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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 – TP

Disclosure Form

EmaraTax Portal – Live

October 2024

Background

The UAE Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses provided that taxpayers will have to file a disclosure form alongside Corporate Tax return, that contains information on arrangements with related parties – Article 55(1). The Transfer pricing Guide (Corporate Tax Guide | CTGTP1) issued by the Federal Tax Authority (FTA) noted that taxpayers having transactions with related party transactions and connected persons will have to file the disclosure form. The TP Guide noted that the disclosure form would be available in due course. The EmaraTax Portal, where taxpayers can file Corporate Tax return, has now enabled the TP Disclosure form and is now live to be updated and submitted with the UAE tax authorities along with the CT return.

The alert covers the several aspects of TP disclosure form.

TP Disclosure Form

The landing page of the TP disclosure form covers three aspects:

1. Related Party Transaction Schedule
2. Connected person Schedule.
3. Adjustments to gains and losses w.r.t. transactions with related parties

1. Related party transaction schedule

The Related party transaction schedule consists of three parts viz., “Summary Table”, “Gross Income received from related parties” and “Expenditure Paid to Related Parties”.

A) Gross Income received from related parties:

Income / revenue transactions as well transactions having a revenue related impact on the profit and loss / balance sheet (such as recovery of expenses) are to be updated in the Gross Income received from related parties tab.

B) Expenditure Paid to Related Parties

Expenditure transactions as well transactions having an expense related impact on the profit and loss / balance sheet (such as reimbursement of expenses paid) are to be updated in the Expenditure Paid to Related Parties tab.

For both the income and expenditure transactions, the below details are required to be included:

1. Name of the related party,
2. Tax Residence,
3. Gross Income (in AED)/Expenditure as the case may be
4. Arm’s length value (in AED)
5. Transaction type:
   1. Goods
   2. Services
   3. Intellectual Property
   4. Interest
   5. Assets
   6. Liabilities
   7. Others
6. Corporate Tax TRN/TIN (where available)
7. Transfer Pricing method:
   1. The comparable controlled price method
   2. The resale price method
   3. The cost-plus method
   4. The Transactional net margin method
   5. The Transactional profit split method

Note:

• This tab requires the Gross Income to disclosed in the TP disclosure form. The financial statements might disclose the net value of revenue / income, the gross income will have to be disclosed in the TP disclosure form.
• The difference between the Gross Income and the arm’s length value is computed as Tax adjustment. Similarly, the difference between the Expenses and the arm’s length value is computed as Tax adjustment.

C) Summary Table:

The Summary Table tab summarizes various related party transactions updated in the other two tabs namely ‘Gross Income received from related parties’ and ‘Expenditure Paid to Related Parties’. The aggregate value of transactions / arrangements with related parties into the following categories:

Transactions	Income (AED)	Expenses (AED)
Sales or Purchases of Goods
Services rendered or received
Royalty, License fees, and other receipt/payments in relation to intellectual properties
Interest Income and expenses
Assets
Liabilities
Other transactions not falling under the items above
Aggregate

In the addition to the above, the total of transfer pricing adjustments included in the other two tabs is disclosed as a consolidated value as “Total Transfer Pricing Adjustments (in AED)”.

2. Connected persons schedule:

The Connected persons schedule is required to be updated w.r.t. transactions entered between the taxpayer and connected persons. The details to be updated include:

• a) Name of the Connected Person,
• b) Payment or benefit:
  1. Payment
  2. Benefit
• c) Corporate Tax TRN/TIN (where available).
• d) Description.
• e) Value of the payment or benefit provided to the Connected person (in AED)
• f) Market value of the service or benefit provided by the connected person (in AED)

The difference between value recorded and the market value (arm’s length price) is computed automatically as adjustment.

3. Adjustments to gains and losses w.r.t. opening balances:

This covers adjustments to gains / losses in relation to assets and liabilities previously received from related parties at non-arm’s length prices. As part of transitional provisions, the Federal Decree law provided that opening balances for the first year for which is subjected to tax will have to be restated having regard to arm’s length standard. This section covers any adjustments as a result of restatement of opening balances based on arm’s length standard.

Document Requirement

In addition to the information to be updated in the Related Party Transaction Schedule and Connected person Schedule, the TP disclosure form has another segment for uploading various documents. The “Additional Attachments” in the TP Disclosure consists of these additional documents to be uploaded as part of the TP Disclosure Form. The documents to be uploaded are:

1. Financial statements
2. Local File
3. Master File
4. Confirmation of ownership and the right to exploit the Qualifying Intellectual Property – Patent. – Copyrighted software/Another right functionality equivalent to a patent
5. Record of qualifying expenditure and overall expenditures incurred
6. Record of overall income (de)rived from the qualifying expenditures and overall income derived from qualifying intellectual property
7. Documentation to support the market value of the qualifying immovable property at the start of the first tax period
8. Documentation to support the market value of the Financial Assets / Liabilities at the start of the first tax period
9. Tax residency certificate in the foreign jurisdiction

Key Points and takeaways

Some of the key points to be considered for taxpayers are as follows:

1. No threshold / de-minimis limit w.r.t. transactions with related party and connected persons for filing of TP disclosure form. The Federal Decree law read with TP Guide by the FTA provide that all related party transactions must meet arm’s length standard, and with which even the TP Disclosure Form is aligned. Though a threshold for the local and master file has been prescribed, taxpayers will have to ensure that all related party transactions are entered on an arm’s length basis. Further taxpayers will also have to be able to substantiate the same, including use of the appropriate transfer pricing method which has to be mentioned in the TP Disclosure form.
2. Similarly, entities opting for small business relief are not required to maintain TP documentation w.r.t. related party transactions, but are required to meet the arm’s length standard. These entities may need to file the TP disclosure, as there is no specific exemption prescribed currently
3. The transfer pricing method does not include Other Transfer pricing method, stipulated as per Article 34(4) of the Federal Decree-Law. Therefore, usage of the other transfer pricing method has to be done with extreme caution and one needs to evaluate if an alternative secondary method should be adopted to be declared in the TP disclosure form and basis provided in the local file to be uploaded.
4. The TP Guide by the FTA states that receivables balance will have to be realised within the arm’s length credit period (para 7.8.2. of the TP Guide). Hence, the tax authorities might view the receivable balance as a separate transaction, where the receivable is outstanding in excess of the arm’s length credit terms. Hence, as part penalty protection measure, taxpayers can consider including the receivable balance as separate transaction. The transfer pricing method used for the base transaction can be adopted for receivable balance as well.
5. Payment related transactions with connected persons are brought under the purview of transfer pricing as per the Federal Decree law. On these lines only payments / expenses are mentioned in the TP Disclosure Form. However, for the connected person schedule, there is no disclosure which is called for on the transfer pricing method adopted for payments / expenses with connected persons.
6. Where parent entity and subsidiary entities have opted to form a Tax Group, Transfer pricing regulations do not apply for transactions between the entities of the Tax Group. In the TP Disclosure Form there is no reference of Tax Group or transactions between entities of the Tax Group. Hence, one can infer that TP Disclosure form may not be applicable to the said exempted transactions.
7. The Federal Decree law exempts tax-neutral transactions from scope of transfer pricing documentation. However, there was no such exemption w.r.t TP Disclosure Form. Hence, these transactions may need to bee disclosed in the TP Disclosure Form.
8. The Federal Decree law and the UAE TP Guide provides for use of combination of transfer pricing method to justify the arm’s length nature of related party transactions. The TP Disclosure Form, however, does not have any provision for submission of combination of TP methods. Taxpayers, might perhaps consider selecting one of the TP methods as primary method and disclosing the said primary method in the TP Disclosure form.
9. In the Gross Income and Expenditure tabs above, only certain transactions heads such as Goods, services, IP, assets & liabilities, etc were provided. Other transactions such as guarantees, reimbursement / recovery of expenses and Free of cost assets will have to be disclosed in the head “Others”.
10. In instances where the taxpayers are considering suo-moto adjustments for transactions with related party / connected persons, question might arise whether the arm’s length price would be the 25th or 75th percentile respectively or the median of the dataset. In this regard the Federal Decree law states that related party transactions not within the arm’s length range will have to be adjusted. (Article 34 (8)). Hence one may consider using the two ends of the range, as may be applicable. However, on a conservative basis, one might consider selecting the median as the arm’s length price and adjusting the related party transactions accordingly.
11. The Federal Decree law provides that local file and master file will have to be maintained where the threshold limits have been met. Further, the law states that the said documents, if requested by the tax authorities, will have to be furnished within 30 days. The UAE TP Guide states that local and master file will have to be maintained contemporaneously viz., by the time the Tax Return / TP Disclosure form is filed (para 6.6.2). There have been certain concerns by taxpayers and stakeholders on the requirement of uploading the TP documents along with the Tax return, since the said documents are required to be furnished within 30 days from date of request by tax authorities. In this regard one can construe that since the documentation requirements is to be maintained on contemporaneous basis as per Federal Decree law and UAE TP Guide, the TP Disclosure Form includes a feature to file the said documents to demonstrate such maintenance.

