TP trends in the technology sector in the APAC region
Manisha Gupta, Vishaka Saraf and Amer Qureshi of Deloitte India provide an overview of the latest TP trends impacting the technology sectors of several Asian jurisdictions.
Rapidly evolving technologies have been a game changer for the way modern day businesses function. With technology being a clear focus for the future, most business functions are expected to go through enhanced levels of automation, and are expected to be powered by AI, machine learning tools and more, thereby replacing traditional ways of doing business. Addressing the resultant tax issues has been one of the primary objectives behind introducing various global tax measures, such as aligning TP principles with value creation as part of OECD BEPS Action plan 8-10, BEPS 2.0, etc.
The importance of the technology sector to the world economy is also evident from the fact that the majority of the top 10 companies in the world by market cap are tech companies. The digitalisation of the economy has ushered in a new era, with new business models emerging at break-neck speed. This dynamism is well explained by TechCrunch, a digital economy news site, which noted: “Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory; and Airbnb, the world’s largest accommodation provider, owns no real estate... ”.
Recently, the usage of various generative AI techniques is gaining traction and is anticipated to soon be the need of the hour. AI chatbots such as ChatGPT, Bard AI and Bing AI will deliver results to user queries in a conversational, human-like manner, based on the inputs received from users.
Tech companies have TP issues that are a bit different from that of brick-and-mortar companies. Tech companies have been coming under the radar of revenue authorities in multiple jurisdictions across the APAC region, given the higher importance of intangibles in their businesses and potential susceptibility towards base erosion and profit shifting.
Let us look at the key TP trends pertaining to the technology sector in select countries in the APAC region.
Japan was one of the first countries to understand the true power of technology and has embraced its benefits. Japan is now one of the most powerful tech giants in the world and is referred to as a technology powerhouse.
Some TP issues raised by the Japanese revenue authorities during TP audits for tech companies include:
Should stock-based compensation be included as part of the cost base for cost plus entities? The premise is that employee stock options are remuneration in the same way as other types of incentives e.g., cash bonuses or benefits in kind. However, due to the lack of uniform accounting treatment of employee stock option plans across jurisdictions, entities are not always required to identify employee stock options in company accounts as salaries or even as expenses. This lack of uniformity has consequences for ensuring comparability between the controlled and uncontrolled transactions and for the application of TP methodologies. Further, there are considerations in terms of determining the valuation of the stock option, period of employment, alignment to accounting principles, fair value approach or a cost-based approach based on market prices; and
Revenue authorities may challenge cost plus markup-based remuneration to a marketing and sales support entity and seek distribution return based on percentage of sales.
Australia is a leading digital economy, and its technology sector is integral to the country’s economy. The Australian technology sector experienced significant growth through the COVID-19 pandemic, with both Australian and overseas headquartered technology companies responding to the digital demands created by the pandemic.
The Australian Taxation Office (ATO) has been alert to the growth of the tech sector and the complex tax and TP issues linked to this growth. In particular, the ATO has continued to focus on the tax and TP aspects of intangible assets, and has recently released draft Practical Compliance Guideline PCG 2023/D2 (draft PCG), which sets out the ATO’s compliance approach to international intangibles arrangements.
The draft PCG will be of relevance to multinational technology companies operating in Australia, and it also provides an indication of the types of arrangements the ATO has concerns with and which taxpayers should be cognizant of (including the bifurcation of intangible assets, the mischaracterisation of Australian development, enhancement, maintenance, protection and exploitation [DEMPE] activities, the relocation or centralisation of intangible assets, and payments for licensing and associated R&D activities).
Also, recent draft legislation introduced by the Australian Government (on March 31, 2023) creates an anti-avoidance rule whereby tax deductions for payments attributable to the exploitation of intangible assets made by an Australian entity, directly or indirectly, to an associate in a low corporate tax jurisdiction will be denied. This new legislation, combined with the draft PCG, the upcoming introduction of the Pillar Two Global Minimum Tax rules, and potential public country-by-country reporting obligations, creates a complex and challenging tax and TP environment for multinational technology companies operating in the Australian market.
The Indian tech sector has recorded strong growth over recent years. According to the National Association of Software and Service Companies (NASSCOM), the premier trade body and chamber of commerce of the tech industry in India, the tech industry in the country has expanded exponentially, and is estimated to reach US$245 billion in FY 2022-23. Overall incremental revenue is estimated to be around US$19 billion during the same period. According to the Deloitte 2021 NASSCOM report, India is the forerunner for the global capability center (GCC) sector, home to more than 1,300 global organisations, which employ more than 1.3 million people, and generated US$33.8 billion in annual revenue as of FY 2020.
A number of these GCCs function as risk-insulated captive service providers, remunerated on a cost-plus mark-up basis, engaged in rendering back-office software development or IT enabled services or contract R&D services. Such GCCs regularly face TP audits in India, with common issues revolving around characterisation of the entities, determination of arm’s length mark-up, selection of comparables, treatment of items as operating/non-operating, and more. Considering the often protracted domestic litigation route, several GCCs prefer to opt for alternate dispute resolution mechanisms such as advance pricing agreements (APAs) or mutual agreement procedure (MAP) to achieve tax certainty.
