DIPLOMA IN INTERNATIONAL TAXATION ASSESSMENT TEST

Paper-1: International Tax – Transfer Pricing

SUGGESTED ANSWERS – November, 2020 ASSESSMENT TEST

Disclaimer

The suggested answers contained in this publication constitute ideal answers for
various questions. They do not constitute the basis for the evaluation of the
candidate’s answers in INTT-AT. These suggested answers are arranged with a view
to assist the candidates pursuing the DIIT Course for their preparation for the
Assessment Test. While due care has been taken in preparation of the answers, if any,
errors & omission is noticed, the same may be brought to the notice of the Secretary,
Committee on International Taxation. The Council and Committee on International
taxation of the Institute are not responsible in any way for correctness or otherwise of
the answers published herein under.

These suggested answers are based on the provisions of Income tax law as amended by
the Finance Act, 2019, Finance (No. 2) Act, 2019 and Taxation Laws (Amendment) Act,
2019 which are relevant for November,2020 examination

Question No. One (1) is compulsory

Answer four from out of rest five questions.

Answer should be in English.

Marks

Question 1

(a) UN TP Manual 2017 has noted that “Transfer pricing theory meets practice in
comparability analysis”. Explain the statement and briefly state how Indian
Income-tax Rules have given a formal recognition to the comparability analysis. 6

(b) Briefly describe any four qualitative factors that are generally applied for the
search of the comparable which are related to provision of software development
services. 4

(c) Reply to the questions raised in the following statements with brief reasons: 2x5=10
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(i) While preparing Transfer pricing report for the financial year 2019-20, CUP
is selected as the most appropriate method. Data for financial year 2019-20
is not available. Can you use the data for financial year 2018-19 instead?

(ii) While preparing Transfer pricing report for the financial year 2019-20,
TNMM is selected as the most appropriate method. Comparables for
current year are not available and it is seen that the net margin realized
from a similar transaction with an AE was accepted at arm’s length in the
immediate preceding year. Can this be used as internal comparable?

(iii) It is noticed that the transaction is between an Indian parent company and
foreign subsidiary. The Indian parent company takes all the risks and
performs entrepreneurial functions. The foreign subsidiary performs as
limited risk distributor in foreign territory. Can foreign subsidiary be taken
as tested party?

(iv) Indian enterprise X Limited, engaged in garment manufacturing, has

borrowed loan from its parent company resident in USA, Y Limited. Interest
is paid on this loan transaction which is required to be benchmarked.
Which method would be the most appropriate method?

(v) While preparing Transfer pricing report for the financial year 2019-20,
TNMM is selected as the most appropriate method and six comparable are
identified. How will you compute arm’s length price from this data set?

Answer 1

1. (a) The application of the arm's length principle for benchmarking any controlled
transaction essentially comes down to establishing its 'comparability' with either an
uncontrolled transaction or an uncontrolled enterprise.

Only when this comparability between the controlled and uncontrolled transactions
or between the tested party and unrelated parties get established, can the process
of comparison of the prices or the margins, as the case may be, could be initiated.

Therefore, the UN TP 2017 has befittingly noted that "Transfer pricing theory meets
practice in comparability analysis".The Indian Income-tax Rules, 1962 has given a
formal recognition to the comparability analysis by laying down several factors which
are to be considered for judging the comparability of the controlled against the
uncontrolled transactions.

For the purposes of determination of the arm's length price (ALP), vis- a-vis selection
of the most appropriate method, sub-rule (2) of Rule 10B states:

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".... for the purposes of sub rule(1)(i.e. for determination of ALP), the
comparability of an international transaction or a specified domestic
transaction with an uncontrolled transaction shall be judged with reference
to the following, namely-

a) The specific characteristics of the property transferred or services

provided in either transaction;
b) The functions performed, taking into account assets employed or to be
employed and the risks assumed by the respective parties to the
transaction;
c) The contractual terms (whether or not such terms are formal or in
writing) of the transactions which lay down explicitly or implicitly how the
responsibilities, risks and benefits are to be divided between the
respective parties to the transactions;
d) Conditions prevailing in the markets in which the respective parties to the
transactions operate, including the geographical location and size of the
markets, the laws and the Government orders in force, cost of labour and
capital in the markets, overall economic development and level of
competition and whether the market are wholesale or retail.

1. (b) Qualitative factors applied for the search of comparables related to software
development services

The following qualitative filters are applied after application of the quantitative
filters:

(i) Product filter: Although, the industry filter being one of the quantitative
filters rightly excludes the companies not operating in the same industry but
yet there are entities producing a variety of products in the same industry.
Therefore, in order to reach a precise measure of comparability, the list of
companies should be shortlisted to exclude companies not dealing in the
same / similar products as that of the tested party.

