PROCEDURES FOR TP COMPLIANCE & BEST PRACTICES FOR TP DOCUMENTATION

Transcription

1 PROCEDURES FOR TP COMPLIANCE & BEST PRACTICES FOR TP DOCUMENTATION CTC Study Circle November 06, 2015 Page 1

2 TABLE OF CONTENTS Background [3] Regulatory Requirements [8] Documentation Process [10] Accountant s Report: Form 3CEB [38] Risk Mitigation [47] Critical issues in TP Documentation [50] International Guidance [64] Latest Developments [70] Key takeaways [77] Page 2

3 BACKGROUND Page 3

4 BACKGROUND Basic Concepts of Transfer Pricing Transfer pricing refers to the pricing of cross-border and domestic transactions between two Associated Enterprises When two related entities enter into any cross-border or domestic transaction, the price at which they undertake the transaction is Transfer Price Due to the fiduciary relationship between related companies, the transfer price may be different than the price that would have been agreed between unrelated companies Price between unrelated parties in uncontrolled conditions is known as the Arm s Length Price Page 4

5 BACKGROUND Introduction Introduced in India w.e.f. FY % of world trade is understood to be carried out with related parties; poor transfer pricing results in double taxation for the group as a whole Administrative Framework Transfer Pricing wing of Income Tax Department being strengthened Number of Specialist Transfer Pricing Officers on the rise Rigorous training imparted to the field officers Scenario Transfer Pricing adjustments continuously increasing Implications on allied laws International Tax, Service Tax etc. Wide Coverage of Indian Transfer Pricing Regulations Page 5

6 BACKGROUND Indian Transfer Pricing Adjustments Value of TP Adjustments 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Amount of adjustments (in crores) No. of TP Audits Completed No of Adj. Cases No of cases Transfer Pricing Law in India since 14 years India not completely aligned to OECD Guidelines High revenue generating subject peak collections in FY 13 of INR crores Adjustments made in almost 50% of cases selected for TP audits Developed appellate/ judicial dispute resolution mechanism 500 plus ruling on the subject Almost 1 TP ruling being pronounced everyday Source: Annual Reports published by Ministry of Finance Page 6

7 BACKGROUND Penalty Provisions Section Default Penalty 271(1)(c) 271G Transfer Pricing Adjustment considered as concealment of income Failure to furnish documentation 271BA Failure to furnish Form 3CEB INR 100, % to 300% of Tax on the Adjustment made 2% of Value of International Transactions and/or Specified Domestic Transactions 271AA Failure to keep or maintain required documentation Failure to report required transactions Furnish incorrect information or documentation 2% of Value of International Transactions and/or Specified Domestic Transactions Page 7

8 REGULATORY REQUIREMENTS Page 8

9 REGULATORY REQUIREMENTS Legal Framework Documentation for International Transactions / Specified Domestic Transactions prescribed by Section 92D of the IT Act r.w. Rule 10D of the IT Rules Documentation required to be contemporaneous and should exist latest by due date of filing ROI o Contemporaneous not defined under the IT Act or IT Rules o Dictionary meaning: "Concurrent", "Consistent", "Simultaneous o Inference: Documentation required to be maintained at the time of entering into the relevant transaction Relaxation provided in maintenance of documentation if the aggregate value of transactions is less than 1 Cr. o Relaxation not applicable for Specified Domestic Transactions Documentation required to be maintained for 8 years Documentation ought to be produced before the Tax Office within 30/60 days from date of receipt of notice Page 9

10 DOCUMENTATION PROCESS Page 10

11 DOCUMENTATION PROCESS Documentation in a Nutshell Identification of International Transactions & Associated Enterprises FAR Analysis of International Transactions Selection of Tested Party Identification of Comparable Uncontrolled Transactions Selection of the Most Appropriate Method Economic & Functional Adjustments Determination of Arms Length Price Page 11

12 DOCUMENTATION PROCESS Year End Documentation Process Planning Understand Background Prepare Plan Information Gathering Interviews/ Questionnaires Management Discussion Characterisation of Entities Review of Agreements Comparable Data Search strategy Access to Databases Internal & External Comparables Benchmarking Adjustment for differences Determination of ALP Documentation Consultation with Management Finalisation of Documentation Certification Page 12

13 DOCUMENTATION PROCESS Documentation Matrix Company / Group overview Industry analysis FAR Analysis Economic analysis Page 13

14 DOCUMENTATION PROCESS Background of Group and Taxpayer Background of Multinational Group Background of Taxpayer Background of AEs Source History and background of origin & growth of group Business Profile Key business verticals and service lines Segmental Revenue Geographical Presence Brief financial summary of the group History and background of the taxpayer Business Profile Service lines / product offerings Geographical Presence Shareholding pattern Brief financial summary of the taxpayer Segmental Revenue Key Competitors / peers Name, address, legal status and country of tax residence Nature of relationship (ownership linkages) with taxpayer Business Profile Service lines / product offerings Geographical Presence Historical Annual Reports Group websites Management Discussions & Representatives Business Profile or Brochure Product Brochures Group Holding Structure Annual Report of Associated Enterprise(s) Global Transfer Pricing documentation Page 14

