pune camp cpe study circle transfer pricing: legislation, experiences and recent developments...

Pune Camp CPE Study CircleTransfer Pricing: Legislation, Experiences and Recent DevelopmentsPresented by : Dinesh Supekar April 24, 2010

Brief Legislative frameworkBrief on Assessment ProceduresThe charging Section and international transactionsAssociated EnterprisesPrinciples of ComparabilityComputation of Arm’s Length Price Documentation requirementsWhat is it that the taxpayer should do

Part ITransfer Pricing Legislation

PricewaterhouseCoopersApril 2010

Slide 3

Background : Why TP

• Increasing participation of MNCs in world economic activities

• General tendency to control profits and transfer the same to low tax heavens

• Legislation felt essential by Governments for protection of their respective tax base

• OECD issued TP guidelines for MNEs and Tax Administrations in 1979 (amended in 1995 and onwards)

• India is an observer of OECD guidelines: not a member, yet

Brief legislative framework


Slide 4

Arm’s length principle


International transactions- goods- services- intangibles

Associated enterprise

Resident

Transfer price

Independent entity

Resident

Arm’s length price


Slide 5

TP in India : Background

• Sections 92 to 92F of the Act read with rules 10A to 10E referred to as framework of Indian TP legislation

• Various circulars, notifications and administrative instructions issued by CBDT



Slide 6

Compliance requirements

• Any income arising from international transaction : to be computed having regard to Arm’s Length Price (also covers cost allocation & cost sharing arrangements)

• Tax payers required to maintain prescribed information & documentation [Section 92D read with Rule 10D]

• Accountant’s Report on international transactions to be filed along with the return of income : irrespective of value of international transactions



Slide 7

Penalties


Sr. No.

Type of penalty SectionPenalty

quantified

1 Failure to maintain prescribed information/ documents 271AA2% of

transaction value

2Failure to furnish information/ documents during assessment

271G2% of

transaction value

3 Adjustment to taxpayer’s income during assessment 271 (1) (c)

100% to 300% of tax on

adjustment amount

4 Failure to furnish accountant’s report 271BA INR 100,000

The Indian TP legislation prescribes stringent penalties for not maintaining / furnishing annual documentation and Accountant’s Report:

No deduction available for TP adjustments after scrutiny by the AO under Sec. 10A, 10AA, 10B or Chapter VI-A


Slide 9

Timelines and selection of cases

• The Assessing Officer may make reference to the Transfer Pricing Officer (‘TPO’) if he considers it necessary or expedient to do so [Sec. 92CA (1)] with previous approval of the Commissioner

• CBDT had issued internal guidelines for selection of cases for TP scrutiny in cases where the aggregate value of international transactions exceeds Rs. 5 crores [Circular 3/2001]

• The threshold limit for selection of cases for scrutiny : Rs. 15 Crores

• Irrespective of the threshold limit instructed by CBDT : the cases may be picked up for scrutiny if the AO deems it fit or the AO may undertake the scrutiny on his own

Brief on Assessment Procedures

Reference to TPO if value of international transactions exceed Rs. 5 Croresbut the case selected for scrutiny due to norms other than filter of International

transactions?


Slide 10

Assessee

Approval for Reference

AO

Commissioner

TPO

Reference

Determination of ALP By TPO after hearing

TPO’s order

Notice u/s 92CA (2)

Show cause notice

Reply to SCN

Draft Assessment Order

TP Audits : framework


AO to compute total income

in conformity with the ALP

determined by TPO

Can AO change the order by TPO?


Slide 11

Appeals : Framework


Rectification application can bemade against the order of TPO

for apparent mistakes

Appeal can be made against the Draft order of AO as order of

TPO included within the order of the AO

Draft Order by AO adjusting Taxable Income of Assessee

Appeal to DRP Appeal to CIT(A)

ITAT

High Court

Supreme Court

Constitutional Bench


Slide 13

The Charging Section

• Any income arising from an international transaction shall be computed having regard to the arm’s length price [Section 92 (1)]

• Arm’s Length Price is price applied or proposed to be applied by unrelated enterprises under uncontrolled conditions

• Following transactions also require compliance with Arm’s Length Principle:

- allowance for any expense or interest arising from an international transaction [Explanation to Section 92 (1)]

- costs or expenses allocated/apportioned under mutual agreement/arrangement for provision of benefit or service or facility by one enterprise to other [Section 92 (2)]

The Charging Section & International Transactions

Base erosion is the important principle for attraction of TP provisions


Slide 14

Case studies on Charging Section

• Whether it would be required for S to comply with TP provisions for issuance of share capital?

