The following transcript has been lightly edited for clarity. The original interview can be heard on The LCN Legal Podcast here.
Paul Sutton: Welcome Akshay, and thank you very much again for joining us on this podcast. I'd like to kick in with the first question, which is about the tax authorities in India. As you know, they do have a reputation for being aggressive, especially when it comes to transfer pricing. So I'd be really interested to hear from you as to your experiences over the last twelve months. Maybe looking ahead over the next twelve months as well. How do you see the TP audit environment in India as compared to other countries?
Akshay Kenkre: So Paul, I may have to just go back a little bit in time, because the principle that I'm going to tell you is about the law of karma. If I talk about the 1990s, in fact, 1991, to be very specific, when India opened up, FDI [Foreign Direct Investment] flew in. There were so many international companies that started setting up shops here. Transfer pricing was absent at that point of time. So transfer pricing was only introduced in 2001, 2002 – formally started from 2002. And for the first ten years, there were a lot of tax avoidance schemes that were running. And when transfer pricing was fully established and the tax authorities started auditing it, they found all type of loopholes and they saw the tax avoidance happening. So when you see something happening, which is like a test, then you start becoming aggressive, you start putting in more rules, right? And that was the, I would say, initiation of the tax authority being aggressive. And then there were a whole lot of innovation in the aggression. So you saw the Vodafone case, one, two, three, so many others where there were paper demands. But it all started with the multinationals, starting with tax avoidances in India.
But things have settled down. After 2015, ‘16, there has been certain change in the regulations, certain notifications brought out. There were certain rights of taxpayers which were published. All those aspects – the taxpayer’s charter, as we called it – once those were done, the tax authorities have become, I think, more assertive. And it's just not because nothing has changed. Things have changed at the ground level too. Multinationals nowadays, they don't want to do tax avoidance. The tax rates in India are also very competitive. Gone are the days when it was 35% taxes, now it is at the level 22% plus plus… goes up to 25, and say for manufacturing we have 15%, right? So every multinational likes to pay tax if it is at a certain level. And if there are regulations around it, they don't just mind paying taxes and getting done with it. So the tax authorities have become assertive. They have started to listen to the taxpayers’ personal experiences. Lot of discussions happen when we go to the tax authorities. Earlier it was only issue-based, but now they want to understand business. They appreciate the contribution of businessmen and taxpayers to the Indian economy.
Earlier it was not the case. Because India comes from that colonial era where the seats were filled by the Indian administration. They are today also. But it's all assertiveness. Litigation is there today also, but the degree has come down. The number of cases that were getting filed at the tribunal, they have reduced. But there is litigation, there is quality litigation, and we just don't get paper demands just to fill up the files. So the aggression has shifted to assertiveness. As compared to other countries, it's still aggressive, things are still stringent. B ut these are, I would say, quality issues that we are talking about.
PS: I completely agree with you about karma. We see the same thing in UK and elsewhere. And from my experience previously, working in a Big Four firm, there was a culture of just… it was like a game, wasn't it? You go to counsel, you try to create a structure, see if you can get a double deduction. And that was just part of the game. And I think it's a natural result that BEPS and so on happened. But it is really interesting.
AK: One more thing that has changed is all about digitalization. I'm sorry to cut you short, but I think this was a necessary extension that digital infrastructure in India has also been attached to taxes. So the one phase of income taxes runs on a faceless basis, which means a notice comes in, we don't know who has sent it. It's all electronic, it's sent by the income tax officers. From which part of the country? We don't know. But we need to answer to that, and everything happens via digital mode. So that's a faceless side. As far as the transfer pricing is concerned, that's also an electronic mode. But because TP is all about businesses, sometimes representations are necessary. But the digital infrastructure is so developed that there is no more need for the tax officer to either visit the taxpayer or the other way around.
PS: Yes. And do you see that as positive or negative, in terms of that progression from aggressive to assertive? Do you see that as helpful or not helpful?
