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Prashant Kotecha

Study Circle – Baroda Branch of WIRC

Transfer Pricing In India An Update

CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC 2

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Transfer Pricing in India

Increased Focus of IRA

Key Triggers for TP Adjustments

Recent Issues in TP Audit

Recent Rulings

Recent Updates in the Finance Bill, 2011

Other Important Topics

Mindset of IRA

Defense Mechanism

8 March 2011

Transfer Pricing in India CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC 8 March 2011 3

Snapshot of Indian Regulation Relatively new legislation - Introduced with effect from

April 1, 2001 International transactions between associated

enterprises need to satisfy the arm’s length criterion (ALP - price applied between independent enterprises in uncontrolled conditions)

Compliance Requirements i. Maintenance of contemporaneous documentation (to

substantiate ALP) ii. Annual filing of Accountant’s Report (Form 3CEB)

Steep Penalties – Fixed Amount of Rs. 1,00,000 if 3CEB is not filed – 2% of International Transactions if no Documentation – Can be Upto 3 times the tax sought to be evaded

Concept of Arithmetic mean Limited judicial precedence Assessment procedure stringent

CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC 4 8 March 2011

Approach to Transfer Pricing

Prescribed Methods Method Functions Approach

Comparable Uncontrolled Price

(CUP)

Direct Method – Product

Comparability Critical

Prices of each transaction is to be benchmarked

Resale Price Distribution Function

Prices to be benchmarked

considering ALM

Cost Plus Service Function;

Contract Manufacturing

Prices to be benchmarked

considering ALM

Profit Split

Transfer of intangibles or

multiple transactions

Analysis of Allocation of Profit

and loss

Transactional Net Margin

Manufacturing & Sales functions –

FAR Comparability critical

Net Operating Margin to be Benchmarked

Typical International Transactions: Import of components; Payments towards technology support; Export of finished products, Reimbursement of expenses

Remuneration based on FAR Analysis

Assists in economic characterization and determination of compensation

Most Appropriate Method (MAM):

To be used for testing ALP Aggregative Approach

Interlink Between transactions required to be established Public Database is required to analyze the ALM earned by ICC

Transaction specific approach Technical Payouts, Management Fee, Cross Charges. Cost Benefit analysis necessary


Functional, Assets & Risk Analysis

Comparable Analysis Financial Analysis Internal External

Compliance – a Step by Step Approach

Selection of Most Appropriate Method

Profit Level Indicator

Accountants Report Documentation


Transfer Pricing Compliance Timeline – Illustration for A.Y. 2011-12

Sr. No. Compliance Timeline Relevant Provision

1. Filing Accountants Report along with Tax Return, Maintenance of Documentation 30 Nov. 2011 Section – 92E r.w.

Section – 139(1)

2. Limitation for Initiating transfer pricing audit by the tax administration 30 Sep. 2012 Proviso to Section –

143(2)(ii)

3. Limitation for completing transfer pricing audit 31 Oct. 2014 Section – 92CA(3) r.w.

Second Proviso to Section – 153(1)

4. Limitation for Completing regular assessment 31 Dec. 2014

If 144C BY 28-02-2015

Second Proviso to Section -153(1)

5. Limitation of Completing regular assessment (If reference is made for exchange of information)

30 June 2015 If 144C

BY 30-08-2015

Second Proviso to Section - 153(1)(b)

5.

Limitation for Re-Assessment (where income escaped < Rs. 1,00,000) 31 Mar. 2016 Section – 149(1)(a)

6. Limitation for Re-Assessment (where income escaped ≥ Rs. 1,00,000) 31 Mar. 2018 Section – 149(1)(b)

7. Date till which documentation is required to be maintained 31 Mar. 2020 Section – 92D and Rule

– 10D(5)


Increased Administrative focus of IRA Finance Act, 2009 – Focused on Transfer Pricing – Introduction of

Safe Harbor Rules Finance Bill, 2011 – Proposes amendments to give more power

to TPO. Proposal in DTC to Increase in Scrutiny time limit from 33 months

to 45 months. DTC proposes to introduce CFC Rulings, thin capitalization and

APA Increase number of cases with transfer pricing adjustments Increased number of training to TPOs on International TP Laws

and Practices. Step to Synchronize Customs and TP Authorities. Significant adjustments to companies in IT, Pharmaceuticals,

Financial Services, Automobiles, and Chemical Sectors. CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC 8 8 March 2011

Audit Process

File tax return and Accountant’s Report (30th November)

Reference to be made to TP Officer (‘TPO’) by the Assessing Officer (‘AO’); Compulsory Reference to be made by AO if international transactions exceed INR 1500 million

for AY 2005-06 onwards (Internal guidelines)

