Guide To Transfer Pricing Law In India

January 14, 2018

1. INTRODUCTION TO TRANSFER PRICING LAW IN INDIA

The Finance Act, 2001 introduced law of transfer pricing in India through sections 92A to 92F of the Income-tax Act, 1961 which guides computation of the transfer price and suggests detailed documentation procedures.

The transfer pricing regulations were introduced due to the increasing participation of multi-national groups in economic activities in India has given rise to new and complex issues emerging from transactions entered into between two or more enterprises belonging to the same group. Hence, their was a need to introduce a uniform and internationally accepted mechanism of determining reasonable, fair and equitable profits and tax in India in the case of such multinational enterprises.

Herewith is a brief overview on the applicability of transfer pricing regulations in India, methods of determining the transfer price and the documentation procedures.

2. SCOPE & APPLICABILITY

Transfer Pricing Regulations are applicable to the all enterprises that enter into an ‘International Transaction’ with an ‘Associated Enterprise’. Therefore, generally it applies to all cross border transactions entered into between associated enterprises. It even applies to transactions involving a mere book entry having no apparent financial impact. The aim is to arrive at the comparable price as available to any unrelated party in open market conditions and is known as the Arm’s Length Price (‘ALP’).

2.1. What is an “Associated Enterprises (‘AEs’)”?

The basic criterion to determine an AE is the participation in management, control or capital (ownership) of one enterprise by another enterprise. The participation may be direct or indirect or through one or more intermediaries.

The concept of control adopted in the legislation extends not only to control through holding shares or voting power or the power to appoint the management of an enterprise, but also through debt, blood relationships, and control over various components of the business activity performed by the taxpayer such as control over raw materials, sales and intangibles.

It appears that one may go to any layer of management, control or ownership in order to find out association

(a) Direct Control

(b) Through Intermediary

For instance, if enterprise B is managed, controlled or owned either directly or through an intermediary, then Enterprise B is said to be an AE of enterprise A.

Further, if Mr A and Mr B control both Enterprise A and Enterprise B then both Enterprise A and Enterprise B AEs.

In the context of Specified Domestic Transactions, a related party (also referred to as Associated Enterprise) includes, amongst others, a director of a Company, a relative of such director, an entity having substantial interest (i.e., holding more than 20% of the voting power) in the other entity, subsidiaries, fellow subsidiaries, etc.

2.2. What is an International Transaction?

An international transaction is essentially a cross border transaction between AEs in any sort of property, whether tangible or intangible, or in the provision of services, lending of money etc. At least one of the parties to the transaction must be a non-resident entering into one or more of the following transactions

(a) Purchase, sale or lease of Tangible or Intangible Property

(b) Provision of services

(d) Any transaction having a bearing on profits, income, losses or assets

(e) Mutual agreement between AEs for allocation/apportionment of any cost, contribution or expense.

An illustration of a distant ‘International Transaction’ could be where a resident enterprise exports goods to an unrelated person abroad, and there is a separate arrangement or agreement between the unrelated person and an AE which influences the price at which the goods are exported. In such a case the transaction with the unrelated enterprise will also be subject to TPR.

Transfer Pricing law for Domestic transactions

With effect from Fiscal Year 2012-13, specified domestic transactions between two related parties or Associated Enterprises are subject to TP Regulations, where the aggregate of all such transactions exceeds a sum of INR 50 mn (this threshold has been revised to INR 200 mn from Fiscal Year 2015-16). The following transactions have been covered under the ambit of Specified Domestic Transactions:

– Payments in the nature of business expenditure made to a related party/ Associated Enterprise.

– Transfer of goods or services between a tax holiday and non-tax holiday unit of an entity.

– Any business transacted between an enterprise claiming tax holiday with another closely-linked enterprise.

3. ARM’S LENGTH PRICE& METHODS OF DETERMINING THE ALP

ALP has been defined to be the price which is applied or is proposed to be applied in a transaction between persons other than Associated Enterprises, in uncontrolled conditions.

In accordance with internationally accepted principles, the TPR have provided that any income arising from an international transaction between AEs shall be computed having regard to the ALP, which is the price that would be charged in the transaction if it had been entered into by unrelated parties in similar conditions.

The ALP is to be determined by any one or more of the prescribed methods. The taxpayer can select the most appropriate method to be applied to any given transaction, but such selection has to be made taking into account the factors prescribed in the TPR. With a view to allow a degree of flexibility in adopting the ALP, a variance allowance of 5 percent has been provided under the TPR. The prescribed methods have been listed below

(a) Comparable Uncontrolled Price Method (‘CUPM’)

(b) Resale Price Method (“RPM’)

(d) Profit Split Method (‘PSM’)

(e) Transactional Net Margin Method (‘TNMM’)

In cases where there is more than one price determined using the most appropriate from the above methods, ALP shall be taken to be at arithmetic mean of such prices. Where the transfer price differs from ALP, no TP adjustment is made where the arithmetic mean falls within the tolerance range of transfer price. Currently, the tolerance range available for wholesale traders is 1%, while that for other taxpayers is 3% of the value of International Transaction/ Specified Domestic Transaction.

Use Of Range Concept

The Central Board of Direct Taxes (CBDT) has also notified the concept of ‘arm’s length range’ for computation of ALP for transactions after April 1, 2014. Under this concept, data points lying within the 35th and the 65th percentile of a data set constructed using comparable data would constitute the arm’s length range. Accordingly, transfer price falling within the arm’s length range would be considered to be at arm’s length. A minimum of 6 comparable entities are required for application of the range concept. In cases where the number of comparables in a data set is less than 6, the arithmetic mean would continue to be considered as the ALP. Where the arithmetic mean is considered as the ALP, the benefit of a tolerance range continues to be available.

Use Of Multiple Year Data

Originally, the TP Regulations did not provide for using data of years other than the year in which transactions were undertaken (except in certain specific cases). The CBDT has amended the Rules and now permitted use of ‘multiple year data’ while performing a benchmarking analysis. If certain conditions are satisfied, the taxpayer shall be permitted to use comparable data of 2 years preceding the relevant fiscal year along with that of the relevant fiscal year (also referred to as current year).

4. DOCUMENTATION

The provisions contained in the TPR are exhaustive as far as the maintenance of documentation is concerned. This includes background information on the commercial environment in which the transaction has been entered into, information regarding the international transaction entered into, the analysis carried out to select the most appropriate method and to identify comparable transactions, and the actual working out of the ALP of the transaction. This also includes report of an accountant certifying that the ALP has been determined in accordance with the TPR and that prescribed documentation has been maintained. This documentation should be retained for a minimum period of 8 years. However, it may be noted that in case the value of the international transaction is below INR 10 million, it would be sufficient for the taxpayer to maintain documentation and information which substantiates his claim for the ALP adopted by him. In effect, they need not maintain the prescribed documentation.

Taxpayers entering into International and/ or Specified Domestic Transactions with their Associated Enterprises, need to report the same to the Indian tax authorities on or before the due date of filing of tax return, by furnishing a certificate obtained from an Accountant. The Accountant needs to certify the following in Form No 3CEB

– That the ALP computed by the taxpayer is correct and in accordance with the Regulations; and

– That the taxpayer has maintained appropriate TP documentation as required by the Regulations.

The said certificate requires the Accountant to report specific details of the International and/or Specified Domestic Transactions, the value of transaction, the method used to determine ALP.

5. BURDEN OF PROOF TO PROVE THAT TRANSACTIONS ARE AT ARMS’ LENTGH

The primary onus is on the taxpayer to determine an ALP in accordance with the TPR and to substantiate the same with the prescribed documentation. Where such onus is discharged by the taxpayer and the data used for determining the ALP is reliable and correct there can be no intervention by the tax officer.

In other cases, where the tax officer is of the view that the

(a) price charged in the international transaction has not been determined in accordance with the methods prescribed,

(b) or information and documents relating to the international transaction have not been kept and maintained by the assessee in accordance with the TPR,

(d) or the assessee has failed to furnish any information or document which he was required to furnish under the TPR the tax officer may reject the ALP adopted by the assessee and determine the ALP in accordance with the TPR. For this purpose, he would then refer the matter to a Transfer Pricing Officer (‘TPO’) (a special post created for valuation of ALP) who would determine the ALP after hearing the arguments of the taxpayer.

6. EFFECTS OF ADJUSTMENT TO THE ALP

In case the ALP determined by the TPO indicates understatement of income by the taxpayer, it could result into the following

(a) Adjustment to reported income of the taxpayer

(b) Levy of penalty

6.1. Adjustment to the Reported Income

The tax officer is bound to adjust the reported income of the taxpayer with the amount of adjustment proposed by the TPO. This would have an effect of increasing the assessed income or alternatively decreasing the assessed loss. Furthermore, the eligible deductions available to the taxpayer under section 80 could not be availed on the enhanced income.

However, those taxpayers who are eligible for deductions under section 10A and 10B remain unaffected as these deductions remain available on the enhanced income.

6.2. Penalties

Penalties have been provided as a disincentive for non-compliance with procedural requirements are as follows.

