing Safe Harbour rates for contract R&D services (both software and generic pharma) and IT/ITES services, which explicitly require the provider to operate with "insignificant risks". Taxpayers claiming insignificant risk status must meticulously document their FAR profile, demonstrating alignment with the CBDT's criteria through robust evidence of the parent's control, risk-bearing, and decision-making authority.
3. The use of DEMPE (Development, Enhancement, Maintenance, Protection, Exploitation) analysis helps scrutinize functions related to intangibles.
4. The treatment of FOC assets can be a point of contention. Refer IQVIA Analytics Services (P.) Ltd. vs. Income-tax Officer [2025] 170 taxmann.com 409 (Bangalore - Trib.)[18-12-2024]

TRANSFER PRICING MODEL AND ARM’S LENGTH PRICING

Reflecting their typical FAR profile, Indian captive IT/ITES service providers commonly adopt a cost-plus remuneration model. Under this arrangement, the captive entity providing services to its AEs is compensated by recovering all relevant operating costs plus a pre-agreed mark-up percentage (the ‘plus’).

This remuneration approach aligns with the economic profile of a low-risk service provider, as it largely protects the captive entity from downside business risks. Essentially, the parent AE guarantees a routine, stable profit margin to the captive, irrespective of the ultimate market performance or commercial success of the products or services supported by the captive. Consequently, the entrepreneurial risks, including market uncertainties and business fluctuations, are borne entirely by the AE, which correspondingly retains any potential upside or absorbs the losses arising from the overall business activities.

However, despite its widespread acceptance and economic rationale for contract service providers, the cost-plus model frequently becomes a focal point for transfer pricing disputes in India, primarily due to disagreements around the appropriate mark-up and the treatment of costs.

CHALLENGES IN IDENTIFYING SUITABLE COMPARABLES

The intrinsic nature of the captive model—an internal service provider operating exclusively for its parent entity—creates inherent complexities in applying the arm’s length principle, which requires comparisons with independent, market-facing enterprises. Independent service providers operate under fundamentally different economic conditions; they assume entrepreneurial risks, invest significantly in their own intellectual property and marketing efforts, and compete openly in the market. Consequently, their FAR profiles rarely align closely with captive entities, whose risk profile is primarily defined by intra-group contractual arrangements rather than genuine market forces.

This fundamental difference significantly complicates the identification of reliable external comparables from commercial databases (e.g., Prowess, Capitaline, Ace TP), despite their extensive usage for transfer pricing methods like the Transactional Net Margin Method (TNMM). In addition, publicly available financial data lacks sufficient granularity, such as segment-specific financial information, detailed cost breakdowns, or standardised accounting policies, necessary to perform accurate and meaningful comparability analyses.

Furthermore, the rigorous application of comparability filters frequently reduces the potential comparables set to a very limited pool, raising legitimate questions about the statistical reliability and representativeness of the resultant arm’s length range. Such challenges underscore that benchmarking remains highly judgmental and subjective, frequently leading to contentious debates and prolonged litigation.

Additionally, the ongoing evolution of Indian captive entities—many now performing complex, higher-value activities such as advanced R&D or even taking ownership of specific processes or products—further complicates their characterisation. As captives transition beyond traditional routine services, the argument for their low-risk profile weakens, rendering the simple cost-plus mark-up potentially inadequate to capture the true arm’s length value of their enhanced functions and risks. Consequently, assessing the captive’s TP characterisation and policies becomes essential, often necessitating consideration of alternative methods, such as the Profit Split Method. This shift inherently increases the complexity of the transfer pricing analysis and the likelihood of disagreements with tax authorities.

ARM’S LENGTH MARGIN – EXPECTATIONS AND THRESHOLDS

Determining an appropriate “arm’s length” margin for captive IT/ITES providers in India is challenging and often contentious. Perspectives and benchmarks vary significantly among stakeholders, creating fertile ground for disputes:

• Tax Authority Expectations – Even when the low-risk characterisation of captives is accepted, tax authorities scrutinise the level of mark-up intensely. Historically, TPOs have proposed significantly higher mark-ups (commonly 25-40% during past audits), compared to margins typically applied by taxpayers (often initially ranging from 7-12% and currently in the range of 12-15%). This discrepancy regularly leads to substantial TP adjustments. Authorities frequently question or reject comparables selected by taxpayers, often excluding loss-making entities or including companies generating “super-normal” profits. Additionally, captives reporting losses or very low margins (inter alia due to extraordinary economic conditions) face scepticism, as tax authorities argue that low-risk entities should consistently earn stable, positive returns.
• Safe Harbour Rates – India’s Safe Harbour Rules prescribe fixed margins—such as 17-18% for IT/ITES services, 18-24% for KPO, and 24% for contract R&D activities—to provide taxpayers a degree of certainty and protection against disputes. However, industry stakeholders commonly perceive these rates as higher than realistic arm’s length margins derived from market comparables. Moreover, the turnover threshold of ₹300 crore severely limits eligibility, making this option impractical for many large captives.
• Benchmarking Study Results – Actual benchmarking analyses conducted using commercial databases typically yield varied results. Median margins identified through such analyses often fall within approximately 8-12% for Indian IT service providers and around 12-15% for ITES providers. These results, however, can fluctuate considerably based on factors such as the specific service type, financial year, choice of databases, comparability filters, and adjustments performed. Notably, the margins observed in India tend to be higher than those for comparable service providers in regions like the US or EMEA5, potentially reflecting regional market dynamics, location-specific cost advantages (“location savings”), or comparability complexities.

Ultimately, there is no universally agreed “correct” margin. Determining an appropriate arm’s length margin for a captive IT/ITES provider depends significantly on the robustness of the benchmarking analysis, the quality and comparability of selected benchmarks, and the reasonableness of adjustments. The persistent gap between taxpayer expectations and tax authority benchmarks—fuelled by inherent complexities in applying the arm’s length principle to captive entities—remains a central driver of transfer pricing litigation in this sector.

