4Global transfer pricing scenario Transfer pricing continues to be a significant source of controversy between the world’s tax authorities and multinational enterprisesTax risk management a priorityExaminations by Revenue Authorities have expanded in scope and complexity and adjustments resulting in interest and penalties are on the riseItaly and emerging countries such as India, China, Indonesia and South Korea are the top jurisdictions imposing transfer pricing penaltiesSignificant increase in unresolved reviews and audits compared with previous yearsIn cases where examinations resulted in TP adjustments, penalties were imposed in 24% of the cases - up from 19% cases in 2010 and 15% cases in 2007Top three countries involved in APAs are the US, Canada and the UK
5BEPS action plan – changes to the international tax landscape Action 15: Development of a multilateral instrument for amending bilateral treatiesAction 1 : Address the tax challenges of the digital economyAction 11: Establish methodologies to collect and analyse data on BEPS and actions addressing itAction 12: Require taxpayers to disclose their aggressive tax planning arrangementsAction 13: Re-examine transfer pricing documentationAction 14: Making dispute resolutions more effectiveIndustry SpecificationExecutionAction plan on Base Erosion and Profit Shifting (BEPS)Action 2: Neutralise the effects of hybrid mismatch arrangementsAction 3: Strengthen CFC rulesAction 4: Limit base erosion via interest deductions and other financial paymentsAction 5: Counter harmful tax practices more effectively, taking into account transparency and substanceTransparency and CertaintyCoherenceSubstanceAction 6: Prevent treaty abuseAction 7: Prevent the artificial avoidance of permanent establishment statusAction 8: Consider transfer pricing for intangiblesAction 9: Consider transfer pricing for risks and capitalAction 10: Consider transfer pricing for other high-risk transactions
6OECD BEPS CbC Reporting As a part of the BEPS Action plan, OECD has released draft guidance on transfer pricing documentation and country-by-country reporting for public commentsObjectives of transfer pricing documentation requirements are:To provide tax administrations with the information necessary to conduct an informed transfer pricing risk assessment;To ensure that taxpayers give appropriate consideration to transfer pricing requirements in establishing p5rices and other conditions for transactions between associated enterprises and in reporting the income derived from such transactions in their tax returns; andTo provide tax administrations with the information that they require in order to conduct an appropriately thorough audit of the transfer pricing practices of entities subject to tax in their jurisdiction.OECD proposes a two tiered approach to transfer pricing documentation consisting of (i) a master file containing standardised information relevant for all MNE group members and (ii) a local file referring specifically to material transactions of the local taxpayer
7OECD BEPS CbC Reporting Templates proposed by OECDTemplate for master fileOrganisation structureDescription of MNE’s businessMNE’s intangiblesMNE’s intercompany financial activitiesMNE’s financial and positionsTemplate for local fileDetails of the local entity ie organisation structure, indication of any business restructuring or intangible transfers in the present or immediately past yearDetails of each of the controlled transactions ieDescription,Aggregate amount,Associated enterprises involved in the transaction,Detailed functional analysis,Choice of most appropriate method, choice of tested party,Assumptions if any in the choice of TP method,Comparability adjustments if any, andReasons for concluding that the relevant transaction was concluded at arm’s lengthFinancial information ie complete audited financial accounts of the local entity and comparables used in the analysis and the source of such data
8Recent transfer pricing developments in India Significant legislative changesExpansion in scope of “international transactions”Strengthening of penalty and enforcement frameworkComprehensive definition of “intangible property”Domestic transfer pricing regulations introducedIntroduction of APAUse of “unspecified” transfer pricing methodReduction in permissible tolerance range3% for all transactions, other than wholesalers (1%)Introduction of ‘range’ concept while computation of ALPCircular on transfer pricing for Development CentersWhat is contract R&D and is Cost plus still the right answer?Safe Harbor RulesSpecified taxpayers undertaking prescribed transactions can opt to be covered by safe harbor rules to avoid litigationUN TP Manual & India Chapter
10Case Study 1 - Share Valuation Company A issues shares to its Group company B in the US for Rs 150, when its fair value as per the valuation certificate obtained from a valuation expert is Rs 140 and its face value is Rs 10Key aspects:Is subscription to share capital an international transaction in the hands of foreign company?Is issue of share capital an international transaction in the hands of Indian companyThe valuation methodologies used for determination of fair value on which shares would be issuedThe taxability of such transaction in the hands of Indian company issuing shares and foreign company subscribing the shares?If shares are issued at less than fair value, will such under receipt be taxed along with interest (as in Shell/ Vodafone’s case)?If shares are issued at more than fair value, will such over receipt be treated as loan from overseas company and a notional interest be charged?