(a) Penalty for Concealment of Income – 100 to 300 percent on tax evaded

(b) Failure to Maintain/Furnish Prescribed Documentation – 2 percent of the value of the international transaction

(c) Penalty for non-furnishing of accountants report – INR 100,000 (fixed) The above penalties can be avoided if the taxpayer proves that there was reasonable cause

	Default				Penalty (from fiscal year 2016-17)

Failure to keep or maintain required				2% of Value of International Transactions and/
documentation, failure to report required				or Specified Domestic Transactions
transactions	and	furnishing	incorrect
information or documentation

Failure to furnish TP documentation when				2% of Value of International Transactions and/
called for by the Indian tax authorities				or Specified Domestic Transactions

Failure to furnish Form 3CEB before the due				INR 100,000
date of furnishing the tax return

Failure to furnish Master file when called for by				INR 500,000
the Indian tax authorities

Failure to furnish CbCR or further information				INR 5,000 – 50,000 per day, depending upon
(called for) in respect of CbCR				period of delay

Providing inaccurate information in CbCR				INR 500,000

In case of TP adjustment during the course of				n	50% of tax on TP adjustment where TP
audit by Indian tax authorities					documentation not maintained.
				n	200% of tax on TP adjustment where
					transaction or material facts not disclosed.

Advance Pricing Agreements (APA)

The legal framework for Advance Pricing Arrangement s was created by the Finance Act, 2012 with effect from July 2012. In August 2012, detailed Rules for executing APAs were introduced by way of Notification No. 36/2012 dated 30-8-2012.

The scheme has attracted keen interest from many MNEs, with close to 250 applications having been filed since the introduction of the scheme.

Five (5) agreements have already been signed and many applications are in advance stage of finalisation.

The Indian APA regime largely follows the pattern/ procedure found in developed economies with some distinguishing features. The objective of this write-up is to provide an overview of the framework of APA in India and the shortcomings that need to be borne in mind while making a decision in this regard.

OECD Guidelines on Transfer Pricing for MNEs explain Advance Pricing Agreements (APA)

OECD Guidelines on Transfer Pricing for MNEs explain APA thus:

“An Advance Pricing Arrangement is an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria [e.g. (a) method, (b) comparables and appropriate adjustments thereto, (c) critical assumptions as to future events)] for the determination of the transfer pricing for those transactions over a fixed period of time. While the OECD approach provides for a wide scope for which an APA can be resorted to, the Indian APA regime provides for (a) determination of Arm’s Length Price (ALP) or (b) the manner in which the ALP has to be determined, including critical assumptions. The scheme however provides that some variations to the statutory methods prescribed for determining ALP1 can also be agreed at. This is an important step towards recognition of the fact that in some unique transactions it is difficult to determine ALP within the rigid framework of statutory methods.

The APA scheme provides for unilateral, bilateral and multilateral APAs. The scheme applies to international transactions (a) which have been undertaken (ie transactions of a continuing nature from dealings that are already occurring) and (b) to international transactions which are proposed to be undertaken.

Initially, an APA was supposed to be valid for a maximum period of five (5) years from the year in which the agreement is entered into. By an amendment in 2014, an APA is now allowed to be rolled back for a period of four (4) years preceding the year of its first applicability. Roll back provisions introduced by the recent amendment is a welcome move to bring higher degree of certainty in the otherwise litigation prone environment.

To secure the objective of APA, the scheme provides for identification of critical assumptions. As per OECD guidelines the assumptions on which the ability of the methodology to accurately reflect the arm’s length pricing of future transactions are important. Such assumptions are ‘critical’ when the actual conditions existing at the time the transactions occur could diverge from those that were assumed to exist, to the extent that the ability of the methodology reliably to reflect arm’s length pricing is undermined. Indian APA scheme does not provide any detailed guidance on this aspect hence drawing broad assumptions should be considered so that the same do not warrant re-negotiation very often.

APA Scheme Requires Critical Assumptions

Step 1 – Pre-filing consultation

The process of entering into an APA involves following steps:

The APA scheme requires that a taxpayer desirous of entering into an APA shall undertake a pre-filing consultation. The Applicant needs to file an application with the Director General of Income Tax (International Taxation) (‘DGIT’) in a prescribed form providing the prescribed particulars. In case the Applicant is seeking a bilateral or multilateral APA, the competent authority in India2 or its representative would also be involved in the pre-filing consultation. At this stage it is permissible to maintain anonymity.

The objective of the pre-filing consultation is to determine the scope of the agreement, identify transfer pricing issues, determine the suitability of APA for the international transaction and to discuss broad terms of the agreement. Undertaking pre-filing stage does not oblige either tax authority or the taxpayer to enter into or proceed with entering into an APA.

Step 2 – Filing an application for APA

After the pre-filing consultation, if the taxpayer desires to proceed further it can file an application for an APA in the prescribed form and with all relevant documents. The application needs to be filed with the DGIT (in case of a unilateral APA) or with the Indian competent authority (in case of a bilateral/multilateral APA). One of the information to be shared with tax authorities at this stage is discussion on un-assessed tax years (Indian and foreign) and related outstanding tax, legal, and other pertinent issues. This information is apparently not relevant for determining ALP/method for the proposed transaction, hence the manner in which it may be used by tax authorities is unclear.

The application should be accompanied by prescribed fee which is based on the amount of international transaction proposed to be or entered into. For transactions upto INR 100 crores (one billion), a fee of INR 10 lakhs (one million) has been prescribed. A fee of INR 15 lakhs is payable where amount does not exceed INR 200 crores.

For international transactions exceeding Rs. 200 crores, the fee payable would be INR 20 lakhs.

Step 3 – Preliminary processing of the APA application

After filing the application, the same is screened for ensuring basic compliance. If a defect is noticed in the application (including if a relevant document is not attached) or if the application is not in line with the understanding reached in pre-filing consultation then either the DGIT or the competent authority in India can serve a deficiency letter on the applicant asking it to rectify the defect or to modify the application. The deficiency letter, if any, is to be served on the applicant within one month from the date of filing of the application. The applicant can rectify the defect/modify the application within 15 days of the date of service of deficiency letter or such extended time as may be requested subject to a maximum of 30 days from the date of service of the deficiency letter.

If the DGIT or the competent authority in India are not satisfied that the deficiency has been removed by the Applicant, they can pass an order providing that the application for an APA shall not be allowed to be proceeded with. However, the applicant would be given an opportunity to be heard before such an order is passed.

Step 4 – Processing of the APA application

Tax authorities / Competent Authority can hold meetings, call for additional documents of information or even visit the premises of the Applicant. Visits are planned with consultation of the taxpayer and are meant for gathering facts to understand the business model and not investigative in nature. Additional information can also be provided suo moto by the Applicant in connection with the application.

In case of a bilateral or multilateral APA, the authorities will, after making due enquiry, forward a draft report to the DGIT, who will in turn send it to the competent authority in India.

In case of a bilateral or multilateral APA process, the competent authority in India would enter into discussions/negotiations with the competent authority of the relevant foreign country of which the Associate Enterprise (‘AE’) of the applicant is a resident. The APA scheme requires that the foreign AE of the applicant initiate an APA with the competent authority of the country in which the foreign AE is a resident. Based on these discussions/negotiations, the two competent authorities would formalise a Mutual Agreement Procedure (‘MAP’) arrangement which would be intimated to the applicant by the competent authority in India.

In case the competent authority in India and the foreign competent authority are unable to reach an agreement, the competent authority in India would intimate the applicant of this development.

At this stage, the applicant will have the option of either proceeding with the APA without the benefit of the MAP process (i.e. convert it into a unilateral APA) or withdraw the application.

Step 5 – Drafting of an APA and execution post approval

The DGIT or the Indian Competent Authority and the Applicant would then prepare a proposed mutually agreed draft of the agreement. This agreement will be entered into between the Central Board of Direct Taxes and the applicant after it receives the approval from the central government.

Post APA compliance

a) Revision of tax returns and tax assessment

APA scheme in India is not a time bound process hence it is likely that by the time an APA is entered into, one or more tax years are already over and stand scrutinised by the tax department. For that eventuality the scheme provides that the taxpayer shall file a revised return of its income for such intervening years within three months from the end of the month in which the APA is entered into. The tax assessment of such revised return is to be carried out within one year from the end of the financial year in which such revised return is furnished.

b) Filing of compliance report

The taxpayer is required to furnish an annual compliance report to DGIT for each year covered in the agreement, within thirty days of the due date of filing the revised income-tax return for that year, or within ninety days of entering into an agreement, whichever is later. Failure to file this report or filing a report containing material errors can result in cancellation of APA. The taxpayer will however given an opportunity of being heard before such cancellation.

c) Audit of the compliance report

The revised return filed after execution of the APA does not undergo a regular transfer pricing audit (for transactions covered by an APA). For covered transactions, the Transfer Pricing Officer (‘TPO’) would audit the compliance report to form an opinion on the taxpayers compliance with the terms agreed in the APA which needs to be completed within 6 months from the end of the month in which the compliance report is received by the TPO from DGIT.