TRANSFER PRICING CONTROVERSIES AND LITIGATION TRENDS

The application of TP regulations to captive IT/ITES service providers has given rise to disputes on several key aspects. Rulings from High Courts and Tribunals provide crucial insights into these disputes, offering valuable guidance for taxpayers navigating TP controversies.

Table 2: Common TP Issues & Litigation Hotspots for Indian Captive IT/ITES Providers

ALTERNATE DISPUTE RESOLUTION

• Advance Pricing Agreement (APA) Regime⁶ 

The APA regime aims to create a non-adversarial tax environment by allowing taxpayers and the Central Board of Direct Taxes (CBDT) to agree on the Arm’s Length Price (ALP) or the methodology for determining the ALP in advance. APAs can cover up to five future years, with an optional rollback provision extending certainty to up to four prior years, offering a total coverage period of nine years.

The Indian APA framework provides both Unilateral APAs (UAPAs, between the taxpayer and CBDT) and Bilateral APAs (BAPAs, involving the taxpayer, CBDT, and treaty partner authorities), effectively mitigating double taxation. India recently concluded its first Multilateral APA (MAPA), further enhancing its dispute resolution landscape.

APA adoption has steadily increased, reaching a record 174 agreements signed in FY 2024-25 (including 65 BAPAs and 1 MAPA). By March 2025, India had cumulatively signed 815 APAs, predominantly within the IT/ITES sector. This sector, largely represented by captive entities engaged in software development and ITES, consistently dominates the APA filings.

Despite its success, challenges remain—primarily lengthy processing times. Unilateral APAs currently average around 44 months, while Bilateral APAs average 59 months, contributing to a considerable backlog. Nevertheless, the collaborative nature and tax certainty offered through APAs make them an attractive alternative to traditional TP audits and litigation.

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6. https://www.taxsutra.com/sites/default/files/sftp/CBDT_APA_Annual_Report__2023_24.pdf

• Dispute Resolution Panel (DRP):

The DRP provides an alternative first appellate forum specifically designed for foreign companies and TP disputes. A significant advantage of the DRP route is that tax demands remain suspended during proceedings, unlike CIT(A) appeals, which typically require payment of at least 20% of the disputed amount. Additionally, while taxpayers retain the right to further appeal DRP directions before the Income Tax Appellate Tribunal (ITAT), the tax department cannot appeal DRP decisions.

However, despite the intended benefits of speed and procedural efficiency, the effectiveness of the DRP mechanism as a final resolution forum is often questioned. Experience indicates DRP decisions frequently favour the revenue, prompting taxpayers to routinely escalate matters to ITAT. Consequently, DRP proceedings may function more as an expedited intermediate step rather than a definitive dispute resolution avenue.

• Mutual Agreement Procedure (MAP):

The MAP, available under India’s tax treaties, is a critical tool for addressing TP disputes that lead to double taxation. Under this mechanism, taxpayers can request intervention from the competent authorities of the treaty jurisdictions involved to collaboratively engage with the Indian competent authority to find a resolution.

Policy Recommendations

Based on the analysis of prevalent disputes, existing dispute resolution mechanisms, international best practices, and judicial guidance, the following policy recommendations are proposed to foster a stable, predictable, and efficient TP regime for captive IT/ITES providers in India:

1. Enhance and Rationalise Safe Harbour Rules (SHR)

• Issue: The existing SHR margins (e.g., 17-24%) are high compared to typical market benchmarks, limiting their attractiveness.

The Economic Survey 2025 recommended that expanding the scope of SHR is expected to make the country’s TP regime more attractive and competitive, thereby boosting IT exports and enhancing ease of business for the IT services industry.

Recommendation:

• Revisit and rationalise SHR margins to reflect realistic market benchmarks, making them more attractive to taxpayers and effective in reducing litigation.
• Consider expanding eligibility thresholds beyond INR 3 billion to accommodate larger captive entities.

2. Improve Audit Quality and Consistency

Issue: Audits are often inconsistent due to varying levels of understanding of IT/ITES business models and TP nuances among TPOs.

Recommendation:

• Adopt a robust, risk-based approach to audit selection, focusing resources on high-risk cases.
• Provide detailed guidance on comparability analysis and permissible comparability adjustments to ensure consistency and transparency in benchmarking analyses.
• Leverage APA/MAP Data (anonymised, aggregated) and Court rulings for Benchmarking Insights.

3. Strengthen Alternative Dispute Resolution (ADR) Mechanisms

Issue: APA and MAP processes face lengthy delays, affecting their effectiveness as dispute prevention/resolution tools. Additionally, the DRP is perceived as revenue-biased, reducing its credibility.

Recommendation:

• Streamline the APA process to reduce average processing times by enhancing resources, capacity, and procedural efficiencies.
• Allocate sufficient resources to MAP, ensuring the timely resolution of international disputes and enhancing coordination with treaty partners.
• Evaluate and reform the DRP mechanism to improve neutrality and credibility.

4. Implement the Block Assessment Scheme Effectively

Issue: The three-year block assessment scheme offers potential to reduce repetitive TP audits, but lacks detailed operational guidelines.

Recommendation:

• Issue clear, comprehensive CBDT guidelines detailing eligibility criteria, defining “similar transactions,” outlining the procedure for taxpayers opting into the scheme, clarifying the role of TPOs in validation, and explaining interactions with annual documentation requirements.

Implementing these targeted measures would significantly enhance predictability, transparency, and efficiency within India’s TP regime for the captive IT/ITES sector, ultimately fostering a more stable investment climate.

CONCLUSION

Transfer pricing remains a highly litigious area for captive IT and ITES service providers operating in India.

While litigation remains prevalent, India has implemented mechanisms aimed at providing greater tax certainty and facilitating dispute resolution (The APA program, DRP). MAP continues to be essential for resolving international double taxation disputes under India’s tax treaties.

