This file will serve as a comprehensive and free eresource on Transfer Pricing.

1. Transfer Pricing
A Presentation by Vikram Singh Sankhala

2. The Logic behind Transfer Pricing
● Where tax rates are different between the
countries,there is a strong incentive to shift
income to a lower tax country and deductions to
a higher tax country so that
● the overall tax effect is minimized.

3. ● Suppose a subsidiary company, resident in country A
(which has a tax rate of, say, 30%) manufactures goods
and transfers them to its parent company in country B
(which has a tax rate of 20%) for trading. In order to
increase the overall profits of the group company, it will
seek to supply the goods at prices which are lower than
the market price. So, in effect, the subsidiary company in
country A will have lower profits and hence, a lower tax
incidence whereas the parent company in country B is
affected in the opposite manner higher profits due to low
costs, but lower taxes because of the tax rate.

4. What was its impact on Governments?
As the aggregate tax payable by MNCs is
reduced, tax authorities across the world incur
significant losses.

5. So what did the Tax Authorities do ?
● To guard against such losses, many countries
have introduced transfer pricing legislation to
govern the pricing of cross border transactions
between related parties.

6. ● India has introduced rules and regulations on
transfer pricing as of 2001 through sections 92A
to 92F of the Indian Income tax Act, 1961 which
guides computation of the transfer price and
suggests detailed documentation procedures..

7. SCOPE and APPLICABILITY
Transfer Pricing Regulations ("TPR") are applicable to
the all enterprises that enter into an 'International
Transaction' with an 'Associated Enterprise'.
Therefore, generally it applies to all cross border
transactions entered into between associated
enterprises.

8. ● The aim is to arrive at the comparable price as
available to any unrelated party in open market
conditions and is known as the Arm's Length
Price ('ALP').

9. Associated Enterprises ('AEs')- How Identified?
The basic criterion to determine an AE is the participation in management,
control or capital (ownership) of one enterprise by another enterprise.

10. The participation may be direct or indirect or through one or more
intermediaries.

11. Participation in management
● Appointment of more
than half of Board of
Directors/ Board of
Members/ one or
more Executive
Directors/ Executive
Members by :
● - The other Enterprise
● - The same person(s)
in both the
enterprises.

12. Participation through Capital
Holding not less than 26%
of the voting power directly
or indirectly
- in the other enterprise
- in each of such enterprise

13. Participation through Control
● Loan not less than 51% of Book value of Total Assets
● Guarantee not less than 10% of Total borrowings
● Use of Know how, patents, copy right, etc., of which
other enterprise is owner or has exclusive rights
● Purchase of 90% or more Raw Materials and
Consumables for which prices and other
conditions are influenced
● Sale of goods manufactured or processed to other
enterprise or person specified by it for which
prices and other conditions are influenced
or Controlled by same person

14. ● Apart from the above, any relationship of
mutual interest, as may be prescribed
● shall also be considered as Associated
enterprise.

15. What is an International
Transaction?
● ‘International transaction’ means any of the following nature of
transactions between
● Two or more “Associated enterprise” where, either or both of whom
are non-residents
● (a) purchase,
● (b) sale,
● (c) lease of tangible or intangible property,
● (d) provision of services,
● (e) lending or borrowing money, or
● (f) any other transaction having a bearing on the profits, income,
losses or assets of such enterprise.
● (e) Mutual agreement between AEs for allocation/apportionment
of any cost, contribution or expense.

16. ● Further section 92B provides that, where a
transaction entered into by an enterprise with a
person other than an associated enterprises
and there exist a prior agreement in relation to
the relevant transaction between such other
person and associated enterprise, or the terms
of the relevant transaction are determined in
substance between such other person and the
associated enterprises then such transaction
shall also be treated as an international
transaction.

17. ARM’S LENGTH PRICE
● ‘Arms length price ‘ means a price which is applied or
proposed to be applied in a transaction between persons
other than associated enterprises, in uncontrolled
conditions.

20. Section 92C
● Section 92C which provides as follows: The
arm’s length price in relation to an international
transaction shall be determined by any of the
following methods, being the most appropriate
method, having regard to the nature of
transaction or class of transactions or class of
associated persons or functions performed by
such persons or such other relevant factors as
the Board may prescribe, namely:

21. TP Methods
● (a) Comparable uncontrolled price method
● (b) Resale price method
● (c) Cost plus method
● (d) Profit split method
● (e) Transactional net margin method
● (f) Such other method as may be prescribed by
the Board

22. Comparable uncontrolled price
method
● In this method, price charged in an uncontrolled deal between
comparable entities is recognized and evaluated with the
verified entity price to determine the Arm’s Length Principle.
● The CUP method offer the finest evidence of ALP.

24. Resale price method
● This method is used where the vendor adds
similarly little value to goods owned from
associate enterprises. Here, Arm’s Length Price
is determined by reducing the relevant gross
profit mark-up from the sale price charged to
free entity.

25. ● The resale price method begins with the price
at which a product is resold to an independent
enterprises(IE) by an associate enterprises
(AE).
● -x sold to AE at Rs.1000 (profit Rs.300)
● -AE sold to an IE at Rs.2000
● (profit of Rs.500 from relevant IE)
● -ALP =Rs.2000-Rs.500 = Rs.1500

26. Cost plus method
● In CP method first
the cost incurred is
determined.
● An appropriate cost
plus mark up is then
added to the cost to
arrive at an
appropriate profit.
● The resultant is the
ALP

27. Profit Split method
● PSM is used when transaction are inter related
and is not possible to evaluate separately.
● PSM first identifies the profit to be split for AE.
The profit so determined is split between the AE
on the basis of the function performed

28. Transaction Net Margin Method
● Compares the net profit margin of a taxpayer
arising from a non-arm's length transaction with
the net profit margins realized by arm's length
parties from similar transactions; and
● Examines the net profit margin relative to an
appropriate base such as costs, sales or
assets.