Other features

a) Confidentiality

The scheme does not provide for any restriction against parting with data and the possible use of the data against taxpayer.

b) Withdrawal

The applicant may withdraw the application for APA at any time before the finalisation of the terms of the same however the fee paid along-with the application is not refundable.

c) APA with non Treaty countries

A unilateral APA can be entered into even if the AE of the applicant is tax resident of a country with which India does not have a Tax Treaty. An official circular released by tax administration suggests that a bilateral or multi-lateral APA with a country with which India does not have a Tax Treaty or has a Tax Treaty without a clause similar to Article 9(2) of the OECD Model convention is not covered in the current APA scheme.

d) APA for determining profit attribution

A foreign enterprise operating in India through a Permanent Establishment (‘PE’) can also seek APA on quantification of profit attributable to the PE. Many foreign enterprises seek advance ruling from Indian Authority for Advance Ruling about whether their operations or business dealings in India create a PE. In such cases they may parallelly seek APA which may apply of the existence of the PE is ultimately upheld.

TYPICAL TRANSFER PRICING ISSUES UNDER LITIGATION

Selection Of Comparables

Typically, comparability analysis is performed and filters are applied while screening comparables. Finally, qualitative analysis is carried out to identify final set of comparables. There is a lot of subjectivity in this matter, leading to numerous litigations. Some issues which are frequently debated upon in the course of TP audits are:

– Selection of loss-making or abnormal profit-making companies as comparables;

– Comparison of high-end services with low-end services;

– Comparison of trading functions with agency functions;

– Comparison of turnover, employee costs, transactions in foreign currency, etc.;

– Comparison of companies catering to export markets to those catering to domestic markets

Calculation Of Profit Level Indicators

Profit Level Indicators (PLIs) are ratios between the profits and costs incurred/ sales achieved/capital employed. It provides a reliable basis to compare operating profits of the taxpayer and the uncontrolled comparable. The dispute arising in this regard pertains to classification of expenses and incomes as operating or non-operating while computing the profit level indicator, since these terms are not defined in the Indian TP Regulations. Also, taxpayers and tax authorities differ in approaches to compute PLI in case of segmental data of diversified business activities.

Comparabilty Adjustments

Indian TP Rules permit making adjustment to the PLI in order to eliminate material differences between controlled and an uncontrolled transaction, which could materially affect the price, cost or profit.

In view of these provisions, taxpayers have been resorting to the computation of working capital adjustments, risk adjustments, capacity utilisation adjustments, to improve comparability analysis. However, in the course of TP audits, there have been disputes around the allowability and manner of computation of these adjustments.

Advertising Marketing & Promotion Expenses (AMP Expenses)

Over the past few years, taxpayers promoting international brands in India have been scrutinised for the level of advertising, marketing and promotion (AMP) expenses incurred by them. Many taxpayers have witnessed large TP adjustments on the issue. This has led to disputes between the taxpayer and tax authorities resulting in the disallowance of AMP expenses and the same being challenged in higher courts. In some cases, the courts have pronounced judgments in favour of the taxpayer and these disallowances have been deleted while in other courts, judgments have been pronounced in favour of the tax authorities. Even though several cases have been disposed by the Delhi High Court and the Appellate Tribunals, there is no clear, undisputed resolution for this controversy and it is still one of the most debated TP issues before the courts. It can be said with ease that the AMP controversy is still far from over.

Interest On Loans / Advances

Lending and borrowing of loans and advances falls within the purview of an international transaction and is to be benchmarked by justifying the interest rates charged on such loans/advances. The actual puzzle that needs to be solved in this transaction is the arm’s length rate to be taken for benchmarking the interest rate at which such loans/advances are given/ received to/from associated enterprises. Going by the recent rulings, the courts have stated that factors like currency of the loan, comparable rates in borrower’s jurisdiction, etc. needs to be taken into consideration while arriving at the ALP.

Corporate Guarantees

With the introduction of an explanation to section 92B of the IT Act by the Finance Act, 2012 corporate guarantee was brought within the ambit of TP and considered to be a qualifying transaction. Therefore, the same is since being regarded as an international transaction/specified domestic transaction by the tax authorities, while conducting TP Audits. Current litigation is dealing with issues such as whether remuneration is to be necessarily paid for the guarantees given and the determination of ALP in such cases.

Issue Of Shares

Court rulings have upheld that TP provisions are applicable to capital transactions and the same are to be reported as part of TP compliances. However, the Courts have stated that although capital transactions (like issue of share capital) qualify as international transactions, TP adjustments cannot be made since being capital in nature, they do not give rise to income and are not subject to tax.

Thin capitalisation

The arm’s-length principle applies to loans and interest charges. However, at present, there are no rules that specifically deal with thin capitalisation and no set permissible debt-to-equity ratios in the Act or the transfer pricing code. However, the Indian government has put forward a proposal for a new direct tax code that will replace the existing Income tax Act with effect from 1 April 20122. A draft of the new direct tax code has been circulated for public comment and includes thin capitalisation provisions.

The proposed regulations do not prescribe any capital gearing ratio unlike typical thin capitalisation regulations, but instead provide for recharachterisation of debt as equity and vice versa upon identification of an impermissible avoidance arrangement – in other words, where the arrangement among parties is (1) not at arm’s length, (2) lacks commercial substance, or (3) adopts means that are ordinarily not adopted for bona fide purposes. The absence of a specified capital gearing ratio allows subjectivity and discretion at the hands of Revenue while it evaluates whether a given capital structure is an impermissible avoidance arrangement.

The proposed thin capitalisation provisions are now becoming an area of concern – it is therefore desirable that multinational enterprises operating in India should review their respective capital structures in light of appropriate and acceptable benchmarks.

Landmark judgements of Courts On Transfer Pricing Law

Quark Systems Pvt. Ltd.

The taxpayer is engaged in providing customer support services to an AE. In the transfer pricing documentation, TNMM was applied as the most appropriate method for determining the ALP. During the scrutiny audit, the Revenue rejected one company selected as a comparable by the taxpayer on the grounds that the said company was in a start-up phase and had made losses for consecutive years.

Before the Appellate Tribunal, the taxpayer contested that once functional comparability is established, the comparable should not be rejected on grounds such as start-up phase, negative net worth, etc. In addition, the taxpayer argued for the rejection of one high-margin comparable company on the basis that the company had significant controlled transactions.

In its ruling, remanding the order back to Revenue, the Appellate Tribunal upheld the need for a proper functional analysis of the tested party and the comparables in determination of ALP and objected to the selection of comparables merely on the basis of business classification provided in the database. The Appellate Tribunal also highlighted the need to follow principles of substantial justice, where the taxpayer should be given an opportunity to rectify a bona fide mistake when it is based on facts on record.

The ruling emphasised that selection of comparables rests on a proper functional analysis and principle of substantial justice to be considered in applying the burden of proof. In addition, the Appellate Tribunal held that the taxpayer may reject its own comparable selected in the transfer pricing study on merits, in light of additional/ substantive facts available at the time of a transfer pricing audit.

Schefenacker Motherson Limited

Schefenacker Motherson Limited (SML) is a joint venture company engaged in the manufacture of rear-view mirrors and cable assemblies for rear-view mirrors for automobile manufacturing companies. The rear-view mirrors were supplied to automobile manufacturing companies in India, and the cable assemblies were exported outside India to group entities.

SML applied the TNMM to substantiate the arm’s-length pricing and used cash profit to sales as the profit level indicator (PLI) to remove the effect of differences in capacity utilisation, technology used, age of assets used in production and depreciation policies between SML and comparable companies. The TPO rejected the use of cash profit to sales as the acceptable PLI.

The Appellate Tribunal opined that the elements that constitute operating income should be decided on a case-by-case basis depending on the facts, circumstances and nature of business involved. The ruling highlights that the fundamental principle of comparability analysis is to compare like with like. For this purpose, adjustments should be made for material differences to make transactions/entities comparable to each other. Furthermore, the ruling creates a precedent in support of the use of cash profit to sales or cash profit to cost as a PLI in applying the TNMM in certain circumstances.

Skoda Auto India Private Limited

The key international transactions of the taxpayer involved the purchase of kits and payment of royalties, the pricings of which were justified using TNMM as the most appropriate method. In addition, CUP data (in the form of transaction price between the parent company and other group companies) was used as a corroborative analysis for the transaction of purchase of kits. The TPO rejected the application of the CUP and further made an adjustment by disregarding certain comparables selected by the taxpayer. At the Appellate Tribunal level, the taxpayer argued on the following issues:

• Differences in business models of comparable companies (full-fledged manufacturers) vis-à-vis the company (operating as an assembler).

• Low-capacity utilisation of the taxpayer as it was in the start-up phase. The Appellate Tribunal laid down that:

• wherever necessary, economic adjustments (for capacity utilisation, unusual high start-up costs) should be made

• the taxpayer cannot be expected to get detailed information, which is not available in the public domain

• in the absence of information in the public domain for making the adjustments, approximations and assumptions can be relied upon

• the benefit of the +/-5% range should be allowed to the taxpayer.

