Less discretion needed: Transfer-pricing proposal may lead to litigation

A parliamentary select committee has submitted a report on the new Income Tax Bill, which is meant to replace the current law, in force since 1961. It has suggested multiple changes to the draft Bill, including those pertaining to the assessment of income from real estate. The committee has praised the clarity of the new Bill, which has 536 sections in 23 chapters, while identifying some areas where greater clarity in definitions might be required. It is surprising, however, that the legislators have not in general pushed back against excessive discretion being granted to the income-tax authorities. For example, it is concerning that the committee report clearly backs the controversial additions to tax officials’ powers, which allow them to forcibly access social-media accounts, online apps, and personal emails. 

Indeed, in some cases additional discretionary powers will be granted by some proposed changes. Scrutiny related to transfer pricing is one such area. Naturally, it is important that laws governing income tax properly identify attempts to shift profits across national boundaries or different companies in order to avoid paying fair amounts of tax. A transparent and predictable treatment of transfer pricing is essential both to reduce avoidance and for a welcoming and growth-enhancing business climate. Central to this effort is the determination of which entities are closely related to one another. For example, if one firm has a substantive influence on the decisions of another, then it might be able to induce the latter to adopt pricing that leads to a reduction in the former’s tax burden. How such associated enterprises are determined is naturally of great importance. 

However, the recommendations before Parliament suggest that participation, “directly or indirectly” in management, control or capital is enough to deem that one entity is close enough to another to be an associated enterprise from the point of view of transfer-pricing scrutiny. In most cases currently, there are specific criteria, some of them quantitative, that should be satisfied — such as control of the board of directors or a certain amount of shareholding with voting rights. It seems that legislators would like to replace these requirements with a more general definition of association. This is unwise. Not just because it would lead to more scrutiny but also because it would vastly expand the discretion available to tax officers to start investigating companies engaging in cross-border payments. 

Such shifts in India’s tax code would run counter to global trends, and hold back the development of cross-border transactions. It is a generally accepted principle worldwide now that tax systems should become more rule-based and less discretionary. The transfer-pricing norms that have now been proposed, however, appear to give the tax authorities disproportionate powers to determine what constitutes associated enterprises, and which transactions should be scrutinised from a transfer-pricing perspective. Whatever the logic behind cutting down on avoidance — and, certainly, India must work to implement principles that minimise base erosion and profit shifting — the reality of Indian officialdom should be factored in. Increased discretion inevitably leads to harassment and a greater number of tax claims that might be disputed, sometimes for years. In the final version of the Bill, the government should focus on reducing discretion while increasing tax coverage. This can best be done by holding tightly to the principle that the system should be transparent, predictable, and rule-based.