INDIA TRANSFER PRICING UPDATES MARCH 2019

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1 Uday Ved Global Tax Partner INDIA TRANSFER PRICING UPDATES MARCH 2019 KNAV Thought Leadership has started an initiative to publish a monthly newsletter dedicated to transfer pricing updates and amendments including the recent important jurisprudence. These highlights will help the readers stay abreast of the important developments in the field of transfer pricing. This initiative would be in addition to our monthly newsletters covering the important judgments and other updates from a corporate tax point of view. 1

2 Transfer Pricing Case Law 1: Aamby Valley Ltd. v. ACIT [2019] 102 taxmann.com 385 (TDel) LIBOR rate being a foreign rate should be preferred against SBI s prime lending rate for international transactions with AEs in foreign currency. The assessee-company was engaged in the business of construction. The assessee granted a loan to its associated enterprise ( AE ) for a period of 7 years at an annual interest rate of LIBOR bps ( basis points ). During the transfer pricing proceedings, the Transfer Pricing Officer ( TPO ) rejected the assessee s contention of using LIBOR for benchmarking purposes and stated that LIBOR was not applicable where currency of origin country of loan (India) was not a currency in which loan was extended. TPO contended that assessee erred in assessing the risks associated with international lending transactions. TPO stated that the assessee should have used the standard of the return that it would have earned in India if money was lent here to company with an economic status as weak as the subsidiary. TPO rejected the search conducted by the assessee to for arriving at comparable rate of interest. The TPO relied on the Safe Harbour Rules ( SHR ) where SBI base rate is suggested for benchmarking interest on loan. Aggrieved by the decision, the assessee appealed before the Dispute Resolution Panel ( DRP ) who enhanced the income of the assessee at LIBOR bps. Aggrieved, the assessee filed an appeal before the Hon ble Tribunal. The assessee submitted that SBI is a bank which is engaged in lending of funds to the third parties. The assessee was not a bank / financial institution. Thus, interest on loans advanced by a bank / financial institution and the assessee could not be considered comparable. Further, the assessee stated that when transaction was of lending money in foreign currencies to foreign AEs, interest rates of unrelated third parties lending foreign currencies should be considered comparable. The transaction should be looked upon applying the commercial principles. Thus, domestic prime lending rate would have no applicability and the international fixed rate i.e. LIBOR should be considered, while determining the arm s length interest rate in respect of international transaction entered by the assessee with the AE. As the assessee had calculated the arithmetic mean of interest rate of comparable borrowings advanced by the third parties at LIBOR bps and the assessee had charged LIBOR bps, it was sufficient enough to be considered at an arm s length. 2

3 Case Law 2: CLSA India (P.) Ltd. v. DCIT [2017] 101 taxmann.com 388 (TMum) TPO is bound to determine ALP of an international transaction in accordance with the methods prescribed under the Act. Thus, if any ad hoc determination of ALP is made by TPO the same would not be sustainable and would be bad in law. The assessee-company was primarily engaged in the business of equity broking and had the membership of Bombay Stock Exchange and the National Stock Exchange. The assessee's customers comprised of Foreign Institutional Investors ( FIIs ) and Domestic Institutional Investors ( DIIs ). The assessee entered into agreements with its AEs to provide services in the nature of international equity sales and sales trading support, dealing sport and regional research and a range of back-office support services to its FIIs clients and thereby maintaining international presence and relation. The assessee benchmarked the said international transaction using Transactional Net Marginal Method ( TNMM ) as most appropriate method ( MAM ) wherein the assessee was the tested party. The TPO rejected the assessee s benchmarking of the cost contribution, holding that cost contribution constituted a small part of the total transactions at the entity level and therefore, the profit margin at the entity level could not be the basis for determining the ALP of the cost contribution. The TPO benchmarked the said international transaction by estimating man hours of services rendered by the AE to the assessee and applied an ad hoc hourly rate on estimated hours to determine the arm s length price ( ALP ) i.e. transfer price. Accordingly, the TPO made an upward adjustment to the total income of the assessee. The assessee filed its objections before the DRP against the draft assessment order passed by the AO with an upward adjustment. The DRP, however, confirmed the adjustment and upheld the contention of the AO. Aggrieved by the order, the assessee preferred an appeal with the Hon ble Tribunal. The Hon ble Tribunal relying on the decision rendered by the Hon ble Bombay High Court in case of CIT v. Johnson and Johnson Ltd [2017] 297 CTR 337 (Bom) and held that the ALP determined by the TPO on ad hoc basis was not as per the provisions of the Income Tax Act, 1961 ( the Act ). Further, the tribunal relied on the decision rendered by the Hon ble Bombay High Court in case of CIT vs. Kodak India Pvt Ltd 288 CTR 46 [2017] (Bom) and declined to restore the matter back to the TPO. Accordingly, the Hon ble Tribunal directed the AO to delete the upward adjustment. 3

