Transfer Pricing landscape in India An Update

Transcription

1 Transfer Pricing landscape in India An Update ICAI - SIRC, Chennai 18 December 2009

2 Setting the Context Snapshot on Indian Regulations Existing and Emerging Controversies Recent Judicial Rulings Finance Act Amendments Direct Tax Code - Proposals B S B R S & R & Co. Co. 2

3 What are tax heads worried about Withholding tax Permanent establishment issues DTAA Indirect tax Provident fund Transfer Pricing emerging as the single largest tax risk facing MNCs today 3

4 Tax is embedded in various aspects of business Transfer Pricing embedded in every aspect of international transaction action 4

5 Toughest Tax authorities for Transfer Pricing India and China are expected to top the charts soon Japan Germany Australia USA France India Korea China Canada UK 5

6 Transfer Pricing In India 6

7 Snapshot of Indian Transfer Pricing Regulations Relatively new legislation - Introduced with effect from April 1, 2001 International transactions between associated enterprises need to satisfy the arm s length criterion (ALP - price applied between independent enterprises in uncontrolled conditions) Compliance Requirements i. Maintenance of contemporaneous documentation (to substantiate ALP) ii. Annual filing of Accountant s Report (Form 3CEB) Steep Penalties Can be upto 3 times the tax sought to be evaded Concept of Arithmetic mean Limited judicial precedence Assessment procedure stringent 7

8 Approach to Transfer Pricing Typical International Transactions: Import of components; Payments towards technology support; Export of finished products, Reimbursement of expenses Analysis of prescribed methods Method Functions Approach Remuneration based on FAR analysis: Assists in economic characterization and determination of compensation Comparable Uncontrolled Price (CUP) Direct method Product comparability critical Prices of each transaction is benchmarked Most Appropriate Method (MAM): To be used for testing arm s length Price Aggregative approach Benchmarking in public databases required to analyse the arm s length margin earned by comparable independent companies Resale Price Cost Plus Profit Split Distribution Function Service function; Contract manufacturing Transfer of Intangibles or multiple transactions GPM (on sales) benchmarked GPM (on costs) benchmarked Analysis allocation of profit / loss Transaction specific approach Transactions such as technical payouts, management fee cross charges Cost benefit analysis necessary Transactional Net Margin (TNMM) Manufacturing & Service functions Product comparability not critical Net Profit Margins 8

9 Why do you need a Transfer Pricing documentation in India?... Burden of proof Tax Exposure Provision Legal Requirement Penalty... Protection Strengthen the Appeal 9

10 What are the Documentation Requirements? Entity related Price related Transaction related Profile of group Profile of Indian entity Profile of associated enterprises Profile of industry Transaction terms Functional analysis (functions, assets and risks) Economic analysis (method selection, comparable benchmarking) Forecasts, budgets, estimates Agreements Invoices Pricing related correspondence (letters, s etc) Contemporaneous documentation requirement Rule 10D Documentation to be retained for 9 years No specific documentation requirement if the value of international transactions is less than one crore rupees 10

11 Accountant s report Obtained by every person entering into an international transaction To be filed by the due date for filing return of income Opinion whether Prescribed documents have been maintained The particulars in the report are true and correct Form No. 3CEB [See rule 10E] Report from an accountant to be furnished under section 92E relating to international transaction(s) 1. We have examined the accounts and records of ENTITY NAME AND POSTAL ADDRESS - PAN No. relating to the international transactions entered into by the assessee during the previous year ending on 31st March In our opinion proper information and documents as are prescribed have been kept by the assessee in respect of the international transaction(s) entered into so far as appears from our examination of the records of the assessee. 3. The particulars required to be furnished under section 92E are given in the Annexure to this Form. In our opinion and to the best of our information and according to the explanations given to us, the particulars given in the Annexure are true and correct. Place : Date : For Chartered Accountants 11

12 Compliance - A step by step approach Accountants Report Documentation Profit Level Indicator Choice of Appropriate Method Financial Analysis Comparable Analysis Internal External Functional, Assets & Risk Analysis 12

13 Key to dos before finalizing Documentation Stage 1 Pre-project planning Preparation of project plan Stage 2 Functional analysis - Information gathering Interviews Questionnaires Discussions with Management Characterisation of each entity Agreement reviews Stage 3 Comparable data / Industry Analysis Search strategy Access to local & global database Analysis of internal comparables Judicious identification of arm s length range Stage 4 Two Key analysis Economic Analysis Understand existing costing mechanism Determination of billing methodology Stage 5 Issuance of Transfer Pricing Documentation Consultation with management Finalization of Transfer pricing documentation 13

14 Systematically meeting the transfer pricing challenge... IT Price Setting Tangibles Financing Management Support Policy / Business Model Central Core TP Documentation Agreements Transfer Pricing Rules & Regulations Country Intangibles Services Systems / Operating Procedures Cost Allocation Value Chain Invoicing Documentation Day-to-Day Operations Accounting Communication Global / Local Transfer Pricing Team 14

