Question

Since the 1950s, companies have seen the advantage of operating in various countries as multinational corporations...

Since the 1950s, companies have seen the advantage of operating in various countries as multinational corporations (MNCs), and today, almost all large companies are considered to be an MNC. Once again, the MNC is under scrutiny by authorities for trying to avoid income taxes and for keeping money offshore.

This information technology company (HP) is an MNC that claims to do business in over 100 countries, and management has concerns that the company might run afoul of the treasury regulations in computing income between subsidiaries that require your input. For this assignment, you will prepare a report to management:

Utilizing the five steps for conducting tax research, complete the following:

  • Give an overview of the history of Internal Revenue Service (IRS) regulations concerning the allocation of income and deductions. Be sure to pay particular attention to the MNC.
  • Prepare a report on at least 2 companies that have been accused of illegal price transfer or allocation of income.
  • Provide guidance to management on how to avoid issues with the IRS in conducting business with overseas subsidiaries.

Homework Answers

Answer #1

Solution:

Explanation of Provisions
I. Allocation and Apportionment of Deductions and the Calculation of Taxable Income for Purposes of Section 904(a)
A. Stewardship Expenses, Litigation Damages Awards and Settlement Payments, Net Operating Losses, and Interest Expense
1. STEWARDSHIP EXPENSES
Under § 1.861-8(e)(4)(i), stewardship expenses are definitely related and allocable to dividends received or to be received from related corporations. This reflects a determination that stewardship expenses are, at least in part, intended to protect the shareholder's capital investment and thus are factually related to the income that arises from the investment. Before the enactment of the TCJA, taxpayers with foreign subsidiaries often included in their income foreign source income only when that income was distributed to the taxpayer. However, as a result of the enactment of sections 951A and 245A, a significant portion of the foreign source income of foreign subsidiaries is included in income on a current basis or not at all. The Treasury Department and the IRS are aware that some taxpayers may be interpreting the “dividends received, or to be received” phrase in § 1.861-8(e)(4)(ii) to exclude the gross up amount treated as a dividend under section 78 (the “section Start Printed Page 6912578 dividend”), as well as inclusions under section 951(a)(1), section 951A, and similar provisions, even though the stewardship expenses may be factually related to such gross income.

With respect to the allocation of stewardship expenses, income arising because of one's capital investment in a foreign corporation's stock ordinarily includes not only dividends, but also inclusions under sections 951 and 951A, as well as amounts included under sections 1291, 1293, and 1296 (the “passive foreign investment company provisions”). Therefore, the proposed regulations provide that stewardship expenses are allocated to dividends and inclusions received or accrued, or to be received or accrued, from related corporations.[1] Thus, stewardship expenses are also allocated to inclusions under sections 951 and 951A, section 78 dividends, and all amounts included under the passive foreign investment company provisions.

With respect to apportionment, the current regulations do not provide an explicit rule but instead provide examples of permissible methods. The Treasury Department and the IRS have determined that an explicit rule would provide certainty for taxpayers and the IRS on the appropriate methodology for apportioning stewardship expenses while ensuring that stewardship expenses are apportioned to gross income in a manner that reflects the purpose of the expenses to protect capital investments or to facilitate compliance with reporting, legal, or regulatory requirements. Therefore, the proposed regulations provide that stewardship expenses are apportioned based upon the relative values of a taxpayer's stock assets, as determined and characterized under § 1.861-9T(g) (and, as relevant, §§ 1.861-12 and 1.861-13) for purposes of allocating and apportioning the taxpayer's interest expense. Therefore, a taxpayer will be required to use the same method to characterize and value its stock assets for purposes of allocating and apportioning its interest and stewardship expenses, and, in some cases as described in Part 1.A.2 of this Explanation of Provisions, certain damages payments. Accordingly, since the fair market value method may not be used for interest allocation and apportionment, it may also not be used for stewardship and certain damages payments. Conforming changes are also proposed with respect to § 1.861-14T(e)(4), which provides rules for the treatment of stewardship expenses with respect to an affiliated group. See also § 1.861-8(g)(18) (Example 18) for an example illustrating the application of the proposed rules for stewardship expenses.