For example, if the tested party being a software developer engaged in

developing software meant for teaching school children (virtual class room)
cannot be a comparable with a software developer engaged in the business
of development of software for procurement and distribution of milk by a
dairy company.

In essence, the product filter postulates that industries engaged in similar

product (software development) are to be considered after ascertaining
similar units in the same industry by applying industry filter which is a
quantitative filter.

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(ii) Functional filter: The chosen companies must be further analysed to select
only those companies (comparables) which are functionally similar to the
tested party. The functions could be in the form of manufacturing of goods,
rendering of services, trading in goods etc. Thus the filter to be applied
depends on the functions performed by the tested party to find transactions
which are functionally similar.

For example, a company engaged in purchase of software and developing it

further with add-on features cannot be compared with another company
who develop software originally from the beginning.

(iii) Ownership filter: Generally, entities in the private sector exist for generating
profits. Government owned entities on the other hand, function to serve the
society and are not necessarily driven by the profit motive.

However, there are conflicting decisions among High Courts and tribunals
both in favour and against the inclusion of government companies as
comparables. The Madras High Court in Same Deutz-Fahr India observed that
"there is……… no provision of law which makes any distinction between a
government owned company and a company under a private management
for the purpose of transfer pricing audit and / or fixation of ALP. There is no
reason why a government owned company cannot be treated as a
comparable".

1. (c) (i) Rule 10B(5) has allowed use of preceding financial 2 year data, if current year
data is not available at the time of benchmarking.

However, this relaxation is only provided for RPM, CPM and TNMM method
and is not available for CUP method. Hence, past year data cannot be used.

(ii) Since the use of past year data is allowed for TNMM, 2 past year data can be
used. However, the data must be from uncontrolled transaction which is
defined to mean a transaction between enterprises other than associated
enterprises.

A transaction between two associate enterprises cannot be used as

comparable even if accepted to be at arm's length by the TPO.

(iii) UN TP guidelines and various courts have held that foreign enterprise can be
taken as the tested party if it is least complex party and data is available.

In this case, the foreign subsidiary is the least complex party and hence can be
taken as comparable if the data is available.

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(iv) On the given facts CUP is the most appropriate method and
ALP is required to be calculated by taking into account the prices (interest
rate) at which similar transaction with other unrelated parties are taken.

(v) Under Rule 10CA(4) for TNMM, where six or more comparable are selected,
arms' length is to be calculated through range method and not by arithmetic
mean. The arm's length range is from 35th percentile till 65th percentile of the
dataset. If the tested party price falls within this range then it shall be held as
at arm's length.

If it falls outside range, then median of the above data set shall be taken to be
the arm's length price.

Question 2
(a) X Limited an Indian company is subsidiary of Y Inc. a US company. During the
previous year 2018-19, X Limited has borrowed funds for working capital from Y
Inc. amounting to USD 500,000 at the rate of LIBOR +200 basis point. The tenure
of loan is 3 years and it is unsecured loan. The credit rating of X Limited is Baa3
(as per Moody’s credit rating model). The details of third party loan agreement
available in public domain are as follows: 6

Sr. Lender Borrower Credit Tenure Currency Secure Basis

No. rating of of Loan or point
borrower unsecure on
LIBOR
1 A Inc US B Inc US Aa1 3 years USD Unsecure 50
2 C Plc UK D Inc US Baa3 3 years USD Unsecure 175
3 E Ltd. F Inc US Baa3 10 years USD Secure 200
India
4 G Gmbh H Plc UK Aa3 3 years GBP Unsecure 200
5 I Inc US J Plc UK Baa3 3 Years USD Unsecure 250
6 K Pte L In US A2 3 Years USD Unsecure 125

Determine the arm’s length rate of interest for loan borrowed by X limited from Y
Inc. US, assuming X Limited has not taken any other loan.

(b) X Limited is an Indian enterprise whose controlled transaction is to be

benchmarked. TNMM is found to be the most appropriate method. Seven
comparables A, B, C, D, E, F and G are identified. The data of the current year (Y3)
is available in respect of comparables A, C, E, F and G and is not available for
comparables B and D. These two comparable have been identified using
immediate preceding financial year (Y2) data which is available. Further the data
for past two years are also available in cases of most of the comparables. The
data available is as under: 10

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Sr. No. Name Year 1 Year 2 Year 3 (Current

Year)
1 A OC=100 OP=12 OC=150 OP=10 OC=225 OP=35
2 B OC=80 OP=10 OC=125
OP=5
3 C OC=250 OP=22 OC=230 OP= 26 OC=250 OP=18
4 D OC=220 OP=22
5 E OC=100
OP=(-5)
6 F OC=160 OP=21 OC=120 OP=14 OC=140 OP=15
7 G OC=150 OP=21 OC=130 OP=12 OC=155 OP=13

During the assessment proceeding it is seen that,

(i) Data of comparable B is available for the current year and that data shows
that it is not a comparable transaction.
(ii) Data of comparable D is available for current year and it shows that it is a
comparable transaction with OC =150 and OP=20
(iii) Further, another data H is now available which is comparable in the current
year (year 3). However, it is found to be not comparable in year 2 but is
found to be comparable in year 1.

