EU Transfer Pricing

BEFIT- Proposal on Transfer Pricing

September 2023

Summary

On September 12, 2023, the EU commission unveiled the much awaited proposal on “Business in Europe: Framework for Income Taxation” (“BEFIT/ BEFIT corporate tax proposal”), which lays down a common set of rules for computing the tax base for EU group companies (“BEFIT Group”), having a combined annual turnover exceeding EUR 750 million and where the ultimate parent entity holds at least 75% of the ownership rights or of the rights giving entitlement to profit.

As part of the BEFIT, the commission issued a second separate proposal on Transfer Pricing (“TP Proposal”/”Proposal”) to harmonise the Transfer Pricing regulations across the EU states, which is also consistent with the implementation of OECD/G20 Inclusive framework Two Pillar Solution and is applicable to all MNE Groups operating in EU.

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.

This article highlights the key facets of the TP Proposal and BEFIT Corporate Tax proposal in relation to Transfer Pricing.

Background

The complexity of the transfer pricing rules and their varied interpretation by each of the EU Member states led to:

• high risk of double taxation and over taxation for businesses with cross border transactions,
• tax uncertainties due to different views adopted by each EU member state on a specific transaction;
• profit shifting and tax avoidance; and
• high legal and compliance cost.

These tax barriers posed as serious impediments to businesses operating in the EU region hampering the competitiveness and growth of the Single Market.

Thus it became crucial to address the above deterrents in light of the ambitious reforms in international corporate taxation over the years. With this objective in mind the EU commission issued the BEFIT Transfer Pricing proposal which:

• incorporates the arm’s length principle into the Union Law;
• harmonises the key transfer pricing rules;
• clarifies the role and status of the OECD TP guidelines; and
• creates the possibility to establish, within the Union a common binding rule on transfer pricing subjects within the OECD TP framework.

Scope of the TP Proposal

The TP Proposal is divided into 3 segments encompassing:

• Part 1: Arm’s length Principle and consequences of applying the principle
• Part 2: Core elements relevant for applying the arm’s length principle
• Part 3: Mechanism for establishing further common rules for simplification and tax certainty

The TP Proposal is designed to be in consensus with existing EU policies like anti-tax avoidance directive (ATAD), directive on administrative cooperation (DAC) and in particular DAC3 and DAC6 which are of particular relevance due to their connection with TP.

It is imperative to note here that the scope of the TP Proposal differs from that of the BEFIT proposal to the extent that TP Proposal is applicable to all MNE groups operating in the EU i.e. it applies to a broader scope of entities as compared to BEFIT.

TP Proposal

The TP Proposal is by far in line with the OECD TP guidelines with regard to the determination of the related party transactions, TP methods including the selection and application of the methods; determination of arm’s length price/quartile range. The key aspects for consideration are provided below:

1. Harmonization of TP Regulations and Documentation requirements

Currently the transfer pricing rules are not harmonized by legislative acts at the Union level, leading to disparity amongst Member States in interpreting various terminologies like for e.g. definition of AE, notion of “control” etc. This also acts as an attributing factor to have a single unified regulation and to curb the current issues in transfer pricing arena faced by EU nations.

The key reform of this proposal is the harmonisation of the Transfer Pricing Regulations and documentation requirements across the EU states which is likely to bring down the compliance cost significantly for businesses apart from addressing the above mentioned deterrents to Transfer Pricing in EU. The Proposal further empowers the commission to define common templates, setting linguistic requirements, defining the type of taxpayer to abide by these templates and the timeframes to be covered with respect to the preparation of the transfer pricing documentation.

The proposal further lays down that the Member states shall be governed by the OECD guidelines as may be updated from time to time.

2. Corresponding, Compensating and Downward Adjustments

Corresponding adjustments are made in response to a primary adjustment and aim at eliminating any double taxation which may occur as a result of a primary adjustment. In fact, when a tax administration increases a company’s taxable profits in one tax jurisdiction (by means of a primary adjustment), a corresponding adjustment may be necessary in order to lower the tax liability of that company in the second tax jurisdiction involved. The proposal sets forth comprehensive rules relating to corresponding adjustments with a view to eliminating any double taxation arising as a result of primary adjustment.

Voluntary adjustments made by the taxpayer before the company’s tax return is filed are known as compensating adjustments. In respect of compensating adjustments, the proposal seeks to establish a common approach within the Union by laying down the conditions under which Member States should recognise a compensating adjustment. This provision is to be interpreted in conjunction with the Commission’s 2013 EU Joint Transfer Pricing Forum Report on compensating adjustments. The said directives are bound to reduce litigations and also address the burden of double taxation arising out of compensating adjustments.

The proposal also authorises the Member states to perform a downward adjustment, in the absence of primary adjustment subject to certain conditions.

Further it also introduces a fast track mechanism to facilitate Member States to grant corresponding adjustments within 180 days, particularly in cases where primary adjustment is well founded or in case of joint audits.

Thus the proposal aims to swiftly resolve and addresses issues of double taxation and double non taxation, thereby promising tax certainty to businesses, promoting a competitive growth environment.

BEFIT Proposal (Corporate Tax)

While the TP proposal is substantive, it is pertinent to note that the BEFIT proposal on corporate tax should also be read and applied in conjunction with the TP Proposal. The BEFIT proposal also lays down certain regulations aimed at simplifying transfer pricing compliance procedures for certain activities.

Introduction of Traffic Light System for low risk activities under BEFIT

The transactions between BEFIT group and associated entities outside the BEFIT group will continue to be governed by the arm’s length principle. However, the BEFIT proposal provides for a simplified risk assessment framework, that is applicable to low-risk activities as defined in Article 50 i.e. low risk distributors and contract manufacturers who do not hold any intellectual property rights or any risk related to the products.

In respect of these activities, BEFIT suggests using “Public Benchmarks” as profit markers set at the Union level. The risk zone shall be determined using the interquartile range of the 5-year average profit performance of independent entities resulting from the public benchmarks. It requires the Member states to follow the below risk framework:

Accordingly, if the profit performance of a low-risk distributor or contract manufacturer is below the 40th percentile of the results in the public benchmark, its transactions will be assessed as ‘high-risk’. This way, the transactions will be categorised into three risk zones (low/medium/high), facilitating the Member State tax administrations to focus their efforts on the high-risk zones.

This feature of BEFIT focuses on simplifying compliance with transfer pricing and does not interfere with the substantive rules that determine whether a certain transaction has been priced at arm’s length, which is laid down in the TP Proposal.

Implementation Timeline

Once the proposal is approved by the council, it shall come into force with effect from January 01, 2026. The application of this Directive will then be examined and evaluated by the Commission every 5 years.

Conclusion

The EU Commission’s proposal on TP Regulations is likely to place the EU Member states in par with the international best practices, promising an environment of tax certainty coupled with elimination of critical tax burdens like double taxation and double non taxation. Harmonisation of Transfer Pricing regulations across the EU member states offers promising benefits in terms of reduction in compliance and litigation costs which is likely to be an impetus for achieving sustainable growth and a competitive single market.

Further synchronizing the TP documentation requirements across EU states is likely to address the drawbacks in the current TP system.

Likewise MNE’s will need to proactively align their businesses and strategies to meet the requirements of the new directives and be best equipped to meet the challenges likely to arise in the transitional phase of implementation.

As businesses expand across borders, navigating complex transfer pricing regulations becomes critical. At VSTN Consultancy, a global transfer pricing firm, we specialize in helping companies stay compliant and competitive across key markets including:

India | UAE | USA | KSA | Dubai | Asia Pacific | Europe | Africa | North America

Whether you’re preparing for benchmarking intercompany transactions, or developing robust TP documentation, our team is here to support your international strategy and Compliance.

Contact us today to explore how we can partner with you to optimize your global transfer pricing approach.

#TransferPricing #TransferPricingFirm#VSTNConsultancy #TaxCompliance #IndiaUAEUSA

#TPExperts#TransferPricingExperts#GlobalTransferPricingFirm

UAE Corporate Tax

Recent Notifications & Updates

September 2023

Introduction

The United Arab Emirates (“UAE”) Federal Tax Authority and Ministry of Finance (MoF) has recently published:

1. A Comprehensive Corporate Tax Guide on the Small Business Relief (CTGSBRI)
2. Corporate Tax Guide on Registration of Juridical Person (CTGRJP1)
3. Corporate Tax – General Guide (CTGGCT1)
4. Cabinet Decision No. (75) of 2023 (“CD 75”)—outlining the administrative penalties for violations of the UAE corporate tax law

This alert is intended to serve as a synopsis of the aforesaid notifications.

