Indian tax administration issues revised guidance on transfer pricing audit procedures

This Tax Alert summarizes Instruction No.3 of 2016 (New Guidance) issued by the Central Board of Direct Taxes (CBDT) on 10 March 2016 to provide guidance to Assessing Officers (AOs) in selecting cases for transfer pricing (TP) audits in relation to international transactions and specified domestic transactions (SDTs). CBDT had earlier replaced Instruction No.3 of 2003 (under which the selection of cases was based on a monetary threshold of the value of the international transactions entered into during a particular tax year) and issued Instruction No.15 of 2015 (Updated Guidance) in Oct 2015 for selection of cases for TP audits on the basis of risk parameters. However, based on suggestions received from stake holders, the New Guidance has been issued. While the New Guidance re-affirms that cases would selected for audits based on “TP risk parameters” under the Computer Assisted Scrutiny Selection (CASS) system, it also indicates circumstances under which cases would also be selected for audits manually. The New Guidance also clarifies that the primary responsibility for undertaking TP audits would be that of specialized Transfer Pricing Officers (TPOs).

This New Guidance is applicable with immediate effect in respect of cases involving international transactions and SDTs.

The New Guidance issued by the CBDT for selection of cases for TP audits can be expected to result in more targeted and more cost-effective use of limited resources from a tax administration’s perspective. One can also expect the audit proceedings to be more detailed and intensive, especially given that senior TPOs are expected to handle a limited number of complex cases. While the New Guidance does not identify the TP risk parameters that would be considered by the AO, taxpayers may need to keep in mind the typical factors that may suggest a TP risk in the Indian context, such as payments for intra-group services and use of intangibles, significant transactions with related parties in low tax jurisdictions, intangible transfer transactions, business restructurings, loss making operations, significant advertising, marketing and promotional spend, excessive debt, entities characterized as limited risk etc. Henceforth, disclosures/ reporting Form 3CEB would not only be relevant from a penalty perspective, but also from an audit risk perspective, in light of the New Guidance.

The low monetary threshold for compulsory TP audits in India has always been a concern as historically a large number of small and medium enterprises have got covered in the audit cycle. This has also put pressure on the tax authorities who are constrained in resources while carrying out an audit. The issuance of clarifications and instructions by the CBDT is consistent with the Government’s objective of minimizing tax litigation and creating a non-adversarial tax regime. Further, with India’s Finance Bill, 2016 proposal to introduce Country-by-Country Reporting and Master File TP documentation in the ITL in line with the recommendations of the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Action Plan 13, the enhanced TP documentation regime can be expected to support effective risk identification and assessment of appropriate cases for TP audits or enquiries.