Transfer Pricing Marketing Intangibles & Issue of Shares

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1 Transfer Pricing Marketing Intangibles & Issue of Shares April 11, 2014 Arun Saripalli 1

2 Contents Concept & Issues Indian Legislation Tribunal Ruling - LG Electronics ( LG Ruling ) International Guidance Way Forward 2

3 Marketing Intangibles Concepts & Issue 3

4 Marketing Intangibles : Issue The tax authorities are of the following view: Excessive advertisement, marketing and promotion ( AMP ) expenses incurred by the taxpayer are considered as non routine. Non routine AMP expenses is incurred by the tax payer for creating or improving the marketing intangibles for and on behalf of the Associated Enterprise ( AE ) The tax payer should be duly compensated for the non routine AMP expenses incurred by it along with a mark up The level of non routine AMP expenses should be determined using bright line test The bright line concept applies to the taxpayer regardless of its functional profile Selling and distribution expenses are incurred by the tax payer in relation to brand maintenance activities and form part of the AMP expenses 4

5 Indian Legislation 5

6 Amended definition as per the Finance Act, 2012 Finance Act, 2012, widened the definition of international transaction by inserting the explanation : (i) the expression "international transaction" shall include (b) the purchase, sale, transfer, lease or use of intangible property, including the transfer of ownership or the provision of use of rights regarding land use, copyrights, patents, trademarks, licenses, franchises, customer list, marketing channel, brand, commercial secret, know-how, industrial property right, exterior design or practical and new design or any other business or commercial rights of similar nature; Further, the expression "intangible property" shall include (a) marketing related intangible assets, such as, trademarks, trade names, brand names, logos (l) any other similar item that derives its vale form its intellectual content rather than its physical attributes 6

7 Amended definition as per the Finance Act, 2012 (Contd.) Finance Act, 2012, widened the definition of international transaction by inserting the explanation : (i) the expression "international transaction" shall include (d) provision of services, including provision of market research, market development, marketing management, administration, technical service, repairs, design, consultation, agency, scientific research, legal or accounting service; Conditions for qualification of activity as a service: Activity was rendered at the behest of recipient Under arm s length remuneration expected The recipient has benefited from the services 7

8 The Bright Line Test AMP on sales or on cost? Composition of AMP expenses? Whether excess AMP necessarily creates intangibles? Is Bright line the conclusion on identification of non-routine spend? Comparables - Foreign vs. domestic players - Whether manufacturers or distributors & manufacturers to be considered? - Onus on the TPO to choose right comparables in light of LG rulings 8

9 Tribunal Ruling - LG Electronics 9

10 LG Ruling Facts of the Case The Indian licensed manufacturer is a subsidiary of an Korean Associated Enterprise ( AE ) Assessee pays 1% royalty as a consideration to use the brand name and trade marks of products manufactured in India The Revenue challenged the AMP expenses incurred which were at 3.85% of total revenues Search for comparables yielded AMP ratio of 1.39% An adjustment for the incremental cost (2.46%) + markup of 13% was made 10

11 LG Ruling Key observations Brand vs. product promotion Economic vs. legal ownership Higher AMP per se cannot justify AMP adjustment Use of bright line test for determining the level of non routine expenses Higher margins at an entity level 11

12 LG Ruling 14 Questions framed by Special Bench Whether the Indian AE is simply a distributor or is a holding a manufacturing license from its foreign AE? Where the Indian AE is not a full fledged manufacturer, is it selling the goods purchased from the foreign AE as such or is it making some value addition to the goods purchased from its foreign AE before selling it to customers? Whether the goods sold by the Indian AE bear the same brand name or logo which is that of its foreign AE? Whether the goods sold bear logo only of foreign AE or a logo which is only of the Indian AE or is it a joint logo of both the Indian entity and its foreign counterpart? Whether Indian AE, a manufacturer, is paying any royalty or any similar amount by whatever name called to its foreign AE as a consideration for the use of the brand/logo of its foreign AE? Whether the payment made as royalty to the foreign AE is comparable with what other domestic entities pay to independent foreign parties in a similar situation. Where the Indian AE has got a manufacturing license from the foreign AE, is it also using any technology or technical input or technical knowhow acquired from its foreign AE for the purposes of manufacturing such goods? 12

