CA Harshil Shah
Introduction– In An increasingly interconnected world, national tax laws have not kept pace with global corporations, fluid capital, and the digital economy thereby leaving gaps that can be exploited by companies who avoid taxation in their home countries by pushing activities abroad to low or no tax jurisdictions. This undermines the fairness and integrity of tax systems. The project, known as Base Erosion and Profit Shifting (“BEPS”) initiated by Organization for Economic Cooperation and Development (“OECD”) is looking at whether the current rules allow for the allocation of taxable profits to locations different from those where the actual business activity takes place and if not, what could be done to change this.
BEPS refers to tax planning strategies that exploits gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity thereby resulting to the scenarios wherein very low or no corporate tax gets paid.
At the request of G20 Finance Ministers, in July 2013 the OECD launched the Action Plans on BEPS, identifying 15 specific actions needed in order to equip governments with the domestic and international instruments to address this challenge. The said Action Plans identified by OECD are in the draft stage yet. The Action Plans recognizes the importance of addressing the borderless digital economy, and will develop a new set of standards to prevent double non-taxation.
Applicability in Indian context
India being a part of G20 summit, will be required to adhere to these action plans and route the implementation of various action plans in the Indian regulations by bringing about necessary amendments through Finance Act. The Action Plans will have a far reaching effect on the Indian TP regulations.
One such action plan is Action Plan 13 which focuses on “Re-examination of transfer pricing documentations” can result in a complete turnaround in the manner in which transfer pricing documentation are currently being maintained in India. BEPS Action Plan 13 sets out guidance on transfer pricing documentation requirements and includes a common template for the reporting of detailed global information to tax authorities on a Country-by-Country (“CBC”) basis, focusing on documenting the information pertaining to the global allocation of income, economic activity, and taxes paid.
“Three tiered approach”
The OECD has prescribed a ‘three-tier’ documentation structure consisting of the following which a taxpayer would require to maintain for the purpose of its transfer pricing analysis:
The guidance under the Action Plan 13 has prescribed the following constituents / requirements that a taxpayer will be required to maintain in its Master File and Local File for the purpose of its transfer pricing analysis. The same is summarized in the below table:
|Master File||Local File|
|1. Organizational Structure:a. Group’s legal and ownership structureb. Geographical location of operating entities||1. Local Entity:a. Local organization chart and management structureb. List of key competitors
c. Detailed description of the business and business strategy pursued (including business restructurings or intangible transfers)
|2. Description of the Group’s Business(es):a. Important drivers of business profits.b. Description of important business restructuring transactions.
c. Description of supply chain for 5 largest products / services.
d. List and brief description of important group service arrangements along with brief functional analysis describing the principal contributions to value creation by individual group entities.
|2. Controlled Transactions (not exhaustive)a. Amount of intra-group payments and receipts involving the local entities broken down by jurisdiction of the foreign payer / recipientb. List of associated enterprises involved in controlled transactions and relationships
c. Detailed comparability & functional analysis with copies of all material intercompany agreements
d. Indication of the most appropriate TP method selected
e. List and description of selected comparable uncontrolled transactions relied on in the TP analysis and possible adjustments performed
f. Copy of APAs or tax rulings to which local tax jurisdiction is not a party but impacting relevant controlled transactions
|3. Group’s Intangiblesa. Description of the overall strategy for development and exploitation of intangibles including Group Transfer Pricing policies, R&D and intangibles.b. List of important Group intangibles with the list of (a) entities legally owning them and (b) important intragroup agreements
c. Important transfers of interests in intangibles within the Group
|3. Financial Informationa. Annual local entity financial accountsb. Information and allocation schedules showing link between financial data used in TP method and annual financial statements
c. Summary schedules and sources of relevant financial data for comparables used.
|4. Group Intercompany Financial Activitiesa. Group’s financing arrangements and related TP policiesb. Identification of central financing entities|
|5. Group’s Financial and Tax Positionsa. List of relevant APAs and tax rulings relating to the allocation of income among countriesb. Annual consolidated financial statement|
Let us now have a look at the nuances of the constituents of Master File and Local File prescribed under the BEPS Action Plan 13 vis-a-vis the present Indian scenario i.e. the Rule 10D of Income Tax Rules, 1962 which list down the contents of transfer pricing documentation.
