The Indian Union Budget is scheduled to be presented on 1 February 2020. Expectations are high from the upcoming budget, especially in the backdrop of various challenges which were highlighted and relaxations which were sought by India Inc from the Indian Government in the pre-budget discussions at various forums. Stakeholders have voiced their concerns/demands before the Finance Minister in terms of various laws such as income tax law, goods and services tax, customs, etc.
A key area in the tax policy of any country is the Transfer pricing (TP) regime. TP provisions help in safeguarding the tax revenues of the country by minimizing the risk of base erosion through manipulation of price(s) of cross-border inter-company transaction(s).
Through this article, we aim to discuss some challenges which are being faced under the existing framework of Indian TP Regulations - one can expect some developments in these areas in the upcoming budget.
Revamping the safe harbour provisions
Safe Harbour provisions were introduced in India in order to help reduce the rising TP litigation faced by taxpayers. These provisions prescribe minimum return / price (such as a minimum return of 17/18% on total operating costs for a captive software developer) for a specified list of intra-group transactions, which if followed by the taxpayer, would be accepted by the Indian tax authorities. The scheme was originally launched in 2013. However, owing to the tepid response received from taxpayers due to exceptionally high minimum returns prescribed under the provisions, the Government launched a revamped version of the scheme in 2017.
The revised rules still received a cold response, primarily due to limited applicability on notified intra-group transactions only and margins still being high, as compared to the margins normally agreed under an advance pricing agreement in the past.
Considering that Financial Year 2018-19 was the last year to which existing Safe Harbour regime was applicable, one would hope that the government comes up with a new scheme, which addresses the challenges faced under old rules by further streamlining the margins and maybe adding more category of transactions to the list of eligible transactions.
Streamlining the requirements pertaining to master file
Master File is a new reporting/ documentation requirement introduced in India post the OECD's Base Erosion and Profit Shifting (BEPS) project in 2016. Since its introduction, it has been highlighted in various forums/ discussions that the existing thresholds (of group turnover of INR 500 crore and cross-border related party transaction of INR 50/10 crore) for applicability of Master File are extremely low.
As Master File requires a taxpayer to collate significant amount of data pertaining to the operations of its entire multinational group, it would be a huge relief for taxpayers if the Indian Government relaxes the above thresholds. At present, the country-by-country reporting (CbCR) limit is 11 times the threshold for Master File. Countries like Australia, Japan, etc. have adopted the same threshold as is applicable on CbCR. Accordingly, the Indian Government may consider to either adopt the same threshold as CbCR, i.e., INR 5,500 crore or move it closer to the said threshold.
Furthermore, a similar rationalization of the limits linked to value of cross-border related party transactions may further help in streamlining the overall reporting requirement.
Considering that the above relief has been repeatedly demanded by the industry as well as professionals, it can be expected that the upcoming budget may deal with this area. Furthermore, it would be interesting to see whether the budget deals with few other challenge areas in the existing Master File reporting norms, as discussed below:
• The existing timeline for filing of Master File, i.e., on or before the due date for filing of return of income, is a little restrictive â€“ it often creates onerous burden for taxpayers, especially those which are part of foreign headquartered multinational groups.
Such entities may not be able to source Master File related information from the group within the prescribed period, as the group may have a more liberal timeline in other jurisdictions for collating such data. Accordingly, extension of this existing timeline in line with the practices followed in other jurisdictions may put the taxpayers in a better position to complete the compliances, by furnishing reliable and complete information.
For example â€“ Australia allows 12 months to file the Master File after the close of reporting accounting period and same is not linked to the due date for furnishing return of income.
• The existing format prescribed for furnishing Master File i.e., Form No. 3CEAA, includes certain information requirements which deviate from the recommendations made by OECD in its report (such as details of top ten unrelated lenders of the group). Such deviations from internationally followed practices adds to the administrative burden on taxpayers.
Clarity on certain areas in respect of CbCR
As mentioned earlier, CbCR is applicable on multinational groups in India if they have a consolidated group turnover of more than INR 5,500 crore in the immediately preceding accounting year. In case of a foreign headquartered multinational group whose financial statements are prepared in foreign currency, the said limit is computed in INR terms by using the telegraphic transfer buying rate of such currency on the last day of the preceding accounting year.
Globally, the threshold followed for CbCR is EURO 750 million or equivalent value, as suggested by OECD under the BEPS Action Plan 13, a minimum standard. OECD further suggested that countries should adopt a near equivalent of EURO 750 million as on January 2015 in their local currency in order to ensure consistency in the reporting requirements.
The provision under Indian law on the foreign exchange rate to be used may result in a situation wherein a multinational group is not required to file CbCR in other countries, but may be required to file in India. This requirement creates unnecessary burden considering the enormous financial data required to be submitted as part of CbCR. This was also highlighted by OECD as a part of its peer review process.
Similarly, there are various terms used in CbCR template, which can be subjected to diverse interpretation. For example â€“ the scope of the terms 'capital' (equity share capital vs. preference share capital vs. hybrid instruments such as compulsorily convertible debentures, etc.), accumulated earnings (specific vs. general reserves), etc. A clear guidance on the scope of such terms will help in eliminating ambiguity and providing certainty to taxpayers.
