FEBRUARY 25, 2016

By Tehmina Sharma, Director, Deloitte Haskins & Sells LLP

BUDGET 2015 delivered a mixed bag for Prime Minister Modi's 'Make in India' vision, to transform India into a global manufacturing hub, presents huge potential for industrial growth.

However, in terms of the changing scenario in relation to law and regulations globally, India is one such country where these changes have also taken place. The Government has also recently taken certain steps in order to improvise the tax regulations in India and reduce the increasing litigation in order to attract more investors and popularise its Make in India initiative.

Majority of the litigative cases are in relation to the disputes arising in the Transfer Pricing domain. One of the important reasons behind it is the uncertainity that has arisen due to non-clarity in the existing TP regulations and the ambiguity in the Rules.If certain clarifications, modifications and amendments are carried out in the TP regulations, cases being scrutinised and held at the stage of litigation shall reduce to a great extent.

(I) Marketing Intangibles

The treatment of advertising, marketing and promotional (AMP) expenses by MNC has been an area of TP controversy. Indian tax authorities are contending that by incurring AMP expenses, Indian manufacturing/distributing taxpayers are enhancing the brand of foreign parent. The tax authority believes that AMP expenses incurred by Indian subsidiary aims to create a brand value for its parent, which being situated outside India is benefitted by increase in its reputation and visibility in the India market. Hence, these expenses have to be re-imbursed by parent after getting certain mark-up on the costs incurred for the value addition created by Indian entity for the parent's brand.

This matter has gone to the Tribunal where there are a plenty of varying judgements without any specific approach being followed. The issue has also reached the High Court where the Court has confirmed that AMP expenses requires the application of TP regulations. However, the High Court declined the use of Bright Line Test as method adopted by the tax authorities for determining the excess of AMP for adjustment.

Thus, guidance should be issued, to recognize certain methodologies/approaches for evaluating the arm's length nature of such a transaction.

(II) Royalty and intra-group charges

The parent or an entity of MNC group usually provides support to its group affiliates by providing them cost effective services. Also, group entities pay some compensation to its parent or an entity of the group, for use of intangibles, in the form of royalty.

The above two transactions are commonly benchmarked by aggregating them with the other international transactions entered into by the entity with its AE. However, the tax authorities have challenged the arm's length analysis of these transactions simply on the grounds of benefit test.

Thus, a particular methodology is expected to test a transaction in relation to royalty payment and with regards to the intra-group services, detailed guidelines should be introduced which shall lay down the specific documents to be maintained by the tax payers that would help in proving actual receipt/availment of services, the benefits derived therefrom and thus the arm's length compensation.

Further, CBDT should introduce certain regulations regarding low end value adding intra-group services which shall be in line with Action 10 of BEPS [ Base Erosion and Profit Split] after keeping a specific threshold limit i.e. if the charges incurred are upto some percent of the total cost then the same shall be considered to be at ALP and minimal documentation requirements should be prescribed. This, shall help in reducing litigation matters.

(iii) Performance guarantee

Guarantee transaction is another litigative transaction which has been a matter of dispute between the taxpayers and tax authorities due to lack of clarity in the law. Guarantee can be of 2 categories- performance and financial. The current law does not clearly specify the nature of the guarantee that would be covered under the Transfer Pricing (TP) provisions. If, the law includes the concept of performance guarantee, the taxpayers wish that budget should carve out the performance guarantee concept in order to stream line the law with the SHR [Safe Harbour Rules] which specifically excludes performance guarantee.

Else, specific guidelines are expected so as to provide a specific benchmarking methodology for the different types of guarantees based on the risks assumed and challenges faced by the entity on default of its AE [Associated Enterprise].

Further, introduction of the range and multiple year concept, APA [Advance Pricing Agreement] , SHR3 are few of the welcoming initiatives taken by the tax authorities to reduce the increased cases of litigation. However, a few clarification/revisions in such schemes will help taxpayers to avail benefit of these schemes.

