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WESTERN INDIA REGIONAL COUNCIL SUB REGIONAL CONFERENCE, BARODA JUNE-2013 in International Transfer Pricing CA WESTERN INDIA REGIONAL COUNCIL SUB REGIONAL CONFERENCE, BARODA JUNE-2013 in International Transfer Pricing CA T. P. OSTWAL

A SNAP SHOT q INTERNATIONAL OVERVIEW q GLOBAL TRANSFER PRICING REGIMES q TRANSFER PRICING A SNAP SHOT q INTERNATIONAL OVERVIEW q GLOBAL TRANSFER PRICING REGIMES q TRANSFER PRICING – A GLOBAL OUTLOOK [UN & OECD] q FUTURE OF TRANSFER PRICING IN DEVELOPING COUNTRIES q TRANSFER PRICING – RECENT TRENDS IN INDIA q A BIRD’S EYE VIEW q EXISTING BACKDROP q CONCERN ON DISPUTE RESOLUTION PROCESS q INDIAN TRANSFER PRICING – EMERGING AREAS OF CONTROVERSIES q FUNDAMENTAL ISSUES q SPECIFIC ISSUES M/s. T. P. Ostwal & Associates

GLOBAL TRANSFER PRICING REGIMES § By the end of 2011 there were around 100 GLOBAL TRANSFER PRICING REGIMES § By the end of 2011 there were around 100 countries with some form of specific transfer pricing legislation as shown by the red shading in the diagram below M/s. T. P. Ostwal & Associates

GLOBAL TRANSFER PRICING REGIMES (contd…) Countries where Transfer Pricing Regulations are in existence Argentina GLOBAL TRANSFER PRICING REGIMES (contd…) Countries where Transfer Pricing Regulations are in existence Argentina Canada Czech Republic Estonia Hungary Italy Latvia Namibia Panama Romania South Africa Thailand Venezuela Australia Chile Denmark Finland India Japan Lithuania Netherlands Peru Russia Spain Turkey Vietnam Austria China Dominican Republic France Indonesia Kenya Luxembourg New Zealand Philippines Singapore Sweden United Kingdom Belgium Colombia Ecuador Germany Ireland Korea, North Malaysia Norway Poland Slovakia Switzerland United States Brazil Croatia Egypt Hong Kong Israel Korea, South Mexico Oman Portugal Slovenia Taiwan Uruguay Countries where Transfer Pricing Regulations is still emerging Algeria Belarus Cambodia Gambia Kazakhstan Malawi Morocco Pakistan Angola Bolivia Cote d'Ivoire Georgia Kuwait Mali Mozambique Papua New Guniea Armenia Botswana Cyprus Ghana Liberia Mauritania Netherlands Antilles Qatar Aruba Bulgaria El Salvador Greenland Libya Mauritius Nicargua Senegal Bangladesh Burkina Faso Ethiopia Iceland Macedonia Mongolia Nigeria Sierra Leone Sri lanka Trinidad and Tobago Ukraine Uzbekistan Zambia Zimbabwe M/s. T. P. Ostwal & Associates

INTERNATIONAL TRANSFER PRICING A GLOBAL OUTLOOK-UN -OECD M/s. T. P. Ostwal & Associates INTERNATIONAL TRANSFER PRICING A GLOBAL OUTLOOK-UN -OECD M/s. T. P. Ostwal & Associates

UNITED NATION’S TRANSFER PRICING MANUAL COUNTRY PRACTICES – CHINA AND INDIA’S VIEWS q Legal UNITED NATION’S TRANSFER PRICING MANUAL COUNTRY PRACTICES – CHINA AND INDIA’S VIEWS q Legal contracts asserting IP is held offshore will be disregarded § If it is found that the developing country subsidiary has engaged in activities that put it in control and create intangibles q Routine cost-plus returns will no longer be acceptable § for those contract R&D companies that are found to exert control or to enjoy a high-tech status q Limited risk distributors spending an excessive amount on AMP § will be expected to enjoy a share of the excess profits related to the local intangibles they are creating q Location rents § should be booked in the developing country under certain circumstances rather than being booked in either the tax favoured jurisdiction or the home country q Companies engaged in toll manufacturing § will need to add back the cost of the consigned materials into their cost base M/s. T. P. Ostwal & Associates

