Companies grapple with transfer pricing woes as tax deadline draws near

Previous approaches fall short amid Covid-19 volatility in numbers

Multinational companies with transactions between group entities have less than three weeks to account for such dealings as accurately as possible. The pandemic is said to have caused valuation uncertainty which could open the door to potential tax disputes.

Companies are looking at various ways to make a more correct assessment including relying on information from the first three quarters of the year and making judgements based on macroeconomic data. They would be looking to wrap up the process by March 15 which is the deadline for corporate entities to pay advance taxes, according to experts.

Pricing such transfers of goods and services between related entities is called transfer pricing. Since companies can use such transfers to lower the taxes they pay, for example by transferring profits from high-tax jurisdictions to low-tax jurisdictions, transactions have to be valued on an impartial basis. Companies depend on industry data and past trends to typically make such valuations so that they don’t face tax issues. The pandemic year has made this difficult to do.

“...conventional approaches of using prior year data would not be typically applicable, as the 2020 year stands out as being exceptionally circumstantial relative to the previous years, and hence not comparable,” said Sanjay Kumar, Partner, Deloitte India.

The margins that typically applied on such transactions may well have changed.

“Whether to retain existing target margins or to revise them will depend on the extent of impact on such company, its group as a whole and the industry in which it operates.  Also, in performing the comparability analysis, some of the historical methods and filters applied may require a careful rethink,” said Hitesh D. Gajaria, Senior Partner, KPMG India.

Companies are working on models based on quarterly financials published by unrelated companies for the first three quarters of the financial year 2020-21 to estimate the trend in margins and the impact of the pandemic said Vijay Iyer, National Leader of the transfer pricing group at EY India. Some are waiting for another 10-15 days to collect any additional information that may help to make estimates for the full year. Annual data would have provided the quantitative impact of the pandemic but comparable companies would publish such audited data only after the year ends.

"As of now we don't have access to that," said Iyer.

Iyer pointed out that companies have till September 2021 to file their documentation with the Registrar of Companies. It could be another quarter or so before it is publicly available. This means that accurate industry data for the pandemic year would potentially only be available by January 2022. There could be a shortfall in taxes paid if these industry numbers turn out to be different than expected. Companies would have to face interest consequences on the advance taxes they paid based on earlier estimates. The deadline for advance taxes is March 15, less than three weeks away.

“...when the tax department will undertake...scrutiny for this year, they will have the advantage of hindsight (often referred to as ex-post data), which might lead to a paradoxical situation wherein there are greater disputes for the most distressed year of the century,” said Deloitte’s Kumar.

Companies would also have to keep in mind the disclosures they’ve made to customs departments for the same transactions while making any adjustments in prices for transfer pricing compliance, said KPMG’s Gajaria. They would need to make sure that any adjustments are in compliance with foreign exchange regulations, he said.

Sectors like travel, tourism, hospitality education and commercial real estate are some of the sectors where uncertainty is expected to continue in 2021 as well.