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** Ministry of Finance and Business Standard article dated 11 May 2013
On an average, TP adjustments are made on 54 percent of cases picked up for scrutiny
Impact may multiply with widening of definition of the term ‘International Transaction’ and application of Specified Domestic Transactions to domestic related party transactions
Implicit Assumption: Due to special relationship between related parties, high possibility of transfer price being different than the price that would have been agreed between the unrelated parties.
And such price charged between unrelated parties in uncontrolled conditions is referred to as the “arm’s length” price (ALP)
Computation of income from international transaction having regard to arm’s length price – Section 92
Any income arising from international transaction shall be computed having regard to the arm’s length price – Section 92(1)
It has been explained that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to an arm’s length price
Agreements / Arrangements towards cost allocations/ apportionments/ contributions in connection with benefit/ service / facility also covered under the TP regulations – Section 92(2)
Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation of the specified domestic transaction shall be computed having regard to the arm’s length price – Section 92(2A)
Transfer pricing provisions not to be applied in case determination of arm’s length price reduces the income chargeable to tax or increases the loss as the case may be – Section 92(3)
Purchase, sale or lease of tangible or intangible property; or
Provision of services; or
Lending or borrowing money; or
Any other transaction having a bearing on the profits, income, losses or assets of such enterprises; or
A mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises
Section 92A (1) of the Income-tax Act states as under :
Associated Enterprise in relation to other enterprise, means an enterprise-
Which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise; or
In respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.
The Legislative Intent – Domestic Tariff Area (‘DTA’) (3/4)
Particulars Co A Co B
Taxes in India 30% 30%
Sales to Related Party
Other Income 200 400
Purchase from RP -
Other Expenses 400 200
Profit/ Loss (100) 100
Tax - 30
Total Tax for the Group 30
Particulars Co A Co B
Taxes in India 30% 30%
Sales to Related Party
Other Income 200 400
Purchase from RP -
Other Expenses 400 200
Profit/ Loss (50) 50
Tax - 15
Total Tax for the Group 15
Scenario 1 Scenario 2
•By shifting of expenses from a loss making company to a profit making company, the group could reduce its tax liability for the current year, though the impact will be reversed in future years given carry forward of losses.•To avoid such tax arbitrage cases and even though there is no erosion of tax base, SDT has been introduced.
• 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 transactions exceeds INR 5 crores in a year
Fair Market Value (FMV) versus Arm’s Length Price (ALP)
Pre-amendment
Arm’s Length Price
Section 92 – International transactions between two or more associated enterprises (either or both of whom are non resident) to be at Arm’s Length Price
Section 40A(2) – Payments to relatives and associated concerns to be at fair market value in order to qualify as business expenditure
Section 80-IA – If goods and services transferred between the eligible units and any other units or vice-versa are not found to be at market value, then deduction to be recomputed
Section 10AA – If goods and services transferred between the eligible units and any other units or vice-versa are not found to be at market value, then deduction to be recomputed
Fair Market Value
Concept of Fair Market Value for Domestic related party transactions
Fair Market Value (FMV) versus Arm’s Length Price (ALP)
Post-amendment
Arm’s Length Price
Section 92(2) – Where in an international transaction or specified domestic transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm's length price of such benefit, service or facility, as the case may be. Section 92(2A) – Any allowance for an expenditure or interest or allocation of any cost or any income in relation to the specified domestic transaction shall be computed having regards to the arm’s length price
Concept of Arm’s Length Price for Domestic related party transactions
Persons covered under section 40A(2)(b) – Applicable in case of Individual assessee
“Relative” - in relation to an individual, the husband, wife, brother or sister or any lineal ascendant or descendant of that individual
“Substantial interest” - A person is deemed to have a substantial interest in a business or profession, if,—(a) in a case where the business or profession is carried on by a company, such person is the beneficial owner of shares carrying not less than 20% of voting power; and(b) in any other case, such person is, at any time during the previous year, beneficially entitled to not less than 20 % of profits
Circular No. 6-P, dated 6 July 1968 refers to direct and indirect relationship“Relative” - in relation to an individual, the husband, wife, brother or sister or any lineal ascendant or descendant of that individual
Domestic Transfer Pricing affecting tax holiday undertakings
Transactions to be reported in Accountant’s Report and arms’ length nature to be substantiated in the TP Documentation
Section Nature of undertaking covered
80IA Undertakings engaged in Developing, operating and maintaining, developing and operating and maintaining infrastructure
facilities Generation/ transmission or distribution of power Reconstruction / revival of power generating plants
80IB Undertakings located/ engaged in Industrially backward districts as notified Scientific research and development Refining mineral oil / commercial production of natural gas Operating cold chain facility for agricultural produce Processing, preservation and packing of meat / meat products or poultry / marine/dairy products Operating and maintaining a hospital of specified capacity
80IC Undertaking located in notified Centre/ Parks/ Areas in Sikkim Himachal Pradesh/ Uttaranchal North –Eastern states
80ID Undertaking engaged in business of hotel / convention centre in specified areas/ districts
10AA Undertakings having a Special Economic Zone unit
Issue 6 - How to benchmark Directors’ Remuneration?