To foster a more stable environment, policy interventions should focus on rationalising Safe Harbour Rules, enhancing audit quality and consistency, strengthening APA, DRP and MAP processes, and ensuring the effective implementation of new initiatives like the block assessment scheme. Improving comparability requires clearer guidance and potentially leveraging anonymised APA data and insights from Court rulings for indicative benchmarks.

In conclusion, navigating the TP environment for captive IT/ITES providers in India requires robust documentation and strategic use of dispute resolution mechanisms. While challenges persist, potential policy reforms could  offer pathways towards greater tax certainty for this vital sector.

The recent amendments to Ind AS 7 and Ind AS 107 introduced disclosure requirements for Supplier Finance Arrangements (SFAs) to enhance transparency around liquidity and working capital financing practices. SFAs—often referred to as reverse factoring or channel finance—involve a buyer, supplier and finance provider, enabling suppliers to receive early payment while buyers obtain extended credit terms. Historically, limited disclosures made it difficult for users to distinguish trade payables from arrangement-driven financing and to assess liquidity risk. The amendments require entities to disclose the terms of each arrangement, the carrying amounts of SFA-related liabilities (including amounts already settled by finance providers), and ranges of payment due dates for both SFA and comparable non-SFA payables. Entities must also explain non-cash changes in these liabilities. Although classification as trade payables or borrowings is not prescribed, entities must exercise judgement considering Ind AS 1 and 109. The amendments apply from FY 2026 with limited transition reliefs.

BACKGROUND

In an effort to enhance the financial transparency of general-purpose financial statements, the Ministry of Corporate Affairs has recently issued the Companies (Indian Accounting Standards) Second Amendment Rules, 2025. This amendment introduces several significant changes across various Indian Accounting Standards (Ind AS). A key concept introduced is supplier finance arrangements, which is covered under Ind AS 107, about disclosures related to financial instruments, as well as Ind AS 7, which focuses on the statement of cash flows. These revisions are designed to improve the clarity of supplier finance arrangements and their effects on financial statements, thereby enabling stakeholders to more effectively assess the financial condition and liquidity risks of any entity.

WHAT IS SUPPLIER FINANCE ARRANGEMENT (SFA)?

The Global Supply Chain Finance Forum1 defines supply chain finance to include a variety of techniques, including financing for receivables (e.g. factoring arrangements), financing for inventories (e.g. pre-shipment financing) and financing for payables (e.g. payables finance arrangements). Many use ‘supply chain finance’ to describe only arrangements that finance payables (such as payables finance or reverse factoring arrangements).

Financing the supply chain is a critical aspect of supply chain management, and thus, in recent years, many organisations have resorted to unique financing structures for better liquidity management and to facilitate faster
payments of their supplier invoices so as to maintain an unaffected supply chain, which becomes more imperative in the current global scenario considering inherent uncertainty.

It can be called by many names, such as channel finance or reverse factoring; however,in basic terms supplier finance arrangement involves 3 parties and primarily transaction flow remains as follows.

Optimizes the working capital cycle

Note – In practical terms, there is involvement of multiple intermediaries, such as negotiating bank and other technical documentation; however, for understanding simplified version is demonstrated above.

In January, 2020 IFRS Interpretations Committee received a submission from Moody’s Investor Services (Moody’s), primarily two questions where they seek guidance were

(a) Presentation of trade liabilities when related invoices are part of a Supply chain finance arrangement and
(b) disclosure related to reverse factoring arrangements.

In response, IFRIC in its Dec, 20 update included agenda decision on the matter, which becomes the foundational pillar for such amendment over time, at that time IFRIC concluded that “the principles and requirements in IFRS Standards provide an adequate basis for an entity to determine the presentation of liabilities that are part of reverse factoring arrangements, the presentation of the related cash flows, and the information to disclose in the notes about, for example, liquidity risks that arise in such arrangements. Consequently, the Committee decided not to add a standard-setting project on these matters to the work plan” (Extract of IFRIC agenda decision – Dec,20), to which Moody’s responded that fewer than 5% of entities they rate disclose information about the use of supply chain finance arrangements and their effects, which poses a challenge in comparing these data points.

Based on the above response and staff recommendations, the board added a narrow-scope disclosure-only standard-setting project on SFA, striking a balance between comprehensive reporting and practical feasibility for preparers. At its June 2021 meeting, the Board tentatively decided on the package of disclosure objectives and requirements that it would propose to add to IAS 7 and IFRS 7.

While drafting the proposed amendment, the board recognised that because entities applying IAS 1 Presentation of Financial Statements might present liabilities that are part of a supplier finance arrangement within different line items (i.e. trade and other payables vs. Other financial liabilities), the board also proposed to require an entity to disclose, the line item in which the entity presents the carrying amount of financial liabilities that are part of SFA.

Finally, in November, 2021 exposure draft was released proposing an amendment to IAS 7 and IFRS 7, post comments from all the relevant stakeholders and analysis thereof, In May, 2023 IASB amended IAS 7 and IFRS 7 introducing new disclosure requirements to enhance transparency and thus, the usefulness of the information provided by entities about SFA, applicable from 01st January, 2024.

As a part of convergence, ICAI in July, 2023 issued an exposure draft to amend Ind AS 7 and Ind AS 107 with no modifications to the amendments as suggested by IASB. In February, 2024 NFRA approved recommendations by ICAI for the Ministry of Corporate Affairs. MCA notified the same in August, 2025.

APPLYING THE AMENDMENTS

The amendments introduce enhanced disclosure rules intended to improve transparency around supplier finance programs. These changes are designed to help investors and other users of financial statements understand the impact of such arrangements on an entity’s liquidity position and overall financial health, while ensuring that the benefits of this additional information outweigh the associated implementation costs for companies.

