This document discusses base erosion and profit shifting (BEPS) in the context of transfer pricing. It defines BEPS as tax planning strategies that exploit gaps and mismatches in tax rules to shift profits to low-tax jurisdictions or make profits disappear for tax purposes. The document outlines several factors responsible for BEPS, including hybrid mismatch agreements, digital economy issues, and aggressive transfer pricing practices. It also discusses the arm's length principle, comparable uncontrolled price method, issues developing countries face with transfer pricing, and solutions like the OECD's BEPS initiatives and improving tax treaty coordination and transparency.

1. BASE EROSION AND PROFIT SHIFTING IN THE
PERSEPCTIVE OF TRANSFER PRICING
ADWITIYA PRAKASH TIWARI
LL M CORPORATE LAW
ROLL NUMBER- 577

2. WHAT IS BASE EROSION AND PROFIT SHIFTING(BEPS)
 BEPS refer to tax planning strategies that exploit gap and mismatch in tax rule to make profit
disappear for tax purpose or to shift the profit where tax are low. This exercise are done in
order to avoid corporate tax.
 BEPS is not illegal per se, but it is relevant for number of reason.
1st – it distort competition.
2nd – it leads toward inefficient allocation of resources.
 Main factor which are responsible for BEPS are
a) Hybrid mismatch agreement and arbitrage.
b) Application of treaty concept to profit derived from delivery of digital good sand services
c) The tax treatment of related party debt-financing, captive insurance and other intra group
financial transaction
d) Transfer pricing practices which include shifting of risk and intangible, artificial split of ownership
of assets, and taking advantage of such intra group transaction
e) The availability of harmful preferential regime.
f) The effectiveness of anti avoidance rule and impact of heavy lobbying and competitive pressure

3. Hybrid Mismatch Arrangement
 Double taxation convention are international agreement between two or more nation.
The main object of tax convention is to allocate fiscal jurisdiction between contracting
state and become part of tax law of each contracting state.
 It take place due to un co-ordinate domestic rule that permit double non taxation.
 The excessive deductibility of interest and other financial expense are important aspect
and this practice promote double non-taxation.
 In order to avoid hybrid mismatch problem it is necessary for every nation to harmonize
the tax treaty and plug the loop hole which provide a pathway for misuse of treaty

4. CONFLICTORY PROVISION WHICH ARE HELPFUL FOR BEPS
 RESIDENCE BASED TAXATION
 SOURCE BASED TAXATION
 The Most Ambiguous Provision Which Are Promote BEPS Problem Is Permanent
Establishment[PE].
 Article 5(1) of the OECD convention define Permanent Establishment as a ‘fixed place of
business through which a the business of an enterprises is wholly or partly carried on.
 Kind of PE
1- FIXED PLACE PE(Visakhapatnam port trust case)
2- AGENCY PE(CIT vs HD Agarwal& sons)
3- SERVICE PE(Morgan Stanley &co. vs DIT)

5. TRANSFER PRICING
 It refer to the consideration arising from a transaction involving goods or services between
distinct entities belonging to the same organization
 It is a intercompany pricing agreement for the transfer of the goods, services, intangibles
between associated person/entities.
 When we look at cursory view we think transfer pricing is same business transaction which take
place between two business houses but in reality it is not as per market standard, such
transaction are take place between related party and price charged by them are factious.
 Often multi national corporation are indulge in such practices but in certain cases individual are
also do the same.
 Globalization and rapid growth of international trade has made inter company pricing an
everyday necessity.
 These practices are harm full for taxation purpose, and to avoid this problem it is necessary to
ensure proper application of the arm length principle.

6. How to analyzing transfer pricing
First economic perspective – according to this view transfer pricing are instrument of resource allocation
within the group, and this is use for MNE co-ordination in order to achieve the proposed objective as well
as for the performance appraisal of subsidiaries.
Second fiscal perspective – it seek to outline the tool to be implemented in order for the transfer pricing
to not deviate from the market value and to not distort competition and tax base in various jurisdiction.
Concept of transfer pricing
The UN model convention article 9(1) state
a) An enterprises of a contracting state participate directly or in-directly in the management, control or
capital of an enterprise of the other contracting state, or
b) The same person participate directly or indirectly in the management, control, capital of an
enterprises of a contracting state and an enterprise of the other contracting state, and in either case
condition are either made or imposed between two enterprises in there commercial or financial
relation which differ from those which would have been made between independent enterprises,
then any profit which would be, but for those condition, have accrued, may be include in the profit of
that enterprises and taxed accordingly.