Possible Benchmarking approaches
Limitations
•Ceilings provided in Companies Act, Central Government approvals, Listing agreement norms, DPE Guidelines, Shareholder and Board of Director resolutions, Remuneration Committee approvals
•Not applicable to private limited companies •Upper ceilings can be challenged by Revenue
•Peer review •Availability of reliable data may be a constraint
•Salary drawn elsewhere, simultaneously or previously
•Generally not available for promoter directors
•External publicly available salary data on HR websites
•Could be unreliable and difficult to obtain •May lead to cherry-picking
Issue 6 - How to benchmark Directors’ Remuneration?
Possible Benchmarking approaches
Limitations
•Comparison of ratio of Director’s remuneration to Total Cost (or Sales) with similar ratio for comparable companies
•No emphasis on individual capabilities of a Director •Limited comparable information on databases •Requires high degree of comparability with selected companies •No known correlation between remuneration and sales / cost of a company
•Subsumed under overall net profit based approach
•Cannot be applied for loss making companies Approach likely to be challenged by Revenue
•Qualitative analysis of educational qualifications, work experience, etc.
What does ‘close connection’ for Section - Reliance on Section 92A and Section 40A(2)(b)80IA(10) mean? - Indirect shareholding covered?
Whether all transactions with a closely connected - View 1 - All transactions to report & benchmarkperson included or only those resulting in more - View 2 - Only transactions resulting in morethan ordinary profits? than ordinary profits to report and benchmark
Whether TP applicable if expense not claimed? - Transaction to be reported, not benchmarked?
Whether SDT applicable for entities covered - Possible to take position that not covered forunder presumptive taxation rules? transactions covered under Section 40A(2)(b)
- Tax holiday units?
Whether transactions between two eligible units - Nothing expressly stated in the provisions(having differential exemption) covered? - ICAI Guidance Note mentions transfers
between ‘eligible’ and ‘non-eligible’ business?
Are free of cost goods/ services/ loans covered? - Should not be an issue under Section 40A(2)(b)- Tax holiday units?
An Uncontrolled transaction shall be comparable to international transactions if:
None of the differences between the transactions being compared or between the enterprises entering into such transactions are likely to materially affect the price, or cost charged, or profit arising from, such transactions in the open market; or
Reasonable accurate adjustments can be made to eliminate the material effects of such differences.
Practical Experience – Kind of adjustments asked for:
The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into :
Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.
Use of multiple year data considered useful to even out fluctuations caused by:
• Business cycles and
• Product life cycles e.g. : Seasonal sale of umbrellas
Multiple year data widely used due to non-availability of relevant year financial statements of comparable companies at the time of finalizing TP documentation
Practical Experience in Transfer Pricing audits:
• TPOs follow first leg of rule 10B(4), reject multiple year data
• Adopt only data relating to the relevant financial year and undertake adjustments (including the data which was not available at the time of filing of return)
Compares price charged for property/ service transferred in controlled transactions with price charged in comparable uncontrolled transactions i.e. related parties vis-à-vis unrelated parties
Requires strict / high level of comparability in products, contractual terms, economic terms, etc.