1. Small Business Relief

Overview

Article 21 of the Federal Decree-Law No.47 of 2022 read with Ministerial Decision No.73 of 2023, allows Small Business Relief (SBR) to eligible businesses to treat their taxable income as “zero” for a specific tax period subject to meeting certain prescribed conditions i.e. qualifying small businesses will be completely exempt from payment of corporate taxes during the eligible tax period.

The Federal Tax Authority recently published a Corporate Tax Guide (CTG) on Small Business Relief with an intent to provide more clarity on application of Corporate Tax laws to small businesses, with a disclaimer that the CTG should not be construed as a legal or tax advice.

A summary of the CTG is provided here below.

Applicability

• Revenue¹ Threshold: To qualify as a small business, a resident² taxable person’s revenue must be below or equal to AED 3,000,000 for the relevant tax year and all previous tax periods³. The Taxpayer will not be eligible for SBR if in any tax period the revenue exceeds AED 3,000,000⁴.
• Even if the revenue threshold is met, SBR is not available to:
  • Constituent entity of a Multinational Group⁵
  • Qualifying Free Zone entity
  • Artificial Separation⁶
  • Permanent Establishment of non-resident persons. However, if the non-resident is based in a Country with which UAE has a Tax Treaty which provides for non-discrimination in respect of its PE, then such PE would be eligible to opt for SBR subject to prescribed conditions.

What is SBR?

Eligible Taxpayers who elect for SBR will enjoy the following benefits:

¹ Revenue refers to all of the income that a business earns even if it’s from one-off transaction and includes exempt income and non cash receipts valued at market price.

² Resident means a Taxable Person specified in Article 11(3) of the Corporate Tax Law

³ The first Tax Period in relation to Corporate Tax commences on or after 1 June 2023. SBR will be available for tax period on or after 1 June 2023 to tax period on or before 31 December 2026.

⁴ Article 2(3) of Ministerial Decision No. 73 of 2023.

⁵ MNEs are groups of companies that operate in more than one country and that have a total consolidated group revenue of more than AED 3.15 billion and are required to prepare a Country-by-Country Report under the UAE’s Country-by-Country Reporting legislation.

⁶ SBR will also not be available where a Person separates the business into more than one entity in order to ensure that the revenue of each entity meets the revenue threshold for Small Business Relief. Factors to determine artificial separation is provided in CTG.

⁷ Businesses are required to however comply with arm’s length principle

Eligible Taxable Persons can elect for Small Business Relief in their Tax Return⁸. Once the election has been made, they will be able to complete a simplified Tax Return and benefit from the relief.

SBR and Corporate Tax reliefs

Business that elect for SBR are excluded from applying certain tax reliefs and rules including:-

• To accrue and utilise tax losses for the relevant tax period (unutilised tax losses incurred during prior tax periods before availing SBR is allowed to be carried forward to subsequent years in which SBR is not availed);
• To accrue and utilise excess interest expenditure for the relevant tax period;
• To apply reliefs for transfers within a Qualifying Group or for Business restructuring transactions.
• The rules relating to exempt income does not apply to businesses that have elected for SBR, implying that all income, even if not taxable, must be included in calculating revenue for SBR purposes.
• Under SBR, since taxable income is considered as zero, the deductible expenditure rules does not apply to businesses electing for SBR.

2. Registration of Juridical Person

Overview

The Federal Decree-Law No.47 of 2022 on the Taxation of Corporations and Businesses (Corporate Tax Law) is the legislative basis for imposing federal tax on corporations and business profits in UAE. The provisions relating to Corporate Tax Laws are applicable from tax period commencing on or after 1 June 2023.

To assist and guide the Taxable persons with the corporate tax registration requirements, the Federal Tax Authority has recently issued a corporate tax guide on registration of juridical person elaborating on the corporate tax registration process, determining whether there is a need for registration for corporate tax and corporate tax deregistration process.

The key aspects of the guide are brought out below.

⁸ SBR is available to the taxpayer only if elected in the tax return at the time of filing the same.

Registration for Corporate Tax

The Corporate tax regime in UAE is a self-assessment regime, meaning the responsibility to assess and determine if corporate tax is applicable and whether any corporate tax obligations are required to be met lies in the hands of the taxable person. Persons who determine that they fall within the purview of corporate tax are required to register for corporate tax to fulfill their obligations of filing tax return and payment of tax due. The table below lists the taxable persons and those exempt from corporate tax registration.

Overview of Corporate Tax Registration requirements

A person who is registered for VAT and Excise Tax will still be required to register for corporate tax if they fall within the scope of the corporate tax regime. Similarly Tax agents assisting tax payers in meeting their corporate tax obligations must get themselves listed with FTA as Tax agents for corporate tax purposes.

Registration Process

• An application to register for Corporate Tax can be made on the EmaraTax portal. A Person who is already registered for VAT or Excise Tax can use their existing login details.
• A Person who wishes to register for Corporate Tax must submit a registration application along with the relevant supporting documentation to the FTA. The FTA will review each application and approve or reject it. Once an application is approved, the FTA will issue the Person with a TRN.

• FTA shall respond within 20 days from the date of receipt of completed registration form. Where additional information is called for, FTA shall respond within 20 days from the date of receipt of such additional information. Where the additional information is not submitted within the specified timeframe, FTA shall reject the application and a fresh application has to be made in such cases.

Documents required for registration

The FTA lists down key documents that a taxable persons should submit while applying for corporate tax registration being copy of Trade License/ Business License, passport of the shareholder (owns>=25% shares), passport, Emirates ID, proof of authorization of authorized signatory.

In addition to the above documentation, FTA can request other information to approve or reject the application.

Obligation on registration

Once a Person has registered for Corporate Tax, they will be subject to a number of administrative Corporate Tax obligations which include:

• Filing a Corporate Tax Return and paying any Corporate Tax due within 9 months of the end of their Tax Period;
• Retaining all records and documents which support their tax position for a period of 7 years following the end of the Tax Period to which they relate; and
• Ensuring that all of their registration details are up to date and FTA is informed of any changes within 20 business days, in order for administrative penalties not to be imposed.

Exempt income & Registration

A taxable person who receives only exempt income, which is not subject to any corporate tax liability would however be required to get registered for corporate tax and meet its corporate tax obligation.

The types of income, and related expenditure, which are exempt from Corporate Tax include:

• Dividends and other profit distributions received from UAE resident juridical persons, participating interest in a foreign juridical person;
• Other income from a Participating Interest as specified in Article 23 of the Corporate Tax Law;
• Income received from a Foreign Permanent Establishment where the election has been made to not take into account its income from Corporate Tax; and
• Income earned by a Non-Resident Person from operating aircrafts or ships used in international transportation, on meeting certain conditions.

Resident Juridical Person

A juridical person is an entity established/ recognised under the laws and regulations of the UAE, or under the laws of a foreign jurisdiction, that has a legal personality separate from its founders, owners and directors. A resident juridical persons include:-

• LLCs, public / private joint stock companies incorporated in the UAE
• Foreign entities that are effectively managed¹⁰ and controlled in the UAE
• Branches of UAE companies’ a branch of resident person is regarded as the same taxable person and hence will not be able to register for corporate tax individually. Head office must register for corporate tax on behalf of all UAE branches. This is also applicable for Free Zone branches of mainland UAE juridical persons and also for mainland branches of Free Zones Persons.
• Resident juridical persons eligible for small business relief are still required to get themselves registered for corporate tax. However they are subject to Zero tax and can file a simplified tax return.

Powers of FTA

FTA is bestowed with discretionary powers to register a person for corporate tax, if based on information available to it, it believes such person is a taxable person who ought to have registered for corporate tax purposes. Such person has the right to appeal against the decision of the FTA at the time of tax assessments.

Corporate Tax Deregistration

Where Juridical Person ceases to carry on business or business activity due dissolution, liquidation or other circumstances, such person should apply for deregistration to the FTA.

