BEFIT – Transfer Pricing Proposal

On September 12, 2023, the European Union commission unveiled the much awaited proposal on “Business in Europe: Framework for Income Taxation” (“BEFIT”) , which lays down a common set of rules for computing the tax base for EU group companies.

As part of BEFIT, the commission issued a second separate proposal on Transfer Pricing to harmonise the Transfer Pricing regulations across the EU states.

It is to be noted that while the TP proposal is substantive, the BEFIT corporate tax proposal also lays down important regulations relating to simplification of TP compliance procedures for certain activities. Hence both the TP proposal and BEFIT corporate tax proposal in so far as it relates to Transfer pricing, will need to be read in conjunction.

The common framework is expected to create a level playing field, enhance legal certainty, reduce compliance cost, encourage businesses to operate cross-border and stimulate investments and growth in the Union.

VSTN’s Newsletter highlights the key facets of the TP Proposal and BEFIT Corporate Tax proposal in relation to Transfer Pricing.

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UAE Reccent Notifications

During August and September, The United Arab Emirates (“UAE”) Federal Tax Authority has published the below corporate tax guides with an intent to make the corporate tax provisions more understandable to the taxpayers and to also address certain frequently asked questions by the taxpayers:-

• A Comprehensive Corporate Tax Guide on the Small Business Relief (CTGSBR1)
• Corporate Tax Guide on Registration of Juridical Person (CTGRJP1)
• Corporate Tax – General Guide (CTGGCT1)

Further the MoF also released #Cabinet Decision No.75, outlining the administrative #penalties for violations of the #UAE corporate tax law which is likely to serve as a major deterrent for any non compliances, and to ensure that taxpayers meet their corporate tax obligations on time!

In the attached alert we have provided a summary of the above guides/ notifications

#Tax #Transfer Pricing #UAE

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APA Annual report

APA Annual Report FY 2019-20 to 2021-22 and FY 2022-23

The CBDT has recently released the 4th and 5th Advance Pricing agreement (APA) annual report for the period FY 2019-20 to 2021-22 and FY 2022-23 respectively. FY 2021-22 marks completion of first decade of the APA programme. APA is one of the foremost tools relied by taxpayers and taxauthorities alike in dispute resolution for transferpricing cases.

APA provides tax certainty through consensus on the arm’s length price (ALP) agreed by taxpayers and tax authority (CBDT in case of India). APA can be a unilateral (UAPA)– where taxpayer enters into agreement with the tax authority of its jurisdiction or bilateral (BAPA)– APA entered into between the taxpayers, the tax authority of the host country and the foreign tax administration

BAPA provide wholistic or complete dispute resolution as it is agreed by tax authorities of both taxpayers and its AE. Jurisdictions where the APA programme is matured usually witness greater BAPA application than UAPA.

The key aspects and insights of the 4th and 5th APA annual report is captured in the below alert including:

A) APA Applications

B) APA Conclusions

C) UAPA related statistics

D) BAPA related statistics

India ’s APA programme is maturing over the decade with increase in the pace of conclusions – both UAPA and BAPA as well as increase adoption of BAPA through change in UAPA:BAPA ratio.

Global dispute resolution landscape, especially in transfer pricing, is evolving. Taxpayers will have to be mindful of these global developments such as AmountB of PillarOne while formulating their strategy on dispute resolution w.r.t. transfer pricing.

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Assessment issues in COVID year

Defending losses during COVID impacted years

October 2023 is an important month for Transfer Pricing with Form3CEB deadline as well as due date for completion of FY 20-21 TP assessment by TPO. This is also first full year impacted by COVID to be scrutinised by tax authorities. Many companies had incurred losses this year owing to lockdown, low demand, supplychain disruptions etc. Taxpayers not routinely selected for scrutiny have been picked due to sudden losses/reduced profitability, based on risk assessment parameters.

Issues that may arise during TP audit

1. Acceptability of economicadjustments considering pandemic was a global issue also impacting comparables
2. Reasons for reduced margins/losses incurred by limited risk entities & also in industries which were able to function remotely
3. Inclusion of loss making comparables
4. Increased impact of overdue receivables because of cash crunch

Taxpayers may have performed economic adjustments in TP document to account for extraordinary circumstances/expenses & these would need to be defended before TPO. OECD released guidance on TP implications of COVID, that recognises the need for performing economic adjustments in the comparability analysis (Guidance also focuses on losses & allocation of COVID specific costs, impact of government grants on ALP etc).

One need to be aware that even in APA cases, during negotiation for limited risk entities, very minimal reduction in targeted outcome was offered for impacted years. The rates prescribed under Safe Harbour rules also had remained unchanged. However, the position tax authorities would take on granting of COVID related adjustments is awaited.

