Docstoc

International Taxation - CA In Delhi India_ CA

Document Sample
International Taxation - CA In Delhi India_ CA Powered By Docstoc
					Presented By


        CA Swatantra Singh,            B.Com , FCA, MBA

        Email ID: singh.swatantra@gmail.com
        New Delhi , 9811322785,
        www.caindelhiindia.com,
        www.carajput.com


                                                          1
Issues on International Taxation




                                   2
What we Discuss To-day
    Why


   What        is
                        International
                          Taxation
               to
   How    understand
           / practice



                                        3
    Why International Taxation
 Globe is called as Global Village
 Globalization
 Movement of People – Concurrent Earnings
 Borderless Global Economy - Internet
 Resource of Competent and Enterprising Tax
  Professionals
 Movement of Cross Border M & A close to
  consumers and Virgin Untapped Markets
 Double Taxation Conflicts


                                               4
     What is Globalization ?


Globalization is the phenomenon of
 Sourcing Capital from where it is cheapest,
 Sourcing People from where it is best available,
 Producing where it is most Cost Effective and
 Selling where there is Market for.        Back




                                                     5
Double Taxation Conflicts
 Residence rule due to personal attachment –
  protection to person etc
 Source rule due to economic attachment –
  economic activities with in that country
 Primary right should be on the activity –if
  all states practice territorial tax no issue-
  many states follow right to tax worldwide
  income of their residents

                                                  6
Double Taxation Conflicts
 Double Tax is built in the system as part of
  the Classical tax system of respective
  country
 Double Tax is harmful for international
  trade




                                                 7
Double Taxation Conflicts
 Types of Conflicts -
  * Source-Source conflicts
  * Residence-Residence conflicts
  * Residence – Source conflicts
  * Income characterization conflict
  * Entity conflicts
  * Mismatching Tax systems (taxable
   income and computation of taxes)

                                       8
    Double Taxation Conflicts
    Resolution
 Bilateral Relief
  - Negotiated sharing of the tax revenues by two countries
    sought
     • Developed countries usually have balanced sharing of
       tax revenues
     • Developing countries may have unbalanced sharing as
       they are governed by economic, social as well as
       revenue considerations
 Unilateral Relief
  - Section 91 of the Act

                                                              9
What is International Taxation

 Purpose of International Taxation


 Objectives of International Taxation


 Legislation of International Taxation



                                          10
Purpose of International Taxation


    Taxing Residents World-Wide Income


    Taxing Non-Residents National Income




                                            11
  Purpose of International Taxation
                 India                       Germany

               Mr. Patel -                   Mr. Patel -
            Indian Resident.              German Interest
             Indian Income                 Income Rs.100.
               Rs. 1,000.
                                             Mr. Smith -
               Mr. Smith -                German Resident.
             Indian Interest              German Income
            Income Rs. 200.                  Rs. 2,000.


INDIA would want to tax Mr. Patel                            Amount
                                                             (in Rs.)
On his Indian Income – On Source + Residence Basis                      1,000
German Income      - On Residence Basis                                  100
                                                Sub Total               1,100
India would also tax Mr. Smith

on his Indian Interest income on Source Basis                            200
                                                    Total               1,300
                                                                                12
 Purpose of International Taxation
Germany would tax Mr. Smith                                    Amount
                                                               (in Rs.)
On his German Income on Source + Residence Basis                      2,000
On his Indian Income on Residence Basis                                   200
                                                       Total          2,200
Germany would tax Mr. Patel


On his German Income on Source Basis                                      100
                                                       Total          2,300
Thus – Domestic Income by a resident causes no problems
of Double tax.                                                   Rs. [3,000]


Only when a resident of one country gets income from
another country, Double tax issues arise                          Rs. [300]


                                                                                13
Objectives of International Tax




                                  14
Legislation of International Taxation
   Global tax rules for cross border transactions
   No separate Codified law – No separate tax - no
    separate court
   Provisions of Domestic law to handle Cross Border -
    Direct & Indirect Taxes
   International Tax Principles
   Accepted Convention - Can not enforce tax on
    territory of another country
   EU Directives / Model Commentaries


                                                          15
Legislation of International Taxation

                International Law



                International Tax




               Tax Treaties


                                        16
How to Understand International
Taxation
      Models
      Tax Treaties
            - Meaning
            - Objectives
            - Formation
            - Types
            - Coverage
            - Treaty Position in India
            - Structure
            - Discussion of the Articles
      Limitation of Benefits
      Interpretation of Treaties


                                           17
MODELS
 Are we talking about Role Models




 Mahathma        Swami        Atal Bihari
  Gandhi       Vivekananda    Vajpayee

                                            18
MODELS
 Are we talking about Super Models




  Aishwarya Katrina       Priyanka
      Rai   Kaif          Chopra

                                      19
MODELS
 We are talking about Model Conventions

     OECD Model Convention

           UN Model Convention

                 US Model Convention

                     Indian Model Convention


                                               20
Model Conventions
 Tax Treaties are based on Model Conventions
 Why do we need a Model Tax Convention?
 What is a Model Tax Convention?
 What is the legal value of a Model Tax
  Convention?
 Model Conventions
   - OECD Model
   - UN Model
   - US Model
                                                21
Model Conventions
 Rules for interpretation of Tax Treaties –
  Vienna Convention on the Law of Treaties,
  1969 (VCLT)
   - codifies customary international law,
     hence, the rules contained in it also apply
     to the interpretation of treaties between
     states which are not parties to the VCLT



                                                   22
      Model Conventions
 OECD Model
   - Emphasis on residency based taxation
   - Usually adopted by developed countries in case of treaties with
      other developed countries
   - Regularly updated / amended - latest version is July 2008
 UN Model
   - Emphasis on source based taxation
   - Used by developed countries for treaties with developing
      countries or between two developing nations
 US Model
   - Used by USA for all treaty negotiations
Most Indian Treaties are based on UN Model


                                                                       23
Tax Treaties - Meaning
 Meaning of Tax Treaty (DTA) - A tax treaty is
  a formally concluded and ratified agreement
  between two independent nations (bilateral
  treaty) or more than two nations (multilateral
  treaty) on matters concerning taxation
  normally in written form.
 Doctrine of Incorporation – Direct effect-
  US & France
 Doctrine of Transformation – Indirect
  effect- Germany, India

                                               24
Tax Treaties - Objectives
                                Avoid Double
                                  Taxation
                Limit tax                       Prevent Fiscal
                                                   Evasion



                                                            Allocating
      Prevent Tax
                                                             Taxing
     Discrimination
                                                           Jurisdiction
                             OBJECTIVES

                                                         Promote
       Certainty of                                    Investment &
     Tax Treatment to                                     Mutual
        Investors                                         Relation
                                           Ease in
                        Exchange of
                                          Recovery
                         Information
                                         of Tax Dues




                                                                          25
Tax Treaties - Formation
 Formation of Tax Treaties –
  A DTA develops in six stages, which follow a
  fairly well established procedure
  (1) Negotiation
  (2) Initialling
  (3) Signature
  (4) Ratification
  (5) Entry into force
  (6) Effective Date


                                                 26
Tax Treaties - Types
 Types of Tax Treaties –

  Comprehensive Agreements – This is wider in scope
  addressing all sources of income.

  Limited Agreements – which has limited scope and covers
      a) income from operation of aircrafts and
         ships,
      b) estates,
      c) inheritance and
      d) gifts.



                                                            27
Tax Treaties - Coverage
 Coverage of Tax Treaties –


  Bilateral Treaties – The treaty is entered into
  between two countries

  Multilateral Treaties – The treaty is entered
  into between two or three countries.




                                                28
Tax Treaties – Position in India
 Treaty Position in India -
  * Section 90 of the Act empowers the Central government to enter into tax
  treaties with the government of any foreign country
  * India has entered into tax treaties with more than 90 countries
  * Place of treaties in the legal system depends on the country’s view on
  international law / constitutional arrangements
   - Most countries: treaty prevails over domestic law
   - Some countries (eg US): treaty equals domestic law
  * The tax payer may opt to be governed by the Act or the tax treaty, whichever
  is more beneficial but cannot pick and choose the provisions
   - Circular No 333 of 1982;
   - Azadi Bachao Andolan 263 ITR 706 (SC);
   - Vishakapatnam Port Trust 144 ITR 146 (AP)



                                                                                   29
Tax Treaty - Structure
   Application              Distributive    Anti-Avoidance      Miscellaneous
    Articles                   Rules          Provisions         Provisions
 •Art. 1 – Persons                          •Art. 9 –          •Art. 24 –
 Covered                  • Active          Associated
                                                               Non Discrimination
                           Income :         Enterprises
 • Art. 2 – Taxes
 Covered                                                       • Art. 25 –
                          Art. 7, 8, 14,    • Art. 23 –        Mutual Agreement
 • Art. 3 – General       15, 16, 17,       Elimination of     Procedure
 Definitions                                Double Taxation
                          19 and 20
                                                               • Art. 28 –
 • Art. 4 – Resident
                                            • Art. 26 –        Members of
 • Art. 5 – Permanent                        Exchange          Diplomatic
 Establishment            • Passive         Of Information     Missions and
                            Income :                           Consular
 • Art. 30 – Entry into                     • Art. 27 –        posts
 Force                                      Assistance
                          Art. 6, 10, 11,                      • Art. 29 –
 • Art. 31 –              12, 13,           In Collection of
                                                               Territorial
 Termination                                Taxes
                          18 and 21                            Extension




                                                                                    30
       Tax Treaty - Structure
Active Incomes                               Passive Incomes

Art. 7 - Business Profits            Art. 6 - Immovable Property
Art. 8 - Shipping, etc.                       Art. 10 - Dividends
Art. 14 - Independent Personal Services       Art. 11 - Interest
Art. 15 - Dependent Personal Services         Art. 12 - Royalties & FTS
Art. 16 - Directors                           Art. 13 - Capital Gains
Art. 17 - Artistes & Sports persons Art. 18 - Pensions
Art. 19 - Government Services
Art. 20 – Students
Art. 21 - Other Income




                                                                          31
Tax Treaty – Definition of Articles
     Scope -
     Article 1- Applicability -Applies to a person who is a resident of one
        or both the countries.

     Article 2- Taxes covered- Taxes on income and capital
      Indian taxes covered are income tax, surcharge and cess
      FBT or DDT? Interest / Penalty?

     Article 30-Entry into force
       This article tells when and how a DTA becomes operative

     Article 31-Termination
       This article tells when and how a DTA can be terminated




                                                                              32
Tax Treaty – Definition of Articles
      Article 3-General Definitions
     1. Person –Individual, Company, taxable unit (Partnership?)
     2. Company-Body corporate or entity treated as company or body
        corporate for tax purposes
     3. Contracting State – India or the other country
     4. Enterprise of a Contracting State
     4. Competent Authority –Ministry of Finance (Dept. of Revenue)
     6. National

     Undefined Terms-meaning to be as defined under the domestic tax laws
        applicable to the taxes covered in the treaty –
     Static or Dynamic
     Different views by 2 countries




                                                                        33
Tax Treaty – Definition of Articles
     Article 4 - Residence
     A person is a resident of a country if he is liable to tax in the country
        by virtue of:
         - Domicile
         - Residence
         - Place of Incorporation
         - Place of management
         - Any other criterion of a similar nature

      Tie-Breaker Rules- In the case of a dual resident, the tie-breaker
        rules shall apply to determine the residential status
         a) In the case of an individual his personal and economic ties
        determine his residential status
         b) In the case of others it is the place of effective management




                                                                                 34
Tax Treaty – Definition of Articles
     Article 5 - Permanent Establishment (PE)
      Means a fixed place from where the business of the
       enterprise is carried on

      PE includes place of management, branch, office,
       factory, workshop, mine, quarry, an oil or gas well, a
       construction site for long duration, a services location
       for long duration and a dependent agency with power
       to conclude contracts




                                                              35
 Tax Treaty – Definition of Articles
ACTIVE & PASSIVE INCOME
 Passive Income-refers to income derived from investment
  in tangible / intangible assets.

      Equity Investment                      Dividend
             Debt                    Yiel     Interest
   Right/Permission to use                     Rent /
                                      ds
            assets
   Disposal of capital assets                Royalties
                                            Capital Gain
             owned
  Active Income is the income derived from carrying on
  active cross border business operations or by personal
  effort and exertion as in case of employment.
 Assignment Rules & Source Rules


                                                            36
                                                             36
Tax Treaty – Definition of Articles
    Type of Distributive Rules -
       Exclusive right to tax is with country of
        source of object
       Source country reserves limited right or
        shared taxation of the object
       Source country can tax fully but does not
        have exclusive right (Business profits)
       Exclusive right to tax with country of
        residence of subject (Mauritius-Capital
        gain)

                                                    37
           Tax Treaty – Definition of Articles
Passive Income Distributive Rights -
 Article      Nature of Income        Taxing Right            Taxing Right         Remarks
  Ref.                                 of Source               of State of
                                          State                Residence
6           Income from Immovable    Has the first right to
            Property                 tax
10          Dividend Income          Has the right                              Dividend is not
                                                                                taxable in India.
                                         to tax                                 DDT is levied upon
                                     provided rate                              the        company
                                        does not               Reserves         declaring dividends
11          Interest Income           exceed the              the right to
12          Royalties and Fees for   agreed rate of               tax
            Technical Services         tax as per
                                         DTAA
13          Capital Gains            Has the first right to                     Tax     can      be
                                     tax                                        determined as per
                                                                                the domestic lax
18          Pensions                 Cannot tax pension       Can tax Pension


                                                                                              38
      Tax Treaty – Definition of Articles
Active Income Distributive Rights -
 Article     Nature of         Taxing Right of             Taxing          Remarks
  Ref.        Income            Source State               Right of
                                                           State of
                                                          Residence
 7         Business Profits   Yes, if PE exists in the                Income attributable to
                              source state                            PE alone can be taxed
                                                                      in source state
 8         Shipping & Air     Cannot tax this income
           Transport
 14        Independent        Yes, if the person has a    Reserves    Income attributable to
           Personal           fixed base or his stay      the right   Fixed Base alone can
           Services           extends beyond 90                       be taxed in source state
                              days                          to tax
 15        Dependent          Yes, if employment is                   If salary is paid on
           Personal           exercised in the source                 behalf     of   foreign
           Services           state. Cannot tax if stay               employer and is not
           (Employment)       is less than 183 days                   borne by PE, then
                                                                      source state cannot tax
                                                                      the salary


