TRANSFER PRICING the whole concept

CA Dhiraj Ramchandani (CA, M. com) (10823 Points)

04 May 2010

Transfer Pricing

Transfer pricing is the mechanism adopted by multinational Enterprises for valuing the goods and services traded with their Subsidiaries or Associate Companies abroad so as to lower taxes and to maximize profits. The yardstick for acceptance of such transfer pricing is the “Arms Length Price” which should represent the price charged in comparable transactions between independent parties, where price is not influenced by the relationship or business interest between the parties in the transaction. The Transfer Pricing policies of several countries are based on the OECD (Organization of Economic Cooperation and Development) Guidelines on the subject.

2. Transfer Pricing law has been enacted for Income Tax purposes in 2001 by amending the Income Tax Act, supplemented by Transfer Pricing Rules, which are broadly based on OECD Guidelines. While Article VII of the GATT and the WTO Agreement on Customs Valuation (ACV) do not refer explicitly to transfer pricing, in the case of related party transactions the Agreement indirectly accepts the arm’s length principle. The Customs Valuation Rules, 1988 (CVR) also provide for transaction value of identical / similar goods, deductive value and computed value methods which are similar to valuation methods in the Transfer Pricing Rules under the Income Tax Act. A paper concerning harmonization of Regulatory Controls under the Custom and Income Tax Laws is at Annexure ‘B’.

3. The Income tax and the Customs authorities are driven by diametrically opposite approaches to valuation in view of the conflicting interests involved for measuring the tax incidence. While the Income Tax authorities may seek to avoid diversion of profits to the exporting country by assessing lower transaction price on imports, the custom authorities would prefer to determine a higher transfer price to enhance customs revenue. It would, therefore be desirable to have a coordinated approach to valuation of imported goods in cases involving transfer pricing so that the same price is adopted for both purposes after necessary verification for authenticity.

4. The transfer pricing rules under the Income Tax treat enterprises as related even on the grounds of consumption of raw materials, dependence on patents, technology etc. whereas, the concept of relationship under CVR is limited. This difference between the CVR and transfer pricing rules could lead to one department treating the same transactions as between related parties and the other taking a contrary view. Thus, while customs may accept the declared price as at arm’s length, the tax authorities may not and may reduce the declared price. Harmonization of definition of related parties is a possible solution. However the definition of “related party” in Customs Valuation Rules (CVR) is based on the WTO definition in the ACV and cannot be revised at national level. There are certain common areas where the definitions are similar and the coordination between the two departments could focus on these areas.

5. In order to circumvent transfer pricing provisions, certain taxpayers structure international Transactions between group companies by involving a third party. In order to plug this loophole, Section 92B(2) in the lncome Tax Act was introduced. The Customs Valuation Rules could be amended to take care of this situation.

6. Income Tax and Customs officials proceed independently to establish arm’s length valuations in related-party import transactions. This may lead to different results which may be far from reality. Legislative action and agency cooperation should create an environment in which the Income tax and Customs authorities can coordinate import valuations as a unified force. In USA, Section 1059A has been introduced to prevent a U.S. importer from jeopardizing the government revenue by valuing merchandise inconsistently for customs and income tax purposes. Under section 1059A, importers are barred from declaring a transfer price that exceeds the value declared for Customs valuation purposes. In USA, the IRS and Customs have executed a document entitled “Working Arrangement for Mutual Assistance and Exchange of Information Between the U.S. Department of the Treasury U.S. Customs Service and the Internal Revenue Service Regarding International Compliance and Importation lssues “ (the “Mutual Assistance Agreement” ) that is designed to facilitate communication and cooperation between the agencies. A similar legal basis could be introduced to harmonize the Income tax and Customs approaches in India also

7. The Documentation requirements under Income Tax Transfer Pricing Rule 10D are quite exhaustive. The documentation requirements under the Customs Act, (Valuation Rules) are however not specific. In case of an adjustment of import valuation by Customs or Income tax, the importer should be obliged to disclose such adjustments to the other department. As there is no such provision in the law as of now, suitable amendments could be made. Transfer pricing documentation including Cost Accountants certificate submitted to Income Tax Authorities could also be mandatory for submission to the Customs department handling special valuation (SVB) cases of related party transactions.

8. For effective administration of transfer pricing policies, a very comprehensive Database is required. There are several databases available with Income Tax and Customs departments, each of which provides information of a niche area. Some of the Databases/Information resources maintained by Customs Department are NIDB (National Import Database), Export Commodity Database (ECDB), Special Valuation Branch Database(SVB), Valuation instructions Valuation Alerts and the Valuation Bulletin. Similar databases will be available in the Income Tax department. Sharing information contained in these databases would be beneficial to both the departments in taking considered decisions as Transfer Pricing questions.

9. Transfer Pricing under the Income Tax Act is administered by the Directorate General of Transfer Pricing in the Income Tax Dept. In the Customs Department, the Special Valuation Branch (SVB) presently functioning at major customs stations (Mumbai, Delhi, Chenna, Bangalore, Kolkata) examine the relationship based imports which include Transfer Pricing. For effective coordination between Customs & Income Tax Departments, it would be necessary to bring the SVBs under a single authority. Directorate General of Valuation which is handling all Customs valuation related matters is best suited or the purpose. This would also facilitate sharing of data bases maintained by the Customs Department and Income Tax Department.