UNITED NATION’S TRANSFER PRICING MANUAL COUNTRY PRACTICES – CHINA AND INDIA’S VIEWS q Comparables UNITED NATION’S TRANSFER PRICING MANUAL COUNTRY PRACTICES – CHINA AND INDIA’S VIEWS q Comparables should be viewed with caution given the paucity of information in developing countries. q MNEs that operate multiple entities, each with a single function, may not be able to claim that each entity is entitled to only a routine return § A holistic approach would be more appropriate. q Where a significant percentage of the global employees or assets are actually in developing country § A formulary approach may be the best method M/s. T. P. Ostwal & Associates

RECENT DEVELOPMENTS - OECD q. Proposed Action Plan/ Recent Updates § Improvements or clarifications RECENT DEVELOPMENTS - OECD q. Proposed Action Plan/ Recent Updates § Improvements or clarifications to the transfer pricing rules • Rules relating to intra-group financing (e. g. interest deductibility, withholding taxes, etc) • Release of Draft Handbook on Transfer Pricing Risk Assessment by OECD's Global Forum on Transfer Pricing • Release of discussion draft on the Transfer Pricing Aspects of Intangibles § Updated solutions to the ‘jurisdiction to tax’ issues § More effective anti-avoidance measures M/s. T. P. Ostwal & Associates

RECENT DEVELOPMENTS - OECD q. Safe Harbour Rules - OECD approves the revision of RECENT DEVELOPMENTS - OECD q. Safe Harbour Rules - OECD approves the revision of Section on safe harbours in the Transfer Pricing Guidelines § On 16 May 2013, the OECD Council approved the revision of Section E on safe harbours in Chapter IV of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“TPG”). § Revised guidance advises countries to weigh benefit & concerns regarding safe harbour. § New guidance on safe harbours provides opportunities for countries to relieve some compliance burdens and to provide greater certainty for cases involving smaller taxpayers or less complex transactions. With that, it provides a basis for countries, especially developing countries, to design a transfer pricing compliance environment that makes optimal use of the limited resources available. § It further recommends use of bilaterally or multilaterally negotiated safe harbours for avoiding double taxation and double non taxation. It also provides a Sample MOU for bilateral safe harbours. M/s. T. P. Ostwal & Associates

FUTURE OF TRANSFER PRICING IN DEVELOPING COUNTRIES q The economic significance of the OECD FUTURE OF TRANSFER PRICING IN DEVELOPING COUNTRIES q The economic significance of the OECD is in rapid decline. § In 2000, OECD nations controlled 60% of gross world product. § Now it is at 50% and is expected to drop to about 40% in 2030. § Power and influence will need to be shared between developed and developing countries q With new players such as Brazil, Russia, India, China, and South Africa (BRICS), and the UN entering the fray, § India and China see themselves as "exceptional countries" and will want a say in writing the rules, whether it is greenhouse gases, transfer pricing, or intellectual property, and that is the way it will be. q Confidence levels among Indian and Chinese tax authorities are growing § It is clear that these developing countries will not allow themselves to be pushed around much longer. q Over 70% of the global transfer pricing litigation worldwide is in India a sign of that country's independent thinking. M/s. T. P. Ostwal & Associates

FUTURE OF TRANSFER PRICING IN DEVELOPING COUNTRIES q The big question is whether India FUTURE OF TRANSFER PRICING IN DEVELOPING COUNTRIES q The big question is whether India and China will pass new regulations to incorporate the positions expressed in the UN manual. § If so, the nature of global transfer pricing will shift. § Location rents and local intangibles will become part of the analysis. q Finally, every global tax director of an MNE will need to figure out a new strategy § Because the principal structure used to provide developing countries a routine profit will get terminated M/s. T. P. Ostwal & Associates

TRANSFER PRICING RECENT TRENDS IN INDIA M/s. T. P. Ostwal & Associates TRANSFER PRICING RECENT TRENDS IN INDIA M/s. T. P. Ostwal & Associates

INDIAN TRANSFER PRICING A BIRD’S EYE VIEW Sr. No. Year of Transfer Pricing Assessments INDIAN TRANSFER PRICING A BIRD’S EYE VIEW Sr. No. Year of Transfer Pricing Assessments Volume of Adjustments Types of Issues 1. 1 st & 2 nd Year Low Rejection of comparables and insertion of new comparables 2. 3 rd & 4 th Year Moderate Rejection of selected method of benchmarking and application of new method 3. 5 th & 6 th Year High Bringing unconventional transactions within the ambit of Transfer Pricing 4. 7 th & 9 th Year High Application of retrospective amendment for bringing transactions under transfer pricing regime and treatment of transactions as deemed international transaction 5. Going Forward Expected to be high Introduction of transfer pricing on domestic transactions Reopening of closed assessments to bring transactions covered under the scope of transfer pricing due to retrospective amendments Litigation Status: More than 650 decisions have been given by the tribunals over the last decade on transfer pricing issues, setting precedents for taxpayers/revenue on wide range of issues. M/s. T. P. Ostwal & Associates

