April - June 2012

A quarterly newsletter on
transfer pricing developments
India, at Arms Length
In this edition:
Viewpoint 02
Insights 04
By order! 06
Around the world 11
Dear readers,
We are happy to present the ninth edition of India, at Arms Length, our quarterly
publication covering transfer pricing developments in India and a round-up on key
international developments on transfer pricing (TP).
Indian TP regulation was introduced with effect from 1 April 2001 and contains fve
transfer pricing methods for computation of the arms length price (ALP). The Central
Board of Direct tax has now issued a notifcation to insert sixth method for computation
of ALP in relation to an international transaction. The sixth method is applicable from
fnancial year 2011-12 and subsequent years. Under the sixth method, any method
that takes into account the price, which have been charged or paid, or would have been
charged or paid, for same or similar uncontrolled transaction, with or between non-
associated enterprises, under similar circumstances, considering all the relevant facts
can be considered for determination of the ALP. The scope of sixth method appears to
be broad and allows taxpayers to choose any method to determine the arms length price
provided it can be established that such method satisfes the arms length test. Further,
the Finance Act 2012 has signifcantly expanded the scope of India TP regulations. The
defnition of term international transaction has been expanded to include transactions
such as business re-structuring, fnancing transaction, trade credit, intangibles, etc. Now
specifed domestic transactions have also been expressly brought within the ambit of Indian
TP regulations. In this context the introduction of sixth method is welcome as it is likely to
provide fexibility in selection of most appropriate method for determination of ALP. The
View point section of this edition covers various aspects of newly inserted sixth method.
In our Insight section, we have provided broad insight on possible APA rules, current
trends and experiences in TP assessments and Dispute Resolution Panel proceedings.
By Order covers TP decisions in India, while Around the world section covers a round-up
of key TP developments from around the world.
We hope you fnd this publication both timely and useful and we look forward for your
feedback and suggestions to improve it further.
Best regards,
Ernst & Young Transfer Pricing team
2 India, at Arms Length
Viewpoint
Background
Indian transfer pricing (TP) legislation was introduced with effect
from 1 April 2001. Section 92C of the Income-tax Act, 1961 (the
Act) contains the transfer pricing methods (TPMs) for computation
of the arms length price (ALP). The provision requires selection of
the most appropriate TPM out of the prescribed methods namely,
(1) Comparable Uncontrolled Price Method (CUP), (2) Resale
Price Method (RPM), (3) Cost-plus Method (CPM), (4) Proft Split
Method (PSM) (5) Transactional Net Margin Method (TNMM) or
(6) any other method as may be notifed by the Central Board of
Direct Taxes (CBDT). Since the introduction of the transfer pricing
provisions in the Act in 2001, the CBDT had not notifed any other
method for determination of the ALP.
The CBDT has now
1
issued a notifcation to insert Rule 10AB in the
Income-tax Rules, 1962 (Rules), which describes a new method
(i.e., the sixth method) for computation of ALP in relation to an
international transaction. The sixth method is applicable from the
fnancial year 201112 and subsequent years.
Under this Rule, any method that takes into account the price,
which has been charged or paid, or would have been charged or
paid, for the same or similar uncontrolled transaction, with or
between non-associated enterprises, under similar circumstances,
considering all the relevant facts can be considered for
determination of the ALP.
The scope of new method appears to be broad and allows taxpayers
to choose any method to determine the ALP provided it can be
established that such method satisfes the arms length test. The
sixth method contains the following two scenarios:
(i) Any method which takes into account the price, which has been
charged or paid; or
(ii) Any method which takes into account the price, which would
have been charged or paid
The frst part refers to a price that has actually been charged or
paid and in that sense necessitates the existence of a real or actual
same or similar uncontrolled transaction. This seems to be similar
to the existing CUP method though broader in scope.
The second part would have been charged or paid appears to
recognize the concept of hypothetical arms length test. Under
this concept where the information regarding reliable and real or
actual comparable uncontrolled transactions cannot be identifed,
the arms length principle may be applied by a hypothetical third
party comparison. In summary, it allows the comparison of a
controlled transaction with a proposed third party transaction.
Applicability of the sixth method
The fve TPMs contained in the Act are similar to the TPMs
prescribed by the OECD TP Guidelines (TPG). However, the TPG also
states that taxpayers have the freedom to apply other methods
not described in the TPG to establish prices, provided those prices
satisfy the arms length principle. In the absence of fexibility
in selection of a TPM other than the fve prescribed methods,
taxpayers often encountered diffculties in applying the prescribed
TPMs for certain transactions such as transfer of intangible,
business restructuring, fnancial services transactions and cost
contribution arrangements. It is expected that the introduction of
the new method is likely to address taxpayer concerns on choice
of appropriate TPM for determining ALP. Under the Indian TP
rules, there is no strict hierarchy of methods. Further, particular
transaction types are not assigned exclusively to particular
methods. Instead, the rules prescribe a fexible most appropriate
method approach. The most appropriate method is the method
that provides the most reliable measure of an arms length result.
The sixth method may accordingly be determined as the most
appropriate method if the facts and economic circumstances
indicate that the same provides the most reliable measure of ALP.
There are some keys points on the use of the sixth method that
require consideration:
Selection of the sixth method as the most
appropriate method (MAM)
Unlike in the case of fve prescribed methods, no further guidance is
provided on the manner in which the new method is to be applied.
