On October 6, 2024, the Inland Revenue Department (IRD) issued the “Transfer Pricing Guideline, 2081” (हस्तान्तरण मूल्यसम्बन्धी निर्देशिका, २०८१) Link: here.
Nepal’s transfer pricing guidelines have been long anticipated and is a significant step toward aligning the country’s tax system with international standards. However, the absence of Safe Harbor Rules, Adjustment Rules and the lack of Comprehensive Public Database for finding comparable cross-border transactions leaves much to be desired. Without these crucial elements, it’s uncertain how beneficial these guidelines will be for taxpayers.
For the tax authorities, this new guideline offers additional tools to impose assessments under transfer pricing regulations. But for businesses, the lack of clear mechanisms may lead to confusion and limited practical value. While there is hope these guidelines will bring some clarity and improve compliance for companies with international transactions we will have to look into the reality that appears less promising, as we will explore in detail below.
What does this transfer pricing guideline look like?
The purpose of this transfer pricing guideline seems primarily to ensure fair and appropriate allocation of costs and revenues for Nepal units of the multinational enterprise (MNE). In absence of such rules, companies could potentially manipulate intra-group transactions to shift profits to low-tax jurisdictions, eroding the tax base of Nepal. This guideline is expected to help enforce transactions between related entities in cross border transactions, ensuring that the taxes collected on the price reflect what would have been in the transaction between independent parties. This prevents profit shifting from Nepal and ensures that tax authorities in Nepal receive their rightful share of taxes. But this guideline as of now doesn’t have any specific provision for domestic transfer pricings – so its focus is therefore mainly only on the cross-border transactions within the multinational enterprises.
Here is an excerpt of each of the chapters in the guideline:
Chapter 1: Introduction
This chapter highlights the significance of transfer pricing guidelines in ensuring fair taxation of multinational companies operating in Nepal. The introduction emphasizes the need to assess transactions between related parties to guarantee they are conducted at market value – at least for tax purposes, as centralized control within multinational corporations can sometimes lead to non-market pricing. The chapter also clarifies that the guideline builds upon existing legal frameworks, particularly the Income Tax Act of 2058 and the Income Tax Regulations of 2059 and provides practical examples to facilitate understanding and application.
Chapter 2: Definitions
Chapter 2 is where the “Transfer Pricing Guideline 2081” defines key terms used throughout the document. This chapter begins by stating that terms already defined in the Income Tax Act of 2058 retain their original definitions. These terms defined in the guideline are exactly as they appear in the Act or Rules and there are some new terms defined in the guideline as well. They have been detailed below.
- Existing Definitions from Income Tax Act, 2058: Income Year Section 2(Jha), Company Section 2(Da), Exempt Controlled Entity Section 14 Explanation, Entity Section 2(Jha), Underlying Ownership Section 2(Ra), Resident Person Section 2(Ka.Nga), Person Section 2(Ka.Cha), Department Section 2(Ka.ta), Permanent Establishment Section 2(Ka.da), Associated Person Section 2(Ka.Na),Market Value Section 2(sSha),
- Existing Definitions from Income Tax Rules, 2059: Act Rule 2(Ka)
- New Definitions in the Guideline: Rule Para 2.1(Wyan), Relative Para 2.1(Chha), Comparability Analysis Para 2.1(Nga), Comparable Uncontrolled Transaction Para 2.1(Cha), Controlled Transaction Para 2.1(Jha), Tested Party Para 2.1(Da), Multinational Company Para 2.1(Dha), Arrangement Para 2.1(tha), Cross Border Transaction Para 2.1(dha), Cross Border Uncontrolled Transaction Para 2.1(Na), Independent Transaction Para 2.1(Pa), Arm’s Length Price Para 2.1(Bha), Transfer Price Determination Para 2.1(Ma)
Chapter 3: Transfer Pricing Determination and the Arm's Length Principle
This chapter underscores the “arm’s length principle” as the cornerstone of transfer pricing regulations in Nepal. This principle mandates that transactions between associated persons should be priced as if they were between independent entities. This chapter outlines the legal basis for this principle in Nepal, citing Section 33 of the Income Tax Act of 2058, which empowers the Department of Inland Revenue to adjust income and tax calculations if transactions deviate from arm’s length pricing.
Chapter 4: Comparability Analysis
This chapter describes the comparability analysis process, crucial for determining the arm’s length price. This process involves a systematic assessment of various factors that can influence transaction pricing. The chapter emphasizes the importance of analyzing both internal and external factors. Internal factors include the specific characteristics of the goods or services, contractual terms, and a functional analysis (FAR analysis) of the entities involved. FAR analysis involves examining the functions performed, assets used, and risks assumed by each party, ensuring accurate profit allocation. External factors include the broader economic environment, market conditions, and industry trends, which can also impact pricing. This holistic approach ensures that the comparability analysis accurately reflects the economic realities of the controlled transaction.
Chapter 5: Methods of Arm's Length Price Determination
This chapter outlines five methods for determining the arm’s length price, providing a toolbox for tax authorities and taxpayers. These methods include the Comparable Uncontrolled Price method, Resale Price method, Cost Plus method, Transactional Net Margin method, and Transactional Profit Split method. Each method is explained with detailed examples to illustrate its application and highlight the factors to consider when selecting the most appropriate method.
Chapter 6: Transfer Pricing Documentation
This chapter emphasizes the importance of documentation for taxpayers involved in cross-border controlled transactions. This documentation requirement outlined in Annex 1, serves as evidence that transactions are conducted at arm’s length and helps tax authorities assess compliance. The guideline, citing legal provisions from the Income Tax Act of 2058, mandates that certain taxpayers maintain comprehensive records and obtain certification from an independent auditor. The guideline also specifies the qualifications for auditors who can certify these documents. The guideline also highlights the need to file this certified documentation with the income tax return, thereby increasing the reporting requirement by the taxpayer.
Chapter 7: Assessment and Administrative Review
This chapter outlines the legal framework for tax assessment and administrative review related to transfer pricing adjustments. It describes the powers vested in the tax administration to review and adjust transfer pricing arrangements, ensuring compliance with arm’s length principles. This also highlights the process for issuing notices to taxpayers, providing opportunities to respond and provide justifications for their pricing methods. Chapter 7 also explains the provisions for advance pricing agreements, which offer taxpayers a mechanism to proactively engage with the tax administration and obtain certainty regarding their transfer pricing arrangements. It further details the administrative review and appeal procedures, allowing taxpayers to challenge adjustments through the Department of Inland Revenue and the Revenue Tribunal.
See the document in full length here: Transfer Pricing Guideline 2081
OECD’s Transfer Pricing Guideline
The OECD has been a leading authority in shaping the global framework for transfer pricing, providing crucial guidance for both taxpayers and tax administrations on the application of the arm’s length principle. Over the years, it has released a series of comprehensive reports aimed at refining transfer pricing standards and minimizing the risk of double taxation in cross-border transactions between multinational enterprises (MNEs).
The “OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations” serve as a cornerstone for international tax practices relating to the transfer prices. These guidelines cover essential aspects such as the arm’s length principle, transfer pricing method selection, comparability analysis, documentation, intangibles, financial transactions, and business restructurings. Published in its latest edition in 2022, this document helps ensure that MNEs’ transfer prices reflect the economic value of cross-border transactions, reducing disputes and fostering consistency across tax jurisdictions 2022 OECD Transfer Pricing Guidelines.
