Methodology to benchmark Intra group services, Management services and Cost allocation

Transcription

1 Methodology to benchmark Intra group services, Management services and Cost allocation with case study Presentation for 3rd Intensive Study Course on Transfer Pricing Organised by The Chamber Of Tax Consultants Hasnain Shroff 6 April 2013

2 Contents Introduction Indian Transfer Pricing Legislation and OECD Types of services Economic Aspect Recent Audit Trends Judicial Precedent Case Study Way Forward 2

3 Introduction

4 Introduction - Intra Group Services / Management charge / Cost Allocations Intra-group services are those which are performed by one member of a multinational enterprise ( MNE ) for the benefit of one or more related members (located in different tax jurisdiction) of the same group Term intra-group services could potentially refer to two broad categories: Management or administrative services Staff functions Virtually risk free Relatively lower returns Commercial or income producing services Line functions Have associated risk Command higher charge Cost allocations may be a part of inter group services or may relate to third party cost borne by a group entity and allocated In today s business environment, it is common for multinationals to seek efficiencies and economies of scale by designating a specialized role for each group entity 4

5 Indian transfer pricing legislation and OECD

6 Indian transfer pricing legislation Section 92(2) of the Indian Income Tax Act Where in an international transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm s length price of such benefit, service or facility, as the case may be However, an allocation should be generally acceptable under the Indian transfer pricing regulations as long as benefits are demonstrated and they are adequate proper workings use of appropriate allocation keys sound documentation and back-ups No specific guidance provided under the Indian transfer pricing regulations in respect of allocation of service charges. Typically reliance placed on OECD transfer pricing guidelines 6

7 OECD Guidelines OECD Guidelines Chapter VII Special Considerations for Intra-Group Services The OECD recognises that there is no fixed rule that could be universally applied to determine whether each participant s proportionate share of the overall contributions is consistent with the participant s proportionate share of the overall benefits expected to be received under the arrangement Although OECD guidelines are adopted worldwide, countries sometimes differ in their interpretation. The OECD guidelines, as it relates to intra group transaction of services, are concerned with : Whether a service has in fact been rendered; and If so, whether a charge is warranted and the arm s length quantum of that charge (given the nature of the services rendered) 7

8 Types of services Chargeable and Non Chargeable

9 Types of services Chargeable Services Chargeable services are those which provide a respective group member with economic or commercial value to enhance its commercial position in the market that it operates Examples of Intra-Group Service (OECD Guidelines) Sr No. Activity 1 Planning 2 Coordination 3 Budgetary control 4 Financial advice 5 Accounting 6 Auditing 7 Legal advice 8 Factoring 9 Financial services Sr No. Activity 10 Assistance in production, buying or distribution 11 Marketing 12 Recruitment & Training 13 R&D administration 14 IP protection 15 Market research 16 Contract R&D 17 Computer services 18 Provision of guarantees 9

10 Types of services Non-Chargeable Services Non-Chargeable services include Shareholder activities Costs of activities relating to the juridical structure of the parent company itself e.g. meetings of shareholders of the parent company, issuing of shares in the parent company, costs of the board of directors Costs relating to reporting requirements of the parent company, including consolidation of reports Cost of raising funds for acquisitions Duplicative services Costs incurred by the Parent on review of financial analysis made by subsidiary, Audit conducted by the parent to avoid risky or erroneous business decision Services that provide incidental benefits Economies of scale or benefit attained by the MNE due to reorganization or disinvestment deal carried out by parent or another group company Higher credit rating attained by the MNE by virtue of affiliation with the parent company Note Specific Guarantee provided by Parent entails a charge 10

11 Economic Aspect

12 To Demonstrate The existence of the service the service actually performed The benefit for the recipient of the service The willingness to pay for the services received in a third party situation The arm s length nature of the charge 12

