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Tax burden of firms to lighten in wake of ruling on transfer pricing
October, 06th 2008

A special court in Delhi recently set new parameters for the evolving law around transfer pricing, or the pricing of tangible and intangible assets sold by one arm of the same company to another, that would lower the tax burden on companies. It did so in a case involving Sony India Pvt. Ltd, the local subsidiary of Japans Sony Corp.

As part of the case, the Delhi Income Tax Appellate Tribunal set new norms for defining the so-called arms-length price, or ALP, and also laid down criteria for selecting companies that can be used to compute the transfer price.
Transfer pricing refers to the pricing of contributions such as tangible or intangible assets which are transferred within the company. To ensure that assets are transferred at a fair price, tax authorities make sure that goods and services are sold at ALP, a price the company would charge an unrelated or third party entity. The purpose is to make companies reflect the fair amount of profit, and not avoid tax.

It is a relatively new area of taxation and is often used by firms to relocate profits within group companies and reduce their tax burden.

A key decision by the special court was on 5% (plus or minus) adjustment in determination of ALP. Currently, if the transfer pricing shown by the complainant is not within this range, the tax authorities assume ALP. The range of 5% range was introduced in the transfer pricing scheme to allow for numerous extraneous considerations that cannot be factored into the computation of the transfer price. Now, the tribunal has ruled in its 112-page judgement that even if the variation is more than 5% for transfer pricing, this adjustment should be allowed. Consequently, the price at which the tax is computed will be ALP less the variation.

One needs to pay taxes on adjustments, and the lesser it is the better it is for a taxpayer. This is one of (the) important rulings and will help taxpayers in computation of ALP, said Mukesh Bhutani, international tax and transfer pricing expert at consulting firm BMR Advisors.
Considering differences in risk profile and ownership of intangibles allowing adjustments will help in the development of Indian transfer pricing legislation, said Uday Ved, head of tax and regulatory services at consultant KPMG.
The tribunal also widened the definition of comparables under transfer pricing legislation. It ruled that an entity can be taken as a comparable for the purpose of transfer pricing if the intra-group transactions do not exceed 10-15% of the total revenue.

Comparables that are most appropriate to the profit margins of the tax payer are taken. For example, for Sony India, comparables could be transactions of Videocon or Godrej, explained Sudhir Kapadia, a tax expert at consultant Ernst & Young in Mumbai. A comparable is viewed as an uncontrolled transaction as opposed to intra-company transactions that are controlled.

Identifying comparables is a challenge when you have restricted comparables, said Bhutani. The KPMG report on the issue of increasing the scope of comparables said considering the fact that the Indian transfer pricing legislation has defined an uncontrolled transaction, it needs to be seen whether this issue would be debated as a question of law before the courts.

Pointing to another aspect of the ruling, Kapadia said reimbursements received by Sony India from its overseas associated enterprises for expenses incurred from advertising in India is to be taken as revenue while computing profits and transfer price. Experts say the ruling will help other distributor entities of multinational companies in India to get benefits on such reimbursements.

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