Controversies in Cross Border Transactions and Transfer Pricing

Transcription

1 Controversies in Cross Border Transactions and Transfer Pricing Case Studies 3 rd Annual regional residential course on International taxation December 2016

2 Indian tax scenario APA applications filed in 4 years. 115 APAs signed to date (4 bilateral APAs) Goal to close 100 APAs during FY , then 100 more by March 2018 Country-by-Country Reporting ( CbCR ) effective from FY Three tier documentation required as specified in Action plan 13 of BEPS (MNE Group turnover more than Euros 750 Mn) GST implementation effective 2017 such as SVB valuation for import of goods and services, ALP valuation for domestic sales and services rendered The general anti-avoidance rule [GAAR], which was planned to be implemented from 1 April TP additions of approx. USD 6400 million proposed in concluded audit cycle in FY Risk based assessment now introduced! Slide 2

3 The Importance of Protocol India Protocol: MFN Clause France A Ltd. is in the business of dredging and marine engineering services involving designing, construction, developing, modernizing, extending and maintaining ports and harbors. The company had hired dredgers on a bare-boat charter basis from nonresidents in France for executing dredging and reclamation works at Sweden International Seaport Dredging Ltd. [ITA No.418/Mds/2015] various ports in India for its clients. In this regard, the company paid bare-boat hire charges. This payment falls under the category of Royalty under Section 9(1)(vi) of the Income-tax Act, 1961 ( the Act ), for the use of equipment. Can we disallow the expenditure relating to hire charges, for nondeduction of tax at source under Section 195 of the Act by invoking the provisions of Section 40(a)(i) of the Act? Slide 3

4 Applicability of Article 9 for juridical double taxation A Netherlands A Netherlands is a company incorporated in and a tax resident of Netherlands. During the year, A Netherlands has rendered technical services to its affiliate, A India. Payment for technical services after deducting 10% as per DTAA A India Technical services The same has been remitted to A Netherlands after deducting tax in 10% in accordance with the Indo-Dutch DTAA. The income of A Netherland was subjected to ALP test under Indian TP regulations. The primary contention of A Netherlands is that Article 9(1) of the tax treaty is only for economic double taxation and not for juridical double taxation. Is this statement of A Netherlands correct? Shell Global Solutions International BV. [TS-921-ITAT-2016(Ahd)] Slide 4

5 Situs of Intangible A Australia Transfer of Trademark TM B Group A Australia had a step down subsidiary company in India, namely A India, which carried out brewery business in India by obtaining license of trademarks from A Australia, which were owned by A Australia. Outside India India License of trademark A India In a bid to divest the Indian business, A Australia had transferred, both ownership of A India, at the level of an intermediary holding company situated outside India; and also the trademarks licensed to A India, in favor of B Global, another foreign company. As per the arrangement of sale, A Australia had terminated the license agreements for the trademarks, previously entered into with A India. CUB Pty Ltd. (Formerly Foster s Australia Ltd.) [TS-401-HC-2016(DEL)] Given the above background, can the offshore transfer of intangible be taxed in India, as the patents were used in India, nurtured in India and some of them were registered in India? Slide 5

6 Source Rule Under Section 9 of the Act, what should determine the source of income? Place of activity (E.g.: manufacturing) Place of concluding the contract Place of performing the service Alstom T&D India Ltd. [ITA No 661 to 663 (Mds.) of 2013 Farida Leather Company [TCA No 484 of 2015 (Mad HC)] Financial Software & System P Ltd. [ taxmann.com 410 Chennai ITAT] Andaman Sea Food P Ltd. [ITA No 1412 (Kol) of 2011] Herbalife International India P Ltd. [ITA No. 7 of 2007 (Del HC)] Other considerations: - Impact of having a make available clause in the DTAA - Payment to non-residents for procurement of goods on a principleto-principle basis could be treated as royalty? - Amended definition provided in Section 9(1) of the Act would override the tax treaties (which are yet to amended)? - Role of non-discrimination clause in connection with Section 40(a)(i) disallowance. Slide 6

7 Secondment of employees A Group newly set up a wholly owned subsidiary A India. Secondment of employee A Group A India Reimbursement of portion of secondment salary (social security cost) paid by the Group In order to assist A India in stabilization of its operations, understanding the best practices of the Group and the Industry, A Group sends its employees on secondment to A India. A portion of the expatriate s salary (generally the social security cost) would be paid by A Group for administrative convenience. The same would be reimbursed by A India at cost, as the entire time of the employee is spent only on A India s operations. Key considerations: Cholamandalam MS General Insurance Co. Ltd (AAR) IDS Software Solutions [ITA No. 87/Bang./2008] Verizon Data Services [[2013] 33 taxmann.com 539 (Madras)] Whether A Group, providing employees to A India, amounts to rendering of service? Is the reimbursement of salary cost taxable in India? Should A India withhold tax on the same? Does the secondees presence in India create a PE of A Group in India? Slide 7