                                                                                           39
     Tax Treaty – Definition of Articles
Active Income Distributive Rights -
Article     Nature of           Taxing Right of             Taxing         Remarks
 Ref.        Income              Source State               Right of
                                                            State of
                                                           Residence
16        Directors’ Fees      Yes, the source state
                               can tax the same
17        Artiste & Athletes   Yes, the source state                   DTA may specify the
                               can tax the same                        extent to which the
                                                                       income may be exempt
19        Govt. Service        No, unless the person       Reserves
          Remuneration         rendering         service
                               happens to be a
                                                           the right
                               resident of and national      to tax
                               of the source state
20        Students &           No taxing rights
          Apprentices
21        Other Income         Yes, the source state
                               can tax the same




                                                                                        40
    Tax Treaty – Definition of Articles
Anti-Avoidance Provisions -
   Article         Title              Comments
    Ref.
             9 Associated Adoption of Arms Length
               Enterprises Price in transactions between
                           Associated Enterprises

         26 Exchange
            of
            Information
         27 Assistance Both the contracting states
            in         shall assist each other in
            collection collection of revenue claims
            of taxes
                                                           41
    Tax Treaty – Definition of Articles
Elimination of Double Taxation -

       Article 23 –Alternate methods are as below:
        The Exemption Method
         - Full Exemption
         - Exemption with progression

        Foreign Tax Credit Method
           - Full Credit
           - Ordinary Credit

        Deduction Method

        Tax Sparing Method


                                                     42
    Tax Treaty – Definition of Articles
Miscellaneous Provisions -

     Article Ref.                        Title


         24            Non-Discrimination


         25            Mutual Agreement Procedure


         28            Diplomatic Missions & Consular Posts


         29            Territorial Extension


                                                         43
Limitation of Benefits
 A limitation clause which permits only
  certain entities to enjoy treaty benefits
 Could be imposed by
  - Minimum expenditure requirement
  - Requirement that the entity is regulated, to be
    considered resident –such as stock exchange etc
 Netherland LOB, Singapore LOB, US
  LOB


                                                      44
Interpretation of Treaties
 MoU to an existing treaty can be considered for
  interpreting such treaty or an earlier treaty or another
  identically worded treaty enacted subsequently
 Protocol
   -   A protocol is an indispensable and integral part of the treaty with the same binding
       force as the main clauses therein and can be relied upon
   -   A protocol to a later treaty between two countries could apply while interpreting
       the predecessor treaty between the same countries

 The preamble to a treaty could be used for interpretation
 Case laws under other Indian treaties
   -   It is permissible to rely upon decisions rendered in respect of corresponding treaties

 Model Commentaries


                                                                                              45
How to Practice International Taxation
      Concepts of International Taxation
      Applying Tax Treaties
      Domestic Law Regulations
      International Tax Planning
      Role of CA’s
      Reference



                                            46
Concepts of International Taxation
      State V/s. Other Contracting State
      Source Country V/s. Residence Country
      Taxable Subject V/s. Taxable Object
      Capital Importing Country V/s.
      Capital Exporting Country
      Juridical Double Taxation V/s.
      Economic Double Taxation
      Active Income V/s. Passive Income

                                               47
Concepts of International Taxation
      Tie-Breaker rule for Residential Status
      Permanent Establishment
      Force of Attraction
      Associated Enterprises Transactions
      Beneficial Ownership
      Make Available
      Tax Relief


                                                 48
Concepts of International Taxation
      Most Favored Nation Clause
      Non-Discrimination Clause
      Mutual Agreement Procedure
      Exchange of Information
      Controlled Foreign Companies
      Treaty Shopping
      Thin Capitalisation


                                      49
Concepts of International Taxation
  State V/s. Other Contracting State -
   In bilateral agreements between two countries one
    country is referred to as “State” and the other country
    as “Other Contracting State”.

  Source Country V/s. Residence Country –
   Source Country – Country in which income arises
   Residence Country – Country in which the assesssee
   is Residing



                                                              50
Concepts of International Taxation
  Taxable Subject V/s. Taxable Object –
  Taxable Subject refers to assessee
  Taxable Object refers to income or capital

  Capital Importing Country V/s Capital Exporting Country-
   Capital Importing Country – More capital is invested into the
   country by foreigners than locals are investing overseas –
   Developing Country
   Capital Exporting Country – More capital is invested overseas
   by locals than foreigners are investing in the country –
   Developed Country



                                                                   51
Concepts of International Taxation
 Juridical Double Taxation V/s. Economic Double Taxation -
  Economic Double Taxation – Same Income Taxed in the hands of
  Different Persons viz., Dividend Income.
  Juridical Double Taxation - Concept
   - Double taxation of a taxable subject - person liable to tax (dual
     residence)
   - Double taxation of an economic event which produces taxable
     object (Royalties / Fees for Technical Services – payment / source
     basis)
   - Double taxation due to differing tax base - world wide basis vs
     territorial basis


                                                                         52
Concepts of International Taxation
 Connecting Factors - For taxing jurisdiction, there are two Connecting Factors
 internationally accepted.




                                                                                  53
Concepts of International Taxation
      India Can not tax US residents for income
       earned in US
      A country can tax
       - activities of resident even outside country
       - activities of non-resident in that country




                                                       54
Concepts of International Taxation
 Assessee                                            Income
Tax Subject                                         Tax Object


                                                  Indian Sourced Income,
   Indian Resident
                                                      Taxable in India.
    World Income
                                  India
                                  India            Irrespective of Status
      Taxable
                                   In                   of Assessee.
                                   di
                                   a

 For Non-resident &     Foreign Sourced Income    Foreign Sourced Income
        NORs            earned by Non-Residents      Taxable ONLY IF
Only Income Sourced       Not Taxable in India.         Earned by
  In India is taxable                                 Indian Resident
                         There is no nexus with
                                 India.



                                                                            55
Concepts of International Taxation
                Tax Subject




          Connecting Factors



  Tax Object                   Tax Country




                                             56
Concepts of International Taxation
  Active Income V/s. Passive Income –
   Active income means income derived from business or
   employment activities.
   Passive income (and gains) is income (and gains) from
   investment in tangible and intangible (including financial) asset.

  Tie-breaker rule for Residential Status –
   For Individuals – Five Level Tie-breaker Test
                    (Permanent Home, Centre of Vital
                       Interests, Habitual Abode, Nationality
                       and Mutual Agreement)
   For Others     - POEM (Place Of Effective Management)



                                                                        57
Concepts of International Taxation
 Permanent Establishment { PE } –
  Permanent Establishment means a fixed place of business through
  which the business of an enterprise is wholly or partly carried on.

 Force of Attraction –
  It is a concept wherein PE is taxed on the income derived not only
  by PE but also by the H.O. in the country where PE is located.

 Associated Enterprise Transactions –
  Transactions between associated enterprises attracts transfer
  pricing provisions and it should be at Arms’ Length Pricing




                                                                    58
Concepts of International Taxation
  Beneficial Owner -
   Beneficial owner’ receives concessional tax treatment

   Legally, ‘beneficiary’ or ‘beneficial owner’ is a person who benefits
   financially from property held by another (‘trust’)

   No benefit to intermediary between beneficiary and payer

   Conduit company not beneficial owner (benefits of DTAA with conduit’s
   state not available)

   ‘Real’ title vs ‘Formal’ title

   ‘Substance’ vs ‘Form’



                                                                           59
     Concepts of International Taxation
    Make Available –
     Technology should be transferred to another person

    Tax Relief –
     The methods of tax relief available from juridical double
     taxation are                      Full Exemption
a.   Exemption Method            Exemption with Progression
b.   Tax Credit Method                       Full Credit
c.   Deduction Method                      Ordinary Credit
d.   Tax Sparing Method


                                                                 60
Concepts of International Taxation
 Most Favored Nation Clause -
  Normally benefit under this clause is restricted to a specific group like
  OECD countries, developing countries

  Nature of benefit
   - lower tax rate
   - limited scope of income liable to tax

  MFN clause is usually found in Protocols and Exchange of Notes
   - Eg - treaties with Netherlands, Belgium, France, Norway, Switzerland,
     etc

  Generally Notification is issued to give effect to MFN clause – However,
  such notifications are mere clarificatory




                                                                              61
 Concepts of International Taxation
 Non-Discrimination Clause -
  This clause prohibits a country from discriminating in its tax
  treatment between its own nationals and nationals of other
  contracting state.

 Mutual Agreement Procedure -
  Where there is a dispute between the two contracting states
  wrt. any of the provisions of DTA, then they have to resolve
  the same by mutual agreement.

 Exchange of Information -
  This clause allows the tax administrations in the contracting
  states to exchange information with each other.



                                                                   62
Concepts of International Taxation
      Controlled Foreign Companies { CFC } –
       This is a legislation to tax foreign sourced income
       on an accrual basis, instead of on a receipt basis
       To explain – for eg. Company P (Parent Co.) a
       resident in Country R incorporates a subsidiary
       (Company S) in a tax heaven country. Income is
       diverted to Co., S. To avoid this circumstances,
       Country R may tax Co., P for income earned by
       Company S.



                                                         63
Concepts of International Taxation
  •Treaty Shopping -
           What does it Mean?  Co.
                         incorporated in               Indian
  Foreign Invest                           Invest
                        Mauritius (Shell              Compan
  Investor    s in                          s in
                          Co.) which in                  y
                               turn
           Tax Evasion Vs Tax Avoidance
            “There are many principles in fiscal economy which,
              though at first blush might appear to be evil, are
              tolerated in a developing economy, in the interest of
              long term development.”



                                                                      64
Concepts of International Taxation
 •Thin Capitalization -
   Interest on loan is a tax deductible
     expenditure, while dividend on                         Australia
     shares is not

   High debt, low equity preferred
                                                      90%

   Thin capitalization rules provide      Interest           Cyprus    Loan
     normative debt to equity ratio

   In case of excess debt, interest re-              60%
     characterized as dividend and tax                      Russia
     deduction not available




                                                                               65
Applying Tax Treaties
Step 1   What is the nature of the income ?
Step 2   Does the treaty apply?
Step 3   Determine which Article applies?
Step 4   How are taxation rights assigned?
Step 5   How is the income calculated?
Step 6   Give Tax Credit or Tax Relief




                                              66
Domestic Tax Systems
 To have knowledge of Domestic Tax
  Systems of various countries
 Incentives provided in various countries
 Anti Avoidance Measures of various
  countries




                                             67
International Tax Planning
 Exemption from Tax- 10A, R&D
 Reduction in tax rate- FTS
 Reduction in tax base-PE, Transfer Price
 Deferral of the tax payment –Royalty, Div
 Credit or exemption of foreign tax paid
 Treaty Shopping



                                              68
             Draft Direct Taxes Code Bill

                                     Revised draft of DTC Bill delayed!
                  Nine Critical Areas on which Position Papers are expected to be released


                                                                  General
                            Tax Treaty Override               Anti- Avoidance
                                                                    Rule




           Management and Control of             Tax on                          Capital
           Foreign Cos.                        Gross Assets                     Gains Tax



                                   Shift from
  Taxation of House                                           Deductions for                  Taxation
                               EEE to EET system
Property for Individuals                                       Retirement                   of Charitable
                                for savings and
   (Self Occupied)                                               Benefits                   Organizations
                                  investments


                                                                                                            69
Section 206AA
- Compulsory furnishing of PAN by Recipient

                       From 1.4.2010, absence of PAN of Payee results in higher
                        Withholding Tax (WHT) by Payer at 20 percent as compared to
                        applicable rate (even Tax Treaty Rate)
                       Key issues for Non-residents
                           Whether PAN mandatory where no income is taxable in
                            India?
                           Whether provision results in Treaty Override?
                           Whether refund of excess WHT can be claimed by filing
                            tax return in India?
                           Whether credit for excess WHT available in Home
                            Country?
                           Whether PAN required even for ‘net of tax’ contracts?
                           Whether applies to TDS on or before 31 March 2010 but
                            deposited after 1 April 2010?



                                                                                    70
                                                                                         70
Withdrawal of Circulars 23/
1969 and 786/2000



                              71
Withdrawal of Circular Nos.
23/1969 and 786/2000
• Circulars withdrawn w.e.f. 22-10-2009


  – Circular 23/1969 : Clarification on taxability of income of non-resident -
       • Non resident exporter selling goods from abroad to Importer
       • Non Resident Company selling goods from abroad to Indian subsidiary
       • Foreign Agents of Indian exporters
       • Non Resident persons purchasing goods in India
       • Sale by Non residents either directly or indirectly through agents

  – Circular 786/2000 : Further clarification in case of export commission

  – Objective of withdrawal (as claimed by CBDT):
    • Circular was being interpreted by some taxpayers to claim relief which was not in
      accordance with the provisions of Section 9 of the Income Tax Act

  – Extensive use of Circular by assessee & reliance by judiciary in case of Dependent
    Agent Permanent Establishment (DAPE) to claim no tax liability of Non-resident seem
    to have triggered withdrawal                                                       72
Effect of Withdrawal
– On positions taken before withdrawal (i.e. 22/10/2009)
  • Withdrawal is prospective [DDIT v. Siemens Aktiengesellschaft (Mum ITAT)]
  • Later withdrawal cannot be the ground to read down the circular in earlier years
    when it was operational
– On earlier decisions of court
  • A circular which is contrary to the statutory provisions of the law has no existence in
    law [CCE vs. M/s Ratan Melting and Wires Industries 220 CTR 98]
  • A circular is binding upon the revenue authorities. It is not binding on the courts.
  • The court decisions represent court’s interpretations of provisions of the statute
    – Withdrawal would not render court decisions ineffective
      • Unless they are solely based on circular without independent interpretation of
        law
– Withdrawal does not mean that the positions were incorrect
  • Principles applied in the Circular may still remain valid
    – The only difference is that now they need to be argued
    – Same conclusions may still be drawn                                                  73
Impact of withdrawal of Circular 23 on Foreign
commission Agents
• Prior to withdrawal foreign agents not liable to tax in India

• Post withdrawal

  – Indian exporter may be regarded as business connection

  – Only income attributable to operations carried out in India to be taxable in India
    [Explanation 1(a) to Section 9(1)(i).]

  – If all the activities by the agent are performed outside India – No profits accrue in India

  – Whether services of foreign agent be termed as technical services?

    • Expression ‘technical’ not defined under the Act

    • As per dictionary meaning ‘Technical’ includes services rendered by expert of
      respective field.