Most Direct Method for testing ALP and the Prices are Benchmarked
Conditions for use of CUP
• none of the differences between the transactions can materially affect price in the open market
• calls for adjustments to be made for differences which could materially affect the price in the open market e.g.:
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`
Transfer Price INR 75
Resale Price INR 100
Subsidiary Co
Parent Co
Unrelated Co. Y
Outside India
India
Compares the resale gross margin earned by associated enterprise with the resale gross margin earned by comparable independent distributors
An arms’ length gross margin should be sufficient for a reseller to cover its operating expenses and make an appropriate operating profit (in light of its functions and risks)
Under this method comparability is less dependent on strict product comparability and additional emphasis is on similarity of functions performed & risks assumed
Method used in case of purchase of goods or services from related parties for resale to unrelated parties without substantial value addition
Preferred method for a distributor buying purely finished goods from a group company (if no CUP available)
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
Direct cost & Indirect cost
of Production INR 30COGS INR 70
Outside India
India
Subsidiary Co
Parent Co
Unrelated Co. ZCompany Y
Method uses the costs incurred by the supplier of goods (or services) in a controlled transaction for goods or services provided to an related party
An appropriate cost plus mark-up is added to the above cost in light of the FAR Arm’s Length Price = Direct and Indirect Cost of Production (+) mark-up (based on benchmarking analysis) earned by comparables
Comparability under this method is not as much dependent on close physical similarity between the products
• Transactions which are not capable of being evaluated separately
• Analyzing tangible, intangible or services issues
• Parties are so interdependent and it is not possible to identify closely comparable transactions
Calculates the combined operating profit resulting from an inter-company transaction based on the relative value of each AEs contribution to the operating profit
The contribution made by each party is determined on the basis of a division of functions performed, valued, if possible using external comparable data
Broad level of product comparability and high level of functional comparability
The application of the TNMM to a specific tested party breaks down when factors other than transfer prices have a material impact upon profits
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 Profit Level Indicator (‘PLI’) 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
• Screen entities by applying appropriate quantitative filters, such as mfg sales <75%, R&D exp >5%, Advertisement exp >5%.
• Review financial and textual information available in the public database of the selected entities – for qualitative filters
Determination of arm’s length prices using methods
Whether you arrive at a single
price? The arithmetic mean of such prices or a price which varies from such arithmetic mean by +/- 3 % / 1 % is the arm’s length price
Yes No
Notification No. 30/2013 [ F. No. 500 / 185 /2011-FTD I ], dated 15 April 2013 For “wholesale traders”- band defined to be 1% For all others- band defined to be 3%
Whether tolerance band is available even when there is single price?
General Atlantic v/s. ACIT (Mum ITAT)– Held - ALP shall be taken to be in the range of +- 5% in case of more than one comparable prices and since there was only one comparable , the benefit under the said proviso would not be available
The Development Bank of Singapore (Mum ITAT) - Held, benefit of +-5% under the second proviso to section 92C is available even when only ‘one price’ determined as ALP;
The revenue / profits generated by a company are attributable to • Functions performed; • Assets deployed; and • Risks assumed
in its business operations
Functions performed
Assets employed
Characterization A functional analysis facilitates the characterization of related parties in respect of
a specific transaction taking into account their functions, assets and risks and assists in establishing a degree of comparability with similar transactions in uncontrolled conditions
To be obtained by every person entering into an international transaction and specified domestic transaction
To be filed by the due date for filing return of income (now e-filing mandatory)
Opinion whether prescribed documents have been maintained, the particulars in the report are “true and correct”
Relevant annexures and appendices be attached
Inputs: • Related party ledgers extracts
• Related party Schedule under AS-18
• Sample Invoices/ Vouchers / DN / CN
• Relevant intra-group agreements
• CUP information
Form No. 3CEB
[See rule 10E]
Report from an accountant to be furnished under section 92E relating to international transaction(s)
1. We have examined the accounts and records of ENTITY NAME AND POSTAL ADDRESS - PAN No. relating to the international transactions entered into by the assessee during the previous year ending on 31st March 2013.
2. In our opinion proper information and documents as are prescribed have been kept by the assessee in respect of the international transaction (s) entered into so far as appears from our examination of the records of the assessee.
3. The particulars required to be furnished under section 92E are given in the Annexure to this Form. In our opinion and to the best of our information and according to the explanations given to us, the particulars given in the Annexure are true and correct.
Typical allegations by Transfer Pricing Authorities
Assessee spends significant amount on AMP benefitting the AE by creating marketing intangibles without corresponding compensation/ reimbursement to the Assessee
Compare expense to sales ratio of taxpayer 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 AMP expense in excess of bright line – mark-up determined itself subjective
A recent ruling by Delhi Special Bench of ITAT now holds an important precedence value to justify department’s stand over AMP issue. Key points held by the ruling:
Approves the use of “Bright line test” to determine cost/ value of international transaction.
