June 19, CA Rajesh S. Athavale

Transcription

1 SEMINAR ON TRANSFER PRICING REGULATIONS Analysis of important transfer pricing decisions, nuances and practical application from India perspective June 19, CA Rajesh S. Athavale

2 Agenda Evaluation of Transfer Pricing Recent Indian jurisprudence on Transfer Pricing Way Forward

3 Evaluation of Transfer Pricing

4 Transfer pricing Evolution - OECD s View Transfer Pricing can deprive governments of their fair share of taxes from global corporations and expose multinationals to possible double taxation. No country poor, emerging or wealthy wants its tax base to suffer because of transfer pricing. The arm s length principle can help. By John Neighbour Organisation for Economic Co-operation and Development OECD Centre for Tax Policy and Administration 4

5 Objectives of Transfer Pricing Regulations (TPR) Protection of tax base Equitable sharing of tax revenues between the nations i.e. Residence and Source countries Principles should be internationally acceptable to avoid economic double taxation Practical difficulties in applying the regulations should be recognised by both countries No discrimination between Multinational Enterprise (MNE) groups and Independent Enterprises the standard of comparability should be impartial 5

6 Evolution of TPR Embedded in the Double Taxation Avoidance Agreement ( DTAA ) Article (9) of the OECD Model Convention The OECD Report on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the Guidelines), is the Foundation Based on Arm s Length Principle The universal principle which is the foundation of TP legislation globally Above principles serve the dual objectives - Securing the appropriate tax base in each jurisdiction and avoiding double taxation 6

7 Arm s Length standard The Universal Standard (ALS) The Arm s length Standard (ALS) is the Universal Standard that is applicable to the various intra-group transactions of a Multinational Enterprise (MNE). It is based on the separate entity approach and is enshrined in the DTAAs signed by the various countries. 7

8 Revenue Authorities Approach Revenue Authorities becoming extremely stringent in protecting tax base Relatively new subject but judicial pronouncements now available Separate set-up for administering TP Dispute Resolution Alternatives available in domestic law and experiences

9 Transfer Pricing Disputes An Overview Six rounds of TP audit completed FY , , , , , and All cases having transaction value > INR 50 million referred by AO to TPO for TP scrutiny Particulars FY FY FY FY FY F Y FY Cases picked 800 Approx. Approx. Approx. Approx. Approx. Approx. up for scrutiny Tax demands INR 1.2 INR 2.5 Approx. Approx. Approx. Approx Approx billion billion INR 3.5 billion INR 5 billion INR 6.5 billion INR 8 billion INR 20 billion 9

10 Recent Case Laws

11 SAP Labs (India) SAP Labs India Pvt. Ltd. Software Development services 100% holding SAP AG (Germany) Facts of the Case SAP India engaged in software development and related services to SAP AG STPI unit Exempt under section 10A SAP India operated under R&D Agreement and remunerated at cost plus 6% or 1.5 times of wages bill, whichever was higher Transfer Pricing Officer (TPO) initially tried to apply CUP method, by comparing rates charged by comparable companies as per NASSCOM data TPO later applied TNMM ignoring the initial intention to apply CUP and made adjustment

12 Tribunal held as under: SAP Labs India Pvt. Ltd. Transfer Pricing provisions are applicable irrespective of the fact, whether income is taxable or not Under the Income Tax Act, even if income is exempt, transfer pricing adjustment is not exempt from tax Aim of transfer pricing provision is to determine the arm s length price by applying the most appropriate method (MAM) In the process of evaluation of MAM, all methods need to be evaluated, hence shifting from one method to another is within law

13 Tribunal held. SAP Labs India Pvt. Ltd. Need to evaluate correctly the operating margin of the tested party Foreign exchange fluctuation gain operating income Interest in income tax refund non-operating income Donation operating cost Proviso to Section 92C(2) provides for +/- 5% range from arm s length price as a standard deduction, however, after amendment by Finance (No. 2) Act, 2009, this leeway is not available and the amendment is prospective in nature Comparable analysis needs to consider the economics of the tested party. Thus in the present case, high profit making, loss making companies, different functionality need to be eliminated from the set of comparable companies Companies having margins less than that contracted by the tested party, needs to be eliminated