INDIAN TRANSFER PRICING A BIRD’S EYE VIEW (contd…) 70, 000 44, 536 23. 238 INDIAN TRANSFER PRICING A BIRD’S EYE VIEW (contd…) 70, 000 44, 536 23. 238 10, 907 6, 491 1, 612 6, 138 M/s. T. P. Ostwal & Associates

INDIAN TRANSFER PRICING – EXISTING BACKDROP q Transfer Pricing is the focus area for INDIAN TRANSFER PRICING – EXISTING BACKDROP q Transfer Pricing is the focus area for the Revenue Authorities ‒ Legislative changes to plug potential loopholes ‒ Increasingly aggressive positions adopted by the revenue ‒ Augmented staffing and training of officers q Widened Scope & intrusive Approach of Transfer Pricing Assessments ‒ Request for higher level of documentation ‒ Legal back-up with greater investigation powers for revenue officials q Newer areas of challenge ‒ Cross-border Financing arrangements, Intangibles, Intra-group Services, Investments in group entities and Share Valuation q Growing cross-country collaboration ‒ Several exchange of information treaties effected ‒ Extensive interaction with OECD officials M/s. T. P. Ostwal & Associates

INDIAN TRANSFER PRICING – EXISTING BACKDROP Revenue Approach – Concerns!! Revenue – Target Driven INDIAN TRANSFER PRICING – EXISTING BACKDROP Revenue Approach – Concerns!! Revenue – Target Driven Approach Updation of comparables with captioned year’s data contemporaneous principle FAR analysis – disregard taxpayers business Use of secret comparables Ad-hoc economic adjustments – rule of thumb applied in most cases Cherry Picking Aggregation of Transactions Unrealistic benchmark for captive service providers TNMM most commonly used by tax payers Precedents set in earlier years – generally followed Tax Authorities prefer CUP and CPM Use of standard benchmarking sets M/s. T. P. Ostwal & Associates

INDIAN TRANSFER PRICING CONCERNS ON DISPUTE RESOLUTION PROCESS q Conventional Approach of Dispute Resolution INDIAN TRANSFER PRICING CONCERNS ON DISPUTE RESOLUTION PROCESS q Conventional Approach of Dispute Resolution - Tiers of Appellate Authorities [DRP/CIT(A) ITAT HC SC] § Time consuming and several tiers of appellate authorities § Appeal by tax authorities in case of favorable resolution at lower levels § Factual nature of issues results in matter being remanded back q Uncertainty on eventual outcome and impact on financial statements q Risk of economic double taxation, if matter is resolved against the taxpayer q Measures to Handle Dispute Resolution – Discouraging experiences with DRP § Independence - Structural issues in constitution of Panel § Achievement- A “fast track” to next level of litigation? § Policy Moderation - Empowering tax authorities to appeal against order pursuant to DRP directions – Will there be any change in approach of DRP? q Modern Approach – International § Mutual Agreement Procedure (‘MAP’) - Emerged a viable alternative in recent times § Advance Pricing Arrangements – Will it result into an approach to bring certainty? M/s. T. P. Ostwal & Associates

INDIAN TRANSFER PRICING REVISED REPORTING REQUIREMENTS [RULE 10 E] q Changes in Form 3 INDIAN TRANSFER PRICING REVISED REPORTING REQUIREMENTS [RULE 10 E] q Changes in Form 3 CEB (Transfer Pricing Audit Report) Sr. No. Reference in Annexure to Form 3 CEB Reporting of Transaction(s) 1. Clause 14 to Part B Particulars in respect of lending or borrowing of money 2. Clause 15 to Part B Particulars in respect of transactions in the nature of guarantee 3. Clause 16 to Part B Particulars in respect of international transaction of purchase or sale of marketable securities, issue and buy-back of equity shares, optionally convertible/partially convertible/compulsorily convertible debentures/preference shares 4. Clause 17 to Part B Particulars in respect of mutual agreement or arrangement 5. Clause 18 to Part B Particulars in respect of international transactions arising out/being part of business restructuring or re-organisations 6. Clause 19 to Part B Particulars in respect of any other transaction including the transaction having a bearing on the profits, income, losses or assets of the assessee 7. Clause 20 to Part B Particulars of Deemed International Transactions 8. Part C Particulars in respect of Specified Domestic Transaction M/s. T. P. Ostwal & Associates

