GST and Transfer Pricing – Need for Harmonization (GST vis-à-vis Income Tax)
By: – CASanjay Kumawat
Goods and Services Tax – GST
Dated:- 7-11-2017
In the present age of globalization, it is a universal phenomenon that multinational Companies (MNCs) have branches/subsidiaries/divisions operating in more than one country. In such a situation, it is common event for MNCs to transfer goods produced by a branch in one tax jurisdiction to an associate branch operating in another tax jurisdiction. While doing so, the MNCs concerned has in mind the goal of minimizing tax burden and maximizing profits but the two tax jurisdictions/countries have also the consideration of maximizing their revenue while making laws that govern such transactions.
It is an internationally accepted practice that such 'transfer pricing' should be governed by the Arm Length Price (ALP) Principle and the transfer price should be the price applicable in case of a transaction of arm's length. In other
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etermination of income from domestic related party transactions and determination of reasonableness of expenditures between related domestic parties, the provisions of section 92 have been extended to include within its ambit the specified domestic transaction.
Under GST regime, in Indian context, supply of goods and/or services between distinct person, as described in section 25(4) and (5) of the CGST Act, 2017, and related person, as defined in an explanation (a) attached with section 15 of the CGST Act, 2017, would be subject to levy of GST. Therefore, it is important to determine the correct value of supply of goods and services to distinct persons or related persons to avoid the litigation.
As business entities look into the appropriate transfer price of transactions, they should be mindful of the GST implications arising from the transfer pricing adjustments.
For instance, the retrospective increase in the transfer price of sales of goods is effectively an increase in the GST
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t of transactions between assessee and its associated enterprises. Meaning of the term “associated enterprises” has been defined in section 92A of the Income Tax Act, 1961.
Under GST Act, 2017, section 2(12) provides meaning of the term “associated enterprises”. Accordingly, “associated enterprises” shall have the same meaning as assigned to it in section 92A of the Income Tax Act, 1961.
Accordingly, the term 'Associated Enterprise' generally means any entity that participates directly or indirectly or through one or more intermediaries in the management or control or capital of another entity. Further, where two entities are commonly controlled by one or more controlling entities, such entities are also considered as 'Associated Enterprises'.
The Regulations further provide specific conditions and circumstances under which two entities are deemed to be Associated Enterprises. Some of these basic conditions include, ownership in the voting power of an enterprise exceeding the stipul
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f both of them;
* one of them directly or indirectly controls the other;
* both of them are directly or indirectly controlled by a third person;
* together they directly or indirectly control a third person; or
* they are members of the same family.
Distinct Persons
As per section 25(4) of the CGST Act, 2017, a person who has obtained or is required to obtain more than one registration, whether in one State or Union territory or more than one State or Union territory shall, in respect of each such registration, be treated as distinct persons for the purposes of GST Act.
As per section 25(5) of the CGST Act, 2017, where a person who has obtained or is required to obtain registration in a State or Union territory in respect of an establishment, has an establishment in another State or Union territory, then such establishments shall be treated as establishments of distinct persons for the purposes of GST Act.
Valuation aspects for transactions between distinct persons and rela
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%, while that for other taxpayers is 3% of the value of International Transaction/ Specified Domestic Transaction.
Under GST, section 15 of the CGST Act, 2017, provides provisions for determination of value of supply. Accordingly, the value of a supply of goods or services or both shall be the transaction value, which is the price actually paid or payable for the said supply of goods or services or both where the supplier and the recipient of the supply are not related and the price is the sole consideration for the supply.
Section 15 of the CGST Act, 2017 deals with a situation where supplier and the recipient of the supply are not related persons. But in our case, we are discussing the situation where supplier and the recipient of the supply are related person.
As per Rule 28 of the CGST Rules, 2017- “Value of supply of goods or services or both between distinct or related persons, other than through an agent” provides the valuation methods for the determination of value of sup
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lue declared in the invoice shall be deemed to be the open market value of the goods or services.
Accordingly, the Rule 28 of the CGST Rules, 2017 provides 4 methods to determine the value of supply, are as follows:
* Open Market Value (“OMV”) Method
* Like kind and Quality Method (Or comparable method)
* Cost Plus Method (Rule 30 )
* Residual Method (Rule 31 )
* Resale price Method
The various methods given in Rule 28 of the CGST Rules, 2017 have been discussed below:
* Open Market Value (“OMV”) Method
The value of the supply of goods or services or both between distinct persons or where the supplier and recipient are related shall be the open market value of such supply. As per explanation (a) attached after Rule 35 of the CGST Rules, 2017, “open market value” of a supply of goods or services or both means the full value in money, excluding the integrated tax, central tax, State tax, Union territory tax and the cess payable by a person in a transaction, where the sup
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ll be payable by the manufacturer to the Government.
Definition of term 'open market value' is as follows:
* As per Black's Law Dictionary: The cost of items as determined by supply and demand.
