changing landscape of indian transfer pricing€¦ · winner of india tax firm of the year 2016 at...

Winner of India Tax Firm of the Year 2016 at the Asia Tax Awards

Changing Landscape of Indian Transfer Pricing

17 August 2017

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Evolution of Transfer Pricing in India

Indian APAs vis-à-vis Safe Harbour Provisions

Secondary Adjustments

BEPS Project – New Era of Alignment and Transparency

Update on Critical Issues

Key Takeaways

Our Story

Coverage

221-08-2017

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321-08-2017

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Significant Legislative Changes

2001 – framework for transfer pricing in India was introduced -u/s 92A-92F r.w.r 10A to 10T

2012 – scope extended to specified domestic transactions over USD 0.78 Million - u/s 92BA

o 2014 – limit was increased to USD 3.12 million

o 2017 – exclusion of payments made to 40A(2)(b) parties

2012 – APA program introduced in India

2013 – safe harbour provisions announced

2014 – definition of ‘deemed international transaction’ clarified to also include domestic non-related party transactions

2017 – secondary adjustments brought in to remove the imbalance between cash profit and actual profit as a result of transfer pricing adjustments

Major Global Alignment Measures

2015 – computation of ALP streamlined:

o Introduction of range concept (rule 10CA)

o Use of multiple year data (rule 10B)

2017 - introduction of country-by-country reporting u/s 92D r.w.s section 286

2017 – introduction of interest deduction limitations in the Indian law

421-08-2017

Multinationals operating in India have experienced a roller coaster ride with respect to transfer pricing matters

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Mechanisms for Mitigating Disputes

2009 – formation of a Dispute Resolution Panel – a three member collegium formed with an intent to provide speaking directions based on well considered findings and for speedy disposal of cases. However, the practical experience is quite to the contrary.

2012 – Advance Pricing Agreement introduced u/s 92CC and 92CD (2015-Rollback Provisions), to provide clarity on ALP –good success

2013 – Safe Harbour Provisions provided u/r 10TA-10THD – not successful due to the high mark-ups

2016 – Internal circular of the CBDT relaxed criteria for reference of cases for transfer pricing scrutiny

2017 – Safe Harbour Provisions amended to make it more viable

Aggressive Stands Adopted by the Revenue

Intangibles (advertising, marketing, promotion expenses and royalties)

Financial Arrangements (interest free loans, guarantee, overdue receivables)

Location Savings

Intra-group Management Services

Shares Transactions

521-08-2017

While various measures have been built in; still India is one of the leading aggressive tax administrations globally

Over 24,000 cases scrutinised by TPO’s with almost 45% facing adverse adjustments that aggregate to approximately USD 42 billion

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Indian Transfer Pricing Audits and Adjustments

621-08-2017

0.20 0.38 0.57

1.291.82

4.02

7.42

11.67

9.93

7.74

0

2

4

6

8

10

12

14

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

0

1000

2000

3000

4000

5000

6000

7000

Nu

mb

er

of

case

s se

lect

ed

fo

r au

dit

Transfer Pricing Disputes Growth

Number of TP audits completed Number of adjustment cases Amount of adjustments (In USD Billion)

Ad

just

me

nt

va

lue

–U

SD

bil

lio

n

Source: CBDT Annual Report 2014-15

However, the high success rate for taxpayers at the Tribunal and HC level of 69% and 86% respectively, is an affirmation of the independence and fairness of the Indian judicial system

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Criteria for Selection of Assessments

Evolution of Transfer Pricing Assessments and Litigations in India

721-08-2017

Selection based on risk parameters decided by computer aided scrutiny selection

Selection based on quantum of international transactions [exceeding USD 0.78 million]

Selection based on quantum of international transactions [limit increased to USD 2.34 million]

The future of transfer pricing assessments – less number of cases, but more intense assessments

2013

2015Mandatory scrutiny for

Cases Involving addition in any earlier year where transfer pricing issue is in excess of USD 1.56 million

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Indian APAs vis-à-vis Safe Harbour Provisions

821-08-2017

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APA Provisions in India

921-08-2017

Concept of APA introduced by the Finance Act, 2012

APA in an agreement between the CBDT and any person:

determining ALP; or

specifying the manner in which ALP is to be determined

Agreement shall be valid for maximum period of five consecutive years

Flexibility in respect of methods adopted

Any of the following six methods in the Act, with adjustments or variations as feasible can be adopted

Comparable Uncontrolled Price Method

Resale Price Method

Cost Plus Method

Profit Split Method

Transactional Net Margin Method

Other Method (as notified by the CBDT)

