B S R & Co LLP
Transfer Pricing
Assessments in India
Pankil Sanghvi
Director
Global Transfer Pricing Services
28 March 2015
Agenda
• Current Transfer Pricing Landscape
• Key Issues and Challenges
• Advance Pricing Agreements
• Base Erosion Profit Shifting
• Question & Answers
• Annexures
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Current Transfer Pricing Landscape
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Transfer Pricing – A proliferation in recent times....
More and more
complex regulation
Business
restructuring and
exit charges
Dissatisfaction with
profit based
methods
Scope of
regulations
expanding
More audits,
disputes and
litigation
Increasing onus on
taxpayer
Location
advantages
Aggressive practices
by tax authorities
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Transfer Pricing in the news in Indian context…
`
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…Transfer Pricing in the news in Indian Context
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Transfer Pricing Litigation Scenario in India
Ten rounds of TP Audits completed- AY 2002-2003 to AY 2011-2012:
Assessment Year
Adjustments
(in INR Cr)
2002-2003
1,220
2003-2004
2,287
2004-2005
3,432
2005-2006
7,754
2006-2007
10,908
2007-2008
24,111
2008-2009
44,532
2009-2010
70,000
2010-2011
60,000
2011-2012
47,000
Source: http://www.financialexpress.com/article/fe-columnist/cleaning-up-the-transfer-pricing-mess/57164/
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Key Triggers and Contributors for Transfer Pricing audits
Key Triggers for Aggressive Audits
Contributors to Aggressive Audits:
•
•
Mounting fiscal deficit on Government
•
Need to preserve tax base
Consistent losses / low margins of the assessee
attributable to inter-company transactions
•
Significant changes in profitability of the assessee
and its Associated Enterprises
•
Constant competitive pressure to
restructure business operations efficiently
•
High Royalty / Technical fee payouts, Cost
recharges, Management Fees, Cost allocations. ‟
•
Unprecedented sharing of information
between revenue authorities
•
Net losses incurred by routine distributors
•
Low mark-ups for services
•
Significant Advertisement and Marketing spends
by manufacturing / distribution companies.
•
Usage of foreign comparable / selection of
tested party
Countries like Canada, Germany, Japan, Australia and China are known to be very aggressive
in transfer pricing audits…. India also ranks amongst one of the most aggressive jurisdiction
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CBDT Circular – Modi Effect
Key Features of Circular:
•
Highlighting the needs for non adversarial tax regime.
•
Appointments given to the public to be honoured in terms of time and commitment
•
Long / non specific questionnaires and high pitched assessment without proper basis to be avoided.
•
Range Heads given responsibility to obviate frivolous additions without proper basis.
•
Recovery of demand, stay of demand, etc. to be rationalized.
•
Remand report in CIT(A) cases only on specified matters.
•
Department appeals to be filed before appellate authority only in meritorious cases.
•
Taxpayer grievances to be resolved expeditiously.
•
Non adherence by tax officers to invite disciplinary action.
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Landmark decision by Government – Vodafone case
High court in Vodafone case ruled as under:
•
“The tax can be charged only on income and in the absence of any income arising, the issue of applying the
measure of Arm's Length Pricing to transactional value/ consideration itself does not arise."
•
“The amount received on issue of shares is admittedly a capital account transaction not separately brought
within the definition of Income.”
•
“The ALP is meant to determine the real value of the transaction entered into between AEs.”
•
“It does not warrant re-computation of a consideration received / given on capital account.”
•
As per the press release dated 28th January 2015, the Government accepted the order of the high court and
decided not to file SLP against it before the Supreme Court of India.
•
The Government was of the view that the decision will bring clarity and predictability for taxpayers as well as tax
authorities.