Examples of documentation to be maintained/approaches to substantiate controlled transactions:

1. Evidence of third party (arm’s length) behaviour in such circumstances & whether there was renegotiation of prices
2. Impact on the Group as a whole including cost cutting measures adopted across locations
3. Determine impact of the pandemic by comparing actual vs budgeted results using variance analysis
4. OECD recommended statistical methods such as regression analysis to demonstrate ALP (Learnings from earlier recession – 2009). Alternatively, BreakEven Point analysis can be adopted. For details on BEP analysis, refer below Taxsutra article
5. Analysis of change in sales volumes and capacity utilisation pre & post COVID
6. Carving out abnormal costs (factory shutdown, PPE equipment cost etc). Proof of same – mention in annual report, company website etc
7. Other adjustments (Forex, Customs, Working capital, Capacity utilisation) to be reviewed in light of COVID.

Impact on PLI of comparables will have to be considered, where COVID adjustments are claimed. Furnishing of robust documentation with genuine reasoning & evidence is key to defending the losses incurred.

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Safe Harbour – key consideration

OECD in its transferpricing (TP) guidelines (TPG) has stated Safe Harbour (SHR) as an administrative procedure to aid minimising TP disputes. SHR was introduced in India in 2013. Covered transactions included software development services, ITeS services, KPO services, interest income, corporate guarantee, contract R&D services.

However, few taxpayers opted under SHR due to high arm’s length price (ALP) prescribed therein. Later, in 2017 the CBDT amended the SHR to reduce the ALP for service transactions and brought lowvalue adding intragroup services in its ambit. From then on, every year, the same ALP gets extended for subsequent years as well. Recently, the CBDT Notification extended the same to FY 2022-23 as well.

Key aspects one has to bear in mind:

1. Intragroup services (IGS)- SHR covers typical management charges payments by Indian subsidiaries. Like in previous years, recently completed audit season witnessed TPOs challenging IGS payments by way of complete/partial disallowance. As most of them obtain very minimal or no relief at the first levels of audit, opting under SHR can provide definite respite from providing evidences for the need/benefit test. Ofcourse the documentation required under SHR – CA certificate on basis, threshold limits, nature of services, mark-up needs to be adhered to.Not many MNEs opt under SHR only for IGS as they are sceptical that it might result in the taxpayer being selected under regular TP scrutiny for other transactions. However, in our experience we understand opting under SHR is usually independent from being selected for transfer pricing audit for other transactions.
2. Intragroup Loans – SHR provides ALP based on LIBOR + Rates when LIBOR is being phased out, it is expected that the CBDT will notify changes in the basis of pricing for the financial transaction. As USD LIBOR rates were available for FY 2022-23, notifications can be expected for FY 2023-24 onwards may be within the year itself.
3. IT/ITES transactions – Captive service providers engaged in covered transactions and within the SHR threshold limits can consider opting for SHR as it is time bound and cost efficient while evaluating dispute resolution programmes. Further, the effective differences in the overall outcomes between the APA and SHR for routine IT/ITES services has been blurring in the recent times, considering costs and time involved in concluding APA for companies with turnover less than 200 Crs

Taxpayers opting under SHR are subject to audit by transfer pricing officer to examine if taxpayer is rightly eligible under SHR. Also, the process laid down for this audit under SHR is largely objective and slightly easier to obtain consensus from the tax authorities on the arm’s length nature of the covered transactions. Therefore, SHR can be a pragmatic approach in dispute resolution for eligible taxpayers.

OECD issues public consultation on Amount B of Pillar One

Following the consultation document issued in December 2022, the OECD / G20 InclusiveFramework (IF) issued public consultation document on AmountB -PillarOne on 17 July 2023.

The document provides scoping framework for baseline distribution activities i.e., qualifying transactions and scoping criteria, as well as simplified and streamlined pricing approach (‘approach’).

No monetary thresholds have been prescribed for applicability of Amount B and hence can be applicable for all MNEs, as against Amount A of Pillar One and Pillar Two. Clarity is awaited on whether Amount B will be a SafeHarbour or will be prescribed.

VSTN’s alert summarises the key aspects of Amount B including the qualifying transactions, scoping criteria – In-scope and Out-scope, pricing approach and adjustments for geographic differences and other aspects such as documentation, transition issues and tax certainty.

A one-pager process flow chart presented diagrammatically, is appended to the Alert for quick overview of the Amount B.

All business keeping the above aspects in mind may need to evaluate the functional activities of their distribution entities as to whether they would fall under qualifying transactions, in scope , whether there is a business need to realign transactions, financial impact with/ without Amount B and documentation of various parameters which are required and ensure alignment of three tier documentation – local file, master file and Country-by-country reporting.