Beyond these primary guidelines, the OECD has produced other influential reports that go further into specific transfer pricing challenges. Some of the key works include:
- Transfer Pricing and Multinational Enterprises (1979): This foundational report marked one of the earliest attempts by the OECD to address transfer pricing. It laid the groundwork for later frameworks by examining the complexities MNEs face in pricing transactions between associated entities. 1979 Report.
- Transfer Pricing and Multinational Enterprises (1984): This follow-up refined the 1979 report, offering more detailed insights into the application of the arm’s length principle. It strengthened the foundation of transfer pricing rules by focusing on practical approaches to pricing cross-border transactions. 1984 Report.
- Thin Capitalisation – Taxation of Entertainers, Artistes and Sportsmen (1987): While this report primarily focused on thin capitalisation and entertainment, it touched upon transfer pricing issues relevant to sectors where profit shifting is easier due to the mobility of talent and capital. 1987 Report.
- International Tax Avoidance and Evasion (1987): This document addressed the growing concerns around MNEs shifting profits to low-tax jurisdictions, exploring mechanisms to counter international tax evasion, a core issue connected to improper transfer pricing. 1987 Report.
- Attribution of Profits to Permanent Establishments (2001): This report developed a more focused approach to determining how profits should be attributed to permanent establishments in cross-border operations, which directly ties into transfer pricing when dealing with multinational entities. 2001 Report.
- Making Dispute Resolution Mechanisms More Effective, Action 14 – 2015 Final Report: Part of the BEPS (Base Erosion and Profit Shifting) initiative, this report emphasized improving dispute resolution mechanisms in the context of transfer pricing disputes, aiming to make resolution processes more efficient and transparent. 2015 Report.
Additionally, resources such as Roy Donegan’s Global Transfer Pricing: Principles and Practice (5th Edition) further help the body of knowledge on transfer pricing by providing practical insights into the principles and global practices of transfer pricing. Roy Donegan’s Work.
Arm’s Length v/s Non-Arm’s Length
The arm’s length principle (ALP) is the internationally recognized benchmark for establishing transfer prices in cross-border transactions for tax purposes. It ensures that transactions between related entities (associated enterprises) are priced as though they were conducted between independent parties under comparable market conditions. This means that the prices, margins, or profits in such controlled transactions must align with those observed in similar transactions between unrelated entities.
The ALP is anchored in Article 9 of the OECD Model Tax Convention, 2017. This Article states that if the conditions between associated enterprises differ from those between independent parties, profits that should have accrued to one enterprise, but didn’t due to those conditions, can be adjusted and taxed accordingly. The ALP is a vital safeguard against tax avoidance practices, such as profit shifting to low-tax jurisdictions, which can otherwise erode a nation’s tax revenues.
Although the arm’s length principle is the most widely adopted and trusted approach in transfer pricing, alternative methods and frameworks are also available and frequently makes its way into conversation when discussing the limitations of the ALP method. The following comparative chart highlights some of these alternative methods and their key distinctions.
|
Attribute |
Arm’s Length Principle (ALP) |
Global Formulary Apportionment (GFA) |
Destination-Based Cash Flow Taxation (DBCFT) |
|
Definition |
Prices transactions between related parties as if they were conducted between independent entities, ensuring market-based pricing. |
Allocates a multinational’s global profits to each jurisdiction using a formula based on sales, assets, and payroll in each country. |
Taxes profits where the goods or services are consumed, rather than where they are produced or where the company is headquartered. |
|
Key Merits |
– Widely accepted internationally |
– Simpler, more holistic approach |
– Minimizes profit shifting by focusing on consumption |
|
Key Demerits |
– Difficult to find reliable comparables |
– Difficult to achieve international consensus |
– May not be suitable for all industries |
|
Example |
A multinational electronics company sells smartphones to its subsidiary in another country. The subsidiary is taxed on a price that reflects what independent retailers charge in the local market, ensuring that the transaction adheres to the ALP. |
A global beverage company operates in multiple countries. If it has 30% of its sales, 40% of its assets, and 35% of its payroll in Country A, the company would allocate its total global profits based on these percentages. If the company earns $1 billion in profit, Country A would receive 30% (averages if the percentages) of that amount, or $300 million, reflecting its economic activity in that market. |
A digital services company sells software subscriptions worldwide. If 50% of its subscriptions are purchased by consumers in Country B, the DBCFT would dictate that Country B is entitled to tax 50% of the company’s profits. For example, if the company reports $200 million in global profits, Country B would tax $100 million, recognizing the significant consumption happening within its borders. |
Demerits of Arm’s Length Pricing Methods
Although the arm’s length pricing model is widely regarded as the best global standard for determining transfer prices, it comes with several significant limitations. Below is a more detailed breakdown of the key drawbacks of the arm’s length principle, illustrated with examples:
|
Basis |
Issue |
Example |
|
Difficulty in Finding Comparables |
Finding truly comparable transactions is often difficult, especially for unique goods or services, intangibles, or when businesses operate in niche markets. |
A multinational company develops proprietary software and licenses it to its subsidiaries. Since no other company produces similar software, it becomes almost impossible to find a comparable transaction with independent companies to apply the ALP. The lack of suitable comparables results in a highly subjective pricing decision, making it prone to disputes. |
|
Subjectivity in Adjustments |
Even if a comparable transaction is identified, the differences between the controlled and uncontrolled transactions require adjustments, which can be subjective and open to interpretation. |
Two companies sell the same product but operate in different markets—one in a developed country and the other in a developing country. The selling prices in both regions might differ due to factors such as local demand, tariffs, and distribution costs. Adjusting for these differences to determine the arm’s length price for an inter-company transaction involves subjective judgment, which could be disputed by tax authorities. |
|
Costly and Time-Consuming |
Conducting a comparability analysis and adhering to the ALP is a complex and resource-intensive process, often requiring extensive documentation and expert involvement. |
A multinational group that operates across multiple countries has to spend substantial time and money on compiling transfer pricing reports for each jurisdiction, justifying the arm’s length nature of its intercompany transactions. This is especially burdensome when dealing with a wide variety of transactions, such as services, intangibles, and goods. |
|
Inconsistent Application Across Jurisdictions |
Different tax authorities may interpret and apply the arm’s length principle differently, leading to conflicting assessments, double taxation, or disputes. |
A U.S. subsidiary of a European parent company might price its intercompany transactions based on comparables sourced in the U.S. However, the European tax authority may reject these comparables, applying different pricing rules or comparability standards, which results in the same income being taxed in both jurisdictions, leading to double taxation. |
|
Ineffectiveness for Highly Integrated Businesses |
The ALP struggles to address value created by highly integrated operations, where the value is shared among different entities in a group, making it difficult to assign individual contributions. |
An automotive company has highly integrated global operations, where design, production, and marketing are spread across multiple jurisdictions. Each subsidiary contributes to the overall success of the product, but the ALP fails to capture this shared value. For example, if the R&D is done in Germany but manufacturing is done in Mexico, it is difficult to price the contribution of each subsidiary’s efforts based on the ALP alone. |
|
Encourages Profit Shifting |
Despite its purpose to curb profit shifting, MNEs can manipulate prices within the acceptable arm’s length range, effectively shifting profits to low-tax jurisdictions. |
A company sells goods from a manufacturing subsidiary in a low-tax country to a distribution subsidiary in a high-tax country. The price is set within the acceptable arm’s length range but closer to the lower end, shifting profits to the low-tax country, despite the fact that the majority of the company’s sales activities and customer base are in the high-tax country. |
|
Limited Use in Complex Transactions |
The ALP can be inadequate for pricing complex transactions, such as intra-group services, loans, or intangibles, where standard comparables are scarce. |
A parent company provides specialized R&D services to its subsidiaries. The nature of the services is highly specific to the company’s proprietary technology, making it hard to find any comparable external transactions. Applying the ALP to such complex services often leads to arbitrary pricing, which may not reflect the true value of the services. |
|
Focus on Individual Transactions |
The ALP looks at individual transactions rather than the overall group structure and its economic activities, which can distort the tax outcome. |
A multinational company sells a product using a global supply chain. While each transaction (such as from manufacturing to distribution) might comply with the arm’s length standard, the overall group’s profitability may not be aligned with its economic activities. For instance, most of the profit might end up in a low-tax country simply because of how the intercompany pricing was structured, even though most of the value creation occurs elsewhere. |
Where do you place this “Transfer Pricing Guideline”?
