Recent updates and case laws on Transfer

Pricing (‘TP’)

November 2016

By CA Tejas Dharwadkar

Partner, Unicus

Mobile : 9823518829

1

Case study 1

2

Subsidiary Co.

Patanjali India

IndiaSale of

DantaKanti

DantaKanti

Distributor

Brand owner cum manufacturer

R&D activity

US

Particulars Amount

Cost to S Co 100

Sale price of S Co

110

Profit of S Co 10

Particulars Amount

Cost to PI 80

Sale price of S Co

100

Profit of S Co 20

How to

benchmark

Particulars Amount

Cost to PI 100

Sale price of S Co

100

Profit of S Co 0

Particulars Amount

Cost to S Co 100

Sale price of S Co

100

Profit of S Co 0

3

Comparability Analysis - Typical Process as suggested

by OECD

1. Determination of years to be covered

2. Broad based analysis of taxpayer’s circumstances

3. Understanding of FAR and selection of tested party

4. Review of existing internal comparables

5. Identifying sources of external comparables considering their relativity

6. Selection of Most appropriate Transfer Pricing Method

7. Identifying potential comparables

8. Determining and making comparability adjustments (wherever

appropriate)

9. Interpretation and use of data collected and determining arm’s

length price

4

– A Transaction has two transacting parties – Which one

needs to be tested / evaluated?

– Selection of the Tested Party is based on the functional

analysis and characterization of entities

– Usually, the tested party is the

• least complex entity

• for which reliable data is available for conducting comparability

analysis

• Few adjustments are required to make the data comparable

– Tested party and MAM – depends on availability of reliable

data

Tested Party...

5

Tested Party...

6

Manufacturer -A Inc

Contract Manufacturer - B

Inc

Distributor -A Ltd

USA

India

Intellectual Property

Entrepreneur -B Ltd

Tested Party

Tested Party

Tested Party...

7

Software Product Company

Manufacturer of Semi finished

products

Captive Service Provider

USA

India

Intellectual Property

Entrepreneur -Manufacturer of

finished products B Ltd

Tested Party

Tested Party

Tested Party : Key rulings…

• Rulings wherein it is held that Foreign AEs can be

considered as the tested party

• Ranbaxy Laboratories Ltd vs ACIT [2008] 110 ITD 428 (del)

• Development Consultants (P) Ltd vs DCIT [2008] 23 SOT 455

(Kol)

• General Motors India Private Limited vs DCIT TS-215-ITAT-

2013-(Ahd)-TP

• GE Money Financial Services Pvt Ltd [TS-697-HC-2016(DEL)-

TP]

• Landis Gyr Limited [TS-518-ITAT-2016(Kol)-TP]

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… Tested Party : Recent rulings

• Rulings wherein contrary view was upheld i.e. Foreign AE cannot be

selected as the tested party

• Onward Technologies Limited TS-94-ITAT-2013(Mum)

• Global Vantage (P) Ltd vs DCIT [2010] 37 SOT 1 (Del)

• Aurionpro Solutions Ltd vs Ad CIT [2013] 33 taxmann 187 (Mum)

• AT & S India Pvt Ltd [TS-539-ITAT-2016(Kol)-TP]

• Royal Canin India Private Limited [TS-294-ITAT-2016(Mum)-TP]

• Tata Motors European Technical Centre Plc [TS-440-ITAT-2014(Mum)-TP]

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Tested Party : Key principles to be considered

• Analysis of functions performed, assets employed and risks assumed by

transacting parties

• Identify the least complex entity

• Availability of data for the purpose of comparability

• Use of foreign databases for foreign tested party

• Availability of back-up documents such as annual reports, agreements, etc

• Ease of doing minimum adjustments to enhance comparability between tested

party and comparables

• Financial data of tested party

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Selection of tested party a very crucial step in the entire TP analysis.

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Use of multiple year data

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Introduced in Finance Act 2014 and applicable for transactions

entered into post April 1, 2014 i.e. FY 2014-15 and subsequent years

Applicable where RPM, CPM and TNMM are selected as most

appropriate method

Weighted average of current year plus previous two years, where

data is available could be used for determining data values of

comparable set

In case current year data is not available at time of filing return of

income, the same will be used at the time of assessment if available

Data values so determined for comparables to be placed in

ascending order for purpose of determining ALP

Use of current year data at time of assessment could distort ALP conclusion

Example on use of multiple year data

Illustration: Computation of ALP using multiple year data

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Particular Previous Year 2 Previous year 1 Current year Total

Operating profit

600 700 600 1900

Total Cost 1200 7400 1500 10100

OP/TC for the comparable would be weighted average of profit/ total costs

i.e.

