Transfer Pricing - 11062016 - SIRC · PDF file§ Transfer Pricing is the Price at which an ... Tax Jurisdictions in which a Multinational Company ... 65th percentile of the data values

Transfer Pricing

T.SaravananGroup Head – TaxationHyundai Motor India Ltd

Contents

§ Transfer Pricing Legislation

§ Transfer Pricing Study

§ Transfer Pricing Compliance Strategy

§ Transfer Pricing Assessment Issues

§ Dispute Resolution

Transfer Pricing Legislation

What is Transfer Pricing?§ Transfer Pricing is the Price at which an Enterprise transfers physical goods,

Intangibles or Provides Services to the Associated Enterprises

§ TP mechanism provides the conceptual frame work for pricing inter-companytransactions and ensuring an appropriate allocation of income between variousTax Jurisdictions in which a Multinational Company operates.

§ > 60 Countries have issued formal Rules regulating TP practices

Indian Transfer Pricing Regulation

§ Introduced with effect from 1st April 2001

§ Generally follows OECD guidelines

§ Key provisions Sec 92 – 92F of IT Act, Rule 10A to 10E and Penal Provisions Sec 271, 271 AA, 271BA, 271G

TP Legislation in IndiaEffective from Act Rules

1st April 2001 Sec 92 to 92 F substituted for Sec 92 Rules 10A to 10E inserted

1st April 2012 • Specified Domestic transactions brought under TP regulation- Insertion of Sec 92BA- Sec. 92(2A), 92C, 92D & 92E

amended

1st April 2014 • Transactions with resident non-AE deemed to be an international transaction – Sec 92B(2) amended

92 Computation of Income from International transaction having regard to ALP

92A Meaning of Associated Enterprises

92B Meaning of International transaction

92C Computation of arm’s length price

92D Maintenance and keeping of information and document by persons entering into an international transaction

92E Report from an accountant to be furnished by persons entering into international transaction

92F Definitions of certain terms relevant to computation of arm’s length price

10A Meaning of expressions used in computation of ALP

10B Determination of ALP u/s 92C

10C Most appropriate method

10D Information and documents to be kept and maintained u/s 92D

10E Report from an accountant required to be furnished u/s 92E

TP Legislation in IndiaEffective from Act Rules

1st April 2011 • Insertion of Rule 10AB - Other method of determination of ALP

Sep 2013 • Safe Harbour Rules- Inserted Sec 92CB w.r.e.f 1/4/2009

• 10TA to 10TG – International Txns• 10TH to 10THD –Specified

Domestic Transactions

July 2012 • Advance Pricing Agreement- Inserted Sec 92CC & 92CD

• Rollback Provision – w.e.f.1/10/2014

• 10F to 10T w.e.f 30/08/2012• 10MA & 10RA w.e.f 1/10/2014

1st April 2014 • Explanation to International transaction inserted with retrospective effect from 1/4/2001- Amendment of Sec 92BA (vi)

1st April 2015 • Threshold limit for Specified Domestic Transactions reduced from Rs.20 Cr to Rs.5 Cr

Key constituents in Transfer Pricing

TransferPricing

Sec 92 of the Act

Associated International Arm’s LengthEnterprises transactions Price

Sec 92A of the Act Sec 92B of the Act Sec 92C of the Act

7

An Enterprise which participates Directly / Indirectly through one or more Intermediaries

in the Management / Control / Capital of other Enterprise

Deemed Associated Enterprises-Sec 92A(2)

8

Existence of Common Control / Mutual Interest

>50% of Directors One / Two Exe.

Directors, Members of Governing Board

Common Executive Directors

Supply of rawmaterials

(90% or more)

Guarantees Not < 10% o

total borrowing

Loans Not < 51% of book value of

Assets

Complete Dependence on

IPR

Deemed Associated Enterprises

Not < 26% of Voting Power

Deemed Associated Enterprises-Sec 92B(2)

Associated Enterprise3rd Party

Assessee 3rd Party

Outside India

India

Pre amendment – Not a deemed international transaction

Post amendment – deemed Intl transaction

Prior agreement/Determination of Terms

Prior Agreement/ Determination of Terms

Pre Amendment : Only when the 3rd Party is non-resident – Deemed International transaction

Post-Amendment : Even when the 3rd Party is resident – Deemed International transaction

Specified Domestic Transactions – Sec 92BA

• Any of the specified transactions, not being any international transaction, namely- Expenditure in respect of which payment has been made to person

referred to in Section 40A(2)(b); - Transaction referred to in Section 80A;- Transfer of Goods or services referred to in sub-section(8) of

section 80-IA- Any business transacted between the assessee and other persons

as referred to in sub-section(10) of Section 80-IA- Any transaction referred to in any other sections under Chapter VI-A or Section 10AA, to which provisions of sub-section (8) or sub-section (10) of Section 80-IA are applicable

- Any other transaction as may be prescribed

Note : The provisions of SDT would be applicable if the aggregate value of the transaction exceedgs INR 20 Crore

ALP Calculation Methods – Sec 92C

11

Methods for the Computation of Arms length price

Transaction Based

Comparable Uncontrolled Price

Method(CUP) Resale Price

Method(RPM)Cost Plus

Method(CPM)

Profit Based

Profit Split Method (PSM)

Transactional Net margin

Method(TNMM)

No hierarchy of Methods is suggested by Indian TP Regulations

Other Method

CUP Method – Rule 10B(1)(a)• Usually considered the most appropriate method for all transactions.

