Recent Case Laws on Transfer Pricing - ctconline.org · Recent Case Laws on Transfer Pricing ... 4 Fosroc Chemicals India Pvt. Ltd. 7 ITC Infotech India Limited. Watson Pharma Pvt

Recent Case Laws on Transfer Pricing

Mrs. Karishma R. Phatarphekar

Partner, Global Transfer Pricing Services and Tax Litigation & Controversies

The Chambers of Tax Consultants

16 September 2015

Recent Case Laws on Transfer Pricing Recent Case Laws on Transfer Pricing

© 2012 KPMG, an Indian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.© 2015 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 3

Recent Transfer Pricing case-laws

1 Watson Pharma Pvt. Ltd.

Rampgreen Solutions Private Limited2

Sony Ericsson Mobile Communication India Pvt. Ltd

Austin Medical Solutions Pvt. Ltd.

Innodata Isogen India Pvt. Ltd.

3

5

6

Fosroc Chemicals India Pvt. Ltd.4

ITC Infotech India Limited7

Watson Pharma Pvt. Ltd. Watson Pharma Pvt. Ltd.


Facts of the case

Remuneration - Total OC plus arm’s length mark-up MAM – TNMM Approach and comparables accepted by TPO/DRP

TPO/DRP contention - Location saving (LS) arises as manufacturing activity transferred from US/Europe (high cost) to India (low cost jurisdiction)

Watson India ought to receive extra compensation on account of LS over and above the margins earned by the comparables

LS - computed based on articles appearing in journal and websites – Ad-hoc allocation of LS equally between both the entities

Watson Pharma Pvt. Ltd. (ITA 1423/Mum/2014 and 1565/Mum/2014)

Watson Laboratories Inc. – Watson US

Watson Pharma Pvt. Ltd. – Watson India

Watson US

Watson India

Wholly owned sub

India

US

Cont. mfg & Cont R&D


Tax Department Contentions

LS does arise as Watson India did not file the details of cost of manufacturing in USA and ultimate selling price to the distributors

Watson India did not submit any evidence that LS has been passed on to the end customer

The tax department relied on certain U.S. Tax Court’s cases on LS and the position taken by the Indian tax administration in the UN TP Manual

Reliance placed on published article to conclude: Manufacturing cost in India – 40% of US cost R&D cost in India - around 50 % of US cost

The TPO computed the LS and allocated equally between both the entities.

Watson India Contentions

Watson India and Watson US - Do not operate in a monopoly market - Any LS that arise would be passed on to the ultimate customers

LS (if any) is factored in the profit margin of local market comparables. Thus, specific adjustment for location savings is not required.

Reliance placed on ruling in case of GAP International Sourcing (India) Pvt. Ltd. and Action 8: Guidance on Transfer Pricing Aspects of Intangibles

Reliance on ruling of Syscom Corporation Ltd. - Where TNMM is accepted as MAM, with Watson India as tested party • Any benefits/advantages to AE – irrelevant, if;• PLI of Watson India is within the range of

comparables.

Bargaining power – important consideration• Watson US - has bargaining power because of

alternatives to procure products, thus LS should not be allocated to Watson India



Tribunal Ruling

Both the entities operate in competitive market and Watson India does not have exclusive access to the factors that may result in location specific advantages.

Rejected TPO reliance on UN TP Manual stating that Chapter 10 of UN TP Manual is the view of the Indian tax administration as the same is not binding on Appellate Authorities.

