Tag Archives: Transfer Pricing

Bright Line, Now blurred : Delhi High Court rejects TP adjustment for AMP

 

After reversal of the Tribunal (famously referred as LG electronic’s case) on the Transfer Pricing Adjustment made towards alleged “excessive” expenses incurred by the Taxpayers , the Revenue once again found itself on the losing side of the battle on the issue of TP adjustment in relation to the Advertising, Marketing and Promotion (‘AMP’) expenses, before the Delhi High Court.

Further Set-Back to Revenue in Maruti Suzuki’s case

After its ruling to the effect that Bright Line Test cannot be applied to deduce an international transaction [Sony ericsson’s case], the Delhi High Court moved one more step closer to the Taxpayer’s position on the issue of Transfer Pricing Adjustment in relation to alleged brand promotion services by an Indian company by virtue of incurring excessive Advertising spends.

The Delhi High Court  negatived the Revenue stand that excessive brand promotion expenses incurred by Maruti Suzuki could be analysed as an “International Transaction”  under the Indian Transfer Pricing provisions.

The Revenue’s case was that companies which use a foreign brand and incur aggressive Advertising and Marketing expenses are helping their parent / associate group company to improve the value of the Brand owned by the foreign associate, at the expense of the Indian entity of the group. The Revenue alleged that there exists an unwritten arrangement between the Indian entity and its foreign associated enterprise as a result of which the Indian company is incurring these expenses. By incurring such abnormal AMP expenses, the Indian company is effectively undertaking brand promotion / brand building for its foreign associated enterprise and therefore it must be compensated at arm’s length for such services, the Revenue contended.

The Court has taken the view that the provisions of the Indian Transfer Pricing law do not permit  an exercise of deducing the existence of an international transaction in the nature of brand promotion assistance / services being rendered by the Indian company, when such expenses have admittedly been incurred by the Indian company for its own business. Any incidental benefit of such expenses to the foreign company by way of improving its brand value cannot be deemed as an International Transaction without there being an express  provision  under the law, the Court ruled.

 

 

No TP adjustment sans base erosion: ITAT Mumbai

In a recent decision rendered in the case of Tata Consultancy Services, the Tax Tribunal has held that a Transfer Pricing adjustment was not warranted in situations where Tax avoidance / Profit shifting is not possible, such as in cases where the Indian company is enjoying Tax holiday or the foreign associated enterprise is located in a high-tax jurisdiction.

The Tribunal also held that a mechanical reference to the Transfer Pricing Officer was improper and the Assessing Officer ought to have applied his mind to the Transfer Pricing report filed by the Taxpayer and given an opportunity of hearing to the Taxpayer, before referring the case to Transfer Pricing Officer.

The other issues that were decided in the aforesaid appeal in favor of Taxpayer were allowing the deduction for State Taxes paid in US, allowing capitalization of software expenses to escape dis-allowance under section 40(a) for non-deduction of Taxes and allowing deduction under section 10A, even though 80HHE relief was claimed in earlier years.

Our Comment

The Tribunal has dealt with two forms of base erosion arguments on the same footing:

(a) That there cannot be any motive to shift profits where the Indian Taxpayer is enjoying a Tax holiday and

(b) Where the Tax rate in the foreign country is higher, again, there cannot be any motive for shifting profits

In cases where the Taxpayer in India is enjoying an undisputed Tax holiday  benefit, the logic that there is no motive to avoid Tax is quite unexceptionable. As regards the argument relating to the foreign associated enterprise being located in a ‘high-tax’ jurisdiction is concerned, in our view, the head-line tax rate per se cannot be a factor to determine if there exists a motive or incentive to shift profits, as what would be relevant is the effective tax rate of the foreign enterprise.  In this context, the other aspect of the ruling on providing an opportunity for hearing to the assessee before a reference to the TPO becomes relevant, as the said opportunity could be used by the Taxpayer to demonstrate the effective tax impact of the Transaction in both jurisdictions.

 

 

 

Revised Transfer Pricing Process under the new TP Rules

The Government has finally notified the new set of rules for determination of Arm’s length price  (‘ALP’) under the Transfer pricing provisions. The new set of rules would also apply in relation to the international transaction entered during the fiscal 2014-15, for which Transfer pricing and filing compliance fall due by end of next month (30 November 2015)

The revised process of determination of ALP under the rules is summarized below:

(1) Arm’s Length Range concept introduced

Where the application of Most Appropriate method results in more than one price, then the Tax payer would have to construct a ‘data set’ for determination of arm’s length mean or range, as  applicable.

(2) The mean concept will apply for smaller data sets

Arm’s length range would apply if there are six or more entries in the data set and the mean would apply if the number is less than six.