8 Liaison office Outside India India Group Companies Representing the Group in India Promoting export and import in India Promoting technical collaborations between Group and companies in India Acting as a communication channel between parent and Indian companies A Group commenced a liaison office ( LO ) in India which acts as a communication link between the Group and its business in India. The LO does not have a separate legal standing of its own. The services performed by the LO are depicted in the figure, and the LO carries on its activities in terms of the conditions specified by the RBI. Key Controversies: Would the LO be taxable under Section 9 of the Act? Can the LO be considered as a PE of the Group in India? Would your answer differ if the LO is a subsidiary of the Group (a legal entity)? Liaison office Columbia Sportwear Company [WP No of 2012 (Kar HC)] Rolls Royce Plc. [ SOT 42 (Delhi)] Slide 8

9 Associated Enterprises Together or not?! A Pte Ltd COO Director A Pte Ltd and B India Ltd, had a common director who held 99.9% shares of B India Ltd, while at the same time he held the position of Chief Operating Officer in A Pte Limited. Can we consider A Pte Ltd and B India as AEs under section 92A(1), even though none of the conditions in section 92A(2) are satisfied? B India Ltd. 99.9% share holder Kaybee Private Limited [TS-233-ITAT-2015(Mum)] Slide 9

10 Associated Enterprises Together or not?! A Inc. Right to manufacture and sell J brand garments In the said case, A Ltd. had entered into a licensing arrangement with A Inc., USA, to become a licensee of the brand-name J for the exclusive manufacturing and sale of readymade garments. A Ltd. was liable to pay a royalty in lieu of such rights. Can we invoke clause (g) of sub-section (2) of section 92A of the Act and considered A Inc. and A Ltd as AEs? A Ltd. Page Industries Ltd. [TS-382-ITAT-2016(Bang)] Slide 10

11 Associated Enterprises Together or not?! AEs Goods for OTW segment Flavours and inputs for Whiskey Segment Company A Customers CBUs Diageo India Private Limited [ITA No. 8602/Mum/2010] Finished goods for sale The Company A was engaged in marketing and selling alcoholic beverages, which was manufactured through contract bottling units ( CBUs ) in India ( manufacturing segment ). The manufacturing segment comprised two distinct segments, viz., Whiskey segment and OTW segment (Other Than Whiskey). In respect of the Whiskey segment certain inputs, i.e., the concentrate/ flavors (raw materials) were imported by the CBUs from the Company A s AEs, while beverages for the OTW segment were manufactured by the CBUs using only local inputs. The import transaction between the CBU and the AEs was disclosed in the Form 3CEB as an international transaction as a matter of abundant caution. The CBUs were to incur all costs and also realize the sale proceeds. From each CBU, the Company A was to receive the difference between the sale proceeds and all costs of the CBU along with the agreed profit margin of the CBU. Company A incurred a loss in the OTW segment and a profit in the Whiskey segment. Can the import transaction between CBU and AEs be considered as an international transaction of Company A? Slide 11

12 Transfer pricing Beyond related parties A Denmark Purchase of RM 3P-CM (Exclusive supplier for A India Ltd.) A India Ltd, a subsidiary of A Pte. Ltd, Singapore and A Denmark, was in the business of trading in pharmaceutical products. A India Ltd purchased finished goods from A Denmark and from a A India Ltd. Finished goods for sale third party Indian contract manufacturer ('3P-CM') (who was manufacturing finished products using raw material procured from A Denmark). Further, A Denmark had granted trademark and know-how license to A India Ltd, which was sub-licensed by A India Ltd to 3P-CM. Is the transaction between (a) 3P-CM and A Denmark (for purchase Novo Nordisk India Pvt. Ltd. [TS-249-ITAT-2015(Bang)] of RM); and (b) 3P-CM and A India Ltd (for sale of FG), were international transactions or not? Slide 12

13 Transfer pricing Beyond related parties A Inc. Sale of imaging division (prior agreement) B Inc. Pursuant to a global sale of the health imaging division from A Inc. to B Inc. for USD 100 billion, A India Ltd sold its medical imaging business to B India Ltd. for USD 100 million. The Asset Purchase Agreement (APA) entered between the Indian A India Ltd Sale of imaging division (Asset purchase agreement) Kodak India Pvt. Ltd. [ITA No. 7349/Mum/2012] B India Ltd parties clarified that the terms and conditions of the sale of imaging division were solely decided by A India Ltd. Can the transaction between A India Ltd and B India Ltd. (two residents) deemed to be an international transaction, as there exists a prior agreement between the respective Associated Enterprises (AEs)? Slide 13

