With the rapid globalisation of the economy, tax authorities in India have become increasingly vigilant in scrutinising the inter-company transactions of multinationals. In just eight transfer pricing (TP) audit cycles beginning from financial year ended March 31 2002, Indian tax authorities have made TP adjustments close to $25.41 billion, including the adjustments of $11.67 billion made in the TP audit cycle completed in January 2013. The issues that are scrutinised have also matured to cover more complex transactions such as valuation of equity share infusions, creation of marketing intangibles, intra-group cross charges and financial transactions. While the tax authorities in India gear up to upgrade and focus further on cross-border transactions, the introduction of domestic transfer pricing regulations from fiscal year 2012-13 is likely to increase TP challenges.
Valuation of Shares
TP adjustments in respect of equity infusion in an Indian company have been one of the most controversial issues in the past two years. Revenue authorities alleged that share investments made by multinationals in their Indian associated enterprises (AEs) were undervalued and made adjustments on the difference between the actual issue price and the arm's-length price (ALP) by considering it as notional income. They re-characterised such shortfall as deemed loan purportedly advanced by the Indian AE to its overseas parent company and have even imputed notional interest in the hands of the Indian taxpayers. There have been several high profile litigations on this issue, where taxpayers have approached the High Court challenging the positions taken by the transfer pricing officers. Taxpayers are eagerly awaiting some clear guidance from the courts on this issue.
Advertising, marketing and promotion (AMP) expenditure resulting in marketing intangibles
The Indian Revenue examines whether marketing intangibles were created by Indian taxpayers by applying the bright-line test. Bright-line means the level of AMP expense of comparables compared with the AMP spend of Indian taxpayers. If the AMP spend of an Indian taxpayer is found to be excessive, it is concluded that such effort has led to the development of marketing intangibles that are legally owned by the foreign affiliate, and an arm's-length compensation (by way of reimbursement of excessive cost with or without a profit margin/markup thereon) should be recovered by the Indian affiliate. A related dispute arises in cases where the Indian taxpayer also pays a brand/trademark fee to the foreign affiliate. The arm's-length value of such brand/trademark fee could be determined at nil by the Revenue on the premise that the Indian taxpayer's local market development activity has enhanced the value of brand/trademark owned by the foreign affiliate, thereby necessitating a pay-in rather than a pay-out.
In a landmark case of LG Electronics India (ITA No. 5140/ Del/2011) in January 2013, a Special Bench of the Tax Tribunal held that the TP adjustment by the Revenue in relation to AMP expenses incurred by the taxpayer for creating or improving the marketing intangible for and on behalf of the foreign AE is permissible; and said function could be construed as provision of service by the taxpayer to the AE. This Special Bench ruling has been followed thereafter by other Indian tribunals in various other cases. Only in a few cases, the Tax Tribunals have expressed contrary views where the taxpayers have been able to distinguish the facts.
Indian TP regulations do not prescribe any guidelines to establish the arm's-length nature of intra-group services. Indian Revenue officials generally rely on the OECD guidelines to ascertain the validity of such charges. In many cases, Revenue has determined the arm's-length value of the intra-group services as nil, alleging that such charges are simply a means of profit repatriation and leads to erosion of India's tax base. Taxpayers are expected to demonstrate (i) that such services are not in the nature of shareholder activity or duplicative; (ii) the authenticity of the total cost pool and the allocation keys used (iii) the need and the evidence of services received and benefit accrued. Indian tribunals have, however, decided in favour of the taxpayer in many cases, stating that the Revenue cannot comment or question the business or commercial need of the taxpayers for procuring such services, but can only determine the arm's-length charge. Here it is important to appreciate that establishing the genuineness of such cross-charges may be practically difficult largely because of the intangible nature of services and benefits received. Maintaining a robust documentation would eventually be the key from a taxpayer's standpoint.
Conventional dispute resolution mechanisms in India
The conventional appellate process under Indian tax law that starts at the level of Commissioner of Income Tax (Appeals) and then moves upward towards the Tax Tribunal and the courts has been supplemented with the dispute resolution panel (DRP) process.
Alternate dispute resolution mechanisms
Dispute resolution panel (DRP)
DRP is a collegiate of three Commissioners of Income Tax and, unlike the above conventional process, it is a time-bound process, which enables taxpayers to have certainty in terms of time spent in reaching the Tax Tribunal. However, until recently, the mechanism's functions and the legislative/procedural limitations had led to widespread disapproval from taxpayers, as most of the times the DRP's directions largely favoured the Revenue. In a few cases where the DRP's instructions were in favour of the taxpayer, it is now possible for the Revenue to challenge such directions before the Tribunal. The time barring nature of the proceedings (directions to be issued within nine months) also considerably limits the ability of the DRP members to do justice to all cases. To make the DRP mechanism more effective, taxpayers have recommended that its members should be full-time dedicated and independent empowered members, which would accord much-needed momentum to the DRP framework.
