presentation - ms. karishma phatarphekar - pharmaceuticals and manufacturing - 22 march 2014
DESCRIPTION
transfer pricingTRANSCRIPT
Pharma and Manufacturing
Industry – Overview and Recent
Updates
Karishma R. Phatarphekar
Partner,
Global Transfer Pricing Services
KPMG India
The Chamber of Tax Consultants
TP study course
22nd March 2014
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Business
restructuring and
exit charges
Location
advantages
More audits,
disputes and
litigation
Increasing onus on
taxpayer
Scope of rules
expanding
More and more
complex regulation
Aggressive practices
by tax authorities
Dissatisfaction with
profit based
methods
Transfer Pricing – A proliferation in recent times....
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Indian TP environment
TP Adjustment scenario at present
“Indian Revenue authorities are reckoned to be tough
globally in TP matters, with India accounting for about 70%
of all global TP disputes by volume”
(Source: Financial Express newspaper 16 July 2012)
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Pharmaceutical industry - Areas of discussion..
1 Pharmaceutical Industry - Overview
Types of International Transactions
• Import of APIs
• Payment of Commission
• Clinical Trail Support Services
• Marketing Intangibles
• Contract R&D
• Royalty Payouts
• Location Savings
2
Other Pharma TP Issues 3
Comparison of Relevant Decisions 4
Key Takeaways
Way Forward 6
5
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Pharmaceutical Industry - Overview
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KPMG International Cooperative (“KPMG International”), a Swiss entity.
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Pharmaceutical Industry - Overview
5
Typical FAR of Pharma Industry
Functions Assets Risks
– Research & Development
– Procurement
– Manufacturing – Primary &
Secondary
– Inventory Management
– Quality control
– Advertising / Marketing
– Sales
– Ordering and distribution
– Invoicing and collection
– Administrative, Financial and
Legal Matters
- Tangible Assets
(e.g Building, Plant &
Machinery, etc.)
- Intangible Assets
: Technical (Know-how)
: Marketing (Brand name)
– Market risk
– Product liability risk
– Inventory risk
– Technology risk
– Research and development
risk
– Credit risk
– Foreign exchange risk
– Manpower risk
– General business risk
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Pharmaceutical Industry - Overview
CUP
• Purchase of API’s
• Sale of API’s
• Import / Export of Formulations
• Royalty for use of technology and
trademark
TNMM
• Manufacture of Formulations
• Contract R&D Services
• Clinical Trail Services
• Marketing and Promotion Services
• Contract Manufacturing Services
RPM • Distribution of API/Formulation
Transfer Pricing Methods
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Import of Active Pharmaceutical Ingredients (APIs)
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Pharmaceutical Industry – International Transactions
Entities Involved Functions / Risks
Overseas AE - Manufacturing and
marketing of API
- Product liability, R&D
Risk
- Processing of API
- Sale of Formulations
- Market, credit, inventory
and forex risk
Outside India
India
Indian AE
Primary
manufacturing
of APIs
Secondary
manufacturing
of FDFs
Import of Actives
Import of Active Pharmaceutical Ingredients
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9
Pharmaceutical Industry – International Transactions
Issues
Documentation
Suggestions
• Comparability with generic API’s;
• Secret Comparables using power u/s 133(6);
• CUP analysis for import of actives / formulations. (using
CIMS data) – geographic differences, quality and grade of
APIs ignored
• Selection of right comparables;
• Carry out analysis on Customs database;
• Exclusion of companies from different geographies;
• Difference in Selling Price, Pharmacopeia;
• Re-iteration of high profits under TNMM, if applicable;
• Analysis of the customs data / relevant industry
publications.
