Assisted by: Sanjay R Mistry, Sanjay A Lalwani.

1.    Background

1.1  The advent of disruptive technologies and emergence of e-commerce has resulted in companies gaining unbridled access to an economy (or rather digital economy) without a significant physical presence. Multi National Enterprises (‘MNEs’) have also been prompted to change and adapt their so-called ‘tax efficient’ business structures due to the introduction of the Base Erosion and Profit Shifting (‘BEPS’) Action Plans – which seek to ensure that profits are allocated to jurisdictions where ‘real economic activities’ take place. 

1.2  Moreover, recent global events such as the USA - China trade war and the supply and demand shocks brought on by the COVID-19 pandemic are forcing MNEs to reassess their business models and diversify their supply chain / footprints across geographies to reduce over-reliance on any particular jurisdiction.

1.3  The emergence of these various factors has given rise to newer and more complex inter-company transactions. With the increase in cross-border transactions, it is likely that there would be greater scrutiny by tax authorities to check for any arrangements resulting in BEPS.

1.4  Further, with tax authorities having access to Country-by-Country Reporting (‘CbCR’), Master File and Local File, revenue audits are likely to be sharper. It would be interesting to observe the manner in which such information is utilised by tax authorities during their audits. This is certainly going to be a focus area of Revenue audits and could potentially open up the next round of disputes between taxpayers and tax authorities.

1.5  With this backdrop, we look at the trends in the transfer pricing controversy landscape and attempt to crystal gaze at what the future beholds.

2.    Traditional Approach

2.1  Transfer Pricing (‘TP’) litigation environment in India has been evolving over the years. The initial years of TP audits witnessed significant litigation, partly due to it being a new area for both taxpayers as well as the tax authorities. This phase was defined by a pretty traditional approach to the audit – starting with the selection of a large volume of cases for TP scrutiny based on the value of international transactions disclosed by the taxpayer as against the preferred approach of selecting international transactions based on well thought out and defined risk based parameters. As the number of cross border transactions increased, the quantum of TP audits proposed by the tax authorities also increased by more than 4 times in a span of a decade from Assessment Year (AY) 2005-06 to AY 2014-15 i.e. from 1,000 cases to 4,290, and the amount of adjustment proposed increased from US$ 188 million to US$ 7,149 million.  

2.2  The most common issue involved in the TP audits revolved around selection of comparables, determination of the most appropriate method, choice of tested party, need for performing economic adjustments to the transactions and manner of computing such adjustments, etc. 

2.3  The resolution of resultant disputes also entailed following conventional litigation routes (spanning across more than a decade!), due to lack of effective fast-track dispute resolution mechanism. Further, lack of thoroughness and sometimes a lack of technical articulation of the approach adopted by the tax authorities, led to either tax authorities losing in courts or of the case being remanded at the appellate levels. This no doubt involved time, energy and efforts on both sides, with of course no additional tax accruing to government coffers. The uncertainty created in the above process was undesirable and needed basic reform of the audit process.    

2.4  Thus, the need of the hour was to evolve mechanisms which focused on identifying high risk areas, stressed on dispute prevention and not on dispute resolution, bringing mechanism on cooperation between the taxpayers and tax administrations with adequate transparency, something which has been so successfully adopted in the UK and in some countries of Europe under “cooperative compliance”.  

2.5  The litigation for dispute resolutions spanning over a period of 12 to 15 years from the TP audit till the final word on the matter at the Supreme Court level was certainly not what the investors and taxpayers in the country were looking for. It is often said, and borne equally by experience, that most TP adjustment cases in appeal move turn by turn, between the taxpayer and the revenue. Almost half a million tax disputes  were pending at various legal stages as on February 2020.   

2.6  Keeping this in perspective and in line with the  mandate of BEPS Action Plan 14 to improve tax administration process, India has also adopted various dispute prevention/resolution/settlement mechanisms like Advance Pricing Agreement (‘APA’), Dispute Resolution Panel (‘DRP’), Safe Harbour Rules, Vivad se Vishwas Scheme (‘VsV’), which have been instrumental, or have at least been aimed at increasing certainty for taxpayers and reducing the overall burden of TP litigation on the judiciary.

2.7  The APA has by far been the most preferred, effective and relatively faster mechanism for disputes, though of late, considering the pandemic situation, the number of APAs signed have been decreasing year-on-year. The VsV scheme whereby taxpayers can settle existing appellate stage disputes by paying certain taxes and ending litigation, has also been a successful scheme. 

