BackTransfer pricing: government lowers tolerance band
Tax dept notification says variation shouldn’t exceed 1% for wholesale traders, 3% in other cases
PremiumIn a notification issued last week, the tax department said that the variation should not exceed 1% for wholesale traders and 3% in other cases. Photo: Priyanka Parashar/Mint
(Priyanka Parashar/Mint)
New Delhi: In a move that is likely to lead to more transfer pricing litigations, the government has narrowed the so-called ‘tolerance band’ for international and domestic transactions between two group entities to as low as 1% for some companies.
The tolerance band is the variation allowed between the arm’s length price arrived at by the income tax department and the actual price of the transaction between two group companies.
In a notification issued last week, the tax department said that the variation should not exceed 1% for wholesale traders and 3% in other cases and will be applicable from the 2012-13 financial year.
Fast moving consumer goods and consumer durable companies, which buy products from the parent company and sell them in India, could get classified as wholesale traders.
Software and business process outsourcing companies would, however, be allowed a variation of up to 3%, analysts said.
Transfer pricing refers to the practice of arm’s length pricing for transactions between group companies to ensure that a fair price—one that would have been charged to an unrelated party—is levied.
Transfer pricing-related disputes have been rising in India with many multinational companies accusing the income tax department of taking an aggressive stand on what constitutes arm’s length pricing.
The recent round of transfer-pricing audits for the period ending March 2009 saw adjustments of more than $9 billion, according to industry estimates. The assessments also saw the tax department scrutinising share issuances within group companies for transfer pricing violations.
Companies such as Shell India and Microsoft India are some of the companies that have recently come under the tax department’s scanner for transfer-pricing related issues. Many are exploring legal options.
“Narrowing of the band to 1% is very stringent and will make life very difficult for taxpayers," said S.P. Singh, senior director, Deloitte Haskins and Sells. “The more the tax department reduces the tolerance band, the possibility of transfer adjustments will increase and this will lead to increased litigation."
The tax department, while arriving at an arm’s length price, computes the average profit margins of companies in similar lines of business. The pricing of the transaction under scrutiny has to be around this price, with the variation allowed defined by the tax department.
If the difference in the pricing is more than the variation allowed, then the tax department could go in for transfer pricing adjustments.
In the last couple of years, the income tax department has progressively lowered the tolerance band from 5% in 2011-12 to up to 3% for 2012-13.
Consulting firm PricewaterhouseCoopers said in a note that there was no clarity on 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," the note said.
In the last one year, the income tax department introduced provisions to reduce transfer pricing litigations in India. It notified advance pricing agreements—an accord between a taxpayer and the tax department on a transfer—pricing procedure for a particular set of transactions.
It also recently issued two circulars based on the recommendations of the N. Rangachary Committee to provide clarity on the taxation of development centres of multinational companies.
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