Union Budget 2017 (the budget) proposes an additional burden of secondary adjustment for Indian companies having transactions with foreign related parties, and thereby moves towards a more stringent transfer pricing (TP) regime in India.
As per the proposed regulation, the foreign related companies will be required to repatriate to India cash equivalent of the TP adjustment (primary adjustment) within a specified time (to be prescribed later) or pay an additional tax on notional interest in case of default on such cash repatriation. This stipulation will be applicable for the primary adjustments exceeding Rs. 1 crore in cases of financial year (FY) 2016-17 and onwards. The primary adjustment may be either on account of suo-moto adjustment by the taxpayer or due to adjustment by the transfer pricing officer (TPO) and accepted by the taxpayer. Advance Pricing Agreement (APA) terms or resolution under Mutual Agreement Procedure (MAP) would also receive similar treatment. Even safe harbour rules have not been spared from the new regulation.
No doubt, secondary adjustment i.e. adjustment on adjustment regime is practiced in many other countries, such as the US, Canada, South Africa etc., what makes the new regulation somewhat queer is the characterization of the secondary adjustments.
In other countries, it is taken as constructive dividend, constructive equity contribution or constructive loans - Canada and the US, for example, treat it as equity contribution and deemed dividend respectively, of the non-resident related party (associated enterprise), Indian amend proposes to characterize it as deemed advance and charge interest on that. The proposed changes, therefore, may not be very conducive to promoting foreign investments in the country.
One may argue that cash repatriation requirement was not new and the Indian government was insisting on this during APA and MAP negotiations, and so the present legal change is only an extension of that. But what needs to be brought out is that APA and MAP are negotiated settlements and so imposition of such stringent conditions could still have been justified, though this condition was often considered a barrier to the two agreements. But with the budgetary change, secondary adjustment condition would now become a mandatory condition for the taxpayers and would be exposed to the risk of subsequent fund flows. This may disrupt the profit allocation between the two parties and the cash flow budget estimates of the group even almost after 3-4 years after the audit is concluded. This puts onerous conditions on the balancing of funds by the MNEs. Since this will even be applicable to TP adjustment for FY 2016-17, taxpayers will have to ensure appropriate arm's length pricing in their books of accounts before closure of the current year's financial statements.
Since cash repatriation comes with several incidental challenges in terms of subsequent invoicing after almost 3-4 years once the financial statements and tax return for the respective year are closed, MAT implications, compensatory interest for delayed payment of taxes, service tax, forex fluctuation on additional invoice, etc., may present other practical complexity during actual implementation of the regulation. All these would result in an additional tax burden.
Overall, it appears that regulation on secondary adjustment may not be really propitious to more FDI, and can present an added complexity to the already uncertain international trade and investment environment.
Information for the editor for reference purposes only
Mr. Sanjay Kumar is Senior Director; and Ms. Chhavi Poddar is Senior Manager with Deloitte Haskins and Sells LLP
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