Transfer Pricing in India
Vishal Gada
28 November 2013
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0
Contents
1
Introduction to Transfer Pricing
2
Key components of Transfer Pricing
3
Specified Domestic Transactions
4
Methods for determining Arm’s
Length Price
5
Transfer Pricing Documentation &
Penalty
6
Transfer Pricing Issues
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Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
1
Contents
7
Base Erosion and Profit Shifting
8
Location Savings
9
Economic Scenario
10
Advanced Pricing Agreement
11
Safe Harbour
12
Case Studies and Case Laws
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2
Transfer Pricing (‘TP’) Introduction
Trend of Transfer Pricing Adjustments
Financial
Year
No. of TP
Audits
Completed
Number of
Adjust
Cases
% of Adjust
Cases
Amount of
Adjust (Rs.
In crores)
%
increase
in Amt
of
Adjust
2004-05
1,061
239
23
1,220
-
2005-06
1,501
337
22
2,287
87%
2006-07
1,768
471
27
3,432
50%
2007-08
219
84
39
1,614
-53%
2008-09
1,726
670
39
6,140
280%
2009-10
1,830
813
44
10,908
78%
2010-11
2,301
1,138
49
23,237
113%
2011-12
2,638
1,343
52
44,531
92%
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4
Transfer Pricing Litigation Scenario in India
TP Adjustments by Revenue
(USD bn)**
13.3
9.3
5.3
1.7
0.3
0.6
2.3
0.9
2002 2003 2004 2005 2006 2007 2008 2009
** Ministry of Finance and Business Standard
article dated 11 May 2013
On an average, TP adjustments are made on 54 percent of cases picked up for scrutiny
Impact may multiply with widening of definition of the term ‘International Transaction’ and
application of Specified Domestic Transactions to domestic related party transactions
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5
Transfer Pricing: A Global Overview
 New and expanding transfer pricing legislation and
rules are in trend in many countries
 Levy of Harsh penalties
 Stepped up enforcement globally in the form of:
•
More auditors, better training
•
Increasingly sophisticated
•
Change in scrutiny mechanism
 Complex issues and transactions are picked up for
scrutiny and increasingly challenged
 India, China, Australia, Korea and Japan have all
recently seen an increase in number of cases picked
up for scrutiny
 Other tax authorities have signaled intent to step up TP
compliance and field audit work
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6
Why Transfer Pricing?
Finance Minister’s speech on the rationale for
introducing Transfer Pricing Regulations
“The presence of multinational enterprises in India and
their ability to allocate profits in different jurisdictions
by controlling prices in intra-group transactions has
made the issue of transfer pricing a matter of serious
concern. I had set up an Expert Group in November 1999
to examine the detailed structure for transfer pricing
legislation. Necessary legislative changes are being made
in the Finance Bill based on these recommendations.”
-Mr. Yashwant Sinha
Finance Minister, Government of India
February 28, 2001
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7
Statutory Regulations pertaining to TP in India
Provision
Section / Rules Reference
Computation of Income from international transaction
having regard to Arms Length Price
Section 92
Associated Enterprises
Section 92A
International Transactions
Section 92B
Specified Domestic Transaction
Section 92BA / Section 40A(2)(b) / Section 80A /
Section 80-IA / Section 10AA
Computation of Arm’s Length Price
Section 92C read with Rule 10B and 10C
Power of Assessing Officer and Transfer Pricing Officer
Section 92C / Section 92CA
Power of Board to make safe harbour rules
Section 92CB
Advance Pricing Agreement
Section 92CC / Section 92CD
Reference to Dispute Resolution Mechanism
Section 144C
Documentation Requirements
Section 92D / Rule 10D
Accountant’s Report
Section 92E / Rule 10E and Form 3CEB
Penalties
Section 271 (1) (c), Section 271AA, Section
271BA and Section 271G
Income escaping assessment
Section 147
Definition
Section 92F / Rule 10A
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8
Background – What is Transfer Pricing?
 Unrelated parties
Transaction
 Related parties
Transaction
Price
Transfer
Price
 Transaction includes goods, services or finance
 Implicit Assumption: Due to special relationship
between related parties, high possibility of transfer
price being different than the price that would have
been agreed between the unrelated parties.
 And such price charged between unrelated parties in
uncontrolled conditions is referred to as the “arm’s
length” price (ALP)
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Computation of income from international transaction
having regard to arm’s length price – Section 92
Any income arising from international transaction shall be computed having regard
to the arm’s length price – Section 92(1)
 It has been explained that the allowance for any expense or interest arising from an
international transaction shall also be determined having regard to an arm’s length
price
Agreements / Arrangements towards cost allocations/ apportionments/
contributions in connection with benefit/ service / facility also covered under the TP
regulations – Section 92(2)
Any allowance for an expenditure or interest or allocation of any cost or expense or
any income in relation of the specified domestic transaction shall be computed
having regard to the arm’s length price – Section 92(2A)
Transfer pricing provisions not to be applied in case determination of arm’s length
price reduces the income chargeable to tax or increases the loss as the case may
be – Section 92(3)
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Key constituents of Transfer Pricing
Transfer Pricing
Section 92 of the Income
Tax Act, 1961 (‘Act’)
Associated
Enterprise
Sec 92A
International
Transaction
Sec 92B
Specified
Domestic
Transaction
Sec 92BA
Transfer Pricing
Documentation
Sec 92D
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Arm’s Length
Price
Sec 92C
Accountant’s
Report
Sec 92E
11
International Transaction - Section 92B(1)
 Components of International transaction :
• Transaction;
• Between two or more associated enterprises;
• Either or both of whom are non-residents
Parent Co.
Resident
India
Supply of goods / services
Subsidiary
Co.
Non Resident
Singapore
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What is an International Transaction?
 Purchase, sale or lease of tangible or intangible property; or
 Provision of services; or
 Lending or borrowing money; or
 Any other transaction having a bearing on the profits, income, losses or
assets of such enterprises; or
 A mutual agreement or arrangement for the allocation or apportionment of, or
any contribution to, any cost or expense incurred or to be incurred in connection
with a benefit, service or facility provided or to be provided to any one or more of
such enterprises
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Deemed International Transaction - Section 92B(2)
As per section 92B(2), transaction
Prior agreement
A’s Parent
3rd party
undertaken with any person other than
100%
associated enterprise shall be deemed
A
to be an International transaction if :
 there exists a prior agreement
A & the 3rd Party to be regarded as AEs
between such person and the
associated enterprise; or
Determination of
terms
A’s Parent
3rd party
 the terms of the relevant
100%
transaction are determined in
substance between such person
and the associated enterprise
A
A & the 3rd Party to be regarded as AEs
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International Transaction – Definition Expanded –
Finance Act 2012
Non reported transactions?
• Guarantee
• Excess credit period
• Advance for services
Financing Transactions covered
• Capital Financing
Business restructuring /
reorganization covered
• Covered transactions even if related profit/ loss
on future date
• Very wide coverage
Intangible properties defined
• Marketing related intangible assets (customer
list, customer contracts etc.)
• Human capital related intangible assets
(organized and trained work force)
• Other property deriving value from intellectual
content rather than physical attributes
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AE – Section 92A(1)
Section 92A (1) of the Income-tax Act states as under :
Associated Enterprise in relation to other enterprise, means an enterprise Which participates, directly or indirectly, or through one or more intermediaries,
in the management or control or capital of the other enterprise; or
 In respect of which one or more persons who participate, directly or indirectly, or
through one or more intermediaries, in its management or control or capital, are
the same persons who participate, directly or indirectly, or through one or more
intermediaries, in the management or control or capital of the other enterprise.
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AE – Primary Association
Parent
Company
Parent
Company
Parent
Company
Intermediary
Management/
Capital/Control
Subsidiary
Company
Management/
Capital/Control
Subsidiary
Company
Management/
Capital/Control
Subsidiary
Company 1
Subsidiary
Company 2
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Deemed AE – Section 92A(2)
Two enterprises shall be deemed to be associated enterprises if, at any time
during the previous year: One enterprise holds directly or indirectly voting power of not less than 26% in
other enterprise
 Any person holds directly or indirectly voting power of not less than 26% in each of
such enterprises
 Loan advanced by one enterprise constituting not less than 51% of the book value
of assets of the other enterprise.
 One enterprise provides guarantee of not less than 10% or more of the total
borrowings of the other enterprise
 More than half of the board of directors or members of the governing board, or
one or more executive directors or executive members of the governing board of
one enterprise are appointed by the other enterprise
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Deemed AE – Section 92A(2)
 Same person/s appoints more than half of directors on board or one executive
director in each of the two enterprises
 One enterprise is wholly dependent on the knowhow, patents, copyrights, trade
marks, licenses, franchises or any other business or commercial rights of similar
nature of the other enterprise
 90 percent of the raw materials consumed for the manufacture or processing of
goods and articles carried out by one enterprise is supplied by the other enterprise.
