indiaat arms length april to june 2012

8/13/2019 Indiaat Arms Length April to June 2012

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April - June 2012

A quarterly newsletter on

transfer pricing developments

India, at Arm’s LengthIn this edition:

Viewpoint 02

Insights 04

By order! 06

Around the world 11

Dear readers,

We are happy to present the ninth edition of India, at Arm’s Length, our quarterly

publication covering transfer pricing developments in India and a round-up on key

international developments on transfer pricing (‘TP’).

Indian TP regulation was introduced with effect from 1 April 2001 and contains ve

transfer pricing methods for computation of the arm’s length price (ALP). The Central

Board of Direct tax has now issued a notication to insert “sixth method” for computation

of ALP in relation to an international transaction. The sixth method is applicable from

nancial year 2011-12 and subsequent years. Under the sixth method, any method

that takes into account the price, which have been charged or paid, or would have been

charged or paid, for same or similar uncontrolled transaction, with or between non-

associated enterprises, under similar circumstances, considering all the relevant facts

can be considered for determination of the ALP. The scope of sixth method appears to

be broad and allows taxpayers to choose any method to determine the arm’s length price

provided it can be established that such method satises the arm’s length test. Further,

the Finance Act 2012 has signicantly expanded the scope of India TP regulations. The

denition of term “international transaction” has been expanded to include transactions

such as business re-structuring, nancing transaction, trade credit, intangibles, etc. Now

specied domestic transactions have also been expressly brought within the ambit of Indian

TP regulations. In this context the introduction of sixth method is welcome as it is likely to

provide exibility in selection of most appropriate method for determination of ALP. The

“View point” section of this edition covers various aspects of newly inserted sixth method.

In our “Insight” section, we have provided broad insight on possible APA rules, current

trends and experiences in TP assessments and Dispute Resolution Panel proceedings.

“By Order” covers TP decisions in India, while “Around the world” section covers a round-up

of key TP developments from around the world.

We hope you nd this publication both timely and useful and we look forward for your

feedback and suggestions to improve it further.

Best regards,

Ernst & Young Transfer Pricing team


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2 India, at Arm’s Length

Viewpoint

Background

Indian transfer pricing (TP) legislation was introduced with effect

from 1 April 2001. Section 92C of the Income-tax Act, 1961 (the

Act) contains the transfer pricing methods (TPMs) for computation

of the arm’s length price (ALP). The provision requires selection of

the most appropriate TPM out of the prescribed methods namely,

(1) Comparable Uncontrolled Price Method (CUP), (2) Resale

Price Method (RPM), (3) Cost-plus Method (CPM), (4) Prot Split

Method (PSM) (5) Transactional Net Margin Method (TNMM) or

(6) any other method as may be notied by the Central Board ofDirect Taxes (CBDT). Since the introduction of the transfer pricing

provisions in the Act in 2001, the CBDT had not notied any other

method for determination of the ALP.

The CBDT has now1 issued a notication to insert Rule 10AB in the

Income-tax Rules, 1962 (Rules), which describes a new method

(i.e., the sixth method) for computation of ALP in relation to an

international transaction. The sixth method is applicable from the

nancial year 2011–12 and subsequent years.

Under this Rule, any method that takes into account the price,

which has been charged or paid, or would have been charged or

paid, for the same or similar uncontrolled transaction, with or

between non-associated enterprises, under similar circumstances,

considering all the relevant facts can be considered for

determination of the ALP.

The scope of new method appears to be broad and allows taxpayers

to choose any method to determine the ALP provided it can be

established that such method satises the arm’s length test. The

sixth method contains the following two scenarios:

(i) Any method which takes into account the price, which has been

charged or paid; or

(ii) Any method which takes into account the price, which would

have been charged or paid

The rst part refers to a price that has actually been charged or

paid and in that sense necessitates the existence of a real or actual

same or similar uncontrolled transaction. This seems to be similar

to the existing CUP method though broader in scope.

The second part ”would have been charged or paid” appears to

recognize the concept of ”hypothetical” arms length test. Under

this concept where the information regarding reliable and real or

actual comparable uncontrolled transactions cannot be identied,

the arm’s length principle may be applied by a hypothetical third

party comparison. In summary, it allows the comparison of a

controlled transaction with a proposed third party transaction.

Applicability of the sixth method

The ve TPMs contained in the Act are similar to the TPMs

prescribed by the OECD TP Guidelines (TPG). However, the TPG also

states that taxpayers have the freedom to apply other methods

not described in the TPG to establish prices, provided those prices

satisfy the arm’s length principle. In the absence of exibility

in selection of a TPM other than the ve prescribed methods,

taxpayers often encountered difculties in applying the prescribed

TPMs for certain transactions such as transfer of intangible,

business restructuring, nancial services transactions and costcontribution arrangements. It is expected that the introduction of

the new method is likely to address taxpayer concerns on choice

of appropriate TPM for determining ALP. Under the Indian TP

rules, there is no strict hierarchy of methods. Further, particular

transaction types are not assigned exclusively to particular

methods. Instead, the rules prescribe a exible most appropriate

method approach. The most appropriate method is the method

that provides the most reliable measure of an arm’s length result.