INDIAN TRANSFER PRICING EMERGING AREAS OF CONTROVERSIES M/s. T. P. Ostwal & Associates INDIAN TRANSFER PRICING EMERGING AREAS OF CONTROVERSIES M/s. T. P. Ostwal & Associates

SIGNIFICANT ISSUES ON TRANSFER PRICING PRINCIPLES Fundamental issues q Deemed International transactions – A SIGNIFICANT ISSUES ON TRANSFER PRICING PRINCIPLES Fundamental issues q Deemed International transactions – A Reasonable Approach? q Tested Party – The right questions? q Location savings q Transfer Pricing Adjustment – Whether restricted to the overall group profits or total revenue from the transaction ? Specific Issues q Intra-Group Financing Transactions – Guarantee/Loans etc. q Marketing intangibles (AMP) – Focus on fundamentals? q Contract Research & Development –Step towards Profit splits Approach! M/s. T. P. Ostwal & Associates

EMERGING AREAS OF CONTROVERSIES FUNDAMENTAL ISSUES M/s. T. P. Ostwal & Associates EMERGING AREAS OF CONTROVERSIES FUNDAMENTAL ISSUES M/s. T. P. Ostwal & Associates

EMERGING AREAS OF CONTROVERSIES DEEMED INTERNATIONAL TRANSACTIONS M/s. T. P. Ostwal & Associates EMERGING AREAS OF CONTROVERSIES DEEMED INTERNATIONAL TRANSACTIONS M/s. T. P. Ostwal & Associates

DEEMED INTERNATIONAL TRANSACTION REASONABLE APPROACH? Deemed International Transactions § Section 92 B(2) of the DEEMED INTERNATIONAL TRANSACTION REASONABLE APPROACH? Deemed International Transactions § Section 92 B(2) of the Act states that a transaction entered into with a person other than AE shall is deemed to be a transaction between two AEs, if there exists a prior agreement in relation to the relevant transaction between such other person and the AE or the terms of relevant transaction are determined in substance between such other person and the AE. A transaction entered into by an enterprise with a person other than an associated enterprise shall be deemed to be an international transaction if: There exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise OR The terms of the relevant transaction are determined in substance between such other person and the associated enterprise M/s. T. P. Ostwal & Associates

DEEMED INTERNATIONAL TRANSACTION REASONABLE APPROACH? § Kodak India Private Limited [ITA No. 7349/Mum/2012] • DEEMED INTERNATIONAL TRANSACTION REASONABLE APPROACH? § Kodak India Private Limited [ITA No. 7349/Mum/2012] • The Tribunal discussed the provisions of section 92(1), section 92 A(1) and section 92 B(1), and the inter-linkage between them, to establish that they all relate to an international transaction between AEs, where both the AEs are non-residents or at least one of them is. • Further, the Tribunal also concluded that section 92 B(2) cannot be read independent of section 92 B(1), and thus section 92 B(2) cannot apply to transactions between domestic entities. • A similar judicial precedent was laid down in the Tribunal ruling in the case of Swarnandhra IJMII Integrated Township Development Co. Pvt. Ltd. v. DCIT [ITA No. 2072/Hyd/2011] § Stratex Networks (India) Private Limited [353/2011 Delhi High Court] • Indian Co. had agreements with local clients to install and maintain equipment supplied by its overseas associated enterprises. • The High Court upheld the Tribunal’s ruling that the installation and maintenance services were not deemed international transactions u/s 92 B(2) because none of the conditions stipulated u/s 92 B(2) existed. M/s. T. P. Ostwal & Associates

DEEMED INTERNATIONAL TRANSACTION REASONABLE APPROACH? q TYPICAL FACTS INVESTMENT – OUTBOUND Indian Holding Co. DEEMED INTERNATIONAL TRANSACTION REASONABLE APPROACH? q TYPICAL FACTS INVESTMENT – OUTBOUND Indian Holding Co. § Indian parent company infuses share capital in the Foreign subsidiary (at premium or at face value per share in case of negative networth of subsidiary) § The Revenue takes a position that the shares have been issued to the Indian Company at an overvalued price/more than the fair market value of the shares; § The difference between the actual issue price and the ALP computed by the department is characterized as: • Deemed Loan by the Indian Parent treated as TP adjustment Subscription of shares of Foreign Co. Outside India Foreign Wholly Owned Subsidiary • Notional Interest on deemed loan- treated as TP decision of q In the recent adjustment Vijai Electricals Ltd vs. Addl. CIT [ITA No. 842/Hyd/2012], tribunal held that investment made in subsidiaries abroad is not an international transaction u/s. 92 B and TP provisions shall not apply as there is no income. M/s. T. P. Ostwal & Associates

