OECD GUIDELINES AND U.S. REGULATIONS

Transcription

1 CONTENTS Preface to Fourth Edition I-5 Preface to Third Edition I-7 Preface to Second Edition I-9 Preface to First Edition I-11 Chapter-heads I-13 List of Cases I-35 1 INTRODUCTION 1.1 Introduction Global formulary apportionment and Transfer pricing adjustments Transfer pricing adjustments - Favoured over global formulary apportionment method Transfer pricing - Meaning and effect Aims and objects Tax avoidance Exchange control and foreign investment Withdrawal of profits in the form of royalties etc Political and economic uncertainties Whatever motive - Tax avoidance is the consequence Characterisation of income Measures to curb abuse 14 2 OECD GUIDELINES AND U.S. REGULATIONS 2.1 Introduction 18 I-15

2 2.2 OECD Guidelines Background US regulations of 1968 setting the trend A Need felt for OECD guidelines Report Report Report International Tax Avoidance and Evasion - Four Related Studies Tax treatment of Transfer Pricing in US - Changes in 1986 and OECD Guidelines - Object and purposes OECD Guidelines - Background OECD Guidelines Salient features OECD Guidelines Reaffirming 1979 Report OECD Guidelines Detailed and Systematic OECD Guidelines Supplement 1979 and other Reports Administrative procedures and approaches to resolving transfer pricing disputes Transfer Pricing compliance and examination practice Simultaneous tax examinations Advance Pricing Agreement Arbitration Documentation which can be reasonably demanded from enterprises OECD Guidelines - Other Reports OECD Guidelines Report - Intangibles OECD Guidelines Report - Intra-group services OECD Guidelines Report - Cost Contribution Arrangements (CCA) OECD Guidelines Annex - Practical examples OECD Guidelines Reports relating to electronic commerce OECD Guidelines Update - Advance Pricing Arrangements (APA) 63 I-16

3 2.17 OECD Guidelines - The Taxation of Global Trading of Financial Instruments - Discussion Draft OECD Guidelines - Four main issues OECD Guidelines, ANNEX 2.1 : E-commerce : Implementing the Ottawa taxation framework conditions 68 3 TRANSFER PRICING - OVERVIEW OF PROVISIONS 3.1 Introduction Computation of income Report from an accountant Arm s length price Definitions Penalty - Non-compliance of procedure Penalty - Non-maintenance of information and documents Penalty - Non-furnishing of report from the accountant Penalty - Non-furnishing of information or documents Penalty - Concealment Transfer pricing provisions Salient features 98 4 INTERNATIONAL TRANSACTION 4.1 Introduction International transaction - Meaning Restricted meaning Transaction - Meaning Transaction between two or more branches of a associated enterprise A Permanent establishment and Head Office International transaction - Not between associated enterprises but deemed 115 I-17

4 4.3-3a Prior agreement between the person and the associated enterprise b Terms of the transaction determined by the associated enterprise Transaction in the nature of a Purchase b Sale c Lease d Tangible or intangible property e Provision of services f Lending or borrowing money Other transaction than specifically mentioned International transaction - Inclusive definition Mutual agreement or arrangement (Cost Contributions Arrangement) In connection with Benefit, service or facility Structure Characterisation Thin or hidden capitalisation Royalty a Software, whether process or a product Treaty shopping a Resident of third state not entitled to treaty benefit b Treaty shopping - Adopted to take tax advantage c Domestic law principles for tax avoidance d X Limited case e Consequence to source Country f Recent trends g Harmful Tax Practices h Anti-treaty shopping provision - Indo-US treaty Arrangements different from adopted by independent parties 174 I-18

5 5 SPECIFIED DOMESTIC TRANSACTION 5.1 Introduction Specified domestic transactions Fair market value Determination subjective Arm s length regime ASSOCIATED ENTERPRISES 6.1 Introduction Enterprise Person engaged in any activity Activity relating to Activity or business Permanent establishment Associated enterprises Parents, subsidiaries and fellow subsidiaries Special relationship Participation in the management, control or capital Management Control Control and management Capital Participate directly or indirectly or through intermediaries Direct or Indirect ownership control Special relationship under deeming provisions ARM S LENGTH PRICE 7.1 Introduction Old provision 216 I-19