29. Points
● Arithmetical mean of
prices obtained by
most appropriate
method to be taken as
Arm’s Length Price
● Concept of Arm’s
Length Range not
found feasible
● Tolerance zone of 5
percent. allowed at
taxpayer’s option.

30. Choice of Most Appropriate Method

31. Safe Harbour
● Section 92CB provides that w.r.ef asst. year 2009-10 Income
tax authorities will accept the transfer price declared by the
assessee provided they are in accordance with the Safe
Harbour Rules to be notified by CBDT. Safe Harbour means
circumstances in which the income tax authorities shall accept
the transfer price declared by the assessee.

32. Comparable uncontrolled price
method
● Comparable uncontrolled price method is
relevant in case of
● transaction of loans,
● royalties,
● services,
● transfer of tangibles.

33. Resale price method
● Resale price method is
relevant in case of marketing
operations of finished products
more particularly in case of
distribution of products not
involving significant value
addition.
● In this method the vendor adds
comparatively small or no
value to goods taken from
associate enterprises.

34. Cost plus method
● Cost plus method is
more relevant where
raw materials or semi
finished products are
sold.
● Similarly, it can also
be used where joint
facility agreements or
long term buy and
supply arrangements
or provisions of
services are involved

35. Profit split method
● Profit split method is relevant
where the transactions
involved provision of
integrated services by more
than one enterprise.
● PSM method is used when
associate enterprises are so
combined that it turns into
difficult to make transfer
pricing analysis on
transactional methods basis.

36. Transactional net marginal method
● Transactional net marginal method is used in
most of the cases including transfer of semi-
finished goods, distribution of products where
resale price method appears to be
inappropriate and also in case involving
provision of services.

37. The obligations of an assessee
having international transactions:
● (1) The income from the international transaction should
be computed as per arm’s length price
● (2) Every person who has entered into an international
transaction shall keep and maintain such information and
document in respect thereof and for such period, as may
be prescribed by the board and produce before the A.O or
commissioner (Appeals) as and when required in the
cource of proceedings under Income Tax Act within a
period of 30 days from the date of receipt of notice. (3) The
assessee entering into an international transaction is also
required to firnish an audit report in the form 3CEB by a
chartered accountant by 31st of October of relevant A.Y
where the assessee is a company and by 31st day of july
in other cases.

38. DOCUMENTATION
● The provisions contained in the TPR are exhaustive as far as
the maintenance of documentation is concerned.
● This includes background information on the commercial
environment in which the transaction has been entered into,
information regarding the international transaction entered into,
the analysis carried out to select the most appropriate method
and to identify comparable transactions, and the actual working
out of the ALP of the transaction.
● This also includes report of an accountant certifying that the
ALP has been determined in accordance with the TPR and that
prescribed documentation has been maintained.
● This documentation should be retained for a minimum period of
8 years.

39. However
● In case the value of the international transaction
is below INR 10 million, it would be sufficient for
the taxpayer to maintain documentation and
information which substantiates his claim for the
ALP adopted by him.
● In effect, they need not maintain the prescribed
documentation.

40. Procedure to be followed by TPO
while determining ALP:
● (1) Where a reference is made to the TPO, the
Transfer Pricing Officer shall serve a notice on
the assessee requiring him to produce or cause
to be produced on a date to be specified
therein, any evidence on which the assessee
may rely in support of the computation made by
him of the arm’s length price in relation to the
international transaction in question.

41. ● (2) On the date specified in the notice , or as soon thereafter as
may be, after hearing such evidence as the assessee may
produce, including any information or documents referred to in
sub-section (3) of section 92D and after considering such
evidence as the Transfer Pricing Officer may require on any
specified points and after taking into account all relevant
materials which he has gathered, the Transfer Pricing Officer
shall, by order in writing, determine the arm’s length price in
relation to the international transaction and send a copy of his
order to the Assessing Officer and to the assessee.

42. ● (3) On receipt of the order under from TPO, the
Assessing Officer shall proceed to compute the
total income of the assessee in conformity with
the arm’s length price as so determined by the
Transfer Pricing Officer.

43. BURDEN OF PROOF - TAXPAYER
OR TAX OFFICER
● The primary onus is on the
taxpayer to determine an
ALP in accordance with the
TPR and to substantiate the
same with the prescribed
documentation.
● Where such onus is
discharged by the taxpayer
and the data used for
determining the ALP is
reliable and correct there
can be no intervention by
the tax officer.

44. Reference to TPO
● In other cases, where the tax officer is of the view that the
● (a) price charged in the international transaction has not been determined in
accordance with the methods prescribed,
● (b) or information and documents relating to the international transaction have not
been kept and maintained by the assessee in accordance with the TPR,
● (c) or the information or data used in computation of the ALP is not reliable or correct,
● (d) or the assessee has failed to furnish any information or document which he was
required to furnish under the TPR
● the tax officer may reject the ALP adopted by the assessee and determine the ALP in
accordance with the TPR.
● For this purpose, he would then refer the matter to a Transfer Pricing Officer ('TPO')
(a special post created for valuation of ALP) who would determine the ALP after
hearing the arguments of the taxpayer.