    • If the services include expert services of any field, it may be treated as technical
      services

      – Consequently may be treated as deemed accrued in India

    • Question to be answered based on facts & circumstances of each case.                        74
Retrospective Amendment to
Explanation to Section 9(1)



                              75
         Judicial Position on Section
         9(1)(vii)
 Judicial opinion before         Judicial Opinion after         Judicial Opinion after
 Amendment by Finance           Amendment by Finance           Amendment by Finance
        Act, 2007                      Act, 2007                      Act, 2010
In absence of explanation     The Explanation inserted       It has been held in
to Section 9(1), it was held   by Finance Act, 2007 to        Ashapura Minechem Ltd. v.
in     Ishikawajima-Harima     Section 9(1) does not          ACIT (Int. tax) that it is no
Heavy Industries Ltd. 288      eliminate the requirement of   longer necessary that, in
ITR 408 in order to be         rendering services in India    order to invite taxability
taxable in india, the          and hence the law laid down    under section 9(1)(vii) of
technical services must be     in Ishikawajima’s case         the Act, the services must be
utilized in India as well as   prevails even after the said   rendered in the Indian tax
rendered in India.             retrospective amendment.       jurisdiction.
                               (Jindal Thermal power co.)




                                                                                              76
Applicability of Tax Treaty




                              77
Jurisdiction
  – Apply treaty of correct jurisdiction and cannot apply treaty if the
    specific territory is not covered

  – Generally DTAA excludes territories which have special status / not
    recognized as part of the country
      • Peurto Rico, Virgin Island, Guam not included in USA
      • Hong Kong & Macau not included in China
      • Bermuda, BV Island, Cayman Island, Isle of Man, Gibralter, Jersy
        not included in UK
      • Denmark does not include Faroe Island & Greenland
      • Netherland Antilles not included in Netherlands

  – Northern Ireland included in DTAA with UK
  – Southern Ireland included in DTAA with Ireland

                                                                           78
Resident
 – Person must be resident of a country in order to apply tax treaty with
   such country
 – Resident is generally a person who is liable to tax on global income in
   such country

 – Significant issues arise in respect of tax transparent entities
     • Partnerships in many countries are tax transparent / pass-through
     • LLCs have option to be treated as pass-through

 – India has given its view that treaty does not apply to pass-through
   entities as these entities fail the test of ‘liable to test’
     • Unless specifically agreed in the treaty




                                                                             79
India – USA Tax Treaty
• Article 4(1):
    For the purposes of this Convention, the term “resident of a Contracting State” means
     any person who, under the laws of that State, is liable to tax therein by reason of his
     domicile, residence, citizenship, place of management, place of incorporation, or any
     other criterion of a similar nature, provided, however, that
    (a) this term does not include any person who is liable to tax in that State in respect
            only of income from sources in that State; and
    (b) in the case of income derived or paid by a partnership, estate, or trust, this
     term applies only to the extent that the income derived by such partnership, estate,
            or trust is subject to tax in that State as the income of a resident, either in its
            hands or in the hands of its partners or beneficiaries.

• India – USA makes specific provision to this effect
    – Treaty benefit available to partnership to the extent it is subject to tax in US as resident
      in hands of its partners

• Provision is only in respect of partnership and not LLC
    – Benefit not available to LLC
                                                                                                     80
India – USA Tax Treaty
•   Article 4(3):
 Where, by reason of paragraph 1, a company is a resident of
     both Contracting States, such company shall be considered to
     be outside the scope of this Convention except for purposes of
     paragraph 2 of Article 10 (Dividends), Article 26 (Non-
     Discrimination), Article 27 (Mutual Agreement Procedure),
     Article 28 (Exchange of Information and Administrative
     Assistance) and Article 30 (Entry into Force).

• Generally, where a company is tax resident of both the countries,
    it is treated as resident of the country in which effective control
    and management is situated.

• However, where a company is resident of India as well as USA,
    it cannot claim benefit of India – USA DTAA.


                                                                          81
Meaning of Royalty




                     82
           Special provisions in the treaty
           regarding Royalty
                  Features                               Treaties covered



Definition of royalties specifically includes
                                                Malaysia, Morocco, Namibia, Russia,
consideration for use of computer software /
                                                Trinidad and Tobago, Turkmenistan,
computer programs
                                                  Kazakhstan and Kyrgyz Republic

Rentals and other income from
cinematographic films are considered as                        Libya
business profits and not as royalties




                                                                                      83
India – USA Tax Treaty
•   Article 12(3):
     The term “royalties” as used in this Article means :
       (a)        payments of any kind received as a consideration for the
         use of, or the right to use, any copyright or a literary, artistic, or
         scientific work, including cinematograph films or work on film,
         tape or other means of reproduction for use in connection with
         radio or television broadcasting, any patent, trade mark, design or
         model, plan, secret formula or process, or for information
         concerning industrial, commercial or scientific experience,
         including gains derived from the alienation of any such right
         or property which are contingent on the productivity, use, or
         disposition thereof ; and

• If the property transferred with payment contingent with productivity, it
    is to be treated as royalty and not Capital Gains




                                                                              84
India – Australia Tax Treaty
•   Article XII(3):
          The term “royalties” in this Article means payments or
          credits, whether periodical or not, and however described
          or computed, to the extent to which they are made as
          consideration for :
      (a) … … …
                  ………
       (g)        the rendering of any services (including those of
          technical or other personnel), which make available
          technical knowledge, experience, skill, know-how or
          processes or consist of the development and transfer of a
          technical plan or design;

• Royalty includes fees for technical services
• Article XII to be applied and not Article VII


                                                                       85
India – Brazil Tax Treaty
• Article 12(3):
 The term “royalties” as used in this Article means payments of any kind
   received as a consideration for the use of, or the right to use, any copyright of
   literary, artistic or scientific work (including cinematography films, films or
   tapes for television or radio broadcasting), any patent, trade mark, design or
   model, plan, secret formula or process, or for the use of, or the light to use,
   industrial, commercial, or scientific equipment, or for information concerning
   industrial, commercial or scientific experience.
• Protocol – Para 2:
 With reference to Article 12, paragraph 3 - It is understood that the provisions
   of paragraph 3 of Article 12 shall apply to payments of any kind to any
   person, other than payments to an employee of a person making such
   payments, in consideration for the rendering of assistance or services of a
   managerial, administrative, scientific, technical or consultancy nature.

 Royalty covers FTS by through Protocol

                                                                                   86
Meaning of Fees for Technical
Services



                                87
          FTS under the Treaty regarding FTS
• Most Indian treaties have a separate article for FTS though it is absent in some treaties (for
  example: India Mauritius)
• If beneficial owner of the FTS carries on business in the other contracting state in which the FTS
  arises through a PE, such fees would form part of the business profits under the Article

No separate article for FTS                                  Australia, Bangladesh, Brazil, Greece,
                                                               Indonesia, Libya, Mauritius, Nepal,
                                                           Philippines, Sri Lanka, Syria, Thailand, UAE
                                                                             and UAR




Covered only if it make available technology              USA, UK, Australia, Canada, Cyprus, Finland,
                                                          Malta, Netherlands, Portugal, and Singapore




Payments for teaching in or by educational
                                                                     USA, UK and Switzerland
institutions excluded in treaties with



                                                                                                          88
India – Norway Tax Treaty
• Article 13(2):
  However, such royalties and fees for technical services may
  also be taxed in the Contracting State in which they arise
  and according to the laws of that State. But insofar as fees
  for technical services are considered, to the extent such
  fees are paid in respect of a contract which is signed
  after the date of entry into force of this Convention, the
  tax so charged shall not exceed 10 per cent of such fees.


• Rate limitation applicable only in respect of contract
  signed after date of entry into force of DTAA


                                                             89
India – China Tax Treaty
•   Article 12(4):
     The term “fees for technical services” as used in this Article means any
    payment for the provision of services of managerial, technical or
    consultancy nature by a resident of a Contracting State in the other
    Contracting State, but does not include payment for activities
    mentioned in paragraph 2(k) of Article 5 and Article 15 of the
    Agreement.

• Treaty wordings suggests that it is treated as FTS only if
    rendered in India for inbound services

• However, in a recent judgement in case of Ashapura
    Minechem, Mumbai ITAT held that these words are in contrast
    to provisions of Article 12(6). It further held that in order to
    avoid absurdity and keeping in mind the amendment by Finance
    Act, 2010 such narrow meaning should not be taken.


                                                                            90
Most favored Nation Clause
(MFN)



                             91
MFN Principle
• Binds the contracting country (‘A’) to offer
  to the other contracting country (‘B’) the
  same benefits which A may offer to a third
  country

• MFN is actually result of compromise made
  by one of the party while signing DTAA
  and then seeks favourable treatment if treaty
  partner offers such treatment to other
  countries                                    92
India - Netherlands Tax Treaty
• Protocol IV:
  “If after signature of this convention under any Convention or Agreement between India
  and a third State which is a member of the OECD India should limit its taxation at
  source on dividends, interests, royalties, fees for technical services or payments for
  the use of equipment to a rate lower or a scope more restricted than the rate or scope
  provided for in this Convention on the said items of income, then as from the date on
  which the relevant Indian Convention or Agreement enters into force the same rate or
  scope as provided for in that Convention or Agreement on the said items of income shall
  also apply under this Convention.”

• MFN triggered only if other OECD country favoured
• Applied immediately
• MFN for scope as well as rate of taxation


• Changes later on incorporated in the DTAA through amendment in DTAA notified vide
  SO 693(E) dated 30-8-1991



                                                                                            93
India - Israel Tax Treaty
• Protocol – Para 2:
  “The competent authorities of the Contracting States shall initiate the proper procedure
  to review the provisions of Articles 12 and 13 (Royalties and fees for technical services,
  respectively) after a period of five years from the date of entry into force of this
  Convention. However, if under any Convention or Agreement between India and any
  third State which enters into force after 1-1-1995, India limits its taxation at source or
  Royalties or Fees for Technical Services or Interest or Dividends to a rate lower or a
  scope more restricted than the rate or scope provided for in this Convention, the same
  rate or scope as provided for in that Convention or Agreement on the said items of
  income shall also apply under this Convention with effect from the date on which the
  present Convention comes into force or the relevant Indian Convention or Agreement,
  whichever enters into force later.

• MFN triggered only if any other country favoured after 1-1-1995
• Applied immediately
  – Based on DTAA with Finland, Malta, Portugal, restricted scope applies – taxable only
    if it make available technology
• MFN for scope as well as rate of taxation
• No notification but still valid to claim benefit as Protocol automatically provides the
  same                                                                                    94
India – Swiss Confederation Tax
Treaty
• Protocol – Para 4:
   If after the signature of the Protocol of 16th February, 2000 under any
  Convention, Agreement or Protocol between India and a third State which
  is a member of the OECD India should limit its taxation at source on
  dividends, interest, royalties or fees for technical services to a rate lower or
  a scope more restricted than the rate or scope provided for in this
  Agreement on the said items of income, then, Switzerland and India shall
  enter into negotiations without undue delay in order to provide the same
  treatment to Switzerland as that provided to the third State.

• MFN triggered only for re-negotiation
• Cannot be applied without formal amendment to DTAA and notification
  thereof
• No notification yet


• Similar provision in case of India - Philippines DTAA as well
                                                                                     95
India – Norway Tax Treaty
• Article 13(2):
  However, such royalties and fees for technical services may also be
  taxed in the Contracting State in which they arise and according to the
  laws of that State. But insofar as fees for technical services are
  considered, to the extent such fees are paid in respect of a contract
  which is signed after the date of entry into force of this Convention, the
  tax so charged shall not exceed 10 per cent of such fees. For the
  purposes of this paragraph, if a lower rate of Indian tax is agreed upon
  with any other State than Norway after the entry into force of this
  Convention, such rate shall be applied.


• Clause in DTAA itself (not in protocol)
• Applicable only for lower rate (not for scope)
  – Lower rate yet not agreed by India with any country
• Immediately applied


                                                                               96
India - Netherlands Tax Treaty
• Protocol V:
    It is understood that in case India applies a levy, not being a levy covered by Article 2,
    such as the Research and Development Cess, on payments meant in Article 12, and if
    after the signature of this Convention under any Convention or Agreement between India
    and a third State which is a member of the OECD India should give relief from such
    levy, directly, by reducing the rate or the scope of the levy, either in full or in part, or,
    indirectly, by reducing the rate of the scope of the Indian tax allowed under the
    Convention or Agreement in question on payments as meant in article 12 of this
    Convention with the levy, either in full or in part, then, as from the date on which the
    relevant Indian Convention or Agreement enters into force, such relief as provided for in
    that Convention or agreement shall also apply under this Convention.

• MFN covers R&D Cess also
• If India agrees with another OECD country, similar position would be applied to
    Netherlands
    – Exemption / Reduction of R&D Cess
    – Reduction of Income-tax to the extent of R&D Cess (something which is presently
      done in case of Service tax)

                                                                                                    97
Force of Attraction Rule




                           98
Force of Attraction Principle
• Generally, in case of PE only profits attributable to the activities
  of PE are taxable in India

• However, even other activities of the assessee can be taxed in
  India because of existence of PE in India
 – Even if such activities are carried out by the Head Office and PE does
   not perform any activity in such event

 – This Principle is referred as ‘Force of Attraction’
   • Additional tax liability is attracted once you have significant presence (PE)
   • Need to read each PE article closely to apply DTAA

 – Presently, internationally this issue is subject matter of debate as
   application of force of attraction principle



                                                                                     99
India – Germany Tax Treaty
•   Protocol to Article 7(1):
 (c)   In respect of paragraph 1 of Article 7, profits derived from the
  sale of goods or         merchandise of the same or similar kind as
  those sold, or from other business           activities of the same or
  similar kind as those effected, through that permanent
        establishment, may be considered attributable to that permanent
  establishment            if it is proved that :
       (i)      this transaction has been resorted to in order to avoid
  taxation in the                     Contracting State where the
  permanent establishment is situated, and
       (ii)     the permanent establishment in any way was involved in
  this                     transaction.

• The protocol gives reason why force of attraction rule is required

• Germany DTAA provides this for clarification.



                                                                       100
India – USA Tax Treaty
• Article 7(1):
  The profits of an enterprise of a Contracting State shall be taxable only in that
  State unless the enterprise carries on business in the other Contracting State
  through a permanent establishment situated therein. If the enterprise carries on
  business as aforesaid, the profits of the enterprise may be taxed in the other
  State but only so much of them as is attributable to (a) that permanent
  establishment ; (b) sales in the other State of goods or merchandise of the
  same or similar kind as those sold through that permanent establishment ;
  or (c) other business activities carried on in the other State of the same or
  similar kind as those effected through that permanent establishment.

