Transfer pricing is an effective tool to allocate profits across the value chain globally so that every tax jurisdiction in the value chain is remunerated with an equitable and fair distribution of taxes. This article is not for the corporations that believe in transfer mispricing and adopts tax avoidance strategies. The beneficiaries of this piece of knowledge and experience should be the corporations that believe in fair practices but get caught in the tax litigations due to reasons other than transfer mispricing.
A transfer pricing litigation is a conflict, where the tax authorities of a country are of the opinion that the activities undertaken by the taxpayer are not remunerated as per the value created by the taxpayer in the country of business.
A dispute in daily life often arises because of a single big reason ie. ‘Lack of TRUST’. Expectation mismatches, misunderstandings, confusions, uncertainty, unclarity etc are all outcomes of Lack of TRUST. We are not covering areas where Lack of TRUST occurs due to cheating, frauds, swindling and evasion policies, as it is made clear at the outset that the right intention of the taxpayer is of utmost importance while following this secret. As you would have guessed by now, the top-secret to avoid transfer pricing litigation is building TRUST with the tax authority.
Taxpayers are the partners in nation-building and an essential element of the partnership is TRUST. A taxpayer’s honesty should be reflected in the deeds that are undertaken (in substance) and also in the documentation maintained (in the legal form). Once you have the TRUST factor with you, your chances of a transfer pricing adjustment go down drastically and therefore avoids litigation every single time. Let us understand the factors that could help you build the TRUST factor with the tax authorities.
- Transfer Pricing setting mechanism: As per the recent survey, 70% of the respondents agree that transfer pricing is all about planning and setting the right prices upfront by following a proactive approach rather than an audit and compliance approach, which becomes too late in a day activity for most of the multinationals. Accordingly, once your prices are set right and well planned for, it becomes easy to gain the trust of the tax authority by explaining the build-up of prices and the thought process through which the entire price-setting exercise was undertaken. A taxpayer that could explain the price-setting mechanism well and a tax authority that understands a price-setting well would live happily ever after.
- Robust Documentation: Transfer Pricing is all about documentation. Unless it is on a piece of paper, it cannot be considered as an evidence in the eyes of law. You could explain the best transfer pricing methodology, but if not documented properly in the right channels, such explanation is of no use. For example, a cost-plus method of setting the price is irrelevant, if the costs are not defined and the rationale behind adopting such costs are not highlighted. Going further, the documentation could be strengthened if such a methodology is approved and finalised by the board of directors, which marks like an approval seal on behalf of the company.
- Utmost Compliant: You could be maintaining transfer pricing policies and documentation, however, if you fail to comply or delay in complying with the provisions of the tax law, you find yourself in the list of defaulters, thereby bringing down the overall trust levels of the Tax Administrations. A well-complied taxpayer is a complete taxpayer.
- Simple Submissions: When the tax authorities call for certain additional documents, details and explanations, it is a good idea to keep the submissions simple, factual and to the point. Bear in mind that you are not writing an exam paper to make it longer or do not beat around the bush. As the tax authorities are the first level auditors, at the outset, avoid submitting case laws and a plethora of judicial precedents, as they tend to send a signal to the tax authorities that you are all ready for a fight and there has been a dispute before on the similar fact pattern, which could be used by the tax authorities to their benefit. Submit judicial precedents only if there is a need and it helps you in bringing out a point to your benefit without arm twisting.
- The larger picture: As mentioned above, taxpayers and tax authorities are partners. It is the duty of a taxpayer to make the tax authorities realise this. One may like to provide certain figures and factual positions on how the taxpayer has contributed to the economy, and the business results are in line with the competitors (not comparable). When it comes to transfer pricing, I have seen the discussions and negotiations getting stuck on the benchmarking and the comparable set used. By using your soft skills, try to build a case that the tax authorities cannot reject. The tax authorities are also humans and per the human psychology, they would like to make decisions on whether the transactions are arm’s length or not when then have positions as provided by you that could tell the story of the taxpayer’s growth, that could make the tax authorities realise by how not making an adjustment on the taxpayer the tax authorities are contributing towards strengthening the relationship and lead to a win-win where the objectives of both the parties get fulfilled.
All the above points would lead to an increased level of TRUST and further build a strong foundation between the taxpayer and the tax authorities. I have personally used all of the above techniques and worked on results in favour without undue tax adjustments. As I said before the idea is to increase TRUST and reduce the possibility of conflict in the mind of the auditor.
In case you would like to know more about representing your case with the transfer pricing authorities or would like to discuss on your transfer pricing strategy to avoid litigation, feel free to write to me at firstname.lastname@example.org. You can also visit the firm’s website at transprice.in and follow the content at the official blog at https://transprice.in/tp-blogs/
Looking forward to your feedback.
CA. Akshay Kenkre