However, the rules relating to factors to judge comparability that
apply for the prescribed methods may apply even to the sixth
method. It may be noted that the sixth method is also likely to
be used by the Tax Authorities as the MAM during the course of
an audit. Challenging the taxpayers selection of the prescribed
method (e.g., the TNMM) and imposing an alternative method
based on the fexibility provided by the sixth method could further
increase the number of TP controversies that taxpayers currently
face. Taxpayers may need to guard against this by ensuring
that their judgment on selection of most appropriate method is
adequately reasoned and documented in their TP reports.
Application to Specifed Domestic Transactions
(SDT)
The newly inserted Rule 10AB states For the purposes of
clause (f) of sub-section (1) of section 92C, the other method
for determination of the arms length price in relation to an
international transaction shall be...
Introduction of new transfer pricing method the sixth method
1. 1
1. Notifcation No. 18/2012 [F. No. 142/5/2012-TPL], dated 23
May 2012
3 India, at Arms Length
Based on a plain reading of the Rule it appears that the sixth
method is available only for benchmarking international
transactions and not SDT. As TP provisions have been extended to
SDT from the fnancial year 201213 onwards and given that Rule
10 BA was notifed before enactment of the Finance Act, 2012,
one would expect that the Government will consider extending the
application of the sixth method even to SDT in due course.
Flexibility of use of other methods in Advance
Pricing Agreements (APA)
The APA mechanism introduced by the Finance Act, 2012 does not
limit the determination of the ALP to those prescribed in section
92C (which includes fve specifed methods and newly inserted sixth
method). Under the APA, any method including those prescribed in
the Act may be adopted with necessary adjustments or variations.
Use of valuation methodologies/quotations or
any other methodologies
Apart from real or actual uncontrolled transaction, the sixth
method provides for use of hypothetical data as well wherein
one may arrive at the comparable uncontrolled price even though
there may not be an actual similar uncontrolled transaction.
Hence, the new method will include all commonly used valuation
methods (such as discounted cash fow analysis, cash fow analysis,
replacement cost, etc), quotations, etc., which depend upon the
facts and circumstances that may be used by third parties to arrive
at the transaction price.
In substance, any variant of the sixth method can be used
for benchmarking an international transaction so long as the
conditions of Rule 10AB are satisfed. However, considering the
wide spread of the availability of uncontrolled transactions (in terms
selection of method of valuation, quotations, etc) the choice of sixth
method shall not be free from litigation and challenge from the tax
authorities.
Future outlook
Post Finance Act 2012, the scope of Indian TP regulations has been
signifcantly expanded. The defnition of the term international
transaction has been expanded to include transactions such
as business re-structuring, fnancing transactions, trade credits
etc. Further, the law now provides for an expansive defnition of
intangible property. The scope has also been expanded to cover
SDT. In this context the introduction of the sixth method is welcome
as it is also likely to provide the fexibility in selection of the MAM
for determination of ALP.
4 India, at Arms Length
Rules governing APA are set for release
An APA is an agreement between a taxpayer and the Tax
Authorities on an appropriate transfer pricing methodology for
a set of transactions over a fxed period of time. An APA could
determine the MAM for transfer pricing, manner of computation
of ALP using such method and the ALP of the international
transactions. From 1 July 2012, APA has become a part of law.
While taxpayers are keenly awaiting the rules and forms to
implement the APA mechanism, recent interactions with the
Finance Ministry by various stakeholders suggest:
The Ministry of Finance is likely to propose bilateral and
multilateral APAs as well as unilateral agreements
2
with a fling
fee and a validity of period of fve years.
APA rules are likely to be based on practices prevalent in other
APA regime countries.
APA rules are likely to propose a minimum fee and the fee could
vary depending on the value of the transaction.
An APA is likely to be available to persons as defned under the
Act.
The applications for bilateral and multilateral APAs will be
handled by competent authority, whereas unilateral APAs will
lie with the APA Directorate to be headed by Director General
International Taxation.
There could also be provisions for rejection, amendment and
withdrawals of the APA request.
APAs may not contain frewall provisions, which mean that in
case of an unsuccessful APA outcome, the information obtained
by the APA team could be freely shared with the Revenue
Authorities.
APA rules are likely to provide for use of CMIE (Centre for
Monitoring Indian Economy) and other available databases as the
main source for identifying comparables.
Further, the CBDT has already announced
3
that APA offcers will be
based in Delhi, Mumbai and Bengaluru. The team will consist of nine
members with two offcers each in Mumbai and Bengaluru and fve
offcers in Delhi.
The APA scheme is ideal for taxpayers, who wish to have tax
certainty and elimination of double taxation; who have complex
transactions, etc. However, one will need to see the rules and forms
governing the APA and its implementation.
Dispute Resolution Panel news
The intent of the Dispute Resolution Panel (DRP or Panel) was
to provide an alternative mechanism to resolve transfer pricing
disputes. The DRP was to replace the frst-level appellate authority
under the current hierarchy of the appeals under the Indian
Tax Laws. However, in the process, DRP has erred in passing
non-speaking orders without truly adjudicating on taxpayers
contentions.
In fact, the Honorable Delhi Tribunal
4
has set aside DRP orders
and asked DRP to pass speaking orders. Further, Honorable
Mumbai Tribunal
5
has set aside the DRP orders due to presence of
jurisdictional Commissioner on Panel.