Conclusion

The TP Disclosure Form is a long-awaited form by the taxpayers in the Corporate Tax Return. With the TP Disclosure Form being live, there is reasonable certainty to taxpayers on the information and documents to be filed / submitted with the tax authorities, as the due date for first filing is approaching viz., 31 December 2024.

However, there are certain aspects mentioned in the aforementioned section in the TP Disclosure Form requiring additional clarification from the tax authorities. The filing of the local file, Master File and other documents along with the TP Disclosure Form is a new requirement, which taxpayers will have to keep note, as the regulations specifically provided only contemporaneous maintenance of these documents.

Perhaps a detailed guidance by the FTA can provide more clarity to the taxpayers w.r.t. information and documentation to be filed in the TP Disclosure form, and would add an element of certainty surrounding the Transfer pricing compliances for businesses.

About us

VSTN Consultancy Private Ltd is a boutique Transfer pricing firm with extensive expertise in the field of international taxation and transfer pricing. VSTN Consultancy has been awarded by International Tax Review (ITR) as Best Newcomer in Asia Pacific – 2024 and is recognised as one of the finest performing transfer pricing firms.

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, Global Documentation, BEPS related compliances (including advisory, Masterfile, Country by Country report), 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 six decades in the transfer pricing space with Big4s spanning clients, industries and have cutting edge knowledge and capabilities in handling complex TP engagements.

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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

CORPORATE GUARANTEE – A DEEP DIVE

Overview

With the rise of globalization and the blurring of national borders in business operations, financial transactions between Indian companies and their international counterparts have increased. Considering the current litigation landscape surrounding financial transactions, it is crucial to ensure that these transactions are conducted with full transparency, at an arm’s length price, and with the necessary approvals. One common type of related party transaction is financial guarantees, where one entity guarantees the obligations of another group entity seeking funds from a financial institution. Often, these guarantees are provided without any consideration, leading tax authorities to scrutinize their reporting and tax implications more closely. Apart from direct tax implications, guarantee is viewed critically from indirect tax perspective – levy of GST on guarantee as a service. In transfer pricing, tax authorities

have become more aggressive obligations if the guaranteed party fails to meet them. on determining the arm’s length application on such transactions, Various terms describe different taxpayers face difficulties in forms of credit support within a determining the taxability and multinational group, ranging valuation of these from formal written guarantees arrangements. to mere implicit support due to group membership (passive association). In this context, a Corporate guarantee involves a guarantee is defined as a holding company assuring the legally binding promise by the financial obligations of a guarantor to fulfil the subsidiary or another affiliated obligations of the guaranteed entity within the same group. entity in the event of a default. This guarantee helps the subsidiary to secure loans with competitive interest rates.

1. What is a Corporate Guarantee?
2. Transfer Pricing Perspective on Corporate Guarantees

A financial guarantee involves a commitment by the guarantor Financial transactions are a to cover specific financial significant source of transfer

pricing disputes between taxpayers and tax authorities. In MNC group, a guarantor provides guarantees to its affiliated entities because it has a vested interest in the subsidiary’s performance. The provision of such guarantees by global multinational enterprises has led to contentious issues in financial transactions.

The Organisation for Economic Co-operation and Development (OECD) Guidelines in the 2022 edition has covered a new section on the financial transactions including guarantees. In order to evaluate the transfer pricing implications of a financial guarantee, it’s crucial to first comprehend the specifics of the guaranteed obligations and their impact on all involved parties, accurately delineating the actual transaction. Some key aspects are given below:

Economic Benefits of Financial Guarantees

An understanding of the economic benefits that the borrower gains, which go beyond the benefits of mere group membership is critical. Financial guarantees can influence borrowing terms. For instance, having a guarantee might enable the borrower to secure a lower interest rate or access a larger loan amount due

to the lender’s assurance of reduced risk.

Enhancement of Borrowing Terms: For a lender, a guarantee means that the guarantor legally commits to covering the borrower’s debt in case of default, potentially lowering the lender’s risk. This might allow the borrower to obtain loan terms as if they had the guarantor’s credit rating rather than their own. Pricing methodologies for such guarantees are akin to those used in loan pricing.

Borrower’s Cost Evaluation: If an intra-group guarantee reduces the borrower’s cost of debt, the borrower might be willing to pay for the guarantee if it does not worsen their overall position. The costs associated with obtaining the guarantee should be compared with the cost of borrowing without the guarantee, considering any implicit support. The guarantee could also impact other loan terms, depending on the specific circumstances.

Increased Borrowing Capacity: When a guarantee allows the borrower to secure a larger loan than possible without it, the guarantee impacts both the borrowing capacity and the interest rate. This scenario raises two questions: whether part of

the loan should be considered as a direct loan to the guarantor (and subsequently as equity from the guarantor to the borrower) and whether the guarantee fee for the remaining portion is at arm’s length. Analysis may reveal that the guarantee fee should apply only to the portion accurately deemed a loan, with the rest treated as a capital contribution from the guarantor.

Key considerations while providing a guarantee include whether group membership provides implicit benefits, whether an explicit guarantee qualifies as a shareholder activity or service, the associated costs of the guarantee, and the likelihood of securing a loan without the guarantee. Explicit guarantee is legal binding and usually provides the relevant rights to the creditor to enforce commitment.

Three types of explicit guarantees are commonly used 1) Downstream guarantees: a parent company issues a guarantee to external creditors for the benefit of one of its subsidiaries when that subsidiary enters into agreements with external creditors (typically used in decentralized business structures or when the location

of the subsidiary is more attractive for obtaining external financing); 2) Upstream guarantees: a group company issues a guarantee to external creditors for the benefit of its parent company where the latter enters into agreements with the external creditors (typically used when the external financing is obtained at a parent or holding level or when the parent company performs central treasury functions); and 3) Cross guarantees: Several group companies issue guarantees to external creditors for the benefit of each other with the effect that they can all be considered as one single legal obligor (typically used in cash pooling).

Implicit guarantee on the other hand is deemed to be present once the borrower is part of a MNC Group (passive association) and has the financial backing of the Group. This implicit group support or guarantee can enhance the credit rating, potentially lowering its financing costs (interest rates) or increasing its borrowing capacity. Since this incidental benefit arises from the controlled entity affiliation with the group, no payment is required for such implicit guarantees. Comfort letters/letters of intent include a promise (generally not legally binding) provided, in most cases, by a parent company to

an MNE company which states that the former will oversee the latter’s affairs in order to be in accordance with the group strategies and rules, and refrain from taking adverse actions that would compromise the financial stability of another group company. Agreements which include a declaration provided, in most cases, by the parent company to an MNE company which states that the former will provide the latter with additional capital to prevent the risk of its default. However, these generally do not transfer risk and generally are not considered as financial guarantees that require an arm’s length payment.

3. Corporate Guarantees as International Transactions

Initially the definition of International Transaction was restricted to “a transaction between two or more associated enterprises, either or both of whom are non residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service

or facility provided or to be provided to any one or more of such enterprises.”

