International taxation has witnessed some major changes in recent times. Many of these changes are attributable to the base erosion and profit shifting (BEPS) project of the Organisation for Economic Co-operation and Development (OECD).
This project was a result of the public outcry in different parts of the world to address rising BEPS issues, including double non-taxation/low taxation in context of global firms. The result was an elaborate set of recommendations in the form of 15 reports with regular updates from OECD.
Accordingly, a three-tier documentation structure was recommended for transfer pricing. These include country-by-country (CbC) reporting, master file and local file.
The new three-tier documentation structure aims at providing access to the revenue authorities on information pertaining to operations of multinational enterprises (MNEs).
Earlier, Indian revenue authorities used to focus on comparability of companies adopted by the taxpayer, the arm’s length nature of margin earned by the taxpayer on routine information technology (IT) and IT-enabled services (ITeS) transactions, etc. Now, the availability of enhanced information as per the new documentation structure will help revenue authorities focus on a more macro-level review of the MNE’s business operations. This will also help them with an in-depth analysis of the functional, asset and risk (FAR) profile and the economic characterization of entities involved in the intra-group transactions.
Under Indian regulations, CbC reporting is applicable on MNE groups having consolidated group revenue of more than Rs5,500 crore (approximately $850 million). Master file reporting is applicable on MNE groups having consolidated group revenue of more than Rs500 crore (approximately $80 million) and cross-border related-party transactions in excess of—(a) Rs50 crore (approximately $8 million) at an overall level; or (b) Rs10 crore (approximately $1.6 million) only related to intangible assets.
The first cycle of reporting deadline is 31 March in India. This has put pressure on MNEs to collate humongous and some hard-to-source data, and ensure timely reporting. Armed with the group-level information, the revenue authorities may come up with an extensive set of follow-up questions.
Use of data analytics and related IT tools would further help them in demanding more explanations and justifications on the overall business structures and tax positions taken by the businesses. The taxpayers may find the overall experience of dealing with more informed revenue authorities a little overwhelming. Therefore, MNEs need to evaluate their existing structures for the foreseeable BEPS risks and take appropriate remedial action.
MNEs need to examine their value chain proactively to identify possible mismatches between location of economic activity, and the resultant value creation, to avoid any disputes at a later date. They also need to review the actual conduct of their various group entities, rather than focusing merely on documentation or paper trails in the form of inter-company agreements to justify their intra-group transactions. Although “substance over form" has always been the guiding principle for any transfer pricing analysis in India, the new BEPS regime has further brought it into limelight.
For instance, parking of intangibles in low-tax or no-tax jurisdictions, with no economic substance in such entities, could be a potential BEPS risk area. Revised guidance requires that a FAR analysis or capacity re-assessment be carried out for such entities. This will help in evaluating whether they have the capability to perform intangible related functions (such as development, exploitation, etc.,) and bearing the associated risks (such as financial risk, obsolescence risk, failure risk, infringement risk, etc.,) or are mere shell entities to avail tax benefits.
Another typical situation wherein similar risk may arise can be an intra-group services scenario, which is quite common in Indian context. The taxpayers would need to substantiate the capability of service providers to render services in terms of availability of necessary resources like fixed assets, employees with relevant skill sets, etc.
The need of the hour is not only to revisit the entire supply chain from a transfer pricing perspective in isolation, but to adopt a more holistic approach with focus on substance over form.
Transparency between revenue authorities and taxpayers has been one of the pillars of the BEPS work. The revised transfer pricing documentation structure has been created as one of the enablers to achieve this objective. In the long run, MNEs need to be more careful and cautious in their approach to any structuring/re-structuring exercise and take necessary corrective steps, wherever required. After all, prevention is better than cure!
Should multinational enterprises (MNEs) stop paying attention to the structure or language of intra-group pacts and simply focus on nature of actual transactions while undertaking any transfer pricing analysis?
Intra-group agreements often serve as the starting point for a transfer pricing analysis. They help in gathering basic understanding of how a transaction is structured. Although the revised guidelines focus on facts of the actual transaction, inclusion of any clause in an intra-group agreement that is not in alignment with the actual transaction may result in unnecessary dispute and litigation. A more pragmatic solution, therefore, would be to restructure the transaction to cover any BEPS-related risks and thereafter align the intra-group agreement with the actual transaction.
Very often, MNE group structures have marketing support entities, which are remunerated at total cost plus fixed mark-up. Can the business/pricing model of these entities be challenged even if they are not involved in or perform the function of final conclusion of contracts?
One needs to evaluate the functions, asset and risk (FAR) profile of such entities and the actual conduct of their employees. A mere shifting of contract conclusion function to principal risk bearing entity, i.e. from one tax jurisdiction to another tax jurisdiction may not be sufficient. Any material involvement of such marketing support entities in the critical sales functions needs to be evaluated as the same may lead to possible permanent establishment (PE) risks or the conclusion that different pricing models (like revenue split or profit split or commission based model) other than a simple cost plus are more suited to such entity.
Once the existence of a PE has been established, does it mean the entire profit resulting from the underlying economic activity should be attributed to the PE only?
Even if a PE is established in India, the entire profits should not be subject to tax in India. It is only the profits that are attributable to the PE which are taxable in India. Therefore, the taxpayer needs to evaluate the role played by the PE before doing such profit attribution exercise. Once there is clarity on the FAR profile of the PE, the TP principles would be used to decide the quantum of attribution. Profit needs to be attributed only for that portion of FAR for which no income has been offered to tax in the concerned tax jurisdiction.
Rajeev Jain and Varun Gupta contributed to this article
Vikas Vasal is national leader-tax, Grant Thornton India LLP
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