13 LG Ruling 14 Questions framed by Special Bench (Contd.) Where the Indian AE is using technical know-how receive from the foreign AE and is paying any amount to the foreign AE, whether the payment is only towards fees for technical services or includes royalty part for the use of brand name or brand logo also? Whether the foreign AE is compensating the Indian entity for the promotion of its brand in any form, such as subsidy on the goods sold to the Indian AE? Where such subsidy is allowed by the foreign AE, whether the amount of subsidy is commensurate with the expenses incurred by the Indian entity on the promotion of brand for the foreign AE? Whether the foreign AE has its presence in India only in one field or different fields? Where it is involved in different fields, then is there only one Indian entity looking after all the fields or there are different Indian AEs for different fields? If there are different entities in India, then what is the pattern of AMP expenses in the other Indian entities? Whether the year under consideration is the entry level of the foreign AE in India or is it a case of established brand in India? Whether any new products are launched in India during the relevant period or is it continuation of the business with the existing range of products? How the brand will be dealt with after the termination of agreement between AEs? 13

14 LG Ruling Verdict The Special Bench upheld the TPO s actions and restored the matter to the file of the TPO for determining the cost/value of the international transaction and the consequent ALP afresh. 14

15 LG Ruling Some Thoughts PwC Positives Set guidelines for appropriate selection of comparables Sales expenses not linked to brand promotion cannot be brought within the ambit of AMP Rejected Department Representative s ( DR ) contention of adopting combination of one or more method to determine the ALP Observations & directions of Special Bench on merits need to be restricted to cases of licensed manufacturers & not extended to distributors Negatives Upholds retrospective application of section 92CA(2B) Use of overseas brand deems presence of a doubt on the AMP spent Economic ownership of brand not recognised by the Act Transaction of brand building akin to provision of services Bright line is used to find cost/ value of the transaction Difference between AMP for product & AMP for brand AMP for brand (excess of AMP spend of licensee over comparables) to be reimbursed by legal owner of brand with mark-up Excess profits earned by licensee over comparables under overall Transactional Net Margin Method ( TNMM ), not insulation against AMP adjustment 15

16 LG Ruling Some Thoughts (Contd.) Economic Ownership Foster s Group: AAR distinguished legal ownership from economic ownership. It recognized that marketing and advertising efforts by the Indian entity generated goodwill and therefore created valuable intangible asset in India. Accordingly, the transfer was considered taxable in India, irrespective of the domicile of its legal owner and also the fact that the brand was registered outside India. Dissenting judge noting in the case of LG Electronics (refer para 36 of the dissenting judge s ruling): Economic ownership is a reality and it resides with the entity bearing the economic burden of creation of a marketing intangible. To the extent of value of marketing intangible created in India, the Indian entity is the economic owner. 16

17 LG Ruling Some Thoughts (Contd.) Functional Profile of taxpayer The Special Bench has specifically mentioned that based on the fact and circumstances of the case of LG India (which is a licensed manufacturer), it was considered to be a transaction pertaining to provision of services Accordingly it can be inferred that the LG Ruling shall be applicable only in the similar case of a licensed manufacturer. The Tribunal held in case of Casio India Co. (P) Ltd that, LG Ruling is equally applicable to licensed manufacturers and distributors, whether full risk or least risk 17

18 Various Characterisation scenarios Let s discuss with reference to: - Entrepreneur - Licensed manufacturer - Limited risk distributor - Normal risk distributor - Super marketing distributor 18

19 International Guidance 19

20 OECD Guidelines (Para 6.36 to 6.38) How should compensation for marketing activities undertaken by enterprises not owning trademarks or trade names be determined? Issue 1 - Whether the marketer should be compensated as a service provider, i.e., for providing promotional services or whether the marketer should share in any additional return attributable to marketing intangibles? Issue 2 - How would the additional return attributable to marketing intangibles be identified? On Issue 1, OECD says:- Need to undertake assessment of obligations and rights implied by the agreement between the parties Often, a return on marketing activities may be sufficient / appropriate 3 scenarios possible 20