Tax deregistration application must be filed within 3 months from the date on which the business ceases/liquidation/dissolved

The date of cessation of business will be date on which such deregistration application is approved by the FTA. Approval is subject to meeting all obligations relating to filing of all tax returns, payment of tax due and administrative penalties.

3. Corporate Tax- General Guide

The Federal Tax Authority has very recently published a comprehensive “Corporate Tax- General guide” with an aim to making the provisions of the CTL more understandable to the taxpayers.

The guide provides :

• An overview of the corporate tax rules and procedures, including corporate tax compliance requirements with respect to determination of tax base, computation of tax, filing of tax returns etc.; and
• a comprehensive FAQ

The said guide is divided into chapters with initial few chapters addressing questions as to where to seek further assistance in case of matters that are not dealt with in the guide. The subsequent chapters cover the provision of the CTL including the administrative process.

4. Administrative Penalty- CD 75

Cabinet Decision No. 75 of 2023 was issued on administrative penalties for violation of provision of the Corporate Tax laws. The CD 75 quantifies the penalties for various violations/ non- compliances for person carrying on business/ business activity or having a tax obligation under the corporate tax law. CD 75 will come into effect from August 1, 2023. The list of violations and the penalty as per CD 75 is provided in the below table.

As businesses expand across borders, navigating complex transfer pricing regulations becomes critical. At VSTN Consultancy, a global transfer pricing firm, we specialize in helping companies stay compliant and competitive across key markets including:

India | UAE | USA | KSA | Dubai | Asia Pacific | Europe | Africa | North America

Whether you’re preparing for benchmarking intercompany transactions, or developing robust TP documentation, our team is here to support your international strategy and Compliance.

Contact us today to explore how we can partner with you to optimize your global transfer pricing approach.

#TransferPricing #TransferPricingFirm#VSTNConsultancy #TaxCompliance #IndiaUAEUSA

#TPExperts#TransferPricingExperts#GlobalTransferPricingFirm

CBDT issues Annual Report on APA

For FY 2019-20 to 2021-22
and FY 2022-23

September 2023

Summary

The Central Board of Direct Taxes (CBDT) recently has issued the fourth¹ and fifth² Annual Report, in the month of August and September respectively, on the Advance Pricing Agreement (“APA”) Programme for FY 2019-20 to FY 2021-22 and FY 2022-23. The APA Report captures data and various statistics of the APA programme ending FY 2021-22 and FY 2022-23.

The APA annual reports includes data on APA applications filed, status of APAs, concluded APAs, nature of transactions covered in APA and location of associated enterprises (AE). APAs play a vital role in ease of doing business in India, through providing tax certainty for transfer pricing. As at FY 2022-23, APA is said to have brought certainty for income around INR 19,000 crores. The data is presented across Unilateral APA (UAPA) and Bilateral APA (BAPA). The Annual report also touches upon the key statistics on Mutual Agreement Procedure (MAP). The closing inventory of MAP cases for 2022 stood at 697 cases and continued the trend of decrease in cases from 2020.

FY 2021-22 marks the conclusion of 10 years of the APA programme and is a milestone reached in the arena of dispute resolution. The latest APA Annual report shows increase in the pace of conclusion of APAs as well as maturity of the APA programme. The key aspects of the APA annual report are captured in the below sections.

APA – Applications

The APA programme has been maturing over the years, witnessed through the change in the UAPA: BAPA ratio. The number of BAPA applications has almost been steady over the years. Though there were reduction in the applications during FY 2019-20 and FY 2021-22, applications for FY 2022-23 were one of the highest. Annual report attributes reduction to two major reasons. One, on account of reduction of cases for transfer pricing audits due to adoption of risk-based audit approach. Two, uncertainty to businesses due to COVID pandemic. Below chart summarizes the applications over the first decade of the APA programme.

APA Applications

The number of BAPA applications have reached the highest since the commencement of the APA programme. This, along with reducing UAPA:BAPA ratio implies a shift in taxpayer’s mindset towards adopting a wholistic dispute resolution by way of BAPA.

APA Conclusions

There has been an increase at the pace at which APAs are being concluded. This can be seen through reduction in the APA average inventory over the last three annual reports (viz., FY 2018-19, FY 2021-22 and FY 2022-23). Though there has been a reduction in the APA applications in the two years, the reduction in APA inventory is organic due to an increase in the number of APA cases concluded. Apart from the summary data provided in the Annual report, we have also computed Average inventory and Average APA signed per year³ in the below table:

The pending inventory of APA applications filed in the respective financial year is computed from the latest annual report and is summarized in the below table. It reflects the tax authority’s focus on completion of earlier APA applications.

The number of APAs signed in each financial year is plotted in the below chart. There was a reduction in number of APAs concluded in FY 2020-21 due to the COVID pandemic, but there has been strong rebound in number of APAs concluded from FY 2021-22 with record conclusions in FY 2022-23. During the pandemic period, adaptive measure such as virtual discussions and remote signing protocols are said to have aided in sign-off / conclusion of APAs.

Unilateral APA (UAPA)

UAPA has witnessed an increase in the pace of sign-off. The average inventory has reduced from 66% as at FY 2018-19, 53% as at FY 2021-22 to 43% as at FY 2022-23. Similarly, the average number of APAs concluded per year has increased from 34 as per Annual report of FY 2018-19, to 36 as per annual report of FY 2019-20 to 2021-22, to 38 as per annual report FY 2022-23 – implying organic reduction in inventory. Analysis of the mean, median and mode of time taken to conclude UAPA provides insights on closure of UAPA applications. The combined reading of increase in the pace of conclusions and increase in the mean and median of conclusions also indicate that there has been focus on clearing of APA applications filed in the initial years.

For FY 2018-19, majority of the APAs signed pertain to service sector approx. 50%, followed by manufacturing & trading. Similarly, for the period from FY 2019-20 to FY 2021-22, 63% of APAs signed pertained to service sector, followed by manufacturing & trading. Major industries for which APA were concluded include IT and Pharmaceuticals/Chemicals.

The below table illustrates the top transactions covered in descending order:

Major jurisdictions in which AEs were located for the covered transactions were United States, United Kingdom and Singapore in FY 2018-19 and FY 2019-20 to FY 2021-22. During FY 2022-23, major jurisdictions were United States, China and United Kingdom. The transfer pricing methods used were majorly Transactional net margin method (TNMM) and other method for FY 2018-19, FY 2019-20 to FY 2021-22 as well as FY 2022-23.

Bilateral APA (BAPA)

The APA programme has been maturing towards complete dispute resolution, which is witnessed through consistent BAPA applications. This is furthered by increased momentum in signing BAPA. Average BAPA inventory reduced from 81% as at FY 2018-19, 76% as at FY 2021-22 and 69% as at FY 2022-23. This reduction was also organic due to increase in average BAPA signed per year. As per the FY 2018-19 Annual report the average BAPA concluded was 4 per year, as per annual report for FY 2019-20 to 2021-22 it was 6 per year and as per FY 2022-23 Annual report it was 9 per year. The mean, median and mode of time taken to conclude BAPA too has increased, implying increase focus on conclusion of long pending applications.

Service was the major sector in which BAPA was concluded during FY 2018-19, followed by manufacturing. In FY 2019-20 to FY 2021-22 and FY 2022-23, service was the major sector followed by manufacturing & trading. Major industries for which APA were concluded include IT and Pharmaceuticals/Chemicals.

Major covered transactions in FY 2019-20 to FY 2021-22 were provision of SWD services, provision of ITeS, purchase of capital goods, reimbursement / recovery of expenses and intra-group services. For FY 2022-23, major transactions were reimbursement/recovery of expenses, provision of ITeS, trade receivable/payable and provision of SWD services.

United States, United Kingdom, Japan and Switzerland were the major jurisdictions with which BAPA applications were filed and BAPA were concluded during FY 2019-20 to FY 2021-22 and FY 2022-23. The transfer pricing method used most to conclude BAPA was TNMM followed by profit split method (PSM) during FY 2018-19. For the period FY 2019-20 to FY 2021-22 and FY 2022-23, the most common method continued to be TNMM followed by the other method.

The annual report also noted that out of 96 BAPA signed (until FY 2022-23), 63 applicants had opted for renewal, implying the taxpayers had trust in the APA programme in obtaining tax certainty.

