international and domestic transfer pricing final
TRANSCRIPT
Overview of Transfer
Pricing
1
Agenda
Key Triggers and Audit Experience
Computation Of Arm’s Length Price- Methods
Concept of Transfer Pricing and related definitions
Transfer Pricing – An introduction
Overview of Indian Transfer Pricing Regulations –
International & Specified Domestic Transactions
Documentation Requirements
Safe Harbour Provisions
Advance Pricing Agreement (APA)
Companies Act 2013
Significant Global development - BEPS
2
Transfer Pricing – An
introduction
3
Why Transfer Pricing?
Parent Co. Germany
35% tax on Rs. 10
Cost - Rs.120
Sub Co. India
Sale price - Rs. 190
33.99% tax on Rs.20
Sub Co. Dubai
Zero tax on Rs. 40
Tax Haven
Sale price Rs.130
To ensure fair share of tax revenue for various jurisdictions
To prevent shifting out of profits by manipulating prices
4
Overview of Indian
Transfer Pricing
Regulations
5
Overview of Indian Transfer Pricing Regulations
Legislation introduced with effect from April 1, 2001.
Generally in line with the Organisation of Economic Co-operation and Development
(‘OECD’) guidelines
Compliance Requirements
Steep Penalties – can be upto 3 times the tax sought to be evaded
Downward adjustment prohibited
Arithmetic mean concept – industry specific relief granted to the Arm’s Length Principle
(‘ALP’)
Safe harbor provisions
Provisions for Advance Pricing Agreements (APA) and Cost Sharing Arrangements
Mandatory annual maintenance of contemporaneous documentation
Annual filing of Accountant’s Report (Form 3CEB)
Stringent revenue audits & Alternative Dispute Resolution Mechanism
6
Statutory Regulations in India
Provision Section / Rules Reference
Computation of Income from international transaction
having regard to Arms Length Price Section 92
Associated Enterprises (‘AE’) Section 92A
International Transactions Section 92B
Specified Domestic Transactions (introduced by Finance
Act, 2012)Section 92BA
Power of Assessing Officer (‘AO’) and Transfer Pricing
Officer (‘TPO’)Section 92C / Section 92CA
Power of Board to make safe harbour rules Section 92CB
Advance Pricing agreement (APA)Section 92CC / Section 92CD/ Form
3CED
7
Statutory Regulations in India
Provision Section / Rules Reference
Reference to Dispute Resolution Mechanism Section 144C
Documentation Requirements Section 92D / Rule 10D
Accountant’s ReportSection 92E / Rule 10E and Form
3CEB
Penalties
Section 271 (1) (c), Section
271AA, Section 271BA and
Section 271G
Definition Section 92F / Rule 10A
8
Penalties – Sec 271A / Sec 271AA
Default Penalty
In case of a post-inquiry
adjustment, there is deemed
to be a concealment of
income
100-300% of tax on the
adjusted amount
Failure to report a
transaction
2% of the value of each
international transaction
Failure to maintain
documents
2% of the value of each
international transaction
Failure to furnish documents2% of the value of each
international transaction
Failure to furnish
accountant’s reportINR 100,000
Maintenance of contemporaneous and robust documentation is the key to avoid penalties
9
Audit Process
TP Audit
File tax return and Accountant’s Report (30th November)
Reference to be made to TPO by the
AO; Compulsory Reference to be made by AO
if international transactions exceed INR 150 million
for AY 2005-06 onwards (Internal guidelines)
Appeal can be made against
the order of AO as order of
TPO included within the
order of the AO
Notice to be issued by the TPO – TPO calls for supporting
documents and evidence
Rectification application can be
made against the order of TPO
for apparent mistakes
Based on results of above mentioned procedure
assessing officer passes the order
Appeal Procedure
Appeal to Commissioner ofIncome Tax (Appeal)
Passes an order
Income Tax Appellate Tribunal
High Court – only on matters related to law
Supreme Court
Constitutional Bench
Dispute Resolution Panel
(‘DRP’) Mechanism-
Finance Act 2009
10
Recent trends in India TP audit environment
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
Value in USD Millions
Estimated TP Adjustments in US$ Million Indian Transfer Pricing
“Facts” and “Stats”
Every Company with intercompany transactions
> $3 million will be audited, annually
If a Company has faced an adjustment of > $2
million during prior years, will be audited again
next year
More than 70% of Companies that were audited
have received an adjustment order
At least 50% of the disputed taxes are payable
upfront (unless stay granted by Tax Authorities),
even before an appeal is filed
Over 1,000 Taxpayers received an adjustment
order in 2013
Total value of adjustments in 2014 (for tax year
2009-10) was close to $10 billion
11
India TP Litigation – A time taking process
Transfer Pricing
audit
1st Appeal
DRP/Commissioner
Appeals
2nd Appeal
Appellate Tribunal
3rd Appeal
High Court
Final Appeal
Supreme Court
Level of Authority/Court
3 – 4 years from date of filing return
Often repetitive additions
9 months to 3 years
2 – 3 years
5 years
5 years
Only substantial
questions of law
Final authority
on factual
issues
Domestic Process Timeline 15+ years
62%
11%
10%
17%
In favor of
taxpayer
In favor of
Revenue
Partly in
favor of
revenue and
taxpayer
Remanded
back for fresh
adjudication
Analysis of 1,230 cases in ITAT
12
Concept of Transfer
Pricing and related
definitions
13
Transfer Pricing Regulations- Concept
Any income arising from an international transaction shall be computed having regard to the arm’s
length price.
Further it is clarified that the allowance for any expense or interest arising from an international
transaction shall also be determined having regard to the arm’s length price.