The data of this comparable is as under:

Year 3
Sl.
Name Year 1 Year 2
No
(Current Year)

8 H OC=150 OC=80
OP=12 OP=10

Find out the arm's length price or range as applicable.

(c) Based on the nature of the following transactions, specify which of transfer pricing
methods would apply (if required more than one method could be provided) 4

(1) Purchase of commodities listed on the Stock Exchange.

(2) Multiple transactions involving intangibles.
(3) Provision of Software development services.
(4) Payment of management fees.

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Answer 2

2. (a) Determination of arm's length rate of interest for loan borrowed from foreign
associated enterprise

X Ltd being the Indian company who is subsidiary of Y Inc. of USA has borrowed
unsecured loan from the holding company viz. Y Inc. It is stated in the question
itself that there exists relationship of associated enterprise between X Ltd and Y
Inc. The transaction between the units is an international transaction since one of
the parties to the transaction viz. Y Inc. is a foreign company located outside India.

Third party loan agreements available in the public domain will have to be
compared with the features of the loan agreement and borrowal made by X Ltd
from Y Inc. The following process is adopted for accepting or eliminating the said
comparable units available in the public domain.

A Inc. USA also took unsecured loan but the credit rating of the borrower was Aa1
and therefore it could not be a comparable. Thus it is to be excluded.

C Plc UK also took unsecured loan like X Ltd and its rating is similar to X Ltd of Baa3
and therefore it is to be considered as a comparable.

E Ltd, India took loan with same credit rating of X Ltd viz. Baa3 but the loan is
secured. Therefore, it cannot be adopted as a comparable.

G Gmbh similarly borrowed unsecured loan but its credit rating is Aa3 and
therefore it is not a comparable as regards X Ltd.

I Inc. US borrowed unsecured loan with same credit rating of Baa3. This can be
considered as a comparable since the credit rating and the loan being unsecured is
comparable with X Ltd.

K Pte borrowed unsecured loan but its credit rating is A2 and therefore it cannot be
considered as a comparable for the purpose of determining the arm's length rate of
interest of X Ltd.

Out of the six parties C Plc. UK and I Inc. US have taken similar loan with common
features such as (i) credit rating; (ii) unsecured and term of the loan being 3 years.

The borrowing by C Plc is LIBOR + 175 points and I Inc. is LIBOR + 250.
The arithmetic mean of the above said should be taken as ALP.

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LIBOR + 175 and LIBOR + 250 / 2 = LIBOR +212.50.

The arithmetic mean i.e. LIBOR +212.50 is more than the actual international
transaction price of LIBOR+200. Therefore, no adjustment is required. The actual
transaction price will be taken as the ALP.

2. (b) Constructing a data set and determination of ALP or range

Since B is found to be not comparable for current year, it cannot be taken as

comparable.

All other comparables are found to be comparable in the current year then they
would be taken as comparable along with past two years data if they are
comparable in those two years. If in any of the two years they are not comparable
(or data not available) that year data would not be included.

Thus, the final calculation is as under:

S. Name Y1 Y2 Y3 Aggregation of Weighted

No. (Current Year)
OC and OP Average
1 A OC=100 OC=150 OC=225 OP=35Total OC=475 OP/OC=12%
OP=12 OP=10 Total OP=57
2 C OC=250 OC=230 OC=250 OP=18Total OC=730 OP/OC=9%
OP=22 OP= 26 Total OP=66
3 D OC=220 OC=150 OP=20Total OC=370 OP/OC=11.35%
OP=22 Total OP=42
4 E OC=100 Total OC=100 OP/OC=(-)5%
OP=(-5) Total OP=(-5)
5 F OC=160 OC=120 OC=140 OP=15Total OC=420 OP/OC=11.9%
OP=21 OP=14 Total OP=50
6 G OC=150 OC=130 OC=155 OP=13Total OC=435 OP/OC=10.57%
OP=21 OP=12 Total OP=46
7 H OC=150 OC=80 OP=10 Total OC=230 OP/OC=9.56%
OP=12 Total OP=22
From the above the data set is constructed in increasing order as below:

(-)5%, 9%, 9.56%, 10.57%, 11.35%, 11.9%, 12% .

There are 7 data and hence range method is to be adopted.

35th percentile would be 35% of 7 = 2.45, which means 3rd data in the chronological
order i.e 9.56%

65th percentile would be 65% of 7= 4.55, which means 5 th data in the chronological
order i.e 11.35%.