Based on results of above mentioned procedure assessing officer passes the order

TP Audit

Notice to be issues by the TPO - TPO calls for supporting documents and evidence

Rectification application can be made against the

order of TPO for apparent mistake

Appeal can be made against the order of AO as

order of TPO included within the order of the AO

DRP Mechanism- Finance Act 2009

Appeal Procedure

Appeal to Commissioner of Income Tax

Passes an order

Income Tax Appellate

Tribunal

High Court - only on matters related to law

Supreme Court

Constitutional Bench


Draft Order by AO

Assessee

Files Objection with DRP

Conveys Acceptance / no action taken by

Assessee

30 days

DRP passes Directions

1 Month AO Passes Final Order

ITAT Order

AO Passes Final order

9 Months

30 Days


DRP Process Chart

Recent Trends Revenue target driven approach FAR analysis – disregarding taxpayers business Ad-hoc economic adjustments - rule of thumb applied in most cases Aggregation of

transactions TNMM most commonly used by tax payers - about 72% of cases Tax Authorities

prefer CUP and CPM Updation of comparables with captioned year’s data during audit proceedings -

contemporaneous principle Use of secret comparables Lopsided selection of comparables - rejection of loss making companies, inclusion

of high profit companies, inclusion of high turnover companies etc. Use of standard benchmarking sets - example IT, ITes, Gem and Jewellery, Contract

R & D etc. Unrealistic benchmark for captive service providers Major adjustments in IT, ITeS, FMCG, Pharma, Automobiles, Chemicals etc.

Precedents set in earlier years - generally followed Cases referred back to the TPO


Status and Statistics 5 years of TP audit completed Various rulings at ITAT level Few rulings at High Court level Increased sophistication in analysis of

comparable database


Assessment Year

No. of Cases selected for

TP Audit

Upward Adjustment in

cases (%)

Approx. Adjustment (`

in crore)

2002-03 1,081 22% 1,500

2003-04 1,501 23% 2,500

2004-05 1,768 27% 3,500

2005-06 1,479 25% 5,500

2006-07 1,717 59% 10,000

2007-08 > 2,000 > 65% >25,000

Source: PTI

Key Triggers for TP Adjustments Losses / low margins with significant transactions with

Associated Enterprises Allocation of common expenditure Intra group management services fees Allocation of Marketing expenditure Royalty / Fees for technical collaboration Payment for Intangibles – patents , trademarks, brands,

logo etc. Significant variation in profitability of Assessee and its AEs. Low Mark-Up for captive services providers (particularly

ITeS Industry) Loan / Corporate Guarantee transactions


Recent Issues of TP Audit

Royalty

Intellectual Properties / Intangibles

Interest on Loans

Corporate Guarantee

Services provided by Captive units

Management Fees, Cost allocation, Cost contribution

Other important TP Audit Issues.


Royalty


Indian regulatory scenario: SIA used to publish information on royalty rates approved by the Government

pursuant to various technical collaboration proposals. SIA has discontinued

publishing this data effective September 2004

Rates for royalty under the automatic route prescribed by Department of

Industrial Policy & Promotion:

Lump sum payment of USD 2 million

Recurring royalty of 5% on domestic sales and 8% on export sales for

technology agreements/collaboration

Recurring royalty of 1% on domestic sales and 2% on export sales for use

of trademark/brand name, to the foreign collaborator

Royalty


Issues considerable: Lack of documentation in respect of receipt of Technology / continued technical

support from AE for which royalty is being paid. Assessee lacks in proving the reasons for paying royalty for more than 20 years Disregards to Specific situation of the Assessee - Nestle India (Delhi ITAT) [111

TTJ 498] - inappropriate to test the reasonableness of the remuneration on the yardstick of profit of the year in which the payment is made

Increase in rates at which Royalty is paid without change in technology being received from AE

Necessary to analyze cost (comparable cost, basis of charge) vs. benefit (need for availing services, value attributable to services)

Application of CUP for benchmarking – inadequate comparables FEMA ceilings / comparable FIPB / SIA approvals are not being accepted as CUP

for defending the arm’s length. Recent relaxation in royalty payout limits increases the challenge of defending the arm’s length nature of royalty payments

Intellectual Properties / Intangibles


Payment for use of brand not accepted unless commercial rationale / benefit test is demonstrated

Economic v. Legal ownership

Marketing Intangibles

Technology

Intangibles

Trademarks

Patents

In recent audits, the TP authorities have examined the marketing activities and spending by Indian subsidiaries developing local market intangibles that are legally owned by overseas parents or other affiliates - Maruti Suzuki (Delhi HC) [233 CTR 105 ]

Special importance to such transactions by OECD (Chapter VI of TP Guidelines)

Interest on loans


Regulatory Scenario - Exchange Control regulations permit raising ECB from foreign collaborator/ equity holder under the automatic route. ECB can be used for capital expenditure

Key factors affecting comparability- terms of loan, credit standing of the borrower, currency of the loan, collateral, fixed vs. floating interest rate etc.

Manner of Benchmarking Evaluation of interest rates charged in similar uncontrolled transactions -

Standard Bank Rates - LIBOR, PLR Practical Issues:

Non-availability of data relating to comparable loan transactions in public domain

Adjustment for differences in risk profile of the borrower Thin-capitalization provisions / Re-characterization of debt into equity -

with the introduction of Direct Tax Code Perot systems (Delhi ITAT) [130 TTJ 685] and VVF Ltd (Mumbai ITAT) [ITA No.673/Mum/06]

Corporate Guarantee


Corporate Guarantee by Assessee against the loan taken by its AE

Nominal fees or no fees charged unlike Banks

Benchmarking:

Comparing total cost of borrowing (interest + guarantee) with

uncontrolled loan transactions

Comparison of fees charged by Banks / financial Institution is

difficult to be considered as CUP

Analysis of the credit worthiness of the AE should be carried out

Calculation of fees based on the benefits derived by AE

Captive Service Provider


Low margins maintained in view of lower risk profile Unavailability of comparable data for captive service providers Comparables selected by the taxpayers and TP authorities are

entrepreneurs assuming significant risks Inadequate guidance on working capital and risk adjustments Ad-hoc

filters applied by the TP authorities for selecting high margin comparables

TP Audit - AY 2004-05 - Various Indian affiliates of US MNCs engaged in IT services were subject to adverse TP adjustments

TP Authorities determined mark-up on costs in the range of 24-30% as ALP

Some US MNCs invoked Mutual Agreement Procedure (‘MAP’) under Article 27 of India- US Tax Treaty.

