Ashwath S Pai, Sameer & Surya – [2024] 167 taxmann.com 591 (Article)

The issue of AMP expenditure has been an issue which has had the judiciary divided. While there are certain rulings which have ruled in favour of the Tax Department and advocated the use of ‘Bright Line’ Test, there are other rulings which have held that the Bright Line Test cannot be applied.

The above issue was again placed for determination before the Delhi HC in the Case of Samsung India1, wherein the major issues which were taken up before the HC was as follows:

1. Whether advertisement, marketing and promotion (‘AMP’) expenditure constitutes as an international transaction?
2. Whether foreign exchange gain/loss arising from international transactions was to be considered as an item of operating revenue/cost and not as a non-operating revenue/cost?

Background

The appellant Samsung India Electronics Pvt. Ltd. (SIEL or Appellant) was a company primarily engaged in the business of manufacture and sale of consumer electronics and home appliances goods. The appellant company is a part of the Samsung group of companies and a wholly owned subsidiary of Samsung Electronics Co. Ltd. Korea (‘SEC’).

The Appellant incurred certain AMP expenditure during the year concerned and failed to disclose the same in Transfer pricing report. The Transfer Pricing Officer (‘TPO’) had determined the Arm’s Length Price (‘ALP’) of the transaction stating it as International Transaction with the help of Bright Line Test (‘BLT’).

Aggrieved by the same, the appellant had filed appeal before the First Appellate Authority and then subsequently before the Income Tax Appellate Tribunal (ITAT). ITAT had issued order in favour of the Appellant and thereafter the Tax Department challenged this order before the Delhi High Court (Delhi HC).

Here are the key questions of law placed before the Delhi HC:

1. Whether the ITAT was justified in holding that the Advertising, Marketing, and Promotion (AMP) expenditure does not constitute an international transaction?
2. Whether the ITAT was correct in stating that the Brightline Test is not mandated by law and cannot be used to determine price but can only be used as an economic tool for determining costs in transfer pricing?
3. Whether the ITAT was right in observing that under the Transactional Net Margin Method (TNMM), AMP expenditure cannot be segregated for benchmarking?
4. Whether the ITAT was correct in stating that a protective adjustment to preserve revenue interests cannot be made when the issue of AMP is still pending before the Supreme Court?
5. Whether the ITAT erred in not appreciating that the ALP should remain unaffected by foreign exchange fluctuations and other post-transaction events?
6. Whether the ITAT erred in not recognizing that the TPO followed Rule 10B(3) by treating foreign exchange fluctuations and provisions as non-operating costs/revenues to ensure a consistent basis for comparison?

The Hon’ble High Court with regard to the Question of facts stated in Sl. No 1 to 3 hereinabove relied on the judgement in the case of Sony Ericsson Mobile Communications India Pvt Ltd. (‘Sony India’) v. Commissioner of Income-Tax 2015 SCC OnLine Del 8083.

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CA Deepak Kakkar – [2024] 166 taxmann.com 650 (Article)

In India, the transfer pricing regulations are governed by Sections 92 to 92F of the Income Tax Act, 1961.

These provisions ensure that transactions between related parties are conducted at an arm’s length price, which is the price that would be charged between independent parties in similar conditions.

The objective of the transfer pricing regulations is to prevent the shifting of profits to low-tax jurisdictions and to ensure that multinational enterprises (MNEs) report appropriate taxable income in India.

The key elements of the Indian transfer pricing regime include the determination of the arm’s length price (ALP), maintenance of comprehensive documentation, and mandatory reporting through the Form 3CEB, which is to be certified by a Chartered Accountant.

Transfer pricing provisions apply to a wide range of transactions, including the sale of goods, provision of services, intellectual property transfers, loans, and even cost-sharing arrangements. The regulations cover both international transactions and specified domestic transactions between related parties, emphasizing transparency and fairness in cross-border dealings to protect the Indian tax base.

However, there are certain aspects that are often overlooked by both taxpayers and tax auditors. This article will focus on two such commonly neglected areas:

• non-reporting of deemed international transactions under Section 92B(2) of the Income Tax Act, and
• incorrect consideration of Associated Enterprise definitions.

1. Non-reporting of Deemed International Transactions (Section 92B(2))

A major gap observed in transfer pricing audits is the non-reporting of deemed international transactions. Under Section 92B(2), even if a transaction is technically domestic, it may still qualify as an international transaction if it involves an arrangement between an Indian entity and another party via a third-party associated enterprise (AE).

Section 92B(2) of the Act states that:

“A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be an international transaction entered into between two associated enterprises, if

(a) there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or

(b) the terms of the relevant transaction are determined in substance between such other person and the associated enterprise where the enterprise or the associated enterprise or both of them are non-residents irrespective of whether such other person is a non-resident or not”

As an auditor, to ensure that, you have covered all necessary aspects, review any potential deemed international transactions that may have arisen in common global arrangements such as:

• Global procurement or supply contracts
• Global service agreements
• Contracts related to common computer software or technology-related common contracts etc.

These kinds of arrangements often create deemed international transactions that could impact your TP compliance.

For instance, suppose a domestic subsidiary enters into a transaction with a third party, but that third party is either controlled or significantly influenced by the foreign parent or another AE.

In such cases, the transaction should be treated as a deemed international transaction. Unfortunately, many taxpayers overlook this provision, leading to underreporting or misclassification in transfer pricing documentation.

As a Transfer pricing auditor, it is mandatory to report in Form 3CEB read with Rule 10E whether the particulars required to be furnished under section 92E are given in the Annexure to that Form. Further, you have to opine to the best of your information and according to the explanations given to you, the particulars given in the Annexure are true and correct.

Clause 20 of Form 3CEB itself requires the assessee to report whether any deemed international transaction is entered or not as follows:

It is also worthwhile to note that, the transaction entered into by assessee falling in any of the two mentioned conditions will be treated Deemed International transaction irrespective of:

• Whether or not the associated enterprises have retained any benefit/discount from third party vendors in India/outside India
• Whether or not the transaction carried out by assessee is fair and arm’s length price

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Case Details: Principal Commissioner of Income-tax vs. Stanley Black and Decker India Ltd. - [2024] 166 taxmann.com 381 (Karnataka)

Judiciary and Counsel Details

• S.G. Pandit & C.M. Poonacha, JJ.
• E.I. Sanmathi., Adv. for the Appellant.
• T. Suryanarayana, Senior Counsel & Smt. T. Tanmayee Rajkumar, Adv. for the Respondent.

Facts of the Case

Assessee-company was engaged in trading power tool products. During the year under consideration, it entered into international transactions, and the matter was referred to the Transfer Pricing Officer (TPO) for determination of the arm’s length price (ALP) in respect of the international transactions. The TPO, after analysing the advertisement and sales promotion expenditure incurred by the comparables, suggested a transfer pricing adjustment. Thereafter, a draft order under section 144C was passed.

The assessee raised objections to the draft order, which the DRP rejected in its order on the ground that the specific details with relevant information had not been furnished to enable them to examine the matter.

On appeal, the assessee submitted that it had placed on record specific details and facts on the nature of alleged expenses before the TPO as well as during a personal hearing before the DRP. The DRP, in its order passed under section 154, accepted the contention of the assessee and rectified its order directing the TPO to exclude trade discounts, sales discounts, warranty expenses and packing expenses from the ambit of advertisement and marketing and promotion (AMP) expenses for transfer pricing comparison and adjustment.

ITAT Held

ITAT also upheld the rectification order passed by the DRP. The matter then reached before the Karnataka High Court.

The Court held that Section 154 empowers the Income-tax Authority referred to in section 116 to rectify any mistake apparent from the record. It was not disputed that the assessee, though, had not filed any objection or explanation before the TPO while raising objections to the draft order under section 144(c) had placed before the DRP, the necessary and specific details on the nature of alleged AMP expenses, selling expenses such as trade and other discount on sales, sales discounts, warranty expenses and packing expenses, which should be excluded in the determination of AMP expenses.

If an order is passed without taking note of the materials on record and subsequently, if it is brought to the notice of the Income-tax Authority under section 154, it would be open for the Income-tax Authority to rectify such mistake apparent from the record. While considering the application under section 154, if the material that was not considered while passing the original order is considered, the Authority would be at liberty to arrive at a just conclusion considering such material.

In the instant case also, the authority, i.e., DRP, on consideration of materials that were not considered earlier, has concluded that it was a case to exclude trade discounts as well as discount warranty expenses and packing expenses from the ambit of advertisement and marketing and promotion expenses for transfer pricing comparison. The Appellate Tribunal, on examination of the entire material, has concluded that it is a case of non-consideration of material on record, which would constitute a mistake apparent from the record and has held that the DRP was justified in assuming jurisdiction under section 154.

Accordingly, the revenue’s appeal failed, and substantial questions of law were answered in favour of the assessee.

List of Cases Reviewed

• Order dated 07.03.2016 in ITA.No.967/Bang/2015 passed by the Income Tax Appellate Tribunal, “A” Bench, Bengaluru[Para 9] affirmed

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The UAE Transfer Pricing (TP) regulations, established under Cabinet Decision No. 44 of 2022, set out comprehensive guidelines for businesses on pricing transactions between related and connected parties to adhere to the "arm's length" principle. These regulations are part of the UAE's efforts to align with international tax compliance standards, specifically the OECD guidelines. Companies engaged in both cross-border and certain domestic transactions must maintain detailed documentation, including a Master File, Local File, and potentially a Country-by-Country Report for larger multinationals. The regulations aim to prevent tax avoidance and ensure tax transparency, requiring businesses to reassess and possibly adjust their transfer pricing practices to avoid substantial penalties for non-compliance. The Federal Tax Authority provides additional guidance on implementation, making it crucial for affected businesses to seek expert advice to navigate these requirements effectively.

BY CA Ajit Jain – Partner | AJMS LG & CA Darshika Agrawal – Consultant & Tax Advisor

Table of Contents

1. Tax Base Erosion
2. UAE TP Regulations – Historical Background
3. UAE TP Regulations – Regulations & Guides
4. UAE TP Regulations
5. Applicability of TP Regulations
6. Related Parties – Article 35
7. Intra-group Services
8. Transfer Pricing Methods
9. Low Value Adding Intra-group Services
10. Selection of Most Appropriate Method
11. Arm’s Length Application – Five Comparability Factors
12. Developing a Robust TP Policy and Documentation
13. Case Study
14. Key Takeaways

1. Tax Base Erosion

• Revenue Loss: Tax base erosion costs governments an estimated $240 billion annually
• Economic Distortion: Over $1 trillion is held in offshore financial centers
• Global Impact: Developing countries lose around $100 billion a year due to tax base erosion
• Compliance Challenges: More than 60% of tax authorities report difficulties in addressing profit shifting
• International Cooperation: The OECD’s BEPS initiative has been endorsed by over 135 countries

2. UAE TP Regulations – Historical Background

• 2019: UAE joined the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS)
• 2019: UAE introduced Economic Substance Regulations (ESR)
• 2020: UAE introduced Country-by-Country Reporting (CbCR) requirements
• 2022: UAE announced the introduction of Federal Corporate Tax including transfer pricing
• 2022: Ministry of Finance (MoF) released public consultation documents on proposed Corporate Tax law
• 2023: UAE Cabinet approved the Federal Decree-Law on Taxation of Corporations and Businesses
• 2023 onwards: Businesses in the UAE are required to comply with the new TP regulations, transfer pricing documentation in line with OECD BEPS Action 13 recommendations

3. UAE TP Regulations – Regulations & Guides

• UAE Corporate Tax Law (Decree-Law No. 47 of 2022): Chapter VII Article 34 to Article 36
• Decision No. 97 of 2023 Requirements for Maintaining Transfer Pricing Documentation
• Cabinet Resolution No. 44 of 2020 on the Requirements for Country-by-Country Reporting
• FTA Transfer Pricing Guidelines October 2023

4. UAE TP Regulations

• Article 34 establishes the Arm’s Length Principle, which mandates that transactions between related parties must be conducted under conditions that would apply if the parties were independent entities dealing at arm’s length.
• Article 35 provides a clear definition of related parties and control relationships.
• Article 36 addresses payments to connected persons, stipulating that such payments must adhere to the arm’s length standard.
• Article 55 mandates the maintenance of detailed transfer pricing documentation. Businesses must prepare and keep both a master file and a local file, as prescribed.

