New arrangement promises to reduce transfer pricing disputes
The new arrangement, called Advance Pricing Agreement (APA), aims to improve clarity in transfer pricing rules and reduce litigation. An APA is a mutual pact between a company and tax authorities that determines in advance the way in which intra-group transactions can be structured.
Come April, India's efforts to untangle the knots it has tied itself into while taxing transactions between multinational companies and their Indian units might start showing results. A new arrangement for taxing such transactions, known as transfer pricing, is generating a lot of interest among multinational companies. The interest shown by companies, say tax experts, augurs well for business environment in India after a messy decade of experimenting with transfer pricing.
The new arrangement, called Advance Pricing Agreement (APA), aims to improve clarity in transfer pricing rules and reduce litigation. An APA is a mutual pact between a company and tax authorities that determines in advance the way in which intra-group transactions can be structured. The APA process was first announced in last year's budget, and the government notified rules in August. But its positive impact, says Rohan K. Phatarphekar, Head of Transfer Pricing at accounting firm KPMG, will be felt only from next financial year as APAs are applicable prospectively Standalone data on tax disputes on account of transfer pricing are not available.
However, income tax disputes for both companies and individuals have soared in the recent past. Between March 31, 2009, and March 31, 2011, the amount involved in tax disputes almost doubled to Rs 4.05 trillion (one trillion equals 100,000 crore). That amount is enough to cover the government's subsidies for two years.
Within this universe of disputes, transfer pricing is the single-largest cause of litigation for both foreign and Indian multinational companies, says Rahul K. Mitra, National Leader, Transfer Pricing Practice, PricewaterhouseCoopers (PwC). The outstanding amount adjusted by tax authorities in transfer pricing cases is around Rs 1 trillion, estimates Vijay Iyer, Partner and Transfer Pricing Leader, Ernst & Young. PwC's Mitra says that almost all adjustments lead to litigation. But tax officials say many companies accept adjustments made in transfer pricing without complaints. However, there is no data available to get a sense of where the truth lies.
In recent months, several multinational companies have seen their transfer pricing being adjusted, sometimes by large amounts. These companies include Cadbury India, Vodafone, Accenture, and Samsung. All the companies declined to talk to Business Today on the subject. The latest incident, which came to light earlier in February, involves energy giant Royal Dutch Shell . Tax authorities say Shell India underpriced shares transferred to its parent by as much as Rs 15,200 crore during 2008/09. Shell India Chairman Yasmine Hilton said in a statement recently that it disagrees with the tax department's calculation and will challenge the notice.
There are two reasons for the rising number of disputes over transfer pricing. One is the growing aggression of India's tax authorities in the wake of an economic slowdown.
The other is the finance ministry's reluctance to introduce specific guidelines on some of transfer pricing's fundamental concepts. In the absence of specific norms, the possibility of whimsical claims is large. Companies and tax consultants fear that the government is using transfer pricing claims as a measure to enhance revenue.
But tax officials disagree. A tax official, who does not wish to be named, says that transfer pricing is meant to deter companies from artificially lowering profits in India to sidestep taxes. It is not meant to be used as a measure to enhance tax collections, he adds.
Finance Minister P. Chidambaram has also sought to allay concerns of multinational companies. "So far as Shell is concerned and the number of cases similar to that, there are orders that have been passed," he said on February 20. "The question has been referred to the Attorney General a few days ago… We are approaching all these cases in a purely professional manner."
Globalisation's after-effect
India introduced transfer pricing rules in 2001/02, as it became clear that increasing integration into the global economy was going to create new challenges for the tax department. An indicator of the extent of India's trade and financial integration with the rest of world is captured by the proportion of total external transaction to gross domestic product. It rose from 44 per cent in 1998/99 to 112 per cent in 2008/09.
Growing globalisation has led to fear among several countries that multinational companies tend to prepare accounts in a way that most of their profits show up in a group company located in a country with relatively low tax rates.
India is not the only country worried about transfer pricing. Other countries, notably the UK, Germany, and the US, have articulated anxiety over the possibility that companies are shifting profits to low-tax jurisdictions. However, no other country seems to be mired in litigation of the magnitude India is experiencing. In 2011, PwC estimated that 70 per cent of outstanding transfer pricing disputes in the world originated in India. "In the last five years, about 500 transfer pricing cases have been decided by tribunals in India," says PwC's Mitra.
"During the same period, the UK had just one case at the level of the tax court." In this backdrop, why should companies be excited by APAs?
Early experience with APAs shows there is a systemic change underway. "The change in mindset is dramatic," says Mitra. "We have an extremely pragmatic and positive set of officers manning the APA process who are committed to resolving cases in a non-adversarial manner."
Tax experts say that several companies have engaged in preliminary talks with tax authorities. The government has not disclosed details about interest in the APA programme, as tax payers can opt for anonymity during preliminary talks. But Mitra says that feedback from APA authorities indicates that the number of companies filing applications to discuss APAs is likely to touch 70 by the end of March. "That's a huge number for the first year itself."
The interest in APAs in India is probably the first positive trend in transfer pricing in a decade. That too, at a time ongoing litigation over tax disputes has dampened business sentiment. Ernst & Young's Iyer says the response to the APA scheme indicates that companies are optimistic about the process. Mitra agrees. "The government is committed to make it a success," he says. "That's where the confidence comes from."
