TRANSFER PRICING ASSESSMENTS – More than 800 COMPANIES IN INDIA ASKED TO PAY ADDITIONAL TAXES
On May 24, 2010 in Auditing, Tax Revenues
Transfer pricing revenues have seen new age in 2009- in terms of tax revenues, number of audits and quality of audits. TP tax laws have been levied to put a check on the loss of revenue to Indian Government involving cross border deals. The additional tax raised due to TP audits in year 2009 is approx. USD 2.1 Billion. Almost 60% of the cases selected for scrutiny saw adjustments as compared to 25% on an average for last 4 years. The TP laws have accumulated approx. $5Bn in revenues for Indian Govt. in last 5 years
What were critical Audit issues?
» Software/ITES companies – Authorities denied adjustments due to lack of support for profit margin. Search process itself has been rejected for lot of companies. Margins of 21% on cost for software companies and 24% of cost on ITES companies have generally been held as benchmarks.
» Complete disallowance of royalties, management fees etc. in lot of cases where the adequacy of “Benefit tests” has not been proved by the tax payer.
» Notional charges – Guarantee fee as additional revenue for Indian companies when letters of guarantee have been issued to their overseas counterparts
» Notional “marketing intangible” where marketing services are rendered by Indian companies.
» Notional Interest income -Interest levied on interest free loans or delays in receipts of trade receivables from overseas group companies.
» Benchmark of 35-40% was used for investment advisory and banking services.
In most of the cases transfer pricing rules have helped Government in unveiling the actual income which is usually hidden by artificial expenses, transactions not at arm’s length basis or by incurring losses year after year. Penalties and other repercussions can have a very detrimental effect on the entity.
How can companies avoid significant additional taxes, interest and penalties?
The one and the only one solution is PROPER DOCUMENTATION. Needless to say Presentation of proper documentation to the Income Tax authorities is equally important.
The current regulations do provide for a comprehensive list of TP documents that need to be maintained such as board description of the industry, assumptions, commercial basis for pricing, economic and market analysis, price negotiations, in depth industry analysis, business strategies and more… Companies need to select comparables with utmost caution as income tax authorities tend to challenge comparisons and may “cherry pick” profitable companies for comparisons.
Given the widespread extent of outsourced services in India and the increasing “high value” services too, it becomes imperative to carefully structure the TP policy, retain and maintain the proper documentation on an ongoing basis where the commercial reasoning is adequately explained.
What is a good Transfer pricing documentation?
One which is maintained on an “as and when” basis- not something put in place a while back and never revised later! The risks can be huge!
A good approach to avoid the future hassles is to examine the quality and adequacy of documents at regular quarterly or semiannual intervals. An internal review can be done by in “in house” team or preferably by external consultants who have expertise and knowledge in the light of current events. A year end final review and sign off should be done by experts. Even the regulations require the documentation to be contemporaneous as this also helps tax payers to document and capture the practical business realities immediately rather than digging at a later date which can prove to be quite costly!
Future Key Transfer Pricing changes proposed by Indian Government
The proposed changes would be effective from April 1, 2011. It’s high time companies start gearing themselves up and meet the compliances set by the authority.
Some highlights-
-Introduction of APA (Advanced Pricing Agreement). This is the agreement between tax payer and the Income Tax authority determining arm’s length pricing and basis.
-Changes to the definition on associated enterprises- Direct or indirect shareholding reducing from 26% to 10% making it stricter.
-Changes to the process of dispute resolution
-Audited report needs to be filed with Transfer Pricing Officer
-Increased penalties for non filing, non maintenance and non furnishing of information
-No tax authority would have power to waive penalties and more..
These proposed tax changes would give immense power to tax authorities. We are yet to see how ready corporate and tax administration are to accept the changes in entirety! Nevertheless, the TP policies will continue to demand increased attention! Get Ready NOW!
For TP documentation reviews, assistance, more information or specific questions, please contact
neetika@accelero-corp.com.