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TRANSCRIPT
Analysis of important transfer pricing decisions, nuances
and practical application from India perspective
SEMINAR ON TRANSFER PRICING REGULATIONS
June 19, 2011 - CA Rajesh S. Athavale
� Evaluation of Transfer Pricing
� Recent Indian jurisprudence on Transfer
Pricing
� Way Forward
Agenda
� Way Forward
Evaluation of Transfer Pricing
“Transfer Pricing can deprive governments of their fair share of taxes from global corporations and expose multinationals to possible double taxation. No country – poor, emerging or wealthy – wants its tax base to suffer because of transfer pricing. The arm’s length
principle can help.”
Transfer pricing Evolution - OECD’s View
principle can help.”
By John Neighbour
Organisation for Economic Co-operation and Development
‘OECD’ Centre for Tax Policy and Administration
4
�Protection of tax base
�Equitable sharing of tax revenues between the
nations – i.e. Residence and Source countries
�Principles should be internationally acceptable to
avoid economic double taxation
Objectives of Transfer Pricing Regulations (TPR)
avoid economic double taxation
�Practical difficulties in applying the regulations
should be recognised by both countries
�No discrimination between Multinational
Enterprise (MNE) groups and Independent
Enterprises – the standard of comparability
should be impartial5
�Embedded in the Double Taxation Avoidance Agreement (‘DTAA’) Article (9) of the OECD Model Convention
�The OECD Report on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the Guidelines), is the Foundation
Evolution of TPR…
Foundation
�Based on Arm’s Length Principle – The universal principle which is the foundation of TP legislation globally
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Above principles serve the dual objectives
- Securing the appropriate tax base in
each jurisdiction and avoiding double taxation
The Arm’s length Standard (ALS) is the Universal Standard that is applicable to the
various intra-group transactions of a Multinational Enterprise (MNE). It is based on the separate – entity approach and is enshrined
Arm’s Length standard – The Universal Standard (ALS)
the separate – entity approach and is enshrined in the DTAAs signed by the various countries.
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� Revenue Authorities becoming extremely stringent in protecting tax base
� Relatively new subject but judicial pronouncements now available
� Separate set-up for administering TP
Revenue Authorities’ Approach
� Separate set-up for administering TP
� Dispute Resolution Alternatives available in domestic law and experiences
� Six rounds of TP audit completed – FY 2001-02, 2002-03, 2003-04, 2004-05, 2005-06 ,2006-07 and 2007-08
� All cases having transaction value > INR 50 million referred by AO to TPO for TP scrutiny
Particulars FY
2001-02
FY 2002-
03
FY 2003-
04
FY 2004-
05
FY 2005-
06
F Y 2006-
07
FY 2007-
08
Transfer Pricing Disputes – An Overview
2001-02 03 04 05 06 07 08
Cases picked
up for
scrutiny
800 Approx.
1500
Approx.
2500
Approx.
3500
Approx.
4500
Approx.
6000
Approx.
7000
Tax demands INR 1.2
billion
INR 2.5
billion
Approx.
INR 3.5
billion
Approx.
INR 5
billion
Approx.
INR 6.5
billion
Approx
INR 8
billion
Approx
INR 20
billion
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Recent Case Laws
SAP Labs India Pvt. Ltd.
� Facts of the Case� SAP India engaged in software development and related services to SAP AG – STPI unit – Exempt under section 10A
SAP Labs (India) SAP AG (Germany)
Software Development
services
100% holding
SAP AG – STPI unit – Exempt under section 10A
� SAP India operated under R&D Agreement and remunerated at cost plus 6% or 1.5 times of wages bill, whichever was higher
� Transfer Pricing Officer (TPO) initially tried to apply CUP method, by comparing rates charged by comparable companies as per NASSCOM data
� TPO later applied TNMM ignoring the initial intention to apply CUP and made adjustment
� Tribunal held as under:
� Transfer Pricing provisions are applicable irrespective of the fact, whether income is taxable or not
� Under the Income Tax Act, even if income is exempt, transfer pricing adjustment is not exempt from tax
� Aim of transfer pricing provision is to determine the arm’s
SAP Labs India Pvt. Ltd.