45. EFFECTS OF ADJUSTMENT TO
THE ALP
In case the ALP determined by the TPO indicates
understatement of income by the taxpayer,
it could result into the following
(a) Adjustment to reported income of the taxpayer
(b) Levy of penalty

46. Adjustment to the Reported Income
● The tax officer is bound to adjust the reported income of the
taxpayer with the amount of adjustment proposed by the TPO.
● This would have an effect of increasing the assessed income or
alternatively decreasing the assessed loss.
● Furthermore, the eligible deductions available to the taxpayer
under section 80 could not be availed on the enhanced income.
● However, those taxpayers who are eligible for deductions under
section 10A and 10B remain unaffected as these deductions
remain available on the enhanced income.

47. ● Section 92 also provides that its provisions shall
not apply where it has effect of reducing the
income chargeable to tax or increasing the loss,

48. Penalties
(a) Penalty for Concealment of
Income - 100 to 300 percent on
tax evaded
(b) Failure to Maintain/Furnish
Prescribed Documentation - 2
percent of the value of the
international transaction
(c) Penalty for non-furnishing of
accountants report - INR
100,000 (fixed)
● The above penalties can be avoided if
the taxpayer proves that there was
reasonable cause for such failures.

49. Drawbacks of the Regulations
● Advance Pricing Agreements (“APA”) which are written
agreements between a business enterprise and the tax
authorities of the State in which it is a resident, are used to
determine a method for determining the ALP in advance of filing
returns for a limited period of time. Several countries such as
the U.S., Canada, Australia and Japan allow for APAs and have
brought APAs within the ambit of their transfer pricing
regulations.
● However, the Regulations in India do not providefor an APA
mechanism.
● Further, the Regulations do not envisage more uniquesituations
such as intangibles, e-commerce, global trading derivatives and
so on. Also, matters such as intra-group services and cost-
sharing arrangements are not dealt with comprehensively.

50. Emerging Issues From Recent Transfer
Pricing Audits

51. ● The tax authorities are more comfortable with
the CUP Method as compared to the other four
methods for determining the ALP.
● Cost sharing arrangements are challenged, if
proper documentation is not maintained and
furnished for establishing the cost-benefit
analysis arising from such cost sharing
arrangements

52. ● The tax authorities are generally not
comfortable with the use of foreign companies
as comparables.
● The tax payers and tax authorities have
experienced difficulty in obtaining “exact
comparables” on account of difference in risk
levels with uncontrolled functionally comparable
companies.

53. ● The tax authorities are more comfortable with a
transaction wise analysis as opposed to
aggregate company wide analysis for
determining the ALP.
● In certain cases, the tax authorities have also
used secret comparables for determining the
ALP.

54. Data for comparability analysis
● India’s TP rules require the use of “current year”
data (data pertaining to the year in which the
taxpayer has transactions with group concerns)
for transfer pricing analysis.
● The use of prior data (up to two years) is
permitted only in certain circumstances when it
reveals facts that could influence the
determination of current transfer prices.25

55. Data for comparability analysis
● Where profit-based methods are used for TP
analysis, taxpayers generally compute the
margins of functionally comparable companies
from publicly available data/databases.
● Although these databases are updated
regularly, the current-year data is usually not
available before taxpayers file their tax return
and finalise their TP analysis.
● Taxpayers thus use the past two years’ average
data to support the transfer prices.

56. Data for comparability analysis
● However, by the time the case comes up for a TP audit, current-
year data has become available.
● Then TP officers request that data and test a taxpayer’s transfer
prices based on the updated results.
● The practice of conducting fresh searches for comparables and
using current-year data causes undue hardship to taxpayers.
● Even though they may have undertaken a thorough
contemporaneous TP analysis while setting transfer prices, the
taxpayers face the risk of TP adjustments and harsh penalties
from 100 to 300% of the tax on the adjustment amount.
● Therefore, taxpayers should keep constantly updated about
prevailing industry/market trends and undertake comparables
selection and economic analysis with utmost care.

57. Use of ‘nonpublic’ comparables
● In some cases, TPOs seek pricing information
from competitors of the taxpayers (for
computing the arm’s length price of the
taxpayer’s transactions) by exercising the
powers granted to them under the tax laws of
India.
● The issue requires careful handling and
analysis, from a legal/tax as well as an
economic viewpoint.

58. Global arrangements determining
India transactions
● Under the Indian TP legislation, a taxpayer’s
transaction with a third party is also covered by
the TP code if such transaction is a part of an
arrangement that the third party has with a
group concern of the taxpayer.
● Indian TP authorities have started evaluating
such transactions in detail to test them from an
Indian TP perspective.

59. Risk adjustment
● The issue of risk adjustment assumes more
significance in view of the huge TP adjustments
undertaken by transfer pricing officers in the
information technology/IT enabled
services/business process outsourcing sectors,
where captive service units bearing limited risk
have been compared with companies having
different business and revenue models and
bearing full entrepreneurial risks.

60. Risk adjustment
● The requirement for comparability adjustments
(including risk adjustments) is an integral part of
the Indian regulations. Recent rulings of
appellate authorities have reinforced the need
for such adjustments.
● However, neither the regulations nor the rulings
provide any guidance on the methodology to be
adopted for computing such adjustment.

