The increasing scope of transfer pricing rules

Caucasian businessman using digital tablet in cafeTransfer pricing regulations were introduced in India more than a decade ago with an aim to curb tax evasion by large multinational groups who could potentially influence the pricing of cross-border intra-group transactions.

While historically, the focus of Indian Revenue authorities was to audit transactions between the Indian arm of an MNC group with its foreign affiliates, the scope of the audit has, in the recent past, also extended to transactions between Indian companies whether related or not.

The recent Vodafone judgement:

In the recent case of Vodafone, which continues its face-off with the Indian Revenue on issues emanating from the Hutch acquisition, the Mumbai Tax Tribunal was required to deal with a transfer pricing adjustment proposed by the Indian Revenue on the sale of its call centre business by Vodafone India Services Private Ltd. (VISPL) to a Hutch group entity in India (HWP India). The Indian Revenue authorities contended that there existed a prior agreement between Vodafone and Hutch globally as regards the sale of this call centre business and the transaction was undertaken to give effect to a global arrangement between Vodafone and Hutch. Consequently, a transfer pricing adjustment to the tune of INR1.4 billion was proposed.

While deciding on this issue, the Tribunal observed that the sale of the call centre business was a pre-condition to the agreement between overseas entities of Hutch and Vodafone. Furthermore, the Tribunal held that HWP India lacked commercial or economic substance prior to this acquisition and the payment was in fact made to the Hutch overseas entity by routing the funds through the bank account of HWP India. Therefore, the Tribunal concluded that it was justified for the Indian Revenue authorities to lift the corporate veil in this case and subject the transaction to a transfer pricing analysis. However, the Tribunal did not agree with the valuation approach adopted by the Indian Revenue and remanded the case back to the Indian Revenue to determine the arm’s length price for this transaction based on the DCF method of valuation.

Amendment to the definition of deemed international transaction:

Section 92B(2) of the Indian Income-tax Act (Act) deals with transactions between a taxpayer and an unrelated party, which could come within the ambit of Indian transfer pricing rules (‘deemed international transaction’) if (i) there existed a “prior agreement” in relation to this transaction between the unrelated party and the overseas affiliate of the taxpayer; or (ii) the terms of the transaction have been determined in substance between the unrelated entity and the overseas affiliate of the taxpayer.

Prior to an amendment in the Finance Act 2014, the view taken by most taxpayers was that the deemed international transaction provisions will not be applicable in case of transactions between two unrelated Indian residents. However, the said Section 92B(2) has now been amended, with effect from 1 April 2014, also to cover transactions between two Indian residents.

What these developments mean:

The above developments have brought the focus on transactions, which were hitherto not generally considered to be transactions that should be subject to Indian transfer pricing rules.

The ruling of the Mumbai Tribunal signifies that it is critical to evaluate the substance, conduct and intent of parties in order to determine the applicability of transfer pricing provisions; especially in situations where transactions may have been undertaken between two Indian parties pursuant to, or to give effect to a global transaction/arrangement. MNCs engaging in global deals/ internal re-organizations will now need to navigate through the principles/observations of the Mumbai Tribunal while evaluating whether the Indian leg of such a transaction should be subject to transfer pricing analysis.

The amendment to the deemed international transaction provisions also poses a significant challenge for MNCs. While the amendment seems to settle the controversy that this provision can also be attracted for transactions between an Indian taxpayer and another Indian unrelated entity, there are other ambiguities, which continue to exist.

It is fairly common in an MNC environment to have global procurement/service agreements, which form the basis of transactions and business dealings between two MNCs and their various affiliates in different jurisdictions. For example, let’s take a situation where ABC India (part of an MNC group) transacts with XYZ India (part of another MNC group) to avail certain services, and the broad contours of the transaction are based on a global agreement between these two groups. With the amendment to Section 92B(2), it is no longer possible to contend that since the transaction is between two Indian companies, transfer pricing should not trigger.

Under these circumstances, most MNCs would need to develop a robust process in order to identify such transactions on an ongoing basis and then carry out a detailed analysis of various terms of the arrangement to evaluate if the same is required to be reported to the Indian Revenue authorities as a deemed international transaction. This analysis gets complicated as the provisions do not specify as to when and in what situations it can be said that the terms of the transaction are determined in substance between the unrelated entity (i.e., XYZ group/ XYZ India) and the ABC group.

This amendment will most certainly increase the reporting and administrative burden on companies, which are anyway grappling with an ever increasing compliance function today. Moreover, the absence of clear and objective criteria/parameters to identify deemed international transactions could also result in increased disputes between taxpayers and the Indian Revenue on this issue.

The need of the hour is for the government to come out with clear guidance on these issues that will help the Indian Revenue identify transactions, which have genuinely resulted in tax evasion/avoidance without burdening the taxpayer with more compliance obligations and potential litigation due to ambiguous rules.


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