Import of Active Pharmaceutical Ingredients
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Pharmaceutical Industry – International Transactions
• Whether the patents for the products have
expired
• Independent reports on differentiation in quality
• Selling price and market share analysis
• Evaluate internal CUPs if any upfront
• Quantify other adjustments – R&D, quality and
other support
• Comparison of the transfer price over the past 5
years – whether increased or decreased
• Understand the policy of the group to price the
API's whether standard cost plus
Imports is generally a high value item and therefore the
department is eyeing this closely so need to be extremely
proactive and detailed
• Meeting with markets team to understand
other competitors similar products and their
procurement strategy
• Whether any licensing agreement executed
earlier
• Why TNMM is the most appropriate method –
make aggregation rationale more conclusive
• Request for quality reports, data and
information on generic comparables proposed
to be utilized by the TPO very strongly and
explicitly
Analysis for APIs where external CUP not favourable
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Payment of Commission
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Pharmaceutical Industry – International Transactions
Payment of Commission
Entities Involved Functions
Overseas AE
- Marketing outside
India of products
manufactured by
Indian AE -
canvasser
- Manufacturing of
formulations
- Distribution of products in
and outside India directly
to the customer
Payment of
Commission
Outside India
India
Indian AE
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Pharmaceutical Industry – International Transactions
Payment of Commission
Issues
Documentary
Suggestions
• Evaluation of commission transaction separately required
as the same is not closely connected to other transactions;
• If no direct documentary evidence to demonstrate, services
rendered could be disallowed;
• Commission percentage more than 3-5% scrutinized;
• Documentary evidences like copy of agreement, marketing
material, letters from overseas AE, CA Certificate / Bank
Realization Certificates, etc. should be maintained;
• Demonstrate tangible benefits;
• Demonstrate that marketing in India is routine and not non-
routine
Documentary evidence very crucial
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Clinical Trial Support Services
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Pharmaceutical Industry – International Transactions
Clinical Trial Support Services
Entities Involved Functions / Risks
Overseas AE - Manufacturing
- Marketing
- Primary R&D
including clinical
trials
- Co-ordinates with
hospital and CROs
- payment to hospitals /
CROs
Outside India
India
Indian AE
Clinical trail
services
Hospitals /
CROs
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Pharmaceutical Industry – International Transactions
Clinical Trial Support Services
Issues
Documentary
Suggestions
• High mark up comparables selected by TPO without carrying
out appropriate FAR as to whether Indian AE does actual
clinical trials or only acts as coordinator;
• Difficulties arise in identifying appropriate comparable
companies
• Charges mark-up even on pass through cost
• Role may vary from mere facilitation/co-ordination v/s
responsibility for the completion of the trials;
• Risk associated with failure of product development primarily
assumed by AE;
• Service being procured from a third party – pass through
cost;
• Demonstrate pass through cost is pure reimbursement
Demonstrate the functional dissimilarity of comparables
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Marketing Intangibles
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Pharmaceutical Industry – International Transactions
Marketing Intangibles
Trade Intangibles
Marketing Intangibles
• Trade intangibles are all commercial intangibles (other than
marketing intangibles)
• Created through R&D activities and expenditure that the
developer seeks to recover over the life of the IP
• Include patents, know-how, designs, and models that are used for
the production of a good or provision of a service, as well as
intangible rights that are themselves business assets transferred
to customers or used in the operation of a business
• These are typically created through marketing activities or
developed over time through customer relationships (goodwill)
• Include trademarks and trade names that aid in the commercial
exploitation of a product or service, customer lists, distribution
channels, and unique names, symbols, or pictures that have a
promotional value for the product concerned
V/s
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Pharmaceutical Industry – International Transactions
Marketing Intangibles
Issues
Documentary
Suggestions
• Determining the ALP
• More than 1 party contribute to the IP – what should be the arms
length share of each party
• Advertisement, Marketing and Promotion expenses (AMP)
construed as marketing intangible
• Indian distributor, even if not the “legal owner”, held to be the local
“developer” of trademark and hence should not pay royalty and /
or recover the AMP
• TPO’s adopt cost plus mark-up assuming more than normal AMP
to be reimbursed at mark-up of 10-15%
• Well drafted agreements and documenting business strategy;
• Demonstrate the tangible benefits and economic substance;
• Demonstrate that marketing in India is routine and not towards
promoting the brand;
• Policy to recover non routine expenditure as reimbursement
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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
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Judicial Precedent
BMW India Pvt. Ltd.- Delhi Tribunal
The Delhi Tribunal observed that:
BMW India though not a licensed manufacturer is fully responsible for sales promotion, full utilization of market
potential, providing customer service and for establishment of efficient distribution network and therefore the
functions far exceed the functions performed by a routine distributor.
