Controversial Issues and Advance Pricing Agreement Seminar- Controversial...2014-15 4,290 2,353 55...

07 October 2017

Seminar on Transfer Pricing

Controversial Issues andAdvance Pricing AgreementBy CA Vijay Iyer

GlossaryAbbreviations Full Name

AE Associated Enterprise

ALP Arm’s Length Price

AMP Advertising, Marketing & Promotion

AO Assessing Officer

APA Advance Pricing Agreement

BAPA Bilateral Advance Pricing Agreement

BLT Bright Line Test

CUP Comparable Uncontrolled Price

IGS Intra-group services

TNMM Transactional Net Margin Method

TPO Transfer Pricing Officer

UAPA Unilateral Advance Pricing Agreement

Abbreviations Full Name

BEPS Base Erosion & Profit Shifting

CIT(A) Commissioner of Income-tax Appeals

DRP Dispute Resolution Panel

ITAT Income Tax Appellate Tribunal

HC High Court

KPO Knowledge Process Outsourcing

BPO Business Process Outsourcing

Contents

Section 1 : Transfer Pricing Environment in India

Section 2 : Recent Controversial Issues

Section 3 : Advance Pricing Agreements (APA)

Transfer Pricing Environment in India

TP Environment in India: Litigation process

AO / TPO(2-3 years)

CIT(A) / DRP(1-2 years)

Tribunal(2-3 years)

JurisdictionalHigh Court(3-4 years)

Supreme Courtof India

(4-5 years)

12 to 16 years

*If the case is remanded back, then the over-all time limit may increase accordingly

► Appeal by either party in case offavorable resolution at lower level

► Build up of cases at Tribunallevel;factual nature of issues results inmatter being remanded back

Audit adjustments createcashflow issues

Time consuming and severaltiersof appellate authorities

Prolonged process, impact on financials and risk of economic double taxation

Domestic tax lawappeal process

Where prudent, APA/MAP are emerging as a viable options for alternate dispute resolutions

► Requirement to payentire tax demand,unless stay isobtained

► Use of coerciveaction to enforce taxcollection

Key statistics on TP related adjustments

Financial YearNumber of TP

AuditsCompleted

Number ofAdjustment

Cases

% of Adjustmentcases

Amount ofAdjustment (in

INR crore)2006–07 1,768 471 27 3,432

2007–08 219 84 39 1,614

2008–09 1,726 670 39 6,140

2009–10 1,830 813 44 10,908

2010–11 2,301 1,138 49 23,237

2011–12 2,638 1,343 52 44,531

2012-13 3,171 1,686 53 70,016

2013-14 3,617 1,920 53 59,602

2014-15 4,290 2,353 55 46,465

Source1: Annual Report of Ministry of Finance relating to financial year 2015-16Source2: http://www.thehindubusinessline.com/companies/transfer-pricing/article7228122.ece for FY 2014-15

Recent controversial issues

Recent controversial issues

Intra-group services/Management services/

Payment of royalty

AMP expenditure (Marketingintangibles)

Intra-group loans/ Corporateguarantee

Consistent loss makers/ lowmargin taxpayers

Reference to Transfer PricingOfficer (TPO)

Profit attribution toPermanent Establishments

(PEs)

Inter-company balance receivables

AMP expenses - Key issuesControversy Key Issues raised by tax authorities

Advertising,Marketing &Promotionexpenses (AMP)

► Treatment of AMP expenses incurred by Indian entity as international transaction

► Alleging the AMP expenses incurred by Indian entity leads to creation of marketingintangible for foreign entity owning the brand name

► Key TP issue : how should the marketer be compensated for the marketing activities –compensated as a service provider (i.e. for providing promotional services) or whethershare return attributable to the marketing Intangible Property (IP)?

► Detailed scrutiny into marketing activities and AMP expenses incurred by the Indianaffiliate. Indian affiliate may be a licensed distributor or manufacturer

► Determine whether AMP expenses are “excessive” by applying the “bright line test”(BLT) and impute compensation on grounds that the excess is the cost incurred forproviding a service to the AE.

► Instances of compensation sought with a mark-up on entire AMP expenses. In somecases, the mark-up was determined to be the gross margin earned by the Indianaffiliate.

► Instances of allocating additional return to Indian affiliate by applying Profit SplitMethod (PSM).

► TNMM based AMP intensity adjustment by comparing the intensity of AMP functions ofcomparable companies

AMP controversy so far..!!

