Partner, International Tax Services, EY and Jaiman Patel, Director, International Tax Services, EY
The Union Budget 2016 will have Mr Arun Jaitley presenting his third budget in the parliament for the present NDA government. This budget will be on the back of the 'Make in India' and 'Start-up India' themes conceived by the Government.
The job of the Finance Minister will be to inspire confidence in the minds of the industry in the background of large scale selling by foreign institutional investors in India and domino effect of reeling emerging markets economies. In this backdrop 'ease of doing business in India' will a key theme. One of the areas from a direct tax perspective where one would expect some more clarity/simplification is transfer pricing. This article seeks to capture some aspects where the industry would expect relief from the budget as far as transfer pricing is concerned.
Rationalization of existing provisions The provisions of domestic transfer pricing were introduced in the tax legislation on the basis of a Supreme Court Ruling in the case of Glaxo Smithkline Asia (P) Limited. In this case the Supreme Court had inter-alia observed that there would be tax arbitrage in two scenarios; the first one being where a related company is loss making and the other is profit making and the profit is shifted to the loss making company. The second scenario, where there are different rates for two related units and if the profit is diverted towards unit paying taxes at a lower rate.
However, in other cases, i.e. where both the domestic entities have taxable profits, there would be no tax arbitrage under normal circumstances, if the profits are shifted from one entity to another. Presently, the provisions of domestic transfer pricing are applicable even to transactions undertaken between two profit making related entities. This increases the compliance burden for the taxpayers and at the same time does not result in any tax leakage to the government.
Accordingly, it is expected that the provisions of domestic transfer pricing are rationalized and should not apply to transactions undertaken between two domestic entities have taxable profits. Alternatively, where an adjustment is made in the hands of one entity (for e.g. reduction in deductible expenditure); then corresponding effect should be given in the other entity also (i.e. reduction in taxable income).
Secondly, the remuneration paid to the directors is considered as a related party transaction since directors are covered in the definition of related parties. It is practically difficult to benchmark the remuneration paid to the directors in absence of precise information on comparable instances in public domain.
Representations made to the Finance Minister in the past to exclude director's remuneration from the ambit of transfer pricing provisions still remain unaddressed. Tax department would be revenue neutral even with the exclusion of director's remuneration from the ambit of transfer pricing provisions since such directors' remuneration is taxable in the hands of the directors. As such, it is recommended that the aforesaid transaction should be excluded from the purview of transfer pricing provisions.
Under the current Income-tax Rules, the threshold for maintenance of documentation with respect to covered transactions is INR 1 crore. The aforesaid limit has remained unchanged since the time the transfer pricing provisions were first introduced in 2001. The low threshold results in increase in compliance cost for the taxpayer. The value of transaction that requires maintenance of documents should be increased to at least INR 10 crores.
The APA regime introduced by the Government, to provide tax certainty, has met with an overwhelming response from the stakeholders. As a logical extension of this process, the APA regime should also cover specified domestic transactions.
The safe harbour rules prescribe the minimum margin to be earned by the taxpayer in relation to certain categories of services from related parties. Where the taxpayer earns such margin as prescribed, the transaction is accepted to be at arm's length by the Indian revenue authorities. Presently, the safe harbour margins as notified by the Government are very high. For example, for provision of back office support services, the prescribed safe harbour operating margin is 20 to 22%. One of the reasons for the lukewarm response to the safe harbour regime was such high operating margins.
Further, the categorization of various services into information technology enabled services, knowledge process outsourcing, software development is vague and at times overlapping. It is expected that the Government clarifies the same expeditiously.
Clarify transfer pricing rules
In the recent past, the government has taken certain steps to align the transfer pricing in India with internationally accepted transfer pricing methodology such as introduction of 'range' concept and clarification on the use of 'multiple year' data to benchmark the international transaction in question. The aforementioned steps are in the right direction and are to be lauded.
However, presently a significant number of transfer pricing cases litigated in tax tribunals are on conceptually trivial grounds such as consideration of a particular item of income/expense as operating/non-operating in nature, threshold for application of related party filter, turnover filter, persistent loss making comparable, etc. To reduce unnecessary litigation, these issues can be suitably clarified by the government in the current Rules.