The “Transfer Pricing Guideline, 2081” was introduced under the authority granted to the Inland Revenue Department under the Income Tax Act, 2058 (2002) and the Income Tax Regulation, 2059 (2002). As outlined in Para 1.3(2) of the guideline, it is intended to guide the application, practice, and interpretation of the Income Tax Act and Regulation. However, it holds a subordinate position to these legal frameworks, meaning it is applied within the scope of the Act and Regulation. Specifically, it aligns with the provisions of Section 33 of the Income Tax Act, 2058, which addresses transfer pricing and related tax management for associated entities. This section allows the tax authority to allocate, distribute, or adjust taxable income or taxes between associated persons to reflect what would occur under arm’s length conditions.
Provision outlined in Section 33 of the Income Tax Act, 2058:
सम्बद्ध व्यक्तिहरूबीच मूल्य हस्तान्तरण (ट्रान्सफर प्राइसिङ्ग) र अन्य प्रबन्धहरूः
३३(१) सम्बद्ध व्यक्तिहरू बीच कुनै व्यवस्था भएकोमा सो व्यवस्था सामान्य बजार व्यवहार (आर्म्स लेन्थ) अनुसार सञ्चालन गरीएको भए तिनीहरूको लागि कायम हुनसक्ने करयोग्य आय वा बुझाउन पर्ने कर प्रतिविम्बित हुने किसिमले ती व्यक्तिहरू बीच आय गणना गर्दा समावेश वा कट्टी गरीने रकमहरू विभागले लिखित रूपमा सूचना जारी गरेर वितरण, विनियोजन वा बाँडफाँट गर्न सक्नेछ ।
३३(२) उपदफा (१) मा उल्लिखित कुनै कुरा गर्दा विभागले देहायबमोजिम गर्न सक्नेछः- (क) कुनै आय, नोक्सानी, रकम वा भुक्तानीको स्रोत र किसिमलाई पुनः चारित्रीकरण गर्न, वा (ख) कुनै व्यवसाय सञ्चालन गर्न कुनै व्यक्तिले मुख्य कार्यालय खर्च लगायत गर्नु परेको विभिन्न खर्चबाट, सम्बद्ध व्यक्ति वा व्यक्तिहरूलाई फाइदा पुग्न गएकोमा त्यस्तो खर्च व्यवसायको कारोबारको तुलनात्मक आधारमा सम्बद्ध व्यक्तिहरूबीच बाँडफाँट गर्न ।
३३(३) यस दफाबमोजिम सम्बद्ध व्यक्तिबीच हुने हस्तान्तरण मूल्य (ट्रान्सफर प्राइसिङ्ग) को मूल्याङ्कन विधि विभागले निर्धारण गरे बमोजिम हुनेछ ।
When does this Guideline begin to apply?
The “Transfer Pricing Guideline, 2081” will come into effect from the fiscal year 2081/2082. According to Para 1.4(2) of the guideline, it states that “this guideline will be applicable from the fiscal year 2081/082.” This when read with the scope defined in Para 1.3(1) means that all cross-border transactions between associated enterprises will need to comply with the guideline starting from the fiscal year 2081/2082.
Who does this Guideline apply to?
This guideline applies to parties engaged in cross-border transactions with related parties, as defined in Para 1.3(1) of the guideline. It specifically targets the pricing of these transactions to ensure compliance with fair market value principles, aligning with the concept of “स्वतन्त्र कारोबार” (independent transactions) characterized by transactions conducted at arm’s length.
According to Para 6.1, the guideline establishes a framework for maintaining records related to “सीमापार नियन्त्रित कारोबार” (cross-border controlled transactions), which refers to transactions between associated persons across two or more countries. Taxpayers must adhere to the specified documentation formats outlined in Annexure 1 and Annexure 2 to facilitate proper evaluation of these transactions and determine necessary adjustments for tax purposes.
In accordance with Section 96 of the Act, every individual is required to submit an income statement, and any additional information specified by the department must also be included. Consequently, individuals required to comply with this guideline must present the auditor-certified documentation as outlined in Annexure 2 alongside their income statements.
However, it is important to note that these documentation requirements do not apply to cross-border controlled transactions where the annual transaction volume does not exceed NPR 100 million. This exclusion acknowledges the varying scale of transactions and the potential administrative burden on smaller entities involved in “नियन्त्रित कारोबार” (controlled transactions), which include the exchange of goods, services, or assets that can impact the income, profit, loss, assets, or liabilities of the involved parties.
Here are the relevant definition from para 2.1 of the Transfer Pricing Guideline, 2081:
(प) स्वतन्त्र कारोबार: “स्वतन्त्र कारोबार” भन्नाले सामान्य बजार (आर्म्स लेन्थ) मूल्यअनुसार हुने कारोबार सम्झनुपर्छ ।
(घ) सीमापार कारोबार: “सीमापार कारोबार” भन्नाले दुई वा दुई भन्दा बढी देशबीच हुने वस्तु वा सेवा वा सम्पत्ति वा ऋणको कारोबार सम्झनुपर्छ । साथै, सो शब्दले सो निकायको आय, मुनाफा, नोक्सानी, सम्पत्ति वा दायित्वमा प्रभाव पार्ने अन्य कुनैपनि व्यवसायिक गतिविधि वा वित्तीय कारोबारलाई समेत जनाउनेछ ।
(झ) नियन्त्रित कारोबार: “नियन्त्रित कारोबार” भन्नाले सम्बद्ध व्यक्तिहरू बीच हुने वस्तु वा सेवा वा सम्पत्ति वा ऋणको कारोवार सम्झनुपर्छ । साथै, यस शब्दले यस्ता व्यक्तिहरूको आय, मुनाफा, नोक्सानी, सम्पत्ति वा दायित्व प्रभाव पार्ने अन्य कुनैपनि व्यवसायिक गतिविधि वा वित्तीय कारोबारलाई समेत सम्झनुपर्छ ।
(न) सीमापार नियन्त्रित कारोबार: “सीमापार नियन्त्रित कारोबार” भन्नाले दुई वा दुई भन्दा बढी देशहरू बीच रहेका सम्बद्ध व्यक्तिहरू बीच हुने सीमापार कारोबारलाई सम्झनुपर्छ ।
Who to call for Transfer Pricing Analysis?
According to the Transfer Pricing Guideline 2081, auditors who certify transfer pricing documentation in Nepal must meet specific qualifications:
- General Qualification: As per Para 6.3.1, only auditors registered with the Institute of Chartered Accountants of Nepal (ICAN) and holding a professional certificate under Section 28 of the Nepal Chartered Accountants Act, 2053 are authorized to certify transfer pricing documents.