• Would it make difference

- if the shares are Preference Shares : entitled to fixed rate of dividend?

- if S issues convertible debentures bearing fixed rate of interest to P?

- if S avails loan from P, bearing interest?

- if the loan is interest-free loan?

• Whether dividends paid by S to P would require compliance with TP provisions?


Parent P

Subsidiary S

Issue of Share Capital

• Whether S would be required to comply with TP provisions for purchase of fixed assets?

• Would it make difference

- if S did not start manufacturing activities and carried the cost of fixed assets as CWIP?

- If S purchased raw material and carried it as stock in trade, since it did not start its manufacturing activities?

Parent P

Subsidiary S

Sale of fixed Assets


Slide 15

International Transaction [Section 92B]

• International transaction is - Transaction between the Group companies : either or both of whom

are non-residents- for purchase, sale, lease of : tangible property or intangible property- for provision of services or lending or borrowing money- other transactions having bearing on profits / income / losses or

assets of an enterprise- also to include cost allocations/apportionments for benefits/ services or

facility provided by one to other • Transaction includes arrangement, understanding or action in concert:

- whether formal or in writing- whether intended to be enforceable with legal proceedings or not

[Section 92F (v)]• Transaction also includes number of closely linked transactions

[Rule 10A (d)]



Slide 16

Deemed International Transaction


Prior agreement

Parent Company Third party

Subsidiary Service

s

Parent Company Third party

Subsidiary Service

s

Determination of terms

Transaction between subsidiary & third party may also be subject to TP:

Prior agreement exists between parent company and third party

Terms of transaction are determined in substance by parent company and third party

Global sourcing?


Slide 17

Case studies on International Transactions

• Are the warranty claims settled by PQR – claimed for reimbursements the International Transactions?

• Whether the provisions for warranties are International Transactions:

- If PQR had to bear warranty costs?

- If ABC was Indian enterprise?


Sale

Group Co : ABC

Group Co : PQR Customer of PQRSale

Settlement of warranty claims

Claim forreimbursement

PQR uses the IT infrastructure of ABC for maintenance of its accounting records, mails, sales tracking data, etc. ABC proposes to charge PQR an allocation for the IT infrastructure costs based on an agreed allocation key : Would the IT Cost allocations qualify to be International Transactions?


Slide 18

… Case studies on International Transactions


Parent P

Customer of P

Sale under contract

Subsidiary S

Assignment of contract

Sale at prices as per contract

Whether sales by S to the Indian customer would qualify as International Transactions : though S and Indian customer are both residents of India?

Transactions not taxable under DTAA?Transactions taxable under presumptive basis under law?


Slide 20

Enterprises

• Section 92F (iii) defines enterprise as any person (including PE) 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

• The term PE has been defined to be an inclusive term to include a fixed place of business through which the business of the enterprise if wholly or partly carried on [S.92F(iiia)]

Associated Enterprises


Slide 21



Associated Enterprises have been defined to include:

• Participation in Management / Control or Capital [Section 92A(1)(a)]

• Common persons in Management/Control or Capital [Section 92A(1)(b)]

• 13 Categories of deeming fictions for enterprises to qualify as Associated Enterprises [Section 92 (2)]


Slide 22

… Associated Enterprises : participation criterion


Participation in management/control/capital:by A INDIRECTLY andby B DIRECTLYThus both A and B are AEs of C

A

C

B

Management/ Control/Capital

A

C

B E

DManagement/

Control/Capital



Participation in management/control/capital:by A INDIRECTLY by B DIRECTLYBy D and E DIRECTLYThus all A, B, D and E are AEs of C

