Discussion on Advance Pricing Agreements 11-13 October 2014
Case studies
Case 1 Facts of the taxpayer An Indian company ( I Co ) is availing certain management services from its Associated enterprise ( AE ) for which ICo pays cost plus 15 percent to its AE Issues What should be the approach to substantiate the charge? What are the documents to be maintained to substantiate the charge? How to determine the Arm s Length Price ( ALP ) of the margins: Whether foreign companies are to taken as comparable or Indian companies are to be taken as comparable Whether December year ending financial statement is to be used which is not in line with the Indian financial statement which usually have March year ending What are the documents to be maintained as part of annual compliance report Page 3
Case 2 Facts of the taxpayer A Foreign Company ( F Co or Licensor ) who is engaged in manufacturing, selling and distribution of consumer goods has a subsidiary in India (i.e. Indian Company I Co ). I Co has obtained a license from licensor to use technical know how to manufacture and sell consumer goods in India. I Co pays royalty for the technology (not for brand) Issues How to determine the ALP? What if a company started its operations and incurred losses in initial years of operation due to significant startup cost and less sales? How to deal with AMP? Page 4
Case 3 Facts of the taxpayer An I Co has taken a rupee loan at interest rate of 12% from local bank and has given a loan to its foreign subsidiary in foreign currency. Issues How to determine the arm s length interest rate for loan given to foreign subsidiary? What would be the role of safe harbor? Page 5
Case 4 Facts of the taxpayer I Co transacts with its AE F1 Co. An APA is to be concluded for the transactions entered between I Co and F1Co. The group proposes to set up another entity F2 Co in the future. The business of F1 Co is to be taken over by F2 Co. Issues Will a fresh APA be required for transaction between I Co and F2 Co? Page 6
Case 5 Facts of the taxpayer F Co manages supply chain for retailers and brand owners all over the world. I Co is a 100 percent subsidiary of F Co and operates as sourcing support service provider. I Co assists F Co in identifying supplier of products of the desired quantity and quality as requisitioned by F Co. Issues How to determine the ALP of the transaction? Would Li & Fung court order have any bearing on this APA? Page 7
Case 6 Facts of the taxpayer I Co is engaged in manufacture and export of core auto components and non-core auto components. 60 percent of the imports are from its AE - F1 Co. The company imports the balance from other AEs. Safe Harbor rules provide for operating margin of 12 percent and 8.5 percent for core auto components and non-core auto components respectively. Issues How to determine the ALP of the transaction? Will Safe Harbor margin impact the determination of operating margins while negotiating an APA? Page 8 Given the fact that the operating margins are market driven and I Co is unable to commit a fixed margin; what are the alternate ways of benchmarking the transaction?
Case 7 Facts of the taxpayer I Co operates as a Limited Risk Distributor ( LRD ) and is assured of say a 3% arm s length return from F Co (including by way of a subvention income if required) after considering all expenses. I Co also incurs expenses which are in the nature of Advertisement, Marketing and Promotion ( AMP ) expenses. Issues How to determine the ALP of the transaction? Whether overall net operating margin shall be considered to be at arm s length or a separate mark-up on AMP expenses is required to be earned by I Co. (would it be over and above the net operating margin)? If I Co is to be separately remunerated for AMP, what should it do with the overall assured return of 3% - should that be reduced to give a balancing effect of a separate compensation on account of AMP? Whether the arm s length margin at net level be considered netting of AMP expense? And then shouldn t the ALP be reduced? If I Co is to maintain an two separate margins (one for distribution net of AMP, and the other for AMP only), how should I Co. deal with pricing adjustments on imports? (especially in cases where rate of customs duty is very high. e.g. Luxury goods, liquor)? Page 9
Case 8 Facts of the taxpayer AEs have global arrangements for sourcing of products / services with third parties for supply to the Group. The global arrangements are driven by need for products meeting global standards, driving cost efficiency, better bargaining power, etc. The resultant 3rd party supply arrangement / agreement may be directly with the Indian group entity. Such transactions may qualify as deemed international transaction in light of 92B(2) provisions. The provisions of 92B(2) now extend to cover transactions between resident entities also. Issues How to determine the ALP of the transaction? Given the nature of transaction, can we look at the transaction differently rather than overall TNMM? Third party certificates on prices charged to other customers Page 10
Case 9 Facts of the taxpayer I Co is engaged in research, manufacture, marketing and sale of pharmaceutical products and has set-up a subsidiary in USA (FCo). FCo is engaged in distribution of I Co products in USA. Issues How to determine the ALP of the transaction? If F Co is treated as a tested party and it does not earn an arm s length margin, how would I Co comply with APA agreement? Out of book adjustment? Page 11
Case 10 Facts of the taxpayer There is a cross border merger between F Co and I Co. After a formal court process, I Co is the surviving entity. Issues Given the fact that the transaction is not taxable, can the valuation of F Co and I Co and swap ratio be the subject matter of APA? Page 12
Case 11 Facts of the taxpayer I Co has applied for APA on 31 March 2013. For FY 2013-14, the company has an operating margin of 10 percent, and pays a royalty of 4 percent. After the conclusion of APA, it has been agreed that the royalty rate should be 2 percent and operating margin (as per TNMM) should be 11 percent. Issues Assuming that upon reducing the royalty rate to 2 percent, operating margin rises to 12 percent, how does the company reconcile such a position? Is it possible to file a tax return at 11 percent? Page 13
Thank you This Presentation provides certain general information existing as at the time of production. This Presentation does not purport to identify all the issues or developments pursuant to the transaction. Accordingly, this presentation should neither be regarded as comprehensive nor sufficient for the purposes of decision-making. EY LLP, does not undertake any legal liability for any of the contents in this presentation. The information provided is not, nor is it intended to be an advice on any matter and should not be relied on as such. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of EY LLP, this document may not be quoted in whole or in part or otherwise referred to in any documents.