A price between unrelated parties is known as the “arm’s length price”
Transfer Pricing refers to the pricing of international transactions or specified domestic transaction*
between two associated enterprises
* Inserted by Finance Act 2012 Transfer Pricing
International Transactions
Associated Enterprise
Specified Domestic Transaction
Sec 92 shall not apply in a case where the computation of income
has the effect of reducing the income chargeable to tax or
increasing the loss.
Arm’s Length Price
14
A
C
B
Both A and B are
associated enterprises
of C
D and E are also associated
enterprises of C since they have a
common ultimate parent (A)
A
C
B E
D
Outside India
In India
Outside India
In India
Direct or indirect participation (through
one or more intermediaries) in
management, control or capital* – Sec
92A(1)
* Shares carrying not less than twenty
six per cent of the voting power.
Associated Enterprises
The above section is further supplemented by 13 clauses
which enlist various situations under which two enterprises shall be
deemed to be AE’s – Sec 92A(2)
15
Deemed
Associated
Enterprises
Common executive director(s)
Loans in excess of 51% of total assets
Guarantees in excess of 10% of total borrowings
Relationships of mutual interest
Complete dependence on IPRs
Existence of common control
Supply of raw materials (90% or more)
Power to appoint more than half of directors
Deemed Associated Enterprises
16
International Transaction – Section 92B of Income Tax Act, 1961 (‘the Act’)
Transaction between two or more associated
enterprises, either or both of whom are non-
residents
In the nature of -
• Purchase, sale or lease of tangible or
intangible property, or
• Provision of services, or
• Lending or borrowing money, or
• Capital financing
• Business restructuring or reorganization
• Any other transaction having a bearing
on the profits, income, losses or assets
of such enterprises,
• Any mutual agreement or arrangement
on allocation or apportionment or any
contribution of cost or expenses
Parent
CompanyNon resident
Subsidiary
companyResident
Singapore
India
10
0%
Su
pp
ly o
f
Go
od
s/s
erv
ice
s
Parent
CompanyNon resident
Subsidiary
companyResident
Singapore
India
10
0%
Third partyNon resident
Supply of
Goods/services
17
Deemed International Transaction – Sec 92B(2) of the Act
B
Agreement on the terms & conditions decided by A
Outside India
Transaction between B and C are also subject to transfer pricing norms irrespective of the
fact that the transaction is between two residents of India, if:
• a prior agreement exists between A and C; or
• terms of transaction between B and C are determined in substance by A.
Third Party transactions deemed to be international transaction - Sec 92B(2)
C- 3rd Party
Prior agreement/
Global contract
India
A
100% holding
18
Introduction to Specified Domestic Transactions (SDT)
TP was earlier limited to “International Transactions‟
The Finance Act 2012, extends the scope of applicability of TP provision to “Specified
Domestic Transactions‟ between related parties with effect from 1 April 2012
The SC in the case of CIT vs Glaxo Smithkline Asia Pvt Ltd [2010-195Taxman 35 (SC)]
recommended introduction of domestic TP provisions .The SC suggested that certain
provisions such as Sections 40A(2) and Section 80IA(10) of the Act, would need to be
amended empowering the AO to make adjustments to the income by adopting generally
accepted methods of determining the ALP, including the methods provided under TP
Regulations
It was intended to provide objectivity in determining the reasonableness of expenditure
and income eligible for tax holiday
Obligation now on taxpayer to report/ document and substantiate the arm’s length nature
of such transactions
Shift from generic FMV concept to focused ALP concept
19
Specified Domestic Transactions
Any expenditure in respect of which payment has been made or to be made to a specified
person [section 40A(2)(b)];
Any transaction referred to in section 80A;
Any transfer of goods or services referred to in sub-section (8) of section 80-IA;
Any business transacted between the taxpayer and other person as referred to in sub-
section (10) of section 80-IA;
Any transaction, referred to in any other section under Chapter VI-A or section 10AA, to
which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable; or
Any other transaction as may be prescribed
Applicability
Applicable where aggregate amount of exceeds INR 5 crores (approximately USD 1
million) in a year.
Applicable from Financial Year (FY) 2012-13 onwards
20
Who are the specified persons - Section 40A(2)(b)
Section 40A(2)(b) - list of persons/ entities to be treated as related parties/ specified persons
Specified persons having substantial interest ( i.e. more than 20% voting power or share in
profits) in taxpayer’s business and vice-versa covered
Scope expanded to include sisters concerns
Illustrative, list of entities/ persons that may be included for a corporate taxpayer (not an
exhaustive list):
a) those holding 20% or more equity in the tax payer;
b) those companies in which the tax payer holds 20% or more equity;
c) Directors of tax payer company, and relatives of such Directors;
d) Directors of companies in category (a) above; and relatives of such Directors;
e) If an individual holds 20% or more equity in the tax payer, then relatives of such an individual; all
other companies where such individual is a Director; all other Directors of such a company, and
relatives of all such Directors; etc
21
International transaction vs SDT
Case Study 1:
Case Study 2:
► Remuneration is paid to NRI Director covered u/s 40A(2).
► Director is not an AE in terms of Sec 92A. Remuneration paid to NRI director
would be SDT as its not an International Transaction.
► F Co, a foreign company holds 21% in I Co, an Indian company. I Co makes
payment for services to F Co.
► I Co and F Co are not AE’s as threshold of 26% of voting power u/s 92A(2)(a)
is not met.
► However payment by I Co to F Co is covered by Sec 40A(2)(b)(iv) – SDT is
applicable.
I Co NRI DirectorsPayment of remuneration
F Co
21% Share Holding
I Co
Payment for services
22
Section 40A(2)(b) – Expenditure transactions
Transactions (illustrative only)
Expenditure on buying goods
Expenditure on procurement of services
Expenditure on interest payments
Expenditure on salary, training services,
marketing expenses
Transactions (illustrative only)
Expenditure on purchase of tangible and
intangible property
Group charges
Reimbursements
Guarantee fees
Refers to ‘expenditure’ incurred for payments made or to be made
Does not refer to any ‘income’
Expenditure by one group entity is income for another group entity - arms length analysis will
consider both transacting parties
Only the entity incurring the expense will need to complete the prescribed compliances.