The principle of adjustment for high start-up costs enunciated in the judgment holds significant value for companies that are in their initial stage of operations. The ruling reemphasises the fact that a comparison should be made after economic adjustments whenever necessary.

Fulford (India) Limited

The taxpayer imported Active Pharmaceutical Ingredients (APIs) for secondary manufacturing of formulations. The TPO rejected the TNMM analysis undertaken by the taxpayer and considered the CUP method as the most appropriate method. The TPO compared the purchase price of APIs imported by the taxpayer from an AE with the price for which generic APIs were purchased by the taxpayer’s competitors.

The taxpayer contended that the CUP method requires stringent comparability and any differences in the third party price and the international transaction price which could materially affect the price in the open market, warrant appropriate adjustment to such third party prices. In the pharmaceutical world, APIs may have similar properties but still could be different on quality, efficacy and levels of impurities present in the drug amongst other things. Therefore, the two products cannot be compared.

Further, the assessee imported the APIs from the AEs and performed secondary manufacturing functions converting the APIs into formulations and marketed and sold the formulations in the Indian market, and therefore, was akin to a value added distributor. It was therefore entitled to a return for its distribution functions and secondary manufacturing functions commensurate to its level of involvement for the relevant product. The selection of the method should be based on functional analysis and the characterisation of the transactions and the entities. CUP method cannot be applied here as the application of the CUP method is blatantly absurd. By applying the CUP method and reducing the import price, the TPO was expecting the assessee to earn an operating margin of 32.09% in the manufacturing AE segment as compared to 11.37% earned in that segment. The profit earned in the AE segment was higher than the operating margin of 8.69% earned by the assessee in its non-AE segment.

Therefore, the assessee made several arguments rejecting CUP as the most appropriate method and distinguished the prior Serdia Pharmaceutical ruling on a similar issue. In the said ruling, the Appellate Tribunal had stated that the arm’s-length price of generic APIs can be computed using the CUP method, as long as comparables for application of CUP are available.

However, in this ruling, the Appellate Tribunal did not make any adverse observations in relation to any of the arguments placed by the assessee. The Tribunal observed that the assessee’s submission that it acted as a secondary manufacturer, which was akin to a ‘value added distributor’, was not made before the lower authorities. Accordingly, the Tribunal opined that in the interest of justice, they deem it proper to restore the issue to the file of the Assessing Officer for fresh adjudication.

IL Jin Electronics (I)(P) Ltd.

The taxpayer is engaged in the manufacture of printed circuit boards for one of its group companies in India. The taxpayer imported 45.51% of its raw materials from its AE in Korea, while the balance of 54.49% was procured locally. The AE in Korea purchased these raw materials from unrelated vendors and charged a mark-up for its procurement services. The taxpayer adopted the TNMM and used the operating margin results of a set of comparable companies to demonstrate the arm’s-length nature of the import transaction. During the audit, the TPO rejected certain high-loss-making comparable companies identified by the taxpayer and made an upward adjustment to the taxpayer’s import prices by applying a higher arm’s-length operating margin to the total turnover of the taxpayer.

The taxpayer contested before the Appellate Tribunal that in arriving at the arm’slength price for the import transaction, it is important to consider the actual purchase price paid by its AE to the unrelated vendors as well as the mark-up charged by its AE for its procurement services. In addition, the taxpayer argued that working capital differences between the taxpayer and the comparable companies needs to be considered in arriving at the arm’s-length operating margin under the TNMM. Finally, the main contention of the taxpayer was that because only 45.51% of the total raw materials were imported from its AE, any upward adjustment to the import price should be based only on 45.51% of the taxpayer’s turnover, not the total turnover.

The Appellate Tribunal observed that an alternative methodology for TP analysis taking a foreign AE as a tested party by applying the resale price method or CPM would have been the ideal approach to determine the arm’s-length price in the present case. However, in the absence of any supporting analysis/information presented in relation to the details of prices of the raw material purchased by the AEs from the third-party vendors by the taxpayer, the Appellate Tribunal held that the adoption of alternative methodology was not possible and hence, only TNMM could be used as the most appropriate method.

The Appellate Tribunal agreed with the taxpayer that transfer pricing adjustment should be made based only on 45.51% of the turnover, not the total turnover. This ruling is important in the context of application of the TNMM, when the method has been applied on an entity-level basis where segmented financial data is not available with the taxpayer for transactions with its AEs. In such a case, any transfer pricing adjustment is to be made only on a proportionate basis and not on the basis of the total turnover of the taxpayer. The Appellate Tribunal also commented on use of foreign AEs as the tested party to determine the arm’s-length price.

Cheil Communication India Private Ltd.

The taxpayer is primarily engaged in the business of rendering advertising services to its AEs against payment of commission. The taxpayer applied the TNMM to confirm the arm’s-length price of the international transactions and selected operating profit/ value-added expenses as the profit level indicator (PLI). As part of its business of providing consultancy services related to advertisement, the taxpayer also facilitates placement of such advertisements in the print/electronic media. For this purpose, the taxpayer makes payment to third parties including advertisement agencies and printing presses for booking of advertising space/time slots, etc. on behalf of its customers, namely its AEs, and recovers them from its AEs.

In its audited accounts, the taxpayer recognises revenue on a net basis (i.e. it recognises the commission received as ‘revenue’ and treats the ‘gross media spends’ passed on to the customers/AEs as ‘pass-through costs’, thereby not including such third-party costs in its profit and loss account and operating margin computation).

The TPO held that the PLI for comparability purposes should be taken as OP/total cost where total cost includes the costs of placing advertisements on behalf of the AEs, which costs were reimbursed by the AEs to the taxpayer on an actual basis.

The Appellate Tribunal accepted that the gross media spends paid to the media agencies do not represent the taxpayer’s value-added activity and accordingly, mark-up is to be applied on the cost incurred by the taxpayer in performing the agency functions and not on the gross media spends. The Appellate Tribunal endorsed the OECD’s view that while applying the TNMM, the costs to be considered should be the costs incurred in relation to the value-added activity (i.e. the costs relating to the agency function in the taxpayer’s case).

This is the first Appellate Tribunal ruling in India on the treatment of pass-through costs. The ruling extensively relies on the OECD guidelines and establishes the principle that in applying a cost-based remuneration model, a return or mark-up is appropriate only for the value-added activities.

Maruti Suzuki India Ltd.

The taxpayer manufactures and sells cars and trades in spares and components of vehicles. The taxpayer had entered into a license agreement with its AE for use of licensed information and a licensed trademark for the manufacture and sale of the products and parts in specified territories. The taxpayer paid composite royalties for the licensed trademark as well as for the technology license. The TPO proposed to make an adjustment by disallowing the royalty paid by the taxpayer to its AE for use of the trademark and imputing as reimbursement with mark-up on the non-routine advertising, marketing and promotion expenses incurred in promoting the AE’s brand name.

The taxpayer filed a writ petition with the High Court against the proposed addition by the TPO. The High Court, while disposing of the writ petition, referred the case back to the TPO with certain observations/directions. One of these was that if there is an agreement between the AE and the taxpayer which carries an obligation on the taxpayer to use the trademark owned by the AE, such agreement should be accompanied either by an appropriate payment by the AE or by a rebate provided to the taxpayer. Appropriate payment should be made on account of benefit derived by the AE in the form of marketing intangibles obtained from such mandatory use of the trademark. However, if the agreement between the AE and the taxpayer for the use of the trademark is discretionary, no payment is required to be made by the foreign entity.

The High Court also directed application of the concept of ‘bright line’ in the context of the taxpayer. Aggrieved by the order of the High Court, the taxpayer filed a special leave petition before the Supreme Court. The Supreme Court has directed the TPO to proceed in accordance with law ‘uninfluenced’ by the observations/directions given by the High Court in the impugned order on merits.

This is a landmark case on the issue of marketing intangibles in the Indian transfer pricing landscape. If the licensed manufacturer contributes to creation of and also economically owns marketing intangibles arising out of advertising and marketing expenses, then it would be entitled to rewards arising out of such spend and thus not required to be compensated by the foreign licensor for any part thereof. The bright line concept is generally applied in cases of distributors and not entrepreneurial licensed manufacturers such as the taxpayer. Further, import of components from group company suppliers needs to be ideally benchmarked in the hands of the foreign suppliers as tested parties, if such components are not embedded with significant intangibles. This approach would ideally be the situation in the majority of the cases where the licensees carry out significant localisation.

Gemplus India Pvt. Ltd.

The taxpayer is a part of the Gemplus group, which is engaged in providing smart card solutions for the telecommunications industry, financial services industry and other e-businesses. The taxpayer entered into a management services agreement with its AE for receipt of services in marketing and sales support, customer service support, finance, accounting and administration support and legal support.

The TPO observed that there was no clear proof that such services had actually been rendered by the AE. There was no specific benefit derived by the Indian entity. The taxpayer had not established the necessity for availing these services from the AE and had already incurred expenses towards professional and consultancy services and employed qualified personnel in India for rendering similar services. The volume and quality of services were disproportionate to the amount paid, and the charge was based on cost apportionment amongst the group entities on a mutually agreed basis and not on the basis of actual services rendered.

