CP vs. TP
Convergence of Income Tax Transfer Pricing (TP) & Customs Valuation (CV) mechanisms is very much essential. As, Mr. S. Dutt Majumdar, Director General of Revenue Intelligence said in an interview "the convergence is no more desirable … it is inevitable, for the simple reason that it is only fair that the same goods are valued by the same standard under two or more statutes."
WHY CONVERGENCE
Difference in Mandate
> TP provisions under the Income Tax Act to investigate the possible over-valuation whereas CVR to investigate the possible under-valuation with respect to tangible or combination of tangible & tangible in one transaction. On demonstration that, the prices are at Arm's Length Principle (ALP) - either under Income Tax Law or Customs Regulations, the question of over or under valuation is ruled out.
> Definition of Arm's Length Price : The price at which a willing buyer and a willing unrelated seller would freely agree to transact or a trade between related parties that is conducted as if they were unrelated, so that there is no conflict of interest in the transaction Financial Dictionary by FARLEX. When the same is demonstrated by importer and accepted by the one department, how it can become a price not at arm's length price transaction other than an ALP under other tax provisions of the same country.
> Both the legislations (Income Tax and Customs) aim to establish that there is no conflict of interest between the related parties. Surprisingly Income Tax and Customs departments appear to have "conflict of interest" between them.
PATHS TO CONVERGENCE
Discussed under different methods - TP vs. CV. For most of the methods, without the intervention of the international bodies (OECD & WTO), convergence is possible
The methods are either descriptive (i.e., focusing on "what is"), normative (i.e., focusing on "what should be"), or a combination of both. While tax payers and consultants face idiosyncratic variables that constitute the "reality on the ground," while revenue tended to focus on more universal factors, conceptually characteristic of a range of situations. As a result, in some situations practice appears to drive theory, and in others theory seems to drive practice. At the end, transfer pricing is not an exact science. Hence it needs many considerations and adjustments which left to the discretion of the AO/TPO. The crux lies here.
The mandate of the government as a whole is that "internationals transactions between AE's / related parties should not lead to revenue loss to the government". To ensure the same, government seeks demonstration from the Indian Tax Payer about no such loss of revenue caused by the transactions held by them. If such transactions are found, modalities are specified to make adjustments in assessable value or allowable expenses to arrive at neutral.
CHALLENGES IN CONVERGENCE
> There are many hard to change differences between income tax and customs mandate :
> Under Income Tax - "Exact taxable Income" - So called best method
> Under Customs - "Substitute". Not concerned to arrive a real market place accurate value for a rejected transaction value - Officer's best judgment
> TP Provisions are governed by the Income Tax Act (ITA) 1961 based on OECD mandate
> CV Rules are governed by the Customs Act (CA) 1962 based on WTO mandate. The Customs Valuation Rules (CVR) 1988 is reproduction of "agreement on implementation of Article VII of the GATT" with minor changes.
> Reconciling the provisions and mandates and arriving at one single provision is not an easy job.
Difference in Mandate
> TP provisions to investigate the possible over-valuation which leads to less tax revenue under ITA 1961. Over valuation with respect to tangible or intangible and combination of tangible & tangible in one transaction.
> CVR to investigate the possible under-valuation which leads to less Customs Duty under CA 1962 read with CVR 1988 (now CVR 2007). Under valuation with respect to tangible or combination of tangible & tangible in one transaction (import of CG and royalty for using the software installed in the CG).
Hence the normal understanding is :
> IT department will not take action if, there is over valuation to an extent of 5% even though there is a loss on a/c of customs duty.
> Customs department will not take action if, there is a over valuation as long as they get their inflated Customs Duties.
How do we define the Arm's Length Transaction?
Customs and Income Tax are, both, under the Ministry of Finance. The contradicting situation is that, an assessee has to prove that the import prices are at arm's length / no influence due to relationship when there is conflict of interest between two sets of provisions.
> two different set of documents,
> two different method of assessment/demonstration,
> There is no clarity and coordination on TP aspects between these two department officers; Eg. Which department's view has precedence over the other (or) are they independent of each other?
