The economic effects of social-distancing measures to contain the COVID -19 virus; along with plummeting consumer and business confidence, have delivered a sharp blow to near-term growth prospects and has slowed down the economy drastically. In a globally connected world, cross border movements of goods, services, people, intangibles and financial flows have been hit badly by the Covid1-9 outbreak. Businesses are looking at plans to survive and ensure their operations continue. 

 In the present distress timesthe global multinationals are chiefly concerned as to how a potential downturn may impact their tax and Transfer pricing (TP) policies. While it will be premature to estimate with certainty the full impact of an economic lockdown and disruption but, for survival it is necessaryto understand its implications and respond proactively. .This article focuses on some of the common TP controversy arising due to economic slowdown, a captive IT/ITES Company might face. 

The Indian economy’s phenomenal growth in the recent past has been primarily fuelled by the services sector, comprising mainly IT and BPO companies. Several captive IT & ITES companies are leaders in the contribution they make to the export revenues of the Indian Industry. 

Majority of the captive IT and BPO companies in India function as low or stripped risk service providers, with the major market, product, credit, capacity and other associated risks vesting with the parent or principal companies abroad. The captive subsidiaries generally maintain the dedicated workforce and infrastructure, through which seamless delivery of services is ensured. Since captive units work with limited risks and functions, they work on low but steady profit margins.But in the current scenario it doesn't seems possible to maintain the similar margins due to current crisis coupled with economic slowdown in last few quarters or even end up in negative margins. 

It is necessary and essential for the group to re-evaluate the functional profiles and margins across the value addition chain and analyze which part is ultimately bearing the risk associated with the decisions taken during the economic disruption. 

According to the IDC, growth in Global IT Spending is expected to reduce by 3-4% and at the same time it has provided an opportunity for IT vendors to become more resilient and innovative which is to be commercialized. IT vendors should look at offering incentives on the existing contract extensions. While some reports shows that renegotiation of existing contracts and pause on the new projects. 

Most of the Captive units operate on fixed mark-up model and the profit margin of the captive unit is a charge to its parent company which are subject to scrutiny of transfer pricing regulations. These regulations are intended to ensure that the profits taxable in India are not understated (losses are not overstated) by declaring lower receipts or higher outgoings then those which would have been declared by persons entering into similar transactions with the unrelated parties in the same manner or similar circumstances. The basic intention is to prevent the shifting out of profits by manipulating the prices charged or paid in an international transaction, thereby eroding the country's tax base[CBDT Circular No. 14 of 2001]. 

The TP provisions require to identify a tested party. The tested party will be the participant in the controlled transaction whose profitability/ pricing attributable to the controlled transaction can be verified on the most appropriate data and requiring fewest & most reasonable adjustments for which reliable data requiring uncontrolled comparable can be located. 

It is quite possible that tested party and comparable companies may react differently, and this could render the TP method unreliable. Benchmarking needs to be revised to include comparable companies that are closer to the tested party in terms of impact of economic downturn. This can be achieved by applying certain quantitative ratios and analysis and screening for relative sales growth.

A multiple-year approach may not be suitable for generating such closer comparable a year-by -year approach could better capture the economic impact due to changes in market. A range beyond inter quartile range should be permitted as a one off relaxation. 

Some of the MNE/group may find TP restructuring a viable option, but it is important to note that a TP remodeling may turn out to be a complex exercise; apart from identifying and setting-up a new model, it may require evaluation of the impact of discontinuation of the old model. MNE may need to relook at critical assumptions in their signed APA vis a vis the continuity of such assumptions in an economic slowdown.  as well as impaction APA negotiations which are under progress.  

On the benchmarking, the trend in last few years for the IT/ITES companies in India is in the range (Median) of 13% - 17%^[1] whereas in USA it is in the range of 2.1% - 4.4% and in case of EMEA 2.6% - 3.5%.In this context and keeping the current situation the MNE/Groups look alternative of AE being the tested the tested party rather Indian entity as tested party if the AE is having least complex entity. This is possible for the pure services and needs to be evaluated in detailed based on the fact pattern. 

The taxpayer can take a cue from the judgment of Delhi ITAT in the case reported in [(TS-12-ITAT-2009(DEL)]. Where the Tribunal held that the total adjustment made in the hands of the appellant together with the ALP already reported by it cannot exceed the total revenue earned by the appellant and its associated enterprise from third party independent clients. One can relate this case to the present economic situation and arrive the ALP of the Indian entity.

Similarly in the present scenario like existence of idle capacity, exceptional costs such as compensation of idle manpower, contract termination charges, might have to be incurred, excessive funds might have been blocked in working capital and the Indian entity might have to encounter all of this. The treatment and impact of such situations might pose a challenge for the taxpayerin determining their ALP. The taxpayer needs to look at cross charge the extraordinary cost or costs without any markup. It becomes imperative to have adequate contemporaneous documentation in place in order to substantiate the reasons for any dip in operating margins or having operating losses to avoid the TP litigation in future. 

Impact of COVID-19 will be long lasting one and staying within the realms of home, with only guess work being available, it’s hard to assess the overall impact and as to when things start getting back to normal. In these tough times of economic turmoil, one cannot anticipate actions of the Tax Authorities. Tax authorities have enhanced access to taxpayer information. Effective planning may go a long way in minimizing unnecessary TP litigation. 

There have been several economic measures announced, by the government of India to address challenges faced by taxpayers amidst this crisis and it would be equally important to see what changes policymakers recommend in tax / transfer pricing legislations to help companies navigate the transfer pricing challenges during the current crisis.

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^[1]Without adjustment