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Transfer Pricing Case Studies
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
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)
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-à-vis third party comparables disallowed
- Working capital adjustments of 2% allowed in some cases
Case Study 1 on Transfer Pricing :-
Applicability of SDT to transactions between non‐residents
Facts:
- Mr. X is director of FCO which has a PE in India
- Mr. X was deputed to work for PE in India from 1 November 2012 during FY 2012‐13.
- For services rendered upto October 2012, Mr. X was paid salary outside India. For services rendered post 1 November 2012, he is paid salary in India.
- PE is liable to tax on net basis in India. Mr. X’s status is non‐resident for FY 2012‐13.
- PE claims salary paid to Mr. post 1 November 2012 as deductible expenditure from its income.
Issue:
- Whether salary paid to Mr. X is subject to Domestic TP considering that both FCO (and hence its
PE) as also Mr. X are non‐residents?
Case Study 2 – Applicability of TP for royalty paid by Indian and foreign subsidiaries to Indian parent
Facts:
- Hold Co is an Indian company.
- Sub 1 is a foreign subsidiary. Sub 2 and Sub 3 are Indian subsidiaries.
- Hold Co. owns valuable brand ‘XYZ’ which is self generated for Hold Co.
- Hold Co is not eligible for any profit linked tax holiday
- The subsidiaries are engaged in manufacturing and distribution of diverse products.
- The subsidiaries sell their products under brand name of ‘XYZ’.
- The subsidiaries pay royalty to Hold Co. for use of brand name.
- Sub 1 has no presence in India and is not liable to tax in India.
- Sub 2 pays royalty of Rs.4 Cr to Hold Co. Sub 3 pays royalty of Rs.7 Cr to Hold Co. Both Sub 2 and
Sub 3 are not entitled to any profit linked tax holiday.
Issue:
- Whether Hold Co. is liable for Domestic TP for royalty received from subsidiaries?
- Whether subsidiaries are liable to Domestic TP?
CASE STUDY 2 on Transfer Pricing
Facts
- A Ltd. is an Indian company and not eligible for any tax‐holiday
- B Ltd. is a foreign company located in U.S.A. and 100% subsidiary of A Ltd.
- C Ltd. is an Indian company, 100% subsidiary of A Ltd., and not eligible for tax‐holiday
- D Ltd. and E Ltd. are Indian companies, 100% subsidiaries of A Ltd. and eligible for deduction u/s.10AA
- A Ltd. granted interest free loans to B Ltd., C Ltd. and D Ltd.
- A Ltd. granted loan to E Ltd. at interest rate of 18% p.a.
Issue
What is the effect of Domestic TP in the hands of A Ltd., B Ltd., C Ltd., D Ltd., and E Ltd.? B Ltd. A Ltd. C Ltd. D Ltd. E Ltd.
CASE STUDY 4 on Transfer Pricing
CASE STUDY 5 on Transfer Pricing
Facts
- A Ltd. is an Indian company engaged in software development and eligible for section 10AA benefit
- B Ltd. is a wholly owned subsidiary of A Ltd. situated in China and provides R & D services to A Ltd.
- B Ltd. charges cost plus 20% mark‐up for providing R & D services to A Ltd.
- With effect from 01.10.2012, shareholding of A Ltd. in B Ltd. was reduced to 25%
- A Ltd. has earned OP/OC of 40% from 01.04.2012 to 30.09.2012 as well as from 01.10.2012 to 31.03.2013. Arm’s length OP/OC is 17%
Issues
- During F.Y. 2012‐13, whether A Ltd. will be subject to International TP or Domestic TP or both?
- In Domestic TP, whether transactions will be covered u/s. 40A(2) or 80‐IA(10) or both?
- Whether any upward adjustment can be made for A Ltd. by the AO under Domestic TP
- Provisions even though there is mere change in the shareholding without any change in the pricing mechanism of transactions with related party?
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