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That means arm's length range would be from 9.56% to 11.35%. If the 1 tested
party X limited margin is within this range it would be acceptable as arm's length.

If it is less than 9.56% then adjustment would be made to bring it to median which
is 10.57%

2 (c) 1. Comparable Uncontrolled Price Method or No Specified Method

2. Profit Split Method

3. Cost Plus method / Transactional Net Margin Method

4. No specified method - benefit test and acceptable allocation

Question 3

(a) What are "additive" and "deductive" approaches for selection and rejection of
comparables. Which of this approach is prescribed in the Indian TP regulations?
Which approach is expected to give better result? 6

(b) What do you mean by transactional profit methods? Name the two
transactional profit methods. What are the circumstances in which transactional
profit methods are considered appropriate? 6

(c) Explain the circumstances under which comparability adjustments can be made.
2+(2x3)=8

(Please mention the type of economic adjustment that can be in each of the cases.
Also provide brief reasons.

(i) Company A is a captive Information Technology enables Services (ITeS)

provider. Transaction Net Margin Method (TNMM) is selected as Most
Appropriate Method (MAM) for benchmarking the international transaction
of provision of ITeS. Company A generally receives advances for services
rendered to its' associated enterprise whereas the final set of external
comparable companies selected are unlikely to receive advances.

(ii) An MNE Group has recently set-up Company B in India which is a contract
manufacturer operating in Electronic Manufacturing Services industry.
TNMM is selected as MAM for benchmarking the international transactions
undertaken by Company B with its associated enterprises. Company B has
operated at less than the normal capacity during the year under
consideration.

(iii) Company C is a captive software development services provider.

TNMM is selected as MAM for benchmarking the international transaction

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of provision of software development services. Company C has no foreign

exchange gain/loss and is insulated from changes in demand or pricing or
competition in the market, and any foreign exchange fluctuations are
passed on to the parent. The final set of external comparable companies
selected are entrepreneurs, which are bearing forex risks.

Answer 3

3. (a) "Additive" and "Deductive" approaches for selection and rejection of comparables

The OECD TP guidelines sets out certain approaches that may be considered by
taxpayers for identification of potential comparables.

Additive Approach: In this approach a list of companies that are believed to be

potentially comparable is drawn up. This list can be collated from multiple sources
(e.g databases, industry publications etc) thereby forming a broader list.

Information is then collected on the potential comparable to confirm whether they

are acceptable comparables in terms of the factors of comparability.

Deductive Approach: In this approach a wide set of companies operating in the

same sector or line of business is taken typically through a search on database(s) of
companies (e.g Prowess or Capitaline Neo or ACE TP).

The list is then refined in accordance with the factors of comparability through a
quantitative and qualitative analysis in order to obtain a set of comparable
companies.

The Indian TP regulations do not prescribe any specific approach for identification
of comparables, but in practice, the deductive approach is followed by the tax
administration in India.

The deductive approach ensures a sufficient degree of objectivity and transparency

as it systematically narrows down from a broader set of potentially comparable
companies to a narrower set of closely comparable companies.

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3. (b) Transactional profit methods and instances where they could be put to use

Transactional profit methods are those methods which examine the net profit
margins earned by taxpayer from controlled and uncontrolled transactions.

Transactional profit methods can be applied where the net profit margin analysis
provides a more reliable result than a gross margin analysis, on account of the
highly integrated transactions undertaken by the taxpayer.

Transactional profit methods are appropriate for transactions involving intangibles,

unique contributions, cost contributions etc. Practically speaking, due to readily
available data of operating profit margins for comparable companies as compared
to reliable gross margin data, one sees the use of transactional profit methods
much more than traditional transaction methods; despite such transactions not
necessarily being integrated or involving intangibles.

There are two transactional profit methods, TNMM and PSM

TNMM is the most appropriate method in transactions involving broad comparable

functions rather than a particular controlled transaction, where data on
uncontrolled transaction is limited. If the available comparables differ significantly
with respect to products and functions then TNMM is preferred than traditional
methods.

PSM is considered as the most appropriate method generally in cases where the
transactions are complex involving the use of intangible and that the transactions
are inter-related that they cannot be evaluated separately for determining the ALP
of any one transaction.

3. (c) Circumstances where comparability adjustments are required and types of

economic adjustments in certain specific instances

As per Rule 10B(3) of the Income tax Rules, 1962, an uncontrolled transaction
should be considered comparable to the controlled transaction only if there are no
material differences between the transactions being compared or the enterprises
entering into such transactions which would materially affect the prices or costs
charged or margins arising in such transactions.

It further provides that in case there are any such material differences, reasonably
accurate adjustments should be made to eliminate such material differences in
order to compare the controlled and the uncontrolled transactions.