Pursuant to ongoing discussions, Competent Authorities of India and US have proposed a resolution based on a mark-up of 18% on costs for software and 24% for ITeS.


Justification of cost benefit analysis

Lack of supporting documentation to substantiate cost

allocation, actual receipt of services, etc.

Confidentiality issues within the group

Inadequate comparable data

Lack of guidance on Cost Contribution Arrangements

Management Fees, Cost allocation / Contribution


Use of captioned year data preferred over multiple year data

Re-run of comparable companies

Interest on delayed realization from debtor AEs

Ad-hoc aggregation / segregation of transactions

Cherry picking of comparables

Rejection of loss making comparables

Ad-hoc risk adjustments in certain cases to account for varying risk profiles

High risk for low margin and loss making companies

Foreign comparables challenged and local comparables preferred

Use of secrete comparable

Discretionary use of OECD guidelines

Other Important TP Audit Issues

Recent Important Rulings CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC 23 8 March 2011

Maruti Suzuki India Ltd. Vs. Addl. CIT (Delhi)

Facts of the Case Maruti Suzuki India Ltd. (“Assessee”) is a Joint Venture company of Suzuki Motor

Corp. (“Suzuki”) [54.20% share holding] Assessee is engaged in the business of manufacture and sale of automobiles and

trading in spares and components. Assessee entered into a license agreement with Suzuki in 1992. The salient features of the said agreement are:

• Suzuki to provide all technical information and know-how for manufacture, sale and after-sales service

• Responsibility of Assessee to develop and promote sales of vehicles / spares • Exclusive right granted by Suzuki to use the licensed information and licensed

trademark “Suzuki” • All products, parts, containers, packages etc, to bear the trademark “MARUTI

SUZUKI” Before entering into said agreement Assessee were using Brand “MARUTI” Assessee started to use brand “Maruti Suzuki” on rear side of the Vehicles

manufactured and sold by it in India.


233 CTR 105 – HC Delhi , 328 ITR 210


Facts of the Case Logo on the front side of the vehicle is replaced from “M” to “S” during the year

under consideration (A.Y. 2005-06) Suzuki charged substantial amount of royalty from Maruti for using the brand

Maruti has incurred advertisement expenditure of ` 4,092 Crores

Order of TPO TPO considering CPM as the Most Appropriate method calculated the Brand Value of

“Maruti” to be at Rs. 4,420 Crores after adding 8% margin over cost. He Asked to show cause as to why this is not to be considered as deemed transfer of Brand and accordingly adjustment should be made.

Assessee replied the show cause notice and also filed writ “Suzuki” was a weaker brand in India as compared to “Maruti” which was a super

brand hence the earlier brand is piggybacked on the latter. No compensation for brand creation and advertisements by Suzuki

• 50% of Royalty paid as no compensation received for trademark piggybacked on the trademark of Maruti (` 99.3 Crores)

• Non-routine advertisement expenditure amounting to ` 107.22 crores • Total adjustment of ` 206.52 crores


233 CTR 105 – HC Delhi , 328 ITR 210


Order of HC HC remanded the matter to TPO for fresh adjudication while doing so HC also gave

certain direction / guidelines to be followed as under: • No obligation on Suzuki to pay if the use of logo is at the discretion of the Maruti.

If Maruit is mandatorily required to use the foreign trademark / logo, appropriate payment should be made by Suzuki for the benefit it derives in form of marketing intangibles

• The ALP has to be determined taking into account all the rights and obligations of the parties under the international transaction

• Suitable adjustments to be made considering the individual profiles of the entities and other facts and circumstances of the case

• Maruti to be compensated only if the promotional expenses incurred by Maruti are more than what a comparable independent domestic entity would have incurred, the use of foreign trademark / logo is mandatory and the benefit to Suzuki is not merely incidental.

• Appropriate comparables to be identified and suitable comparability adjustments to be made

• If Maruti obtained any concession from Suzuki to offset the extra expenditure incurred, this would not automatically entail a payment by Suzuki.


233 CTR 105 – HC Delhi , 328 ITR 210


Order of SC (2010-TII-01-SC-LB-TP) Before the case shall be decided afresh by the TPO, Assessee filed

Appeal to Apex Court and claimed that the when the HC has not only set aside the original show cause notice but it has made certain observation on the merits of the case and has given directions to the TPO the matter virtually concludes the matter.

Apex court held that the TPO, who had already issued fresh show

cause notice in accordance to HC order, shall proceed as per the law uninfluenced by the observations / directions given by the HC.