4.1 UAE TP Regulations – ALP

Article 34(2) of the CT Law states that:

“A transaction or arrangement between Related Parties meets the arm’s length standard if the results of the transaction or arrangement are consistent with the results that would have been realized if Persons who were not Related Parties had engaged in a similar transaction or arrangement under similar circumstances.”

5. Applicability of TP Regulations

• Associated Person: Natural Person (Individual) and Juridical person (established legal entity)
• Transactions and arrangement between related parties or connected person
• Transfer pricing regulations applicable to all the persons including entities claiming small business relief, exempted entities, qualifying free zones
• Transfer pricing documentation (local file and master file) not applicable to exempted entities and entities claiming small business relief

Exempt person:

• Govt entity
• Govt controlled entity
• Extractive business
• Non-extractive natural resource business

6. Related Parties – Article 35

Related Parties under UAE Corporate Tax Law

Article 35 defines Related Parties as associated Persons based on a specified degree of association:

Pre-existing relationship through:

• Kinship (for natural persons)
• Ownership
• Control

Residency status in the UAE is not a determining factor for Related Party classification

6.1 Related Parties – Article 35 (1) (a) to (f)

• Fourth Degree of Kinship
• Parent/Subsidiary/Branches
• Entities under common Control
• Partners in Unincorporated Partnership
• Permanent Establishment
• Exempt and non-exempt business activities of the same group

6.2 Forth Degree of Kinship – Article 35 (1) (a)

Two or more natural persons who are related within the fourth degree of kinship or affiliation, including by way of adoption or guardianship.

• 1st Degree: Parents, children, and those of spouse.
• 2nd Degree: Adds grandparents, grandchildren, siblings, and those of spouse.
• 3rd Degree: Further includes great-grandparents, great-grandchildren, uncles, aunts, nieces, nephews, and those of spouse.
• 4th Degree: Adds great-great-grandparents, great-great-grandchildren, grand uncles/aunts, grandnieces/nephews, first cousins, and those of spouse.

Two natural persons related within fourth degree kinship:

Example: Company owned by brother paying royalties to company owned by sister.

Two natural persons related by adoption:

Example: Adopted son’s company providing services to adoptive mother’s business.

Two natural persons related by guardianship:

Example: Guardian’s firm managing investment portfolio of their ward and charging fees.

6.3 Ownership Interest and Control – Natural Person and Juridical Person [Article 35 (1) (b)]

For the purposes of this Decree-Law, “Related Parties” means any of the following:

A natural person and a juridical person where:

1. The natural person or one or more Related Parties of the natural person are shareholders in the juridical person, and the natural person, alone or together with its Related Parties, directly or indirectly owns a 50% (fifty percent) or greater ownership interest in the juridical person; or
2. The natural person, alone or together with its Related Parties, directly or indirectly Controls the juridical person.

6.4 Ownership Interest and Control – Juridical Person [Article 35 (1) (c)]

For the purposes of this Decree-Law, “Related Parties” means any of the following:

Two or more juridical persons where:

1. One juridical person, alone or together with its Related Parties, directly or indirectly owns a 50% (fifty percent) or greater ownership interest in the other juridical person;
2. One juridical person, alone or together with its Related Parties, directly or indirectly Controls the other juridical person; or
3. Any Person, alone or together with its Related Parties, directly or indirectly owns a 50% (fifty percent) or greater ownership interest in or Controls such two or more juridical persons;

6.5 Ownership Interest and Control – Natural Person [Article 35 (1) (b)]

• Company A and Company B are related to each other
• Individual A and Company are related to each other
• Individual B and Company are related to each other

Individual X B Ltd and C Ltd are related parties

6.6 Ownership Interest – Juridical Person [Article 35 (1) (c)]

Subsidiary 1 and Subsidiary 2 are related
Parents and both subsidiaries are related

A, B and C are related parties

Ownership should be more than 50%. Whether direct or indirect. Whether one or more entities

6.7 Control: Control – [Article 35 (1)]

• Exercise 50% or more of the voting rights of another person
• Determine the composition of 50% or more of the Board of directors of another person
• Receives 50% or more of the profits of another person
• Exercise significant influence over the conduct of the business and affairs of another person

6.8 Control: Significant Influence – [Article 35 (1)]

• Loan Constitutes 50% or more of the Total Capital
• Entitlement to Profit Share of 50% or more
• Entitlement to Profit Share of 50% or more

Responsible for:

• Management of day-to-day operations
• Development of strategies, and
• Formulation of the key market decisions

KSA LLC and UAE LLC are related to each other

KSA LLC is entitled to 50% of Profits of XYZ LLC

The loan constitutes 50% of the total capital of UAE LLC

6.9 Permanent Establishment – [Article 35 (1) (d)]

Branches, Agent in UAE are related parties to its parent/parent/principal entities. Transfer pricing regulations are applicable

6.10 Payment to Connected Persons – Article 36

Any payment made to “Connected Persons” is not deductible if:

• Not occurred wholly and exclusively for the business; and
• Not at market value/arm’s length.

1. Individual with direct/indirect ownership interest or control
2. Director or Officer
3. Related to owner/director/officer to the fourth degree of kinship
4. Partners in unincorporated partnership
5. Related Party of any of these [Article 35 (1)]

6.11 Connected Persons – Article 36 (Exemption)

Article 36(6) specifies the categories of Taxable Persons where the deduction of payments or benefits provided to their Connected Persons is not restricted to the Arm’s Length Price. These Taxable Persons would include any of the following:

• A Taxable Person whose shares are traded on a recognised stock exchange;
• A Taxable Person that is subject to the regulatory oversight of a competent authority in the UAE; and
• Any other Person as may be determined in a decision to be issued by the Cabinet.

7. Intra-group Services

• Service should provide the related party with economic or commercial value that enhances its commercial position.
• One of the tests is to determine whether a third party would be willing to pay for the same service that the related party has received.
• For an intra-group service fee to be arm’s length, prove with verifiable evidence that services received are adequately charged.

7.1 Intra-group services – Arm’s length analysis

• Whether intra-group services rendered
• Type of intra-group services
• Services which do not justify the intra-group charge
• Functional analysis
• Direct vs Indirect charge and allocation keys
• Identification of cost base
• Section of most appropriate method
• Low value adding intra-group services
• Pass through cost

7.2 Benefits of Intra-group Services

• Cost efficiency: By availing intra-group services from specialized entities within the group, UAE entities can benefit from economies of scale and cost savings compared to outsourcing services to third parties.
• Access to expertise: UAE entities can leverage the specialized knowledge and expertise of other group entities in areas such as IT, marketing, or R&D, without having to develop these capabilities in-house.
• Flexibility and scalability: Intra-group service arrangements can be more easily adapted to the changing needs of the UAE entity, providing greater flexibility and scalability compared to third-party contracts.
• Alignment with group strategy: By availing intra-group services, UAE entities can ensure alignment with the overall group strategy and benefit from a unified approach across the organization.
• Reduced administrative burden: By availing intra-group services, UAE entities can streamline their operations and reduce the administrative burden associated with managing multiple external service providers.
• Improved service quality: Intra-group service providers have a deep understanding of the group’s business and can tailor their services to meet the specific needs of the UAE entity, resulting in higher-quality services.

7.3 Types of Intra-group Services

• Management services
• Technical services
• R&D services
• Marketing support services
• Sourcing support services
• Procurement services
• Business support services
• Low value adding support services

7.4 Pricing an Intra-group Service

Was an intra-group service rendered?

What is an arm’s length charge?

7.5 Was an Intra-group Services Rendered

• The benefit test entails that an intercompany service can be acknowledged, when it is expected to benefit the entity receiving the service.
• A service benefits an entity when
• the activity performed adds economic or commercial value for group member(s)
• for which an independent enterprise would have been willing to pay (to a third party), or
• In case an independent third party would perform the activity in house. If an entity would not be willing to pay for the activity, or perform the activity itself, the activity should not be considered an intercompany service based on the arm’s length principle.

7.6 Services that do not justify intra-group charge

7.6.1 Shareholding services

Shareholder activities are activities undertaken to provide an economic benefit only to the shareholder company (ultimate parent company or any other shareholder such as an intermediary holding company, depending on the facts of the case) in its capacity of shareholder

• Preparation and filing of reports of the parent company
• Appointment and remuneration of parent company directors
• Meetings of the parent company’s board of directors
• Parent company’s preparation and filing of consolidated financial reports,
• Raising funds used to acquire share capital in subsidiary companies.

