India’s biggest indirect tax reform in the form of
Goods and Services Tax (GST) was introduced and implemented from July 1, 2017. The new law propagated “One Nation, One Tax” motto and subsumed most of the indirect taxes (VAT, Excise, Entertainment tax, Luxury tax, Cess, etc.) under a single taxation regime.
GST is one of the most complex tax regimes in the history of the nation and has given way to many interpretational issues. One of these issues that have been bothering multi-national companies (MNCs) operating in India today is pertaining to taxability of related party transactions under GST and its direct impact on taxability under the Income Tax Act, 1961 (the Act), specifically pertaining to the transfer pricing provisions.
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GST law has carved out a special valuation mechanism for related party transactions. It requires the value (supply) of related party transactions to be at arm’s length or at the open market value of such supply. Further Schedule I of the GST Act, treats the supply made between related persons during the course of its business, for inadequate or no consideration also as supply. This means that even if a company has received free of cost services, it is liable to be treated as supply under the GST net and accordingly, open market value of the supply is to be determined for payment of GST. Further, the definition of related parties under GST is wide and extends to domestic transactions as well.
The Indian Transfer Pricing law (Section 92 of the Act) requires transactions between Indian resident parties with non-resident related parties to be at arm’s length and domestic related parties, for an only specific situational threshold. Simply put, it states that the related party transactions should be on par with that of unrelated party transactions. The main objective behind the transfer pricing law is to curb avoidance of tax by way of shifting profits outside India.
Even though the interest of both these laws is aligned in so far as both of them intend to curb tax avoidance in India, yet, the intertwined nature of these provisions has led to certain contradictory interpretations as well as controversies. Direct tax and Indirect tax provisions have often in past also looked in different directions leading to a non-harmonious existence. For long, Customs authorities have created valuation issues linking it to the transfer price. Now, GST authorities are probing the taxpayer to submit its Form 3CEB for audits under GST. Form 3CEB is an accountant report certifying the arm’s length price of related party transactions of a taxpayer furnished from Indian income tax perspective. Whether seeking Form 3CEB is a legitimate request or not is also a question? Scrutiny of Form 3CEB by GST authorities can certainly open a Pandora’s box of complications and headless audits for taxpayers. One of the most concerning and emerging issues is pertaining to receipt of free of cost services.
It is a common practice for Indian subsidiaries of foreign multinational parents to use a host of free services such as usage of foreign parent’s brand name, licence, technical know-how, corporate guarantee, other strategy and management related services. Under the Transfer Pricing law, many of these get covered under the bucket of intra-group services or shareholder services, or IP linked payments. Also, in most cases, payment for these services leads to an expense in the hands of the Indian company thereby, leaving lesser profits to be taxed. Thus, the tax authorities are more prone to prove that no compensation is required to be paid for such services. However, GST law requires the taxpayer to determine the arm’s length price of such services and pay adequate GST on it. Hence, a stark contradiction.
Further, where there is a consideration for such services, a lower consideration favours Income tax regime whereas a higher consideration favours GST regime. Therefore, taxpayers are in for a squabble from both ends. Notwithstanding, both regimes advocate a fair price or an arm’s length price.
The authors have tried to set out the interplay in some of the unique transactions, which require taxpayers to plan carefully on such transactions.
Free of cost use of licence/brand name granted to Indian subsidiary by its foreign parent – It is a common practice for MNCs to allow the use of license or brand name to its Indian subsidiary for carrying out operations in India, without attributing any payment towards it. However, such free of cost services between related party transactions may also be considered as supply from GST perspective. Therefore, the taxpayer may be asked to compute the fair market value and pay appropriate GST.
From transfer pricing perspective, since, payment of the fee would lead to outflow in the hands of Indian taxpayer, provisions of Section 92(3) become applicable, meaning, transfer pricing provisions do not apply (assuming Indian entity is otherwise in profits). However, the revenue officers can impute the GST value as the arm's length price of the transaction from the perspective of foreign parent and demand deduction of tax at source.
Licensee fee/ Brand fee charged for use of License/ Brand name granted to Indian subsidiary by its foreign parent – In cases, where a fee is charged for granting use of license fee/ brand fee, GST officials will want a higher price, to increase GST revenue. However, the transfer pricing officer would want a lower price, since the lower price would mean lower outflow, thereby, leaving more profits taxable in the hands of the Indian entity.
Deemed International Transactions – There are certain transactions which when classified as deemed international transactions under transfer price regulations, require adequate reporting and determination of arm’s length price. However, they may not become related parties as per the GST regime. In such a scenario, access of Form 3CEB to GST authorities may expose such transactions to an arm’s length testing from GST perspective, which would have otherwise not been under that ambit.
True-up/ True-down adjustments – Many times, there are year-end true-ups/ true-down adjustments that happen, especially in case of captive/ limited risk entities in order to adequately compensate the Indian entity from an arm’s length perspective. Since these adjustments are not factored in the initial price of the transaction, an additional GST liability may arise in case of subvention payments.
Transaction-level vs Aggregate benchmarking- Under transfer pricing regime, there is a provision to benchmark a host of similar transactions together in a bundled manner. However, GST will warrant a transaction level pricing for the computation of GST liability. This again creates disharmony since a transaction price that is accepted under one statute, may not be accepted under another statute primarily because the approaches of both offices, to determine arm’s length price, is different.The solution to a lot of these complexity lies in re-assessing the functions and risks matrix for all these transactions to take a conscious call, as to whether consideration is required or not, keeping in mind a non- arm’s length scenario. It is also of utmost importance for MNCs in this era to re-look at the prices of their inter-company transactions to align the pricing from both GST and TP perspectives.
It is a blessing that Indian tax authorities are forthcoming in giving certainty to the taxpayer on their inter-company pricing by way of alternative dispute resolution channels, i.e. through APA and MAP. In all fairness to the taxpayer, a price accepted for transfer pricing by the income tax department should ideally also be accepted by the GST department considering both are central government bodies. Therefore, if a taxpayer has concluded an APA agreement on its transfer pricing policies, exposure on the GST front may be reduced to a great extent.
Other than this, the government should also engage in discussions to address such challenges and adopt best practices as adopted by other countries with similar taxing statutes to address similar issues faced by taxpayers.
Bhavik Timbadia is Partner, Deloitte India. He was assisted by Shweta Dhamija, Senior Manager and Shubhi Kala, Deputy Manager, Deloitte Touche Tohmatsu India LLP