• Compares the price charged in a controlled transaction with the price in an uncontrolled

transaction.

• Requires strict comparability in products, contractual terms, economic terms etc.,

Internal CUP

Internal Manufacturer

Non – Related party

Overseas AE

External CUP

Indian Manufacturer ‘X’

Overseas Manufacturer ‘Y’

- Unrelated

Resale Price Method – Rule 10B(1)(b)• Compares the resale gross margin earned by associated enterprise with the resale gross

margin earned by comparable independent distributors.

• An arm’s 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)

• Preferred method for a distributor buying purely finished goods from a group company (if

no CUP available), and reselling it without any value addition

Group Manufacturer (France)

Related distributor (India) Unrelated Wholesalers$75 $100

Actual resale price earned by Indian distributor from sale of group company products to unrelated enterprises (A)

100

Less: Comparable gross profit ( GP ratio 15%) (B) 15

Cost of Sales C=(A-B) 85

Less: Expenses related to the purchase from group companies (D) 8

ALP for products procured from group companies during the year (C+D-E) 77

The arm’s length price is $77, where as Indian distributor has paid $75.

$

Cost Plus Method – Rule 10B(1)(c)

• Compares the gross profit on costs that associated enterprise earns with the gross profit

on costs earned by comparable independent companies.

• Preferred method for :

v Manufacturer supplying semi-finished / finished goods.

v Company providing services.

Indian Co. providing services

Related Manufacturer –B (US) US Market

Cost + 40%

Direct and Indirect cost of production incurred by Indian Co (A) 100

Add: Comparable gross profit margin @ 20% (B) 20

ALP for products sold to AEs during the year (A+B) 120

Profit Split Method – Rule 10B(1)(d)

• Appropriate for transactions which are not capable of being evaluated separately.

• Calculates the combined operating profit resulting from a whole inter – company

transaction based on the relative value of each associated enterprise’s 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.

• Applicable for analyzing tangible, intangible or services issues.

Transactional Net Margin Method – Rule 10B(1)(e)

• Examines net operating profit from transactions as a percentage of a certain base (can use

different bases i.e. costs, turnover etc.,) in respect of similar parties.

• Ideally, operating margin should be compared to operating margin earned by same

enterprise on uncontrolled transaction.

• Can compare to “ comparable transactions” between independent parties.

• Applicable for any type of transaction and often used to supplement analysis under the

methods.

• Most frequently used method in India, due to lack of availability of comparable

uncontrolled prices and gross margin data required for application of the comparable

uncontrolled price method / cost plus method / resale price method.

Typical Transactions

Tangible Intangible

Imports

Raw Material

Capital Goods

Exports

Finished Goods

Raw Material

Loan

Supplier’s credit

Royalty

Know-how

Use of brand

Service

Training

FTS

Loan

Guarantee

Tolerance LimitEffective

Date/Section Provision Effect

1.4.2001

92C(2) - proviso

Where more than one price is determined by the MAM, the ALP shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding 5% of such arithmetical mean

Adjustment is made only to the excess paid over (ALP+5%) or short received under (ALP – 5%)

1.10.2009

92C(2) – second proviso

If the variation between the ALP so determined and price at which the international transaction has actually been undertaken does not exceed 5% of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm’s length price

ALP shall not exceed 105% of Transfer Price paid or 95% of Transfer Price received

1.4.2011


If the variation between the ALP so determined & price at which the international transaction has actually been undertaken does not exceed such percentage of the latter, as may be notified by the Central Government in the Official Gazette in this behalf, the price at which the international transaction has actually been undertaken shall be deemed to the arm’s length price

Notified percentage : 5%

ALP shall not exceed 105% of Transfer Price paid or 95% of Transfer Price received

Tolerance LimitEffective


1.4.2012


If the variation between the ALP so determined and price at which the international transaction or specified domestic transaction has actually been undertaken does not exceed such percentage not exceeding three per cent of the latter, as may be notified by the Central Government in the Official Gazette in this behalf, the price at which the international transaction or specified domestic transaction has actually been undertaken shall be deemed to be the arm's length price:

Notified percentage : -Wholesale Trading : 1%-Other cases : 3%

Adjustment is made if the difference between Transfer Price & ALP is not within +/- (3%/1%)

1.4.2014

92C(2) – third proviso

Where more than one price is determined by the most appropriate method, the arm’s length price in relation to an international transaction or specified domestic transaction undertaken on or after the 1st day of April 2014, shall be computed in such manner as may be prescribed and accordingly the first and second proviso shall not apply

Use of multiple year data and range concept introduced

Comparability Analysis & Determination of ALP

Step Activity What is to be done

1 Selection of Comparable • To select comparable by applying quantitative and qualitative filters on current year data(if available) or immediately preceding financial year data.