4 Case Law 3: Sunquest Information Systems India (P.) Ltd. v. DCIT [2019] 101 taxmann.com 315 (TBan) In case of provision of software development services, companies having less than 15% of related party transactions were to be included as comparable. Giving credit is an integral part of rendering business services, and the same could not be an independent transaction, thus having separate determination of ALP. The assessee was engaged in the business of rendering software development services to its AE. The assessee was compensated for the same on cost plus basis. During the transfer pricing proceedings, the TPO rejected the contentions of the assessee, reshuffled the comparables and thereby, recomputed the average mean margin at a higher rate. Accordingly, an addition for the differential amount was made into the assessee s income by the TPO. Further, since the assessee did not receive a part of its receivables from its AEs for a period of more than 3 months, the TPO treated the same as a loan by the assessee to its AE and added notional interest at the SBI lending rate of 11.25% on the contention that the assessee should have used the standard of the return that it would have earned in India if money was lent here to company with an economic status as that of the AE. Aggrieved by the decision, the assessee appealed before the DRP. The DRP excluded a few companies chosen by the TPO applying a turnover filter and RPT filter of 0%. Further, in the case of notional interest the DRP concurred with the finding of the TPO. Aggrieved, the assessee filed an appeal before the Hon ble Tribunal. The Hon ble Tribunal held that based on various case laws mentioned by the assessee and on the facts of the case, companies that possessed less than 15% transactions with the related parties could be included as comparable by the assessee company for computation of ALP for provision of software development services to its AE and accordingly reincluded the said comparables dismissed by the DRP in the computation of the ALP. Further, in the case of addition of notional interest on the receivables from the AE, the Hon ble Tribunal held that giving a credit period could not be considered as an independent transaction and no separate determination of ALP for the same could be derived, as the same was considered as an integral part of the international transaction of software development services and not a separate transaction. 4

5 Case Law 4: M/s. JE Energy Venture Private Ltd. v. ACIT (ITA No.7602/Del/2017) (TDel) As bank guarantees were different from corporate guarantees, naked quotes of BG commission rates published on the websites of the banks could not be applied without relevant adjustments. The assessee-company provided a corporate guarantee on behalf of its AE. The assessee had selected other method prescribed under Income tax rules, 1962 ( the rules ) as the MAM to benchmark the said transaction. The TPO however selected external CUP and applied the data from various banks available on the bank s website for benchmarking purposes and made an upward adjustment to the total income of the assessee. Aggrieved by the decision, the assessee preferred an appeal before the DRP, which gave a partial relief to the assessee. Aggrieved, the assessee preferred appeal before the Hon ble Tribunal. The Hon ble Tribunal stated that the naked quotes of the bank guarantee commission rates published on the website of the bank should not be applied without adjustment to various factors. The adjustments with respect to risk profiles of the respondents for the guarantee, financial position of the applicants, terms of guarantee, securities involved, quantum of the guaranteed amount, period of guarantee, history and relationship with the customers should be considered. Further, bank guarantees were different from corporate guarantees, since a corporate guarantee does not operate for business considerations. Corporate guarantees were provided to safeguard the financial health of the AEs. An external CUP could be defined as a price charged as comparable uncontrolled price between third parties when compared to the price of a controlled transaction with the AE. The comparables used by the TPO did not fall within the definition of external CUP. The Hon ble Tribunal opined that bank guarantee commission prices could not be used as external CUP to benchmark the corporate guarantee commission prices. Therefore, the comparables selected by the TPO were considered as incomparable uncontrolled prices. and the guarantee commission charged by the assessee was considered reasonable and accepted without any modification. 5

6 Case Law 5: B.G. India Energy Solutions (P.) Ltd. v. DCIT [2019] 101 taxmann.com 360 (TDel) The ALP of management services unit charges paid to AE could not to be taken as NIL, if services were not duplicitous in nature and the payment made for these services were recognized separately and not at par with the payment made for the support services required to achieve huge sales volume. The assessee-company was engaged in marketing and distribution of natural gas and LNG. The assessee company paid for certain Management Services Unit Charges ( MSU ) to its AE and used TNMM as the MAM to benchmark the said transaction. The TPO however rejected the assessee s benchmarking and applied CUP as the MAM to benchmark the said transaction and further asked the assessee to justify the reason for the payment for MSU. The assessee explained to the TPO that since it did not have in-house skilled man power, it sought assistance from its AE. The TPO however rejected the plea of the assessee and made an upward TP adjustment and determined ALP of the said transaction at NIL. The assessee filed its objections before the DRP. The DRP however upheld the draft assessment order and thus decided against the assessee. Aggrieved by this, the assessee made an appeal to the Hon ble Tribunal. The Hon ble Tribunal believed the sales of LNG made by the assessee could not have been achieved without the aid of support staff services provided by the AE. Further, on perusal of various clauses mentioned in the agreement entered with the AE, the Hon ble Tribunal held that there was no payment for duplicative services and the payment of MSU charges were distinct and therefore, the adjustment made by the TPO needs to be uncalled for and deserves to be deleted. Case law 6: M/s Infonox Software Pvt. Ltd. v. DCIT [2019] CMA No (Del HC) The ALP of management services unit charges paid to AE could not to be taken as NIL, if services were not duplicitous in nature and the payment made for these services were recognized separately and not at par with the payment made for the support services required to achieve huge sales volume. Summary of the case: The assessee was engaged in the business of providing software development and support services to its clients. Assessee explained that during the relevant year, owing to mismanagement and removal of two directors and non-availability of critical records / financial documents, it was unable to finalize its audited annual accounts and consequently, it was also unable to comply with the statutory requirements of filing its Return of Income and Form 3CEB within due date. 6

