Budget 2017: Taking 'complex' out of retail supply chain

Retail sector accounts for over 10% of country's gross domestic product (GDP) and around 8% of the employment. Big corporate houses and a number of transnational brands have also entered into the market to set up retail chains.

Besides brick and mortar stores, India's e-commerce market is also growing tremendously. The Business to Business (B2B) e-commerce market is expected to reach $700 billion by 2020 whereas the Business to Consumer (B2C) e-commerce market is expected to reach $102 billion by 2020.

The sector attracted $537.61 million foreign direct investment during April 2000–March 2016.

Given the influx of investments and ever complex supply chain, below are areas wherein Union Budget 2017 can address the industry's concerns and create an alignment with global and local regulations:

Recently, Base Erosion Profit Shifting (BEPS) action plans were introduced in the Budget 2016. The upcoming Budget is expected to introduce further action plans. Accordingly, it is expected for India to align itself with global tax practices not only under the BEPS initiative but also in line with the recently introduced initiatives like Goods and Services Tax (GST), Indian Accounting Standards (Ind As), Income Computation and Disclosure Standards (ICDS), etc.

Complexity of the entire value chain and intertwined functions performed leads to creation and exploitation of group intangibles such as brand names, trademarks, favourable supplier contracts, franchise agreements, etc, in light of which it becomes necessary to remunerate the stakeholders at an arm's length price. BEPS action plans 8 to 10 which aligns transfer pricing outcomes with value creation, is expected to be brought in the Budget along with clarification on operationalising the same.

Further, aforesaid complex structures often rests on the backbone of various centrally run administrative systems. These lead to overall group benefits, efficiencies, standardisation, etc. Accordingly, it becomes important to remunerate such central systems at arm's length (ideally at cost plus a mark-up 5% as suggested in BEPS action plans). So far, the government has not been aligned with this view. Thus, clarification on this would help many ongoing transfer pricing litigations and accordingly is expected to be brought in the Budget.

The retail sector often has parallel existence of both retail and e-tail stores, which have created many intertwined issues, such as data management, not always be able to identify actual point of sales, or sometimes even who the purchaser is. It is unclear at what point and to what extent these intertwined operations create local tax nexus and transfer price for any services availed, creation / use of intangibles, etc.

Clarity is also expected from the government on the taxability of various e-commerce model depending upon people / functions and intangibles such as server placement, cloud computing, user base, local office, etc, and preferred transfer price mechanism for determining the transaction value / attributable profit under these models.

The retail sector is heavily depended upon advertising, marketing and promotion (AMP) activities. Accordingly, to avoid long drawn litigations, and inspite of case laws being available, clarity is expected on the exact nature of AMP expenditure that would deem to constitute an international transaction, if at all.

Further, few points that the industry expects clarification from the upcoming Budget is in relation to:

Criteria that would differentiate between wholesaler and retailer for the purposes of claiming benefit of +1% or 3%; and

To extend the benefit under safe harbour rules to other industries including retail.

As one would expect, retail is a dynamic and fast growing industry, this tremendous growth has led to complex supply chain structures within the MNE groups as well as joint ventures with third parties. Transactions within such MNE groups would require adherence to arm's length principle as applicable in respective geography. At the same time, there is global realignment in tax regulations, with lot of work being done under BEPS project on inter-company pricing of related party transactions pertaining to creation and exploitation of intangible/IP, intragroup services, sourcing, etc, which are typically observed in the retail industry. In particular, fashion retail have seen creation and exploitation of valuable 'brands' as well as favourable supply contracts, which may lead to transfer/exploitation of valuable intangibles, remuneration of which may be challenged by tax authorities under the lens of newly propounded principles in BEPS.

Though India expressly defined intangibles under ambit of transfer pricing in Budget 2012, given the BEPS work on it and the approach therein forwarded by OECD, more clarity is expected in upcoming Budget 2017 on any differences that may be there between the two. The objective of such changes is to reduce litigation on this front thereby contributing to the objective of creating a tax friendly environment to be created in India.

The writer is director, Deloitte India
(Vishesh Agarwal, manager with Deloitte India also contributed to this column)