A joint effort by India and the US to amicably decide on their respective shares of taxes from IT and ITeS companies operating in both countries is threatening to unravel, owing to a big, seemingly unresolvable gap between the transfer pricing (TP) margins individually determined by them. While New Delhi is unwilling to accept the margins made by India-registered IT companies from services rendered to related parties in the US in certain past cases to be anything less than 18%, the US tax authorities want India to agree to a much lower rate of 12-13%.
The discord surfaced in the exploratory Indo-US tax talks under what is called a mutual agreement procedure (MAP) — a provision in the double taxation avoidance treaty between the two countries — held in Washington in February. The inability of both sides to make headway in the first round of MAP talks increased the uncertainty over the tax liability of over 200 companies wanting to avoid their profits to be taxed twice. In case an MAP-based settlement doesn’t materialse, these companies would have little option but to approach courts to resolve the disputes.
For the US taxman, the payments made by a US company to its Indian subsidiary is a business expense that needs to be deducted from the profits of the former. A higher TP rate could mean a higher deduction and a resultant lower tax revenue for the US and hence the inclination to disallow higher deductions. India, on the other hand, reckons the profits of these firms to be higher as can be seen from the 20-30% rate prescribed by it for firms in different businesses to escape transfer pricing scrutiny under safe harbour rules.
TP rates are meant to denote the arm’s length price (what would have been between unrelated parties).
A revenue department official told FE that India has suggested the 18% rate in the MAP talks after an analysis of the margins, adding it was difficult to accept lower rates. Although there are several ways for the revenue department to determine the transfer pricing rates, in case of IT and ITeS companies, the cost-plus method is usually allowed.
With stark differences in the February talks, Indian revenue authorities, sources said, are now trying to find a middle path for making headway in the next round of talks.
Since the 12-13% rate is internationally accepted, India is finding it difficult to hold to the higher margins, analysts said. In fact, under the safe harbour rules (SHR), the 20-30% margins have forced the majority of the companies to be out of it and therefore, only 30 applications were filed for the same in FY14, the first year of SHR.
The Rangachary panel – SHR rates were fixed based on its recommendations – found that while IT companies were quoting profit margins of 15%, TP officials thought they should be as high as 24%. The panel finally settled for a 20% SHR but this is too high to gain traction. Similarly, in the ITeS sector, while companies with a continued…