Professional Documents
Culture Documents
An Update - 2
Prashant Kotecha
Study Circle Baroda Branch of WIRC
C O N T E N T S
Transfer Pricing in India Increased Focus of IRA Key Triggers for TP Adjustments Recent Issues in TP Audit Recent Rulings Recent Updates in the Finance Bill, 2011 Other Important Topics in Respect of Transfer Pricing
1 June 2011
Prescribed Methods
Method
Comparable Uncontrolled Price (CUP)
Functions
Direct Method Product Comparability Critical Distribution Function Service Function; Contract Manufacturing Transfer of intangibles or multiple transactions Manufacturing & Sales functions FAR Comparability critical
Approach
Prices of each transaction is to be benchmarked Prices to be benchmarked considering ALM Prices to be benchmarked considering ALM Analysis of Allocation of Profit and loss
Resale Price
Cost Plus
Profit Split
Documentation
Financial Analysis
Comparable Analysis
Internal External
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Compliance
Filing Accountants Report along with Tax Return, Maintenance of Documentation Limitation for Initiating transfer pricing audit by the tax administration Limitation for completing transfer pricing audit
Timeline
30 Nov. 2011 30 Sep. 2012
Relevant Provision
Section 92E r.w. Section 139(1) Proviso to Section 143(2)(ii) Section 92CA(3) r.w. Second Proviso to Section 153(1) Second Proviso to Section -153(1) Second Proviso to Section - 153(1)(b) Section 149(1)(a) Section 149(1)(b) Section 92D and Rule 10D(5)
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31 Oct. 2014 31 Dec. 2014 If 144C BY 28-02-2015 30 June 2015 If 144C BY 30-08-2015 31 Mar. 2016 31 Mar. 2018 31 Mar. 2020
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Limitation of Completing regular assessment (If reference is made for exchange of information) Limitation for Re-Assessment (where income escaped < Rs. 1,00,000) Limitation for Re-Assessment (where income escaped Rs. 1,00,000) Date till which documentation is required to be maintained
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Audit Process
File tax return and Accountants Report (30th November) Reference to be made to TP Officer (TPO) by the Assessing Officer (AO); Compulsory Reference to be made by AO if international transactions exceed INR 1500 million for AY 2005-06 onwards (Internal guidelines) Notice to be issues by the TPO - TPO calls for supporting documents and evidence DRP MechanismFinance Act 2009
Appeal Procedure Appeal to Commissioner of Income Tax Passes an order Income Tax Appellate Tribunal High Court - only on matters related to law Supreme Court
TP Audit
Based on results of above mentioned procedure assessing officer passes the order
Rectification application can be made against the order of TPO for apparent mistake
Appeal can be made against the order of AO as order of TPO included within the order of the AO
Constitutional Bench
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Assessee
ITAT Order
30 Days
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Recent Trends
Revenue target driven approach FAR analysis disregarding taxpayers business Ad-hoc economic adjustments - rule of thumb applied in most cases Aggregation of transactions TNMM most commonly used by tax payers - about 72% of cases Tax Authorities prefer CUP and CPM Updation of comparables with captioned years data during audit proceedings contemporaneous principle Use of secret comparables Lopsided selection of comparables - rejection of loss making companies, inclusion of high profit companies, inclusion of high turnover companies etc. Use of standard benchmarking sets - example IT, ITes, Gem and Jewellery, Contract R & D etc. Unrealistic benchmark for captive service providers Major adjustments in IT, ITeS, FMCG, Pharma, Automobiles, Chemicals etc. Precedents set in earlier years - generally followed Cases referred back to the TPO
1 June 2011 CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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No. of Cases selected for TP Audit 1,081 1,501 1,768 1,479 1,717 > 2,000
Upward Approx. Adjustment in Adjustment (` cases (%) in crore) 22% 23% 27% 25% 59% > 65% 1,500 2,500 3,500 5,500 10,000 >25,000
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Royalty
Indian regulatory scenario:
SIA used to publish information on royalty rates approved by the Government pursuant to various technical collaboration proposals. SIA has discontinued publishing this data effective September 2004
Rates for royalty under the automatic route prescribed by Department of Industrial Policy & Promotion: Lump sum payment of USD 2 million Recurring royalty of 5% on domestic sales and 8% on export sales for technology agreements/collaboration Recurring royalty of 1% on domestic sales and 2% on export sales for use of trademark/brand name, to the foreign collaborator
1 June 2011 CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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Royalty