Associated Enterprise for an enterprise means an enterprise which participates : • Directly or indirectly or • Through one or more intermediaries

in management or control or capital of other enterprise [Section 92A (1) (a)]


Slide 23

… Associated Enterprises : Common control criterion


Company A

Company B

Mr. X is a Director

A & B are AEs

Associated Enterprise for an enterprise means an enterprise in respect of which : One ore more persons who participate• directly or indirectly or• through one or more intermediaries

in its management or control or capitalARE THE SAME PERSONS WHO PARTICIPATE• directly or indirectly or• through one or more intermediaries

in its management or control or capital of the other enterprise


Slide 24

… Associated Enterprises : deeming fictionsEnterprises deemed to be AEs [Section 92 A (2)]:

a) one has direct or indirect share holding carrying not less than 26% voting power in the other

b) common parent / person holds 26% of voting power in both enterprises

c) one advances loan constituting not less than 51% of book value of total assets of the other enterprise

d) one provides guarantees of not less than 10% of total borrowings of the other enterprise

e) more than half of board of directors of one enterprise are appointed by the other enterprise

f) more than half of the board of directors of both enterprises are appointed by the same person or persons

g) one enterprise is wholly dependent on use of IPRs of the other enterprise

h) At least 90% of raw materials and consumables required by a enterprise are supplied by the other enterprise, or by persons specified by the other enterprise, and prices and conditions relating to supply are influenced by such other enterprise

i) Goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and prices and conditions relating thereto are influenced by such other enterprise

j) Both enterprises controlled by same the same individual singly or jointly with relatives

k) One enterprise controlled by HUF and other controlled by member of HUF or his relative or jointly

l) One enterprise being a firm, association of persons or body of individuals, the other enterprise holds not less than 10% interest therein

m) There exists between the two enterprises, any relationship of mutual interest, as may be prescribed



Slide 25

… Associated Enterprises : deeming fictions


There may still be loopholes in catching the enterprises as AEsAcceptance of influence in anticipation of proposed takeover

and takeover occurs after the financial year?

The deeming fictions may cover genuine third party transactions:• Joint Ventures [Section 92 A (2) (a)]• Extensive financing by Bank to an enterprise [Section 92 A (2) (c)]• Global arrangements for supply of bulk material [Section 92 A (2) (h)]• Use of exclusive technology by an enterprise on which it is fully dependent

[Section 92 A (2) (g)]


Slide 26

Case study on AEs and International Transactions

• Whether A & B would be treated as AEs for the transactions entered into before takeover, i.e. during April 1, 2008 till November 30, 2008?

• Whether the transactions for sale of goods by A to B during the period before takeover would qualify as International Transactions?

• Which amount should be reported by the CA of B in his report in Form 3CEB?


A

B

SalesA acquires B on December

1, 2008


Slide 28

=Whether

Let’s look at principles of comparability before understanding the methods

Principles of comparability

Apple to apple comparability !!!


Slide 29

Factors to be used to judge comparability [Rule 10B(2)]

• Characteristics of the property transferred (service provided)

• FAR by the respective entity

• Contractual terms

• Conditions prevailing in the market

- geographical location

- size of the market

- laws and regulations

- capital invested

- level of competition, etc.


Can related party transactions be considered?


Slide 30


Expenses incurred

Freight Rs. 500/Kg

Insurance Rs 100/Kg

The transactions can comparable after adjustments for to Freight & Insurance

A Inc.

B Ltd.(AE) Third Party

Export of Product ‘X’

Rs. 2500 per Kg, CIF

Rs. 2000 per Kg FOB

Export of Product ‘X’

Criteria for uncontrolled transaction to be comparable [Rule 10B(3)]

• None of the differences between the transactions being compared are likely to materially affect the price or cost or profit in the open market

OR

• Reasonably accurate adjustments can be made to eliminate the material differences


Slide 31

Use of data for comparability [Rule 10B(4)]

The data for analysis of comparability shall pertain to the financial year in which the international transaction has been entered into

However data for previous 2 years to financial year may be used

• if such data could have an influence on the determination of TP

Use of multiple year data also recommended by OECD to consider

• Losses,

• business or product life cycle,

• economic conditions, etc.