7.6.2 Duplicative services

Duplicative services

• Services provided to an associate that has already incurred costs for the same activity
• Usually not chargeable, determined case-by-case

When Duplication May Be Justified

• Independent party would pay for duplicated service in similar circumstances
• e.g. Obtaining a second opinion to minimize non-compliance risk

Avoiding Mischaracterization of Duplication

• Services with same name but at different levels (group, regional, local) are not duplicative
• e.g. Group-level strategic marketing vs subsidiary’s local market analysis

Acceptable Duplication

• May occur during transition phases like centralization of a function
• Parallels outsourcing to third party with temporary overlap

Evaluating Duplicative Services

• Conduct thorough functional analysis
• Determine if the duplicated activity provides a benefit that meets the arm’s length standard
• Absent a benefit, the duplicated service fails the benefit test and is not chargeable

Passive association

7.6.3 Passive association

Benefits arising from mere membership in an MNE group, without active intervention. Not a chargeable service within the MNE group

Examples

• Discounts from suppliers hoping for future group sales
• Improved credit rating due to group membership

Contrast: Active interventions (e.g., formal guarantees) are chargeable

Incidental Benefits:

• May arise from services primarily benefiting one entity
• Chargeable only if independent parties would pay for them

Importance: Distinguishes between passive benefits and active, chargeable services in transfer pricing

7.7 Application of Arm’s Length Principle

Four Key Steps:

1. Identify Related Parties, Connected Persons, relevant transactions, and perform comparability analysis
2. Perform Functional Analysis
3. Select the most appropriate transfer pricing method
4. Determine the arm’s length price

Comparability analysis: Heart of the arm’s length principle

7.8 Functional analysis

• Conducted to determine appropriate arm’s length service charges for transfer pricing
• Value of service to recipient and what an independent party would pay
• Routine/admin services: compensate at cost plus small markup
• Unique/high-value services: can command prices with significant profit
• Functional analysis examines:
• Functions performed, assets used, risks borne by service provider
• Involvement and use of the services by the recipient
• Economic benefit to recipient
• Reliability of available comparables
• More complex analysis if services tied to know-how or intangibles

Example: Functional analysis of marketing services

• Analyze activities, skills, time of provider’s staff
• Assets used (premises, equipment)
• Intangibles (ad firm knowledge, customer lists, know-how)
• Risks in predicting campaign outcomes

7.9 Direct and Indirect Charge Method

Direct Charge

• ABC Group: Multinational company with subsidiaries in UAE (ABC UAE) and UK (ABC UK)
• ABC UK provides specialized IT services to ABC UAE
• Services directly charged to ABC UAE at arm’s length prices

(a) Based on time spent by ABC UK’s IT professionals
(b) Prevailing market rates for similar services in the UAE

• Preferred method when service provider renders similar services to both related and independent parties

Indirect Charge

• XYZ Group: Multinational company with a subsidiary in UAE (XYZ UAE) and global headquarters in the US (XYZ US)
• XYZ US provides centralized marketing services to all group entities, including XYZ UAE
• Costs of marketing services allocated to group entities (along with mark-up) based on allocation keys

(a) Allocation keys: Revenue, headcount, or other relevant metrics
(b) XYZ UAE’s share of costs determined based on its proportion of the allocation key

7.10 Determination of the cost base

Pool Costs: Aggregate annual costs for each service category across the Group Include direct, indirect, and allocated operating expenses

Refine Pool:

• Exclude costs benefiting only the performing entity
• Remove shareholder activity costs
• Eliminate costs for services between specific entities

Allocate Remaining Costs:

• Use appropriate allocation keys linked to expected benefits
• Examples: Headcount for HR services, User count for IT services

Key Considerations:

• Ensure consistency in allocation methods
• Document rationale for chosen allocation keys
• Review and adjust annually for changing business conditions

7.11 Allocation Keys

Proxies for estimating proportional share of expected benefits from intra-group services Allocate costs/value of services within MNE group after satisfying benefit test

Key Requirements

• Measurable, Relevant to service type , Consistently applied, Well-documented

Common Examples

• Sales, profit, units produced/sold , Employees, salaries, IT users, Capital, operating expenses

Service-Specific Keys:

• IT: Number of PCs, HR: Number of employees , Marketing: Sales to independent customers

Considerations:

• Nature of services and their use, avoid keys significantly affected by other intra-group transactions

Intra-group services

8. Transfer Pricing Methods

8.1 CUP

• Compare prices and not cost or mark-up;
• If reliable internal or external comparables available, the preferred method;
• Difficult to apply in practice.

8.2 CPM

• One-sided analysis;
• Compare gross services profit mark-up charged between independent parties;
• Cost base includes direct costs and indirect costs.

8.3 TNMM

• Alternative when cost plus is difficult to apply;
• Compare net profit margin on costs;
• Cost base includes direct costs and indirect costs.

8.4 PSM

• Two-sided analysis;
• Splits profit from a controlled transaction.
• Highly integrated transactions & sharing of risks;
• Unique & valuable contributions to the value chain by more than one entity.

9. Low value adding intra-group services

In general, low value-adding intra-group services should meet the following criteria:

• The services are of a supportive nature;
• They are not part of the core business of the MNE Group (i.e. not creating the profit earning activities or contributing to economically significant activities of the MNE Group);
• They do not require the use of unique and valuable intangibles and do not lead to the creation of unique and valuable intangibles; and
• The services do not involve the assumption or control of substantial or significant risk by the service provider and do not give rise to the creation of significant risk for the service provider

Certain low value-adding intra-group services may be charged out at a cost-plus 5% mark-up without the need for a detailed benchmarking analysis

9.1 Low Value-adding Services

WOULD QUALIFY

• Accounting & Auditing
• HR
• Regulatory issues
• Internal & external communications & PR support
• IT (when not part of principal activities)
• Legal services
• Tax support
• Administrative & clerical support

WOULD NOT QUALIFY

• R&D
• Manufacturing
• Sales, Marketing & Distribution
• Financial transactions
• Exploration or extraction
• Purchasing of raw materials
• Insurance
• Corporate senior management

10. Selection of Most Appropriate Method

11. Arm’s Length Application – Five Comparability Factors

12. Developing a Robust TP Policy and Documentation

• Align transfer pricing policy with UAE’s specific requirements and global best practices
• Tailor policy to the nature and complexity of intra-group services
• Determine appropriate pricing methods (e.g., CUP, cost-plus, TNMM)
• Consider UAE’s preference for local comparables and prescriptive approach
• Develop comprehensive documentation package – Local file and Master file
• Contemporaneous documentation to demonstrate arm’s length nature of transactions
• Maintain robust evidence to support transfer pricing positions
• Intercompany agreements, invoices, and proof of services rendered
• Benchmarking studies and functional analysis to justify pricing
• Regularly review and update policy and documentation
• Keep pace with evolving UAE transfer pricing landscape and business changes
• Proactively address potential gaps and inconsistencies

13. Case Study

Global Tech Solutions (GTS) is a multinational enterprise with operations in countries A, B, C, and D.

Group Structure and Services:

• GTS Parent Co. (Country A): Provides management, R&D, and IT services
• GTS Manufacturing (Country B): Produces high-tech products
• GTS Distribution (Country C): Handles sales and marketing
• GTS Support (Country D): Provides customer support and back-office services

Intra-group Services for FY2023:

• Management services from Parent Co. to all subsidiaries
• R&D services from Parent Co. to Manufacturing
• IT services from Parent Co. to all subsidiaries
• Marketing strategy services from Distribution to Manufacturing and Support
• Back-office services from Support to all group members

Financial Information (in millions USD):

• Parent Co.: Revenue $500, Operating Profit $150
• Manufacturing: Revenue $800, Operating Profit $120
• Distribution: Revenue $1,000, Operating Profit $80
• Support: Revenue $200, Operating Profit $20

Task
Determine appropriate transfer pricing methodologies and calculate arm’s length charges for each service, considering the benefit test, charging approaches, and potential use of safe harbors.

14. Key Takeaways

• Benefit Test and Payment Willingness: Taxpayers should evaluate if intra-group services rendered pass the benefit test and willingness to pay test to determine chargeability.
• Non-chargeable Services: Services such as shareholder activities, duplicative services, and passive association do not qualify for an arm’s length charge.
• Documentation Importance: Maintaining detailed transfer pricing documentation is crucial for compliance and reducing dispute risks.
• Allocation Keys for Charging: Use relevant metrics like revenue or headcount for indirect charging of intra-group services when direct charging isn’t possible.
• Local Compliance: Policies should adhere to UAE’s transfer pricing requirements, use local comparables, and incorporate low value-adding services for simplified compliance.
• Policy Review: Regular updates to transfer pricing policies and documentation are necessary to reflect changes in regulations and business dynamics in the UAE.
• Functional Analysis: Conduct a thorough functional analysis, considering factors like allocation keys and the global value chain to establish arm’s length prices.

Resources for Further Learning and Guidance

1. UAE Corporate Tax Law (Decree-Law No. 47 of 2022): Chapter VII Article 34 to Article 36
2. Decision No. 97 of 2023 Requirements for Maintaining Transfer Pricing Documentation
3. Cabinet Resolution No. 44 of 2020 on the Requirements for Country-by-Country Reporting
4. FTA Transfer Pricing Guidelines October 2023

The post [Analysis] UAE Corporate Tax – Navigating Intra-group Services and Transfer Pricing appeared first on Taxmann Blog.

DEMPE functions refer to the Development, Enhancement, Maintenance, Protection, and Exploitation of intangibles within multinational enterprises (MNEs). These functions are critical in determining the economic ownership and the allocation of returns from intangible assets like patents, trademarks, or technology among related parties within an MNE. The DEMPE framework, outlined by the OECD Transfer Pricing Guidelines, requires that entities performing these functions and bearing associated risks are compensated at arm's length, reflecting their contributions to the value of the intangibles. This approach ensures that returns from intangible assets are aligned with the actual economic activities, risks, and contributions of the entities involved, rather than merely their legal ownership.

Checkout Taxmann's BEPS Implications on Transfer Pricing | Indian Perspective which is a comprehensive guide to understanding the transfer pricing implications of the BEPS project in India, resulting from two years of extensive research by transfer pricing experts. It covers many topics, including an overview of BEPS objectives, international rulings, and their implications for transfer pricing. Key features include insights into Indian law, planning for intangibles, economic ownership, substance in transfer pricing, and benchmarking financial transactions.

Table of Contents

1. Introduction
2. Lessons for MNEs

1. Introduction

Although the legal owner of an intangible may receive the proceeds from exploitation of the intangible, other members of the legal owner’s MNE group may have performed functions, used assets, or assumed risks that have contributed to the value of the intangible. Members of the MNE group performing such functions, using such assets, and assuming such risks must be compensated for their contributions under the arm’s length principle. Ownership of intangibles as per Development, Enhancement, Maintenance, Protection and Exploitation of intangibles (“DEMPE”) confirms that the ultimate allocation of the returns derived by the MNE group from the exploitation of intangibles, and the ultimate allocation of costs and other burdens related to intangibles among members of the MNE group, is according to the principles described in Chapters I-III of the OECD TP Guidelines, 2022 (hereinafter referred to as ‘Guidelines’).

The framework for analysing transactions involving intangibles between associated enterprises requires taking the following steps:

• Step 1: Identification of economically significant risks in relation to a particular transaction (basis of likelihood and size of the potential profits or losses arising from the risk)
• Step 2: Analysing contractual arrangement to determine the assumption of economically significant risks in relation to a transaction
• Step 3: Undertaking functional analysis to determine actual conduct of the AEs in relation to the assumption and management of risks in relation to a transaction
• Step 4: Confirm consistency between contractual arrangements and conduct on ground (as seen from step 2 and 3)
• Step 5: Guidance on allocating risks amongst parties to the transaction, in case, the parties identified in the steps above do not control such risks or do not have the financial capacity to assume such risks
• Step 6: Determination of arm’s length price based on financial and other consequences of risk assumption as documented and understood between points 1 to 5 above

The above steps are discussed in detail below:

1.1 Identify the intangibles and risks

The OECD states that MNEs should start their analysis by identifying the intangibles used or transferred in the transaction. This should be done “with specificity”, as applying too broad or narrow a definition of ‘intangible’ could result in an inaccurate compensation delineation.

For the purposes of the Guidelines, ‘intangible’ refers to something that is “not a physical asset or financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances¹.”

Section A of Chapter VI of the Guidelines provides guidance on identifying risks associated with intangibles for the purposes of transfer pricing. This step involves identifying the “specific, economically significant risks” associated with DEMPE in the transaction.