Delhi High Court Rulingin the case of Sony

Ericsson

Delhi High Court Ruling inthe case of Maruti Suzuki,Whirlpool India, Bausch &

Lomb and Honda Siel

►A Special Bench ofITAT, Delhi wasconstituted in the caseof LG ElectronicsIndia Pvt. Ltd, whichruled as follows:

►Confirmed validity ofjurisdiction of the TPO.

►The transaction of AMPcan be characterizedas an ‘internationaltransaction’.

►Accepted ‘Bright LineTest’ to determine thecost/ value of theinternationaltransaction

Constitution ofSpecial Bench

► Delhi High Court heldthat AMP expenditure isan internationaltransaction

► The ruling dealt with theprinciples applicable to a‘distributor’.

► Rejected the applicationof Bright Line Test for thepurpose of making AMPadjustment

► Recognised the principleof economic ownershipof brands.

► Aggregated vs.segregated approach

► Delhi High Court held thatAMP expenditure is not aninternational transactionunder section 92B of theAct.

► The rulings dealt with theprinciples applicable to a‘manufacturers’.

► Revenue department toshow the existence of anunderstanding or anarrangement or action inconcert between thetaxpayer and its AE withregard to AMP spent inIndia, in accordance withprovisions of section 92F (v)of the Act.

► Bright line test rejected

Delhi High CourtRuling in the case

of Yum!Restaurants

► Delhi High Court directedto determine theexistence of aninternationaltransaction on accountof creation ofmarketing intangiblesby Yum! India for its AEs.

► Once the transaction isestablished, then thequestion arises, whethersuch transaction ofcreation of marketingintangibles is at arm’slength.

Intra-group services/ management services/ payment ofroyalty – Key issues

Controversy Key Issues raised by tax authorities

Intra group services/Managementservices/ Royaltypayments

► Need for the receipt of the services/ benefits by Indian entity

► Whether any cost-benefit analysis has been / was done while entering into theagreement for such payments

► How the rate/payment for intra group services/ royalty has been determined

► Documentary evidence as to when and how these services were requisitioned

► Tangible /direct benefit derived from the receipt of the services/ use of intangibleproperty

► Evidence of cost incurred by the foreign entity and mark-up applied(determination of cost base, allocation keys)

► Whether in comparable circumstances an independent enterprise would bewilling to pay the price for such services

► Whether an independent third party would be willing and able to provide suchservices

► Selection of the most appropriate method for benchmarking such services(TNMM vs. CUP)

► Re-characterization of taxpayer / international transaction

Intra-group services/ management services/ payment ofroyalty – Key issues


Intra group services/Managementservices/ Royaltypayments

► New eligible international transaction i.e. Receipt of low value added services (LVA IGS)introduced in Revised Safe Harbour Rules (SHR 2017)

► The definition of LVA IGS and the SHR for LVA IGS introduced by the IRA is influencedby the Organisation for Economic Co-operation and Development (OECD) Action Plan 8to 10 on Base Erosion and Profit Shifting ‘Aligning transfer pricing outcomes with valuecreation’.

► The SHR are reasonably clear in their definition of what constitutes an LVA IGS andwhat does not (core and non-core activities).

► Some important rulings:

► Knorr Bremse India Private Limited Vs ACIT (P&H High Court)

► Cushman and Wakefield (I) Pvt Ltd Vs CIT (Delhi High Court)

► Avery Denison (India) P Ltd (Delhi High Court)

► CIT Vs EKL Appliances Ltd. (Delhi High Court)

► Dresser Rand India Private Ltd (Mumbai ITAT)

► Mercer Consulting India Pvt Ltd (Delhi ITAT)

Intra-group loans/ Corporate guarantee– Key issues


Intra-group loans /corporate guarantee

► Compare the terms and conditions of loan agreement and determine thecredit rating of the lender and borrower

► Attempt to identify comparables third party loan agreement

► Interest rates quotes and guarantee rate quotes available from bankingcompanies are taken as the benchmark rate to arrive at the ALP

► Also uses the interest rate prevalent in the rupee bond markets in India forbonds of different credit ratings to arrive at the ALP

► Notional guarantee fees is added/charged in cases whereguarantees/letters of comfort etc. are being issued by Indian entities tolenders of overseas subsidiaries/group companies.

► Use of interest rates (i.e. LIBOR vs PLR)

► Revised Safe Harbour Rules (SHR 2017) introduced in relation toadvancing of intra-group loans to wholly owned subsidiaries (WOS) andproviding corporate guarantee to WOS.