Accepted reliance placed on Action 8: Guidance on Transfer Pricing Aspects of Intangibles which states that LS adjustment is not required where local market comparables are available. Further it also accepted Watson India reliance on GAP International Sourcing (India) Pvt. Ltd

As regards non-submission of details, Tribunal relied on Special Bench ruling of UCB India (P) Ltd. wherein it was held that with respect to requirements of Rule 10D(1)(f), ‘the maintenance of these records is procedural and non-maintenance of the same is not such that it would affect the determination of ALP…’

The Tribunal deleted the adjustment made on account of LS by stating that TPO has based his computation on a method, which is not ascribed by the provisions of the Act. Further, the calculation of location saving made by the TPO is based on assumptions since it is based on articles published in different year as compared to year under consideration

“No adjustment on account of Location Savings is required when arm’s length price is determined on the basis of appropriate comparables”


Rampgreen Solutions Private LimitedRampgreen Solutions Private Limited


Taxpayer’s modelTaxpayer’s approach

• AE – overseas entrepreneur

• Rampgreen Ltd. – Offshore voice call service provider

• Rampgreen Ltd. – Compensated on a cost plus model (15 percent on Op. costs)

• MAM – TNMM

• Tested Party – Rampgreen India

A Ltd.’s functions:

• Marketing

• Contracting with end customer

• Product delivery

B Ltd.’s services include:

• Offshore voice call services

AE Customer

Rampgreen India

Voice call services

(ITeS)

Tax Department’s approach

• TPO made adjustment (including KPO companies as comparables)

• DRP – Upheld TPO’s adjustment stating, no further sub-classification under ITeS is warranted

• Tribunal – Upheld DRP’s direction

Recent rulings - KPO vs BPORampgreen Solutions Private Limited vs CIT (ITA 102/2015)


Delhi High Court ruling in case of Rampgreen Solutions Private Limited vs CIT (ITA 102/2015):

High Court expressed reservations on the methodology for selection of comparables on a broad ITeS level as advocated in the Special Bench ruling in case of Maersk Global

Entities performing voice call center services (BPO) and KPO services may be employing different IT systems, services, functions, quality of manpower and undertaking different risks. Thus, comparing high-end KPO service providers with low end BPO centers would be unreliable and possibly flawed

Tribunal view that there can be no sub-classification of services falling under ITeS is difficult to be accepted and is contrary to the fundamental rationale of determination of arm’s length price (ALP)

Organisation for Economic Co-operation and Development (OECD) Guidelines and the provisions of the Income-tax Act, 1961 does not provide for removal of comparables only on the basis of high profits. However, supernormal profits may in certain cases indicate functional dissimilarity having material impact on the profitability. In such situations, further analysis must be conducted to eliminate situations arising on account of any material dissimilarity between the taxpayer and the comparables.



Key Considerations

Functional comparability is the key criteria for the selection of comparable companies

Broad functionality test is inappropriate as not being in accordance with transfer pricing principles. However, in case of a mixed bag i.e. a taxpayer rendering a mix of BPO and KPO services, broad functionality test can first be performed and then materially dissimilar companies can be eliminated

Functionally dissimilar companies cannot be considered as comparable taking recourse to TNMM, which is less sensitive to functional differences

Comparables cannot be excluded only on the basis that their profits are high. However, supernormal profit warrants a further analysis in terms of functional dissimilarity as compared to the tested party



Marketing Intangibles -


Marketing Intangibles -



Marketing Intangibles - Issue involved

F Co licenses brand & distribution right to I Co

AMP; distribution network key business drivers

AMP, other sales and distribution expenses to be borne by I Co or F Co?

Indian Revenue F Co to pick-up “extra” AMP expenses

INDIA

Flow of legal title of goods Physical movement of goods

Indian customer

Marketing intangibles trademark (brand, logo), trade name, distribution network, customer lists etc.