6 7.3 New provision Arm s length principle - Meaning Arm s length principle Arm s length price - Definition Arm s length transaction - Meaning Income splitting or tax fragmentation Contract for work or supply of goods Splitting of integrated business activity Splitting of transaction Avoidance and evasion of tax - OECD reports COMPARABILITY 8.1 Introduction Comparability - Objective Comparability - Meaning Comparability does not mean similarity but striking differences Comparability of price and conditions Comparable adjustable transaction Search for comparability Internal and External Comparables SNF (Australia) case GlaxoSmithKline case DSG Retail Ltd. case Comparability and degree of comparability Degree of comparability - Controlled and uncontrolled transactions Degree of comparability and relative reliability Data-availability, coverage and reliability Assumptions when complete data not available Deficiency in data and assumptions Data of previous years 264 I-20

7 8.10 Comparability - Product functions and enterprise Comparability analysis Characteristics of properties and services Tangible property Intangible property Economic relevant circumstances Functional analysis Enterprise and conditions Functional analysis - Purposes served Method of finding facts in terms of functions, assets and risks Functions are basically activities Functions performed Assets used Risks assumed Risk Allocation Permanent establishment Arm s length principle - Transfer Pricing Guidelines Authorised approach - Two steps analysis Morgan Stanley case Contractual terms factor Economic circumstances Business strategies SPG International Ltd. v. The Queen (98 DTC 1796) case Transaction-by-transaction approach GlaxoSmithKline case Transactions closely interlinked or continuous Transaction comprising of elements for which separate evaluation method provided Form and substance of transaction Transactions lacking economic substance or routed through related enterprise Goods or services independently contracted Transactions - Set off 319 I-21

8 8.20 Evaluation of package deals Comparability data of prior or future years METHODOLOGY 9.1 Introduction Arm s length price of income-tax and customs duties Purpose and methodology different for Customs and Income-tax Act Arm s length price - Methods Methods based on price and profit Comparability of transaction and circumstances Applying the methods - General principles Most appropriate method Methods not followed sequentially Degree of comparability and reliability of data Comparable uncontrolled price method (CUP method) Salient features Comparability and adjustment Examples Price reasonable Services Resale Price Method (RPM) Salient features Transaction comparability other than product itself Comparability and adjustments Reliable if time gap is small Chain of distribution Examples Reliability Profit method preferable to resale price method Resale price method not used solely on evidence of internal transactions Services 376 I-22

9 9.7 Cost Plus Method (CPM) Salient features Comparability and adjustments Examples Berry ratio Reliability Net profit method preferable over cost plus method Cost plus method preferred for Services CUP method is most favoured Traditional methods - Choice depends on subjectmatter of transaction Transactional profit methods Comparable Profit Split Method (PSM) Salient features Comparability and Adjustments Eli Lilly & Company v. CIR 856 F.2d 855 (7th Cir. 1985) E-business E-business - Transfer pricing method difficulty in applying E-business - Profit-split method applied Services Profit split method preferred over cost plus method Transactional Net Margin Method (TNMM) Salient features Comparability and adjustments Widely used Services Examples Example Unspecified method INTANGIBLE PROPERTY 10.1 Introduction 437 I-23

10 Trade intangibles Marketing intangibles Know-how and trade secrets Intangible properties - Arm s length price Comparability determination Comparability analysis Comparability analysis - Identifying arrangements for the transfer of Intangible property Special factors relevant to comparability Functional analysis Same methodology as for tangible property Methodology CUT method Re-sale price method Profit-split method Anticipated benefits What independent parties would have done without using hindsight Perspective of taxing authorities What independent parties would have done INTRA-GROUP SERVICES 11.1 Introduction Recognition Nature Intra-group services - Whether provided a Shareholder or stewardship activities Determination of charge a Direct-charge Method b Indirect-charge Method c Direct and indirect cost both charged d Documentation of cost incurred 501 I-24