61. Risk adjustment
● Any such risk adjustment needs to be
undertaken based on a detailed and well-
documented analysis.
● Companies can use various economic
theories/methods as well as statistical tools for
making a sound risk adjustment.
● Globally accepted TP techniques can be utilised
for undertaking this adjustment on a rational
and scientific basis.

62. Risk adjustment
● In the absence of a robust technical and well-
documented risk adjustment, the revenue/
appeal authorities may not permit the
adjustment during audit/appeal proceedings or
may allow an ad-hoc adjustment that may not
be appropriate or adequate.
● Accordingly, in the absence of specific guidance
under law, it is imperative for taxpayers to focus
on this issue and make a strong case upfront
for computing and claiming the risk adjustment.

63. Royalties
● The payment of a royalty for the use of intellectual property
such as trademarks, knowhow, brand names, etc., is a
significant focus of the revenue authorities.
● In many cases, the authorities have rejected the taxpayer’s
analysis and disallowed payments for use/transfer of intellectual
property, on the grounds that the taxpayer has failed to
commensurately demonstrate the following:
● Need for sourcing such intellectual property and its actual
receipt
● Appropriate documentation evaluating and describing such
intellectual property
● Fulfilment of the benefits test by the Indian entity
● Whether the royalty is embedded in the import price of
goods, etc.

64. Management charges
● Similarly, management charges paid by Indian taxpayers invite
significant attention from tax authorities.
● Extensive documentation is sought by the revenue authorities to
justify the management charges paid by Indian enterprises.
● Such documentation includes
● composition of costs allocated,
● methodology of cost allocation,
● benefits derived from each constituent of the costs,
● need for procuring such services,
● actual receipt of services, etc.

65. Business restructuring
● TP issues relating to business restructuring
have recently started attracting the attention of
tax authorities across the globe.
● Indian TP authorities have also started focusing
on issues such as disposition of intangibles and
consequential exit charges required for implicit
or deemed migrations of intellectual property as
part of acquisitions, reorganisations,
conversions, or business restructurings.

66. Business restructuring
● Such restructuring could include conversion of an entrepreneurial
manufacturer to a contract or toll manufacturer, conversion of a full-
fledged product developer to a contract R&D service provider, or
conversion of a distributor to a commission agent.
● The issue requires detailed analysis of intricate matters, such as
whether it involves a transfer of valuable, protected or unprotected
intellectual property (including identification of it); a loss or migration
of profit potential; a required exit charge and, if so, how to quantify
such charge, and similar issues.
● Therefore, the restructuring necessitates a detailed analysis of
contracts, financial and functional analyses, and industry/market
structure review, followed by preparation of robust, related TP
documentation, economic analysis, written agreements, and the like.

67. Marketing intangibles
● Another issue that has started receiving significant attention during
TP audits in India is marketing intangibles.
● This issue is particularly relevant for Indian group concerns of
multinational enterprises that undertake significant local marketing in
India.
● In recent audits, the TP authorities have examined the marketing
activities and spending by Indian subsidiaries developing local market
intangibles that are legally owned by overseas parents or other
affiliates.
● For instance, where the Indian entity undertakes significant marketing
expenditure above the industry average or comparables levels,
transfer pricing authorities have reduced the transfer prices (of goods
or other transactions) paid by the Indian subsidiary to its group
concerns.

68. Marketing intangibles
● In certain cases, the authorities have imputed a cost reimbursement
to be received by the Indian entity, and in other cases, they have
simply disallowed the “excessive” marketing expenditure incurred by
the Indian entity. In all such cases, the intention has been to
compensate the Indian subsidiary for its contribution toward
development of marketing intangibles.
● It needs to be evaluated whether the local marketing efforts contribute
to the increase in value of marketing intangibles owned by a group
concern or enhance only the value of the contributing entity’s own
rights under a long-term license or distribution arrangement.
● Further, it also needs to be evaluated whether the compensation for
such contributions is already embedded within another transaction or
requires a separate service fee.

69. Marketing intangibles
● In the absence of detailed upfront TP economic analysis as well as
robust documentation (including explicit contracts), such Indian
operations could be exposed to significant issues during TP audits.
● Indian TP authorities are closely following international developments
including case law and overseas regulations on this matter.

70. Attribution of profits to permanent
establishments
● Indian TP law has defined a permanent establishment as an
“enterprise”28 and has applied the “functionally separate entity”
approach authorised by the OECD for attributing profits to permanent
establishments.
● Further, the courts in India have upheld the application of TP
principles for attributing profits to permanent establishments in India.
● The Supreme Court of India and other courts have held that where
the functions, assets, and risks of the permanent establishment have
been appropriately captured while remunerating the enterprise which
created the permanent establishment, attribution of profits to the
permanent establishment stands subsumed in such remuneration and
there can be no further attribution.

