India: Empathy Imperative Of Transfer-Pricing Norms

Legislation should be amended, if necessary, to ensure MNEs do not face undue hardship.

Making It Easier

An advance pricing arrangement can benefit MNEs, who are already faced with a host of tax litigations.

More safe harbour provisions can be introduced for tax authorities to automatically accept transfer prices.

More fairness needed on TP adjustments during TP audit of foreign entities.

India's transfer pricing (TP) legislation dates back to 2001 and has been rapidly evolving since then. TP audits in the country have generated great controversies and revenues to the government, due to an exponential increase in audit activity (three rounds of TP audit have been completed so far) resulting in ever-increasing TP adjustments year after year.

The need of the hour is clarity on a number of issues revealed through the TP audits, in order that those investing in the country are not put to undue hardship. Ensuring the country gets its fair share of global tax revenues is imperative, too.

With the Budget around the corner, it may be worthwhile to discuss some of the issues that need to be addressed.

Multi-national enterprises (MNEs) are faced with a host of tax litigations. Hence, to provide clarity and certainty in TP matters, introduction of an advance pricing arrangement (APA) could be beneficial. Many countries have adopted the APA mechanism, which enables taxpayers to proactively obtain tax authorities' acceptance vis-à-vis proposed pricing of intra-group transactions and obviate controversies and litigation after the transactions are implemented.

Apart from the above dispute resolution mechanism, certain safe harbour provisions could be introduced. Safe harbour rules provide the circumstances in which tax authorities would automatically accept transfer prices. For example, the current rules provide for relaxation of documentation requirements where the aggregate value of international transactions is less that Rs1 crore. Certain additional safe harbours can be introduced, like exemption for statutory filing requirements for certain startup companies or companies having value of international transactions less than a specified threshold limit, etc. This can go a long way to reduce taxpayers' hardship and help the tax authorities focus on other more critical areas of TP.

Another issue the MNEs face is TP audit of foreign entities. Certain international transactions with MNEs, e.g. royalty/interest payments, may give rise to income in the hands of the foreign entity. In such cases, the TP regulations are applicable to both the Indian and the corresponding foreign entity, since the arm's length principle is required to be applied to the international transaction per se and not only to the Indian entity.

Currently, the foreign entity is required to comply with the filing requirements and even an audit of the foreign entity is conducted in certain cases, giving rise to TP adjustments.

The TP regulations in India are anti-abuse provisions and the purpose of introducing the same is to avoid shifting of profits from India to another tax jurisdiction. However, in case o an adjustment in the hands of a foreign entity, an increase in income in the hands of the foreign entity does not automatically allow a corresponding increase in expenditure in the hands of the Indian entity. This results in hardship to the taxpayer, as it leads to double economic taxation, which can never be the goal of TP regulations. Such double taxation should be avoided on the grounds of equity, and hence the law should be amended.

It would also be debatable whether the foreign entity should be made to comply with the Indian TP regulations when the corresponding Indian entity has already demonstrated adherence to the arm's length standard. For the sake of simplicity, the compliance and consequent adjustment to the foreign entity should only be in exceptional cases.

Nearly every NME group has regional or international centralised cost centres with the avid intention of taking advantage of scale, synergy, and costs, etc. These costs will be pooled by a designated cost centre and allocated to various group members worldwide on the basis of a pertinent cost key on full cost basis or on cost plus appropriate mark-up. These transactions need to be in accordance with the arm's length standard; however, no specific guidelines are presently available on the subject.

Further, the tax authorities insist on the benefits derived from above intra-group cost allocation, which may be difficult to substantiate considering the benefits are intangible in nature. There is clearly a need for a more focused set f guidelines on this subject.

While TP is a necessary regulatory tool to deter shifting of profits, it must be administered with greater understanding of MNEs' business model. Weightage should be given to the commercial realities of today and thus TP should be adjudicated fairly on economic substance and not only as a quantitative exercise.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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