WITH TRANSFER pricing (TP) norms extending beyond cross-border transactions to include all domestic financial deals of Rs 5 crore and above, India Inc. is sweating. Conglomerates, such as the Tatas and Mahindras, when buying or selling goods, or availing of or dispensing services to group companies, will now need to adhere to ‘arm’s-length pricing’. This translates into a market-determined price—one that they would have paid or charged if they were dealing with an unrelated entity or third party within the country. For example, if Tata Motors buys steel from Tata Steel for manufacturing cars, it should pay the latter an amount similar to what it would have paid a third party such as Steel Authority of India or Bhushan Steel.
“The extension of the applicability of transfer pricing provisions to cover specific domestic transactions is expected to increase our administrative and compliance burden multifold,” says Sunam Sarkar, chief financial officer, Apollo Tyres. “The expansion of the definition of ‘international transaction’, to include business restructuring or reorganisation between associated enterprises, might create challenges for us with respect to documenting and defending our TP issues.’’
Apart from fulfilling TP norms, companies will now also have to justify why they have charged a certain amount for doing an intra-group transaction even if the exact comparable pricing (prices of similar deals between other group companies here) is not easily available at the time of filing returns. Justifying subjective transactions (where equivalent third-party transactions are not easily available) will also become hugely contentious. Even for non-deals, a company will have to justify why it is paying higherthan- market-salaries to directors or CEOs, or explain the rationale for charging higher rates for the use of intangibles such as trademarks, copyrights, marketing rights etc. by its associate companies.
While it is true that firms were expected to stick to market prices while transacting business among group companies under the Income Tax Act of 1961, the absence of a clear definition of market price meant that TP norms could not really be applied to domestic transactions, says Rahul K. Mitra, national leader, transfer pricing practice, PricewaterhouseCoopers. Even if the tax department detected a deal that was priced too expensive or cheap, there was no mechanism to prove it.
At the same time, it was being increasingly recognised across the world that commercial transactions between associate companies of multinationals were being driven more by profit maximisation than TP. This was being done by shifting profits from offices in countries with high tax rates, such as India, to subsidiaries or branch offices in countries where the tax burden would be less, such as Singapore. But this meant a serious loss of revenue for countries with higher tax rates.
Rohan Phatarphekar, national head, transfer pricing, at global consulting firm KPMG, says that before TP norms came into existence (they were first applied in 2001), the onus of proving whether a company was charging “excessively” or “unreasonably” from its associate was on tax officials. Today, that has shifted to the taxpayer, who not only has to take care of the documentation, but also secure an accountant’s certificate to prove that all the transactions have been done according to TP.
The other big concern for India Inc. is that under the traditional system the final amount that could be taxed was always less than the disputed amount. “Now, officials may use comparable pricing to determine the transfer price, and arrive at a much higher figure [and a higher tax outgo] than that quoted by the company,” says Mitra.
Such ambiguities will lead to increased litigation and lots of paperwork with strong penalties. Inability to maintain necessary documentation will attract a penalty of 2% of the total value of the transaction, and failure to produce an accountant’s certificate could result in a fine of Rs 1 lakh. Misreporting facts will result in hefty fines as well. So, which companies are likely to be most affected by these rules? “Those which have benefited from preferential tax policies such as special economic zone units, export-oriented units, infrastructure developers or operators, telecom services, industrial park developers, or those in the business of power generation or transmission,” says Mitra. In these cases, both the income and expenditure will come under the purview of TP norms. But, if the transaction takes place in states with different tax rates, the TP norms will apply to the payer only.
And what happens if an official is not satisfied with the transaction and believes that less money has been paid than was warranted under TP? The official increases the tax amount that the company has to pay on the basis of his own calculation and taxes the payer on higher revenue, but makes no corresponding adjustment for the recipient’s tax burden. “It’s a double whammy,” says Mitra.
