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An Overview of Transfer Pricing - Fundamental Principles

Vispi T. Patel Vispi T. Patel & Associates

April 22, 2016 1

Agenda Transfer Pricing Origin, Evolution and Basic Concepts

TP – Indian Perspective

Indian Transfer Pricing Regulations v OECD TP Guidelines

Nuances

2

Transfer Pricing (TP) Origin, Evolution and Basic Concepts

3

Origin of Arm’s Length Standard

4

Year Introduction of concept

1934 The arm’s length standard (ALS) was initially stated in the earliest U.S regulations under Section 482 of Internal Revenue Code (the code) issued

1963 The United States was prime promoter of adoption of the standard in OECD Model Tax Convention released

1979 The 1979 OECD Report focused on arm’s length standard and set forth the appropriate methodologies to be used to achieve arm’s length result

1995 / 2010

The OECD Transfer Pricing Guidelines for Multinational Enterprises (MNEs) and Tax Administrations (OECD TP Guidelines) reaffirmed the status of arm’s length standard “as the international standard”

2014 OECD introduced Base Erosion and Profit Shifting (BEPS) Action Plan (Action 8-10 and Action 13)

2016 Amendments in Budget 2016, providing specific regime in respect of Country by Country reporting and Master File

Evolution of TPR…

Foundation of the Transfer Pricing Regulations are embedded in the Double Taxation Avoidance Agreement (‘DTAA’) Article 9 of the OECD Model Convention

The OECD Report on Transfer Pricing Guidelines for MNEs are the foundation for transfer pricing regulations in India

Based on Arm’s Length Principle – The universal principle which is the foundation of TP legislation globally

5

Above principles serve the dual objectives - Securing the appropriate tax base in

each jurisdiction and avoiding double taxation

Transfer Pricing (TP) – Indian Perspective

6

Brief History & Background of Indian TPR

Liberalization of trade and foreign exchange policy started in India in the year 1991

This created huge increase in interest of MNEs in India

Several Indian companies also steadily emerged as global players by either making offshore acquisitions or by setting up overseas subsidiaries

Evaluation of the price charged by one related party to an other related party for goods, services, etc.;

7

Brief History & Background of Indian TPR

The Standing Committee in March 1991 observed that provisions of Income-tax Act, 1961 (Act) were inadequate to curb transfer pricing among MNEs

Objective of the Revenue is to check erosion of the tax base and plug the leakage of the revenue;

8

Brief History….

The Expert Group constituted by Central Board Of Direct Taxes (CBDT) recommended complete revision of the existing section 92 of the Act

The Finance Act, 2001 introduced TPR in India by substituting existing Section 92 of the Act and introducing new sections 92 to 92F w.e.f April, 2001

The Finance Act, 2012 amended TPR for domestic transactions w.e.f AY 2013-14. This was an outcome of suggestions given by Honorable SC in CIT v Glaxo SmithKline Asia (P) Ltd. (236 CTR 113)

9

TPR in India – Section 92

10

Any income

arising from

an international transaction

shall be computed

having regard to

arm’s length price

Vodafone India Services Limited (Writ Petition No. 871 of 2014) Bombay High Court…

Facts of the case:

Vodafone India (the assessee) issued 2,89,224 equity shares of the face value of INR 10/- each on a premium of INR 8,509/- per share to its holding company which was determined in accordance with the methodology prescribed by the Government of India under the Capital Issues (Control) Act, 1947

The assessee, out of abundant caution, disclosed this transaction (i.e. the issuance of shares) as an “international transaction” in Form 3CEB

The AO and the TPO valued each equity share at INR 53,775/- and on that basis made an adjustment of INR 45,256 per share (amounting to INR 1308.91 crores), by treating the shortfall in premium as income

Vodafone India Services Limited (Writ Petition No. 871 of 2014) Bombay High Court…

The AO/ TPO treated the same as deemed loan given by the assessee to its holding company and also contended that periodical interest of INR 88.35 crores had to be charged to tax as interest income

The assessee filed a Writ Petition (Vodafone-III) before the Hon’ble Bombay Court (‘the HC’) challenging the jurisdiction of the AO/ TPO to tax the above transaction of issue of shares considering that the same did not generate any income as defined under the Act

The HC in Vodafone-III accepted the plea of the assessee and directed the Dispute Resolution Panel (DRP) to first decide only the preliminary jurisdictional issue raised by the assessee

Vodafone India Services Limited…

Consequent to these directions, the DRP considered the issue of jurisdiction and rejected the assessee's preliminary objection thereto

Hence, the assessee filed a Writ Petition (present, Vodafone - IV) before the HC, challenging the DRP’s order which had held that the AO/TPO had jurisdiction to tax such shortfall in premium under Chapter X of the Act, as income arose in the above international transaction

Vodafone India Services Limited...

