The sharp increase in these tax claims comes at a time when observers say the increasing tax scrutiny in Asian economies is slowing the pace at which multinationals expand their business in the continent. Over half (53%) of multinationals in Asia believe their expansion plans have been curbed by overzealous tax authorities, said a survey based on interviews of CFOs done by tax consultancy firm Taxand.
The government intensely scrutinises the price at which the Indian arm of a global firm trades in goods or services with its parent called the transfer price in order to prevent companies from showing lesser taxable income here by way of underpricing of goods or services sold or overpricing of purchases. The idea is to prevent shipping of profits to a low-tax country.
The tax claim made last fiscal pertains to assessment year 2008-09 as transfer pricing audit typically happens with a lag of about 30 months. In 2010-11, the Income Tax Department had held that the taxable income of Indian units of MNCs was Rs 24,111 crore ($4.3 billion) more than what companies had declared as their income. That assessment, of course, led to higher tax liabilities and ended up in income-tax tribunals.
Figures also show that Indian tax authorities are using all their wits to ensure that most of the audited cross-border transactions between MNCs and local arms result in a price adjustment and tax claim. In fact, in the 2011-12 audit, every other transaction examined led to a tax claim, a far cry from the situation five years ago, when only one in four had led to a transfer price adjustment and tax notice.
Rahul K Mitra, PwCs national leader, transfer pricing, believes a combination of reasons has led to this escalation in transfer pricing disputes.
The unique method India uses for arriving at the arm's length price of a transaction, aggressive enforcement of transfer pricing rules by the authorities and the lack of proper documentation and homework by companies have led to the sharp increase in transfer pricing disputes, said Mitra. The Rangachari panel that looked into the issue of transfer pricing as well as taxation of development centres and the information technology sector may however, lead to a more friendly policy regime.
The aggressive enforcement of transfer pricing rules by India is making the country's trade partners uncomfortable as higher income of the Indian arm means a corresponding business expenditure deduction and lower taxable income of the global parent in another country, where the authorities stand to lose their revenue. In fact, the way India calculates the arm's length price of a transaction between the Indian and foreign arms of an MNC, which is used as a benchmark to calculate transfer price adjustments, is biased towards arriving at a higher income for the Indian subsidiary and corresponding higher tax liability, accuse both companies and tax advisers. If that claim is true, it results in double taxation because the US, UK and OECD countries follow a different way of calculating arm's length price.
India recently introduced a procedure for tax authorities here and their counterparts in other countries where an MNC has a presence arrive at a consensus on the right transfer price on a transaction. International experts say that is not helping much as the Indian authorities approach the talks with little willingness to compromise.