15 Maintenance of Transfer Pricing Documentation Statute of Limitation An illustration March 2009 S.No. Timeline Compliance Relevant Provision 1 30 Sep 2009 Deadline for maintaining documentation, filing tax return and accountant s report Section 139(1) read with Section 92E 2 30 Sep 2010 Limitation for initiating a transfer pricing audit by the tax administration Proviso to section 143(2)(ii) 3 31 Oct 2012 Limitation for completion of the transfer pricing audit (scrutiny by the Transfer Pricing Officer) Section 92CA(3A) read with Second Proviso to Section 153(1) 4 31 Dec 2012 Limitation for completion of tax audit (scrutiny by the Assessment Officer) Second Proviso to Section 153(1) 5 31 Mar 2014 Limitation for reassessment (where income escaping assessment is less than INR 100,000) Section 149(1)(a) 6 31 Mar 2016 Limitation for reassessment (where income escaping assessment is equal to or greater than INR 100,000) Section 149(1)(b) 7 31 Mar 2018 Date till which documentation is required to be maintained Section 92D and Rule 10D(5) 15

16 Transfer Pricing Priorities - Today Compliance Documentation Penalty Filing and Disclosure of RPT Compliance Costs Internal / External Audit Operations Tax Efficient Supply Chain Management (TESCM) Process Benchmarking Capital Efficiency Planning Loss Utilization Foreign Tax Credits Intellectual Property Business Restructuring Controversy Assessments Advance Pricing Agreements Litigation DRP / CIT (A) ITAT HC SC 16

17 Transfer Pricing Controversy In India Current and Future Issues 17

18 Audit Process File tax return and Accountant s Report (30th September) DRP Mechanism- Finance Act 2009 Reference to be made to TP Officer ( TPO ) by the Assessing Officer ( AO ); Compulsory Reference to be made by AO if international transactions exceed INR 150 million for AY onwards (Internal guidelines) Notice to be issued by the TPO TPO calls for supporting documents and evidence Appeal Procedure Appeal to Commissioner of Income Tax TP Audit Based on results of above mentioned procedure assessing officer passes the order Passes an order Income Tax Appellate Tribunal High Court only on matters related to law Rectification application can be made against the order of TPO for apparent mistakes Appeal can be made against the order of AO as order of TPO included within the order of the AO Supreme Court Constitutional Bench 18

19 Some important statistics (Estimates) AY Cases assessed = 1081 Cases adjusted = 239 Total adjustment = USD 305 Mn AY Cases assessed = 1501 Cases adjusted = 337 Total adjustment = USD 572 Mn Cases adjusted heading northwards but only a handful cases have managed to get past tribunal. Is it just the tip of the Iceberg? Is DRP the solution? AY Cases assessed = 1768 Cases adjusted = 471 Total adjustment = USD 858 Mn AY & AY Cases adjusted = 25 percent Total adjustment = More than USD 3000 Mn 19

20 Increased administrative focus from Indian Revenue Finance Act 2009 and DTC Focus on transfer pricing Increase in audit threshold (from USD 1.25 million to 3.75 million) Scrutiny audit time increased from 33 months to 45 months from the end of financial year Steep expansion of specialist officers [No. of Transfer Pricing Officers (TPOs) from 18 to 80] Coordinated All-India Transfer Pricing (TP) approach Creation of special TP administration at CIT (A) and Tribunal level Training to TPOs on international TP laws and practices % of cases adj usted Audit Statistics AY AY AY AY Assessment Year % of cases adj Amt of Adj (USD Mil) A m t o f adj (U S D Mil) Co-ordination between Customs and Transfer Pricing authorities Significant adjustments to companies in IT, Pharmaceuticals, Financial services, Automobiles and Chemicals Sector 20

21 Transfer Pricing audits in China 21

22 Aggressive Audit Environment Key Triggers Consistent losses / low margins of the assessee attributable to inter-company transactions Significant changes in profitability of the assessee and its AEs High Royalty / Technical fee payouts, Cost recharges, Management Fees, Cost allocations. Need to pass the benefit test Losses incurred by routine distributors Low mark-ups for services Contributors to Aggressive Audits: Mounting fiscal demand on Government Need to Preserve tax base during recession Competitiveness needs business restructuring Unprecedented sharing of information between revenue authorities 22

23 Key Focus Areas Payouts Payout Options Royalty Technical Fees Management Fees Guarantee fees Cost? Potential Benefit? Cost? Potential Benefit? Cost? Potential Benefit? Cost? Potential Benefit? Cost Benchmarking payouts of comparable companies, Basis of arriving at the value of payouts ( Direct / Indirect Method) by the Group Potential Benefits Need for obtaining service from the Group, Analysis of potential benefit obtained by the Company and value attributable to the service 23