The Treasury Department and the IRS are aware that stewardship expenses that are incurred to facilitate compliance with reporting, legal, or regulatory requirements may be more appropriately treated as definitely related to the gross income produced by the particular asset, or assets, whose ownership required the stewardship expenditure. For example, the owner of an entity in a particular jurisdiction might have unique reporting requirements not triggered by the ownership of a similar entity in a different jurisdiction. The Treasury Department and the IRS request comments regarding exceptions to the general rule for the allocation and apportionment of stewardship expenses where it is more appropriate to treat stewardship expenses as definitely related to a more limited class of gross income. Comments are also requested on whether it is more appropriate in certain cases to allocate and apportion stewardship expenses on a separate entity, rather than an affiliated group, basis.

The proposed regulations maintain the definition of stewardship expenses as a duplicative activity (as defined in § 1.482-9(l)(3)(iii)) or a shareholder activity (as defined in § 1.482-9(l)(3)(iv)). See proposed § 1.861-8(e)(4)(ii)(A). In particular, shareholder activities are those that preserve the shareholder's capital investment or facilitate compliance with reporting, regulatory, or legal requirements. See § 1.482-9(l)(3)(iv). However, the Treasury Department and the IRS are aware that it may be difficult for taxpayers to distinguish between stewardship expenses that result from oversight functions and expenses that are supportive in nature, as described in § 1.861-8(b)(3), and are concerned that expenses may be misclassified as either stewardship or supportive expenses in certain cases. For example, day-to-day management activities do not give rise to stewardship expenses and are typically more supportive in nature. However, the distinction between day-to-day management and oversight may change over time as a taxpayer's investments change. Given these concerns, the Treasury Department and the IRS request comments regarding the definition of stewardship expenses and how to readily distinguish such expenses from supportive expenses that are allocated and apportioned under § 1.861-8(b)(3).

The proposed regulations extend the treatment of stewardship expenses to cover expenses incurred with respect to a partnership. See proposed § 1.861-8(e)(4)(ii)(D). Rules similar to those with respect to corporations apply to allocate and apportion stewardship expenses incurred with respect to partnerships.

Finally, the Treasury Department and the IRS are considering whether additional changes to the rules for allocating and apportioning stewardship and similar expenses are appropriate in light of the enactment of the TCJA, and in order to better reflect modern business practices that are increasingly global and mobile in nature. Comments are requested on this topic.

2. LITIGATION DAMAGES AWARDS, PREJUDGMENT INTEREST, AND SETTLEMENT PAYMENTS
The current rule for the allocation and apportionment of legal and accounting fees and expenses in § 1.861-8(e)(5) does not specifically address damages awards, prejudgment interest, or settlement payments arising from product liability and similar claims. The Treasury Department and the IRS are aware that large, unplanned, and relatively rare expenses can have a significant effect on the calculation of a taxpayer's taxable income and foreign tax credit limitation, and, in the absence of clear rules, disputes have arisen regarding the proper treatment of such expenses. Proposed § 1.861-8(e)(5) provides that deductions for damages awards, prejudgment interest, and settlement payments arising from product liability and similar or related claims are allocated to the class or classes of gross income produced by the specific sales of products or services that gave rise to the claims for damage or injury. Damages, prejudgment interest, and settlement payments related to events incident to the production of goods or provision of services, such as damages for injuries caused by industrial accidents, are allocated to the class of gross income produced by the assets involved in the event and, if necessary, apportioned between groupings based on the relative value of the assets in such groupings. In the case of claims made by investors that arise from corporate negligence, fraud, or other malfeasance, the Start Printed Page 69126proposed regulations provide that damages, prejudgment interest, and settlement payments paid by the corporation are allocated and apportioned based on the value of all the corporation's assets. In general, the deductions are allocated and apportioned to the statutory or residual groupings to which the related income would be assigned if recognized in the taxable year in which the deductions are allowed.

