High pitched transfer pricing adjustments equals tax evasion? Huh?

Lubna Kably
30 August 2013, 10:42 PM IST

Zenobia Aunty's niece is caught up in too many different projects, mind you she isn't complaining. She merely thought that she could put this column on the back-burner, for another day. But requests from her readers mounted to write about this absurdity NOW- and perhaps rightly so.

What is it that has had tax folks (her readers) seething? Well, a press release issued today evening (August 30) by the Ministry of Finance, 'showcases' the high pitched transfer pricing adjustments made during the past three years. To add insult to injury the heading of the press release is: TAX EVASION BY FOREIGN COMPANIES. Whoa!!! If only the Ministry of Finance had provided additional details of how many of the demands arising out of the transfer pricing adjustments which have reached the appellate stage, be it the ITAT or High Courts, were upheld would we have a better idea on whether this is really tax evasion or just high pitched demands - some made because of the dire need to meet tax targets.

This is what the press release, which is actually a written reply given to the Lok Sabha (Lower House of the Parliament) by the Minister of State for Finance, J.D. Seelam reads as: "Data on dollars transferred abroad by foreign companies in India is not centrally maintained by the government. However, with a view to prevent shifting of profits out of India and consequent erosion of the Indian tax base, selected international transactions undertaken are analysed every year in accordance with the transfer pricing provisions contained in Chapter X of the Income Tax Act, 1961. The total quantum of transfer pricing adjustments made in the last three years are as under: Financial year 2011-12 (Rs. 23,237 crore), Financial year 2011-12 (Rs. 44,531 crore) and Financial Year 2012-13 (Rs 70,016 crore).

Chapter X, containing special provisions relating to avoidance of tax, was inserted in the Income Tax Act, 1961 vide the Finance Act, 2001. Section 92 (1) of the Income Tax Act, 1961 stipulate that income from an international transaction shall be computed based on the arm's length principle. Further, income of foreign companies operating in India is taxed as per the extant provisions of Income Tax Act, 1961 and the various Double Taxation Avoidance Agreements. Some of the relevant sections of the Income Tax Act in this regard are section 9, 44BB, 44BBA, 44 BBB, 44DA, 115A etc, concludes this press release.

It is true that base erosion and profit shifting is now a global worry. But it is also true that India is regarded as one of the most difficult jurisdictions when it comes to transfer pricing. As some say it, it is just a bag of gas (yes, pun intended as it refers to the Shell case, where issue of shares was caught in a transfer pricing demand).

An EY Global Transfer Pricing Survey Report (2013) points out: The number of survey respondents reporting that they were subject to a review of their transfer pricing policies in India, more than doubled in 2012 from 2007. Emerging markets (India, China, Indonesia and South Korea) made up half of the top eight jurisdictions. imposing transfer pricing penalties. This indicates companies may need to increase their resources and change their focus to deal with transfer pricing matters in those jurisdictions. The survey further suggests that the taxpayers' geographic priorities have begun to shift in response.

Zenobia Aunty learns that in recent times, it is advertisement spends that have caught the fancy of the transfer pricing authorities. In many cases, the Indian subsidairy acts as a distributor cum service provider and incurs a share of advertising and marketing spend for promoting the product. Transfer pricing authorities have contended that since the Indian company incurs advertising and marketing expenses which benefit the foreign associate enterprise, it is the Indian company that should be reimbursed for its expenses. The argument by transfer pricing authorities is that it is the brand of the foreign associate that is being promoted. A comparison is undertaken by them between the level of advertising and marketing expenses incurred by the Indian company (which is an affiliate of an NMC) with those of other Indian companies and transfer pricing adjustments inevitably follow.

Or take royalty payments as another instance. In its recent decision the Delhi Income tax Appellate Tribunal rejected the contention of the transfer pricing authorities that Suzuki was a lesser known brand which had 'piggybacked' on Maruti to become an established brand. The transfer pricing authorities had held that because of this, there was no need for Maruti Susuki India Limtied (MSIL) to pay any royalty for use of brand to Suzuki Japan. Can such a transfer pricing adjustment initially made by the tax authorities be referred to as tax evasion? Not really, especially not when the ITAT has ruled in favour of the tax payer. The Delhi ITAT deleted the adjustment made by the transfer pricing authorities on account of payment of royalty by MSIL to Suzuki JapanFrom R&D spends, to issue of shares, to payment of royalty, the transfer pricing authorities have left no stone unturned and the result has been endless litigation, leaving many MNCs frustrated.

While certain transfer pricing issues plauging R&D centres have been taken care of by the CBDT which withdrew a contentious circular and issued an amended version as regards another circular, the newly annouced draft safe harbour principles have got a tepid response. The profit margins appear too high and the transaction threshold for the safe harbour too low. So yes, litigation is bound to continue, if the safe harbour provisions are introduced in its present form.

Zenobia Aunty isn't implying that all transfer pricing orders are unjustified. However, given the recent trends she affirms that all transfer pricing adjustments cannot be termed as 'tax evasion by MNCs' - especially not when many of these demands are not sustainable in appeal.