Recent developments in Transfer Pricing

Transcription

1 Recent developments in Transfer Pricing 18 August

2 Transfer Pricing in the news Indian Revenue authorities are reckoned to be tough globally in TP matters, with India accounting for about 70% of all global TP disputes by volume Financial Express article dated 1 September 2012 TP Adjustments by Revenue (USD bn)** 13.3 Tribunal's transfer pricing blow for MNCs - Rules in favour of tax department in the matter of levy on advertising and marketing expenses in brand building - Business Standard article dated 27 January 2013 In one of the biggest transfer pricing orders slapped on multinational corporations, the income tax department has alleged under-pricing of a whopping Rs 15,000 crores by Shell India. Economic Times article dated 31 January 2013 I-T department alleges Rs 1,300 crore under-pricing by Vodafone Vodafone refutes the basis of the order - Economic Times article dated 7 February On an average, TP adjustments are made on 50 percent of cases picked up for scrutiny TP adjustments of USD 13.3 billion made on cross-border transactions in last concluded TP audit Impact will multiply with the widened definition of the term international transaction and as TP extended to apply to domestic transactions also ** Ministry of Finance and Business Standard article dated 11 May

3 Recent amendments in Indian Transfer Pricing Regulations

4 Recent amendments key aspects Scope of TP regulations expanded to include the following Specified Domestic Transactions ( SDTs ): Expenses or payments made to domestic related persons as specified in Section 40(A)(2)(b) Specified Domestic Transactions Transactions between undertakings of same taxpayer or transactions by taxpayer with closely connected persons for the purpose of Chapter VI-A (which includes tax holiday provisions like 80IA) and Section 10AA SDT regime applicable from FY where value of SDTs in aggregate exceeds INR 50 million annually Non-compliance with reporting requirements would now result in onerous additional penalties Companies Bill 2013 would further expand the applicability of transfer pricing principles to inter-company dealings 4

5 Recent amendments key aspects International Transaction Enlargement / Clarification of definition of International Transaction - Retrospectively amend (FY onwards) the term international transaction to specifically include the following: - Guarantees - Any debt arising during the course of business (e.g. credit period on outstanding receivables) - Business reorganisations or restructuring, irrespective of whether the same has an impact on current year s profits, income, losses or assets - Intangible properties including marketing intangibles, human assets, technology related intangibles, etc. Penalty Provisions New penalty provisions introduced for SDT and International Transactions - Two percent of transaction value for : Non-reporting of transaction For incorrect maintenance/submission of documents 5

6 Recent amendments key aspects Variation - ALP Variation range for the Arm s Length Price ( ALP ) - An upper ceiling of 3 percent permissible as the variation range for determination of the ALP - A lower limit of 1 percent prescribed for wholesale traders ambiguity around definition of wholesale traders - Effective from 1 April 2013, and shall apply in relation to FY onwards Sixth Method Method which takes into account the price which has / would have been charged / paid, for the same / similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts - Helpful to apply in case where the other five methods difficult to use/ do not deliver correct comparable results - Examples: quotations, revenue split/allocation in the case of investment banking, logistics and other similar complex transactions 6

7 Emerging Transfer Pricing Challenges

8 Emerging transfer pricing challenges Income imputation by re-characterizing difference in valuation of shares: Primary adjustment: Difference in the valuation of shares being treated as income in the hands of the share issuing company Valuation of shares done using the Discounted Cash Flow method Secondary adjustment: Treating the difference as deemed loan and imputing interest thereof Marketing Intangibles: Compensation for extraordinary advertising and marketing expenses required Bright Line Test applied Matter litigative: Rulings pronounced in case of Maruti Suzuki, LG (Delhi Special Bench) also followed in case of Canon India, Glaxo Smithkline, Gillette, Haier and others 8

9 Emerging transfer pricing challenges Contract R & D Services: Revenue Authorities were imputing share of global profits in the hands of Indian contract R&D service provider Huge adjustments made in case of MNEs Stand of the Revenue Authorities fortified by introduction of Circulars 2 and 3 Stringent tests prescribed to qualify as a routine service provider failing which profit spilt method could be applied Location Savings: Refers to Cost Savings due to relocation of business from high cost location to low cost location and Location Specific Advantages (e.g. skilled manpower, large customer base, superior network etc) enjoyed by growing economies like India Quantification and allocation of location savings is subject matter of controversy Depends on functional analysis and bargaining power of the parties Indian Revenue authorities believe profit split method may be used to allocate location savings TP certainty and reduction in protracted litigation need of the hour 9

10 Intra group services Revenue analyses primarily the following parameters: Benefits received to prove parity with the charge Documentary evidence that such services were indeed received Allocation Keys whether in context of Indian operations Comparison of intra-group fees with local market price of similar services Most judicial precedents have stressed on Importance of maintaining robust documentation satisfying the need, benefit and evidence test for services received from the AEs Commercial expediency is the domain of the taxpayer APAs could be a feasible option 10

