Our last blog specifically covered broad level strategies that could be implemented by an MNC due to the business impact that COVID 19 pandemic could have on the global organizations. This blog specifically covers the practical pathways including most relevant points to ponder by the tp management of an MNC (including the CFOs and the Tax Heads/ Directors). Let us go through these top 6 transfer pricing ideas relevant to the current position:
- Cost-plus entities: Cost plus entities are generally perceived as risk-free or low-risk entities. This means the majority of the risk is passed on to the principal entity and the captive service provider is left-back with a guaranteed return on cost. Even if one considers a risk free environment, every business comes with business risk. If the principal entity is facing business crunch and has survival issues, the possibility of re-working of mark-ups could be looked in to from the captive service provider’s perspective. This could be one of the initial and immediate steps that management of MNC could consider in consultation.
- Safe Harbour: MNCs that are using safe harbour mechanisms for benchmarking the international transactions could have a re-look at the strategy of implementation of the safe harbour for FY 2019-20. Generally, the comparable rates (or profit percentages) are a notch higher in Safe Harbours thereby providing certainty to the taxpayers. If due to certain reasons, if the margins are under pressure (in line with the industry and economy), it could be wise to reconsider the use of safe harbours and undergo a normal transfer pricing route for the relevant financial year.
- Advance pricing Agreements: For all the unilateral agreements that were concluded with certain agreed percentages of profits, may have a risk of non-maintenance of the profit percentages due to independent business circumstances. This might lead to a change in critical assumption thereby making the agreement as void. In such a case, an MNC might want to use the provisions of Rule 10M(4) and 10M(5) of the Income-tax Rules, 1962 and approach the office of Director General of Income-tax (International Taxation) as soon as it is practicable to do so and seek a short term revision to the on-going APA and its critical assumption.
- Limitation of Interest Deduction (Section 94B): Section 94B is a Specific Anti-Avoidance Rule (also called as thin capitalisation) in India, which limits the amount of interest deduction on the debts from Associated Enterprises for the purpose of taxability of business income. Such a section limits the deduction of interest as a percentage (30%) of earnings before interest, tax, depreciation and amortisation (EBIDTA). With the global slow down, it is expected that the EBIDTA of companies, in general, would drop, thereby reducing the proportion of allowability of the interest expenditure. The management may like to look into such a possibility, analyse further and think of restructuring its financial obligations.
- Economic Adjustments and Documentation: Transfer Pricing could be a tight rope walk for the FY 2019-20. An MNC could explore the usage of fixed cost adjustment, capacity utilisation adjustment or working capital adjustments depending upon the facts of the case. Such an adjustment to be justified with appropriate documentation and industry analysis.
- Implications under Secondary Adjustments: If an MNC is thinking of undertaking a suo-motu primary transfer pricing adjustment when no other means of economic adjustment is available, one may have to be mindful of the implications around secondary adjustments, where a book position of adjustments is required to be compensated necessarily by the exchange of cash position i.e. making good the debt by paying up and settling in the books of accounts. The effect of not undertaking such settling is an additional tax outgo arising pursuant to Secondary Adjustment (Section 92CE)
Steering a business is an art. A successful business or a transfer pricing model is not the model that earns and spends well in good time but the capacity that the model has to absorb shocks in difficult times. The above ideas could give multinationals a thinking tank to get some buoyancy in its business structure in existing tough times.
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Stay Safe and Best Regards,
Special appreciation and expression of gratitude for contribution from Mr. Sanjay Kapadia and Mr. Kartik Mehta of KNAV.