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© 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.B S R & Co.
18 December 2009
Transfer Pricing landscape in IndiaAn Update
ICAI - SIRC, Chennai
B S R & Co.
2B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Setting the Context
Snapshot on Indian Regulations
Existing and Emerging Controversies
Recent Judicial Rulings
Finance Act 2009 - Amendments
Direct Tax Code - Proposals
010101
020202
030303
040404
050505
060606
© 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.B S R & Co.B S R & Co.
3B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
What are tax heads worried about
Transfer Pricing emerging as the single largest tax risk facing Transfer Pricing emerging as the single largest tax risk facing MNCs todayMNCs today
Withholding taxWithholding tax
Permanent establishment issuesPermanent establishment issues
DTAADTAA
Indirect taxIndirect tax
Provident fundProvident fund
4B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Tax is embedded in various aspects of business
Transfer Pricing embedded in every aspect of international transTransfer Pricing embedded in every aspect of international transaction action
5B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Toughest Tax authorities for Transfer Pricing
UK
Canada
China
Korea
India
France
Australia
Japan
Germany
USA
India and China are expected to top the charts soon
6B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Transfer Pricing In India
© 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.B S R & Co.
7B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Snapshot of Indian Transfer Pricing Regulations
Relatively new legislation - Introduced with effect from April 1, 2001
International transactions between associated enterprises need to satisfy the arm’s length criterion (ALP - price applied between independent enterprises in uncontrolled conditions)
Compliance Requirementsi. Maintenance of contemporaneous documentation (to
substantiate ALP)ii. Annual filing of Accountant’s Report (Form 3CEB)
Steep Penalties – Can be upto 3 times the tax sought to be evaded
Concept of Arithmetic mean
Limited judicial precedence
Assessment procedure stringent
8B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Approach to Transfer Pricing
Typical International Transactions:Import of components; Payments towards technology support; Export of finished products, Reimbursement of expenses
Remuneration based on FAR analysis:Assists in economic characterization and determination of compensation
Most Appropriate Method (MAM):To be used for testing arm’s length Price
• Aggregative approachBenchmarking in public databases required to analyse the arm’s length margin earned by comparable independent companies
• Transaction specific approachTransactions such as technical payouts, management fee cross charges Cost benefit analysis necessary
Net Profit Margins
Analysis allocation of profit / loss
GPM (on costs) benchmarked
GPM (on sales) benchmarked
Prices of each transaction is benchmarked
Approach
Manufacturing & Service functions – Product comparability not critical
Transfer of Intangibles or multiple transactions
Service function; Contract manufacturing
Distribution Function
Direct method – Product comparability critical
Functions
Profit Split
Transactional Net Margin (TNMM)
Cost Plus
Resale Price
Comparable Uncontrolled Price (CUP)
Method
Analysis of prescribed methods
9B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Why do you need aTransfer Pricing documentation in India?
...Tax Exposure
Provision
...
Strengthen the Appeal
Legal Requirement
Burden of proof
Penalty Protection
© 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.B S R & Co.
10B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Entity related Price related Transaction related
Profile of group
Profile of Indian entity
Profile of associated enterprises
Profile of industry
Transaction terms
Functional analysis (functions, assets and risks)
Economic analysis (method selection, comparable benchmarking)
Forecasts, budgets, estimates
Agreements
Invoices
Pricing related correspondence (letters, emails etc)
Contemporaneous documentation requirement – Rule 10D Documentation to be retained for 9 years
No specific documentation requirement if the value of international transactions is less than one crore rupees
What are the Documentation Requirements?What are the Documentation Requirements?
11B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Accountant’s report
Obtained by every person entering into an international transaction
To be filed by the due date for filing return of income
Opinion whetherPrescribed documents have been maintainedThe particulars in the report are true and correct
Form No. 3CEB [See rule 10E]
Report from an accountant to be furnished undersection 92E relating to international transaction(s)
1. We have examined the accounts and records of ENTITY NAME AND POSTAL ADDRESS - PAN No. relating to the international transactions entered into by the assessee during the previous year ending on 31st March 2009.
2. In our opinion proper information and documents as are prescribed have been kept by the assessee in respect of the international transaction(s) entered into so far as appears from our examination of the records of the assessee.
3. The particulars required to be furnished under section 92E are given in the Annexure to this Form. In our opinion and to the best of ourinformation and according to the explanations given to us, the particulars given in the Annexure are true and correct.
Place :Date :ForChartered Accountants
12B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Compliance Compliance -- A step by step approachA step by step approach
Financial AnalysisInternal
Accountants’ Report Documentation
External
Functional, Assets & Risk Analysis
Comparable Analysis
Choice of Appropriate Method
Profit Level Indicator
13B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
• Preparation of project plan • Search strategy
• Access to local & global database
• Analysis of internal comparables
• Judicious identification of arm’s length range
• Understand existing costing mechanism
• Determination of billing methodology
Pre-project planning
Stage 2Stage 3
Stage 4
Functional analysis -
Information gathering
Comparable data /
Industry Analysis
Economic Analysis
• Interviews• Questionnaires
• Discussions with Management
• Characterisation of each entity
• Agreement reviews
Stage 5
• Consultation with management
• Finalization of Transfer pricing documentation
Issuance of Transfer Pricing Documentation
Stage 1
Key to dos before finalizing Documentation
Two Key analysis
14B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Systematically meeting the transfer pricing challenge ...
