2015: Transfer Pricing Round-Up

The year 2015 was arguably a momentous one for transfer pricing (TP). A combination of local and international developments will mark it as a period which defined the future direction of this subject.

Key Developments
The Organization for Economic Cooperation & Development (OECD) released final reports as part of its Base Erosion & Profit Shifting (BEPS) project on 15 action items- amongst which transfer pricing figured prominently. The Final Report on Action 8-10 “Aligning Transfer Pricing Outcomes with Value Creation” provides guidance on strengthening and clarifying the arm’s length principle (that requires related parties to allocate income as it would be allocated between independent entities in same or similar circumstances). Action 13 contains rules regarding transfer pricing documentation that will necessitate taxpayers to articulate consistent TP positions and provide tax administrations with useful information to assess TP risks and make targeted enquiries. The 3 tiered approach of a master file, local file and a country by country report (CbCR) will standardize TP documentation across jurisdictions.

At home, the Advance Pricing Agreement (APA) program continued to deliver results with the total number of signed agreements increasing to 31. The attractiveness of this program was enhanced by the introduction of rollback rules enabling taxpayers to cover, subject to certain conditions, upto four preceding open years. Bilateral dispute resolution got a fillip from the India-US framework agreement to resolve pending cases in Mutual Agreement Procedure (MAP) under the tax treaty. This policy announcement was followed by rapid progress and culminated in the US IRS statement at year end proclaiming acceptance of bilateral APAs applications with India from February 2016 onwards.

Legal jurisprudence on transfer pricing saw courts establish guiding principles on contentious issues. Taxpayers facing disputes on excessive Advertising, Marketing & Promotional (AMP) expenditure leading to a marketing intangible and appropriate compensation for it derived relief from the Hon’ble Delhi High Court rulings in the case of Sony Ericsson and Maruti Suzuki.

Legislative changes included increasing the monetary threshold for applicability of domestic transfer pricing provisions. The final notification, after public consultation, on the use of multiple year data for comparability purposes and a new tolerance range simplified the application of TP rules. In its internal guidance to tax officers, the Central Board of Direct Taxes (CBDT) proposed a risk based approach to select cases for audit scrutiny and onus on the assessing officer to record reasons for referring specific transactions for further evaluation.

The decision of the Government not to appeal the verdict, relating to transfer pricing of share subscriptions, of Hon’ble Bombay High Court in the case of Vodafone was a new first welcomed by one and all.

Winds Of Change And Emerging Themes
It is very encouraging to see the Government’s policy intent of reducing litigation and bringing in clarity and predictability in tax rules translate into credible action. This impression has been strengthened by the consultative process adopted prior to implementing changes. Releasing drafts for public comments before finalizing important rules and acceptance of court rulings signifies immense maturity and has rightly been lauded by the business and professional fraternity. The genuine efforts of the tax authorities to find solutions to complex problems and resolve disputes unilaterally and bilaterally set the correct tone and should be promoted. Problem solving will always require greater information exchange. The emphasis on gathering more taxpayer data and its deployment in a focussed manner symbolizes this trend. The wisdom of the courts contributes to the evolving body of transfer pricing knowledge and is a virtuous influence.

Tax base protection in the face of fiscal stress and the worldwide clamour for fairness in tax systems is expected to underpin future Government action. Many recommendations of the OECD BEPS reports will find its way into local legislation. Companies will be expected to spend more time and effort on business data gathering for tax purposes. The tax authorities will spend similar resources analyzing such data to assess risks and examining best use. Primacy of actual conduct of taxpayers over contractual obligations will to a large extent guide tax authority audit examinations and court proceedings.

Taxpayer Actions In The New Year
New legislation shall present risks and opportunities. Taxpayers would do well to spend time understanding the implications and preparing in advance. Integration of business and tax teams within companies is critical to ensure strong commercial substance on various decisions. Identifying value driving functions and their location, risks and its allocation between group companies, intangibles and associated development, enhancement, maintenance, protection and exploitation activities would all be important considerations in explaining global supply chains and profit distribution across them.

Creating and maintaining timely and detailed documentation will confer greater benefits from an audit defence and litigation success standpoint. The visible success of APAs and MAP as controversy management tools should prompt taxpayers to adopt these increasingly to reduce or eliminate uncertainty and protracted disputes.

Conclusion
It is important for the tax administration and the taxpayer community to synchronize their efforts in evolving a new paradigm where the interest of the state is balanced with the ease of doing business. The year gone by has shown the way and I expect all stakeholders to stay this course in the best interest of the nation.