15 DOCUMENTATION PROCESS Industry overview and Market Analysis Coverage Description of Industry of Taxpayer (for the transactions) Current Scenario Pricing Trends Economic and market analysis Degree and nature of competition Statistics of Industry and Industry Segments Forecasts Global and Domestic Scenario Cross-check with taxpayer s financial situation Special Considerations Highly volatile industries Shipping, Mining, Trading, Financial Service, etc. Source of Industry Reports Authentic Internal / External Sources Economic and Trend Analysis Multinational Group or Taxpayer Reports by Reputed Organisations Industry Reports Rating Agencies (CARE, ICRA, Fitch, D&B etc.) Stock Exchanges Others Newspapers / Journals / Magazines / Newsletters Annual Reports by Government Bodies & Ministries Publications by Trade Associations and Trade Bodies Annual Reports of Taxpayer and peers / competitors Reports of Research Agencies Offer Document / Annual Report of Peers Page 15

16 DOCUMENTATION PROCESS International / Specified Domestic Transactions with AE(s) Coverage Complete list of International/ Specified Domestic Transactions Quantity, Quality & Price Related Information Terms of Transactions Pricing Methodology Characterisation of Transactions Margin Workings Sources Agreements / Arrangements Invoices / Debit Notes / Credit Notes Supporting Documents Relevant Entity / Group Policies Management Discussion / Representation Books of Accounts Disclosures in Financial Statements Page 16

17 DOCUMENTATION PROCESS Comparability of Transactions Coverage Identification of Comparable Uncontrolled Transaction (Internal / External) Quantity, Quality & Price related info Terms of Transactions Margin Workings Selection of Comparable Entities Basis and Process of selection FAR profile of Comparable Entities Sources Internal / External Sources Agreements / Arrangements Industry / Company Reports Specific Benchmarking Annual Reports of Comparable s Expert Analysis Competition Information Management Discussion / Representation Page 17

18 DOCUMENTATION PROCESS - FAR ANALYSIS Meaning & Importance of FAR Analysis Assets employed Functions performed Risks assumed FAR ANALYSIS - Heart of the analysis Page 18

19 DOCUMENTATION PROCESS - FAR ANALYSIS Process of undertaking FAR analysis FAR Analysis is conducted qua transaction FAR planning process FAR Interviews FAR Documentation Identify relevant transactions and transacting entities Industry and group background Review available internal/external documents Prepare Questionnaires & identify interview contacts Create detailed FAR questionnaire Conduct Interviews and makes notes Summarizing FAR findings in the documentation report Tested Party selection: The least complex entity. To which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables can be found Page 19

20 DOCUMENTATION PROCESS - FAR ANALYSIS Requirements for FAR Analysis FAR Analysis requires thorough understanding of: Business of Taxpayer and AE Role of each party in the transaction Contractual Terms: financial and operational Significance of items of FAR in the overall scheme of things Relationship with third parties essential for risk assessment Liability towards third parties in case of default Mapping of the economically relevant facts and characteristics of intercompany transactions with regard to their Functions, Assets, Risks (FAR) Page 20

21 DOCUMENTATION PROCESS - FAR ANALYSIS FAR implications Understanding of the business Documentation Characterization Basis to search for external comparables FAR analysis Planning possibilities Internal comparables Most appropriate method Page 21

22 DOCUMENTATION PROCESS - FAR ANALYSIS Basic Contents Functions Performed Overall Business Planning Formulating Business Plan Key Business Decisions and Day to Day Management Production and allied activities Production Planning Manufacturing Quality Assurance Sales & Marketing Determining Sales Strategy Deciding on Terms of Sale Negotiating Prices Customer Relationship Management and After Sales Support Human Resource Management Financial & Accounting Function Research and Development Assets Employed Physical Assets Infrastructure Production Facility Research & Development R & D Facilities and Technology R & D Personnel Intangible Assets Brand Name & Reputation Customer Contacts & Marketing intangibles Copyrights & Patents Manufacturing know-how Human Capital Risks Assumed Product Liability Risk Market Risk Credit Risk Foreign Exchange Fluctuation Risk Inventory Risk Manpower Risk Legal and Statutory Risk Technology Obsolesce Risk Capacity Utilization Risk Operations Risk R & D Risk Page 22

23 DOCUMENTATION PROCESS - ECONOMIC ANALYSIS Various Methods Transfer Pricing Methods Transaction Price Methods Transactional Profit Methods Comparable Uncontrolled Price Resale Price Method Cost Plus Method Other Method Profit Split Method Transactional Net Margin Method Or any other method prescribed by the board Page 23

24 DOCUMENTATION PROCESS - ECONOMIC ANALYSIS Factors for selecting the Most Appropriate Method Relevant factors for selection of Most Appropriate Method (MAM) Rule 10C(2) Nature and class of international transaction or the specified domestic transaction Class or classes of associated enterprises and their FAR analysis Availability, coverage and reliability of data Degree of comparability between international transactions or the specified domestic transaction and uncontrolled transactions Enterprises entering into such transactions Extent to which reliable and accurate adjustment can be made Nature, extent and reliability of assumptions required to be made Page 24

25 DOCUMENTATION PROCESS - ECONOMIC ANALYSIS General applicability of methods Method CUP RPM CPM PSM TNMM Other Method Transaction Type Loans, Royalties, Service fee, transfer of tangibles, etc. Marketing operations of finished products, where distributor not performing significant value addition to product Raw material or semi-finished goods are sold, long term buy-and-sell agreement Transaction involve provision of integrated services by more than one enterprise or involve unique intangibles Provision of services, transfer of semi-finished goods, distribution of finished goods where applicability of RPM appears to be inappropriate Transactions involving benchmarking with the use of quotations, etc. Page 25

