Transfer Pricing in India
Coverage Evolving Transfer Pricing Regulations in India Legislation and Trends Critical issues in India Advance Pricing Agreements vis-à-vis Safe Harbour Provisions Secondary Adjustments - Rationale and Impact New Era of Alignment and Transparency BEPS Project Action Plans - 4, 8-10 and 13 Impact of Enhanced Documentation on MNEs Strategies to Navigate Future of Transfer Pricing Landscape Key Takeaways Our Story 2
Evolving Transfer Pricing Regulations in India 3
Evolution of Transfer Pricing Regulations in India Domestic Transfer Pricing APA and Safe Harbour BEPS Action Plan 13 Secondary Adjustment Safe Harbour rationalised 2001 2012 2015/16 2017 Introduction of Transfer Pricing Alignment with global regulations Easing of transfer pricing scrutiny 4
Number of cases selected for audit Adjustment value USD billion Audits Adjustment Trends Transfer Pricing Disputes Growth 7000 6000 However, the high success rate for taxpayers at the Tribunal and HC level of 69% and 86% respectively, is an affirmation of the independence and fairness of the Indian judicial system 11.67 14 12 5000 9.93 10 4000 7.42 7.74 8 3000 6 2000 4.02 4 1000 0 1.82 1.29 0.20 0.38 0.57 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2 0 Number of TP audits completed Number of adjustment cases Amount of adjustments (In USD Billion) Source: CBDT Annual Report 2014-15 5
Critical Transfer Pricing Issues in India Marketing Intangibles Revenue paints all licensees of brands with same brush; seeks reimbursement of excess advertisement, marketing and sale promotion (AMP) expenses Procurement, Marketing Functions and PE Issues Revenue applies arbitrary commission, resulting in supernormal operating profits on cost Contract Service Providers Revenue inflicts high profits margins for contract R&D, IT, ITES, and KPO service providers Inbound Corporate Guarantees Revenue imputes guarantee fees charges based on credit worthiness Intra-Group Services Revenue challenges the actual receipt of services as well as the benefit of the same 6
Advance Pricing Agreements Concept of Advance Pricing Agreements (APA) introduced in India by the Finance Act, 2012 Average time for conclusion of unilateral APA is around 1.5-2 years (as compared to global standard of around 3 years) More than 800+ applications have been filed till date - 90% of pre-filing applications got converted to formal APA applications and 85% of the applications are for unilateral APA APAs concluded so far pertain to various segments like captive service centres in India, manufacturing activities, telecommunication services, oil exploration services, management cross charges, healthcare, media, etc. 184 APAs concluded till Nov 2017, including 13 bilateral APAs 5 with Japan, 8 with United Kingdom Indian Revenue has clarified that absent the provisions of corresponding adjustment in TP matters (generally embodied in Article 9(2) in any tax treaty) India shall not entertain any bilateral APA with respect to transactions involving such country Future of Indo-German Bilateral APA is hanging absent corresponding transfer pricing adjustments clause in the DTAA 7
Total APAs Signed APAs Filed APA Filing Key Statistics 2012-13 (FY) 2016-17 (FY) Year 1 2013 Year 2 2014 Year 3 2015 Year 4 2016 Year 5 2017 146 Applications 232 Applications 206 Applications 132 Applications 99 Applications 117 U 192 U 14 B 113 U 19 B 78 U 21 B 29 B 206 U 26 B 160 140 152 141 120 100 80 60 40 55 53 88 80 20 0 5 5 4 8 11 0 3 1 2 2013 2014 2015 2016 Total Total APA Unilateral APA Bilateral APA Source: Annual Report 2016-17 Ministry of Finance 8
Safe Harbour Rules Introduced in 2013, original safe harbour rules hardly received any positive response as compared to the phenomenal success of Advance Pricing Agreement (APA) Taking a cue from the above there was a rationalisation to the Safe Harbour Rules in 2017 Revised Safe Harbour provisions are made applicable with a upper turnover threshold of USD 31 million for all contract services Eligible Transaction Earlier Safe Harbour Revised Safe Harbour Software Development and ITeS 20.00% - 22.00% 17.00% - 18.00% Knowledge Process Outsourcing 25.00% 18.00% - 24.00% Intra-Group Loans SBI Base Rate + (150-300 b.p.) SBI Base Rate + (175 425 b.p.) 6m LIBOR + (150 400 b.p.) Corporate Guarantee 1.75% - 2.00% 1.00% Research and Development Services 29.00% - 30.00% 24.00% Manufacture and Export of Auto Components 8.50% - 12.00% 8.50% - 12.00% Low Value Intra-Group Services NA 5.00% 9