24 Key Focus Areas Management Payouts Typical forms of payouts: Royalty, Technical fee, Management fee, Guarantee fee Transfer pricing requirement: Under the transaction specific approach it is necessary to anlayse potential cost-benefit and maintain appropriate documentation to substantiate arm s length nature of payouts Costs Benchmarking payouts of comparable companies, Basis of arriving at the value of payouts ( Direct / Indirect Method) by the Group Potential Benefits Need for obtaining service from the Group, Analysis of potential benefit obtained by the Company and value attributable to the service Other Regulatory Considerations: FEMA / RBI ceilings (illustrative) Transactions Ceiling Automatic route Technical Fee USD 2 million lump sum payments Royalty 5 percent (domestic) / 8percent (exports) for recurring payments Technical Consultancy support USD 1 million per project Regulatory ceilings cannot be considered as CUP for defending the arm s length nature of the Payout Need for Potential Cost-Benefit documentation 24

25 Current Vs. Future Issues Current Issues Use of multiple year data Re-Run of comparable companies Arithmetical mean and + / - 5 percent range Use of secret comparables Use of Economic and Risk adjustments Foreign comparables challenged and local comparables preferred Use of standard benchmarking sets for IT/ITES companies Future Issues Pricing Policy Transaction-wise analysis Attribution of profits to PE Use of Profit Split Compensating adjustments, correlative relief, secondary adjustment, set-offs Guidance on collateral consequences of TP adjustments Improving dispute resolution process through Mutual Agreement Procedures A long time demand - APAs introduced in DTC 25

26 Typical Industry issues 26

27 Industry Specific Regulations Industry specific Regulations and Transfer Pricing: Certain industries there are regulations that govern the activities and the prices charged by the members of the industry. Pharma: Drug Price Control Order (DPCO) and the National Pharmaceutical Pricing Authority (NPPA) have power to control the drug prices, if found excessive (Hoechst Marion Roussel Ltd. vs JCIT) Port operations: Tariff Authority of Major Ports - (TAMP) regulates the Tariff w.r.t to container operations and handling and therefore the end price to the customer is fixed Telecom Sector: TRAI Telecom Regulatory Authority of India has wide-ranging powers to issue directions on Tariff charged by telecom service providers Oil and Gas: Administered Pricing mechanism and also subsidy provided to PSU vis-à-vis competitive conditions faced by private multinational players Transfer Pricing Authorities do not factor such Industry Regulations 27

28 Typical Industry Issues IT / ITES Captives: Expected to be risk mitigated and not incur operating losses Value chain analysis for service providers Use of standard benchmarking sets for IT/ITES companies - Cherry Picking Comparable Companies Allowance of Risk adjustment - Capacity utilization based on assets and not head count Consumer Electronics Distribution Among the most appropriate methods: RPM Vs. TNMM Use of GPM as a PLI - Absence of definition of direct cost under IGAAP Creation of market intangible - Issue of market support subsidy / subvention and re-characterization Allowance of risk adjustment to facilitate better comparison between commissionaire, sourcing agent, low risk / strip down distributor and full fledged distributor Pharma CUP being increasingly used without getting into the intangible ownership of the API / Formulations Regulated market DPCO regulation on pricing TP Adjustments without evaluating the impact of the price control on the margin of the taxpayers Typical International transaction: R&D Basic / Applied Research Who owns the intangible? Contract manufacturing - Cost plus What is right? Intangibles Cost Sharing Arrangements and Buy In Arrangements 28

29 Typical Issues Auto Industry Recessionary economy: Significant impact expected on auto industry Pricing pressures on automobiles results in push back on component suppliers cost pressure Capital intensive and high fixed cost Start up costs, Idle capacity - Resulting in initial year losses High initial import content with steady localisation, Forex losses Dependent on technical support from Group - High tech fee / royalty payouts Internal comparables need to be analyzed - Pricing of similar transactions with third parties Local documentation preferred to Group global documentation by revenue authorities Limited industry guidance or judicial precedence Issues with Indian benchmarking What do Ford, Toyota, Honda, Volvo, Skoda have in common in India? Transfer Pricing Adjustment! 29

30 Auto Industry Trends and Impact of Transfer Pricing Profit margin (percent) Auto - Foreign / New players Hyundai Motors General Motors Honda Siel Ford India Profit Margin (percent) Auto Ancillary All Engine parts Years Years Auto - Established / Domestic Players Impact on transfer pricing Profit margin (percent) Tata Motors Mahindra and Mahindra Hindustan Motors Well established players (primarily Indian players) earning higher margins vs-a-vis foreign players most of whom are new entrants New entrants incur initial year losses due to high import content, forex issues, start up costs and idle capacity -10 Years Maruti Suzuki India Ltd New players will be benchmarked with Indian players without cognizance of years of presence or industry / economic dynamics 30