3. NET OPERATING LOSS DEDUCTIONS
Under current rules, a net operating loss deduction is allocated and apportioned in the same manner as the deductions giving rise to the net operating loss deduction. However, the rule does not specify how the statutory and residual grouping components of a net operating loss are determined. See § 1.861-8(e)(8). The proposed regulations provide that a net operating loss is assigned to the statutory and residual groupings by reference to the losses in each statutory or residual grouping (determined without regard to adjustments made under section 904(b)) that are not allocated to reduce income in a different grouping in the taxable year of the loss. See proposed § 1.861-8(e)(8)(i). Furthermore, the proposed regulations clarify that a net operating loss deduction for a taxable year is allocated and apportioned by reference to the statutory and residual grouping components of the net operating loss that is deducted in the taxable year. See proposed § 1.861-8(e)(8)(ii). Finally, the proposed regulations provide that except as provided in regulations, for example, in § 1.904(g)-3, a partial net operating loss deduction is treated as ratably comprising the components of the net operating loss.[2] See id.

In connection with the proposed regulations under section 250, comments requested clarification on the application of § 1.861-8(e)(8) with respect to net operating losses arising prior to the enactment of the TCJA when the net operating loss is deducted in a post-TCJA year for purposes of applying section 250 as the operative section. See 84 FR 8188 (March 6, 2019). These comments will be addressed as part of finalizing those proposed regulations.

4. APPLICATION OF THE EXEMPT INCOME/ASSET RULE TO INSURANCE COMPANIES IN CONNECTION WITH CERTAIN DIVIDENDS AND TAX-EXEMPT INTEREST
As explained in Part II.B.2 of the Summary of Comments and Explanation of Revisions to the 2019 FTC final regulations, one comment to the 2018 FTC proposed regulations suggested that insurance companies reduce exempt income and assets to reflect prorated amounts of dividends and tax exempt interest. See sections 805(a)(4), 807, 812, and 832(b)(5)(B). The 2019 FTC final regulations do not address this issue, and the proposed regulations do not adopt this comment.

Under subchapter L, a nonlife insurance company includes in income its underwriting income, which consists of premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred. The proration rules reduce the company's losses incurred by the “applicable percentage” of tax exempt interest or deductible dividends received. See section 832(b)(5)(B). For a life insurance company, the proration rules apply in the case of tax exempt interest by reducing the closing balance of reserve items by the “policyholder's share” (currently a fixed percentage, originally intended to be the portion of tax favored investment income used to fund the company's obligations to policyholders) of tax exempt interest. See sections 807(b)(1)(B) and 812. Similarly, a life insurance company is allowed a dividends received deduction (DRD) for intercorporate dividends from non-affiliates only in proportion to the “company's share” of the dividends, but not for the policyholder's share. See section 805(a)(4)(A). Fully deductible dividends from affiliates are excluded from proration for life insurance companies if the dividends are not themselves distributions from tax exempt interest or from dividend income that would not be fully deductible if received directly by the taxpayer.

While the mechanics of the proration rules differ depending on whether a company is a life or nonlife insurance company and whether the amount relates to dividends or tax exempt interest, the purpose of those provisions is the same. That is, the policyholder's share or applicable percentage of dividends and tax exempt interest should not create a double benefit by reason of a DRD or section 103 tax exemption for interest in the first instance and a reduction to income (via increases in unpaid losses and reserves during the taxable year) in the second. Regardless of the mechanics, however, the policyholder's share and applicable percentage adjustments do not change the fact that tax exempt interest and (for a nonlife insurance company) the applicable percentage of dividends eligible for DRDs remain exempt from U.S. tax. Including those exempt amounts and the corresponding exempt assets in the apportionment formula in allocating expenses under § 1.861-8T(d)(2)(i)(B), as the comment suggests, would effectively apportion reserve deductions (which already do not include the disallowed deductions deemed to be attributable to the exempt income, except in the case of the policyholder's share of life insurance DRDs) to exempt U.S. source income, with the result that those deductions would reduce unrelated U.S. source income, in contravention of the rule in § 1.861-8T(d)(2)(i)(B). See also Travelers Insurance Company v. United States, 303 F.3d 1373 (2002).

