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    Indian Transfer Pricing (‘TP’) – Changing Trends

    The TP Regulations in India were introduced in 2001 under the anti-abuse provisions of the Income-tax Act, 1961 (ITA) largely modelled on the TP principles followed by the organisation for Economic Cooperation and development (OECD) and aimed to ensure that transactions between group companies adhere to the arm's length standard. Initially, the TP law was applicable only to cross border transactions between group companies (referred to as Associated Enterprises or AEs) and now has been expanded to specified domestic transactions to. Chapter X deals with Transfer Pricing Regulations (TPR) with sec 92 to 92F of ITA. The rules for interpretation and implementation of the provisions are Rule 10A to 10E of the IncomeTax rules, 1962 (‘Rules’).

    India as a TPjurisdiction has positioned itself in a reckonable manner in the global tax scenario. Overthe past 8 years, while the basic framework has remained the same, the law has seen substantial changes-some applying retrospectively. In the decade that passed since the introduction of TP regime in India, the country has seen a significant tax disputes and litigation surrounding TP issues reflecting growing aggressiveness on part of the tax authorities to plug purported erosion of tax base. Not surprising, in many global tax surveys, India is often recognized as a country having a very challengingTP regime.

    In the recently concluded the TP audits, the Indian tax authorities continued with their rigorous enforcement and new issues continue to emerge such as allocation of location savings, investment in share capital, marketing intangibles etc. There is a sustained surge in the quantum of transfer pricing adjustments spanning many industries like information Technology, Automotive, Pharmaceuticals and Finance & Insurance, as evidentfrom the statistics in thetable below(INR Crore– Thousands):

    While the Indian Government has been responsive to the taxpayer grievances on growing TP disputes and has initiated a number of steps to resolve TP Disputes (such as introduction of alternative resolution mechanism, APA, safe harbours, clarification on identification of contract development centres etc), the same have notyetyielded results. Further, the failure of the Governmentto bring in detailed guidance in the implementation of Indian TP regulations, has exacerbated the situation. Some of the recent development in TP in India has been discussed below briefly:

    1. Safe Harbour Rules:

    Safe Harbour rules were announced with a view to reduce the number of TP audits and prolonged litigation on TP disputes in India. The CBDT has notified the safe harbour rules based on Rangachary committee recommendations. The safe harbour rules are applicable for 5 years starting from the year of application.

    The safe harbours prescribed for the assessee’s engaged in rendering the prescribed International Transaction are as follows:

    International Transaction

    Turnover limit/Loan

    limit/Guarantee

    amount

    Safe harbour

    rate/margin

    Software development and IT enabled services

    (Net Operating margin as a percentage of Operating Cost)

    < INR 5 billion

    >INR 5 billion

    20%

    22%

    Knowledge process outsourcing services and contract R&D

    services wholly or partly relating to software development

    (Net Operating margin as a percentage of Operating Cost)

    NA

    25%

    Intra-group loans

    (The safe harbour is what can be added to the base rate of

    State Bank of India)

    <INR 500 million

    >INR 500 million

    Interest rate

    150 basis points

    300 basis points

    Corporate guarantee

    (Percentage of commission is calculated on amount

    guaranteed)

    <INR 1000 million

    >INR 1000 million

    Commission

    2% p.a

    1.75% p.a

    Contract R&D services wholly or partly relating to software

    development

    NA

    30%

    Contract R&D services wholly or partly relating to generic

    pharmaceutical drugs

    NA

    29%

    Manufacture and export of core auto components

    NA

    12%

    Manufacture and export of non-core auto components

    NA

    8.5%

    Definitions for eligible assessee with insignificant risk, eligible international transactions, Operating expenses & Operating cost have been prescribed underthe rules.

    If the assessing officer is of the opinion that the assesse is ineligible for the safe harbour option, then he would refer the matter to the TPO. Assesse can appeal to the Commissioner against such action of the assessing officer.

    Where a taxpayer’s transfer price is accepted by the tax authority under the safe harbour rules, the taxpayer is not entitled to invoke Mutual Agreement Procedure (‘MAP’) under an applicable taxtreaty.

    1. Advance Pricing Agreement (APA):

    TP has emerged a key area of litigation in the recent years. The cost, lengthy processes, and inevitable uncertainty make litigation an undesirable alternative for taxpayers and governments.