Here expounds upon the various facets of “risk” that are dealt with in transfer pricing analysis:

Assumption and Allocation of risks

• Control & Authority

1. 1. Decision to accept risk bearing opportunities;
   2. Decision to respond to risks, and
   3. Performance of actual functions

• Risk Management Function

1. 1. Decision to accept risk bearing opportunities;
   2. Decision to respond to risks; and
   3. The capability to mitigate risks

• Financial & Technical Capability: This includes the access to funding to take on or lay off a risk, pay for risk mitigation functions and bear the consequences if the risk materializes

There are many definitions of risk, but in a transfer pricing context it is appropriate to consider risk as the effect of uncertainty on the objectives of the business. In all of a company’s operations, every step taken to exploit opportunities, every time a company spends money or generates income, uncertainty exists, and risk is assumed.

Risk is associated with opportunities and does not have downside connotations alone; it is inherent in commercial activity, and companies choose which risks they wish to assume in order to have the opportunity to generate profits. No profit seeking business takes on risk associated with commercial opportunities without expecting a positive return. Downside impact of risk occurs when the anticipated favourable outcomes fail to materialise.

The significance of a risk depends on the likelihood of the risk and its size. The arm’s length principle of the potential profits or losses arising from the risk. For example, a different flavour of ice cream may not be the company’s sole product, the costs of developing, introducing, and marketing the product may have been marginal, the success or failure of the product may not create significant reputational risks so long as business management protocols are followed, and decision-making may have been effected by delegation to local or regional management who can provide knowledge of local tastes. However, groundbreaking technology or an innovative healthcare treatment may represent the sole or major product, involve significant strategic decisions at different stages, require substantial investment costs, create significant opportunities to make or break reputation, and require centralised management that would be of keen interest to shareholders and other stakeholders.

Risks can be categorised in various ways, but a relevant framework in a transfer pricing analysis is to consider the sources of uncertainty which give rise to risk.

The following list of transfer pricing risks, not hierarchical, emphasizes considering various risks from associated enterprises, whether internally or externally driven, for a comprehensive analysis. Specificity in identifying material risks is crucial.

• Strategic risks or marketplace risks: External risks, stemming from economic, political, regulatory, competition, technological, and social changes, can impact a company’s product focus, market choices, and resource investments. While these uncertainties pose potential downsides, correctly identifying and addressing them can lead to substantial upsides, securing a competitive advantage. Examples include market trends, entering new geographical markets, and concentrated development investments.
• Infrastructure or operational risks: Business execution uncertainties, such as operational effectiveness and process efficiency, can significantly impact a company’s reputation and existence. Successful management enhances reputation, while failures like delays or quality issues can affect competitiveness. Infrastructure risks, externally or internally driven, encompass factors like transport, political situations, laws, employee capabilities, and IT systems.
• Financial risks: All risks are likely to affect a company’s financial performance, but there are specific financial risks related to the company’s ability to manage liquidity and cash flow, financial capacity, and creditworthiness. The uncertainty can be externally driven, for example by economic shock or credit crisis, but can also be internally driven through controls, investment decisions, credit terms, and through outcomes of infrastructure or operational risks.
• Transactional risks: These are likely to include pricing and payment terms in a commercial transaction for the supply of goods, property, or services.
• Hazard risks: These are likely to include adverse external events that may cause damages or losses, including accidents and natural disasters. Such risks can often be mitigated through insurance, but insurance may not cover all the potential loss, particularly where there are significant impacts on operations or reputation.

Analyzing the economic impact of risk on pricing between associated enterprises is crucial in the broader evaluation of how value is created within a multinational group.

Decision-making regarding risk control is distributed among various levels within the multinational group, from board and executive committees setting overall risk levels to line management addressing day-to-day operational risks. The focus is on aligning risk management with commercial objectives and achieving anticipated returns².

1.2 Identify the contractual agreements

The second step of the OECD’s analysis framework is to identify the contractual agreements relating to the transaction. Written contracts for controlled transactions “reflect the intention of the parties at the time of the contract, including […] the division of responsibilities, obligations and rights, assumption of identified risks, and pricing arrangements.”2a At this stage, MNEs should place “special emphasis on determining legal ownership of intangibles based on the terms and conditions of legal arrangements³”. This includes registrations, license agreements and other contracts that indicate the legal ownership of intangibles, and rights and obligations in a transaction.

It is important to note that the determination of legal ownership, by itself, does not influence remuneration under the arm’s length principle. Compensation is dependent on the DEMPE functions performed, assets used and risks assumed by MNE entities in relation to a transaction involving intangibles⁴.

1.3 Identify which parties performed DEMPE Functions (Actual Conduct)

DEMPE Functions

• Development of intangible asset
• Enhancing value of intangible asset
• Maintenance of intangible asset
• Protection of Intangible asset against infringement
• Exploitation of intangible asset

DEMPE roles could be dispersed and operate virtually impacting the sustainability of the IP model

By means of FAR analysis, MNEs must identify which parties performed functions, used assets and managed risks relating to the development, enhancement, maintenance, protection and exploitation (DEMPE) of the intangibles within the transaction. In particular, MNEs should determine which parties control any outsourced functions, and control specific, economically significant risks. As the Guidelines explain, some functions have a significant impact on the value of an intangible. If the legal owner outsources these functions to associated enterprises, then those entities should be compensated with a fair share of the returns gained from the exploitation of the intangible⁵.

For self-developed intangibles, or intangibles that may be used for development in the future, these functions may include:

• Design and control of research and marketing
• Direction and management of creative tasks
• Strategic decision-making for the intangible’s development
• Budget management and control

Important functions that relate to all intangibles (either self-developed or acquired) include:

• Decision-making regarding the intangible’s protection;
• Quality control over functions performed by independent or associated enterprises that may affect the intangible’s value;

The functional analysis will clarify which parties contributed to the value of the profit-generating intangibles within a transaction and help MNEs determine fair compensation.

1.4 Compare contractual terms with party conduct

MNEs need to assess whether the terms of the contractual arrangements (outlined in Step 2 above) are consistent with the conduct of the relevant parties. This involves analyzing whether associated enterprises have followed the contractual terms as per the principles outlined in the Guidelines – how the responsibilities, risks and anticipated outcomes arising from their interaction were intended to be divided at the time of entering into the contract⁶. This step is designed to determine whether the party that contractually assumed economically significant risks actually controls the risk and is financially able to assume the risks relating to DEMPE.

If all parties have fulfilled their contractual obligations and this conduct is consistent with the contractual arrangements, then the delineated transaction can be priced, also taking into account appropriate compensa- tion for risk management functions (step 6)⁷. If a party that is contractually obliged to assume risk does not control the risk or does not have financial capacity to control the risk, then the risk must be allocated to the enterprise that does⁸.

1.5 Delineate the actual controlled transactions

MNEs should now be able to precisely outline the actual controlled transactions related to DEMPE. As per Paragraph 6.34 of the Guidelines, this process should take into account the legal ownership of the intangibles, relevant contractual relations, and the conduct of the parties, including their relevant contributions of functions, assets and risks.
The steps in the process set out in the rest of this section for analysing risk in a controlled transaction, in order to accurately delineate the actual transaction in respect to that risk, can be summarised as follows:

1. Identify economically significant risks with specificity;
2. Determine how specific economically significant risks are contractually assumed by the associated enterprises under the terms of the transaction;
3. Determine through a functional analysis how the associated enterprises that are parties to the transaction operate in relation to assumption and management of the specific, economically significant risks, and in particular which enterprise or enterprises perform control functions and risk mitigation functions, which enterprise or enterprises encounter upside or downside consequences of risk outcomes, and which enterprise or enterprises have the financial capacity to assume the risk;
4. Steps 2-3 will have identified information relating to the assumption and management of risks in the controlled transaction. The next step is to interpret the information and determine whether the contractual assumption of risk is consistent with the conduct of the associated enterprises and other facts of the case by analysing (i) whether the associated enterprises adhere to the contractual terms; and (ii) whether the party assuming risk, as analysed under (i), exercises control over the risk and has the financial capacity to assume the risk;
5. Where the party assuming risk under steps 1-4 (i) does not control the risk or does not have the financial capacity to assume the risk, apply the guidance on allocating risk; and
6. The actual transaction as accurately delineated by considering the evidence of all the economically relevant characteristics of the transaction as set out in, should then be priced taking into account the financial and other consequences of risk assumption, as appropriately allocated, and appropriately compensating risk management functions.

1.6 Determine arm’s length prices for the transactions

The final step of the OECD’s framework for analyzing transactions involving intangibles is to determine, where possible, arm’s length prices for the transactions in question. Section D.2 of the Guidelines discusses situations in which transactions may be disregarded, and perhaps replaced, for transfer pricing purposes Prices should be “consistent with each party’s contributions of functions performed, assets used, and risks assumed, unless the guidance in Section D.2 of Chapter 1 applies⁹”. It states:

“The key question in the analysis is whether the actual transaction possesses the commercial rationality of arrangements that would be agreed between unrelated parties under comparable economic circumstances, not whether the same transaction can be observed between independent parties […] the mere fact that the transaction may not be seen between independent parties does not mean that it does not have characteristics of an arm’s length arrangement¹⁰”.

We can refer to the following illustrations as presented in the Guidelines:

Contractual Assignment of Rights

Illustration I¹¹

• Premiere is the parent company of an MNE group. Company S is a wholly owned subsidiary of Premiere and a member of the Premiere group. Premiere funds R&D and performs ongoing R&D functions in support of its business operations. When its R&D functions result in patentable inventions, it is the practice of the Premiere group that all rights in such inventions be assigned to Company S in order to centralise and simplify global patent administration. All patent registrations are held and maintained in the name of Company S.
• Company S employs three lawyers to perform its patent administration work and has no other employees. Company S does not conduct or control any of the R&D activities of the Premiere group. Company S has no technical R&D personnel, nor does it incur any of the Premiere group’s R&D expenses. Key decisions related to defending the patents are made by Premiere management, after taking advice from employees of Company S. Premiere’s management, and not the employees of Company S, controls all decisions regarding licensing of the group’s patents to both independent and associated enterprises. The below table provides a summary of DEMPE functions performed by each entity within the MNE.

• At the time of each assignment of rights from Premiere to Company S, Company S makes a nominal EUR 100 payment to Premiere in consideration of the assignment of rights to a patentable invention and, as a specific condition of the assignment, simultaneously grants to Premiere an exclusive, royalty free, patent licence, with full rights to sub-licence, for the full life of the patent to be registered. The nominal payments of Company S to Premiere are made purely to satisfy technical contract law requirements related to the assignments and, for purposes of this example, it is assumed that they do not reflect arm’s length compensation for the assigned rights to patentable inventions. Premiere uses the patented inventions in manufacturing and selling its products throughout the world and from time to time sub-licens- es patent rights to others. Company S makes no commercial use of the patents nor is it entitled to do so under the terms of the licence agreement with Premiere.
• Under the agreement, Premiere performs all functions related to the development, enhancement, maintenance, protection and exploitation of the intangibles except for patent administration services. Premiere contributes and uses all assets associated with the development and exploitation of the intangible and assumes all or substantially all of the risks associated with the intangibles. Premiere should be entitled to the bulk of the returns derived from exploitation of the intangibles. Tax administrations could arrive at an appropriate transfer pricing solution by delineating the actual transaction undertaken between Premiere and Company S. Depending on the facts, it might be determined that taken together the nominal assignment of rights to Company S and the simultaneous grant of full exploitation rights back to Premiere reflect in substance a patent administration service arrangement between Premiere and Company S. An arm’s length price would be determined for the patent administration services and Premiere would retain or be allocated the balance of the returns derived by the MNE group from the exploitation of the patents.

