transfer pricing presentation important lesson

Convergence between Customs and Transfer Pricing,

Application of Transfer Pricing to Section 10AA,

Corporate Governance

CA Milind Kothari

4th Intensive Study Course on Transfer Pricing CA Milind Kothari 12 April 2014

TABLE OF CONTENTS

Convergence of Transfer Pricing and Customs

Background of Transfer Pricing and Customs

Key Similarities and Differences

Comparison of Key Evaluation Methods

Issues and Impact

Achieving Price Certainty

Indian Jurisprudence

Recent Convergence Initiatives

Applicability of Transfer Pricing to Section 10AA

Transfer Pricing and Corporate Governance


BACKGROUND

Introduction to Transfer Pricing and Customs Regulations...

Page 4

Transfer Pricing Customs

Transfer Pricing provisions seek to prevent shifting of

profits by MNCs from high tax rate jurisdiction to low

tax rate jurisdictions to minimize tax cost at group

level

Customs Valuation is the process where customs

authorities assign a monetary value to goods for

the purposes of import

Transfer Pricing regulations form a part of the Income

Tax Act, 1961

It is covered under the provisions of Customs Act,

1962

Arms Length Concept used for all inter-company transactions

Arms Length Concept used in respect of imports from related parties

Principally, OECD Transfer Pricing guidelines are

followed

Provisions of WTO Agreement on Customs

Valuation for determination of value on imported

goods are followed

... Introduction to Transfer Pricing and Customs Regulations

TP Adjustment Risk

Customs Duty Risk

0

50

100

150

200

250

Page 5

Price of

Product

Low Medium High

Challenge for Taxpayer - Optimum balance between Transfer Pricing and Customs


KEY SIMILARITIES AND DIFFERENCES

Transfer Pricing and Customs Concern and Objectives

Key Aspects Transfer Pricing Customs

Concern That price paid in a related party purchase

transaction is too high and/or the price

charged in a related party sale transaction is

too low

That price paid in a related party

purchase transaction is too low.

Primary Objective of

Importing County

Maximizing taxable income by minimizing the

value of goods imported [which, in turn, will

show lesser expenditure and greater profits]

Maximizing import duty by maximizing

the value of goods imported

Transfer Pricing and Customs Transactions covered


Transactions Covered /

Scope

Covers import and export of services,

tangibles and intangibles from Associated

Enterprise

Restricted to imports of tangibles

from related parties

Associated Enterprise /

Related Party tests

Enterprise which participates directly or indirectly or through one or more

intermediaries in the management, control

or capital of the other enterprise.

Enterprise in which one or more persons who participate directly or indirectly or

through one or more intermediaries in the

management, control or capital are the

same persons who participate in the

management, control or capital of the

other enterprise.

One of them directly or indirectly controls the other

Both of them are directly or indirectly controlled by third

persons

Together they directly or indirectly control a third party

Transfer Pricing and Customs Valuation Related Aspects


Valuation

objective

Assess whether the transaction price for

purchase of goods/services does not

exceed the arms length price

To determine whether the relationship

between the parties has affected the

price

Deviation from ALP /

fair market value

Deviation of + / - 3% between transaction

value and Arms Length Price is

permissible

No such range specified; left to the

discretion of the Appraiser/ Customs

Valuation Officer

Deviation from ALP No hierarchy of method to be applied

- Use of Most Appropriate Method (see

next slide for details)

Methods to be sequentially followed (see

next slide for details)

Transfer Pricing and Customs Valuation Methods


Comparable Methods

which can be applied

Comparable Uncontrolled Price Method Transaction Value (of

Identical/Similar goods)

Resale Price Method Deductive Value Method

Cost Plus Method Computed Value Method

Profit Split Method No Corresponding Method

Transactional Net Margin Method No Corresponding Method

Other Method Residual Method

Transfer Pricing and Customs Procedures and Compliances


Frequency of valuation Annual At the time of import of goods

Documentation

requirements

Enterprise and Transaction wise

Contemporaneous Documentation to be

maintained by the taxpayer

No requirements specified by the

legislation

Reference to

special

valuation

authorities

Reference to Transfer Pricing Officer (TPO)

made if found necessary, generally based on

certain monetary thresholds

Reference to Special Valuation Branch

(SVB) per import consignment

Audit Prescribed under law lower threshold limit leads to audit on year to year basis

Conducted on need basis

Validity of the

order

TP order valid for the year for which

the audit takes place

Generally, SVB order is valid for three

years unless manner in which import

transactions occur changes materially

Transfer Pricing and Customs Penalties


Penalties 100% to 300% of tax on adjustment amount on account of concealment of income

2% 4% of transaction value for non-maintenance of prescribed documentation

and non-furnishing the same before the TPO

INR 100,000 for non-furnishing of Form 3CEB

100% to 300% of Customs duty not paid/short paid

Interest on non-payment/ short payment of Customs duties

Possible confiscation of import consignments

Possible punitive action on importer


Comparison of Key Valuation Methods

Similarities

Both methods compare the prices charged for identical goods imported at or about the same time as the goods being valued.

