With the new amendment, the Transfer Pricing law has become more stringent, nevertheless much more remains to be done in terms of regulating the profits of multinational enterprises.


The tax authorities are now paying more attention to strengthening the transfer pricing mechanism. Chapter X of the ITAct, 1961, laid a comprehensive law in this regard. The special provisions relating to avoidance of tax laid down that where a business is carried on between a resident and a non-resident, and it appears to the Assessing Officer that owing to the close connection between them, the course of business is so arranged that the business transacted between them produced to the resident either no profits or less than the ordinary profits, which might be expected to arise in that business, the Assessing Officer shall determine the amount of profits that may reasonably be deemed to have been derived from the transaction and the amount of reasonably deemed profits shall be included in the total income of the resident.

The provisions of Section 92 applied only to a resident taxpayer. A non-resident taxpayer is governed by the provisions of Sections 9(1)(i); 160 (1)(i); and 163. The income of a non-resident covered all income accruing or arising through or from any business connection in India, or through or from any asset or source of income situated in India or through an agent in India. If the transaction between the resident and the non-resident is not based on the arm's length principle, profits will have to be determined as per Rule 10.

Section 92C provides for computation of the arm's length price. In relation to an international transaction, it is laid down that this shall be determined by the comparable uncontrolled price method, or resale price method or cost plus method or profits split method or transactional net margin method or any other method that may be prescribed by the Central Board of Direct Taxes.

Supposing in a case the Assessing Officer applies the arm's length principle and arrives at a profit higher than what is declared in the return, proviso to Section 92C(4) lays down certain limitations on the computation of income. If the income as computed finally by the Assessing Officer is higher than that declared by the assessee, then, no deduction will be allowed in respect of profits arising from the newly established undertakings in the free trade zone as per Section 10A.

Nor will deduction be allowed in respect of profits arising from newly established 100per cent export-oriented undertakings as per Section 10B. The denial of these special deductions will relate to the difference between the income declared and that finally determined as per the arm's length principle.

But, then, should not the same principle apply in respect of deduction due on profits and gains derived from exports in the newly established units in the Special Economic Zones? Parliament enacted the Special Economic Zones Act in June 2005. The Second Schedule to the Act made modifications to the Income-Tax Act, 1961, and inserted Section 10AA, making special provisions in respect of newly established units in SEZs. Profits derived from exports of such units are exempted. What applies to export profits under Section 10A and 10B should, therefore, automatically apply to profits derived from exports in the SEZs.

Amendment tightens the string

To rationalise the provisions of Section 92C(4), the Finance Act, 2006 amends the first proviso to Section 92C(4) and declares that no deduction under Section 10AA shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced by resorting to the arm's length principle.

There are two issues about this amendment. First, the amendment applies from the Assessment Year 2007-2008. It, therefore, implies that up to 2006-07, the difference in profits arrived at by the arm's length principle will continue to enjoy the benefits denied from next assessment on. The CBDT will have to confirm this position.

Second, the IT Act and the Sea Customs Act appear to beworking at cross purposes with regard to the Transfer Pricing Law.

In one case, TP adjustments were made in the income-tax assessments alleging over pricing of components imported from an associate enterprise in Japan. Disputing the TP adjustment on pricing of components, a top executive of the company pointed out that if the allegation of overpricing of components is true, then the company must get the Customs duty refund. There is need for harmonising TP regulations under both the laws.

Lot more needs to be done

Much more remains to be done with regard to the TP Lawregulating the profits of multinational enterprises. For example, attribution of income to a permanent establishment (PE) applying the arm's length principle poses problems in the application of the TP methodology. Again, computation of profits by the arm's length principle quite often requires comparison with similar cases of multinationals engaged in similar ventures.

Data collected by the Transfer Pricing Officer will have to be put to the assessee company.

Will there be a violation of the secrecy provisions of the law? Probably principles of natural justice will come into play and public interest will have to be taken into account.

These and other issues will have to be addressed immediately as the law develops with regard to transfer pricing.

(The author is a former Chief Commissioner of Income-Tax.)

(This article was published in the Business Line print edition dated June 3, 2006)
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