Trueup Adjustment

Year End Transfer Pricing adjustments – True ups/True down

As companies move towards closure of audit for FY 21-22, one of the critical aspects which would arise from the transfer pricing side would be on Year end adjustment. A company carries out year end adjustment (Trueup/True down adjustment) if faced with one of the below scenarios:

The actual results/margins deviate from the targeted margin as per the intercompany agreement/pricing policy (or)
The actual margin earned by the company is not at arm’s length when compared to the comparable companies for that particular period

Most of the companies carry out the trueup/true down adjustment at the end of their accounting period before the books are closed.
In case of the scenario (b), a benchmarking exercise is carried out to arrive at the arm’s length range and it is understandable that this happens at the end of the year.
However in the first instance, where a fixed return model would be followed by a limited risk bearing entity (i.e contract manufacturer/Limited risk distributor/contract service provider), there could be a deviation between the targeted and the actual margin, on account of the below reasons:

Difference between budgeted costs and actual costs and billings based on budgeted estimates
Variance in the components of costs considered for billing purpose and for transfer pricing purposes (operating costs).

In this case, it is not a prudent practice to wait for the year end to make these adjustments as it would result in the below repercussions:

In case of truedown, possible that the company has paid additional advance taxes and consequently would need to wait for the refund at the time of filing the return and hence this impacts the working capital
In case of trueup, it results in additional income, thereby leading to a shortfall in payment of advance taxes and thereby resulting in payment of additional interest.
In the case of distributors, when there is a downward price adjustment at the year end, for imports, then the excess customs duty paid on imports from Group companies would be a sunk cost and it may not be possible to claim a refund from the customs department. Hence there is a need for optimal balance/convergence between customs and TP.

One needs to ensure that it is not sufficient just to have an appropriate intercompany policy but the entire crux lies in the effective implementation of the same. Hence it would be preferable to have an evaluation of the profitability at least every quarter. This could also be ensured by leveraging technology. One has to also bear in mind that the intercompany agreements are to be properly drafted to include such clauses on year end adjustments.

OFFLINE TO ONLINE – FORM NO. 3CEF – ANNUAL COMPLIANCE REPORT ON ADVANCE PRICING AGREEMENT

On 16th July, 2022, the Directorate of Income Tax (Systems), New Delhi, has issued the notification where it has been prescribed that Form No. 3CEF which is the Annual Compliance Report (ACR) on Advance Pricing agreement (APA) is mandatorily required to be filed electronically. This comes into effect immediately. The e-filing portal is expected to be updated with the electronic Form 3CEF.

What does it mean for Taxpayers who have an APA in place?

Every Tax payer who has concluded an APA will need to file the ACR in Form No. 3CEF for each of the covered years of the APA. This is filed to intimate to the APA authorities that the Tax payer has complied with the terms of the APA for the covered international transactions. As part of the annexure to the Form, the Tax payer also provides the relevant supporting documents as agreed in the APA.

From the inception of the APA regime, all the forms were required to be filed in physical form. In the case of Form No. 3CEF, the Form and relevant annexures were required to be submitted in quadruplicate with the APA office within 30 days of filing the Income tax return or within ninety days of entering into an agreement, whichever is later.

Perhaps with the online filing of Form 3CEF, one of the laborious procedural aspects in the APA has been brought into the digital mode. This is a welcome move as it stops the physical movement of files to various stakeholders – Competent authority in India, CIT of the relevant tax payer and the TPO and also protects the confidential information of the tax payer. Only the relevant officer handling the Tax payer’s case would be able to view the details with a click of a button. The information gathered in the online utility would facilitate better data analytics and can be used to provide insights to the APA authorities on various quantitative parameters within an industry peer group. This will also provide a tracking mechanism to the APA authorities whether these Forms are actually filed within the prescribed due dates.

One needs to wait and watch whether this is a precursor for an online APA application filing. Several countries including US, UK, Japan, Australia have already implemented e-filing of APA Applications and possible that some of the best practices could be brought into the Indian APA regime.