� Aim of transfer pricing provision is to determine the arm’s length price by applying the most appropriate method (MAM)
� In the process of evaluation of MAM, all methods need to be evaluated, hence shifting from one method to another is within law
� Tribunal held……….
� Need to evaluate correctly the operating margin of the tested party � Foreign exchange fluctuation gain – operating income
� Interest in income tax refund – non-operating income
� Donation – operating cost
� Proviso to Section 92C(2) provides for +/- 5% range from arm’s
SAP Labs India Pvt. Ltd.
� Proviso to Section 92C(2) provides for +/- 5% range from arm’s length price as a standard deduction, however, after amendment by Finance (No. 2) Act, 2009, this leeway is not available and the amendment is prospective in nature
� Comparable analysis needs to consider the economics of the tested party. Thus in the present case, high profit making, loss making companies, different functionality need to be eliminated from the set of comparable companies
� Companies having margins less than that contracted by the tested party, needs to be eliminated
� +/-5% Range - Example
Particulars Amounts in
INR
Operating income
(Transfer Price)
110
Total operating cost (TC) 100
Particulars Amounts in
INR
Operating income
(Transfer Price)
110
Total operating cost (TC) 100
Current Position Amended Position
SAP Labs India Pvt. Ltd.
14
Total operating cost (TC) 100
Operating profit (OP) 10
OP/TC 10%
Comparables margin 17%
ALP 117.00
95% of ALP 111.15
105% of ALP 122.85
Total operating cost (TC) 100
Operating profit (OP) 10
OP/TC 10%
Comparables margin 17%
ALP 117.00
95% of Transfer Price 104.50
105% of Transfer Price 115.50
As per the current position of law and the
view taken by various Tax Tribunals, in the
above example, the adjustment would be
Made as 111.15-110.00 i.e. 1.15
Here, the question arises as to whether
the adjustment shall be made
as 117.00-115.50 or 117-110?
� Take Aways
� Shifting of profit is not a criteria for applicability of TP
� Zero down on a particular method as the MAM
� Selection of MAM will depend upon the facts of the case and the factors mentioned in rules
SAP Labs India Pvt. Ltd.
the case and the factors mentioned in rules contained in rule 10C
� New proviso to section 92C(2) inserted by the Finance (No.2 ) Act is prospective in nature
� Limitation of data base
� Brief Facts
� Maruti India – subsidiary of Suzuki Motor Corporation, Japan, engaged in manufacture and sale of automobiles
� Enters into license agreement with prior approval of Government of India for use of Suzuki logo for sale of certain Suzuki model in India
Maruti Suzuki
certain Suzuki model in India
� Under license agreement, Suzuki was to provide technical information, know-how, etc.
� However, Maruti was to compulsorily use the trademark of ‘Maruti Suzuki’ on containers, packages and wrappings
� Brief Facts….