AMP expenditure to not include expenditure “in connection with” sales.
Disproportionately high AMP spend cannot justify AMP adjustment unless brand promotion for/ on behalf of the foreign AE exists.
Way forward – robust comparability analysis over 14-point comparability criteria, appeal and remand back proceedings for prior year disputes, APA for subsequent years
Payment of management recharges typically disallowed at lower levels on grounds related to failure to satisfy “need”, “benefit” and / or “evidence” tests
Basis of cost allocation scrutinized in detail Disallowances made on arbitrary basis – shareholders’ activity, duplicative etc. Most judicial precedents have stressed on importance of maintaining robust documentation
satisfying the need, benefit and evidence test for services received from the AEs
1. Royalty payment by an Indian entity to foreign AE acceptable. Commercial rationale/ business wisdom cannot be challenged by tax authorities - upheld in various Tax Rulings
2. Brand name/ Intangible property developed by Indian entity and used by the foreign AEs will also require royalty payout by the foreign AE
3. Emphasis on 3 key issues – (1) Need/benefit test; (2) Evidence of having received technical know-how; and (3) determination of arm’s length price
Points to be considered: Tax authorities may challenge royalty payment for current year incase same not paid in the
past years; Tangible benefit received / receivable and quantification of benefit – whether Royalty
embedded in price paid? Payments incurred towards brand royalty along with high AMP (e.g. AMP to popularize
foreign brand) – potential red flag and may lead to tax consequences; Increasingly viewed as a cash repatriation tool by tax officers; and Aggregation approach under TNMM – challenged
TP adjustments being made on account of under valuation of shares where Foreign parent has made investments in an Indian subsidiary
Typical FactsForeign parent company infuses share capital in the Indian
subsidiary (at face value or at certain value per share arrived using DCF or other valuation methodology)
The Revenue takes a position that the shares have been issued to the Holding Company at an undervalued price / less that the fair market value of the shares;
The TP adjustment carried out by the TPO is twofold:Difference between the actual issue price and the ALP
considered as notional incomeNotional interest computed by considering the difference
between the actual issue price and the ALP as loan
Foreign Holding Co.
Indian Wholly Owned
Subsidiary
In India
Outside India
Purchase of shares of Indian
Company
Share Valuation
No specific Indian TP regulations guidance for benchmarking of corporate guaranteesRevenue’s Perspective Insistence on arm’s length compensation for giving guarantee Ad-hoc adjustments made Shareholder/investor function vis-à-vis service Explicit vs Implicit guarantee Credit rating of subsidiary company vs credit rating of the Parent / affiliate company
While the end-result of establishing the “Arm’s Length Price” is divergent from Customs and Transfer Pricing perspective, the arguments to defend the proposed related price as arm’s length price is based on a common set of facts and information
It is essential to maintain the same set of facts and arguments before both authorities
Department of Revenue constituted a “Joint Working Group (JWG)”comprising senior officials from Income Tax and Customs Department to study the subject of Transfer Pricing under the respective Laws and suggest measures of co-operation between the two Departments
Implications Customs
Allegations of “ under-invoicing” if it can be established that the reported value is deliberately reduced to avoid paying additional Customs duties ;
Allegations of misrepresentation of facts/ fraudulent practices leading to possible confiscation of goods at Customs ports
Show Cause Notices alleging the facts presented to justify submissions made before GATT Valuation authorities is inappropriate, hence incremental Customs duty should be deposited with interest and penalty
Income Tax Act Transfer Pricing adjustment resulting in increase in taxable incomeWould trigger penal consequences if concealment of income deemed
The free movement of capital and labour, the shift of manufacturing bases from high-cost to low-cost locations, the gradual removal of trade barriers, technological and telecommunication developments as a result of Globalisation has opened up opportunities for MNEs to greatly minimise their tax burden
This has led to a tense situation in which citizens have become more sensitive to tax fairness issues. It has become a critical issue for all parties since:
• Governments are harmed – In developing countries, the lack of tax revenue leads to critical under-funding of public investment that could help promote economic growth
• Individual taxpayers are harmed – When tax rules permit businesses to reduce their tax burden by shifting their income away from jurisdictions where income producing activities are conducted, other taxpayers in that jurisdiction bear a greater share of burden
• Businesses are harmed – Fair competition is harmed by the distortions induced by BEPS
Digital economy - The spread of digital economy also poses challenges for international taxation.