14 +/-5% Range -Example SAP Labs India Pvt. Ltd. Current Position Amended Position Particulars Operating income (Transfer Price) Amounts in INR 110 Total operating cost (TC) 100 Operating profit (OP) 10 OP/TC 10% Comparables margin 17% ALP % of ALP % of ALP As per the current position of law and the view taken by various Tax Tribunals, in the above example, the adjustment would be Made as i.e Particulars Operating income (Transfer Price) Amounts in INR 110 Total operating cost (TC) 100 Operating profit (OP) 10 OP/TC 10% Comparables margin 17% ALP % of Transfer Price % of Transfer Price Here, the question arises as to whether the adjustment shall be made as or ? 14

15 Take Aways SAP Labs India Pvt. Ltd. Shifting of profit is not a criteria for applicability of TP Zero down on a particular method as the MAM Selection of MAM will depend upon the facts of the case and the factors mentioned in rules contained in rule 10C New proviso to section 92C(2) inserted by the Finance (No.2 ) Act is prospective in nature Limitation of data base

16 Maruti Suzuki Brief Facts Maruti India subsidiary of Suzuki Motor Corporation, Japan, engaged in manufacture and sale of automobiles Enters into license agreement with prior approval of Government of India for use of Suzuki logo for sale of certain Suzuki model in India Under license agreement, Suzuki was to provide technical information, know-how, etc. However, Maruti was to compulsorily use the trademark of Maruti Suzuki on containers, packages and wrappings

17 Maruti Suzuki Brief Facts. According to the TPO the change of brand logo from Maruti to Suzuki amounted to sale of the brand Maruti to Suzuki TPO computed the value of Maruti brand at cost plus 8 % at INR 4,420 crores and issued show-cause notice as to why the international transaction not be adjusted on the basis of deemed sale to Suzuki Maruti in its reply stated that there was no transfer of Maruti brand or logo by it and Suzuki had not charged any additional consideration for the use of such logo on the vehicles manufactured by Maruti Jurisdiction of TPO was challenged by Maruti

18 Brief Facts Action of TPO Maruti Suzuki Issued detailed questionnaire on replacement of logo and clarified that this is transfer of economic value Maruti paid royalty of INR to Suzuki but no compensation given by Suzuki to Maruti However Suzuki trademark had piggybacked on Maruti trademark without payment of any compensation Apportionment of 50% of the amount of royalty paid by Maruti to Suzuki and the ALP was determined at "Nil" using CUP method Maruti had developed marketing intangibles for Suzuki in India, at its own cost and Suzuki had not compensated for the same Based on the 3 comparable companies, TPO concluded that nonroutine advertisement expenditure of INR crores had to be adjusted

19 Maruti Suzuki Decision of the Delhi High Court Suzuki Trade-mark was not piggybacking on Maruti logo No transfer of Maruti brand to Suzuki No right given to Suzuki for using Maruti logo Agreement is critical for payment of license fees Grounds of adjustment must be stated in the notice issued in clear, cogent, specific and in an unambiguous manner The onus is on assessee to demonstrate whether transaction is at ALP or not Compulsory usage of logo of AEs results in creation of marketing intangibles for AEs, hence compensation from AE is required Level of marketing spend by licensee will determine whether the licensee needs to be compensated

20 Maruti Suzuki Maruti filed SLP before SC against observation made by HC The SC has now held that, the HC has not merely set aside the original show-cause notice but it has made certain observations on the merits of the case and has given directions to the TPO, which virtually conclude the matter. Accordingly, the SC has directed that the TPO should now pass his order uninfluenced by the observations/ directions of the High Court

21 Maruti Suzuki Take Aways Normal and excessive advertising and promotional expenditure Whether excessive marketing and advertisement expenditure or promotion of foreign brands create marketing intangibles in India Use of intangibles need to be compensated at arm s length basis