26 DOCUMENTATION PROCESS - ECONOMIC ANALYSIS Documentation of the Most Appropriate Method Documentation of the analysis Document the process of application of Most appropriate method, which includes Details of CUP analysis Search Process and comparables Comparison of outcome of the search with the results of tested party o Availability of data in public domain o Use of databases o Availability of sufficient data for Comparables Determination of Arm s Length Price Comparison of PLI and with margin of comparables If: PLI > Comparable margin, at Arm s Length PLI < Comparable Margin, not at Arm s Length Comparability Adjustments Computation of Tolerance band (When not at Arm s Length) Conclusion on arm s length nature of the transactions Justification for most appropriate method selected Justification for each method rejected Page 26

27 DOCUMENTATION PROCESS - ECONOMIC ANALYSIS Profit Level Indicator (PLI) Convention Commonly used PLIs (also discussed in OECD Guidelines) are as follows: Sr. No. PLI Remarks 1 Net profit/ Sales Appropriate for distribution activity 2 Net Profit/ Operating Costs Appropriate for service or manufacturing activity 3 Net Profit/ Operating Assets Appropriate for a capital intensive industry Other PLIs can also be used based on facts and circumstances of the case as follows: Cash Profit Ratio New Business with Heavy Investment Return on Capital Employed Capital Intensive Business Return on Shareholders Funds Highly Geared Companies Revenue per Employee Human Capital Based Business Berry Ratio Used in conjunction with other ratios for validations Page 27

28 DOCUMENTATION PROCESS - BENCHMARKING ANALYSIS Comparability Factors While identifying comparables, FAR and terms of business can be determined from Financials. Indicative list is discussed below Financial Item Sales / Net Worth Export Sales Non Operating Income Advertising & Marketing Exp Bad Debt & Provision for Doubtful Debt Exchange Gain/Loss Research & Development Exp Debtors & Creditors Turnover Ratio Land & Building and Depreciation thereon Goodwill & Other Intangible Assets FAR & Terms Size of Operations Market Conditions Non Core Functions Marketing Function Business Risk Foreign Currency Risks R&D Function, R&D Risk Credit Risk Asset Base Intangible Assets Page 28

29 DOCUMENTATION PROCESS - BENCHMARKING ANALYSIS Bird s Eye View FAR Analysis Qualitative Filters Related Party Transaction Analysis Characterization of Transaction Quantitative Filters Margin Computation Selection of Most Appropriate Method Initiating a Database Search Economic Adjustments Selection of Tested Party Calculation of PLI Determination and Comparison of Arm s Length Price Page 29

30 DOCUMENTATION PROCESS - ECONOMIC ADJUSTMENTS Types Working Capital Adjustments Idle Capacity Adjustments Depreciation Adjustments Risk and Other Adjustments Page 30

31 DOCUMENTATION PROCESS - ECONOMIC ADJUSTMENTS Working Capital Adjustment - International Guidance is an attempt to adjust for the differences in time value of money between the tested party and potential comparables with an assumption that the difference should be reflected in profits. - OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 2010 Page 31

32 DOCUMENTATION PROCESS - ECONOMIC ADJUSTMENTS Working Capital Adjustment - International Guidance OECD Approach - Facts Tested Party Comparable Sales 100,000 1,50,000 PBIT 2,000 3,750 PBIT/Sales % 2.00% 2.50% Working Capital (at end of year) Trade Receivables (R) 11,900 23,500 Inventories (I) 7,500 18,600 Trade Payables (P) 10,200 17,300 R + I P 9,200 24,800 (R + I P)/Sales % 9.20% 16.53% What point of time? End of the year / Start / Average? OECD Approach - Adjustment WCA Tested party s (R + I P) / Sales % 9.20% Comparables (R + I P) / Sales % 16.53% Difference (D) (7.33)% Interest rate (i) 8.00% Adjustment (D x i) (0.59)% Comparable company s PBIT/Sales (%) (PLI) 2.50% WCA PLI 1.91% Rate of interest? Page 32

33 DOCUMENTATION PROCESS - ECONOMIC ADJUSTMENTS Idle Capacity Adjustment Meaning Idle capacity adjustment is made for differences in capacity utilization between the tested party and the comparable uncontrolled transaction. It is applicable in the case of start-ups and other factors like loss of major business/customer Particulars Tested Party Comparables Profit/Sales % 9% 15% Capacity Utilization 20% A Ltd - 80%; B Ltd - 40% Arithmetic Mean = 60% Underutilized Capacity 40% (60% - 20%) Particulars Actual data of Tested Party Adjusted data of Tested Party Sales Variable Cost Fixed Cost 240 (240*20/60 ) = 80 Profit Margin: Profit/Sales 9% 28% Page 33

34 DOCUMENTATION PROCESS - ECONOMIC ADJUSTMENTS Depreciation Adjustment Applicability Difference in Rate of Depreciation between Tested Party and comparables may arise due to following reasons: SLM vs WDV Companies Act Rate vs Management Decided Rates Methodologies Adjust the Comparables Depreciation Rate and Method to match with the Tested Party Use of Cash Operating Profit for Margin Comparison For Illustration Facts: Particulars Tested Party Comparables Fixed Asset (WDV) 15,000 7,500 Sales 5,000 3,000 Depreciation (@ 10% WDV) 1500 (@ 4% WDV) 300 Other Expenses 2, Profit 1, Margin(incl Depreciation): Profit/Sales 25% 35% Page 34