The third cycle of the DRP proceedings (pertaining to AY200809)
is currently in progress. CBDT has reconstituted the DRP Panel in
Mumbai and Delhi
6
. Further, very recently, the CBDT has notifed
7

reconstitution of 10 DRPs across various cities and taking note of
certain judicial precedents, the CBDT clarifed that in a case where
a specifed member of the Panel happens to be supervising offcer
of the Transfer Pricing Offcer (TPO) at the time of TP Audit, or the
supervising offcer of the Assessing Offcer (AO) at the time of the
issuance of the draft assessment order, then the DRP shall consist
of a different set of members.
Insights
2. Unilateral agreements are directly concluded between the taxpayer
and the Government. Bilateral agreements are obtained after mutual
agreement of the tax authorities of two countries. A multilateral
agreement involves mutual agreement between more than two tax
authorities.
3. Vide Order No 105 of 2012 dated 6 June 2012
4. In a case of Genpact Mobility Services (India) Private Limited and Sojitz
India Private Limited
5. In a case of Huntsman International (India) Private Limited and Abacus
Distribution Systems (India) Private Limited
6. Vide Order no 5/FT&TR/ 2012 dated 20 June 2012
7. Vide Order No 6/FT&TR/ 2012 dated 10 July 2012
5 India, at Arms Length
Transfer Pricing assessment news
The Transfer Pricing (TP) audits for AY200910 are currently
in progress and due to extension of audit completion time limit
(the Finance Act, 2012 has extended completion time limit to 31
January 2013), the trends seem to be that the TPOs are taking
their time to delve deeper into issues. Further, CBDT recently
completed reshuffe of its Offcers in Directorates of International
Taxation and Transfer Pricing and in certain cases, the new
incumbents are yet to take over their charge.
Due to extension of time limit, the TPOs are more concentrating on
the facts and asking for some extraordinary requirements. We have
shared below some of the requirements:
TP study reports (including soft copy) to be submitted within
515 days (from the date of receipt of notice)
Extension of time granted only for other information and not for
TP study report
TP study reports for subsequent years
Reconciliation of comparable set for six years (i.e., the year
under consideration, prior three years and subsequent two years)
alongwith the reasons for change in the comparable set
Withholding of tax-related information not only for international
transactions but for all foreign remittances
Segmental proftability statement (especially where combined
transactions approach has been followed)
Further, there is continued focus on transactions such as intra-
group cost allocation, corporate guarantees, overdue receivable
from associated enterprises and reimbursement/recovery of
expenses.
Especially in the case of reconciliations of comparable set for six
years related requirement, it is important to see how the TPOs are
going to use/view such information. The intention clearly seems to
advocate consistency perspective (i.e., use of consistent approach
to select the comparable set over a period) but the same may
go against the taxpayer if there is a deviation in the comparable
set with no logical argument. Intention could also be to reopen
completed assessment years.
Based on experience so far in the current cycle of TP audits, it
seems that scrutiny is likely to be in depth and will encompass
other areas. One can see sustained activities from the International
Tax offcers also in terms of compliance by foreign companies and
withholding related aspects.
Constitution of Special Bench: on whether
+/-5% is standard deduction before
amendment in 2009
Prior to October 2009, the proviso relating to +/-5% read as
follows:
Provided that where more than one price is determined by the
most appropriate method, the arms length price shall be taken to
be the arithmetical mean of such prices, or, at the option of the
assessee, a price which may vary from the arithmetical mean by an
amount not exceeding fve per cent of such arithmetical mean.
Based on the above proviso, various Appellate Tribunals have ruled
that the +/-5% variation to the ALP would be a standard deduction
and TP adjustment if any, to the transactions price would be after
allowing standard deduction of +/-5%.
Recently, the Finance Act 2012 has passed a clarifcatory
amendment that if the price at which the transaction has actually
been undertaken exceeds 5% of the arithmetical mean, then the
taxpayer shall not be entitled to exercise the option of +/- 5%.
The above amendment is clarifcatory in nature and has overturned
the position adopted and followed by the various Appellate
Tribunals. However, recently, a special bench comprising three
members has been constituted in Delhi by the Honorable Tribunal
President in the case of IHG IT Services India Private Limited
pertaining to AY 200607 to decide whether the taxpayer is
entitled to claim beneft of pre amended (before 2009) provision of
section 92C(2) of the Act as a standard deduction.
The matter was scheduled for hearing on 27 July 2012. Once a
special bench is constituted on a legal point, all who are affected
can evaluate an option to become an intervener irrespective of
the jurisdiction of the case. The only pre-conditions applies to
intervener is that appeal on the similar issue must be pending at
any of the benches of Tribunals in India.
We understand that the special bench has been disbanded as
the taxpayer who sought the formation of the special bench has
withdrawn in view of the clarifcatory amendment in the Finance
Act, 2012.
6 India, at Arms Length
Delhi Tribunal
Payment of management service fees and
coordination costs held to be charged at ALP.
TPO cannot question intrinsic value of services,
which meets beneft test.
S 92 C, 92CA, 92D / AY 2007-08; In favor of taxpayer
The taxpayer, a wholly owned subsidiary of a multinational group, is
engaged in the business of advertising and allied services.
For the year under consideration, the taxpayer entered various
international transactions and selected TNMM as the MAM to
benchmark its international transactions.
During the TP proceedings, the TPO accepted the ALP of all
international transactions applying TNMM, except for management
service fees and client coordination costs. These services are in the
nature of assistance in strategic planning, media support, fnancial
administration and human resource management services. These
services enabled the taxpayer to access various research material,
case studies, presentations, etc.