Illustration II

• The facts related to the development and control of patentable inventions are the same as in Example 1. However, instead of granting a perpetual and exclusive licence of its patents back to Premiere, Company S, acting under the direction and control of Premiere, grants licences of its patents to associated and independent enterprises throughout the world in exchange for periodic royalties. For purposes of this example, it is assumed that the royalties paid to Company S by associated enterprises are all arm’s length.
• Company S is the legal owner of the patents. However, its contributions to the development, enhancement, maintenance, protection, and exploitation of the patents are limited to the activities of its three employees in registering the patents and maintaining the patent registrations. The Company S employees do not control or participate in the licensing transactions involving the patents. Under these circumstances, Company S is only entitled to compensation for the functions it performs. Based on an analysis of the respective functions performed, assets used, and risks assumed by Premiere and Company S in developing, enhancing, maintaining, protecting, and exploiting the intangibles, Company S should not be entitled ultimately to retain or be attributed income from its licensing arrangements over and above the arm’s length compensation for its patent registration functions.
• As in Example 1 the true nature of the arrangement is a patent administration service contract. The appropriate transfer pricing outcome can be achieved by ensuring that the amount paid by Company S in exchange for the assignments of patent rights appropriately reflects the respective functions performed, assets used, and risks assumed by Premiere and by Company S. Under such an approach, the compensation due to Premiere for the patentable inventions is equal to the licensing revenue of Company S less an appropriate return to the functions Company S performs.

Illustration III

• The facts are the same as in Example 2. However, after licensing the patents to associated and independent enterprises for a few years, Company S, again acting under the direction and control of Premiere, sells the patents to an independent enterprise at a price reflecting appreciation in the value of the patents during the period that Company S was the legal owner. The functions of Company S throughout the period it was the legal owner of the patents were limited to performing the patent registration functions described in Examples 1 and 2.
• Under these circumstances, the income of Company S should be the same as in Example 2. It should be compensated for the registration functions it performs, but should not otherwise share in the returns derived from the exploitation of the intangibles, including the returns generated from the disposition of the intangibles.
  In each one of the three illustrations above, we find that contractually, ‘S’ was assigned the Patent Rights and was the legal owner of the intangibles. However, in terms of DEMPE functions, it was ‘P’ that undertook the deci- sion-making and assumed the associated risks. Therefore, in line with the

OECD approach, conduct was accorded precedence over the contract and return on intangible must flow to ‘P’. ‘S’ is only entitled to a routine return for patent administration services.

2. Lessons for MNEs

2.1 Reassess Capabilities

MNEs need to examine their value chain proactively to identify possible mismatches between location of economic activity, and the resultant value creation, to avoid any disputes at a later date. They also need to review the actual conduct of different group entities, rather than focusing merely on documentation or paper trails in the form of inter-company agreements to justify their intra-group transactions. Although “substance over form” has always been the guiding principle for any transfer pricing analysis in India, the new BEPS regime has pushed it to the centre stage.

For instance, parking of intangibles in low-tax or no-tax jurisdictions, with no economic substance in such entities, could be a potential BEPS risk area. Revised guidance requires that a FAR analysis or capacity reassessment be carried out for such entities. This will help in evaluating whether they have the capability to perform intangible related functions (such as development, exploitation, etc.,) and bear the associated risks (such as financial risk, obsolescence risk, failure risk, infringement risk, etc.,) or are mere shell entities to avail tax benefits.

Another typical situation wherein similar risk may arise can be an intra-group services scenario, which is quite common in Indian context. The taxpayers would need to substantiate the capability of service providers to render services in terms of availability of necessary resources like fixed assets, employees with relevant skill sets, etc.

2.2 Reassess Agreements

In the long run, MNEs need to be more careful and cautious in their approach to any structuring/re-structuring exercise and take necessary corrective steps, wherever required. Intra-group agreements often serve as the starting point for a transfer pricing analysis. They help in gathering basic understanding of how a transaction is structured. Although the revisited guidelines focus on facts of the actual transaction, inclusion of any clause in an intra-group agreement that is not in alignment with the actual conduct may result in unnecessary dispute and litigation. A more pragmatic solution, therefore, would be to restructure the transaction to cover any BEPS-related risks and thereafter align the intra-group agreement with the actual transaction.

1. Para 6.6 of TPG, 2022.
2. Paras 1.71 and 1.72 of OECD Transfer Pricing Guidelines, 2022.
   2a. Para 1.42 of TPG, 2022.
3. Para 6.34 of TPG, 2022.
4. Para 6.42 of TPG, 2022.
5. 5. Para 6.56 of TPG, 2022.
6. Para 1.42 of TPG, 2022.
7. Para 1.60 of TPG, 2022.
8. Para 1.98 of TPG, 2022.
9. Para 6.34 of TPG, 2022.
10. Para 1.123 of TPG, 2022.
11. Para 1.148 of TPG, 2022.

The post Understanding DEMPE Functions – Intangible Asset Allocation and Transfer Pricing Compliance appeared first on Taxmann Blog.

Case Details: Total Energies Marketing Services v. Dy. CIT - [2024] 165 taxmann.com 698 (Mumbai-Trib.)

Judiciary and Counsel Details

• Narender Kumar Choudhry, Judicial Member & Ratnesh Nandan Sahay, Accountant Member
• Ketan Ved, A.R. for the Appellant.
• Ms Dhivya Ruth J., Sr. DR. for the Respondent.

Facts of the Case

In the instant case, in response to the notice issued under 92D(3), the assessee submitted its reply and claimed that the assessee company was in the process of appointing their authorised representative and, therefore, the assessee needed time to submit the details. The assessee neither attended nor filed any details until the statutory time limit of 60 days was completed.

Consequently, penalty proceedings under section 271G were initiated under section 274A, read with section 271G for non-compliance to the notice under section 92D(3).

In response to the penalty proceeding notice, the assessee submitted part details such as form 3CEB, a copy of the return of income, a copy of the inter-company agreement, and the inter-company invoices.

The Assessing Officer, unsatisfied with the assessee’s submissions, ultimately levied a penalty under section 271G. CIT(A) confirmed the penalty, and the matter reached before the Mumbai Tribunal.

ITAT Held

The Tribunal held that the assessee was a foreign-based company and was in the process of appointing a new authorised representative. The assessee sought further time by filing its letter dated 04.01.2019, but the AO extended the time to 10.01.2019, admittedly a shorter period, which resulted in non-compliance.

However, subsequently, the assessee complied with the notices by filing relevant details specifically on 25-03-2019. Accordingly, the reasons submitted for non-compliance by the assessee prima facie appear to be bonafide and unintentional. Therefore, considering the reasons for the minuscule delay in filing the relevant documents as reasonable and negligent, the penalty was deleted.

List of Cases Referred to

• M/s. Excel Biolife Private Limited v. National Faceless Appeal Center ITA No.122/M/2024 (para 4)
• ACIT v. Eurostar Diamonds India (P.) Ltd. [2024] 158 taxmann.com 410/205 ITD 324 (Mumbai – Trib.) (para 4).

The post ITAT Deleted Penalty as Delay in Filing Documents with TPO Was Due to Non-Availability of Authorized Representative appeared first on Taxmann Blog.

A Transfer Pricing Database for Benchmarking Analysis is a comprehensive collection of financial and economic data used to determine arm's length prices for transactions between related entities within a multinational corporation. This database aids in transfer pricing compliance by providing benchmarks for evaluating whether the terms and conditions of intercompany transactions align with market conditions and regulatory standards.

CA. Mithilesh Reddy – Founder & CEO | Steadfast Business Consulting LLP (SBC)

Table of Contents

1. Indian Transfer Pricing Landscape
2. Transaction vs Profit – Based ALP Determination
3. Benchmarking Analysis
4. Preferred Transfer Pricing Database for Each Transaction Category
5. Quantitative & Qualitative Criteria for Filters
6. Prowess IQ Search Process
7. Prowess IQ: Case Study
8. Benchmarking 45 – Intragroup Loan
9. Benchmarking – Intangibles

1. Indian Transfer Pricing Landscape

1.1 Why Transfer Pricing Regulations & the Objective of the Session

• The main objective of this session is to provide guidance on databases, as databases have not been specified by the OECD Manual or by Income Tax Authorities.
• In this session, we will discuss the preferred databases used in benchmarking analysis, considering those utilized by transfer pricing authorities, consultants, and Big Four firms, along with their sources and limitations.

Why Transfer Pricing Regulations?

• Preventing Tax Avoidance and Profit Shifting
• Aligning Taxation with Value Creation
• Protecting Tax Revenues of Jurisdictions
• Levelling the Playing Field for Businesses
• Enhancing Transparency and Compliance
• Ensuring Arm’s Length Transactions via Single Entity Approach for MNEs

1.2 Evolution of Transfer Pricing in India

• The Income-tax Act was introduced in 1961 adopting the erstwhile Act of 1922 wherein the laws of taxation of MNEs became significantly important soon after the globalization of the Indian Economy. India has never become part of the OECD; however, UN Model has already adopted the OECD Model of Transfer Pricing back in the 1980s.
• Following the UN Model in line with the OECD Model Transfer Pricing was introduced in India with effect from April 2001 under Sections 92 to 92F of the Income Tax Act, 1961 (“the Act”) which covers intra-group cross-border transactions.
• The sections became applicable from 1st April 2001 for cross border transactions and from 1st April 2012 for Specified Domestic transactions.

