India releases dispute panel rules
The Indian Central Board of Direct Taxes (CBDT) has finally unveiled rules for the country's new dispute resolution panels (DRP), nearly two months after the mechanism became effective. Samir Gandhi and Vineet Chhabra of Deloitte India discuss the rules notified by the CBDT.
The 2009 Indian budget brought in substantive change in the transfer pricing regulations by creating an alternate dispute resolution mechanism within the tax department for quick resolution of tax disputes. Now the CBDT has, in its notification dated November 20 2009, issued the necessary rules in the Official Gazette to regulate the procedure of the DRP. These rules are called the Income Tax (Dispute Resolution Panel) Rules, 2009. Some of the key features of the rules are:
- The CBDT will constitute panels on a pan-India basis in seven major metropolitan cities of India;
- Each panel will assign three commissioners of income tax as its members and such a charge held by the commissioners will be in addition to their regular duties;
- Each panel shall have a secretariat (designated officer) for receiving objections, correspondence and other documents to be filed by the eligible taxpayer;
- The objections to the draft order of the assessing officer may be filed in person by the eligible taxpayer or through its agent, within the specified period and in the prescribed form;
- Such objections shall be filed in paper book form in quadruplicate, duly accompanied by four copies of the draft order, duly authenticated by the eligible taxpayer or the authorised representative of the taxpayer;
- The paper book shall also contain the evidence upon which the eligible taxpayer intends to rely, including any document or statement or paper submitted by the taxpayer to the assessing officer;
- The panel may consider the application by the eligible taxpayer for filing additional evidence, other than those submitted to the assessing officer and may allow such an application;
- The panel shall issue notice to the eligible taxpayer and the concerned assessing officer specifying the date and place of hearing of the objection;
- The panel shall also call for records relating to the draft order and permit the assessing officer to file a report, if any, to the objections filed by eligible taxpayer;
- Where the panel deems it necessary, it may call upon or permit the eligible taxpayer to produce any document or examine any witness or file any affidavit to enable it to issue proper directions;
- At the conclusion of the hearing, the panel shall issue directions within the specified period and communicate these to the eligible taxpayer and to the assessing officer.
Furthermore, the rules provide for filing of objections in the prescribed form, that is, form No 35A, wherein, an annexure is also required to be annexed for each of the objections raised by the taxpayer. The annexure contains a comprehensive list of requirements; ground of objection, facts submitted by the taxpayer to the assessing officer, facts modified by the assessing officer, taxpayer's disagreement on modification of the facts by the assessing officer, legal arguments relied upon by the taxpayer and the assessing officer, and factual and legal arguments against the addition proposed by the assessing officer. This appears to deviate from the existing practice, where the aggrieved taxpayer filed only the grounds of appeal with the appellate authority. Furthermore, it seems that the purpose of having all these facts with the panel at time of filing of the objections is to assist the panel in not only taking an informed decision about the case but also to consider any other matter or grounds, not forming part of the grounds raised by the taxpayer, arising out of the proceedings for further scrutiny. Although these rules are procedural, their efficacy will largely depend on fair and faster disposal of the cases. The rules also prescribe that the commissioners assigned to the panel will also continue with their regular duties/charge. In such situation, the objective of ensuring faster resolution of disputes may not be achieved if such commissioners continue with their regular duties and the charge under the panel is in addition to their existing work.
Looking from the taxpayers' perspective, the rules are a welcome move as they provide a lot more clarity and certainty various procedural issues. Furthermore, taxpayers at large will welcome issues relating to filing of additional evidence before the panel, production of any document, examination of any witness or filing of any affidavit, for example, which will help them in effective discharge of fact-finding and understanding the industry nuances and other economic and commercial justifications, for example, during the course of the hearing before the panel. It is expected that, like other developed nations, the intent of introducing the provision relating to the examination of witnesses, for example, is to enable various industry experts to act as witnesses in the case of disputes and testify to the facts and conclusions with their expert analysis. The implementation of these newly enacted rules is expected to mark the maturity of the dispute resolution mechanism India.
Australia hires 60 officials to scrutinise large taxpayers
The Australian Tax Office has hired 60 transfer pricing specialists to clamp down on abuses undertaken by large taxpayers.
The specialists will join an expanding ATO and will focus solely on transfer pricing. Many of the appointments have come from within the profession or industry. The ATO has promised to target taxpayers with annual incomes over A$250 million ($229 million).
