Introduction
We are pleased to present the latest edition of Tax Street – our newsletter that covers all the key developments and updates in the realm of taxation in India and across the globe for the month of March 2025.
- The 'Focus Point' covers points to ponder on from a transfer pricing perspective as the financial year closes.
- Under the 'From the Judiciary' section, we provide in brief, the key rulings on important cases, and our take on the same.
- Our 'Tax Talk' provides key updates on the important tax-related news from India and across the globe.
- Under 'Compliance Calendar', we list down the important due dates with regard to direct tax, transfer pricing and indirect tax in the month.
We hope you find our newsletter useful and we look forward to your feedback.
You can write to us at taxstreet@nexdigm.com. We would be happy to hear your thoughts on what more can we include in our newsletter and incorporate your feedback in our future editions.
Warm regards,
The Nexdigm Team
Focus Point
Financial Year (FY) end: Points to ponder from Transfer Pricing (TP) perspective
Background
Following the close of FY 2024–25, it is pragmatic for taxpayers to review effective implementation of their TP policies and ensure that financial statements are reflective of defined transfer pricing policies so as to mitigate differences, if any, arising on account of non-alignment with the arm's length principle. While closing the books of accounts for the year under consideration, the taxpayer may consider the following:
TP Checkpoints
- Value of international transactions disclosed in the related party schedule are meticulously reconciled with transactions accounted for in books of accounts.
- Appropriate provisions are recognized for ongoing TP litigations basis the likely outcomes in line with applicable accounting standards.
- Segmental financial information is prepared and maintained in case of taxpayers having multiple revenue streams and transactions with related parties and/or unrelated parties with adequate allocation of common cost using rational allocation ratios.
- All TP related supporting documents viz. invoices, workings, valid intercompany agreements etc are thoroughly maintained.
- Intercompany agreements are valid for the relevant period under consideration or renewed accordingly
TP Adjustments
Taxpayers shall compare actual year-end financial results against the predetermined margins set in their TP policies. If discrepancies exist, adjustments (true-up or true-down) should be performed before finalizing financial statements. The timing of these adjustments is critical, particularly concerning potential implications arising viz. withholding tax and Goods and Service tax (GST), Customs, Accounting Standards and Forex fluctuations etc.
Distributors' losses
Distribution business models, though seemingly simple, often pose challenges in implementing transfer pricing policies. Limited risk distributors must maintain assured net operating margins, while normal risk distributors can incur net losses with strong arm's length rationale. Losses incurred by normal risk distributors require robust documentation, analyzing whether they stem from market penetration strategies. They need to be supported by realistic projections, as for third-party distributors, incurring losses or investing for another third party is unlikely unless they perceive a realistic chance of recouping past losses and achieving a fair market return on their investments.
In case of losses, evaluating subvention or credit notes from Associated Enterprises (AE) and adjusting pricing in future budgets becomes necessary, particularly for exceptional years. Complications arise, especially when distributors undertake significant marketing functions, which is highly litigated by Indian tax authorities for the corresponding returns.
Free of Cost Goods/Services
Cost plus entities being captive service providers, contract manufacturers often face a dilemma from receipt of free of cost goods/services/assets. From an Indirect Tax perspective, the taxpayer is required to pay customs duty on goods/assets and GST on services on reverse charge basis (if not eligible to full Input Tax Credit), to avoid interest and penal implications.
Similarly, from a transfer pricing standpoint there is an expectation that these costs are considered in the cost base and recovered with a mark-up. While services such as shareholder services should not be charged, there are other services such as management services or technical services which the taxpayer would have otherwise availed from third parties for providing the captive services, should be charged.
Similarly, laptops and off the shelf software such as Microsoft software should be charged to the taxpayer and these costs (in the profit and loss account) should be recovered with a mark-up from the AE in a captive scenario. The approach adopted from the GST perspective needs to be aligned from the TP perspective and appropriate disclosure needs to be made in the Form 3CEB for the relevant year under consideration to avoid any misreporting of such transactions from a completeness perspective
Secondary Adjustments
Timely TP adjustments undertaken in the books of accounts would avoid triggering any suo-moto adjustments in the annual returns for the relevant year under consideration and secondary adjustment implications thereon.
Alternate Dispute Resolution Mechanism
Based on past litigation history, the taxpayer may evaluate to opt for any dispute resolution mechanism viz. safe harbour rules or advance pricing agreements. Further, the taxpayer may leverage on the rates prescribed under safe harbour as indicative rates and align its pricing policy based on the economies of scale to mitigate the risk of litigation in future.
Treatment Of Extraordinary Items
Examine any extraordinary income or expense items recorded during the fiscal year to determine their appropriate inclusion/exclusion from the cost base for mark-up calculations or revenue for margin computations. It is pertinent to note that there are a plethora of rulings already available in the Indian judiciary on the treatment of such costs and income while computing the margin earned by the tested party for the relevant year under consideration.
Deemed International Transactions (DIT)
Under Indian TP regulations, transactions undertaken between the taxpayer and independent party, wherein the key terms of such transactions are determined by the foreign AE - either through contractual arrangement or in substance, are construed as DIT. Akin to other international transactions, DIT transactions must adhere to the arm's length principle. Identifying DIT can be complex, requiring taxpayers to recognize, report, and justify such transactions. Thus, reviewing contracts with independent parties is crucial to determine DIT applicability to avoid any misreporting of such transactions.
Overdue Receivables
Litigation over overdue receivables has intensified, with tax authorities often imputing notional interest charges on such overdue receivables. Taxpayers in such cases shall pro-actively ensure that outstanding receivables are settled within agreed credit periods. Aligning credit policies with those offered to independent parties and maintaining strong documentation such as purchase orders, invoices, and agreements can help substantiate compliance. Judicial precedents have favored taxpayers with well-documented cases, reinforcing the importance of thorough recordkeeping.