Conclusion and Key Takeaways

The APA programme has completed its first decade and has provided significant relief to taxpayers through dispute prevention. Despite the COVID pandemic, APA programme has shown resilience through faster conclusion of both UAPA and BAPA, displaying CBDT commitment towards tax certainty. APA programme is maturing towards providing complete dispute resolution through steady inflow of BAPA applications as well as increased pace of conclusions.

With the goal of further reducing the turnaround time in conclusion of APA, one option could be to making available standard questionnaires and checklists in case of typical covered transactions to taxpayers during the initial phase of the APA. This can be through inclusion of questionnaire and checklist during the application or requirement to file within a stipulated time-frame post filing of the APA application (such as 6/9 months window). Increase in staffing to fill vacancies in the APA programme can further lower the turnaround time in concluding APAs, that would be welcome by taxpayers at large and increase participation in the programme as well.

The Organisation for Economic Co-operation and Development (OECD) in January 2023 has issued APA statistics reporting framework, where Inclusive Framework countries will be sharing APA related statistics in a standardized format, that will be published in OECD’s website jurisdiction wise. Such disclosure can provide a region-wise benchmark on time-frame for conclusion and promote speedier conclusion in a healthy manner.

As businesses expand across borders, navigating complex transfer pricing regulations becomes critical. At VSTN Consultancy, a global transfer pricing firm, we specialize in helping companies stay compliant and competitive across key markets including:

India | UAE | USA | KSA | Dubai | Asia Pacific | Europe | Africa | North America

Whether you’re preparing for benchmarking intercompany transactions, or developing robust TP documentation, our team is here to support your international strategy and Compliance.

Contact us today to explore how we can partner with you to optimize your global transfer pricing approach.

#TransferPricing #TransferPricingFirm#VSTNConsultancy #TaxCompliance #IndiaUAEUSA

#TPExperts#TransferPricingExperts#GlobalTransferPricingFirm

Interplay between Statistics and Transfer Pricing

Arm’s length principle is the bedrock of Transfer Pricing (TP). The arm’s length principle requires taxpayers and tax administrations to evaluate uncontrolled transactions and business activities of independent enterprises and compare with transactions between related parties. This requires data, which is often voluminous, incomplete and difficult to obtain. The objective hence is to find a reasonable estimate of arm’s length outcome based on reliable information. TP is not an exact science and requires exercise of judgement in arriving at the arm’s length price^[1].

In order to ensure that these judgments are rational, various statistical techniques could be employed in TP. Statistical techniques have proven to be useful tools for estimates and are capable of providing greater degree of accuracy and reliability.

Currently, there is limited guidance in Indian TP regulations and in the Organisation for Economic Co-operation and Development (OECD) Guidelines on use of statistical techniques in TP. This article covers various aspects on application of statistics, permitted by the current regulations / OECD guidelines, methods adopted by tax authorities and interpretations by the courts. This article also provides various areas where statistics can be more effectively used in TP.

Reference to statistical techniques under the existing laws/Guidance

Guidance available on usage of statistics either in the TP guidelines issued by the OECD or other guidances, have focused only on the below aspects:

a) Computation of arm’s length price

The Indian TP regulations permit application of traditional statistical methods such as mean, median and percentiles in computing the arm’s length price / range^[2] OECD and UN TP Guidelines refer to statistical measures such inter-quartile range for arriving at the arm’s length range.

b) Financing Transactions

The OECD in its recent guidance on Financial Transactions states that concept of probability of default can be used to calculate approximate credit ratings in determining arm’s length price for guarantees^[3].

c) Comparability Analysis

Recently, OECD issued Guidance on Transfer Pricing implications of the COVID-19 pandemic that cites use of statistical methods such as regression, in support of comparability analysis during the ongoing crisis.^[4]

d) Singapore tax authority, IRAS

Singapore tax authority, IRAS has, in the context of the current pandemic, issued guidance on additional information to be included in TP documentation viz., statistical methods such as regression and variance analysis, to predict extent of variance of dependent variable based on independent variable (i.e., predicting the response of corporate profits to estimated GDP movements).

Practical Application

a) India

Indian TP regulations give limited guidance on use of statistics. Nevertheless, taxpayers and tax authorities have adopted certain statistical measures to defend their positions. Some commonly used measures are:

i. Box plot

Box-plot is a method for graphically depicting groups of numerical data through their quartiles. This method was used by taxpayers to identify and eliminate companies which are outliers, (i.e., earning very high margins) using interquartile range and therefore functionally non-comparable^[5].

ii. Regression analysis

In the case of an Indian subsidiary of a MNE Group, the Transfer Pricing officer (TPO) attributed a notional income to the taxpayer on account of compensation for deemed brand development services rendered by the taxpayer for its foreign parent company i.e., benefit accruing to the foreign parent company as a result of increased brand value due to sale of its branded products in India. TPO used statistical methods – non-linear regression using a third-degree polynomial fit to establish the correlation between market capitalization and the brand value, based on which an adjustment for brand building activity was made. However, the Tribunal ruled that brand building exercise is not an international transaction and hence computational limb was not considered / disregarded^[6].

III. Correlation

Tax Tribunals have ruled that there is no correlation (linear relationship) between turnover and profitability and hence companies cannot be rejected for high turnover. However, High Courts have ruled that high turnover companies cannot be comparable, though not based on arguments on correlation^[7].

IV. Probability of default

TPOs during recent audits have used probability-based models such as Hull-White Model to determine arm’s length guarantee fees by equating corporate guarantee with Credit Default Swaps. The expected loss or loss given default was arrived using the model and substituted as guarantee fees to be received by the Indian HQ taxpayer for the guarantee given to its foreign subsidiaries.

b) Global Experience

I. Mutual Agreement Procedure (MAP)

Indian competent authorities and US IRS in 2015, used regression analysis of financial ratios while drafting the framework agreement to expedite resolution of MAP cases of IT/TiCS captive services providers.

II. Evidence during Financial Crisis

In 2009, the EU Joint Transfer Pricing Forum discussed an analysis which linked variation in the profitability of routine service providers in Europe with the health of the European economy^[8].

The COVID-19 pandemic, has been a catalyst for adoption of various statistical techniques in TP, be it for forecasting comparable data for the future years or computing COVID related adjustments.

In the forthcoming sections, we will explore some statistical techniques which may be applied to provide solutions to complex issues on data availability / comparability:

Scenarios where statistical techniques could be applied in Transfer Pricing

A. Alternative to fixed cost adjustment – using Regression and CVP analysis

Taxpayers in their initial years of operations and those operating in competitive sectors, typically face unanticipated reduction in demand. Sales close to break-even levels are not met resulting in the taxpayer incurring losses. However, due to lack of information in general databases, comparable companies may be selected from allied industries, which would not have experienced such market conditions.

In such circumstances, the taxpayer would have incurred losses or registered lower levels of profits vis-à-vis comparable companies, resulting in adjustments being made during the course of TP scrutiny, without considering the level of operations between comparable companies and taxpayer.

The OECD Guidelines state that to be comparable, none of the differences between the situations being compared, could materially affect the condition being examined or reasonably accurate adjustments can be made to eliminate the effect of such differences^[9].

From FY 2011-12^[10], disclosing information on installed capacity and actual production was not mandatory (Revised Schedule VI) resulting in difficulty for effecting an accurate fixed cost adjustment. Taxpayers have adopted various ways of computing capacity adjustment either by considering fixed cost as a percentage of sales, or by reference to RBI report on average capacity utilization, or by adopting ratio of depreciation to average written down value of assets between taxpayer and comparable companies and recomputing fixed cost of comparable companies based on fixed overheads to sales ratio of taxpayer^[11].

Where information on capacity utilized vs installed capacity is available for comparable companies, then the fixed cost adjustment for the taxpayer helps in addressing the question “What if the taxpayer operated at the level of comparable companies”? In case of adoption of CVP (Cost-Volume-Profit) analysis combined with regression analysis, the question “What if comparable companies operated at the level of taxpayer?” can perhaps be answered.

The following concepts in CVP analysis can be applied. Costs are bifurcated into fixed and variable. Contribution margin is excess of sales over variable costs. With increase in the quantity of sales, contribution margin would set off fixed costs, assuming that total fixed costs remain constant. At certain level of sales, contribution margin would be equal to total fixed costs which is break-even point (no-loss no-profit). With further increase in sales, contribution margins would become profits. In order words, farther the actual sales are from break-even sales on the positive side, greater will be the profits. Difference between actual sales and break-even sales is known as margin of safety (MoS).

