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Unclear tolerance bands put Indian taxpayers at greater risk of TP adjus tmentsSource: TP WeekApril 30, 2013

Indian taxpayers that import goods into the country and sell in bulk will be at greater risk oftransfer pricing adjustments as the government has reduced the tolerance band for wholesaletraders to 1%. Advisers have said more clarification is needed on how the tolerance bands will beapplied.

When the difference between the arms-length price determined under section 92C of the IncomeTax Act (1961) and the price at which a taxpayer has undertaken the international transactiondoes not exceed 1% for wholesale traders and 3% for all other cases, the transaction price will be

deemed to be the arms-length price for assessment year 2013-14.

The tolerance band for calculating arms-length price was reduced from 5% to 3% in the FinanceAct 2011 and was effective from FY 2011-12.

The Indian government indicated that a 5% variation was too broad, according to advisers, andtaxpayers conducting transactions on a non-arms-length basis were escaping transfer pricingadjustments.

One of the reasons the government may have reduced the tolerance band for wholesale tradersis because they sometimes have the benefit of the price being available on the open market orthrough a commodity exchange, according to Sanjiv Malhotra of BMR Advisors.

If thats the case then they have a good comparable or benchmark arms-length price and thenthey may not have the benefit of deviating from that market place price by a large amount, saidMalhotra.But that applies to a very limited number of wholesale traders because its not the casethat for every commodity or product that is transacted by a wholesale trader a commodityexchange is available.

The other reason could be because a wholesale trader works on smaller and more stablemargins and optimizes their business through volume, according to Malhotra. Therefore the priceof the margin may not vary to the extreme.

However this is problematic because there are many wholesale traders who deal in products thatare not exchanged on a commodity exchange, Malhotra said. Therefore price discovery is noteasy.

You may not have a good comparable but you will have so little margin for error, said Malhotra.During a transfer pricing audit the chances of you falling outside the range are going to be muchhigher.

Wholesale trader definition unclear

Many advisers have said the definition of a wholesale trader is too broad and requires additionalclarification.

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You name a product you will have someone who is importing and selling in bulk because that ishow most of the multinationals that are not manufacturing in India conduct their businessoperations, said Malhotra. Their margins do fluctuate a lot, whether thats because of howpopular their product is, what their competition is doing or how the economy is doing.

Malhotra said a more drastic measure taxpayers could take to deal with the reduced toleranceband would be to reconsider their functional characterisation in India.

If you were a full redistributer you could move to being a limited redistributer, so you would be

running lower but stable margins, said Malhotra.

Wholesale traders could also review their transfer pricing methodologies and test the foreignsupplier rather than the Indian entity, which in many supply chain models are the limited riskmanufacturers and the limited redistributers to India. This would mean an entity with more stablemargins was being tested.

The interesting thing will be to see if the government comes up with a clarification relating to, forexample, commodity traders, said Malhotra. That is one thing that we are recommending shouldhappen.