The Hindu Business Line : Inter-company deals cross-country

TRANSFER pricing law has become an important issue for multinational companies. More and more countries are taking action on transfer pricing, calling for documentation and insisting on transfer pricing audits. Transfer pricing is the price at which transactions between units of multinational companies takes place, which include inter-company transfers of goods, property, services, loans and leases.

The ability of multinational enterprises to allocate profits in different jurisdictions by controlling prices in intra-group transactions can have an eroding effect on the tax base. Related entities can manipulate prices in such a manner that profits are transferred to low tax jurisdictions. Many countries have, therefore, introduced transfer-pricing legislation.

In India, Chapter X of the Income-Tax Act, 1961 lays down regulations for the computation of income from international transactions and insists on the arm's length rule. The Finance Act, 2001 substituted the old Section 92 from assessment year 2002-03 and inserted Sections 92 to 92F, which govern international transactions of associated enterprises.

The idea was to ensure that taxable profits are not understated, by manipulating the accounts and prices in India. International transactions will have to be computed as per the arm's length principle. This principle, however, will not be used if its adoption results in a reduction of the income chargeable to tax. Section 92C lays down different methods — comparable uncontrolled price, resale price, cost-plus, profit-split, and so on — for the computation of arm's length price, and these are explained in Rule 10B.

The most appropriate method will have to be applied having regard to the nature or class of transactions. Provision is made to arrive at the arithmetical mean of the price determined by various methods. Sections 92B and 92E lay down the requirements on documentation.

India's first transfer pricing audit undertaken in 2001-2002 resulted in a revenue of Rs 1,250 crore. And in 2005, 1200 cases were referred to the Transfer Pricing Officers. At a recent international tax conference in Mumbai, tax expert, Prof. Klaus Vogel of the University of Munich, observed:

"TP is a question in which no fixed criteria exists. It is purely a business decision in the end. There is no real security in advance on whether the price arrived at within a group would be accepted by fiscal authorities."

A TP audit in one country will have to deal with subsidiaries all over the world and there can be different agreements between various countries. Advance Pricing Agreements (APAs) have often been suggested as a remedy to avoid tax disputes. This is not easy. An oft-raised question is whether Mutual Agreement Procedures (MAPs) can be thought of between the various tax authorities across the globe. Taxpayers are not clear on the extent of compliance required. Database is limited and arriving at a single global documentation is not easy.

More than 60 per cent of tax disputes related to transfer pricing cases in other countries. APAs require agreements between the taxpayer and the tax authority, and this can help avoid future disputes. The US applies rollback options, making it possible to apply for APAs retrospectively. The Indian law does not have provision for APAs. It is the documentation part of the law that is the bugbear. Non-maintenance of documentation can attract heavy penalty. Recently, the European Commission introduced a transfer pricing documentation code of conduct for the European Union member-states in order to simplify TP documentation within the EU and prevent multiple-documentation.

The IRS of the US has issued a survey report for improving documentation, which can be relied on by the revenue authorities. The Rules regarding the allocation of profits between head-office and its permanent establishment (PE) are not uniform. Different methods of apportionment are followed for attribution of profits to PEs. Our tax law is somewhat similar to the OECD Discussion Draft. Often, the alternative procedures prescribed in the section and the Rule can result in conflict. Tax authorities can continue to apply non-transfer-pricing provisions for determining taxable profits of the PE in India. There is need for uniformity in applying the TP principles. India is now emerging as the favoured destination for big global companies. At the same time, Indian companies are also venturing abroad, setting up subsidiaries and buying entities in other jurisdictions. The TP law of 2001 will have to take into account the economic realties of 2006. The law and the rules require updating.

(The author is a former Chief Commissioner of I-T.)