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

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AAR: Income not chargeable to tax are also covered under TP provisions

Recent ruling by Advance Ruling Authority (‘AAR’), dated August 14, 2012, in case of Castleton Investment Limited [A.A.R. No.999 of 2010] came as a surprise to many stake holders on applicability of transfer pricing.

Though the ruling was on other issues as well but this write-up is limited to the issue pertaining to applicability of transfer pricing provision in India.

The Applicant, M/s Castleton Investment Limited of Mauritius (‘CIL’), raised a question that if the transfer of shares by the applicant to its associated enterprise is not taxable, whether the provisions of section 92 to section 92F of the Act relating to transfer pricing would be applicable? In response to the same AAR observed that the applicability of section 92 does not depend on the chargeability under the Act. The only saving grace is that the judgement is only applicable in on that applicant and on that transaction for which it is sought.

Facts of the Case

Glaxo Smithlkine Pharmaceuticals Limited (GSKPL) is a company incorporated in India. The applicant had acquired 600,000 shares in it in the year 1993. It also acquired 1,680,170 shares in Burroughs Wellcome (India) Limited (‘BWL’) in the year 1996. GSKPL and BWL merged.  In the year 2004, the applicant received in lieu of the shares held by it in BWL, shares in GSKPL. These shares were held as investment in the books of CIL. As a part of reorganization, CIL propose to transfer shares held in GSKPL to its associated enterprise, Glaxo Smithlkine (Pte) Limited.

On transfer of shares, AAR observed that any capital gain arising from such transfer would not be taxable in India.

Question

Whether the provisions of section 92 to section 92F of the Act relating to transfer pricing would be applicable?

Observation of AAR

It is not material that the gain or income is taxable in the country or not, section 92 to 92F would apply if the transaction is one coming within those provisions. In case, where there is no liability what would be the purpose of undertaking a transfer pricing exercise is not a question that would affect the operation or rigour of a statutory provision on its plain word. There is nothing to show in transfer pricing provisions that the expression ‘income’ has to be given a restricted meaning and the applicability of section 92 does not depend on the chargeability under the Act. 

Comment

This ruling of AAR will only going to create confusion in the minds of taxpayer and consultant. It is quite strange to observe that AAR has disregarded its earlier ruling in the case of Praxair Pacific and Vanenburg Group BV. A view that transfer pricing provisions are applicable even on those transactions wherein income is not taxable in India, is like a shaft without arrowhead. 

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Best Regards

CA Gaurav Garg

JGarg Economic Advisors

www.jgarg.com

Delhi ITAT: Information regarding secret data used by the tax department should be shared with the taxpayer

In the case of Adobe Systems India Pvt. Ltd. vs. JCIT (ITA No.5693, Del, 2011), Delhi Bench of the Income Tax Appellate Tribunal observed that in case tax authorities uses some information or data, in respect of which information is not available in public domain (secret data), for the purpose of computation of the arm's length price in such case such information/ data should be supplied to the taxpayer for his objection or examination. The absence of such opportunity violates the fundamental principle of natural justice. 

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CA Gaurav Garg

Abhishek Agarwal

JGarg Economic Advisors Pvt. Ltd.

New Delhi, India

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Mumbai ITAT: Taxpayer should charge interest on loan given to non resident AEs

In its recent judgment in the case of M/s Tata Autocomp Systems Ltd. vs. ACIT Mumbai bench of Income Tax Appellate Tribunal (‘Mumbai ITAT’) observed that the lending or borrowing money between two associated enterprises comes within the ambit of international transaction and taxpayer should charge interest from its non resident associated enterprise.

Facts of the case:

The taxpayer is a company, involved in the manufacturing of indoor plastic, rendering engineering services, supply chain management services and administrative support for joint venture companies. In order to have better supply chain management and relationship with the customer in Europe, the taxpayer established a manufacturing company TACO Kunstsofftechnik GMBH (‘TKT’) in Germany. During the year under review, in order to assist TKT during start-up phase and because of commercial expediency, the taxpayer granted the interest free loan to TKT.