Using CVP analysis, a close approximation for capacity utilization can be arrived.

MoS is an absolute value and may not be an appropriate measure to be adopted as an independent variable for regression analysis. Comparable companies having higher sales volume may have higher MoS, though they would have only marginally exceeded the break-even level. To eliminate this anomaly, a ratio needs to be arrived at. The ratio of MoS/Break-even sales can be used in this connection. Differences in capacity utilization would be reflected through differences in actual sales, resulting in differences in MoS.

The above ratio will indicate how far comparable companies and taxpayers have moved away from break-even points. Prima facie comparison of the ratios of comparable companies and the taxpayer itself, would show that an adjustment is warranted, to eliminate material differences.

It is a logical extension that greater the ratio of MoS/break-even sales, greater will be the profitability of a business. However, this will have to be proved statistically through correlation / R². by establishing relationship between MoS/break-even sales and the profit level indicator (assuming operating profit / operating income or OP/OI).

Once a statistically strong relationship is established, a model will have to be created to numerically bridge capacity utilization (MoS/ break-even sales) and profitability. This can be achieved through regression analysis.

Based on the OP/OI and MoS/break-even sales data of comparable companies, the regression equation will have to be derived. This equation would estimate profitability at a given level of MoS/ break-even sales. In other words, this equation would answer what comparable companies would have earned had they operated at the level (MoS/ break-even sales) of taxpayer. The regression equation for the given data points can be derived. The regression would be:

Y (OP/OI) = a + (b * (MoS/Break-even sales)) ^[12]

Based on the equation, the MoS/ break-even sales of the taxpayer can be updated and the arm’s length operating profit margin (OPM) obtained. The arm’s length OPM so arrived at can be compared with that of the actual OPM of the taxpayer. The above analysis can be used to substantiate that the taxpayer has earned similar or greater profits as compared to profits earned by comparable companies, had they operated at the level of taxpayer.

Sample set of actual data of comparable companies have been used to compute the above-mentioned ratios to prove the existence of the theoretical relationship between MoS/BEP and OP/OI.

The arm’s length range based on the above comparable companies is 5.22% to 8.58% and the taxpayer margin i.e., 1.74% is not at arm’s length. However, on analysis of the MoS/BEP sales, we can identify that the comparable companies achieved higher level of MoS Sales/BEP Sales (40-50%) as compared to taxpayer (4.30%).

Based on the above data points, the contrast in the level of operations of comparable companies and the tested party, can be brought out, thereby requiring an adjustment to be made. Regression analysis can be used to plot the revised profitability if the comparable companies which can defend taxpayer transfer prices. However, one needs to bear in mind the adoption of sufficient sample size meeting significance tests, to ensure that the regression model adopted is robust.

In most cases there are differences in the sub-industry / sector between comparables and the taxpayer, due to limitation of data availability. The above analysis brings out such differences to warrant comparability adjustment. Further a detailed note on non-availability of close competitors in the database or their rejection due to various quantitative filters, identification of sub-industry of the comparable companies (through extracts of the industry overview documented in the annual report of the comparable companies) and comparing with the taxpayer, would provide credence to the analysis.

Tax authorities could possibly dispute the above approach in instances where sales are to related parties and that lower the MoS/BEP is attributed to reduction in selling price, while the production and sales volume would have taken place at or beyond break-even level. This could be rebutted by supplementary analysis of the contribution margin (CM) percentage of comparable and taxpayer. Where the CMS of the taxpayer is within range or beyond the 65th percentile of comparables, it can be proved that there is no intention of profit shifting by manipulating the inter-company selling price.

B. Use of regression in TP – General

Regression can be used when causation exists between two variables and numerical relationship is required to be established statistically to accurately predict the value of the dependent variable given an independent variable. Few other areas where this approach could fit are provided below:

a) Ex-Ante Analysis:

Relevant regression models can be used to arrive at the margins of comparable companies using macro-economic indicators such as GDP^[13], equity return index, bond yield movement, which can be used as ex-ante analysis for substantiating the arm’s length prices.

b) Ex-post Analysis:

The following can be considered while undertaking an ex-post analysis to substantiate the arm’s length price where data of comparable companies is not available. However, they need to be applied depending on the factual circumstances around the case and other relevant factors.

• Due to COVID-19 pandemic, if a taxpayer wants to estimate the margins of comparable companies based on the decrease in sales volumes, an elementary way is establishing a relationship between costs and revenue for comparable companies based on past year data, and factor the decrease in sales of the taxpayer to estimate the cost of comparable companies based on the regression equation, to arrive at profit margins of comparable companies^[14].
• Where taxpayer makes sales to associated enterprises as well as to third parties, but at different price points due to volume discounts; there is an inverse linear relationship between price and volume. In such cases, a regression equation can be established between volume and price. Based on the regression equation, the arm’s length price can be arrived based on quantity sold to AEs.
• Usage of SG&A/turnover ratio as opposed to AMP/Sales in the case of distributors would help understand the intensity of functions undertaken. This approach can be substantiated by establishing a correlation and fitting a regression line for Gross Profit and SG&A, which can predict the arm’s length gross profits at specific levels of SG&A incurred by the tested party^[15]

C. Justifying Full-Range using Confidence Interval

The OECD guidelines provide that where data points in a range are equally reliable, the ‘full range’ can be considered^[16]. However, the guidelines also state that when there are sizeable number of data points and some unidentified / unquantifiable comparability defects, statistical measures such as mean, median, interquartile range or percentiles can be used to narrow the range^[17] which tax authorities generally prescribe. Transfer pricing regulations in India do not permit use of ‘full-range’ concept. However, the full range concept can be considered as a corroboration to other positions taken by the taxpayer to defend transfer prices.

In one of its rulings, the Swedish Supreme Court decided that companies beyond the interquartile range, were as comparable as those within the range and hence full-range has to be adopted against the contention of tax authorities to use interquartile range^[18].

Due to COVID-19, MNEs would require undertaking a benchmarking study, as part of ex-ante analysis. However, as databases would not have been updated with latest information, the comparable companies used for the earlier year might be rolled forward or searched using the earlier year data.

In such cases and where all the comparable companies can be proved to be equally comparable, a full range can be adopted as against interquartile range, based on the OECD Guidance. To add credence, the concept of confidence intervals can be used.

Traditionally, confidence intervals are used where samples are selected from a population and an estimate is needed on whether the population mean occurs within the range constructed from the sample mean based on a specified probability, or whether the population mean is within acceptable threshold limits with generally acceptable levels of confidence^[19].

Deploying confidence intervals, a range can be constructed using the arrived mean / median at the required confidence level.

Below is an example of how confidence intervals can be used to substantiate adopting full-range. The margins of comparables have been estimated for FY 2020-21. Based on ‘back-of-the-envelope’ calculations, the comparable companies are assumed to follow normal distribution^[20]. Since the statistics of the population is unknown, t distribution has been considered.

Now computing the confidence intervals for the mean using 99% confidence level, we would arrive at the range 0.06% to 9.92%^[21]. Assuming that we compute using 99.5% confidence level, the interval would be -0.69% to 10.67%, which is approximately the full range.

However, the most point in the above discussion is the assumption of normal distribution. Generally, it is assumed that margins of companies follow normal distribution. There are also discussions that operating margins follow gamma^[22] or lognormal distribution. As gamma and lognormal can be applied only for positive data points, it can perhaps be argued that at times of a downturn or during COVID-19 pandemic, not considering non-positive data might be unrealistic. Perhaps these distributions can be considered for license rates such as royalty rates, which cannot be non-positive.

Conclusion

Since TP is not an exact science, appropriate statistical techniques can be deployed on a case-to-case basis. However, before applying any statistical technique, the assumption of the respective technique needs to be tested for the data on which the technique is to be used, This also needs to be documented on a contemporaneous basis.

As businesses expand across borders, navigating complex transfer pricing regulations becomes critical. At VSTN Consultancy, a global transfer pricing firm, we specialize in helping companies stay compliant and competitive across key markets including:

India | UAE | USA | KSA | Dubai | Asia Pacific | Europe | Africa | North America

Whether you’re preparing for benchmarking intercompany transactions, or developing robust TP documentation, our team is here to support your international strategy and Compliance.