It is clarified in the guidance note issued by ICAI on report under section 92E of the Income
Tax Act, 1961 that the provisions of SDT are also applicable to expenditure which are capital
in nature and fully claimed as deduction under other provisions (eg. Section 35(2AB), 35 or
35AD)
23
Undertakings to which profit linked deductions are provided - Section 80A
and 80-IA
Tax holiday unit Other unit
Sub-section (8) of section 80-IA (and similar such provisions in Chapter VI –A)
Inter unit transfers (goods and services etc.)
Other person
having close
connection
Tax holiday
company
Business transacted (wider than transfer of goods or
services)
Sub-section (10) of section 80-IA (and similar such provisions in Chapter VI –A)
Not corresponding to market value (adherence to ALP proposed)
Appropriate allocation keys to be used to allocate costs and overheads for computation of tax holiday
Revenue will challenge use of ad-hoc allocation keys
More than ordinary profits earned by business unit claiming deduction (adherence to ALP proposed)
Corresponding provisions to the above would be covered in Chapter VI-A and Section 10AA
Transactions to be reported in Accountant’s Report and their arms’ length nature to be substantiated
in the TP Report
24
Eligible business covered
Section Tax payers covered Deduction
10AA Persons with income from
SEZ units
100% for the first 5 years
50% for the next 5 years
50% of the profits or amount credited to SEZ re-investment
reserve, whichever is less for next 5 years
80-IA Infrastructure developers 100% for a period of 10/15 years out of 15/20 years, as the
case maybe from the date of commencement of operation
80-IA Telecommunication service
providers
100% for a period of 5 years
30% for the next 5 years
out of 15 years from the date of commencement of operations
80-IA Developers of Industrial park 100% for a period of 10 years out of 15 years from the date of
commencement of operations
80-IA Producers or distributors of
power
100% for a period of 10 years out of 15 years from the date of
commencement of operations
80-IAB Developers of SEZ 100% for a period of 10 years out of 15 years from the date of
commencement of operations
80-IB Small scale industry engaged
in operating Cold storage plant
30% of profits for the first 10 years
80-IB Industrial undertaking in
Industrially backward state as
mentioned in VIII Schedule
(ex: Jammu and Kashmir )
100% of profits for 5 years and
30% for the next 5 years
80-IB Multiplex theaters and
convention centre
50% for the first 5 years
25
Eligible business covered …Cont’d
Section Tax payers covered Deduction
80-IB Company carrying on
scientific research and
development
100% of profits for first 10 years
80-IB Eligible housing projects 100% of profits from such business
80-IB Eligible hospitals 100% of profits for first 5 years
80-IC/
80-IE
Persons with units in North-
eastern states claiming
deduction
100% for a period of first 10 years
80-ID Hotels located in districts
having World Heritage site
100% of profits for first 5 years of commencement of
business
26
SDT- Case study
Particulars Mannur Uttaranchal
(Location Tax holiday)
Oragadum
(SEZ)
1990 2007 2009
Turnover 345 Crores 220 Crores 475 Crores
Product
Manufactured
Fuel Injection Pumps –
Rotary Technology
Fuel Injection Pumps –
Rotary Technology
(Sells only to Tata Motors
Limited)
Fuel Injection Pumps
– Common Rail
Technology
No of People 2600 (Approx) 600 (Approx) 1300 (Approx)
Tax Holiday Claim Sec 10B
( a minor unit )
Sec 80IC Sec 10B
Eligible Unit Benefit under Sec 10B
has not been claimed
Yes Benefit under Sec
10B claimed
Tax Holiday Period NA 2007-2017 NA
► ABC Ltd is engaged in the business of manufacturing of Diesel Fuel Injection Equipments
for Cars.
► The company’s plants are located in Mannur (Tamilnadu), Oragadam (Tamilnadu) and
Uttranchal (Uttarkhand) and has order based manufacturing and selling of goods.
27
SDT Issues
S.No Transactions Section covered
1 Transfer of goods between Mannur & Oragadum (AE) Sec 40A(2)
2 Inter unit transfer of semi finished goods & bought out goods Sec 80IC(7)
3 Common Management & Employee Cost between Mannur &
Uttaranchal
Sec 80IC(7)
4 Allocation of common cost between Mannur & Uttaranchal Sec 80IC(7)
Issues :
► Basis of transfer of semi finished goods & bought out items
► Uttaranchal unit (eligible for tax holiday from 2007-2017) cannot take credit of the ED
paid and hence the ED is added to the cost of goods sold
► Common cost allocation
Implications under SDT
28
Computation of arm’s
length price- Methods
29
Computation of Arm’s Length Price – Section 92C of the Act
Prescribed Methods
Traditional Transaction
MethodTransactional Profit
Method
Determination of ALP using one of the Prescribed methods -
Best suited to the facts and circumstances of each particular international transaction and
Provides the most reliable measure of an arm’s length price in relation to the international
transaction shall be “Most Appropriate Method”
Where more than one ALP is determined, the arithmetic mean of such prices is taken to be the ALP
PSM MethodCPM MethodRPM MethodCUP Method TNMM Method
No hierarchy or preference of methods prescribed under the Act
Finance Act 2012 inserted the sixth method as such other method as may be prescribed
by the Board
30
Most Appropriate Method – Rule 10C of Income Tax Rules,
1962 (‘the Rules’)
Factors considered for selection of the Most Appropriate
Method:
Nature and class of international transaction
Class of associated enterprise and functions performed
Availability, coverage and reliability of data
Degree of comparability between the International
transaction
Extent to which reliable and accurate adjustments can be
made
The nature, extent and reliability of assumptions for
application of the method
31
Comparable Uncontrolled Price Method (CUP)
Most Direct Method for testing ALP and the Prices are
Benchmarked
Requires strict comparability in products, contractual
terms, economic terms, etc.