The sixth method may accordingly be determined as the most

appropriate method if the facts and economic circumstances

indicate that the same provides the most reliable measure of ALP.

There are some keys points on the use of the sixth method thatrequire consideration:

Selection of the sixth method as the most

appropriate method (MAM)

Unlike in the case of ve prescribed methods, no further guidance is

provided on the manner in which the new method is to be applied.

However, the rules relating to factors to judge comparability that

apply for the prescribed methods may apply even to the sixth

method. It may be noted that the sixth method is also likely to

be used by the Tax Authorities as the MAM during the course of

an audit. Challenging the taxpayer’s selection of the prescribed

method (e.g., the TNMM) and imposing an alternative method

based on the exibility provided by the sixth method could further

increase the number of TP controversies that taxpayers currently

face. Taxpayers may need to guard against this by ensuring

that their judgment on selection of most appropriate method is

adequately reasoned and documented in their TP reports.

Application to Specied Domestic Transactions

(SDT)

The newly inserted Rule 10AB states “For the purposes of

clause (f) of sub-section (1) of section 92C, the other method

for determination of the arms’ length price in relation to aninternational transaction shall be...”

Introduction of new transfer pricing method – the “sixth method”

1. 1

1. Notication No. 18/2012 [F. No. 142/5/2012-TPL], dated 23

May 2012


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3India, at Arm’s Length

Based on a plain reading of the Rule it appears that the sixth

method is available only for benchmarking international

transactions and not SDT. As TP provisions have been extended to

SDT from the nancial year 2012–13 onwards and given that Rule

10 BA was notied before enactment of the Finance Act, 2012,

one would expect that the Government will consider extending the

application of the sixth method even to SDT in due course.

Flexibility of use of other methods in Advance

Pricing Agreements (APA)The APA mechanism introduced by the Finance Act, 2012 does not

limit the determination of the ALP to those prescribed in section

92C (which includes ve specied methods and newly inserted sixth

method). Under the APA, any method including those prescribed in

the Act may be adopted with necessary adjustments or variations.

Use of valuation methodologies/quotations or

any other methodologies

Apart from real or actual uncontrolled transaction, the sixth

method provides for use of “hypothetical” data as well wherein

one may arrive at the comparable uncontrolled price even though

there may not be an actual similar uncontrolled transaction.

Hence, the new method will include all commonly used valuation

methods (such as discounted cash ow analysis, cash ow analysis,

replacement cost, etc), quotations, etc., which depend upon the

facts and circumstances that may be used by third parties to arrive

at the transaction price.

In substance, any variant of the sixth method can be used

for benchmarking an international transaction so long as the

conditions of Rule 10AB are satised. However, considering the

wide spread of the availability of uncontrolled transactions (in terms

selection of method of valuation, quotations, etc) the choice of sixthmethod shall not be free from litigation and challenge from the tax

authorities.

Future outlook

Post Finance Act 2012, the scope of Indian TP regulations has been

signicantly expanded. The denition of the term “international

transaction” has been expanded to include transactions such

as business re-structuring, nancing transactions, trade credits

etc. Further, the law now provides for an expansive denition of

intangible property. The scope has also been expanded to cover

SDT. In this context the introduction of the sixth method is welcome

as it is also likely to provide the exibility in selection of the MAMfor determination of ALP.


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Rules governing APA are set for release

An APA is an agreement between a taxpayer and the Tax

Authorities on an appropriate transfer pricing methodology for

a set of transactions over a xed period of time. An APA could

determine the MAM for transfer pricing, manner of computation

of ALP using such method and the ALP of the international

transactions. From 1 July 2012, APA has become a part of law.

While taxpayers are keenly awaiting the rules and forms to

implement the APA mechanism, recent interactions with the

Finance Ministry by various stakeholders suggest:

• The Ministry of Finance is likely to propose bilateral and

multilateral APAs as well as unilateral agreements2 with a ling

fee and a validity of period of ve years.

• APA rules are likely to be based on practices prevalent in other

APA regime countries.

• APA rules are likely to propose a minimum fee and the fee could

vary depending on the value of the transaction.

• An APA is likely to be available to ”persons” as dened under the

Act.

• The applications for bilateral and multilateral APAs will be

handled by competent authority, whereas unilateral APAs will

lie with the APA Directorate to be headed by Director General

International Taxation.

• There could also be provisions for rejection, amendment and

withdrawals of the APA request.

• APAs may not contain rewall provisions, which mean that in

case of an unsuccessful APA outcome, the information obtained

by the APA team could be freely shared with the Revenue

Authorities.

• APA rules are likely to provide for use of CMIE (Centre for

Monitoring Indian Economy) and other available databases as the

main source for identifying comparables.

Further, the CBDT has already announced3 that APA ofcers will be

based in Delhi, Mumbai and Bengaluru. The team will consist of nine

members with two ofcers each in Mumbai and Bengaluru and ve

ofcers in Delhi.