� According to the TPO the change of brand logo from ‘Maruti’ to ‘Suzuki’ amounted to sale of the brand ‘Maruti’ to ‘Suzuki’
� TPO computed the value of ‘Maruti’ brand at cost plus 8 % at INR 4,420 crores and issued show-cause notice as to why the international transaction not be adjusted on the basis of
Maruti Suzuki
international transaction not be adjusted on the basis of deemed sale to Suzuki
� Maruti in its reply stated that there was no transfer of ‘Maruti’ brand or logo by it and Suzuki had not charged any additional consideration for the use of such logo on the vehicles manufactured by Maruti
� Jurisdiction of TPO was challenged by Maruti
� Brief Facts…
� Action of TPO
� Issued detailed questionnaire on replacement of logo and clarified that this is transfer of economic value
� Maruti paid royalty of INR 198.6 to Suzuki but no compensation given by Suzuki to Maruti
� However ‘Suzuki’ trademark had piggybacked on ‘Maruti’ trademark without payment of any compensation
Maruti Suzuki
trademark without payment of any compensation
� Apportionment of 50% of the amount of royalty paid by Maruti to Suzuki and the ALP was determined at "Nil" using CUP method
� Maruti had developed marketing intangibles for Suzuki in India, at its own cost and Suzuki had not compensated for the same
� Based on the 3 comparable companies, TPO concluded that non-routine advertisement expenditure of INR 107.22 crores had to be adjusted
� Decision of the Delhi High Court� Suzuki Trade-mark was not piggybacking on Maruti logo
� No transfer of Maruti brand to Suzuki
� No right given to Suzuki for using Maruti logo
� Agreement is critical for payment of license fees
� Grounds of adjustment must be stated in the notice issued in clear, cogent, specific and in an unambiguous manner
Maruti Suzuki
cogent, specific and in an unambiguous manner
� The onus is on assessee to demonstrate whether transaction is at ALP or not
� Compulsory usage of logo of AEs results in creation of marketing intangibles for AEs, hence compensation from AE is required
� Level of marketing spend by licensee will determine whether the licensee needs to be compensated
� Maruti filed SLP before SC against observation made by HC
� The SC has now held that, the HC has not merely set aside the original show-cause notice but it has made certain observations on the merits of the case and has given directions to the TPO, which virtually conclude the
Maruti Suzuki
given directions to the TPO, which virtually conclude the matter. Accordingly, the SC has directed that the TPO should now pass his order uninfluenced by the observations/ directions of the High Court
� Take Aways
� Normal and excessive advertising and promotional expenditure
� Whether excessive marketing and advertisement expenditure or promotion of foreign brands create marketing intangibles in India
Maruti Suzuki
marketing intangibles in India
� Use of intangibles need to be compensated at arm’s length basis
� Facts of the case� Sardia Pharmaceuticals, a pharma company, was engaged in business of producing drugs mainly in field of anti-hypertension and metabolism
� Assessee imported active pharmaceutical ingredients
Sardia Pharmaceuticals India (P) Ltd
Sardia
Pharmaceuticals
India
pharmaceutical ingredients (API) from its Aes
� Assessee determined ALP by adopting TNMM method
� TPO rejected TNMM method and selected CUP as a MAM
� TPO obtained API data of competitors & made adjustment after allowing difference quality and purity standards
Servier Egypt Servier France
Purchase of
API
� Ruling of ITAT
� Selection of method for determining ALP is not on the unfettered decision on the taxpayer
� TPO can reject method adopted by assessee with cogent reasons and must be through speaking order
� CUP and traditional transaction methods are preferred over the transaction based profit methods
Sardia Pharmaceuticals India (P) Ltd
preferred over the transaction based profit methods
� Price movements and demand sensitivity to the price indicate that APIs imported are not unique items, and therefore by paying exorbitant price to AE for such items leave ample scope to manipulate API prices to regulate profitability of their controlled entities in the end use jurisdiction
� Ruling of ITAT
� APIs were generic drugs and not patent protected when they were purchased from AEs; hence attributing high price to cost and process of developing a new drug cannot be accepted
� It should compete with the generic drug manufacturers, in post patent period, on selling prices
Sardia Pharmaceuticals India (P) Ltd
manufacturers, in post patent period, on selling prices
� Re-characterization provisions in respect of payments made in excess of ALP as dividend, royalty or other income to AEs as done in Glaxo case have not yet been legislated in India
� The overseas judgement are no binding in India but their logic and rational can be relied upon
� Ruling of ITAT
� Branded API can be comparable to Generic API as benefit reaped before patent expiry
� Acceptance of value by custom authorities does not imply the compliance of the same under the Indian Transfer Pricing Regulations
� Sales to unrelated parties in different countries can not be
Sardia Pharmaceuticals India (P) Ltd
� Sales to unrelated parties in different countries can not be considered as internal CUP due to different to geographical location and inadequate data
� CUP has been considered as a MAM
� Take Aways
� Need and importance to demonstrate to revenue authorities the correct business model, so as to bring out the economic rationale behind the conduct of business
� Superiority of CUP over TNMM
� Residue supernormal profits lying with the Indian
Sardia Pharmaceuticals India (P) Ltd
� Residue supernormal profits lying with the Indian entity after applying the CUP method, rightfully belong to whom?