Implications of Reduced Safe Harbour Rates vis-à-vis APAs Putting a threshold for eligibility revised safe harbour is meant to benefit SME contract service provider entities Tax authorities can now concentrate more on complex and high-value transactions under APAs and for scrutiny - considering the risk based assessment selection Offering a safe harbour for low value adding intra-group services one of the most litigation prone transactions is a positive move and it seems to be in line with the BEPS Action Plan 8-10 However, considering various excluded services there is still caution/clarification required in this area 10
Secondary Adjustments Once Secondary Adjustment Provisions are triggered the Indian Co. is required to ensure the primary adjustment is recovered from the AE within the time limit Nature of Primary Adjustment Suo-moto adjustment made in return of income Advance Pricing Agreement (APA) entered Safe Harbour Rule (SHR) exercised Mutual Agreement Procedure (MAP) entered under a Double Taxation Avoidance Agreement (DTAA) Transfer Pricing Adjustment made by the relevant authority in the relevant order Time Limit for Repatriation 90 days from the due date of filing of a return of income 90 days from the date of order (order by the assessing officer or the relevant appellate authority) Interest to be imputed in case of failure to repatriate within the time limits mentioned above Currency of International Transaction Interest Base Rate Spread Effective Interest Indian Rupee 1 year marginal cost of funds (for SBI Lending Rate) 325 basis points 11.25% p.a. Foreign Currency 6-month London Inter-Bank Offered Rate (LIBOR) 300 basis points 4.42% p.a 11
Secondary Adjustments Overseas Parent Co. Indian Subsidiary Providing marketing and sales support services on commission basis Indian entity renders captive marketing and sales support services for the group Remuneration in the form of commission based on percentage of sales. Indian entity net results are losses unable to achieve desired levels of sales Comparable third party commission arrangements not available in the group Set of comparable sales support companies in India showing a net 8-10% profits In order to continue with the arrangement and to avoid falling under the ambit of secondary adjustment provisions in India, the group would need to decide whether it should: 1. Increase the commission rate so that Indian entity reaches to an arm s length rate of margins 2. Record the increased commission income as a receivable in the books of accounts itself 3. Re-evaluate the remuneration model for future years commission based to cost plus basis, depending specific facts of the case Relook inter-company transactions for the presence of any potential primary adjustments (non arm s length conditions) and determine the consequential impact of secondary adjustments 12
New Era of Alignment and Transparency BEPS Project Action Plan 4 Action Plan 8-10 Action Plan 13 Limiting Interest Deductions Aligning Value Creation CbCR 13
Action Plan 4 Limiting Interest Deductions (India s Perspective) Applicability From AY 2018-2019 (Section 94B Introduced) Applicable to Indian Companies and Indian Permanent Establishments (PE) of foreign entities Not Applicable to companies engaged in banking and insurance Applicable for debt extended by foreign related party; or by third party lender (if backed by implicit or explicit guarantee given; or deposit placed, by foreign related party) Restricts deduction in respect of expenditure by interest (or of similar nature) paid to non-resident associated entities to 30% of EBITDA (earning before interest, taxes, depreciation and amortisation) Threshold limit: interest expenditure exceeds USD 0.16 million Interest over the 30% limit could be carried forward and set-off for up to 8 subsequent years 14
Limiting Interest Deductions (Computation Mechanism for Disallowance) Particulars Scenario 1 Scenario 2 Scenario 3 Scenario 4 EBITDA 100 100 100-100 30% of EBITDA (a) 30 30 30 NA Interest paid to AE (b) 15 20 20 10 Interest paid to Non-AE (c) 25 40 10 10 Total Interest (d=b+c) 40 60 30 20 Total Interest in excess of 30% of EBITDA Excess Interest to be disallowed and carried forward (lower of b or e) 10 30 0 20 10 20 0 10 Set-Off of Excess Interest whether treatment same as un-absorbed depreciation or carried forward loss? 15