• Goods sold / services provided by HO which is similar to PE then profits of
  such activities are taxable in India




                                                                                  101
India – Belgium Tax Treaty
•   Article 7(1):
    The profits of an enterprise of a Contracting State shall be taxable only
    in that State unless the enterprise carries on business in the other
    Contracting State through a permanent establishment situated therein. If
    the enterprise carries on business as aforesaid, the profits of the
    enterprise may be taxed in the other State but only so much of them as
    is attributable to (a) that permanent establishment ; (b) sales in the
    other State of goods or merchandise of the same or similar kind as
    those sold through that permanent establishment ; or (c) other
    business activities carried on in the other State of the same or
    similar kind as those effected through that permanent
    establishment.

• Goods sold / services provided by HO which is similar to PE
    then profits of such activities are taxable in India



                                                                           102
Limitation of Benefit




                        103
Limitation of Benefit
• To avoid treaty shopping, DTAA may include
 Limitation of Benefit (LoB) clause

• USA invariably includes such provisions in DTAA

• India now includes LoB clause in most of its DTAA
 signed / renegotiated

• LoB restricts applicability of DTAA to certain
 persons / payments

                                                    104
India – Singapore Tax Treaty
•   Article 24(1):
     Where this Agreement provides (with or without other conditions) that
    income from sources in a Contracting State shall be exempt from tax,
    or taxed at a reduced rate in that Contracting State and under the laws
    in force in the other Contracting State the said income is subject to tax
    by reference to the amount thereof which is remitted to or received in
    that other Contracting State and not by reference to the full amount
    thereof, then the exemption or reduction of tax to be allowed under
    this Agreement in the first-mentioned Contracting State shall apply to
    so much of the income as is remitted to or received in that other
    Contracting State.

• Treaty benefit in case of India – Singapore DTAA is applicable
    only to the extent such income is remitted to Singapore as
    foreign sourced income is taxable in Singapore only on
    remittance basis


                                                                            105
Overview of Transfer Pricing Regulation




                                          106
PRESENTATION OUTLINE
 Introduction


 Indian transfer pricing regulation – A bird’s
  eye view

 Key issues – A macro perspective




                                              107
INTRODUCTION
CONCEPT :
 Enterprise choose to deal with its group
  entities in preference to a non group entity
  for gaining the benefit of group synergy

 Pricing between associated enterprise(AEs)
  with respect to transfer of goods, services,
  know how

                                                 108
Transfer Pricing
 Transfer pricing is an economic term, which
  refers to the valuation process for
  transactions between related entities.
 Defined as “the amount charged by one
  segment of an organisation for product or
  service that it supplies to another segment
  of the same or related organisation”



                                                109
Transfer pricing …
 “transfer pricing” generally refers to prices
  of transactions between associated
  enterprises which may take place under
  conditions differing from those taking place
  between independent enterprises.




                                                  110
                Transfer Pricing
    Transfer pricing issues affect situations when
    goods and services are provided, knowingly or
    otherwise, on non-arm’s length basis by
    related entities. The situations are
•   Transfer of Tangible Property
•   Transfer of In-tangible Property
•   Provision of Services
•   Provision of Finance

                                                     111
INTRODUCTION
RELAVANCE :
 Revenue Authorities :
 Obtain fair share of revenue in respect of
  economic activities carried within its
  jurisdiction
 Management:
   Decision making, group’s performance
  evaluation, fair profit of an enterprise, etc

                                                  112
113
   INDIAN TRANSFER PRICING
REGULATION : A BIRD’S EYE VIEW
 Chapter X –Special provision relating to
  avoidance of tax (prior to 1.4.2002 – section 92)

 Pre TPR provisions – Section 40A(2), Section
  10A/B , Section 80 IA

 Based on Raj Narain committee – Finance Act
  2001 incorporated detailed TP provisions in
  INCOME TAX ACT,1961

 CBDT has set up new post of Director General ,
  International Tax
                                                      114
Indian situations & TP regulation
 Increasing MNC activity – Inbound & sourcing

 Inbound – key sectors : IT, Pharma, chemicals,
  services, telecom , etc

 Sourcing – illustrative applicability :
  BPO activity , global sourcing base for various
  products

 Accelerating trend of Indian companies setting up
  bases abroad
                                                      115
TPR – Developments since
Finance Act , 2001

 1st APRIL 2001   Section 92 to 92F introduced



  21st AUGUST     Rules 10A to 10E notified –
       2001          Documents prescribed


  23rd AUGUST
                     Circular No 12 issued
       2001


                                                 116
Section 40A(2)(b) vs TPR
Section 40A(2)(b) of IT Act           Transfer Pricing Regulation
                                      Section 92 to 92 F of the IT Act.
•    Payment to relative/person       • Payment to associated
     having substantial interest in       enterprise
     taxpayer’s business
                                      •   Either one or both should be
•    Applicable irrespective of           non-residents
     residential status
                                      •   Both Income & Expenditure
•    Only Expenditure
•    No specific documentation        •   Specific set of
     prescribed                           documentation prescribed
•    Burden of proof on the           •   Burden of proof on the
     Assessing officer                    taxpayer
•    No specific report format        •   Form 3 CEB
    SC Decision of CIT v. GlaxoSmithKline Asia Private Limited
                                                                          117
TPR – Developments since
Finance Act , 2001

 December 2001    Circular No 14 issued
                  ( Explanatory nature)


                 Guidance note issued by
   April 2002             ICAI



   May 2002      Finance Act 2002 notified


                                             118
Key Operative Provisions :
Section 92          Income arising from an
                    international transaction to be
                    computed with regard to ALP
Section 92A/B/F r/w Meaning & Definition
Rule 10A
Section 92C r/w     Computation of ALP
Rules 10B/C
Section 92CA        Reference to Transfer pricing
                    officer (TPO)
Section 92D/E r/w   Maintenance & keeping of
Rules 10D/E         information & documents ,
                    Accountant's Report
                                                      119
Applicability of TPR :
             22 Basic Conditions
                 BASIC CONDITIONS


 There should be an international transaction


 Such a transaction should be between two
  or more associated enterprises (AEs) of
  which at least one should be a non resident


                                                120
    IMPORTANT MEANINGS &
        DEFINITIONS :
Section 92A            Associated Enterprise
Section 92B          International Transaction
Section 92C         Computation of Arm’s length
                              price
Section 92F ( i )          Accountant
Section 92F (ii)     Arm’s length price ( ALP)



                                                  121
    IMPORTANT MEANINGS &
        DEFINITIONS :
Section 92F (iii)           Enterprise

Section 92F ( iiia)   Permanent establishment

Section 92F ( iv)         Specified date

Section 92F (v)             Transaction



                                                122
  Section 92: Charging Section

 Any income arising from an international transaction shall
  be computed having regard to ALP

 In computing such income , any allowance for expense or
  interest shall be determined having regard to ALP

 ARRANGEMENT FOR ALLOCATION OR
  CONTRIBUTION FOR COST OR EXPENSES

 NON APPLICABILTY OF SECTION - when ALP has
  the effect of reducing income or increasing loss on the
  basis of entries made in books of accounts

                                                               123
Associated Enterprise

• In order to be AEs the entities must be
  “Enterprises” as defined in S.92F(iii)

• 92A (1) (a) Direct participation .

                 Management,
 A                Capital, etc              B



                                                124
Associated Enterprise
• Indirect Participation

      A            I           Management,     B
                               Capital, etc.



                Intermediary




                                                   125
    Associated Enterprise…
[S.92A(2)(a)] Equity holding of not less than 26
  %
                     Not less
    A Ltd           than 26%              B Ltd




     A Ltd            B Ltd               C Ltd
              40%                   50%


                     Intermediary

                                                   126
    Associated Enterprise…
[S.92A(2)(b)] Equity holding of not less than
  26 %
                        A Ltd



        40%                                    50%
                A Ltd controls not less than
    B Ltd       26% of the voting power
                                               C Ltd
                of B Ltd & C Ltd.




                                                       127
    Associated Enterprise…
[S.92A(2)(c)] Loan advanced


    A Ltd                                 B Ltd



              A Ltd given loan of INR
                 75 lakhs to B Ltd.
             Book value of total assets
             of B Ltd is INR 100 lakhs



                                                  128
    Associated Enterprise…
[S.92A(2)(d)] Guarantees


    A Ltd                                    B Ltd



                A Ltd received loan worth
               INR 100 lakhs from Indian
                  banks on the basis of
              guarantees given by B Ltd to
                 the extent of 50 lakhs.



                                                     129
    Associated Enterprise…
[S.92A(2)(e)] Board of Directors/Governing Board


                       Appoints more
                       than half of the
                     Board of Directors
     A Ltd                    or             B Ltd
                         one or more
                     Executive Director
                      of the Governing
                            Board




                                                     130
    Associated Enterprise…
[S.92A(2)(f)]Board of Directors/Governing
  Board
                         Mr. X




            Appoints more        Appoints two
    A Ltd   than half of the     executive
                                                B Ltd
            directors             directors




                                                        131
    Associated Enterprise…
[S.92A(2)(g)]Use of know-how, patents,etc.


    A Ltd                            B Ltd


              A Ltd provides B Ltd
              with technical know-
                   how for the
                 manufacture of
                     goods.

                                             132
    Associated Enterprise…
[S.92A(2)(h)] Supply of raw materials & price of
supply               B Ltd
                 supplies more
                  than 90% of
    A Ltd                                 B Ltd
   (Manufact        the raw
                                         Supplier
     urer)          material
                 required for A
                                  Price & other
                      Ltd         conditions influenced
                                  by B Ltd.

                                        C Ltd
                                       Supplies
                                      to A Ltd.,

                                                          133
      Associated Enterprise…
[S.92A(2)(i)] Sold to the enterprise or persons specified by the
   other
enterprise
                 Price & other conditions influenced by B Ltd.
                             A Ltd sells                   B Ltd
     A Ltd
     (Manufact                 goods                       (Buye
       urer)                  to B Ltd                       r)

                                                    Price & other
                                                    conditions influenced
                                                    byC Ltd
                                                       B Ltd.
                                                     (Buyer
                                                     specifie
                                                      d by B
                                                       Ltd)
                                                                            134
    Associated Enterprise…
[S.92A(2)(j)] Control by individual/relative
                   Mr.P and Mr.R are relatives

    Mr.P                                         Mr.R
                         Joint control

        Controls                                    Controls



     A Ltd                                       B Ltd



                                                               135
    Associated Enterprise…
[S.92A(2)(k)] Control by HUF/members of HUF
                                   Mr.R, a
                                   member of
    HUF -                          HUF P or
     P                             relative of
                                   Mr.R.

       Controls               Controls



    A Ltd                            B Ltd




                                                 136
    Associated Enterprise…
[S.92A(2)(l)] Control by Firm/AOP/BOI




     A-            Not less              B
    Firm          than 10%              Firm




                                               137
Section 92A : Associated Enterprise
 An Enterprise
 which directly or        DIRECT   INDIRECT
 indirectly                              A
 participate in             A            M
 Management or              M            C
 Control or Capital                      C
                            C
 (M C C) of the             C            I
 other Enterprise                       M
                            B           C
                                        C
 ( Section 92A (1)(a) )
                                        B     138
Section 92A : Associated Enterprise
 AEs in which one        COMMON M C C
 or more persons
 participate, directly         A
 or indirectly,
 in M C C of more
 than one Enterprise

(section 92A( 1 )(b) )    B        C

                                       139
Section 92A (2) : Deemed Associated
Enterprise
1. Holding of shares carrying 26% or more
   voting powers
2. Common ownership- Holding of shares
   carrying 26% or more voting powers in
   more than one enterprises
3. Advance of loan not less than 51% of the
   total assets of the borrowing company
4. Guarantees not less than10% of the total
   borrowings on behalf of the borrower
                                              140
 Section 92A (2) : Deemed Associated
 Enterprise ……...

5   Appointment of more than half of the BOD or
    members of the governing board or appointment
    of one or more executive directors or members

6   Common appointments

7 Total dependence on an enterprise possessing
  exclusive rights for manufacturing or processing
  of goods or articles or carrying on business using
  know how, patents, copyrights, trade marks,
  licenses, franchise , etc
                                                       141
Section 92A (2) : Deemed Associated
Enterprise ……...

8  Dependence , up to 90% or more for the
   raw materials & consumables , on another
   enterprise
9 Influence on prices for goods or articles
   manufactured or processed & sold to an
   enterprise
10 One individual ( or his/ her relative jointly
   or separately) controlling two different
   enterprises
                                                   142
Section 92A (2) : Deemed Associated
Enterprise    ……...
11.One HUF (or member or relative of
   member jointly or separately) controlling
   different enterprises

12. Enterprise holding not less than 10%
    interest in firm / AOP / BOI

13. Relationship of mutual interest as may be
    prescribed
                                                143
     Section 92B:International Transaction
     Means transaction between two or more AE ,
      either or both of whom are non residents, in the
      nature of :
1.    Sale of products
2.    Purchase of products
3.    Provision of services
4.    Lending or borrowing
5.    Cost sharing arrangements
6.    Leasing & hiring of assets,etc

                                                         144
Transaction…
 Transaction:
   – Defined in 92F(v)
   – Includes – arrangement
                – understanding
                – action in concert
   – Whether formal or in writing
   – Whether intended to be enforceable by legal
     proceedings
 Definition
   – Is in addition to normal ordinary meaning


                                               145
Other Definitions u/s 92F :
92F( i )     Accountant     As per sec 288(2)

92F( ii )    ALP            Price in uncontrolled condition
                            other than for AE
92F( iii )   Enterprise     Person (including PE of such
                            person)
92F( iiia ) Permanent       Fixed place of business through
            establishment   which business is wholly or
                            partly carried on
92F( iv )    Specified date Due date as per section 139(1)
                            explanation 2
92F( v )     Transaction    Arrangement,understanding or
                            action in concert
                                                              146
Other Definition in Rule 10A :

10A (a) Uncontrolled Transaction between
        transaction enterprises other than AE,
                     whether resident or non
                     resident
10A (b) Property     Includes goods,articles or
                     things & intangible property
10A (c) Services     Includes financial services
10A (d) transaction   Includes a number of closely
                      linked transaction

                                                    147
Section 92C :Computation of ALP
 ALP shall be determined having regard
     to :
1.   Nature of transaction or class of
     transaction
2.   Class of associated enterprise
3.   Functions performed
4.   Other relevant factors as may be
     prescribed by CBDT

                                          148
Methods for Computation of ALP
1.   Comparable uncontrolled price (CUP)
2.   Resale price method (RPM)
3.   Cost plus method (CPM)
4.   Profit split method (PSM)
5.   Transactional net margin method (TNMM)
6.   Such other method as may be prescribed by the
     Board
    ALP shall be most appropriate method (MAP)
     out of the above

                                                 149
        Division of ALP based on :
         Transaction methods    Other methods /
                                   transactional profit
                                   methods :

         CUP     RPM     CPM

                                  PSM          TNMM


INTER          EXTER
 NAL            NAL

                                                          150
Comparable Uncontrolled Price : CUP
      Method …Rule 10B(a)
Where the price charged for goods, services or property
transferred in a controlled transaction is compared to a
CUT ( comparable uncontrolled transaction )


 CUT is                                     Adjusted
identified                                  Price of
                                           CUT is ALP
              CUT is adjusted to a/c
                For differences in
                    IT & CUT


                                                           151
Types of transactions considered appropriate for
adoption of CUP method

 Transfer of goods
 Provision for services
 Intangibles
 Loans,provision of finance


   This method is particularly good where an independent
    Enterprise Sells the same product or service as sold
            between two Associated enterprises


                                                           152
          Resale Price Method : RPM
                 Rule 10B(b)
Where price @ which goods/property purchased or services
obtained from AE is resold to unrelated party is identified.