35 DOCUMENTATION PROCESS - ECONOMIC ADJUSTMENTS Depreciation Adjustment Method 1: Adjusting the Depreciation of Comparables Tested Party Comp (Actuals) Comp (Adjusted) Fixed Asset (WDV) 15,000 7,500 7,500 Sales 5,000 3,000 3,000 Depreciation 1,500 (@ 10% WDV) 300 (@ 4% WDV) 750 (@ 10% WDV) Other Expenses 2,250 1,650 1,650 Profit 1, Margin(incl Depreciation): Profit/Sales 25% 35% 20% Method 2: Margin Calculation on basis of Cash Profit Tested Party Comp (Actuals) Fixed Asset (WDV) 15,000 7,500 Sales 5,000 3,000 Depreciation 1,500 (@ 10% WDV) 300 (@ 4% WDV) Other Expenses 2,250 1,650 Cash Profit (Ignoring Depreciation) 2,750 1,350 Margin(Ignoring Depreciation): Profit/Sales 55% 45% Page 35

36 DOCUMENTATION PROCESS - ECONOMIC ADJUSTMENTS Other Adjustments Risk Adjustments Adjustment made to align the risks of Comparables with that of the Tested Party(such as technology risk, R&D risk, market risks, credit risk, etc.) Faced by Comparables vis a vis Tested Party Absence of risk of loss and being protected from Market Fluctuations Inventory Valuation Adjustments Adjustment made to align the Inventory Valuation method of Comparables with that of the Tested Party Change in Stock is influenced by Inventory Valuation Methods, which ultimately influence the Operating Profit of the Company under consideration The Company may adopt different Inventory Valuation methods due to following reasons o o FIFO vs WAM (as prescribed by Income Tax Act, 1961) Inventory Valuation method adopted by Management may be different from those prescribed by Income Tax Act, 1961 (eg LIFO, HIFO, Simple Average etc) Page 36

37 TRANSFER PRICING DOCUMENTATION Transfer Pricing Time-line Apr 1, 2014 Beginning of Financial Year Nov 30, 2015 Due date for Filing Form 3CEB Mar 31, 2018 Last Date for making TP reference Mar 31, 2019 Limitation for completion of Assessment Mar 31, 2015 End of Financial Year Sep 30, 2016 Limitation for initiation of Assessment Jan 31, 2019 Limitation for Completion of TP Audit Page 37

38 ACCOUNTANT S REPORT: FORM 3CEB Page 38

39 ACCOUNTANT S REPORT: FORM 3CEB Legal Requirements Report from an accountant to be furnished under section 92E relating to international transactions and specified domestic transactions - *I/We have examined the accounts and records of <<Name of Company>>, <<Address of Company>>, <<PAN of Company>>relating to the international transaction(s) and the specified domestic transaction(s) entered into by the assessee during the previous year ended on 31st March, <<year ending of relevant previous year>>. - In *my/our opinion proper information and documents as are prescribed have been kept by the assessee in respect of the international transaction(s) and the specified domestic transaction(s) entered into so far as appears from *my/our examination of the records of the assessee. - The particulars required to be furnished under section 92E are given in the Annexure to this Form. In *my/our opinion and to the best of my/our information and according to the explanations given to *me/us, the particulars given in the annexure are true and correct. Digital signature, Name, Membership number, Date, Firm Name and Registration number Page 39

40 ACCOUNTANT S REPORT: FORM 3CEB Annexures to Form 3CEB Part A General Information Name, Address, PAN & Residential Status of the assessee Nature of business or activities of the assessee; Previous Year & Assessment Year Aggregate value of international transactions / specified domestic transactions as per books of accounts Part B International Transactions List of associated enterprises with whom the assessee has entered into international transactions o Name, Nature of Relationship & Brief description of the business of associated enterprise Key Consideration: Identification of entities located in Cyprus with whom transactions have been entered into Transactions of tangible property o Purchase / sale of raw material, consumables or any other supplies o Purchase / sale of traded / finished goods o Purchase / sale of any other tangible movable / immovable property or lease of such property Key consideration: Reporting quantities Page 40

41 ACCOUNTANT S REPORT: FORM 3CEB Annexures to Form 3CEB Part B International Transactions Transactions of intangible property (purchase / sale / use of intangible property such as know-how, patents, copyrights, licenses, etc.) Service transactions Key Consideration: Reporting requirements for AMP expenses incurred by Indian entities Lending or borrowing of money (any type of advance payments, deferred payments, receivable, non-convertible preference shares/ debentures or any other debt arising during the course of business) Key Consideration: Reporting requirements for trade receivable/payables Transactions in the nature of guarantee Key Consideration: Arm s length price computation for transactions relating to guarantee? Page 41

42 ACCOUNTANT S REPORT: FORM 3CEB Annexures to Form 3CEB Part B International Transactions International transaction of purchase or sale of marketable securities, issue and buyback of equity shares, optionally convertible/ partially convertible/ compulsorily convertible debentures/ preference shares Key Consideration: Whether issue of equity shares ought to be reported in Form 3CEB? Mutual agreement or arrangement International transactions arising out of/ being part of business restructuring or reorganizations Key Consideration: Details of the agreement and terms of the business restructuring / reorganization Any other transaction Deemed international transaction Key Consideration: Wide coverage of deemed international transaction Page 42

