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Saturday, June 6, 2015

CBDT releases draft scheme on use of multiple year data and percentile for the purpose of computation of ALP

On 21st May 2015, Central Board of Direct Taxes (CBDT) released draft scheme (via notification no.F.No.134/11/2015-TPL) of the proposed rules for computation of Arm’s Length Price (ALP) of controlled transactions entered during financial year 2014-15 and onward.  Summary of such draft scheme is given below;

Multiple Year Data
  1. Multiple year data means financial data for three years including the year in which transaction has been undertaken (current year). For example: for transaction entered during financial year 2014-15, multiple year data means data for financial year 2014-15, 2013-14 and 2012-13.
  2. Use of multiple year data is mandatory for Resale Price Method (RPM), Cost Plus Method (CPM) and Transactional Net Margin Method (TNMM). Further use of multiple year data is restricted to only these three methods and not allowed for Comparable Uncontrolled Price Method (CUP) and Profit Split Method (PSM).
  3. In case if data for any of the comparable is not available for all the three years, data of any two out of relevant three years can be used.
  4. Draft scheme envisage 3 situations under which data for all the three years may not be available, (a) current year data not available in databases, (b) comparable not able to qualify quantitative filter in any one of the three years, and (c) comparable has commenced operations only in the least two years or may have closed down operations during the current year.
  5. Any comparable with only single year data cannot be considered for the purpose of computation.
  6. Wherein current year data is not available at the time of transfer pricing documentation, same can be used at the time of transfer pricing audit.
Arm’s Length Range – Percentile
  1. In addition to variation from arithmetic mean, another statistical tool “Percentile” has been introduced.
  2. Percentile can only be used for RPM, CPM and TNMM.
  3. For the purpose of application of percentile, minimum nine comparable entities (external comparables) are required. Wherein, minimum nine comparable entities are available, it would be mandatory to use Percentile.
  4. The data point lying within 40th to 60th percentile of the data set of series would constitute arm’s length range.
  5. Transfer price of the controlled transaction will be considered at arm’s length if it falls within the arm’s length range. However if it falls outside the arm’s length range, the median of the range would be taken as arm’s length price and adjustment to transfer price shall be made.
  6. For the purpose of computation of data point of each comparable, multiple year data would be considered and the weighted average of such multiple year data of each comparable would construct the data set.
  7. For calculating, the weighted average, the numerator and denominator of the chosen profit level indicator would be aggregateed for all the years for every comparable entity and the margin would be computed thereafter.
  8. In cases where ‘percentile range’ concept does not apply, the arithmetic mean concept shall continue to apply as per current rule.
JGarg’s Observation
Basic intention behind introduction of multiple year and percentile range concepts was to reduce transfer pricing litigation, however, if draft scheme implemented in its current form may not actually bring down litigation. On a minimum, CBDT:
  1.  instead of making multiple year data mandatory, should clearly define scenarios under which multiple year data can be used;
  2. should allow use of multiple year data for other methods as well;
  3.  minimum requirement of 9 comparable entities should be removed; and
  4. Instead of 40th to 60th percentile, inter-quartile range should be introduced.
For further discussion
In case if you wish to discuss it further or if you have any query on transfer pricing, feel free to contact us:
CA.Gaurav Garg
(M) +91-9899994934
(E) gaurav@jgarg.com
(W) www.jgarg.com

Wednesday, July 9, 2014

Webinar: India Union Budget 2014-15: Key Proposals in Corporate Taxation

Hi All,

Register for a webinar on "India Union Budget 2014-15: Key Proposals in Corporate Taxation" on Jul 11, 2014 4:00 PM IST at:

https://attendee.gotowebinar.com/register/8283817720340688898
Webinar ID: 109-979-315

The new highly entrusted Government is all set to present its first budget on 10th July 2014. Uncertainty on the corporate taxation front has been hampering the growth and investments in the Country and taxpayers (including their consultants) have been apprehensive.

So do we see a ray of hope this time around?
Would Finance Minister of Modi's Government meet the exceeding expectations or at least get a nod from all of us?
Are we really going to see "Ache din" in his terms?

Join us in an interactive webinar on 11th July 2014 from 4:00 pm to 5:30 pm, wherein we will discuss the key proposals in corporate taxation including transfer pricing.

Please note the registration for the webinar would be limited and one should register and log in well before scheduled time in order to participate in the webinar.

After registering, you will receive a confirmation email containing information about joining the webinar.

Best Regards
Gaurav Garg
(E) gaurav@jgarg.com
(L) 01147094934

Thursday, March 28, 2013

Application of Profit Split Method on Research & Development Centres in India


Application of Profit Split Method on Research & Development Centres in India [Circular 2/2013 & 3/2013, issued by Central Board of Direct Taxes, Ministry of Finance, Government of India]

Today, Central Board of Direct Taxes, Ministry of Finance, Government of India (in short ‘CBDT’) has issued two circular in respect of application of Profit Split Method (‘PSM’) for the purposes of determination of arm’s length price in case of Research & Development Centres (in short ‘R&D Centres’) operating in India.

Circular 2/2013 elaborates points that should be kept in mind while applying PSM on R&D Centres, Circular 3/2013 provides conditions wherein R&D Centres in India would be treated as contract R&D Centres with insignificant risk.