Issues considerable:
Lack of documentation in respect of receipt of Technology / continued technical support from AE for which royalty is being paid. Assessee lacks in proving the reasons for paying royalty for more than 20 years Disregards to Specific situation of the Assessee - Nestle India (Delhi ITAT) [111 TTJ 498] - inappropriate to test the reasonableness of the remuneration on the yardstick of profit of the year in which the payment is made Increase in rates at which Royalty is paid without change in technology being received from AE Necessary to analyze cost (comparable cost, basis of charge) vs. benefit (need for availing services, value attributable to services) Application of CUP for benchmarking inadequate comparables FEMA ceilings / comparable FIPB / SIA approvals are not being accepted as CUP for defending the arms length. Recent relaxation in royalty payout limits increases the challenge of defending the arms length nature of royalty payments
1 June 2011 CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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Interest on loans
Regulatory Scenario - Exchange Control regulations permit raising ECB from foreign collaborator/ equity holder under the automatic route. ECB can be used for capital expenditure Key factors affecting comparability- terms of loan, credit standing of the borrower, currency of the loan, collateral, fixed vs. floating interest rate etc. Manner of Benchmarking Evaluation of interest rates charged in similar uncontrolled transactions Standard Bank Rates - LIBOR, PLR Practical Issues: Non-availability of data relating to comparable loan transactions in public domain Adjustment for differences in risk profile of the borrower Thin-capitalization provisions / Re-characterization of debt into equity with the introduction of Direct Tax Code Perot systems (Delhi ITAT) [130 TTJ 685] and VVF Ltd (Mumbai ITAT) [ITA No.673/Mum/06]
1 June 2011 CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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Corporate Guarantee
Corporate Guarantee by Assessee against the loan taken by its AE Nominal fees or no fees charged unlike Banks Benchmarking: Comparing total cost of borrowing (interest + guarantee) with uncontrolled loan transactions Comparison of fees charged by Banks / financial Institution is difficult to be considered as CUP Analysis of the credit worthiness of the AE should be carried out Calculation of fees based on the benefits derived by AE
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Before entering into said agreement Assessee were using Brand MARUTI Assessee started to use brand Maruti Suzuki on rear side of the Vehicles manufactured and sold by it in India.
1 June 2011 CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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Order of TPO
TPO considering CPM as the Most Appropriate method calculated the Brand Value of Maruti to be at Rs. 4,420 Crores after adding 8% margin over cost. He Asked to show cause as to why this is not to be considered as deemed transfer of Brand and accordingly adjustment should be made. Assessee replied the show cause notice and also filed writ Suzuki was a weaker brand in India as compared to Maruti which was a super brand hence the earlier brand is piggybacked on the latter. No compensation for brand creation and advertisements by Suzuki
1 June 2011
50% of Royalty paid as no compensation received for trademark piggybacked on the trademark of Maruti (` 99.3 Crores) Non-routine advertisement expenditure amounting to ` 107.22 crores Total adjustment of ` 206.52 crores
CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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Order of HC
HC remanded the matter to TPO for fresh adjudication while doing so HC also gave certain direction / guidelines to be followed as under: No obligation on Suzuki to pay if the use of logo is at the discretion of the Maruti. If Maruit is mandatorily required to use the foreign trademark / logo, appropriate payment should be made by Suzuki for the benefit it derives in form of marketing intangibles The ALP has to be determined taking into account all the rights and obligations of the parties under the international transaction Suitable adjustments to be made considering the individual profiles of the entities and other facts and circumstances of the case Maruti to be compensated only if the promotional expenses incurred by Maruti are more than what a comparable independent domestic entity would have incurred, the use of foreign trademark / logo is mandatory and the benefit to Suzuki is not merely incidental. Appropriate comparables to be identified and suitable comparability adjustments to be made If Maruti obtained any concession from Suzuki to offset the extra expenditure incurred, this would not automatically entail a payment by Suzuki.
CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
1 June 2011
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Order of SC (2010-TII-01-SC-LB-TP)
Before the case shall be decided afresh by the TPO, Assessee filed Appeal to Apex Court and claimed that the when the HC has not only set aside the original show cause notice but it has made certain observation on the merits of the case and has given directions to the TPO the matter virtually concludes the matter. Apex court held that the TPO, who had already issued fresh show cause notice in accordance to HC order, shall proceed as per the law uninfluenced by the observations / directions given by the HC.
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GE US
GE Capital Canada
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Held by ITAT
The concept of taxing only real income as laid by Apex court cannot to come to the rescue of the assessee as the said law is not applied to Chapter X of IT Act. This is not the case of ordinary business transactions and therefore notional interest shall be charged to tax There is no feature in the agreement to prove that the loans were quasi capital in nature The contention of the assessee for not considering the interest on interest free loans as international transaction is rejected. One of the AE is in tax heaven and not charging interest on loans from such AE is classic case of violation of TP norms RBIs Approval can not be the factor for determining ALP 5% variation cannot be allowed as there are only one ALP
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Synopsis
Facts The taxpayer advanced interest free loans to its AEs out of its own funds and determined the ALP as Nil The TPO made an upward adjustment by adopting 14% p.a. (rate charged by Citibank on cash credit) paid by taxpayer as arms length interest Taxpayers Contentions Loan was granted to AEs out of the interest free funds and since the taxpayer had sufficient interest free funds it was justified in not charging interest on the loans given to the AEs Real income concept advocated On a without prejudice basis, the taxpayer submitted that the TPO in subsequent assessment years had computed the arms length price of the international transaction of interest free loan at 4.5 percent per annum The taxpayer submitted a letter from bank as external CUP Tribunal Decision / Observations Cost of funds is not relevant for determining CUP Need to see comparable transactions internal or external CUP compares the price of an international transaction with that of comparable uncontrolled transaction Comparable transaction should be a forex loan ITAT rejected the application of CUP by the TPO (rate on cash credit) VVF Ltd. had availed foreign currency loan from ICICI Using the interest rate charged thereof, confirmed the addition for interest CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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Synopsis
Facts Assessee has provided interest free loan to its AE a wholly owned subsidiary (WOS). Some advances given for purchase of bullion remained outstanding since long. AO invoked provisions of the Sec 92 Assessee objected and claimed that case must be referred to TPO Notional interest should not be charged to tax since it receives regular dividend and pays tax AO determined ALP considering LIBOR + 1.25% CIT (A) agreed with the Assessee and deleted the addition Tribunal Decision / Observations AO is not mandatorily required to refer all the cases to TPO Set aside to CIT(A) for deciding issue afresh
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Synopsis
Facts Assessee is engaged in software consultancy and development It provided services to its AEs. Other international transactions: purchase of software and capital goods from AEs Applied TNMM and determined ALP TPO accepted the TNMM as MAM and all transactions to be at Arms; Length However TPO found that at the last day of FY total outstanding payment from AE was ` 7.73 crores out which ` 5.53 crores was outstanding for more than 6 months TPO charged notional interest at PLR of 10.25% on ` 5.53 crores CIT(A) agree with TPO that such outstanding partook character of loan however allowed relief by applying rate of interest at LIBOR / US-FED instead PLR
