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Indian Direct Tax And Transfer Pricing Changes: Implications For US Multinationals


As US based multinational corporations continue to expand global operations, supply chain initiatives are driving production and management functions increasingly to relatively low-cost jurisdictions. India remains among the commonly considered locations to establish operations. In the past, tax holidays and inexpensive yet skilled labor were enough to entice many multinational companies to relocate certain back office functions. Taxand US looks at the issues now arising for global companies that look to divest or otherwise monetise their Indian investments which appear to stem from Indian authorities that are understandably motivated to preserve the country's tax base.

Current market conditions in India, are exerting downward pressure on the decision to enter India to implement cost savings measures. In particular, many of India's previously available tax holidays are expiring. Additionally, inflationary market pressures are forcing costs up, and tight capital controls on repatriation make redeployment of cash difficult once invested. As a result, some of the multinational corporations that are already operating in India are finding it difficult to devise ways to re-invest their money within the region or repatriate it in tax-efficient ways. Still, economically substantive planning is available to help companies already invested in India to extract the value of their committed capital. And newly contemplated supply chain initiatives may still accomplish a degree of cross-border tax efficiency.

The Vodafone case is examined. With a tax bill of $2.6 billion, this landmark case is slated to go to the Indian Supreme Court this summer. It remains to be seen whether the Indian Supreme Court will side with its taxing authority or Vodafone. This might have been avoided if Hutchison's initial investment into India had been structured differently through the use of certain holding companies that have beneficial treaties with India, in particular with respect to exemptions on capital gains taxes. Going forward, this problem won't be as easy to solve because of some recent and upcoming changes to the Indian tax code that make careful structuring of investments into India now more important than ever.

Indian Environment and Trends
In the last year, India has gone through some extraordinary changes to its tax rules and stance on transfer pricing. There will be even more drastic changes in the future with the impending Direct Taxes Code becoming effective one year from now, in April 2012. Some substantive changes may affect multinational corporations operating in India.

Transfer Pricing and Court Cases
While it is still a relatively new concept in India, the authorities have wasted no time in taking advantage of the rising value of the local Indian subsidiary. In recent years, it has been common to receive a double-digit transfer pricing adjustment on manufacturing activities and even on some lower-level marketing functions. Litigating these adjustments is a multi-year process that can outlast even the most resilient tax director. While the competent authority process is somewhat quicker, the uncertainty of the litigation process remains.

Taxand's Take

As assessing officers grow increasingly aggressive in finding transfer pricing adjustments, it is almost certain that taxpayers' transfer pricing positions will be challenged and the decision to litigate will boil down to the amount of assessment vs. defending the position in court. In this scenario, it is not uncommon now for taxpayers to simply settle in hopes of resolving the matter in a timely fashion. It is important to note that there is a specific provision in the Indian tax code that exempts transfer pricing adjustments from any income tax holidays to which companies are subject.

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