2001

Transfer Pricing was introduced in India with effect from April 2001 under Sections 92 to 92F of the Income Tax Act, 1961 (“Act’)

2012

• Domestic Transfer Pricing Regime (Specified Domestic Transactions)
• Advance Pricing Agreement Regime
• International Transaction has been expanded

2013

Safe Harbour Rules

2016

Framework for use of multiple year data and range concept in benchmarking analysis, three tier TP documentation structure as per BEPS (Base Erosion and Profit Shifting) Action Plan 13

2017

Secondary adjustment provisions and limiting interest deduction for thinly capitalized companies

1.3 Evolution of Transfer Pricing in UAE

Past

• Customs (Assessable Value/Market Valuation)
• VAT 2017 (Market Value for Related Party Transactions)
• ESR 2019 (Substance Test for Relevant Activities – Holding Cos, HQ, IP, Distribution & Service Centres, Banking, Insurance, Investment Fund Management & Shipping)
• Country-by-Country Report (BEPS Action Plan 13) 2019

1. 1. BEPS Action Plans (AP) Implementation
   2. AP 5 (Counter harmful tax practices)
   3. AP 6 (Preventing treaty abuse)
   4. AP 13 (TP documents, including CbCR)
   5. AP 14 (Make dispute resolution mechanisms more effective)
   6. AP 15 (Develop a multilateral instrument)

Present (2023-25)

• Corporate Tax & Transfer Pricing
• ALP test for Related Party & Connected Persons Payments
• Year-end TP compliances (Disclosure Form, Local File & Master File)
• Primary & Corresponding adjustments
• BEPS Action Plans Implementation
  • AP 4 (Thin cap/interest deductions)
  • AP 7 (Prevent artificial avoidance of PE)

1. 1. 1. AP 8 (Align TP with value creation – Intangibles)
      2. AP 9 (Align TP with value creation – Risk and Capital)
      3. AP 10 (Align TP with value creation – high risk transactions)

Future

• UAE Transfer Pricing Rules
• APA/MAP framework
• Possible safe harbour rules
• TP audit/litigation mechanism
• Possible secondary adjustment provisions
• Transfer Pricing Technology – Tools & AI
• BEPS Pillar 2 (Global Minimum Tax Rules)
• BEPS Pillar 1 (Market/users Jurisdictions)

1.4 Associated Enterprise (AE) & Deemed AE – Sec 92A

Associated Enterprise as per Section 92A (1) of Income Tax Act, 1961

1. For the purposes of this section and sections 92, 92B, 92C, 92D, 92E and 92F, “associated enterprise”, in relation to another enterprise, means an enterprise—

• which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise; or
• in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.

Deemed Associated Enterprise as per Section 92A (2) of Income Tax Act, 1961

Capital

1. >= 26% direct/indirect holding by enterprise
OR
2. By same person in each enterprise
3. Loan >= 51% of Total Assets
4. Guarantees > = 10% of debt
5. > 10% interest in Firm/AOP/BOI

Management

6. Appointment > 50% of Directors/one or more Executive Director by an enterprise
OR
7. Appointment by same person in each enterprise

Control

8. 100% dependence on use of intangibles for manufacture/processing/business
9. Direct/indirect supply of > = 90% Raw Materials under influenced prices and conditions
10. Sale under influenced prices and conditions
11. One enterprise controlled by an individual and the other by himself or his relative or jointly
12. One enterprise controlled by HUF and the other by

• a member of HUF
• his relative or
• Jointly by member and relative

1.5 International Transaction – Sec 92B

Transactions between two or more AEs, either or both of whom are non-residents

1.6 Arm’s Length Price – Sec 92C

1.7 Transfer Pricing Methods – Rule 10B, Sec 92C

1.8 Illustrative Applicability of Different Methods

Some common nature of transactions and the most applicable methods is specified below:

1.9 Profit Level indicator (PLI)

• Profit Level Indicators (PLIs) are financial ratios that measure the relationship between profits and costs incurred or resources employed.
• The use of an appropriate PLI ensures better accuracy in the determination of the arm’s length price of a related party transaction.
• The Resale Price Method (RPM), Cost Plus Method (CPM) and Transactional Net Margin Method (TNMM) are the transfer pricing methods that use PLI to determine whether the related party transaction involved is carried out at arm’s length.

Factors to consider include but are not limited to in determining the PLI:

• characterization of business;
• availability of comparable data; and
• the extent to which the PLI is likely to produce a reliable measure of arm’s length profit.

Generally used PLIs

1.10 Operating Items vs Non – Operating Items

• For the purpose of transfer pricing margin computation, it is important to only consider those items of income/expense which are directly related to core operations of the company
• Operating items: Those relating to the day-to-day operations of the enterprise, being incurred in the normal course of business and related to the principle revenue generating activities.
• Non-operating items: Includes investing and financing activities which are not related to principle revenue generating activities.

Operating Items

• Foreign Exchange Gains/Losses
• Sale of scrap
• Provisions/liabilities/balances no longer required written back
• Commission received
• Interest from customers on delayed payment
• Miscellaneous Income
• Deferred/Amortised Expenditure
• Bank Charges
• Business development expense
• Commission paid
• Rent paid

Non-operating items

• Payment or receipt of Interest/Dividend
• Rent Received
• Write-back of provision for diminution in the value of investments/impairment of assets
• Profit or Loss on sale of Assets/Investments/Assets written-off
• Finance charges
• Prior period expense
• Donations/CSR expenses
• Loss on fire/natural calamities/thefts etc.
• Preliminary and pre-operating cost
• Provision for doubtful debts or other contingent provisions
• Extra-ordinary incomes or expenses

1.11 Range Concept and Multiple year Data – Rule 10CA, Notification No. 83/2015

Evolution over years

Data

• Before 2014 – Single year Data
• After 2014 – Multiple year data up to preceding 2 years

Tolerance

• Finance Act 2011: +/- 5% on Transfer Price
• Finance Act 2012: +/- 1% for wholesalers +/- 3% for others On TransferPrice

Range Transactions before 01-04-2014

• Arithmetic Mean with benefit of Tolerance Range
• Arithmetic Mean: If the *conditions are not satisfied

Range Transactions after 01-04-2014

• 35th & 65th Percentile: if Transaction price is within the range if 6 or more comparables are present
• TP Adjustment to be calculated on Median: If transaction price falls outside the range

Applicability to Methods

International Practices

• Range – Inter-Quartile range: 25th & 75th Percentiles
• All methods are applicable for Range and Multiple Year data concept
• No minimum comparables required for Range Concept

Applicability of Range concept

As per Rule 10CA, the ‘range concept’ shall be applicable when:

• the MAM is either CUP, RPM, CPM, or TNMM; and
• there are at least 6 comparables.

1.12 Arms Length Price – Range Sec 92 (C2)

• “Range” concept followed internationally; also propounded by OECD
• Use of inter-quartile range is amongst the globally accepted best practice and also closer to economic realities wherein prices, and or margins, are compared to those within a range and not at to a particular point.
• India has adopted percentile concept instead of inter-quartile range
• Arithmetic mean concept is also used where number of comparable is inadequate

2. Transaction vs Profit – Based ALP Determination

2.1 Transaction v/s Profit based Arm’s Length Price determination

3. Benchmarking Analysis

3.1 Contents of Local File – Sec 92D, Rule 10D

• Local File
• Master File
• CountryCountry (CbC) Report

Structure of TP Documentation

• Executive Summary
• Group Overview
• Industry Overview
• Functional Analysis
• Selection of tested party
• Selection of most appropriate method
• Economic analysis
• Conclusion

3.2 Overview of TP Benchmarking Analysis

Transaction Analysis

• Activity – Services/Manufacturing/Trading
• Scope of Activities
• Transaction Flow – Domestic/International
• Entities Involved
• Segment/Industry
• Remuneration Mechanism/TP Model
• Existing Price/Margin

FAR with Supply Chain Analysis

• Functions Performed
• Assets Employed
• Risks Borne

Characterisation of Entities

• Full-fledged or Contract Manufacturer
• Full-fledged or Limited Risk Distributor
• High-End or Low-End Services Provider

Economic Analysis

• Selection of TP Method (CUP/RPM/CPM/PSM/TNMM/Other Method)
• Selection of Tested Party (Indian Taxpayer or Foreign AE)
• Selection of Profit Level Indicator (PLI)
• Selection of TP database
• Comparability Analysis
• Arm’s Length Range

3.3 Why Benchmarking?

• Tax Compliance Requirement: Companies are obligated to comply with the relevant TP regulations in the country (Ex: In India Sec 92 and Rule 10, in UAE Article 34) which necessitates that transactions with Related Parties meet the arm’s length standard for determining taxable income.
• Arm’s Length Standard: This standard implies that transactions should produce results consistent with what unrelated parties would achieve in similar circumstances/same industry in open market.
• Transfer Pricing Methods: To determine arm’s length prices, companies utilize various transfer pricing methods, such as CUP, RPM, CPM, TNMM, and PSM.
• External Comparable Data: Methods such as CUP, RPM, CPM, and TNMM rely on external data to establish comparable pricing. Even in cases where internal comparable data is present, tax authorities may consider it unreliable or tailored specifically for transfer pricing compliance. Thus, it is imperative to conduct an external industry benchmark for transfer pricing planning and compliance.
• Data Sources: To find potential comparables, companies explore various sources, including TP databases, internal data, and other publicly available information.
• TP Databases: TP databases (TP Catalyst, S&P Capital IQ, RoyaltyStat & Loan Connector) compile publicly available company data in an accessible format, making them a practical and cost effective source of external comparables.
• Geographic Expansion: Normally, the relevant jurisdiction will be considered based on the Service provider, Place of supply or Service Recipient. Depending on the tested party the jurisdiction of search would be relevant. For example, in cases where financial data in a particular region, such as the UAE, is limited, companies may need to broaden their search to regions like Middle East, Africa and Eastern Europe. Multi-jurisdictional data has to be used in case regional companies are not available
• Lack of Authorized Databases: It is worth noting that there is no government database containing such financial information. Based on our experience, none of the mature transfer pricing jurisdictions publish similar financial information for transfer pricing in the public domain.
• The only realistic option available to the taxpayer for finding comparables is to rely on a financial database to obtain financial information for companies operating in the Middle East, Africa, and Eastern Europe across a spectrum of industries.

3.4 Step wise approach for TP Benchmarking

1. Select most appropriate TP method: There are two Types of Methods:

• Traditional Transaction Methods:

1. 1. Comparable Uncontrolled Price (CUP)
   2. Resale Price Method (RPM)
   3. Cost Plus Method (CPM)

• Transactional Profit Methods:

1. 1. Profit Split Method (PSM)
   2. Transactional Net Margin Method (TNMM)

2. Select Tested Party: The entity to be selected as the “tested party” should be the least complex and not necessarily unique.

3. Select Profit Level Indicator: Selecting the right PLI depends on the transaction’s specifics, including:

• business type;
• comparable data; and
• PLI reliability in measuring arm’s length profit.

4. Select publicly available database: Databases such as CapitaLine, AceTP, Prowess, Capital IQ, Bloomberg, Tracxn, RoyaltyStat, RoyaltyRange, etc can be utilized to access relevant data.

5. Industry classification and key words: Select industry classification and key words pertaining to the entity under consideration.

6. Quantitative Analysis: Apply filters/screens such as:

• data availability,
• Sales>1 Cr,
• Positive net worth,
• Core services income > 75%,
• Export earnings > 75%,
• RPT transactions < 25% etc.

7. Qualitative analysis: Download the annual report and review business description, service or product profile, segmental info, extraordinary events, IP holdings etc.

8. Final Set of Comparable Companies: Finalize the set of comparable companies. If there are more than 6, compute the 3-year weighted average mark-up and use the 35th to 65th percentile range. Otherwise, use the average mark-up.

9. Economic Adjustments: If there are any differences in comparables and test party, adjust those differences undertaking economic adjustments

4. Preferred Transfer Pricing Database for Each Transaction Category

4.1 Indian & Global TP databases – Transaction & Region wise

There are no specific public databases recommended for identifying comparable companies as per the United Nations Transfer Pricing (UN TP) guide, the Organisation for Economic Co-operation and Development (OECD) Guidelines, and the Income Tax Act. Following are the preferred databases:

4.2 TP Database – Source

Public Company Financials

• Data Extracted from Annual Reports
• Information from mandatory filings like 10-K and 20-F, for listed companies.

