CONCEPT: ADVANCE PRICING AGREEMENTS
MNCs avoiding taxes ! HOW??
Let’s understand this with a hypothetical situation. Unilever, a holding company, has a subsidiary company in India known by the name of Hindustan Unilever Ltd (HUL). Now, suppose :
Case 1:
The cost of materials supplied by Unilever to HUL is Rs 5000, Overhead expenses are Rs 3000 and, turnover is Rs 10000. So profit before tax is Rs 2000 and with a tax rate of 35 %, tax liability amounts to Rs 700.
Case 2
To reduce its tax liability in India, Unilever can purchase raw materials from the UK through its UK unit (since MNCs have legs in different countries) at a higher price of Rs 6000. So the cost of raw materials supplied to HUL also turns out to be 6000. Thus lowering the profit to Rs 1000 which will reduce the tax liability to Rs 350 (as lower the profit, lower the tax liability).
MNCs avoiding taxes and reduced tax revenue is surely displeasing to the government. So Voici! We discuss and understand the key to this problem. The solution to this is regulating Transfer Pricing which is the price set for internal transactions of the MNC devoid of any market influence. In the above case 1, it is Rs 5000 and in case 2, it is Rs 6000.
Here, Arm Length Transfer Price (ALTP) comes to rescue. In this, the transfer price is set by the company itself. However, it has to be close to the general price which normally exists in a similar circumstance. There is no government involvement during this process. But it is after the end of the financial year that assessment of the transfer pricing has to be ratified by the government through auditing, which is a time-consuming process.
So to make it more hassle-free, the concept of ADVANCE PRICING AGREEMENT(APA) was introduced in 2012 under the Finance Act and was implemented for the first time in 2014. Under APA, the Transfer Price is predetermined by the government (after deliberation with MNCs) for straight 5 years.
The justification of APA, firstly, is that there is more certainty, transparency and no risk of penalty. Under APA the transfer price is dictated by the government, so there is no requirement of validation and the companies are simply required to trade at that price unlike in ALTP, where the holding company (MNC) sells to its subsidiary, materials at higher prices to increase cost of production and reduce profits and in turn avoid tax. It can be penalized for this. So companies always have to be on their toes while setting transfer prices under ALTP.
Second, Growth of Domestic Industries. Since the transfer prices are fixed in advance, there is no point in purchasing raw materials from any other country for its Indian subsidiary. Thus our small scale and producer sector will flourish.
Lastly, increased foreign direct investment, FDI. Since there will be more certainty as discussed in the first point, this will enhance ease of doing business factor and more MNCs will hanker to commence their operations in India.
‘ ALL THAT GLITTER IS NOT GOLD ‘
So even the Advance Pricing Agreement comes with its own blues. Prices once imposed cannot be altered and both the MNCs and the government cannot take advantage of fluctuations in the market price of the (raw) materials.
With the advent of 2020, the government is soon going to introduce and impose new transfer prices with the Central Board of Direct Taxes, CBDT, already signing 300 Advance Pricing Agreements.
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