233 CTR 105 – HC Delhi , 328 ITR 210

GE Capital Canada (International Jurisprudence)

Structure of Transaction


USA Canada

GE US GE Capital

Canada

Third Party creditor

Payment of Guarantee

fees

Guarantee

Borrowing through CP (Canada) and

unsecured debentures (Europe)

2009 TCC 563 and 2010 FCA 290


Facts of the Case GE US is parent of GE Capital Canada Both operate as unregulated financial services entities GE US provides unconditional guarantee for Canada’s debt issuance and

starts charging a fee @ 1% of outstanding debt Between 1996 and 2000, GE Canada paid a ‘guarantee fee’ to GE USA for

the provision of an explicit guarantee relating to commercial paper and unsecured debentures issued in the name of GE Canada.

The guarantee allowed GE Canada to benefit from cheap debt associated with a ‘AAA’ rating.

The Canadian tax authorities disallowed the deduction of the payments totaling approximately $ 136 million on the basis that GE Canada could have raised the funds on the same terms and conditions simply by virtue of its association with the GE Group (‘Implicit support’).


2009 TCC 563 and 2010 FCA 290


Question before Canadian Tax Courts Q1: Whether GE Capital should pay a guarantee fee to GE US?

The judge ruled that GE Capital Canada could not have raised the necessary funds at the low interest rates it benefitted from without the explicit guarantee from GE US

Therefore the guarantee was necessary in order for the subsidiary to execute on its business plan.

Q2: What is the most appropriate transfer pricing method and methodology?

The judge concluded that the correct methodology is to use the yield approach (interest saved) by first applying a two-step: • estimating the stand-alone or status-quo credit rating and then

notching that credit rating for the affect of the parent-subsidiary relationship,

• looking at the spread in corporate bond yields between the parents credit rating of AAA and the estimated credit rating of GE Capital Canada


2009 TCC 563 and 2010 FCA 290


Question before Canadian Tax Courts Q3: Should the parent-subsidiary relationship be considered while assessing the

credit risk? The judge concluded that the parent-subsidiary relationship must be

considered in determining the credit rating of the subsidiary, but that it is not reasonable to expect that implicit support would equalise the subsidiary’s credit rating to that of its parent.


2009 TCC 563 and 2010 FCA 290

Perot Systems TSI (India) Ltd. Vs DCIT

Facts of the Case Assessee is a part of MNC Group and extended foreign currency loan

(interest free) to two of its AEs in Bermuda and Hungary. Loans were extended of USD 1.5 million to Bermuda company and 4.6

million to Hungary Company TPO determined the ALP of interest considering LIBOR of 2001-02 for USD

being 2.39% and added average basis point charged by 5 companies selected by TPO being 1.64%. Therefore the Arm’s Length interest determined at LIBOR + 1.64% applying CUP.

CIT(A) upheld the view of TPO

Argument of the Assessee Notional income cannot be charged to tax only real income can be taxed The Loans are meant to earn dividends and therefore it is quasi capital The AEs were in start-up phase no one would have lent money Claimed variation of + / - 5%


130 TTJ 685 – ITAT Delhi

Perot Systems TSI (India) Ltd. Vs DCIT

Held by ITAT The concept of taxing only real income as laid by Apex court cannot to come

to the rescue of the assessee as the said law is not applied to Chapter – X of IT Act.

This is not the case of ordinary business transactions and therefore notional interest shall be charged to tax

There is no feature in the agreement to prove that the loans were quasi capital in nature

The contention of the assessee for not considering the interest on interest free loans as international transaction is rejected.

One of the AE is in tax heaven and not charging interest on loans from such AE is classic case of violation of TP norms

RBI’s Approval can not be the factor for determining ALP 5% variation cannot be allowed as there are only one ALP


130 TTJ 685 – ITAT Delhi

Key Recent Rulings


Case Synopsis VVF Ltd Vs DCIT [ITAT Mumbai] [1 TTR 326] (Interest Free Loans)

Facts • The taxpayer advanced interest free loans to its AEs out of its own funds and

determined the ALP as Nil • The TPO made an upward adjustment by adopting 14% p.a. (rate charged by

Citibank on cash credit) paid by taxpayer as arm’s length interest Taxpayer’s Contentions • Loan was granted to AEs out of the interest free funds and since the taxpayer

had sufficient interest free funds it was justified in not charging interest on the loans given to the AEs

• Real income concept advocated • On a without prejudice basis, the taxpayer submitted that the TPO in

subsequent assessment years had computed the arm’s length price of the international transaction of interest free loan at 4.5 percent per annum

• The taxpayer submitted a letter from bank as external CUP Tribunal Decision / Observations • Cost of funds is not relevant for determining CUP • Need to see comparable transactions – internal or external • CUP compares the price of an international transaction with that of

comparable uncontrolled transaction • Comparable transaction should be a forex loan • ITAT rejected the application of CUP by the TPO (rate on cash credit) • VVF Ltd. had availed foreign currency loan from ICICI • Using the interest rate charged thereof, confirmed the addition for interest

Key Recent Rulings


Case Synopsis

Nimbus Communication Vs. Asst. CIT [132 TTJ 351] Interest on outstanding amount of AE

Facts • Taxpayer had receivables outstanding from AEs for > 180 days • TPO attributed interest on extended credit and made

adjustment • For adjustment TPO used rate of interest charged for inter-

company loan Tribunal Decision / Observations • Taxpayer has not charged interest on delayed payments from

third parties • Taxpayer has not paid interest on delayed payments to its

creditors • TPO has not followed any of the methods in making

adjustment • Loans and trade credit are different and not comparable • ITAT deleted adjustment on merits and law

