In a step to prevent tax avoidance, the finance ministry has given tax officials the power to audit and restate profits of specified domestic transactions above R5 crore a year between related companies and related individuals.
This is similar to how tax demands are issued to MNCs when their cross-border deals are found not to have been done on an arm’s length basis. Also, the tax department would look at managerial compensation in companies. If found to be above industry standards, the government could ask companies to pay taxes on what it considers is the excess amount paid to an executive.
The revenue department has notified rules for companies, individuals, association of persons and Hindu undivided families, asking them to report transactions with related parties. The idea is to assess whether these result in shifting of profits and gains from one individual to another or from a company to the promoter or relatives or to an associated company that enjoys tax breaks. The first transfer pricing audit of six types of specified domestic transactions will begin in 2012-13 as per the Income-Tax (Sixth Amendment) Rules, 2013.
Taxpayers have to make the disclosure in any year, from FY14 onwards, based on the previous year’s financial transactions. “These measures are not meant for revenue generation but to accurately bring out the true profits and gains made by businesses in their books and are, therefore, anti-abuse measures. These, however, would deepen the tax base,” explained a person privy to the ministry’s move. Officials declined to give an estimate of how much of an increase in transfer pricing adjustments may result from these measures. In 2009-10, the government estimated transfer pricing adjustments of R70,000 crore on cross-border transactions, asking local arms of MNCs to pay up about a third of this amount as taxes.
Tax experts said that the finance ministry’s move could increase the compliance burden on taxpayers disproportionately to the actual problem of revenue leakage. “A large number of transactions between related companies are revenue-neutral. While the actual challenge of revenue leakage for the department may be prevalent in sectors enjoying tax holidays, the new compliance requirement covers a population of taxpayers that are about 10 times more, adding to the overall compliance burden,” said Vijay Iyer, head, transfer pricing, Ernst & Young in India. He said revenue-neutral transactions and managerial remuneration should be kept out of the ambit of new transfer