7. BASIC ISSUE UNDELAYING TRANSFER
PRICING
Transfer pricing determine the income of both parties involved in the cross-border transaction. The transfer price
tend to shape the tax base of the countries involved in cross border transaction.
Cross border tax situation involve issue related to jurisdiction, allocation and valuation
I- JURISDICTIONAL ISSUE- it include the problem of determination of the taxing authority in the case where tax
arise in more then one countries. In this situation problem of double taxation and double non taxation will be arise.
II- ALLOCATION ISSUE- at the MNE point of view transfer pricing provide maximum efficiency in the most optimal
manner. But same time this exercise of MNE are considered by the government as it adversely affected the tax base
of nation. This situation create tug of war between country where the allocation intended and the resource country,
for the tax purpose.
III- VALUATION ISSUE- another contentious issue is valuation of allocated income and expense to one or more
member of the MNE group. Most of MNE has capability to exploit international differential and utilize economies
of integration.
The main problem come with transfer pricing is that it create hurdle for attainment of overall social and economic
goal of countries. Because large size of MNE provide them to additional benefit of economies of scale.

8. ARM’S LENGTH PRICIPLE
 The arm length principle is defined in para 1 of article 9 of the OECD model tax convention. It said
"Where . . . conditions are made or imposed between the two enterprises in their commercial or financial
relations which differ from those which would be made between independent enterprises, then any profits
which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those
conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly”.
 In essence, the application of the arm's length principle: “Treats associated persons not dealing at arm's
length as if they operate as separate entities rather than as inseparable parts of a single unified business”;
and is generally based on a comparison of:
 A. prices, margins, division of profits or other indicators of controlled transactions; with
 B. prices, margins, division of profits or other indicators of uncontrolled transactions.
MEANING OF CONTROL AND ASSOCIATED
. Section 92(A) (1) of Indian income tax act 1962 clearly define "Associated Enterprise", this definition talks
about two situations:
i- When one enterprise controls or is controlled by another, directly or indirectly; and
ii- When there is a relationship of indirect ownership or of mutual interest between the two.

9. Determination of Arm’s Length Price
The determination of an arm’s length price involves the following steps which are interrelated and listed in
no particular order.
1- characterization of business.
(I) manufacturing: full-fledged, licensed, contract or toll;
(ii) distribution: full-fledged, limited risk;
(iii) Service provider
2- identification of comparable transaction
(I) to compare a single transaction (e.g. the sale price and terms of sale of particular product);
(ii) To compare a bundle of transactions;
(iii) To compare results at gross margin level;
(iv) To compare results at net margin level; or
(v) To compare results by reference to some other measures, such as return on capital, ratio of costs to gross
margin, etc.
3- identification of tested parties
4- comparability analysis

10. HOW TRANSFER PRIING WILL TAKE PLACE
Transfer pricing will take place in the following manner.
 Raw materials or processed goods would be purchased from the any company at the lowest price
possible consistent with providing the capital needed to continue operations "SUPPLY CHAIN
TRANSACTIONS“.
 Movable tangible property (machinery and equipment) could be leased by MNE, with leasehold
payments made by company situated in high tax jurisdiction "LEASE TRANSFER PAYMENTS".
 Capital could be provided via loans from low tax jurisdiction company, with interest payments made by
high tax jurisdiction company "INTEREST TRANSFER PAYMENTS".
 To the extent that know-how was required, it could be provided in the form of licenses with royalties
paid by high tax jurisdiction company "ROYALTY TRANSFER PAYMENTS".
 Services provided by low tax jurisdiction company would be paid for via service fees "SERVICE
TRANSACTIONS".

11. Transfer Pricing Methodology
The OECD guideline provide various transfer pricing methodology, this guideline explicitly require the
selection of most appropriate method.
 There are five major transfer pricing method
i- comparable uncontrolled price(CUP)
II- Resale price method (RPM)
Iii- Cost Plus method
Iv- profit based method
two class of transactional profit method are recognized by the USA and OECD they are
A- transactional net margin method
B- profit split method
Other important preferred method
i- return on assets
Ii- berry ratio compared to return on sale

12. TRANSFER PRICING IN TREATIES
United Nation and OECD Model convention
 the OECD Model was most appropriate for negotiations between developed countries and less suitable for
capital importing or developing countries.
 the UN Model preserves more taxation rights to the source state (i.e. host State of investment) or
capital‐importing country than the OECD Model and
 the UN Model has been embraced by many developing states as the basis of their treaty policy.
 Some developed countries also adopt some UN Model provisions, and at times it has influenced changes
to give aspects of the OECD Model a greater source country orientation.
Transfer Pricing and Model Convention
 OECD model article 9 provide the implication of arm’s length principle in case of any dubious transaction
and it require “corresponding adjustment” to avoid double taxation.
 Article 7(2) and 7(4) make provision for avoiding transfer pricing issue between head office and
permanent establishment.[it suggest use of profit split method]
 UN model does not require to make ‘corresponding adjustment’
 Model convention spell out a key transfer pricing dispute resolution mechanism it known as Mutual
agreement procedure in article 25.

