CAG auditing transfer pricing cases a bad idea
If the R2.2 lakh crore of transfer pricing adjustments made by the taxman to the income of MNCs isn’t bad enough, news reports suggest matters may soon get worse. The CAG, it appears, is preparing itself to start examining transfer pricing cases and has already started training its officials. Theoretically, given the poor track record of the taxman, the CAG audit could end up pulling up the department for frivolous tax demands, but given that this hasn’t happened so far, the chances of it happening don’t look that great. In FY13, in the report of the Tax Administration Reforms Commission (TARC), the taxman won under 12% of all cases in the Supreme Court, a little over a fifth in the high court and the income tax tribunals—the data pertains to all CBDT cases, not just to transfer pricing ones.
Which is why, with the number of transfer pricing cases rising rapidly, the government tried to come up with safe harbour rules, where certain profit margins were specified for different types of businesses—if the assessees declared at least these profit margins, the argument was, the taxman would accept the returns. Yet, as it turned out, the safe harbour norms were fixed at such high levels, few assessees are even using them. Instead, 400 companies have queued up to finalise Advance Pricing Agreements (APAs) with the taxman, to firm up how various transactions are to be dealt with. While APAs provide a lot of certainty, by their very nature, they are cumbersome and restrictive—any firm wishing to enter into a new type of business will, for instance, have to sign a new APA. In any case, of the 400 cases before the taxman, just 5 APAs have been finalised so far. Transfer pricing solutions for US firms under what is called the Mutual Agreement Procedure (MAP) are equally tricky and are stuck on what an acceptable profit margin is to be—the US side wants it to be around 12-13% while the Indian side is sticking to an 18% figure.
In such a situation, the department needs to do two things. One, there needs to be a panel of experts, including the private sector, that need to examine transfer pricing cases to see just where the taxman is getting it wrong. In many cases, for instance, the transfer pricing involves share transactions which, logically speaking, do not affect the income of a company and therefore should be kept outside the purview of transfer pricing. The other solution, as suggested by the TARC, is to set a separate dispute management structure within the CBDT—bifurcation of the tax collection and the dispute management functions will take care of excesses committed at the assessment stage.