The Goods and Services Tax (GST) is being introduced in the country after 13 year long journey since it was first discussed in report by Kelkar Task Force on indirect taxes. Agreeably, one could count GST as country’s biggest tax reform which can trigger transformation on how businesses works across all industries and overhaul India’s fractured tax system.
Amongst several changes proposed in GST, one key proposal is valuation rules prescribed for transacting entities that are related to each other. As per the GST rules, the value of supply of goods and services between related persons may be determined based on the open market value of such supply. The term “market value” has been defined in the Central Goods and Services Act, 2017 (CGST Act) as the amount which recipient of a supply is required to pay for like kind and quality of goods/ services at or about the same time and at the same commercial level where the recipient and the supplier are not related. The detailed rules on methodology for valuation of supply to related parties will be elaborated in the Valuation Rules, which are expected during the end of this month.
Expectedly, the definition is strikingly similar to the arm’s length principle under Transfer Pricing that prescribes the price for a transaction between related parties should be valued as if it was carried out between unrelated parties, each acting in his own best interest.
While one needs to wait until the Valuation Rules are out, it is however expected that the same maybe in line with the definition of arm’s length principle as prescribed under the Transfer Pricing regulations, enshrined under the Income-tax Act, 1961 (the IT Act). In certain developed nations where GST is prevalent since long e.g., Canada, the GST regulations borrow the definition of value of supply between related parties from the Income-tax, where Transfer Pricing is a developed subject. A lot of literature is already present on the subject matter which can be leveraged while determining the arm’s length price of a transaction, including guidance by international bodies such as the Organisation for Economic Co-operation and Development (OECD), United Nations, substantial jurisprudence from various Tax Courts etc. It is accordingly natural that the Indian GST rules may also draw reliance from the Income-tax to frame and advocate rules on valuation of supply between related parties.
On the Indirect tax front, currently, there are specific valuation provisions for import of goods under Customs which are broadly similar to what is present in Income-tax. However, despite having broadly similar rules for valuing a transaction, the taxpayers have been witnessing lack of effective ground level administrative coordination between Income-tax and customs authorities to achieve a single price for the same transaction.
In the past, there have been attempts by Government to move towards convergence of Transfer Pricing and Customs and work towards reconciliation of approaches. Earlier, the Government had also formed a Joint Working Group comprising officers from Income-tax and Customs to work towards exchange of information on a ‘Need to Know’ basis and training programs for officers of both Departments.
However practically, it is often observed that the approach adopted by respective authorities (Customs & Income-tax) is irreconcilable resulting in determination of different transfer price for the same transaction. This may be due to host of factors including but not limited to (a) lack of effective coordination amongst both the authorities, (b) traditional practices followed by customs authorities to value a transaction and (c) inherent conflicting goals of Customs (to increase price of goods to achieve more revenue in terms of custom duty) vis-à-vis Income tax authorities (to reduce expense/ increase income of taxpayer to get more income tax). Moreover, during the Transfer Pricing audits proceedings, the tax officers have been selectively using the data furnished by taxpayers before the customs authorities (intending to show that the price paid by the taxpayer is towards the higher end and there is
no loss of revenue to customs authorities) to hold that the taxpayer have overpriced the cost of goods procured from overseas related parties and consequently undertake Transfer Pricing adjustment.
By dwelling further on this issue, one can make out that the root cause of the problem wherein the taxpayer ends up making separate disclosures before the Income-tax and Customs authorities, goes down to how the system has been set up and how the rules are framed by the Government. Some key areas of concern are listed below:
- While in the Income-tax there is a separate wing of officers who are trained and specialized in understanding the economics of the business and appreciates the fundamentals of Transfer Pricing, the Customs department follows the valuation methodology which is sequential application of the valuation rules.
- Under the Income-tax, the method to be used depends on functional assets and risk analysis of a taxpayer and is based on the concept of best method rule (which suits the most to a particular set of facts of taxpayer), while the customs authorities follow transaction centric approach wherein the functional profile of the taxpayer does not play an important role in determination of arm’s length price.
- Pricing for customs and for Transfer Pricing purposes to maximize tax revenue of the respective authorities’ triggers opposite behavior.
Given the above experience and the GST rules adopted by some developed nations, it may be expected that the Valuation Rules which are being currently framed, are based on the existing Transfer Pricing legislations in the Income-tax. Moreover, the Government may take a step further and should consider taking assistance, on a case to case basis, from specialized wing of IT – Transfer Pricing, for determination of arm’s length price for valuation of supply. This may also boost Government’s objective of ease of doing business and ensuring tax certainty for MNEs operating in India.
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Nicely covered, good suggestion, that too well in time.
I have a query: Is there any change in GST Act in rules/ regulations regarding export of software services to related party.