> It is possible for both assessments to be simultaneously finalized and
> If CV is finalized by the Special Valuation Branch (SVB) after TP adjustment is made by AO under IT provisions, then what would happen to the duty subsequently paid on loading % or value;
Will it be an allowable expense under IT proceedings ?
· Can the IT officer reopen the assessments?
· If he can reopen, wlll he allow and accept as it is on providing proof of payment
· Because of single mandate, no coordination, clarity, etc. the tax payers are being penalised with cost of demonstration under two provisions (Eg. For TP one has to subscribe Prowess and for Customs one has to buy import data of similar / identical goods from the market), cost of legal, time spent which could have been spent on business for better returns and better revenue for the government etc.
Is the convergence really possible when the basic mandate itself is different?
It is, if both international organisation move out from their stated positions and work together for a reasonable solution keeping in mind the time being spent by the Corporate in demonstration of the ALP to two different Revenue Departments with two distinct sets of documents
|
# |
Income Tax Method |
Vs. |
Custom s Valuation Methods |
|
1 |
Comparable Uncontrolled Price Method (CUP) |
Vs. |
Transaction Value of Similar / Identical Goods (TVS/TVI) |
|
2 |
Resale Price Method (RSP) |
Vs. |
Deductive Value Method (DV) |
|
3 |
Cost Plus Method (C+) |
Vs. |
Computed Value Method (CVM) |
|
4 |
Profit Split Method (PS) |
Vs. |
NIL |
|
5 |
Transaction Net Margin Method (TNM) |
Vs. |
NIL |
Note: Application of methods # 1 to 3 yields goods result, only when quality data available.
BASIC DIFFERENCES
|
Income Tax |
Customs Valuation |
|
Irrespective of suspicion, the provision is invoked
There is no provision for the AO to accept the transactions as it is, if international transaction exceeds 150minr in any previous year.
If the transaction exceeds 150minr with AE during the FY, then maintenance of document under rule 10A to 10E, Accountant Certificate, etc. are mandatory.
Demonstration of transfer price as ALP is based on the value of transaction and not on the doubt / intelligence on the transaction
Five plus unspecified methods prescribed. Assessee has the option to select any method (method which provides " the most accurate measure of an arm's length result"), without sequentially selecting the appropriate method. |
Only in case of doubt, provision is invoked
As per Rule 4(2)(d) of CVR 2007, the Transaction Value is acceptable u/r 4(3)
As per IN to Rule 4(3)(a), "…..examination will only be required where there are doubts about the acceptability of the price……" It is compulsory in all cases
When doubt exists, ascertain as per provision and demonstrate that the declared value of the goods are closely approximate to the ascertained value
Four plus one residual methods are prescribed. Importer has to sequentially knock off each method before travelling to next method. |
CUP Method vs. TVI/TVS Goods (Comparable Uncontrolled Price Method vs. Transaction Value of Identical/Similar Goods)
|
General Remarks |
|
1. Best fit method if uncontrolled transactions could be identified with authenticate data |
1. Best fit method if import details of similar / identical goods exist, whether from the same supplier or not |
|
Similarity |
Similarity |
|
1. Compares amounts charged in controlled transaction(inter company) with uncontrolled transaction (unrelated third party) |
1. Compares FOB of importer with FOB of similar or identical goods imported by unrelated third party from the same exporter or some other exporter but from the same country of origin |
|
2. Adjustments can be made when precisely comparable transactions are not found |
2. Adjustment can be made on the basis of demonstrable evidences which clearly establishes the reasonableness and accuracy of the adjustment, whether the adjustment leads to an increase or a decrease in the value |
|
Divergence |
Divergence |
|
1. There is no condition on country of origin
2. Adjustments allowed are liberal |
1. Country of origin should be same
2. Adjustments is stringent / rigid |
|
Possibilities for Harmonisation
§ This method provides best evidence of an ALP
§ Application of this data is not possible in most of the cases, because
§ Either the AE doesn't part away with details
§ Non availability of quality data
§ Non availability of comparables, such as medicines
§ Especially internal comparables are extremely difficult. Eg. A is the AE of the Indian company B. A has many PE's all over the world. By which A ensures that all his products are brought in the world market only through its PE's. Hence no possibility of uncontrolled transaction at all
§ Looking into the similarities and divergences, adoption of Customs method is more accurate, demonstrable, adjustments warranted are again scientifically arrived (not by discretion).
