More controversy expected
As Indian companies breathed a sigh of relief after meeting the first compliance deadline of filing of Country-by-Country report (CbCR) and Master File (MF), what could lie ahead is more controversy and questioning from tax authorities as they gain access to new sources of information and increased transparency across the globe. This holds especially true in a transition period where countries may implement rules after the BEPS recommendation in Action plan 13 at a different pace and in different ways. The three-tiered documentation will provide tax authorities with more detailed information regarding the global value chain of a company and may also bring out inconsistencies, if any, in the TP policies and implementation thereof within the MNEs of a group.
In the past, transfer pricing litigation in India happened without full information available to tax authorities about the global policies, value chain analysis of the group and clear understanding of the roles and responsibilities of each member of the group. With CbCR and MF compliance, tax authorities might be able to analyze detailed group structures and global allocation of income, economic activities and taxes, thereby allowing them to combat any possibility of potential tax planning for profit shifting in the group. The arguments of tax authorities in future transfer pricing proceedings may be supported by concrete evidence available to them through exchange of global information. There is also a risk that the excess information made available in the CbCR and MF may trigger inquiries about transactions that may not have an India tax or TP touch point.
How prepared are tax authorities?
OECD has released the Handbook on Effective Tax Risk Assessments, which provides a well-designed risk assessment framework to the revenue authorities in disseminating the information obtained under CbCR into their tax risk assessment processes. The Handbook highlights 19 tax risk indicators that could be derived using information in CbCR, such as results in jurisdictions deviating from potential comparable, jurisdictions showing significant activity but low level of profits, groups having marketing entities located in jurisdictions outside key markets and entities with no tax residence. The Handbook represents the first publicly available information setting out exactly how tax authorities may use CbCR information to supplement their existing tax risk assessment protocols. OECD has also recognized in the Handbook that the onus is on tax authorities to utilize the risk indicator tests as outlined in the report in an effective and appropriate manner and not draw misleading conclusions from the data in CbCR reports.
In the Indian context, from the recent developments in the Indian transfer pricing regime, it is evident that Indian tax authorities are now keener to move away from the arbitrary manner of inflicting routine adjustments, which has been the trend of TP assessments, and are focusing on examining overall value creation. With CbCR and MF information, both tax authorities and the taxpayers would be dealing with new data, in various formats. What is to be seen is how reasonably the transfer pricing risk assessments are conducted by Indian tax authorities after the receipt of detailed data and how the results of the assessment are perceived by them.
Tax authorities may utilize their sophisticated knowledge developed on the transfer pricing issues along with the information available from the CbCR filings and the risk indicators highlighted by OECD in carrying out effective risk assessment. With the use of new tools and technology by tax authorities in conjunction with the CbCR information available, they should be able to screen taxpayers with low tax risks and concentrate their energies on possible high-risk taxpayers.
The possibility of joint tax audits in the future
New and emerging audit techniques are being used by various tax administrations across the globe as a way of dispute resolution. Some tax jurisdictions are also using joint audits wherein two or more tax jurisdictions perform a single coordinated audit on a transaction and issue a final combined report for the taxpayer.
The heads of 48 tax administrations (including India as a participant) met in Oslo for the 11th Plenary Meeting of OECD Forum on Tax Administration (FTA) on 29 September 2017. The tax certainty agenda in the meeting was focused on dispute prevention and resolution, including more closely integrated international audit activity. A new project will look at how to facilitate greater use of joint audits across jurisdictions, reducing costs for firms and allowing tax administrations to work jointly on the assessment of tax liabilities in cross-border operations.
As joint audits might become a reality in future, the taxpayers have to focus more on the management of information in case of an exchange. Each tax jurisdiction involved in a joint audit may ask for detailed information and documentation in relation to a transaction, and hence consistency in the information is a prerequisite for the taxpayers. Transfer pricing policies on intercompany transactions must be prepared at a worldwide level and must also be consistent and adjustable to comply with the norms of each tax jurisdiction.
Best practices to be followed by MNEs
To manage controversy risk efficiently, it is advisable for MNEs to design a robust controversy strategy and develop a strategic approach toward TP planning, implementation, documentation and defense. The following areas can be covered by MNEs while deciding on a controversy strategy:
- Use of technology to manage information: With the possibility of joint tax audits and more intensive scrutiny by tax authorities, MNEs would need to leverage on technological tools to centralize the management of tax functions and to present the information requested in a manner that is consistent across the globe and their various functions.
- Continuous monitoring: Most of the MNEs would have conducted a BEPS impact assessment to prepare themselves for the increased compliance requirements and prepared a transition plan covering all impact areas. However, continuous monitoring of the process of data collection and reporting for the filing of MF and CbCR is required throughout the year. Manual workarounds would need to be supplemented by digital means, thereby reducing the risks of incorrect data.
- Clearly defined roles: MNEs are advised to have clearly defined division of roles between local and central teams. Also, combined and holistic decisions need to be taken before taking a position in one tax audit as they may have repercussions on other jurisdictions.
- Dispute resolution mechanisms: MNEs should proactively evaluate the option of entering into an Advance Pricing Agreement (APA) with tax administrations to minimize the potential for significant controversy and avoid double taxation.
As tax authorities gear up for a review of CbCR and MF data, it is imperative that the Government set parameters and guidance on how the data should be used. Aggressive audits and narrow interpretation of BEPS reports could lead to more tax and TP challenges, which the country cannot afford at this stage. We as a tax jurisdiction need to find the most appropriate balance between collecting taxes and promoting investments, and we must use the BEPS reports to only challenge blatant evaders and not use it as a weapon against all taxpayers.
The author of this blog is Vijay Iyer, Partner and National Leader, Transfer Pricing, EY India
The co-author is Pooja Abbott, Manager, Transfer Pricing, EY India
 BEPS Action 13 CbCR- Handbook on effective tax risk assessment by OECD