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BW Businessworld

Domestic Transfer Pricing

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The Indian Transfer Pricing (TP) Regulations were introduced in 2001 under the anti-abuse provisions of the Income-tax Act, 1961 (ITA). The TP law applied only to cross border transactions between group companies and was aimed to ensure that such transactions adhere to the globally accepted arm's length standard. With the introduction of the TP Regulations, India stepped into the league of nations with a relatively matured cross border tax policy.

More than a decade has passed since and the country has seen a significant amount of tax disputes and litigation surrounding TP issues reflecting a growing aggressiveness on part of the Revenue to plug purported erosion of tax base. Over the years, the TP Regulations have been subject to minor amendments to reflect the changing attitude of the Revenue on different technical aspects. On the whole, such amendments have made the law more stringent rather than being taxpayer friendly.

The onerous Indian TP Regulations along with the aggressive stance of the Revenue has forayed India at the helm of global TP litigation (with the country having the biggest number of TP cases than anywhere else!). Interestingly, in many global tax surveys, India is often recognized as a country having a very challenging TP regime.

In a move that is bound to attract the attention of both multinational and domestic taxpayers, the Finance Bill 2012 edict the applicability of TP Regulations to "specified domestic transactions". Thus, with effect from Financial Year 2012-13, taxpayers with specified domestic transactions in excess of Rupee Fifty Million would need to comply with the onerous provisions relating to maintenance of annual documentation and compliance to corroborate the arm's length pricing of its domestic intra-group dealings.

As per the proposed provisions, the following domestic transactions would be under the purview of the Indian TP Regulations:

  • Taxpayers operating in Special Economic Zones (under Section 10AA of ITA);

  • Taxpayers having domestic transactions with certain related parties [under Section 40A(2) of ITA]; and

  • Taxpayers claiming deductions for undertaking specified business activities [under Section 80A, 80- IA etc of ITA]

These new provisions would have ramifications across industries which benefit from the said preferential tax policies such as SEZ units, infrastructure developers or operators, telecom services, industrial park developers, power generation or transmission etc. Apart from this, business conglomerates having significant intra-group dealing would be largely impacted.

Apparently, the applicability of TP provisions to domestic transactions would augment the spirit of the Indian TP Regulations which were originally designed to prevent cross border tax base erosion by multinational enterprises. It is noted that the policy of broadening the ambit of TP provisions to domestic transactions is globally ubiquitous with most countries incorporating similar provisions in their domestic law, with certain exceptions like China, Japan and  Australia.

It is worthwhile to note that the aforesaid domestic transactions always required passing the test of "fair market value" to avoid misuse of the law. However, in the absence of specific guidelines for computation of such fair market value of goods and services, much was left to the discretion of both taxpayers and Revenue, thus leading to litigation. The Supreme Court Ruling of GlaxoSmithKline dealt on this issue and recommended to the Ministry of Finance that appropriate legal provisions ought to be introduced.

The risk of tax arbitrage abuse by opportune taxpayers may arise due to presence of accumulated losses or differential tax rates. This risk is amplified in view of the increased tax stimulus provided in recent years to entities operating in special economic zones, infrastructure sector or economically backward areas. The new domestic TP provisions would have significant anti-abuse effects to redress any such non-arm's length pricing of domestic transactions.

In what appears to be a silver lining for affected taxpayers, the said TP provisions would help taxpayers formalize their product pricing methods and also enable legitimate tax cost management (TCM) opportunities. It would be possible for such taxpayers to utilize TP concepts and methodologies (such as risk -reward planning, benchmark driven pricing, supply chain re-engineering, location planning study, etc.) for both commercial gains and TCM purposes.

At the same time, affected taxpayers have to design their domestic TP policies based on sound commercial substance and business rationale while maintaining robust documentation to pass any scrutiny of the Revenue. Furthermore, it would be expected that the augmentation of the TP regime would result in an increased pragmatism of the Revenue in setting of arm's length price rather than creating increased litigation and disputes already plaguing India.

Rahul K. Mitra (National Transfer Pricing Leader, PwC, rahul(dot)k(dot)mitra(at)in(dot)pwc(dot)com)
Amitava Sen (Senior Manager, Transfer Pricing, PwC, amitava(dot)sen(at)in(dot)pwc(dot)com)
Soumitra K. Chakraborty (Manager, Transfer Pricing, PwC, soumitra(dot)chakraborty(at)in(dot)pwc(dot)com)