The current regulations already provide the appropriate rules in this area. Section 1.861-8T(d)(2)(ii)(B) provides that the policyholder's share of dividends received by a life insurance company is treated as tax exempt income notwithstanding the partial disallowance of the DRD, and § 1.861-14T(h) provides for the direct allocation to the dividends of an amount of reserve expenses equal to the disallowed portion of the DRDs. The current regulations do not provide a special rule for either tax exempt interest of a life insurance company or DRDs and tax exempt interest of a nonlife insurance company because, when a policyholder's share or applicable percentage is accounted for as either a reserve adjustment or a reduction to losses incurred, no further modification to the generally applicable rules is required to ensure that the appropriate amount of expenses are apportioned to U.S. source income.

Nevertheless, in order to provide greater clarity, the proposed regulations provide in proposed § 1.861-8(d)(2)(ii)(B), (d)(2)(v), and (e)(16) the effect of certain deduction limitations on the treatment of income and assets generating dividends received deductions and tax exempt interest held by insurance companies. More specifically, the proposed regulations provide that in the case of insurance companies, the term exempt income includes dividends for which a deduction is provided by sections 243(a)(1) and (2) and 245, without regard to the proration rules disallowing a portion of the deduction. Similarly, the term exempt income includes tax exempt interest without regard to the proration rules. These provisions apply on a company wide basis and therefore include each separate account of the company. Two examples are provided in proposed § 1.861-8(d)(2)(v)(B) that illustrate the application of these rules.Start Printed Page 69127

5. OTHER REQUESTS FOR COMMENTS ON EXPENSE ALLOCATION
The Treasury Department and the IRS continue to study the rules for allocating and apportioning interest deductions. In addition, the Treasury Department and the IRS expect the implementation of section 864(f) (which is effective for taxable years beginning after December 31, 2020) will have a significant impact on the effect of interest expense apportionment and will necessitate a reexamination of the existing expense allocation rules. Therefore, the Treasury Department and the IRS are studying whether further guidance with respect to allocation and apportionment of interest expense, taking into account the changes made by the TCJA and the future implementation of section 864(f), is required. Comments are requested on this topic.

The Treasury Department and the IRS are also considering whether rules providing for the capitalization and amortization of certain expenses solely for purposes of § 1.861-9 may better reflect asset values under the tax book value method. For example, solely for purposes of § 1.861-9, research and experimental expenditures and advertising expenses could be treated as if they were capitalized and amortized. Comments are requested on this topic.

As noted in Part III.B.4.iii of the Summary of Comments and Explanation of Revisions to the 2019 FTC final regulations, the Treasury Department and the IRS are studying whether additional rules for allocating and apportioning expenses to foreign branch category income or limiting the amount of the gross income reallocated as a result of certain disregarded payments are appropriate. Comments are requested on whether such special rules would more accurately reflect the business profits of a foreign branch, while maintaining administrability for taxpayers and the IRS.

B. Certain Loans Made by Partnerships to Partners
The 2018 FTC proposed regulations included rules addressing the source and separate category of interest income and expense related to loans to a partnership by a U.S. person (or a member of its affiliated group) that owns an interest (directly or indirectly) in the partnership. These rules were finalized in the 2019 FTC final regulations. See § 1.861.9(e)(8).