GP margin of CUT is reduced from such resale price to
arrived at ALP


              10     A         12     AE          15   xyz



                                      13.50 (-)
   NORMAL GP           15 (-) 10%
                         =13.50        EXPS
                                                       ALP
 as per CUT is 10%
                                                               153
Types of transactions considered appropriate for
adoption of RPM method

 Distribution of finished products or other
  goods involving no or little value addition

 Where the entity performs basic sales ,
  marketing & distribution functions

 Where goods are further processed or
  incorporated into other products

                                                   154
        Cost Plus Method : CPM (C+)
                Rule 10B( c )
Direct & indirect cost of production in respect of goods/services
sold to AE is identified , to which normal GP mark up in CUT
is added to arrive @ ALP



   DC 10
                      A
                                       GP
   ID 05                              10%
      ---       STRUCTURE             CUT               ALP
   TC 15
     ==
                     AE
                                 (To consider fn
                                  & other diff. )             155
Types of transactions considered appropriate for
adoption of CPM method
                                         Subsidiary or
 Provision of services                   peripheral
 Contract manufacturing
 Joint facility arrangement
 Transfer of semi finished goods
 Long term buying & selling arrangements




                                                     156
           Profit Split Method : PSM
                  Rule 10B (d)
1. PSM applied when there is transfer of unique intangibles
2. Multiple IT so interrelated that they can not be evaluated
   separately for the purpose of determining ALP
                          Combined NP
                            of AEs
                              15

         A                                                  AE
         9                                                   6

          Relative contribution of each AE to be identified based on:
                              Functions performed
                       Assets employed or to be employed
                                Risk assumed
                         Reliable external market data                  157
Types of transactions considered appropriate for
adoption of PSM
  Integrated services provided by more than
   one enterprise
  Transfer of unique intangibles
  Multiple inter related transactions , which
   cannot be separately evaluated




The profit should be split on an economically valid basis
That reflects the functions & risks of each of the parties
                                                             158
         Transaction Net Margin Method : TNMM
                      Rule 10B (e)

•NP margin in IT with AE established based on cost incurred
  sales effected, assets employed, etc
• NP margin in CUT is calculated based on the same criteria
• NP margin in CUT situations is adjusted to factor open market issues
• NP margin of AE transaction established/ compared with CUT NP



            A                10%                AE


            X                 8%                  Y

                 ALP shall be based on 8%margin
                                                                    159
Types of transactions considered appropriate for
adoption of TNMM

 Provision of services
 Distribution of finished products where
  resale price method cannot be adequately
  applied
 Transfer of semi finished goods


In India,in majority cases, method selection process would
lead to selection of TNMM as MAM, due to Non Availability
of requisite data for other methods.

                                                         160
         Computation Related Documents

       Degree of Similarity Required Under Various Methods:


Methods to   PRODUCT   FUNCTIONS   RESOURCES   RISKS   COMPLEXITY
 be used
CUP                                             
               
CPLM/RPM                                       

TNMM                                          

PSM                                                     




                                                                161
        Computation Related Documents

       Degree of Similarity Required Under Various Methods
      (Contd.):

          • CUP - High comparability of Products and Risks.
          • CPLM and RPM – High comparability of Functions and Risks.

          • TNMM – High Comparability of Risk and Resources. Functions also important.

          • PSM – Exceptionally used in complex cases, such as presence of intangibles.



In India, in majority cases, method selection process would lead to
selection of TNMM as MAM, due to Non Availability of requisite
data in other methods.


                                                                                          162
 Most appropriated method ( MAM) for ALP
 Factors for Selection of MAM [Rule 10C R.W. S. 92C]:



  Rule 10C provides for following factors for selecting MAM:

  •Nature of International Transaction
  • Class of Associated Enterprise
    (e.g. Distributor, Contract Mfgr. Etc.)
  • Functions Performed, Assets Employed, Risks Assumed.
  • Availability, Coverage and Reliability of Data
  • Extent to Which Reliable and Accurate ,Adjustments Can Be Made.
  • Nature, Extent and Reliability of Assumptions Required.




Most Appropriate Method must be Reliable Measure of ALP
                                                                      163
Most appropriate Method - Rule 10C
In selecting the most appropriate method as specified in sub-rule (1) of Rule 10 C,
    the
following factors shall be taken into account, namely:—
• the nature and class of the international transaction;
• the class or classes of associated enterprises entering into the transaction and
    the functions performed by them taking into account assets employed or to be
    employed and risks assumed by such enterprises;
• the availability, coverage and reliability of data necessary for application of
    the method;
• the degree of comparability existing between the international transaction and
    the uncontrolled transaction and between the enterprises entering into such
    transactions;
• the extent to which reliable and accurate adjustments can be made to account
    for differences, if any, between the international transaction and the
    comparable uncontrolled transaction or between the enterprises entering into
    such transactions;
• the nature, extent and reliability of assumptions required to be made in
    application of a method.


                                                                                  164
165
41
Reference to Transfer Pricing Officer ( TPO)
(Section 92CA):

 AO (with CIT prior approval ) may refer
  computation to TPO

 TPO : Authorized JCIT / DCIT / ACIT


 Binding nature of his direction to AO


 ALP computed by Assessee (+/-) 5% of price
  determined by AO – NO adjustment (Circular no
  12/2001 dated 23-08-2001)
                                                  167
Power of Board to make safe harbour
rules (Section 92CB)
 The determination of arm’s length price
  under section 92C or section 92CA shall be
  subject to safe harbour rules.

 The Board may, for the purposes of sub-section
  (1), make rules for safe harbour.

 Explanation.—For the purposes of this section,
  “safe harbour” means circumstances in which the
  income-tax authorities shall accept the transfer
  price declared by the assessee.                  168
Documentation :–
Section 92D r.w Rule 10D
 Every person who has entered into an international transaction
  shall keep and maintain prescribed information and documents.
  (S.92D(1) ).

 Prescribed the period for which such information and documents is
  required to be kept and maintained is 8 years.[S.92D(2), Rule
  10D(5)].

 The information or documents so maintained can be called for
  within a period of 30 days from the date of receipt of notice by the
  assessee. The said period can be further extended by another 30
  days. (S. 92D(3)).

 Rule 10D(2) provides for exemption from documentation
  requirements to the assessees, whose aggregate value as recorded in
  the books of account, of international transactions entered into by
  him does not exceed Rs. 1 crore.
                                                                         169
PRESCRIBED DOCUMENTATION

• Principal Documents [Rule 10D(1)]


• Supportive Documents[Rule 10D(3)]




                                      170
Principal Documents
   ICAI’s classification of Principal
              Documents:
 • Enterprise-Wise Documents [clauses (a) to (c )
   of Rule 10D(1)]

 • Transaction-Specific Documents [clauses (d) to
   (h) of Rule 10D(1)]

 • Computation Related Documents [clauses (i) to
   (m) of Rule 10D(1)]
                                                    171
Supportive Documentation [Rule 10D(3)]

     The information and records maintained shall be
     supported, to the extent possible by authentic
     documents, e.g.:

1.   Official publications, reports and studies and databases
     from the Government of the countries of AEs.
2.   Market research studies carried out and technical
     publications brought out by institutions of national or
     international repute
    Price publications (e.g. stock market / commodity market
     quotations)

                                                                172
Supportive Documentation [Rule 10D(3)]

 Published accounts and financial statements of
  AEs
• Agreements / contracts in respect of transactions
  with unrelated parties which are comparable with
  the relevant international transactions

• Letters/other correspondences documenting any
  terms negotiated with related parties (i.e.
  Associated Enterprises)

• Documents issued for various transactions under
  the accounting practices followed
                                                      173
               Documentation…
o Rule 10D has prescribed 13 different
  information and documents that are to be
  kept and maintained u/s 92D
o These documents can be broadly classified
  as:
  o Enterprise – wise documents
  o Transaction – specific documents
  o Computation related documents



                                          174
Documentation…
 Documents containing the following information
  should be maintained:
    Ownership Structure
      • Details of shares
      • Profile of the group
      • Name, address, legal status, ownership linkages,country of tax
         residence of the each of the enterprises
    Nature of business /industry and market condition
      • Broad description of the business of the taxpayer,
      • Industry background
      • Business of associated enterprises



                                                                         175
Documentation…

 Controlled Transactions
   • Nature and terms of international transactions,
   • Details of property transferred /services provided
   • Quantum and value of international transactions


 Background documents
   • Record of economic and market analysis,
   • Forecasts, budgets or any other financial estimate




                                                          176
Documentation…

 Comparability, functional and risk analysis
    • Record of uncontrolled transactions along with analysis to
       evaluate its comparability with international transactions
    • Record and evaluation of comparability of transactions
    • Description of functions performed, risks assumed and assets
      employed
 Selection of the transfer pricing method
    • Description of methods considered for determining ALP
    • Best method selected, along with reasons for selection




                                                                     177
Documentation…

 Application of the transfer pricing method
    • Record of actual working of ALP.
    • Detail of actual working of the comparable data with respect to
      ALP
    • Details of differences between comparable data and un-
      controlled transaction
    • Mode of adjusting the factors
 Assumptions, strategies, policies
    • Assumption, policies and price negotiations, if any, which
      have critically affected the determination of ALP



                                                                    178
Documentation…

 Supporting information
   • Official reports, publications, databases and studies from the
     government in the country of residence of the AE, or any
     other country, as relevant to the international transaction

   • Market research studies and technical publications brought
     out by institutions of national or international repute

   • Correspondence documenting the terms negotiated between
      the Aes.



                                                                      179
 ACCOUNTANT’S REPORT : Section 92E
 (Rule 10E)

 Every person who has entered into an international
  transaction shall obtain a report form an
  accountant
 Report shall be in Form 3CEB ( Rule 10E)
 Accountant to certify the contents of annexure to
  Form 3CEB as true &correct
 Furnish such report before specified date
 No requirement to furnish along with return of
  income
                                                       180
Important clauses of 3CEB
Clause 8    Transaction in respect of tangible
            property
Clause 9    Transaction in respect of intangible
            property
Clause 10   Particulars in respect of provision of
            services
Clause 11   Particulars in respect of lending or
            borrowing money
Clause 12   Particulars in respect mutual agreement
            or arrangement
Clause 13   Particulars in respect any other
            transaction
                                                      181
                               Penalties
Section under the                   Particulars                  Penalty
Income-Tax Act.
 271 AA               Failure to maintain         2% of the value of each
                      documentation               international transaction

271 G                 Failure to furnish/submit   2% of the value of the
                      any information/document    international transaction
                      to the transfer pricing     for each such failure.
                      officer
271 BA                Failure to furnish          INR 1,00,000
                      accountant’s report
271(1)(c) read with   Transfer pricing adjustment 100-300% of amount of tax
explanation 7         considered as concealed     on adjustments
                      income

                                                                              182
Penalties for non compliance of TPR
Section     Addition made in computing        100% -
271(1)(C) total income u/s 92C(4) shall be    300% of tax
explanation deemed concealed income           sought to be
7                                             evaded
Section     Failure to keep & maintain such 2% of value
271AA       information & documentation as of each
            per section 92D                 international
                                            transaction
Section     Failure to furnish accountant’s   Rs. 1 LAC
271BA       report as per section 92E
Section    Failure to furnish any             2% of the
271G       information or documents as        value of
           required u/s 92D(3)                transaction
    Reasonable Cause                          for each
       Sec 273B                               failure        183
Components of TPR
                        Transfer Pricing
     Is there and        Regulations not
     internationa       applicable to the
     l transaction   No
                     transactions. No ALP
                        to be determined
             Yes




      Between         No
      the AEs



                                            184
Components of TPR…
                         Transfer Pricing
     At l east 1         Regulations not
     AE is Non-          applicable to the
      Resident       No
                     transactions. No ALP to
                          be determined
             Yes


          Are        Adjustments to total
     International
                     No
                      income is made
      transaction
      at ALP ?
                     Levy of penalty
                      u/s 271(1)(c)

                                               185
        Some Landmark TPR rulings
Case law            Important observations




Oracle India        •The Tribunal held that transfer pricing provisions, being
                    specific in nature, override the domestic tax avoidance
                    provisions concerning related party transactions.

                    •Accordingly, if the Transfer Pricing Officer holds a
                    transaction to be at arm’s length, there can be no disallowance
                    under the pretext of excessive payment to related party under
                    the provisions of Section 40(A) of the Act

Canoro Resources,   •where it was held that the Transfer Pricing provisions, being
                    more specific override the general provisions.


                                                                                 186
           Some Landmark TPR rulings
Case law      Important observations

Vertex        •The Tribunal has affirmed that where a taxpayer has computed the arm’s
              length price as per law, in 'good faith’ and with ‘due diligence’, penalty should
              not be levied.

              • This comes as welcome relief to taxpayers subjected to arbitrary or
              procedural penalty on transfer pricing adjustments.

Cargill India •The Tribunal had favored the taxpayer holding that where penalty was levied
              for ‘non-maintenance of documentation’.