Observations, Analysis and Decision:

The word income as defined in Section 2(24) of the Act, though an inclusive definition, cannot include capital receipts unless specified, as in Section 2(24)(vi) of the Act

Capital gains chargeable to tax under Section 45 of the Act are, defined to be income

The amounts received on issue of share capital including the premium were undoubtedly on capital account

Reliance on the decision of :

Bombay High Court in Cadell Weaving Mill Co. vs. CIT 249 ITR 265, which was

upheld by the Apex court in CIT v. D. P. Sandu Bros. Chember (P) Ltd. 273 ITR 1


Due to absent express legislation; no amount received, accrued or arising on capital account transaction can be subjected to tax as income

Chapter X of the Act is a machinery provision to arrive at the ALP of a transaction between AEs

The substantive charging provisions are found in Sections 4, 5 (Scope of income), 15 (Salaries), 22 (Income from house property), 28 (Profits and gains of business), 45 (Capital gain) and 56 (Income from other Sources) of the Act


An income arising from an international transaction between AE must satisfy the test of income under the Act and must find its home in one of the above heads i.e. charging provisions, as Chapter X is only a machinery provision to compute the chargeable income at ALP

Machinery section cannot be read de-hors the charging section, relying on the observations of the Supreme Court in CIT v. B. C. Srinivas Shetty 128 ITR 294


The HC concluded that the issue of shares at a premium by the assessee to its non-resident holding company does not give rise to any income from an admitted international transaction

Thus, there was no occasion to apply Chapter X of the Act in such a case. The HC quashed all the orders of the Revenue authorities i.e. AO/ TPO/ DRP and set them aside as being without jurisdiction, null and void

The Bombay HC passed a similar judgment in the case of Shell India Markets Pvt. Ltd. (Shell) v. ACIT et al., Writ Petition 1205 of 2013, except that Shell did not disclose the issuance of equity shares to its non-resident associated enterprise as an international transaction in Form 3CEB

Further, the CBDT vide Instruction No. 02/2015, dated 29 January 2015 has notified that it has accepted the decision of Vodafone IV and has directed that the ratio decidendi of the judgment must be adhered to by the field officers in all cases where this issue is involved

18


Vodafone India (Assessee) AO / TPO

Bombay High Court Dispute Resolution Panel

Issue of shares not reported as International Transaction,

as no income arises

TP addition (INR 1308 crs) on shortfall in the premium on shares, treating it as income

Directed the DRP to decide on the preliminary jurisdictional

issue raised by the assessee

DRP considered the issue of jurisdiction and rejected the same

Bombay High Court

Issue of shares at a premium does not give rise to any income from an admitted international transaction, thus,

there exists no occasion to apply Chapter X of the Act

Vodafone India Services Limited (Writ Petition No. 871 of 2014) Bombay High Court

TPR in India Income under any head is covered under the ambit of TPR

and it must be real income

Section 4 – Income must be chargeable to tax

OECD TP Guidelines have laid the foundation of the Transfer Pricing Regulations in India

Preconditions: – Two or more associated enterprises

– Enter into an international transaction

– Specified Domestic Transaction (w.e.f. AY 2013-14)

Consequence:

– Income/ Expenditure to be computed having regard to the arm’s length price

20

Arm’s Length Price

Section 92F(ii) of the Indian TPR

“arm’s length price means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions”

Under Rules 10A to 10E of Income-tax Rules, 1962 (Rules); “Uncontrolled transaction” – transaction between enterprises other than associated enterprises, whether resident or non-resident

21

Associated Enterprises as per Indian TPR [Section 92A]

Means direct or indirect participation in

management

control or capital:

– by one enterprise into another enterprise; or

– by the same person in both the enterprises

Equity holding, Control of Board of Directors /

Appointment of one or more Executive Director,

mutual interest will also constitute Associated

Enterprise

Either or both of Associated Enterprises should be a

non-resident

22

Meaning of AEs …..

