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Transfer pricing adjustments: Income-tax notice to IT cos
December, 20th 2006

In a move that could have far-reaching implications on setting up new offshore units in India, the Income-Tax Department here has started issuing orders to IT and ITES captive companies relating to transfer pricing norms leading to revenue adjustments of around Rs 1,000 crore.

According to sources in the industry, these adjustments as per preliminary estimates could translate into a tax demand of between Rs 350 crore and Rs 500 crore. Sources said around 80 companies have been subjected to higher transfer pricing adjustments. The crux of the issue is the assertion of a higher margin than at those currently adopted by these companies. Most of the companies, which have been issued orders, are based out of Bangalore and Hyderabad.

Net margin

Sources said the department has benchmarked the net margin made by these captive units against public companies operating in IT/ITES sectors. The benchmark suggested by the tax authorities is around 25 per cent for IT services' companies and around 37 per cent for ITES companies. Submissions made to the tax department have sought a climb-down on such aggressive benchmarking. Sources said that if the tax authorities do not revise these margins, it could affect foreign direct inflow and India's rating as a preferred destination for setting up offshore companies.

In fact, Nasscom, the industry body, has in its pre-budget wish-list to the government also raised concern over transfer pricing norms. It has sought rationalisation of norms for transfer pricing. It also suggested the creation of an advanced pricing agreement (APA) procedure, which would allow taxpayers to disclose all relevant facts to the tax authorities and obtain a binding ruling on the tax consequences.

Transfer pricing is basically the price at which goods or services are transferred between one country and another within the same organisation.

Transfer pricing regulations have been in place in the country since 2001-02. The Indian regulations are primarily based on the OECD (Organisation for Economic Co-operation and Development) framework. Sources said that the tax authorities should, in fact, adopt uniform and fair approach rather than an aggressive approach leading to high tax demand and protracted litigation.

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