The entire world including India has been greatly affected on account of COVID-19. It is beyond any doubt that the primary expectation from the Union Budget 2021 will focus on managing the existing situation. Highlighted in this article are key points which require attention from the upcoming budget from a transfer pricing perspective, to ensure better clarity on the measures to tackle the existing adversity.
A. Precedence to be set by the government with a publication of detailed guidelines on transfer pricing implications in India under the COVID situation as already provided by OECD:
While carefully considering the impact of COVID-19, it can be said that some areas of the Income Tax Act, 1961 and Income tax Rules, 1962, especially related to transfer pricing are having a hit on some terminologies and this may be the new normal. Some generic principles like the meaning and definition of Arm's Length Price (ALP), Most Appropriate Method (MAM), comparability analysis will certainly require some modification/expansion in their terminology and understanding for controlling the situation.
1. Re-writing functional, assets and risk analysis:
The present ITA and ITR include guidance for maintaining the description of functions performed, risks assumed, and assets employed for international transactions entered by a taxpayer. Currently, due to COVID-19 business operations across the globe are witnessing a sea change in their business models including the entire value chain of services/products. These changes in business models or the FAR analysis of the international transaction are due to the uncontrolled external factor i.e. the pandemic effect and not based on any business or management decision. Moreover, taking a cue from the OECD guidance on managing the COVID-19 impact, the concept of hazard risk also needs to be factored along with other risks like marketplace risk, operational risk, and financial risk. So, a clear demarcation should be made between the COVID-19 hazard risk and other economically significant risks in case of controlled transactions.
Accordingly, the India Transfer Pricing (TP) Guidelines should be flexible enough to take into cognizance these changes on account of the pandemic as mentioned in the OECD guidelines on the TP implications of the COVID-19 pandemic. Thus, the taxpayer will get guidance to factorise the pandemic effect for accurate delineation of controlled transactions which is different from the pre-COVID period.
2. Comparability analysis:
The entire genesis of comparability analysis is going to take a hit due to this pandemic. This may be due to various factors like:
i. Availability of comparable data:
It needs to be understood that the availably of comparable data to determine the arm's length price will be difficult during the COVID-19 period. This is due to the fact the ITA and ITR explain the comparability with an actual transaction for a particular period. The ITA and ITR should include specific guidance on the kind of pandemic adjustment required to be undertaken by the taxpayer which can be linked with any budgeted or forecasted financial results.
ii. ALP and MAM:
The computation of ALP of related party transactions has to pass-through a selection of the MAM. Now there may be a situation where more than one method may deem closely fit under the new normal. Though ITA prescribes for MAM, it is time to expand the horizon to consider alternate approaches. So, more than one method should be considered especially when the basic premise of availability of comparable data is in question under this pandemic.
iii. Flexibility for use of single-year data:
Use of multiple year data has been prescribed in the ITA for comparability purpose, but if the taxpayer can demonstrate any comparability analysis based on a single year data, then such provisions need to be widened in the ITA.
iv. Inclusion of loss-making comparable:
A generic approach by the tax authorities has been observed in excluding the loss-making companies. This approach needs to be changed solely if any comparable suffers a loss. This can be considered by giving specific guidelines at least for the pandemic period.
3. Margins under Safe Harbour Regime (SHR) to be re-considered:
Safe harbour refers to a legal provision to reduce or eliminate liability under specific situations if certain conditions are met. It refers to circumstances under which the tax authorities shall accept the transfer price declared by the taxpayer for certain international transactions and the same shall be without any question or scrutiny.
We are expecting an update in the SHR for FY 2020-21 and it could be continued for the next 2 years. Based on the current scenario and considering the impact of the pandemic, the margins under SHR should be reduced.
4. Advance Pricing Arrangements (APA):
Critical assumption is an important factor to continue APAs across years which have already been finalised. The economic and market condition under the COVID-19 pandemic has affected business normalcy which consequently disrupts the terms required to be maintained as per the agreed critical assumption. Under such a scenario, tax authorities may prescribe procedural provisions in situations if the taxpayer fails to meet the critical assumption.