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India - Definition of 'International Transactions'

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India - Definition of 'International Transactions'

  1. 1. © Copyright 2014 IBFD: No part of this information may be reproduced or distributed without permission of IBFD. Disclaimer: IBFD will not be liable for any damages arising from the use of this information. India Will Budget Proposal To Modify the Term “International Transaction” Increase the Compliance for Indian Companies? Shuchi Ray and Amit Dattani[*] Issue: International Transfer Pricing Journal, 2014 (Volume 21), No. 5 Published online: 13 August 2014 The authors review the proposed amendment to section 92B(2) of the Income Tax Act with regard to the definition of “international transaction” for transfer pricing purposes. Controversies arising from prior judicial decisions, as well as the potential impact of the amendment on global contractual arrangements of multinationals, are also considered. 1. Introduction The Finance Minister of India, in presenting the Finance (No. 2) Bill 2014 on 10 July 2014, stated: “In order to reduce litigation on transfer pricing issues, I propose to make certain changes in Transfer Pricing regulations”.[1] Certainly, this statement triggered high expectations in many a heart that there would be certain positive and qualitative changes in the Indian Transfer Pricing Regulations. And, indeed, some of the contemporary and futuristic budget proposals (e.g. the introduction of APA rollback provisions, the use of multiple year data, the concept of an arm’s length range) should lead to a reduction of transfer pricing litigation in India. This article will focus on another proposal of the Finance (No. 2) Bill 2014, which Bill seeks to provide clarity for the definition of the term “international transaction” as provided in section 92B(2) of the Income Tax Act 1961 (the ITA). The primary endeavour here is to analyse whether this proposed amendment to section 92B(2) of the ITA, while having the central aim of helping to reduce transfer pricing litigation, would also lead to an increase in reporting obligations for corporations entering into genuine contractual arrangements. 2. A Brief Overview of the Law Understanding the background of the provision is the first step of the present analysis. Section 92B(2) of the ITA was introduced into the Transfer Pricing Regulations with the objective of covering within its scope those transactions entered into by an enterprise with unrelated parties where there could potentially be substantial influence from any of its associated enterprises. The apparent focus of section 92B(2) was on: – curbing base erosion and profit shifting (resulting from influence by the associated enterprise(s) on India-related pricing); and – addressing the so-called substance test, namely covering within its scope those transactions involving conduit entities (where a third party is interposed between two transacting associated enterprises so as to avoid triggering the Transfer Pricing Regulations). Under section 92B(2), a transaction between an enterprise and a third party is deemed to be a transaction between associated enterprises if: – there is a prior agreement between the enterprise’s associated enterprise and the third party (referred to as “such other person” in the ITA); or – the terms of relevant transactions are determined, in substance, between this associated enterprise and the third party (i.e. such other person). * Shuchi Ray is Director at Deloitte, Mumbai. Amit Dattani is Manager at Deloitte, Mumbai. All views expressed are those of the authors and not necessarily those of the firm. 1. Budget 2014-15 – Speech of Mr Arun Jaitley, Minister of Finance, on 10 July 2014 (http://indiabudget.nic.in/ub2014-15/bs/bs.pdf).
  2. 2. © Copyright 2014 IBFD: No part of this information may be reproduced or distributed without permission of IBFD. Disclaimer: IBFD will not be liable for any damages arising from the use of this information. Finance (No. 2) Bill 2014 proposes to amend sub-section (2) of section 92B of the ITA to clarify that the said third party may or may not be a non-resident. Thus, pursuant to this clarification, any transaction between two Indian entities (one of them being the enterprise under consideration and the other being an Indian third party) would be deemed to be an “international transaction”, if the same has been undertaken in pursuance of a prior agreement between the enterprise’s associated enterprise and the Indian third party, or the key terms and conditions of the transaction are being influenced by the enterprise’s associated enterprise and the Indian third party. The principle outlined by the clarification can illustrated as in Figure 1. Figure 1 3. Key Judicial Precedents There have been some controversies that arose from judicial decisions concerning the interpretation of section 92B(2) of the ITA. The analysis below considers some of these controversies and how they now stand in view of the proposed amendment. In Stratex Networks (2013),[2] Stratex India was engaged in undertaking installation, commissioning and maintenance of equipment supplied by its associated enterprise. In addition to earning commission and warranty service income from the associated enterprise, Stratex India also earned income from the related installation and maintenance services provided to certain Indian customers of the associated enterprise. The Delhi High Court, while confirming the order of the Income Tax Appellate Tribunal[3] (the Tribunal/ ITAT), held that the rendering of services by Stratex India to Indian third-party customers, in the given facts and circumstances, is not regarded as a deemed international transaction under section 92B(2) of the ITA, given that none of the conditions provided under section 92B(2) were fulfilled. This ruling emphasized the substance test, in that the Delhi High Court opined that there were no specific findings to indicate that the terms of the transaction (of Stratex India with the Indian third-party customers) relating to installation, commissioning and maintenance work, had been determined “in substance” by Stratex India’s associated enterprise. In Kodak India,[4] Kodak US had entered into a global arrangement with Carestream Inc. (a third party) for the sale of “medical imaging business”. Thereafter, Kodak India entered into an agreement with Carestream India (an associated enterprise of Carestream Inc.) for a sale pertaining to the Indian business. The transfer pricing officer invoked section 92B(2) of the ITA on the premise that the Indian sale was consequential to the global sale. The Mumbai Tribunal held that in light of the Transfer Pricing Regulations – with special emphasis on the relevance of the phrase “for the purpose of sub-section (1)” in section 92B(2) of the ITA, as well as taking into consideration the objective of this sub-section – section 92B(2) could not be read independent of section 92B(1). Accordingly, section 92B(2) did not apply to transactions between domestic entities. The Mumbai Tribunal also affirmed that as the global agreement (between Kodak US and Carestream Inc.) did not have any impact on the sale transaction in India, both the conditions outlined in section 92B(2) of the ITA were not fulfilled. 2. IN: HC Delhi, 6 May 2013, Commissioner of Income Tax v. Stratex Net Works (India) Pvt. Ltd., ITA 353/2011, Tax Treaty Case Law IBFD. 3. The Income Tax Appellate Tribunal is a second-level appellate authority and final fact-finding authority. 4. IN: ITAT, 30 Apr. 2013, Kodak India Pvt. Ltd. v. Addl. Commissioner of Income Tax Officer 10(1), ITA 7349/Mum/2012.