“Deemed Associated Enterprises” includes:

– Holding of 26% of voting power by one enterprise into another enterprise; or

by the same person in both the enterprises

– Dependence on intangible assets

– Purchase of 90% or more of raw materials and consumables

– Sale of goods influence on price and conditions of supply by buyer

– Control by individual or his relative

– Financial transaction Loan - 51% or more of book value of total assets of the

borrowing enterprise

Guarantee - 10 % or more of the total borrowings of an

enterprise

23

Associated Enterprise ….. Term of wide import

Following parties also covered: – Venture Capital investors with 26% stake

– FI’s advancing loans exceeding 51% stake of assets of

borrowing enterprise

– Franchisers, licensees, technical collaborators, etc

Is your company covered?

24

Meaning of AEs as per OECD Model Tax Convention

Article 9(1) of OECD “ Where direct or indirect participation in management, control or capital:

by one enterprise into another enterprise; or

by the same person in both the enterprises

then any profits which would accrue to either one of enterprises but have not accrued due to controlled conditions will be included in profits of that enterprise and taxed accordingly “

25

Whether definition of AE under domestic law can be reduced in rigor by falling under relevant article of AE

under the treaty ?

International transaction

Means “transaction” between two or more Associated Enterprises:

Transaction between two or more associated enterprises (at least one of which will be non-resident) of purchase, sale or lease of tangible and intangible property, provision of services, financing, cost sharing / cost contribution arrangements

OR

Any other transactions affecting profits, losses, income, assets or liability of the enterprise

26

International Transactions (Amendments by Finance Act, 2012)

The expression “International Transaction” was amended by Finance Act, 2012 w.e.f 1.04.2002 to specifically include:

Inter-company Guarantees,

Advance payments, deferred payments, receivables,

Capital Financing/ Business restructuring / reorganisation,

Purchase / sale/ use of intangibles such as customer lists, customer contracts, customer relationships,

Transfer / secondment of trained employees, etc.

27

Definition of Deemed International Transaction

(Amendments by Finance Act, 2014)

The Finance Act 2014, has broadened the scope of international transaction. Further, the amendment is effective from 1 April 2015

Where a transaction is entered into by an enterprise with a person other than an AE and

There exists a prior agreement in relation to the relevant transaction between such other person and the AE or,

Terms of the relevant transaction are determined in substance between such other person and the AE, and

Either the enterprise or the AE or both of them are non-resident whether or not such other person is a non-resident

Such transaction will be deemed to be an international transaction

28


29

Indian Co. (Enterprise)

Foreign Co

(AE)

Unrelated Customer

India

Outside India

Transaction

Prior agreement

Deemed International Transaction


The Hyderabad Tribunal in the case of Swarnandhra IJMII Integrated Township Development Co. P. Ltd vs. DCIT [2013-TII-152-ITAT-HYD-TP] held that deeming fiction does not cover transactions between two Indian entities

Similar position taken in Kodak India Pvt Ltd (155 TTJ 69) (Mum ITAT) and Vodafone India Services Pvt Ltd (Bom HC) (262 CTR 153)

30

Specified Domestic Transactions

The Finance Act, 2012 has introduced TPR for specified domestic transactions under section 92BA

Specified Domestic Transactions to include :

Expenditure in relation to which payment has been made to related party as specified in section 40A(2)(b)

Transfer of goods or services between two units, undertakings or companies which are related and one of them is eligible to avail deduction under Chapter VI-A, 80IA

Any transaction in Chapter VI-A or section 10AA to which the transfer pricing clause under section 80IA are specifically made applicable

Any other transaction as may be prescribed 31

Applicability to Domestic Transactions w.e.f AY 2013-14

To file Form No. 3CEB in respect of Specified Domestic Transactions entered into with their related parties

Minimum Threshold: INR 200 millions w.e.f. AY 16-17

May amount to double taxation in certain cases

All existing TP compliance requirements, mandatory documentation, TP audits (assessments) and penalty provisions will be applicable

32

Most Appropriate Method (MAM)

Selection of the MAM from the six specified methods; having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe;

a) Comparable Uncontrolled Price Method (CUP)

b) Resale Price Method (RPM)

c) Cost Plus Method (CPM)

d) Profit Split Method (PSM)

e) Transaction Net Margin Method (TNNM)

f) Rule 10AB -Any other method prescribed by CBDT

33

Transfer Pricing Methods

OECD has historically preferred traditional methods viz. CUP, RPM, CPM over transactional profit method viz. PSM and TNNM, Rule 10AB – Any other method

