Landmark Decisions on Transfer Pricing

Transcription

1 Landmark Decisions on Transfer Pricing CITC Amol Tibrewal Vispi T. Patel & Associates 11 April 2014

2 Global Vantedge - Delhi Tribunal (ITA No 2763 & 2764/DEL/2009) Facts of the case Assessee provided IteS to AE; claims deduction u/s 10A of the Act AE engaged in marketing activities whereas work for clients secured by the AE is carried out by the Assessee Assessee selected AE as tested party for benchmarking under TNMM During the year, 90.6% of revenue received by AE from clients was passed on to the assessee. Total revenue recd from clients amounted to approx Rs 9 crores Further, AE incurred a loss on revenue retained by it

3 Global Vantedge - Delhi Tribunal Action of the TPO Chose Assessee as tested party (having loss of 53.5%) and identified 9 comparables with avg margin of 11.88% Thus, TPO proposed adjustment of Rs crores i.e. the adjustment exceeded total revenue recd from third party clients Key contentions before the CIT(A) AE to be accepted as the tested party for TP analysis In a revenue sharing arrangement between entities, what may be questioned is the proportion of sharing between the entities and not the absolute amount of revenue itself as that is beyond the control of either the Assessee or its AE i.e. in the instant case, what may be questioned is the 90.6% / 9.4% share of revenue but not 100 that is recd from third party clients Assessee being a tax holiday unit had no intention to shift profits

4 Global Vantedge - Delhi Tribunal Order of the CIT(A) It is difficult to obtain data/ all relevant facts for proper FAR analysis regarding foreign comparables and hence AE cannot be selected as tested party However CIT(A) ruled in favor of the Assessee as regards the point that total adjustment in the hands of the Assessee cannot exceed total revenue recd from third party. In the case of a revenue sharing model between two entities (say A & B), it may be contended that the amount of revenue received by an entity (say entity A is lower than the fair amount of revenue receivable by it is due to the other entity (say entity B) receiving a larger share. Such unfairness may be mitigated by requiring the entity B to retain only its fair share and give up the balance amount in favour of entity A

5 Global Vantedge - Delhi Tribunal In the worst case, entity B may be required to give up its entire share of revenue which would result in entity A receiving 100% of the revenue. However, it cannot be logical to say that the fair amount of revenue to be received by entity A is more than 100% of the total revenue earned by both A and B. Under such circumstances, entity B will have to pay the additional amount from its internal sources which, in addition to being a highly absurd proposition, may also lead to the bankruptcy of B since this cannot be sustained over a period of time Based on an independent report which reflected the average selling expenses by BPOs for FY 2003, CIT(A) attributed a margin of 1.4% for the AE s marketing activities

6 Global Vantedge - Delhi Tribunal Order of the Tribunal The Tribunal held that neither the assessee nor the DR for the revenue have been able to point out any basis or material or criteria to controvert or to rebut the findings and conclusion arrived at by the CIT(A) except by relying upon their respective stand taken before the CIT(A). Therefore, the order of CIT(A) is upheld, and the grounds raised by the assessee as well as by the revenue on this issue are rejected

7 Maersk Global Centres (India) Pvt Ltd Mumbai Tribunal Special Bench (ITA No.7466/Mum/2012) Facts of the case Taxpayer is engaged in providing IT/ ITeS to its AEs Selected TNMM for benchmarking with a particular set of comparables TPO rejected taxpayer s TP analysis and selected his own comparables On appeal before DRP, a set of 10 comparables with an average margin of 28.04% was finalized this included companies providing both high-end as well as low-end services In appeal before SB, taxpayer s objections essentially related to selection of comparables

8 Maersk Global Centres (India) Pvt Ltd Mumbai Tribunal Special Bench Questions before the SB Whether for benchmarking back office support services, companies performing KPO functions should be considered as comparable Whether companies earning abnormally high margins should be included in the list of comparable companies

9 Maersk Global Centres (India) Pvt Ltd Mumbai Tribunal Special Bench SB Ruling on Question 1 There exists a very thin line of difference between BPO and KPO services The range of services rendered by the ITeS sector is so wide that a classification into low-end or high-end is not always possible Evolution of BPO sector has given rise to KPOs; BPO trying to upgrade to KPO is likely to render both, BPO as well as KPO services in the process of evolution, thereby making classification difficult Not possible to create third category in between BPO and KPO