With respect to above two international transactions, the TPO
characterized them as intra-group services and computed the
ALP as NIL on the basis that the taxpayer had not been able to
demonstrate provision of such services nor any beneft derived.
Further, low-cost services were available in India and there was no
need to avail these services from AEs at higher cost.
Being aggrieved, taxpayer fled objections before the DRP, which
directed the TPO to give certain relief. The TPO passed a fresh
order giving ad-hoc relief of 40% in respect of management services
charges but confrmed the addition on account of coordination
costs.
Being aggrieved, taxpayer fled an appeal before the Delhi Tribunal.
Tribunal, ruling in the favor of taxpayer, held that entity level TNMM
is MAM considering the fact that the taxpayer is engaged only in
class of business (i.e., advertising and allied services) and there are
no distinct segments or operating activities, which can be said to be
independent of each other.
Tribunal also held that although principle of res judicata is not
applicable, some tangible material has to be brought on record
to draw an adverse inference. The taxpayer had provided
substantial evidence of the management service charges and client
coordination fees and had established the nature and benefts of
the services provided by the AE. This fact has not been negated by
the Revenue Authorities.
Tribunal further observed that the terms beneft to a company
in relation to its business has a very vide connotation. It is diffcult
to accurately measure these benefts separately in terms of money
value. In the arena in which the taxpayer is functioning, it will be
diffcult to imagine a successful business entity without receipt of
the services, which carries considerable intrinsic and creative value.
The TPO cannot evaluate the true intrinsic and creative value of
such services. Further, the TPO need not dictate the business needs
of the taxpayer. The beneft derived must be considered from the
angle of a prudent businessman.
McCann Erickson India Private Limited v. ACIT (ITA No.5871/Del./2011)
Mumbai Tribunal
ALP in case of interest on extended credit period
granted to an AE shall be determined on the
basis of US LIBOR (prevalent at the relevant
point of time) and not on domestic interest rates.
S 92B, 92C, 92CA / AY 2007-08; in favor of tax payer
The taxpayer has provided loan to its three Mauritian subsidiaries
@ 5.25% and 6% in foreign currency. During the TP proceedings,
the TPO observed that the taxpayer was paying interest @ 14% on
certain transactions. Taking this rate as base, the TPO considered
difference in rate of interest for TP adjustment.
The Tribunal relied on Hyderabad Tribunal decision in case of Four
Soft limited (ITA No. 1495/Hyd/10), wherein considering the
facts of the case, use of LIBOR rate was upheld over EURIBOR
rate for computing imputed interest on the loan advanced to AE.
Accordingly, the Tribunal directed the Assessing Offcer (AO)
to consider LIBOR rate prevalent at relevant point of time for
adjudicating the issue under consideration.
Mahindra & Mahindra Limited v. DCIT (ITA No. 7999/Mum/2011)
By Order
7 India, at Arms Length
Hyderabad Tribunal
Depreciation has no direct connection or bearing
on price, cost or proft margin of the international
transactions and taxpayer is entitled to exclude
depreciation while computing operating profts.
S 92C, 92CA / AY 2005-06; in favor of the Revenue
The taxpayer was deriving income from software development
services from its AEs as well as third parties. The taxpayer has
benchmarked its international transactions using internal CUP
method (i.e., comparison with price charged for services rendered
to third parties).
During the TP proceedings, TPO rejected CUP method and selected
TNMM as MAM. On frst appeal, the Commissioner of Income-tax
(Appeals) (CIT (A)), considering the facts of the case, has upheld
the order of the TPO on issue of applicability of CUP method.
Further, under TNMM, on a without prejudice basis, taxpayer has
asked for exclusion of depreciation from operating cost (based on
facts of case, depreciation/total cost works out to 28.69% vis-a-vis
comparable average depreciation cost of 6.36%) stating abnormal
in nature. The CIT (A) did not consider the same favorably.
Being aggrieved by the CIT (A) Order, the taxpayer fled an appeal
before the Hyderabad Tribunal.
The Tribunal, ruling in favor of the Revenue, held that considering
the differences in the services provided to AEs and third parties,
CUP method cannot be considered as MAM.
Further, as regards to taxpayers argument for exclusion of high
depreciation cost, the Tribunal ruled in favor of the taxpayer and
held that:
Under the statutory provisions it is nowhere provided that
deduction of depreciation is a must. Depreciation can be taken
into account or disregarded while computing proft depending
upon the context and purpose for which proft is to be computed.
Net Proft used in Rule 10B can be taken to mean commercial
proft.
Depreciation will depend upon the type of technology employed,
age and nature of machinery used. The claim of depreciation
can lead to great difference in computing profts of comparables
as depreciation is permitted depending upon nature of plant/
machinery and year of use. Further, depreciation, which can have
a varied basis and is allowed at different rates, is not such that an
expenditure, which must be deducted in all situations.
It has no direct connection or bearing on price, cost or proft
margin of the international transactions.
Object and purpose of transfer pricing is to compare like with the
like, and to eliminate difference, if any by suitable adjustment.
Qual Core Logic Limited v. DCIT (ITA No 893/Hyd/2011)
Mumbai Tribunal
Rates charged by unrelated vendors to whom
taxpayer outsourced work can be comparable
under CUP method
S 92C, 92CA / AY 2003-04 to AY 2007-08; in favor of taxpayer
The taxpayer is engaged in providing software development
services to it AEs. The taxpayer had outsourced a part of the job to
external companies such as L&T Software, TCS etc. The taxpayer
benchmarked its international transactions using CUP method and
considered hourly rates charged by external vendors as comparable
prices.
