Business Line : Features / Mentor : Business and transfer pricing provisions

Business Line : Features / Mentor : Business and transfer pricing provisions

Transfer pricing provisions become applicable on international transactions between two or more associated enterprises — either one or both of whom are non-residents — that have a bearing on profits.

Anurag is a Person of Indian Origin (PIO), who surrendered his Indian citizenship a decade ago, after he decided to marry Roselin, an American citizen. Anurag continued to carry on his US business, with procurement of materials from India and China. However, over the last few years, Asian giants such as India and China started inviting investment from the West, in their manufacturing as well as service industries. Anurag was no exception to this invitation.

ASSOCIATED ENTERPRISE

The obvious choice was to have broader connections in India as well as China. Initially, he set up an Indian operation with a liaison office in Chennai, after getting specific permission from the Reserve Bank of India. Considering the cost advantages, coupled with man power resource capabilities, he stepped up buying and exporting of goods to Canada and USA on a larger volume. Unaware of the provisions of the RBI, as well as tax matters such as transfer pricing provisions, the business continued to grow. We take a look today at the provisions of these, and the impact of the violations on Anurag's business.

Transfer pricing provisions become applicable on international transactions between two or more associated enterprises, either one or both of whom are non-residents, that have a bearing on the profits, losses or assets of such enterprises. International transactions include purchase, sale or lease of property, provision of services, or lending or borrowing of money, and any transaction having a bearing on profits, income, losses, or assets of such enterprise.

Associated Enterprise is intended to mean one enterprise participating in the management or control or capital of the other enterprise, directly or indirectly, or through one or more intermediaries, with specific benchmark levels for each criteria, and there are as many as 13 parameters in which two enterprises can be deemed to be associated enterprises. The purpose of the legislation is to control the ability of the associate enterprises, to allocate profits in different countries by controlling prices in intra-group transactions.

ARM'S LENGTH PRICE

Anurag, then, participates in the control, management and capital of both the Indian company and his US company. So they fall under the net of Associated Enterprises, and any transactions of any nature between these two should be at an Arm's Length Price, which has been defined by the Income Tax as, “Where an enterprise enters into transactions with associated enterprises, in order to determine the Fair Profit of that enterprise, the profit of the transactions should be compared with those entered into by two independent enterprises under uncontrolled conditions and under similar circumstances.”

In other words, if Anurag was purchasing a product of service for his US firm from an independent, unrelated entity in India, what would be the price he would pay? The Transfer Pricing officer has the power to adjust the profits that have not been reflected at the market price. Anurag has the responsibility of maintaining the necessary documentation, to arrive at the most appropriate method of computing the Arms Length Price, since his turnover exceeds Rs 1 crore between these companies. In addition to the Transfer Pricing provisions, Anurag overlooked the provisions and notifications of the Reserve Bank of India on Liaison office. The permitted activities of Liaison office are: promoting export and import, technical and financial collaborations between group companies, and acting as communication channels between parent and Indian establishments. Thus Liaison office is clearly prohibited from carrying on buying and selling in its Indian form.

Admittedly, transfer pricing computation rules are complex, and require volumes of documentation, but the underlying logic is simple — you cannot reap the benefits of undercutting, price control and profit allocation. The way forward for Anurag is to implement transfer pricing at the organisational level, and to regularise the activities of the Liaison office with the RBI. Issues with setting up offices / branches must be avoided by thoroughly exploring the market / country one proposes to enter. Regulatory provisions must be studied and advice sought from the right authorities before setting up shop.

Most businesses avoid conduct of this due diligence and end up in situations akin to the one discussed above. It only leads to the additional cost of regularisation and unnecessary stress.

(The author is a Coimbatore-based chartered accountant & the Managing Director of GKM.)