The modus operandi followed was simple. The export of goods or services to India was over invoiced, thereby increasing the cost of the Indian organisation. This would result in lower profits to the Indian concern and consequently, lower taxes to the government. At the same time, profit on export of goods from the source country would be exempt from income tax.

There could be cases even when exports from India are under invoiced, in spite of them being exempt from tax in India. This could be done to safeguard the organisation's interests against a depreciating rupee or if there is not much utility of the money kept in India.

Countries such as the US and the UK have have very strict transfer pricing guidelines, which are being aggressively implemented. However, there were only a few provisions in the Indian Income Tax Act which could keep such transactions under check.

Previously, Section 92 which covered such transactions had many shortcomings. There was no definition of the term "close connection" in the section. Even the method of arriving at the arm's length price (the price at which unrelated parties would deal with each other in an uncontrolled situation) was not mentioned. Due to this ambiguity, the section was rarely used.

It was thus imperative for authorities to put in place a legislation at this juncture when India's international trade is increasing by leaps & bounds.

India's total exports and imports in the nine month ended December, 2000 stood at $32266 million & $38150 million respectively.

According to a study done by Deloitte Haskins & Sells, around 60 per cent of global transactions are potentially open to transfer pricing scrutiny. This study highlights the gravity of the problem and the loss that the government would have to incur owing to non-implementation of transfer pricing guidelines.

Budget 2001 has introduced a series of provisions from Section 92 to Section 92F covering transfer pricing guidelines. The key terms such as "Associated Enterprise" (AE) and "International Transaction" have been thoroughly defined. The methods to be used for the calculation of arm's length price have also been specified in order to leave little scope for ambiguity.

The term AE has been defined widely to include direct as well as indirect control in management or capital. It also covers cases of huge dependence on one entity for debt, raw materials, patent, know-how, copyright etc.

The move to include even entities who supply more than 90 per cent of the total raw material and consumables as AE have raised serious doubts among experts.

They are of the opinion that it is in the Indian company's interests to charge the maximum possible amount from the foreign supplier (who is alleged to control the selling price) and there would not be any transfer pricing issue in such cases.

However, the government's view in such a case would be to check whether the Indian company would supply the goods at the same price to another supplier under similar conditions.

While these guidelines would cover many international transactions, it would not be proper to say that all organisations indulge in malpractices to reduce their tax liability.

The enactment of transfer pricing guidelines is a step in the right direction. However, like other good intentions, the implementation of these guidelines would be the key to their success.

Prashant Kothari