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.