India specifies transfer pricing arm’s length tolerance range

By Gaurav Jain, Chartered Accountant & Priya Bhutani, New Delhi, India

India’s transfer pricing rules set an acceptable tolerance range for the variation between the arm’s length price and the transaction price.  In a September 13 announcement, India’s Central Board of Direct Taxes (CBDT) announced that that the prevailing 1% tolerance range for wholesale trading and the 3% range for all other international transactions and for specified domestic transactions will be retained.

This range will be applicable to all transactions undertaken during financial year ending 31 March 2019, the CBDT said in the new guidance, Notification No.  64/2019/F. No. 500/1/2014-APA-II.

Wholesale trading

According to the notification, to qualify as “wholesale trading,” the purchase cost of finished goods must be 80 percent or more of the total cost pertaining to such trading activities. Further, the average monthly closing inventory of such goods must be 10 percent or less of sales pertaining to such trading activities.

Similar to previous years, no specific explanation or clarification has been provided regarding why wholesale traders have a different tolerance range. Since the range prescribed for wholesale trading companies is very narrow it provides limited benefit to this class of taxpayers.

Interquartile range versus arithmetic mean

To establish an arm’s length price, Indian transfer pricing rules prescribe a range of the 35^th to the 65^th percentile. However, the range concept is not applicable in certain circumstances. In these cases, the arithmetic mean is used to measure the arm’s length price and the tolerance range, as described above, is brought into play

Other countries prescribe a wider interquartile range as a measure of the arm’s length range in all cases. The concept of arithmetic mean and tolerance range is not used in any other country.

The current government has always advocated in favour of reduced litigation and simplification of processes that cause undue hardship to taxpayers.

 By retaining the tolerance range, the Indian government has provided a modest leeway to taxpayers.

There are high expectations that the government will renew the safe harbour rules adding redefined eligibility criteria and thresholds to benefit small and medium enterprises. These rules have not yet been announced.