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However, it needs to be kept in mind that while adjustments

can be made while evaluating these factors so as to enhance comparability,
the number, magnitude and the reliability of such adjustments do affect the
reliability of the overall comparability analysis and the same should be kept in mind
while carrying out such adjustments.

In this context, OECD Guidelines have similar provisions 16: "Controlled and
uncontrolled transactions are comparable if none of the differences between the
transactions could materially affect the factor being examined in the methodology
or if reasonably accurate adjustments can be made to eliminate the material effects
of any such differences".

Type of economic adjustments in each of the case:

(i) Working Capital Adjustment- As it would take in to consideration the

different advances received by the assessee and comparable company
(ii) Capacity Utilisation Adjustment - As the company has operated at less than
the normal capacity.
(iii) Currency/Forex Adjustment- Considering foreign exchange result as non-
operating.

Question 4

(a) ABC Limited is a public listed company in India having wholly owned subsidiaries
across the world. ABC Limited has two wholly owned subsidiaries in India and one
joint venture company. The Consolidated revenue of ABC Limited is EURO 900
Million for the financial year 2019-2020. ABC Limited has entered into several
international transactions pertaining to intangible property with aggregate value
amounting to INR 90 crores for the financial year 2019-2020. 8

Based on the above information, specify the transfer pricing compliance (along
with the name of requisite forms) which ABC Limited has to undertake in India.
Also, specify the statutory due dates of such compliance. What if the US wholly
owned subsidiary would be appointed as an Alternate Reporting Entity?

(Give statutory due dates ignoring any extension given by the Central
Government.)

(b) ABC Inc. is the holding company of two Indian company namely DE Limited and FG
Limited. Following are the inter-company transactions undertaken during the year
under consideration: 6

• Purchase of raw materials by DE Limited from ABC Inc. —INR 10 Crores

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• Sales of finished goods by DE Limited to FG Limited —INR 25 Crores

• Payment of royalty by DE Limited to ABC Inc. — INR 8 Crores
• Purchase of fixed assets by DE Limited from FG Limited — INR 2 Crores
• Reimbursement of expenses by DE Limited to ABC Inc. — INR 3 Crores

Neither DE Limited nor FG Limited is claiming special tax holiday benefits.

Considering the above facts, answer the following:
(i) What are international transactions that are required to be reported in the
Form No. 3CEB of DE Limited? 2
(ii) Whether DE Limited is required to maintain Transfer Pricing Study? Please
explain. 1
(iii) Whether FG Limited is required to file the Form No. 3CEB? Please explain. 1
(iv) Briefly explain the structure of a transfer pricing study. 2

(c) Examine the correctness or otherwise of the following with reference to the
provisions of the Income-tax Act, 1961. 3+3

(i) Transfer pricing rules shall have no implication where total income is
computed on the basis of book profits.
(ii) Assessing Officer can complete the assessment of income from
international transaction in disregard of the order passed by the Transfer
Pricing Officer by accepting the contention of assessee.

Answer 4

4.(a) Compliances required to be done by ABC Limited:

(i) Form 3CEAB - 30 days before the filing of the Master File, i.e. October 31,
2020 (Intimation of designated constituent entity)

(ii) Form 3CEAA - Part A and Part B - To be filed on or before the due date for
filing return of Income, i.e. November 30, 2020 (Master File)

(iii) Form 3CEAD - To be filed within 12 months from the reporting accounting
period, i.e. 31st March, 2021

(iv) Form 3CEAE -Till now, there is no timeline in rules, CBDT will release
notification for the same.

(v) Form 3CEB - October 31, 2020

(vi) Transfer Pricing Study — October 31, 2020 (to be maintained)

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In case the US wholly owned subsidiary is appointed as Alternate Reporting entity,

the following forms are required to be filed:

(vii) Form 3CEAB - 30 days before the filing of the Master File, i.e. October 31,
2020

(viii) Form 3CEAA - Part A and Part B - To be filed on or before the due date for
filing return of Income, i.e. November 30, 2020

(ix) Form 3CEAC-Two months prior to the end of next global accounting year, i.e.
January 2021 if financial year ending is March 2020.

4. (b) TP provisions applicability and other issues:

(i) The international transaction that would be reported in Form 3CEB

Purchase of raw materials by DE Limited from ABC Inc. INR 10 Crores

Payment of royalty by DE Limited to ABC Inc. – INR 8 Crores

Reimbursement of expenses by DE Limited to ABC Inc. INR 3 Crores

(ii) Yes, as it crosses the threshold prescribed under section 92D

(iii) No, if there are no transactions other than reported above as there are no
transaction which qualify as an international transaction for FG Limited

(iv) The structure of the TP Study is as follow:

Executive Summary
Group Overview
Overview of the Company
Industry Overview
Overview of the international transaction
Function, Asset and Risk Analysis
Selection of Tested Party
Selection of Most Appropriate Method
Economic Analysis
Conclusion

4.(c) (i) The statement is correct.

