India to audit transfer pricing based on risk assessments

A proposal has been set forward for the transfer pricing audit threshold in India to be removed in favour of a risk management, finger-picking approach. Currently, firms engaging in transactions above INR 15 crore (€1.8M) must undergo a mandatory transfer pricing audit, a rule which draws resources from taxpayers and tax authorities alike. The purpose of such a threshold is aimed at reducing tax evasion, but the rule has been recognized by India tax authorities as too vigorous for both the taxpayer – which must prepare thoroughly for the audit – and the tax authorities, which will use up resources in a fairly indiscriminate manner.

Risk assessment – the OECD’s best practice

The alternative approach entails use of the old proven risk assessment. Risk assessments are frequently conducted by tax authorities worldwide as a preliminary phase in the auditing process. A risk assessment allows the authorities to define whether there is a significant risk of lost tax in a firm’s transactions – which is to say, there is a significant risk that taxpayers have not complied with transfer pricing regulations. The concept of “reasonable effort” is frequently used and is included in the OECD guidelines to define whether a taxpayer has taken due care to comply with regulations. When tax authorities deem that a taxpayer’s efforts to comply are within reasonable standards, audits will be conducted less frequently.

A more efficient use of resources

On the other hand, the existence of a threshold for transfer pricing audits means transfer pricing auditors are performing audits much more frequently than their foreign counterparts. India performs more transfer pricing adjustments each year than the rest of the world put together, which naturally raises questions about how reasonable its audits are. A transfer pricing auditor in India may perform about 50 annual audits – far more than a comparable official would conduct anywhere else in the world. Moving on to a risk assessment approach not only saves the I-T department’s resources; it may well enable the government to deploy its auditors in favour of discovering the real instances of tax evasion.

"A risk-based approach in selecting international transactions between related parties for transfer pricing audit is more efficient in checking possible shifting of profits. This helps the department in allocating precious resources to cases that can yield maximum revenue. The risk-based approach would also help the revenue department evaluate whether the case is even worth pursuing,” said Amit Maheshwari, partner at Ashok Maheshwary & Associates, a partner firm of Transfer Pricing Associates.

Closing in on international standards

The new regulations are expected to reduce litigation between MNEs and the I-T department – a development of which India is currently in dire need if it is to remain attractive to foreign investors. Should the proposal be approved by the tax department, the next government will see it through among other tax reforms.

Should the proposal be approved, India’s transfer pricing legislation will be moving even closer to the standards upheld by the OECD, which it already resembles. India has shown moderate interest to follow the transfer pricing streamlining movement, particularly because transfer pricing has proven to be such an important revenue mechanism for the tax authorities and the government may feel India has been rather self-sufficient in resolving its own transfer pricing matters. Mostly, being a developing country, India wishes to bear decision power over the developments of the OECD’s Action Plan.

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