Transfer Pricing (TP) Provisions were introduced in India by the Finance Act, 2001. The TP Provisions were introduced with an intent to protect India's right to collect a fair share of tax in respect of cross-border transactions. In simpler terms, TP provisions were introduced to ensure that an international transaction between two associated enterprises is made at arm's length price, so that both the countries involved get a proper share of profits in their respective jurisdiction.
Considerable time has elapsed since these provisions were introduced, but it appears that they are still at a nascent stage. Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD) recognises that "transfer pricing is not an exact science; it will not always be possible to determine the single correct arm's length price ….. Also the choice of methodology for establishing arm's length transfer pricing will not often be unambiguously clear. In a difficult transfer pricing situation, because of the complexity of the facts to be evaluated, even the best intentioned taxpayer can make an honest mistake. Moreover, even the best-intentioned tax examiner may draw the wrong conclusion from the facts."
In an area of uncertainty, tax authorities tend to take a view which is favourable to the revenue department. As a result, for the last many years, transfer pricing adjustments have been made in India which go to astronomical figures and the taxpayers have to face serious consequences.
Of late, the Central Board of Direct Taxes (CBDT) has come out with two circulars on transfer pricing.
The gist of the circulars is given below:
Application of profit split method (PSM) -
Circular No. 02/2013 dated March 26, 2013
Since there is no correlation between cost incurred on research and development (R&D) activities and return on an intangible developed through R&D activities, the use of transfer pricing methods (like the transactional net margin method) that seek to estimate the value of intangible based on cost of intangible development (R&D cost), plus a return, is generally discouraged.
In a case where the transfer pricing officer (TPO) is of the view that PSM cannot be applied to determine the arm's length price of international transactions involving intangibles due to non-availability of information and reliable data, he must record reasons for non-applicability of PSM before considering TNMM or comparable uncontrolled price method (CUP) as most appropriate method, depending upon facts and circumstances of the case.
TPO may consider TNMM or CUP method as appropriate method by selecting comparables engaged in development of intangibles in the same line of business and make upward adjustments taking into account transfer of intangibles without additional remuneration, location savings and location-specific advantages.
Contract R&D services with insignificant risk -
Circular No. 03/2013 dated 26.03.2013
There is divergence of views among field officers and taxpayers regarding the functional profile of development centres engaged in contract R&D services for the purposes of transfer pricing audit. Taxpayers insist that they are contract R&D service providers with insignificant risk. TPOs treat them as full or significant risk-bearing entities.
CBDT has clarified that a development centre in India may be treated as a contract R&D service provider with insignificant risk if the prescribed conditions are cumulatively complied with. The circular also lists the required conditions to be followed.The point to be appreciated is that the government has started looking into the problems which these circulars have depicted. Hopefully, some more clarifications will come out that will address the contentious TP issues.
It will not be out of place to mention that the ambiguous provisions relating to transfer pricing coupled with enormous authority and discretion vested in transfer pricing officers have led to an unbearable situation for taxpayers. The figures will speak for themselves. In FY 2011-12, it has been reported that adjustments have been made to the tune of Rs 44,5OO crore. It is also common knowledge that the institution of dispute resolution panel, which was specifically created to address the TP issues, has only added to the woes of taxpayers.
Therefore, it is strongly felt that CBDT should issue more clarifications on disputed and debatable issues, so that tax litigation is reduced to a reasonable level. This will certainly prove to be a positive step in attracting foreign investment to India.
The article has been co-authored by Alok Gupta
e-mail: hp.agrawal@sskmin.com
a.gupta@sskmin.com
Considerable time has elapsed since these provisions were introduced, but it appears that they are still at a nascent stage. Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD) recognises that "transfer pricing is not an exact science; it will not always be possible to determine the single correct arm's length price ….. Also the choice of methodology for establishing arm's length transfer pricing will not often be unambiguously clear. In a difficult transfer pricing situation, because of the complexity of the facts to be evaluated, even the best intentioned taxpayer can make an honest mistake. Moreover, even the best-intentioned tax examiner may draw the wrong conclusion from the facts."
In an area of uncertainty, tax authorities tend to take a view which is favourable to the revenue department. As a result, for the last many years, transfer pricing adjustments have been made in India which go to astronomical figures and the taxpayers have to face serious consequences.
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It is, therefore, essential that to the extent possible individual judgment should be curtailed so that taxpayers may not suffer and cordial relations prevail between government and foreign enterprises. However, no proficient effort has been made by the government so far to address the contentious issues faced by taxpayers.
Of late, the Central Board of Direct Taxes (CBDT) has come out with two circulars on transfer pricing.
The gist of the circulars is given below:
Application of profit split method (PSM) -
Circular No. 02/2013 dated March 26, 2013
Since there is no correlation between cost incurred on research and development (R&D) activities and return on an intangible developed through R&D activities, the use of transfer pricing methods (like the transactional net margin method) that seek to estimate the value of intangible based on cost of intangible development (R&D cost), plus a return, is generally discouraged.
In a case where the transfer pricing officer (TPO) is of the view that PSM cannot be applied to determine the arm's length price of international transactions involving intangibles due to non-availability of information and reliable data, he must record reasons for non-applicability of PSM before considering TNMM or comparable uncontrolled price method (CUP) as most appropriate method, depending upon facts and circumstances of the case.
TPO may consider TNMM or CUP method as appropriate method by selecting comparables engaged in development of intangibles in the same line of business and make upward adjustments taking into account transfer of intangibles without additional remuneration, location savings and location-specific advantages.
Contract R&D services with insignificant risk -
Circular No. 03/2013 dated 26.03.2013
There is divergence of views among field officers and taxpayers regarding the functional profile of development centres engaged in contract R&D services for the purposes of transfer pricing audit. Taxpayers insist that they are contract R&D service providers with insignificant risk. TPOs treat them as full or significant risk-bearing entities.
CBDT has clarified that a development centre in India may be treated as a contract R&D service provider with insignificant risk if the prescribed conditions are cumulatively complied with. The circular also lists the required conditions to be followed.The point to be appreciated is that the government has started looking into the problems which these circulars have depicted. Hopefully, some more clarifications will come out that will address the contentious TP issues.
It will not be out of place to mention that the ambiguous provisions relating to transfer pricing coupled with enormous authority and discretion vested in transfer pricing officers have led to an unbearable situation for taxpayers. The figures will speak for themselves. In FY 2011-12, it has been reported that adjustments have been made to the tune of Rs 44,5OO crore. It is also common knowledge that the institution of dispute resolution panel, which was specifically created to address the TP issues, has only added to the woes of taxpayers.
Therefore, it is strongly felt that CBDT should issue more clarifications on disputed and debatable issues, so that tax litigation is reduced to a reasonable level. This will certainly prove to be a positive step in attracting foreign investment to India.
The article has been co-authored by Alok Gupta
e-mail: hp.agrawal@sskmin.com
a.gupta@sskmin.com