Following adjustments from the value of identical goods sold are to be considered (common to both the methods):

- Quantity Factors

- Commercial Level Factors

- Significant differences in costs and charges included in goods being valued and transaction value of identical goods

Differences

While under CUP Method, product comparability is to be seen strictly; customs regulations provide for consideration of transaction of similar (if not identical) goods imported.

Where more than one price has been determined, Transfer Pricing Regulations consider arithmetical mean of prices; however as per customs regulations, the lowest value of the transaction values found is to be considered

Transfer Pricing and Customs A Comparison of Valuation Methods Comparable Uncontrolled Price Method vs. Transaction Value of Identical Goods

Illustration

XYZ imports 10 kgs of raw materials from its foreign associated enterprise at a unit price of INR 1000 per kg.

Details of comparable imports made in India at the same time are as follows:

In the above illustration, the arms length price for transfer pricing purposes would be considered as the arithmetical mean of INR 965 per kg. Accordingly, the transfer pricing officer may propose a transfer pricing adjustment for the excess price of INR 35 per

kg paid by XYZ to its associated enterprise.

On the other hand, customs authorities may value the related party import at INR 1050, being the lower of prices for the same quantity as that purchased by XYZ from its associated enterprise (i.e. 10 kgs) and may thereby levy additional import duty on INR

50 per kg.

Transfer Pricing and Customs A Comparison of Valuation Methods Comparable Uncontrolled Price Method vs. Transaction Value of Identical Goods

Quantity (in Kgs) Price

10 1050

12 830

8 905

10 1075

Arithmetical Mean 965

Similarities

These methods are adopted if the imported goods are resold as such, without any processing which might add value to the goods so imported.

Under Resale Price Method, gross margins earned by the taxpayer (from uncontrolled transactions) or by companies engaged in a similar business and direct costs incurred by the taxpayer are reduced from the price at which the imported

goods are resold by taxpayer to an unrelated person to arrive at the arms length price of the imported goods

Similarly, under the Deductive Value Method, the following adjustments from the value of identical goods sold are to be considered:

- either the commission usually paid or agreed to be paid or the additions usually made for profits and general expenses in connection

with sales in India of imported goods of the same class or kind;

- the usual costs of transport and insurance and associated costs incurred within India;

- the customs duties and other taxes payable in India by reason of importation or sale of the goods.

Differences

While the Resale Price Method would fail in a situation where imported goods are resold after processing, deductive value method provides for consideration of such resale value, after providing for due allowances for value added on

account of processing.

Transfer Pricing and Customs A Comparison Resale Price Method vs. Deductive Value Method

Similarities

Both the methods use the cost or value of materials and fabrication or other processing employed in producing the imported goods as the base

They deal with adding an amount for profit and general expenses equal to that usually reflected in sales of goods of the same class or kind as the goods being valued which are made by producers in the country of exportation for export to

India.

Issues

Such an approach may not be feasible especially from a transfer pricing perspective as it entails selection of the foreign Associated Enterprise as the tested party, relevant data for which might not be available to the taxpayer.

Further, determining the profit markup to be added to the cost of materials and/or processing would entail conducting a benchmarking analysis on foreign databases, which again might not be feasible, especially for small taxpayers.

Transfer Pricing and Customs A Comparison Cost Plus Method vs. Computed Value Method

Other Method, under transfer pricing law, indicates any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between

non-associated enterprises, under similar circumstances, considering all the relevant facts.

Residual method, under customs law, provides that where the value of imported goods cannot be determined under the provisions of any of the specific methods, the value shall be determined using reasonable means consistent with the

principles and general provisions of these rules and on the basis of data available in India.

Transfer Pricing and Customs A Comparison Other Method vs. Residual Method


ISSUES AND IMPACT

Impact on customs should be considered while setting a Transfer Price or changing it prospectively

Retroactive upward adjustments to transfer prices may trigger issues from a customs perspective

- May lead to suspicions that previous imports were undervalued

- May result in additional customs duty owed and disclosures

Retroactive downward adjustments to transfer prices, on the other hand, may not be acceptable to customs authorities. Therefore, excess customs duty paid on the differential is an added cost to the taxpayer

ALP under tax law may result in Customs valuation risk

- Under transfer pricing law, it may be possible to justify the arms length nature of purchase of diverse range of products with differential purchase prices, or setting off of higher margin products against lower margin products (say, by adopting TNMM, where

entity level margins are benchmarked). However, the same may not be possible from a customs perspective since examination under

customs is of each transaction, as opposed to annual averages/results.