Transfer Pricing Rules & Regulations
Global / Local Transfer Pricing Team
Man
agem
ent S
uppo
rt Policy /Business Model
TP DocumentationCentral Core Country
AgreementsTangiblesFinancing
IntangiblesServices
Systems / Operating ProceduresIT
Price SettingCost Allocation
Value Chain
Day-to-Day OperationsInvoicing
DocumentationAccounting
Communication
15B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Maintenance of Transfer Pricing Documentation Statute of Limitation – An illustration – March 2009
Section 92D and Rule 10D(5)
Date till which documentation is required to be maintained
31 Mar 20187
Section 149(1)(b)Limitation for reassessment (where income escaping assessment is equal to or greater than INR 100,000)
31 Mar 20166
Section 149(1)(a)Limitation for reassessment (where income escaping assessment is less than INR 100,000)
31 Mar 20145
Second Proviso to Section 153(1)
Limitation for completion of tax audit (scrutiny by the Assessment Officer)
31 Dec 20124
Section 92CA(3A) read with Second Proviso to Section 153(1)
Limitation for completion of the transfer pricing audit (scrutiny by the Transfer Pricing Officer)
31 Oct 20123
Proviso to section 143(2)(ii)Limitation for initiating a transfer pricing audit by the tax administration
30 Sep 20102
Section 139(1) read with Section 92E
Deadline for maintaining documentation, filing tax return and accountant’s report
30 Sep 20091
Relevant Provision Compliance Timeline S.No.
16B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Transfer Pricing Priorities - Today
Compliance• Documentation Penalty
• Filing and Disclosure of RPT
• Compliance Costs
• Internal / External Audit
Planning • Loss Utilization
• Foreign Tax Credits
• Intellectual Property
• Business Restructuring
Controversy • Assessments
• Advance Pricing Agreements
• Litigation
• DRP / CIT (A)
• ITAT
• HC
• SC
Operations• Tax Efficient Supply Chain
Management (TESCM)
• Process Benchmarking
• Capital Efficiency
17B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Transfer Pricing Controversy In India Current and Future Issues
© 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.B S R & Co.
18B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
TP Audit
Audit Process
File tax return and Accountant’s Report (30th September)
Reference to be made to TP Officer (‘TPO’) by the Assessing Officer (‘AO’); Compulsory Reference to be made by AO
if international transactions exceed INR 150 million for AY 2005-06 onwards (Internal guidelines)
Appeal can be made against the order of AO as order of
TPO included within the order of the AO
Notice to be issued by the TPO – TPO calls for supporting documents and evidence
Rectification application can bemade against the order of TPO
for apparent mistakes
Based on results of above mentioned procedure assessing officer passes the order
Appeal Procedure
Appeal to Commissioner of Income Tax
Passes an order
Income Tax Appellate Tribunal
High Court – only on matters related to law
Supreme Court
Constitutional Bench
DRP Mechanism-Finance Act 2009
19B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Some important statistics (Estimates)
Cases adjusted heading northwards butonly a handful cases have managed to get past tribunal.
Is it just the tip of the Iceberg? Is DRP the solution?
AY 2002-03
Cases assessed = 1081
Cases adjusted = 239
Total adjustment = USD 305 Mn
AY 2004-05
Cases assessed = 1768
Cases adjusted = 471
Total adjustment = USD 858 Mn
AY 2003-04
Cases assessed = 1501
Cases adjusted = 337
Total adjustment = USD 572 Mn
AY 2005-06 & AY 2006 – 07
Cases adjusted = 25 percent
Total adjustment = More than USD 3000 Mn
20B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
• Finance Act 2009 and DTC – Focus on transfer pricing
• Increase in audit threshold (from USD 1.25 million to 3.75 million)
• Scrutiny audit time increased from 33 months to 45 months from the end of financial year
• Steep expansion of specialist officers [No. of Transfer Pricing Officers (TPOs) from 18 to 80]
• Coordinated All-India Transfer Pricing (TP) approach
• Creation of special TP administration at CIT (A) and Tribunal level
• Training to TPOs on international TP laws and practices
• Co-ordination between Customs and Transfer Pricing authorities
• Significant adjustments to companies in IT, Pharmaceuticals, Financial services, Automobiles and Chemicals Sector
Increased administrative focus from Indian Revenue
Audit Statistics
2021222324252627
AY 02-03 AY 03-04 AY 04-05 AY 05-06Assessment Year
% o
f cas
es
adju
sted
0
200
400
600
800
1000
1200
Amt o
f adj
(USD
M
il)
% of cases adj Amt of Adj (USD Mil)
21B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Transfer Pricing audits in China
22B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Aggressive Audit Environment – Key Triggers
Consistent losses / low margins of the assessee attributable to inter-company transactions
Significant changes in profitability of the assessee and its AEs
High Royalty / Technical fee payouts, Cost recharges, Management Fees, Cost allocations. – Need to pass the ‘benefit test’
Losses incurred by routine distributors
Low mark-ups for services
Contributors to Aggressive Audits:Mounting fiscal demand on Government
Need to Preserve tax base during recession
Competitiveness needs business restructuring
Unprecedented sharing of information between revenue authorities
23B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Key Focus Areas – Payouts
Cost? Potential Benefit?
