ICAI- HYDERABAD

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1 CASES & EMERGING ISSUES- TRANSFER PRICING ICAI- HYDERABAD BY CA. SAMPATH RAGHUNATHAN ADVOCATE

2 Reclassification NORTH GATE ITAT HYD- outbound Investment in foreign subsidiaries TPO considered the Share Premium is in excess of the value of shares considered the excess as LOAN and imputed deemed interest VODAFONE- BOMBAY HC- inbound Inbound share capital considered below the value of sharesshortfall considered as deemed loan to AE notional interest was added incomedetermination of ALP was only a re-computation exercise to be undertaken only if income arose out of an international transaction. Section 224, which defines income, had to be strictly interpreted. no transfer pricing adjustment can be made on issue of shares since no income exists.

3 Reclassification VODAFONE- BOMBAY HC- inbound CONTD Explanatory Notes to the Finance Act, 2001 The new provision is intended to ensure that profits taxable in India are not understated (or losses are not overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. hapter X of the Act is a machinery provision to arrive at the ALP of a transaction between AEs. The substantive charging provisions are found in Sections 4, 5, 15 (Salaries), 22 (Income from house property), 28 (Profits and gains of business), 45 (Capital gain) and 56 (Income from other Sources). Even Income arising from International Transaction between A.E. must satisfy the test of Income under the Act and must find its home in one of the above heads i.e. charging provisions. A plain reading of Section 92(1) of the Act very clearly brings out that income arising from a International Transaction is a condition precedent for application of Chapter X of the Act. in CIT v/s. B. C. Srinivasa Shetti 128 ITR 294, SC held- there is a qualitative difference between the charging provisions and computation provisions and ordinarily the operation of the charging provisions cannot be affected by the construction of computation provisions. In the present case, there is no charging provision to tax capital account transaction in respect of issue of shares at a premium. Computation provisions cannot replace/ substitute the charging provisions. w.e.f. 1 April 2013, the definition of income under Section 2(24)(xvi) of the Act includes within its scope the provisions of Section 56(2) (vii-b) of the Act. This indicates the intent of the Parliament to tax issue of shares to a resident, when the issue price is above its fair market value. In the instant case, the Revenue's case is that the issue price of equity share is below the fair market value of the shares issued to a non-resident. Thus Parliament has consciously not brought to tax amounts received from a non-resident for issue of shares, as it would discourage capital inflow from abroad.

4 Inter Play- Transfer Pricing provisions DTAA provisions and Section (1A) TPO determines Fees for technical services at N)L Arms Length Price DTAA provides Where by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the royalties or fees for included services, having regard to the use, right, information or services for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last mentioned amount. In that case, the excess part of the payments shall remain taxable according to the law of each Contracting State, due regard being had to the other provisions USING THE of this ABOVE Agreement. CLAUSE, THE ADIT TREATS THE FEES AS OTHER SOURCE INCOME AND DETERMINES WHT AT 40%

5 AMP expenses Distributor risk stripped / entrepreneurial Marketing company Trading company SOGO SHOSHA (General Trading Company) Combination of above PLI FACTOR BERRY RATIO vis a vis COST PLUS OR TNMM DECISIONS TO STUDY MITUBISHI CORPORATION - ITAT DELHI- 21 st OCTOBER upheld Berry Ratio not permitted reconstruction of financial statements for arriving at ALP GAP INTERNATIONAL SOURCING ITAT DELHI- on sourcing services- adopted Berry Ratio- No ownership of materials LG ELECTRONICS ITAT DELHI- 14 tests MARUTI SUZUKI CASE DELHI HIGH COURT AND SUPREME COURT conflicting approach MATTEL TOYS )ND)A AND LOREAL )ND)A PROVIDING FOR RPM MEHTOD IN CASES OF COMPANIES INVOLVED IN TRADING

6 AMP expenses BMW India Pvt. Ltd. Versus ACIT, Range-I, Gurgaon Assessee AMP expenditure- which exceed the activities performed by comparable independent enterprises as selected by the assessee - the assessee has not been reimbursed for such non routine AMP activities and no return was provided to the assessee for carrying out these additional significant marketing functions for its AE. ITAT Delhi held AMP activities has not only enhanced the brand value of the AE in India but has also developed marketing intangible for the BMW products of its AE which resulted in enhanced sale and profit to the AEs Since legal ownership of brand is with the AE the assessee would not be entitled to share in any return attributable to the increase in the value of the brand - the assessee have assumed significantly greater risk than the arm's length price - the assessee is not only entitled for reimbursement of nonroutine AMP expenditure but also a normal return on such AMP activities provided for the benefited of the AEs.