Intra-group loans/ Corporate guarantee– Impact ofRevised Safe Harbour Rules 2017


Intra-group loans /corporate guarantee

► Some unresolved issues/ concerns in revised SHR 2017 are:

► No clarity on exchange rate to be used in case of loan advanced/ guaranteeprovided to WOS in foreign currency.

► No clarity whether ‘advancing of intra-group loans’ includes subscription tobonds and debentures of AE

► Advancing of loans to Joint Venture companies (‘JV’) or other groupstructures have been kept out of the purview of amended SHR 2017

► Not clarified whether SHR 2017 are applicable in respect of new loansadvanced/ guarantee provided during FY 2016-17 and onwards or it alsocovers continuing loans

► Some important ruling:

► Videcon Industries Ltd [TS-127-ITAT-2017(Mum)-TP]

► Micro Ink Limited [TS-568-ITAT-2015(Ahd)-TP]

► Cadila Pharmaceuticals Ltd [TS-715-ITAT-2017(Ahd)-TP

Inter-company balance receivables– Key issues


Inter-companybalance receivables

► Treatment of inter-company balance as separate international transactionand thereby to benchmark separately

► Re-characterisation of inter-company receivables as deemed loanadvanced to related entity

► Determination of arm’s length price using CUP method

► Notional interest charged in cases of delayed receipts on account of tradetransactions from group companies

► Some important rulings (in favor of taxpayer):

► Indo American Jewellery Ltd [TS-3-HC-2013(BOM)-TP]

► Nimbus Communications Limited [TS-1-ITAT-2011(Mum)]

► Lintas India P. Ltd [TS-713-ITAT-2012(Mum)-TP]

► Kusum Healthcare Pvt Ltd [TS-129-ITAT-2015(DEL)-TP]

Reference to TPO– Key issues


Reference to TPOas per revisedCBDT instruction3/2016

► CBDT came out with a new Instruction 3/2016 in March 2016 clarifying that:

► AO not empowered to conduct TP Assessments.

► Expands the circumstances for reference to be made to TPO for casesselected under non-risk parameters

► Also made applicable to specified domestic transactions.

► Instruction 3/2016 issues in supersession of earlier instruction of 2015

► Primary issues:

► Whether the Instruction No. 3/2016 issued in supersession of earlierinstructions is to be given retrospective effect or prospective effect

► Jurisdictional requirement of the AO to record reasons

► Jurisdictional requirement of the AO to provide an opportunity of beingheard before making reference to TPO

► Situations under which reference can be made to TPO

Reference to TPO– Key issues


Reference to TPOas per revisedCBDT instruction3/2016

► Some important rulings:

► Nikon India Pvt Ltd [TS-469-ITAT-2016(DEL)-TP]

► Indorama Synthetics India Ltd [TS-501-HC-2016(DEL)-TP]

► Vodafone India Services Pvt. Ltd. [TS-320-HC-2013(BOM)-TP]

► SG Asia Holdings (India) Pvt Ltd [TS-166-ITAT-2015(Mum)-TP]

► Indorama Synthetics India Ltd [TS-501-HC-2016(DEL)-TP]

Upcoming Controversies – BEPS/ Changes inAct► Increased and intense focus by tax authorities on intangible related transactions - DEMPE

analysis (Development, Enhancement, Maintenance, Protection and Exploitation) influenced by

OECD Action Plan 8 to 10 on BEPS.

► Tax risk assessment to undergo change post filing of County-by-country report (‘CbCR’) and

Master file in line with OECD BEPS Action 13. OECD recently released draft handbook on

effective tax risk assessment.

► Introduction of concept of secondary adjustment in Indian Income-tax Act

► Introduction on new eligible transactions in revised Safe Harbour Rules 2017

► Increased focus on maintenance of documentation covering policies relating to inter company

transactions

► Review of financing arrangements with group entities (amendment to section 94B of the Act)

► Robust arm’s length analysis of transactions involving income taxable in India for foreign

entities (Intsrumentarium ruling)

Advance Pricing Agreements

Indian APA program – Salient features

APAs can be unilateral or bilateral. APAs are valid for a maximum period of 5 consecutive yearswith provision for roll-back up to 4 years

An agreement between the Central Board of Direct Taxes (CBDT) - the Indian Tax Administration andany taxpayer for determining the arm’s length price in advance, in relation to international transactions

Pre-filing consultation made optional. Anonymous pre-filing consultation possible.