One enterprise is controlled by an individual , the other enterprise is also
controlled by such individual or his relative or jointly by such individual and
relative of such individual
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Deemed AE – Secondary Association
Power to
appoint more
than half of
directors
Holding shares
carrying 26% or
more of the voting
power
Existence
of common
control
Loans in
excess of
51% of
total assets
Deemed
Associated
Enterprises
Complete
dependence
on IPRs
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Common
executive
director(s)
Guarantees
in excess of
10% of total
borrowings
Supply of
raw materials
(90% or
more)
20
International Transfer Pricing - Genesis
Not subject to
Transfer Pricing
Associated
International
Transactions
Enterprises
(‘AEs’)
Income / expense to be
computed having regard
to Arm’s Length Price
(‘ALP’)
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Specified Domestic
Transactions (‘SDT’)
The Legislative Intent (1/4)
 Finance Act 2012 intends to extend the scope of Transfer Pricing provision to ‘Specified
Domestic Transactions’
 Coverage of TP expanded based on suggestions of Supreme Court in the case of CIT v
Glaxo SmithKline Asia (P) Ltd. [2010-195 Taxman 35 (SC)]
Recognized revenue neutrality of
domestic transactions except in
situations of ‘tax holiday’ and
‘losses’
Aim is to remove complications in
arriving at Fair Market Value (‘FMV’)
for applying provisions of Section
40A(2) and Section 80IA(10)
Supreme
Court
Held
Tax laws to be amended for
domestic transactions between
related parties to be brought within
ambit of Indian TP provisions
AO’s constraint of relevant
documents can be addressed by
making it compulsory for taxpayer
to maintain relevant documents and
obtain audit report from Chartered
Accountant
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The Legislative Intent (2/4)
Shifting of
Expenses
Loss making
Unit
No tax due
to loss
Shifting of
Expenses
Profit making
Unit
Shifting of
Income
Tax reduced
due to profit
shifting
Tax Holiday
Unit
Tax
Exemption
Taxable Unit
Shifting of
Income
Tax @ 33%
Loss to Indian Revenue as a result of the above
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The Legislative Intent – Domestic Tariff Area (‘DTA’) (3/4)
Scenario 1
Particulars
Scenario 2
Co A
Taxes in India
30%
Sales to Related Party
100
Other Income
200
Co B
Co A
Co B
Taxes in India
30%
Sales to Related Party
150
400
Other Income
200
400
-
100
Purchase from RP
-
150
Other Expenses
400
200
Other Expenses
400
200
Profit/ Loss
(100)
100
Profit/ Loss
(50)
50
-
30
Tax
-
15
30
Total Tax for the Group
Purchase from RP
Tax
Total Tax for the Group
30%
Particulars
30%
15
•By shifting of expenses from a loss making company to a profit making company, the group
could reduce its tax liability for the current year, though the impact will be reversed in future
years given carry forward of losses.
•To avoid such tax arbitrage cases and even though there is no erosion of tax base, SDT has
been introduced.
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The Legislative Intent – DTA and Tax Holiday Unit (4/4)
Scenario 1
Scenario 2
Particulars
Tax
Holiday
DTA
Particulars
Tax
Holiday
DTA
Taxes in India
0*%
30%
Taxes in India
0*%
30%
Sales to Related Party
150
Sales to Related Party
225
Other Income
300
600
Other Income
300
150
Purchase from RP
Purchase from RP
600
225
Other Expenses
300
300
Other Expenses
300
300
Profit/ Loss
150
150
Profit/ Loss
225
75
Tax
*-
45
Tax
*-
22.5
45
Total Tax for the Group
Total Tax for the Group
22.5
* Subject to MAT
•By shifting of expenses from a tax holiday unit (Power) to a unit in the Domestic Tariff Area,
the group could reduce its tax liability by 22.5.
•To avoid such cases Domestic TP has been introduced.
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Scope
 SDT defined to include
•
any expenditure in respect of which payment has been made or to be made to a
specified person [section 40A(2)(b)];
•
any transaction referred to in section 80A;
•
any transfer of goods or services referred to in sub-section (8) of section 80-IA;
•
any business transacted between the taxpayer and other person as referred to in subsection (10) of section 80-IA;
•
any transaction, referred to in any other section under Chapter VI-A or section 10AA,
to which provisions of sub-section (8) or sub-section (10) of section 80-IA are
applicable; or
•
any other transaction as may be prescribed
 Applicability
•
Applicable where aggregate amount of transactions exceeds INR 5 crores in a year
•
Applicable from FY 2012-13 onwards
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Fair Market Value (FMV) versus Arm’s Length Price (ALP)
Pre-amendment
Arm’s
Length Price
Section 92 – International transactions between two or more
associated enterprises (either or both of whom are non resident) to be
at Arm’s Length Price
Section 40A(2) – Payments to relatives and associated concerns to
be at fair market value in order to qualify as business expenditure
Fair Market
Value
Section 80-IA – If goods and services transferred between the
eligible units and any other units or vice-versa are not found to be at
market value, then deduction to be recomputed
Section 10AA – If goods and services transferred between the
eligible units and any other units or vice-versa are not found to be at
market value, then deduction to be recomputed
Concept of Fair Market Value for Domestic related party
transactions
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Fair Market Value (FMV) versus Arm’s Length Price (ALP)
Post-amendment
Arm’s
Length Price
Section 92(2) – Where in an international transaction or specified
domestic transaction, two or more associated enterprises enter into a
mutual agreement or arrangement for the allocation or apportionment of,
or any contribution to, any cost or expense incurred or to be incurred in
connection with a benefit, service or facility provided or to be provided to
any one or more of such enterprises, the cost or expense allocated or
apportioned to, or, as the case may be, contributed by, any such
enterprise shall be determined having regard to the arm's length price
of such benefit, service or facility, as the case may be.
Section 92(2A) – Any allowance for an expenditure or interest or
allocation of any cost or any income in relation to the specified
domestic transaction shall be computed having regards to the arm’s
length price
Concept of Arm’s Length Price for Domestic related party
transactions
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Fair Market Value (FMV) versus Arm’s Length Price (ALP)
Fair Market Value
Arm’s Length Price
Definition
Price which goods or
services fetch on sale in
the open market
Price applied for a
transaction in
uncontrolled conditions
Computation
Mechanism
No method prescribed
Six prescribed methods
Transaction
Value
Any market pricing point
can be treated as FMV
Arithmetical mean of
prices in case of more
than one price
Deviation
No deviation permitted
from FMV
Deviation of
+/- 1% / 3%
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Section 40A(2)(b) – Basics
 Section 92BA extends TP to “any expenditure in
respect of which payment has been made or is to
be made to a person referred to in clause (b) of
sub-section (2) of section 40A”
 Applies
only
to
‘expenditure’ in
respect
of
payments made or to be made to specified
persons
• No impact on income side
 Only the entity incurring the expense will need to
complete the prescribed compliances
 Expenditure by one group entity is income for
another group entity - arms length analysis may
consider both transacting parties
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Section 40A(2)(b) – Specified Persons
Section 40A(2)(b) - list of persons / entities to be treated as related parties/ specified persons
• Specified persons having substantial interest ( i.e. more than 20% voting power or share in profits)
in taxpayer’s business and vice-versa covered;
• Scope expanded to include sister concerns
Illustrative list of entities / persons that may be included for a corporate taxpayer:
a)
Company holds 20% or more equity in the tax payer;
b)
Companies whose 20% or more shares are held by such a company that holds more than 20%
equity in the tax payer;
c)
Companies in which the tax payer holds 20% or more equity;
d)
Directors of tax payer company, and relatives of such Directors;
e)
Directors of companies in category (a) above; and relatives of such Directors;
f)
If an individual holds 20% or more equity in the tax payer, then relatives of such an individual; all
other companies where such individual is a Director; all other Directors of such a company, and
relatives of all such Directors; etc
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Section 40A(2)(b) – Scope (1/2)
Persons covered under section 40A(2)(b) – Applicable in case of Individual assessee
Relatives
Sec 40A(2)(b)(i)
Individual
Assessee
Person in whose
business / profession
assessee or his relative
has substantial interest
Sec 40A(2)(b)(vi)(A)
“Relative” - in relation to an individual, the husband, wife, brother or sister or any lineal ascendant or descendant of that
individual
“Substantial interest” - A person is deemed to have a substantial interest in a business or profession, if,—
(a) in a case where the business or profession is carried on by a company, such person is the beneficial owner of shares
carrying not less than 20% of voting power; and
(b) in any other case, such person is, at any time during the previous year, beneficially entitled to not less than 20 % of profits
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Section 40A(2)(b) –Scope (Illustrative) (2/2)
Relative
Relative
Relative
Relative
Relative
All Directors of
such Company
All Partners of
such Firm
All Members of
such AOP
All Members of
such HUF
All Members
of such BOI
Relative
Firms in
which
individual is
Partner
Companies in
which individual
is a Director
20%
Relative
AOPs in which
individual is a
Member
HUFs in which
individual is a
Member
BOIs in which
individual is a
Member
Director
Relative
Relative
Relative
Relative
Relative
Company
Partner
Director
20%
Member
Member
Member
20%
Individual
20%
20%
Firm
20%
AOP
20%
HUF
20%
BOI
Company
20%
Assesee Company
20%
Company
AOP
Firm
Circular No. 6-P, dated 6 July 1968 refers to direct and indirect relationship
“Relative” - in relation to an individual, the husband, wife, brother or sister
or any lineal ascendant or descendant of that individual
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Illustrations
Section 40A(2)(b)(iv)
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Illustrations
Section 40A(2)(b)(iv)
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Illustrations
Section 40A(2)(b)(v)
Substantial Interest
Taxpayer
Mr. A
ABC Ltd
Director
Relative
Mr. B
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Mr. C
37
Illustrations
Section 40A(2)(b)(vi)
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Issue Relating to Indirect Holding
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Issue 1 - Direct Vs Indirect Shareholding
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Issue 2 - Whether SDT provisions applicable to transactions
with non-residents?
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Issue 3 - Capital Expenditure covered under purview of SDT
provisions?
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Issue 4 - Period of applicability of SDT to tax holiday units?
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Issue 5 - Whether inter-unit cost allocation is a SDT?
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Tax Holiday – Transfer Pricing Test
Sub-section (8) of section 80-IA (and similar such provisions in 10AA and Chapter VI-A)
Tax holiday unit
Inter unit transfers (goods and services etc.)
Other unit
Not corresponding to market value (adherence to ALP proposed)
Sub-section (10) of section 80-IA (and similar such provisions in 10AA and Chapter VI-A
Tax holiday
company
Business transacted (wider than transfer of goods or services)
Other person
having close
connection
More than ordinary profits earned by business unit claiming deduction (adherence to ALP proposed)
Transactions to be reported in Accountant’s Report and arms’ length
nature to be substantiated in TP Documentation
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Possible Tax Leakages – If ALP Not Followed (Illustrations)
X Ltd.
X Ltd.
X Ltd.
(non-tax holiday)
(non-tax holiday)
(non-tax holiday)
Sale at 120
v/s ALP
(ie 100)
Sale at 120
v/s ALP
(100)
Sale at 80
v/s ALP
(100)
Y Ltd.
Y Ltd.
Y Ltd.