As per International Valuation Standards (IVS 1 – Market Value Basis of Valuation, Seventh Edition): The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm's-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion.
From a taxpayer's perspective, open market value (OMV) is the value at which supply of goods and services being made to an unrelated person as per the market trend. The concept of OMV is most commonly invoked in inefficient markets or disequilibrium situations where prevailing market prices are not reflective of true underlying market value. Therefore, a taxpayer's may suffer in determination of value of supply for the sim
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r services or both.
The essential characters of the definition are as follows:
* Supply shall be made under similar circumstances.
Comparable should be selected on the basis of similar to the characteristics, quality, quantity, functional components, materials, and the reputation of the goods or services or both first mentioned, is the same as, or closely or substantially resembles.
This method is similar to the Comparable Method provides under Income Tax Act, 1961. Under GST, selection of comparables will be a tedious task for the taxpayers and any wrong determination of value of supply will invite the litigation in near future.
For the purpose of selection of comparables, comparability analysis is to be performed by a comparison of the business activities and the Functions, Assets and Risks of the taxpayer vis-à-vis that of independent taxpayers.
Several financial parameters and quantitative filters are applied while screening comparables. Finally, qualitative anal
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upply of goods or services. The Rule requires that the supply shall be made in similar circumstances. Similar circumstances needs to be determined based on the external factors or the position of the supplier and the position of the recipient. Clause (b) of Explanation requires that the comparison of the product shall be made between the product in respect of characteristics, quality, quantity, functional components, materials, and the reputation of the goods or services or both.
The GST authorities or Department must demonstrate comparability of these factors in order to determine the value of supply of goods or services of like kind and quality otherwise it will add various interpretational issues, classification issues, etc in newly launched GST, hence, lead to litigation. There are so many judicial pronouncements on selection comparables under Income Tax Act, 1961, some of industry wise issues, for instance, are as follows:
* Consultancy Services : In TA Associates Advisory Pri
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ould not be functionally comparable to assessee engaged in the manufacturing of optical plastic lenses of human care.
From the above discussion, it can be said that for the purpose of determination of value of supply of goods and/or services, selection of comparables is important aspect. Out of goods and/or services, in case of services, the application of this Rule will be very difficult task for the authorities because quality of services or services for the satisfaction can't be measured.
Cost Plus Method
If the value is not determinable under earlier valuation methods, value of supply shall be the value as determined by the application of Rule 30 or Rule 31, in that order. Accordingly, Rule 30-“Value of supply of goods or services or both based on cost” of the CGST Rules, 2017, provides that where the value of a supply of goods or services or both is not determinable by any of the preceding rules of this Chapter, the value shall be one hundred and ten percent of the cost of p
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ther processing has been done.
For determination of value of provision of services, basic principles of CAS-4 shall be applied. In determining the cost of service, cost of employee is main cost. As per para 5.2 of the CAS-4 specify that direct wages and salaries include fringe benefits such as:
* Contribution to provident fund and ESIS
* Bonus/ ex-gratia payment to employees
* Provision for retirement benefits such as gratuity and superannuation
* Medical benefits
* Subsidised food
* Leave with pay and holiday payment
* Leave encashment
* Other allowances such as children's education allowance, conveyance allowance which are payable to employees in the normal course of business etc.
It is important to note that in the case of supply of services, the supplier may opt for Rule 31, ignoring rule 30.
Hence, If the value is not determinable under Open market value method and like kind and quality method then value of the supply may be determined after application of th
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ose of assessment, Department officials will have to make proper efforts to come out with the most suitable value of the supply after considering the various external and internal factors.
Resale price Method
As per first proviso to Rule 28 of the CGST Rules, 2017, where the goods are intended for further supply as such by the recipient, the value shall, at the option of the supplier, be an amount equivalent to ninety percent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person.
The essential characters of this provision are as follows:
* There must be 'as such' supply (i.e., supply in the same form in which received.). In other words, this method can be applied for trading industry only.
This method is available at the option of supplier only.
The value of supply shall be an amount equivalent to 90% of the price charged for the supply of goods of like kind and quality by the recipient to his custo
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price is the sole consideration.
However, it should not be presumed that any value declared in the invoice will be accepted by the Department as the manner of determining the value is contained in section 15 read with Determination of Value Rules as given in CGST Rules, 2017. The value shall be more or less equivalent to the value determined under section 15 or the Rules. If required, supplier will have to substantiate the manner of determining the value of supply.
Tolerance limit for value of supply under GST
Under Income Tax Act, 1961, the tolerance range available for wholesale traders is 1%, while that for other taxpayers is 3% of the value of International Transaction/ Specified Domestic Transaction.
On other hand, no tolerance range available under GST hence it will invite the accuracy related issues, correctness issues, hence, resultant in disputes between the Department and assesse.
Conclusion
Transfer pricing itself is not a means of tax avoidance if transaction value
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