  3. 3. © Copyright 2014 IBFD: No part of this information may be reproduced or distributed without permission of IBFD. Disclaimer: IBFD will not be liable for any damages arising from the use of this information. In contrast to the above, in a recent writ petition in Vodafone India Services (2012),[5] the Bombay High Court, in discussing the applicability of section 92B(2) of the ITA, explored the applicability of that provision to a transaction with a domestic third party. However, the Bombay High Court did not provide any conclusive finding on this issue. With a view to putting to rest these interpretation-based controversies, and also to spell out the exact intent of the Parliament, Finance (No. 2) Bill 2014 has proposed to clarify the applicability of section 92B(2) of the ITA even to transactions between an enterprise and a resident third party, provided that the other condition(s) of prior agreement and/ or influence by the third party and the enterprise’s associated enterprise, is/are satisfied. 4. Global Contractual Arrangements of Multinationals: Interpretation of “Such Other Person” In this context, one should consider centralized global contractual arrangements. Typically, multinationals – with a view to achieving better bargaining power, uniform discounts and pricing across the globe and optimization of cost and services – enter into a global contract or master service agreement with their vendors or customers for the whole group. Pursuant to a master service agreement, the local entities of the group enter into local service agreements with the local group entities of the third party. The local service agreement would mirror or refer to the relevant clauses of the master service agreement for the key terms and conditions. Thus, a local service agreement is generally seen as a supplement to a master service agreement. To implement such a local service agreement, two Indian entities would enter into a transaction in pursuance of an agreement entered into between their respective associated enterprises (both being non-residents). In the given context, it is necessary to examine whether such a transaction between two Indian entities will be considered as a deemed international transaction under section 92B(2) of the ITA. This is illustrated in Figure 2. Figure 2: Master service agreement / local service agreement In this regard, one should consider the amended section 92B(2) of the ITA. (2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be an international transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and 5. IN: HC Bombay, 6 Sept. 2013, M/s Vodafone India Services Pvt. Ltd vs. Union of India (Ministry of Finance), Addl. Commissioner of Income-tax, Asst. Commissioner of Income-tax, Writ Petition 488 of 2012.
  4. 4. © Copyright 2014 IBFD: No part of this information may be reproduced or distributed without permission of IBFD. Disclaimer: IBFD will not be liable for any damages arising from the use of this information. the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise where the enterprise or the associated enterprise or both of them are non- residents irrespective of whether such other person is a non-resident or not. From a plain reading of the above provision, it appears that for the application of section 92B(2), the transaction must be undertaken with a third party termed as “such other person”. However, in the above scenario, the Indian taxpayer is entering into a transaction with an associated enterprise of “such other person” (which has a prior agreement with the associated enterprise of the Indian taxpayer), and not directly with “such other person”. Accordingly, based on a literal and strict reading of the law, one could argue that such a transaction does not trigger a deemed international transaction. Nonetheless, based on a combined reading of judicial pronouncements on the subject and the proposed amendment, it may be possible to take the position that the underlying intent of the Parliament may be to cover all transactions entered into by an enterprise with the Indian arm of a third-party group in pursuance of an initial understanding between the enterprise’s group with the third-party group at a global level. Thus, once there is an understanding at a global level, thereafter, regardless of the actual transaction being undertaken between any of the entities of either of the groups, the deemed international transaction position may still be triggered from an Indian perspective (i.e. in a situation where an Indian entity of the enterprise’s group enters into a transaction with an Indian entity of the third-party group). Where the local service agreement provides sufficient leeway to the Indian entity to supersede the terms and conditions of the master service agreement (i.e. where the Indian entity’s management has the right to negotiate with vendors on the pricing or to choose another vendor in the event of material pricing differential, quality mismatch, etc.), one could argue that such a transaction is independent of influence and involvement of an associated enterprise (and, consequently, section 92B(2) of the ITA is not triggered). Needless to say, this would have to be determined on a case-by-case basis, as there is no uniform formula for universal application. The most vital factors to consider in this regard would be the overall independence and conduct of the transacting parties and the availability of the option to carve out a contractual arrangement which is distinctly different from what had been pre-agreed at a global level under the master service agreement (global agreement). 5. Conclusion The transfer pricing proposals propounded through Finance (No. 2) Bill 2014 are largely progressive and futuristic in nature, and represent a step towards reducing needless transfer pricing litigation and aligning the Transfer Pricing Regulations with globally accepted transfer pricing principles. The same should help achieve a larger objective of presenting India as an investor-friendly jurisdiction. However, one will have to accept the proposed amendment to section 92B(2) of the ITA with a pinch of salt, as it is likely to result in a few more ounces of compliance for already compliance-burdened companies in India!

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