Transfer Pricing Scope and Jurisdiction Presentation By - S.P. Singh - Manoj Pardasani For private circulation amongst participants in NIRC s Seminar on Transfer Pricing on 13 June 2015 at Delhi
Contents Introduction to Transfer Pricing Indian Transfer pricing Regulations Transfer Pricing Controversies in India
Introduction to Transfer Pricing
Why Transfer Pricing has become important The role of Multi-National Enterprises (MNEs) has increased dramatically over the last few decades. Transactions within MNEs have increased in quantum and nature. This growth presents increasingly complex taxation issues for both tax administrations and the MNEs themselves. These issues arise from the practical difficulties of determining the income and expenses of a company that is part of an MNE group that should be taken into account within a jurisdiction.
Transfer Pricing The concept All vertically integrated firms deal with the issue of transfer prices. Generally speaking, a transfer price is the price at which one division of the firm sells to another division. If the two divisions are located in two jurisdictions with different tax rates, there arises an incentive within the firm to choose a transfer price to reduce tax costs. 5
Vertically Integrated Firms and Transfer Pricing Divisional heads within vertically integrated firms are often rated based on divisional profits. Thus, each manager wants to maximize profits in their division. If the two divisions are located in two jurisdictions with different tax rates, there arises a tension within the firm between maximizing profits versus reducing tax costs. transfer pricing is seen not only from a business perspective but also from a tax planning perspective. Transfer prices are also effected by non fiscal factors
Indian Transfer Pricing Regulations
Overview - Indian Regulations Operating Provisions Sections / Rules Computation of Income, Expenses, CCA S. 92 Associated Enterprises ( AE ) Transactions subject to Transfer Pricing Regulations ( TPR ) Computation of Arm s Length Price ( ALP ) Powers of Assessing Officer ( AO ) & Transfer Pricing Officer ( TPO ) Advance Pricing Agreement Documentation Requirements Audit & Transfer Pricing Report Penalties Definitions S. 92A S. 92B / S. 92BA S. 92C(1) / Rule 10B/10C S. 92C / S. 92CA S. 92CC/ S. 92CD S. 92D / Rule 10D S. 92E, Rule 10E & Form 3CEB 271 (1)(c), 271AA/BA/G S. 92F/Rule 10A
Associated Enterprise Defined in two stages: Enterprise Associated Enterprise Any person (including a PE) engaged or proposed to be engaged in: any activity relating to production, storage, supply, acquisition or control of articles, goods or specified intangibles. any activity pertaining to provision of services or carrying out any work in pursuance of a contract any investment or financing activity 9
Associated Enterprise contd.. Two parts Section 92A(1) - Lays down concept Section 92A(2) - Deeming provision Concept - Sec 92A(1) Participation in management or control or capital Directly or indirectly or through one or more intermediaries [section 92A(1)(a)] Common control [section 92A(1)(b)] Deeming Provisions - Sec 92A(2) 13 categories specified
International Transaction S.92B(1) Every conceivable transaction covered Purchase, sale or lease of tangibles, intangibles Provision of services Capital Financing Cost allocation / apportionment / contribution arrangements Business restructuring or reorganization irrespective of whether it has impact on profit, income, losses or assets. Transactions between head office and branch covered (of non residents only) Transactions between two non-residents also covered Normally transactions between two residents not covered
Recent Changes: Deemed International Transaction Rationalization of definition A transaction entered into by an enterprise with a third party is deemed to be a covered transaction, if There exists a prior agreement between such third party and the AE, or; The term of the transaction is determined in substance between such third party and the AE. Recent clarification in the Finance Act 2014 (2) states that transaction with resident third party in such cases is covered under the ambit of the TP Prior agreement with non AE Non-AE Case I Deemed International transaction - Yes AE AE Non-AE Deemed International transaction? Case II Offshore
Typical Transactions A. Manufacture i. Purchase of raw material ii. Sale of finished goods B. Distributor i. Purchase/Sale of Finished Goods for resale C. Services i. Contract Services Arrangements include: Enterprises within an MNE often play specific roles according to the operational or cost advantages provided by their locations. These enterprises are responsible for providing the specific services in which they possess the greatest comparative advantages
Typical Transactions contd.. Intra-group/Management services include: Administrative services such as planning, coordination, budgetary control, financial advice, accounting, auditing, legal, factoring, computer services; Financial services such as supervision of cash flows and solvency, capital increases, loan contracts, management of interest and exchange rate risks, and refinancing; Assistance in the fields of production, buying, distribution and marketing; Services in staff matters such as recruitment and training; Research and development or administer and protect intangible property for all or part of the group.