21 OECD Guidelines (Para 6.36 to 6.38) PwC Scenario 1 Distributor acts merely as an agent and gets reimbursed for its promotional expenditures by the owner of the marketing intangible Entitled to a compensation appropriate to its agency activities alone Scenario 2 Distributor bears cost of marketing activities (with no arrangement for owner to reimburse expenditures) Evaluate extent to which Distributor can share in potential benefits from those activities In arm's length dealings, ability of a party that is not the legal owner of a marketing intangible to obtain future benefits of marketing activities undertaken will depend on substance of the rights of that party (e.g. long term contract of distribution rights for the trademarked product) Scenario 3 Distributor bears extraordinary marketing expenditures beyond what an independent distributor with similar rights might incur for the benefit of its own distribution activities An independent distributor in such a case might obtain an additional return from the owner of the trademark, through a decrease in purchase price of product or reduction in royalty rate 21

22 OECD Guidelines (Para 6.36 to 6.38) On Issue 2, OECD says:- Can be difficult to determine what advertising and promotional expenditures have contributed to the success of a product A new trademark or one newly introduced into a particular market may have no or little value in that market and its value may change over the years Actual conduct of the parties over a period of years should be given significant weight in evaluating the return attributable to marketing activities 22

23 ATO Guidelines Factors that determine value of marketing intangibles: - contractual arrangements between trade name owner and marketer - duration of agreement - nature of rights obtained by marketer in respect of trade name, who bears costs and risks of marketing activities Whether level of marketing activities performed by marketer exceeds that performed by comparable independent enterprises Extent to which marketing activities would be expected to benefit owner of the trade name and/or the marketer Whether marketer is properly compensated for marketing activities by a normal return or should share in additional return on the trade name 23

24 Way Forward 24

25 Way Forward Disclose the selling and marketing expenses separately in Profit & Loss Account Careful drafting of FAR and right characterisation Keep your set of comparables ready for bright line Advance Pricing Agreements ( APA ) for Certainty Appeal filed by Cannon India Pvt Ltd has been admitted by the Delhi High Court on marketing intangibles and the HC has framed the 5 questions of law for adjudication. 25

26 Thank You

27 What is Intangible Property? Per OECD para 6.2 includes rights to use industrial assets such as patents, trademarks, trade names, designs or models literary and artistic property rights, intellectual property like know-how, trade secrets Per Income Tax Act, Intangible assets, being know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature. Per DTC Bill.. intangible property includes know-how, patents, goodwill, copyrights, trademarks, brand name, licenses, franchises, any business or commercial rights, leasehold interest, exploration and exploitation rights, easement rights, air rights, water rights, or any other thing that derives its value from its intellectual content instead of its physical attributes; 27

28 Commercial Intangibles Commercial Intangibles (patents, know-how, designs, models) Marketing Intangibles (trademarks, trade names) Trade Intangibles (created through R&D manufacturing know-how, trade secrets, etc.) 28

29 Ownership of intangibles It is important to evaluate legal vs.. economic ownership of intangible to determined how income generated should be divided amongst related parties who benefit from the intangible For unprotected intangibles (trade secrets, unpatented knowhow) company bearing greatest cost and undertaking significant people functions and decisions with regard to the intangible is the economic owner of the intangible For legally protected intangible - the legal owner is generally is entitled to the income However if another entity performs significant people functions with regard to the intangible it is said to be the economic owner in the case The split of revenue between legal and economic owner is challenged 29

30 Legal vs.. Economic Ownership Scenario R&D Function Control Fund Legal Ownership Economic Ownership I Subsidiary Parent Parent Parent Parent II Subsidiary Subsidiary Parent Parent Subsidiary Control is the key however, the above distinction has been challenged by Indian Revenue 30

31 Marketing Intangibles Image related intangibles. These include the following: Trademarks, Tradenames Service marks, collective marks, certification marks Trade dress (unique color, shape or package design) Distribution Network Customer lists Customer contracts and related customer relationships Non contractual customer relationships Non competition agreements Advertising, marketing and promotion expenses ( AMP ) are incurred to promote the image Dispute is raised Image over = Attribute the promotion + Promotion leg of the above equation 31