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TP Team and their broad approach
TP Team Augmented:
•
2 DITs in Mumbai to become 4 DITs
•
17 TPOs to become 32 TPOs
•
SC appeal pending on promotion matter – implementation stalled
Broad approach and mindset – practical aspects:
•
HQ charges totally disallowed – intention to debate this matter at higher Court levels
•
IT- ITeS – shown leniency – drop in margins alleged – in line with Safe Harbour – 22%
•
Guarantee now based on Bank quotes (around 3%) as against interest rate differential alleged earlier – say 1012%
•
Inbound loan – SBI / Indian rate accepted as against LIBOR
•
Agreeing to transactional level justification rather than imposing aggregate level
•
Differential mindset amongst different officers in approach – accommodative v/s aggressive
•
No share issue adjustment raised – following Vodafone
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Key Issues and Challenges
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Key Issues and Challenges
1
Management Cross Charges
2
Marketing Intangibles
3
Location savings
4
Royalties
5
Financial Transactions
6
IT – ITES and Comparability issues
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Management Cross Charges
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Management Cross Charges
Payment towards management fees by Indian
Associated Enterprises (AEs) to overseas
group company is generally towards the
following services:
Group service
Centre
•
Planning & Coordination,
•
Budgetary Control,
•
Financial advice,
•
Accounting,
•
Auditing,
•
Legal services,
•
Computer services,
•
Financial services,
Arm‟s length price based on
cost plus mark-up determined
based on:
•
Management and administrative services,
•
Functional and
Economic analysis
•
Purchasing, marketing and distribution,
•
•
Human resource services etc.
Availability of internal /
external data
Beneficial
services
Chargeable
services
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NonBeneficial
services
NonChargeable
services
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Revenue approach towards allocation of Management fees
•
Management fee charge-outs by AEs are investigated in great detail by the Revenue department
•
Robust / exhaustive documentation requirement demanded to evidence
•
appropriateness of fee charged
•
receipt of services
•
benefits received .
•
Complete / partial disallowance of fee charged , if all of the above is not provided
•
Revenue also enquires into whether a similar charge is levied on other group entities and rates thereof are also
called for and examined
•
Typical mindset of the Revenue is that management charge are used for profit repatriation.
Benefits
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Payout
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Key Consideration
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Marketing Intangibles
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Marketing Intangibles (Advertisement, Marketing and
Promotion – AMP expenses)
Issue involved / Approach of the Revenue
•
Assessee spends significant amount on AMP expense benefitting the AE by creating marketing intangibles
without receiving corresponding compensation/ reimbursement from the AE.
•
Revenue authorities compare expense to sales ratio of assessee with that of other comparables – Concept of
“bright-line”
•
Disallow AMP expense in excess of comparables ratio and make TP adjustment - alleging contribution by
taxpayer is towards strengthening AE owned brands.
•
Expectation of mark-up on recovery of AMP expense in excess of bright line. The average AMP expenses
incurred by companies in the industry is considered as Bright Line for the purpose of Transfer Pricing analysis.
AMP spend by
Indian licensee
Excess
Bright line
(-)
Arm‟s length
licensee
expenditure
Bright line method adopted
by relying on US Tax
court case in DHL
Assumed to be incurred
for strengthening brand
name of foreign AE
Indian licensee:
Must be reimbursed along
with suitable profit mark-up
Recent Delhi High Court Decision in LG Electronics India Private Limited
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Location savings
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Concept of 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 are in the „Developing World‟ (e.g.- India, China, Malaysia etc)
Location savings = Input cost in a high cost region – Input cost in a low cost region
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Economic analysis necessary to assess location savings
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
Other Profit
Location
Savings
Savings due to difference in
input costs
Cost
Difference
Production Cost
Production Cost
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Issues involved from Transfer Pricing perspective
•
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 ?