(non-tax holiday)
(tax holiday)
(tax holiday)
Disallowance of
INR 20
Double
Disallowance
INR 40
[40A(2)(b)]
[40A(2)(b) and
excessive profit]
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Inefficient pricing
structure – Reduced
tax holiday benefit
46
Domestic Transfer Pricing affecting tax holiday
undertakings
Section
Nature of undertaking covered
80IA
Undertakings engaged in
 Developing, operating and maintaining, developing and operating and maintaining infrastructure
facilities
 Generation/ transmission or distribution of power
 Reconstruction / revival of power generating plants
80IB
Undertakings located/ engaged in
 Industrially backward districts as notified
 Scientific research and development
 Refining mineral oil / commercial production of natural gas
 Operating cold chain facility for agricultural produce
 Processing, preservation and packing of meat / meat products or poultry / marine/dairy products
 Operating and maintaining a hospital of specified capacity
80IC
Undertaking located in notified Centre/ Parks/ Areas in
 Sikkim
 Himachal Pradesh/ Uttaranchal
 North –Eastern states
80ID
Undertaking engaged in business of hotel / convention centre in specified areas/ districts
10AA
Undertakings having a Special Economic Zone unit
Transactions to be reported in Accountant’s Report and arms’
length nature to be substantiated in the TP Documentation
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Issue 6 - How to benchmark Directors’ Remuneration?
Possible Benchmarking
approaches
Limitations
•Ceilings provided in Companies
•Not applicable to private limited companies
Act, Central Government approvals, •Upper ceilings can be challenged by
Listing agreement norms, DPE
Revenue
Guidelines, Shareholder and Board
of Director resolutions,
Remuneration Committee approvals
•Peer review
•Availability of reliable data may be a
constraint
•Salary drawn elsewhere,
simultaneously or previously
•Generally not available for promoter
directors
•External publicly available salary
data on HR websites
•Could be unreliable and difficult to obtain
•May lead to cherry-picking
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Issue 6 - How to benchmark Directors’ Remuneration?
Possible Benchmarking
approaches
Limitations
•Comparison of ratio of Director’s
remuneration to Total Cost (or
Sales) with similar ratio for
comparable companies
•No emphasis on individual capabilities of a
Director
•Limited comparable information on
databases
•Requires high degree of comparability with
selected companies
•No known correlation between
remuneration and sales / cost of a company
•Subsumed under overall net profit
based approach
•Cannot be applied for loss making
companies
Approach likely to be challenged by
Revenue
•Qualitative analysis of educational
qualifications, work experience, etc.
•Can be used as corroborative analysis
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Miscellaneous Issues
Issues
Possible views
What does ‘close connection’ for Section
80IA(10) mean?
- Reliance on Section 92A and Section 40A(2)(b)
- Indirect shareholding covered?
Whether all transactions with a closely connected - View 1 - All transactions to report & benchmark
person included or only those resulting in more - View 2 - Only transactions resulting in more
than ordinary profits?
than ordinary profits to report and benchmark
Whether TP applicable if expense not claimed?
- Transaction to be reported, not benchmarked?
Whether SDT applicable for entities covered
under presumptive taxation rules?
- Possible to take position that not covered for
transactions covered under Section 40A(2)(b)
- Tax holiday units?
Whether transactions between two eligible units - Nothing expressly stated in the provisions
(having differential exemption) covered?
- ICAI Guidance Note mentions transfers
between ‘eligible’ and ‘non-eligible’ business?
Are free of cost goods/ services/ loans covered? - Should not be an issue under Section 40A(2)(b)
- Tax holiday units?
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Methods for determining
ALP
Computation of ALP – Section 92C
 Section 92C prescribes six methods to compute ALP
 Indian legislation provides an option to select the most appropriate method (‘MAM’)
 Where more than one ALP is determined by application of the MAM , the arithmetic mean
of such prices is taken to be the ALP
Prescribed
Methods
Traditional Transaction
Method
Comparable
Uncontrolled
Price
Resale
Price
Other
Method
Transactional Profit
Method
Cost
Plus
Profit
Split
Transactional
Net
Margin
Price charged
or paid / Price
would have
been charged
or paid
No hierarchy or preference of methods prescribed under the Act
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OECD Guidelines Hierarchy
Most Preferred
Comparable
Uncontrolled
Price Method
Cost Plus
Method
Transactional
Net Margin
Method
Traditional
Transaction
Methods
Resale Price
Method
Profit Split
Method
Transactional
Profits Methods
Least Preferred
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Order of consideration of methods
 The Indian transfer pricing regulations do not prescribe any specific
hierarchy of methods
 The OECD guidelines state that traditional transactions methods are
preferable to transactional profit methods (in a situation where both can
be applied in an equally reliable manner).
 Further, the OECD guidelines state that the CUP is the “preferred
method”, this should be used in preference to any others
 Profit-based methods are often “one-sided” methods that use profits to
make inferences about pricing
• Assumes that profits are largely dependent on transfer prices
• Profit-based methods make sense if - and only if – the assumption
holds and profits are largely dependent on transfer prices
 Application of TNMM to a specific tested party breaks down when
factors other than transfer pricing have a material impact on profits
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Selection of Transfer Pricing Methods
 Most appropriate method shall be the method best suited to the facts and
circumstances of each particular international transaction and which
provides the most reliable measure of an arm’s length price in relation to
the international transaction
Rule 10C
 Factors considered for selection of the most appropriate method
• Nature and class of international transaction
• Class of associated enterprise and functions performed
• Availability, coverage and reliability of data
• Degree of comparability between the International transaction
• Extent to which reliable and accurate adjustments can be made
• The nature, extent and reliability of assumptions for application of the
method
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Rule 10B(2) - Comparability Factors
Characteristics
Depends on type: tangible,
intangible or service
Contractual
terms
Where not written,
deduce from conduct
Comparability
factors
Functional
Analysis
Conduct is best
evidence of risk bearing,
should be consistent
with control
Economic
Circumstances
Geography, size of market, date
and time
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Rule 10B(3) - Adjustments for Comparability
An Uncontrolled transaction shall be comparable to international transactions if:
 None of the differences between the transactions being compared or between the
enterprises entering into such transactions are likely to materially affect the price, or cost
charged, or profit arising from, such transactions in the open market; or
 Reasonable accurate adjustments can be made to eliminate the material effects of such
differences.
Practical Experience – Kind of adjustments asked for:
 Working capital adjustment
 Volume adjustment
 Idle capacity adjustment
 Adjustment for difference in risk profile
 Adjustment for differences in accounting policies
 Adjustment for difference in depreciation rates
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Rule 10B(4) - Usage of Multiple Year Data
 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.
 Use of multiple year data considered useful to even out fluctuations caused by:
• Business cycles and
• Product life cycles e.g. : Seasonal sale of umbrellas
 Multiple year data widely used due to non-availability of relevant year financial statements of
comparable companies at the time of finalizing TP documentation
 Practical Experience in Transfer Pricing audits:
• TPOs follow first leg of rule 10B(4), reject multiple year data
• Adopt only data relating to the relevant financial year and undertake adjustments
(including the data which was not available at the time of filing of return)
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Comparable Uncontrolled Price (‘CUP’) Method
 Compares price charged for property/ service transferred in controlled transactions with
price charged in comparable uncontrolled transactions i.e. related parties vis-à-vis unrelated
parties
 Requires strict / high level of comparability in products, contractual terms, economic terms,
etc.
 Most Direct Method for testing ALP and the Prices are Benchmarked
 Conditions for use of CUP
• none of the differences between the transactions can materially affect price in the open
market
• calls for adjustments to be made for differences which could materially affect the price in
the open market e.g.:
Difference in volume/quality of product
Difference in credit terms
Risks assumed
Geographic market
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CUP Method
 Two types of CUPs available - Internal CUP
Parent Co
 Internal CUP - The price that the company
has charged in a comparable uncontrolled
transaction with an independent party
 External CUP - The price charged in a
uncontrolled
Outside India
(e.g. USA)
India
Unrelated
Co. X
transaction
between third parties when compared to a
price of controlled transactions
 OECD - Priority to Internal CUP over
External CUP due to higher degree of
comparability
Subsidiary Co
Unrelated Co. Y
External CUP
comparable
Transfer Price
& External CUP
Outside India
(e.g. USA)
India
Unrelated Co. Z
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CUP Method – Case Study I
 An
Indian company, mainly engaged in the
refining and sale of copper metal
 Indian
Company purchases crude metal from
both related and unrelated parties
 Critical
factors that affect the crude copper
price are –
 Volume;
•
Tenure of supply contract (long term, shortterm)
•
Alloy mix of product (copper crude come
with or without small quantities of other
metal alloys like gold and silver)
•
Unrelated
Supplier A
(Japan)
Unrelated
Supplier B
(Russia)
Related
Supplier
Foreign Co.
(AUS)
Ind Co. (India)
Other terms of contracts (FOB v/s. CIF, port
of shipment etc.)
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CUP Method – Case Study I
Criteria
Related Party
ForCo
(Australia)
Controlled
Unrelated
Party A
(Japan)
Uncontrolled
Unrelated Party B
(Russia)
Uncontrolled
Tenure of
Contract
Long Term (10
yrs)
Long Term (8
yrs)
Short Term (2 yrs)
Volume during
year under
consideration
2200 MT
3000 MT
9000 MT
Alloy Mix
0.5% Gold, 1%
silver
1% Gold, 1%
silver
None
Port of
shipment
Australia
Japan
Russia
Price (per MT)
INR 29,500
(applicable for
entire year)
INR 32,000
(applicable for
entire year)
INR 28,500
(applicable for
entire year)
Other Terms
FOB basis
CIF basis
FOB basis
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Resale Price Method (‘RPM’)
 Compares the resale gross margin earned by
associated enterprise with the resale gross
margin earned by comparable independent
distributors
 An arms’ length gross margin should be
sufficient for a reseller to cover its operating
expenses and make an appropriate operating
profit (in light of its functions and risks)
 Under this method comparability is less
dependent on strict product comparability and
additional emphasis is on similarity of functions
performed & risks assumed
 Method used in case of purchase of goods or
services from related parties for resale to
unrelated parties without substantial value
addition
 Preferred method for a distributor buying purely
finished goods from a group company (if no
CUP available)
Parent Co
Transfer Price
INR 75
Outside India
India
Resale Price
INR 100
Subsidiary Co
Unrelated Co. Y
Price paid by Sub Co. to AE is at arm’s
length if the 25% resale margin earned by
Sub Co. is more than margins earned by
similar Indian distributors`
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RPM – Case Study I
COGS = INR 150
Independent third
party in India
Resale
Price = INR 200
Gross Profit Margin = 50/200
= 25%
Foreign
Manufacturer
Transfer Price = ??