This is the single biggest transfer pricing recruitment drive undertaken by the ATO and is the largest volume of transfer pricing activity in Australia for more than 10 years. Falling tax revenues has been suggested as the impetus behind this latest programme. The first step in the clampdown will see the ATO issue between 150 and 180 transfer pricing questionnaires during late November and early December, with the planned areas of focus being:
- Low profit and/or loss making entities;
- Intra-group finance, guarantee fees;
- Business restructures and transformations;
- Inbound and outbound intellectual property transactions; and
- Foreign banks.
Following the questionnaires, the ATO will undertake a sustained programme of more focused risk reviews and audits. More taxpayers may apply for advance pricing arrangements (APAs) during this period as they seek certainty for their future dealings. The issuance of these questionnaires is likely to be just the start of a campaign which is expected to last for at least four years. This announcement comes three months after the ATO vowed to scrutinise taxpayers' transfer pricing and thin capitalisation policies.
High Court rules in favour of taxpayers in thin capitalisation GLO case
The test claimants in the UK thin-capitalisation group litigation against HM Revenue & Customs have won their challenge in the High Court in London that the rules infringed the freedom of establishment article of the European Treaty.
The case relates to the tax treatment of interest paid by UK taxpayers for loans granted by a non-resident company belonging to the same group. The test claimants, which comprised IBM, Lafarge, Siemens, Standard Bank and Volvo, were represented by Dorsey & Whitney. The European Court of Justice's opinion in the case is more than three years old, having come out on June 29 2006. The judgement was issued on March 13 2007. Justice Henderson said that the rules infringed "because of their failure to provide a separate and independent defence of genuine commercial justification". He said this meant the rules must be disapplied and the tax authorities must produce "positive evidence" to the contrary in any case in the future. They cannot rely simply on the inference that the arm's-length test was not satisfied, he said.
"Henderson has applied the ECJ judgment to hold that, while application of the arm's length standard is an indicative test of whether abuse of law is present, a tax authority must also give the taxpayer the opportunity to show that the loan was for genuine commercial reasons," said Murray Clayson, a tax partner at Freshfields Bruckhaus Deringer in the UK. The judge said that none of the test claimants' transactions were artificial arrangements without commercial justification and that, in fact, the tax authorities were not claiming they were. On that basis, the rules have to be disapplied.
"Article 43 is not engaged, and there is no breach of it, in a situation where the UK subsidiary to which a loan is made has an EU resident parent, but the lending company is neither itself EU resident nor the subsidiary of an EU resident parent," said Henderson. Justice Henderson said, based on the operation of the rules, taxpayers could claim for repayment of additional corporation tax or advance corporation tax. They can also make "claims based on the use of trading losses or capital allowances to set off against unlawful tax". Advisers believe the result may have wide repercussions. "The implications of the judgment and in particular the absence of a commercial justification let-out are significant," said Peter Cussons, head of the direct EU tax group at PricewaterhouseCoopers in London, "and in summary may extend not only to the current thin cap regime applying a restriction as opposed to discrimination analysis, and are equally capable of being applied to transfer pricing measures too."
"The judgment suggests a potential distinction between the volume and perhaps price that a taxpayer would have agreed to at arm's length, on the one hand, and what is a commercial decision for the taxpayer on the other," said Danny Beeton, head of transfer pricing economics at Freshfields Bruckhaus Deringer.
"One can quite imagine that somewhat similar reasoning could be applied in the broader transfer pricing arena, at least for periods prior to the Finance Act 2004 extension of the transfer pricing code to UK-to-UK situations," he added.
The significance of this landmark decision is not lost on the specialists. "Justice Henderson holds that for the first time ever HMRC are liable for claims as there was a serious breach of legislation which was not fit for purpose," said Cussons. HMRC are considering appealing the ruling.
Transfer pricing audits becoming more focused in China
Loss making companies, those with strange profit patterns or with a large amount of related-party transactions are the key targets of audits in China, according to leading advisers.
At an event held by the Suzhou Committee, which is part of the American Chamber of Commerce in Shanghai, held on Tuesday November 17, James Zhou of Deloitte and Cheng Chi of KPMG discussed the recent trends in transfer pricing audits in China.
Despite the number of transfer pricing audits in China falling from 257 in 2006 to 174 in 2008, the amount of taxable income adjusted has risen from ¥5.88 billion ($861 million) to ¥15.7 billion in the same period.
