he increasing participation of multi-national
groups in the economic activities of the country
has given rise to complex issues emerging from
transactions entered into between the enterprises
belonging to the same multi-national corporations.
The transactions between such enterprises are
recognised as ‘Transfer’ and price charged for such
transaction is termed as ‘Transfer Price’.
The multi-national groups are able to avoid/evade
tax by manipulating prices charged or paid in the
cases of transactions entered into with or between
their Associated Enterprises (AEs). In the A.Y.
2002-03, the Government of India introduced
transfer pricing provisions by inserting sections
92 to 92F in Chapter X of Income-tax Act, 1961.
Further, Rules 10B to 10E have also been inserted
in Income-tax Rules, 1962. These sections and
rules provide a scheme for computation of income
from international transactions in a fair manner
having regard to “Arm Length Price”. It is
worthwhile to have a brief introduction of these
sections and rules in order to understand the later
part of this paper:
92 Opening section of transfer pricing
norms
92A Meaning of Associated Enterprises
(AE)
92B Meaning of International
Transaction
92C, Rule 10B Computation of ALP
and Rule 10C
92CA Reference to Transfer Pricing
Officer
92D, Rule 10D Maintenance of records
92E, Rule 10E Report of Chartered Accountants
92F Definitions of ALP, Transaction
and Enterprise
Issues on Transfer Pricing
Ravi Sawana
The author is a student of ICAI (Reg.No. CRO-0206874)
A careful study of these provisions require that in
the case of an international transaction between
two or more associated enterprises, the income
shall be computed having regard to the ALP.
Precisely speaking, the computation of ALP
requires identification of comparables (i.e.
uncontrolled parties as well as uncontrolled
transactions) and suitable adjustments to such
comparable so as to arrive at a price which can be
applied in the international transaction.
Issues on Transfer Pricing
The concept of transfer pricing in the Indian tax
law is a relatively new concept and still in its
childhood. Hence, several issues arise in the
interpretation and application of these rules. Here
an attempt is being made to discuss some of the
important issues:
Definition of Associated Enterprises
(
a) Whether Section 92A(1) overrides Section
92A(2):
The definition of associated enterprises has
been given in Section 92A. The definition has been
given in two parts – first part being section 92A(1)
and second part being section 92A(2). While the
first part gives a general definition of AE, the
second part has specific clauses serially numbered
from (a) to (m) which prescribe a concrete
definition based on certain circumstances. Hence,
it can be a matter of debate and dispute as to which
part shall prevail. One possible view is that the
second part is merely to support the first part and
it does not control the scope of first part. The other
view can be that the second part controls the scope
of first part.
(b) Difficulties in interpretation of some clauses
of section 92A(2):
The thirteen clauses of Section
92A(2) are also prone to different interpretations.
For example - in clause (h), if 90% or more of the
raw materials and consumables required by one
enterprise are supplied by another enterprise, then
ARTICLE
10
May 2011 I The Chartered Accountant Student
two enterprises shall be deemed to the associated
enterprise. But the opening part for section 92A(2)
states that the two enterprises shall be AEs if there
exists any of the relationships as mentioned in
those thirteen clauses at any time during the
previous year. Thus, when clause (h) is read with
the opening part of section 92A (2) it creates a gross
confusion as to whether a particular transaction
should be of 90% or more, or aggregate of all
transactions during a previous year should be 90%
or more.
(c) Use of ‘directly’ or ‘indirectly’:
In section 92A
(1) as well as some of the clauses of section 92A
(2), the Parliament has used the words ‘directly’ or
‘indirectly’. The interpretation and extent of these
words is going to be a matter of gross dispute
between the assesses and the authorities.
Selection of comparables
(a) General
: - Although Rule 10B provides broad
evaluation criteria to be kept in mind while judging
comparability and the Organisation for Economic
Co-Operation and Development (OECD) guidelines
also provide detailed guidelines on comparability,
yet selection of comparable is one of the most
difficult tasks.
(b) Comparable enterprises:
While comparing
two companies in transfer pricing assessment, they
should be similar in business operations, industry
conditions, goods and services provided,
geographical locations
. But while selecting final
comparables, the classification has to be backed
up by the functional similarity of the companies.
In the recent cases, due importance has been given
to the functional analysis and adjustment to be
made in the comparable data to account for
differences in the risk profile of the companies.
Enterprises are using economic as well as statistical
tools for making risk adjustment. But clear
guidelines yet to be provided in this area.
(
c) Profit making Vs. Loss making enterprises:
Tax authorities are challenging selection of loss
making companies by the tax payer & the tax payer
in turn are challenging selection of high profitable
companies by the tax authorities, in computation
of arm length price. The companies engaged in
similar businesses, having similar business model
would be earning similar margins. The difference
in profitability may be due to several factors, for
example - risk profile, level of operations.
Hon’ble Pune Bench of Tribunal, in the case of Egain
Communication has held that companies earning
extraordinary profits should be examined and
necessary adjustment should be made to eliminate
the differences before accepting the comparable. But
if it is not possible to eliminate the differences, then
the company should be dropped.
The Delhi Bench of Tribunal in the case of Mentor
Graphics (Noida) Private Limited vs. DCIT ITA No.
1969/D/2006 has held that high loss making
companies should not be taken into account. If an
enterprise is incurring losses consistently, then the
company should be dropped from the list of
comparables. Tax authorities excluding high loss
making companies, should do the same thing for
high profit making companies.
