Policy Measures on Transfer Pricing

Transfer pricing is one of the methods of tax avoidance. It refers to allocating expenses to high tax countries and profits to low tax countries to reduce tax liability. This is generally done within the associated companies. Transfer pricing is illegal and hurts the economy.

Concept

Take an example here. In 2009-10, TCS had shown a net profit per employee of Rs 4.3 Lakh. For the same period, 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 which is around 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?

As per experts, this difference is because of the menace of Transfer Pricing whereby a foreign company with operations in many countries including tax havens shifts most of its expenditures in India (relatively higher tax jurisdiction) and most of its profits in tax havens (near zero taxation) to reduce overall tax liability in both the jurisdictions. This results in revenue loss and drain of foreign exchange reserves for India.

Legislative and Policy Action on Transfer Pricing

The authorities in India keep a tight watch over transfer pricing. The Government of India had introduced a Transfer Pricing Code in 2001 which stipulates various rules on transfer pricing based on OECD guidelines. The government makes changes into these rules from time to time and Indian Transfer Pricing (TP) Regulations have evolved from that point to recently introduced concepts of BEPS, Range Concept, Base Erosion and Profit Shifting (BEPS) Action Plan 13 in the Finance Budget of 2016. Due to these efforts, the regulations in India are considered to be among the most aggressive regimes on transfer pricing.

Gist of the Indian Transfer Pricing Code is as follows:

Armed Length Principle

For the related party transaction, the arm’s length principle has been adopted as per OECD guidelines. This implies that related party transactions should involve an arm’s length principle and the pricing between related parties 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.

Multiple Year Data and Range Concept

In October 2015, the CBDT issued new rules on transfer pricing to align Indian rules with international best practices. Both of these concepts are introduced to make sure that the companies furnish and use correct information on transfer pricing and calculation of arm’s length price.

Use of multiple-year data and Range Concept

As a general rule, taxpayers are expected to use the data of the current year in which the transaction is executed while determining the ALP by applying the most appropriate method. However, in certain cases, the data for previous year is also to be used for calculation of transfer pricing. This is called “Multiple Year Data” approach. Further, Range Concept is basically a statistical tool which is used for computation of ALP using various data to construct a range. These include use of average three year data of six comparable entities and some other inputs.

The objective of Multiple year Data and Range Concept is to enhance the credibility of the analysis undertaken for the computation of ALP.

Mutual Agreement Procedure (MAP) and Advanced Pricing Agreements (APA)

This concept was introduced in 2012 and first APA was signed in 2014. {we covered it earlier here} Till March 2016, India had signed around 64 APAs. APAs are basically a mean to avoid dispute on transfer pricing. Before this concept, a so called Mutual Agreement Procedure (MAP) was used as per the agreed DTAC or DTAA between two countries. But since this was a post-assessment process and too long time; the Advanced Pricing Agreements (APAs) were signed with several countries. The APAs bring more transparency and efficiency in calculation of ALP prices and bring tax certainty, reduce litigation etc. There is one more advantage that APAs have better persuasive value in Indian courts and while disposal of disputes, courts have given due weight age to APAs.

Base Erosion Profit Sharing (BEPS) Initiative

India is one of the pioneers of the BEPS initiative as a part of G-20 and is already aligning its tax regulations with OECDS’s BEPS report. The government was planning to amend the Indian Transfer Pricing Rules to include specific requirements of BEPS.

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.

Foreign Tax Credit Rules

While India’s tax treaties and the income-tax regulations contain broad provisions enabling tax residents to claim credit for the foreign taxes paid on income which is doubly taxed, there have been no specific rules laying down the manner of computation of such Foreign Tax Credit (FTC). This has led to uncertainties in claiming such credit and at times to litigation with the Indian Revenue. The government is taking steps to bring in certainty in this regard and has framed rules laying down the manner of computation of the FTC.

Equalisation Levy

In order to tax e-commerce transactions of non-residents, an ‘Equalisation Levy’ is introduced in line with the recommendations of the OECD BEPS project.

End Note

Despite of all these efforts, the major issue is litigation. There are numerous cases lying in courts and tribunals and the government needs to deal with them all. Further, due to new regulatory regime under BEPS, it is though that the transfer pricing would go up in all major economies and the government will need to devise innovative methods to deal with them all.