Most of the taxpayers took a position that it was not an international transaction in the first instance and then went on to about the need for a consideration for such guarantee. The issuance of corporate guarantee was considered in the nature of shareholder activity/quasi capital and not having bearing on profits, income, losses or assets of an enterprise and thus could not be included in the provision of services. In the case of Micro Ink Limited (ITS-568-ITAT-2015(Ahd)-TP) – November 27, 2015) ITAT deletes the Transfer pricing adjustment in respect of corporate guarantee considering the issuance of corporate guarantee was in nature of shareholder activity capital and thus could not be included within ambit of ‘provision for services’ under definition of ‘international transaction’ u/s.92B.Also in the case of Delhi Bench Tribunal in Bharti Airtel Ltd v. Addl. CIT(I.T.A. Nos.: 5636/Del/2011 March 11,2014), found that guarantee provided by the assessee does not have any bearing on profits, income, loss or assets of the assessee and hence it is not international transaction.

The scope of definition of international transaction has been extended in Finance Act 2012 with retrospective effect from 1st April, 2002. Various international transactions that were earlier outside the scope of transfer pricing have been brought within the ambit of Indian Transfer Pricing regulations through inserting Explanation to section 92B. The expanded definition included the below:

c. Capital financing, including any type of long term or short term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business;

It gives substantial clarity to the statute that corporate guarantee is included under the ambit of ‘international transaction’ under Section 92B as the word ‘guarantee’ is used under explanation of clause (c) of Section 92B.

For the assessment years after the aforementioned amendment, Tribunals and Courts have ruled guarantee as an international transaction.

4. Benchmarking approaches

OECD guidelines describe several approaches to determining market values for circumstances in which the guarantee payment is considered appropriate.

Companies should consider adopting an appropriate benchmarking analysis for arriving at the Arm’s Length Price of corporate guarantees fees. One could adopt any of the below 5 approaches to price corporate guarantees.

CUP Method

The CUP (Comparable Uncontrolled Price) method is applicable when there is external or internal comparables, such as independent guarantors providing guarantees for similar loans or when the same borrower has other comparable loans with independent guarantees.

To determine if controlled and uncontrolled transactions are comparable, all factors affecting the guarantee fee should be considered. These factors include the borrower’s risk profile, the guarantee’s terms, the underlying loan’s specifics (e.g., amount, currency, maturity, seniority), the credit rating difference between the guarantor and the guaranteed party, and prevailing market conditions. When available, guarantees from uncontrolled transactions are generally the most reliable for establishing arm’s length guarantee fees.

Conversely, there are financial instruments that can be used as proxies to determine the price of

these transactions, for example, letters of credit, bank guarantees, surety bonds (similar to guarantee rates), guarantee contracts.

The challenge with using the CUP method is the scarcity of publicly available information on sufficiently similar credit-enhancing guarantees between unrelated parties, as such guarantees are rare.

Yield Approach

This approach quantifies the profit the secured party receives from the guarantee in terms of lower interest rates. The method calculates the spread between the interest rate the borrower would pay without the guarantee and the interest rate payable with the guarantee.

First step involves determining the interest rate the borrower would have had to pay on his/her own merits, considering the impact of implicit support due to his/her membership in the economic group.

Then, determine the interest rate payable with the benefit of the explicit guarantee. The interest rate can be used in quantifying the benefit gained by the borrower as a result of the guarantee. In determining the extent of the benefit provided by the guarantee, it is important to distinguish the impact of an

explicit guarantee from the effects of any implicit support as a result of group membership. The benefit to be priced is not the difference between the cost to the unguaranteed borrower on a stand-alone basis and the cost with the explicit guarantee but the difference between the cost to the borrower after taking into account the benefit of any implicit support and the cost with the benefit of the explicit guarantee.

The result of this analysis establishes a maximum guarantee rate that the recipient of the guarantee will be willing to pay. The difference of the saved interest is shared between the guarantor and borrower. The interest differential attributed to the guarantor is the maximum guarantee fee payable by the borrower.

It should be noted that this approach is often used to price financial guarantees due to its simplicity and transparency.

Cost Approach

This method estimates the value of a guarantee by calculating the additional risk borne by the guarantor, which could be based on the expected loss or the capital required to support the risk.

Various models can estimate expected loss or capital

requirements. Some pricing models, like option pricing or credit default swap models, treat the guarantee as a financial instrument to approximate the default risk and determine the fee. The accuracy of these models depends on the assumptions used, and the cost method sets a minimum fee, which may not reflect an arm’s length transaction on its own.

The most widely used models for market pricing under this approach are based on the premise that financial guarantee is equivalent to another financial instrument and sets the price of the alternative, for example, by treating the guarantee as a put option or a CDS. In this regard, publicly available CDS spreads data can be used to approximate the default risk associated with the loan and, consequently, the guarantee fee.

This approach sets a minimum fee that the guarantor should be willing to accept.

Valuation of Expected Loss Approach

This approach calculates the guarantee’s value by estimating the probability of default and adjusting for the expected recovery rate. This valuation is then applied to the nominal

amount guaranteed to determine the cost of the guarantee, which can be priced using commercial models such as the Capital Asset Pricing Model (CAPM). Examples: probabilistic methods, Value at Risk

Credit rating. The guarantee can then be priced based on the expected return on this additional capital, reflecting only the impact of providing the guarantee rather than the overall activities of the guarantor.

Capital Support Method

The capital support method is used when the risk profile difference between the guarantor and borrower can be addressed by adding capital to the borrower’s balance sheet. First, determine the borrower’s credit rating without the guarantee but with implicit support, then identify the amount of additional notional capital needed to match the guarantor’s creditable value.

Companies should choose an appropriate benchmarking method for determining the arm’s length price of guarantee fees.

5. Litigation and Corporate Guarantees

Given Corporate guarantee is litigative in nature it is advisable for the tax payers to have the supporting documentation. This should

include information on the nature of the corporate guarantee, its purpose (whether as a shareholder activity or service), how the funds are utilized, thorough benchmarking analyses, and other relevant comparable data.

Some taxpayers do not charge a guarantee fee or set it at a very low level arguing that such fees are related to shareholder activities. Others determine the rate for corporate guarantees on an ad hoc basis or rely on judicial precedents without considering the specific facts of their case.

In practice, tax officers often challenge these ad hoc corporate guarantee fee determinations by applying higher fee rates or comparing them to bank guarantee rates, which are generally higher. Currently, litigation concerning corporate guarantees focuses on determining arm’s length pricing. Tribunal decisions generally support a corporate guarantee fee ranging from 0.5% to 0.85% as being at arm’s length. Bombay High Court in Everest Kento Cylinders Ltd (ITS-200-HC-2015(BOM)-TPI – May 8, 2015) found that a 0.50% fee was appropriate based on the facts of those cases. Conversely, the Madras High Court in Redington (India) Limited (T.C.A.Nos.590 & 591 of 2019 –

10-12-2020) determined that a 0.85% fee was appropriate based on its case specifics. Numerous decisions from Income Tax Appellate Tribunals have also upheld the 0.50% rate.

6. Global Perspectives on Corporate Guarantees

The current US Treasury Regulations do not fully address transfer pricing for financial guarantees. There is ongoing review on whether guarantees should be treated as a service and how to apply valuation methodologies to ensure arm’s length pricing. The IRAS in Singapore has expanded its guidance to include financial guarantees. Taxpayers must adhere to the arm’s length principle for financial transactions, including guarantees, and follow the OECD Transfer Pricing Guidelines for pricing such transactions. Recently UAE has implemented Corporate Tax along with Transfer pricing. UAE has included Financial Guarantee in the transfer pricing regulations and hence tax payers in UAE need to be vigilant while considering corporate guarantee.

7. Global Jurisprudence

One of the most important cases isCanada vs. General Electric Capital(2010 FCA 344) is a landmark decision in the realm

of transfer pricing, particularly for financial transactions. It highlighted the complexities involved in pricing corporate guarantees and a strong credit rating(implicit support) even without the explicit guarantee can be consider when applying the arm’s length principle. It also upheld the view that the valuation of the explicit guarantee was excessive. The pricing of the explicit guarantee should have been lower than the CRA’s assessment due to the implicit support enjoyed.