11Case Study 2 – AMP Expenses Company A, a subsidiary of a foreign company (which owns the brand), has undertaken significant advertisement and marketing promotion (AMP) activities in India. The foreign parent reimburses the Indian company partly for such expenses. However, even after such compensation, the overall AMP spend as a percentage of its revenue is higher than comparable companies (i.e., the bright line)Key aspects:Can AMP be treated as international transaction?Can bright line be used as a benchmarking method?Can compensation received from group company be knocked – off against the AMP spend before computing the adjustment?Will selling expenses be excluded?Will companies owning domestic brands be considered comparable?Will mark-up on the excess AMP expense be added?If overall TNMM position is good, will it still be looked at separately?
12Case Study 3 – Cost recharges/ Intra Group Services Company A is availing treasury, marketing and technical services from its overseas Group company (Company B). For such services, Company B charges back the cost for such services along with a mark-up of 10 percentKey aspects:Proof or evidence in support of availing of servicesPurchasing power parity value for such services?Duplication of services?Cost benefit analysis undertaken for such servicesCost allocation procedure adopted to determine the costs charged back to Indian entityBasis of determining mark-up which can be loaded on the costs allocatedComparable/ third party transactions for such services from overseas or IndiaIf overall TNMM position is good, will it still be looked at separately?
13Case Study 4 – Royalty payments on brand/ technical know-how Company A has taken a license from its overseas parent to manufacture and sell products under a registered trademark of the overseas parent. For such licenses, Company A pays a royalty of 2 percent for trademark and 3 percent for technical know-how on net salesKey aspects:Usefulness/ Uniqueness of the brand/ technical know-how shared?Rates that other group companies are paying for similar know-how/ brandCost benefit analysis undertaken?Basis of determination of the rates of royalty paid?Comparable/ third party transaction analysis for the aforesaid transactionDependency of Indian company on such licensesIf overall TNMM position is good, will it still be looked at separately?
14Case Study 5 – Business restructuring Company A is undertaking full fledged manufacturing activities in India for its overseas group companies. Its parent company (Company B in US) decides to take over the entrepreneurial role from Company A and subsequently restrict the activities of Company A to being a risk mitigated contract manufacturerKey aspects:Does the proposed arrangement result in an international transaction?Is the Indian entity entitled to an exit charge for a change in functional and risk profile?Mechanisms in which exit charge is determined? Methods followed?The taxability of such a charge (if it needs to be paid) in the hands of the Indian company
16APA – Roll back provisions At present, taxpayers can enter into an APA only for a prospective period upto a maximum of 5 consecutive years“Rollback" provisions are proposed to be introduced wherein the outcome of the APA could also be applied to four previous years immediately preceding the first year covered under the APA (subject to certain rules and procedure)This amendment will take effect from 1st October 2014Memorandum to FB 2014 inter-alia mentions as follows: “Providing of such a mechanism in Indian legislation would also lead to reduction in large scale litigation which is currently pending or may arise in future in respect of the transfer pricing matters”Roll back provisioning to apply subject to prescribed condition, procedure and manner – What conditions would be expected?