However OECD’s position has undergone a change in OECD TP Guidelines of July 2010, wherein OECD has treated all methods at par and has recommended the use of MAM applicable

34

Transfer Pricing Methods Thus OECD has in spirit accepted the Indian TPR’s

methodology to accept MAM, without laying emphasis on any particular method

But underlying preference for CUP can still be gathered from the revised OECD Guidelines

Even though Section 92C of Indian TPR do not prescribe preference over any particular method, tribunals in the following cases have laid down preference on traditional methods over transactional profit methods a) ACIT v MSS India (P.) Ltd [Pune ITAT]

b) Serdia Pharmaceuticals Pvt Ltd v ACIT [Mumbai ITAT]

c) ACIT v Sonata Software Ltd [Mumbai ITAT]

d) M/s. Twilight Jewellery Pvt. Ltd v DCIT [Mumbai ITAT] 35

Arm’s Length Standard and Arm’s Length Price

The Arm’s Length Standard (ALS) is the Universal Standard that is applicable to the various intra-group transactions of a MNE. It is based on the separate – entity approach and is enshrined in the DTAAs signed by the various countries

The same principle also applies to specified domestic transactions

The ALP under Section 92F of the Act denotes price which is applied or proposed to be applied in a

– comparable transaction between

– unrelated independent parties in

– uncontrolled conditions

– Usually corresponds to the open market price

36

Documentation…..Seven steps Approach

Understanding the Business Model of the Corporate

Analyzing the Transaction(s)

Functional & Economic analysis

Assessment of comparables

Selection and application of methodology

Benchmarking the transaction

Reviewing the process

37

Documentation Requirements - Rule 10D(1)

This is the mandatory documentation required by law

a. Description of Ownership Structure (Step I)

b. Profile of Multinational Group (Step I)

c. Description of Business (Step I)

d. Nature & Terms of Transactions (Step II)

e. Description of Functions, Risks & Assets (Step III)

f. Record of Economic & Market Analyses, if any (Step III & IV)

38

Documentation Requirements…..

g. Comparability Analysis (Step IV)

h. Record of Uncontrolled Transactions (Step VI)

i. Description of Methods considered (Step V)

j. Record of Actual working (Step VI)

k. Assumptions, policies, price negotiations, if any (Step II & III)

l. Any other information, data or document (Company specific information, if any)

39

Transfer Pricing Adjustment

Absence of arm’s length price in international transaction, or failure to maintain the prescribed documentation, or use of unreliable data can lead to adjustment

Arithmetic mean vs. Range of results

Tax exemption will not be available for the amount of

adjustment (10A, 10AA, 10B, Chapter VI A)

40

Transfer Pricing Assessments -TPA

The revenue authorities across the globe in their wanting to safeguard their country’s tax base, require strict compliance from the taxpayers to the TP rules and regulations

41

TPA…..

Documentation is the key to demonstrate

adherence to the Arm’s Length Standard

42

Advance Pricing Agreements (APA)

The Finance Act, 2012 introduced ‘APA Mechanism’

Salient Features –

Seeks to provide assurance of certainty and unanimity in

transfer pricing approach followed by the tax authorities

and taxpayers

Validity: Upto subsequent five years and four previous

years as well (rollback brought by Finance Act 2014)

Binding on tax authorities as well as taxpayers unless there

is a change in the law or facts of the case

Pre – Consultation process (with anonymous application

option)

43

APA…

Following are important points to be considered:

Each year Annual Compliance Report in Form No. 3CEF needs to be filed before DGIT (IT)

The APA can be cancelled/revised if critical assumptions are violated or conditions are not met, subject to which the agreement has been entered into

If the Compliance Audit results in a finding that the assessee has failed to comply with the terms of the agreement, the agreement can be cancelled

Non filing of Compliance Report or the report contains material errors, it may result in cancellation of the agreement

44

According to industry sources, approximately 650 APA applications have been filed,

out of which CBDT has already signed 64

Safe Harbour Rules

Safe Harbour provisions were introduced in the Finance Act, 2009 in order to reduce transfer pricing disputes, however, no rules were prescribed to the effect

CBDT released final Safe Harbour Rules on 18th September 2013, as regards various financial parameters for the prescribed sectors/activities performed by an eligible assessee