14 Transfer pricing Beyond related parties A Inc. is a major multi-national company in the field of BPO services A Inc. Framework agreement B Inc. across the globe. A Inc. hunts for customers on behalf of the Group and enters into a relationship agreement, in order to crystalize the general terms of Business development fee Statement of work contract (which would not affect the pricing), which need not be again negotiated and agreed by each affiliate. The commercial terms of the contract (scope of services and pricing) A India Ltd is independently negotiated by A India Ltd with the customer in the Statement of Work. Can the transaction between A India Ltd. And B Inc. be considered as international transaction by invoking Section 92B(2) of the Act, as there exists a prior agreement (framework agreement)? Slide 14

15 EU Directive and its impact A India is a wholly owned subsidiary of A Belgium. A India is primarily engaged A Belgium in the manufacturing/assembly of gearboxes for wind turbine generators, for which it imports raw materials from A Belgium. Interest on overdue payable in accordance with EU Directive Import of raw materials A India was in the initial phase of operation and was in the process of stabilization. Accordingly, A India requested A Belgium for deferment of outstanding payment (relating to import of raw materials) to subsequent years. After 3 years, the European Parliament issued a Directive on Combating late payments which necessitated the member states to collect interest on A India Amounts payable to A Belgium outstanding for 3 years ZF Wind Power Coimbatore Pvt. Ltd [ITA.No.440/Mds/2016] outstanding receivables. Thus, A India was bound to pay interest on the overdue payables as goods of EU origin are subject to EU regulations. Can this expense be disallowed as (a) need-benefit test not satisfied; (b) pertains to prior period? (c) EU Directive not binding on A India. Slide 15

16 Validity of TP reference On 20 May 2003, CBDT issued Instruction No.3/2003 Guidelines to TPO and AO to operationalize TP provisions and to have procedural uniformity - Wherever the aggregate value of international transaction exceeds INR 5 crores (subsequently enhanced to INR 15 crores), the case should be referred to TPO under section 92CA. Key controversies: Prior to Instruction 3/2016 Is the instruction constitutionally valid whether its mandatory to refer a case if it crosses the threshold? Validity of reference if transaction value is less than INR 5 crores Should AO form a prima-facie opinion before referring the case? Should the AO give opportunity of hearing before making a reference? Early this year, CBDT issued Instruction 3/2016 (replacing Instruction 15/2015), introducing risk-based selection of cases for reference to TPO. This instruction provides various risk parameters based on which the AO should select cases to be referred to the TPO. These parameters inter-alia includes: AO comes across an international transaction which is not reported in Form 3CEB. TP adjustment in prior years more than INR 10 crores. TP findings made during search and seizure operation. Key controversies: After Instruction 3/2016 Is the AO bound to pass a speaking order on the validity of reference made to TPO? Can Instruction 3/2016 be applied retrospectively? Where the assessee has not filed Form 3CEB as it does not have any AEs, can AO make a reference to TPO, deeming a third party as an AE u/s 92A(2)? Slide 16

17 Other controversies! Is base erosion of profits from India a prerequisite to trigger TP provisions? Does APA have a bearing on the prior year litigation? Is cash PLI an appropriate profit level indicator for cost plus companies? Is amortization of acquired goodwill an operating item? Should payment for online advertising services to be treated as royalty u/s section 9(1)(vi)? Slide 17

18 Thank you! Sriram Seshadri Partner Tax and Regulatory Services Price Waterhouse & Co LLP Direct: +91 (044) Mobile: +91 (0)

19 Appendix A. Section 92A Meaning of associated enterprise: 92A. (1) For the purposes of this section and sections 92, 92B, 92C, 92D, 92E and 92F, "associated enterprise", in relation to another enterprise, means an enterprise (a) which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise; or (b) in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise. (2) For the purposes of sub-section (1), two enterprises shall be deemed to be associated enterprises if, at any time during the previous year, (a) one enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in the other enterprise; or (b) any person or enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in each of such enterprises; or (c) a loan advanced by one enterprise to the other enterprise constitutes not less than fifty-one per cent of the book value of the total assets of the other enterprise; or (d) one enterprise guarantees not less than ten per cent of the total borrowings of the other enterprise; or (e) more than half of the board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of one enterprise, are appointed by the other enterprise; or (f) more than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board, of each of the two enterprises are appointed by the same person or persons; or (g) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights; or (h) ninety per cent or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise; or (i) the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise; or (j) where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual; or (k) where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family or by a relative of a member of such Hindu undivided family or jointly by such member and his relative; or (l) where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than ten per cent interest in such firm, association of persons or body of individuals; or (m) there exists between the two enterprises, any relationship of mutual interest, as may be prescribed. Slide 19