• For CUP,PSM and the other method, only current year data will be used for selection of comparables

2 Data to be used for ALP determination

• Weighted average of the 3 years data or less would be used.

3 ALP Determination • If the comparables are 6 or more & the method used is CUP, CPM,RSM or TNMM, ALP shall be determined based on 35th to 65th percentile of the data values in the comparable set.- if the transfer price falls within the range, such transfer price

shall be regarded as ALP. - If it does not fall within the range, the median of the dataset

shall be regarded as ALP of the related party transaction.

• If the comparables are less than 6 or the method used is PSM or other method, the arithmetic mean shall be applied along with +/- 3% variation for determining ALP

# Refer Notification dated 19th October 2015

Rule 10 CA

Reference to TPO – Sec 92CAEffective


1.6.2002

Insertion of Sec.92CA

AO with the previous approval from Commissioner refer the computation of ALP in relation to the said International transactions to TPO

Only when AO considers it necessary or expedient so to do, refer the matter to TPO

1.6.2011

Insertion of Sub section (2A)

Where any other international transaction other than an international transaction referred u/s 92CA(1), comes to the notice of TPO during the course of the proceedings before him, the provisions of this chapter shall apply as if such other international transaction is an international transaction referred to him u/s 92CA(1) To nullify the appeals filed

by the assessee pointing out that TPO has acted beyond his power.

w.r.e.f. 1.6.2002

Insertion of Sub section (2B)

Where in respect of an international transaction, the assessee has not furnished the report under section 92E and such transaction comes to the notice of the TPO during the course of the proceeding before him, the provisions of this Chapter shall apply as if such transaction is an international transaction referred to him u/s 92CA(1)

Reference to TPO – Sec 92CAEffective


1.7.2012

Insertion of sub section (2C)

Nothing contained in sub-section (2B) shall empower the AO either to assess or reassess u/s 147 or pass an order enhancing the assessment or reducing a refund already made or othewise increasing the liability of the assessee u/s 154 , for any assessment year, proceedings for which have been completed before the 1st day of July,2012

To avoid coercive action from AO due to introduction of sub-section (2B) with retrospective effect.

Transfer Pricing Study

Step 1 Information Gathering & Functional Analysis

• Identify the TP issues• Obtained information

required for Functional Analysis

• Obtain information required to perform an Economic Analysis

Information Gathering

Methods used

• Questionnaries• Interviews with Company Personnel• Business data and market

intelligence web sites and databases• Audit files and industry reports

Functional Analysis

General Company & Industry information including• Organisational structure• Company history• Industry overview• Specific economic conditions

Intercompany transactions

• Products,Services,intangibles or financing involved

• Entities involved• Functions undertaken by each entity• Risks borne by each entity• Potential CUPs, if any

Step 2 Economic Analysis

Objective• To conduct an analysis that tests and supports the arm’s

length nature of the relevant intercompany transactions

Steps• Identify transactions to test• Select method of analysis (CUP,RPM,CPM etc)• Financial Analysis of comparables to determine arm’s length

range of results• Comparison of data collected to comparables using selected

pricing method

Step 2 Economic Analysis

Steps in arriving at an arm’s length priceStep 1

Generation of a first list of companies through the available databases

Step 2

Undertaking acceptation/rejection process

Step 3

List of comparable companies with their respective financial data

Step 4

Performing economic analysis including adjustments

Step 5

Arriving at an arm’s length Price

Factors for judging comparability:1) Nature of transactions2) Company functions3) Risks assumed4) Contractual terms5) Economic & Market

conditions

Step 3 Documentation – Sec 92D & Rule 10D

Type Nature Remarks

Entity related • Profile of industry• Profile of group• Profile of Indian entity• Profile of AEs

• Contemporaneous documentation-Rule 10D(4)

• To be retained for 8 years from the end of relevant assessment year – Rule 10D(5)

• No need to maintain documents if the aggregate value of all international transactions does not exceed Rs.1 Crore –Rule 10D(2)

Price related • Transaction terms• Functional analysis (FAR)• Economic Analysis (method

selection, Comparable benchmarking)

• Forecasts, budgets, estimates

Transaction related • Agreements• Invoices• Pricing related

correspondence (letter,emails etc)

Challenges in Assessment proceedings

••

(A) Maintain Contemporaneous data / price setting / negotiation

(B) Year end documentation summarizing the outcome

( C) TP Audit defense

Taxpayers manage (B) but fail to maintain (A) !!

This results in:• Surprise at the time of

assessment• Possibility of not being

able to provide appropriate information, thus weakening TP defense strategy

• Potential TP adjustment• Revenue authorities

concluding the case in ad-hoc manner, in absence of required information.