Availability of data at the time of entering into transactions?


Slide 33

How to determine ALP [Section 92C (1)]By use of any of the prescribed methods being

the most appropriate method

having regard to :• nature of transaction or • class of transaction or • class of associated persons or • functions performed by such persons

Factors to consider for selection of Most Appropriate Method (MAM) (Rule 10C) :• Nature and class of the international transactions• Class of enterprise and FAR• Availability, coverage and reliability of necessary data • Degree of comparability between international transaction & uncontrolled

transaction • Extent of reliable and accurate adjustment

Computation of ALP


Slide 34

Computation of Arm’s Length Price

Traditional Transaction

Comparable Uncontrolled

Price(“CUP”)

Resale Price

Method(“RPM”)

Cost Plus

Method(“CPM”)

Methods for computation of ALP

Transactional Profit based

ProfitSplit

Method(“PSM”)

TransactionalNet Margin

Method (“TNMM”)

Section 92C : Computation of arm’s length price

No hierarchy of methods suggested by Indian TP legislation


Slide 35

Steps :• Identify price charged in comparable uncontrolled transaction;• Adjust for differences materially affecting the price;• The adjusted price is the ALP

Types of CUP


Comparable Uncontrolled Method (“CUP”)

ParentCompany

Subsidiary

Third Party

Third Party

OutsideIndia

India Internal CUP

External CUP


Slide 36

Resale Price Method (“RPM”)Steps• Identify the third party selling (service) price (fee) for products (services)

purchased (procured) from Group Companies• Reduce the comparable uncontrolled GP Margin in similar products (services)• Reduce the expenses incurred for procuring products/services• Adjust for functional and other differences, if any • The adjusted price is the ALP


GP margin should recover operating costs and ALP profit based on the FAR

Particulars Amount (Rs.)Ultimate Selling price 1,000Less: Comparable GP Margin 300Cost of Sales 700Less: Expenses incurred for procurement 200ALP 500


Slide 37

Steps• Identify direct and indirect costs of production for property (services)• Add uncontrolled normal GP mark-up• Adjust for functional and other differences, if any• The adjusted price is ALP


Particulars Amount (Rs.)

Cost of production (Direct & Indirect Costs) 1,000

Add: Comparable Gross Profit Margin 250

ALP 1,250

Cost Plus Method (“CPM”)

Whether Cost Plus Pricing mechanism = CPM for computation of ALP?


Slide 38

Steps• Determine combined NP for Group from international transactions• Evaluate relative contribution by each of the AEs based on the FAR• Split the combined NP amongst the AEs proportionate to relative contributions• The apportioned portion of the profit is taken to compute ALP

Applicability :• Transactions involving transfer of unique intangibles or interrelated multiple transactions


Detailed guidance about PSM in Proposed OECD Guidelines

Profit Split Method (“PSM”)


Slide 39

Steps

• Compute NP margin for - costs incurred

- sales effected

- assets employed or

- any other relevant base

• Compare NP margin realised from comparable uncontrolled transaction• Adjust for functional and other differences, if any

• The NP is to be taken to compute ALP


Transactional Net Margin Method (“TNMM”)

Popular amongst tax payers Favoured by Revenue Authoritiessince protects tax base erosion


Slide 40

Points to be considered:• Use of databases : Indian databases : PROWESS, CAPITALINE, etc.• Selection of tested party?• Use of foreign databases : PAN European : AMADEUS, North American :

Compustat, etc. • Issues encountered in selection of comparables

- Availability of data in public domain,- Computation of GP?,- FAR of comparables, etc.

• Possible adjustments for comparability:- Working capital adjustment, - Risk adjustments, etc.


… TNMM


Slide 41

… TNMM


PLI Formula Typical Applicability

Operating Margin

Return on sales

OP/Sales Manufacturers

Distributors

Return on Costs OP/TC Service providers

Contract manufacturers

Return on Assets OP/Operating Assets Capital Intensive Manufacturers

Berry Ratio

Return on Operating Expenses

GP/Operating Expenses Distributors

Profit Level Indicator (PLI)


Slide 42

Method Transaction Type

CUP Loans, Royalties, Service fee, transfer of tangibles, etc.