31 Recent Rulings in India 31

32 Key Transfer Pricing Principles Performance of adjustments for better comparability Usage of Multiple Year Data Aggregation of transactions Comparability Analysis Related party transactions in the chosen comparable companies Safe harbour provisions 32

33 Performance of adjustments Law - Rule 10B(3): An uncontrolled transaction should be comparable to an international transaction if there are no differences that materially affect price/margin or reasonably accurate adjustments can be made to account for such differences. Thus Indian regulation expressly require that adjustments to prices/margins should be made (where appropriate) to enhance comparability. Practical issue: However, TPOs are not accepting adjustments such as idle capacity, differences for accounting policy, depreciation etc., by rejecting any approximations, estimations and assumptions Take away from various judicial rulings: Reinforced the importance of well documented comparability assessment in a transfer pricing documentation Favored adjustments for better comparability while adopting TNMM as it would provide practical solution if it is applied with appropriate adjustments to account for differences 33

34 Performance of Adjustments (1/2) Schefenacker Motherson Ltd Delhi ITAT Tribunal has accepted that depreciation cost may be adjusted to eliminate material differences in the asset profile of the taxpayer vis-à-vis comparables based on sufficient evidence on record, thereby enabling use of cash profit as the Profit Level Indicator Skoda Auto India Pvt Ltd Pune ITAT This ruling lays down certain important principles to undertake adjustments in proper and fit cases for the purpose of comparability analysis. This judgment is significant for the companies in start-up stages and recognizes that differences in business models and higher cost incurred during the start-up phase calls for economic adjustments. Adjustments should be factored into the comparability analysis and for the purpose of comparability analysis, the taxpayer cannot be expected to obtain details that are not available in the public domain. Philips Software Centre Pvt Ltd Bangalore ITAT Adjustment needs to be made to the margins of the comparable companies to eliminate differences on account of different functions, assets and risks. More specifically, adjustment needs to be made for, (a) difference in risk profile, (b) difference in working capital position, and (c) difference in accounting policies. An adjustment on account of difference in risk profiles may be derived by subtracting the risk free bank rate from the PLR. 34

35 Performance of Adjustments (2/2) E-Gain Communication Pvt. Limited Pune ITAT The Tribunal held that while comparing under the TNMM, those differences having material effect on price must be taken into consideration with an idea to make reasonable and accurate adjustment to eliminate such differences While applying TNMM, necessary adjustments for differences on account of FAR analysis must be made to enhance comparability. if the differences between comparables and the tested party cannot be subjected to an evaluation, then transaction may be eliminated for purpose of comparison. Potential comparables with abnormal profit / losses need to be excluded. Mentor Graphics (Noida) Pvt. Ltd. The Tribunal stated that depending on specific facts and circumstances of the case which cannot be the same for all companies, the final set of comparables may need to eliminate differences by making adjustments. Delhi ITAT Some adjustments noted in the Tribunal s order were adjustments for working capital, risk and R&D expenses. 35

36 Usage of Multiple Year Data Law - Rule 10B(4): The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared. Practical issue: Taxpayers are using multiple year data as a norm primarily due to non-availability of relevant year financial statements of the comparable companies at the time of finalising the transfer pricing documentation TPOs reject multiple year data adopt only data relating to the relevant financial year and undertake adjustments TPOs hold mandatory rule of adopting current year data for computing ALP cannot be dispensed with Take away from various judicial rulings: Usage of multiple year data is considered useful to even out the fluctuations caused by business, economic and product life cycle. Assessee should document facts that reveal business was cyclic, there was impact of cycle and the duration and the extent of the impact on the data used. 36

37 Usage of Multiple Year Data Customer Services India (P) Ltd. Delhi ITAT The mandatory and absolute requirement of law for use of the current financial year data cannot be dispensed with even if the relevant data was not available with the appellant in the electronic data base at the time of preparation of the TP report. The TPO is empowered to determine the ALP by using the current financial year data available at the time of transfer pricing proceedings and to conduct the comparability analysis by using such data. The OECD Guidelines in Para 1.49 to 1.51 have acknowledged the use of multiple year data under special circumstances. Use of multiple year data is considered useful to smooth out the fluctuations caused by business/economic/product life cycle. However, the mere claim that there exists a cycle is not sufficient. multiple year data should be used only when it adds value to the transfer pricing analysis. Honeywell Automation India Limited Pune ITAT Under Indian transfer pricing regulations, for comparability purposes, consideration of subsequent year data or average profits not permitted In relation to comparability analysis, though the OECD guidelines allowed use of profits for the period under consideration, previous or next year or average of such profits, however, under the Indian TP regulations, Rule 10B (4) there was no provision for consideration of data for a subsequent assessment year. 37

