Transfer pricing in a locked room

Transfer pricing is ultimately concerned with aligning taxable profits with economic reality. This objective cannot be achieved in a system that excludes relevant evidence based on rigid procedural timelines. The proposed Section 122(8A) risks transforming transfer pricing from a substantive inquiry into a procedural exercise, where outcomes are determined not by the merits of the case but by the timing of document submission. In a context where the taxpayer becomes fully aware of the transfer pricing issue only at the stage of assessment and where the burden of proof shifts accordingly, restricting submission of evidence fundamentally undermines the taxpayer’s ability to achieve a fair and accurate outcome. It represents a significant departure from internationally accepted practices and raises serious concerns regarding both fairness and accuracy

• How statutory evidence deadlines undermine arm’s length outcomes in Sri Lanka 

When procedure overrides substance

The proposed Section 122(8A) of the Inland Revenue (Amendment) Bill, 2026 introduces strict statutory timelines, six months for local evidence and nine months for foreign evidence (subject also to any shorter time limits that may be specified by tax officials through formal notice), after which unsubmitted documentation becomes permanently inadmissible. While this proposal raises broader legal and constitutional concerns, its implications are particularly acute in the field of transfer pricing.

Transfer pricing is not a routine compliance exercise. It is a complex, fact-driven discipline grounded in economic analysis, cross-border data, and professional judgment. The determination of an arm’s length outcome depends on a careful evaluation of facts that often evolve over time. Against this backdrop, a rigid evidentiary “lock-out” risks subordinating substantive accuracy to procedural finality, thereby undermining the very foundation of transfer pricing - the arm’s length principle.

The nature of transfer pricing evidence and the Sri Lankan audit reality

Transfer pricing analysis is inherently dependent on information that lies beyond the taxpayer’s immediate control. Multinational enterprises must rely on foreign affiliates, third-party data providers, and external advisors to compile documentation supporting their pricing positions. Intercompany agreements, global transfer pricing policies, benchmarking studies, and financial data of comparable companies across jurisdictions are not static documents that can be produced on demand. Their preparation requires coordination across jurisdictions, compliance with legal and confidentiality constraints, and reliance on third parties whose timelines cannot be dictated by the taxpayer.

In the Sri Lankan context, these inherent challenges are further compounded by the practical realities of the audit process. In many instances, the Inland Revenue Department does not clearly articulate the precise transfer pricing issue during the audit stage. Instead, it is common practice for assessments to be issued together with the Final Order of the Technical Review Committee, often without a prior, fully reasoned communication of the basis of adjustment. As a result, the taxpayer becomes aware of the specific transfer pricing position adopted by the Inland Revenue Department only at the point of assessment.

It is at this stage that the burden of proof decisively shifts to the taxpayer. However, this timing creates a fundamental difficulty. The taxpayer is required to defend a position, frequently involving complex economic analysis and cross-border data, only after the administrative process has effectively concluded. Under the proposed Section 122(8A), this challenge is exacerbated by a statutory limitation on admissible evidence. Even where relevant and probative evidence becomes available after the prescribed period, it would be legally inadmissible.

The difficulty is further intensified by the limited level of detail often contained in Final Orders. In practice, such orders may not fully disclose the transaction under review, the benchmarking analysis undertaken, or the comparability adjustments applied by the Inland Revenue Department. This lack of transparency significantly constrains the taxpayer’s ability to understand, evaluate, and respond to the assessment. In effect, the taxpayer is required to rebut an adjustment without full visibility of the methodology and data on which it is based.

When viewed collectively, these factors create a situation where the burden of proof is not only shifted but rendered disproportionately onerous. The taxpayer is expected to discharge this burden within a restricted evidentiary framework while operating with incomplete information. This represents a marked departure from internationally accepted transfer pricing practices, where transparency, engagement, and access to relevant information are essential to ensuring a fair and accurate outcome.

A progressive narrowing of taxpayer safeguards

This concern is further amplified when considered in light of earlier legislative developments. The Inland Revenue Act No. 24 of 2017 significantly reduced the time bar period from five years to two and a half years and removed the requirement to provide the taxpayer with an opportunity to respond through a formal show cause notice, specifically, a notice calling upon the taxpayer to demonstrate why the arm’s length price should not be determined based on material or information in the possession of the Inland Revenue Department.

These changes have already altered the balance of the audit process by limiting opportunities for taxpayer engagement prior to assessment. The introduction of a rigid evidentiary lock-out risks compounding this shift. It moves Sri Lanka further away from globally accepted transfer pricing practices, where iterative engagement, procedural transparency, and flexibility in the consideration of evidence are integral to determining the correct tax outcome.

The centrality of evidence in transfer pricing

Transfer pricing is fundamentally an evidence-based exercise. Determining whether a transaction is at arm’s length requires a detailed examination of functions performed, assets employed, and risks assumed, supported by reliable comparables and financial data. This process is inherently iterative. Initial analyses are often refined as additional data becomes available, as comparability adjustments are better understood, or as the audit progresses.

The OECD Transfer Pricing Guidelines explicitly recognise that transfer pricing is not an exact science but requires the exercise of judgment based on available information. Crucially, the concept of “available information” is dynamic rather than static. In cross-border contexts, access to relevant data often evolves over time, and both taxpayers and tax administrations are expected to take these practical constraints into account.

Globally accepted audit practices reflect this understanding. In many jurisdictions, transfer pricing audits are conducted through a process of ongoing dialogue. Taxpayers are given opportunities to clarify positions, submit additional documentation, and refine their analyses as issues are identified. Even at the dispute resolution stage, tribunals and courts generally retain discretion to admit relevant evidence where necessary to determine the correct tax liability. The emphasis is consistently on substantive accuracy rather than procedural rigidity.

