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Transfer Pricing and Advance Pricing Agreements

Transfer Pricing and Advance Pricing Agreements

Transfer Pricing refers to the pricing of assets, tangible and intangible, services, and funds transferred within an organisation in cross-border transactions. In other words, transfer pricing is the price at which a company sells goods to its own parent or subsidiary. Tax administrations apply stringent rules to pricing of such transfers to prevent transfer of income from high tax jurisdiction to low tax jurisdictions to escape tax. Multinational companies that have business in India have frequently complained against the aggressive tax administration in transfer pricing disputes that has led to increase in tax disputes.

Rules of Advanced Pricing Agreements (APAs) have been notified by the government to enable MNCs to negotiate with the Indian tax authorities on their potential tax liability with respect to their transactions with their local arms or the local company dealing with its parent, helping avoid frequent transfer pricing litigation with foreign companies which has soured investment sentiments.

An Advance Pricing Agreement (APA) is an agreement between a taxpayer and the tax authorities that allows both to set out in advance, the method of determining the transfer pricing for inter-company transactions, helping avoid post transaction disputes apart from giving Multinational companies (MNCs) certainty about their tax liability. These agreements are made in advance with respect to the pricing of the related party transactions of the taxpayer for a specified period of time.

APAs give taxpayers certainty about their transfer prices for their related party transactions helping cut litigation and trouble. The company seeking AGAs submits its detailed information about costs and margins to the tax authorities. Based on the information submitted and a comparison with what a similar arms length transaction would cost, tax authorities give their opinion.

In a significant policy decision taken in October, 2013, the government has notified ‘Safe Harbour’ rules under which it will accept up to a tax liability of Rs. 50U crores whatever has been declared by a company under APAs, without any objection or threat of litigation. The transfer pricing dispute and a respective legislation to bring old deals under the tax net has been cited as major hindering factors for foreign investment. Indian laws state that companies have to sell goods to parent or subsidiary at the same price at which they sell these to third parties. In other words, the price at which it sells should be arm’s length price.

In a major blow to the government, the Bombay High Court ruled in favour of Vodafone in October, 2014 in a transfer pricing dispute involving a sum of Rs. 3200 crores demanded by Income Tax department from Vodafone in a transfer pricing case of 2009-10. The case relates to Vodafone India Services which issued shares to its parent in 2009-10. The Income Tax department claimed that these shares had been undervalued, which amounted to income transferred to parent company. The company argued that purchase and sale of shares constitute capital transfer, not income and moved Bombay High Court in January 2014 anticipating a tax notice. The Income Tax department issued tax demand of Rs. 3,200 crores. The Bombay High Court ruled in favour of Vodafone in its judgment in October 2014. This ruling may or may not influence other such cases but will definitely encourage foreign investment.

Indian Economy

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