Transfer pricing regulations introduced by countries around the world seek to arrest any form of arrangements entered into between entities which result in shifting of profits from one jurisdiction to another. Typically, such arrangements take the form of receipt or payments relating to goods, services, technology, financing, intangibles, etc., between entities located in various tax jurisdictions. In order to protect their tax base, countries, including India, have been using transfer pricing as a tool to ensure the income that should be rightfully taxed in their country through such cross-border transactions is brought to tax.

India introduced its own transfer pricing legislation in the 2001 through provisions in the Income-Tax Act, 1961. It aims to ensure that any income arising from international transactions between associated enterprises (AEs), that is, enterprises which have some form of relationship/control between them, either or both being non-residents, is carried out at an arm's length price (that is, market price).

The Finance Bill, 2012, has expanded the scope of the Indian transfer pricing provisions to cover certain “specified transactions” entered into within or between two domestic entities within India.

Misuse of incentives

The Indian Government has over the years focused on developing various sectors in India, such as power and infrastructure, by offering tax incentives. This has been done with a view to attract domestic as well as foreign investment in such sectors. Instances of such incentives include benefits provided under section 80IA, 80A and 10AA of the Act whereby entities carrying out certain qualifying activities enjoy partial or complete income tax exemption. However the fallout of such incentives is that they have sometimes been used to avoid taxes. This may result due to over-reporting of profits by the Indian entity which enjoys a tax holiday or over-reporting of profits in the tax-holiday unit within the same Indian entity.

The effect of such misuse is an erosion of India's income-tax base. Further, the proposals require domestic transactions involving payments to related persons to be reckoned with reference to the arm's length price. This would especially be relevant where losses are sought to be cushioned through expense allocations. The Government intends to plug these loopholes by bringing domestic transactions within the ambit of the transfer pricing legislation.

The Bill has, therefore, extended the application of the regulations to specified domestic party transactions. In proposing this amendment, the Finance Minister has followed the suggestion of the Supreme Court in the case of GlaxoSmithKline Asia (P) Ltd ( CIT v. Glaxo SmithKline Asia (P) Ltd, 2010-TII-02-SC-LB-T ) that it needs to be considered whether the regulations should be applied to domestic transactions in cases where such transactions are not revenue-neutral and have an impact on the tax base.

The proposed amendment of bringing such specified domestic transactions within the ambit of the regulations will be effective from April 1 next year and will, accordingly, apply in relation to assessment year 2013-14 (corresponding to the financial year 2012-13) and thereafter.

The transactions

The specified domestic party transactions would essentially include payment made by a company to a related person referred in Section 40A(2)(b) of the Act including payment to a director of the company or any person who has a substantial interest in the company (that is, has a beneficial ownership of shares carrying not less than 20 per cent of voting power); transactions referred to in Section 80A(6) of the Act (for example, transfer of goods or services from a tax-incentivised unit/entity to a non-tax-incentivised unit/entity and vice-versa); and transactions referred to in Section 80IA(8), 80IA(10) and 10AA(9) of the Act (carried out by industrial undertakings, infrastructure companies and units operating in special economic zones). Any taxpayer involved in transactions set out above would be required to file an Accountant's Report in Form 3CEB and maintain the prescribed transfer pricing documentation if the aggregate value of such specified domestic transactions during a financial year exceeds Rs 5 crore.

compliance burden

The proposed amendment, if enacted, is expected to increase the compliance burden for Indian taxpayers availing tax exemptions or having transactions with other related Indian enterprises or those that have several operating companies within India transacting with each other.

At the same time, taxpayers will need to substantiate that their intercompany transactions are at an arm's length price by maintaining robust supporting documentation. Given that the proposed amendment puts increased onus on taxpayers to demonstrate that their domestic party transactions are priced at arm's length, the revenue authorities ought to be judicious in applying these proposed provisions and also provide guidelines for assessment of such transactions during the course of revenue audits.

Rakesh Mishra is Executive Director, Transfer Pricing, Tax and Regulatory Services, PwC India.

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