- Additional Requirements for High-Value Transactions: Para 6.3.2 of the directive applies to companies with cross-border transactions involving goods or services over NPR 50 crore. In these cases, the certification must come from an auditor separate from the one performing the financial or tax audit. This auditor is also required to have at least five years of experience in auditing.
ISA 4400 guides auditors certifying transfer pricing documentation by outlining a framework for performing agreed-upon procedures. The auditor collaborates with the entity to define specific procedures relevant to assessing compliance with transfer pricing regulations, documented in an engagement letter. After executing these procedures—such as verifying the arm’s length nature of transactions—the auditor reports the factual findings without providing assurance. This standard ensures a transparent and focused process, enhancing the credibility of the entity’s transfer pricing practices.
How do you define an “associated person”?
Transfer Pricing Guideline, 2081 highlights that transactions between associated entities might deviate from market prices, potentially leading to tax base erosion in Nepal. The comprehensive definition of associated entities reflects the tax department’s intention to scrutinize various relationships that could influence pricing and profit allocation, going beyond traditional ownership structures.
Here is how the directive goes on to define the relationship of the associated person.
What does the Income Tax Act of Nepal say?
दफा २(कन) सम्बद्ध व्यक्ति: “सम्बद्ध व्यक्ति” भन्नाले एक अर्को व्यक्तिको मनसायअनुसार काम गर्ने एक वा एकभन्दा बढी व्यक्ति वा त्यस्ता व्यक्तिहरूको समूह सम्झनुपर्छ र सो शब्दले देहायका व्यक्तिहरू समेतलाई जनाउँछः-
(१) प्राकृतिक व्यक्ति र सो व्यक्तिको नातेदार वा कुनै व्यक्ति वा सो व्यक्तिको साझेदार,
(२) विदेशी स्थायी संस्थापन र सो संस्थापनमा स्वामित्व भएको व्यक्ति, र
(३) कुनै निकाय आफै वा आफूसँग सम्बन्धित अन्य व्यक्ति वा सहयोगी निकाय वा त्यस्ता सहयोगी निकायसँग सम्बन्धित अन्य कुनै व्यक्ति वा निकायसँग मिलेर कुनै निकायको आय, पूँजी वा मताधिकारको पचास प्रतिशत वा सोभन्दा बढी हिस्सा नियन्त्रण गर्ने वा सोबाट फाइदा प्राप्त गर्ने निकाय ।
तर देहायका व्यक्ति सम्बद्ध व्यक्ति हुने छैनः- (१) कर्मचारी, (२) विभागले सम्बद्ध व्यक्ति होइन भनी तोकेको व्यक्ति ।
The term “associated person,” as defined in Section 2(Ka.Na) of the Income Tax Act, 2058, refers to individuals or entities that operate in accordance with the intentions of another party, indicating a strong connection or influence over decision-making. The definition specifies certain relationships that qualify as associated persons, including:
- Natural Persons and Their Relatives or Partners: This includes individuals with familial or business ties, highlighting the interpersonal relationships that establish association.
- Foreign Permanent Establishments and Their Owners: This refers to the relationship between a foreign entity and the individual who owns it, establishing a link between the entity’s operations and its proprietor.
- Entities Controlling or Benefiting from Over 50% of Another Entity’s Income, Capital, or Voting Rights: This clause addresses situations where one entity, or a related group of entities, exerts significant control or derives benefits from another entity through ownership or voting power.
- Exceptions: The definition excludes employees, and any individuals deemed “not associated” by the Inland Revenue Department.
However, the definition leaves room for interpretation. The opening line—“सम्बद्ध व्यक्ति भन्नाले एक अर्को व्यक्तिको मनसायअनुसार काम गर्ने एक वा एकभन्दा बढी व्यक्ति वा त्यस्ता व्यक्तिहरूको समूह सम्झनुपर्छ,” which translates to “associated person refers to one or more persons or a group of persons acting in accordance with the intention of another person”—is broad and can lead to subjective interpretations. This phrase suggests that any relationship in which individuals or entities align with each other’s intentions, whether formally or informally, may be considered “associated.”
This ambiguity raises questions, such as:
• Does this encompass informal business agreements?
• Are indirect influences (like family pressure or business advice) sufficient to classify a person or group as associated?
As a result, tax authorities have considerable discretion in determining whether a person or entity qualifies as an “associated person.” While this allows for flexibility, it can also lead to inconsistent interpretations in similar cases. Each relationship requires careful evaluation to ascertain whether it meets the definition of “associated.” This open-ended nature may prompt debates and disputes regarding who qualifies as an associated person, depending on the specifics of each situation.
💡Who is a “relative”?
Para 2.1(Chha) of the Transfer Pricing Guideline, 2081 defined नातेदार: “नातेदार” भन्नाले प्राकृतिक व्यक्तिको पति, पत्नी, छोरा, छोरी (धर्मपुत्र, धर्मपुत्री समेत), बाबु, आमा, बाजे, बज्यै, दाजु, भाइ, भाउजु, बुहारी, दिदी, बहिनी, सासु, ससुरा, साला, जेठान, साली, जेठी सासु, काका, काकी, भतिजा, भतिजी, नाति र नातिनी सम्झनुपर्छ।
This includes members from immediate family, extended family and in-laws’ family as well. It includes Spouse: पति, पत्नी, Children: छोरा, छोरी (धर्मपुत्र, धर्मपुत्री समेत), Parents: बाबु, आमा, Grandparents: बाजे, बज्यै, Siblings: दाजु, भाइ, दिदी, बहिनी, Spousal in Laws: सासु, ससुरा, साला, जेठान, साली, जेठी सासु, Siblings in Laws: भाउजु, बुहारी, Uncles and Aunts: काका, काकी, Nieces and Nephews: भतिजा, भतिजी, Grandchildren: नाति र नातिनी
Referring to NFRS and ITA 1961 of India
Regarding the interpretation of the term “associated person” in the context of the Income Tax Act, 2058, the inherent ambiguity in the definition necessitates a reference to additional standards and practices to gain a clearer understanding of what constitutes an associated person—specifically, the phrase “एक अर्को व्यक्तिको मनसायअनुसार काम गर्ने एक वा एकभन्दा बढी व्यक्ति वा त्यस्ता व्यक्तिहरूको समूह” (one or more persons or a group of persons acting in accordance with the intention of another person).
One valuable resource is the Nepal Financial Reporting Standards (NFRS), particularly “NAS 24: Related Party Disclosure.” This standard provides specific guidelines for related party transactions, including definitions of related parties that may align with the concept of “associated persons.” NFRS encompasses relationships that exist through individuals as well as through entities.
Additionally, we can look to Section 92A of the Income Tax Act of 1961 in India, which defines “associated enterprise” based on two primary criteria:
1. An enterprise is considered associated if it participates—directly, indirectly, or through intermediaries—in the management, control, or capital of another enterprise.
2. Alternatively, if individuals involved in the management or control of one enterprise are the same as those in the other, the two enterprises are deemed associated.
Section 92A further outlines specific conditions under which two enterprises may be classified as associated, provided any of the following conditions are met during the previous year:
• Voting Power: One enterprise holds at least 26% of the voting power in the other, or any person or enterprise holds at least 26% of the voting power in both.
• Loan Conditions: A loan from one enterprise to another constitutes at least 51% of the total assets’ book value of the latter.
• Guarantees: One enterprise guarantees at least 10% of the total borrowings of the other.
• Board Composition: More than half of the board members or governing board members of one enterprise are appointed by the other, or more than half of the directors of both enterprises are appointed by the same person(s).