Contact us today to explore how we can partner with you to optimize your global transfer pricing approach.

#TransferPricing #TransferPricingFirm#VSTNConsultancy #TaxCompliance #IndiaUAEUSA

#TPExperts#TransferPricingExperts#GlobalTransferPricingFirm

As businesses expand across borders, navigating complex transfer pricing regulations becomes critical. At VSTN Consultancy, a global transfer pricing firm, we specialize in helping companies stay compliant and competitive across key markets including:

India | UAE | USA | KSA | Dubai | Asia Pacific | Europe | Africa | North America

Whether you’re preparing for benchmarking intercompany transactions, or developing robust TP documentation, our team is here to support your international strategy and Compliance.

Contact us today to explore how we can partner with you to optimize your global transfer pricing approach.

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Design of Amount B-Pillar One

OECD issues public consultation document
July 2023

Summary

The Organisation for Economic Cooperation and Development (OECD) / G20 Inclusive Framework (IF) has issued a public consultation document on 17 July 2023 providing the scoping framework for Amount B of Pillar One, based on inputs received on the earlier consultation document issued in December 2022. Inputs from stakeholders on the design of scope and pricing methodology are invited by 01 September 2023.

The consultation document provides the scope of base distribution activities under Amount B and the simplified and streamlined pricing approach (“approach”) for pricing the qualifying baseline distribution activities for distributors, sales agents/commissionaires. It contemplates two alternatives for qualitative scoping criteria – Alternate A and Alternate B. The arm’s length return using the pricing matrix has also been covered in the public consultation document. On approval / adoption of the approach, sections in Amount B public consultation documentation would form part of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (TP Guidelines). There is still clarity awaited as to whether Amount B would be a safe labour or would be prescribed.

Currently no monetary thresholds have been prescribed for Amount B, unlike Amount A of Pillar 1 and Pilar 2. Amount B is aimed to provide an arm’s length return for undertaking baseline wholesale distribution arrangements i.e., limited or lower functions performed, assets employed and risks assumed by the distributors as compared to its associated enterprises (AEs). The public consultation document is broadly divided into three segments – scoping of qualifying transactions, pricing approach and other aspects. This alert discusses in detail on the public consultation document in the following sections.

Amount B – Transactions in Scope

The simplified and streamlined Approach proposed:

• Applies to wholesale distributors, sales agents, and commissionaires involved in the sale of goods, including the distribution of digital goods(newly included).
• Currently doesn’t cover distribution of services, including digital services.
• Requires retail sales should not exceed 20% of the total annual net sales, when Distributors undertake both wholesale and retail distribution.

Amount B covers baseline distribution activities by distributors (tested parties) that meet qualifying transactions definition and scoping criteria.

Qualifying Transactions

The qualifying transactions under the approach are as follows:

Scoping Criteria

The public consultation document provides for qualifying transactions that are in-scope as well as out-of-scope. The document also contemplates on whether a separate qualitative scoping criteria is required, in addition to the scoping criteria provided to eliminate non baseline contributions from Qualifying transaction, through considering two alternatives. In Alternative A no separate qualitative criteria are considered, while Alternative B considers separate qualitative criteria.

Several reasons for adopting Alternative A – position taken that separate qualitative scoping criteria will not improve reliability of Amount B. One, pricing approach recognizing different operating margins for varying operating assets / expenses, industry and country. Two, removal of non-baseline contributions might give a view that Amount B is minimum return for controlled distribution activities. Three, difficulty in defining qualitative test might result in more dispute and uncertainty, against the purpose of Amount B.

Reasons have also been provided for considering Alternative B – position that separate qualitative scoping criteria will improve reliability of Amount B. Reasons include non-baseline contributions requiring two-sided approach that may not have been otherwise excluded, quantitative metrics unable to statistically identify and exclude non-baseline contributions, Alternative A can give rise to tax planning opportunity and increase risk of base erosion.

In-Scope

Qualifying transactions will be ‘In-scope’ if:

1. They can be reliably priced using one-sided transfer pricing method, with the distributors, sales agents or commissionaire being the tested party and the most reliable method for pricing distribution activity should be Transactional Net Margin (TNMM).
2. Annual operating expenses/Net sales of the tested party is not lower than 3% and greater than 50% (for Alternative B) / 30% (for Alternative A).

The three-year weighted average ratio is considered while computing the above ratio, since revenue and operating expenses will vary and may result in taxpayer moving in and out of scope. To ensure consistency the three-year average is considered. The ratio for Year ‘y’ would be computed as:

\[ \frac{\sum \text{(Operating Expenses)}_y – 3, y – 2 \, \text{and} \, y – 1}{\sum \text{(Net Sales)}_y – 3, y – 2 \, \text{and} \, y – 1} \]

Out of Scope

Qualifying transactions will be ‘Out-scope’ if:

1. In Alternative B – Tested party makes non-baseline contributions to transactions in a certain manner. Since it is not possible to cover various situations exhaustively, the public consultation document has provided certain examples, summarised below:
   • Contributions in the nature of technical or specialised support activities including customization or modification.
   • Non-baseline contributions specific to highly regulated industries
2. They are involved in distribution of services or the marketing, trading or distribution of commodities.
3. Tested party undertakes non-distribution activities in addition to qualifying transactions and where either the non-distribution activities and qualifying transactions cannot be evaluated on a separate basis or cannot be reliably priced separately or does not meet prescribed administrative guardrail.

Commodities may be – renewable / non-renewable physical products primarily derived from earth’s crust, land or water (Examples include hydrocarbon, mineral, mineraloid and agricultural product), renewable or non-renewable physical product that has undergone qualifying processing, or commodities as mentioned in the OECD Transfer pricing Guidelines.

Non-distribution activities include manufacturing, R&D, procurement, financing or retail distribution. The administrative guardrail is intended to address scenarios where there is high dependence on allocation keys to apportion costs between distribution and non-distribution segments, and a cap on the annual indirect operating expenses allocated between distribution and non-distribution segments has been prescribed as not exceeding 30% of the total costs incurred for all the activities.

Amount B – Pricing Methodology

Arm’s length price under the pricing approach is determined through ‘Pricing Matrix’. In the earlier consultation document, the IF provided two options for pricing viz., Pricing Matrix and mechanical pricing tool approach. In this public consultation document, only the pricing matrix has been used. The arm’s length price ranges in the pricing matrix and modified approach will be updated once in 5 years, unless in case of significant change in market conditions, where interim updates will be provided. The risk adjustment percentage and Berry ratio cap-and-collar ranges will be updated annually.

Pricing Matrix

Pricing Matrix is a translation of arm’s length results which is determined from global datasets in a matrix form. Segments of this matrix are Operating asset to sales intensity (OAS), operating expense to sales intensity (OES) and industry. Factory intensity i.e., OAS and OES should be computed using three year weighted average. Industry grouping is based on relationship to level of returns and is as below:

• Group 1 – Statistically significant relationship to lower levels of return. Industries include perishable foods, animal feeds, agricultural supplies, Grocery, household consumables, alcohol and tobacco, pet foods, construction materials and supplies.
• Group 2 – No statistically significant relationship with level of returns. Industries include Domestic vehicles, IT hardware, software and components, electrical components and consumables, clothing and apparel, textiles, hides, furs, jewellery, plastics and chemicals, consumer electronics.
• Group 3 – Statistically significant relationship to higher levels of return. Industries include Medical machinery, pharmaceuticals, medical, industrial machinery/tools/ components, agricultural and used domestic vehicles, motorcycles, vehicle parts.

In determining the arm’s length return for the tested party involved in qualifying in-scope transactions a three-step process will have to be followed. Firstly, determine the industry grouping. Secondly, determine relevant factor intensity classification of the tested party. There are 5 classifications provided viz., A,B,C,D and E. Thirdly, identify the arm’s length price viz., return on sales %, that corresponds to the intersection of relevant parameters.

The pricing matrix derived from the global dataset, as per the consultation document, is as follows:

In determining whether the qualifying in-scope transactions are at arm’s length, the tested party margins should be within the range. If the tested party margins are outside the range, adjustment would be made with reference to the midpoint of the range.

Addressing geographical differences

IF had undertaken econometric analysis and differences in geographies have been observed to influence profitability of baseline marketing and distribution entities in a few jurisdictions, for which relevant data is available. Based on this modified approach and adjustment mechanism are set forth to address the differences.