In general, guidance in the captioned circulars is on the principles as enumerated in the OECD TP Guidelines, with importance being given to “economically significant function, asset and risk” along with other criteria. In a simple example, economically significant function can be a function which is adding greater value to the R&D in value chain.

As per Circular 2/2013, the preferred method for computing arm’s length price of R&D services provided by India Centre shall be PSM. However, wherein PSM cannot be applied due to non-availability of the comparable data, Transactional Net Margin Method (‘TNMM’) or Comparable Uncontrolled Price Method (‘CUP’) could be considered for the purpose of computing arm’s length price.

Reading of Para 1 & 2 of Circular 2/2013 suggests that the Circular 2/2013 would be applicable wherein R&D Centre in India is not characterized as “Contract R&D Centre with insignificant risk”.  Circular 3/2013 enumerates conditions wherein R&D Centre in India would be considered as Contract R&D Centre with insignificant risk. Such conditions are, wherein

Foreign Principle
  •  performs most of the economically significant functions involved in research or product development life cycle, and,
  • provides fund/capital and other economically significant asset including intangibles for research or product development and,
  • have capabilities to control or supervise research or product development, and,
  • control or supervise India Centre through its strategic decisions to perform core functions as well as monitor activities on regular basis, and,
  • is not located in a country/ territory widely perceived as a low or no tax jurisdiction (however, in case if India Centre able to satisfy the Indian Tax authorities on the economic significance of Foreign Principle in value chain, then possibly this condition may be relaxed) and,
  •  has ownership right of research outcome

And, Indian Centre
  •  is largely involved in economically insignificant functions involved in research or product development life cycle, and,
  •  is  not using any other economically significant assets including intangibles in research or product development, and,
  • does not assumes or has no economically significant realized risk, and,
  •  does not have ownership right (legal or economic) on outcome of research.

It is to be noted that the above conditions are required to be satisfied on cumulative basis. Further, purpose of analysis, importance would be given to actual conduct rather than the contractual arrangement between Foreign Principal and India Centre.

Trust the same would find you useful. 

Please feel free to call us for any query on transfer pricing & international taxation.

Regards
CA Gaurav Garg
JGarg Economic Advisors
(M) +91 9899994934
(E) gaurav@jgarg.com

Tuesday, January 29, 2013

TP additions should not be considered for the purposes of Chapter VI A


IN THE ITAT NEW DELHI BENCH 'I'

Assistant Commissioner of Income-tax, Circle-2(1)
v.
Bechtel India (P.) Ltd.

IT APPEAL NOS. 4338, 4339 & 4573 (DELHI) OF 2011
CROSS-OBJECTION NO. 374 (DELHI) OF 2011
[ASSESSMENT YEARS 2004-05 AND 2005-06]
DECEMBER 21, 2012

Key Observation:

Transfer pricing additions should not be considered while computing deduction under Chapter VI-A of the Income Tax Act (‘the Act’).

Relevant Facts:

During transfer pricing audit, the transfer pricing officer (‘TPO’) considered the taxpayer to be in the business of IT/IT-enabled services and enhanced the value of international transaction by Rs. 6,93,21,169/-.
The Assessing officer while computing deduction under section 80HHE of the Act, re-computed the total turnover (Original Turnover + Rs.6,93,21,169) by adding addition prescribed by the TPO and thus re-computed and deduction under section 80HHE of the Act.

Relevant provision of the Act:

As per section 92C(4) of the Act
"Where an arm's length price is determined by the Assessing Officer under sub-section (3), the Assessing Officer may compute the total income of the assessee having regard to the arm's length price so determined
…………..
Provided that no deduction under section 10A [or section 10AA] or section 10B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this sub-section"
Observation of the Tribunal:

“14.From the proviso to Section 92C(4), it is evident that no deduction in Chapter VI-A is to be allowed in respect of the income which is enhanced after the computation of income in the said Section. Thus, the assessee is not entitled for deduction under Chapter VI-A in respect of the addition made as per the TPO's order. Despite the above specific provision, the Assessing Officer enhanced the total turnover by the addition made as per the TPO's order, which has the effect of reducing the deduction under Section 80HHE. However, the finding of the TPO is that the international transaction of the assessee is not at arm's length and, therefore, by determining the arm's length price of the international transaction, he proposed the addition of Rs. 6,93,21,169/-........it will have the impact of increasing the assessee's export turnover, then total turnover and finally, the total income. If all three are increased, obviously, the deduction claimed by the assessee under Chapter VI-A would increase. The proviso to Section 92C(4) prohibits any deduction under Chapter VI-A to be allowed on the enhancement made as per the TPO's order. Therefore, the only logical conclusion that can be drawn is that no effect is to be given to the addition made by the Assessing Officer as per the TPO's order while computing deduction under Chapter VI-A. The Assessing Officer's view cannot be accepted that by the enhancement of income as per the TPO's order, only the total turnover would be increased and not the export turnover or the total income. In view of the above, we uphold the order of learned CIT(A) on this point also. Accordingly, ground No.2 of the Revenue's appeal is rejected.”


Trust the same would find you useful.

For assistance on transfer pricing and other related issues, please feel free to contact us.