13 Benefit Test and Willingness to pay test Benefit test is by far the most important factor Objective of benefit rule Determine the quantum of benefit Relative proximity of benefit Use of proximate and direct standard Exclusive purpose / single recipient easy to determine benefit Services resulting in joint benefit difficult to establish actual / perceived benefit Basis or allocation / allocation key would be of prime importance Whether an inter-group service has been rendered? Activity / services provides economic / commercial value Enhances commercial interests Determination by considering whether an enterprise, in comparable circumstances would have: Been willing to pay for the activity (if performed by an independent, arm s-length enterprise); or Performed the activity in-house by, and for, itself 13

14 Basis of Charge General principle governing allocation of costs in case of Intra-Group Services is based on the benefits of the Recipient Two ways of cost allocation are: 1.Direct Allocation Group members are charged for specific services The specific services performed and the basis for the payment can be clearly identified Provides greater transparency and practical convenience to the tax authorities Costs and time associated with supplying the services will be straightforward to identify 14

15 Basis of Charge 2. Indirect Allocation Used where: proportion of the value of services rendered to each entity cannot be exactly quantified except on an approximate/estimated basis burden of administrative work to record and analyze relevant service activities for each beneficiary disproportionately heavy in relation to the activities themselves Identify all relevant costs and allocate them among all recipients using a sensible allocation keys Indirect cost allocation method must: Be sensitive to commercial features of individual case; Contain safeguards against manipulation; Follow sound accounting principles; and Allocate costs that are commensurate (in proportion) with actual or reasonably expected benefit to the recipient of the service 15

16 Cost allocation keys Should be revealed through functional analysis to reflect the economic benefit resulting from the service Should be a basis that can be measured and documented in a reasonable manner Use of turnover without further consideration of alternative allocation triggers may well be challenged Easily traceable to the original accounting records of the company Some Allocation keys : Turnover, staff employed, number of computers user-ids, area (square meter) etc 16

17 Mark up Whether or not the intra group service should be marked up Factors to consider: the nature of the service Significance of services Functional profiling and characterization of the intra-group transactions involved Similar services provided to an arm s length party ( ALP ) No Mark-up: In some cases no mark-up required (OECD Guidelines paras ): Examples: Group enterprise acting as an agent or intermediary The costs are already equivalent to the market price Unreasonable administrative burden Safe harbors for service mark-up in some countries Safe harbour safe-harbours with respect to the quantum of the mark-up on routine administrative services Examples: Singapore and Australia 17

18 Illustration Management services Group Co. A Provide management services to Group Companies Group Co. B Group Co. C Group Co. D 1. Maintenance of adequate documentation to justify the services character, evidence receipt of services, and demonstrate benefit derived 2. Costs allocation to be audited by an independent accountant (if feasible) The service provider and the service recipient should document the cost benefit analysis i.e.. details of cost allocated, basis of mark-up charged, if any along with the evidences of any service rendered and benefits received. 18

19 Arm s Length Price determination Typical methods applicable 1. Comparable Uncontrolled Price ( CUP ) method 2. Cost Plus Method ( CPM ) 3. Transactional Net Margin Method ( TNMM ) 1. CUP Applicable when: There is a comparable services provided by an external, independent entity to another external, independent entity; The service renderer in the related party transaction also provides similar services to an unrelated party; and/or The service recipient in the related party transaction also purchases similar services from unrelated party. Examples accounting, auditing, legal or computer services being provided 19

20 Arm s Length Price determination 2. CPLM Applicable when: in the absence of a CUP where activities, assets and risks are comparable Cost base is very important Functional analysis important take into account both immediate and long-term impact of service 3. TNMM Applicable when: in the absence of a CUP and CPLM, residual method Net margin tested, after payment of such charge vis-à-vis independent comparables 20