“Roll Back” mechanism is also introduced in the APA scheme which means if facts of the case are similar the APA will apply to international transactions in the previous years upto four years

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The India APA Story

1021-08-2017

More than 800+ applications have been filed till date

90% of pre-filing applications got converted to ‘formal’ APA applications

85% of the applications are for unilateral APA

171 APAs concluded till July 2017, including twelve bilateral APAs – five with Japan, six with United Kingdom and one

with United States

Average time for conclusion of unilateral APA is around 1.5 - 2 years (as compared to global standard of around 3 years)

USA CA has started accepting applications for bilateral APA with India since February 2016

APAs concluded so far pertain to various segments like captive service centres in India, manufacturing activities,

telecommunication services, oil exploration services, management cross charges, healthcare, media, etc.

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APA Filing Key Statistics | 2012-13 (FY) – 2016-17 (FY)

5 4

55

88

152

5 3

53

80

141

0 1 28 11

0

20

40

60

80

100

120

140

160

2013 2014 2015 2016 Total

Total APA Unilateral APA Bilateral APA

1121-08-2017

Year 1 | 2013 Year 2 | 2014 Year 3 | 2015 Year 4 | 2016 Year 5 | 2017

146 Applications 232 Applications 206 Applications 132 Applications 99 Applications

117 U 192 U 14 B 113 U 19 B 78 U 21 B29 B 206 U 26 B

To

tal

AP

As

Sig

ne

d

Source: Annual Report 2016-17 – Ministry of Finance

AP

As

Fil

ed

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Safe Harbour Rules

1221-08-2017

Introduced in 2013, original safe harbour rules hardly received any positive response as compared to the phenomenalsuccess of Advance Pricing Agreement (APA), mainly due to:-

The safe harbour margins were very high and not necessarily reflecting the arm’s length scenario

APA’s for similar transactions were being inked at lower percentages

There was ambiguity in the classification of services

Taking a cue from the above there was a rationalisation to the Safe Harbour Rules in 2017

Eligible Transaction Earlier Safe Harbour Revised Safe Harbour

Software Development and ITeS 20.00% - 22.00% 17.00% - 18.00%

Knowledge Process Outsourcing 25.00% 18.00% - 24.00%

Intra-Group LoansSBI Base Rate + (150-300 b.p.) SBI Base Rate + (175 – 425 b.p.)

6m LIBOR + (150 – 400 b.p.)

Corporate Guarantee 1.75% - 2.00% 1.00%

Research and Development Services 29.00% - 30.00% 24.00%

Manufacture and Export of Auto Components 8.50% - 12.00% 8.50% - 12.00%

Low Value Intra-Group Services NA 5.00%

The revised Safe harbour provisions are made applicable with a upper turnover threshold of USD 31 million for all contract services

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Implications of Reduced Safe Harbour Rates vis-à-vis APAs

1321-08-2017

Pertinent for taxpayers to review their existing transfer pricing policies and re-evaluate them

By aligning revised safe harbour margins with margins that are generally agreed to under the APA signed recently, the government has perhaps signalled its willingness to reduce the APA margins further in such cases

Putting a threshold for eligibility – revised safe harbour is meant to benefit SME contract service provider entities

Tax authorities can now concentrate more on complex and high-value transactions under APAs and for scrutiny -considering the risk based assessment selection

Offering a safe harbour for low value adding intra-group services – one of the most litigation prone transactions is a positive move and it seems to be in line with the BEPS Action Plan 8-10

However, considering various excluded services there is still caution/clarification required in this area

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Secondary Adjustments

1421-08-2017

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Overview

1521-08-2017

If inter-company transactions are not at arm’s length, the tax payer is required to make a transfer pricing adjustment. This is referred to as a ‘primary adjustment’.

Secondary adjustments in books of accounts were introduced in order to reflect actual allocation of profits in the event of any transfer pricing adjustment (i.e. primary adjustment)

As a result of a primary adjustment, there is an increase in the total income or reduction in the loss, the excess money which is available with the AE, if not repatriated to India within 90 days, shall be deemed to be an advance made by the taxpayer to such an AE

Even the OECD gives due importance to such secondary adjustments and there are three distinct method provided to address this – constructive dividends, equity contribution and constructive loan. In Indian context the secondary adjustment has been addressed by treating the primary adjustment as a “constructive loan”.