22 Sardia Pharmaceuticals India (P) Ltd Servier Egypt Sardia Pharmaceuticals India Purchase of API Servier France Facts of the case Sardia Pharmaceuticals, a pharma company, was engaged in business of producing drugs mainly in field of anti-hypertension and metabolism Assessee imported active pharmaceutical ingredients (API) from its Aes Assessee determined ALP by adopting TNMM method TPO rejected TNMM method and selected CUP as a MAM TPO obtained API data of competitors & made adjustment after allowing difference quality and purity standards

23 Ruling of ITAT Sardia Pharmaceuticals India (P) Ltd Selection of method for determining ALP is not on the unfettered decision on the taxpayer TPO can reject method adopted by assessee with cogent reasons and must be through speaking order CUP and traditional transaction methods are preferred over the transaction based profit methods Price movements and demand sensitivity to the price indicate that APIs imported are not unique items, and therefore by paying exorbitant price to AE for such items leave ample scope to manipulate API prices to regulate profitability of their controlled entities in the end use jurisdiction

24 Sardia Pharmaceuticals India (P) Ltd Ruling of ITAT APIs were generic drugs and not patent protected when they were purchased from AEs; hence attributing high price to cost and process of developing a new drug cannot be accepted It should compete with the generic drug manufacturers, in post patent period, on selling prices Re-characterization provisions in respect of payments made in excess of ALP as dividend, royalty or other income to AEs as done in Glaxo case have not yet been legislated in India The overseas judgement are no binding in India but their logic and rational can be relied upon

25 Ruling of ITAT Sardia Pharmaceuticals India (P) Ltd Branded API can be comparable to Generic API as benefit reaped before patent expiry Acceptance of value by custom authorities does not imply the compliance of the same under the Indian Transfer Pricing Regulations Sales to unrelated parties in different countries can not be considered as internal CUP due to different to geographical location and inadequate data CUP has been considered as a MAM

26 Sardia Pharmaceuticals India (P) Ltd Take Aways Need and importance to demonstrate to revenue authorities the correct business model, so as to bring out the economic rationale behind the conduct of business Superiority of CUP over TNMM Residue supernormal profits lying with the Indian entity after applying the CUP method, rightfully belong to whom? it Branded API can be comparable to Generic API as benefit reaped before patent expiry Play between the intangibles and the business model

27 Perot Systems HPS Global Systems Hungary Liquidity Management LLC Perot Systems (India) Foreign currency Interest free loans HPS Global Systems (Bermuda) Ltd Brief Facts Perot Systems was engaged in business of designing and developing technology enabled business transformation solutions and providing business consulting, systems integration services and software solutions & services It had extended foreign currency interest free loans to its two AEs (one is located in tax haven) TPO held that interest free loans were not at arm s length

28 Perot Systems Observations and Ruling of the ITAT Real Income theory not to apply to the Transfer Pricing Agreement is silent on quasi-equity nature of loan Agreement does not bring out the necessity of lending interest-free loan Economic substance of the transaction is that of the debt and not in the nature of equity or quasi-equity Classic case of violation of transfer pricing norms where profits are shifted to tax havens or low tax regimes to bring down the aggregate tax incidence of a multinational group RBI s approval for granting interest-free loan is not determinative of arm s length nature of transaction Benefit of +/-5% not to be granted to LIBOR

29 Perot Systems Take Aways Interest-free loan and guarantee to overseas subsidiary, whether interest/fees to be charged always necessary? Importance of legal agreement in synch with economic rationale, Robust documentation, Loan agreement, economic reasons, special circumstances, need for granting interest-free loan to be brought out Framing of Safe harbour Rules for such transactions Whether LIBOR is a single rate or average rate Benefit of +/-5% under the new law

30 Birlasoft (India) Ltd Brief Facts Birlasoft (India) Ltd. was engaged in the business of software development and related services For determining the ALP in respect of the international transactions with the AEs, the assessee applied internal TNMM TPO rejected the internal bench marking as assessee did not maintain segmental accounts for the related and non-related transactions and there was no segregation of these activities in the audited financials report DRP upheld the order passed by the TPO

