intangible asset, inter-company services and transfer pricing

Key Learning's from

Recent ConcludedTransfer Pricing Audit

2nd Annual International Tax &

Transfer Pricing Conference

Feb 13, 2010, New Delhi

By:CA.Gaurav Garg

JGarg Economic Advisors

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After Effect of TPO’s Order

JGarg Economic Advisors Pvt. Ltd.

3

Transfer Pricing

Additions

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As per estimate, in past 5 years Government is able to mom-up around 23,000 cr. through transfer pricing additions.

For FY 2005-06, out of the companies selected for scrutiny, 60% received transfer pricing bill.

Reason for transfer pricing addition◦ Recommendation of higher margin at net operating

level.◦ Disallowance of fees paid to associated enterprises

for use of intangibles.

Transfer Pricing Addition


◦ Payment for intercompany services to associated enterprises disallowed.

◦ Indian company treated as creator of intangibles asset owned by associated enterprises, thereby addition on account of notional income.

Transfer Pricing Addition


Intangible Asset &

Transfer Pricing


Case Study 1

NR Parent Co.

The Assessee

NR Group Company

Facts of the Case

1. NR Parent Co. provided know how to manufacture particular finished product to its Indian Subsidiary, The Assessee.

2. The Assessee, manufactured the finished goods and sold the same in India and Outside India.

3. As per “Technical Know-how” agreement between the Assessee and NR Parent Co., the Assessee needs to pay royalty of 5% on sales.

4. All the exports were made to NR Group Companies.


Case Study 1

NR Parent Co.

The Assessee

NR Group Company

Revenue’s Stand

1. The Assessee is acting as a contract manufacturer.

2. Royalty on sales made to NR Group Companies amounts to collecting royalty on sales to itself.

3. Such payment of royalty is not at arm’s length and hence disallowed in full.


Case Study 2

NR Parent Co.

The Assessee

Facts of the Case

1. The Assessee is the subsidiary company of NR Parent Co.

2. The Assessee uses trade mark of NR Parent Co. 3. TNMM is used to justify the transaction.


Case Study 2

NR Parent Co.

The Assessee

Revenue’s Stand

1. Trademark owned by NR Parent Co. is not valuable.

2. All the royalty paid to NR Parent Co., accordingly disallowed.


Steps to be Followed

Identify the IP

Define Ownership

Find value/ price

Document it


Four vital, somewhat interrelated questions;◦ Is there actually any intangible property needing

to be considered ?◦ If there is, who owns it ?◦ If there is, would the property have any value at

at arm’s length ?◦ If so, what would an independent pay to use it ?

To Put the Same in Q


Meaning of Intangible Asset◦ Non physical asset of an enterprise i.e. non-financial

or non-physical source of value resulting from claims of future benefit.

As per OECD guidelines, Intangible Property are of two types◦ Trade intangible (also referred technical or

manufacturing) intangibles Patents, know-how, designs etc.

◦ Marketing Intangible Trade-marks, trade-names, customer lists, distribution

channel etc.

Meaning


Legal ownership Control over IP Economic ownership

Ownership


CUP◦ Comparable agreement between independent

party RPM

◦ Where intangible is embedded in the goods transferred

PSM◦ Where no CUP is available and intangibles owned

by both the AEs TNMM

◦ Tested party does not own intangible

TP Methods


Cost Approach◦ Cost of creating and transferring◦ Higher the development cost, higher the value of

intangible◦ Several approaches to measure cost – historical

cost, replacement cost and inflation adjusted cost◦ Can any one tell me historical cost for creating

brands like Dell, Nokia, Coca-Cola, Pepsi, Microsoft, Toyota, Sony etc ?

Valuation


Market Approach◦ Price paid for same or similar intangibles in

comparable transactions among unrelated parties.

◦ Existence of market, comparable transaction, timings of the transaction etc.

Valuation


Income Approach◦ Value of an intangible with reference to future

economic benefits of buyer or lessee◦ Economic benefit should only include benefits

generating directly from the use of intangible◦ Present value of economic rent◦ Example:

Expected benefits Rs.100,000 Expected growth rate 10% Estimated discount rate 20% Effective I.Tax 30%

Valuation


Income Approach

Valuation

Results Year 1 Year 2 Year 3

Revenue 100,000 110,000 121,000

- I. Tax 30,000 33,000 36,300

= Estimated After tax benefit

70,000 77,000 84,700

Discount factor 1/(1.2) 1/(1.2)2 1/(1.2)3

Discounted benefit

58,333 53,472 49,016

PV of Intangible

160,821


Intercompany Services

& Transfer Pricing


Case Study 1

NR Parent Co.

The Assessee

Facts of the Case

1. NR Parent Co. provided management services to its Indian Subsidiary, The Assessee.

2. Pricing policy on Cost plus basis.


Case Study 1

NR Parent Co.

The Assessee

Revenue’s Contention

1. Inadequate documentation to prove receipt of services and benefits from the same.

2. Officer disallowed 100% of the management fee paid to NR Parent Co.


Have intra-group services been provided ? Would an independent company pay for the

services ? Are the services, shareholder services ? What is the arm’s length price of a service ?

“Q” which require “A”


Contact Details;

CA. Gaurav GargJGarg Economic Advisors

Pvt. Ltd.M: +91 9899994934E: [email protected]

intangible asset, inter-company services and transfer pricing

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