DEEMED INTERNATIONAL TRANSACTION REASONABLE APPROACH? q TYPICAL FACTS – INBOUND INVESTMENT § Foreign parent DEEMED INTERNATIONAL TRANSACTION REASONABLE APPROACH? q TYPICAL FACTS – INBOUND INVESTMENT § Foreign parent company infuses share capital in the Indian subsidiary (at face value or at certain value per share arrived using DCF or other valuation methodology) § The Revenue takes a position that the shares have been issued to the Holding Company at an undervalued price / less that the fair market value of the shares; § The difference between the actual issue price and the ALP computed by the department is characterized as: • notional income of the Indian Subsidiary treated as TP adjustment • loan by the Indian Subsidiary to its Holding Company - notional interest on such alleged loan treated as the TP adjustment Foreign Holding Co. Outside India Purchase / Subscription of shares of Indian Co. In Indian Wholly Owned Subsidiary q The TP Officer made TP adjustment to the tune of Rs 15, 200 Cr on the international transaction of receipt of Rs 870 Cr towards issue of fresh equity shares by Shell India stating that there was under-pricing in the issue of shares. M/s. T. P. Ostwal & Associates

EMERGING AREAS OF CONTROVERSIES SELECTION OF ‘TESTED PARTY’ M/s. T. P. Ostwal & Associates EMERGING AREAS OF CONTROVERSIES SELECTION OF ‘TESTED PARTY’ M/s. T. P. Ostwal & Associates

RECENT CONTROVERSIES - TESTED PARTY § Critical elements of a TP analysis, • Functions, RECENT CONTROVERSIES - TESTED PARTY § Critical elements of a TP analysis, • Functions, Assets and Risk analysis (FAR analysis) and • Economic analysis, § The selection of tested party is the first step in any economic analysis and must find it’s “connect” back with the FAR analysis. The “connect” is the characterization of the transacting entities, which a FAR analysis must necessarily conclude with. § The characterization of the transacting entities is the critical determinant in deciding which entity would be the tested party. § While the concept of “tested party” does not find any mention in Indian regulations, the concept has been laid down in • The US Regulations, • OECD Guidelines • UN TP Manual M/s. T. P. Ostwal & Associates

RECENT CONTROVERSIES – ‘TESTED PARTY’ SR. NO. NAME OF DECISION (CITATION) DISPUTED ISSUE FINDINGS RECENT CONTROVERSIES – ‘TESTED PARTY’ SR. NO. NAME OF DECISION (CITATION) DISPUTED ISSUE FINDINGS OF THE APPELLATE AUTHORITIES Selection of tested party – Whether taxpayer or the AE? While the taxpayer had selected the AE as a tested party, the Tribunal held there can be no question of substituting the profit realised by the Indian enterprise from its foreign AE with the profit realised by the foreign AE from the ultimate customers and accordingly, the margin of the taxpayer (and not the AE) has to be tested. Indian assessee, procuring medicines and disposables from suppliers selected by AE & selling medical kits to AE / third parties, to be taken as ‘tested party’. Assessee is less complex than AE, did not own any intangibles in form of ‘low cost suppliers' list whereas AE takes all decisions, bears all types of risk, can't be taken as 'tested party‘. The Tribunal accepted the characterization of the AE as a distributor and selection of the AE as a tested party, since the Indian taxpayer was considered as a more complex entity. Further, the Tribunal accepted the international benchmarking exercise supporting the margins earned by the AE. The AE retained 12% of the client revenues for its marketing, coordination, client liaisoning, credit risk and market risk and the taxpayer had a similar arrangement with a third party. While the issue of tested party was not articulated and disputed, in its final ruling, the Tribunal has remanded the case to examine the application of internal TNMM vs external TNMM to the taxpayer’s margins, thereby treating the taxpayer as a tested party. 1 Onward Technologies Limited (7985/Mum/2010) 2 Missionpharma Logistics Indian procurer appropriate (I) Pvt Limited [ITA No. 954 as 'tested' party over risk& 3149/Ahd/2010] bearing AE 4 Development Consultants Pvt Ltd. [ITA No. 79 & 80/ Kol/2008] Selection of tested party – Whether taxpayer or the AE? 3 Cybertech Systems and Software Limited [ITA No. 7303/Mum/2012] Most appropriate transfer pricing method (Internal TNMM v. External TNMM) M/s. T. P. Ostwal & Associates