In few rulings, justification was provided for not compensating the guarantee transaction when it linked to shareholder activity. In the case of Germany vs. Hornbach-Baumarkt AG((Case No. 1 K 1472/13 august 2023), the ruling reinforced the principle that intra-group financial arrangements must be priced at arm’s length, but it also established that companies can argue economic justification for non-arm’s length transactions, especially when linked to shareholder interests. The decision emphasized the importance of providing sufficient evidence of economic necessity when defending intra-group transactions that deviate from the arm’s length principle.

Also there are decisions which underlines the importance of understanding that intercompany agreements,

especially non-arm’s length transactions such as guarantees, must meet tax authorities’ documentation standards. In the case of Poland vs. A. Sp. z o.o.( Case No. I SA/Rz 1178/18 (March 2019), the decision reinforces the obligation for multinational companies operating in Poland to ensure proper transfer pricing documentation that reflects the full scope of financial interactions between related parties.

8. Interplay between GST and Transfer pricing

The application of GST to corporate guarantees has been a controversial topic. The primary issue has been whether providing corporate guarantees constitutes a service under GST regulations. Previously, under the service tax regime, courts suggested that corporate guarantees did involve a service component. With the introduction of GST, Rule 28(2) of CGST rules 2017 was established, setting the value of corporate guarantees at a maximum of 1% of the borrowed amount or the actual consideration, whichever is higher. It can be noted that reference of 1% cap is also present in the Safe Harbour rules issued by CBDT for transfer pricing. Indian tax

authorities, both direct and indirect, are coordinating to interpret the definition of corporate guarantees and determine the applicable percentages. Effective documentation is crucial for taxpayers to manage risks related to Transfer Pricing and GST and to avoid conflicts with tax authorities.

9. Conclusion

Corporate guarantees play a significant role in financial transactions and transfer pricing. The proper classification, valuation, and documentation of these guarantees are crucial for compliance and dispute resolution. Understanding the nuances of local and international regulations can help companies navigate these complex issues effectively.

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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

Direct Tax Vivad Se
Vishwas Scheme, 2024

Background

The Finance Minister presented the full year Union Budget for 2024-25 on 23 July 2024. As a measure to address the rising number of pending litigation cases at various levels, it has been now proposed to introduce Direct Tax Vivad Se Vishwas Scheme (DTVSV), 2024 with an objective of providing a mechanism for dispute resolution, which shall also apply to pending Transfer pricing Appeals.

The Vivad Se Vishwas Act, 2020, which dealt with appeals pending as of January 31, 2020, was an initiative which received widespread support from taxpayers and contributed significantly to government revenue. However, litigation backlogs have continued to increase, with more appeals being filed than resolved. In light of the success of VSV 2020 and the rising number of appeals pending, the introduction of DTVSV 2024 aims to establish a framework for settling disputed issues, thereby reducing litigation while minimizing the financial burden on the taxpayer.

The alert covers the key aspects of the DTVSV 2024 notification

Notification

As promised in the Union Budget for 2024-25, the notification for Direct Tax Vivad Se Vishwas Scheme was released on September 19, 2024 providing a detailed explanation which covers definitions, eligibility amount payable, forms, filing process. The Direct Tax Vivad Se Vishwas Scheme will come into force on 01 October 2024 however the last date to file the scheme is yet to be notified. The Scheme provides for lesser settlement amounts for a ‘new appellant’ in comparison to an ‘old appellant’. The Scheme also provides for lesser settlement amounts for taxpayers who file declaration on or before 31.12.2024 in comparison to those who file thereafter.

1. Eligibility

A taxpayer is eligible to apply to the scheme if,

• An appeal, writ petition, or special leave petition is pending before CIT(A), ITAT, High Court, or Supreme Court, whether filed by the taxpayer, the income tax authority, or both.
• The taxpayer has submitted objections to the Dispute Resolution Panel (DRP), and no directions have been issued by the DRP before the specified date.
• The DRP has provided directions under section 144C(5) of the Income-tax Act, but the Assessing Officer has not finalized the assessment under section 144C(13) by the specified date.
• The taxpayer has submitted an application for revision under section 264 of the Income-tax Act, and it remains unresolved as of the specified date.

The specified date as per the notification is July 22,2024.

2. Amount payable by the applicant

In line with the provisions of this Scheme, when a taxpayer submits a declaration regarding tax arrears to the designated authority under section 91 by the specified deadline, the amount the taxpayer is required to pay under this Scheme is as specified in the table below, irrespective of any provisions in the Income-tax Act or other prevailing laws.

Timing	Nature of Tax arrear	Amount payable under this Scheme on or before the 31st day of December, 2024.	Amount payable under this Scheme on or after the 1st day of January, 2025 but on or before the last date.
Appeal filed after the 31/01/2020 but on or before 22 July 2024	Where the # Tax arrear is the aggregate amount of disputed tax # Interest chargeable or charged on such disputed tax # Penalty leviable or levied on such disputed tax	Amount of the disputed tax.	The aggregate of the amount of disputed tax and 10% of disputed tax.
Appeal filed after the 31/01/2020 but on or before 22 July 2024	Where the # Tax arrear relates to disputed interest or disputed penalty or disputed fee	25% of disputed interest or disputed penalty or disputed fee.	30 % of disputed interest or disputed penalty or disputed fee.
Appeal filed before 31/01/2020	Where the # Tax arrear is the aggregate amount of disputed tax # Interest chargeable or charged on such disputed tax # Penalty leviable or levied on such disputed tax	The aggregate of the amount of disputed tax and 10% of disputed tax.	The aggregate of the amount of disputed tax and 25% of disputed tax.
Appeal filed before 31/01/2020	Where the # Tax arrear relates to disputed interest or disputed penalty or disputed fee	30% of disputed interest or disputed penalty or disputed fee	35% of disputed interest or disputed penalty or disputed fee:

If an appeal, writ petition, or special leave petition is filed by the income-tax authority regarding any disputed issue before the appellate forum, the amount payable by the tax payer/appellant shall be half of the amount listed in the Table above, calculated for that issue, as prescribed.

Further, if the tax payer/appellant files an appeal before the Commissioner (Appeals), Joint Commissioner (Appeals), or the Dispute Resolution Panel regarding an issue on which they have already received a favorable decision from the Income Tax Appellate Tribunal or the High Court (and this decision has not been overturned by the High Court or Supreme Court, respectively), or if the taxpayer files an appeal before the Income Tax Appellate Tribunal on an issue where they have already received a favorable decision from the High Court (not overturned by the Supreme Court), the amount payable shall be half of the amount listed in the Table above, calculated for that issue, as prescribed.

3. Disputed Tax

The term “disputed tax” for an assessment or financial year refers to the income tax, including surcharge and cess owed by the tax payer/appellant under the Income-tax Act, is as per below:

(A) If an appeal, writ petition, or special leave petition is pending before the appellate forum as of the specified date, the disputed tax is the amount that would be payable by the appellant if the decision were made against them.
(B) If an objection filed by the appellant is pending before the Dispute Resolution Panel (DRP) under section 144C of the Income-tax Act on the specified date, the disputed tax is the amount payable if the DRP were to confirm the variations proposed in the draft order.
(C) If the DRP has already issued directions under subsection (5) of section 144C, but the Assessing Officer has not completed the assessment under subsection (13) by the specified date, the disputed tax is the amount the appellant would owe based on the upcoming assessment order from the Assessing Officer.
(D) If a revision application under section 264 of the Income-tax Act is pending as of the specified date, the disputed tax is the amount that would be owed if the application were denied.

Additionally, if the dispute relates to the reduction of tax credit under section 115JAA or 115JD, or to any loss or depreciation calculated under those sections, the appellant can either include the amount related to the tax credit, loss, or depreciation in the disputed tax amount, or choose to carry forward the reduced tax credit, loss, or depreciation as prescribed.

