Certain significant transfer pricing issues and controversies have emerged from the past assessments and require appropriate resolution.
With few years of experience on transfer pricing regulations in India, the tax authorities and practitioners have made a lot of effort to move up the learning curve. However, certain significant transfer pricing issues and controversies have emerged from the past assessments and require appropriate resolution through issuance of necessary administrative guidelines and/or introduction of suitable amendments to the Income-Tax Act, 1961 and the Income-Tax Rules, 1962. Furthe r, certain other provisions need to be introduced in the Act/Rules for alignment of our transfer pricing regulations to OECD guidelines and other international best practices.
This article deals with various such issues and provide for specific suggestions/amendments in the Indian transfer pricing regulations so that there is more certainty and fairness in the manner in which the law will be applied.
The US transfer pricing regulations prescribe that if material differences exist between the controlled and uncontrolled transactions, adjustments must be made to the results of the uncontrolled transaction so that the arms length range will be derived only from those uncontrolled comparables that have, or through adjustments can be brought to, a similar level of comparability and reliability.
While the Indian transfer pricing regulations provides for making adjustments for differences between the international transactions and uncontrolled transactions, in practice there is no guidance/clarity on the manner in which these adjustments are to be made.
For example, adjustments in areas such as differences in levels of working capital, risk profile and volumes, pricing on marginal cost, start-up losses/capacity utilisation, etc., are not clearly permitted.
Appropriate guidance on the manner in which adjustments may be made to enhance comparability between uncontrolled and international transactions would go a long way in alleviating taxpayer burden.
Advance Pricing Agreements
APA is an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria for determination of the transfer pricing for those transactions over a fixed period of time.
While the Indian transfer pricing regulations have not included provisions for APA so far, countries such as the US, Canada, France, the UK, Australia and Japan have successfully implemented them.
Since Indian transfer pricing regulations are already six years old and about three years of transfer pricing assessments have been completed, this may be an opportune time for India to consider introducing APA provisions to provide an opportunity to enterprises to draw up a binding taxation agreement in advance with the authorities on the price or profitability for the controlled transactions.
Need for intangibles
At present, Indian transfer pricing regulations do not have a specific provision dealing with the transfer pricing of intangibles. Sub-section (2) of Section 92 of the Act is an omnibus provision dealing with intra-group arrangements for services, cost allocations, cost contributions, etc.
Also, the five prescribed transfer pricing methods are generally not found adequate to deal with the transfer pricing issues related to intangibles. Accordingly, in line with international practice and OECD principles, guidance should be issued to recognise certain methodologies/approaches for evaluating the arms length character of transactions involving intangibles.
Non-integral Intra-Group Services
Non-integral services are ones that are not the principal business activity of the entity providing the services. These incidental services could take the form of administrative services, centralised support services, marketing support services, etc. Taxpayers face hardship where tax authorities treat non-integral services as intra-group services requiring cross-charge and attribute a mark-up on the same.
Owing to the lack of clarity, economic double taxation results where the tax authority of the other contracting entity disputes the charge and/or the mark-up.
Suitable guidance should be issued that can help taxpayers and tax authorities deal with the issue of intra-group services in accordance with economic principles.
Use of multiple year data
Tax authorities have been insisting on benchmarking tested party results with margins of comparable companies using single-year financial data relating to the same fiscal year. Practically, same-year comparable data is not completely available with the taxpayer at the time of entering the international transaction as well as at the time of completing the documentation.
Further, from an economic perspective, the use of multiple-year data is based on robust economic logic, as the results of any one-year may be distorted by differences in economic or market conditions and the features and operations of the enterprise affecting the controlled or uncontrolled dealings.
Moreover, participants in an industry may not be uniformly affected by business and product cycles, and therefore differences between dealings may reflect differences in circumstances, not the effects of non-arms length dealings.
Accordingly, for evaluating outcomes from an arms length perspective, it is preferable to use multiple-year data for taxpayers as well as comparables.
Use of Secret Comparables
Collection of data by the tax authorities, which is not otherwise available in public domain, is a global concern from a confidentiality perspective. Many developed countries do not permit use of secret data while carrying out transfer pricing assessments.
Whereas in India, in certain cases, information gathered by the tax authorities, while investigating the transfer prices of competitors, is being used against the taxpayer. It would seem justifiable not to use one taxpayers data against another taxpayer.
In view of the generally accepted international practice, it is proposed that necessary clarification be issued restricting use of secret comparables, which the taxpayer cannot assess to benchmark its transfer price.
Domestic Correlative Adjustments
Indian transfer pricing regulations, as they currently stand, does not permit correlative adjustments, resulting in economic double taxation. For example, in case an India branch of a foreign bank faces transfer pricing adjustment on account of charging less than arms length rate of interest on surplus funds lend to the resident NBFC company of the same group, the NBFC is unable to get a deduction for the higher interest, which has been taxed as income in the hands of the India branch.
This results in economic double taxation. It is important to also note that both the India branch and the NBFC are liable to tax in India, hence the transaction between the two does not affect the Indian tax base.
Considering the hardship faced by the taxpayers, it is suggested that necessary amendments be made in the Act and correlative adjustments should be permitted.
It is time to have a relook at the transfer pricing regulations and settle the issues/controversies through issuance of necessary administrative guidelines and/or introduction of suitable amendments in the Act/Rules. Moreover, introduction of measures such as APAs, guidelines on intangibles, etc., would ultimately lead to growth in the Indian economy.
Rohan Phatarphekar (The author is Executive Director and Head of Transfer Pricing, KPMG.)