Concept of ALP Article 9 of the OECD Model Tax Convention where 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 US Section 482 Regulations: A controlled transaction meets the arm's length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm's length result). 15
Concept of ALP contd.. The Indian TPR defines Arm s Length Price as: a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions Analysis of independent, uncontrolled comparable transactions is at the center of all transfer pricing analysis
Determination of ALP Steps involved in the determination of the ALP: Identification of the international transaction Identification of tested party Identification of an uncontrolled transaction Comparability analysis: Identification and comparison of specific characteristics of the two transactions Finding out whether differences, if any, between the two transactions can be reconciled/resolved Ascertaining the most appropriate method Determination of the arm s length price by applying the method chosen
How does the Arm s Length Pricing work in practice? Determination of arm s length price can raise difficult issues in practice Dealings may occur between related parties that are not observable in the open market between independent parties How is an arm s length price to be determined in the absence of observable market based outcomes? The arm s length principle uses the behaviour of independent parties as a guide, with comparability as the fundamental concept
Transfer Pricing Controversies in India
Taxability vs applicability of arm s length Judicial precedents Dana Corporation AAR TP provisions contained in Chapter X cannot be invoked if there is no income arising in the first place. TP provisions are not independent charging provisions; Section 92 was not intended to bring in a new head of income or to charge tax on income which was not otherwise chargeable under the Act. Vanenburg Group BV - AAR Indian TP provisions are machinery provisions and would not generally apply in the absence of a liability to pay tax in India. Goodyear Tire & Rubber Company and Amiantit International Holding Limited - AAR - As there is no income chargeable to tax, provisions of section 92 to 92F will not be applicable and TP provisions in Chapter X are not attracted. 16 26 Tax Holiday under Section 10 or Section 80IA Exempt but arm s length principle to be satisfied
Taxability vs applicability of arm s length TP adjustments being made on account of under valuation of shares where Foreign parent has made investments in an Indian subsidiary Typical Facts Foreign parent company infuses share capital in the Indian subsidiary (at face value or at certain value per share arrived using DCF or other valuation methodology) The Revenue takes a position that the shares have been issued to the Holding Company at an undervalued price / less that the fair market value of the shares; The TP adjustment carried out by the TPO is twofold: Difference between the actual issue price and the ALP considered as 16 34 notional income Notional interest computed by considering the difference between the actual issue price and the ALP as loan Also, cases where actual issue price is higher than the ALP, alleged excessive premium challenged by the TPO - resulting into a reduced cost of aqcuisition in the hands of the foreign investor - to impact as capital gain in the hands of the foreign investor at the time of disposal of shares Outside India In India Foreign Holding Co. Indian Wholly Owned Subsidiary Purchase of shares of Indian Company
Taxability vs applicability of arm s length Key areas of dispute Does this tantamount to taxing Foreign Direct Investment Taxing Capital Gains Determination of Fair Market Value of shares - Valuation of shares can be a complex exercise Recharacterisation of transaction Vodafone India Services Pvt. Ltd. Bombay High Court Writ Petition No.871 of 2014 (October 2014) Litigation Bombay HC rules in favour of Vodafone India in share valuation case; Absent income, there is no 'international transaction'; Share issue at premium does not give rise to 'income' to trigger TP provisions; Rejects Revenue's contention that income must be given a broader meaning to include notional income Union Cabinet accepts the Bombay High Court order 16 35 The Union Cabinet, decided to accept the order of the High Court of Bombay in the case of Vodafone India Services Pvt. Ltd. and not to challenge it before the Supreme Court of India.