Key Recent Rulings


Case Synopsis DCIT Vs. Jindal Dyechem Industries Pvt. Ltd. [ITAT Delhi] [ITA NO. 2877/DEL/2009] Interest free Loan

Facts • Assessee has provided interest free loan to its AE a wholly owned

subsidiary (WOS). • Some advances given for purchase of bullion remained outstanding

since long. • AO invoked provisions of the Sec – 92 • Assessee objected and claimed that case must be referred to TPO • Notional interest should not be charged to tax since it receives

regular dividend and pays tax • AO determined ALP considering LIBOR + 1.25% • CIT (A) agreed with the Assessee and deleted the addition Tribunal Decision / Observations • AO is not mandatorily required to refer all the cases to TPO • Set aside to CIT(A) for deciding issue afresh

Key Recent Rulings


Case Synopsis Logix Micro Systems Ltd. ITAT Bangaluru [42 SOT 525] [ITA No.423 /Bang/2009] Interest on outstanding amount of AE

Facts • Assessee is engaged in software consultancy and development • It provided services to its AEs. • Other international transactions: purchase of software and capital

goods from AEs • Applied TNMM and determined ALP • TPO accepted the TNMM as MAM and all transactions to be at Arms;

Length • However TPO found that at the last day of FY total outstanding

payment from AE was ` 7.73 crores out which ` 5.53 crores was outstanding for more than 6 months

• TPO charged notional interest at PLR of 10.25% on ` 5.53 crores • CIT(A) agree with TPO that such outstanding partook character of

loan however allowed relief by applying rate of interest at LIBOR / US-FED instead PLR

Tribunal Decision / Observations • AO is not mandatorily required to refer all the cases to TPO • Set aside to CIT(A) for deciding issue afresh

Key Recent Rulings


Case Synopsis Logix Micro Systems Ltd. ITAT Bangaluru [42 SOT 525] [ITA No.423 /Bang/2009] Interest on outstanding amount of AE

Tribunal Decision / Observations • The ALP of such outstanding amount should not calculated

considering the same as loan but it should be determined considering the factor that if the fund were brought back by Assessee within reasonable time it would have earned income on the said funds. [opportunity cost]

• The decision of CIT(A) for considering LIBOR or US-FED rate is overruled and held that the funds were to be brought in India and income lost due to non-remittance was to be generated in India therefore application of US rates is not logical.

• Further, ITAT also rejected the rate of PLR as ALP of blocked funds should be determined on the basis of the deposit rate and not at the lending rate.

• In view of above ITAT held that the Arm’s Length interest on blocked funds amounting to ` 5.53 crores should calculated at the rate of 5% instead of 10.25%

Key Recent Rulings


Case Synopsis Amadeus India Pvt. Ltd. Vs. ACIT ITAT Delhi [ITA No. 5203/Del/2010] Jurisdiction of TPO

Facts Assessee is JV between Bhatia family (95% equity) and German Travel

Services (5% equity) Provides data process and related services to AEs and it is responsible

for allowing access to subscribers to Amadeus products in the Territories of India, Bangladesh and Nepal

Applied TNMM for all the transactions with PLI OP/TC being 43.46% against the comparable 8.02%

TPO accepted the ALP of all the transactions reported by the Assessee. However, he found that the Assessee has incurred abnormal AMP expenditure in respect of AEs Brand being 40.87% of sales

TPO determined AL expenditure of 12.16% of sales being average AMP expenses of three companies selected by him

The TPO made upward adjustment to the income of ` 32.93 crores being 10% mark-up on such expenditure

Assessee questioned the jurisdiction of TPO as said transaction was not referred by the AO

Key Recent Rulings


Case Synopsis Amadeus India Pvt. Ltd. Vs. ACIT ITAT Delhi [ITA No. 5203/Del/2010] Jurisdiction of TPO

Tribunal Decision / Observations Provisions of section – 92CA(1) is very clear that the TPO has to

determine ALP of the Transactions referred by AO.\

The said interpretation is supported by the CBDT Instruction no. 3/2003 wherein role of TPO is explained

Suo moto, he cannot take cognizance of any international transaction for suggesting adjustment in arm's length price.

Additions / Adjustments made by TPO and AO is sought to be deleted.

Key Recent Rulings


Case Synopsis CA Computer Associated Pvt. Ltd. Vs. DCIT Mumbai ITAT [37 SOT 306] [ITA No. 5420 AND 5421/Mum/2006] [2010-TII-05-ITAT-MUM-TP] [Bad Debt cannot be the factor for ALP]

Assessee is a 100% subsidiary of a USA-based software company - engaged in business of licensing infrastructure software products of the parent company - also sets up Technical Support Centre to provide support services to end users on behalf of the parent company - also develops customized software .

Assessee has filed loss return TPO reduces the quantum of royalty payment on the ground that

when some of sales did not fructity for various reasons, and the same were written off by the assessee in the same financial year, there is no question of paying royalty on such sales merely on the basis of raising invoices and has made adjustment accordingly.

The Jurisdiction of TPO was questioned. Further, it was argued that the TPO has not selected any method for determining the ALP as prescribed in 92C.

