Post on 25-Dec-2015
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
PricewaterhouseCoopersApril 2010
Slide 4
Arm’s length principle
Brief legislative framework
International transactions- goods- services- intangibles
Associated enterprise
Resident
Transfer price
Independent entity
Resident
Arm’s length price
PricewaterhouseCoopersApril 2010
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
Brief legislative framework
PricewaterhouseCoopersApril 2010
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
Brief legislative framework
PricewaterhouseCoopersApril 2010
Slide 7
Penalties
Brief legislative framework
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
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 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?
PricewaterhouseCoopersApril 2010
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
Brief on Assessment Procedures
AO to compute total income
in conformity with the ALP
determined by TPO
Can AO change the order by TPO?
PricewaterhouseCoopersApril 2010
Slide 11
Appeals : Framework
Brief on Assessment Procedures
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
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 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
PricewaterhouseCoopersApril 2010
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?
The Charging Section & International Transactions
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
PricewaterhouseCoopersApril 2010
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)]
The Charging Section & International Transactions
PricewaterhouseCoopersApril 2010
Slide 16
Deemed International Transaction
The Charging Section & International Transactions
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?
PricewaterhouseCoopersApril 2010
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?
The Charging Section & International Transactions
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?
PricewaterhouseCoopersApril 2010
Slide 18
… Case studies on International Transactions
The Charging Section & 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?
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 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
PricewaterhouseCoopersApril 2010
Slide 21
Associated Enterprises
Associated Enterprises
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)]
PricewaterhouseCoopersApril 2010
Slide 22
… Associated Enterprises : participation criterion
Associated Enterprises
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
Management/ Control/Capital
Management/ 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)]
PricewaterhouseCoopersApril 2010
Slide 23
… Associated Enterprises : Common control criterion
Associated Enterprises
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
PricewaterhouseCoopersApril 2010
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
Associated Enterprises
PricewaterhouseCoopersApril 2010
Slide 25
… Associated Enterprises : deeming fictions
Associated Enterprises
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)]
PricewaterhouseCoopersApril 2010
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?
Associated Enterprises
A
B
SalesA acquires B on December
1, 2008
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 28
=Whether
Let’s look at principles of comparability before understanding the methods
Principles of comparability
Apple to apple comparability !!!
PricewaterhouseCoopersApril 2010
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.
Principles of comparability
Can related party transactions be considered?
PricewaterhouseCoopersApril 2010
Slide 30
Principles of comparability
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
PricewaterhouseCoopersApril 2010
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.
Principles of comparability
Availability of data at the time of entering into transactions?
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 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
PricewaterhouseCoopersApril 2010
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
PricewaterhouseCoopersApril 2010
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
Computation of Arm’s Length Price
Comparable Uncontrolled Method (“CUP”)
ParentCompany
Subsidiary
Third Party
Third Party
OutsideIndia
India Internal CUP
External CUP
PricewaterhouseCoopersApril 2010
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
Computation of Arm’s Length Price
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
PricewaterhouseCoopersApril 2010
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
Computation of Arm’s Length Price
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?
PricewaterhouseCoopersApril 2010
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
Computation of Arm’s Length Price
Detailed guidance about PSM in Proposed OECD Guidelines
Profit Split Method (“PSM”)
PricewaterhouseCoopersApril 2010
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
Computation of Arm’s Length Price
Transactional Net Margin Method (“TNMM”)
Popular amongst tax payers Favoured by Revenue Authoritiessince protects tax base erosion
PricewaterhouseCoopersApril 2010
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.
Computation of Arm’s Length Price
… TNMM
PricewaterhouseCoopersApril 2010
Slide 41
… TNMM
Computation of Arm’s Length Price
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)
PricewaterhouseCoopersApril 2010
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
Computation of Arm’s Length Price
Choice of MAM : General categorisation
PricewaterhouseCoopersApril 2010
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)
Computation of Arm’s Length Price
Peculiarities in computation of ALP
Whether +/- 5% benefit can be availed if only one ALP computed ?
PricewaterhouseCoopersApril 2010
Slide 44
More than one price determined by MAM:
Computation of Arm’s Length Price
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
PricewaterhouseCoopersApril 2010
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
Computation of Arm’s Length Price
… 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.
PricewaterhouseCoopersApril 2010
Slide 46
Application of +/-5% under TNMM
Computation of Arm’s Length Price
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
PricewaterhouseCoopersApril 2010
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
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 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
PricewaterhouseCoopersApril 2010
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)]
Documentation Requirements
… Mandatory documentation
PricewaterhouseCoopersApril 2010
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
Documentation Requirements
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
Part ITransfer Pricing Legislation
PricewaterhouseCoopersApril 2010
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
PricewaterhouseCoopersApril 2010
• 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
PricewaterhouseCoopersApril 2010
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
PricewaterhouseCoopersApril 2010
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
PricewaterhouseCoopersApril 2010
Issues and Case Studies – Issue 1 : Pricing Policy
• 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
Issues and Case Studies
PricewaterhouseCoopersApril 2010
Issues and Case Studies – Issue 1 : Pricing Policy
• 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
PricewaterhouseCoopersApril 2010
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
PricewaterhouseCoopersApril 2010
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
Issues and Case Studies
PricewaterhouseCoopersApril 2010
Issues and Case Studies – Issue 3 : Comparability Issues
• 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
Issues and Case Studies
PricewaterhouseCoopersApril 2010
Issues and Case Studies – Issue 3 : Comparability Issues
• 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
Issues and Case Studies
PricewaterhouseCoopersApril 2010
Issues and Case Studies – Issue 3 : Comparability Issues
• 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
Issues and Case Studies
PricewaterhouseCoopersApril 2010
Issues and Case Studies – Issue 3 : Comparability Issues
• 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
Issues and Case Studies
PricewaterhouseCoopersApril 2010
Issues and Case Studies – Issue 3 : Comparability Issues
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
Issues and Case Studies
PricewaterhouseCoopersApril 2010
Issues and Case Studies – Issue 3 : Comparability Issues
• 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
PricewaterhouseCoopersApril 2010
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
Issues and Case Studies
Dispute Resolution Panel (‘DRP’)Proposed revision of Chapters I-III of OECD TP GuidelinesOther proposed developmentsRecent TP case laws
Part IIIRecent Developments
PricewaterhouseCoopersApril 2010
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
Dispute Resolution Panel (‘DRP’)Proposed revision of Chapters I-III of OECD TP GuidelinesOther proposed developmentsRecent TP case laws
Part IIIRecent Developments
PricewaterhouseCoopersApril 2010
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
Dispute Resolution Panel (‘DRP’)Proposed revision of Chapters I-III of OECD TP GuidelinesOther proposed developmentsRecent TP case laws
Part IIIRecent Developments
PricewaterhouseCoopersApril 2010
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
Dispute Resolution Panel (‘DRP’)Proposed revision of Chapters I-III of OECD TP GuidelinesOther proposed developmentsRecent TP case laws
Part IIIRecent Developments
PricewaterhouseCoopersApril 2010
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
PricewaterhouseCoopersApril 2010
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.
PricewaterhouseCoopersApril 2010
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
PricewaterhouseCoopersApril 2010
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 !!!
PricewaterhouseCoopersApril 2010
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.”