Covid-19: The changing landscape of tax

The world of tax is no exception, and the government has already announced the roll-out of faceless assessment in income-tax.

By Rahul Renavikar

It is almost six months in India, and more than eight months in other parts of the globe, that the Covid-19 pandemic has played havoc. Whenever this gets over, life isn’t going to be the same for everyone. There has been a paradigm change, from an office-going culture to work from home culture, face-to-face interactions to online meetings/interactions. The world of tax is no exception, and the government has already announced the roll-out of faceless assessment in income-tax. It is time for industry to commence assessing the impact of the lockdown on various aspects of business.

While these are early days to assess the overall impact, already, the World Bank and leading credit agencies have raised red flags with regards to large economies of the world, India included. The largest economies are going to contract this year, and the immediate focus is now on survival rather than growth. Growth is still a couple of quarters away, and given the dwindling of demand for goods and services, businesses are relooking at their cost structures and negotiating new rates to be effective for future transactions. The impact of the pandemic on domestic as well as international transactions is humongous. In India, we have already seen the GDP contract in the April-to-June quarter.

Given the lockdown, there has been a disruption in the supply chain; in particular, the manufacturing and distribution functions have been severely hit. The sales targets and annual budgets for FY21 have been redrawn. The volatility in the markets has led to an increase in the financing costs. The domestic tax collections (direct and indirect taxes) have shown reduction as compared to the previous year’s numbers. De-growth in the revenue collections now looks a reality, and the fiscal deficit is expected to rise significantly this year.

In the transfer-pricing landscape, where there are international transactions between two related parties, the impact would be an unprecedented one with widespread applicability having phenomenal repercussions. Given all these events, the financing arrangements within the group entities have to be relooked considering the debt capacity and the propensity to pay interest. Weak or poor financial results could mean extending more and more intergroup guarantees. As is prevalent in most of the countries, typically, contract manufacturing and low-risk distribution entities within a multi-national enterprise (MNE) carry limited risks and, therefore, earn low but stable profits. In the case of MNEs, it is unlikely that tax administrations in their respective countries would accept tax losses for such entities. Thus, they may end up paying taxes in some countries even though, as a group, they may incur huge losses. Further, high risk-bearing entities may incur huge losses, including those incurred in geographies wherein the limited risk distribution entities or toll/contract manufacturing entities are situated. However, tax authorities in their respective countries may not accept such heavy losses. This would increase the tax burden of the MNEs, even leading to double taxation and non-acceptance of losses and denial of benefit of losses for taxation purposes. All this will result in MNEs being forced to change their existing transfer-pricing model. Historical data will lose its relevance in the new normal. Also, one-sided benchmarking of entities may not be relevant, and hence net profit/gross profit margins may not be relevant any longer in the present circumstances.

Adding to the concerns of the MNEs is also the customs valuation of goods imported from related parties. While the objective of both, the transfer-pricing authorities and the customs authorities, is the same, i.e., to determine whether all the transactions between the related parties are done at an arm’s length and the relationship between the two hasn’t influenced the price, the approach adopted by them is diametrically opposite. Hence, the MNEs should relook the positions taken by them in the transfer-pricing studies vis-à-vis the values adopted for import of goods through related parties. In other words, MNEs would need to relook the declarations given by them in the past/present to the customs special valuation branch (SVB) to ensure parity with valuations considered for the transfer pricing studies.

Having said this, while undertaking all futuristic transactions with related parties, for import of goods/services, MNEs should look at the positions taken under the transfer pricing and customs regulations so that they are harmonious and not at cross purpose to each other. This will reduce the possibility of litigation in either of these legislations. This has to be undertaken throughout the value chain in all those jurisdictions wherever related party transactions are undertaken by the group companies. Better to be safe than to be sorry!

The author is MD, Acuris Advisors Pvt. Ltd. Views are personal