Need-Benefit Test for Availing Intragroup Services
Tax authorities frequently scrutinize intragroup services, questioning their necessity and benefits. To substantiate these services, taxpayers must maintain detailed records, including emails, meeting minutes, internal memos, and timesheets. Additionally, documentation should outline cost details, allocation methods, and benchmarking studies supporting mark-ups. Delays in compiling this information - especially when key employees leave or historical data is inaccessible - can lead to disallowances, attracting additional tax, interest, and penalties. To mitigate risks, it is prudent to maintain documentation on a real-time basis.
Foreign entities TP compliance in India
In case the foreign AE of the taxpayer earns taxable income, viz. fees for technical services, royalty, interest etc. in India then, the foreign AE is required to file its return of income and undertake prescribed TP compliances i.e., Form 3CEB and maintain the transfer pricing study report in India. Further, the taxpayer needs to obtain a Permanent Account Number (PAN), evaluate and opt between withholding tax provisions as prescribed by the Incometax Act, 1961 (ITA) vis-à-vis Double Taxation Avoidance Agreement (DTAA) provisions while making payments to foreign entities. A reconciliation of total value income derived by foreign entities and 26AS of AE should be maintained.
As the financial year closes, addressing key transfer pricing considerations is crucial to ensure compliance, mitigate risks, and align business strategies. By systematically addressing the above areas, Multi-national Enterprises (MNEs) can strengthen their compliance framework, reduce disputes, and build a robust defense mechanism during TP audits. A proactive approach, including early planning for the next financial year, enables businesses to anticipate challenges, implement timely solutions, and maintain operational efficiency
From the Judiciary
Indirect Tax
Whether IGST and Cess can be additionally levied under the Customs legislation on re-imported goods sent outside India for repair and maintenance, when IGST has already been paid on the service imports?
Interglobe Aviation Ltd. vs. Principal Commissioner of Customs ACC [W.P. (C) 934/2023]
Facts
The petitioner had sent aircraft engines and parts outside India for maintenance, repair, and overhaul. However, upon re-import, such repaired goods were subjected to Customs duty on the value of repairs, insurance, and freight, in terms of Notification No. 45/2017-Customs.
As per the petitioner, the export of subject goods for repair outside India and their subsequent re-import fell within the category of "supply of services" by virtue of Schedule II to the CGST Act, 2017 and therefore, no further impost (levy of IGST and Cess) as envisaged under Section 3(7) of the Customs Tariff Act would stand attracted.
On the other hand, the Revenue relied on the 'aspect theory' to argue that the levy under Section 3(7) of the Customs Tariff Act stood attracted on the physical re-import of repaired goods, which is independent of the tax liability payable under Section 5(1) of the IGST Act on the repair services.
Given this, the petitioner approached Delhi HC challenging the amendment to Notification No. 45/2017-Customs vide Notification No. 36/2021-Customs followed by Circular No. 16/2021-Customs which justified the additional levy of IGST and Cess as clarificatory in nature.
Ruling
HC observed that the transaction of sending goods abroad for repairs/refurbishment and their subsequent re-import has been conferred the character of supply of services under Schedule II of the CGST Act. Once classified as a service, it cannot be recharacterized as a supply of goods for the purpose of imposing additional duties.
Referring to the SC judgement in Mohit Minerals [TS-246- SC-2022-GST], HC opined that the Revenue had failed to consider the indubitable fact of rendition of services being embedded in the reimported goods and thus, there being no dichotomy which could have been possibly introduced.
As regards the 'aspect theory,' HC clarified that the work expended by the MROs on the goods constituted the principal purpose of their movement/departure from the Indian shores and therefore, this was not a case where one could legitimately assume or perceive the existence of two separate or disconnected taxable events.
Further, discerning the intent of an 'Explanation', HC observed that Notification No. 45/2017-Customs as it originally stood, only spoke of duty of Customs which was referable to Section 12 of the Customs Act, i.e. Basic Customs Duty (BCD). Thus, the amendment sought to be introduced by Notification No. 36/2021-Customs could not be viewed as being either in the nature of an explanation, a removal of doubt clause, or clarificatory.
As per the Court, the amendments were clearly intended to expand the tax net and attempted to remove the basis on which Principal Bench of CESTAT had rendered its decision (in the petitioner's own case) on a reading of Notification No. 45/2017-Customs. This amounted to a legislative overreach by an authority exercising the power of framing subordinate legislation, held the HC.
Consequently, HC held that Notification No. 36/2021-Customs insofar as it purports to impose an additional levy over and above the IGST imposed under Section 5(1) was ultra vires and unconstitutional. Accordingly, it quashed Circular No. 16/2021-Customs as well as the orders of Commissioner of Customs (Appeals) which had distinguished the CESTAT decision in light of the amendments.
Our Comments
The decision essentially holds that levy of IGST under Section 3(7) of the Customs Tariff Act would sustain only where the transaction qualifies as 'supply of goods in the course of import into India' under Section 5 of the IGST Act. This proposition could have wider ramifications and open a pandora's box. For instance, could one argue that IGST levied on royalty and/or license fee qualifying as 'import of service' under Section 5(1) should not attract the levy under Section 3(7) vis-à-vis imported goods by virtue of Rule 10(1)(c) of the Customs Valuation Rules?
This judgment could lead to multiple scenarios prone to litigation, where dual IGST levy arises – as part of Customs duty, and as reverse charge IGST levy.
However, this begs the question as to how the Government would respond to the Delhi HC verdict.
Given that an appeal against CESTAT's decision lies pending before the Supreme Court, this issue could attain finality only with the Apex Court's decision.
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