As discussed in Part II.C.1 of the Summary of Comments and Explanation of Revisions of the 2019 FTC final regulations, several comments to the 2018 FTC proposed regulations requested that the rules under § 1.861-9(e)(8) with respect to specified partnership loans be expanded to cover loans made by a partnership to a partner (an “upstream partnership loan”). The Treasury Department and the IRS agree with comments that rules addressing upstream partnership loans would reduce distortions that could otherwise affect the foreign tax credit limitation. Therefore, the comments are adopted in proposed § 1.861-9(e)(9)(ii), which generally provides that, to the extent the borrower in an upstream partnership loan transaction takes into account both interest expense and interest income with respect to the same loan, the interest income is assigned to the same statutory and residual groupings as those groupings from which the matching amount of interest expense is deducted, as determined under the allocation and apportionment rules in §§ 1.861-9 through 1.861-13. Additionally, proposed § 1.861-9(e)(9)(i) provides that, for purposes of applying the allocation and apportionment rules, the borrower does not take into account as an asset its proportionate share of the loan, as otherwise provided under § 1.861-9(e)(2) and (3). Proposed § 1.861-9(e)(8)(iv) also applies the upstream partnership loan rules to transactions that are not loans but that give rise to deductions that are allocated and apportioned in the same manner as interest expense under § 1.861-9T(b). An anti-avoidance rule similar to the rule in § 1.861-9(e)(8)(iii) is included to cover back-to-back third-party loans that are intended to circumvent the purposes of the rules. See proposed § 1.861-9(e)(8)(iii). These rules are being proposed in order to provide taxpayers an additional opportunity to comment on the rule.

Additionally, the Treasury Department and the IRS are aware that some taxpayers may be converting existing partnership debt structures that were used to increase a taxpayer's foreign tax credit limitation before the issuance of § 1.861-9(e)(8) from partnership debt into partnership equity that provides for guaranteed payments for the use of capital. The taxpayer then takes the position that the guaranteed payments are neither allocated and apportioned under the rules in § 1.861-9 nor included in subpart F income by reason of § 1.954-2(h).

Guaranteed payments for the use of capital are similar to a loan from the partner to the partnership because the payment is for the use of money and is generally deductible. See section 707(c). Because these arrangements raise the same policy concerns as ordinary debt instruments, the proposed regulations revise § 1.861-9(b) and § 1.954-2(h)(2)(i) explicitly to provide that guaranteed payments for the use of capital described in section 707(c) are treated similarly to interest deductions for purposes of allocating and apportioning deductions under §§ 1.861-8 through 1.861-14 and are treated as income equivalent to interest under section 954(c)(1)(E). No inference is intended as to whether or not § 1.861-9T(b) or § 1.954-2(h)(2) include guaranteed payments for taxable years before the proposed regulations are applicable.

C. Treatment of Assets Connected With Capitalized, Deferred, or Disallowed Interest
Section 1.861-12T(f)(1) provides that, in certain circumstances, where interest expense that is capitalized, deferred, or disallowed under a provision of the Code, the adjusted basis or fair market value of the asset to which the interest expense is connected is reduced by the principal amount of the interest that is capitalized, deferred, or disallowed. One comment with respect to the 2018 FTC proposed regulations recommended that the Treasury Department and the IRS consider narrowing the scope of the rule in § 1.861-12T(f)(1) to prevent taxpayers from taking overly expansive views of the rule in order to minimize the value of controlled foreign corporation (“CFC”) stock that attracts interest expense to reduce the foreign tax credit limitation. In response to the comment, the proposed regulations clarify what it means for an asset to be connected with indebtedness, modify the existing example, and add a new example. See proposed § 1.861-12(f).