1900/10100 = 18.81%Weighted

average

1300

8600

15.11%

ALP ?

Use of multiple year data : Key rulings…

• Lee Hours Pomeroy Architects [TS-644-ITAT-2016(Kol)-

TP]

• Vishay Components India Pvt Ltd [TS-356-ITAT-

2016(PUN)-TP]

• Aptara Technologies Pvt Ltd [TS-309-ITAT-2016(PUN)-

TP]

• Syscom Corporation Limited [TS-648-ITAT-2015(Mum)-

TP]

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The above key rulings apply to FY 2013-14 and before.

Even in the above case laws, it has been held that the assessee can use previous years data if it is proved that previous year

data was used/had impact in current year price determination

Application of Range

15

Introduced in Finance Act 2014 and applicable for transactions

entered into post April 1, 2014 i.e. FY 2014-15 and subsequent years

Applicable where CUP, RPM, CPM and TNMM are selected as most

appropriate method

In case data set contains 6 or more comparable companies, ALP

shall be determined based on 35th to 65th percentile of data values

in the comparable set.

If the transaction price falls within the above mentioned range,

then the same shall be at arm’s length. If the transaction price falls

outside the range, the median shall be considered as ALP.

If the comparables are less than 6 / in case of use of PSM or Other

method, the arithmetic mean of the comparables shall be used for

determination of ALP. Benefit of variation of +/- 3% is available

Example on use of Range

Percentile Formula Result Value to be selected

35th No. of data points*35% = 7*35% 2.45 3rd value

65th No. of data points*65%=7*65% 4.55 5th value

Median Total no. of data points *50% 3.50 4th value

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Illustration: Where the data set comprises of 7 data points arranged in an ascending order and

the percentile computed are not whole numbers

Illustration: Where the data set comprises of 20 data points arranged in an ascending order and

the percentile computed are whole numbers

Percentile Formula Result Value to be selected

35th No. of data points*35% = 20*35% 7.00 Mean of 7th and 8th value

65th No. of data points*65%=20*65% 13.00 Mean of 13th and 14th value

Median Total no. of data points *50% 10.00 Mean of 10th and 11th value

Points for consideration on new rules

17

Use of 35th to 65th percentile not in accordance with globally

followed practices wherein use of quartiles is more acceptable

This would be a point for discussion between competent authorities

during APA/MAP discussions

In case, data for current year is available at time of assessment and

results in TP addition; corresponding relief should be available to

assessee from penalty provisions

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…Transaction wise Analysis vs. Aggregation approach…

Section 92C (1) – Computation of arm’s length price

“The arm’s length price in relation to an international transaction shall be

determined by any of the following methods, being the most appropriate

method, having regard to the nature of transaction or class of transaction

or class of associated persons or functions performed by such persons or

such other relevant factors as the Board may prescribe, namely-

1. comparable uncontrolled price method;

2.resale price method;

3.cost plus method;

4.profit split method;

5.transactional net margin method;

6.such other method as may be prescribed by the Board.”

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…Transaction wise Analysis vs. Aggregation approach…

Section 92F

“transaction includes an arrangement, understanding or action which -

1.is formal or in writing; or

2.is intended to be enforceable by legal proceeding”

Rule 10A(d)

“ ‘transaction’ includes a number of closely linked transactions.”

Form 3CEB - Accountant’s Certificate

Details for “each transaction or class of transaction” needs to be

provided under each clause..

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Case study

21

Parent Co.

Third party

dealers

Subsidiary Co.

India

Sale of

Razor (Rs 100)

RPM?

• Manufacturing of blades –Total Cost Rs 20

• Distribution of Razor

Razor (Rs 100)

Bladé(Rs 40)

• Manufacturing of Razor

• R&D and Brand owner

Particulars Razor

Cost to S Co 100

Sale price of S Co

100

Profit of S Co NIL

Blade Total

20 120

40 140

20 20

Business strategy

ALP?

Aggregate

Aggregation : Key rulings…

• India Pistons Ltd [TS-862-ITAT-2016(CHNY)-TP]

• Tara Jewels Exports Pvt Ltd [TS-481-HC-2015(BOM)-

TP]

• International transaction only to be considered for purpose

of PLI computation

• Syscom Corporation Ltd [TS-808-HC-2016(BOM)-TP]

• TP adjustment to be restricted to Intl’ Transaction

• Alstom Projects India Ltd [TS-758-HC-2016(BOM)-TP]

• Absence of segmental account does not warrant entity

wise adjustment

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23

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Deemed International Transactions -92B(2)25

Company

NR India

Outside IndiaNon - AE

XYZ Inc. USA

ABC Ltd. India

AEsSubsidiary

Sale of goods

Prior arrangement relating to quantity and price of goods

Deemed InternationalTransaction

• Related prior agreementbetween XYZ Inc. and Non –AE

• The terms of the transactions are determined in substance by XYZ Inc.