Royalty Technical Fees
Cost? Potential Benefit?
Management Fees Guarantee fees
Cost?Potential Benefit?
Potential Benefit?
Cost?
Payout Options
Cost – Benchmarking payouts of comparable companies, Basis of arriving at the value of payouts ( Direct / Indirect Method) by the Group
Potential Benefits – Need for obtaining service from the Group, Analysis of potential benefit obtained by the Company and value attributable to the service
24B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Key Focus Areas – Management Payouts
Typical forms of payouts: Royalty, Technical fee, Management fee, Guarantee fee
Transfer pricing requirement: Under the transaction specific approach it is necessary to anlayse potential “cost-benefit” and maintain appropriate documentation to substantiate arm’s length nature of payouts
– Costs – Benchmarking payouts of comparable companies, Basis of arriving at the value of payouts ( Direct / Indirect Method) by the Group
– Potential Benefits – Need for obtaining service from the Group, Analysis of potential benefit obtained by the Company and value attributable to the service
Other Regulatory Considerations: FEMA / RBI ceilings (illustrative)
USD 1 million per projectTechnical Consultancy support
USD 2 million – lump sum payments 5 percent (domestic) / 8percent (exports) for recurring payments
Technical FeeRoyalty
Ceiling – Automatic routeTransactions
Regulatory ceilings cannot be considered as CUP for defending the arm’s length nature of the Payout – Need for Potential ‘Cost-Benefit’ documentation
25B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Current Vs. Future Issues
Use of multiple year dataRe-Run of comparable companies Arithmetical mean and + / - 5 percent rangeUse of secret comparables Use of Economic and Risk adjustmentsForeign comparables challenged and local comparables preferredUse of standard benchmarking sets for IT/ITES companies
Pricing Policy Transaction-wise analysis Attribution of profits to PEUse of Profit Split Compensating adjustments, correlative relief, secondary adjustment, set-offsGuidance on collateral consequences of TP adjustmentsImproving dispute resolution process through Mutual Agreement ProceduresA long time demand - APAs introduced in DTC
Current IssuesCurrent Issues Future IssuesFuture Issues
26B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Typical Industry issues
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27B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Industry Specific Regulations
Industry specific Regulations and Transfer Pricing: Certain industries there are regulations that govern the activities and the prices charged by the members of the industry.
Pharma: Drug Price Control Order (DPCO) and the National Pharmaceutical Pricing Authority (NPPA) have power to control the drug prices, if found excessive (Hoechst Marion Roussel Ltd. vs JCIT)
Port operations: Tariff Authority of Major Ports - (TAMP) regulates the Tariff w.r.t to container operations and handling and therefore the end price to the customer is fixed
Telecom Sector: TRAI – Telecom Regulatory Authority of India has wide-ranging powers to issue directions on Tariff charged by telecom service providers
Oil and Gas: Administered Pricing mechanism and also subsidy provided to PSU vis-à-vis competitive conditions faced by private multinational players
Transfer Pricing Authorities do not factor suchIndustry Regulations
28B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Typical Industry Issues
IT / ITESCaptives: Expected to be risk mitigated and not incur operating lossesValue chain analysis for service providersUse of standard benchmarking sets for IT/ITES companies - Cherry Picking Comparable CompaniesAllowance of Risk adjustment - Capacity utilization based on assets and not head count
Consumer Electronics – Distribution Among the most appropriate methods: RPM Vs. TNMMUse of GPM as a PLI - Absence of definition of direct cost under IGAAPCreation of market intangible - Issue of market support subsidy / subvention and re-characterization Allowance of risk adjustment to facilitate better comparison between commissionaire, sourcing agent, low risk / strip down distributor and full fledged distributor
PharmaCUP being increasingly used without getting into the intangible ownership of the API / FormulationsRegulated market –DPCO regulation on pricing – TP Adjustments without evaluating the impact of the price control on the margin of the taxpayers Typical International transaction:
– R&D – Basic / Applied Research – Who owns the intangible? – Contract manufacturing - Cost plus – What is right?– Intangibles – Cost Sharing Arrangements and Buy In Arrangements
29B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Typical Issues – Auto Industry
Recessionary economy: Significant impact expected on auto industry
Pricing pressures on automobiles results in push back on component suppliers – cost pressure
Capital intensive and high fixed cost
Start up costs, Idle capacity - Resulting in initial year losses
High initial import content with steady localisation, Forex losses
Dependent on technical support from Group - High tech fee / royalty payouts
Internal comparables need to be analyzed - Pricing of similar transactions with third parties
Local documentation preferred to Group global documentation by revenue authorities
Limited industry guidance or judicial precedence
Issues with Indian benchmarking
What do Ford, Toyota, Honda, Volvo, Skoda have in common in India?Transfer Pricing Adjustment!