Two types of CUPs available - Internal CUP & External
CUP
Calls for adjustments to be made for differences which
could materially affect the price in the open market e.g.:
• Difference in volume/quality of product
• Difference in credit terms
• Risks assumed
• Geographic market
OECD - Priority to Internal CUP over External CUP due to
higher degree of comparability
Sub Co.
Parent Co.
Tra
nsfe
r Pric
e
Unrelated Co. X
Outside India
India
Unrelated Co. Y
Unrelated Co. Z
Exte
rna
l CU
P
Outside India
India
32
Resale Price Method (RPM)
Compares the resale gross margin earned by
associated enterprise with the resale gross
margin earned by comparable independent
distributors
Preferred method for a distributor buying
purely finished goods from a group company
(if no CUP available)
To be applied when a goods purchased or
service obtained from an AE is resold to an
unrelated enterprise.
Under this method comparability is less
dependent on strict product comparability
and additional emphasis is on similarity of
functions performed & risks assumed
Sub Co.
Parent Co.
Transfer Price
INR 75
Unrelated Co. Y
Resale Price
INR 100
Outside India
India
Price paid by Sub Co. to AE is at arm’s length if the 25% resale margin earned by Sub
Co. is more than margins earned by similar Indian distributors`
33
Cost Plus Method (CPM)
Compares and identifies the mark up earned on
direct and indirect costs incurred with that of
comparable independent companies
Preferred method in case
• Semi finished goods sold between related
parties
• Contract/toll manufacturing agreement
• Long term buy/supply arrangements
To be applied in cases involving manufacture,
assembly or production of tangible products or
services that are sold/provided to AEs
Comparability under this method is not as much
dependent on close physical similarity between
the products.
Larger emphasis on functional comparability
Sub Co.
Parent Co.
Co. Y / AE
Outside India
India
Co. Z
Price charged by Sub co to AE is at arm’s length if the 25% mark up on
cost is more than that of similar Indian assemblers
Transfer Price
INR 125
CO
GS
INR
70
34
Profit Split Method (PSM)
To be applied in cases involving transfer of unique
intangibles or in multiple international transactions
that cannot be evaluated separately
Calculates the combined operating profit resulting
from an inter-company transaction based on the
relative value of each AEs contribution to the
operating profit
Evaluates allocation of combined profit/loss in
controlled integrated transactions
The contribution made by each party is based upon
a functional analysis and valued, if possible, using
external comparable data
The two methods discussed by OECD Guidelines:
• Contribution PSM Analysis
• Residual PSM Analysis
US Co A –
Technology
intangibles
Mfg. Co B
Mkt Co C
Marketing
intangibles
Outside India
India
35
Transactional Net Margin Method (TNMM)
Examines net operating profit from transactions as
a percentage of a certain base (can use different
bases i.e. costs, turnover, etc) in respect of similar
parties
Ideally, operating margin should be compared to
operating margin earned by same enterprise on
uncontrolled transaction – Internal TNMM
Most frequently used method in India, due to lack
of availability of comparable uncontrolled prices
and gross margin data required for application of
the comparable uncontrolled price method / cost
plus method / resale price method
Broad level of product comparability and high level
of functional comparability
Applicable for any type of transaction and often
used to supplement analysis under other methods
The application of the TNMM to a specific tested
party breaks down when factors other than transfer
prices have a material impact upon profits
Parent A Unrelated Cos.
Subsidiary B
Net margin 5%
Unrelated Cos.
Net margin 3%
Outside India
India
36
Transactional Net Margin Method
Grouping of transaction - Relevant controlled transactions require to be aggregated to
test whether the controlled transaction earn a reasonable margin as compared to
uncontrolled transaction
Selection of tested party - Least complex entity
Selection of Profit Level Indicator such as Operating Margin, Return on Value added
expenses, Return on assets – Unaffected by transfer price
Benchmarking exercise
• Entity with similar industry classification to the tested party – through search in
Prowess and Capitaline plus databases
• Review financial and textual information available in the public database of the
selected entities – for qualitative filters
• Computation of ALP
37
Summary of Methods
MethodsProduct
Comparability
Functional
ComparabilityApproach Remarks
CUP Very High MediumPrices are
benchmarked
Very difficult to apply as very
high degree of comparability
required
RPM High MediumGPM (on sales)
benchmarked
Difficult to apply as high
degree of comparability
required
CPLM High HighGPM (on costs)
benchmarked
Difficult to apply as high
degree of comparability
required
PSM Medium Very High Profit MarginsComplex Method, sparingly
used
TNMM Medium Very High Net Profit MarginsMost commonly used
Method
Other
Method
Based on the price which has been charged or paid, or would have been charged or paid, for
the same or similar uncontrolled transaction, considering all the relevant facts.
38
Computation of ALP in case of SDT - Case study
► XYZ Ltd is engaged in the business of Transaction Processing and Customer Care. It acts as a
Registrar & Transfer agent (RTA) to Mutual funds, Service Partner to Private Equity funds,
Private Insurance companies and Portfolio Managers.
► XYZ Ltd is a Joint Venture company with three shareholders:
► DEF Group – 30%: comprising of a Bank, a Mutual Fund, Insurance and Mortgage
companies.
► LMN International – 29%: A Global Private Equity Firm with a specialty in the Financial
Sector.
