Transfer pricing provisions need to be liberalised

The transfer pricing provisions (TP) are relatively new provisions leading to substantial differences between an assessee and the tax department. Broadly speaking, in principle, an international transaction between two associated enterprises should be made at Arm’s Length Price so that both the countries involved get proper share of profit in their respective jurisdiction. In other words, TP provisions are intended to curb any manipulation in international transactions resulting in the understatement of profits in any country.

The Income-tax Act prescribes several methods for calculating the Arm’s Length Price. The assessee is supposed to apply the most appropriate method for determining the Arm’s Length Price. Where however more than one price is determined by the most appropriate method, the Arm’s Length Price is taken to be the arithmetical mean of such prices.

 

The existing provisions also contemplate that there can be a genuine difference in determining Arm’s Length Price (ALP). Therefore the law allows a leverage of upto 5 per cent in arriving at the ALP. In other words, if the arithmetical mean of Arm’s Length Price determined as per the most appropriate method varies upto 5 per cent compared with the actual price at which international transaction has been made, such variation will be ignored. But if the variation is more than 5 per cent, the assessable income of the tax payer will be adjusted as per the Arm’s Length Price determined under the prescribed method.

Despite the above permissible leverage being available to an assessee, the disputes in relation to determination of fair Arm’s Length Price do arise. The finance bill 2009 seeks to make the following amendments to resolve the above controversy: The Central Board of Direct Taxes is being empowered to formulate “safe harbour rules”. Such rules will provide the circumstances in which the income tax authority shall accept the transfer price declared by assessee.

It is also clarified that where more than one price is determined by the prescribed method, the Arm’s Length Price shall be taken to be the arithmetical mean of such prices. Is this leverage of 5 per cent available to an assessee on the arithmetical mean of ALP or on the actual transfer price? This has led to disputes between the assessee and the department. It is therefore clarified that the leverage of 5per cent is to be calculated by reference to actual transfer price as such and not to the arithmetical mean.

It is however felt that the proposed amendment is not sufficient to resolve the controversy satisfactorily because the leverage of 5 per cent will be available only where more than one price is determined by following the most appropriate method for computing the Arms Length Price. In fact the leverage of 5 per cent should be available in all cases. Restricting the leverage only to the cases where more than one price is determined is probably neither the intent of legislature nor it serves the purpose of resolving disputes between an assessee and the Income- tax department.

It should be appreciated that India is a developing country with lot of constraints. The international transactions in India are susceptible to international economic pressure .The profit margin in India does not often compare favorably with international margins. Therefore the Transfer Pricing provisions in India have to take into consideration the economic realities prevailing in the country. In view of above, it is felt that leverage of 5per cent in calculating ALP is not adequate, and in any ease, the leverage should be available to all international transactions irrespective of the method employed for calculating ALP.

The Finance Minister while presenting the Budget 2009 has taken cognisance of the fact that a large number of International Transactions are being subjected to adjustments due to Transfer Pricing provisions. Such adjustments are giving rise to considerable dispute. Therefore, the aforesaid amendment has been proposed in the Income-tax provisions. Since the amendment is clarifactory in nature, there should be no hesitation to make the same effective retrospectively.

H P Agrawal, (Author is a partner in S S Kothari Mehta & Co)
hp.agrawal@sskmin.com