Notably, the term Supplier financing arrangement has not been defined in IAS 7 or IFRS 7 and consequently not in Ind AS 7 or Ind AS 107, the reason being the dynamic nature of new practices and new type of arrangements entities enter into, which is not possible to be covered in one set of definition and to keep up with the market practice, the definition would need amendments, thus considering the evolving nature of arrangement the amendment (para 44G of Ind As 7) describes the characteristics of a SFA, which are as below :

All arrangements with the characteristics of supplier finance arrangements (as described above) are, therefore, subject to the proposed new disclosure requirements, irrespective of where and how an entity presents and classifies the related liabilities and cash flows in its Balance Sheet and cash flows. Variations in the form or labelling of the arrangement would not affect whether the disclosure requirements apply.

AMENDED DISCLOSURE REQUIREMENTS

Users of financial statements have highlighted to the IASB the information needs that the standard needs to adhere to. The new disclosure requirements are designed to complement the current requirements in IFRS Standards. The objective of the disclosure requirements is to help users evaluate the effect of SFA on an entity’s liabilities and cash flows and on the entity’s exposure to liquidity risk.

The IASB identified that users of financial statements find it difficult to

• analyse the total amount and terms of an entity’s debt, especially when financial liabilities that are part of the arrangement are classified as trade and other payables;
• identify operating and financing cash flows arising from supplier finance arrangements, influencing their understanding of how the arrangement affects an entity’s cash flows and associated financial ratios;
• understand the effect supplier finance arrangements have on an entity’s exposure to liquidity risk; and
• Compare the financial statements of an entity that uses supplier finance arrangements with those of an entity that does not.

IASB aimed to provide the greatest benefit to users of financial statements without asking entities to provide an excessive amount of additional information—in other words, the proposals are intended to balance implementation costs for entities and others with the benefits of the information for users of financial statements

To meet the stated objective, an entity shall disclose in aggregate for its SFA (Ind AS 7)

Disclosure 1 (Para 44H (a)) – Qualitative information

The terms and conditions of the arrangements (for example, extended payment terms and security or guarantees provided). However, an entity shall disclose separately the terms and conditions of arrangements that have dissimilar terms and conditions.

Rationale – would identify the existence of supplier finance arrangements and explain their nature.

Disclosure 2 (Para 44H (b)) – Quantitative information

As at the beginning and end of the reporting period:

(i)the carrying amounts, and associated line items presented in the entity’s balance sheet, of the financial liabilities that are part of a supplier finance arrangement.

(ii)the carrying amounts, and associated line items, of the financial liabilities disclosed under (i) for which suppliers have already received payment from the finance providers.

(iii)the range of payment due dates (for example, 30–40 days after the invoice date) for both the financial liabilities disclosed under (i) and comparable trade payables that are not part of a supplier finance arrangement.

Comparable trade payables are, for example, trade payables of the entity within the same line of business or jurisdiction as the financial liabilities disclosed under (i).

If ranges of payment due dates are wide, an entity shall disclose explanatory information about those ranges or disclose additional ranges (for example, stratified ranges)

Rationale

• Para 44H(b)(i) would indicate the size of the arrangement and enable users of financial statements to identify where in its balance sheet an entity presents financial liabilities that are part of an arrangement (Trade Payables vs. Other financial liabilities)
• Para 44H(b)(ii) would help users of financial statements analyse the entity’s debt and consequential effects on operating and financing cash flows, and display exposure already financed by third parties
• Para 44H(b)(iii) would help users of financial statements assess the effect of each arrangement on the entity’s days payable, i.e. assesses delay or extension of payments through SFAs, IASB also clarified that the disclosure of the range of payment due dates does not overlap with or effect the maturity analysis requirements of IFRS 7 (Ind AS 107). The IFRS 7 maturity analysis is prepared for the liabilities at the reporting date and generally shows the earliest time that an entity could be contractually required to repay financial liabilities. Information about the payment due dates of financial liabilities that are part of SFAs and comparable trade payables shows the potential effect that SFAs have on the time it takes an entity to pay for goods or services.

Disclosure 3 (Para 44H (c)) –Additional information

The type and effect of non-cash changes in the carrying amounts of the financial liabilities disclosed under 44H(b)(i).

Examples of non-cash changes include the effect of business combinations, exchange differences or other transactions that do not require the use of cash or cash equivalents

Rationale – would help users of financial statements assess the effect of each arrangement on the entity’s cash flow and any non-cash changes in liability positions.

The above-stated disclosure

• would help in assessing the extent to which operating cash flows improve from increased use of supplier finance arrangements, because due dates differ for liabilities that are part of an arrangement and trade payables that are not.
• would provide information about the extent to which the entity has used extended payment terms or its suppliers have used early payment terms. That information would help users of financial statements understand the effect of supplier finance arrangements on the entity’s exposure to liquidity risk and how the entity might be affected if the arrangements were no longer available to it.
• would help users of financial statements identify and assess changes and trends in the effect of each supplier finance arrangement on an entity’s liabilities and cash flows.

OTHER ADDITIONAL ASPECTS

44H(b)(ii) (the carrying amount of financial liabilities for which suppliers have already received payment from the finance providers)

Entities would need to obtain the information from finance providers (i.e. banks) that would be required to be disclosed here; finance providers would generally be able to make this information available to a buyer that engages the finance providers’ services—if the information is currently not provided, it could be made available to a buyer before the implementation of amendments. Although for some arrangements there may be restrictions on the information that finance providers could provide, such restrictions would be unlikely to prevent the finance providers from providing the information on an aggregated and anonymised basis.

Non-Cash changes

Para 44A and 44B of Ind AS 7 require disclosure of changes in liabilities from financing activities (cash + non-cash), thus 44H(c) specifically requires disclosure of non-cash changes, for example, an entity buys goods and services from suppliers and would typically classify the future cash outflows to settle amounts owed to its suppliers as a cash flow from operating activities. When an amount the entity owes its suppliers becomes part of a supplier finance arrangement, the entity—having considered the terms and conditions of the arrangement—classifies the future cash outflow to settle the amount owed as arising from either operating activities or financing activities. If the entity classifies the future cash outflow as a cash flow from financing activities (without reporting any cash inflow from financing activities), the outcome is that there has been a non-cash change in liabilities arising from financing activities. Such a non-cash change may not be apparent to users of financial statements without the disclosure.