2.8  Tax authorities have also tried to lower the threshold margins and make safe harbour rules more attractive for taxpayers. However, it often seems that taxpayers do not wish to adopt this path probably because they believe margins are still high for their businesses.      

3.    Emerging Trends

3.1  In the last few years, Indian transfer pricing litigation has shown emerging trends of maturity, which augurs well both for taxpayers and the authorities. Prominent aspects in this phase of litigation arena are mentioned below: - 

•    Audit selection process – Tax authorities have moved from doing en masse audits selected largely on the basis of value of international transactions, to using data analytics on CbCR and other data points to identify high-risk cases. Thus, the focus has shifted from volume based to risk-based assessments. 

Moreover, the nature of disputes has also moved from the selection of appropriate comparables under the TNMM method to areas relating to marketing intensity adjustment resulting in attribution of additional income to the taxpayer due to brand building activity, complex financial transactions etc. In fact, the thrust of the TP audits is now on accurate delineation of transactions and accurate functional profiles resulting into disputes on recharacterization of entities and rewriting of transactions. 

•  Application of non-traditional TP methods – Earlier, traditional methods such as TNMM were most commonly used by taxpayers and tax authorities. Recently, however, there is increasing use of the profit split method or the residual “other method” by tax authorities. Revenue split approaches best estimate assessments based on evidence available, the Comparable Uncontrolled Price methodology, valuation methods, return on investment etc, are tried at the TP audit stage as “Other Method”. Tax authorities are scrutinising details available from the CbC Reports, Master Files to get insights for application of such other methods.

•  Better trained officials – The growing sophistication of transactions has also led to the need for a deeper understanding of business models and tax shifting mechanisms. Tax officials are being trained in India and abroad and this coupled with the experience over the years has enhanced the skill sets at the tax authorities’ end. It is not uncommon for tax officials to be subject matter experts with respect to specific aspects/transactions such as marketing intensity, intra-group services etc. Consequently, TP adjustments proposed by tax authorities are becoming more and more sophisticated and backed with in-depth analysis. There is increased reliance by tax authorities / departmental representatives on the Organisation for Economic Co-operation and Development (‘OECD’) BEPS Action Plan Reports, United Nations (‘UN’) Transfer Pricing Guidance, international judicial rulings, etc. (For e.g. tax authorities have started referring to BEPS Report for challenging the valuation of intangibles that they consider as Hard-to-Value Intangibles; tax authorities also place reliance on DEMPE (‘Development Enhancement Maintenance Protection and Exploitation’) analysis while proposing the AMP (‘Advertising Marketing Promotion’) related adjustments). India is also participating in the Tax Inspectors without Borders (‘TIWB’) initiative by engaging under the TIWB programme with Eswatini and Sierra Leone as partner administration. India is providing experts in the field of transfer pricing and international taxation to Eswatini and Sierra Leone.

•  Shift of focus from FAR to FARM – Developing countries such as India, China have large domestic markets which are also the main drivers of economic growth. These large markets offer significant economic potential to MNEs. Tax authorities of these countries believe that the current manner of arriving at arm’s length prices does not remunerate for the market offered to MNEs and that results in mispricing of transactions. Hence, Tax authorities there advocate on the immediate need to shift focus, or maybe enhance the focus from simply FAR (‘Functions, Assets and Risks’) profile to FARM (‘Function, Asset, Risk and MARKET’) profile of the domestic entities involved in the transactions. The proposed fractional apportionment model as discussed in the OECD’s paper on ‘Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalization of the Economy’ emphasises on the “market” factor for attributing profits to PEs which do not prepare distinct accounts. This can be viewed as a manifestation of the government’s thrust on the “market” factor i.e. the demand side of economics since it believes that the conventional FAR approach accounts for only the supply side of economics. Excess demand in these markets warrants additional profit attribution than what is “arm’s length” by FAR analysis as these markets create additional “value” to the supply chain of a company and should be remunerated as such. 

3.2  Given these emerging trends, we attempt to crystal gaze what the future transfer pricing controversy scenario beholds.  

4.    Future Scenario

4.1  In recent years, the government’s increasing inclination to weave technology in its interactions with the citizenry has been palpable. The capabilities of technology are being harnessed for even mundane day-to-day administrative tasks performed by the government. The future of tax administration is not expected to be much different. 