� it Branded API can be comparable to Generic API as benefit reaped before patent expiry
� Play between the intangibles and the business model
� Brief Facts� Perot Systems was engaged in
business of designing and developing technology enabled business transformation solutions and providing business consulting, systems
Perot Systems
Perot Systems
(India)
Foreign currency
Interest free business consulting, systems integration services and software solutions & services
� It had extended foreign currency interest free loans to its two AEs (one is located in tax haven)
� TPO held that interest free loans were not at arm’s length
HPS Global Systems Hungary
Liquidity Management LLC
HPS Global Systems (Bermuda)
Ltd
Interest free loans
� Observations and Ruling of the ITAT� Real Income theory not to apply to the Transfer Pricing� Agreement is silent on quasi-equity nature of loan � Agreement does not bring out the necessity of lending interest-free loan
� Economic substance of the transaction is that of the
Perot Systems
� Economic substance of the transaction is that of the debt and not in the nature of equity or quasi-equity
� Classic case of violation of transfer pricing norms where profits are shifted to tax havens or low tax regimes to bring down the aggregate tax incidence of a multinational group
� RBI’s approval for granting interest-free loan is not determinative of arm’s length nature of transaction
� Benefit of +/-5% not to be granted to LIBOR
� Take Aways
� Interest-free loan and guarantee to overseas subsidiary, whether interest/fees to be charged always necessary?
� Importance of legal agreement in synch with economic
Perot Systems
� Importance of legal agreement in synch with economic rationale, Robust documentation, Loan agreement , economic reasons, special circumstances, need for granting interest-free loan to be brought out
� Framing of Safe harbour Rules for such transactions
� Whether LIBOR is a single rate or average rate – Benefit of +/-5% under the new law
� Brief Facts� Birlasoft (India) Ltd. was engaged in the business of software development and related services
� For determining the ALP in respect of the international transactions with the AEs, the assessee applied internal TNMM
Birlasoft (India) Ltd
� TPO rejected the internal bench marking as assessee did not maintain segmental accounts for the related and non-related transactions and there was no segregation of these activities in the audited financials report
� DRP upheld the order passed by the TPO
� Observation of Delhi Tribunal � Lack of segmental reporting in the audited financial statements cannot be a
reason of rejecting method of computing the ALP
� Undertaking internal bench marking analysis on stand alone basis is justified
� OECD Guidelines provides that the net margin of the taxpayer from the controlled transaction should ideally be established by reference to the net
Birlasoft (India) Ltd
controlled transaction should ideally be established by reference to the net margin that the same taxpayer earns in comparable uncontrolled transactions, and only where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide
� TPO had no mandate to have recourse to external comparables when internal comparables were available
� Take Aways
� Internal TNMM is more reliable than external TNMM
� Assessee maintain segmental account, applying the proper keys for allocation of income and expenses
Birlasoft (India) Ltd
expenses
� Reporting of such segmental results in the Financials not necessary for Transfer Pricing Analysis
GV-India RCSEnd
Customer
Provision of I.T. Enabled servicesProvision of I.T. Enabled services
Flow of RevenueFlow of Revenue
Revenue = $ 100Revenue = $ 100Retains $9.4 and passes
$ 90.6
Retains $9.4 and passes
$ 90.6
Global Vantedge
Facts of the case
• Global Vantedge (‘GV-India’) was engaged in rendering of IT-enabled
services
• RCS Centre Corp (RCS), provided marketing services and enters into
contracts with the ultimate clients. Passed on the contract to GV-India
on a back-to-back basis
• RCS retained 9.4 % (marketing services) of the total revenue earned
from the client and then passed balance 90.6% of the revenue to GV
• Facts….