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GST on Free of cost Corporate Guarantee (CG)– TP implications

Recently, DGGI has issued demand notices to various local corporate houses and MNCs in connection with CG given on behalf of their subsidiaries. Parent companies give guarantees to banks for their subsidiaries, free of charge.  Issue raised – under GST, supply of services between related parties for furtherance of business is subject to tax even if made without any consideration.

In this context, taxpayer must be aware of possible Transfer pricing consequences of these events before taking a position under GST.

Below TP implications may arise in specific scenarios:

A.     Decides to pay GST

1. Scenario 1 (No CG fee charged by Indian HQ to Domestic & foreign AEs) – The value determined for GST purposes for CG granted to Domestic AEs could be adopted by the Transfer Pricing Officer (TPO) as the ALP in cases of CG granted by the same Indian HQ to foreign subsidiaries
2. Scenario 2 (CG fee charged by Indian HQ to foreign subsidiaries but not to Domestic AEs) – The value of CG paid by foreign entity or ALP determined by the TPO for such fee may be used by GST authorities as value of CG granted to Domestic AE. One may need to account for  differences in credit rating of Domestic AEs and also country adjustment undertaken, if any before adopting the same fee.
3. Scenario 3 ( CG is granted by Foreign HQ to Indian subsidiaries) – For GST Purpose, under the reverse charge mechanism, domestic subsidiary decide to compute a notional value for GST payment. Where there is no consideration for the service, there may be no TP implications as the TPO would not proceed to determine the ALP for CG fee since this would result in reduction of taxable income for the Indian entity. However one may need to also evaluate if there would be any issue on WHT which would be raised

B.     Decides it is not subject to GST

In TP litigation, appellate forums have not accepted taxpayer claims that CG is not a service and that receipt of CG fees is not required, unless proved that it is a shareholder activity with robust evidence.

Quantification- Since there was no consideration for the CG granted, a notional value needs to be determined for GST. It is important that an ad-hoc number is not adopted and a robust benchmarking analysis is followed for arriving at the CG fees.

The value of guarantee determined for GST purposes could be the market value/ALP, which may be derived using TP BM principles. Multiple approaches could be adopted to arrive at the ALP of CG fees. (link to our previous post in comments).

In the past, similar demand notices had also been sent in connection with usage of Corporate brand names ,logos, without consideration.  The above TP principles would equally apply and a brand BM Analysis can support the same.

LIBOR to ARR – TransferPricing (TP) perspective

LIBOR was phased out in December 2021, with final USD based LIBOR ceasing by 30 June 2023, following which financial instruments have to be priced on alternate reference rate (ARR). RBI on 12 May 2023 has asked banks to completely transition away from LIBOR w.e.f. 01 July 2023.

CentralBanks have identified ARR for various currencies such as SOFR for USD, SONIA for GBP, €STR for Euro. While LIBOR is forward looking term unsecured reference rates and includes credit risk, ARR are overnightrates, based on actual transactions in overnight market and is a riskfree rate. Also, LIBOR was available in different currencies and ARR differs with currency. Hence, transition from LIBOR to ARR has various considerations. Further, MNEs would have transitioned to ARR primarily from financial management perspective, based on Group’s financial position, and needs evaluation from a TP angle as well.

Current intercompany agreements for financial transactions have to be reviewed for clauses covering unavailability of reference rates (LIBOR) (fallback provisions), whether alternate reference rate can be mutually agreed or the agreement would be inoperable. Transition can be vide an addendum to the main agreement. It needs to be carefully seen that the transition should not result in it being treated as a new loan arrangement, resulting in other TP implications.

While transition, several factors impact the spread over-and-above the ARR. LIBOR includes credit risk, which has to be quantified and added to ARR. Adjustments, such as specific country risk, made while pricing using LIBOR have to be revisited, since ARR are risk-free rates and is provided by respective central banks.

Difference in approach i.e., LIBOR is forward looking and ARR’s are backward looking is also a key factor during transition and would have to be factored while arriving at the ALP interest based on ARR.

Where intercompany agreements are based on fixed interest rates, one has to revisit the terms, including if payment of interest at a fixed rate is itself at arm’s length. Revision to floating rates based on ARR can also be considered depending on if there are any efficiencies, at the Group level.

Guarantee fees (CG fees) to be revisited, if yield approach is used to arrive at arm’s length CG fees. In the yield approach delta between interest rates of unguaranteed and guaranteed loans (based on LIBOR rates) is the CG fees. Other TP areas referencing LIBOR include Advance Pricing Agreement (APA), Safe Harbour Rules. Transition impact on limitation on interest deduction (94B) to be seen.