43 ACCOUNTANT S REPORT: FORM 3CEB Annexures to Form 3CEB Part C Specified Domestic Transactions List of associated enterprises with whom the assessee has entered into specified domestic transactions o Name, Address and PAN of the associated enterprise o Relationship with associated enterprise o Brief description of the business of associated enterprise Key Consideration: Challenges with obtaining PAN of certain parties Transactions in the nature of payment for any expenditure to persons referred to in section 40A(2)(b) Transfer or acquisition of any goods or services to/from eligible business of the same assessee Any business transacted by an eligible taxpayer Any other transaction Key Consideration: Wide coverage of Clause for transaction with eligible taxpayer (any business transacted by an eligible taxpayer) Page 43

44 ACCOUNTANT S REPORT: FORM 3CEB Procedure for E-filing Page 44

45 ACCOUNTANT S REPORT: FORM 3CEB Procedure for E-filing Page 45

46 ACCOUNTANT S REPORT: FORM 3CEB Challenges in E-filing Reporting challenges Disclosure requirements Procedural challenges Qualified Accountant s Report? Modification in Accountant s Report? Accountant s Report for Foreign Companies? Separate report for international and specified domestic transactions? Acceptance of the Form Notes and additional disclosures? 3CEB by the taxpayer? Specific disclosures Quantitative details PAN of domestic parties Importing data from MS-Excel Carrying forward data to the next year Issues with the Income Tax Department s Utility Imperative to demonstrate due diligence and safeguard from penalties! Page 46

47 RISK MITIGATION Page 47

48 RISK MITIGATION Check Points for the Accountant and Taxpayer Coverage of Relationships Check for completeness and correctness Check points - Previous year s form 3CEB - Financial Statements - Notes to Accounts AS 18 disclosures - Form 3CD Sec. 40A(2)(b) disclosures - Cost Audit Report of the company - Company / group website - Companies Act requirements - SEBI s Listing Agreement requirements - Management discussion and representation Coverage of Transactions Reconciliation with disclosures - Notes to Accounts [AS-18] - Tax Audit Report [Section 40A(2)(b)] - Cost Audit Report - Companies Act compliances - SEBI s Listing Agreement requirements Ledger scrutiny - Ledger of Party Concerned - Transaction Ledger Reconciliation with amounts as per Financial Statements Details of foreign exchange transactions as provided in the audited accounts Management discussion and representation Page 48

49 RISK MITIGATION Roles and Responsibilities Taxpayer Recognition of parties and transactions where transfer pricing applies Determination of the most appropriate transfer pricing methodology o Recognizing comparable transactions / entities, as much as is relevant from TP perspective o Providing relevant industry-level and market-level information, such as key markets, major customers, competitors etc. o Providing insight into price-setting mechanism Determination of Arm s Length Price Compilation of relevant documents as proof of Arm s Length Price on real time basis Maintenance of transfer pricing documentation (as per section 92D r.w. Rule 10D) Accountant Independence in Transfer Pricing work Clearly defined Scope of examination o Importance of signed engagement Letter Communication with outgoing auditor Adherence to Code of Conduct Adherence to Guidance Note Quality control and peer review Timely issuance of the Accountant s Report (Form 3CEB) to client Maintenance of client file and documentation Management Representation Letter Page 49

50 CRITICAL ISSUES IN TP DOCUMENTATION Page 50

51 CRITICAL ISSUES IN TP DOCUMENTATION Typical challenges encountered Benchmarking issues Transaction specific issues General Benchmarking Practices Selection Of Foreign Tested Party Infusion Of Share Capital Advertising, Marketing And Promotion Expenses Location Savings Intra group services Deemed international transactions Page 51

52 BENCHMARKING ISSUES General Benchmarking Practices Availability of data while entering into controlled transaction Availability of data by the due date of filing ROI (Extended due date for Transfer Pricing Cases) Use of earlier years data Use of subsequent years data Database updates Fresh Search by TPO Restatement of Financials Difference in financial year end Page 52

53 BENCHMARKING ISSUES Selection of Foreign Tested Party - Analysis of Potential Approaches Foreign AEs could be selected as tested parties if functional analysis permits Different tested parties can be selected for transactions with different AEs if facts warrant Reliable information of comparables maybe difficult to obtain in jurisdictions such as Bangladesh If taxpayers has numerous AEs, Revenue could rely on Ranbaxy s case to claim that taxpayer should be the tested party Detailed functional & economic analysis is of utmost importance! Acceptability of Foreign Tested Party was permitted in legal precedents like Onward Technologies Ltd. Vs. DCIT [2013] 35 taxmann.com 584 (Mumbai Trib.) However in the case of Ranbaxy Laboratories Ltd. Vs. ACIT [2008] 167 Taxman 306 (Delhi), selection of foreign tested party was disallowed Page 53