• Dependence on Intellectual Property: The manufacture or processing of goods by one enterprise is entirely reliant on the intellectual property of the other (e.g., patents, copyrights).
• Supply Conditions: Over 90% of the raw materials required for one enterprise’s manufacturing are supplied by the other, and prices are influenced by the supplier. Alternatively, goods produced by one enterprise are sold to the other or its specified persons, with pricing influenced by the seller.
• Control Relationships: If one enterprise is controlled by an individual, the other is also controlled by that individual or their relatives. Similarly, if one enterprise is controlled by a Hindu undivided family (HUF), the other is controlled by a member of that HUF or their relative.
• Interest Relationships: One enterprise holds at least a 10% interest in a firm, association, or body of individuals that constitutes the other enterprise.
• Mutual Interest: Any other prescribed relationship of mutual interest exists between the two enterprises.
Although these are not discrete provisions of the transfer pricing guidelines of Nepal, they can serve as a framework for establishing associated person relationships, especially in cases where ambiguity or interpretation arises because they are certain to have interpretative and persuasive value in case of disputes.
Deemed Transfer Pricings Arrangements
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Seven Steps of Comparability Analysis
Comparability analysis is a critical process in transfer pricing that involves comparing controlled transactions between related parties with similar transactions between independent entities. The aim is to determine whether the pricing of controlled transactions is consistent with the principles of arm’s length pricing, which is essential for tax compliance.
Analysis of Economically Significant characteristics of Business and Transaction
The first step in a comparability analysis lays the foundation for determining the arm’s length price. It involves gathering and analyzing information to thoroughly understand the controlled transaction and the business environment in which the taxpayer operates. This step includes:
- Analyzing the Controlled Transaction and Key Business Features: This stage requires examining various aspects such as industry dynamics, regulatory landscape, and the economic environment where the business functions. It’s vital to identify all related parties and the controlled transactions that will be scrutinized. It involves:
- Industry Analysis: Understanding the value chain, profit drivers, and market trends is key to analyzing the controlled transaction. Variations in supply chain structures or competitive dynamics can influence transaction prices.
- Profit Drivers: Identifying the specific elements that contribute to the company’s profitability helps in analyzing the transaction’s impact on overall business performance.
- Market Trends: It’s crucial to examine changing consumer preferences, technological developments, and advertising practices in the industry, as they impact both supply and demand.
- Competitive Environment: The level of competition significantly affects profitability. In industries with low competition, profits may be higher, while in highly competitive markets, profits may shrink.
- Clearly Defining the Transaction: After understanding the business environment, it’s necessary to gain clarity on the specifics of the transaction, including contractual terms and their consistency with the economic actions of the parties involved. This includes analyzing contractual terms, business strategies, the roles of each party (functions performed, assets used, and risks assumed – FAR Analysis), economic conditions, and the characteristics of the goods or services being transferred.
- Selecting the Appropriate Evaluation Method: Once the transaction is well-defined, the next step is to decide whether to evaluate each transaction separately or to bundle them together for analysis. This involves separating the individual or collective analysis that includes determining whether to assess each transaction independently, as a package, or through segmented evaluation based on the specific circumstances of the transaction.
Examining Comparability Factors of the Controlled Transaction
This stage involves a detailed analysis of various factors that can affect the pricing of the transaction. The key elements to consider include:
- Characteristics of the Property or Service Transferred: The specific attributes of the goods or services involved in the transaction can significantly influence market pricing. Key aspects to consider are:
- For Tangible Goods: Physical characteristics such as quality, reliability, availability, and quantity.
- For Services: The nature, quality, and duration of service delivery.
- For Intangible Assets: Factors such as the type and duration of use, benefits derived, and condition (license or sale) can impact the value.
- Contractual Terms of the Transaction: The agreements between the parties, encompassing various arrangements and conditions, can impact the transaction price. Important considerations include Payment terms, delivery conditions, and warranties may lead to significant differences in pricing. A careful examination of these contractual terms is necessary, as any substantial differences may necessitate adjustments in the comparability analysis.
- Functional Analysis (FAR Analysis): Functional analysis is a crucial component of the comparability analysis, focusing on the functions performed, assets utilized, and risks assumed by each party involved in the controlled transaction. Key points include:
- Functions Performed: Identifying the economic activities undertaken by each party, such as production, R&D, marketing, and distribution, helps determine their contributions to profit generation.
- Assets Utilized: Assessing the tangible and intangible assets employed by each party, including property, equipment, intellectual property, and technology, is essential.
- Risks Assumed: Analyzing the various risks each party undertakes, such as market, credit, and operational risks, aids in understanding potential impacts on profitability.
- Economic Circumstances of the Transaction: The broader economic context can influence pricing dynamics. Important factors to evaluate include: Geographical locations, market conditions, competition levels, and currency fluctuations that may affect the transaction price. It is crucial to compare these circumstances with those of potential comparable transactions to ensure a comprehensive analysis.
- Business Strategies: The strategies employed by each business can impact pricing decisions and overall market behavior. Considerations include: Differentiation between businesses seeking market entry, expansion, or maintenance, which may affect pricing. For example, a company aiming to increase market share may adopt lower pricing strategies, while a business focused on brand building may incur higher marketing costs. These strategic choices must be factored into the comparability analysis.
Selection of Tested Party
This step involves selecting one of the parties involved in the controlled transaction as the tested party. This selection is crucial for employing methods such as the Resale Price Method, Cost Plus Method, and Transactional Net Margin Method. Ideally, the party chosen as the tested party should have less complex transactions and possess financial indicators that are readily comparable to those of independent entities. It is essential to ensure that information about the tested party and the comparable independent transactions is available.
The selection of a tested party is crucial for methods like the Resale Price Method, Cost Plus Method, and Transactional Net Margin Method, as these methods depend on the financial performance of the chosen party. In contrast, the Comparable Uncontrolled Price Method compares prices between controlled and uncontrolled transactions, making the selection of a tested party unnecessary. Similarly, the Transactional Profit Split Method allocates profits based on each party’s contributions, also not requiring a tested party, since its focus is on profit allocation rather than benchmarking one party’s performance. Thus, tested party selection is essential for some methods but not for CUP and Transactional Profit Split methods.
In the context of comparability analysis, one party from the related entities must be selected for comparison with independent transactions. This chosen party is referred to as the tested party. The term “tested party” (परीक्षण गरीने पक्ष) refers to the party among the related entities whose financial indicators are used as the basis for pricing in accordance with independent market behavior when applying the Resale Price Method, Cost Plus Method, and Transactional Net Margin Method. It is advisable to select the party with less complex transactions as the tested party. Additionally, it is important to consider whether relevant information on comparable independent transactions in the same context is available during the selection of the tested party. If the taxpayer has chosen a related party outside Nepal as the tested party, it is crucial to ensure that necessary information and data related to both the related party and the comparable independent transactions are also verifiable and available when essential to the tax administration.
Selection of the Controlled Transaction
The selection of the controlled transaction is a crucial step in the transfer pricing process, even if not explicitly provided in the guideline. This step involves identifying the specific transaction between related parties that will be used to determine an arm’s length price.
Controlled transactions can include the sale of goods, provision of services, licensing of intellectual property, or financial transactions like lending or borrowing. Each type has unique factors affecting pricing mechanisms and comparability analysis. For example, when selling goods, one must consider product characteristics and market value, while service evaluations depend on the nature of the service and market conditions.