F Co

I CoDistributor


Recent landmark rulingsSony Ericsson Mobile Communication India Pvt. Ltd vs CIT (ITA No 16/2014)

Delhi High Court ruling in case of Sony Ericsson Mobile Communication India Pvt. Ltd vs CIT (ITA No 16/2014):

If distributor taxpayer performs all-encompassing functions of AMP & buy-sale of products, it is entitled to receive one/ single remuneration model of “margin” through pricing of products

If taxpayer performs higher AMP functions than comparables, it would be entitled to receive higher remuneration than comparables

No straight jacket formula for receiving higher remuneration; taxpayer free to choose between− Pricing of products, i.e. distribution margin (aggregation approach);− Direct reimbursement of AMP expenses (segregation approach)

Revenue cannot insist upon direct reimbursement of AMP expenses as only means of higher reward If taxpayer had already earned higher “margin” after duly factoring in differences in levels of AMP functions, then

no further adjustment on account AMP is permissible For justifying argument of “margin”, selection of comparables, having similar intensity of functions on account of

AMP, as taxpayer, is key; else proper adjustments to be made High Court did not provide guidance on the nature of adjustments that may be required Concepts of economic ownership of brand recognized & approved Complex licensed manufacturers cannot adopt overall TNMM approach - to follow transaction by transaction

approach AMP expenses held to constitute “international transaction”


Fosroc Chemicals India Pvt. Ltd.Fosroc Chemicals India Pvt. Ltd.


Fosroc Chemicals India Pvt. Ltd. vs DCIT [IT(TP)A. No. 148/Bang/2014]

Fosroc Chemicals India Pvt. Ltd. vs DCIT [IT(TP)A. No. 148/Bang/2014]:

Fosroc India - Manufacturer and distributor of specialty construction chemicals.

Fosroc UK – Supply of technical know-how and provision of technical and management service

International Transaction - Payment towards technical and management services under the cost contribution agreement. Other international transactions with AEs - purchase of raw materials, purchase and sale of trading goods, etc.

The costs pertaining to such services was apportioned by the AE based on the turnover of various group entities to whom the services were rendered.

MAM – TNMM at the enterprise level. Technical and management service were integral to the primary business segment of the taxpayer

TPO - Rejected TNMM observing that the payment made by the taxpayer for technical and management cost was an independent transaction - to be analysed using CUP method

ALP determined by TPO – NIL

Fosroc India

B Ltd.

Provision of technical and

mgmt. services

India

Fosroc Chemicals India Pvt. Ltd. – Fosroc India

Fosroc International Ltd., U.K. -Fosroc U.K.

Outside India


Fosroc Chemicals India Pvt. Ltd. vs DCIT[IT(TP)A. No. 148/Bang/2014]

Tribunal’s Ruling:

It is wholly irrelevant as to whether the taxpayer benefits from it or not; the real question is whether a third party would have paid for the services in an independent situation

In a case where expenses are actually reimbursed without a mark-up, tax base erosion can happen only if the costs reimbursed are inflated. It is important to determine whether the costs claimed to have been apportioned between the various group entities have not been inflated and are allocated on a proper basis. Reliance was placed on Delhi High Court ruling in case of EKL Appliances Ltd and Cushman & Wakefield India

Determination of the arm’s length price of intra-group services would involve:a) Identification of the cost incurred by the group entity in providing intra-group servicesb) Understanding the basis for allocation of cost to various related partiesc) Whether intra-group services will require reimbursement of expenditure along with mark-upd) Identification of arm’s length mark-up for rendering of services.

)It should be determined whether intra-group services are duplication of services for which the AE has already paid.

)Filing of voluminous correspondence, reports etc., would not be a proper way of discharging the taxpayer’s burden to establish the ALP

)Profit methods cannot be considered in case of expense transaction and generally, CUP would be the MAM.

)The Tribunal agreed with the approach of aggregating all international transactions, provided the taxpayer is able to establish that different segments have benefited from the services received from the AE


Fosroc Chemicals India Pvt. Ltd. vs DCIT [IT(TP)A. No. 148/Bang/2014]

Key Considerations

• In case of expense transactions having no mark-up, it is necessary for the taxpayer to maintain adequate documentation to substantiate that the cost base is not inflated.

• Add credence to documentation by having the cost base certified by the CPA.