30B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Auto Industry Trends and Impact of Transfer Pricing
Well established players (primarily Indian players) earning higher margins vs-a-vis foreign players most of whom are new entrants
New entrants incur initial year losses due to high import content, forex issues, start up costs and idle capacity
New players will be benchmarked with Indian players without cognizance of years of presence or industry / economic dynamics
Impact on transfer pricing
7
8
9
10
Profit Margin
(percent)
2006 2007 2008 2009
Years
Auto Ancillary
AllEngine parts
Auto - Foreign / New players
-10
-5
0
5
10
2006 2007 2008
Years
Pro
fit
mar
gin
(p
erce
nt)
Hyundai Motors -1996
General Motors -1994
Honda Siel - 1995
Ford India - 1995
Auto - Established / Domestic Players
-10
-5
0
5
10
15
2006 2007 2008 2009
Years
Pro
fit
mar
gin
(p
erce
nt)
Tata Motors -1945
Mahindra andMahindra -1945
HindustanMotors - 1942
Maruti SuzukiIndia Ltd. -1984
31B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Recent Rulings in India
© 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.B S R & Co.
32B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Performance of adjustments for better comparability
Usage of Multiple Year Data
Aggregation of transactions
Comparability Analysis
Related party transactions in the chosen comparable companies
Key Transfer Pricing Principles
Safe harbour provisions
33B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Performance of adjustments
Law - Rule 10B(3):• An uncontrolled transaction should be comparable to an international transaction if there
are no differences that materially affect price/margin or reasonably accurate adjustments can be made to account for such differences.
• Thus Indian regulation expressly require that adjustments to prices/margins should be made (where appropriate) to enhance comparability.
Practical issue:However, TPOs are not accepting adjustments such as idle capacity, differences for accounting policy, depreciation etc., by rejecting any approximations, estimations and assumptions
Take away from various judicial rulings: • Reinforced the importance of well documented comparability assessment in a transfer
pricing documentation
• Favored adjustments for better comparability while adopting TNMM as it would provide practical solution if it is applied with appropriate adjustments to account for differences
34B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Performance of Adjustments – (1/2)Performance of Adjustments – (1/2)
This ruling lays down certain important principles to undertake adjustments in proper and fit cases for the purpose of comparability analysis. This judgment is significant for the companies in start-up stages and recognizes that differences in business models and higher cost incurred during the start-up phase calls for economic adjustments.Adjustments should be factored into the comparability analysis and for the purpose of comparability analysis, the taxpayer cannot be expected to obtain details that are not available in the public domain.
Skoda Auto India Pvt Ltd
Pune ITAT
Tribunal has accepted that depreciation cost may be adjusted to eliminate material differences in the ‘asset profile’ of the taxpayer vis-à-vis comparables based on sufficient evidence on record, thereby enabling use of cash profit as the Profit Level Indicator
Schefenacker Motherson Ltd Delhi ITAT
Adjustment needs to be made to the margins of the comparable companies to eliminate differences on account of different functions, assets and risks. More specifically, adjustment needs to be made for, (a) difference in risk profile, (b) difference in working capital position, and (c) difference in accounting policies.An adjustment on account of difference in risk profiles may be derived by subtracting the risk free ‘bank rate’ from the PLR.
Philips Software Centre Pvt LtdBangalore ITAT
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Performance of Adjustments – (2/2)Performance of Adjustments – (2/2)
The Tribunal stated that depending on specific facts and circumstances of the case which cannot be the same for all companies, the final set of comparables may need to eliminate differences by making adjustments.
Some adjustments noted in the Tribunal’s order were adjustments for working capital, risk and R&D expenses.
Mentor Graphics (Noida) Pvt. Ltd.
Delhi ITAT
The Tribunal held that while comparing under the TNMM, those differences having material effect on price must be taken into consideration with an idea to make reasonable and accurate adjustment to eliminate such differencesWhile applying TNMM, necessary adjustments for differences on account of FAR analysis must be made to enhance comparability.if the differences between comparables and the tested party cannot be subjected to an evaluation, then transaction may be eliminated for purpose of comparison.Potential comparables with abnormal profit / losses need to be excluded.
E-Gain Communication Pvt. Limited
Pune ITAT
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Law - Rule 10B(4):The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.
Practical issue:• Taxpayers are using multiple year data as a norm primarily due to non-availability of relevant year
financial statements of the comparable companies at the time of finalising the transfer pricing documentation
• TPOs reject multiple year data – adopt only data relating to the relevant financial year and undertake adjustments
• TPOs hold mandatory rule of adopting current year data for computing ALP cannot be dispensed with
Take away from various judicial rulings: Usage of multiple year data is considered useful to even out the fluctuations caused by business, economic and product life cycle. Assessee should document facts that reveal business was cyclic, there was impact of cycle and the duration and the extent of the impact on the data used.
Usage of Multiple Year DataUsage of Multiple Year Data
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Usage of Multiple Year DataUsage of Multiple Year Data
The mandatory and absolute requirement of law for use of the current financial year data cannot be dispensed with even if the relevant data was not available with the appellant in the electronic data base at the time of preparation of the TP report.The TPO is empowered to determine the ALP by using the current financial year data available at the time of transfer pricing proceedings and to conduct the comparability analysis by using such data. The OECD Guidelines in Para 1.49 to 1.51 have acknowledged the use of multiple year data under special circumstances. Use of multiple year data is considered useful to smooth out the fluctuations caused by business/economic/product life cycle. However, the mere claim that there exists a cycle is not sufficient.multiple year data should be used only when it adds value to the transfer pricing analysis.