4.2  The availability of data in electronic format along with technological advances such as artificial intelligence (‘AI’), machine learning, data analytics software which are likely to be used extensively by both taxpayers as well as tax authorities, will provide newer insights into the taxpayer’s business. Indian tax authorities have automated the selection of cases for audit based on the computer aided scrutiny system (‘CASS’) and employed the use of analytics to assess the CbCR data to identify gaps vis-à-vis MNEs’ local and master file. Interestingly, French tax authorities scheduled approximately 20% of tax audits based on these technologies while German tax authorities designed a special tool to perform CbCR data analytics. 

4.3 The Indian tax department recently launched ‘Project Insight’, under which, the Income-tax Department plans to use data available with it as well as with other government authorities such as Registrar of Companies, GST database, RBI records, Social network, etc. 

4.4  Further, Income Tax Transaction Analysis Centre (‘INTRAC’) has been operationalised for handling data integration, data processing, data quality monitoring, data warehousing, master data management and data analytics. Data Analytics is being used for identification of high-risk cases including the following:  

•    Identification of high-risk non-filers under NMS (AY 2016-17 onwards);
•    Selection of cases for scrutiny under CASS (CASS from 2018 onwards);
•    Identification of high-risk refund claims (April 2018 onwards);
•    Identification of high-risk remittances (Sep 2018 onwards);
•    Risk assessment of information received under Automatic Exchange of Information; 
•    Risk assessment of information received under CbCR; and 
•    Risk assessment of Suspicious Transaction Reports received from Financial Intelligence Unit – India. 

4.5  Technology has also made it possible for rapid sharing of data across borders and establishment of mechanisms that allow sharing of data between tax authorities and reduction of dual efforts on the same aspects.  

4.6  Some newer initiatives likely to gain popularity in the near future are:

•    International Compliance Assurance Programme (‘ICAP’): A voluntary programme / tool that is piloted by the Forum on Tax Administration (a club for tax commissioners from 53 OECD and Non-OECD jurisdictions), for a multilateral co-operative risk assessment and assurance process where tax administrations engage in joint consultation for joint audits / risk assessment with a view to providing early tax certainty and assurance to MNEs. Under the ICAP, participating tax administrations can identify and evaluate risks based on transfer pricing documentation including an MNE group’s country-by-country reports. It would be interesting to see how ICAP is used to ensure fair allocation of taxes between countries specifically when the transactions are between entities located in developing and developed nations.

As of May 2021, 22 jurisdictions including France, Germany, USA and UK have officially confirmed their participation in ICAP. India has been very actively collaborating with FTA, which is spear heading the ICAP, on various projects .

•    Audits for a block of years: Tax authorities are expected to warm-up to the idea of performing an audit for an entire block of years having similar issues. Whilst, this practice is already prevalent in certain countries, India will need to make some significant changes in its regulations to make this see the light of day.  

With increasing focus on collaboration between tax authorities, the existing dispute prevention/resolution mechanisms are also expected to evolve and drift towards a more collaborative approach. This can be especially helpful in TP cases as the issues under dispute are usually common across the years. Also, in cases where the dispute revolves around use of appropriate comparables, the problem relating to consistency in selection of comparables can also be overcome when different years are consolidated although availability of data maybe a challenge in such cases. Often, when these disputes reach the ITAT these are consolidated and disposed together by the tribunal. Thus, auditing an entire block could result in significant savings of time and efforts spent by taxpayer and tax administrations. 

•    Virtual hearings: While Covid-19 has taught all of us how to work virtually or “Work from anywhere”, it has also left its impact on the functioning of the judiciary. The government has moved on with its plan to implement faceless audits / appeals and whether tax dispute matters in Tribunals and Courts should continue virtually would depend on how productive and efficient the technology systems are for countries to adopt this on a long-term basis. We have seen how effectively competent authorities can schedule meetings virtually and also how lawyers can jump virtually from one court in one state to another court in another state. On the other hand, we have also seen how difficult it is to argue complex TP matters requiring voluminous evidences in the virtual mode. The future of hearings whether virtual or physical will also more likely than not, be a hybrid model where certain non-complex cases or cases involving multi-jurisdictions may encourage use of virtual modes as compared to extremely complex cases or mechanisms like mediation requiring physical hearings. Having said this, as tax professionals and lawyers, we need to be geared to adapt to the newer virtual ways of handling cases and leverage on this opportunity to resolve matters sooner than later. 