The case was referred to the transfer pricing officer (‘TPO’). The TPO rejected the interest free pricing of the transaction and re-computed the arm’s length price by considering lending rate equal to 10.25 % based on loans received by the taxpayer from Indian banks. The taxpayer took an alternative stand before the TPO, without prejudice to the its stand of interest free loan, that even if interest isto be charged on the interest free loan provided by the Assessee to TKT, the same should berestricted to 4.15% which is the rate specified in the benchmarking exercise conducted by theassessee for ascertaining the arm's length interest rate.

The taxpayer filed an appeal before the Dispute Resolution Panel (‘DRP’) against the order of the TPO. On review of the appeal, The DRP upheld the order of TPO but arrived at 12% rate ofinterest and directed the AO to recalculate the adjustment adopting rate of interest at 12% perannum instead of the calculation at 10.25% in the TPO's order.

Against the directions issued by the DRP, the taxpayer filed an appeal with the ITAT. The observation of the same are given below

Observations of Mumbai ITAT:

• Interest free loan extended to the associated concerns as at arm's length lending or borrowing money between two associated enterprises comes within the ambit of international transaction and whether the same is at arm’s length price has to be considered.
• The fact that the loan has the RBI's approval does not put a seal of approval on the true character of the transaction from the perspective of transfer pricing regulation as the substance of the transaction has to be judged as to whether the transaction is at arm’s length or not.
• Relying upon the judgment in the cases of DCIT v. M/s Tech Mahindra Ltd.(Mumbai Tribunal) and M/s Siva Industries & Holdings Ltd. v. ACIT ( (Chennai Tribunal), the tribunal ruled that the claim of the taxpayer to adopt EURIBOR rate as stated before the TPO is reasonable and deserves to be accepted. And also observed that the rate of interest to be used for benchmarking shall be the rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate.

Our Comments:

Judgement is in line with the well recognised arm’s length principle and also reinforces the pricing principle that for foreign currency loan one should not consider Indian currency loan rate. 

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CA Gaurav Garg

CA Parul Mittal

JGarg Economic Advisors Pvt. Ltd.

New Delhi, India

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Chennai ITAT: Uncontrolled price on date of sales contract should be considered as CUP

In case of Liberty Agri Products (P) Ltd (IT APPEAL NO. 1610 (MDS.) OF 2010), the Income-tax Appellate Tribunal of Chennai (‘Chennai ITAT’) has observed that uncontrolled price on the date of sales contract should be considered as comparable uncontrolled price (‘CUP’) instead of uncontrolled price on the date of shipment received on the port.

Liberty Agri Products (P) Ltd. (‘Taxpayer’) is a part of M/s Kuok Group. During FY 2005-06, the taxpayer entered into transactions with its group company in Singapore, wherein the taxpayer purchased edible oil worth USD 23,530,749.06 and applied CUP as the most appropriate method. For the purpose of CUP, the taxpayer relied upon internal CUP (i.e. sales made by the associated enterprise in comparable transactions to third parties in India) and also on notification issued by the Custom Authorities in respect of tariff value on import of edible oils on the date of signing of sales contract. As corroborative evidence the taxpayer also documented the rates of oil published by Solvent Extractors Association of India in relation to degummed soya bean oil could also be well relied on.

During the transfer pricing scrutiny, the transfer pricing officer rejected the CUP data of the taxpayer and instead took Customs average rage at Kandla Port. As there was difference of more than 5% per metric ton, the transfer pricing officer suggested an addition of Rs. 26. 13 million.  

The taxpayer appealed before the Chennai ITAT, after an unsuccessful attempt before lower authorities.

Chennai ITAT agreed to the contentions of the taxpayer that instead of comparing the price with the Customs tariff rate on the date of entry into the port, the transfer pricing officer should have compared the price declared by the taxpayer with the Customs tariff rate at Kandla Port as it is stood on the day of contract of sale entered into between the taxpayer and its associated enterprise. Further, Chennai ITAT also observed that in these types of bulk purchases and sales, it is always better to compare the price of individual consignments rather than on a compromise of average price. 

In case if you have any query on transfer pricing, please feel free to call us.

Best Regards

Gaurav Garg

JGarg Economic Advisors

New Delhi, India

www.jgarg.com

(P) +91 11 470 94934

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(E) gaurav@jgarg.com