The APA scheme is ideal for taxpayers, who wish to have tax

certainty and elimination of double taxation; who have complex

transactions, etc. However, one will need to see the rules and forms

governing the APA and its implementation.

Dispute Resolution Panel news

The intent of the Dispute Resolution Panel (DRP or Panel) was

to provide an alternative mechanism to resolve transfer pricing

disputes. The DRP was to replace the rst-level appellate authority

under the current hierarchy of the appeals under the Indian

Tax Laws. However, in the process, DRP has erred in passing

non-speaking orders without truly adjudicating on taxpayer’s

contentions.

In fact, the Honorable Delhi Tribunal4 has set aside DRP orders

and asked DRP to pass speaking orders. Further, Honorable

Mumbai Tribunal5 has set aside the DRP orders due to presence of

jurisdictional Commissioner on Panel.

The third cycle of the DRP proceedings (pertaining to AY2008–09)

is currently in progress. CBDT has reconstituted the DRP Panel in

Mumbai and Delhi6. Further, very recently, the CBDT has notied

7

reconstitution of 10 DRPs across various cities and taking note of

certain judicial precedents, the CBDT claried that in a case where

a specied member of the Panel happens to be supervising ofcer

of the Transfer Pricing Ofcer (TPO) at the time of TP Audit, or the

supervising ofcer of the Assessing Ofcer (AO) at the time of the

issuance of the draft assessment order, then the DRP shall consist

of a different set of members.

Insights

2. Unilateral agreements are directly concluded between the taxpayer

and the Government. Bilateral agreements are obtained after mutual

agreement of the tax authorities of two countries. A multilateral

agreement involves mutual agreement between more than two tax

authorities.

3. Vide Order No 105 of 2012 dated 6 June 2012

4. In a case of Genpact Mobility Services (India) Private Limited and Sojitz

India Private Limited

5. In a case of Huntsman International (India) Private Limited and Abacus

Distribution Systems (India) Private Limited

6. Vide Order no 5/FT&TR/ 2012 dated 20 June 2012

7. Vide Order No 6/FT&TR/ 2012 dated 10 July 2012


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Transfer Pricing assessment news

The Transfer Pricing (TP) audits for AY2009–10 are currently

in progress and due to extension of audit completion time limit

(the Finance Act, 2012 has extended completion time limit to 31

January 2013), the trends seem to be that the TPOs are taking

their time to delve deeper into issues. Further, CBDT recently

completed reshufe of its Ofcers in Directorates of International

Taxation and Transfer Pricing and in certain cases, the new

incumbents are yet to take over their charge.

Due to extension of time limit, the TPO’s are more concentrating on

the facts and asking for some extraordinary requirements. We have

shared below some of the requirements:

• TP study reports (including soft copy) to be submitted within

5–15 days (from the date of receipt of notice)

• Extension of time granted only for other information and not for

TP study report

• TP study reports for subsequent years

• Reconciliation of comparable set for six years (i.e., the year

under consideration, prior three years and subsequent two years)

alongwith the reasons for change in the comparable set

• Withholding of tax-related information not only for international

transactions but for all foreign remittances

• Segmental protability statement (especially where combined

transactions approach has been followed)

Further, there is continued focus on transactions such as intra-

group cost allocation, corporate guarantees, overdue receivable

from associated enterprises and reimbursement/recovery of

expenses.

Especially in the case of reconciliations of comparable set for six

years related requirement, it is important to see how the TPO’s are

going to use/view such information. The intention clearly seems to

advocate consistency perspective (i.e., use of consistent approach

to select the comparable set over a period) but the same may

go against the taxpayer if there is a deviation in the comparable

set with no logical argument. Intention could also be to reopen

completed assessment years.

Based on experience so far in the current cycle of TP audits, it

seems that scrutiny is likely to be in depth and will encompass

other areas. One can see sustained activities from the International

Tax ofcers also in terms of compliance by foreign companies and

withholding related aspects.

Constitution of Special Bench: on whether+/-5% is standard deduction beforeamendment in 2009

Prior to October 2009, the proviso relating to +/-5% read as

follows:

“Provided that where more than one price is determined by the

most appropriate method, the arm’s length price shall be taken to

be the arithmetical mean of such prices, or, at the option of the

assessee, a price which may vary from the arithmetical mean by anamount not exceeding ve per cent of such arithmetical mean.”

Based on the above proviso, various Appellate Tribunals have ruled

that the +/-5% variation to the ALP would be a standard deduction

and TP adjustment if any, to the transactions price would be after

allowing standard deduction of +/-5%.

Recently, the Finance Act 2012 has passed a claricatory

amendment that if the price at which the transaction has actually

been undertaken exceeds 5% of the arithmetical mean, then the

taxpayer shall not be entitled to exercise the option of +/- 5%.

The above amendment is claricatory in nature and has overturned

the position adopted and followed by the various AppellateTribunals. However, recently, a special bench comprising three

members has been constituted in Delhi by the Honorable Tribunal

President in the case of IHG IT Services India Private Limited

pertaining to AY 2006–07 to decide whether the taxpayer is

entitled to claim benet of pre amended (before 2009) provision of

section 92C(2) of the Act as a standard deduction.