During the TP proceedings, the TPO rejected external CUP method
and adopted TNMM as MAM to make addition to taxpayers income.
On frst appeal, the CIT (A) deleted the addition. However, the
Revenue appealed before the Tribunal against CIT (A) order.
Ruling in favor of taxpayer, the Tribunal held that:
The rates charged by the taxpayer to its AEs were comparable
to the rates charged by L&T Software, and TCS to the taxpayer.
According to the agreement between the taxpayer and its AE,
the billing will be linked to comparable market rates in India for
similar services.
The Tribunal noted that L&T software and TCS are considerably
big companies in the software industry and have substantial
8 India, at Arms Length
reputation. The amounts paid to them represent fair market
value. When the taxpayer adopts these rates as comparable
under the CUP method no fault can be found.
The tribunal also noted that TPO had not brought on record any
material to prove that per hour rate charged by the taxpayer was
lower than what was charged by third parties in the same line of
business. Further, the TPO had not given any reason for rejecting
CUP method. The Tribunal also referred to OECD guidelines
wherein CUP method is considered to be the most direct and
reliable method when comparable uncontrolled transactions are
available.
ACIT v. Vistaar Systems Private Limited (ITA No. 3065/Mum/2008)
Mumbai Tribunal
RPM is one of the standard methods in case
of distribution and marketing activities (i.e.,
when goods are purchased from AE and sold to
unrelated parties) and prevails over TNMM
S 92C, 92CA / AY 2003-04; in favor of taxpayer
The taxpayer is engaged in the business of manufacturing and
distribution of cosmetic and beauty products. The taxpayer
operates in two business segments (i) Manufacturing (ii)
Distribution. The taxpayer, relying on OECD guidelines and
Guidance notes, considered RPM as MAM to benchmark its
distribution segment.
During the TP proceedings, the TPO upheld the transactions in
relation to manufacturing segment to be at arms length. However,
with respect to the distribution segment, the TPO disregarded the
taxpayers contentions and concluded TNMM as MAM. While doing
so, the TPO contended that the taxpayer was consistently incurring
losses, gross margins of comparable companies could not be relied
upon because of product differences, and the degree of similarity
in the functional profle between the taxpayer and the comparable
companies was suffcient for application of TNMM and not RPM.
Being aggrieved, the taxpayer fled an appeal before the CIT
(A). The CIT (A), ruling in favor of the taxpayer, accepted the
benchmarking approach adopted for the distribution segment and
deleted the TP adjustment.
The Revenue Authorities appealed before the Mumbai Tribunal
against the order of CIT (A). The Revenue contended that the
taxpayer was adding substantial value addition to the goods sold, as
it was incurring substantial expenditure on selling and distribution
and hence, RPM is not the correct method.
Mumbai ITAT confrming the Order of CIT (A) provided ruled as
follows:
There is no order of priority in selection of method for computing
ALP. RPM is one of the standard method and the OECD guidelines
also states that in case of distribution and marketing activities
(where goods are purchased from AEs and sold to unrelated
parties) RPM is the MAM.
Based on facts on records, there is no dispute that the taxpayer
buys products from its AEs and sells to unrelated parties without
further processing.
The Revenue Authorities have not disputed the certifcates
produced by the taxpayer to evidence that the margins earned by
AEs lies in the range of 2% to 4%.
RPM has been accepted in preceding as well as succeeding years
in respect of the distribution segment of the taxpayer and hence,
the deletion made by the CIT (A) is found to be appropriate.
ITO v Loreal India Private Limited (ITA No, 5423/Mum/2009)
9 India, at Arms Length
Bengaluru Tribunal
Bengaluru Tribunal allows risk adjustment
observing single customer risk as an anticipated
risk not equivalent to marketing and technical
risk
S 92C, 92CA / AY 2006-07; in favor of tax payer
The taxpayer is a captive service provider operating on a cost
plus model. During the TP proceedings, the TPO rejected the
documentation maintained by the taxpayer, conducted a fresh
search to identify the comparable companies and proposed
adjustment to the transaction of provision of services.
Aggrieved by the order of the TPO and confrmation of the same by
the DRP, the taxpayer preferred an appeal before the Tribunal.
The taxpayer contended that the TPO is bound to conduct
functions, assets and risk analysis to arrive at the ALP. Further,
being a captive service provider, the taxpayer does not bear any
risk as compared to the comparable companies identifed by the
TPO and accordingly adjustment toward difference in risk profle
(computed as 5.5% being the difference between the Prime Lending
Rate (PLR) and the Bank Rate) was contended by the taxpayer.
The Bengaluru Tribunal ruling in favor of the taxpayer held that
the taxpayer is a captive service provider and did not bear any
single customer risk, being an anticipated risk, which may or may
not happen during the relevant period. The comparables were
operating in an open market and were prone to marketing and
technical risks. Accordingly, the single customer risk cannot be
attributed to the taxpayer contrary to the existing marketing and
technical risk borne by the comparables. The Tribunal rejected the
taxpayers methodology of computing risk adjustment being the
difference between PLR and Bank Rate and remanded the matter
to the TPO/AO to allow risk adjustment on the basis of material on
record.
