India tax: India's proposed Direct Tax Code 2009 includes sweeping transfer pricing changes

India's Finance Ministry has released a draft Direct Taxes Code to replace the current Income Tax Act, which dates back to 1961. The draft code's aim is to simplify the existing tax structure and pave the way for a single unified taxpayer reporting system. The draft code proposes extensive changes that would affect the taxation of all taxpayers, including major proposed amendments to India's transfer pricing regime.

The draft code was released with a discussion paper. The Finance Minister has invited public comment on both the draft code and the discussion paper. Once finalized, the code will be presented to Parliament in the winter session, 2009, for enactment. It is intended to become effective 1 April 2011.


Advance pricing agreements

The 2009 Direct Tax Code introduces the concept of advance pricing agreements (APAs). Given the numerous transfer pricing cases under dispute, this is expected to considerably alleviate taxpayer uncertainty regarding pricing of international transactions.

Key features

- The Central Board of Direct Taxes would enter into an agreement, with the approval of the central government, with any taxpayer to determine the arm's length price of an international transaction.
- The board would be empowered to make further adjustments to the price determined as it may deem necessary.
- The term of the APA would be limited to five consecutive financial years.
- The APA would be binding only on the taxpayer and the tax authorities, and only for the international transactions for which the agreement is sought.


Definition of "associated enterprise(s)"

The draft code revises various thresholds for an Indian entity to be deemed an associated enterprise. This change is
expected to increase the number of taxpayers that fall under the ambit of the Indian transfer pricing regime.

Key features

- The general definition of AE (direct or indirect participation in management, control, or capital) has been omitted.
- Direct or indirect shareholding/voting power has been decreased from the earlier threshold of 26 percent to 10 percent.
- The threshold for loan advances is reduced from 51 percent to 26 percent of the book value of total assets.
- The appointment of board of directors threshold is reduced from one-half to one-third of the governing board.
- The raw materials and consumables threshold is reduced from 90 percent to two-thirds of total supply by one enterprise to the other.


Penalty provisions

The penalty provisions have been modified for various defaults under transfer pricing.

Key features

- The penalty for not filing an Accountant's Report would be INR 0.05 million to INR 0.2 million, rather than the current INR 0.1 million.
- Failure to maintain transfer pricing documentation would incur a penalty of INR 0.05 million to INR 0.2 million, compared to the current 2 percent of the value of the international transaction.
- As a deterrent against noncompliance, prosecution followed by imprisonment and fine is prescribed.


Change in transfer pricing assessment procedure

The transfer pricing assessment procedure has been consolidated to ensure that officers with requisite expertise on the subject address disputes.

Key features

- The accountant's report must be filed with the Transfer Pricing Officer rather than the Assessing Officer. This is contrary to the earlier procedure, whereby the Accountant's report had to be filed with the Assessing Officer.
- The selection of transfer pricing cases for scrutiny is to be based on a risk management strategy as may be framed by the Board. The strategy will not be disclosed to taxpayer or members of the public.
- In line with the Finance Bill 2009, the determination of an arm's length price will be subject to safe harbor rules drafted by the Board.


Dispute Resolution Mechanisms (DRMs)

The draft code makes reference to DRMs to reduce the scope of disputes and minimize litigation.

The dispute resolution mechanism provisions, from a transfer pricing perspective, are similar to those introduced in Finance Bill 2009, except that the proposed variation in the income/loss returned is less than INR 2.5 million.


Change in timelines

The draft code proposes significant changes to the timelines relating to the filing of the accountant's report and assessment proceedings.

Key features

- The accountant's report must be filed by August 31.
- A Transfer Pricing Officer will issue a notice for selection of a case within two months from the end of the financial year in which the accountant's report is filed.
- The Transfer Pricing Officer must issue an order within 42 months from the end of the financial year in which the international transaction is entered into.
- When a matter is not referred to the Dispute Resolution Panel, the Assessing Officer would pass an order within three months in which the order is passed by the Transfer Pricing Officer.