20 Appendix 2. Section 92B(2) 92B(2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be an international transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise where the enterprise or the associated enterprise or both of them are non-residents irrespective of whether such other person is a non-resident or not. Slide 20

21 Appendix 3. Protocol 7 - Indo-France treaty 7. In respect of articles 11(Dividends), 12 (interest) and 13(Royalties, fees for technical services and payments for the use of equipment), if under any Convention, Agreement or Protocol signed after , between India and a third State which is a member of OECD, India limits its taxation at source on dividend, interest, royalties, fees for technical services or payments for the use of equipment to a rate lower or a scope more restricted than the rate of scope provided for in this Convention on the said items of income, the same rate of scope as provided for in that Convention, Agreement or Protocol on the said items income shall also apply under this Convention, with effect from the fate on which the present convention or the relevant Indian Convention, Agreement or Protocol enters into force, whichever enters into force later. Slide 21

22 Appendix 4. Article 9 of Indo-Dutch DTAA (1) Where: Article 9- Associated Enterprise a. an enterprise of one of the States participates directly or indirectly in the management, control or capital of an enterprise of the other State; or b. the same persons participate directly or indirectly in the management, control or capital of an enterprise of one of the States, and an enterprise of the other State, and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. (2) Where one of the States includes in the profits of an enterprise of that State and taxes accordingly profits on which an enterprise of the other State has been charged to tax in that other State and the profits so included are profits which would have accrued to the enterprise of the first-mentioned State if the conditions made between the two enterprises had been those which would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be had to the other provisions of this Convention and the competent authorities of the States shall if necessary consult each other. Slide 22

23 Appendix 5. Extract of Section 9(1)(vi) 9 (1) (vi) income by way of royalty payable by (a) the Government ; or (b) a person who is a resident, except where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or (c) a person who is a non-resident, where the royalty is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India : Provided that nothing contained in this clause shall apply in relation to so much of the income by way of royalty as consists of lump sum consideration for the transfer outside India of, or the imparting of information outside India in respect of, any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process or trade mark or similar property, if such income is payable in pursuance of an agreement made before the 1st day of April, 1976, and the agreement is approved by the Central Government : Provided further that nothing contained in this clause shall apply in relation to so much of the income by way of royalty as consists of lump sum payment made by a person, who is a resident, for the transfer of all or any rights (including the granting of a licence) in respect of computer software supplied by a non-resident manufacturer along with a computer or computer-based equipment under any scheme approved under the Policy on Computer Software Export, Software Development and Training, 1986 of the Government of India. Slide 23

24 Appendix 5. Extract of Section 9(1)(vi) (Contd.) Explanation 1. For the purposes of the first proviso, an agreement made on or after the 1st day of April, 1976, shall be deemed to have been made before that date if the agreement is made in accordance with proposals approved by the Central Government before that date; so, however, that, where the recipient of the income by way of royalty is a foreign company, the agreement shall not be deemed to have been made before that date unless, before the expiry of the time allowed under sub-section (1) or sub-section (2) of section 139 (whether fixed originally or on extension) for furnishing the return of income for the assessment year commencing on the 1st day of April, 1977, or the assessment year in respect of which such income first becomes chargeable to tax under this Act, whichever assessment year is later, the company exercises an option by furnishing a declaration in writing to the Assessing Officer (such option being final for that assessment year and for every subsequent assessment year) that the agreement may be regarded as an agreement made before the 1st day of April, Explanation 2. For the purposes of this clause, "royalty" means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head "Capital gains") for (i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ; (ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property ; (iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ; (iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ; (iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB; (v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or (vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v). Explanation 3. For the purposes of this clause, "computer software" means any computer programme recorded on any disc, tape, perforated media or other information storage device and includes any such programme or any customized electronic data. Explanation 4. For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred. Explanation 5. For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not (a) the possession or control of such right, property or information is with the payer; (b) such right, property or information is used directly by the payer; (c) the location of such right, property or information is in India. Explanation 6. For the removal of doubts, it is hereby clarified that the expression "process" includes and shall be deemed to have always included transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic fibre or by any other similar technology, whether or not such process is secret; Slide 24

25 Appendix 6. Extract of Section 9(1)(vii) 9 (1) (vii) income by way of fees for technical services payable by (a) the Government ; or (b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or (c) a person who is a non-resident, where the fees are payable in respect of services utilised in a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India : Provided that nothing contained in this clause shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before the 1st day of April, 1976, and approved by the Central Government. Explanation 1. For the purposes of the foregoing proviso, an agreement made on or after the 1st day of April, 1976, shall be deemed to have been made before that date if the agreement is made in accordance with proposals approved by the Central Government before that date. Explanation 2. For the purposes of this clause, "fees for technical services" means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head "Salaries". Slide 25