Tax authorities in low-cost jurisdictions seek
to deepen their tax bases by retaining back
their portions of cost savings through TP
regimes ( i.e. the overseas subsidiary )
•
Tax authorities in high cost jurisdictions try to
shift savings to their country by applying
CPM with a small profit mark-up ( i.e. the
Parent company )
Existence and allocation of „location savings‟ depends upon the bargaining power of the parties. The
bargaining power is determined by 1) economic or beneficial ownership of intangible property, 2) monopoly
power such ownership bestows (uniqueness of the intangible) and 3) The relative competitive position.
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UN TP Guidelines – India Chapter Abstracts
•
In view of Indian Transfer Pricing administration Location savings should be one of the major aspects to be
considered while carrying out comparability analysis during transfer pricing audits.
•
India provides operational advantages to the MNEs such as labour or skill employee cost, raw material cost,
transaction costs, rent, training cost, infrastructure cost, tax incentive etc.
•
Location specific advantage (LSA) that India provide to MNE‟s in addition to location savings (Incremental profits
from LSA termed as Location rent):
•
Highly specialized and skilled manpower and knowledge;
•
Access and proximity to growing local/regional markets;
•
Large customer base with increased spending capacity;
•
Superior information networks;
•
Superior distribution networks;
•
Incentives; and
•
Market premium
•
Indian transfer pricing administration believes it is possible to use profit split method to determine allocation
of location savings and rent in case comparable uncontrolled transactions not available).
•
Functional analysis and bargaining power should both be considered appropriate factors.
•
It is also emphasized that arm‟s length compensation for cost savings and location rents should be such that both
parties would benefit from participating in the transaction. It should reflect a appropriate split.
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Royalties
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Royalty Payouts - Background
•
Royalty payments have faced stringent tax scrutiny in recent times.
•
Historically India has been a technology importing country.
•
With the advent of MNCs, royalties were increasingly viewed as cash repatriation tools – tax shield on
royalty payments plus credit of withholding tax in receiving country.
Various payment models
Normal Royalty streams
Percentage on sales or profit, per unit royalty, lump sum payment etc.
Package Pricing
Amount included in transfer price of goods, no separate royalty payment.
Industrial franchise
arrangements
Franchise fee paid by licensee to licensor for entire business format including
production process, marketing strategies, etc.
Others
Separate royalty fees for trademark / trade name and technology.
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Issues relating to Royalty payouts
Taxpayers asked to:
•
Satisfy „Benefits test‟
•
Establish direct correlation with sales/ profitability
•
Whether royalty is embedded in price paid
•
Rebut the allegation that India performs high end activities that contribute to development of R&D intangibles
•
Justify royalty in a loss situation
Benchmarking Issues:
•
Approvals received by RBI not acceptable as external CUP
•
Aggregation approach under TNMM – Challenged and general lack of availability of comparables.
•
Transaction specific approach has been adopted by revenue – Outright rejection of rationale for payment. ALP
held to be NIL.
•
Non acceptance of foreign comparable / databases.
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Documentary evidences / analysis to substantiate Royalty
payouts
•
Copies of license agreement.
•
Tangible benefits received / receivable by the tax payer and quantification of the benefit
•
Quote of a comparable independent technology recipient for the Intangible
•
Rates at which the royalty is paid for use of similar intangibles by any other concern / subsidiary of the AE /
Group and comparative profits before and after the use of intangible
•
Unique nature of the intangible, market where it is used and strategic advantage achieved
•
Rights of the taxpayer to receive upgrades
•
Whether there are any geographic restrictions such as to export based on the licensed technology.
•
Form and manner in which the technology was provided i.e. drawings, specifications, moulds, formulae, etc.
•
Dependence of business on the technical know how obtained and inter-linkages between business activities
and technical know how
•
Detail of R&D activities undertaken by AE for developing (and continuously improving) the technology.