38 Aggregation of Transactions and Comparability Aggregation of transactions: As per transfer pricing principles, International transactions are required to be tested on a stand alone basic unless they are inextricably linked In many cases the aggregation approach has been challenged by the TPO s and they are inclined to adopt transaction specific approach. There are rulings in favour and against the aggregation approach Comparability analysis: Rule 10B(2) The comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely: The specific characteristics of the property transferred or services provided in either transaction; Functions performed, assets employed, risks assumed Contractual terms Conditions prevailing in the markets In-depth analysis of comparables is critical In the TNMM approach the Function, Assets and Risk analysis (FAR) of the independent comparable companies need to be undertaken before finalizing the benchmarking analysis. 38

39 Aggregation of Transactions and Comparability Analysis UCB India Pvt Ltd. Mumbai ITAT International transaction under consideration comprised only 50 percent of UCB India s sales and hence it was held that UCB India s approach of entity level TNMM is not appropriate. Star India Mumbai ITAT Aggregation of different business activities for testing arm s length price is contrary to the transfer pricing principles. Development Consultants Kolkatta ITAT Ranbaxy Laboratories Delhi ITAT E-Gain Com Pune ITAT The tribunal upheld the tax payer s contention that to arrive at the most precise approximation, one should compute the arm s length price on a transaction-bytransaction basis. Transaction should not be aggregated unless they are inextricably linked The Tribunal upheld the selection of foreign comparable companies but mentioned that the taxpayer should determine that data pertaining to such comparables should be available in the public domain. The Tribunal noted relevant factors affecting comparability of the transactions includes (a) Nature or line of business; (b) Product or service market; (c) The assets composition employed; (d) Size and scope of operations; and (e) Stage of business or product cycle. Hence any difference that materially affects the market value is to be given serious consideration. 39

40 Related Party and Safe Harbour Provisions* Related party Law Rule 10A(a) Rule 10 A (a) provides the meaning of the term uncontrolled transaction i.e., it means a transaction between enterprises other than associated enterprises, whether resident or non resident. It is given that arm s length standard shall be substantiated when the transactions between persons are in uncontrolled conditions. Practical Issue Can a single rupee of related party transaction be the basis for rejecting a comparable company? There are ruling both in favour and against such exclusions Safe harbour Prior to latest amendment, the proviso to section 92C (2) stated that in the event that more than one arm s length price is determined based on the MAM applied then the ALP would be the arithmetic mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetic mean by an amount not exceeding 5% percent of such arithmetic mean. * Amended Subsequently by Finance Act

41 Related Party and Safe Harbour Provisions* Philips Software Bangalore ITAT Sony India Delhi ITAT Development Consultants Kolkatta ITAT Mentor Graphics Delhi ITAT Rule 10A (a) - For the purpose of comparability analysis, the comparable uncontrolled transaction means a transaction between enterprises other than associated enterprises, whether resident or non-resident; Companies with even a single rupee of transactions with associated enterprises cannot be considered as comparables Development Consultants squarely applies 5 percent Standard deduction The Tribunal held that an entity can be taken as uncontrolled if its related party transaction do not exceed 10 to 15 percent of total revenue. The tribunal confirmed the availability of safe harbor provisions at the option of the taxpayer. The safe harbour +/- 5 percent variance benefit be allowed as a standard deduction, if the margins from the controlled transaction falls outside the said tolerance range. The Tribunal disregarded the selection of comparable companies since they had entered into transaction with either parent company or subsidiary company. * Amended Subsequently by Finance Act

42 Other recent judicial decisions Dana Corporation Authority for Advance Rulings Vertex Customer Services Delhi ITAT In respect of the applicability of the TP provisions to the aforesaid transfer of shares, the AAR held that Section 92 of the Act is not a charging provision but a provision providing computational methodology; If income could not be brought into the purview of tax net in India, the transfer pricing provisions contained in Section 92 would not be applicable. Exclusion of provision of doubtful debts from the operating expenses being a debatable issue and considering full disclosure made by the taxpayer; the taxpayer could not be held liable for penalty It reinforces basic transfer pricing principles laid down in the Indian tax laws which states that penalty proceedings could not be levied on the taxpayer when the computation of the transfer price is done in accordance with the relevant provisions of the Indian transfer provisions in good faith and with due diligence. MSS India Pune ITAT In a case where revenue authorities seek to disturb the method of determining the arm s length price adopted by the taxpayer, it is necessary for them to demonstrate that, on the given facts of the case, a particular method will be more appropriate than the method adopted by the taxpayer. Taxpayer's business results showing lesser profits than industry averages, such profits cannot lead to the conclusion that the international transactions with AEs are not at arm s length. Merely because a method of arm s length price determination presents complexity in approach, it cannot be discarded by the TPO 42

