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Tricky transfer pricing

Mohan R. Lavi | Updated on March 27, 2011

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Arriving at the appropriate arms length price is a complex task and broad guidelines as to the entities the tax officers can choose as comparatives would be of much help.

It is said that Death and Taxes are inevitable, but death does not get complicated every year. Adobe Systems India Pvt Ltd experienced the complications in transfer pricing law recently. They determined their arms length price (ALP) @ 14.96 per cent. The Transfer Pricing Officer (TPO) came out with a figure of 24.91 per cent. His population included three companies whose profits ranged from 91 per cent to 160 per cent.

When a visit to the Dispute Resolution Panel proved unsuccessful, Adobe approached the Tribunal who ruled that it would be improper to compare apples with oranges — an error that is common to many transfer pricing orders. Section 92C of the Income-Tax Act provides the procedure for computation of the arm's length price (ALP) for international taxation transactions.

Though different methods for computation of the ALP have been prescribed, it has been noticed that due to the sheer diversity and complexity of transactions, it is well-nigh impossible to arrive at the appropriate ALP and trigger-happy officers have been shooting orders computing ALP arbitrarily.

Rationalisation of provisions

The Memorandum to Budget 2011 contemplates “rationalisation” of the provisions relating to Transfer Pricing. Section 92C states that in case more than one price are determined by the chosen method, the arithmetical mean of these prices will be the ALP. The second proviso to Section 92C states that if the variation between the actual price of the transaction and the ALP as determined does not exceed 5 per cent of the actual price, then no adjustment need be made and the actual price shall be treated as the ALP.

The Memorandum explains that a fixed margin of 5 per cent across all segments of business activity and range of international transactions has outlived its utility and that with effect from April 1, 2012, the allowable variation will be such percentage as may be notified by the Government. The only thing certain in the above clarification is that it would be a percentage. Even if the percentage is fixed at 10, it would give TPOs the bandwidth to search for comparatives that would ensure the percentage exceeds 10.

Comparative entities

It would probably be more feasible to give broad guidelines as to the entities TPOs can choose as comparatives — percentages of turnover, gross and net margins, employee strength, working capital and such other business parameters vis-a-vis the entity under scrutiny. A smaller population would result in lesser variations and could assist in determining the appropriate ALP.

Section 92CA of the Income-Tax Act states that the TPO can determine the ALP in relation to an international transaction, which has been referred to him by the Assessing Officer. The Budget seeks to specifically provide that the jurisdiction of the TPO shall extend to the determination of the ALP in respect of other transactions noticed by him subsequently in the course of proceedings before him. These would be in addition to the TPO-referred transactions.

Currently, the TPO has powers under Section 131(1) and 133 (6) of the Income-Tax Act to summon or call for details for the purpose of inquiry or investigation into international transactions. Budget 2011 proposes to arm the TPO with the power of survey under Section 133A of the Act. Both these provisions hand over total power to the TPO in respect of an international transaction. Determining the ideal ALP involves getting the comparative entities right since the entity under scrutiny would have given its detailed TP report and a multitude of other information. Power to survey could result in unwelcome visits to gather information that in all probability would be with the Department.

Filing of return

The Budget proposes to extend the date of filing of the returns for transfer pricing cases from end-September to end-November. It acknowledges the fact that corporates find it difficult to get information before end-September and file the necessary forms. Clarity is needed on whether this would apply to all entities that enter into international transactions or it would apply to first-time filers only. With the DTC proposing an Advance Pricing Mechanism wherein the ALP would be fixed in advance for a few years, it remains to be seen if the extended period would be applicable in such cases too.

(The author is a Bangalore-based chartered accountant.)

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Published on March 25, 2011

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