Assessment issues in COVID year
Defending losses during COVID impacted years
October 2023 is an important month for Transfer Pricing with Form3CEB deadline as well as due date for completion of FY 20-21 TP assessment by TPO. This is also first full year impacted by COVID to be scrutinised by tax authorities. Many companies had incurred losses this year owing to lockdown, low demand, supplychain disruptions etc. Taxpayers not routinely selected for scrutiny have been picked due to sudden losses/reduced profitability, based on risk assessment parameters.
Issues that may arise during TP audit
- Acceptability of economicadjustments considering pandemic was a global issue also impacting comparables
- Reasons for reduced margins/losses incurred by limited risk entities & also in industries which were able to function remotely
- Inclusion of loss making comparables
- Increased impact of overdue receivables because of cash crunch
Taxpayers may have performed economic adjustments in TP document to account for extraordinary circumstances/expenses & these would need to be defended before TPO. OECD released guidance on TP implications of COVID, that recognises the need for performing economic adjustments in the comparability analysis (Guidance also focuses on losses & allocation of COVID specific costs, impact of government grants on ALP etc).
One need to be aware that even in APA cases, during negotiation for limited risk entities, very minimal reduction in targeted outcome was offered for impacted years. The rates prescribed under Safe Harbour rules also had remained unchanged. However, the position tax authorities would take on granting of COVID related adjustments is awaited.
Examples of documentation to be maintained/approaches to substantiate controlled transactions:
- Evidence of third party (arm’s length) behaviour in such circumstances & whether there was renegotiation of prices
- Impact on the Group as a whole including cost cutting measures adopted across locations
- Determine impact of the pandemic by comparing actual vs budgeted results using variance analysis
- OECD recommended statistical methods such as regression analysis to demonstrate ALP (Learnings from earlier recession – 2009). Alternatively, BreakEven Point analysis can be adopted. For details on BEP analysis, refer below Taxsutra article
- Analysis of change in sales volumes and capacity utilisation pre & post COVID
- Carving out abnormal costs (factory shutdown, PPE equipment cost etc). Proof of same – mention in annual report, company website etc
- Other adjustments (Forex, Customs, Working capital, Capacity utilisation) to be reviewed in light of COVID.
Impact on PLI of comparables will have to be considered, where COVID adjustments are claimed. Furnishing of robust documentation with genuine reasoning & evidence is key to defending the losses incurred.