The changes proposed would be effective from April 1 2011, subject to deliberations at industry and professional forums before going through the motions in Parliament.
The code has proposed these key changes for transfer pricing regulations:
Introduction of an advance pricing programme;
Changes to the definition of associated enterprises;
Procedural changes to dispute resolution mechanism, assessments and statutory filings;
Changes to penalty provisions; and
Introduction of general anti-avoidance rules.
The highlights of the advance pricing programme are:
An advanced pricing agreement (APA) has been defined as an agreement between a taxpayer and the tax authorities for the upfront determination of the arm’s-length price and pricing methodology in relation to an international transaction;
An APA would be valid for a period specified in the APA, up to a maximum of five consecutive financial years;
An APA would not be binding in case of a change in the law and on the basis of which it was finalised;
The determination of the arm’s-length price is subject to suitable or necessary adjustments made by the Central Board of Direct Taxes(CBDT);
The arm’s-length price determined by the APA would not be disturbed by any other provisions of the proposed code;
In relation to the international transactions, the APA would be binding on the taxpayer and the commissioner of income-tax and his subordinate income tax authorities.
The introduction of APAs is a welcome measure and should provide a fair degree of certainty to business transactions, given the state of transfer pricing litigation in India. The challenges nonetheless will be in the timely disposal of APA applications and the flexibility and willingness shown by the authorities to dispose of complex applications. Also clarity about the treatment of pending matters not covered by the APA programme will have to be looked at.
Changes to the definition of associated enterprises
The definition of associated parties has been modified to omit the reference of direct or indirect participation in management, control or capital. The definition now seeks to illustrate directly the relationship between two associated enterprises. These changes have been proposed:
A direct or indirect shareholding has reduced from 26% to 10%;
A loan by one enterprise as a percentage of book value of total assets of the other enterprise has been reduced from 51% to 26%;
Power to appoint board of directors has been reduced from more than half to more than one-third of the governing board; and
The dependence by one enterprise on another for raw materials for manufacture, has been reduced from 90% or more to two-third or more.
The proposed changes widen the scope of transfer pricing compliance and would also bring into its ambit, transactions with strategic or financial investors.
Procedural changes to dispute resolution mechanism, assessments and statutory filings have also been proposed. These include that:
The code proposes that the Dispute Resolution Panel would only deal with cases in respect of adjustments of more than Rs2.5 million ($52,000);
The annual accountant’s report would now have to be filed with the transfer pricing officer (TPO) instead of the assessing officer;
The due date for filing the accountant’s report has been advanced to August 31, from September 30;
The selection of transfer pricing cases for detailed scrutiny would be based on a risk management strategy as may be framed by the CBDT. This strategy would be confidential and would not be shared with the taxpayers; and
The time limit for selection of cases by the TPO is proposed to be within two months from the end of the financial year in which the accountant’s report has been filed.
The selection of cases for audit based on a risk management strategy is a step in the right direction, as all cases more than a specified monetary limited are being selected for audit now.
Changes to penalty provisions
The penalties for non-filing of the accountant’s report has been proposed at between Rs50,000 to Rs200,000 ($1,040 to $4,160);
The penalties for non-maintenance of documentation has been proposed at between Rs50,000 to Rs200,000 as against 2% of the value of the international transaction;
The penalties for non-furnishing of documentation has been proposed between Rs5,000 to Rs100,000 as against 2% of the value of the international transaction; and
No tax authority would have the power to waive the penalties.
The code has defined certain arrangements as “Impermissible Avoidance Arrangements” whose main purpose is to obtain tax benefits and depart from the arm’s-length principle. These arrangements would be covered by the anti-avoidance measures. The new anti-avoidance rules will have a treaty override. The measures seek to amend or disregard or recharacterise such arrangements.
The code seeks to give significant powers to the tax authorities. It remains to be seen how ready corporates and the tax administration are to accept these changes in their entirety. We believe that the proposed code will undergo some changes before we see it in its final form.
Rohan Phatarphekar, executive director, national head of transfer pricing, KPMG andHardev Singh, director, BSR and Company