10 Maersk Global Centres (India) Pvt Ltd Mumbai Tribunal Special Bench In the report on ITeS sector placed before the SB, KPO segment was referred to as a growing area, moving beyond simple voice suggesting thereby that only such services constituted low-end services of the BPO sector Further, the definition of ITeS as per Safe Harbor Rules includes data search integration and analysis services and clinical database management services Thus, SB concluded that ITeS services could not be further bifurcated into BPO or KPO services for comparability analysis However, having regard to functional profile of taxpayer, qualification of personnel employed by it, SB excluded high end companies from the comparables set

11 Maersk Global Centres (India) Pvt Ltd Mumbai Tribunal Special Bench SB Ruling on Question 2 Companies satisfying comparability conditions could not be excluded merely on account of high margins; inclusion/ exclusion of comparables would depend on facts and circumstances of each case As per OECD guidelines, such situations should trigger further investigation to find out if the abnormal margins are on account of unusual factors or normal business conditions and accordingly such companies should be included/ excluded from the list of comparables

12 TNS (India) Pvt Ltd Hyderabad Tribunal (2014-TII-24-ITAT-HYD-TP) Facts of the case Assessee is engaged in conducting quantitative and qualitative market research, having specialized divisions for media, social development, healthcare projects, opinion polls, automotive and IT & telecom sectors International transactions with AEs pertained to provision of services, payment of royalty, payment of management fees, payment of interest and reimbursement transactions The TPO aggregated the international transactions pertaining to provision of services and payment of royalty, applied TNMM as the most appropriate method and determined such transactions to be at arm s length, as the assessee s margin was higher than that of comparable companies

13 TNS (India) Pvt Ltd Hyderabad Tribunal The TPO also accepted the arm s length nature of the interest payment and reimbursement transactions However, he disallowed the entire expense on account of management fees paid by the assessee observing that the information/ explanations submitted by the assessee were insufficient to prove actual receipt of services from the AE; he thus determined the ALP at NIL Before the TPO, the assessee furnished a detailed write-up of the functions performed by the AEs for the benefit of all group companies, inter-company service agreement and the basis of allocation of cost to group companies The category of services provided, description of services and manner in which services were supplied were detailed in the agreement

14 TNS (India) Pvt Ltd Hyderabad Tribunal Key contentions of the Assessee before the Tribunal Assessee has received benefits in the form of global consistency in business practices, economies of scale, improvements in efficiency and access to skills, expertise on a global level and these benefits being intangible in nature, specific evidence could not be furnished to the TPO/ AO to his satisfaction for verifying the services TPO has already concluded arm s length nature of international transactions by adopting TNMM as a method wherein the margin of assessee, considering the management fee as an expense, was accepted at arm s length. Thus, it was contended that once a method was invoked by the TPO, other methods do not apply

15 TNS (India) Pvt Ltd Hyderabad Tribunal Order of the Tribunal TPO cannot disallow expenditure incurred for the purpose of business at a prima facie level without considering business exigencies. Assessee has given a detailed write-up as well as details of services provided and benefits obtained, which were not contradicted. What sort of evidence satisfies the AO is also not specified TPO is to determine the ALP of a transaction and he cannot reject the entire payment under the provisions of section 92CA as held by the Hon'ble Delhi High Court in the case of EKL Appliances Ltd (2012-TII-01-HC-DEL-TP) The TPO invoked Rule 10B of the Income-tax Rules, 1962 to analyze the transactions under the TNMM. Even after paying the management fee, the assessee s PLI was found to be more than the comparable cases. Therefore, considering that also, denial of management fees is not proper on the part of the TPO

16 Bharti Airtel Ltd - Delhi Tribunal (ITA No. 5816/ Del/ 2012)] Adjustment on account of corporate guarantee given on behalf of AE Facts of the case The assessee issued a corporate guarantee to Deutsche Bank, New Delhi Branch on behalf of its overseas AE guaranteeing repayment for working capital facility granted to AE Assessee contended that since it had not incurred any costs or expenses on account of issue of such guarantee, and the guarantee was issued as a part of the shareholder activity, the same was issued for NIL consideration The TPO made an adjustment stating that the assessee benefitted the AE by increasing its credit rating. He determined the 4.68% under the CUP method on the basis of data obtained from various banks u/s 133(6) of the Act