A statutory restriction on the introduction of new evidence disrupts this process. It may result in outdated comparables being relied upon, prevent necessary adjustments from being made, and ultimately produce arm’s length ranges that do not reflect prevailing market conditions. Such outcomes are unlikely to be accepted by counterparty jurisdictions, thereby increasing the risk of double taxation and undermining the credibility of the tax system.

Ensuring that the evidentiary framework remains flexible, transparent, and aligned with global standards is essential to preserving both fairness and confidence in Sri Lanka’s tax regime

Evidentiary restrictions and the distortion of outcomes

Against this backdrop, the proposed Section 122(8A) represents a significant departure. While it carries a real risk of being applied in a manner that could unduly pressure or disadvantage taxpayers, its more fundamental impact lies in restricting the evidentiary framework within which transfer pricing analyses are undertaken. By limiting the admissibility of evidence to what is submitted within a fixed timeframe, the provision effectively narrows the factual matrix on which the arm’s length analysis can be performed. As a result, taxpayers may be precluded from supplementing their position with additional data or from meaningfully responding to issues that only become apparent upon receipt of the assessment together with the Final Order.

This creates a structural imbalance in the dispute resolution process. While the tax authority may rely on alternative datasets, adjusted comparables, or internal analyses, the taxpayer is confined to a potentially incomplete evidentiary record. The resulting transfer pricing outcomes may therefore be based on incomplete or outdated information, increasing the risk of adjustments that do not reflect economic reality.

Divergence from OECD and United Nations (UN) frameworks

The OECD’s three-tiered documentation framework, comprising the Master File, Local File, and Country-by-Country Report, seeks to balance transparency with administrative feasibility. It recognises that while taxpayers must maintain adequate (largely minimum) documentation, tax administrations must also account for practical constraints and engage constructively with taxpayers.

Similarly, the UN Transfer Pricing Manual for Developing Countries emphasises flexibility and pragmatism, particularly in developing country contexts where information asymmetries and capacity constraints are more pronounced. Both frameworks promote a cooperative, evidence-based approach aimed at determining the most accurate approximation of an arm’s length outcome.

The introduction of a rigid evidentiary lock-out departs from these principles. It prioritises procedural deadlines over substantive correctness and risks placing Sri Lanka at odds with the broader international consensus under the OECD / G20 Inclusive Framework of which Sri Lanka is a member.

Escalation of disputes and reliance on Mutual Agreement Procedure (MAP)

Where domestic processes fail to produce fair and accurate outcomes in transfer pricing disputes, taxpayers are increasingly likely to seek relief through MAP under applicable tax treaties. While MAP serves as an important mechanism for resolving cross-border disputes, it is not a substitute for a well-functioning domestic framework. The MAP process is often time-consuming, resource-intensive, and inherently dependent on effective bilateral cooperation between competent authorities, which may not always be assured.

By restricting the admissibility of evidence at the domestic level, the proposed provision may inadvertently increase the number of cases requiring MAP intervention. This would strain administrative resources and prolong dispute resolution, contrary to the objectives of the international tax framework.

Investment climate and taxpayer behaviour

A predictable and fair tax environment is essential for attracting and retaining foreign investment. Multinational enterprises require assurance that their transfer pricing positions can be defended using relevant and reliable evidence. A regime that excludes such evidence on procedural grounds introduces uncertainty and increases perceived tax risk.

At the same time, the proposed provision may have unintended behavioural consequences. Compliant taxpayers may be penalised for delays beyond their control, while non-compliant taxpayers may simply adapt their strategies. The result is a system that imposes disproportionate costs on compliant actors without necessarily improving enforcement outcomes.

Already addressed matter

It appears that this proposal is aimed at addressing concerns regarding delays and non-cooperation by taxpayers. However, the Inland Revenue Act has already established stringent transfer pricing–specific penalties under Section 184 to address such non-compliance and delays. A taxpayer’s failure to comply with transfer pricing rules may result in heightened scrutiny by the Inland Revenue Department, including risk assessments and potential adjustments based on other information available to the Department or through alternative transfer pricing methods.

These existing measures are more consistent with OECD and UN guidance, as they promote enhanced engagement throughout the audit process while ensuring that the transfer pricing system remains focused on determining the correct tax liability rather than enforcing procedural technicalities. Consequently, there is no need to introduce a rigid restriction on the submission of new evidence, which would deviate from globally accepted transfer pricing audit practices.

Conclusion: Preserving substance over procedure

Transfer pricing is ultimately concerned with aligning taxable profits with economic reality. This objective cannot be achieved in a system that excludes relevant evidence based on rigid procedural timelines. The proposed Section 122(8A) risks transforming transfer pricing from a substantive inquiry into a procedural exercise, where outcomes are determined not by the merits of the case but by the timing of document submission.

In a context where the taxpayer becomes fully aware of the transfer pricing issue only at the stage of assessment and where the burden of proof shifts accordingly, restricting submission of evidence fundamentally undermines the taxpayer’s ability to achieve a fair and accurate outcome. It represents a significant departure from internationally accepted practices and raises serious concerns regarding both fairness and accuracy.

A transfer pricing system that prioritises procedural finality over substantive correctness ultimately compromises its credibility. For transfer pricing, where the determination of arm’s length outcomes already involves significant judgment, the exclusion of relevant evidence is not merely a procedural limitation, it is a direct threat to the integrity of the system. Ensuring that the evidentiary framework remains flexible, transparent, and aligned with global standards is therefore essential to preserving both fairness and confidence in Sri Lanka’s tax regime. 

(The author is a Partner Tax & Regulatory at KPMG, Sri Lanka)