methodology to benchmark intra group services, management ... mr... · methodology to benchmark...

Methodology to benchmark Intra group services, Management services and Cost allocation with case study

Presentation for

3rd Intensive Study Course on Transfer Pricing

Organised by The Chamber Of Tax Consultants

Hasnain Shroff6 April 2013

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent memberfirms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rightsreserved.

Contents

Introduction

Indian Transfer Pricing Legislation andOECD

Types of services

Economic Aspect

Recent Audit Trends

Judicial Precedent

Case Study

Way Forward

•2

Introduction


Introduction - Intra Group Services / Management charge / Cost Allocations…

• Intra-group services are those which are performed by one member ofa multinational enterprise (‘MNE’) for the benefit of one or morerelated members (located in different tax jurisdiction) of the samegroup

• Term “ intra-group services” could potentially refer to two broadcategories:

− Management or administrative services− Staff functions

− Virtually risk free

− Relatively lower returns

− Commercial or income producing services− Line functions

− Have associated risk

− Command higher charge

• Cost allocations may be a part of inter group services or may relate tothird party cost borne by a group entity and allocated

In today’s business environment, it is common for multinationals to seek efficiencies and economies of scale by designating a specialized

role for each group entity

•4

Indian transfer pricing legislation andOECD

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent memberfirms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rightsreserved. •6

Indian transfer pricing legislation

Section 92(2) of the Indian Income Tax Act“Where in an international transaction, two or more associatedenterprises enter into a mutual agreement or arrangement for theallocation or apportionment of, or any contribution to, any cost orexpense incurred or to be incurred in connection with a benefit,service or facility provided or to be provided to any one or more ofsuch enterprises, the cost or expense allocated or apportioned to,or, as the case may be, contributed by, any such enterprise shall bedetermined having regard to the arm’s length price of such benefit,service or facility, as the case may be” However, an allocation should be generally acceptable under the Indian transfer

pricing regulations as long as benefits are demonstrated and they are adequate proper workings use of appropriate allocation keys sound documentation and back-ups

No specific guidance provided under the Indian transfer pricing regulations in respect of allocation of service charges.

Typically reliance placed on OECD transfer pricing guidelines


• OECD Guidelines – Chapter VII “SpecialConsiderations for Intra-Group Services”

• The OECD recognises that there is no fixed rule thatcould be universally applied to determine whether eachparticipant’s proportionate share of the overallcontributions is consistent with the participant’sproportionate share of the overall benefits expected to bereceived under the arrangement

• Although OECD guidelines are adopted worldwide,countries sometimes differ in their interpretation.

• The OECD guidelines, as it relates to intra grouptransaction of services, are concerned with :

− Whether a service has in fact been rendered; and

− If so, whether a charge is warranted and the arm’slength quantum of that charge (given the nature of theservices rendered)

OECD Guidelines

Types of servicesChargeable and Non Chargeable


Types of services – Chargeable Services

• Chargeable services are those which provide a respective group member with economic or commercial value to enhance its commercial position in the market that it operates

• Examples of Intra-Group Service (OECD Guidelines)

Sr No. Activity

1 Planning

2 Coordination

3 Budgetary control

4 Financial advice

5 Accounting

6 Auditing

7 Legal advice

8 Factoring

9 Financial services

Sr No. Activity

10 Assistance in production, buying or distribution

11 Marketing

12 Recruitment & Training

13 R&D administration

14 IP protection

15 Market research

16 Contract R&D

17 Computer services

18 Provision of guarantees


Types of services – Non-Chargeable Services

Non-Chargeable services include• Shareholder activities− Costs of activities relating to the juridical structure of the parent company itself − e.g. meetings of shareholders of the parent company, issuing of shares in the parent

company, costs of the board of directors− Costs relating to reporting requirements of the parent company, including consolidation of

reports− Cost of raising funds for acquisitions

• Duplicative services− Costs incurred by the Parent on review of financial analysis made by subsidiary, Audit

conducted by the parent to avoid risky or erroneous business decision

• Services that provide incidental benefits− Economies of scale or benefit attained by the MNE due to reorganization or disinvestment

deal carried out by parent or another group company − Higher credit rating attained by the MNE by virtue of affiliation with the parent company− Note – Specific Guarantee provided by Parent entails a charge

Economic Aspect


To Demonstrate

• The existence of the service – the service actually performed

• The benefit for the recipient of the service

• The willingness to pay for the services received in a third party situation

• The arm’s length nature of the charge


‘Benefit’ Test and ‘Willingness to pay’ test

• “Benefit test” is by far the most important factor• Objective of “benefit rule”

− Determine the quantum of benefit− Relative proximity of benefit

• Use of proximate and direct standard• Exclusive purpose / single recipient – easy to determine benefit• Services resulting in joint benefit – difficult to establish actual / perceived benefit

− Basis or allocation / allocation key would be of prime importance• Whether an inter-group service has been rendered?