Related party in India
Resale
Price = INR150
ALP= 150 – (150*25%)
=112. 50
End Customer
Sale to independent third party at INR 150 and sale to end customer by third party at INR 200
Sale to end customer by related party at INR 150
Particulars
Amount
Gross Profit
50 i.e. (200-150)
Gross Margin
25% i.e. (50/200)
Arm’s Length Purchase Cost
112.50 i.e. [150 – (25% 0f
150)]
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Cost Plus Method (‘CPM’)
 Method uses the costs incurred by the
supplier of goods (or services) in a
controlled transaction for goods or
services provided to an related party
Parent Co
Transfer Price INR
125
 An appropriate cost plus mark-up is
added to the above cost in light of the
FAR
Arm’s Length Price = Direct and
Indirect Cost of Production
(+) mark-up (based on benchmarking
analysis) earned by comparables
Subsidiary Co
 Comparability under this method is not
as much dependent on close physical
similarity between the products
Company Y
 Larger
emphasis
comparability
on
functional
Outside India
India
COGS INR 70
Unrelated Co. Z
Price charged by Sub co to AE is at
arm’s length if the 25% mark up on
cost is more than that of similar Indian
assemblers
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CPM – Case Study
B Ltd. derives technology support
from
A Ltd. (AE)
Provision of services
100 man-hours @ INR
2,000 per man-hour
Total Costs incurred
(INR 175,000)
C Ltd
(Third Party)
@ INR 3,000 per
man-hour
GP margin earned on
costs 40 %
DIFFERENCES
A Ltd.
Provision of services
B Ltd
(20 percent of normal GP)
Marketing Risks associated with
services rendered to customers
other than A Ltd
(10 percent of normal GP)
B Ltd. offered one month’s credit to
A Ltd.
(1.5 percent GP)
Arm’s Length Price for
transaction between
B Ltd and A Ltd?
B Ltd. – Software Development +
onsite and offsite consultancy
services
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CPM – Case Study – contd…
Direct and Indirect Costs (INR)
175,000
G.P. mark-up in comparable uncontrolled transaction (A)
40 %
Less:
Adjustment for Technology Support from A Ltd. (20% of 40%)
(8%)
Risk adjustment – no market risk as regard trades with A Ltd. (10% of 40%)
(4%)
Sub-total (B)
12%
Add:
Cost of credit to A Ltd.
1.5%
Sub-total (C)
1.5%
Arm’s length GP mark-up = (A) – (B) + (C)
29.50%
Arm’s length Income (INR)
226,625
Increased Income INR (226,625 – 200,000)
26,625
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Profit Split Method (‘PSM’)
 Profit Split Method is appropriate when
•
Transactions which are not capable of being
evaluated separately
•
Analyzing tangible, intangible or services issues
•
Parties are so interdependent and it is not
possible to identify closely comparable
transactions
 Calculates the combined operating profit resulting
from an inter-company transaction based on the
relative value of each AEs contribution to the
operating profit
 The contribution made by each party is determined
on the basis of a division of functions performed,
valued, if possible using external comparable data
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Parent Co A
Technology
intangibles
Outside India
India
Mfg Company B
Marketing Co
C - Marketing
intangibles
68
Transactional Net Margin Method (‘TNMM’) (1/2)
 Applicable for any type of transaction and often
used to supplement analysis under other methods
 Most frequently used method in India, due to
 Lack of availability of comparable uncontrolled
prices and
Parent Co A
 Lack of gross margin data required for
application of the cost plus method/ resale price
method
 Examines net operating profit from transactions as
a percentage of a certain base
Unrelated Cos
Outside India
India
Subsidiary Co B
Net margin 5%
Unrelated Cos
Net margin 3%
 Operating margin should be compared to operating
margin earned by same enterprise on uncontrolled
transaction – Internal TNMM
Usually regarded as an indirect and one-sided method, but is most widely adopted
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TNMM (2/2)
 Broad level of product comparability and high level of functional comparability
 The application of the TNMM to a specific tested party breaks down when factors other than
transfer prices have a material impact upon profits
 Grouping of transaction – Relevant controlled transactions require to be aggregated to test
whether the controlled transaction earn a reasonable margin as compared to uncontrolled
transaction
 Selection of Profit Level Indicator (‘PLI’) such as Operating Margin, Return on Value added
expenses, Return on assets – Unaffected by transfer price
 Benchmarking exercise
•
Entity with similar industry classification to the tested party – through search in Prowess
and capitaline plus databases
•
Screen entities by applying appropriate quantitative filters, such as mfg sales <75%, R&D
exp >5%, Advertisement exp >5%.
•
Review financial and textual information available in the public database of the selected
entities – for qualitative filters
•
Computation of ALP
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Summary of Methods
Methods
CUP
RPM
Product
Comparability
Very High
High
Functional
Comparability
Approach
Medium
Prices are
benchmarked
Very difficult to apply as
very high degree of
comparability required
Medium
GPM (on sales)
benchmarked
Difficult to apply as high
degree of comparability
required
Difficult to apply as high
degree of comparability
required
CPM
High
High
GPM (on costs)
benchmarked
PSM
Medium
Very High
Profit Margins
TNMM
Medium
Very High
Net Profit
Margins
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Remarks
Complex Method,
sparingly used
Most commonly used
Method
71
Determination of arm’s length prices using methods
Yes
Whether
you arrive
at a single
price?
Whether tolerance band is available
even when there is single price?
No
Yes
General Atlantic v/s. ACIT (Mum ITAT)–
Held - ALP shall be taken to be in the range
of +- 5% in case of more than one
comparable prices and since there was only
one comparable , the benefit under the said
proviso would not be available
No
The arithmetic mean of such prices or a
price which varies from such arithmetic
mean by +/- 3 % / 1 % is the arm’s length
price
The Development Bank of Singapore
(Mum ITAT) - Held, benefit of +-5%
under the second proviso to section
92C is available even when only ‘one
price’ determined as ALP;
Notification No. 30/2013 [ F. No. 500 / 185 /2011-FTD I ], dated 15 April 2013
 For “wholesale traders”- band defined to be 1%
 For all others- band defined to be 3%
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Transfer Pricing
Documentation
Documentation - Basics
Entity related
 Profile of industry
 Profile of group
 Profile of Indian
entity
 Profile of
associated
enterprises
Price related
 Transaction terms
 Functional analysis
(functions, assets and
risks)
 Economic analysis
(method selection,
comparable
benchmarking)
Transaction
related
Methodology
related
 Agreements
 Invoices
 Pricing related
 Description
corresponden
ce (letters,
emails etc)
 Description
 Forecasts, budgets,
and analysis of
uncontrolled
transaction
and analysis of
methods
considered and
adopted
estimates
• Contemporaneous documentation requirement – Rule 10D
• Documentation to be retained for 9 years
• No specific documentation requirement if the value of international transactions is less
than one crore rupees
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Entity Related Documentation
Corporate Background
 Understanding taxpayer’s business, including its legal structure and the
terms of its contracts, is fundamental to transfer pricing analysis
 The documentation must start with a basic analysis of who does what and in
what legal capacity
 Identify the related parties to cross-border transactions
 Shareholding pattern viz. name of the shareholder and % of shareholding
 Determine the parties’ legal status (subsidiary or branch) and
 Whether the relationship is as agent or principal
 Profile of the taxpayer and multinational group/ associated enterprises
should be properly documented
 An understanding obtained in this phase will help carrying out Industry
analysis
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Entity Related Documentation
Industry Analysis
 Industry analysis provides the first indication of whether the prices reflect the
market conditions
 It has to be contemporaneous – relate to the period of the documentation
 Important factors to be considered
 Broad description of industry in which the taxpayer operates
 Product characteristics – generic/ specialty products
 Market dynamics – e.g. matured, growing, nascent etc. including
geographical dispersion of activities
 Market positioning – wholesaler/ retailer, contract/ full fledged manufacturer
 Existence of any restrictive regulations e.g. Drug Price Control Order
(‘DPCO’) in pharmaceutical industry
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Functional analysis
 The revenue / profits generated by a company are attributable to
• Functions performed;
• Assets deployed; and
Functions
Assets
• Risks assumed
performed
employed
in its business operations
Risks
assumed
Characterization
 A functional analysis facilitates the characterization of related parties in respect of
a specific transaction taking into account their functions, assets and risks and
assists in establishing a degree of comparability with similar transactions in
uncontrolled conditions
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77
Functions performed
 Analysis of activities carried out by each of
the parties to the transaction
 Focus should be on identification of critical
functions
which
add
value
to
the
transaction
 Assists in comparing principal functions
performed by the entities in a controlled
transaction with the functions performed in
uncontrolled transactions
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Assets employed
 Analysis of the type of assets and their nature needs to be understood
 Helps in determination of their contribution to the business process/economic
activity
 Facilitates understanding of respective roles played by the entities participating in
the International transaction
 Knowledge of assets owned and employed by the entities facilitates determination
of the profit margin to be earned by them
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Risks assumed
 Analysis of risks undertaken by each transacting entity
 As the risk increases, the expected return should increase
as well
 The potential risks are company and industry specific
 Only important risks should be described and quantified
 Important to distinguish between which entity bears risks
as per legal terms and which one bears as per the
economic substance of the transaction
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80
FAR to Characterisation…a journey
FAR is a fact finding process covering inter alia:
• Group Overview
• Company Overview and Product Profile
A functional analysis
facilitates the
characterization of related
party
• Organization Structure (Roles)
• Group Business Strategy
Helps identify the Transfer
Price
• Industry Overview
• Understanding of value-chain
• Agreements
Assist in establishing a
degree of comparability
with similar transactions
in uncontrolled conditions
• Public Documents (Annual Report, Website)
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81
Manufacturing Value Chain
Increasing profit potential
Risks and rewards are directly
related
Full Fledge Manufacturer
Licensed Manufacturer
Contract Manufacturer
Toll Manufacturer
Increasing functions, assets and risks
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82
Price Related Documentation
Economic Analysis
 Economic analysis refers to benchmarking the financial parameters of the taxpayer and
comparable companies
 Document any adjustments made for differences in functions/ risks borne by the
comparables vis-à-vis taxpayer
 Search strategy to be clearly documented
• Selection of Most Appropriate Method (‘MAM’), Tested Party, Profit Level Indicator
• Analysis of internal comparables
• Databases used and applicability of filters used to select comparables
• Search methodology and basis for acceptance / rejection of companies
• Workings of actual application of MAM
 Periodic review of TP Policy and TP documentation
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Transaction Related Documentation
 Agreements / contracts etc. with AEs or unrelated parties in respect of similar international
transactions
 Documents that may be helpful for showing the process of price negotiations with the
related parties such as agreements, invoices, emails/ faxes
 Official publications, reports, studies & databases from Government of foreign countries
 Research reports & technical publications of institutions of national or international repute
 Price publications including stock market quotations or commodity market quotations
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84
Documentation : Key Points under Rule 10D
Indian TP documentation requirements are staggering
Rule 10D prescribes detailed set of requirements pertaining to
 Organizational Structure
 Nature of business/industry and market conditions
 Controlled transactions
 Background documents
 Comparability: functions, assets and risk analysis
 Selection of transfer pricing method
 Application of the transfer pricing method
 Assumptions, strategies, policies
 Supporting information
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85
Transfer Pricing Process
Stage 1
Stage 2
Stage 3
Stage 4
Pre-project
planning
Functional
analysis
Economic
Analysis
Additional
Analysis
Issuance of
Documentation
• Preparation of
project plan
• Interviews
• Questionnaires
• Discussions with
Management
• Characterization
of each entity
• Agreement
reviews
• Search strategy
• Access to local
& global
database
• Analysis of
internal
comparables
• Judicious
identification of
arm’s length
range
• Understand
existing costing
mechanism
• Determination of
billing
methodology
• Consultation
with
management
• Finalization of
Transfer Pricing
Documentation
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Stage 5
86
Accountant’s Report – Section 92E / Rule 10E
 To be obtained by every person entering
into an international transaction and
specified domestic transaction
 To be filed by the due date for filing return
of income (now e-filing mandatory)
 Opinion whether prescribed documents
have been maintained, the particulars in
the report are “true and correct”
Form No. 3CEB
[See rule 10E]
Report from an accountant to be furnished under section 92E relating
to international transaction(s)
1.