• For benchmarking the transaction GV-India considered
its AE, RCS, as tested party and compared profit margin
of RCS with foreign comparable companies
• TPO had chosen GV-India as tested party and arrives at
Global Vantedge
• TPO had chosen GV-India as tested party and arrives at
avg. operating margin of comparables was 11.88% as
against the loss incurred by GV-India
• Applying the Arm’s Length Margin of 11.88% on the total
operating cost, the TPO proposed the adjustment
• If the adjustment to be taken into account, the total value
exceeded the revenue earned from client ultimately
� ITAT upheld the findings of CIT(A) as under:
� Least complex entity should be selected as tested party
� If an entity is unable to earn adequate profits on account
of legitimate business exigencies and not due to
manipulation of transactions undertaken by AEs, such
entity cannot be penalized
Global Vantedge
entity cannot be penalized
� ALP of international transaction between the taxpayer
and its AE can not exceed the total amount of revenue
earned from clients by GV-India and AE together.
� Comparable companies with substantial related party
transactions should be rejected
� Take Aways
� International transaction to be evaluated from end to
end perspective while determining the arm’s length
nature of transaction
� Least complex entity should be selected as tested party,
subject to availability of comparable data
Global Vantedge
subject to availability of comparable data
� Facts of the Case� Symantic Software Solution (SSS) was engaged in business of providing technical and marketing, pre-sale, and after sales support of Veritas group products
� SSS provided two types of services to its AE� Marketing support services� Consultancy Services
Symantec Software Solution
� Consultancy Services
� For Marketing support services SSS was remunerated Cost plus 2 percent and for Consultancy Services SSS was remunerated Cost plus 8 percent
� SSS benchmarked transaction by using TNMM method
� TPO made transfer pricing adjustment by selecting different/new comparables
� Contention of Assessee� TPO can not consider comparables, whose financial information was not available at the time of TP study
� Multi year data of comparables could be considered
� Turnover filter had to be applied for identification of
Symantec Software Solution
� Turnover filter had to be applied for identification of comparable companies
� Adjustment for difference in functional and risk profile between comparable companies & assessee
� Benefit of +/-5% to be granted
� Tribunal held as under
� The comparison should be between the net margin on transaction basis and not at enterprise level
� Material available at public domain, even though not available to assessee at the time TP study is relevant
Symantec Software Solution
� Multi year data has limited role only when the data of earlier years reveals the facts which could have influenced the transactions; in this case the claim of multi year data can not be entertained
� Tribunal held….� Unless and until it is brought under record that turnover of comparables has undue influence on margin it is not general rule to exclude such comparables
� No economic adjustment difference in functional and risk profile as assessee fails to bring any relevant material on
Symantec Software Solution
profile as assessee fails to bring any relevant material on record
� Amendment in proviso to section 92(c) - not clarificatory in nature and therefore to be applied prospectively
� Take Aways
� Limitation of data base
� Contemporaneous date/updatation of data
� Economic analysis/Search filter
� Need for quantitative risk adjustment to be
Symantec Software Solution
� Need for quantitative risk adjustment to be brought out
� Use of multi-year data – Proposed price
� Facts of Case
� Dana Corporation, resident of US, filed bankruptcy
� As part of the bankruptcy proceedings, a reorganization plan was submitted to the US Bankruptcy Court
Dana Corporation
� The reorganization resulted in the transfer of shares of the three Indian companies to the new company
� The transfer was without consideration as per the share transfer agreement
� The AAR held as under:
� Transfer of Indian companies shares was without consideration; or
� At any rate the consideration is indeterminable
� Thus, the charging provision of Capital Gains (Section 45) is not applicable
Dana Corporation
is not applicable
� Hence, such transfer of shares are not chargeable to tax
� Where the charging section fails to operate, the transfer pricing provisions does not come to the rescue of the revenue authorities
� Take Aways
� Compliance under Transfer Pricing Regulations
� Filing of income tax return
Dana Corporation
Issue Position Case law
Functional Analysis Functional analysis of tested party as well as
comparables necessary
�Aztec Software
� E-Gain Communication
� Sony India Pvt. Ltd.