The time limit of 90 days should also act as a general reference for determining inter company credit periods to avoid any interest consequence

The interest rate that is to be imputed is also in line with the economic realities of the transactions, giving due weight to the currency of the transaction

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Secondary Adjustments | Case Study

1621-08-2017

No guarantee commission charged

The transaction is accepted to be an international transaction

Guarantee Commission @ 2% is deemed to be at ALP and offered to tax

Guarantee Commission is over USD 0.16 million and for FY 16-17 onwards would constitute a primary adjustment once it is offered to tax

In order to continue with the financial arrangement and to avoid falling under the ambit of secondary adjustment provisions the Indian parent company would need to decide whether it should:

1. Reduce the guarantee commission rate to less than the threshold – while this may lead to deviation from the safe harbour rate it could lead to litigation at the lower levels but would help absolve the initial onus of recovery of primary adjustment value

2. Record the guarantee commission as a receivable in the books of accounts itself

Indian Parent Co.

Overseas Subsidiary

Providing corporate guarantee to bankers on behalf of the AE for funding the working capital requirements

Relook inter-company transactions for the presence of any potential primary adjustments (non arm’s length conditions) and determine the consequential impact of secondary adjustments

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Secondary Adjustments – Impact

1721-08-2017

Once Secondary Adjustment Provisions are triggered the Indian Co. is required to ensure the primary adjustment is recovered from the AE within the time limit

Interest to be imputed in case of failure to repatriate within the time limits mentioned above

Nature of Primary Adjustment Time Limit for Repatriation

Suo-moto adjustment made in return of income

90 days from the due date of filing of a return of income

Advance Pricing Agreement (APA) entered

Safe Harbour Rule (SHR) exercised

Mutual Agreement Procedure (MAP) entered under a Double Taxation Avoidance Agreement (DTAA)

Transfer Pricing Adjustment made by the relevant authority in the relevant order90 days from the date of order (order by the assessing officer or the relevant appellate authority)

Currency of International Transaction Interest Base Rate Spread Effective Interest

Indian Rupee 1 year marginal cost of funds (for SBI Lending Rate) 325 basis points 11.25% p.a.

Foreign Currency 6-month London Inter-Bank Offered Rate (LIBOR) 300 basis points 4.42% p.a

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BEPS Project – New Era of Alignment and Transparency

Action Plan 4 Limiting Interest Deductions Action Plan 8-10 Aligning Value CreationAction Plan 13 CbCR

1821-08-2017

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Applicability

From AY 2018-2019 (Section 94B Introduced)

Applicable to Indian Companies and Indian Permanent Establishments (PE) of foreign entities

Not Applicable to companies engaged in banking and insurance

Applicable for debt extended by foreign related party; or by third party lender (if backed by implicit or explicit guarantee given; or deposit placed, by foreign related party)

Restricts deduction in respect of expenditure by interest (or of similar nature) paid to non-resident associated entities to 30% of EBITDA (earning before interest, taxes, depreciation and amortisation)

Threshold limit: interest expenditure exceeds USD 0.16 Million

Interest over the 30% limit could be carried forward and set-off for up to 8 subsequent years

Action Plan 4 | Limiting Interest Deductions (India’s Perspective)

1921-08-2017

India has considered most of the recommendations provided under the BEPS Action Plan

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Limiting Interest Deductions (Computation Mechanism for Disallowance)

2021-08-2017

Set-Off of Excess Interest – whether treatment same as un-absorbed depreciation or carried forward loss?

Particulars Scenario 1 Scenario 2 Scenario 3 Scenario 4

EBITDA 100 100 100 -100

30% of EBITDA (a) 30 30 30 NA

Interest paid to AE (b) 15 20 20 10

Interest paid to Non-AE (c) 25 40 10 10

Total Interest (d=b+c) 40 60 30 20

Total Interest in excess of 30% of EBITDA

10 30 0 20

Excess Interest to be disallowed and carried forward (lower of b or e)

10 20 0 10

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Action Plans 8 to 10 | Aligning Transfer Pricing with Value Creation

2121-08-2017

India’s stand on economic activity based transfer pricing gets further strengthened

‘Aligning rewards with the actual conduct’ and ‘substance over form’ have been raised by revenue authorities and adjudicated by the tax tribunals in India

More focus on intangibles – returns generated should be correctly shared with companies who in reality perform value adding functions or bear the actual risks in development of those intangibles

Transfer pricing cannot remain a merely principle driven tax compliance activity any more. It will touch upon the entire domain of the business, starting from the strategy to the ground level operations.

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Action Plan 13 and Enhanced Documentation Requirement

2221-08-2017

Indian Transfer Pricing Regulations introduced a three-tiered standardised approach to documentation in lines with Action Plan 13

of BEPS (w.e.f FY 16-17)

• Local country TP documentation

• To be prepared by each local entity and submitted to local Tax Authority

• In place in India since 2001Local File

• High level blue print of multinational group’s global operations

• Contents like value drivers, supply chain model, Intangibles details, Group financing, etc.