D. Treatment of Section 818(f) Reserve Expenses for Consolidated Groups
Section 818(f)(1) provides that the deduction for life insurance reserves and certain other deductions (“section 818(f) expenses”) are treated as items which cannot definitely be allocated to an item or class of gross income. Therefore, when a life insurance company computes its foreign tax credit limitation, its section 818(f) expenses generally reduce its U.S. source income and foreign source income ratably. However, issues arise as to how to allocate and apportion section 818(f) expenses if the life insurance company is a member of an affiliated group of corporations (including both life and nonlife members) (the group, “life-nonlife consolidated group”) that join in filing a consolidated return.

The Treasury Department and the IRS are aware of at least five potential Start Printed Page 69128methods for allocating section 818(f) expenses in a life-nonlife consolidated group. First, the expenses might be allocated solely among items of the life insurance company that has the reserves (“separate entity method”). Second, to the extent the life insurance company has engaged in a reinsurance arrangement that constitutes an intercompany transaction (as defined in § 1.1502-13(b)(1)), the expenses might be allocated in a manner that achieves single entity treatment between the ceding member and the assuming member (“limited single entity method”). Third, the expenses might be allocated among items of all life insurance members (“life subgroup method”). Fourth, the expenses might be allocated among items of all members of the consolidated group (including both life and non-life members) (“single entity method”). Fifth, the expenses might be allocated based on a facts and circumstances analysis (“facts and circumstances method”).

In response to the request for comments in the 2018 FTC proposed regulations, the Treasury Department and the IRS have received comments advocating for certain of the aforementioned allocation methods. One comment recommended an allocation method similar to the single entity method. The comment proposed that, if all members of a consolidated group were treated as a single corporation, and if that corporation would constitute a life insurance company, then section 818(f) expenses might be allocated and apportioned to all members of the consolidated group, including nonlife members of a life-nonlife consolidated group.

Two other comments disagreed with the single entity method. These comments proposed that section 818(f) expenses generally be allocated on the separate entity method. However, if the facts and circumstances demonstrate a sufficient factual relationship between the expense and the income of more than one life insurance company, these comments proposed that such expenses might be allocated based on the facts and circumstances method. The comments did not provide examples of when facts and circumstances would demonstrate a sufficient relationship to qualify for this treatment.

The Treasury Department and the IRS decline to adopt the single entity method in the proposed regulations. Section 818(f) only applies to a life insurance company; thus, section 818(f) expenses should not be allocated to nonlife members of a consolidated group. The Treasury Department and the IRS also decline to adopt the facts and circumstances method because a broad facts and circumstances approach would introduce substantial uncertainty into the tax system and would be difficult to administer.

The Treasury Department and the IRS considered adopting the life subgroup method in the proposed regulations. This method would reflect a single entity approach for life insurance companies that operate businesses and manage assets and liabilities on a group basis. Under this paradigm, section 818(f) expenses would be treated as not definitely related to an item or class of gross income of the entire life subgroup for purposes of calculating the foreign tax credit limitation, and therefore generally ratably reduce U.S. source income and foreign source income of the life subgroup.

The Treasury Department and the IRS also considered adopting the separate entity method. The separate entity method would allocate and apportion section 818(f) expenses on a separate company basis. This method is consistent with the Code because section 818(f) expenses generally are computed on a separate company basis and relate to the liabilities of a specific life insurance company. In addition, this method is consistent with the treatment of reserves when members of a consolidated group engage in an intercompany transaction. Under § 1.1502-13(e)(2)(ii)(A), direct insurance transactions between members of a consolidated group are accounted for by both members on a separate entity basis. For example, if one member provides life insurance coverage for another member with respect to its employees, the premiums, reserve increases and decreases, and death benefit payments are determined and taken into account by both members on a separate entity basis (rather than on a single entity basis under the general rules of § 1.1502-13). See also § 1.1502-13(e)(2)(ii)(B)(2) (providing that reserves resulting from intercompany reinsurance transactions are determined on a separate entity basis).

