Union Budget: Clear the confusion on transfer-pricing norms

The government has been able to instil a positive sentiment in the country. Various policy initiatives like Make-in-India, aimed to make India a manufacturing hub, and the Clean India campaign; updating age-old laws and tweaking the Goods and Services Tax to a more acceptable form, introducing greater clarity in the Companies Act, 2013; and tax developments like the high court rulings on Vodafone and Shell in the share valuation matter and the announcement of advance pricing agreement (APA) rollback mechanism and the recomposition of the Dispute Resolution Panels (DRPs)—the government has been aiming to give a face-lift to the overall Indian tax environment.
From a transfer-pricing perspective, three broad need further attention.

First, as the roll-back mechanism was applicable to APAs closed after October 1, 2014, many APAs, where the positions have been agreed upon between taxpayers and the government, have been kept on hold, as the detailed implementation rules for the APA roll-back scheme announced in the earlier budget are still awaited.

The concept of range replacing arithmetic mean is to be applied for determination of arm’s length price (ALP) from FY15. The taxpayers need clarity on how range mechanism would be implemented before their financials are closed in March 2015.

Acceptance of multiple-year data also needs to be imbibed in the TP regulations to give a clear direction to the taxpayers and tax authorities. This will can curtail lot of disputes that arise due to adoption of single-year data.

Second, though the controversy regarding valuation of shares issued has been put to rest by the press release issued by the government, there is a need for a clarificatory amendment in the TP regulations providing that TP will not be applicable to transactions where an income does not arise. This will go a long way in curbing litigation and enabling the tax authorities to focus on more important incidences of tax base erosion.

Intangibles have also been at the centre of another controversy and have been debated and litigated upon extensively. It has been alleged by the authorities that the Indian taxpayers should be compensated for excessive advertising, marketing and promotion expenditures, as it constitutes further development of marketing intangibles owned by overseas affiliates and provision of services. We still await the ruling of the Delhi High Court on this issue. Further, since the definition of international transactions (marketing and other intangibles) expanded retrospectively from the inception of Indian TP regulations, clear guidelines are required in TP regulations to recognise certain methodologies and approaches for evaluating the ALP of transactions involving intangibles. The recommendations made by Organization for Economic Co-operation and Development (OECD) under the Base Erosion and Profit Shifting (BEPS) Action Plan 8 could be adopted. BEPS recommendations endorse that location savings is not an intangible; however, the Indian tax authorities are aiming to use the profit-split method to realise this concept. Clarity that location savings is embedded in the ALP of Indian comparables must be provided in the regulations, in line with recent judgement of the Mumbai Tribunal in the case of Watson Pharma.

There is also a need for detailed valuation norms for issue of equity shares, which are currently embedded only in exchange control regulation with a different objective. Further valuation methodology based on income or discounted cash flow method may be prescribed for valuation of intangibles.

Though the government has introduced lot of avenues like APA, safe harbour rules and now independent and autonomous DRPs to limit the TP litigation ratio, it is important that the transfer-pricing officers (TPOs) conducting the first level audits adopt a more pragmatic approach by giving due consideration to business and commercial realities than purely being driven by profitability of the taxpayer.

Based on the re-establishment of ties between Indian and American authorities, if a significant number of mutual agreement procedures (MAPs) pending over years are closed soon, it may reduce the disappointment faced by the MNCs and restore their confidence in the Indian tax regime.

Significant changes in the TP regulations will take time, but while the finance ministry is gearing up to deliver new proposals and guidelines in the upcoming budget, it is important that the awaited clarity and guidance on some of the imminent matters is provided.

As announced by the finance minister at Davos, it is imperative to have a TP regime that is non-adversarial, instils global confidence in India, and ultimately boosts economic growth.