Customer Services India (P) Ltd. Delhi ITAT
Under Indian transfer pricing regulations, for comparability purposes, consideration of subsequent year data or average profits not permitted
In relation to comparability analysis, though the OECD guidelines allowed use of profits for the period under consideration, previous or next year or average of such profits, however, under the Indian TP regulations, Rule 10B (4) there was no provision for consideration of data for a subsequent assessment year.
Honeywell Automation India Limited
Pune ITAT
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Aggregation of transactions:• As per transfer pricing principles, International transactions are required to be tested on a stand alone
basic unless they are inextricably linked• In many cases the aggregation approach has been challenged by the TPO’s and they are inclined to adopt
transaction specific approach. • There are rulings in favour and against the aggregation approach
Comparability analysis:• Rule 10B(2) The comparability of an international transaction with an uncontrolled transaction shall be
judged with reference to the following, namely:—– The specific characteristics of the property transferred or services provided in either transaction;– Functions performed, assets employed, risks assumed– Contractual terms– Conditions prevailing in the markets
• In-depth analysis of comparables is critical• In the TNMM approach the Function, Assets and Risk analysis (FAR) of the independent comparable
companies need to be undertaken before finalizing the benchmarking analysis.
Aggregation of Transactions and Comparability Aggregation of Transactions and Comparability
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Aggregation of Transactions and Comparability AnalysisAggregation of Transactions and Comparability Analysis
International transaction under consideration comprised only 50 percent of UCB India’s sales and hence it was held that UCB India’s approach of entity level TNMM is not appropriate.
UCB India Pvt Ltd. Mumbai ITAT
The Tribunal noted relevant factors affecting comparability of the transactions includes (a) Nature or line of business; (b) Product or service market; (c) The assets composition employed; (d) Size and scope of operations; and (e) Stage of business or product cycle. Hence any difference that materially affects the market value is to be given serious consideration.
E-Gain ComPune ITAT
Transaction should not be aggregated unless they are inextricably linkedThe Tribunal upheld the selection of foreign comparable companies but mentioned that the taxpayer should determine that data pertaining to such comparables should be available in the public domain.
Ranbaxy LaboratoriesDelhi ITAT
Aggregation of different business activities for testing arm’s length price is contrary to the transfer pricing principles.
Star IndiaMumbai ITAT
The tribunal upheld the tax payer’s contention that to arrive at the most precise approximation, one should compute the arm’s length price on a transaction-by-transaction basis.
Development ConsultantsKolkatta ITAT
40B S R & Co. © 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
Related Party and Safe Harbour Provisions*
Related party – Law Rule 10A(a)• Rule 10 A (a) provides the meaning of the term “uncontrolled transaction” i.e., it means a
transaction between enterprises other than associated enterprises, whether resident or non resident.
• It is given that arm’s length standard shall be substantiated when the transactions between persons are in uncontrolled conditions.
Practical IssueCan a single rupee of related party transaction be the basis for rejecting a comparable company ? – There are ruling both in favour and against such exclusions
Safe harbourPrior to latest amendment, the proviso to section 92C (2) stated that in the event that more than one arm’s length price is determined based on the MAM applied then the ALP would be the arithmetic mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetic mean by an amount not exceeding 5% percent of such arithmetic mean.
* Amended Subsequently by Finance Act 2009
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Related Party and Safe Harbour Provisions*Related Party and Safe Harbour Provisions*
The Tribunal disregarded the selection of comparable companies since they had entered into transaction with either parent company or subsidiary company.
Mentor GraphicsDelhi ITAT
The safe harbour +/- 5 percent variance benefit be allowed as a ‘standard deduction’, if the margins from the controlled transaction falls outside the said tolerance range.
Development ConsultantsKolkatta ITAT
The Tribunal held that an entity can be taken as uncontrolled if its related party transaction do not exceed 10 to 15 percent of total revenue.The tribunal confirmed the availability of safe harbor provisions at the option of the taxpayer.
Sony IndiaDelhi ITAT
Rule 10A (a) - For the purpose of comparability analysis, the comparable “uncontrolled transaction” means a transaction between enterprises other than associated enterprises, whether resident or non-resident; Companies with even a single rupee of transactions with associated enterprises cannot be considered as comparablesDevelopment Consultants squarely applies – 5 percent Standard deduction
Philips Software Bangalore ITAT
* Amended Subsequently by Finance Act 2009
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Other recent judicial decisions Other recent judicial decisions
In a case where revenue authorities seek to disturb the method of determining the arm’s length price adopted by the taxpayer, it is necessary for them to demonstrate that, on the given facts of the case, a particular method will be more appropriate than the method adopted by the taxpayer.Taxpayer's business results showing lesser profits than industry averages, such profits cannot lead to the conclusion that the international transactions with AEs are not at arm’s length. Merely because a method of arm’s length price determination presents complexity in approach, it cannot be discarded by the TPO
MSS IndiaPune ITAT
Exclusion of provision of doubtful debts from the operating expenses being a debatable issue and considering full disclosure made by the taxpayer; the taxpayer could not be held liable for penaltyIt reinforces basic transfer pricing principles laid down in the Indian tax laws which states that penalty proceedings could not be levied on the taxpayer when the computation of the transfer price is done in accordance with the relevant provisions of the Indian transfer provisions in good faith and with due diligence.