7 the TPO. As per the CBDT Instruction, in cases where returns have been selected for scrutiny on transfer pricing risk parameters, reference to the TPO is mandatory. AO initiated reassessment proceedings for the year and directed the assessee to file its return of income along with other statutory documents which were duly complied with by the assessee. Simultaneously, AO also levied penalty u/s 271F of the Act for non-filing of its tax return which was subsequently deleted by the CIT(A), opining that assessee had reasonable and genuine cause for not filing its return of income within the due date. However, for cases which are selected on non-transfer pricing risk parameters, it specifies that they can be referred to the TPO only when a) AO comes to know of an international transaction which has either not been disclosed by the taxpayer in its Form 3CEB or no Form 3CEB has been filed by the taxpayer at all; b) Transfer Pricing Adjustment of INR 10 crores or more has been made, in the hands of the taxpayer, in any of the preceding year(s); c) Incriminating material regarding an international transaction has been recovered during search and seizure operations conducted at the premises of the taxpayer. The AO made a reference to the TPO during the reassessment proceedings of the assessee on the grounds that the assessee did not file Form 3CEB within the specified due date. The assessee defended its case by making a reference of the CBDT instruction 3/2016 which inter-alia permits the reference of the cases selected for scrutiny on non-transfer pricing parameters to TPO, only if Form 3CEB was not filed at all. Assessee also contended that had AO s stand of non-filing of Form 3CEB been correct, the same would have been the very reason for reopening of the assessment. However, the same was not correct as per the facts and circumstances of the case. Assessee has further argued that a return filed in response to a notice received u/s 148 of the Act is equivalent to a return filed u/s 139 of the Act and assessee having filed its return along with report in Form 3CEB as required to be filed u/s 92E of the Act within the time allowed in the said notice, had discharged its obligation and hence, the stand taken by AO that assessee did not file the report u/s. 92E within the due date was incorrect. During the reassessment proceedings, AO issued show cause as to why assessee s case should not be referred to the TPO to determine the ALP for international transactions, as the assessee company failed to file Form 3CEB within specified date. In reply, assessee submitted that its case did not fall within any of the conditions/ circumstances outlined in CBDT Instruction No. 3/2016 so as to warrant a reference to TPO. Assessee also submitted that that it had reasonable cause for not filing its Form 3CEB within the due date and those reasons were accepted by the appellate authority while deleting the penalty levied u/s 271F of the Act. However, AO rejected assessee s submissions on the ground that the Form 3CEB was not filed within the specified date and that prosecution proceedings against the assessee were underway. The Hon ble HC considering the representations by the assessee and the DR has stayed the impugned reference to TPO and issued a notice to the Department. Aggrieved, the assessee filed a writ petition before Hon ble Delhi HC. The assessee, vide its writ petition, challenged the validity of reference made to TPO u/s 92CA(3) of the Act and the order passed by the AO rejecting the objections raised by the assessee against reference to 7

8 Disclaimer: This publication contains general information only, and none of KNAV International Limited, its member firms, or their related entities (collectively, the KNAV Association ) is, by means of this publication, rendering professional advice or services. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional adviser. No entity in the KNAV Association shall be responsible for any loss whatsoever sustained by any person who relies on this publication. KNAV refers to one or more member firms of KNAV International Limited ('KNAV International'); which itself is a not-for-profit, non-practising, non-trading corporation incorporated in Georgia, USA. KNAV International is a charter umbrella organization that does not provide services to clients. Each firm within KNAV's association of member firms, is a legally separate and independent entity. Services of audit, tax, valuation, risk and business advisory are delivered by KNAV's independent member firms in their respective global jurisdictions. All member firms of KNAV International in India, North America and UK are a part of the US$ 2.01 billion, US headquartered Allinial Global; which is an accounting firm association, that provides a broad array of resources and support for its member firms, across the globe. For expert assistance, please contact Uday Ved: uday.ved@knavcpa.com or Visit us at: 8 Complex, Bandra East, Mumbai, Maharashtra , India Head office: 201/202, Naman Centre, C-31, G Block, Bandra Kurla Other offices: Canada Netherlands Singapore UK USA

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