45

Summary of Safe Harbour Rules

Eligible international transaction

Safe Harbour Rules

Threshold limit prescribed

Safe Harbour margin

Provision of software development services (other than contract R&D) and information

technology enabled services

INR 500 crores or less 20 percent or more of

Operating Costs

Above INR 500 crores 22 percent or more of

Operating Costs

Provision of knowledge process outsourcing services None

25 percent or more of Operating Costs

Interest on advancing of intra-group loans

Loan amount INR 50 crores or less

SBI base rate + 150 basis points

Loan amount more than INR 50 crores

SBI base rate + 300 basis points

Providing corporate guarantee (other than comfort letter, performance guarantee, etc.)

INR 100 crores or less 2 percent p.a. or more

Above INR 100 crores* 1.75 percent p.a. or more

46 *Credit rating done by an agency registered with SEBI, is of the

adequate to highest safety


Eligible international transaction Safe Harbour Rules

Provision of contract research and development services wholly or partly relating

to software development 30 percent or more of Operating Costs

Provision of contract research and development services wholly or partly relating

to generic pharmaceutical drugs 29 percent or more of Operating Costs

Manufacture and export of core auto components

12 percent or more of Operating Costs

Manufacture and export of non-core auto components

8.5 percent or more of Operating Costs

47


Procedural Aspects

Eligible taxpayers must furnish a self-attested form i.e. Form No. 3CEFA, containing various details of the eligible transactions on or before the due date for filing the income tax return

The Assessing Officer may make a reference to the Transfer Pricing Officer to verify the validity of option exercised by the taxpayer

Various other procedural aspects have been provided by the relevant Rules

48

CBDT notifies amendment in Rule 10D and Safe Harbour Rules for Specified Domestic Transactions

The CBDT via Notification No.11/2015/F.No.142/7/2014-TPL]dated 3rd February 2015:

Eligible assessee –

A person who has exercised a valid option for application of safe harbour rules in accordance with the provisions of rule 10 THC, and

Is a Government company engaged in the business of generation, transmission or distribution of electricity

Eligible specified domestic transaction (SDT)–

Means a SDT undertaken by an eligible assessee and comprises of :-

1. Supply of electricity by a generating company; or

2. Transmission of electricity; or

3. Wheeling of electricity

49

Indian TPR v OECD TP Guidelines

50

Range Concept and Multiple Year Data

OECD Guidelines allow taxpayers the use of multiple year data as it generally captures market & business cycles and smoothens effects of yearly aberrations giving a better overall statistical result

OECD Guidelines allow for a range of comparable data

The budget speech of the Finance Minister in 2014 referred to the concept of range and use of multiple year data to align Indian Transfer Pricing regime with international best practices

The CBDT has now amended (vide Notification No. 83/2015 dated 19 October 2015) the Rules for determining the ALP by introduction of ‘Range concept’ and ‘Use of Multiple year data’ for comparability analysis

The amended Rules are applicable to both international transactions as well as specified domestic transactions from FY 2014-15, i.e. AY 2015-16

51

Multiple Year Data

Use of multiple year data (current year and preceding two financial years) is permissible only in case of specified methods of determining ALP. In such cases, the weighted average price of the comparable entities has to be computed in a specified manner and shall be used to benchmark the transactions entered into by the taxpayer

In cases where the list consists of less than six data sets, the arithmetical mean of such weighted average will be regarded as ALP

It is expected that the use of multiple year data would even-out the variations in the analysis of the transactions

52

Range Concept

Under the range concept, if the price at which the transaction has been undertaken is within the range, such price shall be deemed to be ALP and no adjustment will be made

The range concept will be applicable only in case of specified methods of determining ALP and where there exist six or more entities

The range will begin with the 35th percentile and end with the 65th percentile of the list of entities

When the price at which the transaction has been entered into does not fall within the range, the median of the list will be taken as ALP, for computation of adjustment

53

Range v Mean

However proviso to section 92C require computation of arithmetic mean (AM) if more than one price is determined by MAM

The second proviso to Section 92C says that there will be no adjustment if variation between AM and international transaction or specified domestic transaction does not exceed; 1% for wholesale traders, and; 3% in all other cases

54

Can business transaction be conducted at a single utopian mean price?