• Based on the decision, CUP appears to be a preferable approach in case of cost-to-cost transactions. However choice of method shall depend on the availability of CUP data and the taxpayer could resort to TNMM as the MAM.

• While the Tribunal in this case has disregarded the correspondence and reports maintained by the taxpayer, it still seems important that the taxpayer maintains adequate evidence to substantiate the receipt of services.

• In the absence of any guidelines for maintaining the documentation, the taxpayer can leverage on other decisions as in the case of McCann Erickson India Pvt. Ltd [ITA No. 5871/Del/ 2011] for the detailed guidelines.


Innodata Isogen India Pvt. Ltd.Innodata Isogen India Pvt. Ltd.


DCIT vs Innodata Isogen India Pvt. Ltd. (ITA 1528/Del/2011)

Facts:

Innodata India - providing content related services to its AE

MAM – TNMM using multiple year data

The TPO rejected the taxpayer’s approach of using multiple year data and determined the ALP of provision of IT enabled services using current year data i.e. FY 2004-2005.

TPO observed that the taxpayer is earning only 60% of the overall profit, with the AE retaining the remaining 40%, which is not commensurate with functions performed, as the AE is merely involved in marketing and co-ordination activities while the Taxpayer performs all the other major functions in India.

The CIT(A) deleted the addition made by the TPO with the following observations/clarifications: Taxpayer is not a back office or a captive unit, but faces market and other

related risks/uncertainties just like the AE, as both the AE and the taxpayer are exposed to volume fluctuations in the business. Thus, the taxpayer is not a risk free service provider who is typically compensated on a cost-plus basis and earns a low and consistent return on a year-on-year basis.

project continuity is a key determining factor in the taxpayer and AE’s business. Almost 94 per cent of the taxpayer’s business during FY 2004-05 constituted of recurring projects, which had been contracted at fixed billing rates in earlier years. This necessitated the use of multiple year data of the previous two financial years

the taxpayer’s revenue model is based on a price per transaction undertaken for its AE. This price received by the taxpayer is determined as a percentage of the sale price derived by the AE from sale to its end customer.

Innodata India

AE

Provision of ITeS

Outside India

India



The Tribunal concurred with the contentions of the taxpayer and the various findings of the CIT(A) on the applicability of multiple year data in the taxpayer’s case

Tribunal agreed with the fact that the AE was exposed to various risks on account of market, service liability, R&D/ technology, credit, and price fluctuations. Moreover, majority (76%) of the revenue from India activities was transferred to the Taxpayer during the year, on which the Taxpayer earned a higher operating profit margin (6.63%) than the AE (3.35%)

In view of the prior years TP orders of the taxpayer where multiple year data had been accepted by the TPO and the documents furnished by the taxpayer relating to the U.S. TP audit supporting use of multiple year data, the Tribunal held that the adjustment made by the TPO by ignoring multiple year data and using only the current year data was arbitrary and unjustified

Key considerations

The use of multiple year data vis-à-vis single year data has been a much litigated issue since the inception of TP regulations in India. Coming close on the heels of the draft scheme on range concept and multiple year data, the ruling provides a welcome relief to taxpayers and supports the use of multiple year data, in cases where the condition prescribed in the proviso to Rule 10B(4) is satisfied.

It sets a good precedent of taking into due consideration, a taxpayer’s business and revenue model for ALP determination

DCIT vs Innodata Isogen India Pvt. Ltd. (ITA 1528/Del/2011)


Austin Medical Solutions Pvt. Ltd.Austin Medical Solutions Pvt. Ltd.


Austin Medical Solutions Pvt. Ltd. vs. ITO [I.T.(TP)A. No. 542/Bang/2012]

Facts:

Austin India – Engaged in export of software and ITeS. Total Income as per Return of Income (RoI) – NIL

In the RoI, the taxpayer claimed deduction under Section 10A of the Act, in respect of the entire business income including the amount of suo moto TP adjustment and arrived at nil total income.