We have examined the accounts and records of ENTITY NAME
AND POSTAL ADDRESS - PAN No. relating to the international
transactions entered into by the assessee during the previous
year ending on 31st March 2013.
2.
In our opinion proper information and documents as are
prescribed have been kept by the assessee in respect of the
international transaction (s) entered into so far as appears from
our examination of the records of the assessee.
3.
The particulars required to be furnished under section 92E are
given in the Annexure to this Form. In our opinion and to the
best of our information and according to the explanations given
to us, the particulars given in the Annexure are true and correct.
 Relevant annexures and appendices be
attached
 Inputs:
• Related party ledgers extracts
• Related party Schedule under AS-18
• Sample Invoices/ Vouchers / DN / CN
Place : Ahmedabad
• Relevant intra-group agreements
Date :
• CUP information
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For XYZ Co.
Chartered Accountants
87
Cyprus : Notified Jurisdictional Area u/s 94A
 CBDT vide notification 86/2013 dated 01 November
2013, notified Cyprus under Section 94A of the
Income Tax Act, 1961 for not providing information
to Indian Income Tax Authorities
 This notification would have far reaching
implications on entities of India having
transactions with any person in Cyprus
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Cyprus : Notified Jurisdictional Area u/s 94A
 Brief implications of the same are as follows : • Applicability of TP : If an assessee enters into
a transaction where one of the parties to the
transaction is a person located in Cyprus, then
all the parties to the transaction shall be deemed
to be AE and the transactions shall be deemed
to be an international transaction. Consequently,
all TP provisions will apply;
• Payment to Financial Institution : Assessee
needs to furnish an authorization under Form
10FC to financial institution to provide relevant
information to tax authorities while claiming
deduction in respect of any payment made to
any financial institution in Cyprus;
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Cyprus : Notified Jurisdictional Area u/s 94A
• Conditions for deductibility : Assessee needs to
maintain and furnish information as prescribed
under Rule 21AC(5) in order to avail deduction in
respect of any other expenditure or allowance from
the transaction with a person located in Cyprus;
• Unexplained Receipts : Onus is now on assessee
to satisfactorily explain source of money if received
from person in Cyprus;
• Higher withholding rate : Any payment made to a
person located in Cyprus shall be liable for
withholding tax at 30 per cent or a rate prescribed in
the Act, whichever is higher
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90
Transfer Pricing
Assessment
Key Audit Triggers
 Consistent losses / low margins of the assessee attributable to inter-company transactions
 Significant changes in profitability of the assessee and its AEs
 High Royalty / Technical fee payouts, Cost recharges, Management Fees, Cost allocations
 Net losses incurred by routine distributors
 Low mark-ups for services
 Application of Ratio’s such as ROCE / Berry ratio / cash profit instead of net margins
 Significant Advertisement and marketing spends by manufacturing / distribution companies
 Use of foreign comparables
Substantial increase in transfer pricing audits and disputes across the Globe ,
India is no exception….
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92
Key Transfer Pricing Issues (1/3)
Typical allegations by Transfer Pricing Authorities
 Assessee spends significant amount on AMP benefitting the AE by creating marketing
intangibles without corresponding compensation/ reimbursement to the Assessee
 Compare expense to sales ratio of taxpayer with other comparables – disallows AMP
expense in excess of “bright-line” as TP adjustment alleging contribution by taxpayer is
towards strengthening AE owned brands
 Expectation of mark-up on AMP expense in excess of bright line – mark-up determined itself
subjective
Marketing
Intangibles /
AMP issue
A recent ruling by Delhi Special Bench of ITAT now holds an important precedence value to
justify department’s stand over AMP issue. Key points held by the ruling:
 Approves the use of “Bright line test” to determine cost/ value of international transaction.
 AMP expenditure to not include expenditure “in connection with” sales.
 Disproportionately high AMP spend cannot justify AMP adjustment unless brand promotion
for/ on behalf of the foreign AE exists.
 Way forward – robust comparability analysis over 14-point comparability criteria, appeal
and remand back proceedings for prior year disputes, APA for subsequent years
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93
Key Transfer Pricing Issues (2/3)
 Payment of management recharges typically disallowed at lower levels on grounds related
to failure to satisfy “need”, “benefit” and / or “evidence” tests
Management
Cross charges
 Basis of cost allocation scrutinized in detail
 Disallowances made on arbitrary basis – shareholders’ activity, duplicative etc.
 Most judicial precedents have stressed on importance of maintaining robust documentation
satisfying the need, benefit and evidence test for services received from the AEs
1.
Fee for
brand usage
/ technical
know-how
Royalty payment by an Indian entity to foreign AE acceptable. Commercial rationale/
business wisdom cannot be challenged by tax authorities - upheld in various Tax
Rulings
2. Brand name/ Intangible property developed by Indian entity and used by the foreign AEs
will also require royalty payout by the foreign AE
3. Emphasis on 3 key issues – (1) Need/benefit test; (2) Evidence of having received
technical know-how; and (3) determination of arm’s length price
Points to be considered:
 Tax authorities may challenge royalty payment for current year incase same not paid in
the past years;
 Tangible benefit received / receivable and quantification of benefit – whether Royalty
embedded in price paid?
 Payments incurred towards brand royalty along with high AMP (e.g. AMP to popularize
foreign brand) – potential red flag and may lead to tax consequences;
 Increasingly viewed as a cash repatriation tool by tax officers; and
 Aggregation approach under TNMM – challenged
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94
Key Transfer Pricing Issues (3/3)
Foreign
Holding Co.
Outside India
Share
Valuation
Purchase of
shares of Indian
Company
In India
TP adjustments being made on account of under
valuation of shares where Foreign parent has made
investments in an Indian subsidiary
Typical Facts
 Foreign parent company infuses share capital in the Indian
subsidiary (at face value or at certain value per share
arrived using DCF or other valuation methodology)
 The Revenue takes a position that the shares have been
issued to the Holding Company at an undervalued price /
less that the fair market value of the shares;
Indian Wholly
Owned
Subsidiary
The TP adjustment carried out by the TPO is twofold:
 Difference between the actual issue price and the ALP
considered as notional income
 Notional interest computed by considering the difference
between the actual issue price and the ALP as loan
Corporate
Guarantees
No specific Indian TP regulations guidance for benchmarking of corporate guarantees
Revenue’s Perspective
 Insistence on arm’s length compensation for giving guarantee
 Ad-hoc adjustments made
 Shareholder/investor function vis-à-vis service
 Explicit vs Implicit guarantee
 Credit rating of subsidiary company vs credit rating of the Parent / affiliate company
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95
Transfer Pricing and Customs
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TP & Customs -Need for harmonious analysis
Implications
Customs
While the end-result of establishing the “Arm’s
Length Price” is divergent from Customs and Allegations of “ under-invoicing” if it can be
Transfer Pricing perspective, the arguments to established that the reported value is
deliberately reduced to avoid paying additional
defend the proposed related price as arm’s
length price is based on a common set of facts Customs duties ;
and information
 It is essential to maintain the same set of
facts and arguments before both authorities
Department of Revenue constituted a “Joint
Working Group (JWG)”comprising senior
officials from Income Tax and Customs
Department to study the subject of Transfer
Pricing under the respective Laws and
suggest measures of co-operation between
the two Departments
Allegations of misrepresentation of facts/
fraudulent practices leading to possible
confiscation of goods at Customs ports
Show Cause Notices alleging the facts
presented to justify submissions made before
GATT Valuation authorities is inappropriate,
hence incremental Customs duty should be
deposited with interest and penalty
Income Tax Act
Transfer Pricing adjustment resulting in
increase in taxable income
Would trigger penal consequences if
concealment of income deemed
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97
TP Assessment and Appellate Process
Focused team of
Transfer Pricing
Officers (TPOs)
Advance Pricing
Agreement
(APA)
(introduced in
Finance Act 2012)
Mutual Agreement
Procedure (MAP)
(Alternate Dispute
Resolution
Mechanism)
TPOs revert with findings
on TP matters
Reference by AO to TPO
for TP matters
Assessing
Officer
Commissioner of
Income-tax
(Appeals)
Income-tax Appellate
Tribunal (ITAT)
(Final fact finding
authority)
Dispute Resolution
Panel (DRP)
Panel of 3
Commissioners
High Court
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Supreme Court
98
Penal provisions
Sr.