The matter was scheduled for hearing on 27 July 2012. Once a

special bench is constituted on a legal point, all who are affected

can evaluate an option to become an intervener irrespective of

the jurisdiction of the case. The only pre-conditions applies to

intervener is that appeal on the similar issue must be pending at

any of the benches of Tribunals in India.

We understand that the special bench has been disbanded as

the taxpayer who sought the formation of the special bench has

withdrawn in view of the claricatory amendment in the Finance

Act, 2012.


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Delhi Tribunal

Payment of management service fees and

coordination costs held to be charged at ALP.

TPO cannot question intrinsic value of services,

which meets benet test.

S 92 C, 92CA, 92D / AY 2007-08; In favor of taxpayer

The taxpayer, a wholly owned subsidiary of a multinational group, isengaged in the business of advertising and allied services.

For the year under consideration, the taxpayer entered various

international transactions and selected TNMM as the MAM to

benchmark its international transactions.

During the TP proceedings, the TPO accepted the ALP of all

international transactions applying TNMM, except for management

service fees and client coordination costs. These services are in the

nature of assistance in strategic planning, media support, nancial

administration and human resource management services. These

services enabled the taxpayer to access various research material,

case studies, presentations, etc.

With respect to above two international transactions, the TPO

characterized them as intra-group services and computed the

ALP as NIL on the basis that the taxpayer had not been able to

demonstrate provision of such services nor any benet derived.

Further, low-cost services were available in India and there was no

need to avail these services from AEs at higher cost.

Being aggrieved, taxpayer led objections before the DRP, which

directed the TPO to give certain relief. The TPO passed a fresh

order giving ad-hoc relief of 40% in respect of management services

charges but conrmed the addition on account of coordination

costs.

Being aggrieved, taxpayer led an appeal before the Delhi Tribunal.

Tribunal, ruling in the favor of taxpayer, held that entity level TNMM

is MAM considering the fact that the taxpayer is engaged only in

class of business (i.e., advertising and allied services) and there are

no distinct segments or operating activities, which can be said to be

independent of each other.

Tribunal also held that although principle of res judicata is not

applicable, some tangible material has to be brought on record

to draw an adverse inference. The taxpayer had provided

substantial evidence of the management service charges and client

coordination fees and had established the nature and benets of

the services provided by the AE. This fact has not been negated by

the Revenue Authorities.

Tribunal further observed that the terms “benet” to a company

in relation to its business has a very vide connotation. It is difcult

to accurately measure these benets separately in terms of money

value. In the arena in which the taxpayer is functioning, it will be

difcult to imagine a successful business entity without receipt of

the services, which carries considerable intrinsic and creative value.

The TPO cannot evaluate the true intrinsic and creative value of

such services. Further, the TPO need not dictate the business needs

of the taxpayer. The benet derived must be considered from the

angle of a prudent businessman.

McCann Erickson India Private Limited v. ACIT (ITA No.5871/Del./2011)

Mumbai Tribunal

ALP in case of interest on extended credit periodgranted to an AE shall be determined on the

basis of US LIBOR (prevalent at the relevant

point of time) and not on domestic interest rates.

S 92B, 92C, 92CA / AY 2007-08; in favor of tax payer

The taxpayer has provided loan to its three Mauritian subsidiaries

@ 5.25% and 6% in foreign currency. During the TP proceedings,

the TPO observed that the taxpayer was paying interest @ 14% on

certain transactions. Taking this rate as base, the TPO considered

difference in rate of interest for TP adjustment.

The Tribunal relied on Hyderabad Tribunal decision in case of FourSoft limited (ITA No. 1495/Hyd/10), wherein considering the

facts of the case, use of LIBOR rate was upheld over EURIBOR

rate for computing imputed interest on the loan advanced to AE.

Accordingly, the Tribunal directed the Assessing Ofcer (AO)

to consider LIBOR rate prevalent at relevant point of time for

adjudicating the issue under consideration.

Mahindra & Mahindra Limited v. DCIT (ITA No. 7999/Mum/2011)

By Order


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Hyderabad Tribunal

Depreciation has no direct connection or bearing

on price, cost or prot margin of the international

transactions and taxpayer is entitled to exclude

depreciation while computing operating prots.

S 92C, 92CA / AY 2005-06; in favor of the Revenue

The taxpayer was deriving income from software developmentservices from its AEs as well as third parties. The taxpayer has

benchmarked its international transactions using internal CUP

method (i.e., comparison with price charged for services rendered

to third parties).

During the TP proceedings, TPO rejected CUP method and selected

TNMM as MAM. On rst appeal, the Commissioner of Income-tax

(Appeals) (CIT (A)), considering the facts of the case, has upheld

the order of the TPO on issue of applicability of CUP method.

Further, under TNMM, on a without prejudice basis, taxpayer has

asked for exclusion of depreciation from operating cost (based on

facts of case, depreciation/total cost works out to 28.69% vis-a-vis

comparable average depreciation cost of 6.36%) stating abnormalin nature. The CIT (A) did not consider the same favorably.