1%/3% arm’s length range retained “Wholesale Trading” defined

The CBDT via Notification No. 86/ 2015/F. No. 500/1/2014-ARA-II] dated 29th October 2015 :

retained transfer pricing variation range, i.e.

1% in case of wholesale trading and

3% in other cases;

Defined the term ‘wholesale trading’ i.e.

Purchase cost of finished goods is eighty percent or more of the total cost pertaining to such trading activities; and,

Average monthly closing inventory of such goods is ten percent or less of sales pertaining to such trading activities

55

Whether ‘Purchase cost’ shall mean price paid or it shall also include other incidental charges like custom duty or freight inwards etc.?

Whether ‘Total cost pertaining to such trading activities’ shall only be a sum of all operating costs or it shall also include financial costs pertaining to trading activity?

Range – An illustration

56

Three-year weighted average margin of comparable companies

1 2 3 4 5 6 7 8 9

10 15 16 -4 5 25 30 6 13

Ascending Order -4 5 6 10 13 15 16 25 30

Arithmetic mean 12.89%

Range 35th to 65th percentile 10% to 15% (calculated)

Three-year weighted average margin of comparable companies

1 2 3 4 5 6 7 8 9

10 15 16 -4 5 40 30 6 13

Ascending Order -4 5 6 10 13 15 16 30 40

Arithmetic mean 14.56%

Range 35th to 65th percentile 10% to 15% (calculated)

Scenario 1 – Benchmarking sale of goods

Scenario 2 – Benchmarking sale of goods

57

Range – An illustration

Presumed Margin of assessee

+/- 3%

Arithmetic Mean

Range Whether at AL under

old law

Whether at AL under

new law

Scenario 1 9.75 13.04 12.89% 10-15% Yes No

Scenario 2 10.50 13.82 14.56% 10-15% No Yes

Arithmetic mean deviated from 12.89% to 14.56% when a smaller data point (i.e. 25) was replaced with a higher data point (i.e. 40), whereas the range remained static at 10% to 15% under both the scenarios.

This illustrates that the arithmetic mean reacted to the extreme values, whereas the range remained indifferent.

As a result, compared with the arithmetic mean, one advantage of the range is that it indicates the spread or concentration from the middle of the distribution, ignoring the extremes of the distribution.

Reference to TPO

58

The has issued guidelines for implementation of TP provisions (Instruction No. 03/2016, dated: March 10, 2016) replacing the earlier Instruction no. 15/2015 dated 16.10.2015.

The instruction is applicable to both IT and SDT.

In certain situations, the AO must provide an opportunity of being heard and record his satisfaction that there is an income or a potential of an income arising on determination of the ALP of an IT or SDT before referring the same to the TPO

In the name of administrative efficiency, determination of ALP shall not be carried out by the AO in a case where reference is not made to the TPO

Reference to TPO

59

Case selected for scrutiny on TP risk parameter

Case selected for scrutiny on non-TP risk parameter

If TP risk pertains to only IT, then only IT to be referred to TPO

Where the taxpayer has not filed Form No. 3CEB at all or has not disclosed IT or SDT which comes to the notice of the AO which has not been disclosed in the Form No. 3CEB

If TP risk pertains to only SDT, then only SDT to be referred to TPO

Where there has been a TP adjustment of INR 10 crores or more in an earlier assessment year and such adjustment has been upheld by the judicial authorities or is pending in the appeal

If TP risk pertains to IT and SDT, then both shall be referred together to TPO

Where search and seizure or survey operations have been carried out and findings regarding transfer pricing issues in respect of IT or SDT or both have been recorded by the Investigation Wing or the AO

The guidelines state that the AO shall make reference to the TPO only under the following specified circumstances:

Nuances

60

Risk of Economic Double Taxation

Transfer Pricing involves taxation of the same economic transaction both income and / or capital in the hands of two different tax payers in different countries

Hence risk of double taxation is the biggest problem arising from TPR

A proposed adjustment will lead to taxation of income earned by foreign AE in its jurisdiction of residence, while same income may be taxed in the hands of the other AE in a foreign jurisdiction

61

Bharti Airtel Ltd – Delhi Tribunal

Facts of the case

The assessee issued a corporate guarantee to Deutsche Bank, New Delhi Branch on behalf of its overseas AE guaranteeing repayment for working capital facility granted to AE

Assessee contended that since it had not incurred any costs or expenses on account of issue of such guarantee, and the guarantee was issued as a part of the shareholder activity, the same was issued for NIL consideration