54 TRANSACTION SPECIFIC ISSUES Infusion Of Share Capital - High Court decision in the Vodafone case Vodafone India Services (P) Ltd vs UOI [2015] 228 Taxman 25 (Bombay) Existence of Income for applicability of TP provisions Income arising from international transaction is a condition precedent for Chapter X Tax can only be charged on income In absence of income no question of testing ALP Capital account transactions are not Income Capital account transactions not covered within the definition of Income under the Act Coverage of Section 92B Share issue not covered under Sec 92B since no impact on profits, income, losses or assets Note: Government accepted HC order and did not file SLP before Supreme Court Page 54

55 TRANSACTION SPECIFIC ISSUES AMP Expenses - Background and Approach of the Revenue Authorities Taxpayers into distribution & marketing, using brand name of foreign AEs, face TP adjustments Excessive AMP expenses requires compensation for brand development services Bright Line Test (BLT) applied; illustrated below: Particulars Amt Particulars Amt Sales of taxpayer 1000 Excess AMP % of taxpayer (6%) 60 AMP expense of taxpayer 100 Add: 15% 9 AMP expense/sales ratio of taxpayer (%) 10% AMP expense/sales ratio of comparables (%) 4% Approach upheld by Delhi ITAT in case of LG Electronics vs. ACIT [2013] 29 taxmann.com 300 (Delhi - Trib.) (SB) Further, recent ruling in the case of Sony Ericsson Mobile Communications India Pvt. Ltd. Vs. CIT [2015] 55 taxmann.com 240 (Delhi) has held that AMP is an International Transaction and taxpayers are to be compensated for AMP expense, however has held that BLT cannot be adopted to determine ALP ALP of the International Transaction 69 Page 55

56 TRANSACTION SPECIFIC ISSUES Location Savings - Facts and Issues Key Facts: Agreement for rendering contract R&D / services by Indian taxpayer to foreign AE AE Taxpayer in low cost jurisdiction (India) hence location advantages for the Group Controversy: Outside India India Provision of contract R&D services Allocation of taxing rights of cost savings due to relocation to low cost jurisdiction Taxpayer Page 56

57 TRANSACTION SPECIFIC ISSUES Location Savings - Analysis Watson Pharma Pvt Ltd vs DCIT [2015] 54 taxmann.com 88 (Mumbai - Trib.) Once margins of Taxpayer are commensurate with comparables under TNMM, AE s benefit not relevant In perfectly competitive market, there is no super profit in the supply chain hence additional adjustment not warranted UN TP manual view of Indian tax administration; not binding on appellate authorities Reliance placed on OECD Guidelines Stress on Robust Documentation Comprehensive functional analysis of Taxpayer and group, with specific focus on location specific intangibles Detailed functional analysis and industry analysis to provide insight into stage of maturity and market competitiveness Comparison of location advantages for taxpayer vis-à-vis for comparables Benefits of location savings being passed to end customers Page 57

58 TRANSACTION SPECIFIC ISSUES Recharacterisation of Transactions - Facts and Issues Key Facts: Taxpayer paid share application money to overseas AE Considerable time gap between payment of share application money and conversion into share capital Issue: Revenue recharacterises delay in allotment of shares as deemed loan to AE Notional interest charged on such loan as part of TP adjustment Outside India India AE Taxpayer Payment of Share Application Money Page 58

59 TRANSACTION SPECIFIC ISSUES Recharacterisation of Transactions - decision in the case of Bharti Airtel Bharti Airtel Ltd vs ACIT [2014] 43 taxmann.com 150 (Delhi - Trib.) Share application cannot be pari materia with interest bearing loan At best, Share application could be treated as interest free loan only for inordinate delay period ALP could be interest potentially payable to an unrelated share applicant on delayed allotment of shares Revenue had no such comparable instance, hence adjustment not sustainable Revenue cannot re-characterize a transaction, actual structure of the transaction entered by Taxpayer to be respected unless it is a sham or bogus Page 59

60 TRANSACTION SPECIFIC ISSUES Intra Group Services - Facts and Issues Key Facts: Service agreement for management services to be rendered by AE to Taxpayer: Benchmarking using entity level TNMM Also, some cost allocations charged to Indian taxpayer on cost to cost basis Issue: Justification of the management fees and cost allocations paid to the AE Outside India India AE Taxpayer Provision of management and other group services Page 60

61 TRANSACTION SPECIFIC ISSUES Intra Group Services - Level of Documentation Inter company agreement Group transfer pricing policy Documentation for actual nature of services Details of benefits derived Demonstration of actual rendering of services by the AE ( communication, presentations, minutes of calls / meetings etc.) Demonstration of services being non-duplicate in nature Identification of cost incurred by the AE Arithmetic accuracy of cost allocation workings Certificate from an independent accountant certifying the cost allocation workings Page 61

62 TRANSACTION SPECIFIC ISSUES Deemed International Transactions - Facts and Issues Key Facts: Taxpayer sells raw material to X (Third Party) Contract manufacturing agreement between AE & X X uses raw material purchased from taxpayer Umbrella agreement for arrangement between AE & X Issue: Will such transactions may be deemed as transactions between AEs AE Outside India India Provision of contract manufacturing service Provisions u/s 92B(2): Such transactions may be deemed as transactions between AEs, if there exists a prior agreement in relation to the relevant transaction between the other person (in this case, X) and AE; or the terms of the relevant transaction are determined in substance between the other person (in this case, X) and the AE Taxpayer Sale of Raw Material X (Third Party) Page 62