Being aggrieved by the CIT (A) Order, the taxpayer led an appeal

before the Hyderabad Tribunal.

The Tribunal, ruling in favor of the Revenue, held that considering

the differences in the services provided to AEs and third parties,

CUP method cannot be considered as MAM.

Further, as regards to taxpayers argument for exclusion of high

depreciation cost, the Tribunal ruled in favor of the taxpayer and

held that:

• Under the statutory provisions it is nowhere provided that

deduction of depreciation is a must. Depreciation can be taken

into account or disregarded while computing prot depending

upon the context and purpose for which prot is to be computed.

• “Net Prot” used in Rule 10B can be taken to mean commercial

prot.

• Depreciation will depend upon the type of technology employed,

age and nature of machinery used. The claim of depreciation

can lead to great difference in computing prots of comparables

as depreciation is permitted depending upon nature of plant/

machinery and year of use. Further, depreciation, which can have

a varied basis and is allowed at different rates, is not such that an

expenditure, which must be deducted in all situations.

• It has no direct connection or bearing on price, cost or prot

margin of the international transactions.

• Object and purpose of transfer pricing is to compare like with thelike, and to eliminate difference, if any by suitable adjustment.

Qual Core Logic Limited v. DCIT (ITA No 893/Hyd/2011)

Mumbai Tribunal

Rates charged by unrelated vendors to whom

taxpayer outsourced work can be comparable

under CUP method

S 92C, 92CA / AY 2003-04 to AY 2007-08; in favor of taxpayer

The taxpayer is engaged in providing software development

services to it AEs. The taxpayer had outsourced a part of the job to

external companies such as L&T Software, TCS etc. The taxpayer

benchmarked its international transactions using CUP method and

considered hourly rates charged by external vendors as comparable

prices.

During the TP proceedings, the TPO rejected external CUP method

and adopted TNMM as MAM to make addition to taxpayer’s income.

On rst appeal, the CIT (A) deleted the addition. However, the

Revenue appealed before the Tribunal against CIT (A) order.

Ruling in favor of taxpayer, the Tribunal held that:

• The rates charged by the taxpayer to its AEs were comparable

to the rates charged by L&T Software, and TCS to the taxpayer.

According to the agreement between the taxpayer and its AE,

the billing will be linked to comparable market rates in India for

similar services.

• The Tribunal noted that L&T software and TCS are considerably

big companies in the software industry and have substantial


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reputation. The amounts paid to them represent fair market

value. When the taxpayer adopts these rates as comparable

under the CUP method no fault can be found.

• The tribunal also noted that TPO had not brought on record any

material to prove that per hour rate charged by the taxpayer was

lower than what was charged by third parties in the same line of

business. Further, the TPO had not given any reason for rejecting

CUP method. The Tribunal also referred to OECD guidelines

wherein CUP method is considered to be the most direct and

reliable method when comparable uncontrolled transactions are

available.

ACIT v. Vistaar Systems Private Limited (ITA No. 3065/Mum/2008)

Mumbai Tribunal

RPM is one of the standard methods in case

of distribution and marketing activities (i.e.,

when goods are purchased from AE and sold to

unrelated parties) and prevails over TNMM

S 92C, 92CA / AY 2003-04; in favor of taxpayerThe taxpayer is engaged in the business of manufacturing and

distribution of cosmetic and beauty products. The taxpayer

operates in two business segments — (i) Manufacturing (ii)

Distribution. The taxpayer, relying on OECD guidelines and

Guidance notes, considered RPM as MAM to benchmark its

distribution segment.

During the TP proceedings, the TPO upheld the transactions in

relation to manufacturing segment to be at arm’s length. However,

with respect to the distribution segment, the TPO disregarded the

taxpayer’s contentions and concluded TNMM as MAM. While doing

so, the TPO contended that the taxpayer was consistently incurring

losses, gross margins of comparable companies could not be relied

upon because of product differences, and the degree of similarity

in the functional prole between the taxpayer and the comparable

companies was sufcient for application of TNMM and not RPM.

Being aggrieved, the taxpayer led an appeal before the CIT

(A). The CIT (A), ruling in favor of the taxpayer, accepted the

benchmarking approach adopted for the distribution segment and

deleted the TP adjustment.

The Revenue Authorities appealed before the Mumbai Tribunal

against the order of CIT (A). The Revenue contended that thetaxpayer was adding substantial value addition to the goods sold, as

it was incurring substantial expenditure on selling and distribution

and hence, RPM is not the correct method.

Mumbai ITAT conrming the Order of CIT (A) provided ruled as

follows:

• There is no order of priority in selection of method for computing

ALP. RPM is one of the standard method and the OECD guidelines

also states that in case of distribution and marketing activities

(where goods are purchased from AEs and sold to unrelated

parties) RPM is the MAM.

• Based on facts on records, there is no dispute that the taxpayerbuys products from its AEs and sells to unrelated parties without

further processing.