RECENT CONTROVERSIES – FUNDAMENTAL ISSUES LOCATION SAVINGS M/s. T. P. Ostwal & Associates RECENT CONTROVERSIES – FUNDAMENTAL ISSUES LOCATION SAVINGS M/s. T. P. Ostwal & Associates

RECENT CONTROVERSIES - LOCATION SAVING § Location savings/ Location Specific Advantage/ Location rent & RECENT CONTROVERSIES - LOCATION SAVING § Location savings/ Location Specific Advantage/ Location rent & Market Premium § Who gets location rents ? § Multinationals generate enormous cost-savings by off-shoring § Often these savings end up in a tax haven or back in the home country § UN manual proposes an approach that would give developing countries a bite of the apple. § UN TP Model explains the Approach as under: Location Rent (i. e. incremental profit) +/- => Net location savings Other Location Specific Benefits Location Specific Advantages (“LSAs”) = = Location Specific Advantages (“LSAs”) +/- Other Location Specific Benefits M/s. T. P. Ostwal & Associates

RECENT CONTROVERSIES - LOCATION SAVING § Off-late, Indian authorities have made upward adjustments to RECENT CONTROVERSIES - LOCATION SAVING § Off-late, Indian authorities have made upward adjustments to the income of the Indian taxpayer by splitting the net location savings between the Indian taxpayer and overseas enterprise. § In many cases, the location savings are simply split equally between the Indian taxpayer and overseas enterprise assuming equal bargaining power. § In the recently released United Nations Transfer Pricing Manual for Developing Countries (India Chapter), the Indian authorities has advocated that, in the quantification and allocation of location savings amongst the parties, the profit split method (PSM) can be used wherein the functional analysis and bargaining power of the parties to the transaction would be relevant factors for consideration – benchmarking against local comparables does not take into account the benefit of location savings. § The Tribunal ruling in the case of GAP International Sourcing (I) Pvt. Ltd v. ACIT [2012] 25 taxmann. com 414 (Delhi), has not echoed the above views of the Indian authorities and held that: “the intent of sourcing from low cost countries for a manufacturer/retailer is to survive in stiff competition by providing a lower cost to its end-customers. Generally, the advantage of location savings is passed onto the end-customer via a competitive sales strategy. The arm’s length principle requires benchmarking to be done with comparables in the jurisdiction of tested party and the location savings, if any, would be reflected in the profitability earned by comparables which are used for benchmarking the international transactions. Thus in our view, no separate / additional allocation is called for on account of location savings. . . ” (emphasis supplied) M/s. T. P. Ostwal & Associates

EMERGING AREAS OF CONTROVERSIES SPECIFIC ISSUES M/s. T. P. Ostwal & Associates EMERGING AREAS OF CONTROVERSIES SPECIFIC ISSUES M/s. T. P. Ostwal & Associates

EMERGING AREAS OF CONTROVERSIES INTRA-GROUP FINANCING TRANSACTIONS M/s. T. P. Ostwal & Associates EMERGING AREAS OF CONTROVERSIES INTRA-GROUP FINANCING TRANSACTIONS M/s. T. P. Ostwal & Associates

AREAS OF FOCUS BY TAXATION AUTHORITIES § No agreement in place; § Terms & AREAS OF FOCUS BY TAXATION AUTHORITIES § No agreement in place; § Terms & Conditions lack economic substance; § Non exercise of prepayment or call options; § High debt/equity ratios; § Debt pricing resulting in low profitability; § Interest rates or credit margins; § Credit Guarantee Fees § Interest rates / guarantee fees that are arbitrary or based on a casual analysis, such as stray bank quotations; M/s. T. P. Ostwal & Associates

CORPORATE GUARANTEE – DEFINITION § Explanation to Section 92 B(1) of Income Tax Act, CORPORATE GUARANTEE – DEFINITION § Explanation to Section 92 B(1) of Income Tax Act, 1961– For the removal of doubts, it is hereby clarified that— (i) the expression "international transaction" shall include— (c) capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business; § What is a guarantee? “A legally binding agreement under which the guarantor agrees to pay any or all of the amount due on a loan instrument in the event of non-payment by the borrower” § Whether extension of charge of existing securities with Indian bank for issuance of SBLC to its foreign branch on behalf of Indian company’s foreign AE be treated as guarantee? M/s. T. P. Ostwal & Associates