Tribunal Decision / Observations AO is not mandatorily required to refer all the cases to TPO Set aside to CIT(A) for deciding issue afresh
1 June 2011 CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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Synopsis
Tribunal Decision / Observations The ALP of such outstanding amount should not calculated considering the same as loan but it should be determined considering the factor that if the fund were brought back by Assessee within reasonable time it would have earned income on the said funds. [opportunity cost] The decision of CIT(A) for considering LIBOR or US-FED rate is overruled and held that the funds were to be brought in India and income lost due to non-remittance was to be generated in India therefore application of US rates is not logical. Further, ITAT also rejected the rate of PLR as ALP of blocked funds should be determined on the basis of the deposit rate and not at the lending rate. In view of above ITAT held that the Arms Length interest on blocked funds amounting to ` 5.53 crores should calculated at the rate of 5% instead of 10.25%
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Synopsis
Facts Assessee is JV between Bhatia family (95% equity) and German Travel Services (5% equity) Provides data process and related services to AEs and it is responsible for allowing access to subscribers to Amadeus products in the Territories of India, Bangladesh and Nepal Applied TNMM for all the transactions with PLI OP/TC being 43.46% against the comparable 8.02% TPO accepted the ALP of all the transactions reported by the Assessee. However, he found that the Assessee has incurred abnormal AMP expenditure in respect of AEs Brand being 40.87% of sales TPO determined AL expenditure of 12.16% of sales being average AMP expenses of three companies selected by him The TPO made upward adjustment to the income of ` 32.93 crores being 10% mark-up on such expenditure Assessee questioned the jurisdiction of TPO as said transaction was not referred by the AO
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Synopsis
Tribunal Decision / Observations Provisions of section 92CA(1) is very clear that the TPO has to determine ALP of the Transactions referred by AO.\ The said interpretation is supported by the CBDT Instruction no. 3/2003 wherein role of TPO is explained Suo moto, he cannot take cognizance of any international transaction for suggesting adjustment in arm's length price. Additions / Adjustments made by TPO and AO is sought to be deleted.
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Synopsis
Assessee is a 100% subsidiary of a USA-based software company engaged in business of licensing infrastructure software products of the parent company - also sets up Technical Support Centre to provide support services to end users on behalf of the parent company - also develops customized software . Assessee has filed loss return TPO reduces the quantum of royalty payment on the ground that when some of sales did not fructity for various reasons, and the same were written off by the assessee in the same financial year, there is no question of paying royalty on such sales merely on the basis of raising invoices and has made adjustment accordingly. The Jurisdiction of TPO was questioned. Further, it was argued that the TPO has not selected any method for determining the ALP as prescribed in 92C. Honble ITAT concluded that under the Indian Transfer Pricing Regulation bad debts written off cannot be factor to determine the ALP. Further, the TPO has exceeded his limitation by following the method which is not authorized under the Act or Rules. Accordingly the AO was directed to accept the ALP of Royalty as determined by the Assessee.
CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
1 June 2011
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Synopsis
Turnover or quantity difference: The sale to Non-AE is of 1150 Kgs only, whereas there is a sale to the magnitude of 62,000 Kgs. to the AE which will have a bearing on the prices. Volume sold is a significant factor in fixing the price. Geographical difference: In the case of Ranbaxy Laboratories Ltd. v. Asstt. CIT it has been held that it could have been appreciated if a particular entity in a particular country was sought to be compared with some similar entity in that very country as geographical situations in several ways influence the transfer pricing. Profile of Customer: The transaction with high profile clients such as AKZO Nobel or Isola is different when compared to small sales to small players in South East Asian business. Survival of the Assessee: In order to capture and maximize its profits of the big and flourishing market of USA and Europe, the Assessee has to depend on its AE only
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Synopsis
Structure Bermuda Mauritius India Assessee is engaged in rendering IT enabled services. Enters into an revenue sharing agreement for providing services with one of the fellow subsidiary in USA. US based company contracting with clients in USA to provide services of debt collection and telemarketing services. Due to lack of enough infrastructure for executing the work, it diverts the work to the Assessee. Assessee received 90.6% of the total revenue earned by USA Based AE whereas only 18% of total revenue earned by the Assesssee from services rendered to Independent clients. Assessee benchmarked the International Transaction considering AE as the Tested Party. TPO concluded that the Assesssee itself should be considered as tested party and considering the comparables made adjustment of Rs.14.70 crores against the total transaction of Rs. 8.32 crores. CIT (A) Confirmed the issue of Tested Party in favor of TPO. However held that under revenue sharing total adjustment cannot exceed the amount of total revenue earned by the Assessee and its AE. FAR analysis should be given importance while determining ALP. Transaction of Different nature cannot be aggregated for the purpose of application of TNMM. Adjustment of 33.33% to the profitability has been allowed on account of 1/3rd idle capacity
CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
1 June 2011
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Synopsis
CIT (A) calculated ALP at Rs. 11.38 Crores. In view that the ALP cannot exceed total revenue it has been restricted to Rs. 9.16 Crores. CIT(A) did not allow 5% adjustment as difference was exceeding 5% of ALP. Assessee and Department both filed appeal before ITAT ITAT held that neither assessee nor department had been able to point out any basis or material or criteria to controvert the findings of CIT(A) and hence the order of the CIT(A) is upheld.
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Comparables
Selection of MAM
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The income attributable to CFC shall be included in the income of the person resident in India The resident taxpayer will have to furnish details of investments and interest in entities outside India in the prescribed form and manner The amount received from a CFC as dividend in a subsequent year will be reduced from the total income to the extent it has been taxed as CFC income in any preceding previous year Applicable to taxpayer irrespective of DTAA
1 June 2011 CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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Mindset of IRA
Extracts from FMs inaugural address at the International Seminar on Transfer Pricing organized by CBDT and OECD (17 19 February 2010) The transfer pricing regulations have come of age in India both in terms of quality of audits as well as the revenue generated for the Government. Till date, the Directorate of Transfer Pricing has made an adjustment of Rs. 23,000 crore (approx. US $ 5000 million), which is a great achievement in a small period of time. For this, I appreciate the Income Tax Department. I am very happy to learn that CBDT is making all efforts to improve technical skill of the manpower posted in Directorates of Transfer Pricing. I am sure that CBDT by increasing its dedicated transfer pricing resources and by improving their specialists capabilities will be able to meet emerging challenges in administration of transfer pricing regulation and would augment governments effort to mobilize more revenue for the development work. Views of DG International Tax, as reported in TP Week issue dated 13 April 2010 Indias director-general of international tax and transfer pricing has said thin capitalization, advance pricing agreements and safe harbour provisions are his three priorities for the coming year.
CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC
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Defense Mechanism
Robust documentation in respect of ALP analysis for each of international transactions. Have precise FAR analysis separate for each international transaction If transaction in respect of Intangibles: If recurring payments (royalties) Documents for Technology received Cost of technology by AE Latest valuation of intangibles Status of Patent and Trademark rights held by AE If outright purchase Robust valuation reports Strong base for valuation Cost benefit analysis Background documents Detailed comparative analysis and proper adjustment for differences Detailed document if high value used machineries procure from AE Drafting inter-company agreement or long term transfer pricing group policies with utmost care
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Key Takeaway
TP is an ART and not a precise SCIENCE Application of concepts requires flexibility and judgment TP is CONSULTING i.e. a PROCESS and not a PRODUCT The Revenue will never understand the business as well as you do BUT if you fail to explain your business and pricing in easy language, you will encounter ongoing expensive difficulties.
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Contact Details Prashant N. Kotecha Assistant Manager K. C. Mehta & Co. Mob: 98251 53981 Mail: prashant.kotecha@kcmehta.com
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