• Prepared centrally; submitted with Ttx authorities of all countries

• Ideally prepared by ultimate parent for consolidation

Master File

• Multinationals having consolidated annual revenue > Euro 750 million

• Summary data and economic activity in each country

• Prepared by ultimate parent for consolidation purposes

• Submitted with tax authority of ultimate parent

• Shared with other tax authorities through automatic exchange of information

CbC Report

Penalties for non-compliance are huge

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Action Plan 13 – Master File & Country by Country Reporting

2321-08-2017

Master File

Implemented with an effective date of 1 April 2016, in line with BEPS Action Plan 13

Provide tax administrators with a high level overview of the multinational’s global operations and policies which would broadly include:

Multinational group’s organisational structure, description of business or businesses, intangibles, inter-company financial activities and financial and tax positions

Threshold: No thresholds prescribed

Detailed regulations yet awaited

Country by Country Reporting

Implemented with an effective date of 1 April 2016, in line with BEPS Action Plan 13

First Due Date to file the CbCR is 30th Nov 2017

Provide tax administrators with birds-eye view of the multinational’s global operations and would broadly include:

Jurisdiction-wise - Revenue / Profit / Income Tax / Capital / Employees / Assets

Entity-wise – Main Business / Functions and other information

Threshold: Multinationals having consolidated group’s annual revenue > Euro 750 million

Automatic Exchange of Information between countries is ongoing and various countries have already signed multilateral and bilateral agreements

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Enhanced Documentation Requirement | CbCR

2421-08-2017

Entity Filing with the Prescribed authority in India Due Date

Indian Parent Entity CbCRDue Date for furnishing return of income (30 Nov)

Indian Surrogate Entity CbCRDue Date for furnishing return of income (30 Nov)

Indian Entity of a Foreign Parent

Details of entity designated to file the CbCR (parent or surrogate) with jurisdiction

Prescribed Date

Indian Entity of a Foreign Parent

CbCR - if the filing entity is a resident of a country with which India does not have an agreement for automatic exchange of CbCR

Due Date for furnishing return of income (30 Nov)

All Indian Entities Master File (threshold and contents yet to be prescribed)

Prescribed Date

In India the first filing due date is 30 November 2017 for the period FY 16-17 and Information such as revenue, profit/loss, taxes, capital, earnings, employees, assets, etc. would need to be reported

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Enhanced Documentation Requirement | CbCR

2521-08-2017

India has signed the Multilateral Competent Authority Agreement (MCAA) with 64 countries and notified the same on 28th July 2017 – however further clarification on the filing is yet awaited

However there is no specific notification for the CbCR filing in cases where India has not signed any agreement

If India does not sign country specific agreements for the exchange of CbC reports, Indian counterpart of the MNE group would have to locally furnish the CbC report on or before 30 November 2017 to comply with Indian CbC reporting requirements

USA is not a signatory to the MCAA with India, accordingly, USA and India would require to engage in a bilateral agreement for enforcing automatic exchange of information

The existing regulations in India do not contemplate a situation where the parent entity country has not adopted CbC reporting, even if India has an arrangement for automatic exchange of information with that country

While the CbC report will be shared by various governments, strict confidentiality agreements would still need to be in place between governments

MNE’s would be required to develop technology-enabled data management systems in order to generate, maintain and retain the proposed documentation requirement

The revenue threshold needs to be tested on an annual basis. In the years that such a threshold test is not met, the MNE group should have no obligation to file a CbCR. Therefore, an MNE group might be required to file a CbCR in one year but not in the following or previous year.

Noteworthy Points

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Update on Critical Issues

2621-08-2017

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• Revenue paints all licensees of brands with same brush; seeks reimbursement of excess advertisement, marketing and sale promotion (AMP) expenses

Marketing Intangibles

• Revenue applies arbitrary commission, resulting in supernormal operating profits on cost

Procurement, Marketing Functions and PE Issues

• Revenue inflicts high profits margins for contract IT, ITES, KPO and R&D service providers

Contract Service Providers

• Revenue imputes guarantee fees in all cases (applying general quotes from Indian banks) irrespective of nature of guarantee

Outbound Corporate Guarantees

• Revenue challenges the actual receipt of services as well as the benefit of the same Intra-Group Services

Major Issues in Indian Transfer Pricing Landscape

2721-08-2017

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Favourable High Court (HC) rulings in Maruti Suzuki (licensed manufacturer) and Sony Ericsson (distributor)

In case of Maruti Suzuki the HC didn’t recognise AMP as a separate international transactions

Revenue’s appeals pending in Supreme Court

In case of Luxottica India Eyewear – intensity of functions, an alternative to applying the Bright Line test, has now got judicial blessings and is also in line with the OECD BEPS Action Plan 8-10.