•
Form and manner of initial technical guidance and troubleshooting provided any ongoing/ continuous
improvements provided
•
Record of updates received and record of on-call technical support
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Financial Transactions
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Interest on Loans - Broad approach and issues involved in
interest
•
Interest rate benchmarking analysis consists of two main components: Credit rating of the borrower; and
identifying comparable lending arrangements between third parties with comparable terms and credit ratings
•
Following broad process which can be followed to determine an arm‟s length interest rate and the issues
involved are as under:
Determining
creditworthiness of the
borrower
Steps
Adjusting the risk
factors for specific debt
characteristics
Availability of comparable data
Issues
Strict comparability a challenge
Adjustments on account of risk profiles
Determining arm‟s
length interest rate
range
Corroboration by using
available market data
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Thin capitalization provisions under GAAR
Appropriate interest rate (PLR / Deposit
rate / LIBOR / Base rate)
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Guarantees - Issues involved
Taxpayer‟s Approach
•
If akin to an investor / shareholder activity - no fees attributed
•
If akin to services - fee attribution made
•
Benchmarking - guarantee fees /commission on basis of mutual agreement / bank quotes
•
Also rely on paragraph 7.13 of the OECD TP Guidelines:
Similarly, an associated enterprise should not be considered to receive an intra-group service when it obtains incidental benefits
attributable solely to its being part of a larger concern, and not to any specific activity being performed. For example, no service would
be received where an associated enterprise by reason of its affiliation alone has a credit-rating higher than it would if it were
unaffiliated
Tax Department‟s Approach
•
Insistence on arm‟s length compensation for giving guarantee, as AE avails benefit in form of reduced interest rates
and favourable borrowing terms
•
Domestic interest rates are used as potential benchmarks
•
Information available on the website of Indian banks generally considered
•
Exorbitant guarantee fee in range of 3 to 14 percent considered resulting in huge TP adjustments
Non availability of specialized database, complex inter-company loan instruments and implicit
element of guarantee from parent company – A challenge
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IT- ITES and Comparability Issues
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IT / ITES - Key Challenges faced by Captives
•
Difficulty in finding exact comparables - In TP audits, compared with full
fledged entrepreneurs - Denial of economic adjustments citing single
customer, capacity, forex risk
•
Extensive FAR analysis being done to re-characterize Indian entity
• Routine v/s. value added services (VAS) - Considering VAS as
Contract R&D and asking for arm‟s length compensation for
generation of Intellectual Property (IP)
•
Cost base an issue – different views on points such as forex gain / loss,
provision for doubtful debt, pass through costs (eg travel) etc
• Non-charging of management costs / IT costs etc by parent results in
a lower cost base and consequently low profits in India
•
Enhancement on account of Location Savings
•
Use of secret comparables by exercise of powers u/s. 133(6) to gather
information not publicly available
•
Cherry-picking of favorable / high margin companies for benchmarking
analysis
•
TP authorities impute notional interest on receivables outstanding
beyond reasonable period
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IT / ITES - Key Challenges faced by Entrepreneurs
•
Foreign benchmarking not accepted by the Indian Revenue Authority
•
•
Why not India as Tested Party?
Fluctuating margins for India - adjustment on entity as a whole
•
Profits transferred to Overseas Subsidiaries in case Indian Parent
making losses
•
Demonstration of value addition overseas
•
Indian Tax authorities emphasize on delivery capabilities more than
marketing
•
Overseas tax authorities too expect subsidiaries to earn return on
revenue share
•
No recovery of management costs from subsidiaries
•
Why Indian entrepreneur saddled with costs
•
Provision of corporate guarantees, performance guarantees for nil
consideration by Indian entrepreneur
•
Secondment of trained personnel - whether to charge transfer/
secondment fees?
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Comparability issues
•
Sogo Shosha akin to trading activities and not provision of services –
to earn return on value of goods traded (Delhi Tribunal in the case of
Mitsubishi Corporation India)
•
Trading arrangements – whether differences recognized/respected?
• Full-fledged distribution vs. limited risk distribution vs. commission
agent vs. marketing support services
•
Consistent losses / low margins – whether RPM is the right approach?