Inter-Company Agreements

• Intercompany agreements serve as a valuable source of TP data, detailing the terms and conditions of transactions between related entities.
• These agreements provide essential information for establishing arm’s length nature of transaction, they also outline roles, responsibilities, risks and rewards for accurate analysis

Industry Reports

• Reports from industry analysts and market research firms provide valuable insights.
• Industry-specific studies provide comparative data on margins, royalties, and other pricing metrics.

Private Company Financials

• Using private company financials as a source offers more accurate and relevant comparables for benchmarking analysis, as private companies often operate in specific markets or industries similar to the tested party.
• However, limited access to reliable and comprehensive financial data for private companies can challenge thorough and accurate analysis compared to public companies.

4.3 Database – Limitations

Data Quality:

• Financial data from public sources can vary in detail and accuracy
• Databases may not be updated in real-time

Timing Issues:

• Financial data is often available only after a significant delay
• Using historical financials may not reflect current market conditions

Veracity of Information:

• Public companies are required to disclose more detailed information compared to private companies, leading to potential biases in available data
• Errors in data collection, reporting, or entry can affect the reliability of the databases

Geographical Coverage:

• Some databases have better coverage in specific regions, which may not be representative of the global market
• Differences in tax laws and accounting standards across jurisdictions can complicate the comparability of data

Industry Representation

• Certain industries may be underrepresented in databases, making it challenging to find comparable data
• Companies with unique or innovative business models may not find adequate comparables in existing databases

5. Quantitative & Qualitative Criteria for Filters

5.1 Quantitative Analysis

Application of quantitative filter

Commonly used quantitative filters are:

1. Availability of financial data
2. Different FY Ending
3. Turnover filter
4. Net worth filter
5. Consistently loss-making companies
6. Export filter
7. Employee Cost filter
8. Related party transactions filter

Application of Specific filters

Commonly used qualitative filters are:

1. Employee cost filter
2. Service income/operating income filter
3. Manufacturing income Filter

5.2 Quantitative and Qualitative Analysis

• Directors Report
• Notes to Accounts
• Auditor’s Reports
• Management Discussion
• Annual Reports

Available in:

1. Capitaline
2. ISI Emerging Markets
3. ACE Equity
4. MCA Website
5. ProwessIQ

Application of qualitative filters

Commonly used qualitative filters are:

1. Product/Service Profile
2. Segments
3. Presence of IP/Brand
4. R&D functions
5. Fluctuating/Abnormal Profits
6. Extra-ordinary events/circumstances
7. Government Companies
8. Exceptional year of operations

6. Prowess IQ Search Process

6.1 Prowess – Summary of Search Steps

Prowess – 1. Selection of Comparable Companies

Step 1

• Login to Prowess with User ID and Password.
• From the left dialog box select “Business segment and products” tab.

Step 2: After selecting main product/service group, relevant keywords may be selected by entering the relevant words in the search box. The Keywords selected will then be reflected in the dialog box below as Selected Product/Services.

Step 3: Once all the relevant keywords are selected,

• Under “Select domain”: select “All companies”
• Under “execute” in the bottom right corner, click “send to new OSC”

Note: In case keywords are being selected from tabs “Products & raw materials, Structured search on products & raw materials” after selecting from “main products/services group”, the same shall be “added to current OSC” rather than “sending it to new OSC”.

Step 4: After the Companies get triggered we will be able to see a tab “NEW OUTPUTS” blinking in blue colour on the top right corner. Click on the same and a new dialogue box appears. Press “Continue” and the relevant companies will be listed in the output view

You will be automatically taken to the “Output View” containing the list of companies triggered with the search criteria selected previously.

Prowess – 2. Company Address and Identity Indicators

Step 1: Select “Company Address and Identity Indicators” tab from the left dialog box

Step 2: Select NIC Code, NIC name, Industry Type, Main Product/ Service Group and any other fields from the right adjacent dialog box

Step 3: After selecting the required data choose “Companies in current OSC” for extracting the selected identity indicators for the companies previously triggered.

Step 4: Send the data to current OSC from the dialog box at the right corner. The identity indicators would be added to the companies existing in the output view.

Change of currency: Before extracting the financial information for the companies in output sheet, change the currency from “Rs. Million” to “Rs. Crore”.

Prowess – 3. Financial Information

Step 1: Select “Financial Statements” tab from the left dialog box
Step 2: Select “Annual Financial Statements” from the drop down available below

Step 3: Select the required Annual Information for applying filters from the adjacent dialog box using search box such as :

1. Year
2. Months
3. Total Income
4. Sales
5. Industrial sales
6. Income from non-financial services
7. Trading Income
8. Rent/Operating lease rent income
9. Total Expenses
10. Provisions
11. Prior period and extra-ordinary expenses
12. Provision for direct tax
13. Donations
14. Penalties on direct taxes

Step 4: Select Query on date for the period for which the data is required for the triggered companies in the format YYYYMM – YYYYMM

Step 5: Click “companies in current OSC” to extract financial data for the relevant period for the companies already triggered in the output sheet
Step 6: Add data to OSC and continue

Step 7: Open “Output view” Tab and select “Save as Excel” from the left corner tab to save and extract the output as Excel.

Prowess – 4. Related Party Transactions

Step 8: Under “Ownership and Governance Indicators tab” from the left dialog box select “Related Party Transactions” from the drop down available below

Step 9: From the “Select Party Type(s)” dialog box select “All Party Types”

Step 10: Select “Total revenue receipts/income as a % of Total income” and “Total revenue expenses/payments as a % of Total Expenses” from the adjacent dialog box.

Step 12: Select Query on date as for the period for which the data is required for the triggered companies in the format YYYYMM

Step 13: Further select Companies in current OSC from the dialog box at the right corner to extract the Related Party Transactions for the relevant period for the companies already triggered in the output
Step 14: Further select Output destination as WS tab from the dialog box adjacent to Select Domain

Step 15: Select Send to new WS tab to extract related party data into new work sheet. The data will be triggered after some time

Step 16: After the Data is triggered the “NEW OUTPUTS” on the right end blinks. Further click on the same and a new dialogue box appears. Press “Continue” and the relevant Related party data will be triggered in the Worksheet.

Step 17: We can anytime view data from the “Worksheet Tab” and export it as Excel and save it with the relevant name in any folder.

7. Prowess IQ: Case Study

7.1 Prowess Case Study – Example

7.2 Prowess Case Study – Query

Select Companies in Pre-defined Sets
Computer Software
No.of Companies Added: 1584

Main Product/Services Group of Company
Software Service
No.of Companies: 1584

Query by Products & Raw material – Products Produced and traded
Structured Query – Software Service
No.of Companies – 1868

Query by Structure Search on Products & Raw material – Products Produced and traded
Query on Name – Software services
No.of Companies – 2408

Query on Business Segments – Segment by Products
Query on – Annual Financials
No.of Companies – 2408

7.3 Prowess Case Study – Identity Indicators Extract

Company Address and Identity Indicators – Add Identity Indicators

7.4 Prowess Case Study – Financial Information Extract

Financial Statements – Annual Financial Statements

7.5 Prowess Case Study – Export/Copy/Save data

The final data can then be exported/copied to excel worksheet for quantitative analysis.
The final comparable data can be saved as a “user set” for future use and reference.

1. Export it as Excel and save it any folder

The final data can then be exported/copied to excel worksheet for quantitative analysis.

2. Export it as Excel and save it any folder

7.6 Prowess Case Study – Related Party Transactions Extract

Related Party Transactions – Find related Parties that meet transaction condition

7.7 Keywords Specific to IT Industry

Following Keywords have been used to arrive at the Comparables specific to Software Development Services.

Prowess IQ (a database compiled and managed by Centre for Monitoring Indian Economy Private Limited)

A search query on Prowess updated until 4th October, 2023 using the following keywords in the ‘Query by Business Segments and Products’ module:

7.8 Search Criteria

The following qualitative and quantitative filters have been applied to the master data obtained from the Prowess search to arrive at the final list of comparables similar to the tested party.

7.9 Summarizing Business Descriptions

For the final list of comparables, we need to summarize the business descriptions from financial statements, media sources, the company’s website, and intercompany agreements or any other Internal data.

Below is an illustrative example for your reference.

Brief Business Description of the Comparable Companies – SWD Service Segment

1. Sybrant Technologies Pvt. Ltd.: Sybrant Technologies Private Limited is an acclaimed software development company that provides Software development services, Data services, Platform Based Services, and other Real Estate services.
2. Harbinger Systems Pvt. Ltd.: Harbinger Systems is a private company providing software technology services for independent software vendors and enterprises. Harbinger Systems builds software solutions leveraging digital technologies for domains such as HRTech, Healthtech, and Learning Tech.
3. Wipro Ltd.: Wipro Limited specializes in IT and computer related technologies. The Group’s services encompass a number of areas, including software architecture, business intelligence systems, e-commerce, data warehousing, Internet access devices, network management, system administration, messaging systems, IT consulting and design. Wipro also has a presence in niche markets of consumer products.
4. Athena Global Technologies Ltd.: Athena Global Technologies Limited provides information technology services. The Company offers software application development, infrastructure management, product engineering, e- commerce web, digital transformation, and consulting services.

7.10 Accept Reject Matrix

Accept Reject Matrix: Displays the companies that have been accepted or rejected, which have been extracted from the Prowess search, along with the reasons for their acceptance or rejection. An Illustrative Example is provided below:

7.11 Prowess Case Study – Comparable Summary

Below is the final list of comparables that pass all the quantitative and qualitative filters specified earlier.

Among the six methods, TNMM has been selected as the most appropriate method, and OP/OC has been chosen as the PLI for the provision of software development services.

Range Concept has been used instead of Average Concept since there are more than 6 comparables.

Multiple year data has considered and had computed weighted average for the past three financial years data.

Since the No. of Comparable is even, Median will be average of 5 & 6.

• Tested party Cost Plus mark up is 10%
• Since the tested party percentage is within the range transaction i.e., 6.85% to 21.41%, it can be said to be at Arm’s length.
• If the tested party margin is below the range, adjustment will be proposed.

8. Benchmarking 45 – Intragroup Loan

8.1 TP Catalyst – Login into TP Catalyst Interface

8.2 TP Catalyst – Create Analysis

8.3 TP Catalyst – Selection of Database

8.4 TP Catalyst – Selection of Tested Party

8.5 TP Catalyst – Filters

8.6 TP Catalyst – Status Filter

8.7 TP Catalyst – Size Classification

8.8 TP Catalyst – Industry Classification

8.9 TP Catalyst – All Companies With

8.10 TP Catalyst – BvD Independence Indicator

8.11 TP Catalyst – Activity Text Search

8.12 TP Catalyst – Financial Information

8.13 TP Catalyst – Search Strategy Screenshot

8.14 TP Catalyst – Comparable Results

8.15 TP Catalyst – Qualitative review of Companies

8.16 TP Catalyst – Generate Results

8.17 TP Catalyst – Final Results

8.18 Intra Group-loans

Procedure for establishing the arm’s length price,taking into account TP and ALP

• Analyze the terms of the loan that may impact the pricing including issue date, tenure, currency, interest rate etc.
• Analyze the credit rating of the borrower to understand the credit risk borne by the lender.
• Use reference of third-party loans with similar credit and terms as reference
• Calculate the arm’s length range

Transfer Pricing Methods

• Internal Comparable Uncontrolled Price (CUP)

1. 1. Bank transactions

• External CUP

1. 1. Comparable transactions from databases
   2. Yield curves, statistics (e.g., European Central Bank)

• Cost-plus – especially for pass-through

1. 1. Lender’s refinancing cost

Critical Issues

• Rating

1. 1. The choice between stand-alone and group ratings impacts perceived risk

• The lender’s substance affects loan terms,
• C+: C- rating suggests caution, with debt favored for retaining control and equity for risk-sharing (debt or equity financed loan?)

