Captive outsourcing models
India TP hygiene workshop
Presenter: Vishnu Bagri
October 23, 2013

© 2013 Transfer Pricing Ass...
BACKDROP
+

India has evolved as a premier outsourcing hub for IT, ITES, engineering and
other R&D activities

+

MNEs hav...
STATED VIEWPOINTS OF INDIAN TAX
ADMINISTRATION
+

Scope of intangible property widened
o

+

Captive centres are not neces...
STATED VIEWPOINTS OF INDIAN TAX
ADMINISTRATION
+ Indian tax authorities skewed towards higher returns for captive centres
...
INDIA TP MANAGEMENT: THE EMERGING
DECISION VARIABLES ….
+ How to demonstrate the lower risk characterization of captive ce...
THE VALUE CHAIN CONTEXT
Tertiary
Functions

Primary

Non-core
support
X1

Judgmental

Y3

Core support

Customer
facing

X...
LOCATION SAVINGS

+ Net cost savings that an MNE realises as a result of relocation of
operations from a high-cost jurisdi...
INTANGIBLES : VALUE RELEVANCY
Kind of intangibles

Routine

Premium

Intellectual Property
Rights
Protected by law

Easily...
INTANGIBLES : VALUE RELEVANCY

+ Need to distinguish between:
o

Unique intangibles transforming revenue earning potential...
COMPENSATION TECHNIQUES

+ Is a cost-plus model appropriate to remunerate highly-skilled talent and
services?
+ Does compe...
METHOD OF TRANSFER PRICING

+ TNMM is a single-sided approach and does not throw light on
entrepreneurial margins / losses...
CONCLUDING REMARKS – HYGIENE CHECK

+ India operational profile – review transfer pricing or/and permanent
establishment r...
THANK YOU!

“An organization’s ability to learn, and translate that learning
into action rapidly, is the ultimate competit...
Transfer Pricing Associates
Transfer Pricing Associates is an independent professional service and solution provider of ex...
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Captive outsourcing models india tp hygiene workshop - final

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Transfer pricing decision variables for captive outsourcing units in India

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Captive outsourcing models india tp hygiene workshop - final