For the purpose of computing book profit for levy of minimum alternate tax, the net
profit shown in the profit and loss account prepared in accordance with the
Companies Act can be increased /decreased only by the additions and deductions
specified in Explanation 1 to section 115JB.

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No other adjustments can be made to arrive at book profit for levy of MAT, except
where:

(a) It is discovered that the Statement of Profit and Loss is not drawn up in
accordance with the relevant Schedule of the Companies Act.

(b) Incorrect accounting policies and/or accounting standards have been

adopted for preparing such accounts; and

(c) The method and rate of depreciation adopted is not correct.

Therefore, transfer pricing adjustments cannot be made while computing book profit
for levy of MAT.

(ii) The statement is not correct.

Section 92CA(4) provides that on receipt of the order of the Transfer Pricing Officer
determining the arm’s length price of an International transaction, the Assessing
Officer shall proceed to compute the total income in conformity with the arm's
length price determined by the Transfer Pricing Officer.

The order of the Transfer Pricing Officer is binding on the Assessing Officer.

Therefore, the Assessing Officer cannot complete the assessment of income from
International transaction by disregarding of the order of Transfer Pricing Officer and
by accepting the contention raised by the assessee.

Question 5

(a) ABC Limited is planning to file a Unilateral APA application on November 25, 2020
for software development services provided to its Associated Enterprises. ABC
Limited is also evaluating whether rollback application could be filed by the
Company. The details for evaluating the rollback has been provided below: 2x5=10

FY FY FY FY
Financial
Particulars 2016-17 2017-18 2018-19 2019-20
Year (FY) 2015-16
Provision of
services
Provision of back office support services to its associated enterprises in United
States, Canada and United Kingdom
Date for November 30, November December 31, November November
filing of
2016 17, 2017 2018 30, 2019 30, 2020
return of
Income (to be filed)
Pending Pending before Pending Pending Not yet Not yet
Litigation the Income Tax before the before the picked up for picked up for
Appellate High Court Transfer scrutiny scrutiny
Tribunal Pricing Officer

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In light of the above facts, please provide the answer to the following question:

(i) Whether ABC Limited can opt to file a pre-consultation application on a "no-
name" or an "anonymous" basis (ABC Limited has a history of high
adjustments)?
(ii) Which all years would be eligible for rollback? Also, provide the reason if
the rollback application could not be filed for any of the above years?
(iii) Should there be a separate APA application for the international
transactions entered into with multiple associated enterprises?
(iv) Whether ABC Limited can make a request for conversion of Unilateral APA
into Bilateral APA? Please explain.
(v) Do the APA authorities insist on actual invoicing (i.e. cash repatriation) if
the arm's length price agreed in the APA is more than the actual transfer
price. Please explain.

(b) Location saving is also an important aspect which is required to be considered in

arm's length analysis. Please explain this with the help of OECD guidance and
Indian case laws. 6

(c) ABC Limited has transfer pricing Adjustment on year on year basis and is evaluating
the option for filing a mutual agreement procedure. Based on the below question,
help ABC limited to evaluate the following with respect to MAP? 2+2

(i) Does ABC Limited have to exhaust the appeal options available under the
domestic litigation route to apply for assistance under MAP?
(ii) Is the outcome under MAP binding on ABC Limited and the Revenue?

Answer 5

5.(a) Certain issues in Advance Pricing Agreement and rollback benefit

(i) Yes, the application can be filed on a "no name" or on "anonymous" basis. To
that extent the details in the application form may be omitted.

However, in such cases, the identity of the authorized representatives must

be disclosed in the application form along-with sufficient information about
the business operation and international transaction in order to make any
discussion meaningful.

(ii) FY 2015-16 - Not Eligible year for rollback since it is beyond 4 preceding
previous years.

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FY 2016-17 - Not eligible as the order has been passed by the income Tax
Appellate Tribunal
FY 2017-18 - Not eligible as return has been filed after the due date
FY 2018-19 - Eligible
FY 2019-20 - Eligible
(iii) Not required. All the transaction could be covered under one single unilateral
agreement.

(iv) A unilateral APA can be converted into a bilateral APA before the mutually
agreed draft agreement is forwarded by the Pr. CCIT (International Taxation)
to the Board.

While converting a unilateral APA application to a bilateral APA application,

the applicant or its AE needs to make a similar request with the competent
authority of the other country.

The bilateral request of the applicant shall be forwarded by the Pr. CCIT to
the competent authority in India. The competent authority of India shall
decide whether the bilateral request is allowable based on the existence of
appropriate provision on lines of OECD Model Article 9(2) in the tax treaty
between India and the other country (now dispensed with) and also on the
existence of an APA program in that other country. If the request is allowed,
then the application would be processed as a bilateral APA application.