Identification and Selection of Comparable Transactions
After selecting the tested party and controlled transaction, the next step involves identifying and selecting comparable uncontrolled transactions. This involves searching for transactions between independent entities that share similar characteristics with the controlled transaction. Two types of comparable transactions can be used: Internal comparable uncontrolled transactions and External comparable uncontrolled transactions.
Finding reliable information about comparable uncontrolled transactions is crucial. Various data sources, including the Inland Revenue Department, public databases, industry associations, and commercial databases can be used for this purpose. Selecting the most suitable comparables involves:
- Additive Approach: This approach involves identifying potential comparable transactions based on an initial assessment and subsequently analyzing their suitability using specific criteria.
- Deductive Approach: This approach starts with a larger dataset and systematically narrows it down based on predefined criteria until the most appropriate comparable transactions are identified.
Appropriate Adjustments to Comparable Transactions
After selecting the tested party, the next step involves identifying comparable uncontrolled transactions for comparative analysis of the tested party’s financial indicators. These comparable transactions can be classified into two categories:
- Internal Comparable Uncontrolled Transactions: These involve transactions where the tested party engages with both related and unrelated parties. When the tested party conducts transactions with independent entities, these are considered internal comparables. Because they originate from the same entity, internal comparables are often deemed more reliable. However, if the terms and conditions differ among transactions, necessary adjustments must be made to eliminate discrepancies.
- External Comparable Uncontrolled Transactions: These transactions occur between independent third parties that have no relationship with the tested party. In practice, internal comparables are often rare, making external comparables necessary. Sourcing reliable, accurate, and complete information is essential for comparing external transactions, requiring various information sources.
Sources of Information for External Comparable Transactions
Identifying suitable external comparable transactions relies on various information sources. The Inland Revenue Department serves as a primary resource, collecting income statements and relevant data from taxpayers, which can help identify potential comparable transactions. Additionally, data exchanged under double taxation treaties and anti-avoidance agreements can be instrumental in this process. Government agencies also provide valuable information, as related and independent parties submit data to regulatory bodies such as the Company Registrar’s Office and the Department of Industry, which can be utilized for comparative analysis. Furthermore, industry associations and international organizations, including the World Bank and the International Monetary Fund, may maintain relevant business statistics that aid in identifying comparables.
Methods for Selecting External Comparable Transactions
Choosing suitable comparable transactions can be challenging due to the abundance of available data. The Additive Approach involves initially identifying potential comparable transactions based on estimates and subsequently analyzing their comparability using established criteria. Conversely, the Deductive Approach begins with a broad dataset and systematically narrows down the selection based on predefined criteria until the most appropriate comparable transactions are identified. Employing these methods helps streamline the selection process and enhances the accuracy of the comparative analysis.
Procedures for Selecting Comparable Transactions
To effectively select suitable comparable transactions from a database, specific procedures should be followed. Database screening involves establishing criteria based on the tested party’s financial characteristics, such as industry codes and geographic markets. Following this, quantitative selection employs financial indicators and measurable criteria, like inventory-to-sales ratios, to refine the selection further. It’s also crucial to conduct a qualitative selection to evaluate non-quantifiable aspects of the available data. Finally, after completing these steps, the final selection of suitable comparable transactions should be made for further analysis. This structured approach ensures a comprehensive evaluation of potential comparables.
Selection of the Appropriate Arm's Length Pricing Method
After completing the outlined procedures, the next step is to determine the arm’s length price for the controlled transaction between related parties based on various indicators from comparable uncontrolled transactions. Several methods exist for calculating the arm’s length price, as detailed in Chapter 5 of the guideline. It is essential to select the most suitable method through comparative analysis, ensuring alignment with general market behavior.
Once the comparable transactions are identified and adjusted, the appropriate arm’s length pricing method must be chosen from five accepted methods:
• Comparable Uncontrolled Price Method
• Resale Price Method
• Cost Plus Method
• Transactional Net Margin Method
• Transactional Profit Split Method
The selection of the method should consider the nature of the controlled transaction and the reliability of the available data for comparable transactions. Each method relies on distinct financial indicators and requires a thorough evaluation of its appropriateness for the specific situation.
Determination of the Arm’s Length Price
The final step involves calculating the arm’s length price using the selected pricing method and the adjusted financial data from the comparable transactions. Two primary approaches are recommended for establishing the arm’s length range:
• Range Method: When seven or more comparable transactions are available, calculate the interquartile range, with the median value representing the most reliable arm’s length price.
• Average Method: If fewer than seven comparable transactions are available, the average of the financial indicators is utilized as the arm’s length price.
Should the tested party’s financial indicators fall outside the established arm’s length range, adjustments may be necessary to align their pricing with fair market practices. It’s important to note that these steps are not always linear and may require iterations and refinements depending on the specific circumstances surrounding the controlled transaction and the data at hand. Additionally, maintaining thorough documentation and reporting is crucial to support the chosen arm’s length price and ensure compliance with Nepal’s transfer pricing regulations.
Methods of computing ALP: Which one to apply?
The below is a structured summary outlining the nature of business / transactions suitable for each type of transfer pricing method, based on practices, contents of the guideline and assorted publications and commentaries:
|
Method |
Suitable Nature of Business/Transactions |
|
Comparable Uncontrolled Price Method |
Direct Sales of Goods: Multinational electronics company selling smartphones to a subsidiary using market prices for similar smartphones. |
|
Resale Price Method |
Resale of Tangible Goods: Wholesaler purchasing electronic gadgets from a parent company and selling them to retailers, subtracting an appropriate gross profit margin from the resale price. |
|
Cost-Plus Method |
Manufacturing Agreements: Subsidiary manufacturing automotive parts for a parent company, adding a markup to production costs. |
|
Transactional Net Margin Method |
Routine Functions: Distribution subsidiary marketing and selling products with stable profit margins compared to independent distributors. |
|
Transactional Profit Split Method |
Joint Ventures: Companies collaborating on research projects, splitting profits based on respective contributions (e.g., technology vs. market access). |
Traditional Transaction Method
Comparable Uncontrolled Price Method
The Comparable Uncontrolled Price (CUP) method involves comparing the price of goods or services in a controlled transaction with the price of the same goods or services in a comparable uncontrolled transaction. This method is considered the most reliable when a suitable comparable uncontrolled transaction is available. Both internal and external comparable transactions can be considered when applying this method.
To qualify a comparable uncontrolled transaction, there should not be any factors that materially affect the price being compared. If there are differences, necessary adjustments must be possible which may be for type, quality, terms of trade, quantity discounts, geographical factors, contractual terms, risk allocation and so on.
Resale Price Method
According to the resale price method, the arm’s length purchase price for the related party is determined by reducing the resale price by the gross profit margin typically earned in comparable independent transactions. The tested party’s resale price to an independent party is used as the basis, and the gross profit percentage from similar independent transactions is applied. After subtracting this gross profit, any additional purchase-related costs are also deducted to arrive at the arm’s length purchase price for the tested party.
When selecting comparable independent transactions for the resale price method, it should be ensured that no significant factors should exist that materially impact the gross profit margin and if there are, necessary adjustments should be possible. Key factors that influence comparability in the resale price method include expenses included in the cost of goods, accounting methods, management efficiency, business maturity level, value-added actions of seller, creation of intangible assets like trademarks, brands, additional processing before the sale, the seller’s role (distributor, wholesaler, retailer), exclusive rights to the product like to selling.
