Transfer pricing regulations leave a few questions unanswered

Hemal zobalia

With a reduction in Customs duty and increase in the Indian operations of multinational corporations, the tax authorities have become alive to the subject of transfer pricing policies. The insertion of sections 92 to 92F in the Income-Tax Act, 1961 (IT Act) and rules 10A to 10E is a significant step in the introduction of a formal transfer pricing (TP) regime in India.

Customs
The concept of TP was already present in the Customs Act in the form of Customs Valuation Rules. Under these rules, unless an exception applies, the ’Assessable Value’ is the invoice value (ie ’Transaction Value’). For customs duty, either the transaction value is accepted as the assessable value or the case is referred to the special valuation branch (SVB), which then determines the assessable value.

The issue is whether the assessable value determined under the Customs Act would be accepted by the IT department as an ’Arm’s Length Price’? There is no mandatory provision under the IT Act to this effect.

On September 7, 2001, the government has made two important amendments to the valuation rules vide notification no. 41/2001-NT. Firstly, the invoice value of imported goods shall be the transaction value, only if the customs officer has no reason to doubt the truth or accuracy of the value declared.

Secondly, rule 4(2) introduces four more conditions relating to sale being under competitive conditions and prices (ie no abnormal or special discounts) for acceptance of transaction value as assessable value.

The IT department may contend that customs authorities merely ensure that the import price is at least equal to the assessable value and in particular, customs authorities may not investigate whether the goods are overpriced.

However, it appears that the customs authorities’ acceptance of a transaction value could serve as documentation support for proving that it is an arm’s length price.

Especially because new proviso (a) to rule 4(2) specifically stipulated that the sale is in the ordinary course of trade under fully competitive conditions which implies that it is at arm’s length price.
Further, if the assessable value is determined by SVB, then it could act as a stronger support because the methods employed by SVB under Customs Act are similar to the ones under the IT Act.

In the event, the IT department arrives at an arm’s length price, which is different from the assessable value, can the customs authorities reopen their assessment and revalue the imports? As per the Customs Act, the authorities can reopen assessment within a period of 5 years provided there is concealment. Practically, the chances of reopening the case are remote because the objective of customs authorities and IT authorities are contrary.

FEMA
Under Foreign Exchange Management Act (FEMA), an issue could arise in case of imports, wherein the IT department determines an arm’s length price, which is lower than actual import price.

In such a case, it will be interesting to see whether RBI would take a stand that the Indian entity has overpaid and hence the excess amount paid by Indian entity should be brought back into India.

As per section 8 of FEMA, an Indian resident has to bring into India all foreign exchange amounts, which are due or accrued to him. The issue is whether an Indian resident has to bring into India, additional foreign exchange on account of an adjustment made by the IT authorities under TP regulations? Example: Indian company receives a royalty of Rs 100 from its foreign subsidiary. Under TP Regulations, the IT authorities determine that arm’s length royalty should be Rs 500. Is the Indian company liable to bring into India, the additional royalty of Rs.400? Broadly, the literal interpretation of the word ’due’ would mean the amount ’due’ as per contractual agreement and not the amount assessed by IT authorities which is determined long after the transaction is completed.

Currently, consultancy fees upto US$100,000 can be remitted abroad under automatic approval and for fees exceeding US$100,000, one has to apply to RBI, which may accept or reject the same. The issue is whether RBI approval is sufficient confirmation that the transaction is at arm’s length? Though there is no mandatory provision under the IT Act to this effect, RBI approval could serve as supporting document.

Secondly, can the IT authorities determine an arm’s length price, which is specifically rejected by the RBI? Example: Indian company makes an application for payment of consultancy fees exceeding US$100,000 to its foreign parent company, which is rejected by the RBI.

Can IT authorities assess the foreign parent company for arm’s length price’ exceeding US$ 100,000? This issue was highlighted and several representations were made to the CBDT.

In response, the Final TP Rules have specifically inserted that while arriving at arm’s length price; one has to take cognisance of the laws and government orders in force.

In such cases, assesses may use RBI’s rejection letter as part of their documentary evidence to justify that the arm’s length price for consultancy fees cannot exceed US$ 100,000.

Transfer of shares
In order to transfer the shares of an Indian company from a resident to a non-resident, FIPB approval and RBI permission is obtained. The issue is whether IT authorities can adjust the selling price of shares which is approved by FIPB and RBI? In this context, it is important to note that FIPB does not comment on price, it merely confirms that the purchase of shares by the non-resident is in line with the foreign investment policy. RBI too, does not scrutinise the selling price of shares.

RBI only ensures that the selling price of shares is above the basic floor price (CCI valuation norms) to avoid undue foreign exchange loss to the country.

Thus, the assessee would need to prove before the IT authorities that selling price of shares is at arm’s length even if it is approved by FIPB and RBI. Transfer pricing regulations are new to India. In view of the aforesaid issues, it will be interesting to see how these regulations are implemented vis-…-vis other statutes at the ground level.