Best Regards
CA Gaurav Garg
JGarg Economic Advisors

(M) +91 9899994934
(E) gaurav@jgarg.com



Sunday, January 27, 2013

Unfolding Tribunal’s Special Bench Judgment on Transfer Pricing issues in case of L G Electronics


Year 2013 starts with landmark judgment from Delhi Tribunal’s Special Bench (‘Tribunal’) in case [IT APPEAL NOS. 5140 (DELHI) OF 2011] of M/s LG Electronics India Pvt. Ltd. (‘LG India’ or ‘taxpayer’).The Tribunal analysed various issues including higher expenditure on advertisement, marketing & promotion (‘AMP’) incurred by subsidiary company on brand owned by foreign associated enterprise.

Below is the synopsis and observations made by the tribunal in the captioned case relating to the transfer pricing;
A.      Jurisdiction of the Transfer Pricing Officer (‘TPO’) – Section 92CA
B.      Meaning of Transaction
C.      Economic vis-à-vis legal ownership of brand
D.      Meaning of International Transaction
E.       Cost of the Transaction and Bright line test
F.       Scope of Transactional Net Margin Method
G.     Choice of the Transfer Pricing Method under section 92C

Facts of the Case
The factual matrix of the case is that L.G. Electronics Inc. (‘LGK’), is a Korean based company, engaged in the business of manufacture, sale and distribution of electronic products and electrical appliances. LG India was incorporated in 1997 as a wholly owned subsidiary of LGK.

An agreement was entered between LGK and LG India in March 1997, as per which both entered into a mutual foreign collaboration agreement. Thereafter a technical assistance and royalty agreement was entered into between these two entities on 1-7-2001 by which LG India, in the capacity of a licensee, obtained a right to use the technical information, designs, drawings and industrial property rights for the manufacture, marketing, sale and services of the agreed products from the LGK i.e. the licensor. As per the agreement, the taxpayer agreed to pay royalty to LGK at the rate of 1% as a consideration for the use of industrial property rights, designs and technical knowhow, for the manufacture and sale of the greed products.

LGK also allowed LG India to use its brand name and trade marks to products manufactured in India during the validity period of the agreement, which in the instant case is “without any restriction”.  The agreement also provided that “In case at any stage in future the Licensor demands any royalty payment on this account, the Licensee will take steps to get the Government of India‘s approval for payment of such royalty payment".

The Assessing Officer (‘AO‘) referred the international transactions reported by the taxpayer to the TPO. One of such transactions included in the taxpayer‘s audit report was “Contribution towards Global Cricket Sponsorship”. The TPO observed that the taxpayer had received contribution from its associated enterprise (`AE‘) for the expenditure incurred on sponsorship of Global Cricket events. The quantum of contribution received was considered as a part contribution for the brand promotion carried out by the taxpayer on behalf of its foreign AE.

The TPO observed that the taxpayer‘s expenses on AMP including trade discount and volume rebate, were 3.85% of its sales at Rs.6,553.36 crore. He computed similar percentage in the case of Videocon Appliances Ltd. (0.12%) and Whirlpool of India Ltd (2.66%) with their arithmetic mean at 1.39%. It was opined that the taxpayer was promoting LG brand owned by its foreign AE and hence should have been adequately compensated by the foreign AE. Applying the Bright Line Test, the TPO held that the expenses up to 1.39% of the sales should be considered as having been incurred for the taxpayer‘s own business and the remaining part which is in excess of such percentage, at 2.46% (3.85% - 1.39%) on brand promotion of the foreign AE. Such excess at Rs.161.21 crores was proposed as a transfer pricing adjustment on account of AMP expenses for brand building.

Before the Dispute Resolution Panel (hereinafter called `the DRP‘), it was contended on behalf of the taxpayer that the total AMP expenses so incurred helped in increasing its sales activity and hence no part of the same could be considered as unrelated to its business, being in the nature of brand building for the foreign AE. It was also put forth that the LG brand was in existence globally even before the taxpayer started its operations in India. Thus it was pleaded that the taxpayer did not have any occasion to create this brand in India. The taxpayer also claimed that brand name was available to it without paying any brand royalty, which was an important factor to be kept in mind. Even if such expenses resulted in creation of a brand in India, the taxpayer contended that no further amount was attributable to such brand creation on account of its higher profitability and nonpayment of brand royalty.

The DRP found that the taxpayer incurred extraordinary AMP expenses for the promotion and development of LG brand in India. The taxpayer‘s contention that the incurring of such expenses did not lead to the promotion of brand in India, was found to be not tenable. The DRP concurred with the view taken by the AO in the draft order prepared by the AO u/s 144C in making adjustment of `161.21 crore. It was further observed by the DRP that TPO had not charged markup on such AMP expenses. The same was found warranted as the taxpayer ‘s activity required not only the deployment of its funds but also entrepreneur‘s efforts including the use of its infrastructure. Opportunity cost was finalized at 10.50%, being the interest rate charged by the banks; and compensation for the taxpayer‘s entrepreneurial efforts was taken at 2.5% . Thus, the DRP came to hold that the mark-up of 13% should have been applied on the amount proposed for adjustment. At the same time, the DRP agreed with the taxpayer‘s contention that no opportunity cost of 10.5% should be charged on the expenses for which reimbursement was received immediately after the same were incurred. Pursuant to directions given by the DRP, the ld. AO passed order u/s 143(3) read with sec. 144C making additions, inter alia, of Rs.182.71 crore (inclusive of mark-up @ 13%) towards AMP expenses on brand building incurred for and on behalf of its AE.