No.
Type of penalty
1
a) Failure to keep and maintain prescribed
information/ documents
(b) Failure to report any such transaction
or
Section
271AA
Penalty
2% of the value of each
international transaction or
specified domestic
transaction
(c) Maintain or furnish incorrect
information/ document
2
Failure to furnish information / documents
during assessment u/s 92D
3
Adjustment to taxpayer’s
income during assessment
4
Failure to furnish accountant’s
report u/s 92E
271G
271(1)(c)
271BA
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2% of the value of each
international transaction or
specified domestic
transaction
100% to 300% of tax on
adjustment amount
INR 100,000
99
Key Points for success in Transfer Pricing audits in India
 Detailed Functions-Assets-Risks analysis
 Proactive Planning
 Agreements / contracts should exist for transactions
between Associated Enterprises
 Price setting mechanisms to be documented
 Localization of Global Transfer Pricing policies
 Documentation should completely describe search
methodology, basis for inclusion / exclusion of
comparables, etc.
 Substantiate
rationale
business,
economic
and
commercial
 Maintain detailed cost-benefit analysis with respect to
cross charges (intra-group services)
 Strategizing and providing appropriate information during
the audit
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100
Emerging Issues
Recent Controversies
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Base Erosion and Profit Shifting (‘BEPS’)
Background
 The free movement of capital and labour, the shift of manufacturing bases from high-cost to
low-cost locations, the gradual removal of trade barriers, technological and
telecommunication developments as a result of Globalisation has opened up
opportunities for MNEs to greatly minimise their tax burden
 This has led to a tense situation in which citizens have become more sensitive to tax
fairness issues. It has become a critical issue for all parties since:
• Governments are harmed – In developing countries, the lack of tax revenue leads to
critical under-funding of public investment that could help promote economic growth
• Individual taxpayers are harmed – When tax rules permit businesses to reduce their
tax burden by shifting their income away from jurisdictions where income producing
activities are conducted, other taxpayers in that jurisdiction bear a greater share of
burden
• Businesses are harmed – Fair competition is harmed by the distortions induced by
BEPS
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103
Base Erosion and Profit Shifting (‘BEPS’)
 Digital economy - The spread of digital economy also poses challenges for international
taxation.
• The digital economy is characterized by an unparalleled reliance on intangible assets,
the massive use of data, the widespread use of multi-sided business models;
• Difficulty of determining the jurisdiction in which value creation occurs;
• This raises fundamental questions as to how enterprises in the digital economy
add value and make their profits and how the digital economy relates to the concepts
of source and residence or the characterization of income for tax purposes
• It is important to examine closely how enterprise of the digital economy add value and
make their profits in order to determine whether and to what extent it may be
necessary to adapt the current rules in order to take into account the specific features
of that industry and to prevent BEPS
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Base Erosion and Profit Shifting (‘BEPS’)
 It also relates to arrangements that achieve no or low taxation by shifting profits away
from the jurisdictions where the activities creating those profits take place
 Taxation is at the core of countries sovereignty, but the interaction of domestic tax rules in
some cases leads to gaps and frictions. The international standards have sought to address
these frictions in a way that respects tax sovereignty, but gaps remain.
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Base Erosion and Profit Shifting (‘BEPS’)
 The G20 finance ministers called on the OECD to develop an action plan to address
BEPS issues in a co-ordinated and comprehensive manner
 OECD developed an Action Plan – Action Plan identifies 15 specific actions
 Objective of the Action Plan :
to provide necessary instruments to governments to prevent corporations from
paying little or no taxes
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106
BEPS – 15 Points Action Plan (1/4)
 Address the tax challenges of digital economy
 Neutralize effects of hybrid mismatch arrangements – neutralize the effect of
double non-taxation, double deduction etc.
 Strengthen Controlled Foreign Company (‘CFC’) rules
 Limit base erosion via interest deductions and other financial payments – TP
guidelines need to be developed regarding pricing of related party financial
transactions
 Counter harmful tax practices more effectively, taking into account transparency
and substance – priority on improving transparency
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107
BEPS – 15 Points Action Plan (2/4)
 Prevent treaty abuse – prevent treaty benefits in inappropriate circumstances
 Prevent artificial avoidance of PE status - also include related Profit Attribution
issues
 Assure transfer pricing outcomes are in line with value creations: intangibles –
develop rules to prevent BEPS by moving intangibles among group members
 Assure that transfer pricing outcomes are in line with value creation: risks and
capital – develop rules to prevent BEPS by transferring risks among, or
allocating excessive capital to, group members
 Assure that transfer pricing outcomes are in line with value creation: other high-risk
transactions
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108
BEPS – 15 Points Action Plan (3/4)
 Establish methodologies to collect and analyze data on BEPS and the actions to
address it - Develop recommendations regarding indicators of the scale and
economic impact of BEPS and ensure that tools are available to monitor and
evaluate the effectiveness and economic impact of the actions taken to address
BEPS on an ongoing basis
 Require taxpayers to disclose their aggressive tax planning arrangements Develop recommendations regarding the design of mandatory disclosure rules for
aggressive or abusive transactions, arrangements, or structures, taking into
consideration the administrative costs for tax administrations and businesses and
drawing on experiences of the increasing number of countries that have such rules
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109
BEPS – 15 Points Action Plan (4/4)
 Re-examine transfer pricing documentation - rules regarding transfer pricing
documentation to enhance transparency for tax administration
 Make dispute resolution mechanisms more effective - Develop solutions to
address obstacles that prevent countries from solving treaty related disputes under
MAP
 Develop a multilateral instrument - Analyze the tax and public international law
issues related to the development of a multilateral instrument to enable jurisdictions
that wish to do so to implement measures developed in the course of the work on
BEPS and amend bilateral tax treaties
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110
Concept of Location Savings
What is Location Savings?
Net ‘Cost savings’ realized by an MNC as a result of relocating manufacturing functions /
production / operation sites from a ‘high cost’ to ‘low cost’ jurisdiction to obtain
competitive advantage
 Typical cost savings include savings pertaining to:
•
•
•
•
•
•
Labour costs;
Raw material costs;
Rent and property taxes;
Training costs
Infrastructure costs and
Incentives including tax exemptions
 Most low cost locations occur in the ‘Developing World’ (e.g.- India, China, Malaysia etc)
 Location savings = net savings from difference of input cost (e.g. labour cost) in a specific
location, compared to an alternative location or locations
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Location Savings & Transfer Pricing
 Quantification and allocation of ‘location savings’ is a subject matter of controversy between tax payers
and revenue authorities
 Whether the entire cost difference after the transfer of functions / processes to low cost jurisdiction is
‘location savings’ i.e. how to quantify location savings ?
 Even if ‘location savings’ is quantified, who is rightful owner of additional profits from location savings, the
parent company or the overseas subsidiary (‘AE’) i.e. Attribution ?
 Existence and allocation of ‘location savings’ depends upon the bargaining power of the parties
 Factors determining relative bargaining positions;
•
Economic or beneficial ownership of intangible property
•
Monopoly power such ownership bestows (uniqueness of the intangible)
•
Relative competitive position
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Location Savings & Transfer Pricing
Economic analysis necessary to assess:
 Whether or not an MNE benefits from Location Savings in certain locations – Before/ After comparison
 Which entity (parent/local subsidiary) is entitled to such benefits
After Transfer
Before Transfer
Other Profit
Location
Savings
Savings due to
difference in input
costs
Other Profit
Cost
Difference
Production Cost
Production Cost
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113
Judicial Precedent : GAP International Sourcing (India) Pvt.
Ltd.
GAP International Sourcing (India) Pvt. Ltd. vs ACIT (ITA Nos. 5147/Del 2011
& 228/Del/2012)
 The Delhi Bench of Tribunal in the case of GAP International Sourcing (India) Pvt. Ltd. held :
“that Location Savings arise to the industry as a whole and there is nothing to prove
that the taxpayer was sole beneficiary. The objective of sourcing from low cost
countries is to survive in stiff competition by providing a lower cost to its end-
customers. The advantage of Location Savings is passed onto the end-customer via a
competitive sales strategy. Thus, no separate / additional allocation is called for on
account of Location Savings.”
 GAP International Sourcing has rejected the applicability of “Location Savings” to the
particular case in a competitive situation (where the location advantages are passed onto
customers), however, it has not rejected the concept of “Location Savings”.
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Points to Ponder
Assuming a certain value of location savings the allocation of gains between two parties
depends on their relative bargaining power, which in turn depends on the goals,
resources and constraints on each of the parties.
 What constitutes an appropriate allocation of location savings requires detailed analysis. Highly
subjective.
 Total cost savings in a lower-cost jurisdiction are sometimes offset by additional costs associated with
relatively poor infrastructure in areas, such as power and telecoms, which reduce productivity.
 In many cases location savings are passed on to customers in the form of lower prices and do not lead
to higher profits. In such cases, simple before-and-after comparisons of costs could overestimate
location savings.