(d) Comparable transactions:
In computation of
ALP, the controlled transaction between two
associated enterprises should be compared with
an uncontrolled transaction between two unrelated
parties. But it is very difficult to find enterprises
which do not have a single rupee transaction. Now,
how to identify related party transaction or how
to ascertain reasonable level of RPT? On the
reasonable level of RPT, there are conflicting views
given by tribunals. In some cases, 10-15%
transactions between associated enterprises will
not affect the profitability and in some cases, a
single rupee related party transaction should not
be ignored.
(e) Re-run of comparable search:
Transfer pricing
assessment is carried out after two to three years
from transfer pricing study. While conducting
transfer pricing assessment, tax authorities uses
latest data. Whereas, data used by companies differ
from data used by tax authorities, because there is
a time gap between transfer pricing studies done
by companies and transfer pricing assessment done
by tax authorities. This may be due to latest
developments, rules and regulations. So, necessary
adjustment should be made to taxpayer arm length
price on the basis of latest study.
Computation of Arm’s Length Price
(a) Multiple year data:
According to Rule 10B
(4), to eliminate cyclical changes, abnormality of
operations, enterprise should use multiple year
data. But they restrict the use of multiple year
data up to two years prior to financial year in
which the transaction was entered. The OECD
guidelines also support use of multiple year data.
But the revenue authorities are of the view that
earlier year data normally does not influence the
current year transaction. Most of the judicial
precedents also do not accept use of multiple year
data. So, proper guidelines to be provided to clear
the clouds of ambiguity.
ARTICLE
May 2011
I The Chartered Accountant Student 11
(b) Custom valuations:
In case of import of goods,
the valuation made by custom authorities differs
from valuation done by transfer pricing authorities.
Custom authorities value the goods at higher
prices, whereas for transfer pricing purpose, goods
are valued at lower prices, in order to check
reduction in profits. So whether the valuation
made by custom authorities can be taken for the
purpose of transfer pricing, is an issue of debate.
(c) Government Restrictions:
According to OECD
guidelines, arm length price must be adjusted to
account for government interventions such as price
controls, interest rate controls, control over
payment of management fees, royalties. U.S.
regulations also recognize importance of govt.
regulations in determination of ALP. The Indian
regulators also are of the view that govt restrictions
are factors which are to be considered while
determining ALP.
Some more problems
(a) Cost Contribution Arrangements:
Cost
contribution arrangement is a tool for achieving
efficiency when a firm is undertaking wide range
of activities. For the purpose of computation of ALP,
each participant’s share in cost should be
proportional to the benefit received by it. The tax
authorities are having the same view. But as there
are no proper guidelines regarding valuation of
benefit received. So, the taxpayer should maintain
proper documents in order to avoid significant
adjustment on cost allocations.
(b) Royalty Transactions:
Royalty transactions
between associated enterprises are getting
significant attention of the tax authorities in India.
Royalty payments are commonly benchmarked
through combined transaction approach which is
not acceptable by tax authorities. Practical
problems in benchmarking royalty transactions are
limitation of publicly available data, Valuation is
very costly. Tax authorities value royalty
transactions on transaction to transaction basis and
also require companies to furnish the relevant
documents. So proper guidelines needs to be given
in this area.
(c) Interest free loans:
It is a general practise in
case of group companies that they provide interest
free loans to each other and such transactions are
attracting the tax authorities. So in case, if an
Indian taxpayer provides an interest free loan to
its foreign subsidiary, then no income arises to
Indian taxpayer & to meet the ALP requirements
there must be income. So the transaction is not
subject to the transfer pricing regulations. The
authority of advance rulings is also of the same
view that TP regulations will not apply to those
international transactions, where no income
arises. But the tax authorities are taking a view
that under the normal course of business, no
lender will provide interest free loan to borrower.
Hence interest ought to be charged which should
meet the ALP requirements. Such view is being
supported by the Mumbai Tribunal in the case of
WF Limited. But the Delhi Tribunal in the case of
Perot Systems TSI (India) Ltd. Vs. DCIT Held that
TP regulations would not apply if there arises no
“Real Income”. Same view was taken in
Re Dana
Corporation (AAR)
where it was held that transfer
pricing provisions, not being in the nature of a
charging provision but being mere computation
provisions, could not apply when there was no
income.
(d) Foreign Tested Party:
For the purpose of
determination of ALP, one of the party from an
international transaction is taken as tested party.
Then the tested party transactions are compared
with another unrelated party, which is similar in
business model and operations, to establish the
transaction at the ALP. There is no clear provision
in India regarding selection of tested party. So even
a foreign company can be taken as tested party.
This is view is also supported by OECD transfer
pricing guidelines and U.S. transfer pricing
regulations. But in India, there are conflicting
decisions given by the tribunals. The Calcutta
tribunal has accepted the foreign corporation as
tested party. But Delhi tribunal in the case of Global
Vantage & Ranbaxy Laboratories has rejected the
foreign party as tested party. It’s a challenge to tax
authorities to accept a foreign entity as tested party.
Since they do not have access to global database
and information from publicly available database
are not frequently available.
Conclusion
The multinational enterprises will have to plan
their operations according to the provisions of
transfer pricing in India. But it is becoming very
critical for the companies to plan their operations
since the tax authorities may adopt a biased
approach rather than a realistic approach. Hence
proper provisions and guidelines need to be made
by the Government. Introduction of safe harbour
rules, mutual agreement procedure and proposed
advance pricing agreement in the direct tax code,
can be viewed as a concrete
CAclubindia