28

Adequate back-up documentation to be maintained, which justifies the basis on

which price setting has been done

Indian TP Process

TP Study Functional Analysis & Information collection Economic Analysis

Documentation & Implementation

(Sec 92D; Rule 10D)

Identification of Associated Enterprises CA’s Certificate

(Sec 92E; Rule 10E)

Conditions for AE

(Sec 92A)

Presence of International Transaaction

(Sec 92B)

Analysis of Functions performed

Compliance of TP

Regulations

Most Appropriate Method

(Rule 10C)

Comparable Data (Uncontrolled transactions)

Arm’s LenthPrice (Sec 92C)

Compare with Transfer price

As per Regulati

on

Obtained in Form

3CEB

Filing the Form

Deviation in the

Assessment

Assessment Completed

TP Regulations

(Sec 92 ~ 92F)

CUP

Determination of Arm’s Length Price – Rule 10B

RPM CPM

PSM TNMM Other

TP Regulation Do not apply

NO

NO NO

NO

Not satisfied

PenaltyYes

NO

Not maintained

Transfer Pricing Compliance Strategy

• Existing TP Strategy followed by majority taxpayers:

‒ Aggregation of international transactions for benchmarking such as• Import of raw materials;• Import of capital goods;• Export of finished goods;• Payment of royalty;• Payment of management services fees, etc.

‒ Identifying external comparables from public databases

‒ Comparing the profits earned at enterprise level with the arithmetic mean of profits earned by comparables

‒ TNMM being the most popular Transfer Pricing method

Before entering into transaction After the time of entering into transaction After entering into transaction

• Detailed documentation of terms and conditions

• Price setting mechanism in case of imports: evaluation of policy for Group Companies vis-à-vis pricing policy followed for third parties

• Evaluation of prices charged by AE’s to third parties and evaluation of third party supplies

• Compliance roadmap – compliance with other laws ( e.g. customs etc.)

• Agreement for ‘long – term supply arrangements’

• Adherence to the terms decided

• Adherence to pricing policies

• Price negotiations correspondence attached with invoice / PO

• Clear definition of functions and risks of each of the transaction party

• Analysing similar transaction, if any

• Review of Budget vs. Actual

• Review of margins through external benchmarking

• Re- nogotiations, price escalations, changes in terms of sale / purchase etc. to be documented

• Check price of raw materials against price declared in customs database – TIPS software

• Year – end TP Documentation

TPO’s prefer CUP method over TNMM method

Import of raw material / consumables

Before entering into a transaction

At the time of entering into a transaction

After entering into a transaction

• Detailed documentation of terms and conditions

• Price setting mechanism in case of exports

• Evaluation of prices charged to AEs and evaluation of sales to third party

• Agreements for ‘long-term supply arrangements’

• Adherence to the terms decided

• Adherence to pricing policies

• Price negotiations correspondence attached with invoice / PO

• Clear definition of functions and risks of each of the transacting party

• Analysing similar transaction, if any

• Review of Budget vs. Actual

• Review of margins through external benchmarking

• Re-negotiations, price escalations, changes in terms of sale/ purchase etc. to be documented

• Year- end TP documentation

Export of Finished Goods

Defense strategy Trading Activity – Import of Goods




• Margins earned by AEs on goods exported to taxpayer – whether comparable to third party sale?

• Analysing mark –up earned by distributors of similar goods in India

• Determination of functions, Assets and risks i.e. full fledged distributor or limited risk distributor etc.

• Determined based on functions who undertakes significant people function with respect to advertising, marketing and distribution

• Relevant extract of “Standard Pricing List” of AEs

• Invoicing, POs and other back-up documents

• SVB valuation to be preserved and to be consistent with price setting analysis

• Evaluating the need for re-negotiating mark up

• Year end TP documentation

Trading Activity – Import of Goods

Defense strategy Sales Agency Commission




• Determining price – setting mechanism - “percentage of sales” or “cost-plus” based on evaluation of functional and risk profile

• Negotiations relating to commission percentages

• Evaluation of PE exposure

• “Dos” and “Don’ts” to be documented

• Adherence to mutually agreed terms

• Evidence of negotiations/ communication with the third party customer

• Evidence of negotiations/ communication with the AEs

• Elaborative computation of sales commission

• “DOs” and “DON’ts” to be followed

• Analysing profitability from sales agency activities, especially under “percentage of sales” mechanism

• Evaluating the need for revisiting commission percentages

• Adherence to and Documentation of “DOs” and “DON’Ts”

• Year end TP Documentation

Sales Agency Commission

• Management Service Fee charged by AEs are investigated by Tax Authorities in great detail

• “Benefits Test” – enquiry into nature and value of benefits received by taxpayer as a result of availing Management Service Fees

• Inability to satisfy the “benefits test” – the arm’s length value determined at a substantially lower amount and in some cases even as NIL

• Tax Authorities also enquire into whether a similar charge is levied on other group entities and rates thereof are also called for and examined

Management Service Fees

Charge directly to those affiliates

Retain those costs or charge to parent

Retain costs or charge to owner of intangibles

Yes

Yes

Yes

No

No

No

Review treatment based on exact circumstances

Charge to affiliates using appropriate allocation method

Confirm balance of costs are for

affiliates generally

Are any services done for specific

affiliates?

Are any costs

incurred on behalf of

shareholder?

Are any costs

incurred to develop

intangibles?

Are any of the costs

for acquisition of new

business?

