Case Studies on Transfer Pricing

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Case Studies on Transfer Pricing
Samir Gandhi
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Global TP Enforcement
1996 prior 1997/ 1998 1999/ 2000 2001/ 2002 2003/2004
Italy New Zealand Mexico Korea France Czech Republic Spain Australia South Africa USA China Slovakia Brazil Italy New Zealand Mexico Korea France Czech Republic Spain Australia South Africa USA Germany Kazakhstan Russia Denmark Belgium Venezuela Argentina Canada UK China Slovakia Brazil Italy New Zealand Mexico Korea France Czech Republic Spain Australia South Africa USA Thailand Portugal Poland Peru India Netherlands Germany Kazakhstan Russia Denmark Belgium Venezuela Argentina Canada UK China Slovakia Brazil Italy New Zealand Mexico Korea France Czech Republic Spain Australia South Africa USA Hungary Colombia Malaysia Thailand Portugal Poland Peru India Netherlands Germany Kazakhstan Russia Denmark Belgium Venezuela Argentina Canada UK China Slovakia Brazil Italy New Zealand Mexico Korea France Czech Republic Spain Australia South Africa USA

• First level
• Second level
• Third level
• Fourth level

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Transfer Pricing Audit Process
Transfer Pricing Officer (TPO)
Assessing Officer ( AO )
AO to refer TP cases to TPO international
transactions gt INR 5 Crores ( 15 Crores)
AO to incorporate TPOs order in the Assessment
Order
Send Notice to tax payer - Hearing / Document
Analysis / No site visits / No interviews
Copy of order sent to the AO and tax payer
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TP Administration Structure
TPO I
TPO III
TPO II
Additional Commissioner of Income-tax
Additional Commissioner of Income-tax
Additional Commissioner of Income-tax
Support staff
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Experience from Initial Audits

• Major companies audited.
• 1,800 audits estimated.
• Only Selection Criteria.
• International Transactions above INR 5 Crores.
• Adjustments - INR 1,500 Crores.
• BPO/ITeS, Software, Banks, FMCG, Pharmaceuticals
  etc .
• TNMM method most commonly used by tax payers.
• Reliance on precedents of tax year(s) March 2002
  March 2003.
• Tax Board will develop case selection tools
  more focused examinations in future years.

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• Case Study

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Background

• XYZ Inc., a fortune 500 Company is in the
  business of manufacturing of automobiles
• XYZ India is a 100 subsidiary and provides CAD
  designing services.
• XYZ India is a captive service provider and is
  compensated on a C 10 mark up.
• XYZ India has applied the TNNM as the Most
  Appropriate Method using comparables operating in
  ITeS industry.
• PLI applied - Operating Margin / Operating Cost

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Analysis

• Position of the TPO
• Rejection of Loss Making Companies
• Rejection of Companies having only domestic
  transactions
• Rejection of Multiple year data
• Own set of Comparables provided without any
  search process (cherry picking)
• Proposed mark up of 30 -40

• Position of the Tax Payer
• Loss cannot be the sole criteria for rejection
  (entrepreneurial risk)
• TNNM requires functional comparability
• Financial results of comparables exhibit high
  degree of variation
• Integrated Service Provider to be excluded
• Companies having intangibles to be excluded (
  unique software, brand name etc)
• Adjustment for
• Working Capital
• Intangibles
• Risk ( captive service provider Vs. entrepreneur)

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Audit Outcome

• Captive Service Provider (BPO/ITeS)
• Losses not acceptable
• Proposed cost plus markups range from 25 to 40
• One size fits all approach
• Comparables proposed inappropriate (no
  consideration for intangibles, differences in
  business models, etc.)
• Justifies markup saying even after paying high
  markups, cost savings will be substantial
• Adjustment of risk vis-à-vis third party
  comparables disallowed
• Working capital adjustments of 2 allowed in some
  cases

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Audit Experience
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Major issues in Audit Outcomes - Services

• Consideration for service rendered by Indian
  Enterprises.
• R D, Marketing, Technical Services etc.
• Composition of Costs.
• Direct and Significant Allocations of Indirect
  Costs !
• Denial of Setoff.
• Allocation of management fees ( Information
  Technology, Marketing, Budgeting etc ) by AE.
• Benefit Test critical.
• Evidence of receipt of services.
• Determination of allocated amount.

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Major issues in Audit Outcomes Intangibles

• Application of TNMM and Exchange Control
  Regulations not sufficient.
• Substantiation of receipt of know-how including
  updates.
• Evidence of negotiation.
• Concerns on losses by Indian enterprises.
• Details of Foreign Enterprise.
• owner of intangibles.
• Controlled Transactions - Base for
  determination of ALP.
• Payments for trademark.
• Economic v. Legal ownership.
• Marketing Intangibles.

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Major issues in Audit Outcomes - Manufacturers

• Aggregation of Transactions
• Single entity approach
• Transactionwise analysis preferred.
• Preference for CUPs ( Internal and External )
• Material differences volume, quality, terms of
  sale, geographical differences etc. disregarded.
• Acceptance of TNMM with reluctance.
• Product vs. Functional comparability.
• Choice of profit level indicator.
• Disregarding Loss making companies from
  Comparables set.

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Major issues in Audit Outcomes - Distributors

• Enterprise with Losses Entrepreneur risk not
  acceptable.
• Higher Gross Margin, but losses at Net level due
  to significant marketing expenses.
• Resale Price Method Vs. TNMM.
• Reimbursement of marketing expenses by Foreign
  Enterprise.

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Going Forward

• Rulings Position of Revenue.
• Comparables, Methodology, Cost Sharing,
  Compliance - Foreign Enterprises etc.
• Risk Assessment - Selection of Audits.
• Safe Harbors eg. Services.
• Manning of TP Cell Appellate Authorities.
• Effective MAP Process and APA.

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Confessions to a Tax Auditor

• 10. Everybody does it!

• 9. It improves my bonus!

8. My country needs it more than you!

• 7. Its part of the game!

6. Thought they wouldnt notice!
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Confessions to a Tax Auditor (Contd..)
5. Its really just an accounting adjustment!
4. We already have too much profit over here!
3. Well shift some back here in later years!
2. It makes good commercial sense!
1. My boss made me do it!
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• Inputs

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Thank You