UNLOCKING THE PRELIMINARY IMPACT OF TRANSFER PRICING ON BUSINESSES AMIDST COVID-19

It is a harsh reality that Covid-19 has left Indian businesses and Multi-National Entity (MNE) subsidiaries operating in India in a state of uncertainty. Accordingly, amidst this unprecedented downturn, these MNEs need to adopt a holistic approach coupled with robust analysis having regard to both commercial and business rationale for business re-alignment and re-calibration, to mitigate their Transfer Pricing risks. This assumes more significance in the Base Erosion and Profit Shifting (BEPS) era wherein the Organization for Economic Cooperation and Development (OECD) efforts to reduce the tax evasive movement of profits to low- or no-tax jurisdictions have gained global importance.

Considerations for Indian Captive Service providers and Low-risk Distributors amidst Covid-19

– Certain low-risk entities such as captive service providers or low-risk distributors within the group may continue to operate under the financial garb of the parent company. It becomes important to recognize costs incurred by these Indian Captive units of various MNEs which were earlier categorized as low-risk distributors/service providers;

– In the post-Covid scenario, it is important to recognize that a ‘low-risk’ distributor or service provider is not the same as ‘no-risk’ distributor or service provider. Hence, evaluation of compensation for a “limited-risk” entity such as a distributor, contract manufacturer, or service provider during an economic downturn, because they have ‘low risk’ but not ‘no risk’, becomes an area of concern for Indian subsidiaries;

– The pandemic and work from home have created a unique problem for the Indian outsourcing model where multinationals set up local entities and pay them a fixed margin for work. With many MNE’s bleeding due to Covid-19 pandemic, the situation of arm’s length compensation of captive units by the parent entity calls for immediate action;

– The margins which have been generally pre-decided undergoing any change in the middle of the year could create tax implications and unwarranted tax inquiries;

– A trade-off needs to be made whether these resulting costs should be funded through the commercial transactions by the parent entity or through equity by the parent entity as an investor. Moreover, identifying low-value adding activities could also help in reducing costs by way of reimbursement from the parent entity.

Considerations for Royalty payments post Covid-19

– Most MNE subsidiaries operating in India and have entered into royalty arrangements with their parent entities / overseas group companies for using intellectual property or brand name of the foreign entity;

– It becomes essential for these MNE subsidiaries to have a re-look on these licensing arrangements with the parent entities with reference to the legal implications as well as on the manner and at the rate at which royalties they are being computed;

– This calls for an in-depth analysis of the aforesaid licensing arrangements on the mechanism of charging royalties as well as the role and function of the Indian subsidiary with respect to the Intellectual property/brand name being used by it in both pre and post COVID scenario. Any change in terms and conditions on an abrupt basis coupled with the absence of directives from tax authorities could trigger tax and transfer pricing issues for these MNE subsidiaries in India.

Last Updated: 21st July 2020 This article is contributed by:

Gaurav Khanna Associate Director, Direct Tax

Tag: Direct tax