Deemed international transaction: Key rulings…

• G4S Security Services (India) Pvt Ltd [TS-668-ITAT-

2015(DEL)-TP]

• Swarnandhra IJMII Integrated Township

Development Co. Pvt. Ltd. [TS-178-ITAT-2014(HYD)-

TP]

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Transaction with domestic third party would not constitute as deemed international transaction – Prior to Finance Bill 2014

Deemed International Transactions -92B(2)27

Company

NR India

Outside India

Non - AE

XYZ Inc. USA

ABC Ltd. India

AEsSubsidiary

Sale of goods

Prior arrangement relating to quantity and price of goods

Deemed InternationalTransaction ?

• Related prior agreementbetween XYZ Inc. and Non –AE

• The terms of the transactions are determined in substance by XYZ Inc.

Transaction with third

party situated in India

would be deemed

international transaction :

Finance Bill 2014

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Special Location – Sec 94A29

Any transaction having a bearing on profit, income, losses and assets entered with person

located in ‘Notified Jurisdictional Area’ , then parties to such transaction shall be deemed to

be associated enterprise within the meaning of Section 92A

Transfer Pricing provisions to apply

Cyprus is currently

notified under this

Section

Transaction with any

person (including third

party) in Cyprus would

be covered under

ambit of TP

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Other key hidden/underlying transactions to

look out for…

• Marketing Intangible (aka AMP issue)

• Use of bright line test for identification of such transaction by tax authorities

• Sony Ericsson Mobile Communications India Pvt. Ltd. V Commissioner of Income

Tax – III, New Delhi (2015)

• CIT, New Delhi V Discovery Communication India (2014)

• CIT, New Delhi V Whirlpool of India Ltd (2015)

• Guarantee provided by Group companies

• This transaction would typically arise in case of Indian parent company providing

guarantee to its overseas subsidiary, without charging any guarantee fees

• Whether to charge guarantee fees is a matter of detailed study/analysis

• Siro Clinpharm Private Limited [TS-144-ITAT-2016(Mum)-TP]

• Everest Kanto Cylinder [TS-814-ITAT-2016(Mum)-TP]

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…Other key hidden/underlying transactions to

look out for

• Amount outstanding from/to AEs based on other international

transactions

• Need to compute notational interest a matter of detail

• Business restructuring transactions (Clause 18 of Form 3CEB)

• Conversion of entrepreneur to risk free entity or vice versa

• Change in characterisation would only be the trigger for additional analysis

• Whether the business re-structuring results in any international transaction, is a

matter of detail.

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Applicability - SDT

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Payments to related

parties u/s 40A(2)(b)

Profit linked tax

holiday

units

Other transactions to

be notified

Discourage excessive

payments to

associates

Inter Units

transfers

80IA(8)

Transactions

with

outsiders

80IA(10)

Should not lead to

shifting of excessive

profits to qualifying

units

Should be at ALP

Transfer Pricing provisions to apply to the ‘Specified Domestic Transactions’ if the aggregate value exceeds INR 20 cr [INR 5 cr before FY 2015-16]

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Instruction number 3 of 2016…

• CBDT has issued instruction number 3 of 2016, replacing existing

instruction regarding selection of cases for special TP scrutiny

• Mandatory reference by AO to TPO for cases having TP as the risk

parameter under CASS or CBDT annual instructions

• Cases not having TP as risk parameter in CASS/ manual instruction,

following criteria would be used for reference by AO to TPO:

• Accountants Report in Form 3CEB not filed or not disclosed an international

transaction/SDT in the Form 3CEB

• TP adjustment of Rs 10 crore or more in earlier assessment year, either accepted

by judicial authorities or pending appeal

• The AO/investigation wing has recorded a finding with respect to international

transaction/SDT in a search or seizure operations

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…Instruction number 3 of 2016

• The AO is required to provide adequate opportunity to the assessee

before rereferring the matter to the TPO, wherein there is potential of

income arising from an international transaction/SDT

• AO cannot determine ALP of international transaction/SDT wherein no

reference is made to TPO. In such situation, the AO Order is required to

specifically mention the same in his order giving reference to the

instruction

37

DRP order non appealable for tax authorities

• Tax department would not be able to appeal against DRP Directions

for Orders passed post 1 June 2016

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Happy to

answer any

questions.

Thank

You