(v) Yes, after the introduction of the secondary adjustment the cash repatriation
would be mandatory if the arm's length price agreed in the APA is more than
the actual transfer price. The same is mandatory as per the regulation of the
secondary adjustment. Secondary adjustment can be fulfilled by cash
repatriation or payment of one-time tax at the rate of 18% (plus surcharge
and cess).

5.(b) Significance of location saving in determination of ALP

Location savings are the net cost savings that an MNE realises as a result of
relocation of operations from a high cost jurisdiction to a low cost jurisdiction.
This concept is relevant from transfer pricing point of view as it gives rise to a
question as to how the location savings are to be shared amongst the parties.

According to OECD:

"The question arises of whether and if so how the location savings should be shared
among the parties. The response should obviously depend on what independent
parties would have agreed in similar circumstances. The conditions that would be

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agreed between independent parties would normally depend on the functions,

assets and risks of each party and on their respective bargaining power."

OECD then takes the example of an enterprise in country A sub-contracting clothes

manufacturing to a related enterprise in country B where labour costs are
significantly lower. The enterprise in country A retains all rights and risks and
enterprise in country B does not assume significant risks. In such an example given
that the relocated activity is a highly competitive one, it is likely that the enterprise
in country A has the option realistically available to it, to use either the affiliate in
country A or a third party manufacturer. As a consequence, it should be possible to
find comparable data to determine the conditions in which a third party would be
willing at arm's length to manufacture the clothes for the enterprise. In such a
situation, a contract manufacturer at arm's length would generally be attributed very
little, if any, part of the location savings. Doing otherwise would put the associated
manufacturer in such a situation different from the situation of an independent
manufacturer, and would be contrary to the arm's length principle.

Case law 1: In the Indian context Delhi-ITAT in the case of LI & Fung observed that
the taxpayer created located savings for its AE. It held that benefit of such
advantages should be shared by the taxpayer. The Hon'ble Delhi HC however
reversed the order of the ITAT and held that it had not been demonstrated how the
AE benefitted from such location advantages.

Case law 2: In the case of GAP international the Delhi ITAT held that no additional
allocation is called for on account of location saving. ITAT rejected the TPO's reliance
on a newspaper report in respect of cost of procurement services in various
countries and held that location savings to the developing economy arise to the
industry as a whole and that there is nothing on record to show that the assessee on
standalone basis was the sole beneficiary.

Case law 3: In case of Watson Pharma Private Limited, the Bombay HC dismissed the
revenue's appeal in the case of assessee providing contract manufacture, contract
research and development of drugs services to its AE and upheld ITAT conclusion on
comparable selection, risk adjustment and deletion of adjustment towards location
saving. HC noted that Tribunal finding that since assessee and comparables were
situated in India, no adjustment on account of locational advantage was necessary.

Thus, the court judgments in India are in line with OECD guidelines that if there are
local comparables, locational advantage are factored in comparability analysis.

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5.(c) Timing of taking recourse to MAP and binding nature of MAP

(i) Option of resolution under MAP is an additional dispute resolution option

available to the taxpayer.

It can be pursued simultaneously with the other dispute resolution options

available under domestic regulation.

(ii) While the taxpayers have the option of either accepting or rejecting the
resolution arrived at under MAP, should the taxpayer opt to accept the
MAP resolution, it will be binding on the Revenue for that international
transaction and for that Assessment Year.

Rule 44H (4) of the Indian Income Tax Rules, 1962 provide that the Assessing
Officer shall, within 90 days of receipt of the resolution by the Chief
Commissioner or Director General of Income Tax, give effect to the resolution
provided:

 The taxpayer gives his acceptance to the resolution arrived at under MAP;
and
 Withdraws the appeal filed under the domestic litigation provisions.

Question 6

(a) X Ltd., operating in India, is the dealer of the goods manufactured by Yen Limited
of Japan. Yen Limited owns 55% shares of X Limited and out of 7 directors of the
Company, 4 were appointed by them. The AO, after verification of transaction of
INR 300 lakhs of X Limited for the relevant year and by noticing that the Company
had failed to maintain the requisite records and had also not obtained the
accountants report, adjusted its income by making an addition of INR 30,00,000 to
the declared income and also issued a show cause notice to levy various penalty. X
Limited seeks your expert opinion whether the action of AO is correct. Also, specify
what all penalties can be levied in the instant case, if any. 6

(b) Please explain difference between juridical double taxation and economic double
taxation. What was India's position on resolving economic double taxation cases
in Mutual Agreement Procedure (MAP) under the tax treaty that does not have
equivalent of Article 9(2)? How this position has changed post MLI? 4

(c) List the difference between Dispute Resolution Panel (DRP) and CIT (Appeal) in its
constitution, power to condone the delay, filing fee, stay of demand and time limit
for completion. 5

(d) What are the salient features of thin capitalization rules in India? 5

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Answer 6

6.(a) Relationship of AE and penal consequences on assessment

The facts of the case indicate that X Ltd and Yen Ltd of Japan are AEs since Yen
Limited holds 55% share of X Limited and has appointed more than half of the board
of directors of X Ltd.

