Tax caFe: The dawn of a new era

Updated: Aug 8 2014, 06:02am hrs
Transfer-pricing (TP) has been a contentious area and subject to protracted litigation. Increased transparency, greater clarity, administrative reforms and the overhaul of dispute resolution mechanisms have been the new governments priorities in reducing TP litigation, restoring investor confidence and increasing Indias attractiveness as an investment jurisdiction. Key changes have been introduced in the Union Budget in the area of TP.

Advance pricing agreements (APAs), which are generally valid for a period of five years, have allowed Indian taxpayers to proactively achieve greater certainty on their TP methods with one or more of the tax authorities. A roll-back mechanism has been introduced to deal with arms length price (ALP) issues relating to transactions entered into during the period prior to APA filing. APAs can now also have retrospective effect to cover up to the four years prior to the first prospective year covered under the APA, provided the facts and circumstances of international transactions are similar.

APAs filed being applicable for FY16 onwards may be rolled back as far as FY12. This could enable taxpayers to attain certainty in their transfer prices for international transactions occurring over a period of up to nine years in total (FY12 to FY20). The roll-back option will help taxpayers to conclude open litigation matters peacefully. It would be applicable to APAs signed after October 1, 2014, where the APA specifically recites about its applicability for roll back for the past years.

The finance minister has introduced the globally accepted norms relating to the determination of ALP. They may reduce litigation around the issue of comparability/benchmarking analysis. The range concept, though not reflected in the Finance Bill, may be subsequently introduced through rules/circulars or at the time of enactment of the Finance Bill.

ALP is determined as the arithmetic mean of the range of margins. No comparable companies achieve a perfect level of comparability with the taxpayer so as to transact at the same price or earn the same margin, which has led to manifold tax disputes. The adoption of the internationally-accepted concept of range, which includes a sizeable number of comparables, will provide clarity on this issue and reduce disputes at the first level of assessment.

The use of multiple-year data (instead of single-year) should be allowed for comparability analysis. The detailed rules in this regard will be announced subsequently.

TP rules provide that only contemporaneous data should be considered as far as possible for the purpose of comparing an uncontrolled transaction with an international transaction. But prices/margins in a particular year may be affected due to various economic factors that can have a material effect on TP conditions.

Further, TPOs use current-year data available at the time of TP assessments (generally three years after the closure of a financial year). This creates an additional financial and compliance burden and causes uncertainty for taxpayers, as the mandatory documentation compliance exercise, relating to the return filing date, is rendered futile. These issues may now be addressed through the use of multiple-year data, which is a more reliable approach.

The finance minister has expressed the need for India to converge its accounting standards with the International Financial Reporting Standards (IFRS) and talked about the voluntary adoption of new Indian Accounting Standards (IND-AS) by Indian companies from FY16 and their compulsory adoption from FY17. However, every change brings with it challenges as well as benefits. The same is true of the implementation of IND-AS. The convergence will pose certain challenges from a TP perspective, because of the accounting differences between the current Indian Generally Accepted Accounting Principles (IGAAP) and IND-AS. Some of the key differences relating to the following areas are (1) revenue versus expense recognition; (2) expense versus capitalisation; (3) debt versus equity classification; and (4) valuationsfair value assessment.

The key TP challenges on implementation of IND-AS will impact (1) comparability analysis; (2) computation of Berry ratio for benchmarking limited risk distributors; (3) existing TP policies; (4) cost-sharing arrangements; (5) entity characterisation at the time of valuation of intangibles in business combinations; and (6) impact on global compliance cost and use of the profit-split method.

A positive outcome of alignment with IFRS is that the government has, advertently or inadvertently, given the statistical flexibility to address them by introducing the range concept for determination of ALP and the use of multiple-year data for comparability analysis.

It seems things are moving in a positive direction in TP under the new regime, instead of being bogged down and preoccupied with unwarranted and never-ending litigation around comparability analysis. The approach of the government in this Budget focused on rationalising the TP regulations, providing certainty and reducing litigation, which is expected to improve the confidence of the taxpayers and the investors to conduct business in India. The Budget has provided the requisite momentum and has set the right path to accelerate Indias growth story and marks the dawn of a new era in TP legislation history.

(With inputs from Shruti Kothari, assistant manager,

Price Waterhouse & Co)

Rahul K Mitra is partner and Aditya Hans is senior manager, Price Waterhouse & Co