Yes

No

Management Service Fees – Flow chart analyzing need for charging costs

Management Service Fees - Documentation

Invoice

Service Agreement Cost allocation

calculations

Policy document with:• Functional analysis (Benefit Test) • Justification of allocation keys• Rationale for mark-up

Audit statement confirming invoice in line with policy

document Benchmark of mark up

Management fee to be corroborated at TNMM level

Service Agreement Cost allocation

calculations

Invoice

Policy document with:• Functional analysis (Benefit Test) • Justification of allocation keys• Rationale for mark-up

Audit statement confirming invoice in line with policy document

Benchmark of mark up




• Royalty agreement to be entered into

• Rationale of entering into royalty agreement

• Evaluating group policy for royalty transactions

• Determining the arm’s length royalty rate using databases such as RoyaltyStat, Lexis-Nexis etc.

• Clear documentation of benefits received on account of the use of technical know-how / brand name

• Computation of royalty as per agreement to be kept on record

• Collating documents evidencing benefits received during the year

Royalty

39

• In respect of reimbursement / recovery of expenses paid to AEs

• Not in the nature of any chargeable services

• To confirm whether these are charged without any mark-up

• Back up of adequate third party invoices

Other transactions

Transfer Pricing Assessment Issues

Low margin situation : Case Study

Particulars Data flag INR in Crores

Total Sales A 500

Cost of goods sold

- AE transaction B 50

- Non AE transaction C 250

Other operating costs D 162.5

Total costs E = B + C + D 462.5

Operating profit (OP) F = A – E 37.5

Operating margin (OP / Sales) G = F / A 7.5%

Operating margins of comparables (determined by taxpayer) H 7%

Operating margins of comparables (determined by TPO) I 14%

TP adjustment proposed ( A * I ) – F 32.50

• Adjustment made to the overall costs or revenues based on the differential profit level indicator• Entire revenue is exposed to adjustment irrespective of the value of international transaction

• In the instant case while benchmarking the international transaction of 50 Crores (i.e. 1/10th of the total turnover),the entire turnover is exposed to TP adjustment

• Department is of the view that if aggregating is done, adjustment can be made to Non-AE price as well as itsmarket price and can’t be altered else the entire comparability basis of TP is gone

v Brand FeeIssue Brand Building services are done by the company in India

Impact Notional income attribution for Brand Promotion

Department View Industry View

Brand name belong to foreign companyand for its benefits

Indian company is the economic owner ofbrand name and uses it for its own benefits

Deeming rendition of brand buildingservice is valid

Advertisement expenditure incurred byIndian Company is for the brandpromotion only

Expenditure incurred on advertisement is forproduct specific & product promotion only. Itis apparent that in any advertisement theproduct occupy more space than the brand

Incremental Brand value on aproportionate basis is attributable

Incremental Brand value is not an income andis an asset. Brand Building is a benefit whichhas been accumulated and can only bederived at the time of liquidation or transfer ofproperty. Notional value shall not beattributed

v AMP ExpenditureIssue Adoption of Bright Line Test

Impact Excess Expenditure is disallowed


AMP expenditure is an internationaltransaction subject to transfer pricingregulations

AMP expenditure paid to unrelated partiesdoes not come under internationaltransaction as per section 92B of the IncomeTax Act 1961

Excess AMP by applying Bright Line Testis treated as Brand Promotion expenses

AMP expenditure is incurred on own account– Benefit if any to Foreign company is purelyincidental

AMP expenditure of other companies canbe taken as comparables

AMP expenditure of functionally comparablecompanies can only be considered.

Disallowance of excess AMP & Attributionof Brand Fee on notional brand value ispossible

Double whammy - one in attribution ofnotional income as brand fee and another indisallowance of AMP expenditure

v Royalty

Issues1) Royalty/sales ratio compared with comparable companies2) Artificially Bifurcating composite Royalty into

“Technology”/”Brand Royalty”

Impact 1) Royalty Disallowance2) Treating Brand Royalty not payable


Disregarding the royalty expenses underaggregation of transactions

Transactions are inextricably linked. Henceaggregation is allowed & can be tested underTNMM Method, since Technology is unique

Companies having related partytransactions are considered forcomparison

Companies having related party transactionsshould not be considered for comparison.Foreign Comparables can be consideredLimits specified under Governmentregulations can be taken as CUP – As perOECD GuidelinesLimits specified under Government

Regulations can not be taken as CUP

Artificial bifurcation of Technology/BrandRoyalty is permitted under TP Law

Composite royalty agreements should bebenchmarked using TNMM Method only astype/extent of technology imported by eachcompany is unique. Rendering other methodslike CUP inappropriate.

v Corporate Guarantee

Issues 1) Guarantee fees for “Corporate Guarantee” for foreign acquisitions

Impact 1) Taxation of notional income in hands of Indian company


Indian entity is engaged in “business ofproviding Corporate Guarantee” in thecourse of its normal business

Indian company is not engaged in business ofproviding “Corporate Guarantee”. Its moreaction for oneself (i.e. shareholder’s activity)

Indian company can be compared withthe banking company

Banking companies are providing “Guarantee”in normal course of business which is notcorporate guarantee.Indian company wants to expand its footholdand want to become Global hence providing“Corporate Guarantee” unlike for servicerevenue.