63 TRANSACTION SPECIFIC ISSUES Deemed International Transactions - Implications of deeming provision Rationale for deeming provision Particulars Scenario 1: Transaction at ALP Scenario 2: Transaction below ALP Price charged by taxpayer to X for sale of raw material 10 8 Add : Agreed price chargeable by X to AE for contract manufacturing (excluding raw material purchased) Price charged by X to AE (including raw material purchased) Taxpayer's Revenue 10 8 Profits shifted (indirectly) to AE from Taxpayer 0 2 Caution areas for Taxpayers Ensure that transactions with third party are also at ALP If TP compliances are not undertaken, penal implications maybe applicable to taxpayer Page 63

64 INTERNATIONAL GUIDANCE Page 64

65 INTERNATIONAL GUIDANCE Guidance to Documentation Useful reference can be made to Documentation guidance/recommendations under: OECD Transfer Pricing Guidelines for Multinational Enterprises, 2010 ( European Union Code of Conduct on Transfer Pricing Documentation, 2006 ( Documentation Rules of Pacific Association of Tax Administrators, 2003 ( ATO Ruling TR 98/11 on Income tax: documentation and practical issues associated with setting and reviewing transfer pricing in international dealings ( Page 65

66 INTERNATIONAL GUIDANCE OECD / BEPS ACTION PLAN 13 - Guidance On TP Documentation OECD Guidance on Transfer Pricing Documentation and Country-by-Country Reporting (Action 13) is aimed at: - enhancing tax transparency; seen as essential to tackle BEPS problem - provision of requisite information to tax authorities in the light of increasing volume and complexity of international transactions Objective of TP Documentation: - To ensure that taxpayers give appropriate consideration to TP requirements in establishing prices and other conditions for transactions between AEs and in reporting the income derived from such transactions in their tax returns - To provide tax administrations with the information necessary to conduct an informed TP risk assessment - To provide tax administrations with useful information to employ in conducting an appropriately thorough TP audit, and flow of information as the audit progresses The Action Plan suggests a 3 tier approach to Transfer Pricing Documentation Page 66

67 INTERNATIONAL GUIDANCE OECD / BEPS ACTION PLAN 13-3 Tier Approach Tier 1: Master File Overview of Multinational Enterprise ( MNE ) business Nature, overall Transfer Pricing policies, global allocation of income and economic activity Intends to serve as the blueprint of the MNE group providing details of o MNE group organisation structure o Description of MNE s business or businesses o MNE s intangibles o MNE s intercompany financial activities o MNE s financial and tax positions Tier 2: Local File Detailed information specifying intercompany transactions To contain price analysis related to transaction between local country affiliate and AEs in different country Financial information of transactions, comparability analysis, selection and application of Most Appropriate Method Page 67

68 INTERNATIONAL GUIDANCE OECD / BEPS ACTION PLAN 13-3 Tier Approach Tier 3: Country-by-Country (CbC) Report Shall contain aggregate tax jurisdiction-wide information relating to global allocation of income, taxes paid Requires listing of Constituent Entities for which financial information is available, including tax jurisdiction of incorporation and nature of business of the entities Could be useful in high level TP risk assessments and evaluating other BEPS related risks Shall not serve as a substitute for a detailed transfer pricing analysis of individual transactions and prices based on a full functional analysis and a full comparability analysis Does not constitute conclusive evidence that transfer prices are or are not appropriate Shall not be used by tax administrations to propose TP adjustments based on a global formulary apportionment of income Transfer CTC - Procedure Pricing Documentation for TP compliances & Benchmarking & Best practices for TP documentation Page 68 68

69 INTERNATIONAL GUIDANCE OECD / BEPS ACTION PLAN 13 CbC Reporting - First CbC report to be filed by 31 January For MNEs with a fiscal year ending on a date other than 31 December, the first CbC Report would be required to be filed later in 2018, 12 months after the close of the relevant MNE fiscal year, and would report on the MNE group s first fiscal year beginning after 1 January MNE fiscal year relates to the consolidated reporting period for financial statement purposes and not to taxable years or to the financial reporting periods of individual subsidiaries All MNEs are required to file CbC report except: - MNEs with annual consolidated group revenue in the immediately preceding year less than Euro 750 Million - Though percent of companies are expected to be exempt due to the above threshold, CbC Report will nevertheless be filed by MNE groups controlling approximately 90 percent of corporate revenues Transfer CTC - Procedure Pricing Documentation for TP compliances & Benchmarking & Best practices for TP documentation Page 69 69

70 LATEST DEVELOPMENTS Page 70

71 LATEST DEVELOPMENTS Safe Harbour Rules Sr. No. Eligible International Transactions Page 71 Turnover Threshold A. Non financial transactions 1. Provision of Software development services INR 500 Crore or below 20% or more Above 500 Crore 22% or more 2. Provision of Information Technology Enabled Services INR 500 Crore or below 20% or more Above 500 Crore 22% or more 3. Provision of KPO services No Threshold 25% or more 4. Provision of contract R & D services (wholly or partly) relating to software development 5. Provision of contract R & D services (wholly or partly) relating to generic pharmaceutical drugs 6. Manufacture and export of auto components where 90% or more of total turnover during the previous year is in the nature of Original Equipment Manufacturer sales Core Auto-components Non-core Auto-components No Threshold No Threshold No Threshold CBDT has now released the final Safe Harbour Rules on 18 September 2013 Safe Harbour Rates [Operating profit margin (OP/OC)] 30%or more 29% or more 12% or more 8.5% or more