Therefore, it’s imperative that a detailed analysis is undertaken to revisit the existing financial transactions from a TP perspective.

UAE Corporate Tax Update

The UAE Ministry of Finance issued three documents on Corporate Tax, last week. The Transfer Pricing aspects arising from these decisions are summarised below:

1. Cabinet Decision 55 of 2023 – Qualifying Free Zone Person (QFZ) and its domestic / foreign PE shall be treated as separate and independent persons that are related parties, and accordingly income to be attributed to such Pes. Hence, we opine arm’s length principle should be adhered for transactions between QFZ and its domestic / foreign PEs.Core activities of QFZ should be undertaken in a FreeZone with adequate substance in form of adequate assets, employees and  adequate operating expenses. QFZ can outsource activities to related party or third party in Free Zone. But, QFZ should adequately supervise the outsourced activities. These substance requirements are similar to Economic Substance Regulations prescribed earlier.
2. Ministerial decision 139 of 2023 –Qualifying activities of QFZ also includes headquarter services and treasury & financing activities to related parties. Thereby extending the benefit for business Groups to have regional HQ companies in UAE and be tax efficient.
3. Ministerial decision 134 of 2023 – Adjustments to be made by transferee while computing taxable income while transfer of asset or liability with related parties.
   • Where consideration (Net Book Value or NBV) (say 150) paid by transferee is more than market value (MV) (i.e., Arm’s Length Price) (say 100):
     • in cases other than upon realization, any depreciation / amortization or change in value of asset or liability relating to difference between the NBV and MV (i.e., 50) to be excluded.
     • on realization of asset/liability, difference between NBV and MV (i.e., 50) to be included.
4. Where consideration (say 50) paid by transferee is less than MV (say 100):
   • in case other than upon realization, any change in value of asset or liability relating to difference between the MV and NBV (i.e., 50) to be excluded.
   • on realization of asset or liability, any gain to the extent of difference between MV and NBV (i.e., 50) to be reduced.

Adjustments in A) i) and ii) shall not apply where:

– NBV becomes equal or less than MV in scenario A, or

– transferee opts to recognise the difference between NBV and MV as income

Adjustments in B) i) and ii) shall not apply.

– Where NBV becomes equal to greater than MV in scenario B above,

Adherence with conditions prescribed for QFZ from time to time is critical, as failure to meet such conditions would result in entity ceasing to be QFZ for the said tax period and following 4 tax periods. Hence transfer pricing compliance between QFZ and related parties is crucial.

MALAYSIA – NEW TP AND APA RULES INTRODUCED

Malaysia has replaced its existing Transfer Pricing rules with the New TP  Rules, and this would be effective for the YA 2023 onwards. Additionally, a minimum TP documentation (TPD) template has been published for persons who do not meet the thresholds prescribed for detailed TPD. The Income Tax (APA) Rules 2023 have also been issued which replace the 2012 Rules. In the attached alert we have summarized the key aspects in relation to the new TP & APA Rules.

1. Arm’s length range (ALR) – The ALR has been defined as the 37.5th percentile to 62.5th percentile of the comparable dataset, with median being the mid-point of the ALR.
2. Usage of data points – Use of multiple year data is permitted only to assist in the selection of comparables and not for the purpose of ALR computation.
3. Adjustments by Director General (DG) – If the controlled transaction’s price is not within the ALR, the DG may adjust the price to the median. Even if the controlled transaction’s price is within the ALR, the DG can adjust the price to the median or a higher point within the ALR under specific circumstances.
4. TP documentation – The TPD is quite extensive and must be prepared on a contemporaneous basis prior to the due date of filing tax return along with the date of completion, and furnished within 14 days of request. Contents from the existing TP guidelines along with additional information have been incorporated into the Rules.
5. Intangibles – In line with the OECD guidelines, it has been emphasized that the owner of IP is not entitled to any income arising from the IP if he neither performs the functions nor controls the functions or risks related to DEMPE of the IP.
6. Offsetting adjustment provision removed – The provision relating to offsetting adjustments on request has been removed and this could affect domestic related party transactions.
7. Bilateral/Multilateral APA – Taxpayers can opt only for a Bilateral or Multilateral APA if the covered transaction is with a country where a DTAA exists, even in case of a PE. In other cases, only a Unilateral APA is possible.

Considering the emphasis on contemporaneous documentation in the Rules, it is essential taxpayers are well prepared to maintain TPD within the prescribed timeline. The APA rules have been streamlined and taxpayers can consider this option to achieve tax certainty.

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