With the globalisation of the Indian economy and increasing number of crossborder investments, most large and mid-sized business enterprises are subject to transfer pricing (TP) regulations. These essentially stipulate that international transactions with associated enterprises must be at arm?s length prices (ALPs). In case the tax authorities are of the view that such transactions are not at ALPs, they are entitled to adjust the income liable to tax accordingly.
Recent assessments indicate that TP adjustments have been made to the tune of Rs 2,300 crore for FY03 and Rs 1,200 crore for FY02, which were the first two years of the introduction of comprehensive TP regulations. Now that a Pandora?s box is opening, Indian taxpayers are concerned about their exposure under TP regulations. In ensuring that all international deals are above board, there are some precautionary points to note:
m Proper reporting of international transactions: it is absolutely essential to identify all the associated enterprises with whom international transactions are conducted, as the penalty for non-reporting can be as high as 2% of the value of these transactions, apart from a penalty of thrice the tax on the resultant concealed income. Now, ?associated enterprises? are determined on the basis of ownership or control of management, but under certain circumstances an enterprise can be treated as an associated one in case a loan advanced or guarantee given exceeds specified limits. Plus, ?international transactions? are not confined to purchase or sale of goods, but extend to the provision of services, lending or borrowing money and lease agreements, and they cover tangible as well as intangible property and cost-sharing arrangements or indeed any transaction with a bearing on profits, income, losses or assets of the enterprise.
m Proper contractual arrangements: the determination of an ALP is done on the basis of the exact nature of transaction, functions performed, risks assumed and assets employed by the respective associated enterprises. As such, it is imperative to enter into proper contractual arrangements between the associated enterprises, even though they are part of the same group, to delineate the above aspects.
m Selection of proper comparables for benchmarking: by the TP regulations, any international transaction (IT) between associated enterprises (AEs) is to be computed with reference to the ALP. This is a price that would be obtainable had the transaction taken place between independent parties under uncontrolled conditions. In several countries, the tax authorities notify what are considered ?safe harbour? norms. While we do not have such a practice in India, it is necessary to select proper comparables for benchmarks and endeavour to stay within the range that prevails in the industry or in similar transactions.
m Selection of proper method for computation of ALP: the TP regulations have notified five methods for computation of ALP. These are 1) comparable uncontrolled price method, 2) resale price method, 3) cost plus method, 4) profit split method and 5) transactional net margin method. The selection of a proper method is critical in successfully defending international deals made by an enterprise.
m Compilation of transfer pricing study: it is helpful to compile a study which enumerates all the international transactions, relationships between enterprises, contractual arrangements, functions performed/risks assumed/assets employed, comparables, selection of the most appropriate method for computation of the ALP, computation of the ALP and so on. This would assist an enterprise in defending the basis used and the methodology applied, in case the tax authorities have questions.
m Enterprises eligible for tax breaks need to exercise caution: contrary to popular belief, even enterprises eligible for tax deductions such as SEZs and EOUs are equally subject to TP regulations. Further, in case any adjustment is made on account of the ALP, no deduction under sections 10A, 10AA, 10B, 80IA or 80IB is available for it.
m No adjustment within tolerance range: fortunately, India?s TP regulations provide that no adjustment should be made in case the ALP computed by the tax authorities is within a 5% range of the ALP computed by the enterprise. As such, in case the enterprise can establish that the ALP computed by it is within the above tolerance range, no adjustment can be made by the tax authorities.
?The author is managing partner of M/s Suresh Surana & Associates. These are his personal views