              •In this case, the Tribunal had ruled that Revenue has to call only for
              specific and relevant information and not simply ‘all information’.

              •It further held that the penalty would not be justified if the Revenue does
              not point out any specific default in complying with the documentation
              requirements and does not consider any ‘reasonable cause’ that the
              taxpayer may have resulting in the default                                      187
Revision :
 Applicability
 Charging section
 Associated Enterprise
 Deemed Associated Enterprises – Situations
 International transaction
 ALP & Methods



                                           188
TP METHODOLOGIES -PRACTICAL
           ISSUES



                              189
   SYNOPSIS

• Introduction


• Methodologies and guidelines for selection of a method


• Tested party


• Practical issues arising in selection of a method


• Practical issues in applying any particular method


                                                           190
  Introduction
• The law does not oblige a trader to make the maximum profit
  that he can out of his transactions. It is the income in the hands
  of the trader which is taxable. Any income he could have, but
  not earned, is not exigible to tax as income [CIT v. A Raman
  and Co. [1968] 67 ITR 11 (SC) ]

• As long as prices at which international transactions are
  entered into are ALPs, it is hardly relevant whether or not the
  AE has ensured that the assessee makes reasonable profits
  ACIT v. MSS India (P) Ltd. [2009] 123 TTJ (Pune) 657

• No businessman can be compelled to maximise his profits :
  SA Builders 288 ITR 1 SC

                                                                       191
   Section 92C (1) – Methodologies

• ALP in relation to an international transaction shall be
  determined by one of the five methods

• Being the most appropriate method (MAM)


• MAM shall be determined having regard to
- Nature of transaction
- Class of transaction
- Class of AEs
- Functions performed by AEs
- Other relevant factors as may be prescribed by Board
                                                             192
    Section 92C (1) – Methodolgies
•   Other relevant factors as may be prescribed by Board as per Rule 10C(2)
    are

-   Nature and class of international transaction (I.T.)
-   Class/classes of AEs entering into transaction and FAR performed
-   Availability/coverage/reliability of data necessary for application of
    method
-   Degree of comparibility existing between I.T.s and U.T.s or between the
    enterprises entering into such transaction
-   Extent to which reliable/accurate adjustments can be made to account for
    differences between I.T.s and U.T.s or between the enterprises entering
    into such transaction
-   Nature, extent and reliability of assumptions required to be made in the
    application of a method

                                                                               193
   Section 92C (1) – Certain aspects
• ALP to be determined with reference to an international transaction
  as per sections 92(1) and 92C(1)

• MAM shall be the method which is best suited to the facts and
  circumstances of each particular international transaction as per Rule
  10C(1)

• As per Rule 10A(d), ‘transaction’ includes a number of closely linked
  transactions

• As per Section 92F(v) ‘transaction’ includes an arrangement,
  understanding or action in concert whether or not

- Same is formal or in writing
- Same is intended to be enforceable by legal proceeding


                                                                           194
    Section 92C (3) – ALP determination by AO
• Section 92 C(3) provides for determination of ALP by AO


• If on basis of material/document/information in his possession


• If he is of opinion that


- Price charged/paid in an international transaction has not been determined in
  accordance with sub sections (1) & (2)
- Information/documents have not been kept and maintained in accordance
  with sec 92D(1) and Rule 10D
- Information/data used in computation of ALP is not reliable/correct
- Assessee has failed to furnish information/document


                                                                             195
   Section 92C (3) – ALP determination by AO

• However, the power to determine ALP can be exercised only subject to
   the conditions of section 92C(3)

• Circular No.12 of 2001 makes it clear that AOs can have recourse to the
   above power only
    - under aforesaid circumstances (a) to (d) of sec 92C(3)
    - in the event of material information or document in his possession
    - on the basis of which an opinion can be formed that any such circumstance
      exists

• Circular provides that in other cases, the value of international
   transaction should be accepted without further scrutiny

                                                                              196
  Section 92C (3) – ALP determination by AO

• The aforesaid power can be exercised only during
 the course of assessment proceeding

• Before determining ALP, AO has to give a show
 cause notice as to why ALP should not be
 determined on the basis of material or information
 or document in his possession


                                                 197
    Practical issues arising in selection of a method
•   Is it possible to take a stand that no method is applicable and hence TP is not
    applicable?

-   Importer and its foreign collaborator, even if assumed to be related persons,
    their transaction value is to be accepted, when that relationship did not
    influence price CCE v. PRODELIN India (P.) LTD (2006) 202 ELT 13 (SC)

-   By simply saying that none of the methods prescribed can be applied and citing
    excuses for the same, does not absolve an assessee of his statutory duty in
    determining ALP as per law : Starlite 192 Taxman (ii) [Mum ITAT] 6 Taxman.com
    41

•   Can assessee change the method from one year to another year
-   When there is no change in facts & circumstances
-   When there is a change

•   Can AO/TPO change the method as aforesaid?

                                                                                198
  Practical issues arising in selection of a method

• Considerations for selecting a method


- The assessee is free to adopt any method as prescribed by
  law, if it considers that method as the most appropriate
  method : UCB India Pvt Ltd 121 ITD 131 (Mum.)

- Consideration as to which method will be more beneficial to
  the Revenue authorities is certainly not germane to the
  selection of most appropriate method : ACIT v. MSS India
  (P) Ltd. [2009] 123 TTJ (Pune) 657
                                                           199
  Practical issues arising in selection of a method

• Transaction method v. profit method

- Use only profit methods when transactions methods fail
  [ACIT v. MSS India (P) Ltd. [2009] 123 TTJ (Pune)
  657]

- TNMM is the appropriate method in case of service PE
  :. Morgan Stanley and Co. Inc. (2007) 292 ITR 416
  (SC)

- Trend of OECD – Leans more towards TNMM             200
    Tested Party : Sec. 1.482-5 of the US TP
-   Regulations
    the tested party will be the participant in the controlled transaction

- whose operating profit attributable to the controlled transactions
    can be verified

- using the most reliable data and requiring the fewest and most
    reliable adjustments, and

- for which reliable data regarding CUTs can be located.

- Consequently, in most cases the tested party will be least complex
    of the controlled taxpayers and will not own valuable intangible
    property or unique assets that distinguish it from potential CUTs.

                                                                         201
    Tested Party
•   While determining MAM, it is first necessary to select the ‘tested party’ and
    the tested party will be the least complex of the controlled taxpayer and will
    not own valuable intangible property unique assets that distinguish it from
    potential CUTs: Development Consultants (P) Ltd. (2008) 115 TTJ (Kol)
    577

•   Tested party normally should be the party in respect of which reliable data
    for comparison is easily & readily available and fewest adjustments in
    computations are needed. It maybe local or foreign entity, i.e., one party to
    the transaction : Ranbaxy [2008] 110 ITD 428 (Delhi)

•   If the taxpayer wishes to take foreign AE as a tested party, then it must
    ensure that it is such an entity for which the relevant data for comparison is
    available in public domain or is furnished to the tax administration. He is not
    then entitled to take a stand that such data cannot be called for or insisted
    upon from the taxpayer : Ranbaxy(supra)
                                                                                202
    Tested Party
•   Aggregating of all foreign AEs as tested parties in taking their margin of
    profit for comparison with some American companies and six other
    companies with location not disclosed is not acceptable : Ranbaxy 110 ITD
    428 (Delhi)

•   The least complex party needs to be selected as the tested party for the
    purpose of carrying out Arm’s Length analysis. The reasons for testing the
    margins of a less complex party is that the simpler party requires a fewer and
    more reliable adjustments to be made to its operating profit margins. A
    foreign entity is unsuitable as a tested party because it is difficult to compare
    in different jurisdictions since the facts and circumstances are different in
    each geographical location. Moreover, it is difficult to obtain all relevant
    facts that could lead to a proper FAR analysis. Further the relevant data
    required to make the requisite adjustments is also very difficult to obtain in
    relation to the foreign comparables : Global Vantedge Pvt 2010-TIOL-24-
    ITAT-DEL
                                                                                  203
  METHODS

• CUP method

• Resale Price method

• Cost plus method

• Profit split method

• Transaction net margin method   204
      Practical issues in CUP method
•     When CUP may be chosen

•     CUP is rejected in Eli Lilly and Co. and Subsidiaries v. CIR (84 US Tax Court
      Reports 996) as noted in UCB India 121 ITD 131 (Mum.)

       As difference arising due to –

(a)    credit terms;
(b)    supply of raw material;
(c)    packaging;
(d)    product quality;
(e)    patents.

       between controlled and uncontrolled transactions could not be accounted
       for by a reasonable number of adjustments.

                                                                                      205
    Practical issues in CUP method
• Aggregation of transactions


a) Yes : Rule 10A(d) – “transaction” includes a
    number of closely linked transactions.

a) No :


- Development Consultants 23 SOT 455 Kol
- UCB India 30 STO 95 Mum
- Ranbaxy 110 ITD 428 (Delhi)                     206
  Practical issues in CUP method - CUT

• Gharda Chemicals Ltd 130 TTJ 556 Mum


- Whole sale price and retail price are not comparable


- Price operated in UK/Australia cannot be compared
  with that of USA



                                                     207
  Practical issues in CUP method - CUT
• Can Market Quotations be used as CUT?

- London Metal Exchange quotations provide the most reliable
  prices at which uncontrolled comparable transactions are
  entered into : MSS India (P) Ltd. [2009] 123 TTJ (Pune) 657

- LIBOR could be taken : Perot Systems 2010-TIOL-51-ITAT-DEL

- Certificate of Market Committee produced is public document
  forming record of public body & rates disclosed therein to be treated
  as authentic : Rameshwar Das [2010] 30 VST 531 (P&H) HC

- Rates published in news papers like Economic Times cannot be used
  for benchmarking : Suresh Kumar Bajoria vs. Income Tax
  Officer [2008] 113 TTJ (Jp) 364                                   208
    Practical issues in CUP method – ALP
    determination
•   Gharda Chemicals Ltd 130 TTJ 556 Mum

 External CUP contemplates comparison of price charged by assessee from its AE
    with open market price in that country from transactions between the unrelated third
    parties.
   Take price at which such goods are imported by others on an average basis.
   Such an average price should be some realistic price representing the price from the
    whole or the large part of whole of the imports made in USA of this product and not
    some isolated or a stray transaction.
   If product A is imported by 100 parties at rates ranging between 50 US$ to 70US$
    from different countries, lowest price of 50 USD cannot be taken as ALP.
   Rather in such a situation the average price of 60 USD should be taken as ALP.
   A third party report cannot be the sole basis for determining the ALP on CUP
    method for the reason that the third party is not a Government Agency of USA,
    which could vouch for the price
   The third party, in turn, may have relied on certain stray instance
   Reliance on such selective data is not best guide for the determination of ALP. 209
  Practical issues in CUP method - FAR
• Libor rate to be increased by average basis pont : Perot
  Systems 2010-TIOL-51-ITAT-DEL

• CUT price may be suitably enhanced for

- ‘significant service in producing the raw material’ and
- ‘freight and insurance which is paid by the AE’.

  [ACIT v. MSS India (P) Ltd. [2009] 123 TTJ (Pune)
  657 ]                                          210
  Practical issues in CUP method - Others

• When assessee enters into the raw material purchase
  transaction with the AE at an ALP, it is of no
  consequence whether or not he makes sufficient
  profits on manufacturing products from such raw
  material [ACIT v. MSS India (P) Ltd. [2009] 123
  TTJ (Pune) 657 ]




                                                   211
  Practical issues in TNMM

 Year of data
 Number of comparables
 Different geographical locations
 Loss making companies as CUTs
 Super profit companies as CUTs
 Turnover filters
 Companies with controlled transactions as CUTs
 Internal cut v. External cut
                                                   212
  Practical issues in TNMM

 Search process - filters
 Application of TNMM – Entity level or transaction
  level
 Operating costs/margin
 FAR analysis




                                                      213
     Practical issues in TNMM
 Year of data : Rule 10B(4) read with proviso [See Rule 10D(4) also]


a)   Same year

-    CITv. Denso Haryana (P.) Ltd. [2010] 190 Taxman 389 (Delhi) HC
-    Aztek 107 ITD 141 (Bang.) (SB)
-    Mentorgraphics 109 ITD 101 Delhi
-    Philips 119 TTJ (Bang) 721
-    Customer Service 2009-TIOL-424-ITAT-DEL
-    Skoda 122 TTJ 699
-    Honewell 2009-TIOL-104-ITAT-PUNE [Future year cannot be
     taken]

b) Different year - Development Consultants 23 SOT 455 Kol577
                                                                    214
     Practical issues in TNMM – CUT selection

 Number of comparable companies

a) Even one comparable will do

1.   Rule 10B(1)
2.   ICAI guidance note
3.   Vedaris Technology [2010] 131 TTJ (Del) 309
4.   Mentor Graphics [2007] 109 ITD 101 (Delhi)

b) There should be reasonable number of CUTs       215
   Practical issues in TNMM – Search process
 Primary filters

   – Data not update –
     (i) no directors report
     (ii) no notes to accounts
     (iii) insignificant data
     (iv) no segment information

   – Related party transactions

   – Geography of operation – exports < 25%

   – Consistent losses

   – Functionally different

   – Turnover ie size

   – Exceptional year of operation             216
   Practical issues in TNMM – Search process
 Secondary filters


   – Salary costs being < 25%

   – R & D costs greater than 5%

   – Forex filter

   – Trading activity filter

   – Asset filter when assets > revenues
                                               217
  Practical issues in TNMM – CUT selection

 Different geographical area


   Adjustments merely for volume off take, credit
   period and credit risk, though material are not
   sufficient to make the sale price to AE in Thailand
   comparable with the sale to unrelated party in
   Vietnam unless an adjustment for differential
   end user price in two countries is made : Intervet
   India (P.) Ltd. v. ACIT 130 TTJ 301 Mum
                                                    218
  Practical issues in TNMM – CUT selection
 Loss making companies

- OECD draft notes dt 10.05.2006 has accepted to exclude loss as
  well as high profit making companies where tax payer is a captive
  enterprise

- A business organization with negative net worth cannot be treated
  at par with a normal business organization : Quark Systems Pvt Ltd
  Vs ITO 2010 TIOL 31 Chandigarh

- However, merely because a comparable is making loss, it cannot
  be excluded from the list of comparables : Quark Systems (supra)

- Loss and competition are normal incident of business and merely
  on above factors, exclusion is not justified : Sony India [2008] 114
  ITD 448 (Delhi)
                                                                    219
  Practical issues in TNMM – CUT selection

 Companies making extra ordinary profits should
 be excluded :

- Quark Systems Pvt Ltd Vs ITO 2010 TIOL 31
 Chandigarh

- Philips Software v. ACIT 119 TTJ (Bang) 721


- E-Gain Communication [2008] 118 TTJ (Pune) 354
                                                220
  Practical issues in TNMM – CUT selection
 Turnover filter

- Is captive service provider immune from size of
  turnover?

