Union Budget 2015: Transfer pricing regulations: Need aligning to global norms

Budget should issue a) rules for announcements that were made in the budget in July 2014, (b) clarifications and guidance on matters that were at the centre of controversy during the past few years like equity infusion, valuations, etc. and (c) tax administrations, infrastructure and approach.

The new government in India seems to have been able to instill a positive sentiment in the country. From various policy initiatives like the ‘Make in India’ programe which aims to place India as a manufacturing hub on the world map and the ‘Clean India’ campaign which encourages public participation towards sanitation, to updation of age old laws with the introduction of Goods and Services Tax, the decision of the government not to challenge the high court ruling in case of Vodafone share valuation controversy, announcement of advance pricing agreement (APA) rollback mechanism, and last but not the least, re-composition of Dispute Resolution Panels (DRPs) to give them the required bandwidth and autonomy, the government has been aiming to give a face-lift to the overall Indian tax environment and resolve many more issues and causes which deserve attention.

In particular from a Transfer Pricing (TP) perspective (covering cross border related party transactions), three broad areas that need attention would be (a) issuance of rules for announcements that were made in the Budget in July 2014, (b) clarifications and guidance on matters that were at the centre of controversy during the past few years like equity infusion, valuations, etc. and (c) tax administrations, infrastructure and approach.

(a)Rules for announcements made in the July 2014 budget:

Though the APA rollback scheme was announced in the earlier budget, detailed implementation rules are still awaited. As the rollback was applicable to APAs signed post 1 October, 2014, many APAs where positions have been agreed upon between taxpayers and the government, and APAs which are on the verge of completion have been kept on hold. A clear set of rollback rules can aid in concluding these APAs.

The introduction of range concept to replace the arithmetic mean was another welcome proposal as it would align the Indian rules to international standards. However, as the fiscal year 2014–15 is coming to an end, when the concept of range is to be applied for determination of arm’s length price, taxpayers would need clarity on how range mechanism could be implemented before their financials are closed.

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

(b)Clarifications and guidance on matters that have been at the centre of controversy:

TP provisions not applicable to a transaction where income does not arise: Though the controversy on valuation of shares issued by Indian counterparts to their foreign parents has been put to rest by the press release issued after the Union Cabinet meeting on 28 January 2015, it would help to have a clarificatory amendment in the TP regulations (TP regulations). This can go a long way in curbing litigation and enabling the tax authorities to focus on more important incidences of tax base erosion.

Intangibles: Marketing intangibles have been at the centre of controversy and have been debated and litigated upon extensively. It has been alleged by authorities that Indian taxpayers should be compensated for excessive advertising, marketing and promotion expenditures (AMP), as it constitutes further development of marketing intangibles owned by overseas group companies and provision of services. While we await the ruling of the Delhi High Court on this issue it would aid if adequate guidance is provided in the Indian TP regulations. Further, the definition of international transactions has now been expanded retrospectively from the inception of Indian TP regulations, to include marketing and other intangibles; clear guidelines could be issued to recognise certain methodologies/approaches for evaluating the arm’s length character of transactions involving intangibles which can perhaps be in line with the recommendations made by Organization for Economic Co-operation and Development (OECD) under Action Plan 8 of the Base Erosion and Profit Shifting (BEPS) initiative. BEPS Action Plan also endorses that location savings is not an intangible and despite this, the Indian tax authorities are aiming to use profit split method to realise this concept. Clarity that location savings is embedded in the arm’s length margin of Indian comparable, must be provided in the regulations and will be in line with recent judgement delivered by the Honourable Mumbai Tribunal in the case of Watson Pharma.

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

(c) Tax administrations infrastructure and approach:

Though the government has introduced lot of avenues like; APA, Safe Harbour Rules and now independent and autonomous Dispute Resolution Panels to limit the TP litigation ratio, it is important that the transfer pricing officers (TPOs) who conduct the first level audits also adopt a more pragmatic approach by giving due consideration to business and commercial facts than purely being driven by profitability of the taxpayer. It would be important to understand the economic realities and enable the Indian TP regulations to truly become a vehicle to capture the transactions aiming tax evasion. Such an approach can reduce any disappointment that could be faced by MNCs and restore their confidence in the Indian tax regime.

One area that has been in the news over the past few weeks is the opening of the deadlock between Indian and US American bilateral negotiations. If a number of mutual agreement procedures (MAPs) pending over years are closed soon, it can give the right message and positive confidence to foreign investors.

Conclusion

It is understandable that significant changes in TP regulations could take time, but while the Finance Ministry is gearing up to deliver new proposals and guidelines in the upcoming Budget in February 2015, it would be advantageous if first, clarity and guidance on some of the imminent matters are provided. It would also be heartening to see the rollback rules for APA announced soon so that the piled up pending cases of the first year and second year get cleared out to meet the objective of tax certainty for which this programme was announced.

As announced by our Finance Minister at the Global Business summit at Davos, it is imperative to have a TP administration regime that is non-adversarial, instils global confidence in India, and ultimately boosts economic growth.