AK: I think plus and minuses on both the sides, but the plus overweighs the minuses, most importantly, because it saves time at both the end. Essentially, what it means is it's all about the documentation, it's how you write, it’s what proof you are able to put on the electronic means. Third, what is the ease and the simplicity in which you are documenting it? Because you're going to make… so let's talk of legal agreements, right. These intercorporate agreements, if they are going to be tough, if they are going to be talking the legal language, the tax authorities may not understand it. So although you may have the documentation that might go against you. It's all about simplicity. It's all about practicality. It's all about covering all the points. So if you have all of those right, then it's definitely a positive.
PS: Obviously, definitely agree with you about agreements and keeping them simple, getting to the point commercially. Okay, so if I can maybe move on. I believe that India just passed its annual union budget. So really interested to hear, were there any particular developments from a TP perspective that people need to know about?
AK: This budget was more of a growth budget: heavy expenditures planned on the capital side, which means the country is pushing in the expenditure and very confident about the income that will generate. Sometimes not doing any amendments – heavy amendments – is also a good sign, right? Because that means you are very confident about the law that is already there with you. There were significant amendments on the income tax side, but nothing which will give rise to a litigation or kill a litigation. On the TP side, the importance of documentation has gone up – or the real time documentation has gone up – because earlier there was a regulation which said that after a notice is raised, there is a compulsory 30-day period that you should give the taxpayer to respond. That 30-day period has gone down to ten days now.
AK: Which means if I raise a notice on, say, Monday, then it is the ten day, or say, Wednesday, I need to respond to it. And on the special request, a tax authority can increase that ten days to 30 days. So earlier it was all about you add 30 days, then you add certain more days. And there were days where there was no response being given to the tax authorities. And with the passage of time, we are all human, sometimes we forget what we have done 30 days back. So that's not effective. So with the reduction to ten days, hopefully the assessments and the audience will become very effective from a TP perspective. But on the taxpayer side, it also means that they need to keep all the documentation ready. They cannot wait for the notice to come and then start preparing documentation, or start amending the documents. So this is a very crucial – very small, a very tiny but a very crucial – change on the transfer pricing side, which I think the taxpayers or businesses should really consider very seriously and maintain top-notch and up-to-date documentation.
PS: Yeah, I mean, from my perspective, ten days sounds incredibly tight, as you say. It basically only gives us enough time to collect and pass on the information and not to adjust or create it.
AK: But that means that we need to be ready, then. At all levels.
PS: Okay. And just talking about TP documentation in India, so from a high-level perspective, what would you say is different about TP documentation and the requirements in india as compared to other countries?
AK: Every country has its unique transfer printing documentation, I'm sure, but some of them are very influenced [by the OECD], or maybe they have just reflected what the OECD needs to say. India is not a member country of OECD. It is it has an observer nation status, which means any OECD guidance has a persuasive value in India. But you cannot borrow everything that OECD has said and adopt that on the Indian side. Which means there is a specific TP documentation regulation which you need to follow. So this is the first difference, that it's not OECD oriented. It has its own regulations, where OECD may have certain persuasive value.
OK, the differences are many. Maybe I would just like to point out a few important differences, just to start with. I think the most important would be that Indian documentation is in every year affair. So I see mainly from a US perspective where they say you can do benchmarking once in three years. And most of the US companies carry this particular notion about India also, and that's not true. So you need to maintain documentation every year, because there is no provision in the law which says that you need to maintain benchmarks and documentation once in three years, and then check after three years about your functional analysis and all the economic analysis and all those stuff. Which means every year you need to do those analyses to see whether you are at arm’s length or not.
Second difference is: each year's documentation is audited by a chartered accountant, and he needs to certify in a form called Form 3CEB, after undertaking a transfer pricing audit, that the transactions are at arm’s length. So, India follows two-level audit approach. One is by a chartered accountant and second by the tax authorities. Which means the taxpayer needs to be much more be prepared on a per-year basis, because without that documentation and without that audit report, a taxpayer is not able to file a return of income.
PS: That first stage accountant’s audit report, what does that look like? Does that mean in terms of your practice, Akshay, that that is something that you just have to build in to every client that you look after that you're producing that report? Or does it need to operate in a different way?
