Proposed Union Budget 2017 Introduces Secondary Adjustments to Indian Transfer Pricing Regulations

The Indian Government has included the concept of secondary adjustments as an amendment to the Transfer Pricing Regulations in the proposed Union Budget 2017. Under this proposal, if a primary adjustment arises out of:

  1. a suo moto adjustment made by the Indian entity to the transfer price in the return of income;
  2. an adjustment proposed during the transfer pricing audit (and agreed by the taxpayer);
  3. an adjustment determined upon conclusion of an Advance Pricing Agreement or upon the resolution of a Mutual Agreement Procedure (MAP); or
  4. an adjustment on account of the adoption of safe harbours; and

the primary adjustment exceeds INR 10 million (approximately USD 145,000), then, such amount has to be repatriated by the respective associated enterprise within a stipulated time period (the time period has yet to be declared). In the case of non-compliance with this provision, the primary adjustment shall be deemed to be an advance (deemed loan) made by the Indian entity to the associated enterprise and a secondary adjustment for the interest on such an advance shall be imposed. The interest rate and the rules for computation of the time period have yet to be determined by the government.

This provision should be applicable to adjustments on transactions to be undertaken from 1 April 2017 and onwards. The current draft is not very clear on the applicable date.

Increased cost of adjustments

Transfer Pricing adjustments are common in India, and the imposition of secondary adjustments will increase the financial impact of these adjustments. If an adjustment is agreed through a MAP or domestic litigation and the money is not repatriated to India than there will be a perpetual adjustment carried as interest on a deemed loan. We also expect that the interest rate imposed on the deemed loan will be high as the rate and period will be determined by the Indian Government and not the taxpayer under this regulation.

Increased complexity in accounting

The secondary adjustment is defined in the regulation to mean an adjustment in the books of accounts of the Indian taxpayer and the foreign associated enterprise. The imposition and tracking of these adjustments could present a host of accounting issues for both the Indian and foreign enterprise.

Risk of retroactivity

As noted above, the current draft in not clear on the effective date of this new provision and hence there is a risk that such secondary adjustments may be applied for prior tax years and periods. We are expecting a clarification in this regard shortly.

Other points to consider

India has seen instances of tax officers proposing secondary adjustments upon taxpayers but these have historically not been sustained by the courts. We expect that the establishment of these secondary adjustments by regulation will clear the way for their imposition. Consultants and industry groups intend to provide feedback to the government on these regulations which should help rectify some of the drafting errors and hopefully establish a "prospective only" imposition. There is no guarantee, however, that some retroactivity will not be imposed.

Taxpayers who have maintained FIN 48 reserves for Indian Transfer Pricing adjustments should think about the implications of secondary adjustments on such reserves.

The potential imposition of secondary adjustments on Indian Transfer Pricing adjustments should also provide further support for the consideration of Bilateral Competent Authority resolution of Transfer Pricing matters in India, either through a MAP or APA.

Budget 2017 has also brought in other changes concerning intra-group transactions such as limitation of interest deduction and reducing the scope of documentation for compliance for domestic-related party transactions.

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