  1. 1. Captive outsourcing models India TP hygiene workshop Presenter: Vishnu Bagri October 23, 2013 © 2013 Transfer Pricing Associates Holding B.V.
  2. 2. BACKDROP + India has evolved as a premier outsourcing hub for IT, ITES, engineering and other R&D activities + MNEs have typically adopted the cost-plus mark-up pricing model for remunerating their captive centres in India o Mark-ups ranged between 5%-10 during the 1990s and early 2000s; o MNEs have increased mark-ups to 15-20% to reduce India transfer pricing risks + Transfer pricing is one of the most important issues for tax heads in light of the aggressive enforcements by Indian tax authorities o 8 cycles of TP audits and transfer pricing adjustments to the tune of approx. USD 27 billion. + Captive centres have attracted considerable attention from Indian tax authorities on account of alleged disparity between their functional and risk profile in form vis-à-vis substance + In this presentation, we look at the emerging landscape for these captive centres from an Indian transfer pricing perspective 2
  3. 3. STATED VIEWPOINTS OF INDIAN TAX ADMINISTRATION + Scope of intangible property widened o + Captive centres are not necessarily risk mitigated o + March and June 2013: Administrative circular issued to provide parameters for identifying risk-mitigated captive R&D centres. Inclination towards Profit split method o + 2012 : Retrospective amendment (effective 2001-2002) to define intangible property to cover technology-related, marketing-related, customer-related, contract-related, human-capital related intangibles, location-based intangibles, etc. March and June 2013: Administrative circular encourages use of the Profit Split Method to benchmark transactions involving use /transfer of intangibles; The circular was withdrawn in June 2013. Emphasises higher returns for captive centres (particularly engaged in R&D activities); trend emphasised through the safe harbour rules which are based on above principles. 3
  4. 4. STATED VIEWPOINTS OF INDIAN TAX ADMINISTRATION + Indian tax authorities skewed towards higher returns for captive centres – following views provided in 2013 United Nations Practice Manual for Developing Countries: o Allocation of routine and low cost-plus return for captive centres may not reflect ALP. Decision making by skilled manpower of captive centre reflects the risks are controlled by the captive centre in conduct. o Location savings should be split between the participating parties. Comparability with local comparables determine only the price of the transaction and not allocation of location savings. o Compensation attributable for transfer of intangibles in addition to the arm’s length compensation for R&D activities. The captive centre creates unique intangibles, transfers legal ownership in the intangibles under agreement without appropriate compensation. 4
  5. 5. INDIA TP MANAGEMENT: THE EMERGING DECISION VARIABLES …. + How to demonstrate the lower risk characterization of captive centres? + Have the outsourcing models resulted in any location (dis)savings? Who should benefit/absorb the same? + What intangibles are created in supply chain and what is the role of the captive centres vis-à-vis these intangibles? Should the captive centres be remunerated for any intangible related returns? + Is the current cost-plus compensation technique appropriate? Should alternative techniques, such as revenue share or hourly charge out rates, be considered? + Which is the most appropriate transfer pricing method for testing compliance with ALP appropriate? Is there a case for the application of the Profit Split Method vis-à-vis the Transactional Net Margin Method? 5
  6. 6. THE VALUE CHAIN CONTEXT Tertiary Functions Primary Non-core support X1 Judgmental Y3 Core support Customer facing X2 X3 Core business X4 Highest value Profit Centre; High risks, Location Savings and Intangibles Y2 Routine Lowest value Cost Centre; Y1 minimal risk, Location Savings and Intangibles Also factor: • Key decision makers; employee profile • Business case • Stage in business cycle • Alternatives to captive outsourcing 6
  7. 7. LOCATION SAVINGS + Net cost savings that an MNE realises as a result of relocation of operations from a high-cost jurisdiction to a low-cost jurisdiction. + Review of following parameters to demonstrate existence / non-existence of location savings o Cost-benefit / opportunity cost analysis performed prior to outsourcing o Cost of capital and transition costs associated with outsourcing o Actual benefit vis-à-vis anticipated benefit o Industry / economic environment vis-à-vis efficiency o Bargaining power of captive centre : the value chain context o Trend in location savings over a period of time o Independent intangible transaction vis-à-vis factor of pricing 7
  8. 8. INTANGIBLES : VALUE RELEVANCY Kind of intangibles Routine Premium Intellectual Property Rights Protected by law Easily transferable Not a Critical Success Factor (typically value not dependent on mechanics of adaptability) Easily transferable Critical Success Factor – control exercised through contracts and legislation Competitive Intangibles Can be easily duplicated Can be duplicated only through transition of Human Capital Generate a competitive advantage but do not have legal protection Not a Critical Success Factor (however value could be dependent on mechanics of adaptability – e.g. methodology to use technology in non-tech savvy environment) Critical Success Factor • Competency based • Relational based • May be protected through non-compete arrangements 8
  9. 9. INTANGIBLES : VALUE RELEVANCY + Need to distinguish between: o Unique intangibles transforming revenue earning potential of the entity vis-àvis intangibles resulting in business efficiencies. o Impact of efficiency related intangibles can be demonstrated through productivity increases based on management information reports. + Need to identify the entity that makes decisions on the intangibles and bears intangibles-development risks. 9
  10. 10. COMPENSATION TECHNIQUES + Is a cost-plus model appropriate to remunerate highly-skilled talent and services? + Does compensation technique determine risk allocation? + Would third party service providers provide similar services on a cost-plus pricing model? + Alternative pricing models o Revenue share or charge-out rates Value chain context influences choice of compensation technique 10
  11. 11. METHOD OF TRANSFER PRICING + TNMM is a single-sided approach and does not throw light on entrepreneurial margins / losses earned by MNE group on specific transactions. + Value chain context can influence choice of method : o Profit split method more suitable to captive centres which are profit centres (by performing customer front-ending activities). o TNMM still appropriate for non-core support functions (such as payroll support). + Use of a contribution based approach in the value chain framework can be a strong defense strategy 11
  12. 12. CONCLUDING REMARKS – HYGIENE CHECK + India operational profile – review transfer pricing or/and permanent establishment risks + Document the value chain framework for risk assessment + Perform a mock assessment to not only test model and documentation but also spread transfer pricing awareness with decision makers. + Review policy and aim alignment with business dynamics. + Proactive collation of evidence for use in TP audit defense 12
  13. 13. THANK YOU! “An organization’s ability to learn, and translate that learning into action rapidly, is the ultimate competitive advantage.” - Jack Welch Vishnu Bagri Presenter Coordinates T: 91 80 22261371 E: vishnu@sduca.com 13
  14. 14. Transfer Pricing Associates Transfer Pricing Associates is an independent professional service and solution provider of expert transfer pricing, valuation and customs services. With our vast global network covering over 50 countries and a highly diverse staff with profound knowledge, extensive professional and industry experiences, we deliver premium quality services and solutions customized to your global business. +31 20 462 3530 | www.tpa-global.com | info@tpa-global.com Accretive SDU Consulting Private Limited Accretive SDU is the alliance partner of Transfer Pricing Associates in India based in Bangalore. Accretive SDU is a multi-disciplinary consulting organization, with a dedicated team of professionals focused on advising clients on Indian and International tax issues, including structuring inbound and outbound investments, tax optimization strategies, transfer pricing strategies and representation services. +91 80 22261371 | www.accretiveglobal.com | specialists@accretiveglobal.com The views expressed and the information provided in this presentation are of general nature and is not intended to address the circumstances of any particular individual or entity. The above content should neither be regarded as comprehensive nor sufficient for making decisions. No one should act on the information or views provided in this publication without appropriate professional advise. It should be noted that no assurance is given for any loss arising from any actions taken or to be taken or not taken by anyone based on this publication. © 2013 Transfer Pricing Associates Holding B.V. All Rights Reserved. 14
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