Presentation on theme: "Navigating the Indian & Singapore waters!"— Presentation transcript:
1 Navigating the Indian & Singapore waters! TRANSFER PRICINGNavigating the Indian & Singapore waters!Opening thoughtsNarayan MehtaPartner, Sudit K. Parekh & Co th May 2005
2 An Overview of Indian Transfer Pricing Regulations
3 Transfer Pricing- an Introduction Denotes price charged by one related party to another for goods, services, etc.Objective: To check the erosion of tax base and plug the leakage of revenue
4 An Illustration- Outsourcing Contract for software developmentSingaporeParentSingaporeClientSingapore taxrate= 20%S $ 35 per hour100% EquityOutsourcingArrangementConsideration??Transfer pricing issuesIndianSubsidiaryIndian tax rate-NilOffshore softwaredevelopmentNeed for balancingthe Indian and Singapore TP/ Tax regulations!!
5 Importance of Compliance Any related party transaction undertaken from 1st April 2001 onwards coveredCurrently 60% of world’s cross-border trade is between related parties- Indian tax authority is also going to be vigilant!UK – for every £1 spent investigating transfer pricing cases, £120 was recovered in extra taxesJapan –transfer pricing has been a major revenue churner- individual cases exceeds $100 m!US – transfer pricing remains the topmost priority of IRS’s agenda on international taxIndia - FY assessments complete - Press has reported incremental tax revenues in excess of INR 50 million based on the first year of TP audit adjustments
6 Importance of Compliance No exemption from complianceTransactions exceeding INR 50 million to attract compulsory transfer pricing auditOnus of proof- tax payer primarily liableS.10A / 10B units- thin margin for errorNo deduction under section 10A / 10B on enhanced income!More than ordinary profits taxable & not tax exempt!Adverse tax incidence for the Singapore parent outsourcing BPO operations to Indian entityDouble taxation for the Group in respect of enhanced income
7 Penalties are not tax deductible! Importance of CompliancePenalties are high !Addition to IncomeFailure to maintain documentationFailure to furnish documentationFailure to furnish Accountant’s Report100% to 300% of tax on addition2% of value of transactionRs. 100,000Penalties are not tax deductible!
8 Importance of Compliance An effective tax planning tool to establish the appropriateness of transfer prices
9 Transfer Pricing- The Indian Perspective Income arising to “Associated Enterprises” from “International Transactions” shall be computed having regard to the “Arm’s Length Price”Indian regulations largely modeled on OECD guidelines
10 Legislative Framework InternationaltransactionAssociatedEnterpriseLegislative FrameworkIncome needsto be computed on an arm’s length basis
11 Associated Enterprise Means direct or indirect participation in management, control or capitalby one enterprise into another enterprise; orby the same person in both the enterprisesEither or both of Associated Enterprisesshould be non-residents
12 Associated Enterprise “Deemed Associated Enterprises” include:Holding of 26% of voting powerby one enterprise into another enterprise; orby the same person in both the enterprisesDependence on intangible assetsSale of goodsinfluence on price and conditions of supply by buyerControl by individual or his relativeLoan transaction51% or more of book value of total assets of the borrowing enterprise
13 Associated Enterprise Term of wide import - following parties also covered:VC investors with 26% stakeFI’s advancing loans exceeding 51% stake of assets of borrowing enterpriseFranchisers, licensees, technical collaborators, etc.Term of wide import- is your company covered?
