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Bid to simplify transfer pricing maths
May, 29th 2015

To reduce disputes on transfer pricing, the Central Board of Direct Taxes (CBDT) has proposed to remove practical difficulties companies face while valuing transactions between related entities for taxation.

According to a draft on the proposed scheme released by the direct tax department, companies would be allowed to use multiple-year data for transfer pricing regulations, instead of only one year's as of now. The department has also introduced a "range concept".

It has been clarified that the range concept will only apply where a minimum of nine comparable data about similar transactions are available. In case the number of comparable data is inadequate, the existing provision of "arithmetic mean concept" would apply.

The concept of a range, which involves a number of comparable variables, is internationally accepted.

The announcement to change the rules for transfer pricing was announced by Finance Minister Arun Jaitley in his maiden Budget last year. Companies have long been demanding this change as they claim the prices or margins in a particular year might be affected due to various factors that can have repercussions on transfer pricing conditions and, as such, multiple-year data would be more suitable.

Jiger Saiya, partner-direct tax, BDO India, said, "Use of multiple-year data would help taxpayers overcome challenges of non-availability of data of comparables for the relevant year on public databases at the time of undertaking their transfer pricing compliances."

The amendments also relate to the introduction of a range to determine the arm's length price. The use of arithmetic mean of a range of prices and margins to determine the arm's length price has resulted in several disputes.

The criticism of this method was that computing of the arithmetic mean as an average of the prices and margins was distorted by extreme values and does not give a true arm's length price.

Arm's length price is used to determine the cost of goods or services traded between related entities. This has a bearing on the profitability and tax liability of a company.

CBDT has invited comments from various stakeholders on the draft note till the end of this month. Experts said these changes would simplify and smoothen the tax structure.

"The effort of the department to come with a guideline on arm's length range and multiple-year data concepts is much desired," said S P Singh, senior director, Deloitte Haskin & Sells. "On both issues, there have been a number of disputes. A guideline on the two important issues of transfer pricing will go a long way in reducing litigations."

The range concept has much greater acceptance that the arithmetic concept. "With the development of databases required for transfer pricing analysis, the time had come to move away from the arithmetic mean concept and adopt the range concept, which has greater acceptance. Adoption of the multiple-year data concept will take care of fluctuations in business of a taxpayer," said Singh. Since its introduction in 2001, transfer pricing regulations have been a major area of litigation between the tax department and taxpayers. Taxpayers, mainly multinational companies, usually blame the tax department of being aggressive in imposition of taxes to garner more revenues.

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