The ITAT held that it was necessary for the assessee as a distributor to incur expenditure on sales promotion
and advertising but rejected assessees stand that incurring AMP expenditure is not an international
transaction by relying on LG’s ruling.
The ITAT observed that when the margins earned by the assessee were compared to those earned by the
comparables, it could be concluded that the assessee was sufficiently compensated for excess AMP
expenditure in terms of high profit margin,
The ITAT further observed that rewarding a distributor by way of price adjustment is well recognized and
well accepted remuneration model and that the department cannot insist in the absence of any
provision under the Act that the mode of compensation to the assessee by the foreign AE necessarily
be in the form of direct compensation.
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Casio India Co. Pvt Ltd – Delhi Tribunal The Indian co. is a wholly owned subsidiary of Casio
Japan. The Indian company is a full fledged distributor of
watches and consumer information and other related
products in India.
The TPO made an adjustment for excess AMP expense
relying on SB ruling in case of LG.
The CIT(A) deleted the addition holding that AMP
expense have been incurred as part of its distribution
function and the benefit accruing to the AE was only
incidental.
The revenue was in appeal before the ITAT. While the
assessee relied on ruling in case of BMW, since it was a
distributor and the margins earned by the company
higher than that of comparables.
However the ITAT in this case, held that SB ruling in LG
not only applies to a manufacturer, but also extends to a
distributor whether he is bearing full risk or least risk.
ITAT thus set aside CIT(A) order and restored the matter
to the AO/TPO to decide afresh in conformity with LG SB
ruling
Indian Company
Indian co.
Consumer
Outside
India
India
Judicial Precedent
Import of Goods
Distribution
Almost similar facts to BMW but set aside for deciding the matter afresh
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Contract R&D
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Pharmaceutical Industry – International Transactions
Contract R&D
Issues
• High mark up comparables selected by TPO without carrying out
appropriate FAR as to whether Indian AE does actual R&D
activities or only acts as facilitator;
• Indian R&D Centre considered to be the economic Owner of IP -
use of high cost plus mark ups or profit split method
• TPO’s allege that majority of valuable & Unique IP are generated
due to work undertaken in India
• Prone to high litigation due to lack of clarity – prone to subjective
interpretation;
Documentary
Suggestions
• Robust FAR to justify captive R&D activities
• Primary onus on taxpayer to demonstrate remuneration on cost
plus mark-up
• Reliance can be placed on clarification by CBDT vide Circular
No.06 /2013 dated 29th June, 2013 stating 3 broad categories
based on FAR i.e. Entrepreneurial, Contract R&D and Cost-
sharing arrangements
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Guidelines for
identifying the
characterization
of R&D Centre
Parameters
Funding/ Assets
Risk Profile
Outcome of Research
Foreign Entity
Performs Economically Significant Functions
Economically significant functions’ to include critical functions such as
conceptualization and design of the product and providing strategic direction and
framework
Provides funds/ capital Significant assets & intangibles
Strategic decisions for Core Functions & Monitoring on regular
basis
Economically Significant Risks
Legal & economic owner of resultant IP
Indian Entity
Performs work assigned by foreign entity
Receives remuneration for the services
performed
Operates under direct supervision and actual
control
No Economically Significant realised Risks
No ownership of resultant IP
Functions
Supervision & Control
Entrepreneurial R&D Contract R&D Cost Sharing Arrangements of R&D
Favo
ura
ble
An
aly
sis
Unfavourable Analysis
Contract Research
Services
Note: In the case of a foreign principal being located in a country/ territory widely perceived as a low or no tax jurisdiction, it
will be presumed that the foreign principal is not controlling the risk. However, the Indian Development Centre may rebut
this presumption to the satisfaction of the revenue authorities.
Pharmaceutical Industry – International Transactions
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Royalty payouts
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Charging a royalty or licensing fee within a MNE for the use of valuable
know-how, technology processes, trade names, or other intangible property,
have faced stringent tax scrutiny in pharma industry.
