Transfer Pricing

Sanjay Tolia

Partner, Transfer Pricing

Agenda

• TP audit environment

• Recent Developments in TP

• TP Issues and Solutions

� Marketing Intangibles

� Corporate Guarantee

� Customs and Transfer Pricing

Price Waterhouse & Co.

� Customs and Transfer Pricing

� Price setting v. Price testing

• Recent TP rulings

• Questions?

Slide 2

December 30, 2011

• 10th Year of TP documentation

• 7th round of TP audit completed in

October 2011

� TP adjustment made only in 52% of

cases

� TP adjustment - Rs. 44,500 crores

(approx)

TP audit environment*

30,000

44,500

Amount of TP Adjustment(Rs. in crores)

2008

2002- 2005

Price Waterhouse & Co. Slide 3

(approx)

� TP adjustment in Mumbai region -

Rs. 22,000 crores (approx)

December 30, 2011

10,000

20,000

2008

2007

2006

*Data taken from published source.

Recent developments in TP

• Direct Taxes Code Bill, 2010 (‘DTC’) proposed -

� from April 2012

� to introduce Advance Pricing Agreement (‘APA’)

• MAP between India - US and India - UK

Price Waterhouse & Co. Slide 4

December 30, 2011

TP Issues and Solutions

• Marketing Intangibles1

• Corporate Guarantee2

Price Waterhouse & Co.

• Customs and Transfer Pricing3

• Price Setting v. Price Testing4

Slide 5

December 2011

Marketing Intangibles Issues

AMP Expenditure

Crosses bright-line test?

Routine expenditure in the ordinary course of business

Economic ownership in form of marketing intangible may get created

No

Yes

Solutions

• Identify the entity performing Significant People Functions (‘SPF’) relating to Advertisement, Marketing and Promotion (‘AMP’) activities

• Entity which performs SPF will be beneficiary of AMP activities and accordingly must bear AMP

Price Waterhouse & Co.

may get created

Entrepreneur

Manufacturer

Reimbursement of excessive AMP spend

Yes

No

Slide 6

December 30, 2011

and accordingly must bear AMP cost & corresponding return

• Proper documentation to be maintained

- Survey report

- Industry data, etc.

to demonstrate AMP’s direct nexus with local market

• TP team to work in sync with marketing team

Profit attributable to AMP already taxed in India !

Distributor

Corporate Guarantee

Issues

Guarantee

ImplicitNot intra-group service

Yes

No

Solutions

• Determine arm’s length guarantee fees

- Comparable Uncontrolled Price (‘CUP’) Method

� Internal CUP

� External CUPShareholder’s

Price Waterhouse & Co.

Whether it is Quasi-Equity?

Explicit

Determine arm’s length Guarantee fees

Slide 7

December 30, 2011

� External CUP

- Interest Saved Approach

- Risk of loss Approach

• Robust documentation

• TP team to work in sync with Treasury team

Shareholder’s service not chargeable

Yes

No

Customs and Transfer Pricing….

Comparison of key aspects

Key Aspects Transfer Pricing Customs

Methods Specified

CUP Transaction Value of

- Identical goods

- Similar goods

Resale Price Deductive Value

Price Waterhouse & Co. Slide 8

December 30, 2011

Cost plus method Computed Value

Profit split / TNMM Residual method

Choice of valuation methodology

No Priority to any Methods • Transaction Value (‘TV’) based on

the specified methods

• Upon rejection of the assessee’s

determined TV, the hierarchy of

the valuation methods followed to

re-determine the price

Documentation As per Rule 10D No requirement specified by the legislation. However, as practice SVB questionnaire is issued.

….Customs and Transfer Pricing

Issues

• Divergence of definition and other requirements in Customs Valuation Rules and TP

• Inverse relationship between concern of Customs and Income-tax authorities.

• Can Customs value be used for TP and vice-versa?

Solutions

• Transfer pricing policy to be used for customs SVB order and TP Audit

• Year-end true-up/ true-down adjustment

Price Waterhouse & Co.

vice-versa?