4. Filing of declaration and particulars to be furnished

A Tax payer must file a declaration under section 90 with the designated authority in the prescribed form and manner. Upon submission, any pending appeals concerning disputed income, interest, penalties, fees, or tax arrears before the Income Tax Appellate Tribunal, Commissioner (Appeals), or Joint Commissioner (Appeals) will be deemed withdrawn from the date the certificate under section 92(1) is issued. If the declarant has filed an appeal or writ petition in any appellate forum, High Court, or Supreme Court regarding the tax arrear, they must withdraw it, with court permission if necessary, after receiving the section 92(1) certificate, and provide proof of withdrawal along with payment confirmation to the designated authority.

Additionally, the declarant must provide an undertaking waiving any direct or indirect rights to pursue legal remedies or claims related to the tax arrear, as prescribed. The declaration will be considered void if: (a) any false information is provided; (b) the declarant breaches any conditions of the Scheme; or (c) the declarant violates the undertaking given under 91(4). In such cases, all withdrawn proceedings and claims will be reinstated. Furthermore, no appellate forum can decide on any issue related to the tax arrear once an order or payment under section 92(1) has been made

5. Timing and Manner of Payment

The designated authority must determine the amount payable by the declarant within fifteen days of receiving the declaration, formalizing this in an order that includes details of the tax arrear and the amount payable in the prescribed format. The declarant is required to pay this amount within fifteen days of receiving the certificate and must notify the designated authority of the payment in the prescribed form; upon receipt of this notification, the designated authority will issue an order confirming the payment. Any order issued under this provision will be conclusive regarding the matters it addresses, preventing them from being revisited in any other proceedings under the Income-tax Act or other applicable laws. Additionally, submitting a declaration under this Scheme does not imply acceptance of the tax position, so it is not permissible for either the income-tax authority or the declarant, involved in an appeal, writ petition, or special leave petition, to argue that either party has acquiesced to the decision on the disputed issue by opting to settle the dispute.

6. Non applicability of Scheme in certain cases.

The provision of this scheme does not apply to the following cases

1. In respect to Tax arrear
   1. relating to an assessment year in respect of which an assessment has been made on the basis of search initiated under section 132 or section 132A of the Income-tax Act
   2. relating to an assessment year in respect of which prosecution has been instituted on or before the date of filing of declaration
   3. relating to any undisclosed income from a source located outside India or undisclosed asset located outside India;
   4. relating to an assessment or reassessment made on the basis of information received under an agreement referred to in section 90 or section 90A of the Income-tax Act,
2. Any person in respect of whom an order of detention has been made under the provisions of the Conservation of Foreign Exchange and Prevention of Smuggling Activities Act, 1974 on or before the date of filing of declaration with certain provision to be considered
3. Any person in respect of whom prosecution for any offence punishable under the provisions of the Unlawful Activities (Prevention) Act, 1967, the Narcotic Drugs and Psychotropic Substances Act, 1985, the Prohibition of Benami Property Transactions Act, 1988, the Prevention of Corruption Act, 1988, the Prevention of Money-laundering Act, 2002, has been instituted on or before the filing of the declaration or such person has been convicted of any such offence punishable under any of those Acts;
4. Any person in respect of whom prosecution has been initiated by an income-tax authority for any offence punishable under the provisions of the Bharatiya Nyaya Sanhita, 2023 or for the purpose of enforcement of any civil liability under any law for the time being in force
5. Any person notified under section 3 of the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992 on or before the date of filing of declaration.

7. Conclusion

Given the lengthy nature of tax appellate process, which can take 12 to 15 years to conclude, and the fact that taxpayers remain liable for interest charges even when delays are beyond their control, the accumulated interest can sometimes equal or exceed the disputed tax amount. Consequently, this scheme offers taxpayers a chance to re-evaluate their ongoing disputes and provides a pathway to lower their overall financial burden.

The nuances between the VSV and DTVSV schemes are notable. Under VSV, a separate declaration was required for each tax year, allowing a single declaration to resolve both an assessment order and a reassessment order appeal for the same year. However, DTVSV mandates filing a separate declaration for each order. The DTVSV Scheme offers lower settlement amounts for a ‘new appellant’ compared to an ‘old appellant.’ Additionally, taxpayers who submit declarations on or before 31st December 2024 benefit from reduced settlement amounts, compared to those who file later. This 2024 DTVSV scheme is a positive step from a tax administration perspective, as it will expedite the resolution of tax disputes and help minimize litigation. Moreover, it provides taxpayers with an opportunity to settle dues and conclude disputes efficiently.

About us

VSTN Consultancy Private Ltd is a boutique Transfer pricing firm with extensive expertise in the field of international taxation and transfer pricing. VSTN Consultancy has been awarded by International Tax Review (ITR) as Best Newcomer in Asia Pacific – 2024 and is recognised as one of the finest performing transfer pricing firms.

Our offering spans the end-to-end Transfer Pricing value chain, including design of intercompany policy, 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), safe harbour filing, audit defence 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 brings in cumulative experience of over six decades in the transfer pricing space having worked with multiple Multinational Companies across sectors/industries in the Big 4 and have cutting edge knowledge and capabilities in handling complex TP engagements.

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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

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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

UNDERSTANDING INDIAN SAFE HARBOUR RULES – AN INDEPTH ANALYSIS

Introduction

In the ever-changing field of international taxation, transfer pricing (TP) remains one of the most intricate and scrutinized areas. Countries across the globe have implemented measures to ensure that multinational enterprises (MNEs) are taxed appropriately within their jurisdictions. As transfer pricing compliances become increasingly detailed, one measure introduced by various countries for simplification of TP requirements for certain class of transactions is the establishment of “safe harbour rules,” which provide a degree of certainty and simplicity for taxpayers in the often-complex field of transfer pricing.

On the same lines, India had introduced its safe harbour rules in 2013, and has later made necessary changes in subsequent years. Even in the Union Budget for 2024-25, the finance minister had mentioned that the scope of safe harbour rules would be expanded and revised to make it more attractive.

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This article explores into the concept of safe harbour rules, evolution of the safe harbour rules in India, discovers the specifics of India’s framework, and assesses its impact on the taxpayers.

Overview

Safe Harbour (SH) is a dispute resolution mechanism, which relieves taxpayers from certain obligations, which are generally imposed on the taxpayers by the provisions under Section 92C and 92CA of the Indian Income Tax Act, 1961. The SH rules prescribe the arm’s length terms and conditions for certain routine/ non-complex transactions.

The objective of introducing SH rules was to significantly reduce the disputes between the taxpayers and the tax authorities. These rules provide a straightforward approach and were intended to reduce the burden on taxpayers. Hence, SH Rules provide certainty to taxpayers and protects them from a detailed TP Scrutiny.

Evolution of Safe Harbour Rules in India

After its enactment vide the Finance (No. 2) Act 2009, the first set of SH rules were notified on 18th September 2013 – Rules 10TA to 10TG and Form 3CEFA (for international transactions) and Rules 10TH and 10THA to 10THD and Form 3CEFB (for specified domestic transactions). The rules were initially applicable for a period of five years from the assessment year (AY) 2013-14 to AY 2017-18 and later extended.

Over time, recognizing the low uptake and the need for more practical thresholds, the Indian government revised these margins and expanded the scope of SH rules in subsequent years. These revisions aimed to make the SH framework more attractive and accessible to small taxpayers, thereby reducing compliance and reducing disputes. The evolution of SH rules reflects a broader effort to balance taxpayer interests with regulatory objectives, contributing to a more stable and predictable transfer pricing environment in India.

Safe Harbour rules for Specified Domestic Transactions are applicable to a company engaged in the business of supply, transmission or wheeling of electricity and a cooperative society engaged in the business of purchase of milk and milk products.

Who can opt for Safe Harbour?