Tax authorities are challenging the royalty rate, comparables and arm’s
length price as determined by the taxpayer.
Historically India has been a technology importing country.
With the advent of MNCs, royalties were increasingly viewed as cash
repatriation tools – tax shield on royalty payments plus credit of withholding
tax in receiving country.
Pharmaceutical Industry – International Transactions
Royalty Payouts
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Pharmaceutical Industry – International Transactions
Royalty Payouts
Issues
Documentary
Suggestions
• Satisfy ‘Benefits test’, justify royalty in a loss situation
• Need to establish direct correlation with sales/ profitability
• Whether royalty is embedded in price paid
• Approvals received by RBI not acceptable as external CUP
• Aggregation approach under TNMM – Challenged and general lack
of availability of comparables.
• Transaction specific approach has been adopted by revenue –
Outright rejection of rationale for payment. ALP held to be NIL.
• Non acceptance of foreign comparable / databases.
• Tangible/Strategic benefits received and quantification
• Demonstrate dependence of business on the intangibles
• License agreement, quotations of comparable independent recipient
• Uniqueness of intangible, market where it is used, rights of taxpayer
to receive upgrades
• geographic restrictions - export based on the licensed technology.
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Various payment models
Normal Royalty streams Percentage on sales or profit, per unit royalty, lump sum payment etc.
Package Pricing Amount included in transfer price of goods, no separate royalty payment.
Industrial franchise arrangements Franchise fee paid by licensee to licensor for entire business format including
production process, marketing strategies, etc.
Others Separate royalty fees for trademark / trade name and technology.
Pharmaceutical Industry – International Transactions
Royalty Payouts
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EKL Appliances Ltd. – Delhi High Court (2012)
(ITA Nos. 1068/2011 & ITA Nos. 1070/2011)]
Taxpayer engaged in the business of manufacturing and trading of refrigerators, washing
machines etc.
For FYs 2001-02 and 2002-03 the TPO disallowed the transaction of payment of royalty to
AE, whereas accepting all other international transactions to be at arm’s length.
Revenue’s Allegations
Taxpayer has been incurring losses year after year. Royalty payments did not result in profits from operations
Increase in turnover did not result in any profit to the taxpayer.
The continuous losses incurred showed that the taxpayer did not benefit in any way from the royalty payment. Thus payment of royalty to the AE is not justified.
Taxpayer’s arguments
The allowance of royalty depends on the utility of the brand name and the technical knowhow in respect of which the payment is made and not on the profitability of the paying entity.
Royalty payment is a legitimate expenditure and non-payment of the same would have had serious implications for the taxpayer’s business.
There were profits at the gross level and the losses at the net level were due to significant increases in the operating expenses.
Due to availability of the brand name there was substantial increase in the turnover otherwise there would have been more losses.
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EKL Appliances Ltd. continued
CIT(A) Ruling
It was imperative for the taxpayer to upgrade its technology due to market dynamics.
There were profits at the gross level and the losses at the net level were due to increase in
operating costs. The losses show significant reduction after technical up gradation.
The TPO disregarded the business and commercial realities of the business of the
taxpayer and acted in a mechanical manner ignoring the economic circumstances
surrounding the transaction. TPO cannot question the judgment of the taxpayer as to how it
should conduct its business.
Royalty payment was incurred for genuine business purposes and should have been
allowed even if the taxpayer had suffered continuous losses in the business.
Tribunal Ruling
Tribunal agreed with CIT(A) that the royalty payment was justified and the TPO was wrong
in disallowing the same.
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EKL Appliances Ltd. continued
High court ruling
It is not for the Revenue authorities to dictate to the taxpayer as to how he should conduct his
business and what expenditure should be incurred.
It is not necessary for the taxpayer to show that any legitimate expenditure incurred by him
was also incurred out of necessity or
that the expenditure incurred by him for the purpose of business has actually resulted in profit
or income.
Taxpayer only needs to show that the expenditure should have been incurred “wholly and
exclusively” for the purpose of business.