32 Pointers for selection of right comparables Characterisation of the Taxpayer Normal distributor vs. Value added distributor Brand / Logo of the AE only vs. joint logo Payment of brand royalty Payment of technical know-how royalty Compensation to the Indian entity for the promotion of brand Multiple entities in India? Pattern of AMP spend New vs. established brands New vs. existing range of products How the brand will be dealt, after the termination of agreement 32

33 Royalty Brand / Trademark royalty Right to use Legacy brand value Future brand value 33

34 Distributor Taxpayer Comparables AMP / Sales 15% 10% OP / Sales 18% 4% ATO and OECD Guidelines on marketing intangibles return for excess AMP: Reducing the transfer price; or Receiving a fee and a reimbursement of expenditure incurred 34

35 Foster's Australia Ltd. (AAR Ruling) Facts of the Case Foster Australia Ltd. (FAL) engaged in brewing, processing, packaging, marketing, promoting, selling of beer products in Australia and abroad FAL owns various brands including Foster s brand in relation to beer products, which comprises of:- - Foster s trade marks and logo - Foster s brand Intellectual property - Foster s Brewing Intellectual property FAL grants licenses in respect of Foster s brand to parties in various countries (including India) FAL holds trade mark registration of Foster brand & logo since inception In India, FAL registered Foster's trade mark and "F" logo on 15 July 1993 FAL entered into a Brand License Agreement with Foster's India (FIL) on 13 October

36 Foster's Australia Ltd. (AAR Ruling) Facts of the Case (Contd.) Agreement granted FIL, exclusive license to brew, package, label, and sell Foster's Lager (beer) and exclusive right to use its trade-marks in India. FIL was also authorized to use the mark (Foster's) as part of its corporate name. FAL entered into a composite contract on 4 August 2006 with SAB Miller for transfer of : - Foster's Trademarks - Foster's Brand Intellectual Property - Exclusive and perpetual license in relation to Foster's Brewing Intellectual Property Brand license agreement between FAL and FIL terminated effective 12 Sep

37 Foster's Australia Ltd. (AAR Ruling) Question before AAR Whether receipt arising to FAL, from transfer of its right, title and interest in and to the Trademarks, Foster's Brand Intellectual Property and grant of exclusive perpetual license of Foster's Brewing Intellectual Property is taxable in India? 37

38 Foster's Australia Ltd. (AAR Ruling) Ruling IP comprising Foster's Trademarks and Brand IP can be said to be located in India where business of FIL was being carried on in conjunction with FAL and the said IP was being put to use. Trade-marks registered in India together with other features of Foster's brand generated appreciable goodwill in India by reason of coordinated efforts of FAL and FIL Marketing intangibles comprising Foster's Trademarks and brand which were in use for nearly a decade had their abode in India by the date of transfer of capital assets Irrespective of whether location of Foster's Trademarks could be traced to the place of domicile of the owner, Trademark/Brand IP had its location in India as well where it had perceivable impact on the business being carried out in India by FIL with the exclusive license granted by FAL 38

39 ATO Guidelines Example 1 Company A [Marketing Intangible Owner] Renewable long-term royalty-free contractual arrangement (with exclusive right), where the marketer/distributor does not bear costs and risks of developing the market Company B Distributor [WOS of Company A] Marketing and Distribution activity Customer Outside Australia Australia Company B s compensation = Arm s Length return for distribution + Reimbursement of Marketing Cost + Arm s Length Mark-Up on marketing costs 39

40 ATO Guidelines Example 2 Company A [Marketing Intangible Owner] Renewable long-term royalty-free contractual arrangement (with exclusive right), where the marketer/distributor bears costs and risks of its marketing activities Company B Distributor [WOS of Company A] Marketing and Distribution activity Customer Outside Australia Australia Company B s compensation = Arm s length return which an Independent distributor would obtain in comparable circumstances. B is said to be appropriately compensated for marketing activities from increase in turnover and market share it obtains as a result of marketing activities 40