Vertex Customer ServicesDelhi ITAT
In respect of the applicability of the TP provisions to the aforesaid transfer of shares, the AAR held that Section 92 of the Act is not a charging provision but a provision providing computational methodology;If income could not be brought into the purview of tax net in India, the transfer pricing provisions contained in Section 92 would not be applicable.
Dana CorporationAuthority for Advance Rulings
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Customer Services - Delhi
Schefenacker Motherson - Delhi
Skoda Auto – Pune
MSS India – Pune
Adjustment Multiple year data
RPT
Honeywell – Pune
UCB India – Mumbai
Safe Harbour
Philips Software - Blore
Sony India – Delhi
Develop. Consult. - Kol
Star India - Mumbai
E-Gain – Pune
Cargill - Delhi
Ranbaxy – Delhi
Mentor Graphics – Delhi
Aztec - Blore
Comparability Standard
Ruling
Snapshot of Recent Tribunal Rulings
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Schefenacker Motherson - Delhi
Customer Services - Delhi
Skoda Auto – Pune
Doc Compliance
Selection of MAM
MSS India Pvt Ltd – Pune
Honeywell – Pune
UCB India – Mumbai
Philips Software - Blore
Sony India – Delhi
Develop. Consult. - Kol
Star India - Mumbai
Aggregation of IT
Tested Party
E-Gain – Pune
Cargill - Delhi
Ranbaxy – Delhi
Mentor Graphics – Delhi
Aztec - Blore
LawRuling
Snapshot of Recent Tribunal Rulings
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Synopsis – Some key industry specific rulings
Skoda AutoSchefenacker Motherson
Auto
Sony IndiaConsumer Electronics -Distribution
Mentor GraphicsMorgan StanleyPhilips SoftwareEgainDevelopment ConsultantsComputer Services
IT / ITES
Ranbaxy LaboratoriesUCB
Pharma
RulingIndustry
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Key Takeaways from Recent Rulings
No need to establish diversion of profits outside India to determine applicability of the TP provisions
Detailed FAR analysis for tested party and comparable companies is crucial
International transactions should not be aggregated unless they are inextricably linked
Least complex entity to be selected as the tested party
Adjustments be made to improve comparability
Use multiple year data where the business is cyclic and the trend has impacted the business results
Recent rulings reaffirm basic Recent rulings reaffirm basic Transfer Pricing principlesTransfer Pricing principles
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Key Takeaways from Recent Rulings
Unquestionable inference – taxpayers must have a robust documentation with sound FAR analysis and well developed economic analysis to justify the transfer prices
Mere finding of faults with the approach adopted by TPO - will not help to delete the adjustments at the appellate level
Taxpayer maintains strong documentation - it becomes increasingly challenging for the TPOs to disprove the same.
Considering the factual nature of the transfer pricing disputes - the rulings have a limited precedent value in case there are variation in facts
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Recent updates Amendments in Finance Act 09 & Direct Tax Code Proposals
© 2009 BSR & Co., a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.B S R & Co.
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Anti Avoidance &
Thin capitalizationIntroduction of
Dispute Resolution Panel
Indian Transfer Pricing Regulations – What is evolving?
Finance Act 2009
Finance Act 2009
Change in the +/-5% range benefit
Direct Tax Code
Introduction of Advance Pricing
Arrangements
Direct Tax Code
Scope of Associated Enterprise expanded
Finance Act 2009
Introduction of Safe Harbour
Direct Tax Code
Direct Tax Code
Rationalization of Penalty &
Administrative Charges
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Snapshot of changes
Finance Act 09
Determination of Arm’s Length Price –Concept of +/- 5 percent variance
Introduction of Safe Harbour Rules
Creation of Dispute Resolution Panel
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Determination of Arm’s Length PriceConcept of +/- 5 percent variance
When more than one price is determined as Arm’s Length Price (‘ALP’), the Arithmetical mean (‘AM’) of such prices is taken as the ALP.Proviso to Sec 92C(2)However, the assessee has the option of adopting an ALP which may vary from the AM by an amount not exceeding five per cent of such AM
Various tribunal rulings had confirmed the availability of a 5 percent variance as a ‘standard deduction’(Development Consultants -Kol ITAT; Philips Software –Bangalore ITAT and various others)
Revised Proviso
If the arithmetical mean, so determined, is within five per cent of the transfer price, then the transfer price shall be treated as the arm's length price and no adjustment is required to be made.
If not, adjustment to be computed with reference to AM
To apply in relation to cases in which proceedings are pending before the Transfer Pricing Officer (TPO) on or after 1st October 2009.
Seeks to restrict conflicting interpretationConflict –Revenue authorities did not give a 5% benefit in cases where the difference between transfer price and ALP was beyond 5% of the ALP.
Taxpayers claimed 5% as a standard deduction even in cases where the transfer price fell outside the range.(Development Consultants - KolITAT; Philips Software –Bangalore ITAT)
More favorable to revenue authorities vis-à-vis taxpayers.
