Global trade has increased after the globalization and as a result of it, multinational companies has started operating in different countries with country specific taxation laws and rates. The transactions have also increased between such related or associated enterprises under the different conditions from those taking place between independent enterprises.
In such circumstances, the multinational companies used to set up transfer prices in such a manner that it minimizes the overall tax burden of the company such as corporate taxes, import duties and other tariff, etc. Therefore, many countries have enacted laws to prevent such tax avoidance practice and tax the transaction at arm's length prices. Arm's length prices are those prices which come from the transactions occurred between the independent enterprises without influencing the parties. Generally, tax authorities try to limit the scope for the multinational companies to shift their profit with transfer pricing rules that require trade between affiliates with respect to arms length prices. For instance, the shares of the subsidiary company have been sold to the parent company.
The tax authorities limit the scope because the multinational firms have large flexibility to manipulate for instance, the royalty for the use of a unique trademark or the premium for insurance to minimize their global tax liability.
Tax havens, which are commonly small and well governed states, impose less or zero tax rates on the foreign investors. It also plays a very important role in the international trade market. In the global market the service trade with havens is around six times larger as compare to the non-havens. There is a huge difference because of the low effective tax rates developed by tax havens with their tax regulatory standards and legal framework.
In the case of Vodafone International Holdings vs. UOI, Vodafone successfully used the CGP Investment Holdings situated in Cayman Islands (tax havens) to evade the tax, as it indirectly purchased the shares of Indian company, Hutchison Essar Limited (HEL) because CGP had 67% shares of HEL.
Finance Act, 2001 introduced the concept of Transfer Pricing regulations to curb such tax avoidance between the group of enterprises. The memorandum of Finance Act stated that "with a view to provide a statutory framework for reasonable, fair & equitable profits & tax in India I case of Multinational Enterprises... transfer pricing provisions are introduced".
The main aim of Indian Regulations is to cover the debts arising during the course of business or business reorganization or restructuring the businesses and the intangible properties including human assets or technology related intangible etc.
"Transfer prices mechanism determine the large part of the income and expenses of the taxpayers and tax administrations and therefore it is significant for both of the parties and also determine the taxable profits and liability of associated enterprises in different tax jurisdictions."
Organization for Economic Co-operation and Development issued the transfer pricing guidelines and defined transfer pricing as payment from one part of the multinational enterprise for goods or services provided by another. The definition provided by the OECD model mostly focuses on multinational corporations and focus on the principle of arm's length. Arm's length principle is a principle the related party transactions of transfer pricing should be equivalent to those between independent persons in otherwise circumstances. The principle has been incorporated under Article 9 of the OECD Model Tax Convention on income and on capital.
India has also enacted provisions to curb the problem of tax avoidance under Income Tax Act, 1961. Section 92 to 92F of the Act provides for the methods of computation of arm's length price and documentation requirements with the concept of the terms "international transaction" and "associated enterprises". The legislation also created the authority for the specialized role of determining the arm's length prices. The authority is names as Transfer Pricing Officer and computes the above tax after the assessing officer has made a reference of an international transaction to the said authority.
The Income Tax Tribunals and Higher Appellate Authorities have provided various fundamental guidelines and the rules for the transfer pricing issues across the companies and global trade. The national authorities of every country are seeking more effective way to protect the tax bases and have worked from detailed transfer pricing regulations to stricter documentation requirements. The authorities have focused on sophisticated audit practices and penalties for non-compliance due to which the challenges have increased for multinational corporations.
The disputes relating to transfer pricing has evolved from litigation and controversial to more inimical and business friendly. The government has introduced favorable tax regimes such as safe harbor rules and its revision & Advance Pricing Agreement (APA) for 4 years to control the controversial aspect in domestic transfer pricing. The Advance Pricing Agreement program was in enacted in 2012 followed by introduction of the Advance Pricing Agreement Rollback Regulations in 2015. Under these Rollback Regulations, all the taxpayers who have filed for Advance Pricing Agreement to date will also be eligible for the rollback up to a maximum period of four years. And even the taxpayers who have signed with the government for Advance Pricing Agreements will also be eligible for the rollback. Therefore, it is important for a taxpayer and revenue authorities to avail the rollback of Advance Pricing Agreement, both of them have to withdraw any pending litigation.
Indian Transfer Pricing Regulations are exhaustive in nature in many aspects and are broadly based on the OECD model for pruning down the practice of tax avoidance by multinational companies. Transfer pricing mechanism has also resulted in the existence of many multinational corporations in the Indian market and also allowed the expansion of Indian companies over the world. Therefore, the related party transactions have grown both in volume and scope. International transfer pricing has become an important factor in the corporate world.
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