Outstanding SFA: Trade payables or Other Financial liability

There is no doubt that the purchaser has a financial liability till it settles dues under the arrangement, however it would continue as a trade payables or reclassified to borrowings or other financial liabilities needs additional analysis, IASB considered whether to add requirements to IAS 1 (Ind AS 1) Presentation of Financial Statements to help assess whether the nature of financial liabilities within the scope of the proposed requirements is similar to, or dissimilar from, that of trade payables (which is part of an entity’s working capital) or other financial liabilities. IASB was of the view that a project on the classification and presentation of liabilities in the Balance Sheet or on the occurrence and classification of cash flows in the statement of cash flows would need to consider a wider range of liabilities and cash flows than only those related to supplier finance arrangements. Thus, IASB decided not to address classification and presentation in the Balance Sheet and cash flows as part of this project.

We also need to adhere to derecognition criteria as provided under Ind AS 109 pertaining to derecognition of financial liability, which says that a financial liability is derecognised when the obligation is extinguished by settling, cancelling, or expiration. This occurs when the contractual obligation is discharged/settled, and an entity must remove the liability from its balance sheet. Further, the guidance provided under Ind AS 109 specifies that a financial liability (or part of it) is extinguished when the debtor either:

(a) discharges the liability (or part of it) by paying the creditor, normally with cash, other financial assets, goods or services; or

(b) is legally released from primary responsibility for the liability (or part of it) either by process of law or by the creditor. (If the debtor has given a guarantee, this condition may still be met.)

As a part of the Agenda decision, IASB has considered below key pointers

• entity is required to determine whether to present liabilities that are part of a reverse factoring arrangement:

a. within trade and other payables;

b. within other financial liabilities; or

c. as a line item separate from other items in its Balance Sheet

• entity presents a financial liability as a trade payable only when it

a. represents a liability to pay for goods or services;

b. is invoiced or formally agreed with the supplier; and

c. is part of the working capital used in the entity’s normal operating cycle.

• Further, an entity assessing whether to present liabilities that are part of a reverse factoring arrangement separately might consider factors including, for example:

a. whether additional security is provided as part of the arrangement that would not be provided without the arrangement.

b. the extent to which the terms of liabilities that are part of the arrangement differ from the terms of the entity’s trade payables that are not part of the arrangement.

The above evaluation is not an accounting policy choice but requires the exercise of judgment based on the evaluation of the terms of the arrangement and relevant guidance. There is one more factor that requires some consideration is how finance providers (banks) look at it.

It is imperative to note that the presentation under statement of cash flow, would depend on the balance sheet classification, i.e. if the entity considers the related liability to be a trade or other payable that is part of the working capital used in the entity’s principal revenue-producing activities, the entity presents cash outflows to settle the liability as arising from operating activities in its statement of cash flows. In contrast, if the entity considers that the related liability is not a trade or other payable because the liability represents borrowings of the entity, the
entity presents cash outflows to settle the liability as arising from financing activities in its statement of cash flows.

IFRS 7 (i.e. Ind AS 107)

Reverse factoring arrangements often give rise to liquidity risk. By entering into such an arrangement, an entity typically concentrates a portion of its liabilities with one or a few finance providers (rather than a diverse group of suppliers). Consequently, should the arrangement be withdrawn during times of stress (which finance providers can typically do at short notice), that withdrawal could increase pressure on an entity’s cash flows and affect its ability to settle liabilities when they are due. A supplier may also be able or inclined to renegotiate payment terms with its customer (the entity) during times of stress, whereas finance providers—subject to capital requirements—may not be able or inclined to be as flexible.

Users of financial statements need information to help them assess the effect of SFA on an entity’s exposure to liquidity risk and risk management. The liquidity risk disclosure requirements in IFRS 7 (which apply to recognised and unrecognised financial instruments) are already comprehensive, and IASB concluded that there is no need to add to them as part of this project.

Nonetheless, the Board decided to add supplier finance arrangements as an example within the liquidity risk disclosure requirements in IFRS 7 to highlight the importance of providing liquidity risk information about these arrangements.

This inclusion links Ind AS 107 to Ind AS 7, ensuring coordinated application. The entity now must incorporate SFA-related liabilities into risk disclosures, maturity analysis and liquidity-related disclosures.

CONNECTING THE DOTS – US GAAP

In October 2022, the FASB issued final guidance that requires entities that use supplier finance programs in connection with the purchase of goods and services to disclose the key terms of the programs and information about their obligations outstanding at the end of the reporting period, including a roll forward of those obligations. The guidance does not affect the recognition, measurement or financial statement presentation of supplier finance program obligations, which are classified as either trade payables or bank debt, depending on the terms of the program.

Unlike US GAAP, the IASB would require additional disclosure from the buyer to

(1) specifically disclose amounts recognised as financial liabilities for which the suppliers have already received payment from the intermediary and

(2) disclose payment due dates separately for trade payables that are or are not part of a supplier finance program.

Further, under US GAAP, they have not clarified how to present and disclose amounts payable under supplier finance programs, but they have additionally analysed that Regulation S-X, Rule 5-02(19)(a), requires SEC registrants to present amounts payable to trade creditors separately from borrowings on the face of the balance sheet. Accordingly, a purchasing entity that participates in a trade payable program involving an intermediary should consider whether the intermediary’s involvement changes the appropriate presentation of the payable from a trade payable to a borrowing from the intermediary (e.g., bank debt). Entities often seek to achieve trade payable classification because trade payables tend to be treated more favourably than short-term indebtedness in the calculation of financial ratios (e.g., balance sheet leverage measures) and in the determination of whether financial covenants are met.

