History of Transfer Pricing

History of Transfer Pricing

The First World War was ended way back in 1918/19. It was the first time when the different nations in the world collaborated to form “League of Nations” in order to maintain peace, security, and take decisions in the matter of International Affairs.

First time in the 1920s, League of Nations recognized that the interaction of domestic tax systems can lead to double taxation vis-à-vis double non-taxation of incomes which can affect global prosperity and trade. It was the first time when the UK had introduced the Arm’s Length Principle not only in Europe but in India too by virtue of section 43 of erstwhile tax law i.e., Income-tax Act, 1922.

Later on, OECD was formed after the end of World War II for the reconstruction of the European Economy in 1948 which has taken the concern of International Taxation as priority and published guidelines on Transfer Pricing namely “Transfer Pricing and Multinational Enterprises” in 1979. This was the first time when the International Committee promised to amend their existing tax laws for the introduction of Transfer Pricing in their respective tax laws.

Consequent tax abuse by Multinational Enterprises (MNEs)

It was the 1990s, when the dot-com boom was taking place in the United States and MNEs were spreading across the globe. India had liberalized and globalized its economy in 1992 and opened doors for global MNEs. There were variances in the rate of charging taxes across the different tax jurisdictions and global MNEs were nonetheless shifting their profits to the lower tax jurisdiction not only making the consequent tax abuse but destroying the local enterprises paying higher tax on their income.

According to OECD, 60% of the global trade takes place within the MNEs and as per IMF, tax avoidance through profit shifting is estimated to be around $400 billion for OECD countries and $200 billion for lower-income countries. A study of Tax Justice Network has estimated that India is losing around INR 70,000 crores on account of international tax abuse.

The rise in global trade within MNEs and consequent tax abuse by them has made significance of Transfer Pricing in International Taxation.

History of Transfer Pricing in India

The Income-tax Act was introduced in 1961 adopting the erstwhile Act of 1922 wherein the laws on taxation of MNEs became significantly important soon after the globalization of the Indian Economy. India has never become part of the OECD; however, UN Model has already adopted the OECD Model of Transfer Pricing back in the 1980s.

Following the UN Model in line with the OECD Model, India has introduced Transfer Pricing in 2001 by virtue of a series of Section 92. Since then, it became the most important tax issue for MNEs operating in India. The Indian regulations have described pricing methodologies, maintenance of documentation, etc.