The new arrangement, called Advance Pricing Agreement (APA), aims to improve clarity in transfer pricing rules and reduce litigation. An APA is a mutual pact between a company and tax authorities that determines in advance the way in which intra-group transactions can be structured. The APA process was first announced in last year's budget, and the government notified rules in August. But its positive impact, says Rohan K. Phatarphekar, Head of Transfer Pricing at accounting firm KPMG, will be felt only from next financial year as APAs are applicable prospectively Standalone data on tax disputes on account of transfer pricing are not available.
However, income tax disputes for both companies and individuals have soared in the recent past. Between March 31, 2009, and March 31, 2011, the amount involved in tax disputes almost doubled to Rs 4.05 trillion (one trillion equals 100,000 crore). That amount is enough to cover the government's subsidies for two years.
Within this universe of disputes, transfer pricing is the single-largest cause of litigation for both foreign and Indian multinational companies, says Rahul K. Mitra, National Leader, Transfer Pricing Practice, PricewaterhouseCoopers (PwC). The outstanding amount adjusted by tax authorities in transfer pricing cases is around Rs 1 trillion, estimates Vijay Iyer, Partner and Transfer Pricing Leader, Ernst & Young. PwC's Mitra says that almost all adjustments lead to litigation. But tax officials say many companies accept adjustments made in transfer pricing without complaints. However, there is no data available to get a sense of where the truth lies.
There are two reasons for the rising number of disputes over transfer pricing. One is the growing aggression of India's tax authorities in the wake of an economic slowdown.
The other is the finance ministry's reluctance to introduce specific guidelines on some of transfer pricing's fundamental concepts. In the absence of specific norms, the possibility of whimsical claims is large. Companies and tax consultants fear that the government is using transfer pricing claims as a measure to enhance revenue.
But tax officials disagree. A tax official, who does not wish to be named, says that transfer pricing is meant to deter companies from artificially lowering profits in India to sidestep taxes. It is not meant to be used as a measure to enhance tax collections, he adds.
Finance Minister P. Chidambaram has also sought to allay concerns of multinational companies. "So far as Shell is concerned and the number of cases similar to that, there are orders that have been passed," he said on February 20. "The question has been referred to the Attorney General a few days ago… We are approaching all these cases in a purely professional manner."
Globalisation's after-effect
India introduced transfer pricing rules in 2001/02, as it became clear that increasing integration into the global economy was going to create new challenges for the tax department. An indicator of the extent of India's trade and financial integration with the rest of world is captured by the proportion of total external transaction to gross domestic product. It rose from 44 per cent in 1998/99 to 112 per cent in 2008/09.
Growing globalisation has led to fear among several countries that multinational companies tend to prepare accounts in a way that most of their profits show up in a group company located in a country with relatively low tax rates.
India is not the only country worried about transfer pricing. Other countries, notably the UK, Germany, and the US, have articulated anxiety over the possibility that companies are shifting profits to low-tax jurisdictions. However, no other country seems to be mired in litigation of the magnitude India is experiencing. In 2011, PwC estimated that 70 per cent of outstanding transfer pricing disputes in the world originated in India. "In the last five years, about 500 transfer pricing cases have been decided by tribunals in India," says PwC's Mitra.
"During the same period, the UK had just one case at the level of the tax court." In this backdrop, why should companies be excited by APAs?
Early experience with APAs shows there is a systemic change underway. "The change in mindset is dramatic," says Mitra. "We have an extremely pragmatic and positive set of officers manning the APA process who are committed to resolving cases in a non-adversarial manner."
Tax experts say that several companies have engaged in preliminary talks with tax authorities. The government has not disclosed details about interest in the APA programme, as tax payers can opt for anonymity during preliminary talks. But Mitra says that feedback from APA authorities indicates that the number of companies filing applications to discuss APAs is likely to touch 70 by the end of March. "That's a huge number for the first year itself."
The interest in APAs in India is probably the first positive trend in transfer pricing in a decade. That too, at a time ongoing litigation over tax disputes has dampened business sentiment. Ernst & Young's Iyer says the response to the APA scheme indicates that companies are optimistic about the process. Mitra agrees. "The government is committed to make it a success," he says. "That's where the confidence comes from."
| Simplifying Transfer Pricing What is transfer pricing? The price at which a transaction is concluded between different companies of the same group is called a transfer price. What is transfer pricing in the context of tax? Around 60 per cent of global trade is between companies in the same group. Tax authorities want these companies to transact at an arm's length price. What is an arm's length price? When two unrelated companies transact, it is at a market-determined price. This is known as arm's length price. Tax authorities want companies of the same group to transact at an arm's length price as that results in fair collection of taxes. Why is taxation of transfer pricing a big source of litigation? The litigation follows a dispute between tax authorities and companies on the arm's length price. When tax authorities disagree with a company's arm's length price, they 'adjust' the price. If the company disagrees with the 'adjustment,' it can appeal the decision. The company can also approach a high court to resolve the dispute. Is transfer pricing adjustment the same as tax evasion? No. The tax law places the chapter on transfer pricing under the umbrella of tax avoidance. Tax avoidance does not imply evasion, which is illegal. Does transfer pricing adjustment automatically change a company's tax liability? Yes. An assessing officer has to take a call on the adjustment (made by another tax official) and decide the quantum of change in a company's tax liability |