Since Yen Limited is a non-resident, any transaction between X Ltd and Yen Ltd.
would fall within the meaning of international transaction under section 92B.
Therefore the income arising from such transaction have to be computed having
regard to the arm's length price.

The Action of the AO in making addition to the declared income and issuing show
cause notice for levy of various penalties is correct since X Ltd had committed
defaults, as listed hereunder, in respect of which penalty, as briefed hereunder, is
imposable-

Failure to report any international transaction or any transaction, deemed to be an

international transaction or any specified domestic transaction, to which the
provisions of Chapter X applies, would attract penalty @ 200% of the amount of tax
payable since it is a case of misreporting of income referred under section 270A(9)
read with section 270A(8).

Failure to maintain the requisite records as required under section 92D in relation to
international transaction makes it liable for penalty under section 271AA which will
be 2% of the value of each international transaction.

Failure to furnish report from an accountant as required under section 92E makes it
liable for penalty under section 271BA i.e., a fixed penalty of INR 1 lacs.

The AO shall give an opportunity of hearing to the Assessee with a notice as to why
the arm's length price should not be determined on the basis of material or
information or document in the possession of the AO.

6.(b) Juridical Double Taxation and Economic double taxation

Juridical double taxation involves double taxation which may arise i.e. tax is imposed
by two or more countries as per their domestic laws in respect of the same
transaction on the same person.

While economic double taxation involves double taxation in the hands of two
different persons in one or more tax jurisdictions.

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To illustrate, ABC Inc USA has a PE in India. If Indian tax authorities make adjustment
in the PE it would amount to juridical double taxation as PE of ABC Inc USA in India is
the same person as ABC Inc USA.

However, instead if ABC Inc USA has a subsidiary in India with the name ABC India
Limited and addition is made in the case of ABC India Limited on a transaction
between ABC India Limited and ABC Inc USA, it would amount to economic double
taxation as the double taxation is happening in the hands of two different persons.

In Pre-MLI India had a position that economic double taxation can be solved under
MAP only if the relevant tax treaty has equivalent of Article 9(2) (which allows
corresponding adjustment). If there is no such Article, only juridical double taxation
cases can be taken up under MAP and not economic double taxation cases.

This position has changed post-MLI as India has issued press release clarifying that it
would accept economic double taxation cases too, even if there is no equivalent of
Article 9(2) in its DTAA.

6.(c) Difference between DRP and CIT (A)

Aspect DRP CIT(A)

Constitution Consists of three Consist of one
commissioners Commissioner
Power to condone delay No power to condone Has power to condone
the delay the delay by exercising
discretion.

Filing Fee There is no filing fee. There is filing fee ranging

between Rs. 250 to
Rs.1000
Stay of demand Since the objections are In this case the final order
filed against draft order is passed by AO and hence
there is no demand there is demand
outstanding and hence no outstanding.
question of stay
CIT(A) exercising
discretion can stay a part
or complete demand on
the filing of stay
application by the
appellant
Time limit for completion To be completed within a There is no time limit for
period of 9 months from completion of the process.
the end of the month of
the order of the lower
tax authorities

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6.(d) The salient features of the thin capitalization rules in India are as follows:

(i) It is applicable to borrowers, being an Indian company or PE of a foreign

company, who pay interest in respect of any form of debt issued to a non-
resident or to a PE of a non-resident and who is an AE of the borrower.
Further, the debt shall also be deemed to be treated as issued by an AE
where it provides an implicit or explicit guarantee to the lender or deposits a
corresponding and matching amount of funds with the lender.

(ii) The provisions restrict the payment of interest by an entity to its AE to the
extent of 30% of its earnings before interest, taxes, depreciation and
amortization (ECBIDTA) or interest paid or payable to AE, whichever is less.

(iii) In order to target only large interest payments, it provides for a threshold of
interest expenditure of Rs. 1 crore exceeding which the provision would
apply.

(iv) The provisions also allow for carry-forward of disallowed interest expense to
eight assessment years immediately succeeding the assessment year for
which the disallowance was first made and deduction against the income
computed under the head 'Profits and gains of business or profession" to the
extent of maximum allowable interest expenditure.

(v) It excludes banks and insurance business from the ambit of these provisions
keeping in view the special nature of these businesses.

X-X-X

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