17 Bharti Airtel Ltd - Delhi Tribunal Key observations and decision of the Tribunal The Tribunal analysed the meaning of the term International Transaction as per Section 92B of the Income Tax Act, 1961 (Act) and the Explanation thereto. It observed that the Explanation to Section 92B, being clarificatory in nature, is to be read in harmony with the scheme of provisions u/s 92B. Out of the 5 clauses i.e. clause (a) to (e) mentioned in the Explanation to Section 92B, clauses (a), (b) and (d) find a direct mention in Section 92B(1). Thus, clauses (c) and (e) dealing with capital financing and business restructuring or reorganization can only be covered in the residual clause of Section 92B(1) i.e. any other transaction having a bearing on profits, income, losses or assets of such enterprises

18 Bharti Airtel Ltd - Delhi Tribunal This pre-condition about impact on profits, income, losses or assets is embedded in Section 92B(1) and the only relaxation from this condition precedent is set out in clause (e) of the Explanation to Section 92B, which provides that the bearing on profits income, losses or assets could be immediate or on a future date. Thus, contingent impact situations are excluded It also held that the onus is on Revenue authorities to demonstrate that the transaction is of such a nature as to have bearing on profits, income, losses or assets on a real basis (even if in future), and not on a contingent or hypothetical basis. Such onus was not discharged in the instant case

19 Bharti Airtel Ltd - Delhi Tribunal Thus, the Tribunal held that even after insertion of Explanation to Section 92B, a corporate guarantee given for benefit of the AE, which does not involve any costs to the assessee, does not have a bearing on profits, income, losses or assets and therefore it is outside the ambit of international transaction to which any ALP adjustment can be made

20 Bharti Airtel Ltd - Delhi Tribunal Adjustment on account of notional interest on share application money advanced to AE Facts of the case During the year, payments were made by the assessee towards share application money to its overseas AEs. Being in the nature of share application money payments, the same were not benchmarked by the assessee The TPO did not question the character of the payment. He, however, noted that the shares were allotted against the same after a considerable length of time after the money was advanced. He treated the aforesaid amounts advanced by the assessee to its AEs as interest free loans since the same were not converted into equity for a long time, and made an adjustment on account of 17.26% relying upon information obtained from banks u/s 133(6) of the Act

21 Bharti Airtel Ltd - Delhi Tribunal Key observations and decision of the Tribunal The Tribunal held that there is no dispute that the impugned transactions were in the nature of payments for share application money, and thus, in the nature of capital contribution It observed that the TPO has not brought any material on record to show that an unrelated share applicant was to be paid any interest for the period between making the share application payment and allotment of shares It is not open for the Revenue authorities to recharacterise a transaction unless it is found to be a sham or bogus transaction. The Tribunal held that in the instant case, there cannot even be a suggestion to hold the transaction as a bogus one since shares have indeed been allotted to the assessee. Thus, the adjustment was deleted

22 Mattel Toys (I) Pvt Ltd Pune Tribunal (ITA No.2476/Mum./2008) Facts of the case Assessee is a subsidiary of Mattel Inc USA engaged in marketing and selling of toy brands of the Mattel Group in India Imports finished goods from group companies for resale in India Selected TNMM (after adjustments) in its TP study for benchmarking imports; rejected the RPM for the reason that the said method focuses on gross profit margin which is heavily influenced by the scope and functions performed and may also vary widely among uncontrolled parties However, during the course of TP assessment, Assessee contended to use RPM TPO made an adjustment of Rs 1.32 crores Before the CIT(A), Assessee reiterated use of RPM as loss under TNMM was on account of admin costs paid to third parties (approx 80% of sales revenue)

23 Mattel Toys (I) Pvt Ltd Pune Tribunal However, CIT(A) rejected Assessee s arguments essentially stating that Assessee had itself given detailed reasons for rejecting RPM in its TP study Ruling of the Tribunal ALP has to be determined by following any of the most appropriate methods RPM is applicable in a situation where goods or services are procured from AE and resold without any value addition The OECD as well as ICAI guidelines also support the above view Direct methods viz CUP, RPM and CPM should be given preference over TNMM, which follows an indirect approach of determining ALP The contention that Assessee cannot change method at a later stage could not be upheld as this would defeat the ultimate aim of TP analysis Such cases should be considered if it is demonstrated as to how a change in the method will produce a better or more appropriate ALP on the facts of the case

24 THANK YOU Amol Tibrewal Vispi T. Patel & Associates Chartered Accountants Contact no : id : amol@vispitpatel.com