The Appellate Tribunal decided the case in favour of Revenue. This ruling has laid down some critical principles applicable for service transactions, which would in fact apply to any transactions involving intra group services or intangibles. Simply put, to satisfy the arm’s-length standard, a charge for intra group services or intangibles must at least meet the following conditions:

• The need for intra group services or intangibles is established.

• The intra group services or intangibles have actually been received.

• The benefit from intra group services or intangibles is commensurate with the charge.

It may be noted that in the case of Dresser Rand India Private Limited, the Tribunal held that commercial wisdom of the taxpayer cannot be questioned in deciding the necessity for availing such services. However, a few principles that are common in both the rulings are documentary evidences to establish actual receipt of services and cost incurred must be commensurate with expected benefits.

Logix Micro Systems Ltd.

The taxpayer is a software developer. It entered into a product development services agreement and a professional service agreement with one of its AEs. During audit proceedings, the TPO upheld that all the transactions of the taxpayer with the AE were compatible with the ALP but proposed an adjustment for notional income to be earned by the taxpayer relating to large receivables outstanding with its AEs.

The Appellate Tribunal has considered the concept of charging interest only on the overflowing interest-free period and has clarified that any interest loss on non-receipt of funds on time should form the basis of computing the notional income.

It should be noted that in the explanation added to definition of International transactions by the Finance Act 2012, receivables or any debts arising in course of business are considered as international transactions.

Reliance Industries Ltd.

The taxpayer hired a vessel from its AE and paid time charter hire charges based on a per day rate (PDR). In order to establish the ALP of the transaction, the taxpayer relied on the approval received by the Director General of Shipping (DG Shipping) and contended the same as comparable uncontrolled price (CUP). Further, the taxpayer also relied on monthly charter hire rate indicated in Drewry Monthly Report by contending that the PDR paid by the taxpayer was reasonable taking into account that the vessel provided by the AE was of less capacity i.e. 2,242 cubic meters, as against the rate published in Drewry Monthly Report which was for a capacity of 3,000 cubic meters.

The TPO considered published prices in the shipping publications, the Shipping Intelligence Weekly and the Drewry Monthly Report and arrived at their arithmetic mean. Further, the TPO made a prorated adjustment for the difference in capacity and determined the ALP, without considering any technical and commercial factors. The Appellate Tribunal held that in the absence of comparable transactions (i.e. in view of the unique vessel, with no comparable ships available), the matter should be set aside to the file of the Assessing Officer for the limited purpose of re-computing the ALP by taking the data available in the public domain in the form of publication of Shipping Intelligence Weekly and Drewry Monthly as a ‘comparable price’, and adjusting it for differences in weight, capital cost, risk, etc.

The ruling reiterates the important principle that in the absence of actual transaction which can be considered as CUP, the data available in the public domain can be considered as a ‘comparable price’ after making adjustment for the differences.

Li & Fung (Trading) Ltd.

Li & Fung (Trading) Ltd., Hong Kong (AE) entered into contracts with its global third party customers for provision of sourcing services with respect to products to be sourced by such global customers directly from third party vendors in India. For the sourcing services, the AE received a commission from these global customers at 5% of the FOB value of goods sourced. The taxpayer was engaged in providing sourcing support services to its AE, and was remunerated by the AE at cost plus 5 percent mark-up for provision of these services. The TPO alleged that a cost plus form of remuneration did not take into account substantial intangible assets such as supply chain management and human capital owned by the taxpayer. Based on above, the TPO ascertained that the taxpayer ought to have earned a commission of around 5% on the free on board (FOB) value of the goods sourced from India.

The Appellate Tribunal, in principle, rejected the cost plus remuneration model in favour of a commission based remuneration model (i.e. percentage of value of goods sourced). The Tribunal held that the compensation received by the AE (i.e. 5% of the FOB value of goods sourced) should be distributed between the taxpayer and the AE in the ratio of 80:20 based on the functional profiles of the AE and the taxpayer.

This decision of the Tribunal was based on its conviction regarding the following aspects of the functional profiles of the AE and the taxpayer:

• The taxpayer had actually performed all critical functions, assumed significant risks and had also developed unique intangibles over the years.

• AE did not have either any technical expertise or manpower to carry out the sourcing activities.

GAP International Sourcing (India) Pvt. Ltd.

The taxpayer was engaged in facilitating the sourcing of apparel from India for its group companies. The primary activity of the taxpayer comprised of assistance in identification of vendors, provision of assistance to vendors in procurement of apparel, inspection and quality control and coordination with vendors to ensure delivery of goods to group companies. The necessary technical and intellectual inputs for the discharge of these services were provided by the group companies. The taxpayer adopted the TNMM to benchmark the service fee determined at full cost plus 15% from the foreign group company for its transfer pricing documentation. During the TP audits, TPO disregarded the functional profile and characterisation of the taxpayer by assuming that the functional profile of taxpayer was substantially higher than those of limited risk support service providers.

The TPO alleged that a cost plus form of remuneration did not take into account substantial intangible assets owned by the taxpayer. These intangibles were primarily construed by the TPO to be in the nature of human asset intangibles, supply chain intangibles and location savings. Based on above, the TPO ascertained that the taxpayer ought to have earned a commission of around 5% on the free on board (FOB) value of the goods procured by the group companies.

The Tribunal has stated that for determining the ALP of every international transaction, it is imperative to take the characterisation of the taxpayer and its AEs into consideration through functional analysis of international transactions. While stating this, the Tribunal has observed the following specifically for the taxpayer’s case:

• No significant business risks were borne by the taxpayer.

• The taxpayer did not have capacity to assume business risks.

• No human resource intangibles were developed by the taxpayer.

• No supply chain intangibles were developed by the taxpayer.

• Location savings could not be attributed to the taxpayer.

In view of all of the above, the Tribunal held that the arm’s-length cost plus mark-up for the taxpayer should be 32%, as opposed to the exorbitant numbers (830% and 660% for the two years under consideration) imputed by the TPO in a derived manner, by resorting to a commission based model of 5% on the FOB value of goods procured by the AE directly from Indian vendors.

The Appellate Tribunal has acknowledged that procurement companies may have different remuneration models based on their functional profiles (e.g. cost plus, commission or buy-sell margin), therefore it is important to ensure that the ALP is determined using the appropriate PLI and suitable benchmarking method. The ALP as determined by either the taxpayer or Revenue cannot lead to manifestly absurd or abnormal financial results, as had happened in the present case.

L’oreal India Pvt. Ltd.

The taxpayer is engaged in manufacturing and distribution of cosmetics and beauty products. In respect of the distribution segment, i.e. the international transaction of purchase of finished goods; the taxpayer had applied the RPM by benchmarking the gross margin of the taxpayer at 4o.80% against that of comparables at 14.85%. The TPO rejected application of RPM by the taxpayer on the basis that the taxpayer was consistently incurring losses and the gross margins cannot be relied upon because of product differences in comparables. Accordingly, the TPO adopted Transactional Net Margin Method (TNMM).

The taxpayer contended that it was following market penetration strategy since the commencement of its distribution segment while the comparables had been present in the Indian market since long and had established themselves firmly in the Indian market.

The Appellate Tribunal observed that the taxpayer buys products from its AEs and sells to unrelated parties without any further processing and as per OECD Guidelines, in such a situation, RPM is the most appropriate method. The taxpayer had also produced certificates from its AEs that margin earned by AEs on supplies to the taxpayer was 2% to 4% or even less. The Revenue had not disputed these certificates. Therefore, the TPO’s contention that the AEs have earned higher profit was not based on facts. On the other hand, profit earned by the AEs was also reasonable and hence there was no shifting of profits by the taxpayer to its AEs.

In this ruling, the impact of business strategies has been appreciated and operating losses were not attributed to non-arm’s-length nature of international transactions.

Latest Transfer Pricing Law judgements

S. 92A: Transfer Pricing-"associated enterprise"-The mere fact that an enterprise has de
facto participation in the capital, management or control over the other enterprise does not
make the two enterprises "associated enterprises" so as to subject their transactions to the
rigors of transfer pricing law.[S. 40A(2)(b), 92CA]

Dismissing the appeal of revenue; the Tribunal held that ; The mere fact that an enterprise has de
facto participation in the capital, management or control over the other enterprise does not make
the two enterprises "associated enterprises" so as to subject their transactions to the rigors of
transfer pricing law. Accordingly the Tribunal held that; as these enterprises are not associated
enterprises, the ALP adjustments in respect of the transactions between these enterprises were
wholly unwarranted. For this short reason, and without going any further into the matter, we
approve the impugned deletion of ALP adjustment. The plea of the assessee, in cross objection, is
upheld and, for that reason, grievance of the Assessing Officer, in appeal, is dismissed as
infructuous. (AY. 2008-09)

ACIT v. Veer Gems ( 2017 ) 146 DTR 1 (Ahd.)(Trib.)