Whether or not to enter into the transaction is for the taxpayer to decide. Quantum of expenditure
can be examined by the TPO but he has no authority to disallow the expenditure on the ground
that the taxpayer has suffered continuous losses.
High Court also relied on the OECD Guidelines - Tax administrations should not disregard and
restructure the transactions as actually undertaken by the taxpayer except
where the economic substance of a transaction differs from its form; and
where the form and substance of the transaction are the same but arrangements made in
relation to the transaction, differ from those which would have been adopted by independent
enterprises behaving in a commercially rational manner.
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Location Savings
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Pharmaceutical Industry – International Transactions
Location Savings - Meaning
OECD
Location Savings (LS) derived by an MNE group that relocates
activities to a place where costs are lower than in location where
activities were initially performed
UN
General Parlance
LS are net costs savings that an MNE realizes as a result of relocation
of operations from a high cost jurisdiction to a low-cost jurisdiction
Net ‘Cost savings’ realized by an MNC as a result of relocating
manufacturing functions / production / operation sites from a ‘high
cost’ to ‘low cost’ jurisdiction to obtain competitive advantage
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Pharmaceutical Industry – International Transactions
Location Savings
Typical cost savings include savings pertaining to:
• Labour costs;
• Raw material costs;
• Rent and property taxes;
• Training costs
• Infrastructure costs and
• Incentives including tax exemptions
Most low cost locations are in the ‘Developing World’ (e.g.- India, China,
Malaysia etc.)
Location savings = Input cost in a high cost region – Input cost in a low cost region
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Pharmaceutical Industry – International Transactions
Location Savings
Issues
Documentary
Suggestions
• Quantification and allocation of “location savings”
• Attribution i.e. who is the rightful owner of additional profits from
location savings, the parent company or the overseas subsidiary
(‘AE’) or both
• Existence and allocation of “location savings” depends upon the
bargaining power of the parties
• Bargaining Power highly subjective - depends upon factors like
economic or beneficial ownership, uniqueness and monopoly power
• Benchmark industry cost structure changes rapidly due to shift of
manufacturing activity to low cost locations
• Approaches to allocation of location savings :
- Facts and circumstances based approach
- Indirect approach considering location dis-savings
• LS advantage passed onto end customers to survive stiff
competition
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Pharmaceutical Industry – International Transactions
Location Savings – Recent Case Law
GAP Intl Sourcing
(India) Pvt. Ltd
• Location savings is reflected in the profitability earned by
comparables
• News Paper report cannot partake the character of
comparable data
• Location savings arise to industry as a whole
• LS advantage could be passed to end-customers to survive
stiff competition
GAP International Sourcing has rejected the applicability of “Location Savings” to the
particular case in a competitive situation (where the location advantages are passed onto
customers), however, it has not rejected the concept of “Location Savings”.
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Other Pharma TP Issues
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Pharmaceutical Industry – Other Pharma TP issues
Other Issues
Product Analysis vis-à-vis basket of products approach
• Most Enterprises in Pharma Industry use basket of product approach for TP
analysis and benchmarking using TNMM
• Product portfolio is a mix of established products and the products with future
potential
• Parent companies invest significant time and resources to generate new product
lines
• General Industry trend to promote complete mixture of products across different
therapeutic segments
• Tax authorities ignore the business rationale to aggregate the transactions and
require each international transaction to be benchmarked separately.
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Pharmaceutical Industry – Other Pharma TP issues
Other Issues
Drugs Prices Control Order (DPCO)
• In India, end consumer prices of several drugs are governed by DPCO
• Price control under the DPCO may cause product margins of pharmaceutical
companies to come under pressure
• Where the pricing of raw material inputs procured from AE’s is sought to be
reviewed by the application of profit based transfer pricing methods, the
identification of comparable companies entails challenges
• Ignoring the effect of DPCO on pricing of drugs, tax authorities have been
attributing the lower profits /losses to poor transfer pricing policies of the
taxpayers.
