The Hindu Business Line : To whom does locational advantage accrue in transfer pricing?

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Chennai March 3 Budget 2007 has not allayed a recent worry that has been haunting the IT industry: the action of the tax department with regard to transfer pricing.

"For the first time in India, the concept of locational savings has been indirectly brought up by the transfer pricing authorities in Bangalore while concluding the assessment,'' says Mr K.R. Girish, Partner, Tax & Regulatory Services of BSR & Co, Bangalore.

The approach of the tax authorities for attributing a higher margin on the captive units has been that these units are set up primarily for cost arbitrage, he explains.

"Their `reasoning' is that even if a cost plus 25 per cent in the case of IT services and 37 per cent in the case of BPO services were to be applied taking Indian public companies as the benchmark, then also the parent company is benefited due to the pure cost differential.''

One justification can be that since a software engineer/analyst would cost in the US easily 3 to 4 times more than in India, there is no logic to argue that there is no locational advantage.

"But this approach relates to the fundamental question, whether the service provider can stake a claim on the locational cost advantage, or should the advantage fully accrue to the service recipient,'' argues Mr Girish.

So, what are the answers?

"An extremely complicated issue, and there are no right or wrong answers on this even internationally,'' he frets.

"If the Indian taxman's position were in fact to be upheld as correct, then the cost of operation of all the captive units would go up substantially, and the whole purpose for which the foreign corporation has set up the base here would become questionable including the whole feasibility of the operations,'' cautions Mr Girish.

Also this can seriously hamper any further expansions or new units coming up, as these foreign companies would instead look at alternatives such as Eastern Europe, Philippines etc.

"Is there a way out?

"It is time the CBDT came out with a clear safe harbour provisions such as the Mexican legislation where they have said that for a limited risk service provider (i.e. captive units of multinational companies) a cost plus margin of 6.5 per cent would be construed to at arm's length,'' he suggests.

"If we don't come out with any guidelines there is going to be protracted litigation, as this is a completely new concept. Also, India's attraction as a destination for IT/ITeS itself would be lost, which I believe would be a much larger issue,'' Mr Girish wraps up, on an alarming note.