17Augmenting APA teamConsidering approximately 350 application are filed in the 2 years since the APA program took off operationally, there was need to supplement APA authority with additional manpower with additional competent work forceThis is important to sustain the success and value of the program in addition to living up to taxpayer expectationsFM’s statement to strengthen the administrative set-up of the APA program so as to expedite disposal of APA applications shall give a further boost to the APA program
18Definition of "deemed international transaction" amended The definition of "deemed international transaction" provides that a transaction of an enterprise with a third party shall be deemed to be an international transaction with the AE if there exists a prior agreement in relation to the said transaction or the terms of the said transaction are determined in substance between the AE and the third partyThere had been an ambiguity - whether 'deemed international transactions' would cover a case where both the contracting entities are Indian residentsHyderabad Tribunal in the case of Swarnandhra IJMII Integrated Township Development Co. P. Ltd vs. DCIT [TS-762-ITAT-2012(HYD)-TP] held that deeming fiction does not cover transactions between two Indian entities. Similar position taken in Kodak India Pvt Ltd (155 TTJ 69)(Mum ITAT) and Vodafone India Services Pvt Ltd (Bom HC) (262 CTR 153)Clarification provided by Finance Bill (No.2) deemed international transactions would also cover cases where both the contracting parties are residentsThe amendment will take effect from 1 April 2015Outside IndiaForeign CoIndiaGlobal MSA for Provision of IT ServicesIndia Co(AE of FCo)Unrelated CustomerSOW/ PO pursuant to MSA
19Introduction of ‘range’ concept “Range” concept followed internationally; also propounded by OECDUse of inter-quartile range is amongst the globally accepted best practice and also closer to economic realities wherein prices, and or margins, are compared to those within a range and not at to a particular pointIn order to align the transfer pricing regulations in India with the international best practices, "range" concept is proposed to be introduced for determination of arm's length priceHowever, arithmetic mean concept will continue to apply where number of comparable companies are inadequateDetailed rules would be prescribed in this regard
20Illustration highlighting difference between the arithmetic mean concept and the range conceptName of the companyOperating MarginA Limited-5.08%B Limited6.51%C Limited8.67%D Limited18.08%E Limited27.99%Tested Party5.00%Arithmetic mean 13.23%Highest Observed ValueUpper Quartile*23.04%Median**Lower Quartile***0.72%Lowest Observed ValueNo of observations (n)5Interquartile range (Upper Quartile – Lower Quartile)0.72% %* Upper quartile = [3/4 *(n+1)] th data value in the data set = 4.5 = average of 4th and 5th observation** Median = [1/2 *(n+1) th data value in the data set = 3 = 3rd observation*** Lower Quartile = [1/4 *(n+1)] th data value in the data set = 1.5 = average of 1st and 2nd observationAs evident from the above illustration, ‘range’ concept is expected to provide greater flexibility to the taxpayers in respect of setting of transfer price as compared to the existing ‘arithmetic mean’ approach
21Other amendments Use of multiple year data Issue of ‘single year data vs multiple data’ has been a subject matter of debate and litigation so far.FM in his speech contemplated to allow use of multiple year data for computation of the arm's length priceEmpowering the TPO to levy penalty under section 271GThe existing provisions of section 271G of the Act provide that if any person who has entered into an international transaction or SDT fails to furnish any information/ document as prescribed by the transfer pricing provisions, then such person shall be liable to a penalty up to 2% of the value of international transactions (or SDT) which may be levied by the AO or the CIT(A)Given that determination of ALP in several cases is done by TPOs, TPOs are now empowered to levy penalty under section 271G for failure to furnish information/ documentation.The amendment will come in effect from 1 October 2014.Need to be mindful of the 30 days time limit for submission of information/ documents during the course of transfer pricing audits
23CIT vs Cushman and Wakefield (India) Pvt. Ltd. TS-150-HC-2014(DEL)-TP Brief Facts of the Case:The taxpayer is an Indian company engaged in the business of rendering services connected to acquisition, sales and lease of real estate and provision of advice and research on such matters, project management etc within and outside IndiaThe taxpayer availed certain intra-group services (a) coordination and liaison service from its Associated Enterprises (AEs) which was charged at actual cost and (b) Payment of referral fees to several AEs for referring clients which were paid according to international fee sharing rules and referral fees on Tenant Representation TransactionsThe taxpayer in its TP documentation benchmarked the referral fee transaction and concluded the transaction were undertaken on arm’s length basis. As AEs charged actual cost for the coordination and liaison services, no benchmarking analysis was conducted by the taxpayerAEOutside IndiaProvision of coordination and liaison servicePayment of referral feesIndiaCushman and Wakefield
24CIT vs Cushman and Wakefield (India) Pvt. Ltd. Assessment proceedings:The TPO disallowed the entire payment made towards the coordination and liaison servicesThe TPO was of the opinion that the services were ancillary services and taxpayer did not derive any benefit from the said service. Hence the ALP was determined as “Nil”The AO in his draft order made the addition to the income based on the TPO orderNo adverse inference was drawn with respect to the referral fee paid by the taxpayerFurther, the AO disallowed the referral fees as a deductible expenditure on grounds that the same was not incurred for the business of the taxpayer