For GCCs, during recent TP audits and APA/MAP negotiations, the Indian Revenue Authority (IRA) is also focusing on:
Determination of the cost base for mark-up purposes: The IRA seeks details on any software/tools obtained free of cost, stock-based compensation granted by the overseas affiliates to local employees without any charge to Indian entity, etc. In some cases, the IRA has added the notional cost of such free of cost supplies and imputed the mark-up in the hands of the Indian captive entity;
Seeking additional information over and above local files: The IRA is delving into finer details such as secondment of employees, details of patents registered with names of Indian employees, using references from LinkedIn profiles, minutes of internal meetings, details of any outsourcing to third party vendors in India, etc. to understand the role of India captive entity in overall value chain; and
Outstanding receivables from overseas affiliates: The IRA is seeking invoice-wise details of amounts due from overseas affiliates, thereby proceeding to characterise any overdue balance as loans/ advances and computing notional interest income in the hands of Indian entity.
For Indian headquartered technology multinational companies having multiple subsidiaries overseas, the IRA is anticipated to closely look into the location of R&D activities, role of the overseas affiliates, as well as any migration of intangibles outside India, to ensure alignment of profits in line with value creation.
The technology sector in China faces challenges on the TP front as it moves to a highly digitised environment that includes scale without mass, reliance on intangible assets and the significance of data. Given the nature of these challenges and the difficulty to put borders around the digitalised economy, the focus of TP audits in China are on transactions related to such services and royalty fee payments. The Chinese revenue authorities seek to apply value chain analysis as an approach for TP analysis in some cases, rather than to accept a one-sided transactional net margin method-based analysis.
The Philippines technology industry is escalating with new-age technology startups, telecom expansion and availability of a low-cost English-speaking workforce.
The Philippines’ local tax authorities (Bureau of Internal Revenue, BIR) is placing a growing interest in the TP subject with plans to establish a separate international tax law division that will look into TP cases. The focus is on the large taxpayers enjoying tax incentives, entities with low profitability/ losses, and taxpayers entering into international transactions relating to royalty/ management charges. Further, the BIR has started scrutinising the new-age technology start-up companies (primarily in the gaming and financial services sectors) in terms of appropriate arm’s length remuneration policy for intangibles and financing related transactions. Accordingly, it is recommended to maintain updated TP documentation to substantiate the arm’s length nature of all the related party transactions.
Over the past decade, Singapore has become a hub for several top global and regional technology firms, earning its reputation as the digital capital of Asia. Tech firms with presence in the country form part of an ecosystem where they can partner with each other to develop and deliver new solutions. They also take advantage of Singapore’s infrastructure and connectivity to access Southeast Asia and Asia Pacific markets.
Amidst the growing technology industry, the Inland Revenue Authority of Singapore (IRAS) has a heightened focus on TP controversies and increased its TP audits in the past few years. The audits have focused on intercompany service transactions, expense recharges, R&D activities, valuation of intangible assets, business restructuring, intra-group loans, financial guarantees, adequacy of the contents of local files and preparation of local files within the contemporaneous timeline. In addition to TP adjustments made, in several cases, penalties were imposed on such adjustments.
Given the heightened scrutiny, taxpayers, including tech firms, need to adopt a proactive approach to mitigate and minimise their risk exposure. Potential bilateral or unilateral APAs should be considered for transactions that are perceived to be of medium to high risk or involve significant amounts. Adequate TP documentation, having all necessary information relating to the Singapore local entity and its related party transactions, should be prepared on a contemporaneous basis. Intercompany agreements which are aligned with related party dealings in substance should be put in place as these are often the initial documents sought by IRAS during a TP audit.
South Korea has become a technology powerhouse over the last few decades.
Taxpayers paying significant amounts as royalties, intra-group service fees and/or commission fees based on sales to foreign affiliates are facing higher risk of TP challenges by the revenue authorities in Korea. Recently, inter-company royalty payments for the use of brand names/trademarks have become a key focus area of the Korean Revenue authorities. To deal with potential challenges by the tax authorities, it is recommended that taxpayers proactively develop a reasonable valuation method and economic rationality for the above said transactions.
The emergence of new technologies and tech focused companies is likely to result in newer and unique business models, that require careful evaluation of intercompany arrangements and TP implications.
With several APAC countries at the forefront of technological innovation, technology sector and associated TP issues are likely to be a focus area for revenue authorities in future. Amongst others, TP issues associated with intangibles are likely to be one of the most challenging and controversial areas for the technology industry, with the revenue authorities closely scrutinising value creation and intangibles ownership.
Technology multinational companies should therefore be well prepared, right from TP planning to maintaining comprehensive TP documentation, and having in place a robust TP controversy management strategy.
While we have looked at the TP trends for technology companies, another aspect to consider is how technology has been impacting the field of TP. There are already a number of tax technology tools developed to help multinational companies in preparing TP documentation, operational TP, TP litigation, and more. New tools incorporating generative AI techniques are being developed to support multinational companies on various aspects related to TP. We foresee that technology and TP will continue to significantly impact each other.
This article is supported by Sreemoyee Ghose.