The Chinese tax authority is coordinating industry-focused audits in those industries less affected by the economic crisis. For instance, enterprises engaged in financing for infrastructure, tyre manufacturing, pharmaceutical manufacturing andfranchise restaurants. "Loss making companies with single functions and limited risk do not only include manufacturers," said Chi. "The idea is that enterprises with limited risk and single functions should not make losses."
In China, the statute of limitation for transfer pricing audits is 10 years and the audit itself can last for five years. There are interest and potential interest penalties associated with transfer pricing adjustments and companies have a maximum of 30 days to submit the information required by the tax authorities. The actual audit process is carried out by the local tax authorities unless it is a national audit.
For companies that have been audited and received an adjustment, there are strict rules on what to do next. "You must pay tax, interest and penalties within the prescribed period after the final adjustment notice. Administrative appeal is not a real viable option and filing a law suit may also not be an option," said Zhou.
Arranging an advance pricing agreement may be an option, given the risk of there being an audit without a feasible appeal mechanism. It is also possible for companies to go to the competent authorities (CA) and apply for help under the mutual assistance procedure, companies must do this within three years after the adjustment is issued.
For companies that are being audited, Zhou has some advice. "You must understand which stage the audit is at and adopt corresponding strategies. Do not underestimate the anti-avoidance officials and be persistent and do not give up easily."
Chi also urges corporates not to sit back. "The best practice approach is to proactively manage the risks. You must understand the risk and exposures and be prepared for risks and technical discussions. You must look for ways to mitigate your risk."
Brazil steps up scrutiny of service transactions
The Brazilian government is introducing a new system of reporting imports and exports relating to cross-border transactions involving services and intangibles.
There has been a marked increase in this type of transaction in recent years and the government wants to ensure the right amount of tax is being paid. The Integrated System of Foreign Service Trade (Siscoserv) is similar to the Integrated Foreign Trade System (Siscomex), which is used to register transactions involving merchandise (imports and exports).
The new system will consist of a comprehensive database that will include key information about service and intangible transactions in Brazil.
Users of the system will be asked to provide information about the nature of the service rendered, the value of the transaction, the period during which the supply of the service was initiated and concluded, and information about the country where the buyer/seller of the service is located.
The objective of the system is to gather information that will allow the proposal, follow-up and monitoring of policies involving cross-border services. As this information will be disclosed to the authorities, Brazilian taxpayers are being warned to review their service transactions to confirm the company is paying the required taxes and complying with the country's transfer pricing legislation.
The system will be implemented by the Ministry of Development, Industry and Foreign Trade (MDIC) in three different stages. The first will look at service sales, which is equivalent to the export transactions included in the Siscomex. This module is expected to be implemented by the end of 2009. Next, early in 2010, service purchases, which can be likened to the import transactions included in the Siscomex, will be under scrutiny. Finally towards the end of next year, or even in 2011, Brazilian commercial presence abroad will be looked at; this is an new concept for the government, with no similar segment included in the Siscomex.
Once the system is up and running, the tax authorities can access the data, giving them more scope than ever before to question transactions undertaken by taxpayers.
One of the main items that will be of interest to the tax authorities will be whether the transactions carried out between related parties are implemented in accordance with the Brazilian transfer pricing regulations. Service transactions between Brazilian entities and foreign related entities (also with third parties located in a tax haven jurisdiction) are subject to the transfer pricing legislation.
Transactions subject to the regulations may be calculated either under a cost-plus, a resale less profit margin or a comparable method. There are no specific documentation requirements but transfer pricing calculations should be prepared on an annual basis and taxpayers must be ready to present evidence of these calculations to the authorities in case of questioning.
The Department of Trade and Services of the MDIC held a series of technical meetings across the country in early November to demonstrate the main features of the Siscoserv.
Austrian court demands detailed documentation
The Administrative High Court of Austria has said that a precise and detailed description of the nature and market value of all intercompany services rendered to a domestic recipient is required for the fee paid for those services to be tax deductible.
As there are no specific transfer pricing documentation regulations in Austria so there is some uncertainty in practice. This makes rulings such as this all the more important.
"It is rare for the Administrative High Court to rule on transfer pricing matters," said Herbert Greinecker, a partner at PricewaterhouseCoopers in Vienna. "Rulings like this help to give an indication of the expectations. This one is another confirmation that standards for transfer pricing documentation are high in Austria."