- Turnover of Rs 1 crore to infinite is a not reasonable
  classification as turnover base : Quark Systems Pvt Ltd
  Vs ITO 2010 TIOL 31 Chand

- Oversized  companies to be avoided             E-Gain
  Communication [2008] 118 TTJ (Pune) 354

- Guidance Note of ICAI
                                                       221
    Practical issues in TNMM – CUT selection
Can company with controlled transactions be
 considered?

a) Not even one such transaction is acceptable

-   Mentor Graphics 109 ITD 101 Delhi
-   Philips 119 TTJ (Bang) 721

b) 10% to 15% of such transactions is tolerable

- Sony 114 ITD 448 (Delhi)                        222
  Practical issues in TNMM – CUT selection
 Internal cut or external cut : In case external
 comparables are not available due to lack of data in
 public domain, the AO may accept internal
 comparables including segmental data or internal
 TNMM : UCB India Pvt Ltd 121 ITD 131 (Mum.)

• Is assessee estopped by companies originally
 selected?
 No : Quark Systems Pvt Ltd Vs ITO 2010 TIOL 31
 Chand
                                                   223
  Practical issues in TNMM – CUT selection

• When information available in public domain is not
  sufficient to make the comparisons possible, it is
  inevitable that some approximations and reasonable
  assumptions are to be made : Skoda Auto India (P.)
  Ltd. 122 TTJ 699 Pune




                                                   224
    Practical issues in TNMM – CUT selection
 TNMM evaluates profitability of transactions rather than profitability
    of an enterprise.

•   Transaction of different nature cannot be aggregated for the
    purpose of comparison under TNMM.

•   In practice though the profitability of comparable entities is used to
    benchmark the international transactions of taxpayers, however, in
    such a scenario an underlying assumption overrides the analysis for
    the lack of data.

•   Acting assumption in such case is that due to a well designed
    functional analysis only those companies are taken as comparables
    which have undertaken homogeneous & comparable transactions.

•   Thus, in such a scenario, the profitability of the comparable
    entities, in effect, represents the profitability of comparable
    transactions.
    Source : OECD TP guidelines 1995 clause 3.42 applied in Global
                                                                 225
TNMM to be applied on Entity level or transaction
level

 Comparing the operational margin at entity level
  cannot be termed as TNMM : UCB India 121 ITD
  131 (Mum.)




                                                     226
  Practical issues in TNMM – Operating costs/margin

 Provision for future losses to be deducted :
  Honeywell 2009 TIOL 104 Pune

• TNMM as per Rule 10B refers to net profit and not
  operating profit. Therefore, there is no scope for
  reducing interest and other overheads : T Two
  International Pvt Ltd 2010-TIOL-166-ITAT-MUM

• Profit before depreciation may be taken for
  benchmarking : Schefenacker Motherson [2009] 123
  TTJ (Del) 509                                  227
  Practical issues in TNMM – Operating costs/margin
 If high import content is necessitated by the
  extraordinary circumstances beyond assessee's
  control, may warrant an adjustment in operating
  margin : Skoda Auto India 122 TTJ 699 Pune

 Reimbursement of advertisement expenditure by
  associated enterprise, Provision written back,
  Balances written back, Insurance claim and Interest
  received from customers for delayed payment
  cannot be excluded from normal operating profits :
  Sony India P. Ltd. [2009] 315 ITR (AT) 150 (Delhi)
                                                    228
  Practical issues in TNMM – FAR
 Intangibles and Risks : Make 20% adjustment as per
  Sony India [2008] 114 ITD 448 (Delhi)

• No blind adjustments without examination of vital
  issues : Philips 2009 TIOL 123 Kar HC & Vedaris
  Technology (P) Ltd. [2010] 131 TTJ (Del) 309

• Adjustments should be made for risk, working capital
  and R&D
- Mentor Graphics 109 ITD 101
- Schefenacker Motherson [2009] 123 TTJ (Del) 509
- E Gain Communications 118 ITD 243 Pune
                                                    229
  Practical issues in TNMM – FAR
 Use of trademark and logo by domestic AE : Maruti Suzuki
  India Ltd. [2010] 31 CAPJ 158

- Where use is discretionary : No adjustment

- Where use is mandatory : Appropriate payment should be
  made by foreign AE, on account of the benefit it derives in the
  form of marketing intangibles, obtained by it from such
  mandatory use of its trademark and/or logo.

- Expenditure incurred by domestic AE on advertisement etc.,
  need not be paid by foreign AE as long as such expenses don’t
  exceed what an independent person would have incurred in
  similar situations                                         230
  Practical issues in TNMM – FAR
 Start up assessee v. Established comparables –
  Adjustment towards idle capacity: Global Vantedge Pvt
  2010-TIOL-24-ITAT

- Looking into the IT industries which were in booming
  stage, a surplus capacity to the extent of 1/3rd of the
  existing capacity is treated as normal in this industry in
  anticipation of future growth in business and an
  adjustment to the profitability of the comparables
  should be made to the extent of 33.33%.

- the profitability of the comparables need to be adjusted
  by the above %age to bring them to a level of
  inefficiency that appellant operated at.
                                                          231
  Practical issues in TNMM – Other aspects
Is fact of AE suffering losses justification for lower
   margin?

- No as per Gharda Chemicals Ltd Vs DCIT, 130 TTJ
  556 Mum

- Yes as per DCIT v. M/s. Indo American Jewellery 131
  TTJ (Mumbai) 163

- The total adjustment made to assessee together with the
  ALP already reported by him cannot exceed the total
  revenue earned by him and his AE from third party
  independent clients : Global Vantedge 2010-TIOL-24-
  ITAT-DEL
                                                         232
  Practical issues in TNMM – Other aspects
Can industry    average/norm     be   used   as   a
 benchmark?

- Yes as per CIT. v. DUA and associates P. Ltd.,
 [2009] 316 ITR 224 (P & H) HC [Hotel industry –
 Non TP case]

- Report on the Indian BPO Industry prepared by
 INGRES, a division of ICRA Ltd could be used to
 benchmark marketing effort in the absence of any
 other evidence : Global Vantedge Pvt 2010-TIOL-
 24-ITAT                                        233
  Practical issues in TNMM – Other aspects
• Can ALP margin be worked when assessee is
  working as per Government regulations?

- Where no profits is inferable, there in no option
  except to accept declared price [In Exxon Corpn. &
  Affiliated Companies al v. CTC Memo 1993-616]

- Where payment is made to cane growers as per the
  directions of the State Govt, assessee cannot be
  accused of paying to the cane growers in excess of
  the fair market price : CIT v. Manjara Shetkari
  Sahakari Sakhar Karkhana [2008] 301 ITR 191 (Bom)
                                                       234
  Practical issues in TNMM – Other aspects
• Is TPO bound by acceptance of transaction by other
  department?

- RBI's approval does not put a seal of approval as per
  Perot Systems Tsi 2010-TIOL-51-ITAT-DEL

- Declaration in customs does not bind the assessee in TP
  proceedings DCITVs M/s United Racing & Bloodstock
  Breeders Pvt Ltd 2009-TIOL-423-ITAT-BANG

- Circ No.6 dated 6th July, 1968 with reference to sec 40A(2) :
  payment approved by one wing of Government, cannot be
  treated as unreasonable by another wing of the same
  Government.
                                                                  235
  Practical issues in TNMM – Other aspects

     Customs TP                       Income tax TP
     Intangibles are ignored          Intangibles are considered
     Functional analysis is not       Functional analysis is
     recognised                       recognised
     Post import adjustments are      Post import adjustments are
     not usually carried out          usually carried out

     Aggregation of transactions is   Aggregation of similar
     not accepted                     transactions is acceptable

 OECD : Customs adjustment cannot be automatically taken




                                                                    236
    Practical issues in TNMM – Other aspects
 Is TPO bound by acceptance of transaction by other department?


-   Agreements having been approved by the various Government authorities
    from time to time, the terms thereof could not be regarded as unreasonable
    or excessive and the same, in any case, cannot be considered as sham or
    collusive merely on the basis of surmises and conjectures.

- Sheraton International Inc. vs. DDIT (2007) 107 ITD 120 (Delhi) :
- CIT vs. Lucas TVS Ltd. (1997) 226 ITR 281
- CIT vs. Sriram Pistons and Rings Ltd. (1990) 181 ITR 230 Del
- The expenses have been incurred after obtaining FIPB approval from the
  R.B.I cannot be said to be not at ALP : KLM Royal Dutch Airlines v. ADIT
  [2007] 292 ITR 49 [Delhi HC]


                                                                           237
    Practical issues in TNMM – Other aspects
 Adoption of operating margin?


-   To be applied only on international transactions and not on all transactions :
    IL Jin Electronics 2010 TIOL 151 (Mum Tri)

-   TNMM should be applied by working out the average net profit. The
    adjustment should be worked out by reducing the net profit declared by the
    assessee from the gross sales and then divide the same in the controlled and
    uncontrolled sale and apply the net profit rate : T Two International Pvt
    Ltd 2010-TIOL-166-ITAT-MUM

-   Revenue earned by assessee from servicing independent clients, without
    involvement of related party should not be benchmarked. The proportionate
    costs attributable to such revenue should be ignored while computing ALP :
    Global Vantedge Pvt Ltd 2010-TIOL-24-ITAT-DEL
                                                                               238
  Practical issues in TNMM – Other aspects

• Is TP applied on cost sharing?

- Section 92(2)

- OECD Guidelines on TP [noted in ABB Ltd., In Re [2010] 322
  ITR 564 (AAR)]

  “each participant in a CCA would be entitled to exploit his
  interest in the CCA separately as an effective owner thereof
  and not as a licensee, and so without paying a royalty or other
  consideration to any party for that interest. Conversely, any
  other party would be required to provide a participant proper
  consideration (e.g., a royalty), for exploiting some or all of
  that participant’s interest”
                                                               239
  Practical issues in TNMM – Other aspects


• Is assessee/AO/TPO bound to adopt same ALP
  margin as earlier year when facts have not changed?

- Mandate to use contemporaneous data : Rule 10B(4)

- In absence of any change in factual position, profit
  rate declared and accepted in preceding years
  constituted a good basis for working out gross profit
  rate as per CIT v. Inani Marbles (P) Ltd. [2008]
                                                     240
  Practical issues in TNMM – Other aspects


• How is IPR to be dealt with in TNMM?

- The income arising from the transfer of its right, title
  and interest in and to the trade-marks is taxable in India
  under the Income-tax Act, 1961. 'Independent valuation
  report' obtained by the applicant may be accepted by the
  department if it is found true and correct on
  examination : 2008 - TMI - 4676 - AAR


                                                             241
  IS THERE A TIME LIMIT FOR MAKING TP REFERENCE?

   AY 2010-11


     Sep 30               Sep 30             Dec 31                Oct 31            March 31
      2010                 2011               2011                  2012              2019




  Deadline for        Limitation for         Limitation         Limitation for      Date till which
   maintaining      initiating scrutiny     for initiating      completion of      documentation is
documentation,         assessment             TP audit            TP audit          required to be
filing tax return                                                                     maintained
       and
  accountant’s
      report

     Second proviso to Sec 153(1) – “during the course of proceeding for the assessment of total
     income, a reference u/s.92CA(1) is made”



            | 242
         TP ASSESSMENT BY JDIT – VALIDITY?
   Explanation to section 92CA(7) —For the purposes of this section, “Transfer Pricing Officer”
    means a Joint Commissioner or Deputy Commissioner or Assistant Commissioner
    authorised by the Board to perform all or any of the functions of an Assessing Officer
    specified in sections 92C and 92D in respect of any person or class of persons


   Sec 2(28C) - “Joint Commissioner” means a person appointed to be a Joint Commissioner of
    Income-tax or an Additional Commissioner of Income-tax u/s.117(1)
   Sec 2(9A) - “Assistant Commissioner” means a person appointed to be an Assistant
    Commissioner of Income-tax or a Deputy Commissioner of Income-tax u/s.117(1)


   Sec 2(28D) - “Joint Director” means a person appointed to be a Joint Director of Income-tax
    or an Additional Director of Income-tax u/s.117(1)
   Sec (19C) - “Deputy Director” means a person appointed to be a Deputy Director of Income-
    tax u/s 117(1)
   Notification by CBDT authorising JDITs as TPOs – Validity in view of provisions?


        | 243
    VALIDITY 133(6)
    INFORMATION
 Second proviso to sec.133(6) – Provided
  further that the power in respect of an inquiry,
  in a case where no proceeding is pending,
  shall not be exercised by any income-tax
  authority below the rank of Director or
  Commissioner without the prior approval of
  the Director or, as the case may be, the
  Commissioner
 Validity of centralized collection of
   | 244
        AE TRIGGER
 Sec 92A(1) – AE definition - Participation in management or control or capital of
   other enterprise
 Sec 92A(2) – deemed to be AE - 12 triggers
    – CBDT clarified that falling under 92A(2) is necessary to be treated as AE
 Will it hold good even if there is no participation in management or control or
   capital
 Usage of “for the purpose sub-section (1) in sec 92A(2)”
    – Principle of deeming fiction and purpose interpretation
 Sec 92A(2)(i) – “the goods or articles manufactured or processed by one
   enterprise, are sold to the other enterprise or to persons specified by the other
   enterprise, and the prices and other conditions relating thereto are influenced by
   such other enterprise” – will cover all customers? What words to be supplied to
   interpret?


       | 245
    TRANSFER PRICING -
    UNLIMITED
 Ranbaxy
 Fab India




   | 246
     IS PROFIT SHIFTING INCENTIVE A PRE-REQUISITE?
 Aztec software (5 member spl bench)
   – Necessary and expedient; Tax avoidance need not be
     established before reference
   – TP reference is valid even if unit is enjoying tax holiday
   – Philips software x MSS India
   – Indo-American Jewellery
 Coca Cola India
   – Pure domestic transaction between project office in India
     (status is non-resident) and Indian co (AE)


     | 247
    TP NOT TO APPLY IN THE ABSENCE OF CHARGE
 Dana Corporation (AAR)
 Amiantit International (AAR)