(i) Rollback provision

It was introduced to reduce litigation, with a condition that the transactions entered into by the taxpayer during the year of filing APA are similar to the transactions in 4 previous years. The rules even specify that if the applicant does not comply with the requirements of conditions under the rollback provisions of the Act, the entire agreement shall stand cancelled. The taxpayers wish that instead of the mandatory applicability of the rollback of APA for all 4 previous years; the taxpayer should also be given an opportunity to opt for any of those 4 years and exclude a specific year from APA. Also, the rollback provisions should be relaxed to certain extent and shall also be applicable for similar transactions entered into within the group entities. Regarding the cancellation of entire agreement, it can be expected that certain amendment be brought in the Rules and relaxation be provided so as to enable the taxpayer to get APA benefits.

(ii) Safe Harbour Rules (SHR)

These rules have been introduced for IT [Information Technology], ITeS [Information Technology enabled Services] and KPO [Knowledge Process Outsourcing] services, contract research and development in relation to IT services, etc. The cost plus margins proposed are too high if compared to the recent APAs concluded and a confusion stays in the minds of the tax payers regarding the categorization between the above mentioned services.

The taxpayers do expect a downward reduction in the current rates in order to get SHR stream-lined with APA and which would also encourage them to opt for the Safe Harbour Rules. Also, for removing the confusion regarding the categorization amongst the services, it is expected that clear criterias are introduced for classification of services. Further, low end services provided should also be a part of the SHR with a certain cost plus margin i.e. approximately 5% which shall be in line with BEPS.

(iii) Range and multiple year concept

The introduction of range concept was a welcoming step for reducing TP disputes. However, after deep analysis of the final guidelines issued by the CBDT, there are certain queries which have been raised in the minds of the taxpayers. Currently the data to be used for analysing comparability of an uncontrolled transaction shall be of the current year or of the financial year immediately preceding the current year (if current year data is not available at the time of filing the return of income). However, if the current year data is subsequently available i.e. at the time of any assessment proceedings (considering it upto the DRP [ Dispute Resolution Panel] level) then, it is mandatory to use such data and revise the TP study and also consider the additions/deletions made in the list of the comparables by the TPO [Transfer Pricing Officer].

In such a situation, the taxpayer would face major challenges and would lead to increased litigation. Thus, it is expected,since the TP study has to be contemporaneous, that necessary guidance should be provided. Also, if there are modifications made in the list of comprables, clear guidance needs to be provided whether changes would be required to be made in the benchmarking strategy based on the revised set of comparables i.e. to adopt the range concept or to calculate margins based on the arithmetic mean.

Further, the taxpayer's expectations have increased with the introduction and permissibility of using the multiple year data, that the revenue shall now also allow it to be used retrospectively for all the open assessments.

Considering the recently concluded APAs, clarity needs to be provided whether range concept shall be applicable and if yes, whether its applicability would be restricted to the transactions entered on/after 1 April 2014.

(iv) Risk based transfer pricing assessments

The revised guidelines issued by CBDT has shifted focus from selecting cases of transfer pricing exceeding monetory threshold to risk based assessments. The same is in line with the best practices followed globally. With the introduction of risk based scrutiny, a rational step has been adopted to streamline the process of transfer pricing audit and aim to control the volume of tax disputes alongwith enhanced confidence of taxpayers in the system.

However, taxpayers's expect government to come up with detailed guidelines giving them clear insight about the process and conduct of risk based assessments, as the implementation and execution of the same remains to be seen.

The India Finance Act 2015 has introduced an amendment in section 6 of the Income Tax Act 1961 (the Act), which alters the conditions under which a foreign company shall be considered as a resident in India by including the concept of PoEM [Place of Effective Management]. The recent draft guidelines issued are comprehensive and largely focus on 'substance' rather than 'form'. However, clarification needs to be given, if such an entity is treated at par with an Indian resident company, then whether the transactions entered by it with other group entities shall attract TP provisions in India.

Considering BEPS, Action 13 in relation to maintenance of document considering the Country by Country (CbC) requirement, the domestic rules and regulations that the taxpayers are required to follow should be laid down with the specific instructions on how to disclose the information ensuring that it remains confidential and facilitates automatic exchange of CbC reports. It is also expected that certain threshold limit for the value of the international transaction shall be specified for which a taxpayer is required to comply with CbC requirement and in order to smoothen the flow of data and information, agreements shall be entered into with various countries.