Earlier Provision Change Impact
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104As per Taxpayer
1010As per revenue authorities
Adjustment
110110International Transaction Value
115.5114Adjusted ALP
6Less - Mark Up (5 percent)
120120Arm's Length price (Receipt)
NowEarlier
Scenario IParticulars
Illustration of + / - 5 percent application
Overrides Important Tribunal Decisions that provided liberal interpretation on the usage of +/- 5% range
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Safe Harbour Provisions
• Considering the increase in transfer pricing litigation, Central Board of Direct Taxes (CBDT) is to formulate safe harbour provisions. - Applicable from 1 April 2009
• Aim to reduce the impact of judgemental errors in transfer pricing
• Safe harbour has been defined to mean ‘circumstances’in which the revenue authorities shall accept the transfer pricing declared by the taxpayer.
Internationally safe harbours have taken various forms
• Exclusion of certain classes of transactions based on quantitative thresholds
• Stipulation of margins / pricing norms for specified industries / functions (USA, Singapore)
• Specifying thresholds whereby the onerous documentation requirement is reduced (Brazil)
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Internationally used safe harbours
Proposed code is expected to specify certain safe harbour margins based on functions performed and risks assumed.
Cyprus
Specified mark up on non-core activities and for services below a specified threshold
New Zealand
Specified Services/ Margin based
Rules provide for safe harbour provisions in respect of intra-group services availed / provided depending on the nature of activities and functional analysis
Australia
A mark-up of 5% for provision of related party services of ‘routine’nature is accepted as being at arm’s length if the service provider does not provide similar services to unrelated parties.
Singapore
Certain “covered services” can be provided to a related entity without a markup.
USA
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Internationally used safe harbours
Price based
Specified industry
Relief from detailed documentation requirement
Taxpayer is exempted from detailed documentation if the taxpayer has a minimum of 5% net profit on its total export revenues to related parties or whose export revenue in the calendar year does not exceed 5% of its total revenue in the same period.
Brazil
Africa, Germany, Netherlands - Prescribe acceptable levels of debt equity ratios for related party loans
Others –
If annual revenue is below the specified threshold, transfer pricing documentation need not be maintained. However, other documentation may be called for during audit.
Taiwan / India
Transfer pricing rules will apply to exports only if the average export price is lower than 90% of the average price of similar goods / services sold under similar circumstances in the domestic market.
Brazil
Law provides for ‘safe harbours’ for traditional Maquiladaros (contract manufacturers) with a requirement as regards profit or return on foreign owned assets
Mexico
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Dispute settlement process in India
Alternate Mechanisms
MAP Settlement Commission
AARAPA
TPO CIT(A) ITAT High Court Supreme Court
Traditional Mechanism
2-4 yrs
2-4 yrs
10yrs
10yrs
DRP now introduced
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DRP Mechanism
• When a TP adjustment is proposed, AO will issue draft order to taxpayer
• Taxpayer will confirm or file objections with AO and DRP within 30 days
• DRP will issue guidance to AO after having regard to evidences, further enquiries etc within 9 months from the date draft order was issued to taxpayer
• Panel may confirm, reduce or enhance the proposed transfer pricing adjustments. It cannot set aside the proposed adjustment for further enquiry
• In case of differences within DRP, opinion of the majority stands
• AO shall pass the order in conformity with directions of DRP, within one month without granting any additional opportunity to the taxpayer
• Appeal by taxpayer lies before the Appellate Tribunal and DRPs order is binding on the revenue and no appeal lies for the revenue
• CBDT to frame rules - The Central Board of Direct Taxes has notified the Income-tax (Dispute Resolution Panel) Rules, 2009 on 20 November
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Notification - S.O. 2958-(E).- Dispute Resolution Panel Rules, 2009
• Board may, on the basis of workload and for efficient functioning, constitute panel in specified places • Three Commissioners of Income-tax to each panel as Members who will have additional duty• Each panel shall have a secretariat for receiving correspondence and for issuing on behalf of the panel
• Procedure for filing objections - Form No. 35A− The evidence, if any, the eligible assessee intends to rely upon including any document or
statement or paper submitted to the assessing officer:− Provided that where the eligible assessee intends to rely upon any additional evidence other than
those submitted to the assessing officer, to be filed as a separate application stating the reasons for filing such additional evidence.
− The panel may consider the application for filing additional affidavit and may either allow such application or reject it
− Power to call for or permit additional evidence − The panel shall not be confined to the grounds set forth in the objections but shall have power to
consider any matter or grounds arising out of the proceedings.
• Rectification of mistake or error • Appeal against Assessment Order to ITAT - Form No. 36B.