► ABC Software India Pvt. Ltd - 40%: A software house into Financial and Mutual Fund
practice. 80% of its business is provided to XYZ Ltd
► XYZ has 2 subsidiaries:
► XYZ Repository Services Limited is 57% subsidiary of XYZ Ltd and serves all the service
requirements of Life Insurance and Non- Life Insurance Policy Holders.
► XYZ Investor Services Private Limited – 100% subsidiary of XYZ Ltd. It is engaged in
providing all services pertaining to KYC compliances.
39
Computation of ALP in case of SDT - Case study …Cond’t
Domestic transactions of XYZ Ltd
Transactions Entity Sec covered
Payment of License Fees ABC Software India Pvt Ltd 40A(2)
Payment of Manpower
Deputation Fees
ABC Software India Pvt Ltd 40A(2)
Directors Commission & Sitting Fees ABC Software India Pvt Ltd 40A(2)
40
Approach for selecting most appropriate method
ABC Software Pvt Ltd Perspective:
► Primary Analysis – CUP
► External CUP - billing rates charged for similar services in uncontrolled transactions from
various sources in public domain like offshoretimes.com, NASSCOM, kpoexperts.com etc
► Internal CUP - Quotes obtained by XYZ Ltd from third parties for similar services.
► Secondary Analysis – TNMM
Adjustments - Rental adjustment
ABC Software India Pvt Ltd does not incur any cost towards rental expenditure, whereas the
comparable companies incur rental of facility cost.
XYZ Ltd Perspective - TNMM
Aggregated approach has been followed for the following transactions:
► Payment for software license fees,
► Payment for on-site man power service,
► Directors commission and
► Sitting fees
41
Documentation
Requirements
42
Transfer Pricing Documentation – Sec 92D / Rule 10D
Profile of industry
Profile of group
Profile of Indian entity
Profile of associated
enterprises
Transaction terms
Functional analysis (functions,
assets and risks)
Economic analysis (method
selection, comparable
benchmarking)
Forecasts, budgets, estimates
Agreements
Invoices
Pricing related
correspondence (letters,
emails etc)
Entity related Price related Transaction related
Contemporaneous documentation requirement – Rule 10D
Documentation to be retained for 9 years
No specific documentation requirement if the value of international transactions is less than one crorerupees.
Penalty for non maintenance and non furnishing of documentation – 4% of the value of internationaltransaction
43
Transfer Pricing Documentation – Sec 92D / Rule 10D
Pre-project planning
Functional analysis -Information gathering
Comparable data / Industry Analysis
Economic Analysis
Issuance of TP Documentation
Preparation
of project
plan
Interviews
Questionnaires
Discussions with
Management
Characterisation
of each entity
Agreement
reviews
Search strategy
Access to local
& global
database
Analysis of
internal
comparables
Judicious
identification of
arm’s length
range
Understand
existing
costing
mechanism
Determination
of billing
methodology
Consultation with
management
Finalization of
Transfer pricing
documentation
44
Country by Country Reporting (‘CbC’) - A new phase to documentation
Three-tier documentation structure proposed for all countries
Master file to provide the MNE’s blueprint i.e.
• The group’s organizational structure
• A description of the group's business, intangibles, intercompany financial activities, and
financial and tax positions
Local file to provide material transfer pricing positions of the local entity/ taxpayer with its foreign
affiliates
• Demonstrates arm’s length nature of transactions
• Contains the comparable analysis.
Country by Country (‘CbC’) Report to provide
• Jurisdiction-wise information on global allocation of income, taxes paid / accrued, the stated
capital, accumulated earnings, number of employees and tangible assets.
• Entity-wise details of main business activities which will portray the value chain of inter-
company transactions.
45
Country by Country Report- Template (1/2)
46
Country by Country Report- Template (2/2)
47
Key Triggers and
Audit Experience
48
Key Triggers and Contributors for Transfer Pricing Audits
Contributors to Aggressive Audits:
Mounting fiscal demand on Government
Need to Preserve tax base
Constant competitive pressure to restructure
business operations efficiently
Unprecedented sharing of information
between revenue authorities
Key Triggers for Aggressive Audits
Consistent losses / low margins of the assessee
attributable to inter-company transactions
Significant changes in profitability of the assessee
and its Associated Enterprises
High Royalty / Technical fee payouts, Cost
recharges,
Management Fees, Cost allocations. ’
Net losses incurred by routine distributors
Low mark-ups for services
Application of Ratio’s such as ROCE / Berry ratio /
cash profit instead of net margins
Significant Advertisement and marketing spends by
manufacturing / distribution companies.
Use of foreign comparables
Substantial increase in transfer pricing audits and disputes across the Globe ,
India is no exception….
49
Documentary evidence / analysis to substantiate
Royalty:
• Copies of license agreement
• Benefits received / receivable by the tax payer and
quantification of the benefit
• Unique nature of the intangible, market where it is
used and strategic advantage achieved
• Rights of the taxpayer to receive upgrades .
• Comparative profits before and after the use of
intangible.
• Whether there are any geographic restrictions such
as to export based on the licensed technology
• Details of patents / intangibles registered by taxpayer
in India
• Quote of a comparable independent technology
recipient for the intangible.
• Rates at which the royalty is paid for use of similar
intangibles by any other concern / subsidiary of the
AE / Group.
Issues relating to Royalty pay-outs:
Royalty is widely adopted appropriate mechanism tocompensate for use of manufacturing intangible
Benchmarking Issues:
• Aggregation approach under TNMM –
Challenged and general lack of availability of
comparables
• Transaction specific approach has been
adopted by revenue – examine the
‘cost – benefit ‘ analysis
• Non acceptance of Foreign Comparables /
Databases
Possible Solutions on Valuation:
• Market approach – Value based on current
purchase / sale of such intangible
• Income approach – Calculating the present
value of future benefits
• Cost approach – Replacement cost of
similar intangible
Is Royalty Payment justified in case of
loss situation?