43 Snapshot of Recent Tribunal Rulings Ruling Comparability Standard Adjustment Multiple year data RPT Safe Harbour Aztec - Blore Mentor Graphics Delhi Ranbaxy Delhi Cargill - Delhi Develop. Consult. - Kol Star India - Mumbai E-Gain Pune Sony India Delhi Philips Software - Blore UCB India Mumbai Honeywell Pune Skoda Auto Pune Schefenacker Motherson - Delhi Customer Services - Delhi MSS India Pune 43

44 Snapshot of Recent Tribunal Rulings Ruling Law Doc Compliance Selection of MAM Aggregation of IT Tested Party Aztec - Blore Mentor Graphics Delhi Ranbaxy Delhi Cargill - Delhi Develop. Consult. - Kol Star India - Mumbai E-Gain Pune Sony India Delhi Philips Software - Blore UCB India Mumbai Honeywell Pune Skoda Auto Pune Schefenacker Motherson - Delhi Customer Services - Delhi MSS India Pvt Ltd Pune 44

45 Synopsis Some key industry specific rulings Industry Auto Pharma IT / ITES Consumer Electronics - Distribution Ruling Skoda Auto Schefenacker Motherson Ranbaxy Laboratories UCB Mentor Graphics Morgan Stanley Philips Software Egain Development Consultants Computer Services Sony India 45

46 Key Takeaways from Recent Rulings No need to establish diversion of profits outside India to determine applicability of the TP provisions Detailed FAR analysis for tested party and comparable companies is crucial International transactions should not be aggregated unless they are inextricably linked Least complex entity to be selected as the tested party Adjustments be made to improve comparability Use multiple year data where the business is cyclic and the trend has impacted the business results Recent rulings reaffirm basic Transfer Pricing principles 46

47 Key Takeaways from Recent Rulings Unquestionable inference taxpayers must have a robust documentation with sound FAR analysis and well developed economic analysis to justify the transfer prices Mere finding of faults with the approach adopted by TPO - will not help to delete the adjustments at the appellate level Taxpayer maintains strong documentation - it becomes increasingly challenging for the TPOs to disprove the same. Considering the factual nature of the transfer pricing disputes - the rulings have a limited precedent value in case there are variation in facts 47

48 Recent updates Amendments in Finance Act 09 & Direct Tax Code Proposals 48

49 Indian Transfer Pricing Regulations What is evolving? Finance Act 2009 Change in the +/-5% range benefit Finance Act 2009 Introduction of Dispute Resolution Panel Finance Act 2009 Anti Avoidance & Thin capitalization Direct Tax Code Direct Tax Code Introduction of Advance Pricing Arrangements Direct Tax Code Scope of Associated Enterprise expanded Direct Tax Code Rationalization of Penalty & Administrative Charges Introduction of Safe Harbour 49

50 Snapshot of changes Finance Act 09 Determination of Arm s Length Price Concept of +/- 5 percent variance Introduction of Safe Harbour Rules Creation of Dispute Resolution Panel 50

51 Determination of Arm s Length Price Concept of +/- 5 percent variance Earlier Provision Change Impact When more than one price is determined as Arm s Length Price ( ALP ), the Arithmetical mean ( AM ) of such prices is taken as the ALP. Proviso to Sec 92C(2) However, the assessee has the option of adopting an ALP which may vary from the AM by an amount not exceeding five per cent of such AM Various tribunal rulings had confirmed the availability of a 5 percent variance as a standard deduction (Development Consultants - Kol ITAT; Philips Software Bangalore ITAT and various others) Revised Proviso If the arithmetical mean, so determined, is within five per cent of the transfer price, then the transfer price shall be treated as the arm's length price and no adjustment is required to be made. If not, adjustment to be computed with reference to AM To apply in relation to cases in which proceedings are pending before the Transfer Pricing Officer (TPO) on or after 1 st October Seeks to restrict conflicting interpretation Conflict Revenue authorities did not give a 5% benefit in cases where the difference between transfer price and ALP was beyond 5% of the ALP. Taxpayers claimed 5% as a standard deduction even in cases where the transfer price fell outside the range. (Development Consultants - Kol ITAT; Philips Software Bangalore ITAT) More favorable to revenue authorities vis-à-vis taxpayers. 51

52 Illustration of + / - 5 percent application Particulars Scenario I Earlier Now Arm's Length price (Receipt) Less - Mark Up (5 percent) Adjusted ALP International Transaction Value Adjustment As per revenue authorities As per Taxpayer Overrides Important Tribunal Decisions that provided liberal interpretation on the usage of +/- 5% range 52

