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Transfer Pricing Reforms in the Direct Tax Code



The new Transfer Pricing policy introduces two concepts which are novel only to the Indian tax system known as 1) Safe Harbour rules and 2) Advance pricing agreement (APA). Safe Harbour rule intends to specify the tolerable mark up to the cost of the goods or service for the taxation authority to accept the Transfer price computed by the assessee 'as such'. APAs can be unilateral, bilateral or multilateral and they are between the taxpayer and the taxation authority or authorities as the case may be, in advance on the computation of the Arms length price for tax purpose. But these are existing practices in the West as well as some Asian economies. Sec.118 of the DTC talks about an Unilateral APA (one to one) between the assessee and the Board which will be binding on the transaction, the respective assessee and the Commissioner including his subordinates.



There are concerns that the 'Safe Harbour' rule might have the effect of double taxation since the Safe Harbor (accepted mark up %) in one country will not be accepted by the other country only to tax the transaction value at their end. This is quite true if there is no Double taxation avoidance agreement (DTAA) with the other country. For this we may draw some inspiration from the IRS (Internal Revenue Service of the US) in future which encourages its taxpayers to request the competent authority to enter into bilateral or multilateral APAs with other foreign tax jurisdictions to counteract the double taxation. If a DTAA already exists, there is a remedy through a standard article on 'Mutual Agreement Procedures' wherein it is provided that any assessee who feels that he has not been taxed in accordance with the tax treaty can approach a competent authority in the state where he is a resident (or national) for resolution. It then becomes the onus of that authority to either unilaterally or in consultation with the other contracting state to redress the grievance of the assessee.  



As per clause.118 of the DTC, the agreement will be valid for a period of 5 years from a specified date. Also, being a non obstante clause, it overrides the entire Chapter XI which means the 'Safe harbour Rule' will not apply if there already exists an APA. The content of the agreement is the manner or the 'parameter' with which arm’s length price is to be determined in relation to an international transaction to be entered into by that person. Our existing Rule 10B(2) of the Income tax rules allows data usage up to a maximum period of 2 years provided the factors influencing the price at the time of those comparative transactions are known. Thus the assessee gains a privilege of additional 3 years. The provision for revisiting the factors determining the influence over price is conspicuously missing under DTC. What will happen if the ’control’ relationship subsides to a 'significant influence' within the 5 years where presumably no control exists? We will have to wait and see how the CBDT deals through the scheme for the APAs in respect of an international transaction. Any amendment to the agreement for the above purpose will not make it null and void because as per clause 118, the agreement will become invalid only if there is an amendment in the Tax Code itself which has a bearing on the agreement.



Also it remains to be seen if there will be potential issues by using a data generated from a 5 year old method in a dynamic economy such as India. Assuming in the year 2012, Company X has an APA with the Board for computing the Arms length price under Comparable Uncontrolled Price (CUP) method in respect of certain automotive components. Company X would import all these components from its parent company say in Germany. This product then turns globally obsolete within 2 years due to market dynamics and Company X would like to reexport the same back to its parent company. Given this scenario it might become difficult to arrive at the Comparable uncontrolled price in 2 years down the line due to no active market! This would require modifications in the agreement to change the method say to Transactional Net Margin approach and for which our law should accord approval. We can add some more like situations. It is a challenge to the Board and the taxpayer to work with proper foresightedness and for the Board to not get overwhelmed by the current revenue targets.



It is interesting to see whether the Transfer pricing officer will have any role at all to play under these conditions given the fact their superior most authority has frozen the TP assessment in advance. It may be remembered that a TPO is an Additional or Joint or Deputy or Assistant commissioner who is a subordinate to the CBDT and the Commissioner as well implying that he is also bound by the APA. Probably this is the reason why the law maker was prompted to provide under Sec.88 of the Code that the Transfer pricing report (existing Form 3CEB ) from the accountant will have to submitted to the Transfer pricing Officer instead of the Assessing officer to whom we have been submitting all along.



Let us see how the concept of APA is comparable to our existing system of Authority for Advance Ruling (AAR). To recap, as per IT act 1961, AAR is a body where the taxpayer can secure an advance ruling on his tax impact in the transaction which is either incomplete or complete. Method of Computation of ALP or the issues thereof are still within the powers of the AAR. The relevant clause in DTC says as follows,


"The Board, with the approval of the Central Government, may enter into an advance pricing agreement with any person in respect of the arm’s length price in relation to an international transaction which may be entered into by that person on the basis of the prescribed method being the most appropriate method.”


This gives rise to the folowing differences. Under DTC, devising of the agreement looks to be the initiative of the Board even before the transaction is entered into by the taxpayer, whereas AAR works only on application from the taxpayer and covers even completed transactions. It is interesting to see whether CBDT will be able to effectively use this tool because it has to keep track of the economy very proactively! Both of them are subordinated to further amendments in law. The second difference is that the AAR has a larger time limit of up to 6 months to decide on the application which does not apparently seem to be so linient for CBDT since after all the process is to be kick started by CBDT itself . The significant fact is that there lies no appeal against the ruling of an AAR (except by a petition to the High Court or Supreme Court), whereas actions or orders of the Board are generally appealable (An appeal concerning the APA is not explicitly mentioned in 21st schedule to the code, but since as per the Code, the agreement will be initiated and virtually dictated by the Board, it is opined that the taxpayer will not be denied the right to appeal against the same). Also since AAR is accorded the status of a Civil court in exercising its powers, the assessee might find its process less comfortable in the Indian scenario and tend to welcome the APA with Board. Neither of these two approaches serve as alternative to the other since neither the Board nor the AAR (Sec.245R) will have the power to consider cases already pending at the other's end. In effect, there seems to be a slight advantage to the taxpayer when the Board calls on him!



Hoping that there might be some amendments in the Code itself in future along the following lines to avoid ambiguities,


  • A sub clause may be added in Clause 118 of Chapter XI to provide for intermittent reviews and amendments in APA keeping in line with the current conditions
  • Encourage Implementation of bilateral APAs with other foreign tax authorities as mentioned above to avoid double taxation.
  • Permission to the taxpayer to make an application at his instance to the Board for entering into an APA in respect of his international transaction.


'Nature abhors vacuum' is a phenomenal saying to mean that there is ultimately nothing as unfilled or empty. This is a frequent happening in our country since 1991 with every reform brought in to bridge the gaps in the Globalization process. It is now the turn of our Transfer Pricing policy under this new Direct Tax code system to align with the global economy.


Published by

(IFRS Consultant)
Category Income Tax   Report

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