    The Finance Act 2012 introduced provisions to enable Advance Pricing Agreements (APAs) in the ITA with effect from 1 July 2012 the rules for implementingAPAs were notified. The Rules enable a taxpayer to file an application for a unilateral, bilateral or a multilateral APA. The Rules contain procedures for APA applications, information, data, and forms that need to be filed, circumstances under which the Board may discontinue an APAand compliance procedures for monitoring a concluded APA.

    The introduction of APAs is expected to provide an alternative remedy to resolve TP disputes in advance. The success of APA programs in many countries offers a significant opportunity for the Indian tax administration to resolve international TP issues mutually in advance.

    As a first step for initiating the APA process, a taxpayer is required to undertake a pre-filing consultation, which canalso be requested on an anonymous basis, before a formal APA application is submitted.

    The taxpayers’ AE is expected to initiate an APA process with the Competent Authority (CA) in the other country in case a bilateral or multilateral APA is envisaged.

    The Rules provide for an application fee which could be INR 1 to 2 million depending upon the value of the international transactions entered into or proposed to be entered into during the proposed period of the APA.

    TheAPAmechanism isbroadlyasfollows:

    • The taxpayer can approach the Board for determination of the arm’s length price(ALP) in relation to an internationaltransaction that may be entered into bythe taxpayer.
    • TheALP in an APA is determined using any method includingthe prescribed methods, with necessary adjustments or variations.
    • The ALP determined under the APA deemed to be the ALP for the international transaction with respect to which the APA has been entered into.

     

    • The APA is binding on both the taxpayer and the tax authorities as long as there are no changes in law or facts that served as the basisfortheAPA.
    • The APA is valid for the period specified in the APA subject to a maximum period of 5 consecutive financial years.
    • Rollback option has been also provided in the recent FA 2015 and with which the taxpayers can opt for a rollback of APA and hence the taxpayers can opt for a litigation free Five years going forward and fouryears backward (totally9years)from the date of signingthe application.
    1. India’s new Company Law -Arm’s length concept for Related Party Transactions (RPT):

    With the new Companies Actseeking arm’s length concept for dealing with RPTs, companies need to assess whether their RPTs comply with the arm’s length principle and thereafter evaluate their compliance and reporting obligation under company law. The scope of RPTs under the Companies Act ismuch wider in scope than the TP provisions.

    While the Companies Act does not provide any guidance for determining the manner in which thearm’s length principle would need to be applied, companies may find it useful to refer to the manner in which the principle is applied under the Income Tax Act to test whether the transactions are in accordance with thearm’s length principle.

    1. Specified DomesticTP:

    The Finance Act 2012 has extended the scope of TP provisions to specified domestic transactions based on the suggestion made by the Apex Court in the case of Glaxo smithkline Asia Pvt Ltd. The intent is to curb tax arbitrage possible in cases where companies tend to shift profits from one tax paying entity to another tax exempt or loss making entity within India. (Threshold limit for applicability of SDT Provisions is the value of the transactions (consolidated) till FY 2014-15 is 5 Crores and from FY 15-16 the threshold limit has been extended to 20 Crores).

    As perthe provisions, thefollowing domestictransactions would be underthe purview of the Indian TPR: Payments to related parties;

    Inter-unit/inter-company transactions that impact tax holiday profits;

    Other transactions as may be specified;

    1. Revision in Tolerance range calculation and usage of multiple year data:
    • In Budget 2014, the finance minister has made an announcement that ‘range concept’ (where there are adequate number of comparables and usage of multiple year data, for determination of ALP, would be introduced;
    • The finance Act, 2014 has introduced a proviso to section 92C(2) of the Act, that provides for ALP determination in relation to a international transaction or SDT undertaken on or after April 1, 2014. (i.e. from Assessment Year 2015-16), ALP shall be computed in such manner as may be prescribed.

    The CBDT on May 21, 2015, announced draft rules on the application of range concept and use of multiple year data.

    Arithmetic mean under the following scenarios:

    • In cases where “range” concept does not apply, the arithmetic mean concept shall continueto apply along with benefit of tolerance range;
    • In cases where multiple year data is to be used, the same would apply whether “range” concept is used or arithmetic mean is used for determining the ALP.
    1. Conclusion

    Taxpayers in India find themselves in a challenging position of documenting and defending their transfer pricing as transfer pricing controversies continue to rise. In view of the current trend of transfer pricing in India, it is crucialfortaxpayersto strengthen theirtransfer pricing policies as well asthe documentation to support them, explore and evaluate risk mitigation strategies and alternate mechanisms with regard to already concluded transactions and future transactions

     

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