(3) Multi-year data (current year+ 2 previous years) to be used for margin-based methods

Where the margin-based methods (i.e. Transaction Net margin method, cost plus method or Resale price method) are used for determination of ALP, then the weighted average margin for the current year (i.e. the year under analysis) and two prior years would have to be considered for determination of the arm’s length price (margin).

(4) Previous year data can be used for comparable selection

While applying the margin-based methods, if current year data is not available for a company, then its comparability would be analysed based on the previous year’s data, and if a company meets the comparability criteria, then two prior years’ data would be considered for constructing the data set.

(5) Comparable companies selected on Previous year data to be re-validated upon availability of current year data

While applying the margin-based methods, if a company is selected as a comparable based NOT on current year data, but instead on previous year data (as discussed under point 4 above),  and subsequently current year data for such a ‘comparable’  is available at the time of assessment, then the suitability for inclusion as a comparable would be re-determined based on current year data. If the current year data reveals that a selected company was not really a comparable, then such a company would have to be excluded from the analysis. Should the current year data however validate the selection, there is no provision to ‘update’ the weighted average margin of such a comparable with the current year’s result, as is the practice normally adopted by the Transfer Pricing officers currently.

(6) Range defined

Where the data set consists of six or more ‘entries’, then the values in data set lying between the 35th and 65th percentile would be regarded as the arm’s length range.

Practically, on account of the way the 35th and 65th percentile have been defined, the actual range would be slightly higher at both the lower and the higher bounds of the range, than the actual / ‘pure statistical’ values.

(7) Mean ALP to apply for smaller data sets

Where the number of the ‘entries’ in the data set is less than six, then the ALP would be determined at the mean of the values or a permitted deviation (not exceeding 3%) from such a mean, which may be notified.  This is the same as the method which was in use till now.

(8) No impact on Profit Split Method / Residual Method

The revised process would not impact the application of the Profit Split method and the ‘residual method’ – both rarely used in practice in the Indian context.

Our Comments

The introduction of the Arm’s length range concept and use of earlier years data are steps which are in line with the Taxpayers expectation, although the use of multi-year data can prove to be a double-edge sword and can result in unrealistically higher ALP in a period of secular decline in margins in an industry.

The new rules however would have little impact on the core of the Transfer Pricing problem being faced by Taxpayers, which revolve around the selection of comparables per se, with both Taxpayers and the Taxman seldom agreeing on comparables which are fit for inclusion / exclusion in the data set to be used for determining the ALP.

 

Delhi Tribunal sets out TP Adjustment formula for late realization of sales

In a recent ruling in the case of Techbooks International Private Limited, the Delhi Tax Tribunal proceeded to lay down the formula for making Transfer Pricing adjustment for late realization of sales proceeds.

 

Formula adopted by TPO

The Transfer Pricing officer noted that the Taxpayer had realized the sales invoices late and carried out Transfer pricing adjustment by applying interest rate of 15% on the late receipts, after allowing for a normal credit period of 60-days.

The Taxpayer protested the adjustment and also pointed out that as  the terms of the services agreement provided for a credit period of 150-days.

Tribunal Ruling

The Tribunal upheld in-principle the need for making the TP adjustment for late realization, taking note of the fact that the Finance Act 2012 widened the scope of international transactions to include inter-alia debts arising during the course of the business.

The Tribunal however altered the basis adopted to carry out the adjustment. The Tribunal reasoned that since the sale price of the Taxpayer was arrived on the basis of a 150-day credit period, the adjustment to late realization had to be made on the following basis:

(i) In the first instance, the credit period of the comparables had to be determined and the revenue of comparable companies had to be re-computed based on the 150-day credit period, to bring them on par with the Taxpayer

(ii) The delay in realization by the Taxpayer beyond the contracted 150-day credit period to be taken as another international transaction, and adjustment made therefor

For the purpose of making the adjustment, the Tribunal upheld the use of LIBOR rate in foreign currency relevant to a particular Associated Enterprise

 

Other Issues

a) Companies following different financial year

The Tribunal also provided an opportunity to the Taxpayer to re-determine the margins of the comparable companies which were rejected for following financial year-end different from fiscal year-end and reporting period of more than 12 months.

b) Selection /Rejection of comparable companies

Companies which had undertaken M&A transactions were held not comparable. Claims for selection / rejection of comparable companies on grounds of high / low turnover were also not entertained.

c) Risk Adjustment

Claim for Risk adjustment by the Tax payer since it was a “captive” service provider was negatived on the basis that it faced a “single-customer” risk and also on finding that the Taxpayer had created a provision for doubtful Advances against Associated concerns.

d) Margin computation

Forex fluctuation and provision for doubtful debts held to be an operating item while bank charges held as a non-operating item for the purpose of margin computation.