Partho Dasgupta, Shweta Gokhale
As we move towards the final quarter of an exceptional monetary year and many other nations step into their subsequent monetary year amidst the ‘new normal’, the OECD released final week a Guidance on the Transfer Pricing Implications of the COVID-19 Pandemic (‘Guidance Note’). A important aspect elucidated in the Guidance Note pertains to losses incurred by Multinational Enterprises (‘MNEs’) due to COVID-19.
What the Guidance Note lays down and how it impacts India
MNEs with operations in India are actively attempting to fathom the danger of transfer pricing challenges in the wake of sudden modifications in revenues, unfavorable/low profitability, and the influence of unexpected charges incurred amidst the pandemic. Whether a restricted danger-bearing entity can incur losses? Can intercompany agreements be renegotiated to address existing challenges? Can charges incurred due to COVID 19 be regarded as exceptional? These are some of the nagging concerns that OECD’s Guidance Note has sought to address.
Given the presence of sales & distribution centres, R&D centres, and back-offices / shared services centres of a lot of massive MNEs in India, the important query is irrespective of whether reporting losses or reduce mark-ups in low-danger entities could pose a transfer pricing danger. In the pre-COVID regime, it was usually argued that a restricted danger-bearing entity ought to not incur losses, and the return on their expense incurred whilst rendering their services/activities to their connected enterprises ought to be at arm’s length.
Accordingly, inter-organization agreements are drawn up to demonstrate the distribution of danger in between connected enterprises, more importantly, to spell out who has manage more than the dangers. Most of the widespread dangers like marketplace / monetary / credit danger and so forth. are pretty low or negligible in the case of a restricted danger bearing entity.
The Guidance Note supplies an general believed on this concern and some-exactly where concludes that it may perhaps be probable to justify such losses as getting triggered by a ‘hazard risk’ that has materialised due to the pandemic, as nicely as uncommon outcomes arising from other ‘economically significant’ dangers such as marketplace danger, operational danger and monetary dangers. Taxpayers ought to demonstrate consistency in danger profiles of such entities pre and post COVID-19 and re-allocation of dangers ought to be substantiated by enough information and company rationale.
These dangers primarily pertain to collapse in demand, disrupted production and provide chains, improved borrowing charges and terrible debts. MNEs ought to recognize the precise dangers to which their losses through the pandemic are attributable and assess irrespective of whether their low-danger entities have been historically profiled to assume any of these dangers (straight or indirectly). A important element described right here is ‘consistency’. Further, in case taxpayers do pick out to report losses in low-danger entities, correct comparable corporations ought to be chosen to substantiate the extent of loss that can be regarded as as “arm’s length”.
The Guidance Note recommends tax authorities to view renegotiation of intercompany arrangements in light of marketplace situations and any equivalent modifications in pricing or other important terms of third-celebration contracts. It is probable for independent parties to extend relaxations, as also ask for concessions to maintain up with existing hardships. For instance, pre-COVID-19, an Indian connected enterprise that is regarded as to have low danger is assured of getting payments inside a stipulated time irrespective of the time taken by ultimate shoppers to spend the overseas entrepreneurial connected enterprise.
However, it is probable that through the pandemic, payments from the ultimate shoppers are more severely impacted. Such renegotiations in turn influence intercompany arrangements that are above or beneath in the worth chain. However, taxpayers ought to substantiate the arm’s length testing of such revisions by means of robust comparability evaluation and sufficient proof. The observations in the Guidance Note are equivalent on losses arising due to the invocation of force majeure clause in intercompany agreements, with due value also offered to the precise language of this clause in the respective agreements.
What the Indian Government and taxpayers ought to do
It is very advised for taxpayers to take the following quick actions: (a) relook at their intercompany agreements (b) revisit their historical transfer pricing documentation minutely to assure that functional and danger profiles of group corporations, monetary and contractual obligations are appropriately spelled out and are constant with monetary choices taken in COVID-19 context and (c) recognize irrespective of whether and to what extent hazard danger and other considerable dangers have impacted their existing danger profile.
Robust documentation to assistance the above and an in-depth market evaluation covering geographical and associated company impacts ought to be captured in the transfer pricing documentation maintained through the pandemic years. These activities ought to not be pushed towards the finish of the year and ought to be constantly monitored and updated.
In order to keep away from unnecessary transfer pricing litigation, the CBDT ought to provide India-precise perspectives on this Guidance Note as nicely as their layout ‘risk areas’ for conducting transfer pricing audits for pandemic years. Another necessary action would be for tax authorities to provide their perception of arm’s length or an acceptable level of losses if incurred by taxpayers on account of the pandemic.
Partho Dasgupta is Partner – Tax and Regulatory Services, and Shweta Gokhale is Associate Director – Tax and Regulatory Services, BDO India. Views expressed are the authors’ individual.