International Taxation and Transfer Pricing Conference

February 17, 2007

Case Studies on Transfer Pricing
Samir Gandhi
February 2007
2
Global TP Enforcement
First level
Second level
Third level
Fourth level
1996 & prior 1997/ 1998 1999/ 2000 2001/ 2002 2003/2004








Italy
New Zealand
Mexico
Korea
France
Czech Republic
Spain
Australia
South Africa
USA



China
Slovakia
Brazil
Italy
New Zealand
Mexico
Korea
France
Czech Republic
Spain
Australia
South Africa
USA
Germany
Kazakhstan
Russia
Denmark
Belgium
Venezuela
Argentina
Canada
UK
China
Slovakia
Brazil
Italy
New Zealand
Mexico
Korea
France
Czech Republic
Spain
Australia
South Africa
USA


Thailand
Portugal
Poland
Peru
India
Netherlands
Germany
Kazakhstan
Russia
Denmark
Belgium
Venezuela
Argentina
Canada
UK
China
Slovakia
Brazil
Italy
New Zealand
Mexico
Korea
France
Czech Republic
Spain
Australia
South Africa
USA
Hungary
Colombia
Malaysia
Thailand
Portugal
Poland
Peru
India
Netherlands
Germany
Kazakhstan
Russia
Denmark
Belgium
Venezuela
Argentina
Canada
UK
China
Slovakia
Brazil
Italy
New Zealand
Mexico
Korea
France
Czech Republic
Spain
Australia
South Africa
USA
February 2007
3
Transfer Pricing Audit Process
Assessing Officer
( AO )
Transfer Pricing
Officer (TPO)
AO to refer TP cases to TPO international transactions >
INR 5 Crores ( 15 Crores)
Copy of order sent to the AO and tax payer
AO to incorporate TPOs order in the
Assessment Order
Send Notice to tax payer - Hearing /
Document Analysis /
No site visits / No interviews

February 2007
4
TP Administration Structure
DGIT International Taxation & Transfer Pricing)
Director of Income-tax,
(Transfer Pricing)
(Each location)
TPO I
TPO III
Additional
Commissioner of
Income-tax

Additional
Commissioner of
Income-tax

Support staff
TPO II
Additional
Commissioner of
Income-tax

February 2007
5
Experience from Initial Audits
Major companies audited.
1,800 audits estimated.

Only Selection Criteria.
International Transactions above INR 5 Crores.

Adjustments - INR 1,500 Crores.
BPO/ITeS, Software, Banks, FMCG, Pharmaceuticals etc .

TNMM method most commonly used by tax payers.

Reliance on precedents of tax year(s) March 2002 & March 2003.

Tax Board will develop case selection tools more focused
examinations in future years.
February 2007
6



Case Study
February 2007
7
Background
XYZ Inc., a fortune 500 Company is in the business of
manufacturing of automobiles
XYZ India is a 100 % subsidiary and provides CAD designing
services.
XYZ India is a captive service provider and is compensated on a C +
10 % mark up.
XYZ India has applied the TNNM as the Most Appropriate Method
using comparables operating in ITeS industry.
PLI applied - Operating Margin / Operating Cost


February 2007
8
Analysis
Position of the TPO
Rejection of Loss Making Companies
Rejection of Companies having only
domestic transactions
Rejection of Multiple year data
Own set of Comparables provided
without any search process (cherry
picking)
Proposed mark up of 30% -40%
Position of the Tax Payer
Loss cannot be the sole criteria for
rejection (entrepreneurial risk)
TNNM requires functional
comparability
Financial results of comparables
exhibit high degree of variation
Integrated Service Provider to be
excluded
Companies having intangibles to be
excluded ( unique software, brand
name etc)
Adjustment for :
Working Capital
Intangibles
Risk ( captive service provider Vs.
entrepreneur)
February 2007
9
Audit Outcome
Captive Service Provider (BPO/ITeS)
Losses not acceptable
Proposed cost plus markups range from 25% to 40%
One size fits all approach
Comparables proposed inappropriate (no consideration for intangibles,
differences in business models, etc.)
Justifies markup saying even after paying high markups, cost savings
will be substantial
Adjustment of risk vis--vis third party comparables disallowed
Working capital adjustments of 2% allowed in some cases

February 2007
10
Audit Experience
February 2007
11
Major issues in Audit Outcomes - Services
Consideration for service rendered by Indian Enterprises.
R & D, Marketing, Technical Services etc.

Composition of Costs.
Direct and Significant Allocations of Indirect Costs !

Denial of Setoff.

Allocation of management fees ( Information Technology,
Marketing, Budgeting etc ) by AE.
Benefit Test critical.
Evidence of receipt of services.
Determination of allocated amount.
February 2007
12
Major issues in Audit Outcomes Intangibles
Application of TNMM and Exchange Control Regulations not sufficient.

Substantiation of receipt of know-how including updates.

Evidence of negotiation.

Concerns on losses by Indian enterprises.

Details of Foreign Enterprise.
owner of intangibles.

Controlled Transactions - Base for determination of ALP.

Payments for trademark.
Economic v. Legal ownership.
Marketing Intangibles.

February 2007
13
Major issues in Audit Outcomes - Manufacturers
Aggregation of Transactions
Single entity approach
Transactionwise analysis preferred.

Preference for CUPs ( Internal and External )
Material differences volume, quality, terms of sale,
geographical differences etc. disregarded.

Acceptance of TNMM with reluctance.
Product vs. Functional comparability.
Choice of profit level indicator.

Disregarding Loss making companies from Comparables set.
February 2007
14
Major issues in Audit Outcomes - Distributors
Enterprise with Losses Entrepreneur risk not acceptable.

Higher Gross Margin, but losses at Net level due to
significant marketing expenses.

Resale Price Method Vs. TNMM.

Reimbursement of marketing expenses by Foreign
Enterprise.
February 2007
15
Going Forward
Rulings Position of Revenue.
Comparables, Methodology, Cost Sharing, Compliance -
Foreign Enterprises etc.

Risk Assessment - Selection of Audits.

Safe Harbors eg. Services.

Manning of TP Cell & Appellate Authorities.

Effective MAP Process and APA.
February 2007
16
Confessions to a Tax Auditor


10. Everybody does it!

9. It improves my bonus!

8. My country needs it more than you!
7. Its part of the game!

6. Thought they wouldnt notice!
February 2007
17
Confessions to a Tax Auditor (Contd..)
1. My boss made me do it!
2. It makes good commercial sense!
3. Well shift some back here in later years!
4. We already have too much profit over here!
5. Its really just an accounting adjustment!
February 2007
18




Inputs
February 2007
19
Thank You