I am sure all of you would have had instances in life when you wanted a little more for a little less. Remember the days in school, when you pleaded with your mom (definitely not with Dad) for a few extra rupees to buy that delicious popsicle or samosa. A classic example is the ‘sukha poori’ one asks for after a gastronomically delightful plate of ‘gol gappas’. Things don’t change much with age – I still ask for an incentive when buying from my regular shopkeepers (“Kuch complimentary de na bhai!”)
If you think about it, you could get away with these extras because you know the shopkeeper or ‘pani puri wala’ well. Chances are, he has seen you since your toddler days and doesn’t mind throwing in a freebie now and then – in fact, we demand this as a birth right!
Regular scenario
Simple, at least I used to think so, before I entered the field of tax. Then I learnt about transfer pricing and simple common sense got replaced by an even deeper confusion. Under the broad umbrella of transfer pricing, the tax law sought to replace everyday transactions between companies of the same group – albeit in different countries – on par with transactions between third parties.
After a little bit of research – the underlying logic came to light. In a single line, transfer pricing seeks to ensure that transactions between related parties (or between the ‘pani puri wala’ and me) are not arranged in such a way that one/ other country loses out on tax revenues.
Fair enough – but there was always a nagging doubt I had on this logic. I will come to this later. But let’s look at how the regulatory scenario is today.
Transfer pricing, by definition and mostly by practice, is a study of economics. How? Well, the underlying principle is to ensure that related party transactions are on par with a transaction between unrelated parties. It seeks to do this by ensuring that adequate profits are captured/ allocated to the entity based on the role it does in a supply chain. One looks at the functions performed by an entity and determines how much profits it should make based on a study of other companies similar to it.
Fair enough! That is, if I go by the assumption that the companies I am going to compare myself with companies that have both the tangible and intangible strengths that my company has. A company’s philosophy, its HR policies, its brand value, perception of working culture, environmental factors, several other unidentifiable factors make a company what it is.
Third-party terms
So, if I only look at a small part of the company’s transactions and its role and responsibilities, is it sufficient to figure out whether related party transactions are being undertaken at third party terms or not? Sadly, I do not think that the alternative approach is either practical or feasible – in fact, it is open to clever manipulation by someone who is skilled enough to market the intangible assets of a company. But one cannot discount its importance in the overall profitability of a company as well.
Studies have shown that transfer pricing has become the top agenda of CFOs every where. In fact, it is the top agenda of tax officers too as is evident in the increasing litigation on the transfer pricing front resulting from constant questioning of such related party transactions. Recently, transfer pricing provisions were introduced for transactions between Indian entities as well.
Now this brings me back to the original nagging worry which I had – why can’t my favourite ‘pani puri wala’ give me an extra ‘sukha puri’ if he wants to? In other words, isn’t there an in-built covenant that related party transactions are intentionally meant to NOT BE on third-party terms? Yes – I get it – you can skilfully avoid taxes – but does the current taxation regime address this in any case? What if I make sufficient profits, as compared to comparable companies, but I still manage to regulate my supply chain to claim unintended tax benefits? What if I am a company with a very unique product (Yes – I am looking at you, Apple iPhone 7) and there can never be a close enough comparable for my product? How do I ensure that related party transactions are on third party terms?
The larger question – what if a company genuinely wanted to help out its related party since it is a start-up and therefore, gave it more favourable supply terms as compared to its other Group companies elsewhere? Will that not help in boosting the growth of the company leading to more income/ employment generation which serves the larger good?
Finally, does the current manner of regulating related party transactions achieve its objective or are we needlessly plunging ourselves into a litigative tax environment?
Well, the comfort comes from the fact that tax (and transfer pricing law) is evolving. Even the new Companies Act, in its own way, seeks to regulate related party transactions – one can only hope that additional legislation regulating related party transactions only helps in unifying the law surrounding related party transactions and not complicate it further.
To conclude, I would only like to say that this article has made me hungry for ‘pani puris’ – and transfer pricing or not, I am always gonna get that ‘sukha puri’.
(Nitika Fernandes from EY also contributed to this article)