The Chamber of Tax Consultants 3 rd Intensive Study Course on Transfer Pricing KEY CONTROVERSY AREAS: CASE STUDIES MARCH 30, 2013

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1 The Chamber of Tax Consultants 3 rd Intensive Study Course on Transfer Pricing KEY CONTROVERSY AREAS: CASE STUDIES MARCH 30, 2013 CA MILIND KOTHARI milindkothari@mzsk.in

2 Recent judicial updates Case Study 1: Transfer of Shares Case Study 2: Share Valuation Case Study 3: Intra group services Case Study 4: Notional Interest on overdue receivables Case Study 5:Entering into an Advance Pricing Agreement (APA) Case Study 6: Marketing Intangibles 2 MZSK & Associates

3 3 Case Study 1: Transfer of Shares

4 Case Study 1: Transfer of shares 4 MZSK & Associates Key Facts: Taxpayer owns shares of its Group company, I Co Taxpayer transfers its stake in I. Co. to its overseas AE Shares are transferred Without consideration (gift, exempted transfer under Section 47 (iii) For adequate consideration Issues: Applicability of transfer pricing provisions in case of: Transfer of shares which are not liable to tax in India as per Treaty Exempted transfers

5 Case Study 1: Transfer of shares... Taxpayer's contentions: Revenue s contentions: Capital gains, if any, are exempt under treaty provisions Transfer pricing provisions are machinery provisions, and hence, do not apply in case of such transactions not being liable to tax in India Applicability of section 92 (Transfer Pricing provisions) does not depend on whether or not the transaction is liable to tax in India, and hence, transfer pricing provisions are applicable to such transactions 5 MZSK & Associates

6 ...Case Study 1: Transfer of shares Case References: Dana Corporation [A.A.R. No. 788 of 2008] Transfer of shares of Indian Subsidiaries of an American company without consideration pursuant to bankruptcy proceedings in US is not chargeable to tax in India as capital gains and consequently, transfer pricing provisions cannot be applied to such transactions Deere & co [AAR No. 934 of 2010] Transfer pricing provisions are not applicable to shares transferred without any consideration Castleton Investment Limited [AAR No. 999 of 2010] Notable departure from precedents to hold that transfer pricing as well as MAT provisions apply despite transfer of shares being not liable to tax in India 6 Remarks: Relevance of applying Transfer Pricing provisions in cases where the transfer of shares is not liable to tax in India What if transaction held not to be at arm s length? MZSK & Associates

7 7 Case Study 2: Share valuation

8 Case Study 2: Share valuation... Key Facts: Taxpayer has issued additional equity shares to its overseas AE Taxpayer had obtained a Valuation Certificate from a Chartered Accountant Valuation os shares was defended by the Taxpayer by relying on CCI Guidelines Issue: Justifying ALP for fresh issue of shares 8 MZSK & Associates

9 Case Study 2: Share Valuation... Taxpayer's contentions: Revenue s contentions: Issue of shares as well as premium on share issue are capital transactions Recharacterising a capital transaction to a revenue transaction is not permissible under the Act Issue of shares to AE is an International transaction; especially relying on retrospective amendment to Section 92B CCI guidelines are not relevant for valuation under Transfer Pricing Valuation of shares is in accordance with CCI Guidelines DCF value justified using cost of capital of 16% and terminal growth rate of 5% (Valuation of Rs.870 crores) If share allotment was routed through a Private placement or IPO, taxpayer would command a higher premium Under-valuation of shares resulted in diminution of wealth of taxpayer DCF using cost of capital of 12.55% and terminal growth rate of 7% (Valuation of Rs crores) 9 MZSK & Associates

10 ...Case Study 2: Share Valuation References: Shell India TPO concluded that there was under valuation in the shares issued to AE. DCF valuation of the Taxpayer rejected, and revised DCF valuation adopted based on different parameters. Difference in Valuation estimated to be over Rs. 15,000 Crores. Ascendas India P Ltd [ITA No. 1736/Mds/2011] For determining ALP in case of share transfer, Internal CUP relied on by the Taxpayer is not appropriate and DCF method for valuation of shares is most appropriate. 10 MZSK & Associates