Eligible Assessee has been defined under Rule 10TB and such person should have exercised a valid option for application of SH rules in accordance with rule 10TE. For certain eligible transactions viz., software development services, ITeS, KPO and R&D services, the eligibility criteria which are mentioned in the SH rules were aligned with the Circular 6/2013 issued by the Central Board of Direct Taxes (CBDT). For the purposes of identifying an eligible assessee, that bears insignificant risk for provision of services, the following conditions should be satisfied:

1. The foreign principal performs most of the economically significant functions involved, and provides the strategic direction and framework, either through its own employees or through its other associated enterprises, while the eligible assessee carries out the work assigned to it by the foreign principal;
2. The capital and funds and other economically significant assets including the intangibles required, are provided by the foreign principal or its other associated enterprises, and the eligible assessee is only provided a remuneration for the work carried out by it;
3. The eligible assessee works under the direct supervision of the foreign principal or its associated enterprise which not only has the capability to control or supervise but also actually controls or supervises the activities carried out through its strategic decisions to perform core functions as well as by monitoring activities on a regular basis;
4. The eligible assessee does not assume or has no economically significant realised risks, and if a contract shows that the foreign principal is obligated to control the risk but the conduct shows that the eligible assessee is doing so, the contractual terms shall not be the final determinant;
5. The eligible assessee has no ownership right, legal or economic, on any intangible generated or on the outcome of any intangible generated or arising during the course of rendering of services, which vests with the foreign principal as evident from the contract and the conduct of the parties.

Eligible International Transactions

SH rules can be applied on specific categories of transactions which has a set of targeted operating profit margins. Thus, the tax administration would accept, with limited scrutiny, transfer prices within the SH parameters. Eligible international transactions are defined under rule 10TC. ‘Eligible international transaction’ means an international transaction between the eligible assessee and its associated enterprise, either or both of whom are non residents. They are listed below:

1. Provision of software development services;
2. Provision of information technology enabled services;
3. Provision of knowledge process outsourcing services
4. Advancing of intra-group loans;
5. Providing corporate guarantee;
6. Provision of contract research and development services wholly or partly relating to software development;
7. Provision of contract research and development services wholly or partly relating to generic pharmaceutical drugs;
8. Manufacture and export of core auto components;
9. Manufacture and export of non-core auto components; and
10. Receipt of low value-adding intra-group services

Procedure for applying Safe Harbour Rules

In order to apply Safe harbour rules, the procedure as mentioned under Rule 10TE has to be followed, a summary of which is given below:

1. Application in Form 3CEFA to be furnished to the AO on or before the due date for furnishing of Return of Income
2. Upon receipt of the Form 3CEFA, the AO shall verify whether the assessee is an eligible assessee and the transaction is an eligible international transaction.
3. In case the AO doubts the eligibility, he shall make a reference to the TPO for determination of the eligibility. Reference to be made to the TPO within 2 months from the end of the month in which Form No. 3CEFA is received by the AO.
4. The TPO may require the assessee to furnish necessary information or documents by notice in writing within specified time.
5. If the TPO finds that the option exercised is invalid, he shall serve an order regarding the same to the assessee and the AO. An opportunity of being heard is provided to the assessee before passing the order. TPO needs to pass the said order within 2 months from the end of the month in which reference from the AO has been received.
6. If the assessee objects the same, he shall file an objection within 15 days of receipt of order with the Commissioner, to whom the TPO is subordinate.
7. On receipt of objection, the Commissioner shall pass appropriate orders after providing an opportunity of being heard to the assessee. The Commissioner needs to pass the said order within 2 months from the end of the month in which objection is filed by the assessee.
8. Where the option is valid, the AO shall verify the TP in respect of the eligible international transactions is in accordance with the circumstances specified in rules 10TD(2) or (2A) and if the same is not in accordance with the said circumstances, the AO shall adopt the operating profit margin or rate of interest or commission specified in the said sub-rules, as applicable.
9. If no reference is made or no order has been passed within the specified time limit, the option for SH exercised by the assessee shall be treated as valid.

Reasons for Low Adoption of Safe Harbour by many Taxpayers

Despite the potential benefits and revision of the SH rules, adoption of dispute resolution mechanism has been largely skewed towards Advance Pricing Agreement (APA) and Mutual Agreement Procedure (MAP). There are several reasons why taxpayers are hesitant to opt for SH rules. The SH rules often require companies to adhere to profit margins that are higher than what they might achieve under normal market conditions. For many businesses, particularly in competitive industries like IT and ITeS, these margins are considered commercially unviable, leading them to not evaluate SH as an option.

SH rules are rigid, offering redefined benchmarks with little room for negotiation or adjustment based on the specific circumstances of a company. This lack of flexibility can be a deterrent, especially for businesses with unique operational models or those operating in volatile markets. The SH rules apply only to certain types of transactions and industries, such as IT services, ITeS, Auto, intra-group loans etc. Companies with diverse or complex transactions that fall outside the scope of SH rules may find them irrelevant or insufficient for their needs.

While SH rules are designed to reduce scrutiny, they do not completely eliminate the possibility of audits or inquires, especially if the company engages in transactions outside the scope of SH rules, it is still possible for tax authorities to audit other transactions.

Aspects under Safe Harbour which are not utilised/undervalued

For the below categories of transactions, one should reevaluate SH option after considering the effectiveness and resourcefulness of this option vis-à-vis other alternate dispute resolution mechanisms.

1. IT & ITeS companies with revenue less than 200 crores can evaluate their transactions and can opt for Safe Harbour instead of choosing APA. The targeted margins under these two dispute resolution mechanisms varies only by a marginal percentage. The Companies can benefit from the short and simple audit process of SH and avoid the increased cost of resources, reduce the timeline for closure.
2. Companies which pay management charges to its group entities are under litigation constantly. One can opt for SH and eliminate the process of a need benefit test documentation. Under SH these documents are not required and the process is very simple. Companies with management fees less than 10 crores and where the mark-up is 5% can benefit from this provision. Where the intragroup charges exceed the threshold limit, the taxpayer can analyse if the said intragroup charges can be grouped / segmented based on the services covered under the SH Rules and opt for SH Rules for the eligible services.
3. Indian headquartered company which extends corporate guarantee to banks on behalf of their subsidiary can opt for SH and pay a flat 1% on the amount guaranteed. In case of litigation, at the first level the expectation is as high as 2% to 3% on the amount guaranteed. If they opt for this mechanism, no further back-end benchmarking analysis is required.

Expectations / Recommendations on updates in Indian SH Rules

As the government expects to amend the safe harbour rules for improving the acceptance by taxpayers, some of the recommendations are listed below:

• Introduction of royalty as a covered transaction: Royalty expenses are among the most frequently contested international transactions. Like low-value-adding activities, certain safeguards could be implemented, such as setting an upper limit on the value of royalty transactions and requiring a Chartered Accountant’s certificate to verify aspects like the calculation of royalty payments, among others.
• Arm’s length mark-up for knowledge process outsourcing services: It has been traditionally linked to the ratio of employee costs to total costs. However, with the post-pandemic shift to a hybrid work model, businesses have seen a reduction in overhead expenses like office rentals and employee transportation. As a result, this ratio may increase even though the assessee continues to perform the same functions. Therefore, revisions to these ratios can be anticipated.
• Widening the coverage of IT, ITeS and KPO services: The SH Rules have an upper cap of INR 200 crores for IT, ITeS and KPO services. This threshold limit can be expanding with certain safeguards such as employee cost related ratios linked with profitability.

Further, the Finance Minister stated that the SH rates would be introduced for foreign mining companies which are into raw diamonds in India.

Global SH Practices

It would be good to evaluate the Safe Harbour practices adopted by other countries. They are summarised below:

Australia

The Australian Taxation Office provides safe harbour guidelines for low-value-adding intra-group services, including a fixed mark-up of 5% on costs. This simplifies compliance for companies involved in routine services.

Brazil

Brazil is known for its unique transfer pricing regime, which includes specific fixed margins for different types of transactions. Safe harbour provisions can be applied to certain low-value-adding intercompany service transactions. The department of federal revenue (RFB) has set a safe harbour with a 5% gross margin based on the total costs of these low-value-adding services.

