India is one of the largest contributors globally to transfer pricing litigation and our contribution is increasing by the day. Ever since its introduction in 2001, the transfer pricing laws have been evolving at a significant pace. Before we get further, let’s try and understand the need for transfer pricing and its effect. An Indian company sells goods to its holding company at Singapore at 100 per unit which in turn sells it for 120. To ensure that the selling price of 100 is fair, we have transfer pricing provisions. If the revenue feels the price should be 104 and proposes a revision, such revision of four, i.e. 104-100 is called primary transfer pricing adjustment. Once a primary adjustment is proposed/assessed, the tax payer can either accept and pay tax on it or litigate. So in our case, the Indian company shall pay tax on 4 and the issue is closed. Practically, the adjustment could be made by the assessee suo moto or he may accept the adjustment made by the Revenue to‘buy peace’ since the process of litigation is long drawn, expensive and uncertain.

In the recent budget, our Honourable Finance Minister proposed the introduction of secondary adjustment. ‘Secondary adjustment’ means an adjustment in the books of accounts of the Indian asses see and its related entity to ensure that the actual allocation of profits as per books are consistent with the transfer price determined as a result of primary adjustment, thereby removing the imbalance between cash account and actual profit of the asses see. As per our illustration, consequent to the primary adjustment of 4, the Indian company should now make an entry to show a receivable of 4 from the Singapore holding company and the holding company should in turn pass a contra entry for a payable of 4 to its subsidiary. If this sum of 4 is not brought into India, such amount could be treated as a loan to foreign holding company. Consequent to Sec 2(22)(e), the said sum could be treated as ‘deemed dividend’ which is subject to an additional tax of 30-40 percent over and above tax on primary adjustment.

Further there could be an impact of RBI regulations on loans to overseas entities which might have to be adhered. The Companies Act 2013, places enormous restrictions on loans to related parties with serious consequences for violations. Hence, by entering the impact of primary adjustment in books, there could be a slew of regulatory implications which could in-turn have monetary and penal consequences.

The intentions to introduce the provisions are laudable and the fact that these provisions are in vogue in many developed economies makes it a compelling case for India

As per the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD transfer pricing guidelines), secondary adjustment may take the form of constructive dividends, equity contributions or loans. Viewing it from the Indian context, if the primary adjustment is not brought into India such sum could be treated as:

- Dividend – having a further taxation of 15-30 percent in India
- Capital – having FEMA (FDI/ODI) and Company Law implications
- Loan – having FEMA (ECB), Company Law and Income Tax – Sec 2(22)(e) considerations.

Further, in practice, most multinational group companies operate as separate franchisee outlets and may be unwilling to act upon corresponding adjustments owing to restrictions in its home country regulations.

Consequent to the above issues, going forward, Indian companies may not be willing to accept primary adjustments made by the department merely to 'buy peace' and would prefer to litigate the matter to eternity. Further, only 15 percent of the tax due on primary adjustments needs to be paid to litigate hence there could be an immediate dip in tax collections to the tune of 85 percent from primary adjustments.

The proposed threshold for exemption of secondary adjustment is pegged at Rs.1 crore. Large multinationals have the luxury of entering into Mutual Agreement Procedure or Bilateral Advance Pricing Agreements- wherein such corresponding adjustments can be proposed and made owing to mutual acceptance of all stake holders. However imposing these provisions on SMEs makes it harsh and literally impractical to comply in most cases.

The Budget 2016, introduced Country by Country (CBC) provisions for large multinationals with a turnover in-excess of €750 million to adhere to OECD recommendations which was considered fair as these organisations had the wherewithal to comply. A similar threshold would have been an ideal starting point for the introduction of Secondary Adjustments in India.

The intention to introduce the provisions are laudable and the fact that these provisions are in vogue in many developed economies makes it a compelling case for India – however the prevailing domestic circumstances needs to be appreciated prior to importing a western law. With mounting transfer pricing cases at various courts, the proposed provisions would only reduce/defer tax collections and add more bulk to the pending lot across various legislations.