� Customs valuation not allowed for TP purpose - Panasonic India Pvt Ltd (2010-TII-47-ITAT-DEL-TP) and Serdia Pharmaceutics (India) Pvt Ltd (2011-TII-02-ITAT-MUM-TP)

� Customs value derived from Customs database considered as comparable uncontrolled price for TP purpose -Coastal Energy Pvt Ltd. (ITA No. 2099 / Mds / 2010)

Slide 9

December 30, 2011

Price setting v. Price testing

Issues

• Approach of ‘testing’ the year end result to determine whether transfer price is at arm’s length is inconsistent

• Operating outcome at year end may be effected by several factors like market conditions, government policy etc.

Solutions

• Transfer price should be tested the way they are set

• Proper TP policy elucidating basis and rationale of setting transfer price should be maintained by the taxpayer

• Document the journey of price setting

Price Waterhouse & Co. Slide 10

December 30, 2011

Example: A Ltd an Indian company is providing marketing support services and earns commission of 5% on sales made by group companies directly into India. The operating margin earned by the A Ltd vis-à-vis comparables over period of 3 years is as follows:

Year Sales madeby group

companies (in cr)

Commission @ 5%

Total Cost (‘TC’)

Operating Profit (‘OP’)

OP/TC Comparables margin

1 1200 60 50 10 20% 20%

2 900 45 50 -5 -10% 15%

3 1100 55 50 5 10% 8%

Recent TP Rulings….

Sr. No. Case law Ruling

1 Four Soft Ltd. (ITA No. 1495/HYD/2010)

Corporate guarantee • Does not fall within scope of international transaction u/s 92B - Hence no TP adjustment is required

Inter-company loan • Rate of interest in borrowers country to be used for benchmarking inter-company loan

• LIBOR held to be an appropriate benchmark for

Price Waterhouse & Co. Slide 11

December 30, 2011

• LIBOR held to be an appropriate benchmark for determining ALP as it is internationally recognized and accepted.

Applicability of TP provision• TP provision to be applied only to AE transactions- only cost attributable to AE segment to be considered

2 Tally Solutions Pvt .Ltd. [TS 576 ITAT 2011 (Bang)]

Valuation of intellectual property rights (‘IPR’)• Excess Earning Method (‘EEM’) can be considered as well accepted method for valuation of IPR

• EEM is equivalent to CUP method

….Recent TP Rulings

Sr. No. Case law Ruling

3 Diageo India Pvt. Ltd.(ITA No. 8602/Mum/2010)

Deemed AE• Contract Bottling Units (‘CBU’) of the taxpayer was wholly dependent on use of Trademarks on which taxpayer has exclusive right- Meets the test of de facto control on decision making as set out in Sec. 92A(2)(g)

• Thus, Diageo PLC (through the taxpayer as intermediary), indirectly controls CBU. Therefore

Price Waterhouse & Co. Slide 12

December 30, 2011

intermediary), indirectly controls CBU. Therefore the taxpayer, overseas Diageo Group entities and CBU are AE

• Import transaction between CBU and overseas Diageo group entities covered by TP provision

Disallowance of AMP expenses• The TPO has no powers to scrutinize transactions which have not been referred to him by the AO1. Thus, tribunal deleted adjustment on account of AMP

1 Sec. 92CA(2A) inserted by the Finance Act, 2011 w. e. f 1.06.2011

….Recent TP Rulings

Sr. No. Case law Ruling

4 Bayer Material Science Pvt. Ltd.(ITA No. 7977/Mum/2010)

Trading v. Indenting activities• Vast difference in FAR of Trading and Indenting activities - separate benchmarking required

• Turnover of Trading segment cannot be compared with commission from Indenting

• Rate of Indenting commission does not vary with

Price Waterhouse & Co. Slide 13

December 30, 2011

• Rate of Indenting commission does not vary with Turnover and hence comparables could not be rejected merely on basis of Turnover

Use of controlled transaction for benchmarking• In absence of comparable uncontrolled transactions, Tribunal upheld use of controlled transaction for determining ALP

• Turnover to be used as basis for allocating employees cost in absence of details relating to time spend by employees

Questions?

Thank You