|Constituents of Master File||Presence in Rule 10D|
|Organizational structure of the MNC||Broadly covered under Rule 10D (1) (a), Rule 10D (1) (b) and Rule 10D (1) (c)|
|Description of MNC’s business|
|MNC’s intangible||Not specifically covered under Rule 10D, however, intangibles relating to the Indian operations are required to be described under Rule 10D (1) (e)|
|MNC’s inter-company financial activities||Not covered under Rule 10D|
|MNC’s financial and tax position||Not covered under Rule 10D|
|Constituents of Local File||Presence in Rule 10D|
|Information relating to local entity||Broadly covered under Rule 10D (1) (a), Rule 10D (1) (b) and Rule 10D (1) (c)|
|Information relating to controlled transactions of the local entity||Covered under Rule 10D (1) (d) to Rule 10D (1) (m) – except details relating to unilateral/ bilateral APAs and similar rulings|
|Financial information of the local entity|
Under the CBC reporting template a taxpayer is required to maintain the following documents jurisdiction wise:
i. Revenues – To related party and to unrelated party;
ii. Earnings before tax;
iii. Income tax paid (on cash basis) and accrued;
iv. Stated capital and accumulated earnings;
v. Number of employees;
vi. Tangible assets (other than cash and cash equivalents)
Further, an addendum to the template should list for each tax jurisdiction the following details:
i. Constituent entities resident in tax jurisdictions.
ii. Details of the tax jurisdiction of incorporation if it is different from tax jurisdiction of tax residence;
iii. Business activities for each constituent entity from a pre-defined list of options options provided in this regard.
While the reporting disclosure and prescribed documentation under the Indian TP regulations broadly covers the local file documentation, the master file and the CBC report as contemplated in Action Plan 13 is generally not currently available to the Indian Tax authorities.
Applicability of the CBC reporting template
The CBC reporting template is applicable only to the companies with consolidated sales of EUR 750 million or more, or approximately USD 850 million. The CBC report will be shared automatically by governments that have strict confidentiality agreements in place. The first report will be due December 31, 2017, for the 2016 year for calendar-year companies. It also appears that the OECD is trying to get countries who agree to share the CBC to enter into bilateral or multilateral dispute resolution procedures if they do not have a treaty or other agreement that contains such a provision with the countries that will receive the CBC report.
Package of measures for implementation of CBC reporting template
The OECD has released a package of measures for the implementation of a new CBC reporting plan developed under the OECD/G20 BEPS Project. The CBC reporting implementation package will facilitate a consistent and swift implementation of new transfer pricing reporting standards developed under BEPS Action Plan 13, ensuring that tax administrations obtain a complete understanding of the way MNEs structure their operations, while also ensuring that the confidentiality of such information is safeguarded. These requirements will require MNEs to provide aggregate information annually, in each jurisdiction where they do business, relating to the global allocation of income and taxes paid, together with other indicators of the location of economic activity within the MNE group, as well as information about which entities do business in a particular jurisdiction and the business activities each entity engages in. The package contains three Model Competent Authority Agreements to facilitate the exchange of CBC reports among tax administration. The model agreements are based on the Multilateral Convention on administrative assistance in tax Matters, bilateral tax conventions and tax information exchange agreements.
Timing of preparation and filing
The first CBC reports will be required to be filed for MNE fiscal years beginning on or after January 1, 2016. MNCs will be allowed 1 year from the close of the fiscal year to which the CBC report relates to prepare and file the CBC report, the first CBC reports would be filed by 31 December 2017. It should be noted that the MNE fiscal year relates to consolidated reporting period for financial statement purposes, not to taxable years or the financial reporting periods of individual group entities.
Based on the views expressed in the UN TP Manual, the tax authorities could possibly use the CBC report information to apply the profit split method to determine the arm’s length allocation of location savings and rents in cases where the comparable uncontrolled transactions are not available, while in arm’s length scenario, the data in the CBC reporting template may not constitute evidence that transfer prices are not appropriate.
Given the global scope of information provided in the master file and CBC report, use of the information provided would require a detailed analysis and focused audit, which, given the resource and constraints, may not be possible.
Therefore, where a need for increased transparency from administrations in understandable, Indian taxpayers face the risk of litigation and double taxation, in cases where the audit procedures, dispute avoidance and resolution procedures are not efficiently designed and implemented, in coherence with the OECD TP guidelines.
The other practical difficulty that may be faced in the implementation of the BEPS Action Plan 13 is the adoption of different accounting principles and conventions by the entities stationed in different jurisdiction in the CBC template thereby leading to the distortion of results.
Further, since the Indian TP regulations do not provide maintenance of the information contemplated in the master file; it would require a change in law in order to be enforceable on taxpayers. However, given the aggressive tax enforcement in India, such information may still be called for by the tax authorities as necessary or relevant for documentation of the ALP of the international transactions of the taxpayer. While the BEPS Action Plan 13 notes that the information in the CBC reporting template “may be useful in risk assessment processes” and “should not be used as a substitute for a detailed transfer pricing analysis”, the challenge for the taxpayers could be defending the tax authorities aggressive analysis of such information.
The taxpayer and the revenue authorities are left with no option but to adopt a mantra of “Wait and Watch” to witness the repercussions of this complete turnaround in the methodology of maintaining the transfer pricing documentation. Let’s hope the regulations to be implemented on this front will not be a burden on the taxpayer and at the same time lead to a transparency in exhibiting a global value chain of the taxpayer’s business for the “reasonable evaluation” of an appropriate transfer price….
**The author is a Transfer Pricing Professional and the views expressed are strictly personal. He can be reached at firstname.lastname@example.org for any queries.