Aggrieved by the same, the Taxpayer appealed in the Tribunal, wherein Tribunal observed on various transfer pricing issues discussed below in detail.


A.      Jurisdiction of the Transfer Pricing Officer (‘TPO’) – Section 92CA

Contention of the Taxpayer
In the current case, it was contented by the Taxpayer that AO did not refer the international transaction of marketing intangibles to the TPO and as such the latter was precluded from determining the arm‘s length price in respect of such transaction.

Relevant Provisions of the Act
Section 92CA of the Income Tax Act (‘the Act’) defines the jurisdiction of the TPO in determination of the arm’s length price in case of international transactions entered between the taxpayer and its associated enterprise during the assessment year under audit.

As per section 92CA(1) the Act, the AO can refer the transactions to the TPO for the purposes of computation of arm’s length price if he considers the same necessary or expedient  after taking prior approval from the  Commissioner.

Once reference is made to the TPO, TPO is competent to exercise all powers that are available to the AO under sub-section (3) of Section 92C of the Act for determination of ALP and consequent adjustment.

Section 92CA(2A) of the Act was added through Finance Act 2011 (w.e.f 1-6-2011), wherein it was specifically provided that in case if the TPO notice any other transaction, transactions other than the transactions referred by the AO under section 92(1), he may compute the arm’s length price of the same after giving proper opportunity of the Assessee in additions to the transactions referred to him by the AO under section 92(1) of the Act.

Further, it was realized by the law making body that as per section 92E of the Act there is reporting requirement on the taxpayer and the taxpayer is under obligation to file an audit report in prescribed form before the AO containing details of all international transactions undertaken by the taxpayer during the year. However, wherein in a case the transaction has not be disclosed in the Form 3CEB, AO may not be able to refer the same to the TPO and TPO may not be able to compute the arm’s length price of such international transactions.  Accordingly, to avoid any litigation or disputes section 92CA(2B) of the Act (w.e.f 1-6-2002) was introduced to empower TPO to compute arm’s length price of an international transaction noticed by him in the course of proceedings before him, even if the said transaction was not referred to him by the Assessing Officer, provided that such international transaction was not reported by the taxpayer as per the requirement cast upon him under section 92E of the Act.

Observation of the Tribunal
 7.7…….A conjoint reading of sub-secs (1) & (2) of section 92CA makes it manifest that the TPO can determine ALP of an international transaction only when a valid reference is made to him by the AO and not otherwise……

7.8…..It thus becomes apparent that with the insertion of sub-sec. (2A), the TPO can compute ALP in respect of any transaction other than those referred to him by the AO. However, it is pertinent to note that sub-sec. (2A) has been inserted w.e.f. 1-6-2011. Thus, the mandate of sub-sec. (2A) cannot apply to a period anterior to this cut-off date. As the TPO passed the order in the instant case on 29-10-2010 which is obviously prior to 1-6-2011, sub-section (2A) cannot be of any help to save his action.
7.18 Realizing that sub-sec. (2A) did not serve the purpose in entirety to validate the action of the TPO in determining ALP in respect of transactions not referred to by the AO, the legislature came out with sub-sec. (2B) with retrospective effect from 1-6-2002. As per this sub-section, any international transaction in respect of which the assessee has not furnished report u/s 92E can be considered by the TPO for determining ALP. Thus, sub-sec. (2B) has the effect of validating the action of the TPO with effect from 1.6.2002, thereby covering even the period prior to 1-6-2011, being the date of insertion of sub-sec. (2A) of sec. 92CA. The contention that sub-sec. (2B) of sec. 92CA cannot be invoked to regularize the otherwise invalid action of the TPO, in our considered opinion, is farfetched……

7.20…….. The jurisdiction of the TPO is activated only when the AO makes reference to him under sub-section (1) for determining ALP in respect of certain transactions. Sub-secs. (2A) and (2B) come into play only when sub-sec. (1) has already been set into motion. Thus, it is only when the AO makes a reference to the TPO in terms of sub-sec. (1) for determination of ALP in respect of the referred international transactions, that the TPO gets power under subsections (2A) and (2B) to determine ALP in respect of non-referred international transactions as well. In the absence of any such reference under sub-section (1), the TPO cannot suo motu undertake the determination of ALP in respect of other international transactions not referred to him…..

7.21… There is no requirement of previous approval of the Commissioner in respect of the international transactions which come to the notice of the TPO during the course of proceedings before him. The prerequisite of seeking approval of the Commissioner is incorporated in sub-sec. (1) alone and the same cannot be read into sub-secs. (2A) and (2B) by the doctrine of incorporation. Our view is fortified by the judgment of the Hon‘ble Supreme Court in the case of CIT Vs. Pawan Kumar Laddha [(2010) 324 ITR 324 (SC)].