CORPORATE GUARANTEE – WHETHER AN INTERNATIONAL TRANSACTION? § Corporate Guarantees under consideration are generally CORPORATE GUARANTEE – WHETHER AN INTERNATIONAL TRANSACTION? § Corporate Guarantees under consideration are generally in either of following forms: § Corporate Guarantee is extended by Indian company on behalf of its foreign AE to the foreign branch of an Indian bank – Is it transaction between two Indian entities? § Corporate Guarantee is extended by Indian company on behalf of its foreign AE to the foreign bank or foreign branch of foreign bank § Corporate Guarantee is extended by Indian company to an Indian branch of Indian bank for issue of Stand-By Letter of Credit (‘SBLC’) or Letter of Comfort (‘LOC’) to its foreign branch on behalf of its Indian company’s foreign AE. § Benchmarking? There is no transfer pricing regulation across the world which prescribes or defines a method for benchmarking guarantee fees. § The various approaches for benchmarking guarantee fees are: § CUP Approach § Risk of Loss Approach § Valuation of Benefit Approach/ Interest Saving Approach M/s. T. P. Ostwal & Associates

EMERGING AREAS OF CONTROVERSIES ‘MARKETING INTANGIBLES (AMP)’ M/s. T. P. Ostwal & Associates EMERGING AREAS OF CONTROVERSIES ‘MARKETING INTANGIBLES (AMP)’ M/s. T. P. Ostwal & Associates

RECENT CONTROVERSIES – MARKETING INTANGIBLES § Issue/Controversy Indian tax authorities have been identifying excessive RECENT CONTROVERSIES – MARKETING INTANGIBLES § Issue/Controversy Indian tax authorities have been identifying excessive Advertising, Marketing and Promotion (‘AMP’) expenses incurred by the Indian taxpayer by applying the bright-line test and applying a markup on such expenses to allege that the taxpayer was provide a service to the foreign brand owner, for which a compensation is due. § In case of LG Electronics India Pvt. Ltd. v. ACIT [2013] 29 taxmann. com 300 (Delhi)(SB), tribunal held that TP adjustments in relation to the AMP expenses incurred by the Indian taxpayer for creating and improving the marketing intangible for and on behalf of the foreign parent company is permissible. § Following the LG ruling, there have been series of other rulings on TP adjustment on account of AMP Expenses & marketing intangibles in the case of Name of the Decision Citation Reebok India Co. v. Addl. CIT I. T. A. No. 5857/Del/2012 Sony India Pvt. Ltd. v. Addl. CIT ITA Nos. 4978/Del/ 2011 & 6389/Del/2012 Panasonic Sales & Services India Pvt. Ltd. v. ACIT ITA No. 1911/Mad/2011 Ray. Ban Sun Optics India Limited v. DCIT ITA No. 5933/Del/2012 Glaxo Smithkline Consumer Healthcare Ltd. v. ACIT ITA No. 1148/Chd/2011 Canon India Pvt. Ltd. v. DCIT ITA Nos. 4602/Del/2010, 5593/Del/2011 & 6086/Del/2012) Haier Appliances India (P) Ltd. V. DCIT ITA No. 4680/Del/2010 & ITA No. 5235/Del/2011 Ford India Pvt. Ltd. v. DCIT (ITA No. 2089/MDS/2011) M/s. T. P. Ostwal & Associates

RECENT CONTROVERSIES – MARKETING INTANGIBLES § Key Issues in the Special Bench Ruling in RECENT CONTROVERSIES – MARKETING INTANGIBLES § Key Issues in the Special Bench Ruling in case of LG Electronics The special bench has specified the following considerations which need to be applied to a taxpayers’ facts in determining whether any adjustment needs to be made: • Whether the foreign enterprise is compensating the Indian taxpayer for promotion of brand in any manner such as subsidy on goods sold to the taxpayer? • Whether the level of subsidy is commensurate with the brand promotion expenditure? • Whether the brand is at an entry level or at an established stage? • Whethere have been any new product launches or continuation of existing product range? • How the brand will be dealt with after termination of the agreement with the Indian taxpayer? M/s. T. P. Ostwal & Associates