11 Quantitative Qualitative Intra group services: Key consideration Key issues Rationale Key considerations Need test? Establish need to obtain such services than perform in-house Robust qualitative discussion on nature of services, need and expected benefits Benefit test? Evidences of receipt of services Establish expected benefits to Indian entity ( revenue impact, cost saving, criticality for business, AE s expertise etc.) Detailed discussion of each type of service, manner of provision, manner of receipt along with supporting documentation Allocation reasonable allocation drivers, globally consistent Agree on evidences that are to be maintained produce previous year s documentations Benchmarking of markup (if any) Impact on other intl transactions (royalty, purchase of material etc.) Arm s length determination Arm s length nature of cost, cost allocation methodology and mark-up (if any) Impact on entity level profitability Shareholder s activities / duplicative activities are excluded 11

12 Headquarter and Management Services Judicial precedents Case McCann India Pvt. Ltd. Knorr- Bremse India Pvt. Ltd. Ruling Substantial evidence placed on record. Benefits of services provided by AE Entity level benchmarking using TNMM accepted Assessing Officer (AO) cannot dictate the business needs. The term benefit has wide connotations. Taxpayer s contention on commercial expediency rejected Taxpayer not discharged the obligation of maintaining and producing records The perusal of documents maintained reveal that only incidental and passive association benefit had been provided by the AE. F A Maintaining relevant robust documentation and corroborative support is the differentiator 12

13 Headquarter and Management Services Judicial Precedents (cont.) Case Dresser Rand Ruling TPO / AO cannot question the commercial wisdom of the taxpayer Disapproved that since the taxpayer has qualified staff on its roll, there was no need to obtain such services from its AE. Services availed by the taxpayer is legitimate - furtherance of its business interests such costs Allocation of cost on the basis of headcount and turnover is reasonable. F Gemplus India Pvt. Ltd. The charge for management services must be commensurate with the nature, volume and quality of services. There were no evidence/details available on record to demonstrate the nature of services rendered The Tribunal held that the expenses incurred should ideally be apportioned on the basis of actual services rendered to the individual units A Documentation and evidence of services rendered is critical 13

14 Re-characterization of Market/Procurement Support as Distributor Revenue s Position Marketing/ Procurement support service provider re-characterized as buy/ sell distributor and his compensation benchmarked accordingly (similar approach in case of commission agent in India) Activities of Indian support service provider have created valuable marketing/ supply chain/ human asset related intangibles in India Cost of service does not factor in the value of these intangibles Arms length profit mark-up on service cost alone does not give adequate return to the intangible related value addition by the Marketing/ Procurement support service provider Thus, Marketing/ Procurement support service provider entitled to an arms length return as a distributor i.e. a profit margin on the value of underlying goods procured/sold Way Forward Intercompany agreements to be clear on demarcation of functions and risks FAR analysis to be documented appropriately to bear out that Indian entity is a mere service provider and not a distributor Differentiate Marketing/ Procurement Support from distribution activities on all relevant parameters, including: Substantiating routine nature of intangibles if any, created/utilized by the Indian subsidiary Limited role in price negotiations, contract finalization, physical handling of goods (customs clearances, transportation, etc) No investment in working capital No risk of bad debt / delayed collection of debt Appropriate selection of comparables with reliable comparability adjustments for the differences 14

15 Re-characterization of Market / Procurement Support as Distributor Judicial Precedents Case GAP Internationa l Sourcing (India) Pvt. Ltd. Li & Fung (India) Pvt. Ltd Ruling Revenue could not substantiate that taxpayer has borne any business risks and developed any valuable supply chain or human asset intangible No separate allocation for location savings PLI of percentage of FOB value of goods has resulted in absurd and distorted results Li & Fung case distinguished Taxpayer performed all critical functions in the value chain and developed unique supply chain and human asset related intangibles Exports from India were made possible only because of taxpayer s efforts, therefore remuneration based on percentage of FOB value of goods sourced was appropriate F A FAR analysis and evidence are the differentiators 15

16 New Advance Pricing Agreements (APA) Program

17 New APA Program Effective controversy management tool internationally Unilateral / Bilateral / Multilateral option Valid for 5 years Salient Features Withdrawal / renewal possible Filing fees - Rs 1 million to Rs 2 million Annual compliance requirement / audit Pre-filing consultation anonymous also possible Estimated timeline: 9-15 months in case of Unilateral APAs; 2-3 years in case of Bilateral/Multilateral APAs Anonymous Pre-filing no downside Experience thus far 146 APA applications have been filed 117 Unilateral and 29 Bilateral/Multilateral Large MNCs are part of initial set of companies to participate in the program Approach of the APA team thus far has been rational and pragmatic Discussions in the conferences are comparable with international standards Considering aggressive approach of the Tax Authorities, APAs could be a feasible option 17