Royalty Pay-outs
50
Issues relating to management fee payouts
Justification of the following aspects:
• Was there service received from Group
• Why not from third party
• Would there be same payment if rendered
by third party
• Services rendered by group are not in the
nature of stewardship, duplicative services
• Services in nature of back-office like
accounting / payroll etc., being questioned
that while others are off-shoring to India
why taxpayer has to receive such service
from Group
Challenge: Inadequate comparable data in
the public domain
Documentary evidence to substantiate
management fees
• Business reports
• Training manuals
• Marketing brochures
• Time sheets / logs
• Copies of emails
• Minutes of meeting confirming receipt of
services
• HR Schemes
• IT network / e-mail systems
Payment justified for services not in the nature of shareholding services, duplicative
services and passive association benefits.
Management Fees
51
Strategic Planning
◘ Business Reports / Plans
◘ Trainings
◘ E-mails
◘ Telecon-notes
◘ Corporate Governance initiatives
Information Technology Support
◘ IT Security Policy and Manual;
◘ Details of trainings received;
◘ E-mail system
◘ Intranet
◘ Servers including Remote Servers
Accounting and Finance
◘ Accounting system
◘ Accounting manual
◘ Business Reporting system
◘ Trainings
Human Resources
◘ HR Manuals
◘ Appraisal and Evaluation
◘ Welfare Schemes
◘ Trainings
Supply chain Management (‘SCM’)
◘ SCM Manual and Policies
◘ Write-up on inventory management
◘ Daily distribution plan
◘ Demand forecasting and production scheduling
Sales and Marketing
◘ Details of any marketing strategic inputs
◘ Details of sales converted due to marketing
assistance
◘ Brand and Sales Promotion Material
◘ Trainings
Documentation requirement specific to certain services
Management Services – Illustrative Model Documentation
52
Marketing Intangibles (Advertisement, Marketing and Promotion – AMP
expenses)
Issue involved / Approach of the Revenue
A assessee spends significant amount on AMP expense benefitting the AE by creating
marketing intangibles without corresponding compensation/ reimbursement to the assessee.
Revenue authorities compare expense to sales ratio of assessee with other comparables –
disallows AMP expense in excess of “bright-line” as TP adjustment alleging contribution by
taxpayer is towards strengthening AE owned brands.
Expectation of mark-up on recovery of AMP expense in excess of bright line. The average
AMP expenses incurred by companies in the industry is considered as Bright Line for the
purpose of Transfer Pricing analysis.
ExcessAssumed to be incurred for
strengthening brand name
of foreign AE
Indian licensee:
Must be reimbursed along
with suitable profit mark-up
AMP spend by
Indian licensee
Arm’s length
licensee
expenditure
(-)
Bright line
Bright line method adopted
by relying on US Tax
court case in DHL
53
LG Electronics : Special Bench decision to deal
with legal issues not factual issues
Indian company, engaged in manufacturing of
Electronic goods in India , is a subsidiary of a
Foreign Company
Indian Company incurs AMP expenses for
marketing the goods produced in India
Indian company has incurred AMP expenses
which exceeds the Bright Line limit
Excess AMP expenses incurred by the Indian
Company is perceived to enhance the brand
value of Foreign Company
Indian tax authorities have contended that AMP
expenditure incurred by a taxpayer at a level that
exceeds the “bright line” is to be reimbursed by
the foreign AE with a mark-up
Brand
Creation /
Marketing
Intangible
Indian Company
Foreign Company
Excessive
AMP
Expenses
Owner of
Brand
In India
Outside
India
Judicial Precedent
• Incurring of AMP expenses by the assessee towards brand legally owned by the foreign AE
constituted a 'transaction' subject to TP provisions;
• Upholds use of Bright Line Test for determining cost / value of such transactions:
• Under IT Act, it is legal ownership of brand that is recognized - Special Bench Majority View
• Matter on the quantification set aside to re-look at comparables and appropriate cost base
54
Determination of cost/value of international transaction through AMP
expenses- Important Factors
Whether the Indian AE is simply a distributor or is holding a manufacturing license from its
foreign AE?
Whether the goods sold by India AE bear the same brand name or logo which is that of its
foreign AE?
Payment of royalty to foreign AE for usage of brand/logo of foreign AEs
Whether the payment made as royalty is comparable with domestic entities?
Whether foreign AE is compensating the Indian entity for the promotion of its brand in any
form, such as subsidy on the goods sold to the Indian AE?
Whether the year under consideration is the entry level of the foreign AE in India or is it a
case of established brand in India?
How the brand will be dealt with after the termination of agreement between AEs.?
55
Share Valuation- HC judgment in case of Vodafone
Facts
The assessee (Vodafone India) was a wholly owned
subsidiary of a Mauritian Entity- Vodafone Tele- Services
(India) Holding Ltd. (‘the Holding Company’)
Vodafone India issued few equity shares having face value
Rs. 10 at a premium of Rs. 8591 per share to its holding
company.
The Transfer Pricing Officer (TPO) determined ALP of shares
at Rs. 1555.30 Crores as against price charged by Vodafone
of Rs. 246.38 Crores.
Before the AO, Vodafone argued that provisions of Chapter X
were not applicable to impugned transaction since there was
no bearing on income
Foreign
Holding Co.
Indian Wholly
Owned
Subsidiary
In India
Outside India
Issue of shares
of Rs. 10 each
at a premium of
Rs. 8591 per
share
56
Share Valuation- HC judgment in case of Vodafone …Cont’d
Assessee’s contentions:
The prerequisite, for application of Section 92(1) of the Act (applicable in present case) was
that income should arise from an International Transaction. However, he submitted that there
was no income arising from issue of equity shares.
