Draft rules on 'Range' and 'Multiple Year Data' -An aid or

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1 ...,111e Draft rules on 'Range' and 'Multiple Year Data' -An aid or woe? RAKESH NANGIAANDAMIT BHALLA I 18/ :17 PM 'Range' and 'multiple year data' are among the best transfer-pricing practices and also closer to economic realities wherein prices, and or margins, are compared to those within a range and not at to a particular point The introduction of concepts of 'range' and 'multiple year data' in Indian Transfer Pricing (TP) regime is a welcome step towards alignment of Indian TP regulation with developed international TP practices. The concept of 'range' will furnish a more accurate result for Arm's Length Price (ALP), as the extreme 1f7

2 results or outliers comparable would be left out of the range which does not happen while using the arithmetic mean approach. Similarly, the usage of multiple years' data shall help in improving the overall exercise of comparability analyses. The use of both the concepts are amongst the globally accepted best TP practice and also closer to economic realities wherein prices, and or margins, are compared to those within a range and not at to a particular point. Finance Minister Aron Jaitley, while presenting the Finance Bill made an announcement that 'range concept' would be introduced in Indian Transfer Pricing (TP) regulations. In addition to the same, it was announced that the 'use of multiple year data' would also be allowed for undertaking comparability analysis. The principal intent of announcing the aforesaid concept was to make Indian TP regime with the globally followed TP practices. The other purpose of ushering in the same was to reduce the prolonged and unwarranted TP litigation. The announcement of 'range concept' and 'use of multiple year data' was the result of the Finance Minister's prompt sensing of the exhort of epitome shift of the Indian TP regime and thereby squaring off lengthy and unwarranted litigation issues. Consequent to the same, section 92C(2) of the Income-tax Act, 1961 (the Act) was amended by the Finance Act 2014, to provide that where more than one price is determined by application of the most appropriate method, the Arm's Length Price (ALP) 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. In this connection, Central Board of Direct Taxes (CBDT) has recently issued the much awaited draft scheme for the application of 'range concept' and use of 'multiple year data' for determining the ALP. These draft rules, once get finalised, would be applicable to all international transactions and specified domestic transactions undertaken by the taxpayers with its associated enterprises (AEs) during and subsequent to the financial year ending 31 March Seeking public comments before issuing final rules, is a laudable initiative taken by the Government that has given opportunities to corporate 2f7

3 and stakeholders to provide their comments and concerns in this regard. The proposed scheme, which lays down the terms and conditions in relation to the use of 'range concept' and the concept of 'use of multiple year data' along with our corresponding remarks, have been discussed in the following sections of this article: The 'Range' Concept

4 Our comments on the proposed 'concept of range' have been t abulated below : Basis Proposed rules our observations/ remarks TP Methodologies The 'range concept' shall be used only when Transactional Net Margin Method (''TNMM 11 ), Resale Price Method ("RPM") or Cost Plus Met hod ("CPM") are used for determining ALP of the international t ransaction or specified domestic transaction. > The same could have been ext ended to other TP methods which have been excluded viz. Comparable uncontrolled method ("CUP Methodu) or Any Other Method ("AOM" ) [since there may exist multiple comparable transact ions usi ng these methods as well]. Minimum number of comparable companies Range A minimum of nine comparable entities are required to be selected based on t he similarity of t heir functions, assets and risks w ith that of t he t ested party. The dat a points lying w ithin the 4C1" to 60th percentile of the data set of series would be considered as t he range. > This condit ion is bit irrat ional as for a number of industri,es (manufact uring and distribution specifically); it is not easy to arrive at the set of nine comparable companies. > Also, if the t axpayer at the t ime of filing return determines the ALP of its international or specified domestic transactions with less than nine comparables and su bsequently, at the time of TP audit, more than nine comparables are available, t hen to concord from arithmetic mean concept to range concept would be difficult. The vice-versa scenario is also possi ble. > On t he cont rary, a number of developed countries' TP regulations, OECD Guidelines and UN TP Guidelines adopt t he classical concept of int er-quartile range i.e. 25!fi to 75 ~.h percentile. The ra nge suggest ed by CBDT in its draft rules provides a very narrrow range of margins/comparables. > Further, t he guidance on computation of percentile is also required t o be incorporated therein due t o t he exist ence of various methods of comput at ion of percent iles w hich will eventua1lly render different result s leading to further controversy. The draft rules further provides that in case if the transfer price of the tested party falls outside the range (i.e. 4oth to 6oth percentile), the median of the range will be considered as ALP and adjusttnent to transfer price shall require be made accordingly. If the transfer price is within the range, no adjusttnent shall be made. The introduction of range concept would facilitate in determination of more 4f7

