BBC under lens for violating I-T transfer pricing rules; what are these?

Income Tax (I-T) surveys were carried out at the British Broadcasting Corporation’s (BBC) Delhi and Mumbai offices on Tuesday (February 14) and Wednesday (February 15) for alleged violation of transfer pricing rules.

Government sources have said the BBC has been “persistently and deliberately” violating transfer pricing rules, has “deliberately diverted a significant amount of the profits,” and has not followed the “arm’s length arrangement” while allocating the profit.

So, what are transfer pricing rules and what is the arm’s-length arrangement?

What is transfer pricing?

To put it simply, transfer pricing is an accounting practice by which one division or subsidiary of a company charges another or the parent company when they exchange goods and services.

The arm’s-length arrangement states that the transfer price should be based on market rates. That is, one division of a company should charge another division or subsidiary the usual market rates for the goods or services exchanged.

Also read: I-T ‘survey’ at BBC offices: How is it different from an I-T ‘search’ or ‘raid’?

However, multinational companies often use transfer pricing to reduce the parent company’s tax burden. Company divisions charge a higher price from those in high-tax countries to reduce the latter’s profit, while charging a lower price from divisions in low-tax countries, to increase theirs.

How transfer pricing helps companies lower their tax burden

Suppose a computer manufacturer has a subsidiary that produces software in another country. The subsidiary sells the software to other computer manufacturers as well as the parent company. Everything is fair if the parent company pays the same rates for the software as the subsidiary charges other computer manufacturers, that is, the market rates.

But imagine a scenario where the subsidiary sells the software to the parent company at a much lower price as it charges other computer manufacturers. The subsidiary’s income or revenues are much lower that it should be because of the lower pricing.

The parent company, on the other hand, pays a lower price and increases its profits. The parent company’s overall income is not affected because of this arrangement. But if the subsidiary is in a country where income tax rates are high, it can save on taxes by showing a lower profit. If the parent company is in a country with lower tax rates, it can save a lot with this arrangement.

Also read: BJP slams BBC’s ‘venomous reporting on India’, says I-T dept should do its work

This same method can work between different divisions or subsidiaries of a multinational company if these are in different countries with tax disparities. It is the country with the higher tax rate that loses out on its I-T earnings. As the Indian I-T Department website explains, “The result is revenue loss and also a drain on foreign exchange reserves.”

What is arm’s-length principle?

Section 92F of the Income Tax Act 1961 defines “arm’s-length price” as “a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.”

It essentially means that the price a division or subsidiary of a company pays to buy goods or services from another division or subsidiary should be the same as the market rate — as if the two entities were unrelated. That is, just because the entities are related, there should be no price arrangement or special conditions for transactions between them.

This is the rule the BBC has allegedly violated.

(With agency inputs)