Mexico

Mexico offers safe harbour provisions specifically for maquiladoras (manufacturing operations in free trade zones). These rules allow maquiladoras to use a simplified profit margin method to determine the taxable income attributable to the Mexican subsidiary. The safe harbour margin is set at 6.5% of operating costs or 6.9% of the total value of assets, whichever is higher.

Netherlands

Netherland provides a safe harbour regime for intercompany financing transactions. A fixed mark-up of 100 basis points over the risk-free interest rate is allowed for certain low-risk financial transactions.

Singapore

The Inland Revenue Authority of Singapore (IRAS) offers Safe Harbour provisions to reduce the compliance burden for businesses in certain related party transactions. These provisions include a 5% mark-up on costs for routine support services, such as administrative, payroll, and IT support, provided to group companies. These services must meet specific criteria under the TP Rules to qualify. Additionally, for related party loans not exceeding SGD 15 million, an annually published indicative margin can be applied, simplifying transfer pricing compliance without the need for detailed Transfer Pricing Documentation (TPD).

Conclusion

India’s safe harbour rules have been a good step in the direction of simplifying compliances in the country’s transfer pricing regime. They have provided much-needed certainty and simplicity for taxpayers, while also reducing the administrative burden on tax authorities.

As SH has received a lukewarm response, one can expect some developments on this front soon in terms of the notification as mentioned during the Budget 2024. Adjusting the profit margins to more commercially realistic levels would make the SH rules more attractive to companies. Further simplification of the compliance requirements under SH rules, such as reducing the documentation burden (Rule 10D) and streamlining the application process, could encourage more businesses to opt in.

Providing additional incentives for opting into SH rules, such as reduced penalties for minor non-compliance or quicker resolution of transfer pricing disputes, could make the SH regime more appealing. These could make Safe Harbour rules more practical, attractive, and beneficial for a broader range of taxpayers, thereby increasing their adoption and effectiveness.

Apart from reduced litigation and obtaining higher certainty, especially for transactions such as software development services, ITeS and KPO services, catalysed adoption of SH rules would unclog alternate dispute resolution mechanisms – Advance Pricing Agreement, which has significant applications related to the IT space.

(The authors are part of a VSTN Consultancy Private Limited, Transfer Pricing boutique firm and can be reached at snithya@vstnconsultancy.com and krithikao@vstnconsultancy.com).

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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

INTEREST ON OVERDUE RECEIVABLES

Introduction

In the recent era of imposing innovative transfer pricing adjustments by the tax authorities, “Interest on overdue receivables” holds a prominent position. In a TP environment, long overdue receivables (O/R) often being alleged as deemed loan/ capital financing / working capital finance among Associated Enterprises (“AE”) thereby construed as an international transaction u/s 92B by the tax authorities.

Trade receivables (T/R)/ Accounts receivables (A/R) represent the money a business is entitled to receive from its customers for the sale of goods or services. The A/R arising on account of international transactions with the AEs are being critically viewed by the tax authorities as an international transaction, pursuant to a retrospective amendment (w.e.f 1.4.2002) in Section 92B. However there is still no clarity whether the overdue receivables to be treated as a Deemed interest free-loan and if yes, whether

C.A. RANJANI
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interest imputed for providing such loan can be brought under the purview of “International transaction”.

Given this background, in the forthcoming sections we will be discussing about the following:

• Treating Accounts receivable as an International transaction
• Re-characterisation of A/R as loan
• Various approaches adopted by tax authorities to impute interest on the O/R
• Outcome of jurisprudence by various tax forums
• Similar positions taken by other foreign tax jurisdictions

A. Accounts Receivable – an international transaction

In order to analyze whether Accounts Receivable is an international transaction or not, we may have to draw references from explanation given in Section 92B of the Income Tax Act, 1961 (“the Act”)

Explanation – For the removal of doubts, it is hereby clarified that –

(i) the expression “international transaction” shall include –

(a)………

(c) capital financing, including any type of long-term or short-term borrowing, lending or guarantee,

purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business;

The above explanation commences with capital financing and inter alia include any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business. Capital financing by definition refers to raising funds for purposes such as acquiring assets, expanding operations, or undertaking projects, and often support the core capital structure of a company. Though capital financing is typically long term and strategic in nature, the explanation also includes receivable or any other debt arising during the course of business.

Further reference may be drawn from “The Institute of Chartered Accountants of India (ICAI) Guidance Note on Report under Section 92E of The Income-Tax Act, 1961 (ICAI Guidance Note)” which throws light on Transfer Pricing compliance in India. Even though ICAI Guidance note has not specifically commented on the fact whether A/R needs to be treated as a separate international transaction or not, it discusses on the aspect of capital financing transactions and notes that receivable arising on account of a principal

transaction will have to be analysed and ensure that there is no repetition / double counting of the principal transaction and the corresponding balance.

Based on combined reading of the above, it may perhaps be inferred that the intent of law is to cover the Receivable as an international transaction, especially pursuant to the retrospective amendment to Section 92B of the Act vide Finance Act 2012.

The A/R balances remaining typically arise out of the primary international transaction i.e., Sale/Service and accordingly the taxpayers, by adopting aggregation approach, contend that when the said sale/service transaction is concluded to be at arm’s length price, no separate analysis is warranted for the receivable balances.

Having said that, the tax authorities often adopt a contrary position that the accounts receivables outstanding for a longer period partakes the character of a loan and thereby attempt to impute interest on such overdue balances.

B. Re-characterisation of Overdue receivables

The overdue balances are recharacterized as Interest-free loans provided by taxpayer to

the AE and are accordingly subject to interest adjustments by the tax authorities.

The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 2022 (“OECD Guidelines”) provide for recharacterization of the transaction, based on the actual functional analysis (Analysis of Functions performed, Assets deployed and Risk assumed). The following is the extract from the OECD Guidelines:

“1.140. In performing the analysis, the actual transaction between the parties will have been deduced from written contracts and the conduct of the parties. Formal conditions recognised in contracts will have been clarified and supplemented by analysis of the conduct of the parties and the other economically relevant characteristics of the transaction. Where the characteristics of the transaction that are economically significant are inconsistent with the written contract, then the actual transaction will have been delineated in accordance with the characteristics of the transaction reflected in the conduct of the parties.”

The OECD Guidelines provide for recharacterization in the context that when there exists differences between actual

conduct vis-à-vis contractual terms, the conduct of the parties will be considered, and the contractual terms will be disregarded.

The key aspect of recharacterizing O/R as interest free loan is business circumstances / economic relevance surrounding the international transactions. These business circumstances include the following:

• Whether the service provider is a debt-free company
• What is the credit period offered to third parties in comparison with that of the AEs
• What is the industry practices followed in which the taxpayer operates
• Whether the interest component is embedded in sale price, etc.,

For the issue of overdue accounts receivable being treated as loan, it is therefore necessary to understand the position of the Tax authorities, as well as the jurisprudence on this issue.

C. Approaches adopted by tax authorities – imputing interest adjustments

As discussed in the preceding paragraphs, the position of the

Transfer Pricing authorities at a lower level is that the O/R constitute a separate international transaction. The moot argument placed by the TPOs are that pursuant to amendment by the Finance Act, 2012 to Section 92B, the Income Tax Act unequivocally provides that overdue accounts receivable is an international transaction, and therefore the said international transaction should be at arm’s length i.e., an arm’s length interest should be charged for the loan provided to the AEs.

With regard to the issue on O/ R with AEs, customarily the tax authorities adopt the following process:

• Evaluating the credit period offered to the AEs and computing the excess credit period
• Re-characterization of excess credit period to the AEs as deemed financing transaction
• Selection of transfer pricing method
• Computing the arm’s length interest – arriving at the transfer pricing adjustment

i) Credit period evaluation

Examination of credit period of the A/R of the AEs is undertaken through review of

general ledger of the AEs comprising of invoice-wise listing for the respective AEs. With the invoice wise listing, the credit period offered is compared with the actual realisation to arrive at the difference. Alternatively, taxpayers provide the aging for the outstanding accounts receivable as at the year-end for the relevant assessment year.