•    Multilateral APA

While Multilateral APA is presently being used by taxpayers sparingly, it is expected to gain prominence in coming future. 

Under a multilateral APA, tax authorities of respective countries agree on the characterization and transfer pricing methodology to be applied to intra-group transactions covered under the APA and not to adjust or audit the transfer pricing for a fixed period as long as the critical assumptions of the APA are met. Such APAs are an especially useful risk mitigation tool for complex or high-risk intra-group transactions as well as restructurings. Even in cases of MNEs, where the supply chain is scattered across jurisdictions, a multilateral APA provides an option to resolve tax disputes by bringing together the tax authorities from different jurisdictions.   Multilateral APAs are also endorsed as best practice in Action Plan 14 of the BEPS project.

While many countries are still catching up or have not yet even started on any Multilateral APA, the USA has already executed so far 20 Multilateral APAs.  

•    Bilateral Safe Harbours

A bilateral safe harbour is a regime agreed between two taxing jurisdictions to apply to taxable entities who are related and transact with each other. Unlike unilateral safe harbours, a bilateral safe harbour could relieve taxpayers from the problems of double taxation.

The OECD guidelines have also encouraged the use of bilateral safe harbour mechanisms due to the following advantages:
- Can be tailored to economics of a particular market and circumstances
- Can be easily entered into with countries having similar tax rates and can be used in limited situations where transfer pricing risk is low
- Can be made applicable to small tax payers/small transactions thus limiting exposures to government revenue
­- Countries facing resource constraints can adopt bilateral APA to protect revenue base without inordinate enforcement effort.

The USA and Mexico have successfully implemented a bilateral safe harbour regime, which covers eligible taxpayers engaged in manufacturing operations near the US-Mexico border. 

•    Arbitration

Arbitration is a process in which the parties to a dispute, submit the case voluntarily to a private arbitrator, present arguments and evidences that help the arbitrators to make a determination. 

In 1984, the OECD Committee on Fiscal Affairs noted that the support expressed by MNEs for compulsory arbitration procedure to resolve the transfer pricing disputes was sufficient to indicate that it needed to be given serious consideration. However, at that time, the OECD found that there were conclusive arguments against recommending such a scheme, especially as it would involve “an unprecedented surrender of sovereignty”.

In 2008, arbitration finally found its place in the OECD’s Model Tax Convention in Article 25(5). Even the UN Model convention was amended in 2011 to provide for optional arbitration. In both the Models, arbitration shall be available only in cases which are subject to MAP. 

Till date, 31 jurisdictions have already chosen to apply mandatory binding arbitration clause. However, India still does not accept it, since it believes that such processes are against a jurisdiction's sovereignty in tax matters. 

Recent example of arbitration in the case of Cairn Energy also reflects India’s position on arbitration wherein India appealed the verdict on grounds of sovereignty and tax avoidance by Cairn Energy. India believes that it has the sovereign right to tax, and private individuals cannot decide on that. Besides, it falls outside the domain of a bilateral investment treaty and beyond the jurisdiction of international arbitration. 

Arbitration as a concept is not new to India. In fact, India has an Act titled “Arbitration and Conciliation Act”. This is one area where India should re-think on their views and incorporate arbitration in their tax treaties as it will go a long way to boost investor confidence by showing commitment to participate in the process of eliminating double taxation. 

•    Mediation

Mediation is a diluted version of arbitration as it is a voluntary non-binding process, wherein each party retains 100 percent control over whether to settle the case or not. Mediation is expected to offer a more efficient, less expensive and faster way to prevent or solve tax appeals. Some of the advantages of Mediation are as follows:
- Confidential process for the taxpayer
- Saves time and cost for tax authorities as well as tax payer
­- Meditators maybe well versed with tax laws as well as finer business aspects
- Results in speedy collection of taxes for tax authorities.
 
While India still has to embrace mediation in its regulations, there is a growing legislative and judicial support for mediation in India. One such instance can be found in the decision of the Supreme Court of India in M.R. Krishna Murthi v. New India Assurance Co. Ltd. (2019 SCC OnLine SC 315.), wherein the Court stated:

“29… mediation as a concept of dispute resolution, even before dispute becomes part of adversarial adjudicatory process, would be of great significance. Advantages of mediation are manifold. This stands recognised by the legislature as well as policymakers and need no elaboration. Mediation is here to stay. It is here to evolve. It is because of the advantages of mediation as a method here to find new grounds. It is here to prosper, as its time has come.…In fact, the way mediation movement is catching up in this country, there is a dire need to enact Indian Mediation Act as well.”