41 ATO Guidelines Example 3 Company A [Marketing Intangible Owner] Renewable long-term royalty-free contractual arrangement (with exclusive right), where the marketer/distributor bears costs and risks of developing the market and incurs marketing expenses far beyond those of comparable independent enterprises Outside Australia Company B Distributor [WOS of Company A] Marketing and Distribution activity Customer Co. B may own certain marketing intangibles such as distribution rights Australia Company B s compensation = Arm s length return which an Independent distributor would obtain in comparable circumstances. B should obtain an additional return from the owner of intangible through: Decrease in transfer price, or Reimbursement of excess marketing expenditure with a mark-up 41

42 ATO Guidelines Example 4 Company A [Marketing Intangible Owner] Short-term royalty-free contractual arrangement (with exclusive right), with no option to renew, where the marketer/distributor bears costs and risks of developing the market Company B Distributor [WOS of Company A] Marketing and Distribution activity Customer Outside Australia Australia Company B s compensation = The short-term nature of the contract makes it unreasonable to expect B to have an opportunity of obtaining appropriate benefits under the contract within the limited term of the agreement. B has acted to increase the value of the trade name intangible owned by A and therefore, B should be compensated by A for the market development activities it undertakes for A s benefit. 42

43 ATO Guidelines Example 5 Company A [Marketing Intangible Owner] Renegotiation of renewable long-term royalty-free contractual arrangement (with exclusive right), before its term expires, into a renewable licensing agreement (with exclusive right) under which the marketer/distributor pays a royalty, and bears the costs and risks of developing the market Company B Distributor [WOS of Company A] Marketing and Distribution activity Customer Outside Australia Australia Company B s compensation = Where B obtains no rights to use a trade name other than to market and distribute a branded product, B would not be expected to be charged a royalty. 43

44 ATO Guidelines Example 6 Company A [Marketing Intangible Owner] Facts of example 5, however, under the arrangement the licensee agrees to pay a royalty for processing, marketing and distributing the branded product, and bears the costs and risks of developing the market and also incurs expenses far beyond those of comparable independent enterprises Outside Australia Company B Distributor [WOS of Company A] Marketing and Distribution activity Customer Co. B may own certain marketing intangibles such as distribution rights Australia Company B s compensation = B is expected to be compensated by an additional return from A, the owner of the trade name, for market development activities undertaken for A s benefit. Lack of compensation to B with respect to renegotiation of original agreement may not be challenged, since B has suffered no loss of value as it effectively retains the same marketing and distribution rights under the new agreement. 44

45 Trends of Judgements Rulings before LG Ruling Held Remarks Amadeus India Private Limited (Del ITAT & HC) Glaxo Smithkline Consumer Healthcare Limited (Chand ITAT/AY ) McDonald s India Private Limited (Del-ITAT) Nokia India Private Limited (Del-ITAT) Genom Biotech Private Limited (Mum-ITAT) In favour of the taxpayer on the legal ground that TPO has no jurisdiction on the matters not referred to him by the Assessing officer ITAT set aside the matter to the file of the AO to decide the matter in wake of amendment to the definition of international transaction under section 92B of the Act TPO has not provided the reason of rejection of CUP applied by the taxpayer Application of average AMP/Sales to the set of pharmaceutical companies to determine the arm s length value of AMP is not TNMM No more valid due to subsequent amendment in Section 92CA(2A)/(2B) through Finance Act 2011 & Finance Act 2012 Revenue and the taxpayers both requested the Hon ble Tribunal to set aside the matter to the file of the AO Average advertisement expenditure of the comparable companies cannot be considered as an arm s length benchmark to disallow excess advertisement expenditure 45