Generally, a supplier’s decision to factor a trade receivable to a bank or other financial institution does not affect the purchaser’s presentation of the associated trade payable if the factoring terms are negotiated and agreed to independently by the supplier and the institution without any involvement of the purchaser, which may not even be aware of the factoring transaction. Similarly, an entity’s decision to outsource its supplier processing payments to an intermediary and involvement of mere intermediary does not necessarily cause a reclassification of associated trade payables if the terms of the payables remain unaffected and the entity is not involved in, or does not benefit from, transactions between the suppliers and the intermediary. In other words, if the intermediary’s involvement does not change the nature, amount, and timing of the entity’s payables and does not provide the entity with any direct economic benefit, continued trade payable classification may be appropriate. However, reclassification may be required if such changes or benefits result from the intermediary’s involvement.

ILLUSTRATIVE DISCLOSURES

Although the amendments do not necessitate such disclosures, however in line with Ind AS 1 requirements and considering inherent subjectivity and involvement of management judgement, an entity should consider providing material accounting policy information and significant judgements that management has made in the process of applying accounting policies that have the most significant effect on the SFA recognition.

The IASB developed a package of disclosure requirements illustrated below (a company might decide to disclose the information in a different format to that shown).

Disclosure under Notes to accounts

Disclosure pertaining to Cash Flows

Source : IFRS May, 23 Investor Perspectives

GLOBAL ADOPTION AND DISCLOSURE PRACTICE

The amendments were effective from annual reporting periods beginning on or after 1 January 2024. Early adoption was permitted with adequate disclosures.

A few transition reliefs were offered by the amendments. For instance, for any reporting periods submitted before the start of the annual reporting period in which the modifications initially take effect, a business is exempt from disclosing comparative data. Additionally, part of the quantitative data given at the start of the yearly reporting period, when the amendments initially take effect, is relieved. Additionally, the amendments make it clear that during the first annual reporting period in which those amendments apply, organizations are not obliged to make disclosures in accordance with the new requirements during any interim reporting period.

Extracts of Consolidated Financial Statements of the Nestlé Group 2024

Reporting period – 01st January, 2024 to 31st December, 2024 , being the first year of adoption of such amendments

Disclosure 1 under Accounting policies

Disclosure 2 under notes to accounts – Trade and Other Payables

APPLICABILITY

An entity shall apply the amendments from FY 26 Annual Financial Statements. In applying this amendment, an entity is not required to disclose:

(a) comparative information for any reporting periods presented before the beginning of the annual reporting period in which the entity first applies those amendments.

(b) the information otherwise required by paragraph 44H(b)(ii) – (iii) as at the beginning of the annual reporting period in which the entity first applies those amendments.

(c) the   information   otherwise   required   by   paragraphs   44F– 44H   for   any interim   period presented within the annual reporting period in which the entity first applies those amendments.

PRACTICAL APPLICATION NOTES

• Neither Ind AS nor Schedule III to Companies Act, 2013 define borrowings, however it specifies that a payable shall be classified as ‘trade payables’ if it in respect of amount due on account of goods purchase or services received in the normal course of business.
• For ease in adoption of amendments, corporates need to modify its MIS related to borrowing and vendor so as to capture additional data points such as

1. Payment received by suppliers under SFA
2. Range of payment due dates
3. Key terms and conditions of each arrangements

• Under Indian supplier finance eco-system many products exist with differing terminologies such as trade credits, buyer’s credits, suppliers’ credits, letter of credits, import bills collections, Bills acceptances etc. (which may have overlapping transaction flow or terms). corporates need to assess each and every such products initially based on its terms & conditions and transaction flow, does it fall under definition of SFA or not.

COMMENT

It would be interesting to observe the first set of disclosures by India Inc. in FY 26 Annual reports, wherein we would find many different practices and implementation subjectivity, along with explanations and terms of such arrangements. It remains to be seen whether these requirements will evolve into an additional reporting burden for preparers or a valuable analytical tool for stakeholders.

The Income-tax Act, 2025 (“ITA 2025”) marks a structural overhaul of India’s direct tax legislation, replacing the six-decade-old Income-tax Act, 1961 (“ITA 1961”) with effect from 1 April 2026. In international tax and transfer pricing, ITA 2025 preserves the substantive foundation of ITA 1961, focusing on structure, coherence and interpretational certainty. Indirect transfer rules have been re-drafted, with refined language that broadens the scope of taxable offshore interests while omitting the earlier retrospective deeming phrase “shall always be deemed,” thereby signaling a shift toward prospective clarity. Transfer Pricing provisions remain largely intact, though key clarifications include the uniform applicability of the ±3% tolerance range even where a single arm’s-length price is determined, and a re-organised definition of Associated Enterprises that simplifies interpretational hierarchy and integrates Specified Domestic Transactions within the AE framework. Withholding tax provisions undergo the most significant structural rationalisation. Forty-three TDS sections of ITA 1961 are consolidated into a single comprehensive Section 393, supported by tabular presentation and expanded eligibility for lower/nil deduction certificates, including for non-residents. Presumptive taxation provisions applicable to non-residents are similarly consolidated. Overall, ITA 2025 enhances readability and structural coherence but does not materially simplify long-standing substantive complexities. Further administrative guidance will be critical to ensuring interpretational certainty for taxpayers and professionals.

INTRODUCTION AND BACKGROUND

There has long been recognition that the Income-tax Act, 1961 (‘ITA 1961’) had become complex and voluminous due to its traditional drafting style and frequent amendments. To modernise and simplify the law in line with global trends, the Government initiated a comprehensive restructuring exercise. In her July 2024 Budget speech, the Hon’ble Finance Minister emphasised the objective of making the legislation “concise, lucid, easy to read and understand,” following which the Income-tax Bill, 2025 (‘Original Bill’) was introduced in the Lok Sabha on 13 February 2025.

