The Hindu Business Line : Major changes to transfer pricing

Since the introduction of Transfer Pricing Regulations in 2001, certain significant issues and controversies have arisen, which required appropriate resolution through issuance of necessary administrative guidelines and/or suitable amendments to the Income-Tax Act, 1961.

The major amendments in the transfer pricing regime are discussed hereunder:

Arithmetic Mean

The existing concept of determining the arm’s length price is to compute arithmetic mean of comparable prices and apply a narrow band of (+/-) 5 per cent for such determination. There are disputes on application of this 5 per cent band during the course of transfer pricing audits.

In some of the cases, the appellate authorities have accepted the claim of the taxpayer to give benefit of this 5 per cent band and make adjustment to the lower/higher point of the range as the case may be as against the position of the revenue authorities that no benefit of 5 per cent band can be given once the taxpayer’s price falls outside the 5 per cent range of the arithmetic mean.

The amendment seems to confirm the position of the revenue authorities though the controversy on this aspect is not settled.

The other change is that the 5 per cent band is now to be applied to the transfer price of the taxpayer rather than on the arithmetic mean.

It would have been better that India adopted the concept of inter-quartile range in place of arithmetic mean. Many developed jurisdictions follow the “arm’s length range” concept, which, apart from being endorsed by the OECD guidelines, recognises the fact that in commercial dealings, independent enterprises could transact at a range of values and price points, all of which would be at arm’s length.

Using the approach of an arm’s length range would provide greater certainty for taxpayers as compared to the approach of arithmetical mean currently being followed and, accordingly, such inter-quartile range can serve as a robust alternative to the application of the arithmetical mean. Moreover, this will also lead to significant reduction in transfer pricing litigation.

Dispute Resolution Mechanisms

Setting up a Dispute Resolution Panel is a welcome step as at present a taxpayer facing a transfer pricing adjustment is required to go through a normal appeal process to the Commissioner of Appeal and then to the Tribunal and further to courts. Besides involving high litigation cost and administrative burden, this process is time consuming and the outcome is uncertain.

Under the proposal, the taxpayer can file objections before the Panel on receipt of draft of the order of assessment of variations in the income or loss returned within 30 days. The Panel shall issue the directions of confirming, reducing or enhancing the variation proposed by the authorities after considering various evidences and reports submitted by the taxpayer and the TPO.

The time limit of nine months provided for disposing of the reference and the binding nature of the same on the revenue authorities will hasten the process and give certainty to taxpayers.

Transfer pricing is neither a formula-based approach nor an exact science, to give the exact result every time. Moreover, while determining transfer prices one is required to consider business and commercial realities and to rely more on economic reasons rather than just annual financial statements.

Senior revenue authorities, consisting of Commissioners, have the experience and expertise in dealing with the nuances of transfer pricing and to dispose of reference made by the taxpayers in a fair and equitable manner. A similar concept prevails in other countries.

For example, in the US, the penalty oversight committee consisting of senior commissioners determine whether a penalty can be levied for a transfer pricing adjustment or otherwise.

Though this step has to be appreciated, it would have been better if the Dispute Resolution Panel can include persons outside the revenue department, for example, industry experts and/or an experienced transfer pricing practitioner/economist so that the Panel can take a reasonable decision considering views and positions covering all aspects.

Safe harbour rules

Although India has emerged as a globally preferred destination for outsourcing of services, such outsourced/captive units are experiencing significant adjustments to their margin during the course of audit, which might actually defeat one of the purposes of the off-shoring — cost arbitrage

To alleviate uncertainty faced by captive units and at the same time ensure an acceptable level of taxable profit, introduction of safe harbour provisions is a step in the right direction. A safe harbour provides circumstances in which a taxpayer can follow a simple set of rules/margin under which transfer prices are automatically accepted by the tax authorities.

The CBDT has been empowered to formulate safe harbour rules specifying circumstances under which the transfer prices of the taxpayers will be accepted.

The objectives of safe harbour provisions are to confer the following benefits on taxpayers and tax administrators: i) compliance relief; ii) administrative simplicity; and iii) certainty. Many tax authorities apply safe harbour as a better administrative practice

Advanced Pricing Arrangements

Advanced Pricing Arrangements (APAs) are arrangements that determine, 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. Administratively, APAs are similar to the existing mechanism for issuing advance rulings to provide certainty on issues of tax interpretation and principles.

Many countries, including the US, Canada, Mexico, China, Taiwan, Korea, Japan, Australia and almost every European country, have already included APA as part of their tax legislation.

The adoption of safe harbour will considerably reduce the transfer pricing dispute if not remove it completely. On the other hand, adoption of an alternate dispute resolution mechanism will facilitate expeditious resolution of the transfer pricing disputes.

All in all, these are welcome steps in the implementation of the transfer pricing regime and some more reforms on regulatory and administrative side would assist in facilitating further inbound and outbound investments.

(The author is Partner, Deloitte Haskins & Sells.)

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