31 Birlasoft (India) Ltd Observation of Delhi Tribunal Lack of segmental reporting in the audited financial statements cannot be a reason of rejecting method of computing the ALP Undertaking internal bench marking analysis on stand alone basis is justified OECD Guidelines provides that the net margin of the taxpayer from the controlled transaction should ideally be established by reference to the net margin that the same taxpayer earns in comparable uncontrolled transactions, and only where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide TPO had no mandate to have recourse to external comparables when internal comparables were available

32 Birlasoft (India) Ltd Take Aways Internal TNMM is more reliable than external TNMM Assessee maintain segmental account, applying the proper keys for allocation of income and expenses Reporting of such segmental results in the Financials not necessary for Transfer Pricing Analysis

33 Global Vantedge Retains $9.4 and passes $ 90.6 Revenue = $ 100 GV-India RCS End Customer Facts of the case Provision of I.T. Enabled services Flow of Revenue Global Vantedge ( GV-India ) was engaged in rendering of IT-enabled services RCS Centre Corp (RCS), provided marketing services and enters into contracts with the ultimate clients. Passed on the contract to GV-India on a back-to-back basis RCS retained 9.4 % (marketing services) of the total revenue earned from the client and then passed balance 90.6% of the revenue to GV

34 Global Vantedge Facts. For benchmarking the transaction GV-India considered its AE, RCS, as tested party and compared profit margin of RCS with foreign comparable companies TPO had chosen GV-India as tested party and arrives at avg. operating margin of comparables was 11.88% as against the loss incurred by GV-India Applying the Arm s Length Margin of 11.88% on the total operating cost, the TPO proposed the adjustment If the adjustment to be taken into account, the total value exceeded the revenue earned from client ultimately

35 Global Vantedge ITAT upheld the findings of CIT(A) as under: Least complex entity should be selected as tested party If an entity is unable to earn adequate profits on account of legitimate business exigencies and not due to manipulation of transactions undertaken by AEs, such entity cannot be penalized ALP of international transaction between the taxpayer and its AE can not exceed the total amount of revenue earned from clients by GV-India and AE together. Comparable companies with substantial related party transactions should be rejected

36 Global Vantedge Take Aways International transaction to be evaluated from end to end perspective while determining the arm s length nature of transaction Least complex entity should be selected as tested party, subject to availability of comparable data

37 Symantec Software Solution Facts of the Case Symantic Software Solution (SSS) was engaged in business of providing technical and marketing, pre-sale, and after sales support of Veritas group products SSS provided two types of services to its AE Marketing support services Consultancy Services For Marketing support services SSS was remunerated Cost plus 2 percent and for Consultancy Services SSS was remunerated Cost plus 8 percent SSS benchmarked transaction by using TNMM method TPO made transfer pricing adjustment by selecting different/new comparables

38 Symantec Software Solution Contention of Assessee TPO can not consider comparables, whose financial information was not available at the time of TP study Multi year data of comparables could be considered Turnover filter had to be applied for identification of comparable companies Adjustment for difference in functional and risk profile between comparable companies & assessee Benefit of +/-5% to be granted

39 Symantec Software Solution Tribunal held as under The comparison should be between the net margin on transaction basis and not at enterprise level Material available at public domain, even though not available to assessee at the time TP study is relevant Multi year data has limited role only when the data of earlier years reveals the facts which could have influenced the transactions; in this case the claim of multi year data can not be entertained

40 Tribunal held. Symantec Software Solution Unless and until it is brought under record that turnover of comparables has undue influence on margin it is not general rule to exclude such comparables No economic adjustment difference in functional and risk profile as assessee fails to bring any relevant material on record Amendment in proviso to section 92(c) - not clarificatory in nature and therefore to be applied prospectively

41 Symantec Software Solution Take Aways Limitation of data base Contemporaneous date/updatation of data Economic analysis/search filter Need for quantitative risk adjustment to be brought out Use of multi-year data Proposed price

42 Dana Corporation Facts of Case Dana Corporation, resident of US, filed bankruptcy As part of the bankruptcy proceedings, a reorganization plan was submitted to the US Bankruptcy Court The reorganization resulted in the transfer of shares of the three Indian companies to the new company The transfer was without consideration as per the share transfer agreement