5 accurate ALP as the loss making or the abnormal profit making comparables would be left out of the range and would not influence the ALP as it generally happens while computing ALP through using arithmetic mean concept. Use of 'Multiple Year Data' Concept The draft rules have proposed the use of multiple year data which has been a matter of significant litigation and debate so far. Our observations/ comments with respect to draft rules in relation to the use of multiple year data are provided as below: 517

6 Basis Proposed rules Our observations/ remarks TP Methodologies No. of years to be used (including current year) Data for UNO years instead of three years can also be used The 'concept of use of multiple :> The same could have been extended to other year data' shall be used only TP methods which have been excluded viz. when TNMM, RPM or CPM are CUP Method or AOM (sinoe t here may exist used for determining of ALP of multiple comparable transactions using these the international transaction or methods as well). specified domestic transaction. The multiple year data would > The draft rules further provide that, if the comprise of three year data current year data becomes available at the including the current year dat a time of TP audit, it can be used by the (in \lllhich the transactions is taxpayer as well as tax authorities. In case, if undertaken) and its use for the data for current year is not available till above mentioned shall be the filing of Form 3CEB/ return, and a mandatory. company is not comparable in year 1 and 2, then such company should not be considered as comparable. However, the taxpayer and The data of 2 years can be us,ed tax authority can use such comparable at a if 3 year data is not available later stage rt data for current year is available due to any one of following at the time of audit. This would result in the reasons: taxpayer having to refresh to TP > Unavailability of data of documentation at a later stage for the most current year of updated data of the current year. This com parables on the approach does not render much needed databases at the time of certainty to the taxpayer at the time of filing filing return; the tax return. > Failure to clear a > It is observed that there has been no quantitative filter in any of the three years; and > A comparable may have st arted operations only in the last t wo years or may have closed down the operations during the current year. reference provided to the qualitative filters in the draft rules. For instance, if there is any business restructuring or change in accounting policies in case of the potential comparable company's data in one of t he three years, then would it be possible for taxpayer to consider two years' data for aforesaid comparable in order to determine the ALP of its international or specified dome.stic transactions?' Multiple year data would apply whether the ALP has been determined through range concept or arithmetic mean. In case the range concept does not apply, the arithmetic mean concept shall continue to apply as it is applied in the existing scenario along with the benefit of tolerance range (3% in for all the taxpayers other than wholesale distributors and 1% for wholesale distributors). Concluding Remarks 617

7 Our few final remarks in relation to the introduction of the concepts of 'range' and 'use of multiple year data' are provided as below: if- The requirement of having minimum nine comparable companies for the application of range concept may lure the tax authorities to intentionally cull out certain comparable companies and apply the concept of arithmetic mean in case of the taxpayers which would finally nullify the concept of introducing the concept of range in the Indian TP regime. It is thus, recommended that the 'inter-quartile range' shall substitute the proposed 4oth to 6oth percentile range to make it in line with the global TP practices. This may eventually help in negotiating the bilateral advance pricing arrangements or MAP proceedings with number of developed countries following the concept of 'inter quartile range' concept. In addition to the same, the computation mechanism for determination of range should also be provided in the rules. if- The usage of range and multiple year data should be extended to other methods also. if- The minimum number of comparables can be reduced from nine to a lesser number in the light of practical difficulties. We are hopeful that these concepts help in reducing the TP litigation in India subject to above suggestions and recommendations. (Rakesh Nangia is Managing Partner and Amit Bhalla is Senior Manager at Nangia&Co) 7f7