B.      Meaning of Transaction

Contention of the Taxpayer & Tax Department
The whole argument between the tax payer and the tax department was around intent for incurring the expenditure, wherein the taxpayer was arguing that the very intent for incurring the expenditure is to promote India Business and there is no formal or written understanding between the taxpayer and its associated enterprises. Whereas contention of the tax department was as the expenditure incurred by the tax payer is more than the normal AMP spend by similar companies and in certain instances AMP spend was only in respect of Logo and Brand name of foreign associated enterprises, it can very well be deduced that the taxpayer was involved in brand promotion activity of the foreign enterprises and accordingly the same is in the nature of services.

Relevant Provisions of the Act
Transfer pricing provisions are applicable on international transactions and accordingly it is important to analyse the meaning of “transaction”. Definition of the transaction is given under section 92F(v) of the Act and it includes an arrangement, understanding or action in concert whether or not it is formal or in writing or intended to be enforceable by legal proceedings.

Observation of the Tribunal
 9.9…so long as there exists some sort of understanding between two AEs on a particular point, the same shall have to be considered as a transaction, whether or not it has been reduced to writing….

9.10. We do not find any force in the contention of the ld. DR that the mere fact of the assessee having spent proportionately higher amount on advertisement in comparison with similarly placed independent entities be considered as conclusive to infer that some part of the advertisement expenses were incurred towards brand promotion for the foreign AE. Every businessman knows his interest best. It is for the assessee to decide that how much is to be incurred to carry on his business smoothly.

9.12….What is relevant to consider is as to whether an independent enterprise behaving in a commercially rational manner would incur the expenses to the extent the assessee has incurred. If the answer to this question is in affirmative, then the transaction cannot be recharacterized. If, however, the answer is in negative, then the transaction needs to be probed further for determining as to whether its recharacterization is required….

9.12…….Once by making such a comparison, the result follows that the Indian AE, prominently displaying brand of its Foreign AE in its advertisements, has incurred expenses proportionately more than that incurred by independent enterprises behaving in a commercial rational manner, then it becomes eminent to recharacterize the transaction of total AMP expenses with a view to separate the transaction of brand building for the foreign AE. Even the United Nations Transfer Pricing Manual, which has only a persuasive value, provides for the allocation of such cost between the MNE and its subsidiaries. We, therefore, hold that in the facts and circumstances of the present case, there is a transaction between the assessee and the foreign AE under which the assessee incurred AMP expenses towards promotion of brand which is legally owned by the foreign entity.


C.      Economic vis-à-vis legal ownership of brand

Contention of the Taxpayer
Taxpayer claimed that Indian entity is the economic owner of the brand in India and accordingly no adjustments should be made.

Observation of the Tribunal
 10.2. We do not find any weight in the contention put forth about the economic ownership and legal ownership of a brand. It is not denied that there can be no economic ownership of a brand, but that exists only in a commercial sense. When it comes in the context of the Act, it is only the legal ownership of the brand that is recognized…….Suppose the foreign company, who is legal owner of the brand, sells its brand to a third party for a particular consideration, can it be said that the Indian assessee or for that purpose the wholesalers or retailers should also get share in the total consideration towards the sale of brand because they were also economic owners of such brand to some extent? The answer is obviously in negative. It is only the foreign enterprise who will recover the entire sale consideration for the sale of brand and will be subjected to tax as per the relevant taxing provisions. There can be no tax liability in the hands of the Indian AE or the wholesalers or the retailers for parting with the economic ownership of such brand under the Act. In that view of the matter we are of the considered opinion that the concept of economic ownership of a brand, albeit relevant in commercial sense, is not recognized for the purposes of the Act. The above discussion leads us to irresistible conclusion that the advertisement done by the assessee also carrying the brand/logo of its foreign AE coupled with the fact that it spent proportionately higher amount on AMP expenses, gives clear inference of a `transaction‘ between the assessee and its AE of building and promoting the foreign brand.


D.      Meaning of International Transaction

Meaning of international transaction is given in section 92B of the Act, according to which "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.

Observation of the Tribunal
14.14 When we read sec. 92B(1) it comes to fore that in order to be characterized as an international transaction, the following salient features must be present : - (1) There should be a `transaction‘ (2) Such `transaction‘ should be between two or more AEs and either or both of whom should be non-residents. (3) Such transaction should be of the nature as referred to in section 92B.

14.18.2. We do not find any force in this submission advanced on behalf of the assessee for the reason that the language of section 92B simply mandates the “provision of services” by one AE to another. It is not qualified by any words to restrict its scope only to such services as are provided by the assessee in its regular course of business. What is significant in this regard is the factum of rendition of service, which is an international transaction. Source of service is inconsequential. It can be produced by the AE as primarily engaged in the business of rendering such service or it can be produced by the Indian AE otherwise than by being primarily engaged in such business or it can be outsourced. The fact that the Indian entity is rendering any service to the foreign AE, which is not its main business, would not convert the otherwise international transaction into a non-international transaction.

14.21. Thus it is palpable that all the three necessary ingredients as culled out from a bare reading of section 92B are fully satisfied in the present case. There is a transaction of creating and improving marketing intangibles by the assessee for and on behalf of its foreign AE ; the foreign AE is non-resident ; such transaction is in the nature of provision of service. Resultantly, we hold that the Revenue authorities were fully justified in treating the transaction of brand building as an international transaction in the facts and circumstances of the present case.