7 AMP expenses WHETHER AMP EXPENSES TESTED SEPARATELY? CHAPTER 10- COUNTRY PRACTICES- UN PRACTICAL MANUAL ON TRANSFER PRICING ON TRANSFER PRICING- INDIA POSITION- Marketing )ntangibles ALP using bright line test carried out on no risk or limited risk distributor who need to have routine expenditure of Advertisement, Marketing and Sale Promotion (AMP) A Division Bench of the High Court at Madras in Standard Electric Appliances v. Supdt. of Central Excise [(1986) 23 ELT 302 (Mad)]. The Court said that it was common knowledge that when a consumer purchased an article from a dealer, in the case of service facilities he looked to the dealer and not to the manufacturer. For replacement of defective parts also he looked to the dealer from whom he had purchased and, notwithstanding the fact that the wholesale dealer might ultimately have the parts replaced by it reimbursed from the manufacturer, the service facilities were provided by the wholesaler with a view to earn goodwill and attract customers. The advertising of a product by the wholesaler was one of the well-known methods by which the wholesaler attracted customers and if, as a result of increasing its business, the demand for the product of the manufacturer also increased, the advertising by the manufacturer could not be said to be for and on behalf of the manufacturer.

8 GUARANTEE FEE DECISIONS TO REFER: Bharti Airtel Limited -ITAT NEW DELHI Four Soft - ITAT HYDERABAD Prithvi Information Solutions ITAT HYDERABAD Micro Inks Ltd.- ITAT, AHMEDABAD DOES IT COVER SITUATIONS WHERE NO SERVICE IS RENDERED TO THE GUARANTEE? Intra-group finance guarantees and loans - Application of Australias transfer pricing and thin capitalisation rules Australian Taxation Office ATO It would not be expected that a company pay for the acquisition of the equity it needs for its formation and continued viability. Equity is generally supplied by the shareholder at its own cost and risk. Accordingly, to the extent that a guarantee substitutes for the investment of the equity needed to allow a subsidiary to be self-sufficient and to raise the debt funding it needs, the costs of the guarantee (and the associated risk) should remain with the parent company providing the guarantee.

9 SOFTWARE DEVELOPMENT SERVICES BACK TO BACK BUSINESS MODEL VS CAPTIVE SERVICE MODEL SOFTWARE DEVELOPMENT SERVICES BACK TO BACK MODEL VS CAPTIVE SERVICE MODEL REAL INCOME THEORY

10 OTHER ISSUES CONTRACT R & D SERVICES- also refer Rule 10 TB- Safe Harbour Rules CIRCULAR 6/2013 Research and Development Centres - 1. Centres which are entrepreneurial in nature; 2. Centres which are based on cost-sharing arrangements; and 3. Centres which undertake contract research and development. A Development Centre to be treated as a contract R&D service provider with insignificant risk. 1.Foreign principal performs most of the economically significant functions involved in research or product development cycle either through its own employees 2. foreign principal provides funds/ capital and other economically significant assets including intangibles 3. Indian Development Centre works under the direct supervision of the foreign principal which has not only the capability to control or supervise but also actually controls or supervises research or product development through its strategic decisions to perform core functions as well as monitor activities on regular basis; 4. Indian Development Centre does not assume or has no economically significant realized risks. If a contract shows that the foreign principal is obligated to control the risk but the conduct shows that the Indian Development Centre is doing so, then the contractual terms are not the final determinant of actual activities;

11 OTHER ISSUES BENEFIT ANALYSIS MANAGEMENT SERVICES FOREX LOSS WHETHER OPERATING EXPENDITURE ICWA REGULATIONS FOREX LOSS WHETHER TO BE TREATED AS FINANCE COSTS

12 Thank You