Related Party Transaction | Interplay between GST and Transfer Pricing

According to tax experts’ assessments of the GST implementation, the old issue of transfer pricing has the potential to shake the system in the future. The goods and services tax (GST) was implemented with the goal of creating “one nation, one tax,” and it is the country’s largest indirect tax reform in history. 

The truth is, with the implementation of GST, several challenges are faced during the usual Transfer Pricing transaction. In this article, we’ve listed a few for you so that you can get ahead of the game!

1. Transfer pricing provisions on Related Party transaction

1.1 Specified International Transactions

• Special provisions are given under Income Tax Act to deal with Specified International transactions between related parties where either of the parties is located outside India and Specified Domestic transactions between related parties.
• Many MultiNational Companies curbs Income Tax by shifting profit from Business in the countries where higher tax is payable to the country where lower tax is payable.
• Transfer pricing provisions make sure that no income tax is avoided in India by shifting profits outside India. 
• Therefore, transaction pricing provisions ensure that international transactions between related parties have been entered at Arm’s Length Price, i.e., at par with the price of unrelated party transactions.

1.2 Specified Domestic Transactions

• In case of domestic transactions, generally change in transaction price doesn’t have tax liability implication unless either of the parties is incurring losses or coming under lower tax rate bracket. 
• However, Certain persons in India are eligible for Tax holidays, i.e., no Income tax is payable for a certain period of time or higher deduction of expenses is allowed, i.e., 150% or 200% of actual expense incurred. Therefore, certain person tries to curb Income Tax by shifting profit to such entities.
• To avoid such practise, provision of transfer pricing is made applicable on certain domestic transactions.
• Domestic TP provisions make sure that a transaction has been entered at Arm’s Length Price.

1.3 Determination of Arm’s Length Price 

• Under Income Tax, following methods are provided to compute Arm’s Length price under Section 92C of Income Tax Act:
  • comparable uncontrolled price (CUP) method;
  • resale price method;
  • cost plus method;
  • profit split method;
  • transactional net margin method;

• The most appropriate method shall be selected and applied for computation of Arm’s Length Price.

2. Related party transaction under GST

• Section 15 of CGST Act, 2017 deals with provisions of Determination of value of Goods and services.
• As per section 15, where supply is made between related parties then value of supply shall be:
  • Open Market Value of Such Supply
  • If Open Market value is not available, value of supply of like kind and quality;
  • If the value is not determinable under clause (a) or (b), be the value as determined by the application of rule 30 or rule 31.

• In case where the recipient is eligible for Input Tax Credit then value declared in Invoice shall be considered to be Open Market Value.
• Further, as per Schedule I of CGST Act, supply made between related persons without consideration is still considered as supply and therefore is liable to GST.
• Scope of related party is wide under GST and covers domestic transactions as well.

3. Contradiction between Provisions of Transfer pricing and GST

• Interest of both the laws is to curb the tax avoidance practises in India. However, the intertwined nature of these provisions has led to certain contradictory interpretations as well as controversies.
• Perspective of both the tax laws are different in following manner:
  • For any transaction related to expenditure, the Income tax department would like to determine Arm’s Length price at the lower side as it would increase the profits of Indian Entity and therefore, would increase the Income tax liability in India.
  • Whereas, the Goods and Service Authority would like to determine it at the higher side as it would increase the collection of GST on Import of Service.

• Therefore, determination of Value of any supply can move in the opposite direction under Income Tax and Goods and Service Tax.

• There are certain transactions which requires taxpayer to plan carefully.

3.1 Free Of Cost use of licence/brand name granted to Indian subsidiary by its foreign parent

• Foreign Companies generally allow their Indian Subsidiary to use Licence/Brand Name of their foreign company without any cost,  i.e., on Free of cost basis.
• Therefore, such transactions are not recorded in books of accounts as no monetary value is available.
• As per Schedule I of CGST Act, 2017, supply between related parties without any consideration is considered as supply and therefore is liable to GST. For the purpose of computation of GST liability, value shall be determined as per Section 15 of CGST Act.
• Therefore, taxpayers shall be asked to determine value and pay GST accordingly.
• However, if the value of such a transaction is considered then it will lead to reduction in income chargeable to tax or shall increase the loss, therefore, as per Section 92(3) of Income Tax Act, 1961, provision of transfer pricing shall not apply.
• However, Income Tax authority may rely on valuation carried out for GST purpose as Arm’s Length price and can demand deduction of TDS.

3.2 Copyright/License fee/ Brand fee charged on Indian Subsidiary to use License/ Brand name of foreign companies

• In cases, where a fee is charged for granting use of license fee/ brand fee, Income Tax Officers would like to determine a lower price as would lead to higher profits and higher income tax liability.
• Whereas, GST officials would like to determine higher price as it would lead to higher GST Collection on import of service.

3.3 Deemed International Transactions

• As per Section 92B(2) of Income Tax, 1961, an international transaction entered into between any person other than associated enterprise shall be deemed to be entered between two associated enterprises if price and terms of such transaction are determine in accordance with an a prior agreement entered into between such such other person and the associated enterprise.

E.g. 

1. A holding Company in the USA has a subsidiary in India.
2. USA company entered into an agreement with an independent USA company wherein various terms of supply of goods to Indian Subsidiary are determined.
3. Such USA Company entered into an agreement with Indian Subsidiary for supply of goods in accordance with terms determined by such USA Company and Holding Company.
4. Therefore, as per Section 92B(2), a transaction between Indian Subsidiary and Independent USA Company is a Deemed to be entered between associated enterprises.

• However, such a transaction is not considered as a transaction between related parties under GST law.
• In such a scenario, access of Form 3CEB to GST authorities may expose such transactions to an arm’s length testing from GST perspective, which would have otherwise not been under that ambit.

3.4 True-up/ True-down adjustments:

• To determine Arm’s Length price, various adjustments are made to initial transaction value.
• Since these adjustments are not factored in the initial price of the transaction, an additional GST liability may arise in case of subvention payments.

4. Possible solution to contradiction in valuation under GST and Transfer Pricing 

• Keeping in mind the challenges mentioned above, it is quite natural to ask “how to resolve these issues?”. Well, according to analysts, the indirect tax system is time-bound as a time of supply, and undervaluation regulations play a significant part in price computation.
• Relief to taxpayers is since three years, the tax department has been working hard to settle transfer pricing difficulties by signing Advance Pricing Agreements (APA) with multinationals.

4.1 Advance Price Agreements (“APA”)

• As per OECD transfer pricing guidelines, APA (or arrangements) is an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria for the determination of the transfer pricing for those transactions over a fixed period. 
• In other words, an APA is an agreement between board and taxpayer/ any person for determining ALP for specifying the manner of determining ALP in relation to international transaction.
• Section 92CC of income tax act, 1961 enables the board to enter into APA with any person for determining ALP or manner of determining ALP in relation to international transaction.
• In all fairness to the taxpayer, a price accepted for transfer pricing by the income tax department should ideally also be accepted by the GST department considering both are central government bodies. 
• Therefore, if a taxpayer has concluded an APA agreement on its transfer pricing policies, exposure on the GST front may be reduced to a great extent.

Conclusion

Every coin has two sides, so does GST and Transfer pricing combined. The possible solution to the challenges can be further explored to figure out an easier and more fruitful outcome.