Arm's length tolerance band lowered to 1-3%

Lowering the band may further increase disputes between tax dept and taxpayers in transfer pricing

A variation of more than eight per cent in 'arm's length' transactions between two related parties could now lead to transfer pricing adjustments.

The finance ministry has lowered the 'tolerance' band for accepting an arm's length price paid by an assessee to eight per cent for FY13 from nine per cent earlier. For wholesale traders, the band is even lower at one per cent of the transaction price.

In other words, if the variation between the actual price of the transaction and the arm's length price does not exceed one-three per cent of the actual price, then no adjustment would be made by the tax department. Lowering the band could further increase the disputes between the tax department and taxpayers in transfer pricing. Last year, many multinationals such as Shell, Microsoft and Vodafone received tax notice for undervaluation of their deals with an associated company.

According to analysts, keeping the band at one per cent for wholesale traders would dampen sentiments. "It appears the one per cent range has been notified to curtail the MNC wholesale trader's variance with context to the arm's length policy. This drastic reduction from the three per cent tolerance band available for other transactions may not be a welcome move," said Grant Thornton's in a note.

PwC said the notification did not provide clarification as to which taxpayers would be classified as 'wholesale traders'. The term 'wholesale trader' could have a wide connotation in common commercial parlance, and would therefore require clarification, it added.