The AO, for the purpose of computing the deduction under Section 10A, disallowed the amount of suo moto TP adjustment

Reliance placed by taxpayer on iGate Global Solutions

CIT(A) upheld the action of the AO. Reliance was placed upon the ruling of the Karnataka High Court in the case of Yokogawa India Ltd. It distinguished the decision in case of iGate Global Solutions Ltd., holding that the methodology of computation of deduction under Section 10A of the Act was not brought to the notice of the Tribunal in the case of iGate Global Solutions Ltd.

Suo moto TP adjustment - INR 20

Austin India(Tax Holiday

Entity)

AE

Provision of services - TP

- INR 80

Outside India

India

ALP of services - INR 100



The Tribunal held that the taxpayer be allowed a deduction under Section 10A of the Act, in respect of the suo moto transfer pricing adjustment carried out in the ROI

Reliance was placed by the Tribunal on the ruling of the coordinate bench and Hon’ble Karnataka High Court in the case of iGate Global Solutions Ltd., wherein the Bench had allowed deduction under Section 10A of the Act in respect of suo moto TP adjustment carried out by the taxpayer and High Court upheld the decision of coordinate bench.

The Tribunal held that judgement of the Hon’ble Karnataka High Court in the case of Yokogawa India Ltd. relied upon by the CIT(A), did not deal with the question of allowability of deduction under Section 10A of the Act, in respect of the suo moto TP adjustment made by the taxpayer.

However, in case of Agilisys IT Services India Pvt. Ltd., the Mumbai Tribunal has held that the taxpayer is not entitled for deduction under Section 10B of the Act in respect of the suo moto addition made by the taxpayer as per Form No. 3CEB but not brought into India within the stipulated time frame

Austin Medical Solutions Pvt. Ltd. vs. ITO [I.T.(TP)A. No. 542/Bang/2012]


ITC Infotech India Limited ITC Infotech India Limited


Recent rulings - ITC Infotech India Limited Recent rulings -

Arrangement - 1 Arrangement - 2

Under both arrangements – AE shares 25 per cent of the total revenue from the customers

IT Services

Sub-contract Mktg. and

Admin function

AE

ITC India

Customer

Direct contract

Outside India

India

Sub-contract IT services

AE

ITC India

Customer

Direct

con

tract

ITC Infotech India Limited – ITC IndiaAssociated enterprises - AE

IT S

ervic

es


Recent rulings - ITC Infotech India Limited

Business Model - Integrated ‘Global Delivery Model’ - customers may choose to enter into the contract with ITC India directly or its AEs.

MAM - cost plus method; Tested party - AEs were selected as tested parties

TPO made adjustments in respect of the contracts directly entered into by the taxpayer with the customers i.e. for account management charges paid to its AEs for availing of marketing and administrative support services

Tribunal’s observations/ruling:

ITC India performed non-administrative i.e. IT services under both the business models and thus entire risks were being borne by ITC India irrespective of the business model

Under both the business models - Essential factor for awarding a service contract would be technical and commercial expertise and experience of ITC India

Conduct of the taxpayer and its AEs should be given due cognizance which is same in both the business models

Execution of the agreement directly by the taxpayer or by the AE – No substantial difference in the sharing of functions or risks and hence, does not change the functional characteristic of the parties

Contracting parties different in both the business models - however functional and risk profile remain same in both the models and deleted the adjustment

Conduct of parties an essential factor in application of the concept of risk allocation between taxpayer and its AE

© 2015 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The KPMG name, logo and "cutting through complexity" are registered trademarks or trademarks of KPMG International Cooperative ("KPMG International").

Thank You

Documents

Recent Case Laws on Transfer Pricing - ctconline.org · Recent Case Laws on Transfer Pricing ... 4 Fosroc Chemicals India Pvt. Ltd. 7 ITC Infotech India Limited. Watson Pharma Pvt