The word 'Income' has not been separately defined for the purpose of Chapter X of the Act.
Thus, it had to be understood as defined by other provisions of the Act such as Section 2(24)
of the Act.
Chapter X of the Act was not designed to bring to tax all sums involved in a transaction, which
were otherwise not taxable.
No tax can be charged on potential income which tantamount to guess work or assumption or
conjecture in the absence of any such income arising
Explanation (i)(c) and (e) to Section 92B would only have application if such capital financing
or restructuring/ reorganizing impacts income. He thus argued that such a contingency did not
arise as there was no impact on Income which would be chargeable to tax.
57
Share Valuation- HC judgment in case of Vodafone …Cont’d
Revenue’s contentions:
Issue of shares by the assessee to its holding company, resulted in financial benefits to its holding
company. A conjoint reading of Sec 92(1) with Sec 92(2) would indicate that what was brought to
tax under Chapter X of the Act was not share premium but was the cost incurred by the assessee
in passing on a benefit to its holding company by issue of shares at a premium less than ALP.
Under Chapter X of the Act, real income concept had no application, otherwise the words used
therein would have been 'actual Income’.
The word 'Income' for purposes of Chapter X of the Act was to be given a widest meaning to be
deemed to be income arising, for the purposes of total income in Section 5 of the Act.
Held:
HC held that share issue at premium did not give rise to 'income' to trigger TP provisions.
HC upheld assessee’s contentions and ruled that the transaction on capital account or on account
of restructuring would become taxable to the extent it impacted income i.e. under reporting of
interest or over reporting of interest paid or claiming of depreciation etc.
HC held “the entire exercise of charging to tax the amounts allegedly not received as share
premium fails, as no tax is being charged on the amount received as share premium. Chapter X is
invoked to ensure that the transaction is charged to tax only on working out the income after
arriving at the ALP of the transaction”
58
Detailed FAR analysis
Taxpayer Associated Enterprises Comparables
Proactive Planning
Agreements / contracts should exist for transactions between Associated Enterprises
Price setting mechanisms to be documented
Localization of Global Transfer Pricing policies
Documentation should completely describe search methodology, basis for inclusion / exclusion of comparables, etc.
Substantiate business, economic and commercial rationale
Maintain detailed cost-benefit analysis with respect to cross charges
Strategizing and providing appropriate information during an audit
Key Points for success in Transfer Pricing audits in India
59
Safe Harbour
Provisions
60
In order to reduce number of transfer pricing audits and prolonged disputes, the Safe Harbour
Legislation was introduced in India by the Finance (No.2) Act, 2009 with retrospective effect from
1 April 2009.
A new section i.e. Section 92CB was inserted in the Act.
“Safe Harbour” is defined to mean circumstances in which the income-tax authorities shall accept
the transfer price declared by the Assessee.
Central Board of Direct Taxes (‘CBDT’) issued the final safe harbour rules on 18 September 2013.
The Safe Harbour announced for various sectors to be valid for a period of 5 years commencing
from Assessment Year (‘AY’) 2013-14 i.e. AY 2013-14 till AY 2017-18 or for a lesser period at the
option of the taxpayer.
Non-permissibility of comparability adjustments.
Specified domestic transactions not covered within the ambit of Safe Harbour Rules
Range of +/-3% not allowed
Safe Harbour provisions- Overview
61
Intercompany Transaction Value of Intercompany
Transaction
Safe Harbour
Software Development or Back-
office support Services
• Upto INR 500 Cr
• Exceeds INR 500 Cr
• 20% or higher
• 22% or higher
ITES being knowledge processes
outsourcing services
• No monetary limit • 25% or higher
Contract R&D services • No monetary limit • 30% or higher
Intra-group loan to wholly owned
subsidiary
• Upto INR 50 Cr
• Exceeds INR 50 Cr
• SBI base rate plus 150
bps
• SBI base rate plus 300
bps
Corporate guarantee • Does not exceed INR 100
Cr
• Exceeds INR 100 Cr and
the credit rating of the AE is
of the adequate to highest
safety
• Commission rate not
less than 2% p.a. on the
amount guaranteed
• Commission rate not
less than 1.75% p.a. on
the amount guaranteed
Safe Harbour – Various sectors, ceilings and circumstances
62
Safe Harbour – Various sectors, ceilings and circumstances (continued)
Intercompany Transaction Value of Intercompany
Transaction
Safe Harbour
Contract R&D services, with
insignificant risks, wholly or partly
relating to generic pharmaceutical
drugs
• No monetary limit • Operating profit margin to
operating expense ≥ 29
percent
Manufacture and export of core or
non-core auto components (where
90 percent or more of total
turnover relates to Original
Equipment Manufacturer sales)
• core auto components
• non-core auto components
Operating profit margin to
operating expense:
• ≥ 12 percent
• ≥ 8.5 percent
63
Advance Pricing
Agreement (APA)
64
Indian APA Program – Key Features
Indian APA Program announced in August 2012
Provides certainty for 5 tax years
Anonymous filing option
More cooperative
approach, as compared to desk audit
Significant cost saving (internal
and external resources)
Bilateral option would
mitigate double tax
Possibility of Roll-back (i.e. include open
tax years)
65
Indian APA Program – Advantages
• No transfer pricing audits and adjustments for five years.
Certainty
• Pre-filing application and meeting can be anonymous
Anonymous
• Can decide not to pursue an APA if it does not like the results
Non-committal
• Taxpayer does not have to pay any filing fee for pre-filing application
No Filing Fee
• Pre-filing application is simple - does not require significant time commitment form tax payers team
Simple
• May spend only a small portion of total APA budget for pre-filing
Cost Efficient
• The APA Team provides open and honest feedback based on facts presented during pre-filing meeting
Open Feedback
• Can evaluate the APA environment without significant investment of time and money
Evaluate APA Approach
Primary Advantages Secondary Advantages
66
Indian APA Program – Experience so far
Indian Revenue received 378 applications filed
during the second phase of APA applications.