• The Revenue Authorities have not disputed the certicates

produced by the taxpayer to evidence that the margins earned by

AEs lies in the range of 2% to 4%.

• RPM has been accepted in preceding as well as succeeding years

in respect of the distribution segment of the taxpayer and hence,

the deletion made by the CIT (A) is found to be appropriate.

ITO v L’oreal India Private Limited (ITA No, 5423/Mum/2009)


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Mumbai Tribunal

Use of “brightline” approach to benchmark

advertising, marketing and promotion (AMP)

expenses is not equivalent to application of

TNMM

S 92C, 92CA / AY 2004-05; in favor of taxpayer

The Mumbai Tribunal, deciding on the issue of excessive AMPexpenditure incurred by the taxpayer, held that the TPO had to give

cogent reasons to reject the analysis undertaken by the taxpayer

and why his own analysis was superior. The Tribunal further stated

that a comprehensive comparability analysis should be undertaken

before choosing a set of comparables to determine the ALP. Finally,

the Tribunal held that the arithmetic mean of AMP expenditure as

a percentage of sales for a set of companies cannot be considered

to be an ALP nor can such analysis be said to be consistent with

TNMM as prescribed by the Act. The Tribunal also observed that

the taxpayer being a manufacturer, any benet derived from AMP

expenditure belonged to taxpayer.

You may also refer to our EY Alert dated 24 May 2012 for furtherdetails.

Genom Biotech Private Limited (ITA No. 5272/Mum/2007)

Delhi High Court

The tax department cannot dictate to the

taxpayer whether or not to incur expenditure

S 92C, 92CA / AY 2002-03, AY 2003-04; in favor of taxpayer

Delhi High Court (HC) deciding on the TP aspect of a royalty

payment held that royalty payment cannot be disallowed on

account of perpetual loss where the expenditure was proven to be

incurred “wholly and exclusively” for the purpose of the businessof taxpayer. The HC held that it is not for the tax authorities to

question the commercial expediency of a transaction. The HC

further observed that it is appropriate to rely on the OCED TP

guidelines to judge the position adopted by the tax authority since

these guidelines have been recognized in the tax jurisprudence

of India. Relying on the OCED TP guidelines, the HC held that

re-characterization of legitimate business transactions by the tax

authorities is not permitted. The HC further held that once it is

established that payment has been incurred or laid out for the

purpose of business, the TPO can only question the quantum of any

expenditure and make suitable adjustments if required.

You may also refer to our EY Alert dated 18 April 2012 for furtherdetails.

CIT v. EKL Appliances Limited (ITA Nos. 1068/2011 & ITA Nos.1070/2011)


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OECD releases discussion draft on safeharbours

The OECD, on 6 June 2012, released a discussion draft on safe

harbours as part of its project to improve the administrative aspects

of TP. The discussion draft includes proposed revision to the section

of safe harbour in Chapter IV of the OECD TP guidelines.

What is safe harbour?

A safe harbour in a TP regime is a provision that applies to adened category of taxpayers or transactions and that relieves

eligible taxpayers from certain obligations otherwise imposed

by a country’s general TP regime. A safe harbour substitutes

simpler obligations for those under the general TP regime. Prices

established under a safe harbour will be automatically accepted by

the tax administrations that have expressly adopted safe harbour

rules.

Key aspects of the discussion draft

The draft reviews the safe harbour rules in a positive light,

indicating that safe harbour will specically be appropriate where

taxpayers entail low transfer pricing risks. The draft has attemptedto address the problems relating to use of safe harbour rules in the

existing OECD TP guidelines.

The basic benets of safe harbours as set forth in the discussion

draft are simplifying/reducing compliance cost for eligible

taxpayers, providing certainty to taxpayer and permitting tax

administrations to redirect their administrative resources from

examination of low risk transactions to examinations of more

complex and high risk transactions and taxpayers.

The discussion draft has also highlighted various concerns

connected to implementation of safe harbour rules. These concerns

include — possibility of divergence from the arm’s length principle,risk of double taxation and double non-taxation, potentially open

avenues for inappropriate tax planning. This raises issue of equity

and uniformity amongst taxpayers.

The discussion draft further recommends that safe harbour to

be adopted on bilateral or multilateral basis. However, in case of

unilateral safe harbour rules, the country adopting the safe harbour

should consider modication of safe harbour in individual cases

under mutual agreement procedures to mitigate the risk of double

taxation/double non-taxation.

According to the existing OECD TP guidelines, safe harbour rules

may be inconsistent with the ALP. Thus the draft recommends an

option to the taxpayers to elect safe harbour rules or ALP as may

be benecial to the taxpayer. Further, in order to ensure certainty

from the tax administrations perspective, the safe harbour rules

may require taxpayers to notify tax authorities in advance of using

safe harbour rules or to commit its use for certain number of years.

India scenario

Although India is not an OECD member country, TP provisions

introduced in 2001 have a number of similarities with existing

OECD TP Guidelines. Several TP rulings in India have also relied on

the same.

