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Provisions for transfer pricing need review
September, 17th 2007
When two related enterprises enter into a cross-border transaction and in the process profits are transferred from high tax jurisdiction to low tax jurisdiction, the transfer pricing provisions come into play. The transfer pricing concept, no doubt, is new to the Indian tax system, but for the last several decades, the tax authorities and courts have been determining open market value of properties of all kinds.
 
As observed by the Delhi High Court in Sony Indias case (288 ITR 52):It is often seen that a multinational company (MNC) transfers goods and services to its local subsidiaries at a price not reflective of the market price and in turn the subsidiary is able to avoid, partly or wholly, payment of local tax. The finance minister in his Budget speech had said that the presence of multinational enterprises in India and their ability to allocate profits in different jurisdictions by controlling prices in intra-group transactions has made the issue of transfer pricing a matter of serious concern.
 
A bare reading of the basic provisions of transfer pricing gives an impression that their objective is to prevent tax avoidance. Therefore, before proceeding with determination of arms length price (ALP), the assessing officer should prima-facie demonstrate that there is a case for tax avoidance. However in a recent special bench decision of ITAT Bangalore (107 ITD 141), it has been held that avoidance of tax is not a condition precedent for invoking transfer pricing provisions. There is no requirement of establishment of tax evasion before initiation of proceedings for determination of ALP. The above judgment is clearly against the intent and purpose of the transfer pricing provisions.
 
The transfer pricing provisions are already very harsh in several ways: the law specifically provides for making addition to income on account of transfer pricing irrespective of the fact that the income could be exempt from tax under Section 10A, 10AA, 10B of the Act or under chapter VI A. Further, when income of one related enterprise is increased due to non-adherence to transfer pricing norms, the income of the other enterprise should correspondingly be reduced, but the Indian Income-Tax Act specifically prohibits it.
 
However, where there is a tax treaty between India and the other country for avoidance of double taxation, the tax liability of related enterprises will be determined by reference to the tax treaty, which supersedes the domestic tax laws of both the countries. Article 9 of most of the tax treaties that India has signed with other countries provides that when the income of an associated enterprise is increased, a reduction in the income of the other enterprise may be allowed by the other country.
 
Therefore, where the income of an enterprise increases in India, a corresponding reduction in the income of the other enterprise could be sought in accordance with the provisions of the tax treaty between two countries. In certain cases, particularly where there is no provision in the tax treaty like Article 9 as discussed above, a relief could still be sought under the Article relating to mutual agreement procedure.
 
It appears that the provision in the Indian Income Tax Act, which denies the benefit of corresponding reduction in income, is against the basic principles of international law.
 

In the above background, it is respectfully submitted that the decision of Bangalore Special Bench (supra) needs a review and reconsideration. The harsh provisions should not be made more bitter by legislative interpretation.

HP Aggarwal

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