AK: You have a statutory audit, but there is an audit guidance on the transfer pricing side on how a chartered accountant should be auditing a company for transfer prices. So there is an audit report and there is a transactional report which is on the summary side, which is again uploaded electronically, based on which the tax authorities run risk parameters. And that's how the cases are selected for scrutiny. So it's just not that we are auditing it and then it's uploaded and forgotten. The tax authorities do work on that and it's a transactional report, so it does not give you a whole lot of details of what is there in the TP documentation. Your TP documentation is still separate, but your form 3CEB is an electronic form that we need to fill in and digitally sign, stating that as a certified accountant, we have audited this particular taxpayer for its international transactions, and we feel that the transactions are at arm’s length because of XYZ reasons.
PS: I see. OK. Any other high-level differences that you would highlight?
AK: I think one more important aspect for our global audience is that India accepts only Indian comparability data. It does not accept region-wide comparability. Yes. If you have a tested party which is outside India, and you're testing that company, then you can use a foreign tested party. But if you have the tested party, which is an Indian company, then you cannot basically be looking at comparable data outside of India. Which has been a mistake happening at various levels, with groups managed from, say, South Korea or Japan or UK or US. They generally try to look at the region wide comparability, which is absolutely not acceptable.
PS: I see.
AK: Talking about comparability, I think the next change would be a narrower range. The OECD says and interquartile range. India follows a 35% to 65th percentile, so they cut 10 percentile points on each side. So the rate is narrower. The concept is similar. And I think recently we had an electronic discussion about the intercorporate agreements in India. An intercorporate agreement could be oral, or written. Both are accepted. There is a concept of substance or form. We always say it has to be written, so that you can showcase in the court of law. But if you have certain things which is agreed on a piece of paper and that's email, that's also considered as an agreement. So that's another thing. Intercorporate agreements are important, but they may or may not be in the form of how generally we understand it to be.
PS: Yeah. I guess, in essence, it's similar to the OECD guidelines. The starting point is looking at the agreements. But obviously, if the substance of the operations – if the capacity to assume risk and so on – is not correctly reflected in the agreements, then the agreements are going to be disregarded. So we're really looking at what is the most practical way of creating the evidential trail to back up the TP policies. I assume that's the general principle that applies universally.
AK: True. Yeah.
PS: Well, it sounds like there are pretty fundamental differences between TP in India, or documentation in India, compared to other countries. One question I have, which is not about documentation as such, but just about markup. The classic thing that is that in terms of cost plus markups, it will be the rest of the world will be like 5% or 6% for routine. And in India it's, what, 12, 15 or something like that. So a big discrepancy between the standard accepted markups. Do you see that as changing? Do you see that as something that is basically built into the culture of Indian transfer pricing? Or do you see that as something that there'll be a tendency to converge those rates over time.
AK: So, Paul, I don't see cost plus five as standard, or maybe five or seven. The reason is that plus percentage: that's dependent on the type of markups the comparable companies make in that particular jurisdiction. Now, if you look at India. india is one of the top emerging economies, and there are opportunities here available. And for similar service – let's talk about services to start with – the comparable data are making higher markups. And India, they don't allow regional benchmarks. And that's the reason.
Because if you want to do business in India, you will not do it for 5% or 6%. I might as well invest my money into, say, a fixed deposit. I will get 7% return. But if I put it into my equity markets, I will get 10%, 11% returns, right? So if I want to start a business, of course it has to be above that, and possibly because of a little bit higher inflation, different economics, my markup as such goes up. Right? But that doesn't make India an unpopular economy for the west.
The reason is, if you if you look at the formula, it's cost plus, let's say, 20% versus a cost plus 5%. The percentage is on the cost. Now, if you compare a cost on the European side, which could be on the higher side, a 5% in absolute terms could be much heavier than the 20% if you compare on the actual terms in India. So the cost builds and makes a big factor there. And that's why: because the Indian costs are more competitive as compared to the west. Even if you look at cost plus 15% or 20%, it's still beneficial for some of the foreign jurisdictions to have their operations here, or a back office operations here, being on a cost plus basis. It's different economics.
