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Transfer Pricing in Nepal : Need to have comprehensive guidelines and Practice
Transfer pricing is a mechanism adopted in relation to transactions between two related entities, so as to minimize the overall tax liability of the group of companies of which the two entities are members. The existing provisions of the Inland Revenue Act are inadequate to apply the arm length principle that neutralizes the adverse effect of transfer pricing. It is therefore, proposed to incorporate in our tax statute a legal basis to enforce the arms length principle. It is expecting additional revenue of Rs. 300 millions by removing this loophole in our tax laws.
In 2004,Nepal has become the member of world trade organization which has brought major significance and changes in business in the country in global market. Although the concept of Transfer Pricing has been introduced in/with Income tax reforms and act 2002. But the drasting changes with inflow Foreign Direct Investment and foreign company in Nepal and some Nepalese companies also made an investment outside Nepal only after 2004 .Nowadays over 60 countries have adopted transfer pricing rules and over 60% of the international trade is carried out within Multinational entity.
There are about 400 to 500 foreign companies having associated with Nepali Business environment out of which about 282 to 285 are Indian company. Since there are huge business transactions and foreign companies in Nepal, Transfer Pricing concept is very necessary to have fair taxation practice in Nepal.
Earlier Seminar on “International Taxation & Transfer Pricing was also conducted by SAFA International for implementation of Transfer Pricing in Nepal. However there is still some confusion and unawareness regarding importance of implementation of Transfer Pricing in Nepal.
Importance of TP
Globalization and economic growth have driven the level of inter-company transactions to new heights. It is estimated that more than 2/3 of all business In particular, developing countries are observing immense growth in intra-group transactions due to the fact that their economies are still in the process of opening up and attract large amounts of FDI. transactions worldwide take place within groups. Therefore, TP is not only of importance to business but also for tax administrations, which have to implement or adapt their national TP legislation and practices accordingly. International consistency in TP is beneficial to creating a basic structure of taxable persons and events, which ensures proper application of the arm’s length principle. Further Transfer pricing helps to identify practical issues in business restructurings and manage risk of double taxation.
Provision of Transfer Pricing in Income Tax
As per section 33, In any arrangement between persons who are associates person, the department may, by notice in writing, distribute, apportion, or allocate amounts to be included or deducted in calculating income between the persons as is necessary to reflect the taxable income or tax payable that would have arisen for them if the arrangement had been conduction at arm’s length price.
In making any adjustment under subsection the department may re-characterize the source and type of any income, loss, amount, or payment; or Allocate costs, including head office expenses, incurred by one person in conduction a business that benefit an associate or associates in conducting a business to the associates based on the comparative uncovers of the businesses.
Associated persons means two or more persons or group of such persons where one may reasonably be expected to act in accordance with the intentions of the other Associated persons may act on as permanent Establishment and Subsidiary.
Provision on Tax Treaty
Contraction States may conduct the transfer pricing audit and the State in which profit was shifted has to recalculate the taxable income
Need To Have Comprehensive Manual/Guidelines
Seeing the business transaction with cross boarders transactions among associates enterprise by foreign company in Nepal, the tax authority has very limited tax provision and practice to identify the issue of transfer pricing cases in the country. Absence of catch in transfer pricing shall increase the Possibility of transfer pricing to shift profits in the contracting states where tax rates are lower.
To implement Transfer Pricing concept, the Tax Authority has to take appropriate step for coming up with comprehensive manual or guidelines and have to work on war stage without any delay. A compressive manual is required for implementation of Transfer Pricing specially containing:-
- Proper study of Nepali Business Market.
- Proper study regarding need of Transfer Pricing concept.
- Study of foreign investors in Nepal.
- Study on top 10 foreign companies for case studies with available data.
- Study of top 10 trading partners of the country.
- How to integrate transfer pricing into business and tax strategies
- How to perform the required transfer pricing analyses
- Selection and implement appropriate transfer pricing policies
- Study to know which evidence needs to be gathered
- Study to identify and manage transfer pricing risk
- Brief study of international market implementing Transfer Pricing.
- Proper Guidelines and policy regarding Transfer Pricing required
- Study regarding difficulties and challenges emerging from implementation Transfer Pricing.
Challenges of Transfer Pricing Practice through Authority.
Not Sufficient number of qualified officers and auditors who lacs accounting techniques or expertise; lack knowledge within the private sectors, lack of provision of advance price agreement, limited number of tax treaties between trading countries, lack of available sufficient data and information to calculate arms length price.
To mitigate these challenges, the department may have to come up with comprehensive guidelines on transfer pricing with capacity building program of the tax officers and tax professionals, establishment of data bank in existing transfer pricing materials and potential transfer pricing materials depending on the trading partners and investing countries and finally rasing an awareness among stakeholders.