• The digital economy is characterized by an unparalleled reliance on intangible assets, the massive use of data, the widespread use of multi-sided business models;
• Difficulty of determining the jurisdiction in which value creation occurs;
• This raises fundamental questions as to how enterprises in the digital economy add value and make their profits and how the digital economy relates to the concepts of source and residence or the characterization of income for tax purposes
• It is important to examine closely how enterprise of the digital economy add value and make their profits in order to determine whether and to what extent it may be necessary to adapt the current rules in order to take into account the specific features of that industry and to prevent BEPS
It also relates to arrangements that achieve no or low taxation by shifting profits away from the jurisdictions where the activities creating those profits take place
Taxation is at the core of countries sovereignty, but the interaction of domestic tax rules in some cases leads to gaps and frictions. The international standards have sought to address these frictions in a way that respects tax sovereignty, but gaps remain.
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 occur in the ‘Developing World’ (e.g.- India, China, Malaysia etc)
Location savings = net savings from difference of input cost (e.g. labour cost) in a specific location, compared to an alternative location or locations
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
Quantification and allocation of ‘location savings’ is a subject matter of controversy between tax payers and revenue authorities
Whether the entire cost difference after the transfer of functions / processes to low cost jurisdiction is ‘location savings’ i.e. how to quantify location savings ?
Even if ‘location savings’ is quantified, who is rightful owner of additional profits from location savings, the parent company or the overseas subsidiary (‘AE’) i.e. Attribution ?
Existence and allocation of ‘location savings’ depends upon the bargaining power of the parties
Assuming a certain value of location savings the allocation of gains between two parties depends on their relative bargaining power, which in turn depends on the goals,
resources and constraints on each of the parties.
What constitutes an appropriate allocation of location savings requires detailed analysis. Highly subjective.
Total cost savings in a lower-cost jurisdiction are sometimes offset by additional costs associated with relatively poor infrastructure in areas, such as power and telecoms, which reduce productivity.
In many cases location savings are passed on to customers in the form of lower prices and do not lead to higher profits. In such cases, simple before-and-after comparisons of costs could overestimate location savings.
It is not an easy task to quantify and allocate location savings.
• A careful evaluation of historical data (e.g. comparison of the unit level price), the FARs of both the parties, the product life cycle, the approach of the market players and the available alternatives etc. should be considered.
•First round of discussions already in process - experience satisfactory so far
•International TP experts have welcomed the collaborative approach of the Indian APA team
•Some cases are discussed at specific locations based on specific activities. E.g. IT / ITES activities will be primarily done by APA team in Bangalore
FAR
•The APA team has been laying strong emphasis on first establishing and mutually agreeing on detailed FAR – logical and sensible approach.
•Based on the FAR analysis, the economic analysis will be done followed by rounds of discussions and negotiations
Site Visit
s
•Site visits by the APA teams in progress (about 50 conducted) which are helpful in assessing the correct functional profile.
•To date the visits have been scheduled in consultation with the taxpayers and have been conducted in a cordial and un-intrusive manner.