11 Calculating arm s length consideration a Value to the recipient b How much independent enterprise willing to pay c Cost to the provider d Profit mark-up e Adjustments Cost sharing and service charge Debt-factoring centre Contract for manufacturing Contract for Research and Development Development centres engaged in contract R&D services Administration and enforcement of the intangible property rights COST CONTRIBUTION ARRANGEMENT 12.1 Introduction Allocation or apportionment of expenditure Cost contribution arrangements - Bona fide 522B 13 BUSINESS RESTRUCTURING 13.1 Introduction Business restructuring - Meaning Arm s length principle SAFE HARBOUR 14.1 Introduction Definition Scope Objectives 530 I-25

12 14.5 Advantages Disadvantages Salient features Eligibility, standard, circumstances, etc Eligibility Eligible assessee With insignificant risks Eligible international transactions Exercising option - Procedure Eligibility under the changed circumstances Transfer price - Acceptance ADVANCE PRICING AGREEMENT 15.1 Introduction Definition Objects and purpose Disadvantages Attributes Kinds Salient features Manner for determination of arm s length price Obtaining an agreement Pre-filing consultation Application for advance pricing agreement Procedure Terms TNMM frequently applied Legal effect Ab initio void, fraud, misrepresentation Critical assumptions Retroactive application (Rollback) Annual compliance report 563 I-26

13 15.20 Compliance Audit Consequences of non-compliance Revision Cancellation Renewal Assessment COMPUTATION 16.1 Introduction Methods Most appropriate method Determination by taxpayer - Steps Object of audit Steps for audit Acceptance of taxpayer s determination Assessing Officer power to determine Power to form opinion and to determine Arm s length price why not so determined - Two views Power to determine - Three stages Notice of tentative determination Power to examine correctness of the assessee s claim even if Assessing Officer s determination found arbitrary Power to rely on theories other than used in notice of prima facie determination Power to determine even if transaction not recognised Power to determine even if transaction results in loss Actual and deemed (best judgment) arm s length price Burden of proof Assessee s duty to co-operate Assessee obligation to act in good faith Assessing Officer is of the opinion 607 I-27

14 Opinion on the basis of material in his possession a Information relating to third party not used, if not authorized b Information from the taxpayer Opinion during the course of any proceeding Arm s length price - Determination In accordance with sub-section (1) and sub-section (2) of section 92C On the basis of such material and information Determination and assessment - Distinction Show-cause notice Show-cause notice - Meaning and requirement Show-cause notice - Effective Show-cause notice - Adequate Show-cause notice - Reasonable opportunity of defence Show-cause notice - Fair consideration of the explanation Show-cause notice - Service Arm s length price determination and computation Computation of total income Assessment proceeding continuing if appeal is pending, whether adjustments be made a Two computations involved Process and burden of proof under sections 143(3) and 92C(4) Computation - Examination process Examination process of controlled transaction - OECD Guidelines for the Assessing Officer Set off income against losses from non-arm s length transactions Transfer pricing provisions not applied if computation results in reducing income Transfer Pricing Officer - Reference Reference if necessary or expedient Reference - Recording of reasons 646 I-28

15 Reference - Section 92CA and section 92C(3) be read together Aztec Software case Aztec Software case - Many chinks Sections 92CA and 92C(3) integral part of the process of determination of arm s length price Making a reference an administrative and not a ministerial act Considers it necessary or expedient requires deliberation and application of mind Reading sections 92C(3) and 92CA independently leads to absurdity Board s circular not binding on the assessee or the Tribunal Cause not pending before the Assessing Officer cannot be referred to another authority What cannot done directly cannot be done indirectly Referring to Transfer Pricing Officer is subject to judicial review Dispute resolution mechanism Salient features of section 144C Powers of the Panel - Appellate, investigative and adjudicative Whether two assessment orders in case of eligible assessee Whether the assessee deprived of right to appeal, if he fails to file objection Appeals Burden on the assessee to prove determination incorrect INFORMATION AND DOCUMENTS 17.1 Introduction Information and documents - Keeping and maintaining Documents - Kinds, principal/supporting 682 I-29

