In this era of globalization, it is natural that MNCs operate across the world.

They came in india as

well. As economic activity in post LPG era grew, so did their complexity, and thus disputes. However,
no country can ignore foreign investment, despite their ill-effects.
MNCs have operations in many countries, and apart from dealing with market, they do transactions
within themselves too sometimes because of necessity and sometimes to maximize profit.
Consider this - company A purchases goods for 100 rupees and sells it to its associated company B in
another country for 200 rupees, who in turn sells in the open market for 400 rupees. Had A sold it
direct, it would have made a profit of 300 rupees. But by routing it through B, it restricted it to 100
rupees, permitting B to appropriate the balance. The transaction between A and B is arranged and not
governed by market forces. The profit of 200 rupees is, thereby, shifted to the country of B. The goods
is transferred on a price (transfer price) which is arbitrary or dictated (200 hundred rupees), but not on
the market price (400 rupees).
Drawbacks of such a mechanism:
-

loss of taxation revenue to govt,

loss of foreign exchange and
unethical corporate governance.

To avoid this kind of scenario, it is necessary that transactions between subsidiaries of a MNC
operating in various countries is properly regulated.
Regulation
The Finance Act, 2001 introduced law of transfer pricing in India through sections 92A to 92F of the
Indian Income tax Act, 1961 which guides computation of the transfer price and suggests detailed
documentation procedures.
Transfer price
-

Commercial transactions between the different parts of the MNCs may not be subject to the
same market forces shaping relations between the two independent firms.
One party transfers to another goods or services, for a price. That price is known as transfer
price.
This may be arbitrary and dictated, with no relation to cost and added value, diverge from the
market forces.

Transfer Pricing
refers to prices of transactions between associated enterprises which may take place under conditions
differing from those taking place between independent enterprises. It refers to the value attached to
transfers of goods, services and technology between related entities.
Transfer Pricing Regulations (TPR) are applicable to the all enterprises that enter into an 'International
Transaction' with an 'Associated Enterprise'. Therefore, generally it applies to all cross border
transactions entered into between associated enterprises.
Aim of Transfer Pricing Regulation
to arrive at the comparable price as available to any unrelated party in open market conditions and is
known as the Arm's Length Price (ALP).

Arms length price

the price that would be charged in the transaction if it had been entered into by unrelated parties in
similar conditions.
The ALP is to be determined by any one or more of the following methods :
(a) Comparable Uncontrolled Price Method
(b) Resale Price Method
(c) Cost plus method
(d) Profit Split Method
(e) Transactional Net Margin Method
The primary onus is on the taxpayer to determine an ALP in accordance with the TPR and to
substantiate the same with the prescribed documentation.
The tax officer may reject the ALP adopted by the assessee and determine the ALP in accordance with
the TPR. For this purpose, he would then refer the matter to a Transfer Pricing Officer - a special post
created for valuation of ALP - who would determine the ALP after hearing the arguments of the
taxpayer.
In case the ALP determined by the TPO indicates understatement of income by the taxpayer, it could
result into levy of penalty.
It is here that the tax disputes come into picture. Taxpayer tries to reduce his tax burden by
manipulating accounts, the tax officials try to maximize tax buoyancy by imposing higher prices of
transaction.
Many MNCs, including Nokia, Royal Dutch Shell and Vodafone are stuck in tax disputes in india.
Consequences
-

India is seen as a combative tax administration.

Discourages overseas investors.
Makes india as an unwelcoming and troublesome investment destination.
Need is to be seen as a stable and non-adversarial tax regime.
Increase tax litigation causing valuable expenditure.

Today when we need foreign investment, and that too in the form of long term, stable FDI, such a
condition is highly undesirable.
We did bring Transfer pricing regulations in 2001, but it could not bring clarity on the issue and tax
disputes did not reduce.
Finance minister in his 2013 budget announcement pledges to bring clarity on the issue so as to revive
investor confidence.
Govt sets up N. Rangachary panel in 2013. It comes with recommendations on Safe Harbour Rules.
Safe Harbour Rules (SHR)
-

Section 92CB of Income Tax Act provides for it.

Determination of Arms Length Price is subject to these SHR.

It means circumstances under which the IT authorities shall accept the transfer price declared by
the taxpayer.

Govt accepts most of the recommendations of Rangachary panel and notifies new rules in sept 2013.
Salient features of new SHR:
-

More liberal than the draft rules.

Begins from assessment year 2013 14.
Applicable for 5 years. (draft rules said 2 years).
Does not cover pre-existing disputes, but are likely to curb future litigations.
Brings clarity on the determination of ALP.
Ceiling of Rs 100 crore on IT and ITES activities removed helping technology companies like
Microsoft and Google.
For transactions upto Rs 500 crore safe harbor margin of 20%
For transactions more than Rs 500 crore safe harbor margin of 22%.
Ceiling of Rs 100 crore on corporate gurantees removed.
Definition of Knowledge Process Outsourcing rationalized.

How will they help?

-

Expected to bring down transfer pricing litigation.

Charges of excessive and aggressive tax demands on MNCs will get reversed.
In line to make indias tax regime stable and non-adversarial.
First real concrete step towards increasing investor confidence and sentiments.
Hopes to improve indias position of 132 in the Doing Business 2013 index compiled by the World
Bank.

Word of caution
-

Internation business, taxation, avoidance methods are very dynamic.

Itd be nave to assume that one set of guidelines will make the most attractive destination for
investment.
Or they can curb all disputes. Corporate will seek to maximize profit and thus litigation will
happen.
Tax officials need to be trained in how to deal with such issues.
Domestic conditions, political climate, infrastructure, other aspects of business climate need to be
looked into as well.

SHR vs APA (Advance Pricing Agreement)

-

Both are meant to determine the tax liability of an MNC.

If MNCs go for SHR route, then Under certain conditions, their liability is not questioned by the
tax department
Alternatively, companies can go for APAs as well to know their liability in advance
In APAs, the margin is generally 15-17 per cent
In SHR margin varies from 20% to 30% depending upon the nature of activity of the company.
Thus the liability of MNCs will vary under the two methods and they are free to choose among the
two.
MNCs would consider this difference with APA and the hassles in case it goes for litigation if it
adopts SHR method.

the parent company gets tax deduction in the case of APA but not in the case of safe-harbour rules
SHR margins are already set by tax officials, while an APA is a negotiation between these
companies and tax authorities.
while the SHR still entice small companies, larger players might not opt for these. They might
prefer APA for upfront resolution.
To judge whether a company is KPO, IT/ITeS or contract research and development company is on
the discretion of tax officer. The distinction between them is narrow. Hence disputes can
compound.
So the whole purpose of bringing more companies under the SHR structure, to bring down tax
litigation, may get defeated, as they may choose APA route.

by Rahul Kumar
Sources
1. http://www.cci.in/upload%5CArticle%5Cfile

%5CFileKCKXXZHlaw_transfer_pricing.pdf
2. http://www.doingbusiness.org/data/exploreeconomies/india/
3. http://law.incometaxindia.gov.in/DIT/inttpcont.aspx
4. http://pib.nic.in/newsite/erelease.aspx?relid=99442
5. http://www.business-standard.com/article/companies/safe-harbour-rules-might-not-drawlarge-companies-113092200198_1.html