The success story of the Indian economy since the 1990s has increasingly attracted transnational corporations into India and many such multinationals have set up Indian subsidiaries/group companies. Multinational corporations involved in cross-border trade with group companies are significantly concerned with Indian “transfer pricing” compliance, where such transactions are taxable in India. Introduced with the objective of preventing erosion of the Indian revenue base, the law on transfer pricing is one of the few anti-abuse provisions in Indian tax law.
Transfer pricing compliance has become all the more relevant after a Supreme Court ruling in a case involving investment bank Morgan Stanley (2007), in which it was held that where the “permanent establishment” of a non-resident in India has been remunerated on arm’s length basis, no further business income of a non-resident would be attributable to the permanent establishment, and therefore, would not be subject to Indian tax. However, regulations are still in the process of evolving to meet the requirements of multinational companies with such cross-border trade.
Illustration: Jayachandran / Mint
Transfer pricing rules under Indian income-tax law require that income from “international transactions” between “associated enterprises” be computed at an “arm’s length price”. Put simply, in principle, income from international transactions, where one or both parties are not Indian, between group entities (such as companies having common shareholders or being commonly controlled), is required to be computed at a price comparable with that which would have been payable had the entities been unrelated (that is, not associated enterprises).
As deals get increasingly complicated, and given other regulatory considerations that parties may be subject to, determining the arm’s length price becomes a delicate exercise and transfer pricing reporting and compliance becomes difficult.
Often, there are no comparable uncontrolled transactions (that is, similar transactions between unrelated parties) and prices applied by related parties are always subject to challenge. While the Authority for Advance Rulings set up under the Income-tax Act, 1961, may be approached to determine the taxability of an international transaction, it has no jurisdiction to determine the arm’s length price. Transfer pricing has, therefore, increasingly become a cause for dispute for entities engaged in cross-border trade with related entities.
The Finance Bill (No. 2), 2009, prescribes certain amendments to the provisions of the Income-tax Act relating to transfer pricing, including the introduction of “safe harbour” rules. “Safe harbour” in tax parlance refers to the circumstances under which the income-tax authorities will accept the transfer price declared by the assessee, not challenging the arm’s length nature of the price. It has been left to the Central Board of Direct Taxes (CBDT) to prescribe rules on which situations would constitute a “safe harbour” for transfer pricing.
Internationally, safe harbours aim to reduce transfer pricing compliance requirements and provide certainty to taxpayers by reducing the challenges of reported prices. Safe harbours typically fall into two categories, one where certain types of transactions are exempt from transfer pricing compliance, and the other, where industry-specific price ranges may be prescribed and compliance with such ranges will deem a price to be an arm’s length price.
With respect to the first type—where exemptions are prescribed based on the threshold values of international transactions or entity size—these would prove useful to entities where the value of international transactions with associated enterprises are minimal or small entities. In such cases, the entities should be exempted from documentation and reporting requirements. The Finance Bill is silent on this.
As a part of this type of safe harbour, CBDT may also want to consider exempting transactions inherently in the nature of transactions between unrelated parties. For example, where an Italian company A subscribes to convertible debentures at a fixed interest rate in an unrelated Indian company B, would the transaction need to comply with transfer pricing provisions in subsequent year/s if the size of the loan in later years becomes not less than 51% of the book value of total assets of company B, making A and B “associated enterprises” under the Income-tax Act?
Also, when the debentures are later converted into shares, would the conversion price be subject to transfer pricing compliance, if it had been pre-agreed when the parties were unrelated?
In the second type of safe harbour—where an industry-specific price range is prescribed by the CBDT—this would need to be coupled with easier reporting requirements in order to be effective. Also, this type of safe harbour is not free from difficulties; the range prescribed, while providing certainty, would also need to keep up with market dynamics in order to be realistic. In addition, taxpayers may comply with the ranges prescribed in order to fall within the safe harbour, although such a price may not be an arm’s length price for the taxpayer given specific circumstances. In such a case, the risk of double taxation (on account of the price not being acceptable to other jurisdictions) is already well recognized internationally.
More importantly, if Indian transfer pricing requirements are satisfied by complying with this type of safe harbour, would the Supreme Court ruling in Morgan Stanley’s case, holding that non-residents will not be subject to further tax on business income in India, where the permanent establishment in India has been remunerated on arm’s length basis, still hold? The question is, would a price falling within a safe harbour really be an arm’s length price?
It remains for relevant laws to evolve in order to resolve these various issues on transfer pricing and safe harbours.
This column is contributed by Annapoorna Jayaseelan of AZB & Partners, Advocates & Solicitors.
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