§ There can be instruction from the board to accept one department's order by another department (the correct flow is Customs Income Tax) if the assessee had demonstrated under this method.
§ The feature is, this can be done without being international organisations brought into the frame |
RSP Method v. DV Method (Resale Price Method vs. Deductive Value Method)
|
General Remarks |
|
1. Best fit for resale of imported goods as is |
1. Best fit for resale of imported goods as is |
|
2. The method is reverse computation, starts from resale price of the distributor to arm's length party |
2. The method is reverse computation starts from RSP of the distributor to arm's length party |
|
Similarity |
|
1. The costs incurred from import to sale are allowed as deduction. |
1. Loading is arrived by reducing profit & general expenses, duties & taxes, Freight & Insurance, Cost of repacking & Warehousing |
|
2. Residuary figure is arm's length price |
2. Residuary figure is arm's length price |
|
3. It fits where a reseller does not add substantial value to a supply |
3. It fits where a reseller does not add substantial value to a supply |
|
4. The emphasis on comparability of functions increased when comparability on goods reduced |
4. The emphasis is to functions - from similar/identical moved to same class or kind fall within a group or range of goods produced by a particular industry or industry sector |
|
Divergence |
|
1. Costs not included in operating costs are not allowed as deduction |
1. No such stipulation |
|
2. No time stipulation on data being compared |
2. Limited time, within 90 days from the data of subject import |
|
3. Addition of intangibles - no clarity. Since left to the discretion of the officer, no trend is set so far. |
3. Addition of intangibles - it is clear. If the intangibles are payable as a "condition of sale", then addable |
|
Possibilities for Harmonisation - Easy to harmonise, without even escalating to forum of both international organisations
1. Except for valuation of and treatment to intangibles, both the methods are one and same.
2. Till the time best alternative method is worked out, condition of sale can be the yard stick.
3. As for the valuation is concerned, it is an unresolved issued world wide. When some amount of justification is possible from the AE's for trade intangibles, it is not at all possible for market intangibles. Market intangibles are the perception of the intangible, which has no yard stick to measure.
4. There can be instruction from the board to accept one department's order by another department (the correct flow is Customs Income Tax) if the assessee had demonstrated under this method.
5. The feature is, this can be done without being international organisations brought into the frame
6. This will cover almost all the import traders, procuring from AE's |
CPM vs. CVM (Cost Plus Method vs. Computed Value Method)
|
General Remarks |
|
1. May be best fit method for SKD or long term purchase agreements without intangibles, as per OECD. |
1. Best fit method, provided the supplier is prepared to part with all details and there are no intangibles |
|
Similarity |
|
1. This method ensures that the transfer price includes all cost of production plus gross profit
|
1. This method ensures that the transfer price includes all cost of production plus gross profit |
|
2. Costs need to be determined in accordance with sound accounting practices |
2. Costs need to be determined in accordance with sound accounting practices |
|
3. GP % is determined through a comparison. |
3. GP % is determined through a comparison |
|
4. Adjustments for GP% is needed for difference in cost structure, business experience and relative management efficiency |
4. Adjustments for GP% is needed for difference in cost structure, business experience and relative management efficiency |
|
|
1. Unpopular method of valuation for businessman as well customs officials
2. Customs Authority has to conclude based on CPA certificate issued by the seller
3. GVC limits application of this method in Art 6, Notes 6(1) indicating that the CVM will generally be restricted to related party transaction and not be resorted to widely to determine a substitute transaction value |
|
Possibilities for Harmonisation - Easy to harmonise, without even escalating to forum of both international organisations
1. GVC / Customs doesn't emphasise this method since they have no big role once importer submits CPA certificate stating that goods were sold only after adding reasonable profit.
2. Even if the profit is not reasonable, there is computation method specified for arriving at the substitute value
3. There a common Concern with consistency of accounting records, reliance on GAAP and preference of internal comparables
Since GVC/Customs doesn't emphasis much on the method and similarities are found more than divergences, Convergence of these two methods is highly possible |
K.Senguttuvan, B.Sc., MFT, LL.B
9911796707