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Pharmaceutical Industry – Other Pharma TP issues
Other Issues
Distribution – start-up losses
TP Documentation to take into account the following :
• Loss analysis stating demonstrating factors triggering losses i.e. unfavourable
business decision, external / extraordinary causes,
• Variance analysis between budgeted and actual figures with regards prices and
volumes
• Countermeasures taken to cope with the loss situation
• Documentary evidence in defending losses stating not only profits of the taxpayer
but overall profitability (including other related parties in the supply chain of the
business decreased
• Consider applying for Mutual Agreement Procedure (MAP) based on taxpayer’s
position
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Pharmaceutical Industry – Other Pharma TP issues
Other Issues Entity level Comparison v/s Segment Comparison
• Rule10B(1)(e)(i) “net profit margin realised by the enterprise from an international
transaction entered into with an associated enterprise……”
• Taxpayer to maintain segmental accounts separately for transactions with AE’s and
Non-AE’s
• Expenses to be allocated between AE and Non-AE Segment using appropriate basis /
allocation keys :
- Direct Expenses : On actual basis
- Indirect Expenses : Based on allocation keys such as turnover, employee
headcount, time spent, area occupied, number of computers etc
• Adoption of segmental data upheld in the decision of UCB India Pvt Ltd v/s ACIT
(Mumbai) and Iljin Electronics India Pvt Ltd v/s ACIT (Delhi).
Real time audited segmental data preferred over unaudited segmental data by the
authorities during assessment
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Pharma Industry – Comparison of Relevant Decisions
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KPMG International Cooperative (“KPMG International”), a Swiss entity.
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Pharmaceutical Industry – Comparison of Relevant Decisions
UCB India
GlaxoSmitkLine Inc
Serdia India
Branded products
cannot be
compared with
generics
Tax Court - Price of generic
API constitutes CUP
Federal Court of Appeal –
Overruled tax court,
importance should also be
given to commercial factors
such as the agreement
After the patent
expiry branded
product can be
compared to generic
products.
Issue
Branded V/s
Generic API
Quality Differences
Even a minor
difference in quality
will affect price,
efficacy and safety
of product.
Quality difference cited in
granulation. GMP, HSE
practices bear no
significance on import
prices.
Allowed adjustment
based on
pharmacopeia
standards.
Requirement for
authoritative quality
grading systems.
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Pharmaceutical Industry – Comparison of Relevant Decisions
(contd….)
UCB India
GlaxoSmitkLine Inc
Serdia India
Rational judgment
needs to be adopted
for CUP method.
Rejection of TNMM
based on entity level
margins.
Hierarchy of methods
citing CUP as the most
preferred methods. Also in
OECD hierarchy taken into
consideration.
Transactional methods
to be preferred over
profit based methods
Issue
Priority of Methods
Final Decision
Importance of
Agreement
NA License and royalty
agreement are separate.
Need to be considered for
ALP calculation
Hidden Technical fees
needs to be supported
by agreement.
Fresh adjudication
with rejection of
TNMM and CUP
method. New TP
documentation study
to be undertaken.
Extra amount above ALP
treated as dividend.
Additional evidence
required and referred back
for fresh adjudication to
take into account the
licensing agreement
Upheld the CIT(A)
order.
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Manufacturing - Areas of discussion..
1 Manufacturing Industry- Types of Manufacturer
Compensation Model 3
Typical Transfer Pricing Issues 4
Specific Transfer Pricing Issues 5
Challenges for Contract Manufacturers
Management Payouts 7
6
2 FAR Analysis
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Manufacturing Industry
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Manufacturing Industry – Types of Manufacturer
Functions
and risks
Toll
Manufacturer
Contract
Manufacturer
Licensed
Manufacturer
Entrepreneur
Intangibles
Sales
Inventory
Manufacturing
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Manufacturing Industry – FAR Analysis
Functions Risks
Products and entities
Transactions
Forecasts/ business
plan
Business process
Asset Agreements/
terms
Financial results
Organization/ staff
Internal comparables
Characterization
Basis to search for external comparables
Planning possibilities
Forecasts/ business
plan
Risk opportunity assessment
Documentation Understanding
of business
FAR
Analysis
Inputs Outputs
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Manufacturing Industry – Compensation Model
Functions Typical Compensation model
Contract / Toll
manufacturing operations
Full cost plus mark up (or)
Return for value added services plus appropriate return on
capital investments in material and finished goods inventory
Routine manufacture /
assembly activity with
licensed technology from
Group.