Intellinet Technologies India Private Limited v. ITO (ITA No. 1237(Bang)/
2010)
Delhi Tribunal
Tribunal upheld the adjustments for idle time and
abnormal costs incurred while relocating offce
premises
S 92C, 92CA / AY 2006-07; in favor of taxpayer
The taxpayer is a captive unit providing design and software
development-related services to its AEs. The taxpayer has
benchmarked its international transactions by selecting TNMM as
MAM. The TPO by disturbing the comparable set made a transfer
pricing addition to the taxpayers income.
Before Tribunal, the taxpayer argued that the TPO has erred in not
allowing following adjustments while determining ALP:
Relocation expenses: The taxpayer argued that it could not carry
out normal operations due to relocation of its offce premises.
Salary paid for unproductive/idle hours: The employees of the
taxpayer were idle and unproductive during March 2006 and new
offce commences normal operations toward end of March.
The Tribunal observed that the Municipal Corporation of Delhi had
undertaken a sealing drive, due to which the taxpayer had to shift
to new premises. Hence, the TPOs claim that premises were not
actually sealed was unjustifed and unfounded.
The Tribunal further held that dismantling and re-installation of
necessary equipment and devices (such as computer systems,
servers, storage devices etc.) at the new premises required
considerable time and technical skills. Further, quarterly capacity
utilization statement of taxpayer also demonstrates fall in capacity
utilization.
Accordingly, the Tribunal deleted the addition granting the above
adjustment resulting in satisfaction of ALP.
Transwitch India Private Limited v. DCIT (ITA No 6083/Del/2010)
10 India, at Arms Length
Mumbai Tribunal
Use of brightline approach to benchmark
advertising, marketing and promotion (AMP)
expenses is not equivalent to application of
TNMM
S 92C, 92CA / AY 2004-05; in favor of taxpayer
The Mumbai Tribunal, deciding on the issue of excessive AMP
expenditure incurred by the taxpayer, held that the TPO had to give
cogent reasons to reject the analysis undertaken by the taxpayer
and why his own analysis was superior. The Tribunal further stated
that a comprehensive comparability analysis should be undertaken
before choosing a set of comparables to determine the ALP. Finally,
the Tribunal held that the arithmetic mean of AMP expenditure as
a percentage of sales for a set of companies cannot be considered
to be an ALP nor can such analysis be said to be consistent with
TNMM as prescribed by the Act. The Tribunal also observed that
the taxpayer being a manufacturer, any beneft derived from AMP
expenditure belonged to taxpayer.
You may also refer to our EY Alert dated 24 May 2012 for further
details.
Genom Biotech Private Limited (ITA No. 5272/Mum/2007)
Delhi High Court
The tax department cannot dictate to the
taxpayer whether or not to incur expenditure
S 92C, 92CA / AY 2002-03, AY 2003-04; in favor of taxpayer
Delhi High Court (HC) deciding on the TP aspect of a royalty
payment held that royalty payment cannot be disallowed on
account of perpetual loss where the expenditure was proven to be
incurred wholly and exclusively for the purpose of the business
of taxpayer. The HC held that it is not for the tax authorities to
question the commercial expediency of a transaction. The HC
further observed that it is appropriate to rely on the OCED TP
guidelines to judge the position adopted by the tax authority since
these guidelines have been recognized in the tax jurisprudence
of India. Relying on the OCED TP guidelines, the HC held that
re-characterization of legitimate business transactions by the tax
authorities is not permitted. The HC further held that once it is
established that payment has been incurred or laid out for the
purpose of business, the TPO can only question the quantum of any
expenditure and make suitable adjustments if required.
You may also refer to our EY Alert dated 18 April 2012 for further
details.
CIT v. EKL Appliances Limited (ITA Nos. 1068/2011 & ITA Nos.1070/2011)
11 India, at Arms Length
OECD releases discussion draft on safe
harbours
The OECD, on 6 June 2012, released a discussion draft on safe
harbours as part of its project to improve the administrative aspects
of TP. The discussion draft includes proposed revision to the section
of safe harbour in Chapter IV of the OECD TP guidelines.
What is safe harbour?
A safe harbour in a TP regime is a provision that applies to a
defned category of taxpayers or transactions and that relieves
eligible taxpayers from certain obligations otherwise imposed
by a countrys general TP regime. A safe harbour substitutes
simpler obligations for those under the general TP regime. Prices
established under a safe harbour will be automatically accepted by
the tax administrations that have expressly adopted safe harbour
rules.
Key aspects of the discussion draft
The draft reviews the safe harbour rules in a positive light,
indicating that safe harbour will specifcally be appropriate where
taxpayers entail low transfer pricing risks. The draft has attempted
to address the problems relating to use of safe harbour rules in the
existing OECD TP guidelines.
The basic benefts of safe harbours as set forth in the discussion
draft are simplifying/reducing compliance cost for eligible
taxpayers, providing certainty to taxpayer and permitting tax
administrations to redirect their administrative resources from
examination of low risk transactions to examinations of more
complex and high risk transactions and taxpayers.
The discussion draft has also highlighted various concerns
connected to implementation of safe harbour rules. These concerns
include possibility of divergence from the arms length principle,
risk of double taxation and double non-taxation, potentially open
avenues for inappropriate tax planning. This raises issue of equity
and uniformity amongst taxpayers.
The discussion draft further recommends that safe harbour to
be adopted on bilateral or multilateral basis. However, in case of
unilateral safe harbour rules, the country adopting the safe harbour
should consider modifcation of safe harbour in individual cases
under mutual agreement procedures to mitigate the risk of double
taxation/double non-taxation.