14 International Transaction Means “transaction” between 2 or more Associated Enterprises:For sale of products / other propertiesORAffecting profits, losses, income, assets or liability of the enterprise
15 Arm’s Length PriceDenotes price which is applied or proposed to be applied in acomparable transaction betweenunrelated independent parties inuncontrolled conditionsCorresponds to the open market price
16 Computing Arm’s Length Price Arm’s Length Price to be computed as per “Most Appropriate Method”, to be selected out of:Price based methodComparable Uncontrolled Price Method (CUP)Margin based methodResale Price Method (RPM)Cost Plus Method (CPM)Profit Split MethodTransactional Net Margin Method (TNMM)
17 Comparable Uncontrolled Price Method or CUP Compare price charged in a controlled transaction with uncontrolled transactionAdjustment for differences materially affecting the price is permissible
18 Comparable Uncontrolled Price Method or CUP 3P-IndiaAE - Singapore$ 60 (internal comparable)TP$ 60(externalcomparable)AE-India$ 60 (internalcomparable)3P - Singapore3P - SingaporePrice charged by AE–India to AE–Singapore should be as per open market price$ 60 represents the open market price - Internal comparable preferable to external comparable
19 Resale Price Method (RPM) Reduce arm’s length Gross Profit Margin and procurement expenses from resale price of goods / services resold to an unrelated partyCertain adjustments permissible
20 Resale Price Method $ 100 $ 100 – 20% AE-India AE - Singapore 3P - Singapore3P-India3P-Singapore3P-Singapore20% GPMargin on sales$ 100 = The price at which sales made by AE-Singapore to 3P- Singapore20% = Gross Profit Margin identified from gross profit margin earned by Italian distributors on similar / comparable uncontrolled transactions
21 Cost Plus MethodAdd an arm’s length gross profit margin to the production cost of supplier providing goods / services to related purchaserCertain adjustments permissible
22 Cost Plus Method $ 100 – 15% AE-India AE - Singapore 3P - Singapore 3P-India3P - Singapore3P - Singapore15% GPMargin on salesProduction Costs of AE-India = 10015% = Gross Profit Margin on production costs earned by 3P-India on comparable sales made by other Indian software manufacturers
23 Profit Split MethodSplitting the combined net profit of associated enterprises arising from international transaction between respective entities based on their relative contribution to the net profitsRarely used in practice
24 Transactional Net Margin Method (TNMM) Comparing net profit margin of Associated Enterprise arising from international transaction with adjusted net profit margin for similar transaction with unrelated parties in comparable circumstancesSimilar to RPM / CPM
25 How methods are chosen in practice? Most AppropriateMethod ?????? ?Cost PlusProfit SplitTNMMResale PriceMethodComparableuncontrolled priceOtherYet to be prescribed
26 Computing Arm’s Length Price- summary Selection of the most appropriate method – relevant factors:Business model and organizational structureFunctional and risk profiling of related partiesContractual termsNature of products and services
27 Powers of Indian Tax Authorities Powers to:Call for informationDetermine Arm’s Length PriceDetermine total income having regard to Arm’s Length Price5% difference allowedNo deduction under section 10A / 10B / 80HHC on enhanced income!Corresponding adjustments not permitted !Permitted under certain Indian Treaties!No adjustment to withholding tax!Compulsory scrutiny for transactions exceeding INR 50 million
28 Transfer Pricing Assessment TPO will makefurther enquiriesTPO will review compliance by the tax payer with the arm’s length principle??Does the TPO agree with the views of the tax payerNoYesTaxpayer given an opportunity to respond to TPO’s positionTPAdjustmentTPO would pass a favourable order in relation to the international transaction examinedHas the taxpayer responded with sufficiently detailed facts & arguments to enable a re-evaluation of TPO position?This is very much a simplified processIt is the application where the hurt starts and continues:- loss of control of agenda - incredible diversion for management - defensive / reactionary behaviour - costly in professional advice - likely to revisit in penalties and interestWill almost always exceed cost of doing a proper study and/or having a good process of contemporaneityThis is the very serious end of the journey - to be avoided at all cost.ATO re-evaluates its position: Your response may just correct ATO mistakes & disclose your basic defence if litigation was pursuedIs ATO view materially diff from taxpayers: Generally set out in a “Position Paper”Taxpayer invited to respond to ATO position: Silence may be acquiescenceHas taxpayer responded with detailed facts: If “No” or poor response, assessment will issue?NoYesTPO re-evaluates his positionDoes the TPO now agree with the taxpayer’s position?NoYes?18
29 Documentation- why necessary? To be better prepared for transfer pricing auditTo support your arm’s length price in futureEspecially important in loss situationsThe tax authorities will never understand your business as well as you, therefore…Effective communication of your TP policy is critical!
30 Documentation- fixing the jigsaw puzzle! Accountant’sReportDocumentationAgreementsFunctionalAnalysisBenchmarkingIndustryAnalysis
31 Primary Documentation required under Indian Regulations Associated Enterprise related documentsTransaction related documentsDescription of functions performed, risks assumed and assets utilisedALP computation related documentsRecord of transactions considered for determining price of international transactionsAnalysis performed to evaluate comparabilityDescription of all methods considered and reasons for selection of the most appropriate methodRecord of actual working for determining arm’s length priceDetails of comparable data used in applying most appropriate method
32 Secondary Documentation required under Indian Regulations Government publications, reports, studies, databasesMarket research studies and technical publications of recognized national or international institutionsPrice publications including stock exchange and commodity market quotationsRelevant agreements and contracts entered into with associated enterprises or with unrelated enterprisesLetters and correspondence documenting terms negotiated with the associated enterprise
33 Indian Documentation No need for fresh documentation every year Requirement for filing of CA’s report31st Oct/31st July
35 Compliance and Certification Timeline April 1st ’05March 31st ’06Oct 31st ’06Oct 31st ’07March 31st ’09March 31st ’15Beginning of tax yearEnd of tax yearDeadline for maintaining documentationFiling tax returnFiling Accountant’s ReportLimitation for initiation of assessmentLimitation for completion of assessmentDate till which docn. is required to be maintained
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