S. 92A: Transfer Pricing-Associated Enterprises- Even if the conditions of S. 92A(2)(i) are
fulfilled, these enterprise cannot be treated as ‘associated enterprise’ if the requirements of
s. 92A(1) are not fulfilled.[S.92C]

Allowing the appeal of assessee the Tribunal held that ; the fact that an enterprise can “influence
prices and other conditions relating to sale” does not make it an “associated enterprise” of the
assessee if it does not participate in the (a) capital, (b) management, or (c) control of the assessee
and thus does not fulfill the basic rule u/s 92A(1). S. 92A(2)(i) has to be read with s. 92(A)(1).
Even if the conditions of s. 92A(2)(i) are fulfilled, these enterprise cannot be treated as
‘associated enterprise’ if the requirements of s. 92A(1) are not fulfilled. There is an inadvertent
omission , with respect to threshold application of Section 92A(2)(i), whether in terms of a
percentage of such sales or otherwise , in the statute .It is the apparent omission which is resulting
in wholly avoidable litigation on the applicability of section 92(A)(2) ( ITA No.
771/CHNY/2016, dt. 30.11.2016)(AY. 2011-12)

Orchid Pharma Limited v. DCIT (Chennai)(Trib.);www.itatonline.org

S. 92A : Transfer pricing-Associated enterprises-In cases of public sector companies, even
all or majority of shareholdings may be kept by Union or State Governments, these
companies, for that reason alone, cannot be said to be associated enterprises for purposes of
section 92A. [S.92C]

Dismissing the appeal of the assessee the Tribunal held that; in cases of public sector companies,
even all or majority of shareholdings may be kept by Union or State Governments, these
companies, for that reason alone, cannot be said to be associated enterprises for purposes of
section 92A. ( AY.2009-10)

DCIT v. Hazira LNG (P.) Ltd. (2017) 163 ITD 223 / 184 TTJ 440 / 147 DTR 1 (Ahd.)(Trib.)
S. 92A : Transfer pricing-Associated enterprises-Assessee being a partnership concern
could not be said to be controlled by an ‘individual’ hence, clause (j) of s.92A(2) has no
application in the present case. [S.92C]

A partnership concern cannot be said to be controlled by an ‘individual’ and, hence, as per section
92A(2)(j), cannot be an AE of another enterprise run by relative of partners even though it may
have a de facto participation in capital, management or control of other enterprise. (AY. 2008-09)

ACIT v. Veer Gems (2017) 146 DTR 1 (Ahd.)(Trib.)

S.92B: Transfer pricing-International transactions- Advertisement, marketing and
promotion expenditure-Whether outbound business constituted international transaction
for which arm’s length price to be determined-Matter remitted to Appellate Tribunal.
[S.92C].

Court remanded the matter to the Tribunal to decide whether reporting of AMP expenditure in
regard to outbound business constituted an international transaction for which ALP determination
was necessary .(AYs.2009-2010, 2010-2011 )

Le Passage to India Tour and Travels (P) Ltd v. Dy. CIT (2017) 391 ITR 207/ 245 Taxman
129/292 CTR 241/ 147 DTR 57 (Delhi)(HC)

S. 92B : Transfer pricing – International transaction-Interest– Non-charging or under
charging of interest on excess period of credit allowed to AE for realization of invoices
amounts to an international transaction-Matter sent to AO for redetermination of working.
[S.92C]

Non-charging or under charging of interest on excess period of credit allowed to AE for
realization of invoices amounts to an international transaction. Matter sent to AO for
redetermination of working. (AY. 2011-12)

CPA Global Services (P.) Ltd. v. ITO (2017) 162 ITD 64 / 151 DTR 385 (Delhi)(Trib.)
S.92C: Transfer pricing- Arm’s length price-If the advances are made to a AE situated
abroad, the LIBOR rate has to considered to determine the Arms Length interest and not
the interest rate in India (SBI PLR). This would be reasonable and proper in applying
commercial principles

Dismissing the appeal of the revenue the Court held that ; If the advances are made to a AE
situated abroad, the LIBOR rate has to considered to determine the Arms Length interest and not
the interest rate in India (SBI PLR). This would be reasonable and proper in applying commercial
principles. Followed ,In CIT v. Tata Autocomp [2015] 56 taxmann.com 206,( Bom)(HC) The
Tribunal has directed the appropriate rate would be LIBOR plus 2% instead of LIBOR plus 3%
applied by the TPO.( ITA No. 1869 of 2014, dt. 09.06.2017)(AY. 2007-08)

CIT v. Aurionpro Solutions Ltd. (Bom.)(HC) , www.itatonline.org

S.92C:Transfer pricing-Arm’s length price-Selection of comparables-Company outsourcing
major part of its business cannot be taken as comparable for company not outsourcing
major part of its business.

Dismissing the appeal of the revenue , the Court held that ,both the companies were not
appropriate comparables, since a major part of their business was outsourced, whereas the major
part of the assessee’s business was not outsourced. Moreover, the company Vishal Information
Technologies Ltd had a low employee cost of 1.25 per cent. of operating revenue. The assessee’s
wages to sales was 53 per cent. which was not comparable to Vishal Information Technologies
Ltd. Thus the exclusion of Nucleus Net soft and Vishal Information Technologies Ltd was
justified. (AY. 2006-07)

PCIT v. IHG IT Services (India) P. Ltd. (2017) 392 ITR 77 (P&H)(HC)

S. 92C: Transfer pricing-Arm’s length price-Enabled services (ITES) to AE-Financial
aspects of dissimilar activities of two enterprises not comparable-Companies rendering
entirely different services not comparable-Company following different financial year can
be adopted as comparables if data for relevant period available.

Dismissing the appeal of the revenue, the Court held that; transfer pricing was not an exact
science. It was not capable of arithmetical precision. A minuscule difference could not result in
the rejection of the case, if it was otherwise comparable. There was no difficulty in permitting
reasonable deviation so long as the deviation did not render the case incomparable to the one in
question. The financial results of enterprises involved in dissimilar activities could not be
compared. Similarly the financial aspects of dissimilar activities of two enterprises could not be
compared. Only the similar activities of the two could be considered, provided they were
financially comparable. (AY. 2009-2010)

CIT v. Mercer Consulting (I) P. Ltd. (2016) 76 taxmann.com 153 / (2017) 390 ITR 615/292
CTR 42 / 146 DTR 108 (P&H)(HC)

S. 92C: Transfer pricing- Reference to Transfer Pricing Officer –Writ court will not
interfere with order of reference to Transfer Pricing Officer- Res Judicata-Principle not
applicable to income-tax proceedings. [Art. 226]

Dismissing the petition the Court held that Assessing Officer need not come to definite finding
that transactions were international. Opinion of Transfer Pricing Officer not binding on
Assessing Officer. Assessee has second opportunity to raise issue before Assessing Officer or
Dispute Resolution Panel – Prima facie material to infer international transaction. Writ court will
not interfere with order of reference to Transfer Pricing Officer. Res Judicata – Principle not
applicable to income-tax proceedings. (AY. 2009-2010, 2010-2011, 2011-2012)

Lovelock and Lewes v. CIT (2017) 390 ITR 356/ 291 CTR 121 / 245 Taxman 1 / 145 DTR
145 (Cal) (HC)

Price Waterhouse v. CIT ( 2017) 390 ITR 356/ 291 CTR 121 / 245 Taxman 1 / 145 DTR 145
(Cal)( HC)

S.92C: Transfer pricing–Arm’s length price-DEPB includible in determining operating
profit and depreciation includible in determining total costs as in comparable companies-
Loss suffered in a particular year does not exclude a company from comparability analysis

Dismissing the appeal of the revenue, the Court held that ; while determining the arm’s length
price, DEPB includible in determining operating profit and depreciation includible in determining
total costs as in comparable companies. Loss suffered in a particular year does not exclude a
company from comparability analysis. (AY. 2008-2009 )

CIT v. Welspun Zucchi Textiles Ltd. (2017) 391 ITR 211/ 245 Taxman 132/292 CTR 1 /146
DTR 128 (Bom)( HC)

S. 92C: Transfer pricing-Licensing of brand and supply of technical know-how-
TPO/DRP/Tribunal disaggregated transaction & benchmarked technical support
arrangement applying CUP method – Matter remanded for determining whether
aggregation is warranted or not

Tribunal disaggregated transaction & benchmarked technical support arrangement applying CUP
method. On appeal ;High court held that that aggregation of closely linked transactions are
permissible, therefore the matter was remanded back for fresh consideration. On the issue of
applicability of most appropriate method, the High Court did not give any definite ruling and
opined that it should be determined based on the aggregation/de-segregation of transactions.
(AY.2011-12)

Gruner India (P) Ltd. v. DIT (2017) 146 DTR 266 (Delhi )( HC)

S. 92C:Transfer pricing – Where the assessee applied more than one of permissible
methods, then qua each transaction, the TPO was required to give reasons as to why he
preferred one of such methods over others.