11 11 Case Study 3: Intra Group Services

12 Case Study 3: Intra Group Services... Key Facts: Indian Taxpayer entered into service agreement with its AE for receipt of following services: Management fee Professional fee SAP implementation fee Taxpayer benchmarked these payments together using TNMM Issue Justifying Arm s length price for Intra Group Services Taxpayer's contentions: Transactions are closely linked and can be benchmarked together using TNMM Services received helps in smooth functioning of business Copies of s, invoices, cost allocation agreement etc. submitted to prove genuineness of expenses incurred Revenue s contentions: TNMM is not MAM as all the international transactions have to be benchmarked separately Services received are routine in nature; no payments are required 12 No tangible benefits derived by taxpayer MZSK & Associates

13 Case Study 3: Intra Group Services... Case References: M/s Knorr-Bremse India Pvt. Ltd. Vs. ACIT [ITA No 5097/Del/2011] Taxpayer failed to demonstrate how the transaction-by-transaction approach is not possible in its case; TNMM to be rejected Onus on taxpayer to prove that an independent third party would have made such payments Benefit anticipated at the time of entering into agreement has not materialized in case of management and consultancy services; adjustments rightly made considering ALP at NIL Perusal of s and other records only reveal incidental and passive association benefit provided by AE ; payments made by taxpayer not justified Gemplus India Pvt. Ltd. Vs ACIT [ITA No.352/Bang/2009] Intra Group service payments not at ALP because payments were independent of nature and volume of services availed by the taxpayer, and robust documentation for benefits received was not available on record McCann Erickson India Pvt. ltd. Vs. Addl. CIT [ITA No.5871/Del./2011] The Intra Group service transactions considered to be at Arm s Length since Benefit Test demonstrated and evidences provided by the taxpayer considered sufficient 13 MZSK & Associates

14 ...Case Study 3: Intra Group Services Remarks: Robust documentation to be maintained, including: Services rendered by AE Benefit derived by the taxpayer from services rendered by the AE Cost incurred by the AE in rendering services Arithmetic accuracy of cost allocation workings 14 MZSK & Associates

15 15 Case Study 4: Notional Interest on overdue receivables

16 Case Study 4: Notional interest on overdue receivables... Key Facts: Taxpayer sells goods to AE Amounts receivable from AE are generally outstanding for 12 months Credit period as per invoice is 60 days. No interest is charged to AE for such overdue receivables Issue: Whether interest ought to be charged for outstanding receivables, beyond the credit period? 16 MZSK & Associates

17 Case Study 4: Notional interest on overdue receivables... Taxpayer's contentions: Revenue s contentions: Interest Income is associated with lending or borrowing of money, not in case of overdue receivables from a sale transaction. Overdue receivables essentially in the nature of loans given to AE and interest should be charged on such overdue receivables Arm s length principle to be applied to underlying commercial transaction (sale), not outstanding receivables Extended credit also granted to Non- AEs, and no interest charged from them No transfer pricing adjustment can be made on overdue balances kept with AE 17 MZSK & Associates

18 Case Study 4: Notional interest on overdue receivables... References: Indo American Jewellery Ltd [ITA (L) NO OF 2012(Bom)] The overdue period of amounts receivable from both AE and Non AE is same; no transfer pricing adjustment warranted Nimbus Communications Ltd v. ACIT [ITA No.: 6597/Mum/09] A continuing debit balance per se, in the account of associated enterprises, does not amount to an international transaction. No transfer pricing adjustment can be made on overdue balances kept with AEs Logix Micro Systems Ltd v. ACIT [I.T.A No.423/Bang/2009] Interest must be charged on the overdue balances kept with the AE, based on interest receivable by the Indian taxpayer on short term deposits DCIT vs Tech Mahindra Ltd [ITA No. 1176/Mum/2010] Interest on overdue payments from AE should be based on prevailing interest rates in the same foreign currency in which the transaction has taken place 18 MZSK & Associates

19 ...Case Study 4: Notional interest on overdue receivables Remarks: Overdue receivables and trade advances specifically covered within the definition of international transaction due to the amendment by Finance Act, 2012 Bombay HC decision (Indo American jewellery) is not a blanket approval for not charging interest on overdue receivables Thorough analysis of business arrangement with AEs and Non AEs, as well as industry practice to be considered. Important to carry out adjustment for differential credit period in the underlying commercial transaction itself 19 MZSK & Associates

20 20 Case Study 5: Entering into an Advance Pricing Agreement (APA)