After considering both methods, proposed § 1.861-14(h)(1) adopts the separate entity method. As noted previously, this method generally is consistent with section 818(f) and with the separate entity treatment of reserves under § 1.1502-13(e)(2). Nevertheless, the Treasury Department and the IRS are concerned that this method may create opportunities for consolidated groups to use intercompany transactions to shift their section 818(f) expenses and achieve a more desirable foreign tax credit result. Accordingly, the Treasury Department and the IRS request comments on whether a life subgroup method more accurately reflects the relationship between section 818(f) expenses and the income producing activities of the life subgroup as a whole, and whether the life subgroup method is less susceptible to abuse because it might prevent a consolidated group from inflating its foreign tax credit limitation through intercompany transfers of assets, reinsurance transactions, or transfers of section 818(f) expenses. The Treasury Department and the IRS also request comments on whether an anti-abuse rule may be appropriate to address concerns with the separate entity method, and regarding the appropriate application of § 1.1502-13(c) to neutralize the ancillary effects of separate-entity computation of insurance reserves, such as the computation of limitations under section 904.

E. Allocation and Apportionment of R&E Expenditures
Part I.G of the Explanation of Provisions of the 2018 FTC proposed regulations discussed the interaction between the current rules for allocating and apportioning R&E expenditures and the changes made to section 904(d) by the TCJA, and requested comments on how the regulations should be revised to account for the new category in section 904(d)(1)(A) (the “section 951A category”). The comments received are addressed in this Part I.E.
[20/03, 8:50 PM] Pk: The special valuation branch of the customs department is scrutinising transfer pricing methodologies of several multinationals with a view to reconcile their tax and import-expert submissions.

Up until now, the MNCs used to file separate transfer pricing positions to both departments, one for taxation purpose and other for international trade. Since the two departments wouldn't share data or information with each other, companies could get away with the information arbitrage in some ca ..

[20/03, 8:52 PM] Pk: ses said insiders.

Transfer price is basically a price charged by a subsidiary or a division of a company to another. The rules suggest that there has to be an ‘arm’s length’ while fixing this price so that it’s not too low or too high than the existing open market prices. Tax officers can question and demand tax in case they suspect that companies are escaping taxes.

The customs department too has its own valuation mechanism whereby it checks the price of the imports and exports to subsidiaries outside India.

“Collaboration between customs and income tax department was initiated few years ago, it’s only recently that we have seen that data and information provided by businesses to one is being used by the other more frequently. While the objectives of both the departments could be different, there could be disputes where multinationals' may see their methodologies and positions challenged by either of the departments,” said Pratik Jain, partner, national leader, indirect taxation, PwC India. Tax experts say that often the objective of the customs’ department is to challenge the arm’s length pricing and check if companies are underquoting the prices. For the tax department the main objective is to see if the arm’s length price quoted by a company is high and should be lower.

Arm’s length pricing basically is an industry average price at which companies buy and sell goods even when they are not dealing with group companies.

For the first time in 2016, the customs department had sought details from multinationals about their transfer pricing positions with the tax department.

While no notices have been issued yet, that could happen in some cases, say industry trackers in the coming months.

“Customs circulars (on valuation) issued in early 2016 mandate submission of transfer pricing reports apart from other relevant valuation related information. Given that the methodology under both laws for a given transaction could be different, this could be an area of disconnect from a SVB proceedings standpoint,” said Suresh Nair, partner at EY India

In some cases, avow investors, the transfer pricing figures would be different for genuine reasons. “The transfer pricing for customs is a subjected matter of logistics department in a company. While the finance or the tax team looks at transfer pricing for taxation, and often these two departments don’t talk to each other in a company,” said a senior financial official in a multinational.

“It’s important for companies to align their customs and transfer pricing strategies. Extensive use of data provided under one regulation by other government officials seems to be a fundamental shift in tax administration and it here to stay,” said Jain.

People in the know said that some companies would show lower margins for custom submissions and higher margins for taxation purposes for transfer pricing on the same transaction with subsidiaries outside India.

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