Allowing the appeal of the assesse the Court held that ;Where the assessee applied more than one
of permissible methods, then qua each transaction, the TPO was required to give reasons as to
why he preferred one of such methods over others. (AY.2006-07)

Honda Motorcycle & Scooters India (P) Ltd. v. ACIT (2017) 146 DTR 201 (P&H)( HC)
S. 92C: Transfer pricing- Arms length price- Where there was a strike in the assessee
company, the net profit margin was required to be adjusted on account of such abnormal
event .

Allowing the appeal of the Court held that ;where there was a strike in the assessee company, the
net profit margin was required to be adjusted on account of such abnormal event and further
directed TPO to make appropriate adjustment in the profit margin of comparable company.
(AY.2006-07)

Honda Motorcycle & Scooters India (P) Ltd. v. ACIT( 2016) 76 taxmann.com 75 (2017) 146
DTR 206 / 292 CTR 318 (P&H)( HC)

S.92C: Transfer Pricing-Transfer Pricing Officer does not reflect any justifiable factors for
selecting the RPM method in preference to the TNM method selected by the assessee as the
most appropriate method-Arm’s length rate of the corporate guarantee commission/fee was
estimated at 0.5% .

Tribunal held that considering the unsustainability of the approach of the Transfer Pricing
Officer in selecting the RPM can also be gauged if one takes into consideration the provisions of
Rule 10C of the Rules. As noted earlier, the computation of arm’s length price under section
92C(1) of the Act is required to be made in terms of the most appropriate method prescribed
therein. Sub-section (1) of section 92C of the Act also enumerates the methods prescribed and
Rule 10C(1) of the Rules postulates that the most appropriate method shall be the method which
is “best suited to the facts and circumstances of each particular international transaction”, and
which provides the “most reliable measure” of an arm’s length price in relation to the
international transaction . Sub-rule(2) of Rule 10C provides the factors which shall be taken into
consideration while selecting the most appropriate method. Quite clearly, the entire discussion in
the order of the Transfer Pricing Officer does not reflect any justifiable factors for selecting the
RPM method in preference to the TNM method selected by the assessee as the most appropriate
method. Moreover, it is factually evident that assessee has undertaken similar international transactions of sale of television programmes and film rights to its associated enterprises in the
past as well as in subsequent years and the same were benchmarked by considering the TNM
method as most appropriate method; and, such position has been accepted by the assessing
authority in the respective years. No doubt, the principles of res judicata are not strictly applicable
to the incometax proceedings, so however, if a qualitatively comparable situation exists in more
than one assessment year, then the rules of consistency cannot be given a go by. In the instant
case, we find that the impugned international transaction of sale to the associated enterprise, ATL
Mauritius is effected in terms of Memorandum of Understanding dated 01/10/2005, which clearly
shows that qualitatively similar transactions have been undertaken by the assessee in the past
year, wherein benchmarking done by selecting the TNM method as the most appropriate method
stands accepted. In the course of hearing, the Ld. Representative for the assessee had asserted that
similar fact situation prevails in the subsequent assessment years also, and such assertion has not
been controverted by the Revenue before us. Even otherwise, we find that the Transfer Pricing
Officer has not brought out any justifiable reasons to depart from adopting the TNM method,
which has otherwise been found to be applicable in the assessments of past as well as subsequent
assessment years upto to the assessment year 2012-13, as stated before us by the Ld.
Representative for the assessee before us. Therefore, on the principle of consistency also, we are
unable to uphold the selection of RPM method as the most appropriate method by the Transfer
Pricing Officer in preference to the TNM method selected by the assessee.

As regards corporate guarantee commission , considering the entirety of facts and circumstances,
Tribunal up held the rate of 0.5% for the purposes of determining arm’s length rate of the
corporate guarantee commission/fee and set aside the order of CIT(A). (ITA No.
3406/Mum/2014, dt. 05.05.2017)(AY. 2008-09)

Zee Entertainment Enterprises Ltd. v. ACIT (Mum)(Trib) : www.itatonline.org

S. 92C : Transfer pricing-Arm’s length price–Comparable- Functional difference -A
company engaged in rendering KPO services, and a company providing highly technical
engineering consultancy services, could not be accepted as comparables while determining
ALP.

Tribunal held that the,assessee Company was providing IT enabled services (ITES) to its AE. A
company in whose case extraordinary event of amalgamation took place during relevant year
which affected its financial results, could not be accepted as comparable. A company which
outsourced major part of its work resulting in very low employee cost, was also not acceptable as
comparable. Acompany earning revenue from sale of its own software products, could not be
accepted as comparable. A company engaged in rendering KPO services was also not acceptable
as comparable. A company providing highly technical engineering consultancy services was also
rejected as comparable on account of functional difference. (AY.2007 – 08)

TNS India (P.) Ltd. v. ACIT (2017) 162 ITD 556 (Hyd.)(Trib.)

S. 92C : Transfer pricing – Arm’s length price -Working capital adjustment was remanded
back for disposal afresh.

Tribunal held that, when working capital adjustment was wrongly considered by considering
total receivables and arrivals including third party transactions and making a negative working
capital adjustment. TPO was directed to examine issue relating to working capital adjustment
afresh. (AY 2007 – 2008)

TNS India (P.) Ltd. v. ACIT (2017) 162 ITD 556 (Hyd.)(Trib.)

S.92C: Transfer pricing–Arm’s length price–Resale price method ( RPM)was held to be as
most appropriate method to determine ALP of aforesaid international transactions-
Rejection of cup method was held to be justified.

Dismissing the appeal of the revenue , the Tribunal held that ; in respect of purchase of Liquified
Natural Gas (LNG) from its foreign AEs and thereupon sold re-gasified LNG (R-LNG) to various
customers in India, RPM (resale price method) was to be adopted as most appropriate method to
determine ALP of aforesaid international transactions.Tribunal also held that Cup method cannot
be thrust upon the assessee. ( AY.2009-10)

DCIT v. Hazira LNG (P.) Ltd. (2017) 163 ITD 223 / 184 TTJ 440 / 147 DTR 1 (Ahd.)
(Trib.)

S.92C:Transfer pricing–Arm’s length price-Resale price method( RPM) is best suited for
determining ALP of an international transaction in nature of purchase of goods from an
AE, which are resold as such to unrelated parties.

Assessee adopted RPM method where as the TPO has applied TNMM method , which was
confirmed by the CIT(A). On appeal allowing the appeal of the assesse, the Tribunal held that;
Resale price method(RPM) is best suited for determining ALP of an international transaction in
nature of purchase of goods from an AE, which are resold as such to unrelated parties. ( AY.
2003-04)

Bose Corporation India (P.) Ltd. v. ACIT (2017) 163 ITD 186 (Delhi) (Trib.)

S. 92C: Transfer pricing-Arm’s length price-Reimbursement costs should be excluded as
they do not involve any functions to be performed so as to consider it for profitability
purposes while computing operating cost.

Tribunal held that reimbursement costs should be excluded as they do not involve any functions
to be performed so as to consider it for profitability purposes while computing operating
cost.(AY.2011-12)

CPA Global Services (P.) Ltd. v. ITO (2017) 162 ITD 64 / 151 DTR 385 (Delhi)(Trib.)
Editorial : Affirmed , PCIT v. CPA Global Services (P.) Ltd. ( 2017) 151 DTR 161 (
Delhi)(HC)

S.92C:Transfer pricing-Arm’s length price-Service industry-Working capital adjustment
not to be denied on ground of non-matching of working capital adjustment with financials opportunity
to be given to assessee to get financials corrected- Software development-

Selection of comparable–Functional comparability in current year only. [S .92CA]
Tribunal held that opportunity to be given to assessee to get financials corrected and assessing
Officer to examine assessee’s claim for grant of working capital adjustment on merits. As regards
software development, selection of comparable, functional comparability in current year only.
Software Product Company having intellectual property rights over some of products developed
by it not comparable. Companies said to be functionally dissimilar was to be excludible from list
of comparable. (AY. 2008-2009)

Comverse Network Systems India P. Ltd. v. ACIT (2017) 54 ITR 158 (Delhi)(Trib.)

S.92C: Transfer Pricing-The accretion of brand value, as a result of use of the brand name
of foreign AE under the technology use agreement, which has been accepted to be an
arrangement at an arm’s length price, does not result in a separate international
transaction hence a notional adjustment cannot be made in the hands of the Indian AE
towards compensation receivable from the foreign AE for “deemed brand
development”.[S.2(24),92B]

Tribunal held that the arrangement under the technology use agreement, which permits the
assessee and binds the assessee to use the brand name of the AE on the products manufactured by
the assessee, has been specifically held to be an arm’s length transaction. An aspect covered by
this agreement, therefore, cannot be subject matter of yet another benchmarking exercise. Every
benefit accruing to an AE, as a result of dealing with another AE, is not on account of service by
the other AE. That takes us to last component of definition of ‘international transaction’ under
section 92 B. This refers to a transaction in the nature of any other transaction having a bearing
on the profits, income, losses or assets of such enterprises. An accretion in the brand valuation of
a brand owned by the AE does not result in profit, losses, income or assets of the assessee
company, and it cannot, therefore, result in an international transaction qua the assessee. Unless
the transaction is such that it affects profits, losses, income or assets of both the enterprises, it
cannot be an international transaction between these two enterprises. If the assets of one of the
enterprises are increased unilaterally, without any active contribution thereto by the other
enterprise, such an impact on assets cannot, in our humble understanding, amount to an
international transaction. The accretion in brand value of the AE’s brand name is not on account
of costs incurred by the assessee, or even by its conscious efforts, and it does not result in impact
on income, expenditure, losses or assets of the assessee company. It is not, therefore, covered by
the residuary component of definition of ‘international transaction’ either.