43 The AAR held as under: Dana Corporation Transfer of Indian companies shares was without consideration; or At any rate the consideration is indeterminable Thus, the charging provision of Capital Gains (Section 45) is not applicable Hence, such transfer of shares are not chargeable to tax Where the charging section fails to operate, the transfer pricing provisions does not come to the rescue of the revenue authorities

44 Dana Corporation Take Aways Compliance under Transfer Pricing Regulations Filing of income tax return

45 Recent case-laws - Key takeaways Issue Position Case law Functional Analysis Maintenance of segment wise P&L for diversified activities Rejection of taxpayer s method Functional analysis of tested party as well as comparables necessary Separate evaluation for different functional activities Taxpayer s method / comparables should be rejected by the RA before adopting another method / comparables Aztec Software E-Gain Communication Sony India Pvt. Ltd. Skoda India Pvt. Ltd. UCB India Pvt. Ltd. Quark System Development Consultants Star India Pvt. Ltd. UCB India Pvt. Ltd. Aztec Software MSS India Selection of tested party 45 Party having least complex functions and not owning valuable intangibles should be selected as tested party. Foreign Company may be selected as tested party. Foreign Company rejected as tested party as it is difficult to compare entitlements of different geographical locations Development Consultants Ranbaxy Laboratories Global Vantedge

46 Issue Position Case law Comparables rejected on the basis that they are incurring losses Recent case-laws - Key takeaways Comparable cannot be rejected merely because it is incurring losses. Sony India Pvt. Ltd. Quark System Principles of natural justice Adjustments to be in synch with show cause notice. Taxpayer should be given opportunity to rebut Tax Officer s material Moser Baer Dufon Laboratories Maruti Suzuki Quark System Maintenance of documentation Taxpayer should reasonably comply with Cargill India Pvt. Ltd. documentation requirements under the law. Tax Officer cannot reject taxpayer s UCB India Pvt. Ltd. analysis merely on the ground that all documentation required under the regulations is not maintained. Methods to be followed as prescribed under section 92C 46 TPO cannot exceed his limitation by following any method to determine the ALP which is not authorised by the Act. It is mandatory for the assessee to follow one of the methods prescribed under the Act CA Computer Associates Starlite

47 Recent case-laws - Key takeaways Issue Position Case law Payment for use of trademark Adjustments under Transfer Pricing Compulsory use of logo results in creation of marketing intangibles of the AEs. Compensation from AEs is required Quantum of marketing spend by the licensee will determine whether the licensee needs to be compensated Transfer Pricing Adjustments cannot exceed the total revenue earned by the assessee and its AEs from the third parties Maruti Suzuki Global Vantedge Non-applicability of Transfer Pricing Provisions Where the charging section fails to tax the income, Transfer Pricing Provisions does not come to the rescue of RA Dana Corporation Applicability of Transfer Pricing Provisions Transfer Pricing Provisions are applicable irrespective of the fact whether income is taxable or not and whether assessee is enjoying 10A / 10AA / 10B benefits SAP India Aztec Software Oracle India Use of External CUP Data for comparability 47 analysis Nasscom Rates used for evaluation of transfer pricing Aztec Software (Against) 3 Global

48 Way Forward

49 Way Forward Revenue Authorities becoming extremely stringent in protecting tax base Multinationals need to factor in Revenue Authorities stand in their business strategy in India Taxpayers need to bring out the true economic substance of the controlled transaction, the depiction of risks undertaken and other relevant documentation to discharge their burden of proof, under the Indian TPR Mechanical approach to TP with emphasis only on mere quantification analysis may not be sufficient to protect the taxpayer

50 Thank You CA Rajesh S Athavale, Partner Vispi T. Patel & Associates Chartered Accountants #10, Dwarka Ashish, Jambul Wadi, Opp. Edward Cinema, Kalbadevi Road, Marine Lines, Mumbai Contact No.: / rajeshsathavale@vispitpatel.com