RPM Marketing operations of finished products, where distributor not performing significant value addition to product

CPM Raw material or semi-finished goods are sold, long term buy-and-sell agreement

PSM Transaction involve provision of integrated services by more than one enterprise or involve unique intangibles

TNMM Provision of services, transfer of semi-finished goods, distribution of finished goods where applicability of RPM appears to be inappropriate


Choice of MAM : General categorisation


Slide 43

Options under proviso to Section 92 C (2)where more than one price is determined by the most appropriate methodthe ALP shall be taken to be the arithmetical mean of such prices

OR

if the variation between the ALP so determined and price at which the international transaction has actually been undertaken does not exceed five per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arm’s length price.

(Amended by the Finance (No. 2) Act, 2009)


Peculiarities in computation of ALP

Whether +/- 5% benefit can be availed if only one ALP computed ?


Slide 44

More than one price determined by MAM:


Company Comparable

ABC Ltd 114

XYZ Ltd 106

LMN Ltd 95

Arithmetic Mean 105

Subsidiary S purchases article A from Parent P at Rs. 104. Parent P also sells the article A to the third party Indian companies at negotiated prices.

Following would be illustration of computation of ALP:

Therefore, the transaction of purchase of article A would be at arm’s length.

What if S purchased article A at Rs. 107?

Case studies on computation of ALP


Slide 45

S can opt for availing benefit under proviso to Section 92C (2) and compute the ALP with +/-5% range

Situation before 2009 amendment


… Case studies on computation of ALP

Particulars Rs. Arithmetic mean of uncontrolled purchase prices

105.00

+ 5% 110.25-5% 99.75The purchase price by S (Rs. 107) is lower than the +5% amount, i.e. Rs. 110.25.Therefore the purchase transaction would be considered to be at arm’s length.

Situation after 2009 amendmentParticulars Rs. Price at which the international transaction has actually been undertaken

107.00

(100%-5%) = 95% of above 101.65The variation between ALP determined (Rs. 105) and actual price (Rs. 107) does not exceed 5% of actual price, thus fits within arm’s length.


Slide 46

Application of +/-5% under TNMM


Particulars Rs. Operating Income 110.00Total Costs (TC) 100.00Operating Profit (OP) 10.00OP/TC 10.00%Average OP/TC of comparables 13.00%ALP based on OP/TC of Comparables 113.00105% of price at which the international transaction has actually been undertaken

115.50

… Case studies on computation of ALP

The ALP so determined (Rs. 113) does not exceed 105% of the operating income (Rs. 115.50). Therefore the transactions would be considered to be at arm’s length.

Important to note that +/-5% can be applied on arithmetical mean of ALP and NOT the margins


Slide 47

Computation of ALP

When can AO compute ALP himself???

Mandatory satisfaction of any ONE of the following conditions for AO to compute ALP [Section 92C (3)]:• Price not determined under Section 92C• Information & document have not been maintained under Section 92D• Use of incorrect/unreliable data• Failure to furnish information & document under notice


Slide 49

Mandatory maintenance of prescribed information and documents by every person entering into an international transaction [Section 92D read with Rule 10D]

Documentation Requirements

Entity Related

• Profile of the Group• Profile of the Indian entity• Profile of AE • Profile of Industry

Price Related

• Transaction terms• Functional Analysis

(Functions, Assets, Risks)• Economic Analysis

(Method selected, Benchmarking analysis)• Forecasts, budgets, estimates, etc.

Transaction Related

• Agreement• Invoices• Price related correspondence

Mandatory documentation


Slide 50

Supporting Documents [Rule 10D(3)]

• Official publications, reports, studies from Government

• Reports of market research studies, technical publications

• Price publications

• Published accounts and financial statements

• Agreements & contracts related to international transaction

• Letters and other correspondences

The information and documents should be contemporaneous and shall be kept for a period of eight years from the end of the relevant assessment year [Rule 10D (5)]


… Mandatory documentation


Slide 51

Relaxation from mandatory maintenance of documentation offered by Rule 10D(2) in respect of value of international transactions not exceeding Rs. One Crore

However the taxpayer would need to substantiate ALP on the basis of material available with him


Filing of Accountants Report is necessary irrespective of value of International Transaction

Relaxations???