8.19 Credit Rating Methodology Framework

Step 1: Identify the members of a group

Step 2: Determine a group credit rating (GCP)

Step 3: Assess group status of group members: core, highly strategic, strategically important, moderately strategic, nonstrategic

Step 4: Determine if a stand-alone credit rating is required

• Core members receive a credit rating equivalent to GCP
• Strategic members receive a credit rating within three notches of GCP

Step 5: Assign a potential issuer credit rating based on:

• Criteria for insulated companies (Independent Companies, Less affected by changes in interest rates)
• External credit enhancements (Government support of financial guarantee)

Step 6: Apply constraints to potential issuer credit rating posed by:

• Sovereign risk
• Structural leverage

8.20 Credit Rating Table

8.21 Practical Case Study

Illustrative Example

Search Criteria

8.22 Accept Reject Matrix

Accept Reject Matrix: Display the companies that have been accepted or rejected, which have been extracted from the Loan Connector, along with the reasons for their acceptance or rejection.

An Illustrative Example is provided below:

8.23 Arm’s length range of Interest rates

Below is the final list of comparables that pass all the quantitative and qualitative filters specified earlier.

Among the six methods, CUP has been selected as the most appropriate method.

Range Concept has been used instead of Average Concept since there are more than 6 comparables.

Multiple year data has considered and had computed weighted average for the past three financial years data.

• Tested party receives interest rate at the rate of 6%
• Since the receipt of interest rate by tested party is within the range of comparable companies i.e., 5.33%% to 6.17%, it can be said to be at Arm’s length

9. Benchmarking – Intangibles

9.1 Benchmarking – Royalty Range

Illustrative Example

9.2 Royalty Range – Intangibles

Search process conducted – Royalty Stat License Agreement database.

Qualitative analysis conducted on the initial set of agreements

9.3 AR Matrix

9.4 Arm’s Length Range

• Tested party royalty rate is 4% of net sales.
• Since the tested party percentage is within the range transaction i.e., 3.50% to 5.00%, it can be said to be at Arm’s length.

9.5 Addition of Comparables

• ABC Chart

• Search for comparables can be updated during the assessment proceedings
• Include companies accepted last year even if they fall outside the current relevant ‘product classifications’ after ensuring no new reasons for rejection have surfaced.
• If a company which was accepted last year, but was not present on the current database, then we should include this company for both previous and current years after confirming no change in the underlying basis for acceptance and no substantive reasons for its absence. Please note that the above tow positions should only be adopted for updation of study but not for a benchmarking/new study.
• In the event of Annual Report review if any subsidiaries or group companies of potentially acceptable companies are identified include this company, even if they are not part of the database.
• Even if the Client insists on cherry picking of comparables to be with in the range, it should not be done. There should be a proper basis for the selection of comparables.

9.6 Do’s and Don’ts for TP

9.6.1 Related Party Transaction

Do’s: Consider only transactions with relating parties during the relevant year
Don’ts: Do not consider outstanding balances as at the end of the relevant year

9.6.2 Export Filter

Do’s: To be considered only for International Transaction
Don’ts: Do not consider while evaluation domestic transactions

9.6.3 TP Methods

Do’s: Evaluate the applicability of all the methods
Don’ts: Avoid proceeding directly to TNMM

9.6.4 Benchmarking exercise

Do’s: Consider the jurisdictions of both entities during the benchmarking exercise.
Don’ts: It should be not be carried out from only one perspective

9.6.5 Selection of Tested Party

Do’s: Entity that performs least complex functions and has lower risks must be selected as tested party.
Don’ts: Do not change/shift the tested party without any base

9.6.6 Selection of Comparable

Do’s: Evaluate and select the comparables after applying all the quantitative and qualitative filters
Don’ts: Cherry picking of companies is not acceptable

9.7 India v/s UAE TP Regulations

The post How to use Transfer Pricing Database for Benchmarking Analysis – Step-by-Step Guide | Best Practices appeared first on Taxmann Blog.

Case Details: GE Power Conversation India (P.) Ltd. vs. NFAC - [2024] 163 taxmann.com 718 (Madras)

Judiciary and Counsel Details

• C. Saravanan, J.
• S. Sivaraman for the Petitioner.
• Prabhu Mukunth Arunkumar, Jr. Standing Counsel & B. Ramana Kumar, Sr. Standing Counsel for the Respondent.

Facts of the Case

The petitioner was issued an order under section 143(3) read with 144C(1) proposing to make the transfer pricing adjustment to the total income. The petitioner challenged the Impugned Order before the Madras High Court, contending that although the order stated that such an order was a Draft Assessment, the order was indeed an Assessment Order as it was passed under Section 143(3) read with Section 144B of the Act.

High Court Held

The High Court held that the order under section 92CA(3) and the Assessing Officer (AO) should have ordinarily passed a draft assessment order in terms of Section 144B(1). Instead, in the present case, the order was formatted as an order under Section 143 r.w.s 144B.

The order also stated that it was a draft assessment order. The National Faceless Assessment Centre (NFAC), New Delhi, forwarded the order to the petitioner. A mistake crept in, as the order was formatted electronically by the National Faceless Assessment Centre under the mechanism evolved in Section 144B.

The mistake in formatting the preamble to the order based on a template meant for passing orders under Section 143(3) and Section 144B was not fatal. It will not render the order an assessment order.

The attempt by the Parliament to make an assessment faceless under the Income Tax Act, 1961, up to the appellate stage before the Appellate Commissioner, cannot be scuttled merely because the order formatting was improper. Mistakes that are not fundamental are not fatal to the assessment proceedings initiated. Assessment proceedings cannot be allowed to abate on account of technical glitches in the system-generated orders.

The impugned order was only a “Draft Assessment Order”, as was evident from a reading of the impugned order. It should have been correctly formatted as an Assessment Order in the system. Since the formatting and dissemination of all notices and orders are system-driven, the Assessment cannot be abated.

List of Cases Referred to

• • Vijay Television (P.) Ltd. v. Dispute Resolution Panel, Chennai [2014] 46 taxmann.com 100/225 Taxman 35/369 ITR 113 (Madras) (para 12)
  • Asstt. CIT v. Vijay Television (P.) Ltd. [2018] 95 taxmann.com 101/407 ITR 642 (Madras) (para 13)
  • SHL (India) (P.) Ltd. v. Dy. CIT [2021] 128 taxmann.com 426/282 Taxman 334/438 ITR 317 (Bombay) (para 18)
  • Bekaert Mukand Wire Industries Pvt.Ltd., v. Additional (para 18).

The post Assessment Couldn’t Be Abated if NFAC Forwarded an Assessment Order Instead of Draft Order Due to Technical Glitch appeared first on Taxmann Blog.

Case Details: Computer Sciences Corporation India (P.) Ltd. v. DCIT - [2024] 163 taxmann.com 693 (Hyderabad-Trib.)

Judiciary and Counsel Details

• • K. Narasimha Chary, Judicial Member & Madhusudan Sawdia, Accountant Member
  • Vikram Vijayaraghavan, AR for the Appellant.
  • Kumar Pranav, CIT-DR for the Respondent.

Facts of the Case

The assessee was a private limited company engaged in software development. During the year under consideration, the assessee filed its return of income under the normal provisions of the Income-tax Act and declared book profits under section 115JB of the Act.

The case was selected for scrutiny, and notices were issued to the assessee. The Assessing Officer (AO) completed the assessment under section 143(3) of the Act, determining the total income under the normal provisions of the Act and book profit under section 115JB.

On appeal, CIT(A) consolidated all the grounds of appeal into a single issue and disposed of the appeal. Aggrieved-assessee filed the instant appeal before the Tribunal.

ITAT Held

The Hyderabad Tribunal held that the CIT(A) adjudicated the grounds on only one issue, i.e., whether the comparables are valid or not, and dismissed the grounds on all the other issues without considering the merits.

The CIT(A) held that assessee failed to furnish any evidence/documents before him. However, the relevant portion of the order of CIT(A) clearly mentioned that the assessee had filed all the necessary documents and evidence before him.

Accordingly, the Tribunal deemed it appropriate to remit the issue back to the file of the CIT(A) with a direction to look into the facts and decide the issue as per law by giving the assessee an opportunity to be heard.

The post ITAT Remanded Matter as CIT(A) Dismissed All Grounds of Appeal Based on a Single Issue appeared first on Taxmann Blog.

Case Details: PCIT v. Sarens Heavy Lift India (P.) Ltd. - [2024] 163 taxmann.com 447 (Delhi)

Judiciary and Counsel Details

• Yashwant Varma & Purushaindra Kumar Kaurav, JJ.
• Indruj Singh Rai, Sr. SC, Sanjeev Menon, Rahul Singh, Jr. SCs & Anirudh, Adv. for the Petitioner. 
• Ved Jain, Nischay Kantoor & Ms Soniya Dodeja, Advs. for the Respondent.

Facts of the Case

The assessee, Sarens Heavy Lift India Pvt. Ltd., was engaged in the business of providing heavy lifting and transportation services. During the year under consideration, the assessee entered into a purchase transaction of cranes with its associated enterprise (AE). The assessee determined the arm’s length price (ALP) of the cranes by using the cranes’ price as derived from a Chartered Engineer’s valuation report. The case was referred to the Transfer Pricing Officer (TPO).

While computing the ALP of cranes, the Transfer Pricing Officer (TPO) considered the Written Down Value (WDV) of the assets as reflected in the books. The Tribunal rejected the method adopted by the TPO. The matter reached the Delhi High Court.

High Court Held

The Delhi High Court held that the WDV methodology appears to have been rejected, bearing in mind the undisputed mandate of Rule 10B of the Income Tax Rules, 1962, which requires the identification of ALP from the point of view of the uncontrolled price method as being referable to a comparable uncontrolled transaction.

The expression “uncontrolled transaction” has been defined in Rule 10A(ab) of the Rules as being a transaction between enterprises other than associate enterprises. Admittedly, the equipment had been purchased from the AE. Resort to WDV would have thus fallen foul of this fundamental precept. In any case and in the considered opinion, the WDV, as may be reflected in the books, would not be liable to be considered while answering the issue of ALP.

The post WDV as Reflected in Books of AE Can’t Be Considered While Computing ALP of Assets Purchased From AE | HC appeared first on Taxmann Blog.