Hon’ble ITAT concluded that under the Indian Transfer Pricing Regulation bad debts written off cannot be factor to determine the ALP. Further, the TPO has exceeded his limitation by following the method which is not authorized under the Act or Rules. Accordingly the AO was directed to accept the ALP of Royalty as determined by the Assessee.

Key Recent Rulings


Case Synopsis ACIT vs. Dufon Laboratories Mumbai ITAT [39 SOT 50] [IT Appeal No. 1399 (Mum.) of 2009] [2010-TII-26-ITAT-MUM-TP] [Various Adjustments to PLI]

Turnover or quantity difference: The sale to Non-AE is of 1150 Kgs only, whereas there is a sale to the

magnitude of 62,000 Kgs. to the AE which will have a bearing on the prices. Volume sold is a significant factor in fixing the price.

Geographical difference: In the case of Ranbaxy Laboratories Ltd. v. Asstt. CIT it has been held

that it could have been appreciated if a particular entity in a particular country was sought to be compared with some similar entity in that very country as geographical situations in several ways influence the transfer pricing.

Profile of Customer: The transaction with high profile clients such as AKZO Nobel or Isola is

different when compared to small sales to small players in South East Asian business.

Survival of the Assessee: In order to capture and maximize its profits of the big and flourishing

market of USA and Europe, the Assessee has to depend on its AE only

Key Recent Rulings


Case Synopsis Global Vantedge Pvt. Ltd. Vs. DCIT – Delhi ITAT [1 TTR 326] [37 SOT 1] (Tested Party) (Revenue Sharing Agreements) (Adjustment to PLI) (Application of TNMM) (Comparability)

Structure Bermuda – Mauritius – India Assessee is engaged in rendering IT enabled services. Enters into an revenue sharing agreement for providing services with one

of the fellow subsidiary in USA. US based company contracting with clients in USA to provide services of

debt collection and telemarketing services. Due to lack of enough infrastructure for executing the work, it diverts the work to the Assessee.

Assessee received 90.6% of the total revenue earned by USA Based AE whereas only 18% of total revenue earned by the Assesssee from services rendered to Independent clients. Assessee benchmarked the International Transaction considering AE as the Tested Party.

TPO concluded that the Assesssee itself should be considered as tested party and considering the comparables made adjustment of Rs.14.70 crores against the total transaction of Rs. 8.32 crores.

CIT (A) Confirmed the issue of Tested Party in favor of TPO. However held that under revenue sharing total adjustment cannot exceed the amount of total revenue earned by the Assessee and its AE.

FAR analysis should be given importance while determining ALP. Transaction of Different nature cannot be aggregated for the purpose of

application of TNMM. Adjustment of 33.33% to the profitability has been allowed on account of

1/3rd idle capacity

Key Recent Rulings


Case Synopsis Global Vantedge Pvt. Ltd. Vs. DCIT – Delhi ITAT [1 TTR 326] [37 SOT 1] (Tested Party) (Revenue Sharing Agreements) (Adjustment to PLI) (Application of TNMM) (Comparability) (5% Variance)

CIT (A) calculated ALP at Rs. 11.38 Crores. In view that the ALP cannot exceed total revenue it has been restricted to Rs. 9.16 Crores. CIT(A) did not allow 5% adjustment as difference was exceeding 5% of ALP.

Assessee and Department both filed appeal before ITAT ITAT held that neither assessee nor department had been able to point

out any basis or material or criteria to controvert the findings of CIT(A) and hence the order of the CIT(A) is upheld.

Key Recent Rulings


Case Synopsis

CIT Vs. Glaxo Smithkline Asia (P.) Ltd. [Supreme Court] [195 TAXMAN 35] [2010-TII-02-SC-LB-TP]

The Apex Court in deciding the Special Leave Appeal observed and opined that that the transfer pricing provisions should also be extended to domestic related party transactions and laid down some principles as under:

No interference if exercise is revenue neutral

As per Apex Court, under invoicing of sales and over invoicing of purchase would be revenue neutral under domestic transaction unless:

If one party is loss making and other is profit making

If there are difference in rates charged between two different related party on account of different status, area based incentives, nature of activity etc.

Apex court , further, opined that though it normally does not make recommendations or suggestions, but in order to reduce litigation in complicated matters, the question of extending Transfer Pricing Regulations to domestic transactions require expeditious consideration by Ministry of Finance and CBDT

Key Recent Rulings


Case Synopsis

Intel Asia Electronics Inc, India Branch Office Vs. ADIT [Bangalore ITAT] [ITA No. 131/Bang/2010] [2011-TII-14-ITAT-BANG-TP] [Transfer of Assets]

Facts The assessee is a foreign company having a branch office in India. The Intel Technologies India Pvt. Ltd. is the AE of the Assessee Primarily engaged in sales and market support services Assessee decided to close down the office in India and transfer all its

assets and liabilities to its AE as going concern. The Consideration was determined as difference of value of assets

and liabilities in the books of the Assessee. The Value of assets was determined in accordance to the certificate of

Chartered Engineer and Registered Valuer TPO disregarded the valuation certificate on the ground that the

valuer has charged depreciation arbitrarily and applied net book value method for determining ALP of transfer of PE business

CIT(A) upheld the order by TPO and AO Tribunal Decision / Observations Rejection of Valuation report is upheld – Assets should be valued

using IT depreciation rates. Therefore the matter is set aside to the file of AO with direction to

determined the ALP using IT rates of depreciation.