Interest limitation rules
Section 94B lays down certain conditions on deduction of interest expense incurred by an Indian company, or a permanent establishment of a foreign company in India, by limiting the deductibility of such expenses paid to a non-resident AE to 30% of the earnings before interest, taxes, depreciation and amortization.
The existing provisions are also applicable to interest paid/payable on debt issued by a third party, which is guaranteed by the AE of such entity. The existing law is worded in such a manner that leads to the conclusion that even the interest paid on a debt guaranteed by a resident AE will be subject to interest limitation rules. It would be helpful if a clarification is provided by the Government in this regard.
Furthermore, the provisions of section 94B are not applicable on an Indian company or a permanent establishment of a foreign company which is engaged in the business of banking or insurance. It has often been questioned if this exemption will also be available to a non-banking finance company (NBFCs). Considering that the Indian financial services sector is already facing multiple challenges, it would be helpful if availability of such benefit to NBFCs is confirmed.
Other miscellaneous issues
Apart from the above, it would be helpful if the Indian government addresses the following procedural challenges, which are faced while complying with Indian TP regime:
• Clarity on applicability of TP provisions in the absence of base erosion in India : Indian TP provisions are framed in such a manner that in case of any outbound payments (such as royalty) made by a resident person to its non-resident AE, TP compliance requirements (namely TP documentation and Form No. 3CEB) are applicable even on such non-resident AE in case such royalty transaction is taxable in the hands of non-resident AE.
As per Circular 14 of 2001, TP provisions were not intended to be applied in cases where application of arm's length price would result in a decrease in the overall tax incidence in India in respect of the parties involved in the international transaction. This spirit of the circular is also resonated in the Income Tax Act, 1961 (the Act), vide section 92(3) of the Act, which provides that TP provisions shall not apply in the cases where the computation of income with regard to arm's length price (ALP) has the effect of reducing the income chargeable to tax or increasing the loss. However, contrary views have often been adopted, leading to unnecessary litigation. It would be helpful if the government provides clarity in this regard. This situation is explained through the illustration below.
For example â€“ Co. A, a resident in India, pays royalty @ 5% of sales to Co. B, a non-resident (assuming Co. A and Co. B are AEs). However, the ALP was computed as 8%. In this case, adopting 8% as the ALP would result in reducing the income chargeable to tax (or increasing the loss) for Co. A, i.e., cause base erosion in India. Accordingly, the transaction price, i.e., 5% would be adopted as the ALP. In this scenario, it maybe onerous to apply TP provisions on Co. B and adopt 8% as the ALP.
• ''Range' and multiple year data: 'Presently, 'range' is computed as 35-65 percentile. The same maybe aligned to internationally adopted inter-quartile range, i.e., 25-75 percentile.
Furthermore, the concept of 'range' is applicable only to cases where Comparable Uncontrolled Price (CUP) method, Resale Price Method (RPM), Cost Plus Method (CPM), and Transactional Net Margin Method (TNMM) are applied. However, the benefit is not available in cases where 'Other Method' or Profit Split Method (PSM) are used.
Considering that 'Other Method' is only an extension of CUP method, wherein quoted prices/ prices proposed to be applied under comparable third party transactions (unlike actual transaction prices used under CUP method) are used, the government should extend the benefit of range to this method as well.
Furthermore, considering PSM also requires determination of routine returns under the residual approach, the government should clarify that whether 'range' can be applied for determining such routine returns, while applying PSM methodology.
Similarly, presently, use of multiple year data is restricted to cases where RPM, CPM and TNMM are applied as most appropriate method. The government may consider allowing its use in cases where PSM, CUP Method or Other Method are used.
• Option of inserting appropriate notes in the e-utility/ XML schema of Form No. 3CEB:
The existing utility does not provide the taxpayer an option to insert appropriate explanatory notes against each clause forming part of the Form No. 3CEB. This often creates a challenge, when insertion of such notes is critical in order to ensure complete understanding of the nature of an international transaction/ specified domestic transaction or clearly specify the assumptions underlying the transactions reported in the said form. A new utility providing adequate space for such notes, may not only help the taxpayers and the accountant's issuing such certificates to ensure true and correct reporting, but also ensure availability of reliable information with the tax authorities for the purpose of assessment.
The Indian Government has always welcomed suggestions for streamlining the tax laws of the country. The Government has also adopted an inclusive approach while framing the upcoming budget, by holding multiple rounds of meetings with various stakeholders to get their feedback on the existing framework. Ambiguous provisions and onerous compliance requirements may only end up adding to the difficulties of the taxpayer(s), by exposing them to recurring litigation and additional compliance responsibilities respectively. Considering that TP provisions are integral part of the tax policy framework, streamlining the provisions further may help in boosting investor confidence. It would be interesting to see to what extent the above expectations find place in the upcoming budget.
(Note:- Views expressed are personal. Comments are generic in nature, and readers may seek specific professional advice based on their respective facts.)