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DRP Process Chart
Draft Order by AO
ITAT order
Files objection with DRP
Conveys acceptance / No
objection communicated
DRP passes direction
AO passes final order
Assessee
AO passes
final order
30 days
9 months
1 month
30 days
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CIT-I - Mr A J Khan ; CIT-II - Mr S K Mishra DIT (Intl Taxation), Ahmedabad - Mr L N Pant
PunePune
CIT-I - Bibhab Dutta ; CIT-II -Gautam Kar ; DIT (Intl Taxation), Bangalore - Anil Agarwal
Karnataka, Kerala and LakshadweepBangalore
CIT-I - D. Ravindran ; CIT-II - P.K. Saranghi ; DIT (Intl Taxation), Bangalore - D.K. Gupta
Tamil Nadu and Pondicherry Chennai
CIT-I, CIT-II; DIT (Intl Taxation)-II, Delhi(1) West Bengal, North-east States and Andaman and Nicobar (2) Bihar, Orissa and Jharkhand
Kolkata
CIT-I, CIT-II; DIT (Intl Taxation), PuneGujarat, Daman Diu, Dadra Nagar HaveliAhmedabad
CIT-I - Mr. J.C. Mishra ; CIT-II - Mr. K.Gopinath DIT (Intl Taxation), Mumbai - Ms Poonam Dutt
(1) Mumbai (2) Rest of Maharashtra except Pune (3) Goa, Madhya Pradesh and Chattisgarh
Mumbai
CIT-I - Mr. Vijay Sharma; CIT-II - Mr. JP Masser DIT (Intl Taxation)-I, Delhi - Mr. Gopal Kamal
(1) NCT of Delhi (2) Punjab, Haryana and Chandigarh, J&K (3) Uttar Pradesh, Uttaranchal, Rajasthan and Himachal Pradesh
Delhi
Members of DRPJurisdiction Headquarters
DRP Panel
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Potential Benefits and Open issues
Potential BenefitsSpecialist panel
Speedy resolution – Time-bound
Direct appeal to ITAT by assessee
Department cannot appeal against the DRP directions
No demand till AO issues final order based on directions of DRP
Open IssuesDRP yet to become functional
If AO does not make a reference to TPO – Appeal only to CIT(A)
If AO does not file a reply – appeal will lie before CIT(A)?
Does 144C need to be complied with in case of remand by ITAT
If DRP does not give directions within the period mandated ?
Revision proceedings
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Advance Pricing Arrangement
Upfront determination of an arm’s length price (ALP)
The Board would be empowered to make further adjustments to the price determined as per the transfer pricing rules.
APA term would be limited to a maximum term of five consecutive financial years.
The APA would be binding on the taxpayer and the tax authorities, and only in respect of the international transactions for which the agreement is sought.
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(2) Evaluation and
Analysis
(4) Competent Authority
(3) Negotiation
(1) Pre Filing /
Filing
APA Administration
(5) Drafting of the
APA
APA Process
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Pros and Cons of entering into an APA
May affect established working relationships with local tax authorities
Cooperative process with experienced professionals considering the case
Exposes all aspects of the business because of voluntary nature of the process
Flexibility developing practical approaches for complex problems
Changes in the business during the APA term may reduce its applicability or necessitate modification/potential revocation
Ability to discuss considerations in a pre-filing meeting, which some countries permit on an anonymous basis
Can take multiple years to finalize Reduces the need for documentation and costs associated with audit and appeals over APA term
Initial APA submission preparation cost may be high relative to annual documentation costs
Low annual reporting cost and certainty with respect to outcome of covered transactions during the APA term
ConsPros
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Proposals relating to TP Assessment – DTC
Dispute Resolution Mechanism retained – However only for cases of adjustments exceeding INR 2.5 million.
Form 3CEB lodged directly with the TPO instead of the AO.
Selection of TP audit through risk management strategy framed by the Board. Such strategy or criteria will not be made public.
Change in timelines of submission of certificate, commencement and completion of scrutiny
Best judgement assessment if assessee does not cooperate
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Other proposals
Definition of Associated Enterprises widened –Threshold criteria reduced:-
Direct and indirect participation – 10% from 26%loan to asset ratio – reduced to 26% from 51%nomination of director – more than 1/3rd from half
Concept of impermissible avoidance arrangements introduced – thin capitalization.
Safe Harbor provisions retained
Penalty provisions eased
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Parting thoughts
Formation of Dispute Resolution Panel, Safe Harbour Mechanism, APA procedure, Risk based assessments are welcome steps in the right direction
Effectiveness of the above proposals would depend on the global best practices adopted by the revenue authorities and the preparedness of the taxpayers.
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Questions
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Thank YouContact detailsContact details
Name :A. PradeepName :A. Pradeep
Designation :Senior ManagerDesignation :Senior Manager
Email :Email :pradeepa@kpmg.compradeepa@kpmg.com
Tel: +9940017061Tel: +9940017061
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Mumbai
Kamala Mills Compound,448, Senapati Bapat Marg,Lower Parel,Mumbai 400 013Tel +91 22 3983 6000Fax +91 22 24913132
New Delhi
Building No.10, Tower B, 8th Floor, DLF Cyber City,Phase – II,Gurgaon 122002 HaryanaTel +91 124 3074000Fax +91 124 2549101
Bangalore
Solitaire, 139/26, 3rd Floor, Inner Ring Road,Kormangala,Bangalore 560071Tel +91 80 3980 6000Fax +91 80 3980 6999
Hyderabad
8-2-618/2Reliance Humsafar, 4th Floor,Road No. 11, Banjara Hills,Hyderabad 500 034Tel +91 40 6630 5000Fax +91 40 6630 5299
Chennai
No. 10 Mahatma Gandhi Road, Nungambakam, Chennai 600 034Tel +91 40 3914 5000Fax +91 40 3914 5999
Kolkata
Park Plaza, 6TH FloorBlock F, 71 Park StreetKolkata 700 016Tel +91 33 2217 2858Fax +91 33 2217 2868
Pune
703, Godrej Castlemaine, Bund Garden,Pune 411 001Tel +91 20 305 85764/65Fax +91 20 305 85775
Kochi
4/F, Palal Towers M.G.Road, Ravipuram, Kochi 682 016 Tel +91 484 309 4120 Fax +91 484 309 4121
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