Transfer Pricing- Key Challenges Faced by Industry CA. Pramod Jain

1. Transfer Pricing-Key Challenges Faced by IndustryCA. Pramod Jain

2. Key Challenges faced by industry • Long time gaps between TP setting and TP assessments • No moratorium/ cooling period after a successful defence of transfer pricing assessment • Approach in TP assessments • Denial of tax holiday u/s 10A on TP adjustments • Ambiguity and lack of certainty

3. Long time gaps • Every transfer pricing cycle has to go through four phases-setting, monitoring, documentation and assessment • Example • TP setting for transactions between 1st April 2004 to 31st March, 2005 would have been completed in general by 30th April, 2004. • Transfer pricing agreements and other records have been completed during the course of financial year • Transfer pricing study and report would have been initiated in June-July 2005 and filed in Oct. 2005 • Transfer pricing and assessment can be completed by 31st December, 2008 • A gap of almost 4 years 9 months since the whole TP cycle was started in April, 2004 or 3 year 2 months since the filing of tax return

4. No moratorium/ cooling period • TP assessments are exhaustive and time consuming for both-tax payer and tax department • There should be at least 3 year moratorium/ cooling period after a comprehensive and no adjustment TP assessment • This will enable department to do few but thorough and quality assessments rather than current approach of assessing all above a threshold limit • This will also enable tax payer to focus on learning from the assessment and preparing for the next assessment

5. Assessment approach • The approach to assessment should generally start with trust rather than lack of it • The tax department has the challenge of completing too many assessments of different industries within a short period of time • TP assessments get indirectly linked to collection targets also somewhere and put pressure on independence in the process • The data of the ‘comparables’ which was not available to the tax payer at the time of preparing TP documentation is not excluded • Many times, the characterisation of the business or transactions itself is re-positioned • Reasonable adjustments due to differences in business models, cost structures, maturity of the business, competitive landscape, product differences with the comparables etc. should be allowed

6. Different business situations • Risk stripped business models • Cost plus remuneration: No entrepreneurship risk (risk of making loss) and guaranteed profits in cost plus models. Hence, low profits justifiable for captive businesses. • Low risk marketing/ distributors: Indian subsidiaries which act as distributors and sell branded goods of their foreign parents have almost no or very little price risk, credit risk, market risk, inventory risk. Low risk, low profits • Parent funded low risk R & D: The entire risk of sponsoring R & D activities in India and its outcome-failure/ success including patent/ IPR belongs to parent. A typical cost plus model should be acceptable.

7. Denial of tax holiday • Any TP adjustment done during assessment does not qualify for tax holiday u/s 10A to STP units • Assessing officers have to understand pricing process in MNCs in a different perspective-why would Indian entity be paid less when India has a tax holiday until FY 09? • Price determination is done in the light of TP rules in the parent country; need for price consistency for similar services done in other countries • Pricing is an art and not science. Denial of tax holiday in both situations- excess profits due to overpricing and profits arising from adjustments due to ‘under-pricing’. Pricing can never be one scientifically derived number

8. Industry expectations-Tax Certainty • Advance Pricing Agreements (APA) • Very similar to advance ruling process • Tax payer files an application explaining his business and giving a description of functions, assets and risks • The application evaluated by a tax committee consisting of members from economics, accounting and technical background • APA valid for 2-3 years unless there is a change in business facts and circumstances • Win-win situation for both-tax department and tax payer as it provides certainty and also, avoids protracted litigation

9. Other Industry expectations • Expedited assessments/ appeals: TP assessments must be completed within 2 years of filings and appeals should be disposed off within 6 months • Replace arithmetic mean of comparables by inter-quartile range: The arithmetic mean gets skewed by extreme comparables and method should be replaced by inter-quartile range • Relaxed view to stay demands: The department should stay 100% of the demand in all the cases where TP adjustments is too high (say-more than 50% of mark up or profit reported by tax payer)

10. THANK YOU