Disregarding the fact that CorporateGuarantee is provided as “Parent” or“Flag Bearer Company” in the group for“Group’s expansion” – Its shareholdersactivityDisregarding the fact that providing“corporate guarantee” and “performanceguarantee” are different.

Corporate Guarantee is shareholder’s activityas against performance guarantee which isservice activity.

v Granting of loan to Foreign subsidiary AE

Issues 1) Rate of interest for loans granted to foreign subsidiaries

Impact 1) Adopting hypothetical and impracticable rate of interest for loans granted to foreign AEs


Rate of interest on loan granted in foreigncurrency and in INR remains same.

Rate on loan varies with country and baserate (Libor/ Euribor/ Sibor). INR rate andforeign currency rate will be highly differentdue to “interest rate parity theory.

Indian company should charge “rateprevalent in India” on loan granted toforeign AEs

Rate of interest depends upon many factorslike, GDP, inflation, current a/c. capital a/c.deficit, monetary policy, etc of borrowercountry.Commercial rational are completely ignored.Regulatory frameworks behind - “Participataryloan” or “Capital contribution” are ignored

Each and every loan is equal and foreignAE should be charged interest thereon.

If no separate credit rating then highestpossible rate is applied

Credit rating is complicated exercise anddepends upon the nature of activities andcustomers, shareholder, etc and completedetachment to Indian owner is not possible.Which need to be recognized..

v Comparative TP Regulations/Practices- Intangibles

Country

Detailed guideline

savailable

Acceptable ALP

methods specified?

APA available? Audit Risk Judicial

Decisions

Inter quartile

range

U.S.A Yes Yes Yes High Several Yes

Netherlands No No Yes High Few Yes

U.K. Yes Yes Yes High Few Yes

Germany Yes Yes Yes High Few Yes

France Yes Yes Yes High Several Yes

Japan Yes Yes Yes Medium-High Several Yes

Singapore No No Yes Medium Few Yes

India No No No High Very Few No

v Other IssuesIssue Industry view

Rejecting company as comparable since the company has reported loss in the relevant year

Loss making companies should be included in the set of comparable. Loss makers are part of the industry and excluding them would result in a biased comparability.

Non - Acceptance of valuation by Special Valuation Branch under Customs Act as ALP

When the valuation is done by another Government agency, it should be taken as ALP

Comparable companies having less than 25% of related party transactions of its total revenue can be taken as comparable

Normally an entity can be taken as uncontrolled for transfer pricing purpose if its related party transaction does not exceed 10 to 15% of its total revenue

TPO consider different comparables by calling information u/s 133(6) which is not available in public domain.

Specific guidelines for finding/accepting/rejecting comparable should be common and to be standardized

Adjustment for functional differences between tested party and comparable companies

Reasonable adjustments should be allowed to bring down the differences between the two. It should be allowed in tested party due to lack of availability of comparable company in public domain.

v Other IssuesIssue Industry view

No distinction between business support IT service carried out by manufacturing concern and similar service provided by a pure IT service provider while comparing the transactions

Standard margin applicable to IT industry should not be applied for business support services carried out by Manufacturing concern

Rates prescribed under Safe Harbour Rules are at higher level To revisit and rationalise the rates

TP adjustments are carried out by TPO on total transactions without restricting only to AE transactions when TNMM is applied.

When the cost base, consists of AE as well as Non AE transactions, adjustment should only happen to the value of international transaction on pro-rata basis and not to the entire profitability of the company

Expenses disallowed in normal computation of income should be allowed to be reduced from operating expenses while calculating PLI in TNMM

Disallowed expenditure under Income-tax Act should be considered as expenses while calculating PLI to avoid double taxation

v Other IssuesIssue Industry View

Exclusive bench at ITAT to handle TP Appeals are not available. TP appeals are considered as time consuming appeal and postponed indefinitely causing undue delay in resolving issues

Exclusive bench to be available at all major ITAT to handle TP appeals. Like tax bench is there in High Court, TP bench should be there to understand the complexities of TP issues better.

No timeline provided for CIT(A) to completeappeal & pass order

Specific time line as in case of AO/DRP should be provided . Further CIT(A) should be exclusively available for TP appeals

OECD Guidelines – Indian contextRef Details Applicability Acceptability by

TP Authorities

Para 1.55

Effect of Government interventions such as price controls and controls over payment of royalties must be taken into account while evaluating the transfer price

Royalty payments made in line with FEMA Regulations

No

Para 1.42 ~ 1.44

Where the transactions are interrelated and interlinked, the transactions can be aggregated to determine the ALP

Adoption of TNMM method at the entity level including all transactions relating to Manufacturing

Yes

Para 7.13

AE should not be considered to receive an intra-group service when it obtains incidental benefits attributable solely to its being part of a larger concern, and not to any specific activity being performed