A Parliamentary Select Committee (‘PSC’) was constituted to conduct an in-depth examination of the Original Bill. After extensive consultations and identification of drafting, structural and interpretational issues, the PSC recommended substantial clarifications and refinements. Incorporating these recommendations, the Government introduced the Income-tax (No. 2) Bill, 2025 (‘Revised Bill’) in the Lok Sabha on 11 August 2025. The Income-tax Act, 2025 (‘ITA 2025’) received presidential assent on 21 August 2025 and was subsequently notified in the Gazette. The new Act will come into force on 1 April 2026, replacing the six-decade-old ITA 1961.

KEY SIMPLIFICATIONS IN THE ITA 2025

ITA 2025 is designed to align closely with the ITA 1961 in terms of substantive policy principles. While ITA 2025 aims to simplify, modernize, and restructure the law, it retains the same core framework on key aspects. To reframe Income Tax law framework, the simplification exercise followed three guiding principles:

• Textual and structural simplification for improved clarity and coherence
• No major tax policy changes to ensure continuity and certainty
• No modifications of tax rates, preserving predictability for taxpayers.

Accordingly, the following key modifications have been made for the purpose of simplification:

• Reduction of word count and simplification of language and layout compared to ITA 1961
• Compliance provisions have been simplified, and clarity has been achieved by consolidating scattered clauses.
• Consolidation of TDS provisions under one single section making it easier for taxpayers, professionals, and authorities to locate and interpret TDS regulations without having to stride through complex provisions.

SIGNIFICANT INTERNATIONAL TAX AND TRANSFER PRICING REFORMS INTRODUCED BY THE ITA 2025

The international tax framework under the ITA 2025 largely preserves the substantive principles contained in the ITA 1961, with changes primarily aimed at improving structure, clarity and interpretational consistency. Core concepts such remain intact. No new compliance requirements or administrative procedures have been introduced.

The overall Transfer Pricing framework remains unchanged with minor clarifications to provisions. There are no changes in the proposed timelines, compliances, procedural aspects and penalty provisions.
Section 536 provides the transition mechanism to ensure continuity, with the repeal of the ITA 1961 governed by the General Clauses Act, 1897.

Indirect Transfer Provisions

The indirect transfer under the ITA 1961 states that if a foreign company derives most of its value from assets located in India, then gains from selling the shares of that foreign company are taxable in India, even though the transaction happens entirely outside India. In simple terms, selling an overseas holding company is treated as if you have sold the underlying Indian business. Explanation 5 to section 9(1)(i) of the ITA 1961 reads as follows:

“For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.”

The provision was introduced in 2012 after the Supreme Court decision in the Vodafone International Holdings BV case. Vodafone bought shares of a foreign company that indirectly owned an Indian telecom business. The Court held that India could not tax this offshore share transfer. To counter this outcome and prevent similar avoidance structures, the Government amended section 9(1)(i) of the ITA 1961 to clarify that indirect transfers that derive substantial value from Indian assets are deemed taxable in India, even when the transaction takes place abroad.

Section 9(10) of the ITA 2025 (corresponding to Explanation 5 of the ITA 1961) now reads as under:

“In sub section (2), –
(a)
An asset or a capital asset, being any share of, or interest in, a company or entity registered or incorporated outside India, which derives substantial value from assets (whether tangible or intangible) located in India shall be deemed to be situated in India.”

There are 2 key take aways from the slight change in the language:

1. It may be said that the placement of commas in the phrase — “any share of, or interest in, a company or entity registered or incorporated outside India” — is deliberate and affects interpretation. The commas separate two distinct taxable assets:

“any share of” a foreign company; and “interest in” a foreign company.

Because of this drafting, “share” and “interest” operate as independent charging triggers. The law therefore may apply not only to equity shares but also to any other form of economic, beneficial, participative, or derivative interest in a foreign entity (e.g., partnership interests, membership interests, convertible instruments, contractual rights that confer value).

By isolating the phrases through commas, the provision appears to broaden the scope and make it unambiguous, and not restrict the application to traditional shareholding, thereby capturing a wider range of indirect transfer situations.

2. The retrospective deeming provisions with respect to location of a capital asset in India are not present in ITA 2025. The wordings ‘always be deemed to have been situated in India’ have been removed.

The removal of the retrospective deeming language—specifically the phrase “shall always be deemed to have been situated in India”—from the indirect transfer provisions in ITA 2025 suggests a potential policy shift toward greater tax certainty and the avoidance of reopening historical transactions. While this indicates an intention to move away from the retrospective framework embedded in Explanation 5 to section 9(1)(i) of the ITA 1961, the legislation does not expressly clarify whether this omission is intended to eliminate retrospective tax positions or merely streamline drafting. Accordingly, the precise legislative intent remains uncertain until supported by judicial interpretation or explicit administrative guidance.

Overhaul of withholding tax provisions

There are multiple provisions under the ITA 1961 which govern withholding tax provisions, prescribing different rates and threshold limits based on the nature of the payment and the category or status of the payee. ITA 2025 seeks to streamline and simplify the existing framework by consolidating all such provisions into a single section (except for TDS on salary) i.e. Section 393.

Section 393 brings together 43 different sections from ITA 1961 into one unified framework. Section 393 provides for following categories:

• withholding on payments to residents [Section 393(1)]
• withholding on payments to non-residents [Section 393(2)]
• withholding on payments to any person (viz. resident or non-residents)

Although the rates are largely unchanged, the revised provisions are presented in a tabular format, enhancing clarity, accessibility, and consistency, thereby minimizing ambiguity for both taxpayers and tax authorities.

Further, the ITA 1961 permits obtaining both lower as well as Nil TDS/TCS certificates by payees, but only for specified payments and receipts. The ITA 2025 has addressed this limitation by significantly broadening the scope of the lower deduction/collection certificates. ITA 2025 permits obtaining both lower and nil deduction TDS/TCS certificates for all payments/receipts, including for non-residents.