Modified Approach

For certain qualifying jurisdictions (having sufficient local datasets), there are observed differences in the profitability between global dataset and qualifying jurisdictions, a modified pricing matrix has been established. The list of qualifying jurisdictions for the modified approach will be published on the OECD website and periodically updated. The matrix under the modified approach is in the same format as pricing matrix above, and the 3-step process prescribed under the pricing approach will have to be applied for modified approach as well. The datapoints for modified approach matrix have not been provided in the public consultation document.

Adjustment Mechanism

For certain qualifying jurisdictions there is no local data available but there is evidence of country risk in that jurisdiction, which may influence the profitability attributable to baseline distribution and marketing activities. The country’s sovereign credit ratings is being used as an approximation for quantifying credit risk. Adjusted return on sales is arrived by:

\[ \text{UROST}^p + (\text{NRA}^j * \text{OAST}^p) \] where UROST^p is the unadjusted return on sales of tested party, NRA^j is the net risk adjustment percentage with reference to the sovereign credit rating of the jurisdiction of the tested party and OAST^p is the operating asset to sales intensity of the tested party for the relevant period and should not exceed 85% for computing the adjusted return on sales. The list of qualifying jurisdictions for the adjustment mechanism will be published on the OECD website and periodically updated.

Corroborative Mechanisms

IF considers that there are certain arrangements that may be at risk of being over or under-remunerated for their functions performed under the net profit indicator – return on sales. Hence, a Berry ratio (gross profit to operating expense) cap-and-collar approach is considered as a corroborative test under this pricing approach. The 3-step process to applied under the corroborative mechanism is –

1. Based on the tested party net profitability, in line with the pricing matrix and addressing geographical differences sub-sections, the implied Berry ratio will have to be derived.
2. Test the tested party’s berry ratio with the cap-and-collar range. The range prescribed is 1.50 to 1.05.
3. Where the tested party Berry ratio within the cap-and-collar range, no adjustment is required. In case the Berry ratio of tested party is outside the cap-and-collar range, the profitability (return on sales) of the tested party will have to be adjusted to the nearest edge of the cap-and-collar range.

Other Aspects

• Documentation: Local file of the taxpayer opting under Amount B should include accurate delineation and detailed functional analysis of the qualified in-scope transaction, calculations and workings to align with pricing approach, etc. Taxpayers and tax administration can also leverage information in Master File to support their position. Once the taxpayer decides to adopt Amount B for the first time, it needs to notify the local tax authorities and may need to continue to apply the approach for minimum three years
• Transitional Issues: MNEs may restructure the entities either to meet or not meet the scoping criteria of Amount B evaluating both the pros and cons. When doing so the transfer pricing implications provided in OECD guidelines (Chapter IX – Restructuring) will have to be considered
• Tax certainty: In MAP (mutual agreement procedure) cases where primary adjustments is on the premise of application of pricing approach, the same should be resolved by competent authorities as per the guidance laid down in the respective sections. Where APA or MAP cases have already been settled prior to the adoption of the pricing approach, the agreed terms and conditions to prevail for the covered years. This will ensure uncertainty is not created owing to pricing approach, which is against the premise of Amount B.

Key Takeaways and Conclusion

The ongoing work on Amount B is part of the finalization of Amount B by January 2024 for incorporation into the OECD TP Guidelines, as agreed by 138 countries to implement global tax deal on 12 July 2023. With the aim to simplify the application of arm’s length principle, the pricing approach indeed presents a practical and a transparent methodology, that can be adopted globally, for pricing of baseline marketing and distribution activities, backed by sophisticated analysis, including econometric analysis.

Amount B can act as inputs to aid risk assessment for tax authorities in various jurisdictions. Adoption of Amount B in tax legislations of all the jurisdictions in letter and spirit by tax authorities is key to ensure its complete success. Amount B can also aid resolving allied issues such as marketing intangible (AMP issue), where the taxpayer undertakes qualifying transaction and satisfies scoping criteria.

It is however to be noted that divergence between countries on their stand on qualitative criteria, that has materialized as Alternative A and B, has to be agreed in spirit by both the sides. This is crucial as a mere paper agreement to push through the Amount B will result in discontented countries applying additional qualitative filters to identify non-baseline contributions during first level of transfer pricing audits, defeating the purpose of Amount B in the first place.

Another aspect to be wary about in this consultation document is the exclusion of distribution of services, including digital services. While it may be easier to delineate non-digital goods and services, discussion on the digital front is a dispute by itself. Moreover, legal positions on whether it is goods or services in certain jurisdictions may differ as compared to the position of Amount B, resulting in divergence in treatment for Amount B purpose and local tax law purpose. It may be another stand-off between countries while agreeing on Amount B in the first place.

Other aspects requiring deliberation include certain costs included on behalf of the AEs that require to be reimbursed at cost and require treatment as pass through costs, making public the detailed search process (including the accept reject matrices) based on which the pricing matrix have been prepared and other softer aspects on implementation.

Amount B is one of few occasions where the OECD itself has pronounced the arm’s length price, and considering over 138 countries have pledged their support on Amount B, adequate clarity on all aspects of Amount B could enable a reduction in transfer pricing disputes on baseline marketing and distribution activities. This can result in reduced resources being devoted to transfer pricing litigation both from taxpayer and revenue sides, which can be channelized in other critical areas such as fast tracking of more complex APA and MAP.

About us

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Our offering spans the end-to-end Transfer Pricing value chain, including design of intercompany policy and drafting of Interco agreement, ensuring effective implementation of the Transfer Pricing policy, year-end documentation and certification, BEPS related compliances (including advisory, Masterfile, Country by Country report), Global Documentation, safe harbour filing, audit defense before all forums and dispute prevention mechanisms such as Advance Pricing agreement.

We are structured as an inverse pyramid where leadership get involved in all client matters, enabling clients to receive the highest quality of service.

Being a specialized firm, we offer advice that is independent of an audit practice, and deliver it with an uncompromising integrity.

Our expert team bring in cumulative experience of over five decades in the transfer pricing space with Big4s spanning clients, industries and have cutting edge knowledge and capabilities in handling complex TP engagements.

Pillar One – Amount B : OECD Public Consultation 2023

Distributors (act as tested parties)
– wholesale distributors sales agents and commissionaires
– distribution to customers except end customers. Retail sales ≤ 20% of total annual net sales

Amount B Applicability:

Baseline distribution activities by distributors that are qualifying transactions and meet the scoping criteria.

Qualifying transactions

Buy-sell marketing & distribution transactions – Purchase from AEs and sell to unrelated parties.

Sales agency, commissionaire transactions – contribute to wholesale distribution of goods by AEs to unrelated parties.

In Scope

• Transactions can reliably be priced using one-sided TP method – TNMM
  – 3 year Weighted average of Annual Operating expenses/Net sales not lower than 3% and greater than 50% (for Alternative B) # / 30% (for Alternative A) #

Out Scope

• Under Alternative B tested party makes non-baseline contributions
• Distribution of services or marketing, trading or distribution of commodities
• Tested party undertakes non-distribution activities, and they cannot be accurately delineated or cannot be reliably priced separately or indirect expenses allocated between segments is more than 30% of total costs for all activities

Pricing of Baseline distribution activities

Pricing Matrix:

Arm’s length results from global dataset in matrix.

Modified Approach:

For qualifying jurisdictions having observed difference between local datasets and global datasets. Similar matrix will be issued.

@ to be listed in OECD website

Adjustment Mechanism:

For qualifying jurisdictions with no local datasets but evidence of country risk. Formula: Unadjusted ROS + (Net Risk Adjust. using sovereign credit rating* OAS of tested party)

OECD contemplating on two alternative position on qualitative criteria. Alternative A – No separate qualitative review, Alternative B -Separate qualitative review

Tested party’s Berry Ratio (gross profit to operating expenses) to be within range of 1.5 to 1.05. Adjustment to net profit until within the range

As businesses expand across borders, navigating complex transfer pricing regulations becomes critical. At VSTN Consultancy, a global transfer pricing firm, we specialize in helping companies stay compliant and competitive across key markets including:

India | UAE | USA | KSA | Dubai | Asia Pacific | Europe | Africa | North America

Whether you’re preparing for benchmarking intercompany transactions, or developing robust TP documentation, our team is here to support your international strategy and Compliance.

