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S. C. Mishra

S. C. Mishra on the law relating to transfer pricing

THE European explorers opened the trade routes and from trading to empire building was merely a rite of passage. The first multinational enterprise (MNE) was born when Queen Elizabeth granted, on December 15, 1599, a charter of incorporation to the East India Company to trade in the markets of the East. In 1757, Robert Clive, leading the forces of East India Company, defeated the rulers of Bengal. This paved the way for the transition from Company Raj to British Raj. With colonisation of the rest of the world by the British and other European powers, the process of globalisation of the national economies had been initiated.

The growing influence of the British in forging unequal commercial and financial relations with the Indians would not have been possible in an open market. Later, the industrial revolution in the eighteenth century was more profitable to the Empire with the underpriced import of raw materials from India and other colonies along with overpriced export of finished goods from England. This process culminated in the Sterling companies acquiring a stranglehold over all the sectors of Indian economy during the nineteenth century. This resulted not merely in the transfer of wealth from India to England but also helped to unshackle the spirit of enterprise of the Indians.

Guiding principles in fiscal enactments: Thus, under every fiscal enactment, the transaction between associated or related persons or enterprises are not always accepted at their face value for the purposes of levying any duty or tax unless price is the sole consideration for the transactions and the price is not influenced by factors which are not commercial and financial. The silver thread of the arm's length price or market price or ordinary price or reasonable price runs through all such enactments so as to prevent the erosion of the tax or the duty base.

Unique character of intangibles: A major part of the intra-group transfers within an MNE is that of the intangibles and the services. The traditional tools of measurement of arm's length price often prove to be inadequate in examining the comparability of such transactions. The reason for the same is because of the unique character of intangibles, the information is scarce on comparable properties or arrangements. The US Regulations give the `commensurate with income' concept. However, determining the future economic value of an invention that has been patented or a registered design relating to a class of goods or a trademark or a brand name of a consumer product or the copyright of a cinematograph film or a computer programme can take one to the realm of speculation.

Guidelines for exercise of powers under Section 92C(3): In the light of settled legal position in respect of the aforesaid provisions, certain specific guidelines emerge for the exercise of powers under Section 92C(3). What is basic is that the assessing officer or the transfer pricing officer has to relate his determination of transfer price (TP) to the evidence or material brought on record by him.

The information in possession of the aforesaid officer for invoking these provisions has to be some valid, definite information and not any imaginary information. It will mean instruction or knowledge derived from an internal or external source concerning facts or particulars or as to law relating to transfer pricing. It must be derived from an authentic source, it must be precise and certain and it must have relation to the documentation of transfer price to infer that the price charged for an international transaction has not been determined by the most appropriate method.

Documentation: The foundation for determination of arm's length price, whether by the taxpayer or the tax administration, is documentation. The formulation of transfer pricing policy by any MNE group requires also the designing of management information system for implementation, internal audit and review of the policy.

Documentation as evidence to discharge burden of proof: It is not always recognised that in the event of a case being taken up for audit by the tax administration, contemporaneous documentation is the only basis for the taxpayer to establish that the pricing of international transactions were at arm's length. Moreover, for speedy resolution of transfer pricing disputes, adequate documentation is the basic resource.

It is not enough that international transactions have been entered into at arm's length prices. It is also necessary that contemporaneous documentation establishes such pricing. The legal requirements of documentation are linked with burden of proof to establish arm's length pricing, the failure of which will result in levy of penalty.

Curbing globalisation of tax frauds: The transfer pricing rules, essentially, seek to defend the interests of honest taxpayers and to ensure that investment decisions are not distorted by tax considerations. The process of gradual global integration because of the movement of goods and services across the Mother Earth is certainly removing the barriers to economic choices. But this process has also created unlimited choices and devices for hiding the income and capital from the tax and other enforcement authorities.

While globalisation has contributed to the strengthening of institutions, which are engaged in changing the lives of the underprivileged by enhancing their welfare, its raw market philosophy poses grave problems for the society and the enforcement agencies of the governments. On the one hand, the economic barriers are being removed and, on the other, new avenues for illegal activities, including tax frauds and money laundering, are being opened. The money launderers have their own global village. This dark side of globalisation may direct the trade and investment flows to destinations, which the law abiding do not seek.

The search for the perfect global market may prove to be elusive if there is no convergence in the international efforts to counter the globalisation of tax frauds, cyber laundering and other such illegal activities. The transfer pricing rules represent one such effort.

(Edited extracts from Transfer Pricing Manual. Courtesy: Law Publishing House, Allahabad. www.lphouse.com)

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