•
Manufacturing arrangements
• Unutilised / Idle capacity
• Different arrangements – full risk manufacturer vs. licensed
manufactures vs. contract manufacturer
•
Filters:
• Turnover filter
• Related party transactions filter
• IP owning vs non-IP owning companies
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Advance Pricing Agreements
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Indian APA Program – Key Features
Indian APA Program announced in August 2012
(FY 2015-16 through 2019-20)
Provides certainty for 5 tax years
(FY 2015-16 through 2019-20)
Anonymous filing
option
More cooperative
approach, as
compared to desk
audit
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Bilateral option
would mitigate
double tax
Significant cost
saving (internal and
external resources)
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Indian APA Program – Advantages
Primary Advantages
Certainty
Simple
• Pre-filing application is simple
- does not require significant
time commitment form tax
payers team
Cost Efficient
• May spend only a small
portion of total APA budget for
pre-filing
Open Feedback
• The APA Team provides open
and honest feedback based
on facts presented during prefiling meeting
Evaluate APA
Approach
• Can evaluate the APA
environment without
significant investment of time
and money
• No transfer pricing audits and
adjustments for five years.
Anonymous
• Pre-filing application and meeting
can be anonymous
Non-committal
• Can decide not to pursue an APA
if it does not like the results
No Filing Fee
Secondary Advantages
• Taxpayer does not have to pay
any filing fee for pre-filing
application
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Transfer Pricing litigation system V/s APA mechanism
Transfer Pricing Documentation
Transfer Pricing Audit
Dispute Resolution Panel (DRP)
1st Appeal (Commissioner (Appeals)
2nd Appeal
Income tax Appellate Tribunal
3rd Appeal
High Court
Final Appeal
Supreme Court
8 months
1 year
2 years
3 years
4 years
4 years
Total, over 12 years for
each tax year
Timelines
2 to 3 years
APA process
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Our experience so far
•
146 APA applications filed in the first year
•
Of the applications received, 117 applications have been received for
Unilateral APAs and 29 for Bilateral APAs
•
Over 90 percent of pre-filings (146 out of 158) converted to applications
•
CBDT signed 5 unilateral APAs i.e. within one year of filing which is highly
appreciated globally
•
232 applications filed in the second year
•
Of the above, 206 pertain to unilateral APAs, while the rest 26 pertain to
bilateral APAs
•
A total of about 500 APA applications are expected to be with income-tax
department currently.
FY 2012 - 13
FY 2013 - 14
FY 2014 - 15
Pragmatic approach of the APA authorities with strong emphasis on establishing and
mutually agreement on detailed FAR
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Roll Back Rules
Salient Features of the rollback rules are as follows:
•
An applicant for an APA is allowed to request a roll-back provision if:
•
The international transactions for which the roll-back is requested are the same as the international
transactions proposed to be covered in the APA;
•
The applicant has filed its return of income and Form 3CEB for the roll-back years within the due date;
•
No order of the Income-tax Appellate Tribunal („ITAT‟) has been passed (before the signing of the APA)
covering the determination of the arm‟s length price of an international transaction proposed to be covered
during the roll-back, in any of the roll-back years; and
•
The application of the roll-back provision does not have the effect of reducing the total income or
increasing the loss, as declared in the return of income pertaining to the roll-back years.
•
The application for roll-back of an APA in Form 3CEDA is required to be filed along with the Main APA
application.
•
If APA is already filed earlier, the Rollback application is to be filed on or before 31 March 2015.
•
The government filing fee for the roll-back application is INR. 500,000.
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Base Erosion Profit Shifting (BEPS)
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Intangible related - Indian perspective…
•
Location Savings - Where local comparable are available, specific adjustments on account of location savings
are not required.
•
Marketing Intangibles - Whether the marketer / distributor should also be compensated for enhancing the value
of trademarks and other marketing intangibles.
