Report of the Expert Group on Transfer Pricing Guidelines
1 Background and Terms of Reference
In April 2002, the Central Government constituted an Expert Group to recommend transfer pricing guidelines for companies for pricing their products in connection with the transactions with related parties and transactions between different segments of the same company. The composition of the Expert Group is given in Annexure 1.
The terms of reference of the Group were as follows:
"The Expert Group shall deliberate upon the scope and extent of the comprehensive transfer pricing guidelines under the provisions of Companies Act, 1956 in the context of related party transactions. The above guidelines shall also encompass segmental transfers within the same corporate entity. The Expert Group shall identify and develop the form of these guidelines and shall particularly consider:
(a) whether the desired objective of laying down of comprehensive transfer pricing guidelines could be achieved within the framework of the existing provisions of the Companies Act, 1956; or
(b) if (a) above is not considered feasible, suggest such legislative framework and contents thereof, as may be necessary to achieve the desired objective.
The Group may take into account similar guidelines relating to transfer pricing as enshrined in other tax statutes such as Income Tax Act, 1961, Central Excise Act, 1944 and Customs Act etc. The prevalent practices in this regard in the global scenario may also guide the Group in its endeavour in prescribing the most practical methodologies for pricing of such transfers."
The Group held four meetings during the course of its deliberations. In addition, the members interacted extensively through the medium of email. Moreover, several subgroups had their own meetings and interactions while preparing the initial drafts that formed the basis for the Group's deliberations.
Dr. Ashok Haldia disagrees with several aspects of this report. His note of dissent is attached to and forms part of this report.
2 The Group's Approach and Procedure
2.1 Acknowledgements
The Group would like to acknowledge the valuable contribution of the Institute of Chartered Accountants of India, the Institute of Company Secretaries of India and the Institute of Cost and Works Accountants of India in providing valuable research support to the Group through their representatives on the Group. The Group would also like to thank the Institute of Company Secretaries of India and the Institute of Cost and Works Accountants of India for their hospitality when the meetings of the Group were held in their premises.
The Group would like to place on record its appreciation of the outstanding support provided by its member-secretary, Mr. I. P. Singh and his colleagues in the Department of Company Affairs. Mr. Singh displayed an extraordinarily high level of dedication and commitment.
The Group would also like to thank the various subgroups that helped the Group to complete its task.
2.2 Current Regulatory Regime in India and Globally
The Group began by studying the laws and practices relating to transfer pricing in India and abroad. Annexure 2 summarises the provisions relating to transfer pricing under the various Indian laws and regulations in the form of a comparative chart. Annexure 3 summarises the global legal regimes relating to transfer pricing.
The following conclusions can be drawn from these two annexures.
(a) Indian and global tax authorities have armed themselves with substantial powers to plug the tax evasion that arises from creative transfer pricing.
(b) Transactions between related parties come under the ambit of Accounting Standard AS 18 in India and IAS 24 internationally. These standards require disclosure of certain aspects of such transactions.
(c) Neither in India nor elsewhere in the world have company law authorities prescribed transfer pricing methods or disclosures.
(d) The methodologies for determining arm's length transfer prices (Comparable Uncontrolled Price, Resale Price Method etc.) are broadly the same in India and abroad.
(e) There is a great deal of diversity in the definition of related party.
2.3 Current Corporate Practices in India
The Group also looked at current corporate practices related to transfer pricing in India. While some Indian companies have no doubt set high standards of corporate governance and fairness in this area, many Indian companies have more to do. Several members of the Group observed that in the course of their professional life, they had come across companies that have resorted to unhealthy practices in the area of transfer pricing. Considerable anecdotal evidence is also found in the financial press. Annexure 4 summarises some of the transfer pricing abuses that have given rise to concerns among shareholders, creditors and other stakeholders about transfer pricing regulation.
2.4 Adequacy of Accounting Standard AS 18
It was pointed out in 2.2 above that as far as shareholders and creditors are concerned, the only protection against transfer pricing abuses is the accounting standard on related parties. It thus becomes necessary to evaluate whether Accounting Standard AS 18 on related party disclosures is adequate to deal with the problem of transfer pricing in India.
The Group recognises that the introduction of AS 18 last year has greatly enhanced the quality of disclosure about transfer pricing and thereby potentially limited the abuses in this area. The principal provision dealing with pricing in AS 18 is Paragraph 25:
"Paragraph 23 (v) requires disclosure of ''any other elements of the related party transactions necessary for an understanding of the financial statements'. An example of such a disclosure would be an indication that the transfer of a major asset had taken place at an amount materially different from that obtainable on normal commercial terms."
This is a major step forward in that it does require some gross transfer price abuses to be disclosed. However, the Group is of the view that it would be useful to impose a positive obligation on the part of the company to use an arm's length transfer price. It would also be useful to have a more elaborate adequate mechanism to determine whether transfer prices are fair or not.
2.5 Global Best Practices and Beyond
This analysis suggests the need for a transfer price guideline under the Companies Act to ensure the fairness of transfer prices from a shareholder/creditor perspective. At the same time, the Group is well aware that the current regulatory regime in India is similar to that elsewhere in the world. In most jurisdictions in the world, the company law is yet to regulate transfer prices. All over the world, this appears to have been left to company management alone to determine in accordance with the business judgement rule.
In today's environment where we are attempting to incorporate global best practices in all our laws and regulations, introducing a new regulation that is yet to be introduced anywhere else in the world is not something to be done lightly. The Group debated this issue at length. A number of factors swung the Group's thinking in favour of such a guideline despite this concern:
-
There is global dissatisfaction with corporate governance and corporate disclosure practices in the wake of some well publicized corporate failures during 2001 and 2002 in the United States and elsewhere. Regulators in many jurisdictions are rethinking their approach towards regulation and contemplating measures to tighten the laws regarding corporate abuses. In this situation where global regulatory practices are evolving, there is scope for countries like India to innovate and set new standards of disclosure and transparency that leapfrog current global best practices.
-
There have been corporate governance abuses in India too. Many observers believe that violations of investor and creditor rights have damaged the financial system severely. On the one hand, the erosion of investor confidence has dealt a body blow to our capital markets. On the other hand, mounting corporate delinquencies have debilitated the banking system. In this situation, it could be argued that there is a case for a regulatory regime to check transfer-pricing abuses.
2.6 Transfer Pricing Guidelines under the Companies Act
After extensive discussion and deliberations, the Group came to the conclusion that transfer pricing guidelines should be framed under the Companies Act. The Group noted that the Companies Act (S 209 and S 211) requires that the books of account of the company as well as its Balance Sheet and Profit and Loss Account present a true and fair view of the affairs of the company. The Group believes that the "true and fair view" obligation requires substantial disclosures of transfer pricing policies. It also requires a mechanism to ensure that transfer prices approximate arm's length prices.
The need for transfer pricing guidelines therefore arises for all users of the financial statements of the company who rely on these statements for a true and fair view:
* shareholders who wish to evaluate the performance of the company management and assess the future prospects of the company
* creditors who wish to ascertain the credit worthiness of the company and monitor compliance with debt covenants
* revenue authorities who may rely partly or wholly on the financial statements to determine tax liability
* other government authorities who may rely on the financial statements to monitor compliance with various laws and regulations (for example, exchange control) or for statistical purposes (for example, price indices or GDP statistics)
* other stakeholders (for example, employees, customers, suppliers) who may use the financial statements for various purposes
For some of these purposes the requirement of arms length transfer prices applies to inter-divisional transfers within the same legal entity. For example, shareholders need a true and fair view of segment revenues and profits as different...
To continue reading
Request your trial