Applicability of Base Erosion Concepts – Transfer Pricing – Case Study
The case of Alpha Inc. was picked for scrutiny assessment u/s 143(2). Given the large number of international transaction, the AO referred the case to the Transfer Pricing Officer to determine the arm’s length price. Keeping in mind the provisions of Base Erosion, you are required to comment whether the following adjustments proposed by the Transfer Pricing officer can be validly made : –
| Situation | Transaction | Amount determined by Assessee (Rs. in crores) |
Amount Proposed by TPO |
| 1. | Purchase of raw-materials | 250 | 200 |
| 2. | Payment of royalty | 10 | 12.5 |
| 3. | Sale of finished goods | 100 | 125 |
| 4. | Interest-free loan obtained | – | 15 |
| 5. | Receipt of fee for Technical Services | 125 | 155 |
| 6. | Guarantee fees paid to Holding Company | 1.5 | 1.25 |
Applicability of Base Erosion Concepts – Transfer Pricing Case Study – Solution:-
The Transfer Pricing provisions are intended to ensure that profits taxable in India are not understated (or losses are not overstated) by declaring lower receipts, or higher expenditure or other deductions, than those, which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. However, in certain cases, application of the Transfer Pricing provisions, may result in : –
- Reduction of profits taxable in India ; or
- Increase the expenses, allowable as a deduction for Indian tax purposes.
In all such cases, Transfer Pricing provision are not required to be applied where the adoption of the arm’s length price would result in a decrease in the overall tax incidence in India in respect of the parties involved in the international transaction. The Base Erosion concept provides that the principle of arm’s length price shall not apply where its applicability would result in reducing the income or increasing the loss.
In the present case, the impact of Transfer pricing adjustment proposed to be made by the TPO are as under : –
| Situation | Transaction | Amount determined by Assessee
(Rs. in crores) |
Amount
Proposed by TPO |
Impact of the Proposed Adjustment |
| 1. | Purchase of raw-materials | 250 | 200 | Increase in Taxable Profit by Rs. 50 |
| 2. | Payment of royalty | 10 | 12.5 | Reduction in Taxable Profit by Rs. 2.5 |
| 3. | Sale of finished goods | 100 | 125 | Increase in Taxable Profit by Rs. 25 |
| 4. | Interest-free loan obtained | – | 15 | Reduction in Taxable Profit by Rs. 15 |
| 5. | Receipt of fee for Technical Services | 125 | 155 | Increase in Taxable Profit by Rs. 30 |
| 6. | Guarantee fees paid to Holding Company | 1.5 | 1.25 | Increase in Taxable Profit by Rs. 0.25 |
In Situation 2, 4 and 6 and above, the proposed adjustment by the TPO shall result in reduction of the overall tax liability. In view of this, the Base Erosion concept shall apply, and accordingly the TPO shall not make any adjustment to the price proposed by the assessee. However, in all the other cases, since the proposed adjustment results in an increase in the overall tax liability, the TPO can make the proposed adjustment.
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