72. The Tax Authorities Perspective
● F.Y.2004-05 was the first year of transfer pricing
audits
● Cases involving transactions above threshold
value taken up
● Adjustments made in about 25% of cases

73. Some typical grounds for
adjustments
● Rejection of method – taxpayer’s method not
found ‘most appropriate’ having regard to
degree of comparability, availability of data
● Set of comparables modified – comparables
found through FAR (Functions, Assets and Risk
analysis)
● Interest free loans, free inter-company services

74. ● Operating margin recomputed by excluding
non-operating income and including
expenditure re-imbursed by parent
● Taxpayer’s working in using CUP modified,
● Rejecting adjustments not supported by
documentation
● Choice of tested party

76. ●
Moser Baer India Ltd. and Others vs.ACIT(Delhi HC)
December 2008

77. ● Brief Facts / Assessee’s
contentions
● Writ petitions were filed before the Delhi HC by six taxpayers
against the orders passed by the TPOs in their respective
Cases.
● As all the writ petitions had a common issue on violation of the
principle of natural justice, the same were clubbed together
● Orders passed by TPOs without giving oral hearings as
required under the Act
● Taxpayers were not provided an opportunity to verify or rebut
the material used by the TPOs during assessments
● In some of the cases, adjustments made were not in synch with
the show cause notices

78. Revenue's contentions
● In the absence of a specific requirement, oral hearing was not a
necessary facet of natural justice and a right to effective
representation (by way of submissions etc.) would suffice
● Failure to afford oral hearings does not render the decision
invalid as the same can be cured during appellate proceedings
●

79. Decision / Observations
● Order passed by the TPO is in breach of the principles of
natural justice and is a nullity in the eye of law
● Oral hearing is required to be accorded

80. ● Section 92CA(3) of the Act has cast an obligation on the TPO to
grant an opportunity of oral hearing even in cases where no
specific request is made by the tax payer for oral hearing.
● Appellate proceedings as provided for under the Act are not a
substitute for the original proceeding before the TPO
● Show-cause notice issued by the TPO should make a reference
to the materials and evidence available and also give an option
to the assessee to inspect materials available with the TPO
● Order passed by the TPO should not travel beyond the show
cause notice
● Proper analysis should be carried out by the TPO for
accepting / rejecting any comparables and the reasons for the
same should be provided to the tax payer, so that the tax payer
can rebut the same

81. Skoda Auto India Pvt. Ltd. vs. ACIT
(ITAT Pune)
March 2009

82. Brief Facts
● The Assessee/taxpayer is an Indian company engaged in the
business of manufacturing and selling of passenger cars
● The international transactions consisted purchase of raw
material and payment of royalty and technical know how fees
● Assessee used TNMM as most appropriate method
● Assessee corroborated the raw material purchase transaction
by using CUP method
● TPO rejected certain comparables used viz. General Motors
(onaccount of persistent losses) and Ford India (on
unavailability of contemporaneous data)
●
TPO relied on the remaining comparables and made an
adjustment to the tune of Rs.23.59 crores

83. Assessee’s Contentions
● If any company is functionally comparable, it cannot be
rejected on account of sustained losses
● Benefit of (+/-) 5 percent variation from the arm’s length
price should be allowed
● Adjustment towards differences between comparables and
the assessee on account of high import by taxpayer not
considered
● Adjustments on account of lower capacity utilization
affecting the profitability were not considered by the TPO
● Use of multiple year data should be allowed

84. Decision / Observations
● Application of CUP:
● Rejected the CUP analysis observing that a
transaction can be considered as an internal
CUP only when it has been entered into
between two independent parties.

85. Decision / Observations
Determination of ALP under TNMM:
● The vast variation in proportion of imported raw materials could be on
account of difference in the functionality. Hence, adjustment for high
content of imported raw materials is required
● It is permissible in principle to make adjustments in the costs and
profits in fit cases
● If information required for making the adjustment as available in the
public domain is not sufficient, it is permissible to make some
approximations and reasonable assumptions while making the
adjustments for functional and other differences
● TPO should provide adequate opportunity to the assessee to support
its claim in relation to the multiple year data since its use hinges on the
impact of product life cycle on the profitability
● TPO should give due consideration to the proportion of raw materials
imported by the assessee in the succeeding years while deciding
whether an adjustment on account of high content of imported raw
materials is warranted

86. Decision / Observations
● Benefit of 5% range given based on the
decision in case of Sony India Private Limited

87. UCB India Pvt. Ltd. vs. ACIT
(ITAT Mumbai)
February 2009

88. Brief Facts
● UCB India Pvt. Ltd. (‘UCB India’), is a 100% subsidiary of UCB SA, Belgium
(‘UCB Belgium’),
● Engaged in the business of manufacturing and marketing of prescription
drugs
● During AY 2002-03 and AY 2003-04 UCB India had imported raw materials
i.e. Active Pharmaceutical Ingredients (‘APIs’) from UCB Belgium
● UCB India characterised itself as a ‘licensed manufacturer’ and selected
TNMM as the most appropriate method
●

89. Brief Facts
● Dissatisfied with the analysis carried out by UCB India, the TPO questioned
the veracity of the analysis and posed UCB India certain questions regarding
applicability of CUP method
● TPO also gathered information from UCB India’s competitors by issuing
notices to them u/s 133(6) of the Act
● TPO summoned the managing director and marketing manager of UCB
India and recorded their statements on oath
● While rejecting the application of TNMM and applying the CUP method, the
TPO proposed an addition to the UCB India’s transfer price

90. Questions before the ITAT
● Aggrieved by the order of the TPO, on filing of an appeal before
the CIT(A) part relief was granted to UCB India.
● UCB India further carried the appeal to the ITAT and raised
objections and disputed the determination of arm’s length price
by the TPO, especially with regard to following matters
● Non acceptance of TNMM by the TPO, especially in light of
scientific and robust process followed
● Erroneous application of CUP by the TPO

91. Assessee’s contentions
● UCB India had complied with all the documentation
requirements
● Robust analysis carried out and accordingly TNMM was
selected as a most appropriate method
● CUP was rejected due to absence of information in the
public domain
● Revenue department did not carry out proper analysis and
also failed to substantiate the comparability of the
companies selected by them

