Vijay Iyer: Avoiding double trouble in transfer pricing

Most countries today target multinationals to help tax recoveries in their slow-moving economies, but only those tax regimes that offer policy certainty and are open to dialogue stand a better chance of attracting global investment

Late last month, Parthasarathi Shome, economic advisor to the finance minister, stated that tax laws should not be applied retrospectively as a measure to generate revenue. "There are three conditions under which retrospective taxation can be envisaged," he said at an Assocham conference. "One is to clarify, one is to correct for mistakes and the third one is to really address a very egregious tax structure."

Dr Shome has been engaging with industry representatives to understand their concerns to ease the administrative challenges taxpayers face. It is obvious that taxpayers who do not follow the arm's-length standard in transfer pricing (TP) - the pricing of transactions between group companies in different countries - need to be penalised suitably for non-compliance. Given, however, the subjectivity involved in TP, tax authorities need to take a magnanimous view in assessing these issues.

It is easy to disagree with the taxpayer on qualitative parameters such as the selection of comparables, allowing adjustments for differences in risks and so on. Transfer pricing is an inexact science, so interpreting it can lead to multiple conclusions from the same set of facts and, therefore, create controversy. But this is one issue India must address to build investor confidence. Taxpayers find other tax jurisdictions in South East Asia more supportive and flexible and less adversarial. To compete with these jurisdictions for information technology (IT) and IT-enabled businesses, India also needs to adopt a non-adversarial tax administration policy.

Globally, TP administrations fall in one of three categories: passive/non-existent policies; aggressive/evolving policies; and experienced/stable policies. India needs to move to a regime with stable policies to make investors comfortable.

Largely, governments frame their TP administration policies based on their positions on the following three principles:

• clarity and certainty in TP policy;
• non-adversarial assessment rather than enforcement; and
• efficient dispute resolution.

Certainty in policy: Certainty is a scarce commodity in a dynamic business environment, so businesses tend to focus on jurisdictions that can at least assure them stable tax and TP policies. Businesses have restructured their supply chains and inter-company transactions to favour those administrations that provide for tax benefits as well as certainty on the amount of tax to be paid. In India, recent safe harbour rules and the Advance Pricing Agreement (APA) programme have been welcomed because they provide clarity and certainty to taxpayers. However, retrospective amendments in the laws challenge the basic tenet of consistent tax policies and place businesses in a precarious position. There have been a set of retrospective changes in the TP rules in the Finance Act, 2012, and such material clarifications should have been prospective rather than retrospective.

Certainty in TP practices needs to be demonstrated both in the law as well as in TP audits and enforcement. Further, a method of sharing position papers internally with industry could help bring about consistency in approach across the country. For example, certain transfer pricing officers (TPOs) allow working capital adjustments and some may not.

Non-adversarial assessment: TPOs may also be eager to make TP adjustments that are often frivolous since they do not care about the sustainability of the matter in litigation. That is because the TPO is not accountable for the ultimate outcome, so he has a short-term view of tax collection. The outcome may be healthier if the TPOs are provided guidance and position papers. Companies pursuing an APA programme need comfort that the TPO will not summarily reject the agreement. Similarly, companies opting for safe harbour rules expect their claim not to be rejected without a strong reason and it is important for the tax administration to display a collaborative approach in dealing with these matters. The APA programme has proven a brilliant experiment and the authorities' collaborative approach is providing taxpayers a lot of confidence. TP audits also need to follow this approach.

Dispute resolution: Globally, most countries are aggressively targeting multinationals to help tax recoveries in their slow-moving economies. Given the subjectivity of TP, this area of controversy has been a low-hanging fruit. The existence of all kinds of anti-avoidance measures (such as the General Anti-Avoidance Rules, Controlled Foreign Corporation rules, and so on) are seen as a cornerstone of an effective TP and tax policy that would help the government mop up the extra revenue it needs to keep the economic engine running. Many tax administrators have reinforced their anti-avoidance laws and stepped up scrutiny of inter-company transactions.

As a result of such stringent measures, however, many multinationals have had to face double taxation. In many cases, foreign companies have been asked to pay taxes on income that is already included in the tax base of their subsidiaries in the host countries. This economic double taxation of taxpayers' profits has been a bone of contention in all TP disputes and is against the ethos of the double tax avoidance agreements. India does entertain a Mutual Agreement Procedure (MAP) for TP dispute resolutions with some countries where there is a double tax treaty. However, the country has taken a very aggressive view on the admissibility of MAP for countries in which the treaty does not contain paragraph (2) in the Article on Associated Enterprises. Globally, tax authorities would entertain a MAP even with countries where the Associated Enterprise article does not have the second paragraph. In fact, India is an outlier in this regard and has blocked dispute resolution options for a bunch of taxpayers from Korea, France, Germany and Singapore. It needs to dilute its position and try to eliminate economic double taxation for taxpayers.

Further, India needs to beef up its dispute resolutions mechanism by empowering the Dispute Resolution Panel (DRP) to settle disputes. The DRP could have an independent chairperson (a retired judge of the income tax appellate tribunal or a high court) who can take the decisions for settlement. On their part, taxpayers need a forum that can moderate the TPO's order and waive penalties. This could ease taxpayers' pains since they may be able to resolve their disputes more efficiently.

An effective tax administration that provides the taxpayer easy access to contest an action by lower tax authorities in a court of law without having to pay a huge sum by way of a tax demand may just be the need of the hour. Coupled with a strong domestic judicial system, TP disputes could also be avoided through bilateral dialogue in the form of mutual agreement procedures and advance pricing agreements that heavily rely on the will and motivation of the tax administrators to resolve such disputes. The writer is Partner and National Leader - Transfer Pricing, EY. These views are personal