The philosophy of transfer pricing is fairly old under which a country attempts to tax a fair share of revenue arising in the course of cross-border transactions. The Organisation for Economic Cooperation and Development (OECD), of which the United States and other major developed countries are members, had formulated some guidelines about transfer pricing by 1979. The US led the development of the detailed comprehensive transfer pricing guidelines with a White Paper in 1988 and with proposals in 1990-1992, which ultimately became regulations in 1994. In India, The Finance Act, 2001 substituted section 92 with new sections 92 to 92F with effect from 1st April, 2002, Rules 10A to Rule 10E of the Income Tax Rules were notified and that marked the beginning of the transfer pricing era. Over the last 10 years, the interpretation of the relevant provisions has gradually evolved in India. In the last few years the tax administration has suddenly become very aggressive in respect of transfer pricing additions termed as adjustments, as they find it to be a very lucrative tool for meeting their ever-increasing revenue targets. The provisions on transfer pricing are fairly subjective and can be interpreted and implemented with flexibility. There are no safe harbour rules for transfer pricing in India. As the provisions in the Act are subjective and open to diverse interpretations, the tax authorities interpret them in a way beneficial to the Revenue and thereby demand higher taxes from assessees who have entered into international transactions with their associate enterprises. This is posing a major risk to foreign multinationals doing business in India, as well as Indian multinationals having businesses in foreign countries.
The Income-tax Act has given a liberal time frame of 31 months to the tax authorities to determine the Arm’s- Length Price (ALP) from the end of a financial year. By 31st October, 2011, the tax authorities determined the ALPs for the year ended 31st March, 2008. For the year ended 31st March, 2008, they have assessed transfer pricing additions of a staggering amount of Rs.44,500 crore. Such additions were only to the tune of around Rs.22,000 crore for the F.Y. 2006-07 and just around Rs.10,000 crore for the F.Y. 2005-06. The phenomenal increase in the adjustments over the last few years clearly indicates how eager and aggressive the Tax Department is to mop up revenues on account of transfer pricing additions. The Finance Ministry also seems to be very supportive to these efforts of the income-tax authorities as it is usually lagging on controlling budgetary deficits and wants to be innovative in its efforts of mopping up more tax without apparently affecting the common man. However, a balanced approach is the need of the hour.
Multinational companies having presence in various parts of the world with different tax laws and tax rates, try to take advantage of those differences to boost their post-tax profits for maximising shareholders’ value. Transfer pricing mechanism was initially introduced by the developed countries for enhancing their tax revenues from such multinationals. These countries realised that tax on some part of the revenues which could have been taxed in their jurisdiction was being siphoned off to low-tax jurisdictions by such companies. They made various laws for protecting the tax on these revenues. Encouraged by the revenue gains realised by these countries pioneering transfer pricing regulations, many other countries gradually introduced transfer pricing provisions in their tax laws. Over the years, their implementation is becoming aggressive and at times beyond justification.
The multinational companies, who had great moneymaking run till the end of the 20th century, have realised that the times are changing. Their global presence makes them deal with number of countries and their respective diverse laws. There is an increased possibility that two or more countries may tax the same profit by trying to justify that it was earned in their respective jurisdiction or such profit being even otherwise taxable under their tax laws. In such a situation, a multinational entity faces grave risk of being subject to duplicity of taxation.
Today, many multinationals are encouraged to come to India considering the huge market, skilled labour and technical and managerial talent that India offers. Multinationals already present in India are further encouraged by the growth of their businesses in India, in spite of the worldwide recession. Many of these companies are today suffering due to the aggressive stands on issues regarding transfer pricing by the Income Tax authorities. The Government needs to be mindful and cannot be oblivious to the fact that these multinationals can create employment and can also increase exports, which are the two critical needs of Indian economy. In the zeal of increasing the revenue, one should not slay the hen that lays golden eggs. India should not just copy the attitude of some developed countries in respect of transfer pricing as it may harm the economy and destroy some stable sources of revenue.