 It is not an easy task to quantify and allocate location savings.
• A careful evaluation of historical data (e.g. comparison of the unit level price), the FARs of both the
parties, the product life cycle, the approach of the market players and the available alternatives etc.
should be considered.
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115
Economic Scenario
High Fiscal Deficit
 Weak global demand due to economic slowdown in
European Union and the US led to widening of India’s
trade deficit to USD 167.2 billion during April 2012January 2013 from USD 154.9 billion during the same
period last year
 India
even
witnessed
13.6
percent
rupee
depreciation from an average value of 47.9 during
April 2011-January 2012 to 54.4 during April 2012January 2013
 The investment inflow this year was also slow
during the first half of 2012-13, as investors turned
towards the US dollar amid global uncertainty
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117
Measures to mitigate Fiscal Deficit
Motive :

Government wants to create an investor friendly
environment in India in order to have desired economic
growth and the fiscal deficit in FY13 at 5.2 percent of GDP
Measures :

Relaxation in FDI caps (for aviation, broadcasting,
retail, Insurance and pension etc.)

Disinvestment in PSUs

Postponement of GAAR implementation

Introduction of APA and Safe Harbour
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Paradox

Recent TP notices against the companies like Shell, Vodafone,
Nokia etc. would definitely lead to undermine the credibility of
Finance Minister P Chidambaram's repeated promises to
overseas investors that India would provide a non-adversarial
and stable tax regime.

Moreover, Shell has argued that taxing the money received by
Shell India is in effect a tax on foreign direct investment, which is
contrary not only to law but also to the spirit of the recent global
trip by finance minister P Chidambaram to attract further
investment to India.
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119
Advance Pricing
Agreement (‘APA’)
APA - Basics
 Typically adjustments by TP officer in
any tax year are replicated by TP
officers in subsequent years as well
 Given this an APA could be considered
in India in order to mitigate litigation in
India and move towards tax certainty
 Under the newly introduced APA rules in
India an APA can be entered into for:
 determining the ALP; or
 specifying the manner in which the
ALP is to be determined
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APA - Key Provisions (1/2)
 APA legislation effective 1 July 2012 & APA Rules notified 30 August 2012
 Types - Unilateral, Bilateral, Multilateral
 Can be entered into for determining Arm’s Length Price (ALP) or specifying manner in which ALP is to be
determined
 Validity – Up to 5 years (renewal possible)
 Cannot be applied retrospectively
 Coverage – Existing/ongoing transactions & New transactions - ‘Specified domestic transactions’ not covered
 Mandatory Pre-Filing Application & Consultation – option to remain anonymous
 Specified formats for Pre-Filing Application & Final Application
 Option to withdraw from APA process at any stage – after Pre-Filing or during Final APA negotiations
 APA Directorate to include panel of experts - Economists, Statisticians, etc.
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APA - Key Provisions (2/2)
 Annual APA Compliance Report & Compliance Audit – in lieu of TP Documentation & TP
Assessment
 Processing Fees (only at Final Application stage):
Transaction Value
Fees
Up to Rs 1 billion / approx US$ 20 million
Rs 1 million / approx US$ 20,000
Up to Rs 2 billion / approx US$ 40 million
Rs 1.5 million / approx US$ 30,000
Over Rs 2 billion / approx US$ 40 million
Rs 2 million / approx US$ 40,000
 Estimated timeline for Unilateral APAs – 1 year; Bilateral / Multilateral APAs – 2 to 3 years
 Effective controversy management tool internationally
“We agree that implementation will be the key and I can assure you
that the Indian tax administration is keen to make this APA program a
huge success.” Director General of Income Tax, Mrs Promila
Bhardwaj, during the first ever webinar
initiated by KPMG in September 2012
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123
Key advantages of an APA in India
 Provides
tax
certainty
for
covered
transactions upto 5 years.
 Reduces the risk of double taxation (in
case of bilateral / multilateral APAs).
 No exposure to interest and penalty where
terms of the APA are complied with.
 Reduction of documentation and saving in
time, cost and resources.
 Even the Indian tax authorities prefer APAs
which provides them certainty as well.
 Even though an APA in India applies only
prospectively, it may have a persuasive
value in litigation and open audit years.
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APA in India - Experience thus far (1/2)
 Over 150 formal pre-filing APA applications were received as on 31 March 2013*
 Approximately 90 percent pre-filings converted to applications i.e. 146* APA applications
have been filed to date
 Large Multinational corporations are a part of initial set of companies to participate in
the APA
 Approach of the APA team has been rational and pragmatic during the APA meetings
 International TP experts attending some of these meetings have welcomed the
collaborative approach and pragmatism of the Indian APA team
* Based on Taxsutra articles dated 19 March 2013 and 2 July 2013
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APA in India - Experience thus far (2/2)
 Discussions on the various APA cases happening in
Bangalore, Delhi and Mumbai
 Some cases are discussed at specific location based
on specific activities. For e.g. the IT / ITES activities
will be primarily done by APA team in Bangalore
Sector-wise APAs
filed*
Services
Manufacturing
 The initial focus is on the Functions Assets and Risks
(‘FAR’) analysis to which the APA team is paying
attention in great details
 Site visits by the APA teams in progress. To date the
visits have been scheduled in consultation with the
taxpayers and have been conducted in a cordial and
un-intrusive manner.
 Based on the FAR analysis, the economic analysis
will be done followed by rounds of discussions and
negotiations
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* Approximate
126
APA Program – Summary
• First round of discussions already in process - experience satisfactory so far
• International TP experts have welcomed the collaborative approach of the Indian APA team
• Some cases are discussed at specific locations based on specific activities. E.g. IT / ITES activities will be primarily
Discussions
done by APA team in Bangalore
FAR
• The APA team has been laying strong emphasis on first establishing and mutually agreeing on detailed FAR –
logical and sensible approach.
• Based on the FAR analysis, the economic analysis will be done followed by rounds of discussions and negotiations
Site Visits
• Site visits by the APA teams in progress (about 50 conducted) which are helpful in assessing the correct functional
profile.
• To date the visits have been scheduled in consultation with the taxpayers and have been conducted in a cordial
and un-intrusive manner.
• Over 150 formal pre-filing APA applications were received as on March 31, 2013. 146 APA applications filed to date
• MNC giants from pharma, consumer electronics, media, cement, telecom, etc. have filed applications
Applications • Currently no cases on PE attribution
• After the cadre restructuring (due later this year), the APA department would get additional manpower
• Due to sensitivity of business information highest level of confidentiality will be maintained
• The fact that cancellation of APA could be done only by CBDT is sufficient safeguard. APA will not be cancelled for
Revenue
perspective
any arbitrary reason
Unilateral APAs expected to be concluded in a time frame of 9-15 months
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127
Safe Harbor
Safe Harbor Rules - Background
 “Safe harbour” - Circumstances in which the income-tax authorities shall accept the transfer
price declared by the assessee
 Introduced in India by Finance (No.2) Act, 2009 w.r.e.f. 1.4.2009 and new Section 92CB inserted in the
Act
 Safe Harbour Rules have been framed based on the recommendations of the Rangachary Committee –
Committee to Review taxation of development centres and the IT sector chaired by N. Rangachary
 Rangachary Committee has submitted six reports including specific sector-wise/transaction-wise reports
for
•
IT Sector,
•
ITES Sector
•
Contract R&D in the IT and Pharmaceutical Sector
•
Financial Transactions-Outbound loans
•
Financial Transactions-Corporate Guarantees
•
Auto Ancillaries-Original Equipment Manufacturers
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129
Safe Harbor Rules - Background
The below Safe Harbour margins shall be applicable:
International Transaction
Value of International
Transaction (INR)
IT / ITES Services
ITES being knowledge processes outsourcing services
Safe Harbour Margin
20% or more up to transaction
value of INR 500 cr. And at
least 22% beyond 500 cr.
25% or more
Intra-group loan to wholly owned subsidiary
•does not exceed INR 50 crore
•exceeds INR 50 crore
•SBI base rate plus 150 bps
• SBI base rate plus 300 bps
Corporate guarantee
•does not exceed INR 100 crore
•exceeds INR 100 crore +credit
rating related conditions
•Commission /fee of 2 % or
more
•Commission /fee of 1.75 % or
more
Specified contract research and development services
wholly or partly relating to software development
-
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30% or more
130
Landmark Rulings
Shell India (1/2)
Indian Company
Issue of shares based on valuation
report obtained by the Independent
valuer
Foreign Group
Entity
Facts:
 Shell India issued equity shares to its foreign group entity at the valuation
undertaken by an independent valuer
The valuation is challenged by the transfer pricing officer and revalued based on
certain assumptions following the discounted cash flow approach;
Issue:
Foreign entity subscribed shares of its Indian group entity at prices much lower
than the market price
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Shell India (2/2)
Transfer Pricing (TP) Adjustments:
The shortfall in total value of shares, as alleged by the TPOs, has been
considered as a TP adjustment and to this extent an addition has been
made to the total income of Indian Company. [Primary TP]
Further, the TPOs alleged that since there was a shortfall in the
consideration paid by the Foreign group entity, Indian company has not
received the full amount it should have received from its Foreign group entity
and the said shortfall actually resided with Foreign group entity. This shortfall
therefore could be characterized as a loan advanced by Foreign group enity
in favour of Indian Company, on which there should be an arm's length
interest receivable in India by the Indian Company. [Secondary TP
adjustment]
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133
LG Electronics (1/2)
Brand
Creation /
Marketing
Intangible
Facts:
 Indian company is a subsidiary of its Foreign
Company
Indian Company
 Indian company is engaged in manufacturing
of Electronic goods in India
 Indian Company incurs Advertising Marketing
and Promotion (AMP) expenses for
marketing the goods produced in India
 The average AMP expenses incurred by
companies in the industry is considered as
Bright Line for the purpose of Transfer Pricing
analysis
Excessive
AMP
Expenses
In India
Outside
India
Foreign
Company
 Indian company has incurred AMP expenses
which exceeds the Bright Line limit as
determined above
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Owner of
Brand
134
LG Electronics (2/2)
Excess AMP expenses incurred by the Indian Company enhances the brand value
of Foreign Company
Indian tax authorities have contended that AMP expenditure incurred by a
taxpayer at a level that exceeds the “bright line” is to be reimbursed with a mark-up
Tribunal accepting the contentions of TPO held that excessive AMP expense
incurred by Indian company enhances the brand legally owned by the foreign AE
The amounts enhancing brand value should be paid by the foreign AE along with
an arm’s length mark-up
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135
Maruti Suzuki India Ltd
Facts:
Indian Company entered into a License Agreement with Foreign Company for manufacture
and sale of automobiles
Under the agreement, the Indian Company is under contractual obligation to use the joint
trademark ‘Maruti Suzuki’ on all the vehicles as well as parts manufactured sold by it in India
Indian Company had incurred high expenditure on advertisement, marketing and distribution
activity for developing the brand
Foreign Company did not compensate the Indian Company for developing the market
intangibles
Issue:
The Indian Company does not require any compensation for the use of logo / trademark of
the Foreign Company so long as the advertising, marketing expenses incurred by the
domestic entity do not exceed the expenses incurred by the comparable independent Indian
Company
In case, the expenses incurred by domestic entity are more than the expenses incurred by
comparable independent domestic entity, the foreign AE needs, to suitably compensate the
domestic entity, in respect of brand building and the advantage obtained by the foreign AE
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Serdia Pharmaceuticals India Private Limited – (1/2)
Facts
Serdia a pharmaceutical company imported “Active Pharmaceutical Ingredient”
(API) from its AE for manufacture of drugs.