� Skoda India Pvt. Ltd.
� UCB India Pvt. Ltd.
�Quark System
Maintenance of segment wise P&L
for diversified activities
Separate evaluation for different functional
activities
� Development Consultants
� Star India Pvt. Ltd.
Recent case-laws - Key takeaways
45
� UCB India Pvt. Ltd.
Rejection of taxpayer’s method Taxpayer’s method / comparables should be
rejected by the RA before adopting another
method / comparables
�Aztec Software
�MSS India
Selection of tested party Party having least complex functions and not
owning valuable intangibles should be
selected as tested party. Foreign Company
may be selected as tested party.
Foreign Company rejected as tested party as
it is difficult to compare entitlements of
different geographical locations
� Development Consultants
� Ranbaxy Laboratories
�Global Vantedge
Issue Position Case law
Comparables rejected on the basis
that they are incurring losses
Comparable cannot be rejected merely
because it is incurring losses.
� Sony India Pvt. Ltd.
� Quark System
Principles of natural justice Adjustments to be in synch with show
cause notice. Taxpayer should be given
opportunity to rebut Tax Officer’s material
�Moser Baer
� Dufon Laboratories
�Maruti Suzuki
� Quark System
Maintenance of documentation Taxpayer should reasonably comply with � Cargill India Pvt. Ltd.
Recent case-laws - Key takeaways
46
Maintenance of documentation Taxpayer should reasonably comply with
documentation requirements under the
law. Tax Officer cannot reject taxpayer’s
analysis merely on the ground that all
documentation required under the
regulations is not maintained.
� Cargill India Pvt. Ltd.
� UCB India Pvt. Ltd.
Methods to be followed as
prescribed under section 92C
TPO cannot exceed his limitation by
following any method to determine the
ALP which is not authorised by the Act.
It is mandatory for the assessee to follow
one of the methods prescribed under the
Act
� CA Computer Associates
� Starlite
Issue Position Case law
Payment for use of trademark Compulsory use of logo results in creation
of marketing intangibles of the AEs.
Compensation from AEs is required
Quantum of marketing spend by the
licensee will determine whether the
licensee needs to be compensated
�Maruti Suzuki
Adjustments under Transfer Pricing Transfer Pricing Adjustments cannot
exceed the total revenue earned by the
�Global Vantedge
Recent case-laws - Key takeaways
47
exceed the total revenue earned by the
assessee and its AEs from the third parties
Non-applicability of Transfer Pricing
Provisions
Where the charging section fails to tax the
income, Transfer Pricing Provisions does
not come to the rescue of RA
�Dana Corporation
Applicability of Transfer Pricing
Provisions
Transfer Pricing Provisions are applicable
irrespective of the fact whether income is
taxable or not and whether assessee is
enjoying 10A / 10AA / 10B benefits
�SAP India
�Aztec Software
�Oracle India
Use of External CUP Data for
comparability analysis
Nasscom Rates used for evaluation of
transfer pricing
�Aztec Software (Against)
� 3 Global
Way Forward
� Revenue Authorities becoming extremely stringent in protecting tax base
� Multinationals need to factor in Revenue Authorities’ stand in their business strategy in India
� Taxpayers need to bring out the true economic substance of the controlled transaction, the depiction of risks undertaken
Way Forward
the controlled transaction, the depiction of risks undertaken and other relevant documentation to discharge their burden of proof, under the Indian TPR
� Mechanical approach to TP with emphasis only on mere quantification analysis may not be sufficient to protect the taxpayer
CA Rajesh S Athavale, Partner
Thank You
CA Rajesh S Athavale, Partner
Vispi T. Patel & Associates
Chartered Accountants
#10, Dwarka Ashish, Jambul Wadi,
Opp. Edward Cinema, Kalbadevi Road,
Marine Lines, Mumbai – 400 002
Contact No.: +91 22 2208 7742/+91 99670 64422
Email: [email protected]