Globally, mediation is already being practiced successfully. For instance, UK has seen favourable results in its use of mediation for resolution of tax disputes. It provides the option to individuals or organisations to resolve their personal or business disputes to apply for mediation. Interestingly, the appeal structure in UK and India is similar with four appellate forums. The practices followed by UK’s HMRC can serve as an example for the Indian tax authority to embrace and use mediation to prevent /resolve tax disputes.

Other jurisdictions such as the USA, Netherlands and Belgium have also successfully utilised mediation as a viable alternative dispute resolution mechanism for tax disputes. 

USA has a voluntary mediation programme known as fast track mediation to expediently resolve tax disputes. The objective of the said programme is to ensure that disputes are resolved efficiently within 40-120 days. The experience in the USA indicates that such a practice is significantly faster than the traditional appeals process. 

In contrast to the USA, Canada has not seen success in usage of mediation. Canada could only settle negligible number of cases through mediation, and as a result it has decided to stop providing the option of mediation to its taxpayers. 

Therefore, the success of mediation, as a tool, for resolution of tax disputes, will depend on the specific conditions under which it is utilised, and must be introduced in a manner that is optimal for both, taxpayers and tax officials.

5.    Conclusion

5.1  With the G7 agreeing on a threshold minimum level of taxes to arrest the race to bottom on tax rate competition amongst countries and the parallel endeavour by OECD and G20 to reach an international consensus on the Pillar One - Pillar Two approaches also expected to achieve a position this year, one may expect that MNEs will probably have lesser means for tax planning (or may we say tax avoidance as alleged by tax authorities?). 

5.2  However, increased complexity of businesses operating across countries coupled with the growing cooperation amongst tax authorities of the world, will surely lead to a rise in transfer pricing related controversies across the world. While efforts to arrive at consensus-based manner of tax calculations should continue to minimise disputes, it is incumbent upon businesses as well as government authorities to ponder over faster and more reasonable dispute prevention or dispute resolution mechanisms. Businesses would be well advised to embrace the use of technology in managing their tax affairs as well as to ensure greater integration not just between various departments within an organisation but a larger integration within the MNE group as a whole. A more coherent, co-operative approach within MNE group entities and between MNEs and various countries’ tax authorities, would enable a more acceptable resolution of disputes.

The global Transfer Pricing (“TP”) landscape has undergone a notable and significant transformation with the release of final reports on the Base Erosion and Profit Shifting (“BEPS”) Action Plans by the Organisation for Economic Co-operation and Development (“OECD”) and G20 countries in 2015. The prevailing international taxation rules in force then, which were formulated more than a century ago, were increasingly viewed as being inadequate for addressing the challenges posed by the significant change in the way global businesses were operating.

With increasing digitalisation as well as the far reaching impact of the coronavirus pandemic (“COVID-19”), global businesses have transformed at a pace greater than ever before; resulting in a multitude of TP complexities coming to fore for Multinational Enterprises (“MNE”) and tax authorities. This article attempts to analyse key recent developments in the global TP framework, the changing dynamics of global businesses along with the associated TP considerations, and reflections around the potential future of TP.

I) Formulary Apportionment and Going Beyond the Arm’s Length Standard

Rapid digitalisation is one of the most significant developments in the last decade which has led to a vast shift in the way businesses are conducted across the globe today. Current international tax rules have not kept up with this change in business realities and the increasingly digitalised global economy; and are therefore unable to fully align taxation with value creation. Addressing the tax challenges arising from digitalisation has been the top priority of the OECD/G20 Inclusive framework since 2015 when the BEPS Action Plan 1 was released. As part of further work conducted in this area, a two-pillar approach was proposed by the OECD in 2019 to reach a consensus-based solution on various tax issues involved at the earliest. This was followed by the release of the Blueprints to Pillar One and Pillar Two by the OECD in 2020 which provided a detailed framework of the proposed solution under both the pillars. More recently, in July 2021, a statement was released by OECD/G20 Inclusive Framework on BEPS where majority of the member jurisdictions have expressed solidarity and commitment towards resolving all the pending issues and achieving consensus by October 2021.