The TDS rates in respect of certain key payments to non-residents are given below:

Presumptive Taxation of Non-Residents

The ITA 2025 has introduced changes to the presumptive taxation regime, including for non-residents. All identical presumptive taxation schemes for non-residents are consolidated into one section i.e. Section 61 of the ITA 2025 in a tabular form, while simplifying the language and the common eligibility conditions are listed as sub-sections below the table. Section 61 of the ITA 2025 covers the following:

• Business of operation of ships, other than cruise ships (Section 44B of ITA 1961)
• Business of providing services or facilities (including supply of plant or machinery on hire) for prospecting, extraction or production of mineral oils. (Section 44BB of ITA 1961)
• Business of operation of aircraft (Section 44BBA of ITA 1961)
• Business of civil construction or erection or testing or commissioning of plant or machinery, in connection with a turnkey power project, approved by the Central Government (Section 44BBB of the ITA 1961)
• Business of operation of cruise ships (Section 44BBC of the ITA 1961)
• Business of providing services or technology in India, for the purposes of setting up an electronics manufacturing facility or in connection with manufacturing or producing electronic goods, article or thing in India to a resident company (Section 44BBD of ITA 1961)

Key comparison of changes applicable for non-residents engaged in providing services, engaged in business of exploration, etc. of mineral oils or engaged in the business of civil construction, etc. in certain turnkey power projects are as under:

Meaning of Undefined Terms in Tax Treaties

• Presently, ITA 1961 provides that if any term is not defined in the Double Taxation Avoidance Agreement (‘DTAA’) assigned by India with other country, then the meaning given under ITA 1961 or any explanation given to it by the Central Government is required to be referred to. Further, if the term is not defined under ITA 1961, the term will have the same meaning as given to it in the notification issued by the Central Government and will be effective from the date on which the tax treaty came into force.
• Interpretation of terms used but not defined in DTAAs has often been a source of litigation. The ITA 2025 has clarified India’s position in relation to terms used in DTAAs entered into by India with various countries. Section 159(7) of the ITA 2025 provides hierarchy for interpreting undefined terms in a DTAA.

1. Any term used in the ITA 2025 and DTAA will have the meaning assigned to it under the DTAA
2. Any term used in the DTAA but not defined under the respective DTAA but defined under the ITA 2025 will have the meaning assigned to it in the ITA 2025 or under any explanation which is given to the term by the Central Government and the meaning will be applicable from the date on which the agreement entered into force.
3. Any term used in the DTAA and neither defined under the DTAA or ITA 2025 will have the meaning assigned to it in the notification issued by the Central Government and the meaning will be applicable from the date on which the agreement entered into force.
4. Any term used in the DTAA and neither defined under the DTAA or ITA 2025 or in any notification will have the meaning given in any Act of the Central Government relating to taxes, or in its absence, in any other law of the Central Government and such meaning will be applicable from the date on which the agreement entered into force.

Meaning of Associated Enterprises

The criteria of direct and indirect participation in the management, control or capital of another enterprise remains the same under Section 92A of ITA 1961 and Section 162 of ITA 2025. However, the structure of the definition of Associated Enterprises (‘AE’) under Section 162 of the ITA is now different since all the conditions for determining an AE relation are listed under sub-section (1) of Section 162 as compared to Section 92A of the ITA wherein the general conditions in the first part of the definition and specific deeming conditions under the second part had to be read conjunctively for two enterprises to be regarded as associated enterprises.

The Supreme Court had dismissed the Special Leave Petition filed by the Revenue against the ruling of the Hon’ble Gujarat High Court in case of PCIT vs. Veer Gems [2018] 407 ITR 639 (Guj) wherein the Hon’ble Gujarat High Court ruled in favour of the assessee and held that the conditions under sub-section (1) and (2) of Section 92A of the ITA must be read together for the assessee and the other entity which were controlled by the same family members to be considered as AE’s.

In view of the above, as per section 162 of the ITA 2025, the general definition of AE in sub-section (1)(a) remains applicable even if the specific deeming conditions in sub-section (1)(b) to (1)(l) are not met.

Further, the definition of AE under Section 162 of ITA 2025 has been expanded to include Specified Domestic Transactions (SDT) under the AE framework. The scope of SDTs has not been expanded; however, a new sub-section (3) has been included under Section 162 to include the meaning of AE for SDTs.

Determination of arm’s length price

The manner of determining arm’s length price is provided under Section 92C(2) of ITA 1961. The language of the Section is not very clear regarding applicability of tolerance range (+/-3%) when a single price is determined as the ALP.

Section 165 of ITA 2025 clearly states that the tolerance range of (+/-3%) is applicable even in case of a single ALP determination, ensuring uniform application in transfer pricing arrangements. Further, in case where multiple prices are determined, the final ALP is required to be computed in accordance with the prescribed rules, as against the current requirement of determination by taking the arithmetical mean

Advance Pricing Agreement (‘APA’)

The current provisions under ITA 1961 do not provide a time limit upto when proceedings shall be deemed to be pending. Section 168(10) of the ITA 2025 clarifies that APA proceedings will remain pending until the agreement is signed or formally closed as per prescribed rules, eliminating ambiguity among tax payers.

The above change is clarificatory in change and the rules in this regard are yet to be prescribed.

CONCLUSION

The shift from ITA 1961 to ITA 2025 reflects a structural clean-up rather than a substantive modernisation of India’s international tax regime. While the new Act improves readability, many long-standing complexities continue to remain largely unchanged. The absence of deeper policy rationalisation, clearer safe harbours, or simplified compliance mechanisms indicates a missed opportunity to make the law more user-friendly and globally competitive. As a result, ITA 2025 must still be read with caution, and further clarification from the Government will be essential to provide the level of certainty that taxpayers and practitioners expected from a once-in-a-generation redrafting exercise.