Action Plans 8 to 10 Aligning Transfer Pricing with Value Creation India s stand on economic activity based transfer pricing gets further strengthened Aligning rewards with the actual conduct and substance over form have been raised by revenue authorities and adjudicated by the tax tribunals in India More focus on intangibles returns generated should be correctly shared with companies who in reality perform value adding functions or bear the actual risks in development of those intangibles Transfer pricing cannot remain a merely principle driven tax compliance activity any more. It will touch upon the entire domain of the business, starting from the strategy to the ground level operations. Business arrangements would need a close evaluation: Captive high end R&D services in India remunerated on cost plus basis Limited Risk Distribution in India, remunerated with a guaranteed low level margins Indian distributor performing excessive brand building and not getting remunerated from the group for such activities 16
Action Plan 13 and Enhanced Documentation Requirement Indian Transfer Pricing Regulations introduced a three-tiered standardised approach to documentation in lines with Action Plan 13 of BEPS (w.e.f. FY 16-17) under Section 92D and Section 286 of the Income Tax Act 1961 Local File (Rule 10D) Local country TP documentation To be prepared by each local entity and submitted to local Tax Authority In place in India since 2001 Master File (Rule 10DA) CbC Report (Rule 10DB) High level blue print of multinational group s global operations Contents like value drivers, supply chain model, Intangibles details, Group financing, etc. Prepared centrally; submitted with Tax authorities of all countries Ideally prepared by ultimate parent for consolidation Multinationals having consolidated annual revenue > Euro 750 million Summary data and economic activity in each country Prepared by ultimate parent for consolidation purposes Submitted with tax authority of ultimate parent Shared with other tax authorities through automatic exchange of information Penalties for non-compliance are huge 17
Master File (u/s 92D - Rule 10DA) Effective date- 1 st April 2016 (applicable for FY 2016-17 and onwards) Description of Group s business (es) Organisational Structure Group s important profit drivers Intangible property strategy and policy Master File Intercompany financial activities and policy FAR of key group entities Description of Supply chain Group s financial and tax positions Threshold: 1) Consolidated group revenue > INR 500 Cr (Euro 65.4 Mi.); AND 2) Aggregate value of international transactions > INR 50 Cr (Euro 6.5 Mi.) OR Transactions related to intangible property > INR 10 Cr (Euro 1.3 Mi.) Compliance: 1) Filing in Form 3CEAA (Part A & B) by 30 th November (for FY 16-17 it is 31 st Mar 2018) 2) Intimation in Form 3CEAB (1 March 2018) 18
Country by Country Reporting (u/s 286 - Rule 10DB) Effective date- 1 st April 2016 (applicable for FY 2016-17 and onwards) Overview of allocation of income, taxes and business activities (no of employees and tangible assets)- tax jurisdiction wise List of all constituent entities including main business activity tax jurisdiction wise CbCR Additional information Threshold: Consolidated group revenue > INR 5500 Cr (Approx. Euro 750 Mi.) Compliance: 1) Intimation in Form 3CEAC (31 Jan 2018) 2) Filing in Form 3CEAD by 30 th November (for FY 16-17 it is 31 st Mar 2018) 3) Intimation in Form 3CEAE for multiple constituent group entities in India No timeline mentioned in the rules. It needs to be clarified by the CBDT. 19
Enhanced Documentation Requirement Impact on MNEs Operating in India Entire global scope is present before the Indian tax authority would lead to more questions and detailed enquiries at the time of audit Migrating from old transfer pricing requirements (country specific documentation) to new requirements could be daunting initial years are crucial In cases where Master File has been prepared for other jurisdiction, aligning the same with Indian requirements Uncertainties over tax authorities approach on rise Increased disclosure will have impact on other tax areas treaty benefits, PE profit attributions, anti-abuse provisions Countries (such as India) where on ground quantum are huge (market size, human resources, customer/vendor base) would gain more force Combined Contents of Master File and CbCR having far reaching implications Sum of the parts is more powerful than individual parts 20
