The Income-Tax department conducted surveys at the premises of the British Broadcasting Corporation (BBC) in Delhi and Mumbai on February 14. According to some government sources, the action was taken due to BBC's alleged non-compliance with the transfer pricing rules and its reported diversion of profits.
Globalization has resulted in a dramatic increase in the number of multinational companies operating across borders. With the growth of this phenomenon, governments have had to come up with new laws and regulations to ensure that these businesses pay their fair share of taxes. One such law is transfer pricing, which has become increasingly important as more companies are engaging in cross-border transactions.
Let us understand it in detail.
What is transfer pricing?
Transfer pricing is the practice of determining the price at which goods or services are exchanged between related entities within a multinational group. It is used to allocate profits and losses among associated companies within the same corporate group, often located in different countries. The concept has become increasingly important due to globalization, as more businesses are expanding their operations across borders.
Suppose, Company A buys goods for 1000 rupees and sells them to its associated company B in another country for 2000 rupees, who then sell them on the open market for 4000 rupees. If Company A had sold the goods directly, it would have made a profit of 3000 rupees.
However, by routing the goods through Company B, they only made a profit of 1000 rupees, with Company B taking the remaining 2000 rupees. The price at which the goods were sold (2000 rupees) was not determined by the market but was instead decided between Company A and Company B. This price is hence, known as the transfer price.
Transfer pricing can be used to manipulate corporate tax liability, as companies may set prices that are higher or lower than those found on the open market. This can allow them to move profits from higher-tax jurisdictions to lower-tax jurisdictions. This can lead to revenue losses for high-tax countries, as well as a drain on foreign exchange reserves.
The rise of transfer pricing
The concept of transfer pricing emerged in the early 1950s when multinational companies began operating in multiple countries. As these companies sought to minimize their overall tax burden, they began shifting profits across borders by charging different prices for intra-group transactions.
In India, the income tax law was amended in 2000 to include provisions on transfer pricing. The Indian government introduced the Income Tax (IT) Amendment Act of 2000, which provided guidelines on how to determine the arm’s length price (ALP) that should be charged for inter-company transactions.
This was followed by the introduction of the Transfer Pricing Regulations (TPR) in 2001, which stipulated the methods for determining ALP and gave the Income Tax Department the authority to adjust the profits earned by a multinational company in India if it was found to have engaged in transfer pricing.
The impact of transfer pricing
The impact of transfer pricing can be felt in both high-tax and low-tax countries. In high-tax countries, it can lead to a loss of revenue, as companies shift profits to lower-tax jurisdictions. In low-tax countries, it can lead to an influx of capital, as companies seek to take advantage of the lower tax rates.
The practice can also lead to unfair competition between companies in different countries. For example, companies in high-tax countries may find it difficult to compete with those in low-tax countries, as the latter are able to offer lower prices due to their lower tax burden.
The Income Tax Act, 1961 provides for penalties in cases of non-compliance with transfer pricing rules. If a taxpayer fails to comply with the transfer pricing regulations, he/she may be liable to pay a penalty of up to 200% of the amount of the underpayment of tax. The IT department may also impose additional penalties in cases of wilful non-compliance.
The bottom line
Transfer pricing is a complex issue that has been made even more complicated by globalization. Companies have been able to take advantage of differences in tax regimes to reduce their overall tax burden. As a result, governments have had to introduce new laws and regulations to combat the practice.
However, there are still opportunities for companies to manipulate the system and gain an unfair advantage over their competitors. To ensure a level playing field, countries must continue to cooperate and introduce measures that will increase transparency and ensure that companies pay taxes in the countries where they make their profits.