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Issues Cases

Dispute Resolution Panel

JCB India Ltd GAP International Sourcing India Pvt. Ltd. (2010-TII-59-ITAT-DEL-TP) AIA Engineering Ltd. Vs. DRP (2010-TII-02-HC-AHM-TP) Vodafone Essar Ltd. Vs DRP (Delhi HC) (2010-TII-22-HC-INTL) Pankaj Extrusion Ltd. Vs ADIT (Guj. HC) (2010-TII-03-HC-AHM-TP) Aircon International (India) Pvt. Ltd. Vs. DCIT (2011-TII-25-ITAT-DEL-TP) Actis Advisers Pvt. Ltd. Vs. DCIT (2011-TII-05-DEL-TP) Atotech India Ltd. Vs. ACIT (2011-TII-10-ITAT-DEL-TP)

Comparables Adobe Systems India Pvt. Ltd. Vs ACIT (2011-TII-13-ITAT-DEL-TP) Bechtel India Pvt. Ltd. Vs. DCIT (2011-TII-07-ITAT-DEL-TP) Intervet India Pvt. Ltd. Vs. ACIT (2010-TII-12-ITAT-MUM-TP) Vedaris Technologies (P) Ltd. Vs. ACIT (2010-TII-10-ITAT-DEL-TP) ACIT Vs. Toshiba India Pvt. Ltd. (2010-TII-14-ITAT-DEL-TP) ACIT Vs. Cheminova India Ltd. (2010-TII-19-ITAT-MUM-TP)

Selection of MAM Star Diamond Group Vs. Dy. DIT (2011-TII-20-ITAT-MUM-TP) Clear Plus India Pvt. Ltd. Vs. DCIT (2011-TII-23-ITAT-DEL-TP) Monsanto Holdings Pvt. Ltd. Vs. DCIT (2011-TII-11-ITAT-MUM-TP) ACIT Vs. Twinkle Diamond (2010-TII-09-ITAT-MUM-TP) DCIT Vs. 3 Global Services Pvt. Ltd. (2010-TII-15-ITAT-MUM-TP) Serdia Pharmaceuticals (India) Pvt. Ltd. Vs. ACIT (2011-TII-02-ITAT-MUM)

Other Recent Rulings


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Penalty J J Exporters Ltd. Vs. DCIT (2011-TII-08-ITAT-KOL-TP) – Delay in filing ACIT Vs. Firmenich Aromatic (India) Pvt. Ltd. (2010-TII-17-ITAT-MUM-TP) – 271(1)(c) Open Technologies India Pvt. Ltd. Vs. DCIT (2010-TII-43-ITAT-DEL-TP) – Non filing of 3CEB ACIT Vs. Foster Wheeler India Pvt. Ltd. (2010-TII-56-ITAT-MAD-TP)

Jurisdiction of AO Ericsson AB Vs Addl. DIT (Delhi HC) (2010-TII-02-HC-TP)

Rejection of TP Report

DCIT Vs. Indo American Jewelry Ltd (2010-TII-24-ITAT-MUM-TP) Star Diamon Group Vs. DCIT (2011-TII-20-ITAT-MUM-TP)

Royalty Nestle India Ltd. Vs. DCIT (2007-TII-04-ITAT-DEL-TP) [111 TTJ 498] ACIT Vs. Sona Okegawa Precision Forging Ltd. (2010-TII-41-ITAT-DEL-TP)

Loss making comparable

ACIT Vs. Wockhardt Ltd. (2010-TII-46-ITAT-MUM-TP) Quark Systems Pvt. Ltd. Vs. DCIT (2010-TII-02-ITAT-CHD-SB-TP)

Proposed Changes in Tax Law CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC 49 8 March 2011

Proposed Changes in Finance Bill, 2011

Determination of Arm’s Length Price

– Concept of +/- 5% Variance

Additional powers to TPOs

Transaction with person located in

notified territory

Power to call information from

foreign competent authority

Other important changes relating to

NR



Determination of Arm’s Length Price – +/- 5% Variance Proviso to section – 92C(2) ALP determined is within the range of +/- 5% of

International transactions, is to be considered to be at ALP

It is argued and debated that the static cushion of 5% for all type of industry segments and nature of transactions .

The Finance Bill, 2011 proposes to amend the proviso for withdrawing static cushion of 5% and to allow Central Govt. to notify industry specific and transaction specific variance.

Step forward for implication of Safe Harbour



Additional Powers to TPO There is dispute in respect of power of TPO is restricted

to transactions referred to him by AO In the case of Amadeus India Pvt. Ltd. , TPO determined

ALP of a transaction not mentioned in 3CEB and nor referred by the AO

ITAT held that the such Action of TPO is ultra vires Finance Bill, 2011 proposes to introduce new provision

under section 92CA(2A) to empower the TPO to determine the ALP of such transactions.

Further, powers of TPO is proposed to be enhanced by amending Sec – 92CA(7) for conducting survey u/s 133A



Transaction with person in notified territory (proposed new section – 94A)

New tool in “Tool Box” or a Deadly Weapon Transaction with person located in Notified territory

would be subjected to transfer pricing provisions Person located means: resident, Place of Business, or PE Such transactions shall not be allowed the accepted

variation band of ALP 30% TDS if assessee fails to provide required information In case amount received or credited to the account of

assessee the source of such person to be provided The provisions proposed to be applied from 1-06-2011



Other important changes The last date for Filing of Return where TP provisions are

applicable is proposed to be extended to 30th November from the A.Y. 2011-12

The Liaison office are now required to file a Statement of Activity in prescribed form within 60 days from the end of FY.