According to the existing OECD TP guidelines, safe harbour rules
may be inconsistent with the ALP. Thus the draft recommends an
option to the taxpayers to elect safe harbour rules or ALP as may
be benefcial to the taxpayer. Further, in order to ensure certainty
from the tax administrations perspective, the safe harbour rules
may require taxpayers to notify tax authorities in advance of using
safe harbour rules or to commit its use for certain number of years.
India scenario
Although India is not an OECD member country, TP provisions
introduced in 2001 have a number of similarities with existing
OECD TP Guidelines. Several TP rulings in India have also relied on
the same.
In the Budget 2009, the Ministry of Finance empowered CBDT to
formulate safe harbour rules. The CBDT however, has not so far
introduced the safe harbour rules. While safe harbour rules are
yet to come in the Indian TP regime, the Government of India (GoI)
has introduced APA mechanism in a recent budget and this may
encourage taxpayers with complex or high risk transactions to
resort to APA and have certainty on TP aspects.
The discussion draft emphasizes that safe harbour rules have been
implemented successfully in certain countries. Hence, considering
the trend of TP litigation in India, the GoI could take a cue from
various recommendations made in the discussion draft and may
appropriately formulate the safe harbour rules.
OECD releases revised draft of guidance
on TP aspects of intangibles
On 6 June 2012, the OECD published its proposals for revised
guidance on TP aspects of intangibles. The draft proposes a revision
to the provisions of Chapter VI of the OECD TP guidelines and to the
Annexure to Chapter VI containing examples and illustrations for
application of the foresaid provisions.
What is intangible(s)?
According to the guidelines, the word intangible is intended to
address something, which is not a physical asset or a fnancial
asset, and which is capable of being owned or controlled for use in
commercial activities.
Key aspects of the discussion draft
The discussion draft has categorized intangibles in various types
such as patents, know-how and trade secrets, trademarks, trade
names, brands, licenses (and similar limited rights in intangibles),
goodwill going concern value, group synergies, etc.
The draft places considerable emphasis on the functions
performed, assets utilized and risks assumed by the parties (in
Around the world
12 India, at Arms Length
practice, often referred to as economic substance) to determine
whether any intangibles exist for TP purposes; and in the
determination of which entity(ies) should be entitled to the returns
from an intangible. The draft also contains a detailed discussion
of pricing issues and large number of examples illustrating the
application of the principles it sets out.
The draft states that the cornerstone of transfer pricing should
be based on how independent third parties would behave in
comparable situations rather than accounting or legal defnitions.
It does not differentiate between trade and marketing intangibles.
However, the draft distinguishes between intangibles, intellectual
property and market conditions that are not capable of being
owned, controlled and transferred by a single enterprise.
The draft further says that goodwill and going concern should not
be considered separately as intangibles (with certain exceptions)
but should be taken into account as part of a businesss assets. It
also argues that not all intangibles are valuable and not all deserve
separate compensation. The draft takes guidance from the chapter
on business restructuring and emphasizes control over functions
and risks.
Further, the draft contains 22 examples providing practical
guidance on how to apply the principles discussed in the draft.
Next steps
The OCED has sought comments on the draft by 14 September
2012. It is anticipated that a public consultation meeting will be
held in November 2012. It seems likely that the revised guidance
will be formally confrmed in 2013.
EI Salvador issues transfer pricing
guidelines
On 23 March 2012, the Direccin General de Impuestos Internos
(DGII) issued Administrative Guideline No. DG-001/2012 to provide
general guidance to taxpayers on the tax treatment of related party
transactions or transactions with entities domiciled in tax havens
jurisdictions.
The Administrative Guideline (Gua de Orientacin) is intended to
supplement the Salvadoran Tax Code by defning guidelines for both
taxpayers and tax auditors. For taxpayers it provides guidance on
topics such as the identifcation of related parties, transfer pricing
methodology and documentation requirements, as well as on the
application of withholding tax and the non-deductibility of costs and
expenses in related party transactions and transactions with tax
havens. For tax auditors it provides guidance on disclosure in the
tax report.
The TP methodologies established in OECD TP guidelines for
Multinational Enterprises and Tax Administrations are also
recognized in the Salvadorian Gua de Orientacin.
The guidelines recognized fve TP methods such as CUP, RPM, CPM,
TNMM and PSM.
Among the documentation requirements, information about the
taxpayer and its multinational group should be included, as well
as a complete functional analysis, the criteria for the selection
of the comparables and the applicable methodology. Further,
the Administrative Guideline provides general guidance on the
determination of the amounts of the transactions with related
parties for the information return that has to be fled by the
taxpayer.
Government of Brazil introduces
provisional measure modifying TP rules
Published on 4 April 2012, Provisional Measure (MP) 563
introduced changes to the Brazilian TP rules. These are the frst
signifcant changes since the introduction of transfer pricing rules
in 1986, which received further interpretation by the Brazilian
tax authorities in administrative regulations in 2002 (Normative
Instruction (IN) 243 of 2002). The rules determine the deductibility
of intercompany purchases or the minimum price for tax purposes
for export transactions. The MP include following amendments in
the area of transfer pricing:
Minimum requirement for the application of the Brazilian
uncontrolled price method (PIC)
The minimum statutory gross proft margin required when
applying the Resale Price Method (PRL) for the import of goods,
services or rights range from 20% to 40% depending on the
companys industry
FOB price as basis for the PRL calculation
New transfer pricing method for import/export of commodities
traded publicly
Changes to the deductibility of interest
Further, the Brazilian companies are eligible to apply the amended
transfer pricing methodology for calendar year 2012 and are
obliged to do so from 1 January 2013. Even though, the MP has
status of law, there is a statute of limitation to convert the MP
into law. Therefore, during the course of the conversion, we may
expect certain amendments/exclusions/inclusions on the rules to be
addressed.