E.       Cost of the Transaction & Bright Line Test

For the purposes of computing arm’s length price of the transaction in the nature of services it is important to identify cost of the service provider. After identification of cost price is determined by adding arm’s length mark-up to such cost of services.

In the captioned case Bright Line test was used to identify the cost of services.

Observation of the Tribunal
 15.7.…..Bright line is a line drawn within the overall amount of AMP expense. The amount on one side of the bright line is the amount of AMP expense incurred for normal business of the assessee and the remaining amount on the other side is the cost/value of the international transaction representing the amount of AMP expense incurred for and on behalf of the foreign AE towards creating or maintaining its marketing intangible…..

15.8. In the present case, the assessee did not declare any cost/value of the international transaction in the nature of brand building. As such, it fell upon the TPO to find out such amount out of the total AMP expenses incurred by the assessee. In the absence of any assistance from the assessee in determining such cost/value, logically it could have been by first identifying comparable independent domestic cases ; ascertaining the amount of advertisement, marketing and promotion expenses incurred by them and percentage of such AMP expenses to their respective sales ; noting the total AMP expenses incurred by the assessee ; discovering the amount of AMP expenses incurred by the Indian entity for its business purpose, by applying the above percentage of comparable cases to assessee‘s sales. The excess of total AMP expenses over such amount as determined as per the immediately preceding step ought to have been and has been rightly taken as a measure to determine the amount of AMP expenses incurred by the assessee for the brand promotion of foreign AE. In other words, the amount coming up as per the last step is the cost/value of such international transaction.

17.2. We find that the first step in making comparability analysis, is to find out some comparable uncontrolled cases. It goes without saying that a comparison can be made with the cases which are really comparable. A case is said to be comparable when it is from the same genus of products and also other relevant factors, such as, type of products, market share, assets employed, functions performed and risks assumed, are also similar. Once proper comparable cases are chosen, then the next step is to neutralize the effect of the differences in relevant facts of the case to be compared and the assessee‘s case, by making suitable plus or minus adjustments.

17.6. …. We find that choosing cases using the foreign brand ex facie cannot be accepted. It is but natural that the AMP expenses of such cases will also include contribution towards brand building of their respective foreign AEs. In such a situation the comparison would become meaningless as their total AMP expenses will stand on the same footing as that of the assessee before the exclusion of expenses in relation to brand building for the foreign AE. The correct way to make a meaningful comparison is to choose comparable domestic cases not using any foreign brand. Of course when effect will be given to the relevant factors as discussed above, it will correctly reflect the cost/value of international transaction.

18.3. Having heard the rival submissions on this issue, we find that the AMP expenses refer only to advertisement, marketing and publicity expenses. A divider needs to be placed between the expenses for the promotion of sales on one hand and expenses in connection with the sales on the other. Both these expenses are required to be kept in different compartments. While expenses for the promotion of sales directly lead to brand building, the expenses directly in connection with sales are only sales specific.

18.6….. We, therefore, hold that the expenses in connection with the sales which do not lead to brand promotion cannot be brought within the ambit of  “advertisement, marketing and promotion” expenses  for determining the cost/value of the international transaction.

F.       Scope of Transactional Net Margin Method (‘TNMM’)

The basic rule of transfer pricing suggests that the transaction should be benchmarked on standalone basis and the aggregation should be only done if they are inter-related. In the captioned case, as the Tribunal observed that the taxpayer is involved in providing brand promotion services to its AEs, would it be correct to aggregate all the transactions for the purposes of justification of arm’s length price under TNMM.  Otherwise also, if the taxpayer has various types of transactions, how correct it would be justify the profitability at entity level was the question in front of the Tribunal.

Observation of the Tribunal
 21.4….This method (TNMM) provides for benchmarking of `an‘ international transaction by considering the operating profit from the concerned international transaction vis-à-vis certain basis as given in Rule 10B(1)(e), being total cost, sales, capital employed etc. Here it is significant to note the meaning of the term `transaction‘ as given in rule 10A(d). It provides that: `transaction includes a number of closely linked transactions‘. Plural of transactions becomes singular when the transactions are closely linked to each other or are identical. These closely linked transactions can be processed as one transaction under any of the prescribed methods. If an Indian enterprise has made sale of similar goods to its foreign AE through several invoices and has also incurred some expenses or paid interest to it, it would mean that all the transactions of sales are closely linked and these can be processed as one unit. However the transactions of payment of interest or incurring of any other expense would be required to be separately scrutinized under Chapter-X because these are of a different nature vis-a-vis the transactions of sales.

21.5. ….The correct approach under the TNMM is to consider the operating profit from each international transaction in relation to the total cost or sales or capital employed etc. of such international transaction and not the net profit, total costs, sales, capital employed of the assessee as a whole on entity level……Thus it is clear that the sanction is for applying the TNMM only on a transactional level and not on entity level. Of course, the TNMM can be correctly applied on entity level if all the international transactions are of sale by the assessee to its foreign AE and there is no other transaction of sale to any outsider and also there is no other international transaction. But if there are several unrelated international transactions, as is the case before us and the assessee or the TPO has applied the TNMM in a wrong manner on entity level for testing any of such transactions, then the remedy lies in correcting such mistake rather than drawing legally unsustainable conclusions by taking such mistake as a correct legal position.

