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Applicability of Base Erosion Concepts – Transfer Pricing

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May 5, 2021

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6 mins read

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.

International Taxation Services

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.

For any queries, please write them in the Comment Section or Talk to our tax expert

Arinjay Jain

Bio of author

Arinjay is a Chartered Accountant with more than 20 years of post-qualification experience. He worked as Director, in the M&A Tax Division at KPMG in India. Presently, he is advising several MNCs in UAE on Economic Substance Regulations and impact of the UAE Corporate Tax Law on their business and clients across globe on International Tax issues . He is a well recognised Trainer of International Tax and UAE Corporate Tax. The areas of service include the following : - Advise and Compliance relating to International Tax Issues; Advise relating to UAE Corporate Tax Issues; Advise and Compliance relating to UAE Economic Substance Regulations; Advise and Compliance relating to Indian Income Tax Issues; Other connected matters from a Regulatory perspective.

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