25CIT vs Cushman and Wakefield (India) Pvt. Ltd. Appellate Proceedings:The taxpayer filed its objection before Dispute Resolution Panel (DRP). The DRP upheld the adjustments proposed by the AO. Aggrieved by the DRP order, the taxpayer filed an appeal before the Income-tax Appellate Tribunal (ITAT)With respect to the coordination and liaison services, the ITAT held that the taxpayer had furnished documentary evidence to substantiate the services were received and subsequent benefit was derived from servicesThe ITAT held that the assessee had shown to have earned substantial revenue from its client and it could not be said that the revenue earned by the assessee in respect to the services rendered by the AEs, was only on account of incidental benefitThe ITAT held that it was necessary for the assessee to provide service outside India and if such services were rendered by the employee of the assessee it would have resulted in extra expenditure. As the services were received and benefit was derived, ITAT deleted the adjustmentFor the referral fees the ITAT held that once ALP is determined by the TPO, the AO does not have the power to re-examine the transaction. The Tribunal also held that the taxpayer had furnished sufficient evidence to support the payment of referral fees and disallowed the adjustment on meritThe tax authority challenged the order of the Tribunal before the HC
26CIT vs Cushman and Wakefield (India) Pvt. Ltd. Revenue’s Contention:No benchmarking of the cost charged by the AEs was conducted by the taxpayer. The cost paid by the taxpayer to its AEs must be compared on other similar transaction, on the basis of one of the methods determined for calculating the ALPIn the absence of determination of ALP by TPO and AO, ITAT could not have taken upon itself the primary task of determining the ALP and holding the cost claimed was reasonableTaxpayer’s Contention:The AEs have only charged cost in accordance with the intra-group arrangement and there is no charging of mark up/profit marginThe Tribunal’s approach was statutorily sanctioned under Section 92 (3) of the Act, which states that TP provisions will not apply if the result of the ALP determination is a reduction of the overall tax incidence in IndiaQuestions before the High CourtWhether services have indeed been provided by the AEs to the taxpayer?Whether these services ought to be benchmarked under the Indian TP provisions considering the fact TP Provisions will not apply if the result of the ALP determination is a reduction of the overall tax incidence in India?
27CIT vs Cushman and Wakefield (India) Pvt. Ltd. High Court ruling – Coordination and liaison services availed by AEsHigh Court (HC) observed that the cost incurred by the AEs have not been disputed and equally admitted that the ALP has to be determined as per the provisions of the Act. High court held that it was necessary to test if third party in an uncontrolled transaction would have charged lower, equal or greater amount as compared to what was charged by AEHC opined that concept of base erosion is not logical inference from the fact that the AE have only asked for reimbursement of cost. Further, whether the cost itself is inflated or not is a matter to be tested under comprehensive TP analysisUpholding the principle in Dresser-Rand India, the HC ruled that the authority of the TPO is restricted to the determination of ALP and not to determine whether there is a services or not from which the taxpayer benefitsHC held that the details of the specific activities for which cost was incurred by both AEs and the attendant benefit to the taxpayer have not been considered till date. This has to be provided in addition to the consideration of the ALP vis-à-vis total cost claimed. Thus, the matter is remanded back for consideration of ALP determination
28CIT vs Cushman and Wakefield (India) Pvt. Ltd. High Court ruling – Referral feesHC observed that the jurisdiction of the AO and TPO are distinct. A referral by the AO to TPO is only for the limited purpose of determining the ALP. It does not imply a concrete view as to the existence of services or the accrual of benefits (such that allowance under Section 37 must be permitted)Relying on ITAT ruling in Deloitte Consulting and HC ruling in Sony India, HC observed that AO can determine that expenditure claimed was not for the purpose of business and thus disallow the amount. This would not restrict or bypass the functions of the TPOThe HC ruled TPO’s determination of ALP is binding on the AO and hence the AO cannot reassess the issue on the quantum of payment. However, the AO in his assessment decide whether the work or services were actually rendered as claimed by the assessee and if the services are real and genuineThe HC noted that neither the AO nor the Tribunal have discussed the correctness of evidence of the existence of referral transactions and hence remanded the matter back to AO for a detailed verification of facts and provisions of reasoned conclusions with the AO being bound by the TPO’s approval of the pricing of referral fees
29Tilda Riceland Private Limited vs ACIT TS-47-ITAT-2014(DEL)-TP Brief Facts :The assessee has exported brown basmati rice and milled basmati rice to its AEs and applied CUP method by comparing the average of transfer prices with the average of uncontrolled prices. (as reported in “Daily Export Port Data – April 2007 to March 2008” compiled by TIPS Software Services Pvt Ltd., Mumbai.)The TPO rejected CUP method stating quotes given by a private company are not covered within the provisions of Rule 10D(3) and CUP requires same products (including Brand) and thereafter the TPO made adjustments applying TNMM at the entity levelITAT Ruling:The information input provided by Tips Software are with regard to the information available with the customs department at various portsRule 10D(3) is illustrative in nature and it merely describes the information required to be maintained by the assesseeTIPS software is public data maintained by customs department. If TPO had any doubts, he could call for information to examine authenticity of data furnishedThe product categorization has been done on the basis of reasonable generic description, and the product being generic in nature, such categorization in reasonable and sufficient.