- Under transfer pricing law, it may be possible to justify a lower import price on the basis of arguments such as new product launches;

marketing spend by importer, etc. However, these arguments may not succeed with the customs authorities.

Issues and Impact Issue Trigger Points

Local adoption of Global TP policies

- Global transfer pricing policies might be acceptable for determination of arms length price under local transfer pricing regulations; however the same might not be accepted by the Customs authorities

Royalty payments, Cost Contribution Agreements, payment of Management Service Fees

- Payments such as royalty, management service fees may be justified to be at arms length by maintaining rigorous transfer pricing documentation to support the same

- However, Customs Authorities may treat such payments as compensation for lower import value of goods and may thus levy

additional duty by adding the value of such payments to import value of goods

Advance Pricing Agreements (APAs)

- APAs obtained by taxpayers to achieve certainty in TP matters may not include Customs Authorities in discussions,

- Therefore, though the transfer prices agreed in an APA might provide certainty from a transfer pricing/income tax point of

view, the uncertainty regarding customs valuation may still persist.

Issues and Impact Issue Trigger Points

Double taxation

- No provision for tax refunds under either laws in case of adjustments made in the other law

- Corresponding adjustments to associated enterprise/related party not available

- Results in additional global tax cost to the Group

Hardship to the taxpayer on account of differences in

- Methodologies

- Documentation requirements

- Use of comparables

- Asymmetrical information availability

- Timing of valuation/audit

- Assessment and audit provisions

Due to differences in compliance requirements under the two laws, maintenance of records increases the cost of administration of the taxpayer.

No provision for joint price setting/evaluation for transfer pricing and customs purposes

Issues and Impact Impact on Taxpayer


ACHIEVING PRICE CERTAINTY

APAs are agreements entered into between the taxpayer and the income tax authorities for pre-determining transfer prices to be applied for transactions to be entered with associated enterprises. APAs are generally seen by taxpayers as

the ultimate achievement of certainty around the acceptability of their transfer prices from an income tax perspective.

Similarly, Indian Custom Authorities issue Advanced Rulings for determining the customs valuation in advance, providing certainty to taxpayers.

However, the prices agreed in an APA from an income tax perspective may not be acceptable to the customs authorities and vice-versa. Thus, there is a need to have a mechanism wherein both the income tax as well as custom authorities

can be jointly approached in negotiations for setting prices for transactions involving cross-border movement of goods.

Achieving Price Certainty Advanced Pricing Arrangement (APA) vs. Advanced Rulings


INDIAN JURISPRUDENCE

Panasonic India Pvt. Ltd. vs. ITO [[2011] 43 SOT 68(DELHI)]

The Tribunal rejected taxpayers reliance on valuation done by SVB for customs valuation by observing that customs valuation and determination of ALP for income tax purposes serve different purposes and rules under the respective laws

need to be followed

Serdia Pharmaceuticals (India) Pvt. Ltd. vs. ACIT [[2011] 44 SOT 391 (Mumbai)]

The Tribunal rejected taxpayers contention that import prices being accepted by customs authorities, ought to be considered as arms length for transfer pricing purposes as well. It observed that the onus of the taxpayer is discharged only when the ALP is determined in accordance with the transfer pricing regulations

Fuchs Lubricants (India) Pvt. Ltd. vs. DCIT [ITA NO. 6339/Mum/2011]

The Tribunal observed that value of raw material imports accepted by custom authorities cannot be considered as arms length price under the provisions of Income Tax Act.

Indian Jurisprudence Transfer Pricing Rulings for use of / reliance on customs data

Mobis India Ltd. vs. DCIT [ITA No. 2112/Mds/2011]

The Tribunal held that the valuations made by customs authorities on import of raw material for purpose of levy of

customs duty cannot be considered as a comparable. The purpose of valuation by the customs authorities is to determine

undervaluation, which by its very nature, would not fit with the scheme of transfer pricing analysis under the Income Tax

Act.

Tilda Riceland Pvt. Ltd. vs. ACIT [[2014] 42 taxmann.com 400 (Delhi - Trib.)]

The Tribunal upheld taxpayers reliance on database maintained by Tips software for comparison of prices of basmati rice as it consisted of information publicly available with the customs department.

Coastal Energy Pvt. Ltd. vs. ACIT [[2011] 12 ITR(T) 347 (Chennai)]

The Tribunal held that the taxpayer has no locus standi to question the credibility of customs data relied upon by TPO.

Customs authorities assign values to imported goods on the basis of scientifically formulated methods and is not an

arbitrary exercise.

