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Related party transactions
Convergence of corporate governance and transfer pricing principles
Over the past two decades, India has witnessed an evolution in Transfer Pricing (TP) regulations. With each passing year, the focus of the legislators has been on qualitative aspects of TP, i.e., aligning with The Organisation for Economic Co-operation and Development (OECD) TP guidelines, BEPS Action 8-10, global best practices (using multiple year data, introducing range concept, etc.). Aspects, such as value creation, delineation of transaction, structured approach to risk analysis, etc., have gained significance in any TP analysis. As a corollary, the utility of TP analysis/documentation extends well beyond that undertaken for TP compliance or advance pricing arrangement. Today, it is common for customs department to request for TP analysis; furthermore, robust analysis/documentation is a fillip to good corporate governance (around related party transactions), as well.
Corporate governance has always been a priority area for policy makers. Towards this, improving transparency—specifically around related party transactions (RPT)—has been one of the key highlights. Building effective self-regulated frameworks around RPT, from corporate governance perspective, not only enhances transparency and disclosures, it also facilitates qualitative and smooth approval process, i.e., Audit Committee/Board approvals for material RPTs, etc. Under the current regulatory framework (in India), effective self-regulation around RPTs—from arm’s length and corporate governance lens (under Companies Act 2013 and SEBI LODR )—is mandatory only for Indian listed entities. Ideally, such good corporate governance practices may be adopted by non-listed entities as well.
Needless to say, challenging times require strong regulatory measures—therefore, any effective self-regulatory mechanism (say, strong governance for RPT) would act like torchbearers providing confidence to stakeholders and enabling entities to sail through these adverse economic conditions (stemming from onslaught of pandemic), ongoing geo-political environment, trade wars, etc.
All this highlights the need for convergence in principles related to RPT under different laws (Income tax, Companies Act, and SEBI LODR)—simply put, TP principles outlined in OECD TP guidelines and BEPS Action 8-10 provide a pathway for implementing a robust governance framework around RPTs. Towards this, some illustrative points for consideration (for any RPT analysis) are as follows:
- As a practice, any new RPT arrangement to be based on a business case, i.e., internal document clearly outlining the need, benefit, sensitivity analysis, group policy, etc.
- RPT policies to be formulated having regard to nature of arrangement, substance of transaction, value creation, detailed functional analysis, and robust price-setting documentation (economic analysis to determine arm’s length price).
- RPTs to be undertaken in line with agreement, understanding, and conduct. For example, any inter-company services agreement to have a clause that clearly outlines type of service, roles and responsibilities of parties (to the agreement), pricing, credit terms, indemnity clauses, force majeure, etc.
With information overload (in public domain) around any multinational’s business structures, value-chain, IP strategy, supply chain, value drivers, taxation aspects, RPT policy, etc., a sound corporate governance framework around RPT—in line with TP regulations, OECD TP guidelines and BEPS Action 8-10—would provide much needed assurance to the stakeholders, including, Board, Audit committee, shareholders, business partner, financial institutions; needless to say, it has utility for income-tax purposes also.
OECD's Action Plan on Base Erosion and Profit Shifting (BEPS)
Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015