Withdrawal and amendments to application permitted under the Rules. Flexibility to determine ALP withadjustments/variations, as necessary

Application for roll-back, if opted for, would entail an additional statutory filing fee of INR 0.5 million

Statutory filing fee (to be paid only at the time of formal filing) of INR 2 million where the value ofinternational transactions during the APA period exceed INR 2 billion

APA vs. no APA

Cost and efforts involved under the non APA route would be higher than under the APA route

► Requirement to pay a portion of additional tax demanded to the revenue authorities under protest► Difficult to obtain a refund of the amount of demand paid to the tax authorities and there is also no timeframe under law

within which the tax authorities need to refund the demand.► This creates a significant cash flow issue/shortage of working capital for carrying out operations.

Types of APA: UAPA and BAPA

UnilateralAPA (UAPA)

Benefits

► Mitigation of TP controversy risk in the country withmost risk on account of business model change i.e.India

► Relatively easier negotiation process

► Less time consuming (can be concluded in 18 to 24months)

Considerations

► Framework to be agreed only as per provisions ofdomestic law – Example downward adjustment notallowed for roll back years, non invoicing leads toincreased mark up (DDT) or secondary adjustment

► Reliance on existing judicial precedence

► One-sided solution may not be as efficient

Bilateral APA (BAPA)

Benefits

► Mitigation of TP controversy risk from the perspective ofboth countries

► Relief from economic double taxation (on account ofcompensation for restructuring)

► Greater bargaining leverage

► Eases data collection and examination process

► Flexibility on methods

► Reduce taxpayer’s disclosure requirements under TPMasterfile. UAPAs are required to be disclosed separatelyunder Masterfile and could serve as reference for 3rdcountries

Considerations► Time period of consensus building and finalization is

slightly lengthy

Administrative structure in India for APAs

Advance Pricing Agreement(APA) Directorate – Central

Board of Direct Taxes

Director APA

Unilateral APA Bilateral / MultilateralAPA

Team of Officers,economists and

statisticians

Team of Officers,economists and

statisticians

Director APA

Competent AuthorityDirector General ofIncome Tax

► All APAs to be approved bythe Central Government

► Hand picked officials for theAPA process

► Common team at the backend for unilateral andbilateral / multilateral APAs

APA process flow

APA – Advance pricing agreement;CA – Competent Authority;CG – Central Government;DGIT – Director general of Income tax

Indian APA program – Key statistics andmilestones

Source: APA programme of India –Annual Report2016-17 by CBDT

* Bifurcation of applications between UAPA andBAPA after conversion of initial UAPAapplications into BAPA

Source: CBDT Press release on APA dated 04September 2017

Indian APA program – Key statistics andmilestonesTypes of industry availing APA programme Nature of transactions covered by APA

► Information Technology► Banking & finance► Industrial/ commercial goods manufacture► Pharmaceutical► Consumer goods manufacture► Oil & Gas► Engineering services► Telecommunication► Foods and beverages► Power & Energy► Shipping► Automobile► Healthcare► Infrastructure & Real Estate► Media & Communication► Textile► Chemical► Forestry► Tourism & Hospitality► Trading & Logistics

► Provision of Software development services► Provision of IT enabled services► Intra-group payments► Sale/ Purchase of goods► Provision of investment advisory services► Interest payment► Provision of business/ marketing support services► Provision of engineering design services► Provision of technical services► Provision of R&D services► Provision of corporate guarantee► Provision of KPO/ BPO services► Receipt/ Payment of royalty► Commission payments/ receipts► Payment for corporate guarantee fees► Transfer of shares

Indian APA program – experience so far

Experience so far Some concerns

► Patient and proactive approach towards theentire program;

► Showed willingness to hear the business storyof the applicant;

► Demonstrated fair understanding of theapplicant's business and the industry;

► Spent considerable time on understanding,verifying and validating the FAR and theeconomic analysis;

► Clearly spelt out their expectations from thetaxpayer;

► Shared their comparable companies searchprocess and maintained transparency withobjectivity in the negotiations;

► Most importantly, the APA authority was keenand inclined to complete cases wheretaxpayers were forth coming with all therequired information / details and where theissues were straight forward.

► Frequent transfer of APA personnel includingother additional responsibilities could be avoided;

► Long and definite term for the APA authority ismuch desired from the perspective of continuityand timely completion;

► Need to involve subject matter experts for betterunderstanding and interpretation of nuancesrelating to business and industry;

► A positive re-examination of the interpretation oftreaties in cases where Article 9(2) is absent,would facilitate more number of bilateral andmultilateral APAs.

Thank you

Controversial Issues and Advance Pricing Agreement Seminar- Controversial...2014-15 4,290 2,353 55...

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