The brunt of transfer pricing provisions in India is equally faced by Indian companies expanding their business footprints outside India. The regime is also affecting the ambitions of Indian industry to set up Greenfield operations abroad or to acquire foreign businesses. They are not able to support the operations of their foreign subsidiaries through interest-free lending or giving bank guarantees for their borrowings, which is extremely important for the survival and sustainability of their operations. Genuine business efforts are adversely affected by the aggressive transfer pricing additions. The action of the tax authorities may be within the provisions of law but can be very harmful for a developing country like India. Indian policy makers as well as the policy implementers need to take the cognizance of the facts before it is too late. It also needs to urgently notify and implement the ‘safe harbour rules’.
Some of the major reasons of additions made on account of transfer pricing provisions in India are as follows:
- Recommendation of higher margin at net operating level.
- Disallowance of fees paid to associate enterprises for use of intangibles.
- Payment for inter-company services to associated enterprises disallowed.
- Indian company treated as creator of intangible assets owned by associated enterprises, thereby making addition on account of notional income.
- Notional fees being attributable to corporate guarantees given by Indian companies.
- Notional interest on advances given or outstanding of recoverable reimbursements by an Indian company to its associated enterprises.
- Notional fees being attributable to pledge of shares given as security to lender by Indian companies for the borrowings made by its associated enterprises.
The list is not exhaustive but only indicative and it is expanding year after year with the novel ideas of the income-tax authorities.
Newly set up businesses outside India have their own teething problems like a new-born child. They are subjected to brutal global competition and need to withstand it in order to survive. They need to be aptly supported by their parents till they take off and are able to sustain on their own. The support given by the parent in the form of interest-free/low-interest loan, corporate guarantees, preferential pricing, longer credit period, technology support and even manpower support is looked at by the transfer pricing authority as unfair practices and notional income from such practices are added as adjustments. While doing so, adequate cognizance of the gain that the parent makes by being full or part owner or being an economic beneficiary of the associated enterprise is not taken.
It seems that the time has come for the Government to review the provisions of transfer pricing in India and also to do introspection of the methodology of the implementation of the provisions for the health and faster growth of Indian businesses. The current attitude will not only dampen the interest of foreign multinationals to do business in India, but it will also damage the enthusiasm of Indians to fare overseas in search for opportunities. India is trying to project herself as a service hub to the global community. It is trumpeting the skill of its manpower and its cost advantage to the developed world in service-orientated businesses. If the aggression in implementation of transfer pricing does not subside to a reasonable level, India will fast gain a reputation of being an unfriendly and high-risk tax jurisdiction. The advantage which India gathered over the last couple of decades in the service sector may vanish overnight. In case of such an unfortunate situation, other developing nations who are waiting in the wings to compete with India in the service sector will have the last laugh and India may have one more story of a lost opportunity to tell.
Though various countries may have their points of view and justification for taxing an income which is also taxed in the other country, it can make the taxpayer suffer. To give respite to such a harassed taxpayer, Double Taxation Avoidance Agreements (DTAA) between many countries provide for ‘Mutual Agreement Procedures’. A taxpayer who gets torn between the taxation laws and transfer pricing regimes of two countries in respect of the same income, may make an application under the procedure. In such cases, the authorities of the two countries try to provide a solution which is acceptable to both the countries so that the taxpayer does not get into a double jeopardy of being made liable to pay double tax on the same income. However, if they fail to agree, the poor taxpayer may suffer tax in both the countries.
For the speedy resolution of transfer pricing disputes between the tax authorities and taxpayers in India, the Finance Act, 2009 introduced the provisions relating to Dispute Resolution Panel (DRP). Though the process was expected to speedily resolve the transfer pricing disputes, the response of the taxpayers, based on their recent experience of the panel is not very encouraging. Today, many taxpayers stung by the transfer pricing additions are not inclined to take advantage of these provisions as they are fairly certain of not getting relief, even in deserving cases. Such thinking amongst the taxpayers is harmful for speedy settlement of tax disputes, as the normal appeal process takes a long time. The delays increase the uncertainty of the taxpayers and also negatively affect the due tax collections by the authorities. To make DRP more assessee-friendly and meaningful, it is essential that the members of DRP are assigned the duty on a full-time basis and they should be as independent as possible.
The methodology used for implementation of transfer pricing regulations has far-reaching ramifications on an economy. The Indian Government as well as the authorities should not lose sight of the fact that business in India needs support and encouragement to achieve the targeted growth rate. They need to take a holistic view. At the same time businesses have to realise that attempt to artificially accrue income in low-tax jurisdiction is not beneficial in the long term.
