India’s Transfer Pricing Problem
Transfer Price is the price of the goods and services sold between related entities such as – parent company and daughter (subsidiary) company; or between branches of same entity. The fixing of price of goods and services between parent-subsidiary is called Transfer Pricing.
Tax Avoidance Using Transfer Pricing
Transfer pricing itself is not a means of tax avoidance if transfer price matches what the seller entity would charge to an unrelated customer (called customer at arm’s length). However, since lowering or increasing the prices between parent-daughter entities don’t affect the whole organization, the companies artificially increase or decrease the transfer price to avoid corporate tax. This processing of using unusual transfer pricing to avoid tax is called Base Erosion and Profit Sharing (BEPS).
Transfer Pricing Case Study
In 2009-10, TCS (Tata Consultancy Services) ad shown a net profit per employee of Rs 4.3 lakh. At the same time, Capgemini, a foreign IT firm with operations in India, recorded a net profit per employee of Rs 1.5 lakh. Thus, Capgemini showed a net profit per employee one third of TCS. Despite of similar business, similar in contract pricing and similar in salaries and other expenses, why the foreign IT firms reporting profitability numbers that are a fraction of their Indian peers? Moreover, the same difference went on the same lines on other scales such as revenue per employee, operating profit margin, net profit margin. This was due to the menace of Transfer pricing as per experts.
How it is done?
The subsidiaries of the foreign companies in India use transfer pricing to allocate most expenses / loss to India and most profits to their high-tax home country thus produce low taxable income or excessive loss on transactions. The Transfer Pricing has been under tough scrutiny by the authorities in India, which look for a better share in the tax from the companies. However, sometimes the companies claim and insist that they have done transfer pricing correctly. Due to this, Transfer pricing has been a key issue for both multinational corporations and tax authorities for a long time.
Most of the countries in the western world have their own rules regarding the transfer pricing. Indian Government also has took some proactive measures to resolve the disputes arising due to the transfer pricing.
Government Efforts in this Direction
The Government had introduced Transfer Pricing Regulations (TPR) through the Finance Act, 2001 on the basis of OECD guidelines. Currently, the transfer pricing rules are part of section 92 and 92F of the Income Tax Act. Basic premise of these rules is that the related party transactions should involve an arm’s length principle and the pricing should be such as if it would have been charged from an independent buyer. The rules postulate several methods of defining an arm’s length price such as Comparable uncontrolled price (CUP) method; Resale price method (RPM); Cost plus method (CPM); Profit split method (PSM); Transactional net margin method (TNMM) etc.
To handle the dispute in calculation of tax liabilities, government established a Dispute Resolution Panel (DRP) under Income Tax Act via the Finance Act 2009.
Dispute Resolution Panels
DRPs had been constituted at Delhi, Mumbai, Ahmedabad, Kolkata, Chennai, Hyderabad, Bengaluru and Pune. DRP consists of three commissioners or directors of income tax appointed by the Central Board of Direct Taxes (CBDT). Any foreign company, or any domestic company with transfer pricing issues, in whose case the income-tax assessing officer proposes to make any variation in the income or loss returned, may apply within a month of receiving the draft assessment order before the DRP for appropriate remedy by way of direction to the assessing officer.
Further, via the Finance Act 2012, the government extended these rules to domestic related party transactions exceeding Rs. 5 Crore also.