Background – The Indian Transfer Pricing Regulations were reinforced from April 2001 in accordance with the OECD regulations and was made mandatory for all Indian companies having transactions with its overseas affiliates. Tax assessments from a transfer pricing perspective began from 2003 onwards and the third year of tax assessments were concluded recently. The learning curve for the revenue over the past three years, has driven the compliance-driven mindset to that of a traditional revenue focused tax collection one.
The spell of the Revenue Authorities’ assessments across some locations in India reached its peak at the end of December 2006 when aggressive positions was adopted in respect risk-insulated captive service units located in India, providing Information Technology (IT) Services and Information Technology Enabled Services (ITeS). The transfer pricing assessments confront the captive units of large and medium size multinationals, with net margins as high as cost plus 25 per cent for software service companies and cost plus 37 per cent for ITeS companies.
This act by the Revenue Authorities could result to defeat the very purpose of off shoring and MNEs may find it more economical to leave the shores of India to more competitive destinations such as Romania, Philippines, Hungary etc. The Revenue Authorities have totally ignored the fact that the rationale behind off-shoring of services to India has been to leverage on cost advantage in a free global market, as against revenue maximisation.
Why has it been done? The India advantage of a low cost base and a large and rapidly growing English-speaking work-force, has helped it emerge as the globally preferred destination for outsourcing of services, whether software or BPO. Rapid advances in convergence of technologies have enabled multinational enterprises (MNEs) to migrate service functions to India, either engaging third-party service providers or setting up dedicated in-house units. The unprecedented growth achieved by India’s IT Services and ITeS Sectors stands testimony to this. This growth story cannot be impeded by overzealous revenue consideration.
How has it been done? The Revenue Authorities have left no stone unturned to achieve their internal revenue collection targets by using rather arbitrary and unconventional methods for conducting assessments. To name a few, the positions taken by the Revenue Authorities are (i) arbitrary exclusion of comparable companies selected by the taxpayer, (ii) cherry-picking super-profit making companies in the comparability analysis and leaving the loss making ones out, (iii) total disregard of the risk-insulated model of the taxpayer vis-à-vis risk bearing entrepreneurs, (iv) paying no importance to the economic business cycle of a business.
Having drawn first blood, the Revenue Authorities are in no mood to re-look and analyse the impact of their stance on the emerging IT and ITeS industry of India. They continue to follow the same path and find newer ways to attack the golden goose which has helped India emerge as a growing and maturing economy and becoming the most preferred outsourcing destination.
Where do we go from here? Even though the Indian tax laws provide for several levels of appeals and petitions, it seems quite unlikely that the quasi-judicial or judicial infrastructure of India would grant full and immediate relief in the area of transfer pricing. The other possible way of seeking any relief may come from a Government to Government arbitrage procedure called the ‘Mutual Agreement Procedure’ under the inter-country tax conventions.
Even otherwise, transfer pricing will continue to be one of the major areas of attention for the Revenue Authorities and it is of utmost importance that multinationals operating in India at legacy cost plus models have a re-look at their transfer pricing methodology. It is also important that specific cognizance is taken to the constant and fast growth in the Indian economy and how it would impact their transfer prices.
Do we need a resolution or a revolution? As mentioned above, the methods and ways in which transfer pricing cases in India are being resolved, it is unlikely for the taxpayers to see any light at the end of the tunnel. So the question is whether we need to revamp the transfer pricing law in India? The answer to this question may be available in a place from where the law incepted. Most of the developed nations have specific guidelines such as inter-quartile range, safe harbour provisions, etc. For the new entrants, an advance pricing agreement is also available, where, before determining a transfer price for inter-company transactions, one gets it blessed by the Revenue Authorities, from a transfer pricing perspective.
What can be done? While guessing the fate of future transfer pricing assessments will be nothing more than crystal-ball gazing, nonetheless, the fact cannot be discounted that the transfer pricing assessments will not be easy and could lead to significant tax exposures. Thus, it is important for companies to take a hard look at their transfer pricing policies from their own perspectives rather than following some set standard on margins. There will be a need to pro-actively seek out strategies to mitigate risks on this account. Also, they will have to brace themselves for increased litigation.
Contributed by:
Vikram Doshi, Partner – Tax and Regulatory, KPMG &
Deepak Kumar Jain B, Manager – Indirect Tax, KPMG |