72 LATEST DEVELOPMENTS Safe Harbour Rules Sr. No. B. Financial transactions Eligible international transactions 7. Intra-group loans given to wholly owned subsidiary where loan is sourced in INR (excludes loan given by enterprises engaged in lending or borrowing in the normal course of business) 8. Explicit corporate guarantee provided to wholly owned subsidiary (Corporate Guarantee excludes performance guarantee and letters of comfort) Amount of the Loan/ Guarantee INR 50 Crores or below Above INR 50 Crores INR 100 Crores or below Above INR 100 Crores Safe Harbour Interest/ Commission Rates Basis points above base rate of State Bank of India as on 30 June of the relevant previous year plus 150 basis points 300 basis points 2% per annum on the amount guaranteed 1.75% per annum on the amount guaranteed provided the credit rating of the Associated Enterprise as per a SEBI registered agency is of Adequate to Highest Safety Page 72

73 Conclusion of APA LATEST DEVELOPMENTS Overview of APA in India APA preparatory Health Check Pre-Filing Consultation (Optional) Filing of APA Application Negotiation & Finalization Fact gathering and Analysis Performing a detailed FAR and Economic analysis APA Strategy to be adopted Preparing pre-filing documentation Exploring suitability of an APA with the APA authority Upfront discussion of the process, and data likely to be needed for the APA submission etc. Preparing and filing the APA application containing information on the covered AEs, covered RPTs, industry, TP method, critical assumptions, etc. Submission reviewed by APA Team Site visit Meetings and discussions with APA Team Negotiations on the mark up and the comparables Position Paper Indian APA Programme so far Approx 550 APAs applications have been filed till 31 March 2015 & 13 Unilateral and 1 bilateral APAs have been signed Roll back of APAs has made it viable for companies to apply for APAs for the previous 4 years too More than 35 countries around the world has adopted APA for transfer pricing tax certainty Page 73

74 LATEST DEVELOPMENTS New Range Concept The CBDT has introduced a notification on 19 October 2015 wherein a revised range concept has been introduced and usage of multiple year data while carrying out transfer pricing analysis is permissible The notification is applicable from FY Range concept can be used for all methods except for Profit Split Method and Other Method For PSM and Other Method, only arithmetic mean concept would have to be used Range concept will be applicable only if 6 or more comparable companies are available. If not, arithmetic mean concept will continue to be used The arm s length range will constitute of the values falling between the 35th and 65th percentile of the weighted average margins of comparable companies. If the transaction price falls outside the arm s length range, the median value of the comparable prices shall be considered as ALP Page 74

75 LATEST DEVELOPMENTS Application of New Range Concept Sr. No Company Name Margin 1 A B C D E F G Calculation of Arm s Length range 35th percentile --> 35% * 7 (no. of comparables) = 2.45 (round off to 3) 65th percentile --> 65% * 7 (no. of comparables) = 4.55 (round off to 5) Third value of weighted average margins in ascending order = Fifth value of weighted average margins in ascending order = Therefore, arm s length range = 11.00% to 12.00% If transaction value falls within arm s length range Arrange in Ascending order Sr. No Company Name Margin 1 F A C G B D E Transaction value is at arm s length If transaction value is outside the arm s length range Median (i.e. 50th percentile) is the ALP = 11.11% Page 75

76 LATEST DEVELOPMENTS Use of Multiple Year Data Compliance stage Multiple year data to be used whether range concept is applicable or not Only in cases of TNMM, RPM and CPM Data for CY to be considered compulsorily, if available If CY is available but not comparable reject comparable If CY is available and comparable, data for CY-1 and CY-2 can be used it passes all qualitative/ quantitative filters in each year/(s) If CY is not available, check CY-1 and/or CY-2 for availability/comparability: If available & comparable- accept comparable; If not available/comparable - reject comparable Assessment stage CY data is to be considered compulsorily, if available Analysis of CY data: If available & not comparable (for qualitative/ quantitative reasons) - reject comparable (if it is comparable for CY-1 and CY-2) If not available TPO has to consider CY-1 and CY-2 taken by the assessee in the TP study Fresh comparables not appearing in the benchmarking set at the time of compliance can be used at the time of assessment Page 76

77 KEY TAKEAWAYS Page 77

78 Key Takeaways Infeasibility of Benchmarking Exhaust all possible sources of benchmarking & documents Demonstrate due diligence Reliance on International Guidance Reliance on Expert Opinions Documentation for inter-company negotiations Documenting complete transactional profile Next best possible comparable (Lateral Comparable) Earlier/subsequent year s benchmark Group level transfer pricing policies Industry best practices Compile robust documentation for each stage Page 78

79 Key Takeaways Concluding Remarks Expanded coverage o Expanded definition of Associated Enterprise and International Transactions o Coverage of capital transactions o Deemed international transactions o Specified domestic transactions o Business Restructuring Change in approach due to applicability to tax holiday taxpayers Impending introduction of Arm s length Range and Multiple Year Data Challenges with e-filing Tolerance Band notified Clarification on the term Wholesale trading Wide gamut of application of other method Increased penalty exposure Importance of Management Representation Letter and its coverage No provision for revision of Form 3CEB DOCUMENTATION IS THE KEY!! Page 79

80 THANK YOU Page 80