− Activity / services provides economic / commercial value− Enhances commercial interests

• Determination by considering whether an enterprise, in comparable circumstances would have:− Been willing to pay for the activity (if performed by an independent , arm’s-length

enterprise); or− Performed the activity in-house by, and for, itself


Basis of Charge…

General principle governing allocation of costs in case of Intra-Group Services is based on the benefits of the Recipient

Two ways of cost allocation are:

1.Direct Allocation

•Group members are charged for specific services

•The specific services performed and the basis for the payment can be clearly identified

•Provides greater transparency and practical convenience to the tax authorities

•Costs and time associated with supplying the services will be straightforward to identify


… Basis of Charge

2. Indirect Allocation • Used where:− proportion of the value of services rendered to each entity cannot be exactly quantified

except on an approximate/estimated basis− burden of administrative work to record and analyze relevant service activities for each

beneficiary disproportionately heavy in relation to the activities themselves• Identify all relevant costs and allocate them among all recipients using a sensible

allocation keys• Indirect cost allocation method must:− Be sensitive to commercial features of individual case;− Contain safeguards against manipulation;− Follow sound accounting principles; and− Allocate costs that are commensurate (in proportion) with actual or reasonably expected

benefit to the recipient of the service


Cost allocation keys

• Should be revealed through functional analysis to reflect the economic benefit resulting from the service

• Should be a basis that can be measured and documented in a reasonable manner

• Use of turnover without further consideration of alternative allocation triggers may well be challenged

• Easily traceable to the original accounting records of the company

• Some Allocation keys : Turnover, staff employed, number of computers user-ids, area (square meter) etc


Mark up

Whether or not the intra group service should be marked up Factors to consider:

• the nature of the service• Significance of services• Functional profiling and characterization of the intra-group transactions

involved• Similar services provided to an arm’s length party (‘ALP’ )

No Mark-up: In some cases no mark-up required (OECD Guidelines paras. 7.33 - 7.37):Examples:• Group enterprise acting as an agent or intermediary• The costs are already equivalent to the market price• Unreasonable administrative burden• Safe harbors for service mark-up in some countries

Safe harboursafe-harbours with respect to the quantum of the mark-up on routine administrative servicesExamples: Singapore and Australia

Illustration

1. Maintenance of adequate documentationto justify the “services” character,evidence receipt of services, anddemonstrate benefit derived

2. Costs allocation to be audited by anindependent accountant (if feasible)

Group Co. A

Group Co. B

Provide management services to Group Companies

Management services

Group Co. C

Group Co. D

•18

The service provider and the servicerecipient should document the costbenefit analysis i.e.. details of costallocated, basis of mark-up charged, ifany along with the evidences of anyservice rendered and benefitsreceived.


Arm’s Length Price determination …

Typical methods applicable

1. Comparable Uncontrolled Price (‘CUP’) method

2. Cost Plus Method (‘CPM’)

3. Transactional Net Margin Method (‘TNMM’)

1. CUP

Applicable when:

− There is a comparable services provided by an external, independent entity to another external, independent entity;

− The service renderer in the related party transaction also provides similar services to an unrelated party; and/or

− The service recipient in the related party transaction also purchases similar services from unrelated party.

Examples − accounting, auditing, legal or computer services being provided


…Arm’s Length Price determination …

2. CPLM

Applicable when:

− in the absence of a CUP where activities, assets and risks are comparable

Cost base is very important

− Functional analysis important – take into account both immediate and long-term impact of service

3. TNMM

Applicable when:

− in the absence of a CUP and CPLM, residual method

Net margin tested, after payment of such charge vis-à-vis independent comparables

Recent Audit Trends

Indian TP regulations silent on the subject. Reference has to be made to guidance given in the OECD

Taxpayer’s Approach The allocation charge of total costs made by the Headquarter to subsidiaries around the globe by using

certain allocation keys like headcount, turnover, computer expense, etc. is accepted by the Indian AE. The cost base of the Headquarter may or may not be authenticated. The details of the cost base may

not be communicated by the Headquarter. There is not much focus on the “Need” for the service and the “Benefit” from the service.