Cost Plus Method
Under this approach, the tested party’s direct costs form the basis for calculating the transfer price. The arm’s length markup, derived from comparable uncontrolled transactions, is added to the base cost to arrive at the appropriate transfer price for the related party. This method calculates the arm’s length price by taking the cost of goods or services and adding a markup that reflects an arm’s length margin. The markup is determined by analyzing comparable uncontrolled transactions where similar goods or services are sold. This method is particularly useful in situations where the related party incurs significant production costs but performs limited additional functions like marketing or distribution.
When selecting comparable uncontrolled transactions for the cost-plus method, it must be ensured that there should not be any factors that materially affect the markup being applied and if there are, necessary adjustments must be possible to ensure comparability. The cost-plus method is most effective in situations like production activities, such as basic manufacturing or service provision, contract manufacturing, co-production agreements, or assembly operations where the producer or service provider assumes minimal risks.
Traditional Transaction Method
Transactional Net Margin Method
The Transactional Net Margin Method (TNMM) compares the net profit margin of a controlled transaction to that of comparable uncontrolled transactions. It is typically used when direct comparisons of goods or services between controlled and uncontrolled transactions are difficult, but it is possible to find comparable uncontrolled transactions for the overall business operations of the tested party. The method focuses on net profitability relative to key metrics such as costs, sales, or assets.
In this approach, the net profit of the tested party is compared against the net profit of similar independent companies, ensuring that the result reflects an arm’s length transaction. Net profit is calculated after deducting direct and indirect expenses but before subtracting interest and taxes. The TNMM uses various profitability indicators based on the business model. Commonly used indicators include return on assets, return on capital employed, operating margin, return on total cost, berry ratio, return on cost of goods sold. When applying TNMM, several factors that affect net profit must be considered, such as: barriers to market entry, competitive environment, management efficiency, business strategy, challenges from substitute products, cost structures and industry experience
The TNMM is best suited for situations where gross profit data is unavailable, making methods like the Resale Price or Cost-Plus methods impractical. It is also effective when accounting differences impact gross profit, in transactions involving licensed manufacturers, high-risk distributors, or when one party holds intangible asset rights. Additionally, TNMM can be used to cross-verify the results of other methods to ensure accuracy.
Transactional Profit Split Method
The Transactional Profit Split Method is used to allocate profits between related parties engaged in a controlled transaction, especially when each party provides unique and valuable contributions. This method splits the profits based on the relative value of the contributions from both parties, and is commonly applied in situations where the parties are highly integrated, making it difficult to establish the arm’s length price for individual transactions. If no comparable uncontrolled transactions are available, the split is determined by evaluating the parties’ functions, assets used, and risks assumed. This method is ideal for transactions involving joint value creation, such as when both parties share significant risks, contribute intangible assets, or are so integrated that their roles cannot be easily separated.
Range Methods of computing ALP: When to apply?
To compute the Arm’s Length Price, a comparability analysis is conducted to select appropriate comparable transactions, and financial indicators are calculated based on relevant methods. The task is to identify the indicator that represents the arm’s length price. Two main approaches are used:
Median Approach
This method applies when there are seven or more comparable transactions. The range is considered within the 35th to 65th percentiles. If the tested party’s financial indicator falls within this range, or within 5% above or below the minimum or maximum financial indicators, it is deemed to be at arm’s length. If the indicator is outside this range, the transaction is not considered to be at arm’s length, and adjustments must be made. If not within the range, the financial difference from the median is calculated, and the adjustment is made for tax determination.
Mean Approach
For six or fewer comparable transactions, the mean approach is used. The average of the financial indicators is computed, and if the tested party’s financial indicator is within 5% above or below this average, it is considered to be at arm’s length. If the difference exceeds this, adjustments are required to align the transaction with the average and determine taxes accordingly.
Advance Pricing Arrangements
An Advance Pricing Arrangement (APA) is an agreement between a taxpayer and one or more tax administrations that establishes, in advance, an appropriate set of criteria for determining transfer prices for specific controlled transactions over a fixed period. These criteria might include the transfer pricing method, comparable companies and adjustments, critical assumptions about future events, and other relevant factors. APAs can be unilateral, involving one tax administration and a taxpayer, or bilateral/multilateral, involving the agreement of two or more tax administrations. While most jurisdictions prefer bilateral or multilateral APAs due to concerns about double taxation, some jurisdictions may grant unilateral APAs. APAs supplement existing administrative, judicial, and treaty-based dispute resolution mechanisms and are particularly useful when those mechanisms are difficult to apply or have failed.
According to Section 33 of the Income Tax Act, 2058 and Rule 15 of the Income Tax Rules, 2059 provides a framework for advance pricing arrangements based on fair market value pricing. Specifically, this rule allows for the advance determination of transfer pricing for individuals concerning the calculation of income, ensuring clarity in the allocation, distribution, or sharing of amounts included or deducted based on arm’s length principles.
Under this provision, if one or more individuals request clarification regarding the distribution or allocation of amounts based on fair market value, the department may issue written guidance. This written notice can cover a period of no more than five assessment years and is renewable. The guidance issued is binding on both the department and the requesting party unless the department agrees to nullify the request. This framework aims to promote transparency and compliance in transfer pricing practices in Nepal.
ऐनको दफा ३३ बमोजिम सामान्य बजार मूल्यअनुसारको मूल्य निर्धारणका सन्दर्भमा नियमावलीको नियम १५ मा अग्रिम मूल्य निर्धारण गर्न सकिने व्यवस्था रहेको छ । नियम १५ मा “अग्रिम रूपमा मूल्य निर्धारण गर्ने” सम्बन्धि गरिएको व्यवस्था:
१५(१) ऐनको दफा ३३ को उपदफा (१) बमोजिम कुनै व्यक्तिको आय गणना गर्दा समावेश वा कट्टी गरीने रकम सम्बन्धमा सामान्य बजार मूल्य (आर्म्स लेन्थ) को आधारमा विभागले वितरण, विनियोजन वा बाँडफाँट गर्ने सम्बन्धमा स्पष्ट हुन एक वा एकभन्दा बढी व्यक्तिले लिखित रूपमा अनुरोध गरेमा विभागले देहायबमोजिम लिखित सूचना जारी गर्न सक्नेछः- (क) लिखित सूचनाको अवधि एक पटकमा पाँच आय वर्षभन्दा बढी नहुने गरी, (ख) खण्ड (क) मा जुनसुकै कुरा लेखिएको भए तापनि सो लिखित सूचना नवीकरण हुन सक्ने गरी ।
१५(२) उपनियम (१) बमोजिमको लिखित सूचना विभाग तथा अनुरोध गर्ने पक्षलाई बाध्यात्मक हुनेछ । तर सम्बन्धित निवेदकले गरेको अनुरोधमा विभाग सहमत भएमा सो लिखित सूचना निष्कृय हुनेछ ।
How do APAs work?
- A taxpayer initiates the APA process with a formal request to the tax administration.
- The taxpayer, associated enterprises, and tax administration(s) negotiate the terms of the APA, including the transfer pricing methodology and critical assumptions.
- The APA process typically involves a thorough analysis of the facts, business strategies, and economic circumstances surrounding the controlled transactions.
- The taxpayer may be required to provide extensive documentation supporting the reasonableness of its proposed transfer pricing methodology.
- Once agreed upon, the APA provides assurance that the agreed-upon transfer pricing methodology will not be challenged by the participating tax administrations for the covered transactions and period, as long as the taxpayer complies with the terms of the APA.
