Crackdown on transfer pricing

Some significant amendments in the existing provisions of Indian transfer pricing (TP) law are on the cards. The Finance Bill, 2012, proposes to apply existing transfer pricing provisions on certain specified domestic transactions. This is a significant change, underscoring the shift in tone of the tax policy towards anti-avoidance measures.

TP REGULATIONS

The existing Indian TP regulations, which came into force a decade ago, are designed to primarily cover transactions between a resident and a non-resident. In order to ensure that the international transactions between associated enterprises are at arm's length, there are reporting and detailed documentation requirements, which a taxpayer must maintain to avoid stringent penalties.

A domestic transaction — a transaction between two tax residents of India — was not specifically covered under the transfer pricing provisions till now. However, the Finance Bill, 2012, seeks to expand the ambit of Indian transfer pricing legislation by specifying certain domestic transactions where the transfer pricing provisions are proposed to be applied. An examination of the specified sections elucidates that the Finance Bill intends to cover transactions where the taxpayer can possibly contemplate manipulation of prices to achieve a lower tax outflow.

For instance, manipulation of prices could result in shifting of profits between a loss-making entity and a profit-making entity, so as to achieve an overall reduced tax rate.

DOMESTIC TRANSACTIONS

The Supreme Court, in Commissioner of Income tax-IV, Delhi Vs M/s Glaxo Smithkline Asia (P) Ltd , alluded to the possibility of profit shifting in domestic transactions and suggested that the Ministry of Finance could consider bringing in legislation similar to the transfer pricing rules to help the tax officers in applying provisions governing transactions between related parties at a domestic level. The Ministry of Finance has paid heed to the suggestion of the Court. This has been acknowledged in the memorandum explaining the Bill which explains the rationale behind this introduction.

The move could, however, misfire. It is true that there may be avenues of profit-shifting domestically; however, with most of the profit-based deductions having been phased out or set to expire, the leakages, if any, get plugged anyway. So then, is the solution going to be a bigger headache than the problem itself?

It could well be, if one were to look at the increase in the administrative burden for the revenue authorities themselves. The expansion in scope of transfer pricing requires more resources or increased pressure on existing resources. There is an attempt to mitigate this burden by prescribing a threshold monetary limit of Rs 50 million for the specified domestic transactions. However, there would still be an increase in the administrative burden of the officers in the tax department.

That apart, one needs to factor in the compliance cost and burden put on the taxpayer itself. India is not considered a taxpayer-friendly jurisdiction because of the complicated legislation and its aggressive implementation. The responsibility on the taxpayer to demonstrate the correctness of tax declaration leads to a significant cost of compliance. Viewed from a cost-benefit perspective, the proposed change might do little to augment the coffers of the treasury. The proposal can perhaps be justified as being part of a larger policy initiative to curb tax avoidance. But you don't kill a bee with a bomb.

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