Transfer Pricing Rules In India
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TRANSFER PRICING RULES IN INDIA
Some Problem Areas, Issues and Suggestions
R. Das,
PGPPM-2007, IIM Bangalore
Definitions and Background:
Transfer pricing was till recent years a subject of interest only for tax administrators and subject specialists. But recent economic developments in the world have ensured that a large spectrum of society – businessmen, multinational employees, banks and so on – have realised the importance of this subject in the era of globalisation and with it, the proliferation of multinational corporations over the globe. Today, as more than 60% of world trade takes place within multinational enterprises, the importance of transfer pricing increases with tax authorities warming up to the phenomenon and rapidly taking steps to place their national revenue interests on the table.
The term “transfer pricing” refers to the valuation of sales and other transactions, loans, investments etc which occur between different arms of the same corporation or business group. A transfer price is the price charged for intercompany transactions within the group. The concept relates not only to trade operations proper, but also to other intra-firm transactions, such as those relating to transfer of technology, dividend remittances, royalties and technical fees payments.
Transfer pricing as a concept in direct taxation did not receive much attention until the mid-1990s when following the liberalization of the Indian economy, cross-border flows of capital and investments and increasing setting up of subsidiaries of multinational companies in India made it necessary to examine the tax implications of related-party transactions. The new Indian economy has seen the purchasing power of its population go up substantially, and this has manifested itself in increasing demands for FMCGs, vehicles, and electronics. Household items and fittings have also seen a surge in demand. This has encouraged multinationals to set up units in Indian to supply these items and there are transactions between themselves which affect the incomes of the respective bodies. This market is variously described to hold a potential of over 400 million customers.
As the Indian economy has become more and more integrated with the worlds, the valuation of buying and selling prices vis-Ðo-vis taxation of profits assumes larger significance and governments across the globe have become alert to the so-called “loss of revenues” due to the effect of pricing methodologies adopted by corporations in their dealings with related entities. The expected GDP growth of 8-9% for 2006-07 promises more activities in the transfer pricing front and newer fronts for applicability of the principles of valuation are opening up. This paper seeks to examine some of these trends from the viewpoint of the issues involved vis-Ðo-vis the practicability of the approaches taken so far in handling these – from the side of the taxing authorities as well as the taxpayers.
Basic concepts in transfer pricing:
The essence of transfer pricing concerns the prices at which a principal and its associated enterprise(s) exchange goods and services among themselves. These transactions could have the character of sale/purchase, cost sharing and contribution, investment, financing, allowances, expenses or interest payments, risk-compensation agreements and so on. The basic terms which have specific implications and which are to be understood before proceeding further at this stage are “international transactions”, “associated enterprises”, “uncontrolled transactions”, and “arms length price”. These are briefly discussed below:
International transaction: For a transaction to be concerned with transfer pricing, at least one of the parties have to be a non-resident. The transactions – some types of which have been mentioned above – may take place between a non-resident and its Indian subsidiary, or even between associated enterprises in India itself not covering cross-border flows of capital or know-how etc.
Associated Enterprises: Article 9 of the OECD Model Convention on Transfer Pricing provides some guidelines which state that where two entities share direct or indirect participation in the management or control of one anothers business, or have capital investments in these, an association deems to arise for purposes of taxation under the canons of transfer pricing. Indian definitions of associated enterprises largely flow from this article of the OECD convention.
Uncontrolled transactions: These transactions refer to those which exist between enterprises which are independent of each other and driven solely by market forces, and cover both resident and non-resident bodies.
Arms Length Prices: The concept of arms length prices arises from the uncontrolled transactions referred to above. These are prices which exist between independent entities which enter into business transactions without externalities affecting their pricing. In this sense, their pricing is the result of market negotiations and the dynamics of pure demand and supply. In short, we can classify arms length prices as those that prevail in transactions between completely unrelated enterprises (in terms of management, control and capital investment). Income arising from an “international transaction” berween “associated enterprises” must be computed with due regard to the arms-length price. The allowance of any expense or interest is also to be determined with regard to the arms-length price. Cost sharing/cost contribution arrangements in connection with a benefit, service, or facility will also be required to be determined in accordance with the arms-length pricing standard.
Although ostensibly a simple concept, the arms length standard has in actuality spawned a huge amount of discussion, controversy and literature. This aspect will be discussed later in this paper.
OECD Guidelines:
A standard in the guidelines for transfer pricing has been set by the Organisation for Economic Cooperation and Development(OECD) which came out with comprehensive transfer pricing research and recommendations. The OECD transfer pricing guidelines were first issued in 1979 and have become internationally respected. They maintain the arms length principle of treating related enterprises within a multinational group and affirm traditional transaction