India’s commentary in revised UN TP Manual

Cue taken from High court rulings, OECD/G-20 BEPS Action Plans 8 to 10

Accepts concept of economic ownership of marketing intangibles

Accepts carrying out of FAR analysis for proper characterization

No separate compensation needed for marketing functions in all cases

Reward for marketing functions may be embedded in pricing of products

Marketing Intangibles

2821-08-2017

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Marketing and Procurement functions under cost plus model in India

Revenue challenges functional profile of Indian taxpayer and re-characterise to commission model

Revenue considers supernormal operating profits on cost/berry ratio (even 600% in some cases)

Agency PE: Revenue attributes profits under formulatory approach

Large scale litigations in India: favourable High Court rulings available

APA team open to address issues: Proper economic modelling with respect to intensity of functions;

Commission capped to “Berry ratio” of commission agents/limited risk distributors

PE profit attribution as per transfer pricing methods with respect to significant people functions

Indenting services “Sogo Shosha companies” (favourable) “Berry Ratio” – Profit Level Indicator (PLI) for stripped-risk distributors – Delhi High Court

Marketing, Procurement Services and PE Issues

2921-08-2017

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Indian Revenue considers aggressive mark-up between 25% to 40% in Transfer Pricing audit

Indian safe harbour regulations

20%/22% for IT and ITES

25% for KPO (design engineering services, analytics services, etc.)

30% for R&D services

Safe harbour rates applied as “floors” in normal audits

Huge additions not sustainable at tribunal – plethora of favourable judicial rulings on comparables available

CBDT’s Circular on R&D services and position in revised country chapter to UN Transfer Pricing Manual

Broadly in line with OECD and UN Transfer Pricing guidelines on intangibles

Emphasis on substance at level of foreign principal

“Tests” laid down for contract service provider (cost plus) model versus profit split

Accepts local comparables as answer to location savings

APA is preferable against litigation for value of time, money and certainty

41 unilateral and 1 bilateral APA and numerous MAP cases concluded till 31 March 2017 (IT and ITeS)

Contract Service Providers | IT, ITes, KPO, R&D

3021-08-2017

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Location Saving: “net cost savings” realised by multinationals (MNEs) by relocating from a high cost to a low cost jurisdiction. The net savings arising are determined after accounting for possible costs involved in relocating an activity and any dis-savings (higher costs for transportation, quality control, warranty costs, etc.)

Concept was acknowledged and discussed by OECD in new Chapter IX of transfer pricing guidelines on business restructuring in 2010

A new section was added in 2013 draft discussion on intangibles relating to location savings, location specific characteristics and workforce in place stating that they are not considered as intangibles, but considered as comparability factors that should be considered in transfer pricing analyses

Location Specific Advantages (LSA): LSA access to factors of production and distribution that can be exploited to produce a particular product or service cheaper, better or with less risk, or to increase the ability of a company to sell more product or achieve a larger market share

Few Indian Tribunal Rulings on Location Savings:

In case of GAP International Sourcing India Pvt Ltd: no separate allocation is necessary, when benchmarking is done using the comparable in the tested party’s jurisdiction. In such a case, the location savings would automatically be reflected in the profitability of comparable and hence, would be taken care of in arriving at the arm's length price (so based on the profitability of comparable)”

In case of Watson Pharma Pvt Ltd: multinationals operate in perfectly competitive market and absent exclusive access to factors resulting in location specific advantages, no super profits arise warranting an adjustment”

Location Savings

3121-08-2017

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Plot and re-look at shareholding and operating structure of your group

Having a tax-efficient transfer pricing policy for the group as a whole

Adequate implementation of the transfer pricing policy

Impact of transfer pricing policy on other areas

Ensure coherence and compliance of local and global laws

Required enhanced documentation in place – on ground details would be crucial

Timely assessment of transfer pricing risks for any change in the business and taking measures to mitigate the same

Key Takeaways

3321-08-2017

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3621-08-2017

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https://www.facebook.com/SKPGroupIndia

https://twitter.com/SKPGroup

https://twitter.com/SKPGroup

https://plus.google.com/+SKPGroup

https://plus.google.com/+SKPGroup

http://www.skpgroup.com/associates/associates-nexia-international.php

http://www.freepik.com/

changing landscape of indian transfer pricing€¦ · winner of india tax firm of the year 2016 at...

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