In the Budget 2009, the Ministry of Finance empowered CBDT to

formulate safe harbour rules. The CBDT however, has not so far

introduced the safe harbour rules. While safe harbour rules are

yet to come in the Indian TP regime, the Government of India (GoI)

has introduced APA mechanism in a recent budget and this may

encourage taxpayers with complex or high risk transactions to

resort to APA and have certainty on TP aspects.

The discussion draft emphasizes that safe harbour rules have been

implemented successfully in certain countries. Hence, considering

the trend of TP litigation in India, the GoI could take a cue from

various recommendations made in the discussion draft and may

appropriately formulate the safe harbour rules.

OECD releases revised draft of guidanceon TP aspects of intangibles

On 6 June 2012, the OECD published its proposals for revised

guidance on TP aspects of intangibles. The draft proposes a revision

to the provisions of Chapter VI of the OECD TP guidelines and to the

Annexure to Chapter VI containing examples and illustrations for

application of the foresaid provisions.

What is intangible(s)?

According to the guidelines, the word “intangible” is intended toaddress something, which is not a physical asset or a nancial

asset, and which is capable of being owned or controlled for use in

commercial activities.

Key aspects of the discussion draft

The discussion draft has categorized intangibles in various types

such as patents, know-how and trade secrets, trademarks, trade

names, brands, licenses (and similar limited rights in intangibles),

goodwill going concern value, group synergies, etc.

The draft places considerable emphasis on the functions

performed, assets utilized and risks assumed by the parties (in

Around the world


12/16


practice, often referred to as economic substance) to determine

whether any intangibles exist for TP purposes; and in the

determination of which entity(ies) should be entitled to the returns

from an intangible. The draft also contains a detailed discussion

of pricing issues and large number of examples illustrating the

application of the principles it sets out.

The draft states that the cornerstone of transfer pricing should

be based on how independent third parties would behave in

comparable situations rather than accounting or legal denitions.

It does not differentiate between trade and marketing intangibles.

However, the draft distinguishes between intangibles, intellectual

property and market conditions that are not capable of being

owned, controlled and transferred by a single enterprise.

The draft further says that goodwill and going concern should not

be considered separately as intangibles (with certain exceptions)

but should be taken into account as part of a business’s assets. It

also argues that not all intangibles are valuable and not all deserve

separate compensation. The draft takes guidance from the chapter

on business restructuring and emphasizes control over functions

and risks.

Further, the draft contains 22 examples providing practical

guidance on how to apply the principles discussed in the draft.

Next steps

The OCED has sought comments on the draft by 14 September

2012. It is anticipated that a public consultation meeting will be

held in November 2012. It seems likely that the revised guidance

will be formally conrmed in 2013.

EI Salvador issues transfer pricingguidelines

On 23 March 2012, the Dirección General de Impuestos Internos

(DGII) issued Administrative Guideline No. DG-001/2012 to providegeneral guidance to taxpayers on the tax treatment of related party

transactions or transactions with entities domiciled in tax havens

jurisdictions.

The Administrative Guideline (Guía de Orientación) is intended to

supplement the Salvadoran Tax Code by dening guidelines for both

taxpayers and tax auditors. For taxpayers it provides guidance on

topics such as the identication of related parties, transfer pricing

methodology and documentation requirements, as well as on the

application of withholding tax and the non-deductibility of costs and

expenses in related party transactions and transactions with tax

havens. For tax auditors it provides guidance on disclosure in the

tax report.

The TP methodologies established in OECD TP guidelines for

Multinational Enterprises and Tax Administrations are also

recognized in the Salvadorian “Guía de Orientación.”

The guidelines recognized ve TP methods such as CUP, RPM, CPM,

TNMM and PSM.

Among the documentation requirements, information about the

taxpayer and its multinational group should be included, as well

as a complete functional analysis, the criteria for the selection

of the comparables and the applicable methodology. Further,

the Administrative Guideline provides general guidance on thedetermination of the amounts of the transactions with related

parties for the information return that has to be led by the

taxpayer.

Government of Brazil introducesprovisional measure modifying TP rules

Published on 4 April 2012, Provisional Measure (MP) 563

introduced changes to the Brazilian TP rules. These are the rst

signicant changes since the introduction of transfer pricing rules

in 1986, which received further interpretation by the Brazilian

tax authorities in administrative regulations in 2002 (Normative

Instruction (IN) 243 of 2002). The rules determine the deductibility

of intercompany purchases or the minimum price for tax purposes

for export transactions. The MP include following amendments in

the area of transfer pricing:

• Minimum requirement for the application of the Brazilian

uncontrolled price method (PIC)

• The minimum statutory gross prot margin required when

applying the Resale Price Method (PRL) for the import of goods,

services or rights range from 20% to 40% depending on the

company’s industry

• FOB price as basis for the PRL calculation

• New transfer pricing method for import/export of commodities

traded publicly

• Changes to the deductibility of interest

Further, the Brazilian companies are eligible to apply the amended

transfer pricing methodology for calendar year 2012 and are

obliged to do so from 1 January 2013. Even though, the MP has

status of law, there is a statute of limitation to convert the MP

into law. Therefore, during the course of the conversion, we may

expect certain amendments/exclusions/inclusions on the rules to be

addressed.