MARKETING INTANGIBLE – CHARACTERIZATION OF DISTRIBUTOR A CRUCIAL ELEMENT TYPE OF DISTRIBUT OR PROFILE MARKETING INTANGIBLE – CHARACTERIZATION OF DISTRIBUTOR A CRUCIAL ELEMENT TYPE OF DISTRIBUT OR PROFILE REMUNERATION MODEL Limited function and risk profile Low and steady returns guaranteed by the manufacturer – achieved either through (i) adjustment of pricing of products or (ii) reimbursement of expenses Key people functions performed by principal Limited Risk Distributor Marketing strategies determined by manufacturer – Distributor merely executes the strategy AMP expenses incurred by Distributor - not significant Arm’s length return on sales ensures AMP expenses incurred by distributor are “picked up” by principal MARKETING INTANGIBLE / REMUNERATION FOR EXCESS AMP EXPENSES Remuneration model of guaranteed return on sales automatically mitigates any further issue on account of marketing intangibles Economic ownership and associated rewards of marketing intangibles vest with the principal Unlikely to incur start up losses Takes necessary decisions and performs functions with respect to Advertising & Marketing and other distribution strategies Bears entrepreneurial risks Full. Fledged Distributor Can suffer start up losses, entitled to future higher profits Ideally remunerated with reference to gross margin and bears the volume risk – commensurate to comparable companies’ gross margin having similar “intensity of functions” In case the “intensity of functions” i. e. advertising and marketing function intensity is higher than comparable distributors, there is a need for higher remuneration – such extra remuneration can even come either through reduction in purchase price of products and can be addressed through the intercompany pricing policy Above guidance provided by Australian Revenue and the OECD Reimbursement of AMP expenses not the only way of compensation M/s. T. P. Ostwal & Associates

EMERGING AREAS OF CONTROVERSIES ‘CONTRACT RESEARCH & DEVELOPMENT’ M/s. T. P. Ostwal & Associates EMERGING AREAS OF CONTROVERSIES ‘CONTRACT RESEARCH & DEVELOPMENT’ M/s. T. P. Ostwal & Associates

RECENT CONTROVERSIES – CONTRACT R&D CIRCULAR 2 OF 2013 - CIRCULAR ON APPLICATION OF RECENT CONTROVERSIES – CONTRACT R&D CIRCULAR 2 OF 2013 - CIRCULAR ON APPLICATION OF PROFIT SPLIT METHOD § Methods such as Transactional Net Margin Method (‘TNMM’) evaluating value of intangibles on a Cost plus Return basis discouraged – no correlation between R&D cost and return on intangibles. § Preference for Profit Split Method (‘PSM’) - determines appropriate return on intangibles considering relative contribution by each AE. § Selection and application of PSM dependent upon factors prescribed under Rule 10 C(2) § Onus on TPO to record reasons for non-applicability of PSM before considering other methods. In such cases, TPO empowered to consider TNMM or CUP. § Onus on taxpayer to have sufficient reason for non-applicability of PSM due to nonavailability of information CIRCULAR 3 OF 2013 - CIRCULAR ON CONDITIONS RELEVANT TO IDENTIFY DEVELOPMENT CENTRES ENGAGED IN CONTRACT R&D SERVICES WITH INSIGNIFICANT RISK § Provides for 5 conditions to be satisfied cumulatively satisfied in order to treat a development centre in India as a contract R&D service provider: § Functions - economically significant functions are performed by AE § Funding - economic significant assets are provided by AEs. § Supervision & Control - direct control & supervision of the AE. § Risk Profile - significant risks are borne by the AE § Ownership Rights - rights of the intangible developed vests with the AE M/s. T. P. Ostwal & Associates

RECENT CONTROVERSIES – CONTRACT R&D Recently, the Delhi Tribunal in the case of GE RECENT CONTROVERSIES – CONTRACT R&D Recently, the Delhi Tribunal in the case of GE India Technology Centre Pvt. Ltd. v. DDIT [ITA Nos. 789/Bang/2010, 487 & 925/Bang/2011] made some interesting observations in relation to Contract R&D services, as under: “Identification of risk and the party who bears such risks are important steps in comparability analysis. The conduct of the parties is key to determine whether the actual allocation of risks conforms to the contractual risk allocation. Allocation of risk depends upon the ability of the parties to the transaction to exercise control over risk. Core functions, key responsibilities, key decision making and level of individual responsibility for the key decisions are important factors to identify the party which has control over the risks. . The notion that risk can be controlled remotely by the parent company and that the Indian subsidiary engaged in core functions, such as carrying out research and development activities or providing services are risk free entities is something which needs to be demonstrated by the assessee. ” (Emphasis supplied) The question as to “who exercises control” is a factual exercise i. e. the significant people functions and conduct of the parties involved must be necessarily substantiated and documented by taxpayers. M/s. T. P. Ostwal & Associates

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