46 Trends of Judgements Rulings after LG Rulings Canon India Pvt. Ltd (Del-ITAT) Sony India Private Limited (Del-ITAT) Haier Appliances India (P) Ltd (Del- ITAT) Glaxo Smithkline Consumer Healthcare Ltd. (Chd-ITAT) (AY ) RayBan Sun Optics India Ltd. ( Del- ITAT) Held In favour of the revenue on the legal ground following LG Electronics ruling Granted relief to the taxpayer on sales related expenses. In Haier, the matter was remanded for verification Set aside the matter to the file of TPO for fresh adjudication on selection of comparable as guided by LG ruling Note: In Sony s case the taxpayer had recovered 50% of the AMP in relation to Memory Stick Business. In Haier s case as well, the assessee received capital grants towards a portion of AMP Same as above AMP related TP addition to be made only in relation to expenses incurred for brands owned by foreign company Set aside the matter to the file of the TPO for fresh adjudication considering the factors affecting the value/cost of international transaction for brand promotion Exclusion from AMP Cash discount, trade discount, volume rebate, commission, AMP subsidy received from its AE In Haier s case expenses in connection with sales were categorized as sales promotion expenses. ( 0% finance scheme cost, dealer expenses, gifts on products, sales counter expenses) Market service charges paid to selling agents, expenses on market research, Sales promotion, Selling and distribution expenses, Discount on sales No specific exclusion 46

47 Trends of Judgements Rulings after LG Rulings Panasonic Sales & Services India Pvt. Ltd (CHNY-ITAT) Ford India Pvt. Ltd (CHNY-ITAT) Held In favour of the revenue on the legal ground following LG ruling The ITAT denied assesses s claim that some expenses such as dealer meet expenses, training, seminar, product demonstration, consumer gifts, product finance scheme be treated as business promotion though classified under Advertisement by the assessee itself In favour of the revenue upheld LG ruling for TP adjustment for excess AMP expenses ITAT allows relief to Ford India from TP adjustment of market promotion 1% of sales Domestic companies not using foreign brand should be considered as comparable Exclusion from AMP Key dealer incentive, exhibition & trade fair, Billboard, Hoardings, Signage, Catalogues, Newsletter, calendar Note: ITAT does not seem to have focused on nature and merely relied on accounting classification Selling expenses 47

48 Trends of Judgements Based on the ITAT rulings post LG ruling, following expenses can be excluded for the purpose of AMP adjustment: - Commission expenses - Cash discount - Volume rebates - Trade discount - Remuneration to sales consultants - Expenses on conducting consumer survey - Expenses on Market research - Sales promotion expenses - Selling and distribution expenses - Service charges to selling agents - Rate / margin difference - Expenses on free samples - Trade fair expenses 48

49 Disclosure of AMP expenses in financials 49

50 Cannon India Pvt Ltd. 5 Questions framed by HC Whether the Assessing Officer/Transfer Pricing Officer can make adjustment in respect of International Transactions on account of advertisement, marketing and publicity in India by the subsidiary of the foreign associated enterprise? Whether the Transfer Pricing Officer could have examined advertisement, marketing and publicity expenses in his report and if the said question could not have been examined by the Transfer Pricing Officer, whether the directions / findings of the Assessing Officer pursuant to the order of the Disputes Resolution Committee are legal and valid? Whether adjustments can be made by applying the Bright Line Test? Whether the directions given in the order of remit for benchmarking and comparables relating to advertisement, marketing and sale promotion expenses were non-routine? What items and expenses can be included under advertisement, marketing and publicity in India.? 50

51 Issue of Shares 51

52 Background Recent approach by the TPO s to apply Transfer Pricing on issue of shares Notices issued to a number of companies including: - Vodafone India Services Pvt. Ltd. - Shell India Markets Pvt. Ltd. - International Business Machines Corp. (IBM), Nokia Oyj, Sanofi SA and WNS (Holdings) Ltd Transfer pricing adjustment for Vodafone and Shell cases sums upto INR 19,000 crores (approx) 52

53 Transaction of issue of shares F Co. TPO contested the issue price of Rs. 100 per share Issue of Rs. 10 per share Differential 90 treated as loan Notional interest on the loan I Co. 53

54 Journey so far (Vodafone case) Objections filed with the DRP with respect to the valuation issue TPO Order Draft AO Order Dispute Resolution Panel DRP directed to deal with the jurisdictional issue as the preliminary issue DRP rules in favor of the Revenue High Court Writ petition filed with the HC with respect to the jurisdictional issue Vodafone challenged this order in the HC calling it patently illegal 54