To provide a brief overview, Pillar One deals with a new nexus rule that proposes to create taxation rights for jurisdictions without reference to current tax rules which are based on residency or source / physical presence parameters. It also refers to new profit allocation rules that propose to allocate a part (20-30%) of the residual profits of a multinational group to market or user jurisdictions (“Amount A”) by applying a formulaic approach that goes beyond the traditional arm’s length principle. The current scope of Amount A intends to cover the largest and most profitable multinational businesses that have global turnovers above Euro 20 billion and profitability above 10% (measured as profit before tax over revenue). On the other hand, Pillar Two is primarily focused on ensuring a global minimum tax regime, which proposes that covered MNEs pay a global minimum tax of atleast 15% determined on a country-by-country basis.

From a TP perspective, the reallocation of taxing rights under Pillar One has the potential to significantly impact multinational businesses not just in terms of their global tax liabilities but also their governing business and operating models. MNEs also face the risk of double taxation in case all jurisdictions do not implement the proposed changes simultaneously. Companies that may potentially fall under the scope of the new rules need to ensure that they are fully aware of the ongoing developments, undertake an assessment of how the rules may impact them from a business and financial standpoint, as well as proactively and carefully plan for any measures that they may need to put in place to make the process of transitioning to the new rules as seamless as possible.  

While a multilateral consensus-based solution is currently awaited and highly anticipated, the interim delay has led several countries around the world to introduce new or proposed unilateral digital services taxes (DSTs) and other levies, creating additional complexity, and financial as well as administrative burden for multinationals. India is no exception.

In 2019, the Central Board of Direct Taxes (“CBDT”) released a draft on revised profit attribution principles/rules that prescribed a formula driven methodology through the use of a fractional apportionment method for attribution of income to permanent establishments of non-resident enterprises in India. The CBDT observed that business profits depend on both supply and demand side factors, and that a traditional Functions, Assets and Risks (“FAR”) based attribution only takes into consideration supply side factors, while ignoring the contribution of demand side factors such as access to markets. This approach is based on a point of view that deviates from the principles that are currently followed as well as considered appropriate globally, for performing a TP analysis which dwell essentially on the performance of a robust FAR analysis of the transacting entities. The use of such formula-based approach may potentially lead to a profit allocation that is at variance with the result from a traditional arm’s-length pricing approach.

India’s equalisation levy and the concept of Significant Economic Presence (“SEP”) as well as the related profit attribution rules are other examples of formulary apportionment-based approaches that are increasingly being followed by countries for preserving their tax base. While most of these approaches are simplified and pragmatic, there are growing concerns that their proliferation around the world could increasingly lead to non-arm’s length outcomes and double taxation for multinational businesses, resulting in overall higher tax uncertainty for taxpayers.  The increased use of such formulary approaches running concurrently with the arm’s length standard would require MNEs to constantly evaluate their options and balance the two potentially conflicting approaches.  The framework of domestic country rules, treaty options available and multilateral mechanisms possible would need a careful evaluation.

II) Simplified TP Methodologies for Baseline Functions

OECD's Pillar One also includes the concept of a separate Amount B which essentially aims to standardise the remuneration of related party distributors, that perform baseline marketing and distribution activities in a manner that is aligned with the arm's length principle.  While more technical analysis is being conducted with regards to Amount B, the initial proposal is that Amount B shall be determined based on comparable company benchmarking analysis, undertaken based on TP principles. The comparable companies undertaking routine marketing and distribution activities would be identified by industry/ geography/region and would require development of standard search strategies.

While the proposed approach seems appropriate and acceptable at the outset, the selection of "comparables" for Amount B may lead to a "one size fits all" approach to a wide variety of taxpayers which could be counterproductive. The primary intention of Amount B is to simplify TP compliance and enhance tax certainty by reducing disputes, which are both welcome objectives. However, at this juncture, it is difficult to ascertain how successful Amount B would be in meeting its dual goals. First of all, it is not yet clear as to whether individual taxpayers will have some flexibility to revisit or adjust the comparable sets to account for their unique business scenarios, including differentiation in functional intensities. Moreover, using a standard distribution profit margin may also not be acceptable to jurisdictions that prefer the use of local comparables to account for location specific characteristics. Unless the design features of Amount B factor in the potential of some kind of corrective adjustments, it may be difficult to apply a standardised level of remuneration, across a purportedly homogeneous bouquet of companies, that may otherwise have such unique underlying differences which makes the process more unreliable, arbitrary and uncertain for multinationals.  Depending on the final guidance that comes on Amount B and how various jurisdictions adopt such guidance in their domestic TP rules, it would be interesting to see to what extent the above-mentioned twin objectives are practically achieved.