Serdia imported API from its AE at prices higher than that paid for similar APIs by
other companies
Serdia adopted Transactional Net Profit Margin (‘TNMM’) as the most appropriate
method with operating profit of 8.76% and justified the arm’s length price.
TPO rejected TNMM and adopted the Comparable uncontrolled price (‘CUP’)
method for benchmarking the international transaction of import of APIs
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137
Serdia Pharmaceuticals India Private Limited – (2/2)
Issues
Ruling
Sale price by AEs to third parties
in other countries
Sale price in transaction between AEs and third party
overseas customers cannot be compared to sales
price between AEs and Serdia due to geographical
differences and non availability of data
Acceptance of price by Customs
Authorities
Acceptance of price by Customs Authorities does not
imply that transactions are at arm’s length from
transfer pricing perspective
Priority of methods for transfer
pricing analysis
TPO can decline taxpayer’s selection of most
appropriate method with cogent reasons-Traditional
transactional methods (CUP,CPLM,RPM) are to be
preferred over traditional profit based methods (PSM
and TNMM)
Reliance on overseas judicial
pronouncements
Though not binding, rationale and logic of said
decisions may be relied upon
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138
No Income – No TP?
Dana Corporation - AAR
Facts:
 A non resident company holds shares in Indian Company
 Non resident company transfers shares of Indian Company to US
company without any consideration
Non
Resident
Company
Issues:
 Whether capital gains is attracted ?
Transfer of shares
in Indian Company
without
consideration
 Are transfer pricing provisions applicable in the above transaction ?
Ruling :
 AAR held that since the transaction was without any consideration ,
the computation mechanism for determining capital gain failed
 Hence the transaction was not liable to capital gain tax in India
 Further AAR also held that Section 92 was not independent charging
section. As there was no income under the section 45 read with section
48, transfer pricing provisions were not applicable
US
Company
No Income - Transfer Pricing provisions are not applicable
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140
Castleton Investment Limited - AAR
Facts:
 A Mauritius Company holds shares of an Indian Company
 It transfers the shares of Indian Company to the Singapore Group Company
 As per India Mauritius tax treaty, the above transfer of shares by Mauritius Company
to the Singapore Company is exempt from capital gains tax in India
Issue:
 Whether transfer pricing provisions are applicable even though transfer of shares is
exempt from capital gains in India?
Ruling:
 The above transfer of shares is not taxable in India by resorting to the beneficial
provisions of India – Mauritius Tax treaty.
 It was further held that non-chargeability to tax under the beneficial provisions of a tax
treaty does not absolve the applicant from filing the return of income under section
139 of the Act.
 Accordingly, transfer pricing provisions would be applicable even though the transfer
of shares is not chargeable to tax in India
No Income - Still Transfer Pricing provisions applicable
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141
Summary : Key
Takeaways
Problems with Indian TP : Summarized
TP is not art, its not science…..its magic!
 No proper comparables available
 Grossly improper comparables being used
 No clear method or quantification for adjustments
 Cherry-picking of comparables by all parties
 Disparate Data sources are a bone of contention
 Documentation requirement overload
 Lack of knowledge & skill-set
 Concepts such as ‘Location Savings’ not even acknowledged
 Growth of “intangible” economy ignored completely
 Overburdening of taxpayer
Bottom-line: Current TP implementation devolves frequently into absurdities and can
provide inequitable results
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Problems with Indian TP : Summarized

In connection with these controversies, tax experts are of the opinion that handling of transfer
pricing in India by the tax authorities is in developing stage and, hence, requires major finetuning and improvement

Unless and until a pragmatic approach is adopted by the revenue authorities in the matters of litigation
especially on Transfer Pricing front, India will fail to boost investors’ confidence

Having said that, if the government fails to do so, it might get difficult for the Government to meet
fiscal deficit target set at 4.8 per cent of GDP and to achieve 5.7 percent growth for FY 2014 on a
possible fall in the revenue mop-up side
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144
Case Studies
Case Study # 1
Facts:
 Indian Company and its Foreign Group entity are associated
enterprise as per Section 92A of the Act.
Indian Company
 Indian Company had issued Zero Coupon Bond to its Foreign
Group Entity
 No payment of interest is to be made by Indian Company to its
Foreign Group Entity
 No Transfer Pricing implications from Indian Company
perspective.
Issue:
Whether there can be any Transfer Pricing implications for
Foreign Group entity in India?
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In India
Issue of Zero
Coupon Bond
Outside
India
Foreign Group
Entity
146
Case Study # 2
Facts:
 A Ltd is into manufacturing of Pharmaceutical
products in India
A Ltd.
(Manufacturer)
 A Ltd. sale its product in USA through independent
agents in USA.
 A Ltd. and B Inc. are associated enterprise as per
Section 92A of the Act.
Supplier of
Raw Material
 Indian Company does not receives same or similar
services from any third party
Business Support Services
 B Inc. provides Business Support Services to A Ltd.
India
USA
Independent
Agent
B Inc.
(Manufacturer)
 Also, B Inc. does not provides same or similar
services to any third party
Issue:

How to compute Arm’s Length Price for the
services provided by B Inc. to A Ltd.
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End
Customer
End
Customer
147
Case Study # 3
Facts :
Holding company receives service fees
from :
Foreign Co.
overseas
India
Holding Co.
 INR 6 crores from Sub Co. 1
 INR 4 crores from Sub Co. 2
 INR 8 crores from Foreign Co.
Implications :
Sub Co. 1
Sub Co. 2
Applicability of domestic TP provisions
to
a) Holding Co
b) Sub Co. 1
c) Sub Co. 2
d) F Co.
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148
Case Study # 4
Facts :
Foreign Co.
overseas
India
Holding Co.
Holding company makes payment for
services to :
 INR 2 crores to Sub Co. 1
 INR 2 crores to Sub Co 2
 INR 2 crores to Foreign Co.
Total services payment – 6 crores
Implications :
Sub Co. 1
Sub Co. 2
Whether Domestic TP would apply to the
Holding Company
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149
Case Study # 5
Interest
Implications
Company X
Loan
 Company X has given a loan of INR 10
crores @ 18% to Company Y
 Arm’s Length Price (‘ALP’) of the
interest determined at INR 1.2 crores as
against the actual payment of INR 1.8
crores by Company Y
Implications for Company X and
Company Y?
Company Y
Scenario : What will the implications if in
this case, the interest free loan is utilized
by Company Y for its tax holiday unit?
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Glossary
Abbreviations and Acronyms
Full Name
AEs
Associated Enterprises
ALP
Arm’s Length Price
AMP
Advertising Marketing and Promotion expense
APA
Advance Pricing Agreement
AO
Assessing Officer
BEPS
Base Erosion and Profit Sharing
CBDT
Central Board of Direct Taxes
CIF
Cost Insurance and Freight
CIT(A)
Commissioner of Income Tax Appeals
CPM
Cost Plus Method
CUP
Comparable Uncontrolled Price Method
DPCO
Drug Price Control Order
DRP
Dispute Resolution Panel
DTA
Domestic Tariff Area
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151
Glossary
Abbreviations and Acronyms
Full Name
FOB
Free on Board
FAR
Functions, Assets and Risks
FDI
Foreign Direct Investment
FMV
Fair Market Value
FY
Financial Year
GAAR
General Anti Avoidance Rules
GDP
Gross Domestic Product
GP
Gross Profit
INR
Indian Rupee
IPR
Intellectual Property Rights
ITAT
Income Tax Appellate Tribunal
MAM
Most Appropriate Method
OECD
Organization for Economic Co-operation and
Development
PLI
Profit Level Indicator
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152
Glossary
Abbreviations and Acronyms
Full Name
PSM
Profit Split Method
R&D
Research and Development
ROCE
Return On Capital Employed
RPM
Resale Price Method
SDT
Specified Domestic Transaction
The Act
Income Tax Act, 1961
The Rules
Income Tax Rules, 1962
TPO
Transfer Pricing Officer
TNMM
Transactional Net Margin Method
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153
Questions & Answers
Answers
&
Questions
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154
Thank You
Vishal Gada
Tax & Regulatory Services
Ahmedabad
Tel: +91 (079) 4040 2223
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The information contained herein is of a general nature and is not intended to address
the circumstances of any particular individual or entity. Although we endeavour to provide
accurate and timely information, there can be no guarantee that such information is accurate
as of the date it is received or that it will continue to be accurate in the future. No one should
act on such information without appropriate professional advice after a thorough examination
of the particular situation.