After nearly a decade of introducing transfer pricing (TP) regulations, the Government has proposed several changes/additions.
The recent Budget proposed is welcome for the proposed introduction of the Advance Pricing Agreement programme on the one hand. On the other hand, it contains several riddles to be solved by taxpayers. We discuss some of the significant changes proposed by the Finance Bill, 2012 (FB 2012).
Disputes management
Taking the Indian TP regime to the next stage of its evolution is the proposed introduction of the much-awaited Advance Pricing Agreements (APA).
As we wait for further clarity on whether it would cover both bilateral and unilateral APAs, if a roll-back would be allowed the Government's initiative to allow the taxpayer to adopt any method beyond the five prescribed methods showcases its willingness and maturity to appreciate the level of flexibility that may be required while negotiating APAs. Further, the budget has removed one of the main constraints faced earlier by the Dispute Resolution Panel (DRP) by giving the Assessing Officer (AO) an equal opportunity to appeal against the ruling of the DRP. Considering the collective wisdom of three senior tax officials in the DRP, it is expected that this would result in a speedy resolution of TP disputes.
International transactions
Another significant change is the inclusion of certain domestic transactions under the purview of TP regulations.
With this inclusion, the principles of arm's length price, as enshrined in the TP regulations would squarely apply to the ‘specified domestic transactions'.
This would make sure that profits are not arbitrarily shifted within group companies. However, with domestic transaction now under the ambit of TP regulations, economic double taxation is a possibility.
The Government has also clarified the definitions of ‘international transactions' and ‘intangibles' retrospectively with effect from FY 2001-02. ‘International transactions' now specifically include corporate guarantees, transfer of intangibles, deferred payments; and specifically includes business restructuring regardless of their effects on the profits or assets of a business.
‘Intangibles' has been clarified to include intangible relating to marketing, technology, contracts, human capital, location, goodwill, among others.
As a result, transfers of skilled resources from Indian captives to group companies for onsite projects would be considered an international transaction and, therefore, require an arm's length price.
Arm's length
Arm's length range: 5 per cent to “uncertainty” to a limit of 3 per cent
Since its inception, Indian TP regulations peculiarly do not follow the inter-quartile range. Instead it embraces the concept of arithmetic mean as a measure of central tendency.
Originally, the TP regulations contained a provision allowing taxpayers to transact at prices differing from the arm's length prices by 5 per cent. Effective April 1, 2011, this provision was to be replaced by industry-wise specific ranges, which are yet to be prescribed.
However, in Finance Bill 2012, the Government has proposed that any such range, to be announced by the Board, will be limited to 3 per cent from the financial year commencing April 1, 2012. The arm's length range for financial year 2011-12 has been left unattended forcing the taxpayers to transact above the arithmetic mean, thus creating undue hardship for the taxpayers in concluding its March 2012 accounts.
Further, the Government has inserted a clarificatory note with retrospective effect from April 1, 2002 that the range prescribed is not to be treated as a standard deduction.
While the amendment appears to make sense, as even in other developed countries if a taxpayer's prices fall outside the inter-quartile range, an adjustment is made with reference to the median and not the lower quartile.
Staying ahead
The Finance Bill 2012, as far as TP is concerned, is a mixed bag. On the one hand, it significantly widens the TP net and provides increasing powers to the authorities, including retrospective amendments, going back to the inception of TP.
On the other hand, it has rationalised the constraints of the DRP process which should make it a robust mechanism, and further introduced an APA programme.
(The author is Executive Director, Tax & Regulatory Services, Price Waterhouse & Co. With inputs from Kunj Vaidya, Associate Director.)