53 Safe Harbour Provisions Considering the increase in transfer pricing litigation, Central Board of Direct Taxes (CBDT) is to formulate safe harbour provisions. - Applicable from 1 April 2009 Aim to reduce the impact of judgemental errors in transfer pricing Safe harbour has been defined to mean circumstances in which the revenue authorities shall accept the transfer pricing declared by the taxpayer. Internationally safe harbours have taken various forms Exclusion of certain classes of transactions based on quantitative thresholds Stipulation of margins / pricing norms for specified industries / functions (USA, Singapore) Specifying thresholds whereby the onerous documentation requirement is reduced (Brazil) 53

54 Internationally used safe harbours Specified Services/ Margin based USA Singapore Australia Certain covered services can be provided to a related entity without a markup. A mark-up of 5% for provision of related party services of routine nature is accepted as being at arm s length if the service provider does not provide similar services to unrelated parties. Rules provide for safe harbour provisions in respect of intra-group services availed / provided depending on the nature of activities and functional analysis New Zealand Cyprus Specified mark up on non-core activities and for services below a specified threshold Proposed code is expected to specify certain safe harbour margins based on functions performed and risks assumed. 54

55 Internationally used safe harbours Specified industry Mexico Price based Brazil Relief from detailed documentation requirement Taiwan / India Brazil Others Law provides for safe harbours for traditional Maquiladaros (contract manufacturers) with a requirement as regards profit or return on foreign owned assets Transfer pricing rules will apply to exports only if the average export price is lower than 90% of the average price of similar goods / services sold under similar circumstances in the domestic market. If annual revenue is below the specified threshold, transfer pricing documentation need not be maintained. However, other documentation may be called for during audit. Taxpayer is exempted from detailed documentation if the taxpayer has a minimum of 5% net profit on its total export revenues to related parties or whose export revenue in the calendar year does not exceed 5% of its total revenue in the same period. Africa, Germany, Netherlands - Prescribe acceptable levels of debt equity ratios for related party loans 55

56 Dispute settlement process in India Traditional Mechanism TPO CIT(A) ITAT High Court Supreme Court 2-4 yrs 2-4 yrs 10 yrs 10 yrs Alternate Mechanisms DRP now introduced MAP APA AAR Settlement Commission 56

57 DRP Mechanism When a TP adjustment is proposed, AO will issue draft order to taxpayer Taxpayer will confirm or file objections with AO and DRP within 30 days DRP will issue guidance to AO after having regard to evidences, further enquiries etc within 9 months from the date draft order was issued to taxpayer Panel may confirm, reduce or enhance the proposed transfer pricing adjustments. It cannot set aside the proposed adjustment for further enquiry In case of differences within DRP, opinion of the majority stands AO shall pass the order in conformity with directions of DRP, within one month without granting any additional opportunity to the taxpayer Appeal by taxpayer lies before the Appellate Tribunal and DRPs order is binding on the revenue and no appeal lies for the revenue CBDT to frame rules - The Central Board of Direct Taxes has notified the Income-tax (Dispute Resolution Panel) Rules, 2009 on 20 November 57

58 Notification - S.O (E).- Dispute Resolution Panel Rules, 2009 Board may, on the basis of workload and for efficient functioning, constitute panel in specified places Three Commissioners of Income-tax to each panel as Members who will have additional duty Each panel shall have a secretariat for receiving correspondence and for issuing on behalf of the panel Procedure for filing objections - Form No. 35A The evidence, if any, the eligible assessee intends to rely upon including any document or statement or paper submitted to the assessing officer: Provided that where the eligible assessee intends to rely upon any additional evidence other than those submitted to the assessing officer, to be filed as a separate application stating the reasons for filing such additional evidence. The panel may consider the application for filing additional affidavit and may either allow such application or reject it Power to call for or permit additional evidence The panel shall not be confined to the grounds set forth in the objections but shall have power to consider any matter or grounds arising out of the proceedings. Rectification of mistake or error Appeal against Assessment Order to ITAT - Form No. 36B. 58

59 DRP Process Chart 9 months 30 days Files objection with DRP DRP passes direction 1 month AO passes final order Draft Order by AO Assessee ITAT order Conveys acceptance / No objection communicated 30 days AO passes final order 59

60 DRP Panel Headquarters Delhi Mumbai Ahmedabad Jurisdiction (1) NCT of Delhi (2) Punjab, Haryana and Chandigarh, J&K (3) Uttar Pradesh, Uttaranchal, Rajasthan and Himachal Pradesh (1) Mumbai (2) Rest of Maharashtra except Pune (3) Goa, Madhya Pradesh and Chattisgarh Gujarat, Daman Diu, Dadra Nagar Haveli Members of DRP CIT-I - Mr. Vijay Sharma; CIT-II - Mr. JP Masser DIT (Intl Taxation)-I, Delhi - Mr. Gopal Kamal CIT-I - Mr. J.C. Mishra ; CIT-II - Mr. K.Gopinath DIT (Intl Taxation), Mumbai - Ms Poonam Dutt CIT-I, CIT-II; DIT (Intl Taxation), Pune Kolkata Chennai Bangalore Pune (1) West Bengal, North-east States and Andaman and Nicobar (2) Bihar, Orissa and Jharkhand Tamil Nadu and Pondicherry Karnataka, Kerala and Lakshadweep Pune CIT-I, CIT-II; DIT (Intl Taxation)-II, Delhi CIT-I - D. Ravindran ; CIT-II - P.K. Saranghi ; DIT (Intl Taxation), Bangalore - D.K. Gupta CIT-I - Bibhab Dutta ; CIT-II -Gautam Kar ; DIT (Intl Taxation), Bangalore - Anil Agarwal CIT-I - Mr A J Khan ; CIT-II - Mr S K Mishra DIT (Intl Taxation), Ahmedabad - Mr L N Pant 60