10. Income Tax and Customs Departments may also exchange data regarding adjustments/revisions made during assessments for uniformity in approach. It is also desirable to have joint action plan in important areas such as valuation rulings, documentation, and audit controls for effective coordination over the Transfer Pricing controls of Multinational Enterprises. These would also reduce transaction costs to the trade. Joint programme for training of officers on the Income Tax and Customs Laws relating to transfer pricing is also recommended.

11. Finally, an institutional mechanism for harmonization and coordination of transfer pricing matters between Income Tax and Customs departments with adequate legal backing is desirable.

12. This issue was discussed at length Chief Commissioner’s Conference on 1-10-05 and the relevant extract of the Minutes of Meeting is given in the Annexure A. This issue was again discussed in the Board meeting on 28.11.2005 and the Board has directed that a committee consisting of the DG, Valuation and Chief Commissioners of Customs, New Delhi, Mumbai – I, Kolkata, Chennai would consider the following issues arising in this area and submit its report with in a period of one month. (i) Strengthening the SVB branch of Customs House on transfer pricing (ii) whether SVB should be brought under the control of single authority like DG of Valuation (iii) nomination of DG, Valuation as nodal agency to study the basis followed by Income Tax department in its legislation and study the administrative and institutional arrangements in handling transfer pricing work and for interaction with the IT department.

13. The DGOV has contacted Income tax Dept and studied about relevant provisions of I.T. Act dealing with Transfer Pricing, the details of which are given below:

13A. Transfer Pricing under I.T. Law. & Relevant Provisions of I.T. Act

The Income Tax Act was amended in the Finance Act, 2001, to incorporate suitable provisions in sections 92 to 92 F, and section 27 so as to regulate Transfer Pricing. These were broadly based on the OECD guidelines. Supplementary provisions in Income Tax Rules were incorporated to prescribe the procedures on Transfer Pricing controls.

A summary of these legal provisions is given below:

Section	What it provides
92	Computation of Income from International transactions involving transfer pricing having regard to ''Arm’s length price''
92A	Meaning of ''Associated Enterprise''
92B	Meaning of ''International Transaction''
92C	Computation of ''Arm’s Length Price''
92CA	Reference to Transfer Pricing Officer
92D	Maintenance of Documents and Information
92E	Requirement of Audit Report
92F	Important Definitions.
271(1)(C)	Adjustment to income on account of Transfer Pricing Provisions to be regarded as concealed Income.
271AA	Penalty for failure to keep and maintain information and documents
271BA	Penalty for failure to furnish Audit Report
271G	Penalty for failure to furnish information or documents
Rules
10A	Meaning of expression used in computation of ''Arm’s Length Price''
10B	Determination of ''Arm’s Length Price’ under section 92C
10C	Most Appropriate Method
10D	Information and Documents to be kept and maintained under section 92D
10E	Report from an Accountant to be furnished under section 92E

The new regulation requires that "international transaction" between "associated enterprises" should be at an "arm's length price." International transaction is defined to mean a transaction between two (or more) associated enterprises that has a bearing on the profits, income, losses or assets of such enterprises. Associated Enterprises have been defined to cover those having direct/indirect participation in the management, control or capital of one enterprise by another enterprise. Section 92 of the Income tax Act states that "Any income arising from an international transaction shall be computed having regard to the arm's length price". “Arm's length price” is defined as a price, which is applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.

13B. Organization Setup:

The organizational set up in Income Tax Department for dealing Transfer Pricing is as follows:-

INTERNATIONAL TAXATION AND TRANSFER PRICING

DIRECTORS IT TP

MUMBAI CHENNAI BANGALORE DELHI

The Director Income tax Transfer Pricing in Mumbai is assisted by two Additional Directors. In 2004 – 2005, the Mumbai Transfer Pricing division has received 700 cases of Transfer Pricing.

As per CBDT instruction No.3 of 2003 dated 25/03 wherever the aggregate value of international transaction exceeds Rs.5 crores the case is transferred by the regular jurisdictional assessing officer to the Transfer Pricing Officer (TPO). The cases are transferred by the jurisdiction assessing officer along with Form No.3CED. After receipt of documents from the jurisdictional assessing officer, the TPO calls for details from the assessee under Section 92CA(1) of IT Act, 1961 in a detailed proforma. The TPO offers personal hearing to the assessee under Section 92CA(2) of IT Act, 1961. In the personal hearing, the assessee is given an opportunity to justify how the prices at arms length. After studying of the documents given by the assessee and the submissions made by the assessee in the personal hearing, the TPO brings out draft order. The draft copy of the order is sent to Director IT Transfer Pricing for his approval. After his approval, formal order is issued Under Section 92CA(3) of IT act, 1961. A copy of formal order is sent to the jurisdictional assessing officer and a copy is also marked to the assessee. Till the receipt of this order, the jurisdictional assessing officer holds the assessment and after receipt of TP order he issues payment notice to the assessee.