About 90 percent of the pre-filings were
converted to actual APA applications
5 APAs concluded by the Indian Government as
on 31st March 2014
Primary focus of APA teams is to reach
consensus on Function Asset Risk (FAR)
analysis for which site visits are planned
The APA entered into has binding effect on both
the assessee and the Income-tax authorities.
The Indian APA authorities in the process of
arriving at the most appropriate method, are
willing to consider methods beyond the six
specified methods as per the Indian transfer
pricing law and are conducive in providing
certainty and unanimity of approach
The agreements have been signed at
three levels:
i. The competent Authorities of India
and Japan
ii. CBDT and the Japanese company
iii. Japanese tax authority and the
group company in Japan.
67
Sector-wise APAs filed*
Manufacturing Services
* Estimates based on various
sources
Discussions on the various APA cases happening in
Bangalore, Delhi and Mumbai
Some cases are discussed at specific locations based on
specific activities. For e.g. the IT/ ITES activities will be
primarily done by APA team in Bangalore
The initial focus is on the Functions Assets and Risks
(‘FAR’) analysis to which the APA team is paying attention
in great details
Site visits by the APA teams in progress. To date the visits
have been scheduled in consultation with the taxpayers
and have been conducted in a cordial and un-intrusive
manner.
Based on the FAR analysis, the economic analysis will be
done followed by rounds of discussions and negotiations
Indian APA Program – Experience so far
68
Introduction of APA “Rollback”
“Rollback” - Application of
negotiated position under
an executed APA to prior
years
Proposal to introduce
rollback to maximum 4
previous years
Conditions, procedure and
manner of rollback to be
prescribed
Applicable w.e.f. October 1,
2014
APA
(For 5 Future Years)
APA Rollback
(For 4 Previous Years*)
FY 2015-16
FY 2016-17
FY 2017-18
FY 2018-19
FY 2019-20
FY 2011-12
FY 2012-13
FY 2013-14
FY 2014-15
69
Companies Act , 2013
Related Party
Transactions – Interplay
with Transfer Pricing
70
Comparison of Income Tax Act, 1961 vis-à-vis Companies Act, 2013
Concept of related party transactions and determination of arm’s length price exist under the Income
Tax Act, 1961 (Transfer Pricing laws)
However, analysis of domestic related party transaction for Income-tax purposes may not suffice the
obligations cast under the Companies Act, 2013 due to several differences between the provisions of
Income Tax Act, 1961 and the Companies Act, 2013 as summarized below:
Income Tax Act, 1961 (Domestic
Transactions)
Companies Act, 2013 / SEBI norms
Related parties include:
• Direct Holding company
• Direct subsidiary
• Sister subsidiary – i.e. a company where
there is a common direct parent
Related parties include holding
companies, subsidiaries, associates, JVs
etc taking into consideration direct and
indirect holdings.
Much broader in scope.
Applies only to the expense side of the
transaction (except tax holiday units)
Covers expenses and income vis-à-vis
related party dealings
Only equity stake considered for computing
the 20% threshold for related parties
Equity and convertible preference stake to
be considered for computing the 20%
threshold under Companies Act, 2013
Concept of Arm’s length price Concept of Arm’s length basis
Imperative for Companies to document and provide reasonable justification to demonstrate arm’s
length nature of all related party transactions
Wide coverage
of related
parties and
transactions
under
Companies
Act, 2013 /
SEBI norms
71
Significant Global
Development
72
OECD Base Erosion and Profit Shifting (‘BEPS’) Action Plan – In a nutshell
A group of twenty- ‘G20’ countries realized the need of preventing
BESP and approached OECD to address the issue related to
BEPS.
On 19 July 2013 the OECD released an Action Plan on Base
Erosion and Profit Shifting (BEPS) which was presented to the
meeting of G20 Finance Ministers in Moscow.
The purpose of the Action Plan is “to prevent double non-taxation,
as well as cases of no or low taxation associated with practices that
artificially segregate taxable income from activities that generate it.”
The report indicates that “no or low taxation is not per se a cause for
concern, but it becomes so when it is associated with practices that
artificially segregate taxable income from the activities that generate
it.”
The Action Plan covers 15 specific Actions which are broadly to be
achieved within a two year time frame (i.e. by the end of 2015).
September / October / November 2014, OECD released various
recommendations for 9 out of 15 Action Points.
The
coherence of
corporate tax
at the
international
level
Transparency, coupled
with certainty and
predictability
Realignment of
taxation and
substance
15 Actions organized around
three main pillars
73
Release of 7 recommendations as action points from OECD
Addressing the tax challenges of the digital economy
Neutralizing effects of hybrid mismatch arrangements
Preventing the granting of treaty benefits in inappropriate circumstances
Developing a Multilateral Instrument to Modify Bilateral Tax Treaties
Countering harmful tax practices more effectively, taking into account transparency and substance
Transfer Pricing aspects of intangibles
Transfer Pricing Documentation and country-by-country reporting
Action-1
Action-2
Action-6
Action-15
Action-5
Action-8
Action-13
74
Way Forward
Tax and Morality debate: Here to stay
BEPS – Game changer for the Revenue and the Taxpayers
Domestic anti-abuse tax legislations being adopted globally
Substance and Transparency – part of life
Corporate Tax Rates may be reducing, but the base is
increasing
Companies to not only adhere to compliance regulations but also review their operating
structures in various jurisdictions, as countries are expected to incorporate the BEPS action
points in their local regulations
75
Q&A
&Questions
Answers