Advantages of APAs include providing certainty and predictability for taxpayers regarding the tax treatment of cross-border transactions, which facilitates better investment planning and financial forecasting. They also reduce compliance costs by minimizing the potential for disputes and the administrative burdens associated with transfer pricing audits. Additionally, APAs enhance cooperation between taxpayers and tax authorities, allowing for a more collaborative approach to resolving transfer pricing issues and enabling tax administrations to focus resources on more complex cases.
However, there are disadvantages to consider, such as the risk of double taxation with unilateral APAs, which may not be recognized by other jurisdictions involved in the transaction. The APA process can also be complex and resource-intensive, requiring significant time and effort from both taxpayers and tax administrations. Furthermore, since APAs are based on predictions about future events, unforeseen circumstances may render the agreed-upon transfer pricing methodology inaccurate, and there is a risk that APAs could be misused for aggressive tax planning if not properly structured and monitored.
Key considerations for APAs include the scope, duration, critical assumptions, monitoring, and potential revisions. The scope can range from addressing all transfer pricing issues for a taxpayer to focusing on specific affiliates and transactions. Typically negotiated for an average term of 3-5 years, APAs require clearly defined critical assumptions regarding market conditions and business strategies, along with mechanisms to adapt to changes. Compliance is generally monitored by tax administrations through annual reports and periodic audits, and APAs can be revised, canceled, or revoked if significant changes in business operations or economic conditions arise.
APAs can be particularly useful in managing complex transfer pricing challenges in various contexts. For example, they can effectively address profit allocation issues in global securities and commodity trading operations. Additionally, APAs provide a structured approach for determining contributions and benefits in multilateral cost contribution arrangements (CCA) involving multiple jurisdictions. They can also establish arm’s length pricing for transactions related to business restructurings, ensuring appropriate profit allocation between involved entities.
Some important provisions are absent: But we need to watch out
Primary, Corresponding and Secondary Adjustments
Primary Adjustments
A primary adjustment occurs when a tax administration in one country (the “first jurisdiction”) increases a company’s taxable profits because it believes the price for transactions with an associated enterprise in another country (the “second jurisdiction”) was not at arm’s length. This essentially means the tax administration believes the price was manipulated to shift profits to a lower-tax jurisdiction. For example, if a subsidiary in a low-tax country sells goods to its parent company in a high-tax country at a price below market value, the tax administration of the high-tax country may make a primary adjustment to increase the subsidiary’s profits, and therefore its tax liability.
Corresponding Adjustments
To avoid double taxation, the tax administration of the second jurisdiction may make a corresponding adjustment, reducing the associated enterprise’s tax liability. This ensures that the allocation of profits between the two jurisdictions is consistent. Corresponding adjustments, while encouraged, are not mandatory. The tax administration of the second jurisdiction will only make a corresponding adjustment if it agrees with the first jurisdiction’s assessment that the primary adjustment was justified. The mutual agreement procedure (MAP) is a mechanism for resolving such disputes between tax administrations. Competent authorities from both jurisdictions negotiate to reach a mutually acceptable solution.
Secondary Adjustments
While primary and corresponding adjustments reallocate profits for tax purposes, they don’t address the fact that the original transaction wasn’t at arm’s length. Secondary adjustments aim to align the actual allocation of profits with the primary adjustment. This is done by constructively treating the excess profits resulting from the primary adjustment as a separate transaction.
Common types of secondary transactions include:
• Constructive dividends: The excess profits are treated as dividends paid to the parent company, potentially triggering withholding tax.
• Constructive equity contributions: The excess profits are treated as an investment by the parent company in the subsidiary.
• Constructive loans: The excess profits are treated as a loan from one associated enterprise to another, with imputed interest potentially applied.
Secondary adjustments can create practical difficulties and potentially lead to double taxation. They often involve creating hypothetical transactions, which may not be recognized in all jurisdictions. This can lead to uncertainty and complexity in determining tax consequences. For example, a secondary adjustment in the form of a constructive dividend may lead to withholding tax that’s not relievable in the other jurisdiction. Some jurisdictions reject secondary adjustments entirely due to these complexities.
Safe Harbor Rules
The guideline specifically “Transfer Pricing Guideline 2081,” does not mention or discuss “safe harbor rules” in the context of transfer pricing. Safe harbor rules, in general transfer pricing terms, are predetermined sets of conditions or criteria established by tax authorities that, if met by taxpayers, provide them with certainty regarding the arm’s length nature of their transactions. These rules simplify compliance and reduce the risk of transfer pricing adjustments. The absence of specific safe harbor provisions in Nepal’s transfer pricing guidelines suggests that taxpayers must rely on the detailed comparability analysis and the five prescribed transfer pricing methods outlined in the guideline to justify their pricing decisions. This emphasizes the need for robust documentation and a thorough understanding of the arm’s length principle to minimize the risk of transfer pricing adjustments.
Country by Country Reporting
The guideline specifically doesn’t have any provision relating to the Country-by-Country Reporting (CbCR). In the context of international taxation and transfer pricing, CbCR is a reporting requirement for multinational enterprises (MNEs) to provide detailed financial and tax information for each jurisdiction in which they operate. This information typically includes revenues, profits, taxes paid, employees, and assets. CbCR is intended to enhance transparency and assist tax authorities in assessing transfer pricing risks and potential profit shifting.
MAP and Domestic Dispute Resolution
While Nepal’s Transfer Pricing Guidelines do not explicitly define “Mutual Agreement Procedures” (MAP), they do address the resolution of transfer pricing disputes through administrative reviews and appeals within the country’s domestic legal framework. In the context of international taxation, MAP serves as a mechanism established under tax treaties to resolve cross-border tax disputes, including those arising from transfer pricing adjustments. This process enables taxpayers to work collaboratively with tax authorities in the relevant treaty partner countries to find a mutually acceptable resolution.
The absence of a specific MAP reference in “Transfer Pricing Guideline 2081” implies that Nepal’s domestic dispute resolution mechanisms may serve as the primary means for addressing transfer pricing issues. The guideline seems primarily focused on outlining the substantive rules and documentation requirements for transfer pricing compliance. In the absence of detailed MAP procedures within the guidelines, taxpayers can refer to the Mutual Agreement Procedure articles in the Double Tax Avoidance Agreements (DTAA) that Nepal has signed with various countries or the provisions outlined in Section 73 of the Income Tax Act, 2058, concerning international agreements.
According to Para 7.1 of the guidelines, the Department of Internal Revenue, Nepal’s tax authority, has the jurisdiction to audit taxpayers and make necessary adjustments to transfer pricing when it finds that the taxpayer’s pricing does not comply with the arm’s length principle, as stipulated in Section 101 of the Income Tax Act, 2058. If taxpayers are dissatisfied with a transfer pricing adjustment, they may file an administrative review request with the department in accordance with Section 115 of the Income Tax Act, 2068. Should the outcome of this administrative review be unsatisfactory, taxpayers have the right to appeal to the Revenue Tribunal under Section 116 of the Income Tax Act and the Revenue Tribunal Act of 2031.
Fines and Penalties
Taxpayers who fail to maintain the required documents as mandated by the Act or do not submit their returns will incur a penalty as specified under Section 117 of the Act. Additionally, taxpayers making installment payments who do not submit their due amounts on time will be subject to interest charges according to Section 118 of the Act. Furthermore, if taxes due under this Act are not paid on time, interest will accrue under Section 119. In cases where a taxpayer submits a tax return that indicates an underreporting of tax, a penalty will also be imposed in accordance with Section 120. These fines and penalties are consistent with the requirements for similar non-compliance issues outlined in the Income Tax Act.