13 India, at Arms Length
Vietnam Tax Authority reveals 2012 TP
inspection plan
On 5 April 2012, the Investment and Trade Promotion Centre and
the Peoples Committee of Ho Chi Minh City organized a conference
on Vietnams TP with participants from provincial tax departments
and around 100 companies.
In the conference, the General Department of Taxation (GDT)
informed that a specialized TP team was established to administer
the TP compliance of taxpayers with related-party transactions.
Further, the highlights of GDTs 2012 Transfer Pricing inspection
plan are as follows:
7,800 companies with related-party transactions to be targeted
Special focus on foreign-invested companies
Key triggers for the TP audits include:
Signifcant volume of related-party transactions
Under suspicion of TP manipulation
Loss-making
Signifcant amount of tax due
Have not been audited or inspected
Entitled to tax incentives
Malaysia issues new transfer pricing and
APA rules
On 11 May 2012, the Government of Malaysia issued TP rules
and APA rules. The rules provide guidance on requirements
for the preparation of contemporary TP documentation and
APA application for cross-border transactions. The rules are
retroactively effective from 1 January 2009.
TP rules
The TP rules provide that persons entering into a controlled
transaction must prepare documentation when developing or
implementing the controlled transaction.
The TP rules require the hierarchical selection of TP methods,
which places the traditional transaction methods as the primary
methods. If none of the primary methods is applicable, one of the
transactional proft methods may be selected. TP rules provide
guidance on establishing an arms length pricing for the following
transactions:
Intra group services
Intangible property transfer
Financing transactions
A year-by-year comparison is preferred, but if it is not feasible,
multi-year data may be considered. Arms length pricing should
be determined for each controlled transaction; however, an
aggregation of transactions on a combined basis may be considered
when it is more appropriate to evaluate the transactions. The
Director General of Taxation (DG) is granted authority to disregard
any structure if the economic substance differs from the form, or
the transaction lacks economic reasons. When any adjustment is
made by the DG, a corresponding or offsetting adjustment may be
requested for domestic related-party transactions. For cross-border
transactions, however, such adjustment can only be made under
a mutual agreement procedure through a relevant competent
authority.
APA application
A taxpayer may apply for an APA. The APA rules describe the
process and expected timeline for the application and negotiation
of the APA. Certain key requirements of APA are pre-fling meeting,
submission of application, covered period and rollback, compliance
report and renewal of APA.
The introduction of the TP and APA rules together with the recent
issuance of TP disclosure forms applicable to corporations clearly
demonstrate that the Malaysian tax authority has increased its
focus on TP compliance.
Hong Kong releases fnal guidelines on
APA program
On 3 January 2012 the Hong Kong Inland Revenue Department
(HKIRD) announced that it plans to introduce an APA program in
Hong Kong by April 2012. Following this on 18 January 2012,
the HKIRD releases a draft version of Departmental Interpretation
and Practice Note 48- Advance Pricing Arrangements (DIPN 48)
outlining its proposed approach to administer, negotiate and
conclude an APA program in Hong Kong. Draft DIPN 48 was open
for consultation. Finally on 29 March 2012, the HKIRD released a
fnalized version of DIPN 48 after considering the feedback from
the consultation process in a positive manner.
Certain key aspects of the Hong Kong APA program are as follows:
Pre-fling of meetings on a no-name basis
Lower cap for covered transactions
Use of independent experts to process the APA application
Rollback of a transfer pricing methodology agreed under an APA
to prior years
Scope of DIPN extended to cover unilateral APA
14 India, at Arms Length
IRS issues thirteenth annual APA report
for 2011
The IRS issued the thirteenth congressionally mandated annual
APA report on 2 April 2012. The thirteenth annual report provides
an updated discussion of the APA Program including its activities
and structure for calendar year 2011. The report provides useful
insights about the operation of the Program.
Particulars Unilateral Bilateral Total
Year 2011 2010 2009 2011 2010 2009 2011 2010 2009
APA applications 20 46 39 76 98 88 96 144 127
APA executed 8 20 21 34 49 42 42 69 63
APA renewals executed 2 14 8 13 18 20 15 32 28
Revised or amended APAs 1 5 4 0 4 4 1 9 8
Pending requests for APAs 93 85 70 352 315 282 445 400 352
Pending requests for new APAs 44 38 47 214 186 174 258 224 221
Pending requests for renewal APAs 49 47 23 138 129 108 187 176 131
APAs canceled or revoked 2 0 0 0 0 0 2 0 0
APAs withdrawn 4 8 6 5 11 8 9 19 14
During early 2012, the APA program merged with the portion of
the US Competent Authority (USCA) that resolves TP cases under
the mutual agreement procedures of the US bilateral income
tax conventions. As the successor to the APA program, the new
Advance Pricing and Mutual Agreement (APMA) Offce issued this
years APA report.
The APA statistic for 2009, 2010 and 2011is summarized below:
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