The Hindu Business Line : Top transfer pricing issues the Budget should address

Weightage should be given to the commercial realities of today and thus transfer pricing should be adjudicated fairly on economic substance and not only as a quantitative exercise. -- MR VISPI T. PATEL, HEAD, DIRECT TAX PRACTICE, ECONOMIC LAWS PRACTICE, MUMBAI.

With global financial markets in turmoil, even as credit lines remain frozen, the major concern for the managements is the preserving of cash flow. To maintain profits or at least stay afloat companies in sectors such as real estate, aviation, information technology (including BPOs) have started downsizing their employee base, with the consequent negative impact on the economy.

"This is the appropriate time for the Government to introduce fiscal measures to withstand the global slowdown and give a boost to our economy," says Mr Vispi T. Patel, the head of direct tax practice at Economic Laws Practice (ELP), Mumbai.

The Government should also consider making appropriate changes in the legislation and other regulatory aspects which could ensure that businesses (especially multinational enterprises or MNEs - Indian as well as foreign) do not face undue hardship and, hence, do not have to resort to short-term solutions such as reduction in workforce, he adds, during the course of a recent email interaction with Business Line.

"In today's gloomy economic scenario, the Indian Revenue authorities could be more proactive and ease the pressure on MNEs to encourage investment and growth in our economy by providing transparency in the law," Mr Patel suggests.

"Softening the stand taken by TP (transfer pricing) authorities during the slowdown would be the need of the hour. This will help our economy to sustain itself in the financial crisis."

TP, for starters, is one of the most-debated topics in international tax and has given rise to billions of dollars in adjustments throughout the globe, due to the Revenue authorities being zealously protective of their tax base.

While TP is a necessary regulatory tool to deter shifting of profits, it must be administered with greater understanding of MNEs' business model, reminds Mr Patel.

Weightage should be given to the commercial realities of today and thus TP should be adjudicated fairly on economic substance and not only as a quantitative exercise, he emphasises.

"TP as well as other tax legislation should not be hindrances in the Indian growth story.

"The easing of administrative burden on the MNEs and certainty in TP and other tax matters could give a fillip to the industry to continue its march forward, especially in these difficult times."

Excerpts from the interview, in which Mr Patel also looks at the issues the next Budget can address in the area of TP.

Why a focus on TP?

India's TP legislation dates back to 2001 and has been rapidly evolving since then.

TP audits in the country have generated great controversies and revenues to the Government, due to an exponential increase in audit activity (four rounds of TP audits have been completed so far) resulting in ever-increasing TP adjustments year after year.

The need of the hour is clarity on a number of issues revealed through the TP audits, in order that those investing in the country are not put to undue hardship and, at the same time, ensuring the country gets its fair share of taxes.

What are the top TP and related issues that the next Budget should address?

APA (advance pricing arrangement): MNEs are faced with a host of tax litigations. Hence, to provide clarity and certainty in TP matters, introduction of APA could be beneficial.

Many countries have adopted the APA mechanism, which enables taxpayers to proactively obtain tax authorities' acceptance vis-…-vis proposed pricing of intra-group transactions and obviate controversies and litigation after the transactions are implemented.

This allows the MNEs to plan their business strategy with a reasonable fiscal certainty.

Safe harbour rules: Apart from the above dispute resolution mechanism, certain safe harbour provisions could be introduced. Safe harbour rules provide the circumstances in which tax authorities would automatically accept transfer prices.

For example, the current rules provide for relaxation of documentation requirements where the aggregate value of international transactions is less that Rs 1 crore. The same could be increased to Rs 5 crore. This will reduce the administrative burden of many small players.

Specific exemptions: Certain additional safe harbours can be introduced, like exemption for statutory filing requirements for certain start-up companies or companies having value of international transactions less than a specified threshold limit, etc. This can go a long way to reduce taxpayers' hardship and help the tax authorities focus on other more critical areas of TP.

Range: Further, the use of `range' concept instead of `arithmetic mean' and also defining the standard set of range to be followed by a particular industry can reduce the hardship on the taxpayer.

TP audit of foreign entities: Certain international transactions with MNEs - example, royalty/ interest payments - may give rise to income in the hands of the foreign entity. In such cases, the TP regulations are applicable to both the Indian and the corresponding foreign entity, since the arm's length principle is required to be applied to the international transaction per se and not only to the Indian entity.

It would also be debatable whether the foreign entity should be made to comply with the Indian TP regulations when the corresponding Indian entity has already demonstrated adherence to the arm's length standard. For the sake of simplicity, the compliance and consequent adjustment to the foreign entity should only be in exceptional cases.

Double economic taxation: The TP regulations in India are anti-abuse provisions and the purpose of introducing the same is to avoid shifting of profits from India to another tax jurisdiction. However, in the case of an adjustment in the hands of a foreign entity, an increase in income in the hands of the foreign entity does not automatically allow a corresponding increase in expenditure in the hands of the Indian entity.

This results in hardship to the taxpayer, as it leads to double economic taxation, which can never be the goal of TP regulations. Such double taxation should be avoided on the grounds of equity, and hence the law should be amended to avoid such a scenario.

Centralised cost centres: Nearly every MNE group has regional or international centralised cost centres with the avid intention of taking advantage of scale, synergy, costs, etc. These costs will be pooled by a designated cost centre and allocated to various group members worldwide on the basis of a pertinent cost key on full cost basis or on cost plus appropriate mark-up.

These transactions need to be in accordance with the arm's length standard; however, no specific guidelines are currently available on the subject. Some more clarity is needed in this regard and the Indian Revenue authorities also need to factor in the business exigency for setting up such centralised cost centres by global companies.

Intangible benefits: Tax authorities insist on the benefits derived from above intra-group cost allocation, which may be difficult to substantiate considering that most of the benefits are intangible in nature. There is clearly a need for a more focused set of guidelines on this subject.

Attribution of profits to PE: The Central Board of Direct Taxes (CBDT) needs to give clarity on the subject of attribution of profits to permanent establishment (PE), especially on how the PE should correctly capture its economic substance so that the profits attributable to the PE are in sync with its functions performed, assets employed and risks assumed, so that further attribution of profits to the foreign enterprise may be obviated.

D. MURALI

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