Associated Enterprises Section 92A(1) versus Section 92A(2) Section 92A(1) AE 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. Section 92A(2) Direct or indirect voting power of not less than 26% Loan advanced by one enterprise constituting not less than 51% or the book value of assets One enterprise provides guarantee of not less than10% or more of the total borrowings More than half of the board of directors or members of the governing board, executive directors or members of the governing board are appointed by the same person Common parent appoints more than half of directors on board or one executive director in both Dependence on the knowhow, patents, copyrights, trade marks, licenses, franchises or any other business or commercial rights of similar nature of the other 90 percent of the raw materials consumed for the manufacture or processing of goods and articles carried out by one enterprise is supplied by the other enterprise. 16 Goods or articles manufactured by one enterprise are sold to other enterprise or parties specified by the other enterprise.
Associated Enterprises Section 92A(1) versus Section 92A(2) Two enterprises treated as AEs without satisfaction of the deeming fiction set out under Section 92A(2) of the Act. Kaybee India Pvt. Ltd. Facts of the case Taxpayer and Kaybee Singapore had a common director, who was also the shareholder of the taxpayer and held key position in the management of Kaybee, Singapore. Based on the common directorship and participation in management of both the enterprises, the AO held that the said enterprises are AEs. Shareholder Director COO Tribunal ruling Whether the meaning of expression AE as per Section 92A(1) is subjected to Section 92A(2) - if the condition provided in clause (a) and (b) of Section 92A(1) are independently satisfied, then the two enterprises for the purpose of Section 92B to 92E of the Act will be treated as AEs. Since the said companies had a common director who is a major shareholder of the taxpayer company and holds key position [Chief Operating Officer (COO)] in the management of the other enterprise, the condition of participation in management or control or capital as prescribed under Section 92A(1) is satisfied. The said companies qualify as AEs as per the provisions of Section 92(A) of the Act. Kaybee India Kaybee Singapore
Deemed International Transaction Sec 92B(2) of the Act Third Party transactions deemed to be international transaction - Sec 92B(2) A s Parent Prior agreement 3rd party Determination of terms A s Parent 3rd party A A Transaction between A and Third party also subject to TP norms, if: a prior agreement exists between A s parent and Third party; or terms of transaction are determined in substance by A s parent and Third party 92B(2) A transaction entered into by an enterprise with a person other than an AE shall, for the purposes of sub-section (1), be [deemed to be a transaction] entered into between two AEs, if there exists a prior agreement in relation to the relevant transaction between such other person and the AE, or the terms of the relevant transaction are determined in substance between such other person and the AE [where the enterprise or the AE or both of them are non-residents irrespective of whether such other person is a 16 31 non-resident or not].
Advertising, Marketing and Promotion (AMP) expenses Focus Point: Scrutiny by revenue authorities of high marketing expenditure incurred by subsidiary AMP spend by Indian licensee (-) AMP: Advertisement, marketing, promotion Arm s length licensee expenditure Bright line Excess Assumed to be incurred for strengthening brand name of foreign AE Indian licensee: Must be reimbursed along with suitable profit mark-up Sony Ericsson Mobile Communication India Pvt. Ltd (ITA No. 16/2014) Delhi High Court TPO empowered to adjudicate on transactions which have not been reported in Form 3CEB. AMP expense constitutes an international transaction Differentiating Chapter X from Section 37(1) of the Act, High Court held that Revenue is not questioning the reasonableness of AMP expenses incurred by the taxpayer towards third parties in India. Issue at hand is adequacy of compensation received by the taxpayer for performance AMP functions. 16 36 By virtue of application of the TP provisions, the TPO seeks to determine an arm s length compensation for the AMP functions performed by the taxpayer towards related parties.
Thank You