30Tilda Riceland Private Limited vs ACIT ITAT Ruling:Even if there are minor variations in prices of generic goods, such factors are adequately taken care of by average in the case of large size of comparables‘The international transaction’ referred to in rule 10 B(1)(a)(iii) is used in singular and does not permit taking into account ‘a number of such transactions ’. While averaging is thus permissible for the uncontrolled transactions, each international transaction is to be taken on standalone basis. (followed similar ruling on CPM in case of Tara Ultimo Pvt Ltd)TP is not a perfect science but we still have to choose a less imperfect alternative from the various alternatives available.
31Redington India Limited vs JCIT TS-208-ITAT-2014(CHNY)-TP Existing Structure and StepsResultant StructureGulf CoRedington India LimitedIndiaOutside IndiaMauritius CoCayman CoRedington India LimitedIndiaOutside IndiaMauritius CoCayman Co*Gulf CoSet up Mauritius CoMauritius Co, in turn sets up subsidiary in CaymanGift of shares by the Taxpayer in Gulf Co to Cayman Co*Mauritius Co holds shares in Cayman Co along with other PE Investors
32Redington India Limited vs JCIT Brief Facts of the Case:The taxpayer provides end-to-end supply chain solutions for all categories of Information Technology(IT) products. It also carries on business in office automation products. The taxpayer provides supply chain solutions primarily in India, Middle East and AfricaThe taxpayer has overseas wholly owned subsidiary (WOS), Redington Gulf FZE (RGF Gulf) which is also engaged in similar line of business as that of tax payer. In order to attract investments to expand its business operations in Middle East and African, the taxpayer had initiated setting up of certain WOSTaxpayer set up an WOS in Mauritius, Redingtion International Mauritius Ltd. (RIML Mauritius). RIML Mauritius in turn set up a subsidiary in Cayman Islands by name Redington International (Holdings) Limited (RIHL Cayman)The taxpayer transferred its entire shareholding in RGF Gulf to RIHL Cayman, making RGF Gulf a step down subsidiary of RIML Mauritius and the taxpayer. As the shares were transferred without consideration, the taxpayer took the stand that it is not an “international transaction”The taxpayer issued guarantees on behalf of its subsidiaries and other companies and also paid trademark license fees to its AE for use of trademark “REDINGTON”
33Redington India Limited vs JCIT Assessment proceedings:The TPO held that the transfer of shares made by the taxpayer is an international transaction coming under the purview of transfer pricing regulations and determined the INR 865 croresThe TPO observed that the taxpayer had issued corporate guarantees on behalf of its subsidiaries and in light of the amendments brought in the Finance Act 2012, held that corporate guarantees have to be treated as international transaction and made an ALP adjustment of INR 9.28 croresWith respect to the trademark license fees, the TPO made a downward adjustment of INR 1.89 crores and added to the total income of the assesseeThe AO modified the long term capital gains adjustment by setting off the indexed cost of acquisition and determined the revised INR 610 crores. Further, the AO added two disallowances pertaining to bad debts and factoring chargesThe taxpayer filed its objection before DRP, who upheld the adjustment and provided marginal relief in the capital gains addition proposed against the transfer of shares and restricted the corporate guarantee or guarantee fee to a lower rate determined as ALP in the earlier assessment yearsAggrieved by the DRP order, the taxpayer filed an appeal before the Tribunal
34Redington India Limited vs JCIT Transfer of shares to a subsidiary as an international transaction:Department’s Contentions:Transfer of shares made by the taxpayer is a case coming under the purview of Chapter X of the Act, discussing the special provisions relating to avoidance of taxThe taxpayer by way of transferring its shares in its subsidiary, RGF Gulf to its step down subsidiary, RIHL Cayman has not only avoided the payment of tax but also made schemes to avoid tax perpetually, through a series of corporate re-structuresGift can be made only to natural persons and concluded that a corporate body cannot make a gift to another, as the pre-condition to make a gift in natural love and affectionCapital gains tax is computable and hence the TPO has rightly applied the TP provisions to arrive at the arm’s length consideration for determination of amount chargeable to taxAssessee’s Contentions:The voluntary transfer of shares to the step down subsidiary is the nature of gift and therefore the same is exempted from capital gains tax under the provision of ITL. Further, the transfer of shares was purely on commercial and business expediency and there was no motive to avoid taxConsidering that gift is not defined under the ITL, reliance was place on the provisions of transfer of property of Act (TOPA) and the Gift Tax Act to support the argument that a corporate body can make gift to another corporate body as like any other personEven otherwise, since no consideration was received or receivable, computation mechanism would fail. Since the transfer of shares were without consideration, there is no income chargeable to tax and hence the TP provision would not be applicable
