BACKGROUND
The finalisation of transfer price between an assessee and the Income-tax Authorities with respect to related party transactions could take several years. In the meantime, the related party transactions are priced on a provisional basis. This article deals with the accounting of the adjustments required when there is finality on the transfer pricing between the assessee and the Income-tax Authorities.
ISSUE
- An Indian subsidiary bills the parent and recognises revenue for services provided @ 10% margin;
- Three years later, the Income-tax Department settles transfer pricing @ 15% margin as per the Advance Pricing Agreement (APA);
- The parent contributes to the subsidiary the 5% difference for the past three years, let’s say, INR 100;
- Whether INR 100 is an equity contribution by the parent to the subsidiary in the books of the subsidiary under AS?
- What are the disclosures required in the financial statements of the subsidiary?
REFERENCES
Paragraph 11 Ind AS 32 – Financial Instruments: Presentation
An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Paragraph 51 Ind AS 115 – Revenue from Contracts with Customers
An amount of consideration can vary because of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties or other similar items. The promised consideration can also vary if an entity’s entitlement to the consideration is contingent on the occurrence or non-occurrence of a future event. For example, an amount of consideration would be variable if either a product was sold with a right of return or a fixed amount is promised as a performance bonus on achievement of a specified milestone.
Ind AS 12 Appendix C – Uncertainty over Income-tax treatments
4. This Appendix clarifies how to apply the recognition and measurement requirements in Ind AS 12 when there is uncertainty over income-tax treatments. In such a circumstance, an entity shall recognise and measure its current or deferred tax asset or liability applying the requirements in Ind AS 12 based on taxable profit (tax loss), tax bases, unused tax losses, unused tax credits and tax rates determined applying this Appendix.
Ind AS 115 – Revenue from Contracts with Customers
118 An entity shall provide an explanation of the significant changes in the contract asset and the contract liability balances during the reporting period. The explanation shall include qualitative and quantitative information. Examples of changes in the entity’s balances of contract assets and contract liabilities include any of the following:
(a) …….;
(b) cumulative catch-up adjustments to revenue that affect the corresponding contract asset or contract liability, including adjustments arising from a change in the measure of progress, a change in an estimate of the transaction price (including any changes in the assessment of whether an estimate of variable consideration is constrained) or a contract modification;
(c) ………………….;
(d) ………………….; and
(e) …………………….
119 An entity shall disclose information about its performance obligations in contracts with customers, including a description of all of the following:
(a) …………..;
(b) the significant payment terms (for example, when payment is typically due, whether the contract has a significant financing component, whether the consideration amount is variable and whether the estimate of variable consideration is typically constrained in accordance with paragraphs 56 – 58);
(c) ………………..;
(d) …………………; and
(e) ……………………
122 An entity shall explain qualitatively whether it is applying the practical expedient in paragraph 121 and whether any consideration from contracts with customers is not included in the transaction price and, therefore, not included in the information disclosed in accordance with paragraph 120. For example, an estimate of the transaction price would not include any estimated amounts of variable consideration that are constrained (see paragraphs 56 – 58).
126 An entity shall disclose information about the methods, inputs and assumptions used for all of the following:
(a) determining the transaction price, which includes, but is not limited to estimating variable consideration, adjusting the consideration for the effects of the time value of money and measuring non-cash consideration;
(b) assessing whether an estimate of variable consideration is constrained;
(c) allocating the transaction price, including estimating stand-alone selling prices of promised goods or services and allocating discounts and variable consideration to a specific part of the contract (if applicable); and
(d) ………………..
RESPONSE
The APA between the Indian subsidiary and the Income-tax Authorities will require the Indian subsidiary to raise an invoice for the amounts under-invoiced earlier. The Indian subsidiary will now have to bill the difference in margin of 5% to the parent entity, i.e., INR 100. The parent entity will have to remit this amount to the Indian subsidiary. If the parent does not remit this amount to the subsidiary, it would be treated as a deemed loan to the parent in the hands of the subsidiary, and the subsidiary will have to pay tax on deemed interest income.
As per paragraph 11 of Ind AS 32, an equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. They are, therefore, non-reciprocal in nature. In the fact pattern, the invoicing of the incremental 5% margin, INR 100, is not a non-reciprocal transfer. The parent is transferring INR 100 to the Indian subsidiary because it was under-invoiced in the past. In accordance with paragraph 51 of Ind AS 115, this would constitute variable consideration and the billing by the subsidiary to the parent company would be included in the current year revenue of the subsidiary as a cumulative catch-up adjustment. This will not constitute a prior-period error as there was no error in the given fact pattern. The earlier years invoicing was provisional and the final invoicing, once a conclusion was reached with the Income-tax Authorities, was based on the contractual arrangement between the parent and the subsidiary. The final billing of an additional INR 100 reflected the arrangement between the parent and the subsidiary as a supplier and a customer, rather than in the capacity as a shareholder.
Appendix C of Ind AS 12 – Uncertainty over Income-tax treatments applies when the uncertainty is with respect to income-tax treatment by Income-tax Authorities. From the perspective of the subsidiary, there is no uncertainty over income-tax treatments since it is fully compensated by the parent as per their agreement. However, there is uncertainty over variable consideration. Therefore, from a disclosure perspective in the financial statements of the subsidiary, the disclosure as required by paragraphs 118, 119, 122 and 126 of Ind AS 115 will be required.
