Robust documentation is key to winning transfer pricing controversies, say Vijay Iyer and Ashwin Vishwanathan

Importance of Transfer Pricing

Documentation

In Ernst & Young’s Global Transfer Pricing Survey 2010, three-quar-ters of the respondents consid-ered transfer pricing documen-tation as being more important

than it was two years ago. Commonly recognised as one of the most press-ing issues, transfer pricing dominates tax agendas around the world. India is no exception. The transfer pric-ing legislation is only a decade-old, but it has already seen considerable controversy. It is estimated that ap-proximately Rs 30,000 crore is locked up in transfer pricing disputes alone, in the country.

There have been six rounds of transfer pricing audit examinations by the Indian tax authorities, scrutinising various inter-company transactions. The quantum of transfer pricing adjustments cutting across various industries, have seen a sustained in-crease. Cases have travelled through

However, a common theme under-lying the judicial precedence that is currently evolving in the country is the need for robust transfer pricing documentation.

ITaT seeks documentary proofThe Income Tax Appellate Tribunal

(ITAT), which is the ultimate fact find-ing authority in the Indian dispute resolution framework, has repeatedly emphasised the need for the taxpayer to possess documentation supporting the positions adopted in a transfer pricing analysis. Wherever the ITAT has eventually ruled in favour of the taxpayer, the case has been supported by extensive documentary proof. A cue can be taken from the recent case of Symantec Software Solutions Private Limited, which dealt with issues relating to use of single-year versus multiple-year data, application of turnover filters, and adjustment for functional and risk differences. In al-lowing the tax authorities to use only data for the year under consideration, the ITAT held that multiple-year data cannot be used as a rule, and the taxpayer has to make out a case for how the prior-year data influences the prices of the year under review to justify its usage. On the turnover filter, it was mentioned that the taxpayer did not demonstrate how turnover im-pacts the profitability thereby, negat-ing its application. Even in the case of economic adjustments, the ITAT cited the lack of documentation to prove how functional and risk differences affected the margins of comparable companies. This ruling therefore, underscores the importance which the ITAT attaches to documentation of facts and rationale.

A common theme underlying the judicial precedence that is currently evolving in the country is the need for robust transfer pricing documentation

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the appellate chain and are pending adjudication at various levels. Dispute resolution has been a time-consuming process and many issues of diver-gence between the tax authorities and the tax payers are still to be settled.

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advantages of documentationThe advantages of preparing and

maintaining prescribed documenta-tion are manifold. Documentation captures the terms and conditions of inter-company arrangements; helps identify the functional attributes of the parties to transactions and the risk allocation entailed in such ar-rangements thereby, giving a better insight into the business. A proper description of the industry in which the taxpayer operates, aids in spot-ting trends which have a bearing on profitability. A correlation of these trends to actual financial performance can often help in substantiating spe-cific business strategies or defending against losses. These aspects then feed into the comparability analysis where description of the search methodology, the screens applied to filter companies, the computation of financial ratios of comparable companies, reasons necessitating economic adjustments, and a quantification of such adjust-ments demonstrate the due diligence undertaken by the taxpayer. Detailed documentation also serves as a tool to explain the business purpose and economic substance of controlled transactions to protect against the tax authority disregarding the form of the transaction and re-characterising it during audits.

Related-party transactions in focus

We observe a trend among the tax authorities requesting for a greater level of detail around related-party

Vijay Iyer, Tax Partner, Ernst & Young and Ashwin Vishwanathan, senior tax professional with Ernst & YoungThe views expressed herein are the personal views of the author and do not necessarily represent the views of Ernst & Young Global or any of its member firms

Transfer pricing documentation is globally motivated by risk mitigation and audit-defense factors

Protection from the tax department

With the sustained pressure on raising revenues, the tax department is seeking to levy penalties in almost all cases. Suitable documentation facilitates penalty protection in case of a dispute and reduces the risk of additional financial costs to the company. The global economic crisis has triggered off a need to re-look at business operations to achieve effi-ciency, synergy, and competitiveness. The transfer pricing documentation process provides a useful framework to discover opportunities for supply chain optimisation, streamlining global policies, and reconfigur-ing functions and risks to derive maximum benefit. The legislative and regulatory landscape is rapidly altering. Contemporaneous docu-mentation endows companies with the benefit of taking into account these changes, anticipating potential implications thereof, and tackling them appropriately to stay ahead of the curve.

ConclusionHeightened scrutiny by the tax

department and the augmented levels of disclosure expected from taxpayers, significantly inflates the transfer pricing risks confronting companies. Transfer pricing docu-mentation is globally motivated by risk mitigation and audit-defense factors. In the Indian context, robust documentation is a key ingredient for success in controversy and will continue to shape the views of the judicial authorities in future transfer pricing judgments. Greater rigour in preparing and maintaining documen-tation will keep corporate taxpayers in good stead in facing the challenges of the new world.

transactions, specifically intra-group services. Last year, in many instances, Indian tax payers paying for manage-ment services availed from group companies suffered disallowances of these charges on the grounds that adequate documentation was not available to evidence actual availing of services or benefits received from them. Additionally, the basis of arriv-ing at the service charge encompassing the cost elements of the service charge and the allocation keys was scruti-nised. Tax authorities are increas-ingly investigating the value chain to understand the contribution of the Indian taxpayer to the overall product or service offering of the group. Inad-equate or inconsistent documentation opens the taxpayer to allegations of intangible creation and a demand for higher compensation or attribution of a portion of the global profits to tax in India. Documentation plays a very critical role in addressing these questions and enables the taxpayer to enter into an audit situation from a position of strength.

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