• Certification in Form 3CEB without documentation?• Relaxation : Truth or Myth?• What if the documentation was maintained for last year and there is no change in

business?

Brief Legislative frameworkBrief on Assessment ProceduresThe charging Section and international transactionsAssociated EnterprisesPrinciples of ComparabilityComputation of Arm’s Length Price Documentation requirementsAccountant’s ReportWhat is it that the taxpayer should do



Slide 53

What is it that the taxpayer should do?

Execute Comparability / Benchmarking

analysisConduct

Functional Analysis and

Industry Analysis

Maintain the required

Documentation

Submit the Accountant’s

Report

Transfer Pricing Audit Environment in India Issues and case studies

Part IITransfer Pricing Experiences


• Eight Years of TP Documentation

• Fifth round of TP audits completed in October 2009

• High volume of cases handled per Transfer Pricing Officer (“TPO”)

• Aggressive positions adopted

• Service companies – high mark-ups expected

• Transaction wise TP analysis expected

• Exchange of information between TP and customs authorities

• Introduction of Safe Harbour and Dispute Resolution Panel (“DRP”)

• Advance Pricing Arrangements expected soon

Experiences till now…

Slide 55

Transfer Pricing Audit Environment in India


Effort to adopt global

best practices

Introduction of safe harbour

provisions

Guidance to

the taxpayers

Learning Process

Eight years of TP documentation, andFive rounds of TP Audit completed

Providing certainty

Introduction of APA

Development of a matured

market

20012009

Introduction of

TP Rules

TP Journey

2011

2010

Slide 56

Transfer Pricing Audit Environment in India

Transfer Pricing Audit Environment in India Issues and case studies

Part IITransfer Pricing Experiences


Issues and Case Studies – Issue 1 : Pricing Policy

What is Pricing Policy / TP policy ?

• A pricing policy means a document that lays down and describes the different nature of transactions which take place between the affiliated companies and provides guidance to determine the prices for these transactions ensuring that the arrangements

- Are in line with the arm’s length principle

- Ensure tax optimization for the group

- Reward each entity based on its characterization and as per group’s objective

• Case Study 1 :

- ABC India (manufacturing company) earns a margin of 15% (OP/Sales)

- International transaction of purchase of goods

- Benchmark at 10% (assuming overall TNMM adopted)

Slide 58

Issues and Case Studies



• Questions asked by TPO ?

- Existence of Global TP policy ?

- How are the imports priced ?

- Whether Contemporaneous Data maintained ?

• Importance of pricing policy

- In the course of assessment, TPO’s often require the assessee to explain how prices were set/ negotiated in respect of AE transactions

- Where the assessee’s have a well documented TP policy, it has been easier to demonstrate the basis of pricing

Slide 59




• Best Practices

- Detailed pricing policy governing the prices of products exported to different countries / regions to be maintained

- Adequate back-up documentation to be maintained, which justifies the basis on which price setting has been done (e.g. budgets)

- Transfer pricing documentation to adequately bring out the facts mentioned in such pricing policy and highlight reasons for differences in prices

- To have a global pricing policy in advance

- Pricing policy to be followed across the group

Slide 60



Issues and Case Studies – Issue 2 : Multiple year data

• TP Regulations

• Case Study : 2

- Documentation maintained for 2007

- Data used for benchmarking purposes 2007, 2006, 2005

- PLI (OP/Sales) Weighted Average used

- TPO adopts the case for scrutiny in 2010 and uses 2007 data

• What should be the defense strategy ?