92. Revenue’s contentions
● UCB India failed to produce documentation as
required by Rule 10D
● Rejected the whole entity approach followed by
UCB India while carrying out TNMM
● UCB India did not produce information to
demonstrate the non-comparability of the
transactions selected by the department

93. Decision / observations
● Non-maintenance of or deficiency in the
maintenance ofso me records should be seen
in light of fact that whether such non-
maintenance fundamentally affects or distorts
the computation of ALP.
● What needs to be seen is that the assessee
has substantially complied with the law in
relation to maintenance of records

94. Decision / observations
On issue of entity level margin:
● The international transaction contributed only to
50% of UCB India’s production and that UCB
India also had trading activity,
● Hence, the analysis carried out by UCB India by
aggregating all the transactions is not in
accordance with the law and hence not correct;

95. With regard to comparability analysis carried out
by UCB India:
● The revenue of comparable companies
consisted of licensed manufacturing, patented
drugs, trading and other revenues.
● Hence, UCB India’s comparability analysis,
without making any adjustments to the
comparables for the aforementioned factors,
was wrong and hence was set aside

96. On applicability of CUP:
● While considering whether controlled and
uncontrolled transaction are comparable,
regard should be had to the effect on price of
broader business functions and not just the
product comparability.
● Accordingly, ITAT set aside the CUP analysis as
it suffered from many deficiencies and
infirmities.

97. ● The ITAT remanded the matter to the files of the assessing
officer for adjudication of the issue afresh. While doing so
the ITAT directed as under:
● UCB India may file fresh documentation report and any
other document or evidence to support its report
● UCB India is to apply any of the prescribed methods, even
the TNMM
● The assessing officer to adjudicate issue afresh after
giving adequate opportunity to UCB India and after
examining the documents placed on record with an open
mind

98. MSS India Pvt. Ltd.
(ITAT Pune)
June 2009

99. Brief Facts
● MSS India, a 100% EOU, was engaged in business of
manufacturing and supplying of strap connectors
● International transactions and methodology of justification was
as under:
International TP Method Selected Comparable Selected
Transaction
Import of raw material Cost Plus Method London Metal exchange
and components prices plus a mark-up
(Copper and lead)
Sale of finished goods Cost Plus Method Internal – Gross margin
earned
from sale to unrelated
parties
Interest paid on foreign CUP
currency loan

100. TPOs’s Order
● Import of raw materials – MSS India having
losses at the net level;
● Sale of finished goods – MSS India’s allocation
basis is inconsistent and ambiguous;
● The TPO selected TNMM as the MAM and
proposed an adjustment to MSS India’s
international transactions

101. CIT(A) order
● MSS India being a 100% EOU didn’t have
reasons to manipulate prices;
● No TP adjustment therefore can be made to
MSS India’s international transactions (Relied
on Philips Software [119 TTJ 721])

102. Revenue’s contentions
● The decision of Aztec Software should have
been adopted by the CIT(A), being a special
bench decision
● The decision had held that for application of
transfer pricing provisions it is not necessary for
the revenue to establish any tax evasion;
● TNMM was the most appropriate method best
suited to the facts and circumstances of the
case and same should have been adopted by
the CIT(A)

103. MSS India’s contentions
● The decision of Philips India should be applied
as it had considered the decision of Aztec India
while delivering judgment;

104. Decision / observations by ITAT
● Decision of special bench (Aztec India) prevails
over the divisional bench (Philips India)
● Traditional methods shall have preference over
profit based methods; profit based methods
shall be applied only when application of
traditional method fails;
● Less than industry average profits or losses per
se cannot lead to the conclusion that the
taxpayer’s international transactions are not at
arm’s length;

105. ● Prices quoted on independent organization like
LME can provide most reliable prices vis-à-vis
comparable uncontrolled transactions and
therefore can be adopted;
● When internal comparison is made, as long as
the taxpayer does not follow different
accounting norms for different transaction, the
nuances of allocation of costs are not relevant

106. Rolls Royce Plc. vs. DDIT
(ITAT Delhi)
October 2007

107. Facts
● Rolls Royce PLC (RR Plc), a UK resident
company, was a ‘non-resident’ for the purpose
of the Income Tax Act and was not filing return
in India
● RR Plc was supplying aero-engines and spare
parts of Indian Customers, mainly to M/s.
Hindustan Aeronautics Limited (HAL), Indian
Navy and Indian Air force

108. Facts
● RR Plc entered into support service agreement
with Rolls Royce India Ltd. (RRIL) and
remunerated at 5.1% to 6% over cost
● RRIL has a liaison office in India which was
carrying out activities only in respect of RR Plc
in India.
● RRIL’s responsibility included securing orders
and soliciting requests for quotation / purchase
price of RR Plc’s products

109. ● The employees of RR Plc visit India frequently
and use premises of RRIL
● Employees of RRIL participate in the meetings
with customers where matters regarding
contracts with RR Plc are discussed and
decisions are taken
● RRIL also marketed certain after sales and
other services to RR Plc’s existing/ potential
customers and also provided advice /
recommendations to RR Plc as regards certain
customer proposals

110. Questions before the ITAT
● Whether the assessee has any income chargeable to tax
in India u/s 5(2) of the Act and whether it has any business
connection in India u/s. 9(1)(i)?
● Whether, in terms of DTAA between India and UK, the
appellant has any PE in India?
● If answer to the above is in affirmative to what is the extent
of income earned in India and whether the same can be
held as paid by the appellant to RRIL and no further
income is attributable to the PE in India?
● To what extent the income arises in India which can be
charged to tax in India?

