Expanding scope of transfer pricing

The Budget 2012 contained major proposals to plug adverse practices of taxpayers. Among the various anti-abuse proposals, a significant proposition included extension of the transfer pricing regime to ‘specified domestic transactions'.

The proposal

It is proposed that from this fiscal year, taxpayers with specified domestic transactions exceeding Rs 5 crore will have to ensure that their intra-group transactions are carried out at arm's length.

While such anti-abusive measures exist in the current law, the proposal has gained importance owing to a shift in measuring the rationale of domestic related party transactions. Such transactions were earlier valued at a generic fair market value.

They will now have to be valued at a more specific and methodical arm's length price.

Transfer Pricing regulations shall be applicable to:

Expenditure paid or payable to a specified related party;

Taxpayers claiming undertaking specific deduction and

Units operating in Special Economic Zones and claiming deduction under Section 10AA.

The relations specified for the first category have an exceedingly far reach. For instance, it is common among larger corporate houses to have promoters of other bigger groups on their board as director or independent director.

By virtue of the new transfer pricing provisions, all dealings between the company and such other entities in which such director or independent director holds more than 20 per cent voting rights, would be required to be at arm's length. Extending transfer pricing provisions to units claiming tax holiday would bring a check on the pricing of intra-business/intra-unit transfer of goods and services, by an assessee.

The existing provisions restrict intra-business/intra-unit transfer of goods and services to be carried out at the value which such goods or services would have fetched in the open market.

Applying the arm's length price to such transfers would lead to a more accurate pricing.

Extraordinary profits

The current provisions give powers to the assessing officer to make adjustments if it appears that ‘more than ordinary profits' were earned by tax exempt businesses/units owing to its ‘close connection' with transacting parties.

It is a common practice for companies in IT and manufacturing industries to park excessive profits in tax-exempt units/businesses. However, justifying such excessive profits is relatively easier as per the current provisions. By applying arm's length principle, an imprecise concept of ‘more than ordinary profits' has suddenly started appearing more specific and certain.

Having said this, the ambiguity still remains as to the exact meaning of ‘close connections' between parties.

As it is evident, extension of domestic transfer pricing provisions has direct impact on various business activities eligible for claiming tax holiday like power generation and transmission, industrial park developers, infrastructure developers and operators, SEZ units, units claiming location based tax deductions, and so on. Further, the proposal is also set to impact the business houses with large intra-group transactions. These provisions also have some drawbacks — the most apparent one being the benchmarking requirement for remunerations paid to directors. If not implemented wisely, this could lead to unjustified hardship for already burdened taxpayers.

Further, the increase in compliance requirements in these provisions is a worry. This would involve identifying the related parties, the transactions with such related parties and then benchmarking such transactions to arrive at the arm's length price.

The transfer pricing officers are all set to apply their experience gained from assessing international transactions to specified domestic transactions as well. However, one hopes that the extension of transfer pricing provisions to specified domestic transactions does not create the same level of chaos as existing in assessment of transfer pricing for international transactions.

(The author is Associate Partner & Head of Transfer Pricing, Economic Laws Practice. The views are personal.)