- Non- availability of data at the time of filing return

- Pricing policy & price setting process

- OECD guidelines

Slide 61



Issues and Case Studies – Issue 3 : Comparability Issues

Use of CUP method

• General preference of the Revenue authorities to use CUPs

• Inexact CUPs sometimes preferred over TNMM

• Typical approaches used by the Revenue authorities:

- Comparing price at which other AEs sell/ buy in the group to/ from third parties

- Comparing export prices with domestic prices and vice versa

- Comparing price of imported raw material with import prices reported in Customs databases/ price paid by Competitors for similar materials

- In case of management fees/royalties, information on management fees/royalty paid by other AEs in the region is also called for

- Existence of CUPs generally examined in detail when an assessee having adequate net operating margins seeks to rely on the TNMM

Slide 62




• Other Points

- Whether generic charge out rates reported by industry associations / trade journals can be used as a CUP to benchmark the assessee’s billing rates to associated enterprises

- Whether prices of original researched raw materials imported by the assessee from AEs, can be compared with prices of generic materials obtained by TPO’s from the customs database / issuing notices under S. 133(6)

- Whether export prices to AEs can be compared with the price of same or similar goods in the domestic market

- Local third party purchases v/s imports from AEs

Slide 63




• Case Study : 3 - Export Profitability

- Assessee is engaged in the business of manufacture and sale of certain

automobile ancillaries, primarily sold in the domestic market

- The assessee has a monopoly in the market with a market share of

approximately 90%

- The operations of the assessee are profitable, but the domestic sales are

more profitable as compared to the export sales to AEs

- The relatively lower profits in the exports business are questioned by the

TPO

Slide 64




• Arguments advanced:

- Domestic Market for the assessee is saturated

- Assessee has to necessarily look at other markets for growth

- Unlike the domestic market, the assessee does not have a monopolistic

situation in then export market.

- AE is free to buy from third parties, including other AEs

- To gain a foothold in the export markets, competitive pricing is essential.

- Above business factors, including lower volumes in export markets, make

the export profitability non comparable with domestic profitability.

Slide 65




• Related issue while selecting comparables

- Persistent loss making companies

- Outliers

- Start ups etc.

Slide 66

Best Practice

OECD proposed 10 step process for performing a comparability analysis




OECD proposed 10 step process for performing a comparability analysis

• Step 1: Analysis of the taxpayer’s circumstances

• Step 2: Determination of years to be covered

• Step 3: Understanding the controlled transaction(s) based on functional analysis

• Step 4: Review of existing internal comparables, if any

• Step 5: Determination of sources of information on external comparables if required

Slide 67




• Step 6: Selection of the most appropriate transfer pricing method and PLI (if appropriate)

• Step 7: Identification of potential comparables

• Step 8 : Determination of and making comparability adjustments where appropriate

• Step 9: Interpretation and use of data collected, determination of the arm’s length remuneration

• Step 10 : Implementing support processes. Installing review process to ensure adjustment for material changes and documenting these processes

Slide 68



Issues and Case Studies – Issue 4 : Risk and Other Adjustments

• Capacity adjustments

- Account for difference in capacity utilisation between tested party and uncontrolled comparable transactions

- Low profitability of tested party not always attributable to pricing of international transactions

• Others

- Working capital

- Adjustment of business risk (entrepreneur v/s. captive) etc.

Slide 69


Dispute Resolution Panel (‘DRP’)Proposed revision of Chapters I-III of OECD TP GuidelinesOther proposed developmentsRecent TP case laws

Part IIIRecent Developments


Dispute Resolution Panel (‘DRP’)

• Introduced by Finance (No. 2) Act, 2009

• Speedier resolution of disputes – 9 months from the issuance of “Draft Order” by the AO

• Period of 30 days given to the assessee for approaching DRP

• AO shall pass assessment order after receiving directions from DRP

• Appeal against such order lies with ITAT

• Constitution of DRP: 3 Commissioners of Income-tax

• Application in Form 35A in quadruplicate (3 copies to DRP members and 1 copy to AO)

• 51 DRP applications filed in Pune

• First round of DRP hearings in progress

Slide 71

Recent Developments


OECD proposed revision of chapters I – III of the TP guidelines

• Objective to update Chapters I – III of the TP guidelines

• Draft released for comment September 9, 2009

• Comment period closed January 9, 2010

• Likely to finalize model revisions in 2010

• No further public consultation likely

• Key Changes

- Most appropriate method

- Comparability analysis

- Application of the transactional profit methods

Slide 73

Recent Developments


Other proposed developments

• Safe Harbour Rules proposed to be introduced by Finance (No. 2) Act, 2009

• Advance Pricing Arrangements (APA) expected to be introduced by Direct Tax Code (‘DTC’)