The TPO made an adjustment stating that the assessee benefitted the AE by increasing its credit rating. He determined the ALP @ 4.68% under the CUP method on the basis of data obtained from various banks u/s 133(6) of the Act

62

(ITA No. 5816/Del/2012)

Bharti Airtel Ltd… Tribunal Ruling

Situations wherein a transaction has no bearing on profits, incomes, losses or assets of the assessee, such transaction will be outside the ambit of expression ‘international transaction’

The Tribunal deleted the TP adjustment and held that issuance of corporate guarantee in question, did not involve any costs to the assessee and does not have any bearing on profits, income, losses or assets of the assessee

It also held that the onus is on revenue authorities to demonstrate that the transaction is of such a nature as to have ‘bearing on profits, income, losses or assets’ on a real basis (even if in future), and not on a contingent or hypothetical basis

Such onus was not discharged in the instant case

63

Corporate Guarantee

Relying on the decision of Bharti Airtel, similar view has been taken by the Ahmedabad Tribunal in the case of Micro Ink Limited (ITA No. 2873/Ahd/10) and the Mumbai Tribunal in the case of Siro Clinpharm Private Limited (ITA No. 2618/Mum/2014)

• Issuance of corporate guarantee by parent company to its subsidiary company was in the nature of shareholder activities/ quasi capital and thus could not be included within the ambit of ‘provision of service’

• The said transaction was not to be included in the definition of ‘international transaction’ under Section 92B of the Act

64

The Tribunal judgment of the Bharti Airtel is before the High Court

Notified Jurisdictional Area [Section 94A]

Section 94A(1) empowers the CG to specify any country as a

notified jurisdictional area (NJA), having regards to lack of

effective exchange of information with such country.

If an assessee enters into a transaction where one of the parties to

the transaction is a person located in NJA then:

All the parties to the transaction shall be deemed to be AE as defined

in Section92A;

Any transaction entered into as defined in Section 92B shall be

deemed to be international transaction

and the transfer pricing provisions shall apply accordingly

65

NJA [Section 94A]

No Deduction shall be allowed of any payment made to financial

institution or any other expenditure or allowance arising from the

transaction with a person located in NJA, unless the assessee

furnish an authorization in prescribed form and maintains and

furnish prescribed documents.

Any sum received from any person located in NJA shall be deemed

to be income of the assessee, unless the assessee explain the source

of the said sum in the hands of such person located in NJA.

Any person located in NJA is entitled to receive any sum, or

income or amount on which tax is deductible, shall be deducted at

rate in force or at a rate prescribed in the Act or at 30 percent,

whichever is higher.

66

Madras High Court - Writ Petition Challenging Section 94A

Facts of the case

The petitioners entered into tripartite Agreement with the Indian Company and the Cyprus Company for the purchase of securities (i.e. shares and compulsory convertible debentures) of Indian Company from the Cyprus Company

ITO rejected the contention of the petitioners that they are not liable to deduct tax U/s. 195 in spite of the fact that they had purchased the securities at a rate below their face value and that the Cyprus Company has suffered a loss.

The Petitioners filed statutory appeals U/s. 246A before CIT(A) and simultaneously, had filed writ petition challenging the constitutional validity of section 94A(1)

67

Madras High Court (...contd.)

Questions before HC

Whether Section 94A(1) of the Act is ultra vires Articles 14, 19, 51, 253 and 265 of The Constitution of India (the Constitution)

Whether Notification No. 86 dated 1.11.2013 issued by the CBDT (specifying Cyprus as an NJA) is ultra vires Section 94A of the Act r.w. Articles 14, 19 and 265 of the Constitution

Whether Press Release issued by Ministry of Finance titled “Concerning The Double Tax Treaty between Cyprus and India” dated 1.11.2013 is ultra vires Section 4, 5, 94A(5) and 195 of the Act r.w. Articles 14 & 265 of the Constitution

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Key Observation and Relying on various decisions:

In Jolly George Varghese, the Hon’ble SC held that the executive power of the Government of India to enter into international treaties does not mean that international law, ipso facto, is enforceable upon ratification.