Reduced rate (15%) of tax on Dividends received from foreign subsidiary (provision only for A.Y. 2012-13)

The time taken for obtaining information (under DTAA or EIA) from foreign tax authority shall be excluded for final date of passing order u/s 153(2) (overall limit is 6 months)



Advance Pricing Agreements OECD defines APA as:

“an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria for the determination of the transfer pricing for those transactions over a fixed period of time”.

Objective to provide certainty to taxpayers with respect to their tax liability relating to international transactions with associated enterprises

APAs can be applied for a variety of transactions, e.g. dealings in goods/ services, financing arrangements, transfer and use of tangible / intangible assets, etc. APAs are a voluntary process as the taxpayer decides what transactions to address

Types of APA: Unilateral APA Bilateral APA



Advance Pricing Agreements Direct Taxes Code Bill 2010 proposes to introduce APA

The CBDT with the approval of the Central Government may enter into an agreement with the tax payer, specifying the manner in which the arm's length price is to be determined in relation to an international transaction.

The said agreement will be valid for a maximum period of five consecutive financial years unless there is a change in law or facts.

The agreement will be binding on the tax payer and the CIT and the income tax authorities below him.


Other Important Topics Mutual Agreement Procedure (in respect of TP) TP Adjustments may result into economic double taxation In view to avoid double taxation the enterprise of the

contracting state may initiate MAP for allowing corresponding adjustment to the income if TP adjustments made in the case of enterprise of the other contracting state.

The right to initiate MAP has been given under the Article – 9 / 10 of DTAA with many countries

Mostly a procedure of consultation not litigation Application can be made as per Rule 44G in prescribed Form

34F Competent Authority of both the Countries would resolve the

issue Recently a MAP has been decided in respect of Arm’s Length

Margin to be kept by Captive service provider under the DTAA between India and USA


Other Important Topics Controlled Foreign Company (“CFC”)

Provisions in respect of Controlled Foreign Company proposed to be introduced by DTC Bill 2011.

The Foreign company shall be regarded CFC if • It is a resident of a territory with lower rate of taxation (i.e. where taxes paid

are less than 50 percent of taxes on such profits as computed under the DTC), and

• Its shares are not listed on any stock exchange recognized by such Territory, and • It is, individually or collectively, controlled by persons resident in India (through

capital, voting power, income, assets, dominant influence, decisive influence, etc.), and

• It is not engaged in active trade or business, and • It has specified income exceeding ` 25 Lacs

The income attributable to CFC shall be included in the income of the person resident in India

The resident taxpayer will have to furnish details of investments and interest in entities outside India in the prescribed form and manner

The amount received from a CFC as dividend in a subsequent year will be reduced from the total income to the extent it has been taxed as CFC income in any preceding previous year

Applicable to taxpayer irrespective of DTAA CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC 58 8 March 2011

Mindset of IRA Extracts from FM’s inaugural address at the International Seminar on Transfer Pricing organized by CBDT and OECD (17 – 19 February 2010) “The transfer pricing regulations have come of age in India – both in terms of quality

of audits as well as the revenue generated for the Government. Till date, the Directorate of Transfer Pricing has made an adjustment of Rs. 23,000 crore (approx. US $ 5000 million), which is a great achievement in a small period of time. For this, I appreciate the Income Tax Department.”

“I am very happy to learn that CBDT is making all efforts to improve technical skill of

the manpower posted in Directorates of Transfer Pricing. I am sure that CBDT by increasing its dedicated transfer pricing resources and by improving their specialists capabilities will be able to meet emerging challenges in administration of transfer pricing regulation and would augment government’s effort to mobilize more revenue for the development work.”

Views of DG International Tax, as reported in TP Week issue dated 13 April 2010 “India’s director-general of international tax and transfer pricing has said thin capitalization, advance pricing agreements and safe harbour provisions are his three priorities for the coming year.”


Defense Mechanism Robust documentation in respect of ALP analysis for each of international

transactions. Have precise FAR analysis separate for each international transaction If transaction in respect of Intangibles:

If recurring payments (royalties) • Documents for Technology received • Cost of technology by AE • Latest valuation of intangibles • Status of Patent and Trademark rights held by AE

If outright purchase • Robust valuation reports • Strong base for valuation • Cost – benefit analysis • Background documents

Detailed comparative analysis and proper adjustment for differences Detailed document if high value used machineries procure from AE Drafting inter-company agreement or long term transfer pricing group policies

with utmost care CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC 60 8 March 2011

Key Takeaway TP is an ART and not a precise SCIENCE

Application of concepts requires flexibility and

judgment

TP is CONSULTING i.e. a PROCESS and not a PRODUCT

The Revenue will never understand the business as well as you do BUT if you fail to explain your business

and pricing in easy “language”, you will encounter ongoing expensive difficulties.


Contact Details Prashant N. Kotecha Assistant Manager K. C. Mehta & Co. Mob: 98251 53981 Mail: [email protected]


CA. Prashant N Kotecha Study Circle - Baroda Branch of WIRC

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