Contact us today to explore how we can partner with you to optimize your global transfer pricing approach.

#TransferPricing #TransferPricingFirm#VSTNConsultancy #TaxCompliance #IndiaUAEUSA

#TPExperts#TransferPricingExperts#GlobalTransferPricingFirm

As businesses expand across borders, navigating complex transfer pricing regulations becomes critical. At VSTN Consultancy, a global transfer pricing firm, we specialize in helping companies stay compliant and competitive across key markets including:

India | UAE | USA | KSA | Dubai | Asia Pacific | Europe | Africa | North America

Whether you’re preparing for benchmarking intercompany transactions, or developing robust TP documentation, our team is here to support your international strategy and Compliance.

Contact us today to explore how we can partner with you to optimize your global transfer pricing approach.

#TransferPricing #TransferPricingFirm#VSTNConsultancy #TaxCompliance #IndiaUAEUSA

#TPExperts#TransferPricingExperts#GlobalTransferPricingFirm

As businesses expand across borders, navigating complex transfer pricing regulations becomes critical. At VSTN Consultancy, a global transfer pricing firm, we specialize in helping companies stay compliant and competitive across key markets including:

India | UAE | USA | KSA | Dubai | Asia Pacific | Europe | Africa | North America

Whether you’re preparing for benchmarking intercompany transactions, or developing robust TP documentation, our team is here to support your international strategy and Compliance.

Contact us today to explore how we can partner with you to optimize your global transfer pricing approach.

#TransferPricing #TransferPricingFirm#VSTNConsultancy #TaxCompliance #IndiaUAEUSA

#TPExperts#TransferPricingExperts#GlobalTransferPricingFirm

As businesses expand across borders, navigating complex transfer pricing regulations becomes critical. At VSTN Consultancy, a global transfer pricing firm, we specialize in helping companies stay compliant and competitive across key markets including:

India | UAE | USA | KSA | Dubai | Asia Pacific | Europe | Africa | North America

Whether you’re preparing for benchmarking intercompany transactions, or developing robust TP documentation, our team is here to support your international strategy and Compliance.

Contact us today to explore how we can partner with you to optimize your global transfer pricing approach.

#TransferPricing #TransferPricingFirm#VSTNConsultancy #TaxCompliance #IndiaUAEUSA

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Malaysia – TP updates

New TP and APA rules

June 2023

Summary of the new developments

Malaysia has replaced its existing Transfer Pricing rules i.e. the Income Tax (TP) Rules 2012 with the Income Tax (TP) Rules 2023, and this would be effective for the YA 2023 onwards. Additionally, a minimum TP documentation (‘TPD’) template with explanatory notes has been published in connection with persons who do not meet the thresholds prescribed¹ under the Malaysia TP guidelines 2017 (paragraph 1.3.1) for maintaining detailed TPD.

The Income Tax (Advance Pricing Arrangement) Rules 2023 have also been issued which replace Malaysia’s Income Tax (Advance Pricing Arrangement) Rules 2012.

In our alert we have summarized the key aspects in relation to the new TP and Advance Pricing Arrangement (‘APA’) Rules.

Transfer Pricing Rules 2023 – Key updates

1. Arm’s length range (‘ALR’) – The ALR has been defined as the \(37.5^{\text{th}}\) percentile to \(62.5^{\text{th}}\) percentile of the comparable dataset, with the median being the mid-point of the ALR. The range is derived from applying the same transfer pricing method to multiple comparable data or by applying any other method allowed by the Director General (‘DG’).
2. Usage of data points – Earlier, the use of multiple year averages (weighted average) for the comparable companies was common. In the new rules and in line with the existing TP guidelines, it has been stressed that the usage of multiple year data is permitted only to assist in the selection of comparables and not for computation of the ALR.
3. Adjustments by the Director General – 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 (where the uncontrolled transaction has lesser comparability, or any comparability defects cannot be quantified, identified or adjusted).
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, and furnished within 14 days of request. Further guidelines may also be issued by the DG to facilitate the implementation of the TPD rules. The contents prescribed for the TPD are as follows:
   1. Schedule 1 (MNE Group information) – Most of the contents in relation to Master file from the existing TP guidelines have been incorporated in the Rules with certain additions (MNE’s key competitors, business models and strategies, industry and economic conditions in which it operates etc.). So, this looks like a laborious process for taxpayers who don’t have a global Master file to collate this data.
   2. Schedule 2 (Business information) – Covers most of the contents prescribed in the existing TP guidelines. Further, comprehensive details such as information on the heads of local departments (including whether they are expatriates or local citizens) and number of employees in each department are required.
   3. Schedule 3 (Cost Contribution Agreement or ‘CCA’) – Contents from the TP guidelines have been incorporated with certain additions (policies and procedures for adjusting the terms of the CCA, mechanisms for managing and controlling the responsibilities in relation to DEMPE of assets used in the CCA etc.).
   4. The date of completion of the TPD is to be mentioned to ensure it is contemporaneous.
5. Selection of TP method – Reference to Most Appropriate Method (out of CUP, RPM, CPM, PSM, TNMM, any other method allowed by the DG) has been made for determining the Arm’s Length Price unlike the old rules where there was a preference to the Traditional Transactional methods over the other methods. Taxpayers have to document the reasons for choosing any method over the others, and the DG can replace the selected TP method if not satisfied.
6. 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.
7. Offsetting adjustment provision removed – As per the old Rules, any adjustment made by the DG to one party in a controlled transaction could be reflected by an offsetting adjustment on the assessment of the other party upon request. This provision has been removed in the new Rules and this could affect domestic related party transactions.

¹ Detailed TPD is required to be maintained where:
– for a person carrying on a business, gross income > RM25 mn, and the total amount of related party transactions > RM15 mn.
– for a person providing financial assistance, the financial assistance > RM50 mn. Transactions involving financial institutions are excluded.
The above thresholds are not applicable in case of a PE.

It is interesting to note few similarities between the new Malaysian Rules and the Indian TP legislation especially the adoption of a unique arm’s length range (37.5th percentile to 62.5th percentile as against 35th-65th percentile in the case of India) and a short time period for TPD submission upon request (14 days as against 10 days in the case of India).

Considering the emphasis on contemporaneous documentation in the Rules, it is essential taxpayers are well prepared to maintain TPD within the prescribed timeline. Even in cases of taxpayers who do not meet the thresholds for maintaining detailed TPD, the new minimum TPD template would call for aligning the documentation requirements to ensure compliance.

APA Rules 2023 – Key updates

• 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 where the head office will make an application). In other cases, only a Unilateral APA is possible. Malaysia has DTAAs in place with more than 70 countries², including most of its major trading partners, and hence looks like only a Bilateral or Multilateral APA may be a viable option for most of the Tax payers
• Along with a pre-filing request, additional documents would need to be submitted including the contemporaneous TP documentation as per the Income Tax (TP) Rules 2023; financial statements and tax computations for the latest 3 years etc.
• Once the DG accepts a pre-filing request, the APA application must be submitted within 6 months of the notification, as against 2 months in the earlier Rules. In case of renewal requests, the application must be submitted within 2 months. If not submitted within the timeline, the applications will be deemed to be withdrawn.
• An APA application can be declined where the proposed transaction involves improper use or abuse of the application of the DTAA.
• If the request of the DG or Competent Authority (‘CA’) for further information during the APA process is not fulfilled within 30 days, the APA application shall be deemed to be withdrawn. This would enable them to expedite the conclusion of cases.
• Rollback of only Bilateral or Multilateral APA is permitted and under certain prescribed situations, rollback option will not be available. Rollback will be available for the immediately 3 preceding years.
• Certain additional information has also been prescribed to be included in the APA compliance report.
• The DG or CA may cancel/revoke an APA in case the Bilateral or Multilateral APA entered into with the participating CA has been cancelled/revoked.
• An APA can also be revoked if any of the parties fails to disclose any occurrence of voluntary disclosure, investigation, audit or incentive approval.
• Fees have been prescribed in connection with application for APA and renewal of APA, and these are non-refundable if the taxpayer withdraws the application.

The APA rules have been streamlined with clear timelines and taxpayers can consider this option to achieve tax certainty. Allowing for only Bilateral or Multilateral APAs where DTAAs exist will also ensure avoidance of double taxation.

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