Mutual agreement procedure (MAP)
MAP provides a mutually acceptable solution for the governments of both transacting countries, thus avoiding double taxation for the taxpayers. Article 9 (dealing with AEs) and the article dealing with MAP of the Indian DTAs provide guidance on how to invoke MAP in the situation of a TP adjustment. In 2010, India and US competent authorities (CAs) concluded a series of mutual agreements by reaching a settlement on cost-plus margin percentages in the range of 17% to 20% for certain IT/IT-enabled service operations of Indian captive centres. The original TP adjustments were made using cost plus margins in the range of 25% to 30%. In the time since the 2010 settlements, not much progress has been made, though recent updates suggest that constructive dialogue between the Indian CA and the US CA has resumed.
Advance pricing agreements (APAs)
The APA programme was introduced in 2012 to bring certainty in potential TP controversies.
The APA programme has been a relief to multinationals operating in India and has gained popularity, which is evident from the number of applications (146) that have been filed in the first year. Several rounds of discussions are already in process, with site visits being conducted in consultation with taxpayers. The experience of the taxpayers has been very positive as such visits are conducted to understand the taxpayers' operations rather than to investigate. International TP experts have welcomed the pragmatic approach of the Indian APA team. The first batch of APAs are expected to be signed by the end of March 2014.
The Indian safe harbour rules provide circumstances where certain taxpayers can avail an option whereby cost-plus margins or transfer prices in respect of certain transactions like services related to IT/ITES and contract R&D, manufacture of automobile components and financial transactions (loans and guarantees) would be automatically accepted by the Indian tax authorities. Taxpayers availing the option would be able to safeguard their transfer prices against potential litigation for a maximum period of five years. However, most of the margins prescribed under the safe harbour mechanism are considerably higher than industry standards, even after factoring in the premium for the certainty accorded by a safe harbour. As such, the response from multinationals towards the safe harbour regime has not been enthusiastic. Taxpayers are still awaiting clarifications on certain subjective and interpretational issues regarding services covered, rationalisation of margins and procedural aspects surrounding this regime.
At present APAs could be a preferred option because of the positive, pragmatic and business oriented approach of the Indian APA team and the possibility of achieving a well negotiated price proximate to ALP. Further, while bilateral APAs would mitigate the risk of double taxation, the safe harbour mechanism will not be able to avoid potential double taxation.
India's perspective on BEPS – Intangibles and TP documentation
As part of the BEPS Bureau, India has been actively and closely involved in all the different action points of the BEPS action plan. India is expected to seek to implement the OECD-issued guidelines under the BEPS initiative where applicable. Specifically, developments in connection with treaty abuse, transfer pricing of intangibles, and the TP documentation rules are likely to have a significant impact on taxpayers and foreign investors in India. Action 8 of the OECD BEPS plan calls for developing rules to prevent BEPS when groups move their intangibles among their members; profits associated with the transfer and the use of intangibles should be appropriately allocated in accordance with value creation. India has adopted the OECD's approach on BEPS in relation to intangible-related returns, and concurs that such returns should reside with the entity which takes strategic decisions around creation of the intangibles and not with the entity which has mere ownership of title and funding capacity. India therefore believes that by adopting the ''significant people functions'' approach in determining the economic owner of intangibles, the problem of disconnect between profit and economic activity would largely be resolved.
As per the OECD's draft guidance on TP documentation and country-by-country reporting based on Action 13 of BEPS plan, lots of information is envisaged to be provided in the proposed two-tiered (master file and local file) TP documentation structure, with an aim to curb tax avoidance through TP mechanisms. The Indian Revenue is of the view that the proposed two tier structure would help them in making proper risk assessment of cases where TP audits are required and hence would also be beneficial to taxpayers. Since the existing TP documentation rules in India require all the information as suggested in the master file to be maintained, the recommended documentation structure would result in minimal additional compliance burden for the taxpayers initially.
Taxpayers are concerned and waiting to see how the rules relating to sharing of the master file and country-by-country reporting template will shape up, considering the current TP audit trends in India. They advocate adequate safeguards to be built into the rules to ensure that such information is not generally made available and shared only when necessary under treaty information exchange provisions. Another important aspect from an Indian perspective is materiality; volume of transactions ought to be the key to trigger the maintenance of such detailed documentation.