Revenue’s Approach : Revenue requires the following parameters to be satisfied: “Need” for services and documentary evidence that such services were indeed received Quantification of “Benefits” received to prove parity with the charge Services should not be duplicative in nature and should not include shareholder services Authenticity of allocation keys and cost base of the parent Comparison of intra-group fees with local market price of similar services (if applicable) Payments for services in the nature of shareholder’s activity, duplicating services, Incidental

Activities and passive association benefits are not allowed

Revenue conclusion in most cases - “Need test” or “Benefit test” is not passed; “Evidences” are not conclusive or demonstrative of value received; and hence arm’s length price is determined at NIL

Recent Audit Trends

•22

Judicial precedents

© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authorityto obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

Judicial precedents

•24

Case Ruling

McCann India Pvt. Ltd.

Substantial evidence placed on record. Benefits of services provided by AE Entity level benchmarking using TNMM accepted Assessing Officer (AO) cannot dictate the business needs. The term “benefit” has

wide connotations.

Knorr-Bremse India Pvt. Ltd.

Taxpayer’s contention on commercial expediency rejected Taxpayer not discharged the obligation of maintaining and producing records The perusal of documents maintained reveal that only incidental and passive association benefit

had been provided by the AE.

F

A

Maintaining relevant robust documentation and corroborative support is the differentiator

© 2012 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authorityto obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

Judicial Precedents

•25

Case Ruling

Dresser Rand

TPO / AO cannot question the commercial wisdom of the taxpayer Disapproved that since the taxpayer has qualified staff on its roll, there was no need to obtain such

services from its AE. Services availed by the taxpayer is legitimate - furtherance of its business interests such costs Allocation of cost on the basis of headcount and turnover is reasonable.

Gemplus India Pvt. Ltd.

The charge for management services must be commensurate with the nature, volume and quality ofservices. There were no evidence/details available on record to demonstrate the nature of services rendered The Tribunal held that the expenses incurred should ideally be apportioned on the basis of actual

services rendered to the individual units

F

A

Documentation and evidence of services rendered is critical

Case Study

Case Study...

•27

Facts of the Case• XYZ, a US corporation (‘XYZ US’) wishes to charge a management support and IT

support service fee for some of the following centrally provided services to the Indian AE.• The fees is proposed to be charged to various AEs across the globe including the Indian

AE on the basis of forecasted turnover achieved by these AEs in each of theirjurisdictions.

• Given below is the nature of services provided to the Indian AE as Management SupportServices and IT Support Services.

I. Management Support Services• Sales Marketing and Business Development Services• Human Resource Support Services• Legal and Compliance Services• Finance

II. IT Support Services• Local IT support in terms of required softwares and related upgradation• Undertaking specific projects like global receivables project, compliance projects, etc.,

Way Forward

Way forward

Way Forward Indian entity’s in-house capability to perform such services – to check for duplicate / shareholder services

and need for procuring such services

Documenting “Benefits” received - to document tangible evidence

Evidence (correspondence, mails, reports, etc) substantiating the fact that the services were actually received, should be documented

Authenticity & details of the costs incurred; and appropriateness of allocation keys/ratios

Overall TNMM need not necessarily be acceptable

Should have a formal agreement for receiving management services, covering full details, similar to an agreement between two independent entities

Establishing proper pricing policy for intra-group services at the outset – defining the right allocation keys and also establishing the authenticity of costs incurred

Robust documentation to be maintained including Documentary Evidence (illustrative)

Intercompany agreements Composition of costs allocated Methods of cost allocation Need for procuring such services Actual receipt of services and benefits derived by

Indian entity from each component of cost – tangible evidence sought

Business reports Training manuals Marketing brochures Time sheets / logs Copies of emails Minutes of meeting confirming receipt of services HR Schemes IT network / e-mail systems

•29


What Matters ??

One should consider what something is worth through the

eyes of a independent party!

•30


Questions

•31


Thank You !

Thank You

Hasnain Shroff

Email: [email protected]

methodology to benchmark intra group services, management ... mr... · methodology to benchmark...

Documents