III) Business Model Shifts and TP in the “New normal”

The worldwide spread of COVID-19 has impacted the global economy adversely and has caused unprecedented challenges for consumers, businesses and communities.  Broadly speaking, it has led to loss of revenue for many businesses across the world, supply chain disruptions, reduced demand, and in many cases retrenchment of employees and re-allocation of responsibilities among employees. The restricted movement of consumers and periodic lockdowns have further contributed to adoption and growth of online/digital mode of doing businesses. Businesses have started adapting to this new normal by diversifying their supplier bases to ensure continued supply, enhancing digital means to reach their customer base, permitting employees to work remotely, streamlining operations to reduce costs, etc.

Undoubtedly, these shifts in modus operandi of businesses and the new economic environment would drive changes in TP policies and processes of cross border transactions for MNEs. From a TP perspective, companies need to closely track and analyse the various ways in which business is adapting to meet these changes such as – (i) business restructurings, resulting from reallocation of key functions across jurisdictions,  (ii) movement of personnel across jurisdictions, (iii) re-alignment of remuneration models, (iv) rationalising profit mark-ups, (v) recognition and treatment of extra-ordinary expenses, arising due to abnormal business disruptions, and (vi) implications resulting from renegotiation or discontinuity of inter-company contracts.

The business impact of COVID-19 has also brought to fore the increasing relevance of intellectual property (“IP”) for global businesses in the current era. MNEs need to reflect on how the process of value creation has undergone a change with the shifts in business, what are the new value drivers spurring the business in the new normal and how they interact with each other as well as contribute to the overall success of the business (for example diminishing contribution of traditional sales and marketing efforts due to lockdowns, and increasing thrust on technology and brand awareness; coupled with digital modes of approaching customers). It is further important to understand if the change in key value drivers also signal a related change in the location of the DEMPE[1] functions in respect of intangibles, due to movement of key managerial personnel and reallocation of responsibilities across jurisdictions.

Tax authorities around the world are expected to undertake a much closer analysis of the COVID-19 business impact assessments, positions adopted, and documentation put together by MNEs.  Therefore, it is absolutely imperative for companies to recognise these requirements and plan ahead of time for tax authority reviews, especially if they anticipate use of any unconventional approaches or methodologies to substantiate their inter-company pricing arrangements.

IV) Global TP audits and Dispute Prevention/Resolution

The significant operational and financial disruption caused by COVID-19 would have an impact on tax collections of jurisdictions across the globe. The situation has been exacerbated not just by the reduction in tax collections worldwide, but also due to the various incentives and schemes offered by governments to support businesses in this crisis. It is therefore widely anticipated that once the immediate impact of COVID-19 is over and tax audits commence the way they were in the pre-COVID era, authorities may follow an even more aggressive approach to make up for the revenue shortfall.

TP has been a prime area of focus for tax authorities in recent years and more specifically, following the increased documentation requirements stipulated by the OECD in its BEPS Action Plan 13 final report (issued in 2015). The enhanced scrutiny of TP arrangements and positions is only expected to intensify, with MNEs adopting more unique and unconventional positions to account for the impact of COVID-19. Companies can generally expect to undergo more difficult TP audits and vexed questions from tax authorities, in addition to more detailed information and data requests to justify their positions.  The increased use of two-sided approaches (like the profit split method) and enhanced focus on TP, relating to intangibles are also anticipated.

Certain important aspects that multinationals need to factor in are – (i) consistency in global documentation (Country-by-Country report, Master File and Local files), (ii) alignment of economic outcomes with on-ground functional, asset and risk substance, as well as with contractual and legal obligations, and (iii) a robust economic analysis to support the TP positions adopted.

The OECD’s work on the development of a Multilateral Instrument (“MLI”) has helped in setting certain minimum global standards focused towards dispute resolution. It was recommended that all countries that implement the BEPS package must publish comprehensive Mutual Agreement Procedure (“MAP”) guidance. In India, the CBDT had revised the MAP Rules and issued MAP guidance in August 2020 to align the regulations with the minimum standards laid down in OECD’s BEPS Action Plan 14, which would be helpful for taxpayers to gain more clarity in MAP proceedings.