55 Points to ponder Whether any income arises in the hands of the assessee on issue of equity share Whether transaction of issuance of shares is an international transaction Splitting international transaction Incorrect valuation approach 55

56 Whether any income arises in the hands of the assessee on issue of equity share? 56

57 Chapter X special provision Chapter X heading Special Provision relating to avoidance of Tax is a separate code, applicable to not only real income but notional income as well The Act does not envisage that all income shall be necessarily classified under the five heads of income as per Section 14. Income under Chapter X of the Act is one such situation The Section 14 of the Act begins with Save as otherwise provided in the Act.. 57

58 Income has an inclusive definition Under Section 2 (24) of the Act which defines Income is an inclusive definition. Under Section 2(24)(vi) of the Act Capital Gains chargeable under Section 45 in Chapter IV-E are specifically included as income. Computation of ALP required, even if it is assumed that there is no income chargeable to tax (reliance placed on Castleton Investments Ltd). 58

59 No exemption for Capital Gain tax No exemption is provided in relation to transfer of shares by an Indian Company to a foreign company by virtue of Section 47 (iv) & (v) of the Act. In certain circumstances transfer of shares may give rise to capital gain as illustrated in provision of Section 47(vi)d of the Act. The Act envisages situation existing in law so as to hold that even in the issuance of shares there can be a transfer in terms of Section 45 of the Act Section 56(2)(viia) & (viib) also enable the law to tax any consideration received or paid towards the shares. 59

60 Extinguishment and relinquishment deemed as transfer Under Section 2(47) (i) & (ii) Transfer in relation to capital assets includes relinquishment of asset or extinguishment of any right therein. Thus extinguishment / relinquishment of right to receive the fair market value of shares by the assessee is transfer for determination of such capital gains 60

61 Whether transaction of issuance of shares is an international transaction? 61

62 Expanded definition of international transaction Clause (c) and (e) of Explanation (i) to Section 92B of the Act provides (c) capital financing, including any type of long term or short term borrowing, lending or guarantee, purchase or sale marketable security or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of the business (e) a transaction of business restructuring or reorganisation, entered into by an enterprise with an associated enterprise, irrespective of the fact that if it has a bearing on the profits, income, losses of such enterprises at any time of the transaction or at a future date 62

63 Impact on the balance sheet Share issue impacts not only liabilities but also assets, by issuing shares at a lower value the corresponding effect of lower liability is lower assets base, as the impact is never one sided Equity share holders have voting powers 63

64 Splitting the international transaction into two international transactions 64

65 Deemed Receivable Non- receipt of the amount receivable on shares is clearly an arrangement and action in concert as per definition of Transaction under Section 92F(v) As a result of undervaluation monies rightfully belonging to the assessee have been parted with out adequate returns. Thus the amount not received is to be considered as a deemed receivable arising out of the international transaction and thus the issue of equity shares. Revenue has reiled upon Logix Microsystem (ITA No. 423&524/Bang/2009) for the same. Difference between the transfer price and fair market price to be treated as receivable. 65

66 Deemed Receivable No re-characterisation as the activity entails onlooking the substance of transaction and uncovering an existing arrangement, of providing an interest free loan facility. Relied upon the Mac Dowells case It mandates any interest arising out of the international transaction shall be determined according to arms length price. <<Perpetuity payment of interest>> Undervaluation of the shares issued to the AE has in effect led to assesses dependency on debt capital for future financing 66

67 Incorrect Valuation approach 67

68 Correct Valuation approach Controller of Capital Issues ( CCI ) valuation is from a regulatory standpoint and does not apply to transfer pricing regulations Discounted Cash Flow ( DCF ) method is the right approach to value the shares CCI Valuation Guidelines adopted was mandatory by RBI regulations and not for the purpose of calculation of the ALP. Relied upon the ruling of M/s Coco cola India, Inc (309 ITR194) & Ascendas India Private Limited (ITA 1736/mds/2011) 68

69 Thank You