Finance Minister Arun Jaitley has proposed to increase the threshold for application of transfer pricing for domestic companies from ₹5 crore to ₹20 crore.

This increase is expected to bring respite to small and medium enterprises (SMEs).

It will also ease the administrative burden on revenue authorities, relieving from auditing low value transactions.

Domestic transfer pricing was introduced in Budget 2012-13. This amendment had brought within the ambit of transfer pricing domestic taxpayers who engaged in specified domestic transactions (SDT) with certain specified associated enterprises.

Introducing objectivity

The backdrop to bringing SDT within the ambit of TP regulations was that it would provide objectivity in determining income from domestic related party transactions and reasonableness of expenditure between related domestic parties. It was intended to create a legally enforceable obligation on taxpayers to maintain proper transfer pricing documentation.

Two types of transactions that required the assessing officer to compute their fair market value without any prescribed methodology for the same were brought within the ambit of TP regulations.

One is section 40A of the Act which empowers the AO to disallow unreasonable expenditure incurred between related parties. The other is, chapter VI-A and section 10AA, where the AO is empowered to re-compute the income (based on fair market value) of the undertaking to which profit-linked deduction is provided if there are transactions with the related parties or other undertakings of the same entity.

Higher burden

The threshold for compliance for domestic transfer pricing was a mere ₹5 crore computed as the aggregate of the value of SDTs entered into during the financial year. This significantly increased the compliance burden on SMEs that had to put in place detailed and mandatory transfer pricing documentation as well as obtain certification of SDTs from a chartered accountant. The increase in threshold will also have a positive impact on taxpayers whose only SDT is payment of remuneration to director(s).

Remuneration commanded by directors is a function of multiple factors such as the specific skill sets of the individual, the objectives that he/she is tasked with achieving in the company, availability of similarly skilled people and so on.

All these factors do not result in application of any of the six transfer pricing methods available in the regulations, thereby reducing the TP compliance to a mere formality.

While there is significant merit in applying the TP regulations to SDTs, which provide tax arbitrage opportunities to taxpayers such as over invoicing in a tax holiday undertaking, one of the significant drawbacks of the TP compliances to SDT is that it does not distinguish between revenue neutral transactions.

Let’s take the example of Company A, which avails business support services from its associated enterprise Company B for a sum of ₹1,00,000; both companies are fully taxable not availing any tax holidays or setoff of losses. Company A will claim a deduction of ₹1,00,000 while Company B will offer the same amount to tax.

The net result of both the companies’ taxes in such a case is nil and thereby revenue neutral. In such a case, even if the value of services is determined to be lower at, say, ₹80,000, there is no tax leakage to the exchequer.

Owing to this there is y more room for rationalisation of application of transfer pricing regulations to revenue neutral SDTs.

The writer is partner, Grant Thornton India LLP

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