21 Recent Audit Trends

22 Recent Audit Trends Indian TP regulations silent on the subject. Reference has to be made to guidance given in the OECD Taxpayer s Approach The allocation charge of total costs made by the Headquarter to subsidiaries around the globe by using certain allocation keys like headcount, turnover, computer expense, etc. is accepted by the Indian AE. The cost base of the Headquarter may or may not be authenticated. The details of the cost base may not be communicated by the Headquarter. There is not much focus on the Need for the service and the Benefit from the service. Revenue s Approach : Revenue requires the following parameters to be satisfied: Need for services and documentary evidence that such services were indeed received Quantification of Benefits received to prove parity with the charge Services should not be duplicative in nature and should not include shareholder services Authenticity of allocation keys and cost base of the parent Comparison of intra-group fees with local market price of similar services (if applicable) Payments for services in the nature of shareholder s activity, duplicating services, Incidental Activities and passive association benefits are not allowed Revenue conclusion in most cases - Need test or Benefit test is not passed; Evidences are not conclusive or demonstrative of value received; and hence arm s length price is determined at NIL 22

23 Judicial precedents

24 Judicial precedents Case Ruling McCann India Pvt. Ltd. Substantial evidence placed on record. Benefits of services provided by AE Entity level benchmarking using TNMM accepted Assessing Officer (AO) cannot dictate the business needs. The term benefit has wide connotations. F Knorr- Bremse India Pvt. Ltd. Taxpayer s contention on commercial expediency rejected Taxpayer not discharged the obligation of maintaining and producing records The perusal of documents maintained reveal that only incidental and passive association benefit had been provided by the AE. A Maintaining relevant robust documentation and corroborative support is the differentiator 2012 KPMG International Cooperative ( KPMG International ), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights 24

25 Judicial Precedents Case Dresser Rand Ruling TPO / AO cannot question the commercial wisdom of the taxpayer Disapproved that since the taxpayer has qualified staff on its roll, there was no need to obtain such services from its AE. Services availed by the taxpayer is legitimate - furtherance of its business interests such costs Allocation of cost on the basis of headcount and turnover is reasonable. F Gemplus India Pvt. Ltd. The charge for management services must be commensurate with the nature, volume and quality of services. There were no evidence/details available on record to demonstrate the nature of services rendered The Tribunal held that the expenses incurred should ideally be apportioned on the basis of actual services rendered to the individual units A Documentation and evidence of services rendered is critical 2012 KPMG International Cooperative ( KPMG International ), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights 25

26 Case Study

27 Case Study... Facts of the Case XYZ, a US corporation ( XYZ US ) wishes to charge a management support and IT support service fee for some of the following centrally provided services to the Indian AE. The fees is proposed to be charged to various AEs across the globe including the Indian AE on the basis of forecasted turnover achieved by these AEs in each of their jurisdictions. Given below is the nature of services provided to the Indian AE as Management Support Services and IT Support Services. I. Management Support Services Sales Marketing and Business Development Services Human Resource Support Services Legal and Compliance Services Finance II. IT Support Services Local IT support in terms of required softwares and related upgradation Undertaking specific projects like global receivables project, compliance projects, etc., 27

28 Way Forward

29 Way forward Way Forward Indian entity s in-house capability to perform such services to check for duplicate / shareholder services and need for procuring such services Documenting Benefits received - to document tangible evidence Evidence (correspondence, mails, reports, etc) substantiating the fact that the services were actually received, should be documented Authenticity & details of the costs incurred; and appropriateness of allocation keys/ratios Overall TNMM need not necessarily be acceptable Should have a formal agreement for receiving management services, covering full details, similar to an agreement between two independent entities Establishing proper pricing policy for intra-group services at the outset defining the right allocation keys and also establishing the authenticity of costs incurred Robust documentation to be maintained including Intercompany agreements Composition of costs allocated Methods of cost allocation Need for procuring such services Actual receipt of services and benefits derived by Indian entity from each component of cost tangible evidence sought Documentary Evidence (illustrative) Business reports Training manuals Marketing brochures Time sheets / logs Copies of s Minutes of meeting confirming receipt of services HR Schemes IT network / systems 29

30 What Matters?? One should consider what something is worth through the eyes of a independent party! 30

31 Questions 31

32 Thank You Hasnain Shroff Thank You! 32