The case involves Colas, a company involved in the production and sale of bitumen emulsion. In 1998 and 1999 the French parent company of this international group rendered services to its Austrian subsidiary based on a technical assistance agreement.
The services consisted of the provision of technical know-how including patents as well as assistance with marketing, financing, administration, legal, tax, human resources, risk management and the use of brands. The Austrian subsidiary paid a fee of 3.3% of its yearly turnover for these services. During a tax audit in 2002, the Austrian tax authorities accepted only those services rendered under the title "provision of technical know-how" amounting to 1.8% of the domestic subsidiary's turnover as tax deductible expenses as being in line with the arm's-length principle. Officials ruled that all other expenses paid for the further services (1.5% of turnover) were qualified as a hidden profit distribution to the French parent company since the actual provision of these services by the parent company was not documented adequately.
The court decided that the tax authority should require the Austrian subsidiary to prove evidence on all of its expenses in a comprehensible and detailed way. The submission of a large amount of files consisting of several (stand alone or incoherent) documents cannot be accepted as sufficient. The documents have to demonstrate satisfactorily and to represent clearly the content and the market price of each service received.
This additional guidance will be appreciated by taxpayers, their advisers and tax inspectors who are eagerly awaiting the
outcome of government work on new transfer pricing guidelines. "They [the guidelines] are expected in the first quarter of 2010," said Greinecker. "There will be some documentation requirements included." The court case illustrates the need for adequate transfer pricing documentation for intercompany transactions involving Austrian companies.
"Taxpayers should invest in quality transfer pricing documentation," said Greinecker. "It should be consistent and reasonably complete in advance of audit."
Another key focus for multinational companies with operations in Austria is benchmarking. "Austria has specialist teams reviewing benchmarking studies, they are very strict on comparables," warns Greinecker. "There have been instances where entire benchmarking studies have been rejected."
Xilinx answers commissioner for Internal Revenue
The company was given leave to file a reply in answer to the commissioner for Internal Revenue's response to the petition for a rehearing.
The document addresses all the points made by the IRS and stresses the need for a rehearing. The IRS based its argument to deny a rehearing on three main points. First, that "rehearing on the basis of "exceptional importance" – the only ground proffered by Xilinx – is not warranted." The IRS cited case law to say that exceptional importance is not a sufficient basis for rehearing; rather, it must be accompanied by the need to correct an erroneous judgment.
In response to this, Xilinx states that "these tortured efforts to deny the importance of this case only underscore the need for rehearing."
The court papers go on to explain how the company believes there is a fundamental error of law at stake; stating that every judge on the panel in the Tax Court rejected the position that the sharing of employee stock option costs is the arm's-length result.
Second, the IRS argued that "in any event, Xilinx's claim of "exceptional importance" is wholly undermined by the subsequent changes to the QCSA [qualified cost-sharing arrangement] regulation and the overall regulatory scheme." This relates to the significant changes to the regulatory regime. The court papers state "the panel majority's validation of a former regulation that, in the panel's view, did not produce an arm's length result as described in former Treas. Reg. § 1.482-1(b) – the aspect of the decision that forms the basis of Xilinx's petition for rehearing – has no continuing significance."
Xilinx states that the "IRS has no statutory authority to adopt regulations that depart from an ordinary understanding of the arm's-length standard. The 2003 amendments are then unenforceable to the extent they would produce non-arm'slength results."
The final arm of the government's rebuttal is "this case is not the proper forum for addressing whether the United States and Ireland – or any other US treaty partner – have a common understanding of the arm's-length principles contained in tax treaties." In the Xilinx petition for rehearing there was a damning letter from the Irish government, which the IRS claims has no place being addressed in this case.
Xilinx lays out some important points in response to this argument. "The fact that the entire international tax treaty system requires use of the arm's-length standard by all signatory countries is highly relevant to the proper interpretation of US law," states the document.
"Furthermore, the panel majority's erroneous interpretation of domestic law to permit departures from the international standard is especially significant because of the effect it will have on the proper operation of the treaty system.
A transfer pricing standard must be applied reciprocally or it will not work at all." It remains to be seen whether the US Court of Appeals for the Ninth Circuit will grant a rehearing.
Stop press: The Ninth Circuit withdrew its opinion and dissent on January 13 2010.
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