  – Absence of charge due to failure of computational
    provisions
  – Did not consider Sec 47 exemption
 Vanen burg (AAR)
  – Transfer not liable to tax in India as per DTAA
    provisions

    | 248
    TP VS OTHER PROVISIONS
 40A vs TP provisions
  – Jurisdiction of AO vs TPO
  – Aztec Software
  – Oracle India

 45(3) vs TP provisions
  – General vs Specific
  – Canoro Resources


    | 249
       TP AND 10A/10B
 Tweezerman India – Beware of super profits!
    – More than ordinary profits in eligible business due to close relationship with
       any other profits – sec 80IA(10)
 I-gate : Suo motu TP adjustment
    – 92C(4): Where an arm’s length price is determined by the Assessing Officer
       u/s.(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
    – However, realization in foreign exchange condition to be met for availing 10A
       deduction


      | 250
    AMENDMENT TO 5 PERCENT ADJUSTMENT
 Position prior to amendment - “Provided
 that where more than one price is determined
 by the most appropriate method, the arm’s
 length price shall be taken to be the
 arithmetical mean of such prices, or, at the
 option of the assessee, a price which may vary
 from the arithmetical mean by an amount not
 exceeding five per cent of such arithmetical
 mean.”
  | 251
        AMENDMENT TO 5 PERCENT ADJUSTMENT..2
 Amendment with effect from 1.10.2009 - “Provided that where more than one
   price is determined by the most appropriate method, the arm’s length price shall be taken to
   be the arithmetical mean of such prices; Provided further that if the variation between the
   arm’s length price so determined and price at which the international transaction has actually
   been undertaken does not exceed five per cent of the latter, the price at which the
   international transaction has actually been undertaken shall be deemed to be the arm’s length
   price”

 Memorandum explaining Finance Bill, 2009 – “amendment is effective for
   all assessments done after 1.10.2009”
 Amendment prospective or retrospective?
 SAP Labs India Pvt Ltd (Bang ITAT) – Amendment applicable from AY
   2009-10 only
    – Should it be read as AY 2010-11 and subsequent years only?


       | 252
    TP AND ROYALTY
 Maruti Suzuki and the Concept of Reverse
  royalty
  – TP risk to import distributors on possible
    disallowance of advertisement expenditure
  – Mere arm’s length revenue not sufficient
  – Expenditure also to be at arm’s length

 Royalty on sales and claim of bad debts
  – CA Computer Associates - Bad debts written off
    cannot be a factor to determine arm’s length
    | 253
    TP AND INTEREST ON LOANS
 Loan vs Quasi equity – Perot Systems
 PLR vs LIBOR – VVF

 Netting off receivables – Boston Scientific
 Loan vs Trade receivables – Nimbus
  communications


 Promoter’s guarantee to foreign subsidiary

 GE Canada ruling and implicit guarantee
   | 254
    DEVIATING FROM 3CEB AND
    DOCUMENTATION
 Quark systems
  – Company selected in own documentation can be
    sought to be excluded

 AM Todd co
  – Spot rates inadvertently taken in 3CEB




   | 255
    BENCHMARKING ISSUES
 Rejection of TP documentation without
  reasons – Mentor graphics, Indo american
  Jewellery
 Tested party – Ranbaxy x Development
  consultants
 Contemporaneous search – Philips, Toshiba

 Aggregation of transactions – Star India,
  Ranbaxy
    | 256
    BENCHMARKING ISSUES
 Loss making comparables – Sony India
 Entity wide TNMM and segmentals – UCB

 Business model differences and adjustments –
  Skoda auto
 Adoption of cash profits as Profit Level Indicator
  (PLI):Schefenecker
 Foreign exchange fluctuation is operating income
  – SAP labs
    | 257
      TP IN THE CUP
 Patented vs Generics – UCB, Cheminova
 Spot rates at the time of entering into contract – AM Todd
 Rates stated in expert report as CUP – Gharda chemicals

 Industry average rates – Aztec, 3Global services, Essar
 Market/Geographical comparability – Gharda, Intervet, Dufon

 Retail vs wholesale – Gharda, Dufon

 Comparison on weighted average price of all tested
  transactions in the year - Dufon



     | 258
Samsung Electronics - Karnataka High Court


                                                              Karnataka High Court decision
    Textronics US           French Co.                         Payer cannot determine the taxability in India
                                                                of Non-resident (No reference to CBDT
                                                                Circulars by HC)
                                                               Withholding tax obligation relieved only by
                                                                application and Certificate / Order from the
                                                                Tax authorities
USA                                  France                    Taxability of software import transaction per se
                                                                not dealt with
                                                               Relied on it’s own interpretation of Supreme
                                                  Samsung
                                                   Korea
                                                                Court decision in A.P. Transmission
                                                                Corporation
Korea
                                    100 percent               Current Position
                                                               Hearing before Supreme Court fixed in August
India    Import of shrink wrapped                               2010
         software
                                              Samsung India    Payment of demand stayed

                                                                                                           259
                                                                                                                 259
Van Oord ACZ India (P) Ltd. vs. CIT – Delhi HC

                              On VO India’s application for Nil withholding on
                               reimbursements of mobilization, demobilization costs to
                               Netherlands Parent Company, the Tax Authorities:
                                  Directed tax withholding at 11 percent
                                  Sum disallowed u/s 40 (a) (i) n absence of thereof
                              Delhi High Court ruled:
                                  VO India was not liable to deduct tax under Section
                                   195(1) since the payments were mere
                                   reimbursements and not income
                                  Obligation to withhold tax is only when the payments
                                   are income chargeable to tax in India
                                  Karnataka HC decision in Samsung not followed
                              Delhi HC in Maharishi Housing is on same lines




                                                                                   260
                                                                                         260
Prasad Production – Chennai Tribunal (SB)

                  The SB deviated from the decision in Samsung (Kar HC) and held as
                    under:
                   SC decision in A.P Transmission related to sums chargeable to tax
                    including income embedded in the sums paid
                   On proper construction of SC decision, witholding tax obligation is
                    attracted only on payments to non-resident which are liable to tax in
                    India - not otherwise
                   There is no basis to contend that Payer cannot determine the tax
                    liability of the Payee qua the payments proposed
                   Certificate from a CA is an alternate procedure to Section 195(2) as
                    laid down by the CBDT Circulars
                   The withholding tax process is tentative and is subject to assessment
                    thereby protecting interest of all parties involved




                                                                                       261
                                                                                             261
             E*Trade – AAR
             - Validity of Treaty Shopping
                                            AAR Ruling
                                               CBDT Circular No. 789 applies and the Certificate of
                                                Residence is relevant to determine beneficial ownership /
E*Trade USA
                                                confer treaty benefits
          WOS                                  The SC in Azadi Bachao found no legal taboo against
                                                treaty shopping
 E*Trade                      HSBC Violet      The motive does not impact legality or validity of the
 Mauritius                     Mauritius        transactions
       Sale of shares of ILFS, India           Tax Treaty benefits are to be granted so long as
                                                transaction done within the framework of law
 IL&FS                                         E*Trade Mauritius is eligible to benefits of the India-
  India
                                                Mauritius Tax Treaty
                                            Note: Earlier the Bombay HC had refused to go into merits
                                               and the matter with consent of Parties was restored back
                                               to Tax Office


                                                                                                      262
                                                                                                            262
    Amiantit – AAR
    - No Capital Gain on Nil Consideration

                                                   Facts
       SAAC, Saudi Arabia                             Under Group Restructuring process, all non European
                                                       investments (including India) were proposed to be held
                                                       by ACHL Cyprus
                            Share contribution
                           without consideration   AAR Ruling
        AIH, Bahrain                                  Charging Section and Computation provision to be
                                                       read together and where Computation provision fails,
             100 percent                               Charging Section also fails
                                                      In absence of consideration on share transfer,
                                                       Computation mechanism fails - Charging Section fails
70 percent       ACHL, Cyprus
                                                       – B C Srinivasa Setty (SC)
                                                      In view of above, no taxes were required to be
                                                       withheld in India, since there was no Income
                                                       chargeable to tax
       AFIL, India
                                                      Transfer pricing provisions not applicable in absence
                                                       of Income chargeable to tax
                                                      Caution – Impact of Section 56(2)(viia)
                                                                                                          263
                                                                                                                263
AAR-- Share Transfer not taxable as per Treaty

                                    Facts
  PG Germany                           Post incorporation, all shares in PG India were transferred
                                        by PG Germany to PG Netherlands for a consideration
                                        determined under FEMA Regs.
                                       PG Netherlands thereafter made substantial equity
          Proposed share transfer
                                        investment in PG India to support expansion plans
  PG Netherlands                       PG Netherlands proposes to transfer shares of
                                        PG India to another Non resident – which Treaty to apply
                                        Netherlands or Germany?
                                    AAR Ruling
              Non resident
                                       Netherlands Treaty applies as PG Netherlands
                                             Has substance – Significant investment in India
                                             Is a separate legal entity
   PG India
                                             No legal / factual basis to show PG Germany is real
                                              beneficial owner of shares and the capital gains
                                              that would accrue
                                             Conduit approach or colorable device seem
                                              conspicuously absent
                                                                                                264
                                                                                                      264
Sea Gate Singapore – AAR
 - Demarcated warehouse space is PE
                                                               Facts
          SCo.                                                  ISP to provide earmarked warehouse
                                                                 space to SCo. with requisites such as
  (Manufacturer & Seller                                         storage racks, electronic devices etc.
     of Hard Disk)                         Ships goods based
                                           on OEM purchase      SCo.’s representatives have a right to
                                            order & property     enter the warehouse for inventory
                                           in goods remains      verification, inspection, audit,
                   Invoices for
                   goods directly              with SCo.         repackaging etc.
Singapore                                                       ISP to give delivery to OEM on behalf
India                                                            of SCo.
                                                               The AAR Ruled:
                                             ISP                Demarcated space in the warehouse
Pays directly                       (Independent Service         of ISP constitutes PE of SCo. under
                                          Provider)              Article 5(1) – ISP-SCo act in cohesion
                                                                 to effect Delivery

            OEM                                                 Attribution – PE should be treated as
          Customers                                              a distinct enterprise carrying on part
                               Keep stock of SCo.
         (Equipment            and delivers goods                of sales activity in India – Amounts
        Manufacturer)         on Just-in-time basis              paid to ISP and other expenses
                                                                 deductible


                                                                                                     265
                                                                                                           265
Recent judgments on Transfer Pricing

Ruling                   Key principles / Takeaways
Indo American             Transfer pricing study and ALP determined cannot be rejected
Jewellery, Mumbai          simply without any cogent reasons
ITAT
                          The fact that AE earned meager profit or incurred losses as
                           compared to the taxpayer showed that there was no transfer
                           of profit by the taxpayer out side India
                          As tax rates were higher in the overseas jurisdiction as
                           compared to India, there would be no incentive to shift profits
                           offshore
Firmenich Aromatics       No penalty for bona fide difference of opinion between the
(India) Pvt. Ltd,          Revenue and the taxpayer on the Most Appropriate Method, as
Mumbai ITAT                it cannot be construed to be concealment of facts or
                           furnishing of inappropriate particulars

Intervet India Private    Reasonably accurate adjustments for differences in economic
Limited, Mumbai ITAT       and market conditions in different locations must be made in
                           applying the CUP method


                                                                                     266
                                                                                           266
 Recent judgments on Transfer Pricing

Ruling                      Key principles / Takeaways

Chrys Capital Investment     Non-operating income - such as interest, dividend, income
Advisors India Pvt. Ltd.,     from share trading, etc. to be excluded in determining the
Delhi ITAT                    amount of the profit margin under TNMM
                             Expenses incurred on behalf of AE if included in operating
                              cost, any reimbursement pertaining to such expenses
                              must be included in operating revenue

Toshiba India Private        AO not to make any changes to the set of comparable
Limited, Delhi ITAT           companies without providing cogent reasons for the same
                             ALP to be determined by a systematic approach and
                              cherry-picking of comparables is not acceptable

3 Global Services Private    Hourly rate billing for the customer care business
Limited, Mumbai ITAT          segment published by NASSCOM is an acceptable external
                              CUP for benchmarking IT enabled services
                             Detailed FAR analysis for tested party and comparable
                              companies is crucial


                                                                                      267
                                                                                            267
 Recent judgments on Transfer Pricing

Ruling                        Key principles / Takeaways
IL Jin Electronics (I) Pvt.     Computation of transfer pricing adjustment must be
Ltd, Delhi ITAT                  restricted only to the international transactions of the
T Two International Pvt.         taxpayer and not on the entire sales of the company
Ltd., Tara Jewels Exports       Only net profit margin should be considered for TNMM
Pvt. Ltd. and Tara Ultimo
                                and there is no scope for reducing interest or other
Pvt. Ltd v. ACIT, Mumbai
ITAT                            overheads
CA Computer Associates         ALP is to be determined by the methods prescribed in the
Private Limited, Mumbai         Indian Tax Laws
ITAT                           Bad debts written off cannot be a factor to determine the
                                ALP
Perot Systems TSI (India)      Interest –free loans by Indian Companies to foreign
Ltd, Delhi ITAT                 subsidiaries do not comply with arm’s length standard
VVF Limited, Mumbai ITAT       Benefit of +/- 5 percent safe harbor is available only
                                where more than one arm’s length price is determined.
                               RBI’s approval does not endorse the arm’s length
                                character of the international transaction

                                                                                        268
                                                                                              268
Section 56(2)(viia) – Key Issues

            Whether shares in an Indian Co. can be considered to be received
            outside India by a NR if the transfer agreement is executed outside
            India? and hence, could it be argued that such receipt is not taxable in
            India under Section 5(2)?


            Whether receipt of shares from an AE at a price below FMV or for a
            Nil consideration could result in transfer pricing adjustment under
            Section 92 in the hands of the transferor? Could this lead to double
            taxation i.e. taxation in the hands of recipient as well as transferor?


            Whether FMV as notified by CBDT under Section 56 could also be
            considered as an “ALP” for the purpose of transfer pricing provisions
            under Section 92?


            Can a NR seek to rely on DTAA to mitigate the impact of Section
            56(2)(viia)?

                                                                                269
                                                                                      269
Presented By




            CA Swatantra Singh, B.Com , FCA, MBA
            Email ID: singh.swatantra@gmail.com
            New Delhi , 9811322785,
            www.caindelhiindia.com,
            www.carajput.com


      270
271

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:2
posted:12/18/2012
language:Latin
pages:271