Applicatio
ns
•Over 150 formal pre-filing APA applications were received as on March 31, 2013. 146 APA applications filed to date
•MNC giants from pharma, consumer electronics, media, cement, telecom, etc. have filed applications
•Currently no cases on PE attribution
Revenue perspective
•After the cadre restructuring (due later this year), the APA department would get additional manpower
•Due to sensitivity of business information highest level of confidentiality will be maintained
•The fact that cancellation of APA could be done only by CBDT is sufficient safeguard. APA will not be cancelled for any arbitrary reason
Unilateral APAs expected to be concluded in a time frame of 9-15 months
The shortfall in total value of shares, as alleged by the TPOs, has been considered as a TP adjustment and to this extent an addition has been made to the total income of Indian Company. [Primary TP]
Further, the TPOs alleged that since there was a shortfall in the consideration paid by the Foreign group entity, Indian company has not received the full amount it should have received from its Foreign group entity and the said shortfall actually resided with Foreign group entity. This shortfall therefore could be characterized as a loan advanced by Foreign group enity in favour of Indian Company, on which there should be an arm's length interest receivable in India by the Indian Company. [Secondary TP adjustment]
Excess AMP expenses incurred by the Indian Company enhances 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 with a mark-up
Tribunal accepting the contentions of TPO held that excessive AMP expense incurred by Indian company enhances the brand legally owned by the foreign AE
The amounts enhancing brand value should be paid by the foreign AE along with an arm’s length mark-up
Facts: Indian Company entered into a License Agreement with Foreign Company for manufacture
and sale of automobiles
Under the agreement, the Indian Company is under contractual obligation to use the joint trademark ‘Maruti Suzuki’ on all the vehicles as well as parts manufactured sold by it in India
Indian Company had incurred high expenditure on advertisement, marketing and distribution activity for developing the brand
Foreign Company did not compensate the Indian Company for developing the market intangibles
Issue:The Indian Company does not require any compensation for the use of logo / trademark of
the Foreign Company so long as the advertising, marketing expenses incurred by the domestic entity do not exceed the expenses incurred by the comparable independent Indian Company
In case, the expenses incurred by domestic entity are more than the expenses incurred by comparable independent domestic entity, the foreign AE needs, to suitably compensate the domestic entity, in respect of brand building and the advantage obtained by the foreign AE
Serdia Pharmaceuticals India Private Limited – (1/2)
Facts
Serdia a pharmaceutical company imported “Active Pharmaceutical Ingredient” (API) from its AE for manufacture of drugs.
Serdia imported API from its AE at prices higher than that paid for similar APIs by other companies
Serdia adopted Transactional Net Profit Margin (‘TNMM’) as the most appropriate method with operating profit of 8.76% and justified the arm’s length price.
TPO rejected TNMM and adopted the Comparable uncontrolled price (‘CUP’) method for benchmarking the international transaction of import of APIs
Serdia Pharmaceuticals India Private Limited – (2/2)
Issues Ruling
Sale price by AEs to third parties in other countries
Sale price in transaction between AEs and third party overseas customers cannot be compared to sales price between AEs and Serdia due to geographical differences and non availability of data
Acceptance of price by Customs Authorities
Acceptance of price by Customs Authorities does not imply that transactions are at arm’s length from transfer pricing perspective
Priority of methods for transfer pricing analysis
TPO can decline taxpayer’s selection of most appropriate method with cogent reasons-Traditional transactional methods (CUP,CPLM,RPM) are to be preferred over traditional profit based methods (PSM and TNMM)
Reliance on overseas judicial pronouncements
Though not binding, rationale and logic of said decisions may be relied upon
A non resident company holds shares in Indian Company
Non resident company transfers shares of Indian Company to US company without any consideration
Issues:
Whether capital gains is attracted ?
Are transfer pricing provisions applicable in the above transaction ?
Ruling :
AAR held that since the transaction was without any consideration , the computation mechanism for determining capital gain failed
Hence the transaction was not liable to capital gain tax in India
Further AAR also held that Section 92 was not independent charging section. As there was no income under the section 45 read with section 48, transfer pricing provisions were not applicable
US Company
Non Resident Company
Transfer of shares in Indian Company without consideration
No Income - Transfer Pricing provisions are not applicable
Facts: A Mauritius Company holds shares of an Indian Company It transfers the shares of Indian Company to the Singapore Group Company As per India Mauritius tax treaty, the above transfer of shares by Mauritius Company
to the Singapore Company is exempt from capital gains tax in India
Issue: Whether transfer pricing provisions are applicable even though transfer of shares is
exempt from capital gains in India?
Ruling: The above transfer of shares is not taxable in India by resorting to the beneficial
provisions of India – Mauritius Tax treaty. It was further held that non-chargeability to tax under the beneficial provisions of a tax
treaty does not absolve the applicant from filing the return of income under section 139 of the Act.
Accordingly, transfer pricing provisions would be applicable even though the transfer of shares is not chargeable to tax in India
No Income - Still Transfer Pricing provisions applicable
The information contained herein is of a general nature and is not intended to addressthe circumstances of any particular individual or entity. Although we endeavour to provideaccurate and timely information, there can be no guarantee that such information is accurateas of the date it is received or that it will continue to be accurate in the future. No one shouldact on such information without appropriate professional advice after a thorough examinationof the particular situation.