111. Decision
regarding Business connection
● RRIL was providing various services to RR Plc
like marketing, advertising, media relations,
business development etc.
● Customers were requested to correspond with
RRIL
● Consequently, it was held RR Plc had business
connection in India

112. Agency PE
● RRIL was totally dependent on RR Plc
● RRIL was soliciting and receiving orders wholly
and exclusively on behalf of RR Plc
● It was held that RR Plc had Agency PE in India

113. Fixed Place PE
● • Fixed place PE would be constituted if foreign
entity is entitled to:
● – Use any premises and
● – There is an identified distinct location on
which the foreign entity can exercises control

114. In the present case:
● – RR Plc employees visited RRIL regularly and
– RRIL premises was available to all employees
of RR Plc for business operations in India
● – RR Plc reimbursed the cost of maintenance of
such premises
● RR Plc was held to have Fixed Place PE in
India

115. Preparatory and auxiliary
● RRIL acted as marketing office to receive
orders / promote business / negotiate and
receive business orders
● The activities were held not to be Preparatory
and Auxiliary in nature

116. Attribution of Profit
● The appellant has a PE in India and hence profits
attributable to the PE need to be identified
● Article 7 - All the profits accruing directly or indirectly
attributable to the PE are taxable in a State in which
such PE is situated
● The profits attributable are to be computed as if the PE
is a distinct and separate enterprise
● The profits could be determined on the basis of
separate accounts maintained by the appellant for its
PE operations or on the based on attribution for its
significant activities

117. Attribution of Profit
● The Tribunal identified the following
economically significant activities carried on by
the PE and attributed the profits as follows:
● Manufacturing – 50% (Not liable to tax in India)
● Research and Development – 15% (Not liable to tax
in India)
● Marketing – 35% (Liable to tax in India)

118. Key Takeaways
● The decision acknowledged the principle of
substance over form
● Brought to the fore the importance of economic
nexus in attributing profits to a Permanent
Establishment.
● Importance of FAR analysis and synchronizing
business model with operational realities
brought out

119. Gist of some Important Judgements

120. ● TNMM requires comparison of net profit
margins from an international transaction and
not net profit of the enterprises as a whole.
● Notional interest on interest free loans can be
assessed under transfer Pricing law.
● Merely because a comparable is making loss,
the same cannot be excluded from TP
Comparision.
● Data for comparision should be data in the year
in which international transaction is carried out.

121. Honeywell Automation India Ltd.
● The taxpayer is engaged in providing integrated
automation and software solutions for industrial
and residential applications.
● In its transfer pricing documentation, the
taxpayer bifurcated the system integration
division into two functionally separate
segments, one of which was incurring losses.
● The taxpayer argued that the loss in that
segment was due to certain economic and
commercial reasons.

122. ● During the assessment proceedings, the TPO did not approve of the arm’s-length
nature of international transaction involving purchase of raw material for the system
integration division, which was benchmarked by the taxpayer applying TNMM as
the most appropriate method.
● However, the TPO held that since the subsegments were part of the business of
rendering system integration activities under the system integration division, the
operating profit of the entire division ought to be considered for benchmarking
analysis. Furthermore, not agreeing with the comparables selected by the taxpayer,
the TPO conducted a fresh comparables search.
● On an appeal by the taxpayer to the appellate commissioner, the latter upheld the
adjustment made by the TPO.

123. ● Aggrieved by the order, the taxpayer appealed
before the Appellate Tribunal and raisedlim ited
arguments pertaining to the following:
● Rejection of one loss-making comparable,
which was considered by the TPO as a
comparable company in the previous year’s
assessment; and
● Exclusion of certain expenses while computing
the operating margin.

124. ● Specifically, in respect of provision for future
losses made in the financial statements,
countering the appeal of the taxpayer, the
● Revenue argued that the financial statement of
the loss-making comparable was not available
for the relevant financial year and submitted
that the appeal of the taxpayer on exclusion of
costs should not be entertained, as it was not
made before the TPO and appellate
commissioner.

125. Ruling
● On perusal of the case, the Appellate Tribunal ruled that the
comparable financial data of earlier or subsequent years may be
considered under India’s transfer pricing regulations only in certain
circumstances, wherein such data revealed facts or has an influence
on the determination of transfer prices in relation to the transaction
being compared.
● Accordingly, exclusion of a loss-making comparable to which the
financial data was not available for the financial year ended 31 March
2004, was upheld. In other words,where the financial data of the
company transgresses the relevant financial year, it may not be
regarded as a valid comparable. Furthermore, the Appellate Tribunal
● upheld that in the application of TNMM as the most appropriate
method, only those incomes or losses having nexus to operating
income or loss of the enterprise should be considered. The matter
was remanded to the TPO for determination on this account.

126. Schefenacker Motherson Limited
● Wherever necessary, economic adjustments (for capacity
utilisation, unusual high startup costs) should be made;
● The taxpayer cannot be expected to get detailed
information, which is not available in the public domain;
● In the absence of information in the public domain for
making the adjustments, approximations and assumptions
can be relied upon; and
● • The benefit of the +/-5% range should be allowed to the
taxpayer

127. Quark Systems Pvt Ltd
● The ruling emphasised that selection of
comparables rests on a proper FAR analysis
and principle of substantial justice to be
considered in applying the burden of proof.
● In addition, the Appellate Tribunal held that the
taxpayer may reject its own comparable
selected in the TP study on merits, in light of the
additional/substantive facts available at the time
of a transfer pricing audit.

