Unclear tolerance bands put Indian taxpayers at greater risk of TP adjustments

Source: TP Week April 30, 2013

Indian taxpayers that import goods into the country and sell in bulk will be at greater risk of transfer pricing adjustments as the government has reduced the tolerance band for wholesale traders to 1%. Advisers have said more clarification is needed on how the tolerance bands will be applied. When the difference between the arms-length price determined under section 92C of the Income Tax Act (1961) and the price at which a taxpayer has undertaken the international transaction does not exceed 1% for wholesale traders and 3% for all other cases, the transaction price will be deemed to be the arms-length price for assessment year 2013-14. The tolerance band for calculating arms-length price was reduced from 5% to 3% in the Finance Act 2011 and was effective from FY 2011-12. The Indian government indicated that a 5% variation was too broad, according to advisers, and taxpayers conducting transactions on a non-arms-length basis were escaping transfer pricing adjustments. One of the reasons the government may have reduced the tolerance band for wholesale traders is because they sometimes have the benefit of the price being available on the open market or through a commodity exchange, according to Sanjiv Malhotra of BMR Advisors. If thats the case then they have a good comparable or benchmark arms-length price and then they may not have the benefit of deviating from that market place price by a large amount, said Malhotra.But that applies to a very limited number of wholesale traders because its not the case that for every commodity or product that is transacted by a wholesale trader a commodity exchange is available. The other reason could be because a wholesale trader works on smaller and more stable margins and optimizes their business through volume, according to Malhotra. Therefore the price of the margin may not vary to the extreme. However this is problematic because there are many wholesale traders who deal in products that are not exchanged on a commodity exchange, Malhotra said. Therefore price discovery is not easy. You may not have a good comparable but you will have so little margin for error, said Malhotra. During a transfer pricing audit the chances of you falling outside the range are going to be much higher. Wholesale trader definition unclear Many advisers have said the definition of a wholesale trader is too broad and requires additional clarification.

You name a product you will have someone who is importing and selling in bulk because that is how most of the multinationals that are not manufacturing in India conduct their business operations, said Malhotra. Their margins do fluctuate a lot, whether thats because of how popular their product is, what their competition is doing or how the economy is doing. Malhotra said a more drastic measure taxpayers could take to deal with the reduced tolerance band would be to reconsider their functional characterisation in India. If you were a full redistributer you could move to being a limited redistributer, so you would be running lower but stable margins, said Malhotra. Wholesale traders could also review their transfer pricing methodologies and test the foreign supplier rather than the Indian entity, which in many supply chain models are the limited risk manufacturers and the limited redistributers to India. This would mean an entity with more stable margins was being tested. The interesting thing will be to see if the government comes up with a clarification relating to, for example, commodity traders, said Malhotra. That is one thing that we are recommending should happen.