As for the emphasis placed by the learned Departmental Representative, as also by the authorities
below, on the exhaustive definition of ‘intangibles’ in Explanation to Section 92B, Tribunal held
that,this definition would have been relevant only in the event of there being any transaction in
the nature of sale, purchase of lease of intangible assets but then, it is not even the case of the
revenue, that there was any sale, purchase or lease of intangibles. In view of these discussions, as
also bearing in mind entirety of the case, we are of the considered view that the accretion of brand
value, as a result of use of the brand name of foreign AE under the technology use agreement which
has been accepted to be an arrangement at an arm’s length price, does not result in a
separate international transaction to be benchmarked. ( I.T.A. No. 739 and 853 /Chny/2014, 563
and 614 /Chny/2015, 842 and 761/Chny/16 and CO 73/Chny/16, dt. 27.04.2017)(AY. 2009-10 to
2011-12)

Hyundai Motor India Limited v. DCIT (Chennai)(Trib.); www.itatonline.org

S.92C:Transfer Pricing-Arms length price-International transaction can be clubbed, if such
transactions are closely connected with each other, contention that when TNMM is applied
at the entity level, there was no necessity of separate bench marking in respect of royalty
transactions cannot be accepted.

An international transaction can be clubbed / aggregated with other international transactions if
such transactions are closely connected with each other. The onus is on the assessee to establish
the justification for clubbing the transactions. If the TPO has not applied TNMM at the entity
level and has bench marked the royalty payment on standalone basis and not subjected the cost of
production or other transactions to bench marking, the contention that when TNMM is applied at
the entity level, there was no necessity of separate bench marking in respect of royalty
transactions cannot be accepted.( IT(TP)A Nos. 159/Bang/2015, 132/Bang/2016 &
86/Bang/2017, dt. 21.04.2017)(AY. 2010-11 to 2012-13)

Kaypee Electronics & Associates Pvt. Ltd. v. DCIT (Bag.)(Trib.); www.itatonline.org
S.92C: Transfer pricing-Arm’s length price-Royalty-Five per cent. on domestic sales and
eight per cent. on export sales to be considered as at arm’s length rate.

Tribunal held that in respect of royalty payable to associated enterprise, five per cent. On
domestic sales and eight per cent. on export sales to be considered as at arm’s length rate.
(AY.2005-2006, 2006-2007, 2008-2009)

ACIT v. Dow Agro sciences India Pvt. Ltd. (2017) 53 ITR 590 (Mum.)(Trib.)

S.92C: Transfer pricing – Arm’s length price-Interest on loans -International interest rate
fixed being LIBOR linked interest rate to be applied.

Tribunal held that; Comparable uncontrolled price method is most appropriate method. Reserve
Bank of India approval cannot be considered as benchmark for arriving at arm’s length price.
Transactions to be considered on commercial principles in international market. International
interest rate fixed being LIBOR linked interest rate to be applied.(AY.2007-2008, 2008-2009)

Dr. Reddy’s Laboratories Ltd. v. (2017) 53 ITR 285 (Hyd.)(Trib.)

S.92C: Transfer pricing-Arm’s length price-Interest-free loans to associated enterprise-
LIBOR rate applicable and not domestic rate.

DRP directed the TPO to compute the upward adjustment applying an arm’s length interest rate
of 11 percent. i.e. 8 percent .plus 3 percent ( Credit spread) .On appeal the Tribunal held that
instead of the base rate of 8 percent. ( based on lending rates of banks in India for commercial
borrowing) , it would be appropriate to apply LIBIR rate and not the domestic lending rate. (AY.
2003-2004 to 2011-2012)

Electrosteel Castings Ltd. v. DCIT (2017) 53 ITR 5 (Kol.)(Trib.)

S.92C: Transfer pricing-Arm’s length price-Giving guarantee on a loan availed of by its
associated enterprises is an international transaction, arm’s length guarantee commission
at 0.5 per cent was directed to be adopted against at 2 percent adopted by DRP.

Giving guarantee on a loan availed of by its associated enterprises is an international transaction,
arm’s length guarantee commission at 0.5 per cent was directed to be adopted against at 2
percent adopted by DRP. (AY. 2003-2004 to 2011-2012)

Electrosteel Castings Ltd. v. DCIT (2017) 53 ITR 5 (Kol.)(Trib.)

S. 92C : Transfer pricing–Arms length price-proportion to international transaction bears
to the total turnover.

The Tribunal held that CIT(A) was justified in directing the AO to make transfer pricing
adjustment of the expenses in the proposition which the international transactions bear to the total
turnover. (AY. 2004-05, 2005-06, 2006-07)

ACIT v. Timex Watches Ltd. (2017) 183 TTJ 27/ 145 DTR 81 (Delhi)(Trib.)

S. 92CA: Reference to transfer pricing officer -Before making a reference to the TPO, the
assessee is required to be given an opportunity to show-cause why the reference may not be
made to the TPO and thereafter a speaking order is required to be passed by the AO.
[S.92C, Art. 226]

The assessee filed a Writ Petition, challenging the action of the AO in making a reference to the
TPO without disposing of the objection raised by the assessee as provided under the Instruction
No. 3/2016 dated 10th March 2016. The HC quashing the reference made by the AO, held that as
per the CBDT Instruction No. 3/2016 dated 10th March 2016, the AO before making a reference
to the TPO, is required to give an opportunity to the assessee showing cause as to why a reference
may not be made to TPO and thereafter, a speaking order is required to be passed disposing of the
objections so raised by the assessee. The HC remitted back the matter to AO to pass a speaking
order while making a reference to TPO after considering the objections raised by the assessee.

Alpha Nipon Innovatives Ltd. v. DCIT( 2016) 76 taxmann.com 166 / (2017) 291 CTR 309
(Guj) (HC)

S. 92CA: Reference to transfer pricing officer – jurisdiction of TPO is extendable to other
international transactions which come to his notice during the course of proceedings before
him.

Even though original jurisdiction of TPO is confined to international transactions referred to him
by AO for determination of ALP, but, such jurisdiction is extendable to other international
transactions which comes to his notice during the course of proceedings before him. (AY. 2011-
12)

Nikon India (P) Ltd. v. Dy. CIT (2017) 146 DTR 107 (Delhi)(Trib.)

Tags:APA scheme, transfer pricing india

1. INTRODUCTION TO TRANSFER PRICING LAW IN INDIA

2. SCOPE & APPLICABILITY

2.1. What is an “Associated Enterprises (‘AEs’)”?

2.2. What is an International Transaction?

Transfer Pricing law for Domestic transactions

3. ARM’S LENGTH PRICE& METHODS OF DETERMINING THE ALP

Use Of Range Concept

Use Of Multiple Year Data

4. DOCUMENTATION

5. BURDEN OF PROOF TO PROVE THAT TRANSACTIONS ARE AT ARMS’ LENTGH

6. EFFECTS OF ADJUSTMENT TO THE ALP

6.1. Adjustment to the Reported Income

6.2. Penalties

Advance Pricing Agreements (APA)

OECD Guidelines on Transfer Pricing for MNEs explain Advance Pricing Agreements (APA)

APA Scheme Requires Critical Assumptions

Step 1 – Pre-filing consultation

Step 2 – Filing an application for APA

Step 3 – Preliminary processing of the APA application

Step 4 – Processing of the APA application

Step 5 – Drafting of an APA and execution post approval

Post APA compliance

a) Revision of tax returns and tax assessment

b) Filing of compliance report

c) Audit of the compliance report

Other features

TYPICAL TRANSFER PRICING ISSUES UNDER LITIGATION

Selection Of Comparables

Calculation Of Profit Level Indicators

Comparabilty Adjustments

Advertising Marketing & Promotion Expenses (AMP Expenses)

Interest On Loans / Advances

Corporate Guarantees

Issue Of Shares

Thin capitalisation

Landmark judgements of Courts On Transfer Pricing Law

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Skoda Auto India Private Limited

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IL Jin Electronics (I)(P) Ltd.

Cheil Communication India Private Ltd.

Maruti Suzuki India Ltd.

Gemplus India Pvt. Ltd.

Logix Micro Systems Ltd.

Reliance Industries Ltd.

Li & Fung (Trading) Ltd.

GAP International Sourcing (India) Pvt. Ltd.

L’oreal India Pvt. Ltd.

Latest Transfer Pricing Law judgements

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