Risk free assured return in line with industry benchmarks
As a variant of the above
with significant local
marketing efforts
Receipt of compensation for marketing intangible in addition
to the above
Full fledged manufacturer
and contributing to the R&D
effort of the Group
Profit Split Method (PSM) to determine the contribution
towards routine functions and towards intangibles
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Manufacturing Industry – Typical Transfer Pricing Issues
Start up phase challenges
Application of the TNMM method – Dealing with losses
Application of CUP – Comparability issues
Aggregation of transactions – Trading, Sourcing, Product Bundling
Payment towards Technical Know - How
IPR Valuation
TP Vs. Customs
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Manufacturing Industry – Specific Transfer Pricing Issues
Business Restructuring
Challenges for Contract Manufacturers
Comparability Adjustments – Specific focus working capital
Payouts - Specific focus on Royalty
Imports V/s Local
Apparent transfer pricing risk
Global effective high tax rate
Potential need for ongoing capital contributions
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KPMG International Cooperative (“KPMG International”), a Swiss entity.
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Manufacturing Industry – Challenges for Contract
Manufacturers
Functional profile of Contract Manufacturers - Risk-free operations
Remuneration model - remunerated with a Cost Plus Mark-up with reference to third party
manufacturers Challenge
Third parties available as benchmarks are Entrepreneurial manufacturers
• Undertake full gamut of risks
• Not remunerated on “Cost Plus” basis
Solutions
Adjustments for better comparability
• Possible adjustments for working capital and Risk differential
Alternate PLIs
• Use of Return on Assets (ROA) as PLI
• Use of Return on Capital Employed (ROCE) as PLI
Safe Harbours
• As a percent of return on value of assets employed/return on total costs
• Recent safer harbours announced in India for auto manufacturing industry
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Manufacturing Industry – Management Payouts
Typical forms of payouts - Royalty, Technical fee, Management fee, Guarantee fee
Primary challenge – Payouts through having economic substance are challenged in the start up
phase due to existing losses
Benchmarking - Is a challenge due to inadequate comparable data in public domain
Documentation - Under the transaction specific approach it is necessary to analyze potential
“cost-benefit” and maintain appropriate documentation to substantiate arm’s length nature of
payouts
• Cost- Benchmarking payouts of comparable companies, Basis of arriving at the value of
payouts ( Direct / Indirect Method) by the Group
• Potential Benefits - Need for obtaining service from the Group, Analysis of potential benefit
obtained by the Company and value attributable to the service
Other Regulatory Considerations - The recent relaxation of the statutory RBI / FEMA limits on
royalty and technical fee payouts increases the challenge of defending the arm’s length nature of
such transactions.
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Key Takeaways
Need for proactive and robust CUP analysis.
Mere reliance on the reason of difference in quality not
sufficient for rejection of CUP
Commercial justification to be built on to source APIs
from AEs vis-à-vis third parties
Need to have a detailed licensing agreement where
trademark/brand is involved taking care of possible
imputation of royalty
Appropriate documentation of business rationale
FAR very crucial to defend the transaction and
determination of value and non-value additions
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KPMG International Cooperative (“KPMG International”), a Swiss entity.
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Key Takeaways
Strong and robust economic analysis with supporting
documentation along with business rationale
Cost-benefit analysis vital
Internal CUPs preferred over external CUPs
Important to characterize value added and non-value
added activities for tested party and attribution of profits
Segmented financials play key role
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Way Forward
Be Proactive – not reactive - consider APA?
Adopt Coordinated and centralized approach.
Involve operational teams in tax and TP
planning and documentation process
Holistic solutions – not fragmented responses
Global awareness and vision – not myopic
Harmonize TP documentation with other
regulatory requirements
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KPMG International Cooperative (“KPMG International”), a Swiss entity.
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Questions & Answers
Questions
&
Answers