35Redington India Limited vs JCIT Corporate and bank guarantee charges and trademark license fees:Department’s Contentions:Corporate guarantees have to be treated as international transactions in the light of the amendment brought in by the Finance Act, 2012, with retrospective effect from 1st April, 2002The taxpayer made a payment towards trademark/ license fees to its AE for using the trademark “REDINGTON”. There is no genuine rationale for making such a payment for trademark/license fees and supported the action of the TPO in determining the ALP at NilAssessee’s Contentions:No fresh guarantees were issued during the relevant previous year. Further, no fees is charged from the AE since the same is considered to be in the nature of a shareholder activity. Relying on decision of Delhi ITAT in the case of Bharti Airtel Ltd held that it is not an international transactionWith regard to adjustment against trademark/license fees, the Revenue Authorities are not justified in analyzing the commercial rationale and justification to determine, whether the taxpayer ought to have incurred an expenditure or not. Further, the transaction need not be tested independently as the same is already at arm’s length under combined transaction TNMM approach
36Redington India Limited vs JCIT ITAT ruling:Considering that the term “gift” has not been defined under ITL, reference was made to TOPA and Gift Tax Act. ITAT held that the essential ingredient of a valid gift are existence of property, which is transferred voluntarily, without consideration and there is no requirement that the same should be out of love and affectionITAT held that the under the ITL gift transaction is exempt from capital gain tax and there is no specific provision which states that the exemption would be available only to gift made by individuals. In the absence of specific restriction under the ITL to this extent, there is no need to read down the law to make an interpretation that a company cannot claim exemption. Accordingly, gift by the Taxpayer should be exempt from capital gainsEven otherwise, in case of gift tax, since no consideration was received or receivable, neither can the consideration be ascertained, the computation mechanism for ascertaining capital gains will fail. Consequently, the charge in respect of capital gains also failsThe computation of ALP is dependent on the income arising to an assessee from an international transaction. In the present case since no income arises to the taxpayer, TP provisions will not apply
37Redington India Limited vs JCIT ITAT ruling:Since the taxpayer has not issued any fresh corporate guarantees in the relevant previous year, the reliance placed by the TPO on the definition of “international transaction” as retrospectively amended by the Finance Act, 2012, is not properITAT held that the corporate and bank guarantees provided by the Taxpayer enable its associates to secure credit in their overseas jurisdiction. Thus, taxpayer has provided the corporate and bank guarantees for the over-all interests of its businessIn view of the nature of corporate and bank guarantees and placing reliance on Delhi ITAT ruling in the case of Bharti Airtel Ltd, the TP addition was deleted by ITATWith regard to payment made for trademark/ license fees, the ITAT held that the taxpayer is exploiting the trademark for the purpose of carrying its business and therefore there is nothing uncommon in the taxpayer making payment to the use of the trademark to its AEFurther, the ITAT held that it is for the taxpayer to decide the dynamics of its business and placed reliance on Supreme court ruling in the case of S.A.Builders where it was held that expenditure incurred by the assessee if justified by commercial expediency is allowable for purpose of taxation and what is commercial expediency is a matter to be decided by the assessee