PS: Yeah, it makes complete sense. And it goes back to your point about TP authorities or tax authorities in India only accepting Indian comparables, not regional, because it is a distinct market and it has its own characteristics. OK, that's really helpful to clarify that for me.
So looking ahead in terms of what multinational groups need to know about or specific challenges, things they might need to change or do differently going forward, you've already mentioned one very important thing, which is that ten-day window to respond to notifications or requests for information. Obviously, that is a major difference and anything else that multinationals need to be aware of?
AK: So I think if a multinational is looking at India as a market, or maybe as setting up their back offices, they should understand that India is a separate country and it's separate economics. Right. So from a TP perspective, any type of modelling that needs to be undertaken, they may not be right if they mirror what they already have in their country. So it's important, first of all, to take local assistance or have that local knowledge of how transfer prices are looked at in the country. And that local expertise is very important when you are talking of transf pricing in India. So that's possibly point number one after what you said.
Second one is on penalties. Indian TP documentation timelines, the way how it should be, they're quite stringent. So if you are missing on any part, there are heavy penalties. It goes up to like 4% of your international transaction: 2% on non-maintenance, 2% on non-furnishing. Which could become heavy if you have one million as an international transaction. Right. So that becomes quite significant. That could be the second point to look at what could be the other one. Again, as I said, every year you need to do a benchmark.
And again, documentation is essential because you are looking at the digital side of re-presenting. So if your documentation is going to be complex and if it's not being understood by a person reading it, then that's a failed documentation being made. So these are things you should consider while you are looking at India from a transfer pricing point of view. And I think it's become a very mature economy for TP. 21 years of existence of TP now in India. Learned a lot in this space. Highly litigious to more of an assertive [approach]. You have set a good example, I think.
PS: Great stuff. Yeah. And actually, I just wanted to go back to the point we were discussing before about the independent chartered accountants’ reports. What's your view? Is this widely understood in terms of multinationals, or do you see a lack of awareness in that requirement? And is there a particular threshold that is required before that requirement kicks in?
AK: So, for the audit report, I don't see there is lack of awareness about the audit report. The lack of awareness is more on the documentation side. The reason is when you come to India and when you start talking about compliance, it's one part of compliance. So I'm sure your statutory auditor, your accountant, who is a local person, will definitely know this and they will say that this needs to be done. But what they don't know is the positions that they need to take for this to be undertaken. The 3CEB or audit report is an outcome, after you do the documentation.
So that awareness, that bridging between the documentation and the 3CEB, that's lacking. And sometimes you might make or take wrong positions in this audit report because this documentation is not very strong or maybe it's not understood. So companies might take wrong positions in the audit report. Like instead of a CUP method, they might just put transactional net margin method, because [as well as] the 3CEB or the TP report or the audit report… the intercorporate agreement is also one of the documentation which is important by the auditor to be seen. If you don't know that and if you haven't seen it, you will not be able to come to a conclusion of what methods to use, or what is the allocation of risk between two associated enterprises. So it needs a thorough understanding for implementation. I don't see a lack of awareness as such. Everybody knows that the 3CEB needs to be undertaken.
PS: Yeah, OK. But the points that you've gone through before about how fundamentally TP is different in India compared to other countries, that's certainly so foundational. Great. Well, thank you very much, Akshay, I've certainly learned a lot. It's been a pleasure having you on. Final question is, how can people reach you if they need help with their Indian TP arrangements?
AK: I think what we can do is I can just mention the email ID that they can write us to. It's firstname.lastname@example.org. Any type of clarifications that can be mailed over there. And we have all of our experts sitting in our office. So if the mail receives us, surely there will be a response to it. If somebody wants to reach us through phone, the details are available on our website, which is www.transprice in. That's an easier way to reach out to us.
PS: Fabulous. Great. Well, thank you again and look forward to having you on the show again.
AK: Thank you, Paul. Thanks a lot for this invite. And it was a pleasure discussing all these issues with you. Thank you.
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