21.8. … Earning an overall higher profit rate in comparison with other comparable cases cannot be considered as a licence to the assessee to record other expenses in international transactions without considering the benefit, service or facility out of such expenses at arm‘s length. All the transactions are to be separately viewed…

21.10…The fact that the assessee has a better net profit rate in comparison with other comparable entities is not decisive in itself of the assessee having purchased the goods at a concessional rate from its foreign AE as a compensation for its incurring AMP expenses towards the promotion of their brand.

21.12..There is no provision which permits set off of negative adjustment with the positive adjustment to the income on account of different international transactions. The outcome of both the transactions has to be given effect distinctly. It, therefore, divulges that two or more international transactions are required to be separately processed under the TP provisions….


G.     Choice of the Transfer Pricing Method under section 92C

For the purposes of computation of the arm’s length price 5 methods are prescribed in section 92C of the Act. The law mandates the use of the any of the method, out of those 5 methods, being the most appropriate method.

Observation of the Tribunal
22.9….When we read sub-section (1) of section 92C in entirety along with Rule 10B(1), there remains no doubt that the arm‘s length price is required to be determined by any single method out of the five prescribed methods…… In our considered opinion the general and a non case specific argument advanced by the ld. DR that there can also be a combination of the one or more of the five methods for determining the ALP, is not correct.

22.10. As regards the contention that methods are tools for determining the ALP, we find that there is no dispute that the main purpose of Chapter X is to determine the ALP of an international transaction, but such determination can be done only by way of the methods specified by the statute….


My Comments

When in para 10.2 the Tribunal agrees to the concept of “economic ownership” in commercial sense but deny the same from tax perspective or more precisely from transfer pricing perspective it raises doubt on very mechanism of transfer pricing as understood. We need to be clear that transfer pricing is first a commercial concept and then a tax concept.  To validate the transaction price including terms & conditions of the commercial transaction between two associated enterprises it is required under the tax law to identify another commercial transaction between two independent enterprises and then deduce price including terms & condition from the same i.e. arm’s length price. Accordingly, the Tribunal instead of rejecting the “economic ownership” concept from transfer pricing perspective could have reviewed or analysed whether any direct return would accrue to legal owner because of economic value that is being generated by AMP spend in India. Assuming capital gain on sale of brand by foreign company seems to be far-fetched and based on assumption.

The observation of the Hon’ble Tribunal that the taxpayer was displaying brand of its Foreign AE in its advertisements, has incurred expenses proportionately more than that incurred by independent enterprises behaving in a commercial rational manner and accordingly it is a transaction in the nature of services needs review. The prime objective of the advertisement and marketing is to communicate, is to reach potential or prospective customers and influence their awareness, attitudes and buying behavior. Such communication might happen by displaying full ad or just by displaying logo or brand name, till such ad is communicating about the taxpayer in India to its potential customer it should not be of much relevance that someone else is the legal owner of the brand name. The question which needs an answer in this case if logo of “LG” is displayed in India, the Indian customer will go to Korea or some local market in India for buying a product.

Trust the same would find you useful.

For assistance on transfer pricing and tax issues, please feel free to call us.

Best Regards
CA Gaurav Garg
JGarg Economic Advisors

(M) +91 9899994934
(E) gaurav@jgarg.com


Saturday, January 26, 2013

Key observation on Transfer Pricing issues by Delhi Tribunal in case of LG Electronics


Key observation on Transfer Pricing issues by Delhi Tribunal in case of LG Electronics;
  1. The Transfer Pricing Officer ('TPO') can determine ALP of an international transaction only when a valid reference is made to him by the Assessing Officer ('AO').
  2. As per section 92CA(2A), w.e.f  1-6-2011 , the TPO can compute ALP in respect of any transaction other than those referred to him by the AO.
  3. As per section 92CA(2B) w.e.f 1-6-2001 any international transaction in respect of which the taxpayer has not furnished report u/s 92E can be considered by the TPO for determining ALP.
  4. The jurisdiction of the TPO is activated only when the AO makes reference to him under section 92(1) for determining ALP in respect of certain transactions. Section 92(2A) & (2B) come into play only when sub-sec. (1) has already been set into motion.
  5. There is no requirement of previous approval of the Commissioner in respect of the international transactions which come to the notice of the TPO during the course of proceedings before him.
  6. So long as there exist some sort of understanding between two Associated Enterprises ('AE') on a particular point, the same shall have to be considered as a transaction, whether or not it has been reduced to writing.
  7. Proportionately higher amount on advertisement in comparison with similarly placed independent entities spent by the taxpayer cannot be considered as conclusive to infer that some part of the advertisement expenses were incurred towards brand promotion for the foreign AE.
  8. Proportionately higher amount on AMP can be considered as brand promotion services depending upon facts of the cases like prominently displaying brand of Foreign AE by the taxpayer in its advertisements.
  9. When it comes in the context of the Act, it is only the legal ownership of the brand that is recognized and not economic ownership.
  10. Brand promotion services in this case satisfies three salient features of international transaction.
  11. In order to be characterized as an international transaction, the following salient features must be present: - (1) There should be a `transaction‘ (2) Such `transaction‘ should be between two or more AEs and either or both of whom should be non-residents. (3) Such transaction should be of the nature as referred to in section 92B.
  12. In case the taxpayer fails to identify cost for brand promotion services, bright line test can be used as an alternative method to identify the cost.
  13.  For the purpose of bright line test, domestic companies not using foreign brands should be considered.
  14. AMP expenses refer only to advertisement, marketing and publicity expenses.
  15. The expenses in connection with the sales which do not lead to brand promotion cannot be brought within the ambit of “advertisement, marketing and promotion expenses” for determining the cost/value of the international transaction.
  16. Under the TNMM the operating profit from each international transaction in relation to the total cost or sales or capital employed etc. of such international transaction should be considered and not the net profit, total costs, sales, capital employed of the taxpayer as a whole on entity level.
  17. All the transactions needs to be separately analysed for the purposes of computation of arm's length price.
  18. There is no provision which permits set off of negative adjustment with the positive adjustment to the income on account of different international transactions.
  19. The arm‘s length price is required to be determined by any single method out of the five prescribed methods.
  20. Determination can only be carried out by way of the methods specified in the Act.
Trust the same would find you useful, soon I would be updating full discussion on the captioned case law.

