By Ramaly Rahuman, Semi Senior Tax Consultant, Numerix (Pvt) Ltd, Sri Lanka
Sri Lanka’s Inland Revenue Department introduced a new regulation on 20 July, effective from fiscal year 2020–21, outlining requirements for country-by-country reporting, the master file, and local file.
Transfer pricing regulations were introduced into Sri Lanka income tax legislation in April 2006. The regulations rely on the arm’s length standard as the guiding principle for transactions between associated undertakings. At the time of introduction, the transfer pricing regulations created compliance difficulties for companies and regulatory challenges for the revenue authorities.
The Sri Lankan tax system is currently regulated by the Inland Revenue Act, No. 24 of 2017. The Inland Revenue Department is the primary agent for collecting taxes and dealing with issues arising with taxes on behalf of the government. The Commissioner General of Inland Revenue has the ultimate power to issue regulations on tax matters.
Transfer pricing assessments and penalties
For transfer pricing purposes, income, gains, profits, and losses of persons having transactions with associated enterprises should be ascertained considering arm’s length price. Associated enterprises are persons who participate in the control, capital or management of other persons. For transactions that are not at arm’s length, the Inland Revenue of Sri Lanka has the power to disallow expenses or add notional income.
The Inland Revenue Department follows an internal procedure in raising assessments for transfer pricing. First, a preliminary order will be raised by an assistant commissioner, which will be followed by an interim order or final order by the technical review committee if the assistant commissioner is unable to resolve and settle the issue. If the technical review committee also fails to provide a solution, the dispute resolution panel will give a final order to the issue.
There are penalties specified by policymakers in relation to transfer pricing. Companies will have to pay 1% of the aggregate value of transactions with associated enterprises if they don’t maintain documentation properly. A penalty not exceeding USD 1,250 will be imposed if the required documents are not submitted. If there is not sufficient information in the disclosure, 2% of the aggregate value of transactions with associated enterprises will be charged. If a company fails to submit required documents on a specific date, a penalty not exceeding USD 500 will be charged. Incorporation of false or misleading information to evade taxes will result in the imposition of a penalty of 200% of the value of additional tax.
Key elements of the transfer pricing regulations
Under the transfer pricing regulations, covered transactions include all international transactions and domestic transactions. In relation to domestic transactions, the regulations apply to transactions between two associated enterprises that are not international transactions where one of the associated enterprises is exempt from tax, the tax rate applicable to the associated enterprises are different, or either one or both the associated enterprises is/are entitled to deduct tax losses.
There are some generally accepted methods to calculate transfer prices. Direct price comparison includes the comparable uncontrolled price method. Margin comparison methods include the cost plus methods, resale price methods and transaction margin method. Through allocation of profits methods, the profits split method can be used.
The Inland Revenue Department requests that the transfer pricing disclosure form be filed along with the income tax return for each year of assessment. If the aggregate value of the transactions exceeds USD 1 million, the complete disclosure should include information on the transaction in column 1, the associated enterprises in column 2, the transfer pricing method in column 3, and the arm’s length price in column 4. If the aggregate value of the transactions is less than USD 1 million, columns 1 and 2 would be sufficient.
Insights in the latest regulation
The country-by-country reporting regulations apply to those groups whose consolidated group revenue for the preceding financial year exceeds EUR 750 million (USD 888 million). The master file regulations apply if the group revenue exceeds EUR 50 million (USD 59 million). Local file requirements apply for the aggregate value of transactions with associated entities exceed USD 1 million and for categories of transactions that exceed USD 1 million.
The master file requires an internationally operative group of the company to deliver a brief explanation of the business structure, important drivers of business profit, important service arrangements, important geographic markets of the group and other information. A general description of intangibles, including location of principal research and development (R&D) facilities and their management should also be included. In addition, intercompany financial activities that reveal the financing arrangements within the group and the general transfer pricing policies adopted in relation to financing within the associated companies should be included.
The country-by-country report requires aggregate tax jurisdiction-wide information relating to the global allocation of income, taxes paid, and certain indicators of the location of economic activity among tax jurisdictions in which the multinational group operates. The report should include a listing of all the financial information for the tax jurisdiction of incorporation, if different from the tax jurisdiction of residence, and the main business activity carried out. The country-by-country report will be an ultimate source for the commissioners for transfer pricing risk assessment purposes.
A local file includes a description of the management structure of the local entity, an organizational chart, and a detailed analysis of the individuals to whom local management reports and the countries in which such individuals maintain their principal offices. Details of the most appropriate transfer pricing method and the reason for adopting such a method will also be included in a local file.
The OECD has recommended that Sri Lanka consider signing the Multilateral Competent Authority Agreement and Qualifying Competent Authority Agreement to ensure the confidentiality of the information that has been automatically exchanged through these international agreements.
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