38Deloitte Consulting India Pvt. Ltd. vs ACIT TS-224-ITAT-2012(MUM) Brief Facts of the Case:The Taxpayer is a joint venture between Mastek Limited (Mastek) and Deloitte Consulting (DC), engaged in providing software development and IT servicesDC is responsible for undertaking marketing activities i.e. generation of sales, managing and maintaining customer relationships, etc and enters into consulting assignment with the clients. Mastek provides and manages infrastructure, operations recruitment, training, administration, etcDuring FY and the taxpayer and DC entered into several international transactions: (i) Provision of software and IT services (ii) Availing Software and IT services (iii) Reimbursements for marketing services (iv) Reimbursement for receipt of support servicesMastek Limited (AE)Provision of Software and IT servicesAvailing of Software and IT servicesReimbursements for marketing servicesReimbursement for receipt of support servicesOutside IndiaIndiaDeloitte Consulting India Private Limited
39Deloitte Consulting India Pvt. Ltd. vs ACIT Assessment proceedings:Post commencement of audit proceedings, the taxpayer filed a revised tax return and voluntary performed a TP adjustment by not claiming the allocated marketing cost as tax deduction and claimed tax holiday on the enhanced total incomeThe tax authority disregarded the revised tax return and thereafter made a TP adjustment by disallowing the claim made for marketing cost as a tax deduction in the original return and denied tax holiday on the enhanced income arising from TP adjustmentThe tax authority initiated penalty proceedings on the ground that the taxpayer had concealed true particulars of income and thereafter levied a penalty of 100% to the amount of tax arising on TP adjustment. The same was confirmed by the first appellate authority and the taxpayer has appealed before the ITAT on the validity of penalty
40Deloitte Consulting India Pvt. Ltd. vs ACIT Assessee’s contentions:The taxpayer argued that from commercial perspective it was prudent to incur the cost of marketing personnel of DC who were specifically engaged in marketing the Taxpayer’s off-shore capabilitiesThe taxpayer argued that it had voluntarily filed a revised return reversing the marketing expenses and claiming tax holiday on the enhanced income and hence should not be denied the benefit of tax holiday deduction. Tax holiday can be denied only if a TP adjustment is made and not in case of a voluntary TP adjustmentNo penal consequence would follow as the returned income and assessed income would be the same as the taxpayer having admitted to a wrong claim, increased its income to that extent that and deductions under section 10A could not be validly deniedRevenue’s contentions:The taxpayer’s role was to execute projects and render software development services. It was not assigned any marketing function and hence allocation of marketing cost would not ariseThe entire revenues of the taxpayer was from job work from DC and it was not a case where contract from clients were passed on back to back basis. The taxpayer and not rendered any services to third parties. Further, the taxpayer had not been able to demonstrate any benefit derived from the such marketing costThe taxpayer filed a revised tax return but revised Form 3CEB was not furnished and thus the claim on quantum of international transaction was not changed
41Deloitte Consulting India Pvt. Ltd. vs ACIT ITAT ruling:The ITAT held that no marketing function was assigned to the Taxpayer and its role was limited to provision of software development, and hence the arguments that expenses were borne out of commercial expediency is not validITAT held that the return were filed after initiation of TP audit, in anticipation of TP adjustment. “Voluntariness” and “bona fides” are essential for a valid revised tax return and thus the revision was not voluntary as it was guided by the motive to avoid adjustment and impact of tax holiday denialITAT held that the revised return were not valid and hence the original return should be considered as valid. Consequently, the enhancement of income due to TP adjustment would be applicable and also the provisions for denial of tax holidayITAT did not accept Taxpayer’s argument that there is no specific provision for revising the Form 3CEB. ITAT held that anything which is wrong or is not valid has to be withdrawn and correct information should be furnishedA taxpayer may be protected from penalty if the taxpayer can establish that the price charged or paid was computed in accordance with the provision of the law, in good faith and with due diligenceITAT held that the taxpayer has being unable to prove the truthfulness of the transaction stating marketing expenses to be considered as a discount to its principal buyer. The taxpayer is in contradiction to its own report in Form 3CEB, which the taxpayer is under law obliged to defend and prove as representing true and correct account of its international transactions