For any query or assistance on transfer pricing, please feel free to call us.

Best Regards
Gaurav Garg
JGarg Economic Advisors

(M) +91 9899994934
(E) gaurav@jgarg.com





Sunday, January 20, 2013

Communiqué of BRICS Heads of Revenue Meeting Issued in New Delhi on 18th January, 2013


Following is the Joint Communique issued after the meeting of the Heads of the Revenue of BRICS Countries:

Communiqué of BRICS Heads of Revenue Meeting Issued in New Delhi on 18th January, 2013
We, the Heads of Revenue of the Federal Republic of Brazil, the Russian Federation, the Republic of India, the People's Republic of China and the Republic of South Africa held a meeting on 17th and 18th January, 2013 at New Delhi to discuss the potential areas of cooperation based on our existing commitment to openness, solidarity, mutual understanding and trust, as stated in the Delhi Declaration issued on March 29, 2012. In this context, we would like to refer to the decision taken during the BRICS Finance Ministers and Central Bank Governors meeting held in Washington DC on 19th April, 2012, wherein it was agreed by all countries to develop a cooperative approach on issues relating to international taxation, transfer pricing, exchange of information and tax evasion and avoidance.
Tax Administration Cooperation
In accordance with the above, we conducted the meeting with the primary objective of identifying specific areas of common interest and concern and finding ways and means for improving cooperation in these areas related to international taxation, transfer pricing, exchange of information, prevention of tax evasion and avoidance, and tax legislation and administration. We
   •  affirm our continued commitment to the objectives of the BRICS Heads of Revenue of promoting closer coordination and cooperation on issues of mutual concern;
   •  recognise the importance of the economic and commercial links between Brazil, Russia, India, China and South Africa and the need for us to contribute to the strengthening of these links.
We agree to extend the cooperation on the following issues of tax policy and tax administration:
 (i)  contribute to development of International Standards on International Taxation and Transfer Pricing taking into account the aspirations of developing countries in general and BRICS Countries in particular
(ii)  strengthening the enforcement processes by taking appropriate actions for non-compliance and putting more resources on international cooperation
(iii)  sharing of best practices and capacity building
(iv)  sharing of anti-tax evasion and non-compliance practices, including abuse of treaty benefits and shifting of profits by way of complex multi-layered structures
(v)  development of a BRICS mechanism to facilitate countering abusive tax avoidance transactions, arrangements, shelters and schemes
(vi)  promotion of effective exchange of information
(vii)  any other issues of common interests and concerns related to taxation.
Confronting Non-Compliance with the Tax Laws in an International Context
We express our concern at the erosion of the tax base by practices that involve abuse of tax treaty benefits, incomplete disclosure of information and fraudulent claims, and jointly agree to work together to address these concerns. We commit to prevent the base erosion and profit shifting through cooperation amongst ourselves and with other countries. We also agree to produce a paper on these subjects for mutual benefit of BRICS countries.
Capacity Building
We agree to work together towards capacity building of personnel and improvement of our systems and express our commitment to share resources, knowledge and best practices to achieve this end.
Multilateral Cooperation
We also agree to establish a central point of contact in each of the BRICS Countries for coordination of issues relating to taxation. The central points of contacts will identify issues of common interest in areas of International Taxation and Transfer Pricing and will develop a common response, interact and meet regularly, including pre-meeting before important multilateral meetings. The agreed common response of the BRICS countries would be communicated to international organisations engaged in development of standards on International Taxation and Transfer Pricing.
Governance Issues
We agree to make a commitment to continue the process of cooperation in tax administration. We agree to establish a Governance Framework in accordance with the overall BRICS commitment by May, 2013.
We reiterate the spirit of cooperation and solidarity that underlies the BRICS partnership, and look forward to extend it to the area of tax administration in a way that will benefit the people and our countries and contribute to their overall wellbeing.
We also agree:
 (i)  to inform the BRICS Summit of the outcomes of our deliberations; and
(ii)  to decide the date and place of next meeting BRICS Heads of Revenue after mutual consultation.