Attribution of notional income for brand promotion

No

Dispute Resolution

Approach of TPO• Mindset is generally revenue biased

• Significant proportion of cases audited face adjustment; -Approach of TPO/DRP is generally aggressive to strengthen the case for Revenue in further litigation

• Every year is audited on a stand alone basis; therefore, the Company is very likely to face TP audit every year and to defend the same positions on a repeated basis

• Increasing trend of TPOs seeking a variety of information including those pertaining to foreign AEs, that too during the last moments of the tax hearings. This makes information collation and timely compliance during audit difficult

• Litigation could take at least 7 to 9 years in respect of each year under TP audit before it is treated as concluded

• Penalty exposure – 100% to 300% of tax exposure; Interest at 12% per annum on the shortfall between assessed taxes and taxes paid

Transfer Pricing Litigation Scenario

• Eleven years of TP audit completed –trends indicate greater scrutiny, ever increasing adjustments and resultant litigation

• Approximately 50% of cases picked up for audit adjusted by tax department

• Trend of transfer pricing adjustment:

SC

23,649

HC

93,384

ITAT

348,181

No. of cases pending in Appeal

Safe Harbour Rules

Background• Law introduced in India in Finance (No.2) Act, 2009

• Rangachary Committee set up to recommend Safe Harbour Rules for a number

of sectors.

• Draft Rules, released by Central Board of Direct Taxes in August 2013, are

based on the Committee’s report.

• Consultative approach adopted by the Government in finalizing rules – certain

changes were made based on stakeholders comments.

• Final rules have been notified in September 2013.

• Provide that the transfer price declared by the “eligible taxpayer” in respect of

“eligible transaction”, shall be accepted by tax authorities in specified

circumstances

Details (1/2)Nature of international

TransactionCondition Safe Harbour operating margin

on operating expenses

• Software development services with insignificant risk.

• IT enabled services with insignificant risk.

• Aggregate value of transactions does not exceed Rs.500 crores(Approx USD 75 Mn)

• Aggregate value of transactions exceeds Rs.500 crores (ApproxUSD 75 Mn)

• Not less than 20 per cent

• Not less than 22 per cent

• Knowledge Process Outsourcing (KPO) services with insignificant risk

• No turnover threshold • Not less than 25 per cent

• Contract R&D services (wholly or partly), with insignificant risk, relating to- Software development- Generic pharma drugs

• No turnover threshold

• Not less than 30 per cent• Not less than 29 percent

• Manufacture and export of- Core auto components- Non-core auto component

• 90 per cent or more of total turnover are in nature of Original Equipment Manufacturer sales

• Not less than 12 per cent• Not less than 8.5 percent

Details - (2/2)Nature of international

TransactionCondition Safe Harbour operating margin

on operating expenses

• Advancing intra-group loan

• To wholly owned non-resident subsidiary.

• Loan sourced in Indian Rupees.• Excludes loans by enterprises engaged

in lending or borrowing in the normal course of business.

Interest rate is not less than base rate of SBI as on 30th June of the relevant previous year plus• 150 basis points [where

amount of loan does not exceed Rs. 50 crores (approxUSD 7.5 Mn)].

• 300 basis points [where amount of loan exceeds Rs.50 crores (approx USD 7.5 Mn)]

• Providing explicit corporate guarantee

• On behalf of wholly owned non-resident Subsidiary

• Amount of guarantee does not exceed Rs.100 crores (Approx USD 15 Mn)

• Amount of guarantee exceeding Rs.100 crores ((Approx USD 15 Mn)) and the credit rating of the borrowing AE done by an agency registered with SEBI is of adequate to highest safety.

• excludes performance guarantees and letters of comfort

• Commission or fee at the rate of not less than 2 per cent per annum on the amount guaranteed.

• Commission or fee at the rate of not less than 1.75 per cent per annum on the amount guaranteed.

Procedure• For exercising the safe harbour option, a taxpayer would need to furnish Form 3CEFA on

or before the due date for furnishing return of income for the relevant year (in case

option is exercised for one year) or for the first year (in case option is exercised for

more than one year).

• A validly exercised safe harbour option will continue to remain in force for a period of 5

years or period opted by the taxpayer (in Form 3CEFA), whichever is less.

File Form3CEFA

Tax Officermight

refer the matter to

TPO ifneeded

Pass anorder

regardingacceptenc

e orrejectionwithin 2months

Deemedto be

considered as

accepted,if no orderis passedwithin 2months

If eligibility is not

accepted,Taxpayerhas to fileobjections

withCommissi

onerwithin 15

days

Commissioner

passes hisorder

within 2months

Advance Pricing Agreements

Advance Pricing Agreement (APA)

v APA is an agreement between the Taxpayer and CBDT for determining the Arm’s Length Price (ALP) or for specifying the manner of determination of ALP in respect of International transaction / s covered.

v APA is not available for domestic controlled transactions

Types

APA

MultilateralBilateralUnilateral

One Country –Taxpayer and Tax Authority of host Country

Two Countries –Taxpayer, Tax Authority of host Country and

Foreign Tax Authority

More than two Countries –Taxpayer, Tax Authority of host Country and Multiple Foreign Tax Authorities

v One sided APA

v It is binding only on the taxpayer

v Double taxation not eliminated

v Can be opted only if DTAA contains Article 9(2).