The arm’s length credit period taken by the TPO is observed to be ranging from 30-60 days, varying due to the stand taken by the TPO for the particular assessment year. Nevertheless, the stand taken by the Revenue in previous year may set a precedence. Though the basis of arriving at the arm’s length credit period viz., 30-60 days is not provided through a robust analysis, references to jurisprudence is cited, at times, in defence of their position.

Based on the above, the TPO proceeds to arrive at the value to accounts receivable that was received / to be received beyond the stipulated arm’s length credit period (30-60 days), along with the tenure of excess credit (viz., number of days beyond the 30-60 day credit period).

ii) Re-characterisation – Deemed Loan

The quantum arrived at in the previous step is re-characterised as a loan given to the AEs by stating that such excess credit period may not be made available by the parties in an uncontrolled situation, as it is in the best interest of the independent party to timely collect such receivable to facilitate smooth working capital.

Further no independent party would grant any excess credit period unless any benefit accrues for the business. The delay in such collection meant the AEs were provided a line of credit for management of the AEs working capital. Therefore, the TPO may contend that such excess credit provided to the AEs would partake the nature of loan granted to the AEs, which is squarely covered under the explanation to Section 92B amended vide Finance Act, 2012 – Capital financing. This credit facility offered to the AEs, a deemed loan, would have to earn an arm’s length consideration viz., Interest.

iii) Selection of TP method

transaction will have to be under the tenants of transfer pricing, the next step is to select the appropriate transfer pricing method to benchmark the transaction. By and large the authorities adopt CUP method similar to traditional financial transactions such as loans.

iv) Computation of Arm’s length price

In audit proceedings as discussed above, the tax authorities call for debtors ageing and in the event of O/R falls due beyond the credit period (industry standards), they tend to impute notional interest on the basis of SBI Prime Lending Rate (PLR) / LIBOR (ARR) plus BPS, etc., TPOs initially arrive at the interest based on SBI PLR, which is shared at the time of issuance of show cause notice to taxpayer. Indian benchmark rates are selected by the TPO as the taxpayer operate in India and the Indian benchmark rates are higher than their foreign counterparts. TPO at times select interest rates issued by the Reserve Bank of India (RBI), when considering use of Indian based benchmarks. Unlike

Indian benchmark rates, where foreign benchmark rates are considered for computing the interest, spread of 200 – 400 basis points (bps) is added. The spread is dependent on the judgment of the TPO, and jurisprudence is given due weightage.

With the benchmark rates, the excess credit period as tenure and corresponding invoice value as principal, the interest is computed by the TPO. This imputed interest is stated as the transfer pricing adjustment in the show cause notice and, as the case may be, in the Transfer Pricing Order for the taxpayer

D. Indian judicial precedence

The amendment to Section 92B of the ITA, by bringing ‘receivables’ under the purview of TP sparked the controversy on alleging O/R as a deemed loan. Having said that the Indian courts held that receivable mentioned under Explanation to Sec. 92B does not mean accounts receivable and thus the O/R cannot be treated as an independent transaction for TP audit.

Various judicial precedents have shed some light on this particular issue, wherein the following cases were ruled in favour of the taxpayers:

CASE REFERENCE	FORUM	PREMISE
Bechtel India Pvt Ltd [TS-591-SC-2017-TP]	Supreme Court	The Hon’ble Supreme Court (SC) have set aside the Special Leave Petition (SLP) filed by the Revenue against Delhi Highcourt (HC). Assessee being Debt-free company, no question of interest adjustment arise
Kusum Healthcare (P.) Ltd [TS-412-HC-2017(DEL)-TP]	Delhi High Court	Hon’ble High Court upheld the view of the ITAT that outstanding receivable is not a separate international transaction and hence not required to be benchmarked independently. Further, it was demonstrated that the impact of excess credit period on working capital was factored in the pricing.

EKL Appliances Ltd. [(2012) 345 ITR 241]	Delhi High Court	When the receivables are factored in the working capital adjusted margins, no further adjustment in the form of interest is warranted, as it will falsify the nature of transaction and re-characterise it.
Msource (India) Pvt Ltd [TS-581-ITAT-2017 (Bang)-TP	Bangalore Tribunal	The transaction needs to be analyzed from the perspective of being undertaken in an uncontrolled situation in order to impute any interest on O/R from AE
Seaways Liner Agencies [TS-71-ITAT-2021(HYD)-TP] AY 2014-15 and ADP Private Ltd [TS-172-ITAT-2021 (HYD)-TP] (AY 2015-16)	Hyderabad Tribunal	Due consideration need to be given to the outstanding amount by Assessee to AE / instances where receivables from AEs were settled well within the due date

The key features transpired from the above rulings were:

1. Re-characterising O/R as an interest free loan is unwarranted
2. Delineating O/R from the main transaction (Sale) in the event of exceeding credit period is unjustified
3. Imputing notional interest on Debt-free companies is unjustified
4. No additional imputation of interest on O/R is warranted if the pricing/profitability of taxpayer is more than working capital adjusted margin of comparables companies
5. Transaction needs to be looked into from the angle of uncontrolled situation – between unrelated parties
6. Due consideration to be given to Accounts payables with AEs and the receivables settled within due date

In-spite of having various judicial precedence in favour of the taxpayers in this subject matter, there have been decisions which have ruled against the taxpayer by treating Interest on Overdue receivables as an international transaction and thereby emphasizing separate benchmarking for the same. Since there still exists some ambiguity in dealing with this issue, the tax authorities continue to impose adjustments during the transfer pricing audit.

E. Position taken by other tax jurisdictions

Globally, few countries like UAE, Korea, etc., in their law also impose arm’s length compensation from the taxpayers i.e., interest, in case the receivables are not settled consistently.

UAE Transfer pricing guide – Corporate tax Guide CTGTP1 (“UAE corporate Law”) opines that there should be a reasonable mechanism between Related Parties or Connected Persons on raising intercompany invoices and the time period of settlement. Hence in case of any extended credit period offered, it could be regarded as an “Advancement of loan” and accordingly interest could be imputed as a compensation.

Similarly, Korean tax Tribunal in a ruling ¹ held that the tax authority’s imputation of an arm’s length rate of interest on overdue accounts receivable from the taxpayer’s foreign affiliate was reasonable, because inspite of overdue accounts receivables, the taxpayer continued to sell goods to its affiliate on credit without developing any measure to collect the accounts receivable.

¹ (2022 Joong 2863, 20 March 2023)

Concluding remarks

This issue has been subject matter of various tax proceedings and as detailed in the preceding sections, various principles have emanated from the tax rulings. Considering the same, some of the key pointers one needs to evaluate are as below:

• Transaction needs to be looked into from the angle of uncontrolled situation – between unrelated parties-charging interest to third parties
• Whether the taxpayer is paying any interest in case of delayed payment on overdue payables to AEs and option of knocking off of such overdue payables with that of the overdue receivables can be explored as a defense strategy
• Taxpayers can resort to claiming working capital adjustment as additional imputation of interest on O/R is not warranted if the pricing/profitability of taxpayer is more than working capital adjusted margin of comparables companies
• In case of debt free companies one could take a position that there is no opportunity cost on account of delayed realisation of receivables

• O/R cannot be treated as a separate transaction as it originates from the main transaction of Sale, which has already been benchmarked
• The actual outcome of O/R needs to be aligned with the terms of the agreement

Further, taxpayers’ nature of business (manufacturing/ trading/service) has a strong bearing on O/R and hence it has to be treated accordingly. For eg., Service recipient gets benefitted as soon as Service provider renders the work, whereas in case of manufacturing & sales, though invoice is raised immediately, the buyer (in case of overseas sales) will not make any payment before the goods are received. So one needs to also factor in the shipping lead time before imputing such interest for product sale companies.

In a nutshell, as the treatment of overdue receivables varies from case to case basis, at this juncture it is imperative to have a clear understanding of the business model, market dynamics and third party receivables of the taxpayer which might help in arriving at a conclusion whether to or not to deem the Accounts receivable as an advance subject to interest charge.

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