Developments in India Transfer Pricing and How They May Affect Your Business
Despite having transfer pricing regulations that fundamentally follow guidelines provided by the Organization for Economic Co-operation and Development ("OECD"), India is considered to have some of the most aggressive transfer pricing authorities in the world.This is evidenced by important amendments included in the 2009 Finance Act and various proposals in the Draft Direct Taxes Code Bill of 2010 ("DTC"). If the DTC, as proposed, comes into law, it may be effective in April of 2012.Given the significance of U.S.-India trade and supply chain relationships, we have highlighted some of the significant effective and expected developments for consideration.
The arm's length price is the general measure that is required to be used in order to analyze the pricing of a transaction with a related party.The Indian transfer pricing authorities generally calculate the arm's length price using the most appropriate method (e.g., Comparable Uncontrolled Price, Transactional Net Margin Method, etc.).Historically, as long as the taxpayer was within a five percent range of the most appropriate price determination, the Finance Minister would accept the taxpayer's calculation.Proposed changes would instead allow the transfer pricing authorities to determine the range on an industry-by-industry basis as opposed to using a simple five percent range that is the same for all substantially similar types of transactions.
Furthermore, because of the subjectivity of determining the arm's length price and the administrative burden of defending the taxpayer's determination when under audit, the concept of safe harbor provisions have been introduced in order to mitigate this burden prospectively. There has been little guidance or expansion on this topic to date, however, as the concept is being more fully explored the committee that was established for this purpose. Nonetheless, there is the potential that taxpayers will stand to benefit from the increased certainty that such provisions may provide.
In keeping with the theme of predictability and ease of administrative burden, an Advance Pricing Agreement program has also been proposed. As with similar programs in other jurisdictions, this will allow a taxpayer to enter into an agreement with the revenue authorities to establish a mutually agreeable transfer price for a particular transaction.Such an agreement would be valid for five years and would virtually eliminate the possibility of transfer pricing adjustments in connection with the relevant transactions during the period.
While the proposals seek to enhance predictability and to ease administrative burden, however, they also increase the enforcement capabilities of the revenue authorities when determining arms length prices.For example, current law only allows the Transfer Pricing Officers ("TPOs") to address cross border transactions referred to it by the tax officer.It has been proposed that the TPOs be empowered to enter the premises of a taxpayer and conduct on-the-spot inquiries in order to identify arm's length prices at the TPO's discretion.Such a change could result in a material level of intrusion and scrutiny by the transfer pricing authorities.Further guidance that would further explain these enhanced powers is currently awaited.
Although the foregoing list of proposed changes is by no means comprehensive, it demonstrates the level of focus of the revenue authorities on the issue of transfer pricing and related compliance.Furthermore, the proposed changes may increase the potential impact that a multinational company's Indian operations could have on the company's financial statements.The Indian revenue authorities are expected to look at a wider range of transactions and to more aggressively scrutinize the arm's length price. Depending on the materiality of a particular transaction, it may be prudent for a business to pursue an Advanced Price Agreement from both the IRS and the Indian revenue authorities in order to mitigate tax audit and financial statement risk.