•
•
Adjustment (if any) to be subsumed in the FAR and comparability analysis - principle reiterated in
recent Delhi High Court ruling.
R&D arrangements - appropriate compensation for research services will depend on all the facts and
circumstances (whether research team possesses unique skills and experience, bears risks, uses its own
intangibles etc.)
Various issues included in the Guidance are contemporary, highly debated and
frequently litigated transfer pricing issues in India
Also refer to the Annexure for more details
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…Intangible related - Indian Perspective
•
Even before the introduction of the BEPS action plan the Indian Revenue authorities issued Circular no. 6 which
discusses circumstances in which profit split method will apply for determination of compensation in case of R&D
centers developing intangibles. India also adopts the „Significant Peoples Function‟ as a criteria in allocation of
profits relating to intangibles which is in line with OECDs guidance.
Circular No. 6
Contract R&D
Entities with minimal functions, assets and risk, foreign
entity funds and monitors progress
Cost plus remuneration is appropriate and
share in profits not necessary
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Entrepreneurial R&D Centers
Entities performing significantly
Important functions, assets and risk
Intangible related return to be attributed to the
Indian researchers under Profit Split Method
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Action 13 – TP Documentation and CbC report
Three-tier documentation structure proposed for all countries
• Master file to provide the MNE‟s blueprint i.e.
•
The group‟s organizational structure
•
A description of the group‟s business, intangibles, intercompany financial activities and financial and tax
positions
• Local file to provide material transfer pricing positions of the local entity / taxpayer with its foreign affiliates
•
Demonstrates arm‟s length nature of transactions
•
Contains the comparable analysis.
• Country by Country („CbC‟) Report to provide
•
Jursisdiction-wise information on global allocation of income, taxes paid / accrued, the stated capital,
accumulated earnings, number of employees and tangible assets
•
Entity-wise details of main business activities which will portray the value chain of inter-company
transactions.
Hint of adoption by India – GAAR v/s BEPS an issue
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Country by Country Reporting template…
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…Country by Country Reporting template
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Questions & Answers
Answers
&
Questions
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Annexure to BEPS
2015 B S R & Co. LLP, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved
48
Transfer Pricing aspects of intangibles
Objective
•
•
Guidance issued has certain areas in “interim
draft”
Prevent BEPS that may result from abuse of
transfer pricing rules related to cross-border
relocation of intangibles and other transactions
involving use of intangibles
To be finalised in 2015 along with other BEPS
action points that are closely related (risks and
capital, high-risk transactions and hard to value
intangibles
Ensure that transfer pricing outcomes are in
line with 'Value Creation”
Key areas covered in the Guidance
• Detailed guidance on location savings,
assembled workforce and MNE group
synergies as part of Chapter I of OECD
guidelines
•
Ownership of intangibles and entitlement to returns –
who is entitled to returns from intangibles
•
Relevant considerations for various transactions
involving intangibles
• Broader definition of intangible property (six
specific categories of intangibles discussed)
•
Supplementary guidance around determining arm‟s
length conditions involving intangibles – considers
unique features of intangible transactions
2015 B S R & Co. LLP, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved
49
Implementation and India Perspective
Implementation:
•
•
OECDs endeavor to balance:
•
usefulness of TP documentation under 3-tier structure to tax authorities, and
•
increased compliance cost and efforts for taxpayers
Though consented by OECD member countries and G20 countries, which includes India:
•
Mechanism for sharing information with tax administrations yet to be formalized
•
– whether Master File and CbC report to be filed by Parent Co. or local entity
•
Taxpayers concerns about sharing business sensitive data
•
CbC report ought not be used by tax administrations to propose transfer pricing adjustments based on
a global formulary apportionment of income.
•
Indian Competent Authority commented – India is actively and closely involved in BEPS action plan and
will seek to implement OECDs recommendations on TP documentation*
2015 B S R & Co. LLP, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved
50