While the government may have doled out tax sops to special economic zones, (SEZs) its taking all steps to ensure that there is no misuse of incentives. And one such step is transfer pricing (TP) regulations, which would come into play on SEZ units. These norms would ensure that units in an SEZ are not able to claim less revenue to earn tax exemptions.

TP means arms length pricing in transactions between organisations. This is particularly important for the pricing of goods and services within multi-divisional organisations, especially cross-border deals. The principle means that prices in the transaction are equivalent to what they would have been, had the parties involved in the transaction not been related to each other.

The TP rules have become important for SEZs, like those units involved in gems and jewellery. The export promotion council for EOUs and SEZ units had, therefore, recently taken up the issue of applicability of TP norms on these SEZ units with the revenue department. But the revenue department is of the view that units would have to conform to TP norms, sources said.

They also said since an SEZ unit would be treated as a foreign territory, without application of TP rules companies in domestic areas could siphon off their profits to related companies in the zones to earn tax breaks.

In the past, some of the export incentive schemes were found to be misused by exporters by changing their profits. Since, units in SEZs have a 15-year exemption from income tax 100% for first five years, 50% for next five years and 100% on profits ploughed back chances of such a misuse are high. The department is anticipating a direct tax loss of Rs 54,000 crore between fiscal 07-08 and 09-10.

Amitabh Singh, partner, Ernst & Young, said: TP norms will apply to units in SEZs just as they do currently on units set up in software technology parks and export-oriented units which have 100% tax holiday. The TP norms will apply to ensure that the units receive arms length price even if their profits are exempt from income tax. Of course, the TP adjustments made, if any, will be subject to normal rates of tax. China, too, has made effective use of TP norms in a comprehensive way in these zones. This became necessary as some of the enterprises in SEZs, despite the favourable tax policies, chose to avoid taxes.