Indian Jurisprudence Transfer Pricing Rulings for use of / reliance on customs data


RECENT CONVERGENCE INITIATIVES

Many countries have initiated processes to increase interaction between the Customs and Transfer Pricing authorities

Various governments have issued guidelines to resolve the Customs / TP conflicts USA, Australia, Canada, Chile, France, etc.

Review of TP Studies, Advance Pricing Arrangements and other TP documentation for determining customs value

World Customs Organization/OECD Conference on TP and Customs Valuation in Brussels May 2007 followed by meeting of the Focus Group on Transfer Pricing , 26 October 2007

Recent Convergence Initiatives Global Initiatives

Australia

The Australian Customs authorities have published Practice Statements to provide guidance for Customs staff and industry stakeholders on Customs policies on valuation of imported goods that involve transfer pricing arrangements.

Further, legislative changes are being recommended to facilitate transfer pricing arrangements to allow refund of overpaid duty by reason of any downward adjustments.

USA

Recently, the US customs authorities have shown some willingness in certain circumstances to consider a multinational importers Internal Revenue Service(IRS) approved Advance Pricing Agreements (APAs), transfer pricing studies, and other tax-related pricing practices in establishing the customs valuation of imported goods.

Further, in a policy change proposed by the customs authorities, importers ought to report any post-importation price adjustments (either upward or downward) made pursuant to a documented transfer pricing policy. Depending upon the

circumstances, an upward adjustment may require an additional customs payment and a downward adjustment may

permit a refund.

Recent Convergence Initiatives Global Initiatives Select Jurisdictions

A Joint Working Group comprising senior officers from Income Tax and Customs Departments was constituted to study the subject of Transfer Pricing (Price adjusted in Related Party Transactions) in the context of Income Tax and Customs

laws, and to suggest measures on co-operation between the two Departments. The Group was co-chaired by Member

(IT), CBDT and Member (Customs), CBEC.

Vide Customs Circular No. 20/2007 dated. 8 May, 07, it was decided to implement the following recommendations of the Joint Working Group:

- Two Tier co-operation through recommended Bi-monthly and Six-monthly joint meetings

- Training programs for officers of both Departments

- Sharing of Related Party information on a Need to Know basis

- Exchange of information on specific-cases

Recent Convergence Initiatives Indian Initiatives


APPLICATION OF TRANSFER PRICING TO SECTION 10AA

Tax holiday Units covered under sections 10AA

No tax holiday on more than ordinary profits i.e. excessive profits

Application of ALP principle prescribed under Indian TP Regulations

Impact of introduction of Domestic TP

- Fine balance required between transfer pricing and tax holiday provisions

- Suo-motu reporting of inter-unit and inter-entity transfers/transactions implies better availability of relevant data and information with

the revenue authorities

Applicability of Transfer Pricing to Section 10AA


TRANSFER PRICING & CORPORATE GOVERNANCE

Increasing trend of Transfer Pricing Adjustments from INR 45,000 Crore in FY 2011-12 to INR 70,000 crore in FY 2012-13 and INR 60,000 crore in FY 2013-14

Uncertainty - Limited guidelines and contradictory rulings by Indian courts

Significant value adjustments by TPOs on account of share valuations, corporate guarantees, marketing intangibles, etc.

Corporate Governance pressure points:

- Being aware of legal positions and ensuring their alignment with other Indian laws

- Understanding of Pricing Methods being followed for various transactions and appropriateness thereof

- Ensuring Documentation requirements are strictly and completely met with

- Updation with judicial and legislative developments in India and overseas, on a real-time basis

- Ensuring timeliness and completeness in compliances

- Being aware of penal consequences

Transfer Pricing & Corporate Governance

Governing Boards should increasingly take responsibility for identification, quantification and management of transfer pricing risks from a corporate governance perspective:

- Identify material intra-group transactions, especially off-balance sheet items

- Ensure co-ordination among cross-functions such as operations and finance so that pricing adjustments are appropriately

documented in intercompany agreements

- Conduct an impact analysis of potential transfer pricing risks that could lead to double taxation, increase in effective rate of

tax at the Group level

- Reporting and justifying transactions not at ALP in Board Report

- Recourse to TP documentation for statutory disclosures i.e. Alignment with Cost Audit Rules 2011, Companies Act 2013, AS-18

issued by ICAI, tax audit report disclosures

- Pro-active approach for amendments in the legislation or introduction of new legislation; for instance, proposed DTC 2013

- Use of APAs and safe harbours for better certainty

Transfer Pricing & Corporate Governance


THANK YOU

CA Milind Kothari

Contact details

e: [email protected]

t: +91-22-24393601

transfer pricing presentation important lesson

Documents

aa transfer pricing

customs concern

customs authorities

customs key similarities

provisions of customs

group level customs

value of goods

related party sale transaction