21 Case Study 5: Entering into an Advance Pricing Agreements (APA) Key Facts: Issue: Taxpayer received MAP resolution between the Indian competent authority and US competent authority As per MAP resolution, ALP margin was determined at 17.5% on operating cost During the year, taxpayer incurred loss on damage of computer shipment Taxpayer considered such loss as non-operating for computing PLI Revenue authorities treated such loss as operating cost and made a transfer pricing adjustment Achieving certainity in Agreements between Competent Authorities (MAP) or in Agreements with Revenue Authorities (APA) Reference: M/s Texas Instruments (India) Pvt. Ltd. [ITA No.1/Bang/2011] Whether ALP arrived at after having accepted the MAP resolution passed by the competent authority can be altered? Matter remanded to lower authorities. 21 MZSK & Associates

22 ...Case Study 5: Entering into an Advance Pricing Agreements (APA) Remarks: This case highlights the fact that a taxpayer could be subjected to litigation even after complying with the MAP resolution Similar litigation could arise in cases involving APA (unilateral, bilateral or multilateral) Taxpayer has a better footing in APA as compared to MAP, since it is also a party to the negotiations Essential to draft the APA elaborately, to avoid interpretation differences and possibility of litigation going forward 22 MZSK & Associates

23 23 Case Study 6: Marketing Intangibles

24 Case Study 6: Marketing Intangibles... Key Facts: Indian Taxpayer (I. Co) is a wholly owned subsidiary of a Korean company engaged in home appliances business under L brand name I. Co is the distributor of such branded goods in India I. Co incurred AMP expenses which were debited to its P&L Account The expenses incurred amounted to 3.85% of its sales as against 1.29% of comparable companies Issues: TP implication on expenses incurred by the taxpayer: Compensation for Brand Building Disallowance of excessive AMP expenses incurred 24 MZSK & Associates

25 Case Study 6: Marketing Intangibles... Taxpayer's contentions: Revenue s contentions: No International Transaction of brand building, since no agreement with AE Bright Line Test not among 5 prescribed methods, hence, cannot be applied Overall Net Profit margin is higher than other comparable cases, therfore, AMP expenses not to be viewd independently Taxpayer advertised brand owned by its AE therefore builds brand owned by AE Transaction of brand building qualifies as International Transaction under the Indian TP regulations Bright Line Test to be applied even if not specifically prescribed under Indian Transfer Pricing Regulations No mark up should be applied to the cost incurred on brand building since mark up earned by independent comparables unavailable All international transactions are required to be viewed independently; overall Net Profit margin comparison not appropriate 25 Mark up should be added to the cost incurred on brand building as taxpayer s entrepreneurial efforts are involved MZSK & Associates

26 Case Study 6: Marketing Intangibles... Case References: M/s L.G Electronics India Private Limited Vs. ACIT [ITA No 5140/Del/2011] There exists an implied agreement between taxpayer and its AE for brand building International Transaction pertains to creating and improving marketing intangibles by the taxpayer for and on behalf of its AE in India Expenses incurred by the taxpayer are intermingled and inseparable, hence, Bright Line Test is appropriate for ascertaining cost/value of the International transaction Unless two transactions are closely linked, each transaction should be benchmarked separately and hence AMP cannot be benchmarked applying overall TNMM 1.39% of expenditure was considered as incurred for promotion of its own business and 2.49% was treated as cost of service for its AE Mark up should be charged on such costs and the mark-up should be based on mark up charged by independent comparables 26 MZSK & Associates

27 ...Case Study 6: Marketing Intangibles Case References: Maruti Suzuki India Ltd vs ACIT [W.P. (C) 6876 OF 2008] For determining ALP of International transaction of brand building for foreign AE Consider benefits obtained and obligations incurred by both - Maruti and Suzuki Use appropriate comparables considering nature of product, number of products launched in market, territories served, turnover etc Remarks: Important to distinguish Brand Promotion and Product Promotion Appropriate selection of comparables Comparables with same customer focus Comparables having similar year of set-up Documenting the benefits derived by Indian Taxpayer from its AMP efforts 27 MZSK & Associates

28 Contact Details CA Milind Kothari E : milindkothari@mzsk.in M: D: MZSK & Associates Chartered Accountants Mumbai Office: The Ruby, Level 9, North West Wing, Senapati Bapat Marg, Dadar (W), Mumbai , INDIA T : THANK YOU Pune Office: Level 3, Business Bay, Wellesly Road, Near RTO, Pune , INDIA T :