Enhanced Documentation Requirement Impact on MNEs Operating in India Positives Opportunity to streamline transfer pricing policies, processes and documentation Opportunity for tax optimisation, if there are present leakages Bringing in efficiency avoiding duplications, efficient benchmarking and updations Help in explaining the group transfer pricing story to aggressive tax jurisdictions Inputs for business strategic decision making Approaching the reality there are positives also 21
Enhanced Documentation Requirement Impact on MNEs Operating in India Potential questions from Revenue authorities after perusing Master File / CbCR Inbound Arrangements Scenario Payment of royalty by Indian subsidiary Contract R&D/captive services rendered by Indian subsidiary Potential Questions Whether entity charging royalty is actually carrying out any economic activity [Development, Enhancement, Maintenance, Protection, Exploitation (DEMPE) functions]? Whether Indian entity received any economic benefit from availing the brand/technology More enquiries on following aspects: - Department wise bifurcation of employees - Qualification of employees - Services defined under inter-company agreement - Role played by Indian entity in entire value chain Whether remuneration for the Indian entity matches with the FAR contribution it makes? Profit split more suitable? 22
Enhanced Documentation Requirement Strategies to Navigate Strategies for Initial Preparedness Prepare group s global map and plot transfer pricing legal requirements in each individual country Determine applicability of CbCR and master file for every group entity Define roles and responsibilities within the group to comply with country specific and group level requirements Perform skill gap analysis in-house capabilities and transfer pricing specialist help Evaluate the preparedness of data collation systems in the group Define a system for real time/periodic monitoring of data Prepare a calendar for compliances, transfer pricing benchmarking searches and updates 23
Enhanced Documentation Requirement Strategies to Navigate Strategies to Mitigate Risk and Being Future Ready Appropriate interpretation of group wide data collated Perform what-if analysis for the potential questions/inquiries from the tax authorities Make appropriate changes in the transfer pricing policy, where required Define a system to gather real time evidences that will support the policy - developing justifications Design a system of regular communication between tax teams and business strategy/operations team Systems in place to track additional information i.e. addition of new entity in the group, supply chain changes, etc. Give a harmonised picture between CbCR, Master file, and local files Year-on-Year disclosures in transfer pricing documentation Aim for a fine balance between Protect trade secrets and provide sufficient information Standardisation and customisation 24
Enhanced Documentation Requirement Future of Transfer Pricing Landscape Use of technology for collation of data and use of data analytics for transfer pricing risk detection Collating information through exchange of information and coordinated audit by representatives from two or more jurisdictions Tax and business and operations team should work in sync as there could be use of subject matter expert witnesses during audit Not to treat transfer pricing as year end compliance exercise Having substance based transfer pricing policy with emphasis on establishing fundamentals of transfer pricing instead of legal arguments Reviewing inter-company transfer pricing policy on regular intervals Evaluating option of Advance Pricing Agreements Seeking timely advice of transfer pricing experts Transfer pricing documentation is no more a standard data driven exercise. It is designing and telling a story. 25
Key Takeaways 26
Key Takeaways Plot and re-look at shareholding and operating structure of your group Having a tax-efficient transfer pricing policy for the group as a whole Adequate implementation of the transfer pricing policy Impact of transfer pricing policy on other areas Ensure coherence and compliance of local and global laws Required enhanced documentation in place on ground details would be crucial Timely assessment of transfer pricing risks for any change in the business and taking measures to mitigate the same 27
Our Story 28
SKP Today 29
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