• Thin Capitalisation Rules expected to be introduced after implementation of the DTC

• Other regulatory changes having impact on Transfer Pricing:

• Removal of upper limit on payment of Royalty

• Introduction of IFRS

Slide 75

Recent Developments


Recent TP Case Laws – Pune ITAT

Slide 77

Recent Developments

Decision Key points

Honeywell Automation India Limited

Comparable financial data of subsequent years cannot be considered

Data for earlier financial years can be considered only in circumstances prescribed under Rule 10B(4)

Under TNMM, only those items of income or expenditure having nexus with the operating profit / loss of the enterprise can be considered

E-Gain Communication Private Limited

Appropriate adjustments have to be performed on comparable for material differences

The comparables’ margins should be adjusted to remove the income attributable to non-operating assets

Risk adjustments have to be made for comparability analysis

In the case of companies earning extraordinary profits, it is necessary for the tax authorities to evaluate whether the said companies ought to be taken as comparables


Recent TP Case Laws – Pune ITAT

Slide 78

Recent Developments

Decision Key points

Skoda Auto India Private Limited

Transactions between AEs, being controlled transactions, cannot be considered for determining internal CUP.

It is permissible to make economic adjustments in fit cases.

For purpose of making comparison and economic adjustment, when information available in public domain is not sufficient, reasonable approximations and assumptions can be made.

MSS India Private Limited

For Transfer Pricing purposes, it is immaterial as to whether or not the income of assessee is exempt from Income-tax.

When the assessee’s method of determination of ALP is not accepted by the Revenue Authorities, the onus shifts to the Revenue for proposing an alternative method.

Reference to OECD principles can be made to seek clarity on application of Indian Transfer Pricing provisions.


Recent TP Case Laws

Slide 79

Recent Developments

Decision Authority Key points

Perot Systems TSI (India) Ltd

Delhi ITAT Granting of interest-free loans to the AEs is an “international transaction”

Interest-free loans given to AEs are not at arm's length, irrespective of commercial expediency.

Such transactions should be benchmarked by considering comparable transactions of foreign currency lending, by the Parent Company itself (internal comparable transaction) or unrelated parties

VVF Limited Mumbai ITAT

Global Vantedge Delhi ITAT Transfer pricing adjustments along with the Arm’s length price cannot exceed total profits in value chain


Recent TP Case Laws

Slide 80

Recent Developments

Decision Authority Key points

Vertex Customer Services India Private Limited

Delhi ITAT Nature of ‘Provision for bad and doubtful debts’ for transactions with AE: Operating expense or extraordinary item – debatable issue

Penalty u/s 271 (1)(c) cannot be imposed where there is merely a difference of opinion between the assessee and the revenue

BBC Worldwide Delhi ITAT No further attribution of profits is required if the Dependent agent (i.e. the Indian subsidiary) is paid arm’s length commission

Quark Systems Chandigarh ITAT Merely because a comparable is making a loss, it cannot be excluded

Importance of Functional (FAR) Analysis was stressed by the Tribunal

Emerging Practice Area

Good understanding of business and Knowledge of economics is necessary (not just knowledge of taxation)

Focus area for Revenue Authorities

Very relevant for all Large Corporates

Not just about TNMM, Comparables and Margins!

Not mere compliance (involves exhaustive exercise)

Robust Documentation is a must

Concluding Remarks

© 2008 PricewaterhouseCoopers. All rights reserved. “PricewaterhouseCoopers” refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers LLP (US).

Thank You !!!


Issues and Case Studies – Issue 2 : Multiple year data

1.Contemporaneous documentation – Rule 10D(4)

• “The information and documents specified under sub-rules (1) and (2), should, as far as possible, be contemporaneous and should exist latest by the specified date referred to in clause (iv) of section 92F”

2. Use of current year data and the proviso – Rule 10B(4)

• “The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into :

Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.”

pune camp cpe study circle transfer pricing: legislation, experiences and recent developments...

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