India’s attractiveness as a destination of FDI has suffered another blow, by yet another tax issue, as it is revealed that the level of tax demands for alleged transfer pricing violations in India has spiked in the past few years.

Ahead of the union budget for 2013 to 2014, India's finance minister, P Chidambaram, has visited London, Hong Kong and Singapore to reassure foreign investors on the government’s policies. He has also stated that the government would review proposals on retrospective taxation, and the unpopular General Anti-Avoidance Rule has been deferred to 2016 or 2017. However, a surge in tax demands for alleged transfer pricing violations is threatening to undermine his cause.

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Transfer pricing relates to the determination of the the correct market price at which multinational corporations and their subsidiaries transfer products, services or assets across borders. India currently has the third highest number pending transfer pricing disputes in the world, according to an Ernst & Young survey in August 2012. At least 1500 transfer pricing disputes were in litigation as of February 2011, compared to less than six in the US, and none in Singapore or Taiwan. 

India's tax authorities have come down on multinational corporations such as Shell, Nokia and Vodafone for alleged transfer pricing violations. One in two multinational corporations have been hit with such demands compared to one in four just five years ago.

Shell India Markets Private has been handed a $1bn bill for a $160m equity infusion by its parent Shell Gas BV four years ago. There has been a 75% spurt in transfer pricing allegations in the period between 2011 and 2012, with demands amounting to $9.3bn (for cases pertaining to 2008 to 2009) from $5.3bn of demands in 2010 to 2011 (for cases pertaining to to 2007 to 2008) and $276m in 2005 to 2006 (for cases pertaining to 2002 to 2003), according to Indian newspaper Financial Express.

Shell India considers this matter of taxing the money received by it as “a tax on FDI” and contrary to the spirit of the recent global trip by Mr Chidambaram. According to the company, the  demand was an incorrect interpretation of tax regulations as the equity infusion was only a “capital receipt” for which an income tax cannot be levied; that the funding of subsidiaries through the issue of shares was common globally. How these issues are resolved bears watching as they adversely impact on India’s attractiveness as a destination of FDI.

N Chandra Mohan is a business and economic commentator based in New Delhi