128. CA Computer Associates Pvt Ltd
● The ruling emphasises that the Revenue is
bound to follow only the methods prescribed in
Indian transfer pricing regulations and may not
go beyond the four walls erected by the Income
Tax Act.

129. Vertex Customer Services India Pvt
Ltd
● This ruling is significant because it highlights
that penalties should not be levied in case of
any transfer pricing adjustment for which the
taxpayer has made reasonable efforts to
establish that the transfer price meets the
arm’s-length standard.

130. Customer Services India Pvt. Ltd
● The ruling emphasises the use of current-year
data for determination of the arm’s length price
and allowed +/-5% range in line with the earlier
Tribunal rulings.

131. Perot Systems TSI (India) Ltd
● This is the first Indian transfer pricing ruling that dealt
with the arm’s-length nature of an outbound loan
transaction.
● The Indian transfer pricing regulations applicable for
all cross-border transactions and an MNC cannot
escape its tax liability by arguing that its interest-free
loan was actually a capital contribution to its AEs.
● An interest-free loan between two related parties is a
clear case of transfer of profit from India to its AE
located in a tax haven where there is no corporate tax.

132. Morgan Stanley and Co.
● In this case, MS Co., which is engaged in financial
advisory, corporate lending, and securities underwriting
services, outsourced some of its activities to MSAS. MSAS
was to support the main office functions of MS Co., which
included equity/fixed income research, account
reconciliation and providing IT-enabled services.
● MS Co. sent certain staff members to India for stewardship
activities to ensure that its standards of quality are met.
MS Co. also sent staff members on deputation to MSAS
(as and when requested by MSAS), where such
employees continued to be employed by MS Co. and their
salaries and fees paid directly by MS Co.

133. Morgan Stanley and Co.
● The Supreme Court ruled that MS Co. did not have a fixed-
place PE or an agency PE in India under the tax treaty, as a
consequence of the back-office operations outsourced to
MSAS.
● Further, the visit by employees of MS Co. to MSAS for
stewardship activities was also not found to create a PE in India
under the tax treaty.
● However, with reference to the personnel of MS Co. on long-
term deputation to MSAS, the Supreme Court held that as such
personnel continued to be employees of MS Co., having a lien
on their jobs with MS Co., the employees could result in MS Co.
having a service PE in India.

134. Morgan Stanley and Co.
● As regards profits attributable to the PE, it was
observed by the Supreme Court that as MSAS
was remunerated at operating cost plus arm’s-
length markup determined using TNMM, and as
the transfer pricing analysis of MSAS
adequately reflected the functions performed
and the risks assumed by it, no further profits
would be attributable to the PE. Here, it would
be necessary to ensure that all operating costs
are adequately captured in the cost base, on
which the markup is to be applied, before a
taxpayer can be said to be at arm’s length.

135. Morgan Stanley and Co.
● However, there have been two judicial cases in the recent
past that diverge from the above principle. In the case of
SET Satellite Singapore, it was held by the Appellate
Tribunal that payment of arm’s-length remuneration to a
dependent agent PE does not necessarily extinguish the
tax liability of the non-resident in India. Furthermore, in the
case of Rolls Royce Plc, the Appellate Tribunal has
disregarded the argument of the taxpayer that payment of
arm’s-length remuneration to a PE extinguishes the tax
liability of the non-resident in India and has proceeded to
attribute the profits of Rolls Royce Plc, which can be said
to accrue or arise directly or indirectly through the
operations of its PE in India.

136. Mentor Graphics (Noida) Private
Limited
● The Appellate Tribunal thus held that once a
taxpayer undertakes appropriate due diligence
in preparing a transfer pricing analysis to justify
the arm’s-length nature of its international
transactions, the analysis may not be arbitrarily
rejected during audits based on inferences and
presumptions

137. Development Consultants Private
Limited
● The TPOs often have been hesitant to use or
review foreign benchmarking studies, but this
ruling strengthens the taxpayer’s position for
using such benchmarking studies.

138. Cargill India Private Limited
● The Appellate Tribunal, while reversing the levy of penalty
on account of nonsubmission of documents, arrived at
certain fundamental conclusions, which will have far-
reaching implications on almost all transfer pricing cases in
India.
● The Appellate Tribunal clarified that the documents and
information to be kept and maintained as per Rule 10D is
extensive, and the information and documents prescribed
under all the clauses of Rule 10D would be required only
in the rarest of cases. Therefore, the taxpayer and the tax
authorities, depending upon the facts and circumstances
of the case, are required to consider relevant information
and documents needed for determining the arm’s-length
price.

139. ● The Appellate Tribunal further observed that, having regard to the purpose of
the regulations, a notice issued by the TPO requiring the taxpayer to furnish
any prescribed information/documents, cannot be vague or nonspecific.
● Such a notice must require the taxpayer to furnish specific information,
which according to the TPO, is necessary for determination of the arm’s-
length price of the international transactions of the taxpayer and should be
issued after examination of documents on record and proper application of
mind.
● The Appellate Tribunal noted that such a notice issued undersection 92D(3)
is a serious notice, as noncompliance could lead to imposition of penalty,
and accordingly specifying the information and documents in the notice was
important.
● Furthermore, the specific clause of the rule or the details of the international
transaction relating to which default was committed by the taxpayer also
should be stated in the show-cause notice in order to treat it as valid, and to
enable the taxpayer to file a proper reply in defence.

140. Thank You