16 Documents - Contemporaneous Documentation - Object and purpose Power of the Assessing Officer Supporting, background and authenticating documents Transfer Pricing Officer not empowered to call for documents Form 3CEB an opinion of accountant Cargill India (P.) Ltd. case Demand for keeping and maintenance be reasonable Rules Period for keeping and maintaining Consequences for non-maintenance according to rules Report from the accountant PENALTIES 18.1 Introduction Penalties - Meaning Penalties - OECD Guidelines, some features Non-compliance with procedural requirement Failure - Meaning Failure should be deliberate Every failure is penalised Failure - For Furnish a report from an accountant Any person Value of international transaction Understatement of profits Concealment or inaccurate particulars of income Every addition or disallowance not concealment No fault penalty Penalties - Criminal Wilful attempt to evade tax 734 I-30

17 Avoidance of tax but not wilful evasion Procedure DOUBLE TAXATION AVOIDANCE AGREEMENTS 19.1 Introduction Article 9 of the Model Tax Convention Ingredients of article 9(1) Corresponding adjustments under article 9(2) Permanent establishment and business profits Interest (Article 11) Royalties (Article 12) Non-discrimination (Article 24) Mutual Agreement Procedure (Article 25) Exchange of information (Article 26) INTERPRETATIVE PRINCIPLES 20.1 Introduction Interpretation of statute, meaning of A statute is not a divine revelation Statutory text and intention of the Parliament Statutory construction is regarded an exercise in legal reasoning Rules of interpretation The Purposive Interpretation Purposive and literal approaches combined Principle of Interpretation, summing up Updating construction Interpretation - Internal aids Preamble Definition Functions of a definition 771 I-31

18 Interpretation clause is used if the words are ambiguous or equivocal Definition is not meant to be exhaustive Means Includes The word includes may also have exhaustive meaning Means and includes Means and includes - Distinguishing features Unless the context otherwise requires Referential definition Proviso Interpretation of a proviso Provided further Proviso, whether refers to the last or all paras in a series of paragraphs Explanation Explanation, interpretation Exception Legal fiction and deeming provisions Marginal notes and headings Parliamentary debates Setting of the Act Punctuation Other expressions Notwithstanding Subject to In accordance with In addition to In derogation of In connection with In (by) writing In relation to Pertaining to 790 I-32

19 20.34 Incidental Incident In respect of - With respect to Within In and within Namely, or that is to say Liable Under the Act Otherwise Without prejudice As the case may be So far as may be Similar Like / Having regard to Or And and Or At any time During and In all A An The Any Where, when if Etc After Hereafter Mandatory or directory/meaning Whether a provision is mandatory or directory Link between the broad principle of the statute and object of the particular provision is important Consequences of non-compliance of mandatory and directory provisions 800 I-33

20 May Shall Shall and may are interchangeable Simultaneous use of may and shall Negative or prohibitive word is mandatory Time limit for performance of a duty is rarely mandatory Provisions relating to avoidance of public mischief is not mandatory Procedural Rule is not mandatory Mode of performing a duty has to be mandatorily followed Conditions of a provision should be mandatorily followed Guidelines Schedule 805 APPENDICES APPENDIX 1 : Relevant sections of Income-tax Act, APPENDIX 2 : Relevant Rules of Income-tax Rules, APPENDIX 3 : Relevant Forms of Income-tax Rules, APPENDIX 4 : Extracts from Explanatory Memorandum to Finance Bill, APPENDIX 5 : Circulars & Notifications 916 APPENDIX 6 : Model Tax Convention on Income and on Capital 986 SUBJECT INDEX 1005 I-34