The proposals described in the discussion draft are being developed pursuant to the OECD Base Erosion and Profit Shifting (BEPS) Action Plan, which was issued July 19 2013.
The Discussion Draft proposes a replacement to “Chapter V – Documentation” of the OECD Transfer Pricing (TP) Guidelines, which provides general guidance on the TP documentation process from the perspective of both the taxpayer and tax administration.
The Chapter did not provide for a list of documents to be included in the TP documentation and rules of documentation and burden of proof were left to the relevant jurisdiction.
Action Plan point 13 “Re-examine Transfer Pricing Documentation” was directed to:
“Develop rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business. The rules to be developed will include a requirement that MNE’s provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template.”
The Discussion Draft identifies the following three objectives for requiring TP documentation:
1. to provide tax administrations with the information necessary to conduct an informed transfer pricing risk assessment;
2. to ensure that taxpayers give appropriate consideration to transfer pricing requirements in establishing prices and other conditions for transactions between associated enterprises and in reporting the income derived from such transactions in their tax returns; and
3. to provide tax administrations with the information that they require to conduct an appropriately thorough audit of the transfer pricing practices of entities subject to tax in their jurisdiction
With the above objectives in consideration, the Discussion Draft proposes a standardised approach to TP documentation to be adopted by countries. The proposed two-tier structure of documentation consists of
(i) A master file containing information relevant for all MNE group members. The Master file shall be prepared either for the MNE group as a whole or by line of business, depending on which would provide the most relevant transfer pricing information to tax administrations.
The master file includes a country-by-country (CBC) reporting of certain information, relating to global allocation of profits, the taxes paid and certain indicators of the location of economic activity (tangible assets, number of employees and total employee expenses) among countries in which the MNE group operates. It also requires reporting of the capital and accumulated earnings as well as aggregate amounts of certain categories of payments and receipts between associated enterprises (AEs) (royalties, interest and service fees).
Its purpose is to elicit a reasonably complete picture of the global business, financial reporting, the allocation of the MNE’s income, economic activity and tax payments, so as to assist tax administrations in evaluating the presence of significant transfer pricing risks.
(ii) A local file referring specifically to material transactions of the local taxpayer, including detailed functional and economic analysis.
While India is not a member of the OECD, it has been engaging with the organisation through various OECD meetings. India is a regular observer in the OECD Committee of Fiscal Affairs. Further, as part of the G20, India is actively involved in OECD’s work on BEPS. Tax authorities and courts also generally refer to OECD guidelines for resolving TP disputes, unless the Indian TP regulations specifically deviate from the OECD guidelines.
The Indian TP regulations require the taxpayer to disclose all international transactions and adequacy of the TP documentation in a report certified by an accountant before the due date of filing of tax return for the fiscal year. Further, such taxpayer is required to maintain prescribed TP documentation, which shall be submitted to the tax authorities during audit.
Rule 10D of the Income-tax Rules, 1962 (Rules) provides a detailed list of information and documents to be maintained by the taxpayer, for supporting the determination of the arm’s-length price (ALP) of its international transactions with AEs. Such information is required to be supported by authentic documents, which include published accounts and financial statements relating to the business affairs of the AEs.
In addition to the above, the Indian tax authorities have powers to call for any other specific information and documents, considered relevant or necessary, from the taxpayer or any other person, for determination of the ALP.
While the reporting disclosure and prescribed documentation under the Indian TP regulations broadly covers the local file documentation of the Discussion Draft, the master file and the CBC report template information is generally not available to the Indian tax authorities.
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 determination of the ALP of the international transactions of the taxpayer. While the Discussion Draft 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 taxpayers could be defending the tax authorities analysis of such information. For example: The India Chapter of the UN TP Manual states the Indian tax administration is of the view that, apart from locations savings, profit from location specific advantages (referred to as “location rent”) such as skilled manpower and a superior information network, incentives etcetera should also be allocated between AEs.
Accordingly, based on the views provided in the UN TP manual, the tax authorities could possibly use the CBC report information to apply the profit split method to determine arm’s-length allocation of location savings and rents in cases where comparable uncontrolled transactions are not available, while in an 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 the 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 constraints, may not be always possible.
Therefore, while a need for increased transparency from tax administrations is 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.
(Views expressed are personal)
By Pankaj Jain, associate director - international tax and transfer pricing, EY India
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