The Hon’ble SC in supra has held that Indian Constitution follows dualistic doctrine, it must be taken that an international treaty, can be enforced only, so long as it is not in conflict with the municipal laws of the State

The Hon’ble SC in Azadi Bachao held that “the provisions of such an Agreement, with respect to cases to which where they apply, would operate even if inconsistent with the provisions of the Income Tax Act”, cannot be viewed in isolation. If viewed in isolation, it would result in mutually inconsistent results

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In Ram Jethmalani, the Hon’ble SC took note of the Vienna Convention as well as the decision in Azadi Bachao and came to a conclusion that "The Government cannot bind India in a manner that derogates from the Constitutional provisions, values and imperatives."

The Hon’ble Madras HC observed and held that

Once it is stated that India has followed the dualistic model, it is impossible to think that the supremacy of the Parliament could be compromised by the Executive entering into a Treaty. The collective will and the collective conscience of the people, which the Parliament is supposed to reflect, cannot be subordinated to the power of the Executive.

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The Hon’ble Madras HC observed and held that

If the purpose of the CG entering into an agreement under Section 90(1) is defeated by the lack of effective exchange of information, then Section 90(1) is actually diluted by one of the contracting parties and not by Section 94A(1) of the Act.

Hence, all the writ petitions challenging the constitutional validity of Section 94A, Notification No. 86 dated 1.11.2013 and Press Release issued in this regards were dismissed.

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Emerging international tax issues and effect on tax policies

Increasing concern for both developed and developing countries on ‘base erosion and profit shifting (BEPS)’, double non-taxation

Impact of BEPS report and other changes on existing structures and proposed commercial transactions

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BEPS Action Plan

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Action 10: Low value-adding intra-group

services – Discussion Draft

Action 15: Developing a multilateral instrument to

modify bilateral tax treaties

Action 14: Making dispute resolutions more effective

Action 1 : Addressing the tax challenges of the

digital economy

Action 2: Neutralising the effects of hybrid

mismatch arrangements

Action 3: Strengthen CFC rules

Action 4: Limit base erosion via interest

deductions and other financial payments

Action 5: Countering harmful tax practices

more effectively, taking into account transparency

and substance

Action 6: Preventing the granting of treaty benefits

in inappropriate circumstances

Action 7: Prevent the artificial avoidance of

permanent establishment status

Action 8: Transfer pricing aspects of intangibles

Action 9: Consider transfer pricing for risks

and capital

Action 12: Require taxpayers to disclose their

aggressive tax planning arrangements

Action 13: TP Documentation and

Country-by-Country (CbC) reporting

Action 11: Establish methodologies to collect

and analyse data on BEPS and actions addressing it

Action 13 – TP Documentation and CbC Reporting

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Three Tier documentation structure proposed for all countries

Template for master file – To

provide the MNE’s blueprint

The group’s organisation structure

A description of the group’s business, intangibles, intercompany financial activities and financial and tax

positions

Template for local file – To provide material transfer

pricing positions of the local entity/ taxpayer with its foreign affiliates

Demonstrates arm’s length nature of transactions

Contains the comparable analysis

Country-by-Country (CbC)

Report

Jurisdiction-wise information on global allocation of income, taxes paid/ accrued, the stated capital,

accumulated earnings, number of employees and tangible assets

Entity-wise details of main business activities which will portray the value chain of inter-company transactions

In the 2016 Budget, the Indian government has proposed introducing rules in relation to CbC reporting and the master file requirement that are in line with BEPS Action 13

Section 92D of the Act has been proposed to be amended to require a constituent entity of an international group to keep and maintain such information and documents in respect of an international group as may be prescribed

The information and documents are required to be furnished to the prescribed authority before the prescribed date

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Country-by-Country Reporting…

CbC Reporting…

MNEs would be required to provide details in the CbC report in relation to revenue, profits, tax payments, capital, accumulated earnings, number of employees and assets, etc. for each country in which the group operates

Penalty has been prescribed for not furnishing the information and documents

The details of documents and information to be kept will be specified in the Rules to be notified

Section 286 of the Act has been inserted to provide for CbC reporting obligations

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CbC Reporting…

The CbC Reporting will be applicable only for taxpayers having an annual consolidated group turnover of over INR 53,950 for FY 2015-16

The new regime will be applicable from financial year 2016-17

The first filing will be due on 30 November 2017

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THANK YOU

Vispi T. Patel

Vispi T. Patel & Associates

Chartered Accountants

Contact no : +91 22 2288 1091/1092

+91 -98 6763 5555

Email id : [email protected] 78

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