v Conversion of unilateral to bilateral / multilateral is possible before finalizing APA.

v High time and cost involved

v Cost benefit analysis play a crucial role here

v applicable in cost sharing / profit sharing arrangement involving more than 2 parties from different countries

Period covered under APA

Filing Fees

Rollback APA

v Form 3CEDAv Available ≤4 FY (preceding the first FY of the

APA applied period). v Available for any / all transaction covered in

main APA applicationv Determination of ALP / TP methodology will be

similar to main APA.v Rollback is not available if:

Ø ITAT disposed off before signing of APA.Ø The APA has the effect of reducing Total

Income or increasing the Loss.

v Application 3CEDv For existing transactions, to be filed before the

first day of the relevant financial year (Ex: for FY 2017-18, application should be filed before 01-04-2017)

v For new transactions, filing to be done before commencing the transaction

v Valid ≤5 consecutive years.v Pre – filing application has to be filed in Form –

3CEC.It may be Anonymous.v Binding on Applicant and income tax authorities in

respect of applicant

Amount of International Transaction INR in Lacs

not exceeding INR 100 Cr. 10

Not exceeding INR 200 Cr. 15

exceeding INR 200 Cr. 20

APA

Roll back Rs. 5 Lacs

FY 2013-14

FY 2014-15

FY 2015-16

FY 2016-17

FY

2018-19

FY

2019-20

FY

2020-21

FY

2021-22FY

2017-18

1st FY for which APA applied for4 years 5 years (incl. 1st FY APA applied for)

Phase

Activity

I

Feasibility study Pre-filing consultation

v Review / analysis of global TP policy

v Intl. Transactions to be covered / not to be covered

v Analysis of information required / ability to provide

v Cost benefit analysis

v Risk of sharing confidential information

v Filing (Form 3CEC)

v Anonymous filing is optional

v Pre-filing meeting

v Issuance of letter of understanding

v Filing of APA application [Form No.3CED]

v Frequent interaction/ meetings with APA team by means of questionnaires

v filing of response to questionnaire

v Site visit by officers

v Interaction with the key management personnel

v Detailed understanding of entities involved and transaction under APA

v Discussion on most appropriate method, mark-up percentage

v Finalization of pricing approach including mark-up percentage

v Conclusion/signing of the agreement

v Annual Compliance report to be filed

v Compliance/ monitoring of the APA in lines with the Rules notified

v Compliance audit by TPO.

2 3 4 5 6

Finalizing and signing an APA

Formal APA application filing

Post-filing meetings/ negotiations

Annual compliance/ monitoring

Internal (Optional)

With the Indian Tax authority (Mandatory)Process

Benefits of APAAn APA provides the following benefits: • Ensures certainty of TP methodology and approach for future years

• Provides flexibility in developing practical approaches for complex TP issues

• Reduces the incidence of double taxation in bilateral APA

• Certainty with respect to tax outcome of the taxpayer’s international transactions

• Removal of an audit threat (minimize rigors of audit), and deliverance of a particular tax outcome based on the terms of the agreement

• Resolves potential litigation on existing disputes through roll back

• Cuts down the costs associated with audit defense, litigation and document preparation

• Reduces the year-on year transfer pricing compliance requirements

• Enables the management to Focus on the business core competencies

• Is a proactive approach with relatively shorter timelines and better control over process

APA in India

No of APAs concluded (by Mar’16)

64 Nos.(61 unilateral & 3 Bilateral)

No. of Applications filed (till Mar’15)

Industriescovered

International transactionscovered

vautomotive and industrial components

v Information Technology (IT)v Information Technology enabled

services (ITES)v Pharmaceuticals

vAnimation services vOil ExplorationvTelecommunication vFinance/Banking

vRoyaltyvManagement ChargesvCorporate Guarantees

v IT / ITES v Investment advisoryvTrading

Consequence of TP Non-compliancePunitive consequences:• Additional tax on income arising from TP adjustment

• Denial of ‘tax holiday’ on income arising from TP adjustment(Proviso to Sec 92C)

• Deemed tax evasion, resulting in a penalty of 100% to 300% of tax arising from

the adjustment, unless good faith and due diligence is demonstrated –

Sec 271 (1)(c) (Effective from 01/04/2006 – 50% for under reporting & 200% for

mis-reporting of facts)

• 2% transaction value penalty for not maintaining prescribed documentation/

furnishing of incorrect information – Sec 271AA(1)

• Rs.500,000 for non furnishing of document and information as required u/s

92D(4) w.e.f. 01/06/2016

• 2% transaction value penalty for not furnishing prescribed information as

required u/s 92D(3) within specified time – Sec 271G

• Rs.100,000 penalty for non-filing/belated filing of Form 3CEB– Sec 271BA

Transfer Pricing - 11062016 - SIRC · PDF file§ Transfer Pricing is the Price at which an ... Tax Jurisdictions in which a Multinational Company ... 65th percentile of the data values

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