The advent of globalization and the rise in cross-jurisdictional operations has resulted in concerns over pricing of intra-group transactions.
In response to such concerns, in 2001 transfer pricing laws were introduced in India; in over a decade, the law has adapted swiftly to address contentious issues. However, India remains relatively litigious among jurisdictions applying transfer pricing rules: it is estimated that India accounts for a third of the global total of transfer pricing disputes.
Among the most contentious issues is the selection of comparables and methodology adopted for benchmarking. As a result, protracted disputes on such grounds tend to exacerbate uncertainty in company operations as well as government revenue collection. Transfer pricing remains the preferred method to calibrate corporate tax incidence.
The extent of litigation therefore demands a causal analysis, to help identify the changes that can be introduced to the existing regime to improve the process. In this context, this article assesses India’s transfer pricing regime through an analysis of 6,731 cases that were appealed before the Income Tax Appellate Tribunal (ITAT).
Chronology of a Dispute
The chronology of a transfer pricing dispute is outlined below.
An assessee can object to a transfer pricing adjustment made by an assessing officer (AO) before the Dispute Resolution Panel (DRP) or Commissioner of Income Tax (Appeals) (CIT(A)), depending on whether it is a draft or final order, respectively.
If the assessee remains dissatisfied with the outcome they can further appeal against the order of the DRP or CIT(A) before the ITAT. The ITAT is the final fact-finding authority and any matters of law may then proceed to the High Court or further to the Supreme Court.
The orders pronounced by the ITAT carry details of the case, providing an opportunity to analyze patterns. Using such information, we can construct a dataset for transfer pricing disputes in India. The transfer pricing regime is assessed on parameters such as duration of dispute, efficacy of alternate dispute mechanism and the quality of case outcomes.
Duration of Disputes
Since companies tend to regularly undertake related party transactions, matters that are not settled swiftly can contribute to uncertainty. Therefore, the duration of cases is estimated. Each case refers to the assessment year to which the transfer pricing adjustment relates. Taking that as the beginning of the dispute (although the date of the order of the AO is considered as the beginning of the dispute, the same is not available in all cases. If the duration of the dispute is to be considered as the period for which there is uncertainty, then we may count it from the assessment year) and the year in which the order is passed by ITAT as the year of conclusion, the total duration of a case is estimated.
Further, the case also refers to the year in which the appeal was filed in the ITAT. Therefore the total duration can be split into that relating to processes pre-ITAT and time taken exclusively in ITAT.
It is observed that the average duration of cases has declined from 10 years at the beginning of the regime to close to six years in 2014. Similarly, the variation in the duration also declined across the period 2004–14.
This decline is largely attributable to the decline observed for case disposal in ITAT. On the other hand, the decline has been muted for pre-ITAT process except for the step decline in assessment year 2006–07.
Alternative Dispute Resolution Mechanism
To prevent prolonged disputes, the alternative dispute resolution mechanism or the DRP was introduced in 2009. The panel, comprising experts from the department is mandated to issue direction within nine months. It was expected that such alternative dispute resolution mechanism would offer quick case resolution.
The evidence suggests that the DRP did contribute to the reduction in the duration of the cases, as is observed for the step decline in average duration for assessment year 2006–07. The first set of cases that would enter the DRP would be those only relating to assessment year 2006–07. In fact, cases that were referred to the CIT(A) on average took a year and a half longer than those referred to the DRP.
Interestingly, however, in the period following the introduction of the DRP, the duration for cases through the CIT(A) also declined. This convergence may be attributed to factors such as learning or build up of expertise, suitable amendments to the tax law such as use of multiple year data or range concept, and expansion of administrative capacity.
In summary then, the DRP is found to have had some positive impact on the duration of the cases.
Quality of Outcome
An assessment of the dispute resolution process must be based not only on the duration of cases but also the quality of the outcome. There is a nuanced distinction between case resolution and disposal. A case order that refers the case back to the AO for fresh computation or repeated disputes on similar grounds in subsequent assessment years does not amount to closure, but results in continued uncertainty.
A positive feature is that the incidence of remand has been only 6.4% across the assessment years. On the other hand, 39% of the cases refer to the assessee’s past case. This means that a relatively high proportion of cases are litigated on identical grounds. One possible way to mitigate cost to the department and the taxpayer from repeated disputes is the combined transfer pricing assessment for a few assessment years.
Finally, the transfer pricing regime can be evaluated in terms of case outcomes. As is expected, the bulk of the appeals (72%) filed in ITAT against orders of the CIT(A) and DRP are by the assessee. Assessees also a have high success rate: the assessee’s appeal was allowed or partly allowed in 82% of the cases. On the other hand, 61.4% of the revenue’s appeals were dismissed.
A law evolves over time with strengthening of institutional capacity and availability of precedents. This is true for India’s transfer pricing law.
In so far as the duration of cases is concerned, there has been some visible improvement. The introduction of the DRP also contributed to the observed decline in duration.
However, the system still requires reform with regard to repeated disputes on identical grounds and poor success rates for the revenue authorities.
To minimize the associated costs, advance pricing agreements must be encouraged.
Further, there is limited availability of transfer pricing experts in the tax department. To reduce the workload and to avoid repeated disputes across years, the combined assessment may be a practical solution.
Suranjali Tandon is Assistant Professor at the National Institute of Public Finance and Policy, New Delhi.
The author may be contacted at: email@example.com
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.