The Indian Government has now provided two structured mechanisms in the form of APAs and safe harbours for taxpayers to achieve certainty on their transfer prices and to provide some relief towards reducing protracted litigation. It is expected that the DRP mechanism will be more focused and lead to a reduction in litigation and the MAP will progress smoothly to resolve pending cases. Taxpayers are also hopeful that some concrete guidance would be forthcoming in relation to the contentious TP audit issues. Further, many more changes in the TP arena are expected with the implementation of the BEPS Action Plan. Overall, the Indian TP landscape in the global arena should be carefully tracked in the coming years to witness whether the Indian taxation scenario folds up to boost foreign investor confidence in India.
KPMG in India
Rohan is a partner and the national leader of global transfer pricing services. He leads a team of more than 275 transfer pricing professionals spread across seven locations in India. He represents India in the KPMG's global transfer pricing steering committee.
Rohan has been advising multinational companies on transfer pricing issues from 1997 long before the transfer pricing regulations were introduced in India in 2001. Rohan has been recognised as a leading transfer pricing adviser and features in the Euromoney's Guide to the World's Leading Transfer Pricing Advisers 2013.
Rohan has also been rated in the top 10 transfer pricing advisers in India in a survey carried out among Indian taxpayers in January 2011 by an International Tax Review publication.
Rohan specialises in advance pricing agreements and has serviced clients across various industries including IT, ITES, Financial Services, Electronics, and FMCG.
KPMG in India
Alpana is an executive director with the global transfer pricing practice of KPMG in India, and is presently on secondment to KPMG US since January 2012. She joined KPMG India after taking voluntarily retirement from the Indian Revenue Service in April 2010 where she was Commissioner of Income Tax.
She has rich experience of 25 years with Indian Revenue Service and has supervised and audited more than 2000 transfer pricing audits during the period 2005-09. She also represented the Revenue before the Tax Tribunal for international tax and transfer pricing appeals in the period 2006-2007, and was twice awarded Certificate of Appreciation by the Ministry of Finance for her work.
She works closely with US competent authority on India US MAP cases and with the Indian tax authorities on advance pricing agreements. She has been rated in Top 10 TP advisers in India in January 2011 by ITR.
KPMG in India
Karishma Phatarphekar is a partner in the global transfer pricing services practice of KPMG India and focuses on TP litigation and APA work. She was leading the TP practice for Grant Thornton in India from 2007 until 2013. She represented the firm on the global and Asia-Pacific transfer pricing co-ordination committee.
She has been nominated among the top 10 transfer pricing advisors in India by International Tax Review. In addition to corporates in India she has advised MNCs across the Americas, Europe and Asia-Pacific continents in planning their transfer pricing policies and dispute resolution.
She has been on working stints in US, UK, Germany and other countries in APAC and is is a prolific speaker. Karishma is on the panel discussion of FIT, ITR, IFA Mauritius, IFA India etc. She has penned numerous articles and papers for the ITR, BNA, Tax Analyst, Outsourcing, ET, and HBL.
KPMG in India
Rajan is a Partner since 2007 with TP practice of KPMG in India. He leads firm's TESCM initiative at national level. He works closely with the regulators and field authorities to understand their perspective with a view to help clients evolve successful defence strategies. He has more than 20 years of experience in providing specialised tax advisory services to multinational corporations in areas of TP, cross-border structuring and international taxation. He has successfully led large multi-disciplinary teams on some of the firm's marquee global assignments.
He spent formative years of his career with Arthur Andersen and subsequently was a part of core M&A tax team at PwC. Immediately before joining KPMG, Rajan was designated as the Asia-Pacific tax director of Honeywell Group. He was involved in making recommendations to the IRS on safe harbour provisions and advising on key TP issues impacting the industry.
KPMG in India
Vinod Mangotra voluntarily retired from the Indian Revenue Service on April 30 2010 as chief commissioner of income tax. He was with the Indian Revenue for 33 years and was awarded Certificates of Appreciation by the Ministry of Finance for work in the sphere of transfer pricing.
He participated in the OECD Global Forum on Taxation in Paris in 2005, represented India at transfer pricing multilateral discussions at the Australian Tax Office in 2009 and was a member of Indian delegation at IBSA (India Brazil South Africa) Heads of Tax Administrations Meeting in 2009.
He has been senior transfer pricing adviser with KPMG India since May 2010 and has been a regular speaker at various international tax and transfer pricing Conferences in India. He had also been to Japan in June 2012 for meetings and seminars organised by KPMG on transfer pricing and advance pricing agreements.