Ultimately, with the rapid increase in global TP audits and most disputes involving multiple countries, taxpayers will have to adopt a well thought-through and closely coordinated approach to ensure consistent messaging and uniformity of outcomes across jurisdictions. Taxpayers would also need to increasingly rely on multilateral mechanisms like MAPs or Advance Pricing Agreements (“APA”) to effectively execute their dispute resolution and prevention strategies. At the same time, taxpayers would also expect more clarity and guidance from the tax authorities on the rules relating to some of these controversy management and avoidance measures, in order to collaborate more effectively and agree upon the most optimal approach from the viewpoint of all the transacting entity jurisdictions.

V) Increased role of TP in Mergers & Acquisitions (“M&A”)

Many MNEs facing business crises or opportunities due to the unique challenges posed by COVID-19 have chosen to restructure their operations through M&A activities. Large groups having significant financial resources are investing in new businesses to complement their existing offerings. It would be important for MNEs to recognise early in the M&A cycle that TP needs to be a critical consideration in the entire exercise, starting from the initial due-diligence for identifying potential risks, and more importantly to identify opportunities for potential changes to business models, IP planning and policy integration in the planning and implementation stages.

MNEs would need to evaluate implications, if any, arising from re-allocation of functions and risks, movement of intangibles from (one or more) existing principal entities, movement of key personnel, changes in key performance indicators, modifications to financing structure, etc. which may result as a consequence of a M&A related strategic initiative. MNEs would also need to ensure careful evaluation and analysis of TP considerations from the start of the M&A process to derive maximum value for all stakeholders.

VI) Embracing Automation

With the enhanced significance of technology across all spectrum of life, TP process of MNEs would also need to undergo a transformation. It would be important for MNEs to recognise various areas in which technology can help in ensuring robust control over inter-company transactions and making sure that the financial outcomes are aligned to TP policies. In recent audits, it is observed that tax authorities are also keen to understand the computations and controls within the group to ensure that appropriate mechanisms are adopted for inter-company accounting (for instance back-up data for costs charged to group entities, segmenting local entity financials as per TP policy, ensuring all relevant costs to be charged to overseas entities are included in the cost base, etc.). Further, statutory auditors of MNEs are also equally interested in ensuring robust controls are in place for appropriate inter-company pricing.

Technology enabled processes may help organisations in minimising manual interactions, thereby, reducing errors, ensuring correct inter-company accounting, ensuring easy data storage/retrieval, availability of audit trails, etc. With the advent of OECD BEPS initiative and evolving TP environment, it is essential for MNEs to streamline their operational TP processes. Further, with the increasing adoption of technology enabled processes by the tax authorities globally, it is critical for corporations to match the pace and start embracing technology tools towards automating TP related matters.

Conclusion

The tax landscape is transforming at a pace faster than ever, with key changes likely to take place in reallocation of taxing rights under Pillar One, minimum tax under Pillar Two and several countries announcing unilateral measures to tax MNEs. The advent of technology within TP processes of MNEs and tax authorities is changing the way information is shared/accessed by stakeholders. The current rapidly evolving, and dynamic business and economic environment have resulted in significant changes within businesses.  Such changes coupled with more intense audits would result in higher tax uncertainty for MNEs, which can be counter balanced by upfront planning and preparation.  Taxpayers also feel a need for tax authorities to provide more clarity and guidance in these uncertain times, work in a collaborative non-adversarial manner, and also ensure access to robust/time bound dispute prevention and resolution measures (unilateral as well as bilateral/multilateral, such as MAP and APA).

TP regime in India over the last two decades has seen significant evolution in terms of knowledge and issues from both the sides viz., taxpayer and tax administration.  Issues range from comparable companies and methods to many more complex matters.  Indian courts and appellate authorities have issued many pathbreaking rulings, creating rich jurisprudence that world has not seen in more than half a century.  It is time now for all the stakeholders to embrace the new norms and look for less litigative environment, faster dispute resolution and prevention mechanisms by providing greater certainty, while looking ahead with India aspiring to become a US$ 5 trillion economy, where cross border trade will have a much bigger role with evolving digital and new age business models. Our TP rules and implementation needs gear up for the interesting as well as challenging times ahead of us.