13. TRANSFER PRICING IN DOMESTIC LAW
Article 9 of the tax treaty only regulate the basic condition for adjustment of transfer pricing and
advice the application of arm’s length principle.
 At domestic level every nation has his own teller cut requirement, so in order to attain the optimum
level of statutory benefit most country formulate there own legislation in the line of model
convention.
 The definition of “ASSOCIATED ENTERPRISE” in is based on domestic need and it vary as per need
of nation.
 Some countries introduced ‘SAFE HARBOR PROVISION’ [section 92CB of I T act 1962 provide a
framing for safe harbor rule, (Sony private India ltd vs DCIT)]
 Some countries operate CONTROLLED FOREIGN CORPORATION RULE (CFC). Such rule treat all
income (which is parked in low tax jurisdiction) as repatriated income and impose tax on it before
repatriation.
 THIN CAPITALIZATION- to prevent tax avoidance by such excessive leveraging, many countries have
introduced rule to prevent thin capitalization typically by prescribing a maximum debt to equity
ratio
 DOCUMENTATION- another important issue for implementing the domestic law is the
documentation requirement associate with transfer pricing.
 Advance pricing agreement-

14. TRANSFER PRICING AND DEVELOPING
NATION
Developing nation face some of specific challenge in dealing effectively with transfer pricing
 Lack of comparable
 Lack of knowledge and requisite skill-sets
 Complexity
 Growth of intangible economy
 Location saving

15. TRANSFER PRICING REGULATION IN INDIA
 Indian legislation is broadly based on OECD guideline and it follow five of the six method to
compute arm’s length price with the confirmation of most suitable method should be applied.
 Section 92 to 92f of the Indian Tax Act 1962, cover intra group cross border transaction, it is
applicable from 1 April 2001,
 In India following taxing authorities take cognizance of transfer pricing related issue
A- central board of direct tax
B- income tax department
 Tax law which deal with transfer pricing issue
 Section 92-92F, 144C, 271, 271AA, 271BA, and 271G of the Indian income tax act 1962.
 Rule 10A to 10 TG and rule 44GA of the income tax rule.
 On 18th December CBDT introduced ‘safe harbor provision’
 Indian TP legislation make hares penal provision, in case of improper documentation or failure to
reporting or inaccurate particular the taxpayer is fined 2% of transaction value.

16. PROBLEM FACED BY INDIA DUE TO
TRANSFER PRICING
Vodafone Case
In this case two issue are involved,
1- taxability of transaction
2- Vodafone liability to deduct tax at source

17. SOLLUTION FOR THE PROBLEM OF BASE EROSION
 OEDC initiative
1- Addressing the Tax Challenges of the Digital Economy
A- Ensuring that core activities cannot inappropriately benefit from the exception from permanent establishment (PE)
status, and that artificial arrangements relating to sales of goods and services cannot be used to avoid PE status.
B- The importance of intangibles, the use of data, and the spread of global value chains, and their impact on transfer
pricing.
C- The possible need to adapt CFC rules to the digital economy.
D- Addressing opportunities for tax planning by businesses engaged in VAT-exempt activities.
2-Neutralizing the Effects of Hybrid Mismatch Arrangements
3-Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance.
4- Preventing the Granting of Treaty Benefits in Inappropriate Circumstances-
A. Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the
granting of treaty benefits in inappropriate circumstances.
B. Clarify that tax treaties are not intended to be used to generate double non-taxation.
C. Identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax
treaty with another country.

18. Continued…..
 Guidance on Transfer Pricing Aspects of Intangibles-
(i) adopting a broad and clearly delineated definition of intangibles;
(ii) ensuring that profits associated with the transfer and use of intangibles are appropriately allocated
in accordance with (rather than divorced from) value creation;
(iii) developing transfer pricing rules or special measures for transfers of hard to value intangibles; and
(iv) updating the guidance on cost contribution arrangements
 Guidance on Transfer Pricing Documentation and Country-by-Country Reporting-Action 13 of the
Action Plan on Base Erosion and Profit Shifting (OECD, 2013) recognizes that enhancing transparency for tax
administrations by providing them with adequate information to conduct transfer pricing risk assessments and
examinations is an essential part of tackling the base erosion and profit shifting (BEPS) problem.

19. conclusion
 Transfer pricing is a brain child of aggressive tax planning and aggressive tax planning is more
harmful then black money.
 Aggressive tax planning is responded by aggressive anti avoidance legislation, but at same time we
not have all thief only few of them are liable to tax evasion through aggressive tax planning
measure
 At present economic environment it is necessary to promote dialogue and co-operation between
government and MNEs
 It is demand of the time the government worked on
A- tax transparency, aggressive tax planning
B- tax treaties, transfer pricing, harmful tax practice
C- tax policy analyses, tax administration, and tax and development.
 Every state should be cautious about tax treaties because they may create opportunity for tax
avoidance
 International co-operation and transparency will be key in addressing the inconsistency of current
un-coordinate domestic rule, and in tackling the dilemma of collective action.