61 Potential Benefits and Open issues Potential Benefits Specialist panel Speedy resolution Time-bound Direct appeal to ITAT by assessee Department cannot appeal against the DRP directions No demand till AO issues final order based on directions of DRP Open Issues DRP yet to become functional If AO does not make a reference to TPO Appeal only to CIT(A) If AO does not file a reply appeal will lie before CIT(A)? Does 144C need to be complied with in case of remand by ITAT If DRP does not give directions within the period mandated? Revision proceedings 61

62 Advance Pricing Arrangement Upfront determination of an arm s length price (ALP) The Board would be empowered to make further adjustments to the price determined as per the transfer pricing rules. APA term would be limited to a maximum term of five consecutive financial years. The APA would be binding on the taxpayer and the tax authorities, and only in respect of the international transactions for which the agreement is sought. 62

63 APA Process (1) Pre Filing / Filing (5) Drafting of the APA APA Administration (2) Evaluation and Analysis (4) Competent Authority (3) Negotiation 63

64 Pros and Cons of entering into an APA Pros Low annual reporting cost and certainty with respect to outcome of covered transactions during the APA term Reduces the need for documentation and costs associated with audit and appeals over APA term Ability to discuss considerations in a prefiling meeting, which some countries permit on an anonymous basis Flexibility developing practical approaches for complex problems Cooperative process with experienced professionals considering the case Cons Initial APA submission preparation cost may be high relative to annual documentation costs Can take multiple years to finalize Changes in the business during the APA term may reduce its applicability or necessitate modification/potential revocation Exposes all aspects of the business because of voluntary nature of the process May affect established working relationships with local tax authorities 64

65 Proposals relating to TP Assessment DTC Dispute Resolution Mechanism retained However only for cases of adjustments exceeding INR 2.5 million. Form 3CEB lodged directly with the TPO instead of the AO. Selection of TP audit through risk management strategy framed by the Board. Such strategy or criteria will not be made public. Change in timelines of submission of certificate, commencement and completion of scrutiny Best judgement assessment if assessee does not cooperate 65

66 Other proposals Definition of Associated Enterprises widened Threshold criteria reduced:- Direct and indirect participation 10% from 26% loan to asset ratio reduced to 26% from 51% nomination of director more than 1/3 rd from half Concept of impermissible avoidance arrangements introduced thin capitalization. Safe Harbor provisions retained Penalty provisions eased 66

67 Parting thoughts Formation of Dispute Resolution Panel, Safe Harbour Mechanism, APA procedure, Risk based assessments are welcome steps in the right direction Effectiveness of the above proposals would depend on the global best practices adopted by the revenue authorities and the preparedness of the taxpayers. 67

68 Questions 68

69 Thank You Contact details Name :A. Pradeep Designation :Senior Manager Tel: Co BSR & Co., 2009 a firm B S of R Chartered and Co, a Accountants, firm of Chartered duly Accountants. registered under All rights the Indian reserved. Partnership Act, All rights reserved. 69

70 Mumbai New Delhi Bangalore Hyderabad Kamala Mills Compound, 448, Senapati Bapat Marg, Lower Parel, Mumbai Tel Fax Building No.10, Tower B, 8 th Floor, DLF Cyber City, Phase II, Gurgaon Haryana Tel Fax Solitaire, 139/26, 3 rd Floor, Inner Ring Road, Kormangala, Bangalore Tel Fax /2 Reliance Humsafar, 4 th Floor, Road No. 11, Banjara Hills, Hyderabad Tel Fax Chennai Kolkata Pune Kochi No. 10 Mahatma Gandhi Road, Nungambakam, Chennai Tel Fax Park Plaza, 6 TH Floor Block F, 71 Park Street Kolkata Tel Fax , Godrej Castlemaine, Bund Garden, Pune Tel /65 Fax /F, Palal Towers M.G.Road, Ravipuram, Kochi Tel Fax Co B S R and 2009 Company, BSR & a Co., firm a firm of Chartered of Accountants, duly registered under under the Indian the Indian Partnership Partnership Act, Act, All rights reserved. All rights reserved. 70