18 Indian Revenue Positive perspective on APA Program APA program based on International Best Practices Revenue APA team has been proactive and positive in its approach The key perspectives of the APA team are: To reduce litigation and provide certainty Early filings could leading to possible first mover advantage/ quick resolution Negotiation with open mind in collaborative environment Adverse audit history not to impact negotiations APA proposal to be looked at from a fresh perspective Not bound by past history Attempt to reconcile differences /contentious positions Open to mutually agreeable solutions Changed attitude reflected in composition of APA teams, specialists included in teams We agree that implementation will be the key and I can assure you that the Indian tax administration is keen to make this APA program a huge success. DGIT, Mrs. Promila Bhardwaj during a webinar initiated by KPMG in September 2012

19 Typical transactions for APAs Software development & ITES services Management services and royalty payouts Contract R&D (Pharma / Software) Contract manufacturing Intercompany loans, advances and guarantees Distribution and marketing intangibles Start up companies with losses Any new transactions - no dispute history

20 Planning: TP and Customs Attempt to integrate APA Application Lodge copy of APA Application with SVB Lodge copy of SVB Application with APA Customs Intimate Special Valuation Branch (SVB) and seek review Adhere to TP Methods Adhere to Customs Valuation Methodology Consistent with Custom Valuation / SVB Methodology Use Custom Valuation as a relevant factor in APA negotiations To the extent feasible, leverage discussions with APA Team, for SVB, and vice-versa Consistent with TP Methods Use TP Methods as a relevant factor in SVB Procedure/ Submission APA for TP (consistent with Customs to the extent possible) Achieve Consistency Optimize TP and Customs Position SVB Order (consistent with TP to the extent possible)

21 Safe Harbour Rules

22 Draft Safe Harbour Rules Salient Features Proposed to be an effective controversy management tool internationally Compliance with documentation requirements as captured in Section 92D of the Act and Rule 10D of the Income-tax Rules, 1962 ( Rules ) would still be required Safe Harbour announced for various sectors, subject to certain ceilings/ conditions Safe Harbour announced for various sectors to be valid for a period of 2 years commencing from Assessment Year Salient Features No filing fees need for additionally filing Form 3CEG with Assessing Officer along with Return of Income Form 3CEG along with contents to be reviewed by Assessing Officer for compliance with ceilings and conditions as prescribed under Rules 10TA to 10TG of the Rules If all conditions and ceiling are met the international transactions of the Company would be considered to be at arm s length In the event that the Assessing officer is not satisfied with the content of the Form 3CEG and compliance with the prescribed conditions and ceilings, he would direct the file to the Transfer Pricing Officer for testing the arm s length nature of the international transactions in the normal course Specified domestic transactions not covered within the ambit of Safe Harbour Rules

23 Safe Harbour Various sectors, ceilings and circumstances Software development services other than contract R&D ceiling value of international transaction does not exceed Rs. 100 crores Information technology enabled services other than contract R&D & KPO ceiling value of international transaction does not exceed Rs. 100 crores Information technology enabled services KPO and not contract R&D ceiling value of international transaction does not exceed Rs. 100 crores Advancing of intra-group loan to wholly owned subsidiary ceiling loan does not exceed Rs. 50 crores The operating profit margin declared in relation to operating expense incurred is 20 percent or more The operating profit margin declared in relation to operating expense incurred is 20 percent or more The operating profit margin declared in relation to operating expense incurred is 30 percent or more The Interest rate declared in relation to the international transaction is equal to or greater than the base rate of SBI as on 30th June of the relevant previous year plus 150 basis points

24 Safe Harbour Various sectors, ceilings and circumstances Advancing of intra-group loan to wholly owned subsidiary ceiling loan exceeds Rs. 50 crores Provision of explicit corporate guarantee to wholly owned subsidiary ceiling amount guaranteed does not exceed Rs. 100 crores The Interest rate declared in relation to the international transaction is equal to or greater than the base rate of SBI as on 30th June of the relevant previous year plus 300 basis points The commission or fee declared in relation to the international transaction is at the rate of 2 percent or more per annum on the amount guaranteed Provision of specified contract R&D services relating to software services The operating profit margin declared in relation to operating expense incurred is 30 percent or more Provision of specified contract R&D services relating to generic pharmaceutical drugs The operating profit margin declared in relation to operating expense incurred is 29 percent or more

25 Safe Harbour Various sectors, ceilings and circumstances Manufacture and export of core auto components The operating profit margin declared in relation to operating expense is 12 percent or more Manufacture and export of noncore auto components The operating profit margin declared in relation to operating expense is 8.5 percent or more

26 Thank you Contact Details - K R Girish Senior Partner, B S R & Co. T: E: krgirish@kpmg.com kpmg.com/in The information contained herein is of a general nature. The content provided here treats the subjects covered here in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. A detailed analysis of the tax and regulatory implications should be done prior to implementation in order to determine the feasibility of the transaction at the time of implementation. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. Specialist advice should be sought with respect to any individual circumstances. firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.