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Legal pulse: Major transfer pricing dispute settled, offers relief to some Indo-US businesses

A recently negotiated settlement under the mutual agreement procedure (MAP) between the Indian and US tax authorities has favourably resolved transfer pricing disputes from 2004 and 05, according to reports.

The significant development will help India retain its competitive advantage with respect to availability of high quality cost effective manpower while maintaining its reputation of being a lucrative destination for investments, according to the Economic Times.

Tax experts believe that the MAP will serve as an efficient alternate dispute resolution (ADR) mechanism which will allow designated representatives or competent authorities from both sides to resolve international tax disputes without prejudice to substantive remedies available under the domestic laws.

The agreement falling under Article 27 of the tax treaties India entered into with various countries including the US sought to provide relief to entities suffering from double taxation and the significant mark-up imposed on transfer pricing cost valuations.

Such determination of taxing profits of captive IT, software, business and knowledge process outsourcing (BPO & KPO) services by the Indian transfer pricing authorities had led to disagreements over assessment with the overseas affiliates.

A tax alert by Mumbai chartered accountancy firm Sudit K Parekh & Co (SKP) read:

"The Indian tax authorities have been assessing the transfer price of such software service providers at a mark?up of 25-30 per cent on total costs, while the service providers have been generally charging 10?15 per cent on total costs.

Pursuant to on?going discussions... the Indian and US Competent Authorities have apparently reached a negotiated settlement whereby they have agreed to mark?up of 17.50% on total costs for software/IT service providers for FY 2004?05.

The settlement provides relief of around 10?12 per cent for those tax payers who have made applications under MAP. It could also provide correlative adjustment/corresponding deduction at the US end thereby eliminating double taxation."
SKP international tax and transfer pricing partner Maulik P Doshi noted: "This is of relevance to Indian enterprises that have transactions with USA affiliates involving software services which have been subject to a transfer pricing assessment. It may also provide a reference point to Indian enterprises providing software services that may / may not have invoked the MAP under the Tax Treaty."

This legal pulse alert is based on media reports and a summarised version provided by Sudit K Parekh & Co which was yet again based on secondary sources.

Transfer pricing definition: transfer pricing is a price that is assumed to have been charged by one part of a company for products and services it provides to another part of the same company, in order to calculate each division's profit and loss separately.

Generally, transfer pricing rules indicate that one affiliate must charge another affiliate the same price as would be demanded in an 'arm's length transaction' a transaction between two related or affiliated parties that is conducted as if they were unrelated, so that there is no question of a conflict of interest.

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