TAXMEN USE DIRECTOR'S REPORTS TO SLAP TRANSFER PRICING ORDERS Be careful
of what you speak because whatever you say can be used against you.
Multinational corporations (MNCs) are realising this the hard way, as
the income tax department is using some forward- looking statements
given in statutory documents, such as annual reports and directors'
report, in calculating transfer pricing adjustments.
The transfer pricing assessments for the assessment year March 2009 ended last month and many MNCs, such as Shell and Vodafone, have received huge adjustment orders. Many of these orders are on a new item — subscription of shares. These orders are raised on the grounds that the foreign entity subscribed to shares of its Indian arm at prices much lower than the market price. It is in the calculation of the market price of unlisted shares that the tax department is taking recourse to the directors reports. "Directors often make loosely- worded, forward- looking statements, saying the company can ` double' or ` triple' the growth rate. While these are targeted to keep shareholders happy and attract new ones, the tax department is using these growth rates in transfer pricing calculations to slap huge adjustments," said Ajit Tolani, associate partner, economic laws practice. To calculate the market price, guidelines put down by tribunals mandate use of the discounted cash flow (DCF) method. DCF analysis uses future free cash flow projections and discounts these (most often using the weighted average cost of capital) to arrive at a present value, used to evaluate the potential for investment. Top tax consultants in the country Business Standard spoke to said the number of companies facing adjustment on share subscriptions had crossed 50. "Several companies in top centres such as Delhi, Mumbai and Chennai have received orders on this basis. There are a number of assumptions made in the calculation of valuations through the DCF method. A small change in any of these can lead to a big difference in valuations," said a senior partner with a Big Four tax consultant. Consultants point out there are three broad areas where there could be differences in assumptions between the company and the tax authorities – future growth rate, weighted average of cost of capital and Beta, which is a measure of the tendency of a particular security to respond to the broader market swings. Tolani said assessees are likely to have an upper hand if the disputes are challenged. "The DCF method makes a lot of assumptions to assess the future earnings potential of the company. One key area of dispute is the future rate of growth. Here, usually, companies are in better control of facts. The tax authorities are vague. Depending on the assumption made, valuation swings widely," he said, "True valuation lies somewhere in between." Shell India Pvt Ltd, the Indian unit of Royal Dutch Shell Plc, has already said it will challenge an order by the tax department raising a transfer pricing adjustment for Rs. 15,220 crore in a share subscription transaction. – www.business-standard.com
The transfer pricing assessments for the assessment year March 2009 ended last month and many MNCs, such as Shell and Vodafone, have received huge adjustment orders. Many of these orders are on a new item — subscription of shares. These orders are raised on the grounds that the foreign entity subscribed to shares of its Indian arm at prices much lower than the market price. It is in the calculation of the market price of unlisted shares that the tax department is taking recourse to the directors reports. "Directors often make loosely- worded, forward- looking statements, saying the company can ` double' or ` triple' the growth rate. While these are targeted to keep shareholders happy and attract new ones, the tax department is using these growth rates in transfer pricing calculations to slap huge adjustments," said Ajit Tolani, associate partner, economic laws practice. To calculate the market price, guidelines put down by tribunals mandate use of the discounted cash flow (DCF) method. DCF analysis uses future free cash flow projections and discounts these (most often using the weighted average cost of capital) to arrive at a present value, used to evaluate the potential for investment. Top tax consultants in the country Business Standard spoke to said the number of companies facing adjustment on share subscriptions had crossed 50. "Several companies in top centres such as Delhi, Mumbai and Chennai have received orders on this basis. There are a number of assumptions made in the calculation of valuations through the DCF method. A small change in any of these can lead to a big difference in valuations," said a senior partner with a Big Four tax consultant. Consultants point out there are three broad areas where there could be differences in assumptions between the company and the tax authorities – future growth rate, weighted average of cost of capital and Beta, which is a measure of the tendency of a particular security to respond to the broader market swings. Tolani said assessees are likely to have an upper hand if the disputes are challenged. "The DCF method makes a lot of assumptions to assess the future earnings potential of the company. One key area of dispute is the future rate of growth. Here, usually, companies are in better control of facts. The tax authorities are vague. Depending on the assumption made, valuation swings widely," he said, "True valuation lies somewhere in between." Shell India Pvt Ltd, the Indian unit of Royal Dutch Shell Plc, has already said it will challenge an order by the tax department raising a transfer pricing adjustment for Rs. 15,220 crore in a share subscription transaction. – www.business-standard.com
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