13/16


Vietnam Tax Authority reveals 2012 TPinspection plan

On 5 April 2012, the Investment and Trade Promotion Centre and

the People’s Committee of Ho Chi Minh City organized a conference

on Vietnam’s TP with participants from provincial tax departments

and around 100 companies.

In the conference, the General Department of Taxation (GDT)

informed that a specialized TP team was established to administer

the TP compliance of taxpayers with related-party transactions.Further, the highlights of GDT’s 2012 Transfer Pricing inspection

plan are as follows:

• 7,800 companies with related-party transactions to be targeted

• Special focus on foreign-invested companies

• Key triggers for the TP audits include:

− Signicant volume of related-party transactions

− Under suspicion of TP manipulation

− Loss-making

− Signicant amount of tax due − Have not been audited or inspected

− Entitled to tax incentives

Malaysia issues new transfer pricing andAPA rules

On 11 May 2012, the Government of Malaysia issued TP rules

and APA rules. The rules provide guidance on requirements

for the preparation of contemporary TP documentation and

APA application for cross-border transactions. The rules are

retroactively effective from 1 January 2009.

TP rules

The TP rules provide that persons entering into a controlled

transaction must prepare documentation when developing or

implementing the controlled transaction.

The TP rules require the hierarchical selection of TP methods,

which places the traditional transaction methods as the primary

methods. If none of the primary methods is applicable, one of the

transactional prot methods may be selected. TP rules provide

guidance on establishing an arm’s length pricing for the following

transactions:

• Intra group services

• Intangible property transfer

• Financing transactions

A year-by-year comparison is preferred, but if it is not feasible,

multi-year data may be considered. Arm’s length pricing should

be determined for each controlled transaction; however, an

aggregation of transactions on a combined basis may be considered

when it is more appropriate to evaluate the transactions. The

Director General of Taxation (DG) is granted authority to disregard

any structure if the economic substance differs from the form, or

the transaction lacks economic reasons. When any adjustment is

made by the DG, a corresponding or offsetting adjustment may be

requested for domestic related-party transactions. For cross-border

transactions, however, such adjustment can only be made undera mutual agreement procedure through a relevant competent

authority.

APA application

A taxpayer may apply for an APA. The APA rules describe the

process and expected timeline for the application and negotiation

of the APA. Certain key requirements of APA are pre-ling meeting,

submission of application, covered period and rollback, compliance

report and renewal of APA.

The introduction of the TP and APA rules together with the recent

issuance of TP disclosure forms applicable to corporations clearlydemonstrate that the Malaysian tax authority has increased its

focus on TP compliance.

Hong Kong releases nal guidelines onAPA program

On 3 January 2012 the Hong Kong Inland Revenue Department

(HKIRD) announced that it plans to introduce an APA program in

Hong Kong by April 2012. Following this on 18 January 2012,

the HKIRD releases a draft version of Departmental Interpretation

and Practice Note 48- Advance Pricing Arrangements (DIPN 48)

outlining its proposed approach to administer, negotiate and

conclude an APA program in Hong Kong. Draft DIPN 48 was openfor consultation. Finally on 29 March 2012, the HKIRD released a

nalized version of DIPN 48 after considering the feedback from

the consultation process in a positive manner.

Certain key aspects of the Hong Kong APA program are as follows:

• Pre-ling of meetings on a no-name basis

• Lower cap for covered transactions

• Use of independent experts to process the APA application

• Rollback of a transfer pricing methodology agreed under an APA

to prior years

• Scope of DIPN extended to cover unilateral APA


14/16


IRS issues thirteenth annual APA reportfor 2011

The IRS issued the thirteenth congressionally mandated annual

APA report on 2 April 2012. The thirteenth annual report provides

an updated discussion of the APA Program including its activities

and structure for calendar year 2011. The report provides useful

insights about the operation of the Program.

Particulars Unilateral Bilateral TotalYear 2011 2010 2009 2011 2010 2009 2011 2010 2009

APA applications 20 46 39 76 98 88 96 144 127

APA executed 8 20 21 34 49 42 42 69 63

APA renewals executed 2 14 8 13 18 20 15 32 28

Revised or amended APAs 1 5 4 0 4 4 1 9 8

Pending requests for APAs 93 85 70 352 315 282 445 400 352

Pending requests for new APAs 44 38 47 214 186 174 258 224 221

Pending requests for renewal APAs 49 47 23 138 129 108 187 176 131

APAs canceled or revoked 2 0 0 0 0 0 2 0 0

APAs withdrawn 4 8 6 5 11 8 9 19 14

During early 2012, the APA program merged with the portion of

the US Competent Authority (USCA) that resolves TP cases under

the mutual agreement procedures of the US bilateral income

tax conventions. As the successor to the APA program, the new

Advance Pricing and Mutual Agreement (APMA) Ofce issued this

year’s APA report.

The APA statistic for 2009, 2010 and 2011is summarized below:


15/16

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