© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated...
© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated...
© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated...
© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated...
© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated...
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Delhi Tribunal upheld taxpayer's residual PSM over TPO’s TNMM and held that allocation of residual profits to be done based on contribution from each entity

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Recently, the Delhi bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Global One India Private Limited (the taxpayer) upheld taxpayer's residual Profit Split Method over the Transfer Pricing Officer application of the Transactional Net Margin Method for determining arm's length price. The Tribunal also held that where uncontrolled transactions are not available, the residual profits can be allocated based on how much each of the independent enterprises of the group might have contributed and relative contribution can be determined on the basis of key value drivers.

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Delhi Tribunal upheld taxpayer's residual PSM over TPO’s TNMM and held that allocation of residual profits to be done based on contribution from each entity

  1. 1. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG FLASH NEWS KPMG IN INDIA Delhi Tribunal upheld taxpayer's residual PSM over TPO’s TNMM and held that allocation of residual profits to be done based on contribution from each entity 25 April 2014 B Background Recently, the Delhi bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Global One India Private Limited 1 (the taxpayer) upheld taxpayer's residual Profit Split Method (PSM) over the Transfer Pricing Officer (TPO) application of the Transactional Net Margin Method (TNMM) for determining Arm's Length Price (ALP). The Tribunal also held that where uncontrolled transactions are not available, the residual profits can be allocated based on how much each of the independent enterprises of the group might have contributed and relative contribution can be determined on the basis of key value drivers. ________________ 1 Global One India P.Ltd. v. ACIT [ITA nos. 5571/Del/2011 Assessment Year : 2007-08 AND ITA No.5896/Del/2012 Assessment Year 2008-09] Facts of the case  The taxpayer is a company incorporated in India and is a subsidiary of EGN BV, Netherlands. The taxpayer is engaged in providing internet and related network services to the group’s customers in India. The group operates in a globally organised manner with critical customer- facing and revenue generating activities being undertaken by the group’s various operating entities across the globe.  The TPO rejected the PSM adopted by the taxpayer as the Most Appropriate Method (MAM) and adopted the TNMM and determined an upward adjustment to be made to the ALP for the Assessment Year (AY) 2007-08 and AY 2008-09. The Dispute Resolution Panel (DRP) upheld the conclusion drawn by the TPO.
  2. 2. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Tax department’s contentions  The PSM is not the MAM as it is possible to determine the cost incurred by the Indian entity separately. Hence, the taxpayer should be benchmarked on a standalone basis.  The taxpayer did not apply the PSM correctly as the residual profits were not split based on reliable external market data.  The key value drivers identified by the taxpayer are routine in nature and do not lead to creation of any unique intangible. The taxpayer has not put forth any evidence of any intangible created by it based on which it can justify the application of PSM as the MAM.  The acceptance of taxpayer PSM in other jurisdictions is of no consequence since applicability of PSM is to be judged with reference to Indian TP regulations.  The taxpayer has not been able to demonstrate any unusual reasons for the losses earned by it during the relevant Financial Year (FY). The taxpayer is relying on PSM merely to camouflage its losses at the net level.  The sixth method is prospective and is applicable w.e.f. 1 April 2012 and no ALP can be determined without benchmarking with external comparables. The Tribunal cannot read down enactments and has to simply enforce the law as enacted by the Parliament. Taxpayer’s contentions  The operations of the Group are highly integrated, interconnected and intrinsically linked wherein one Group entity records the revenues generated, whereas another Group entity incurs the expenditure for providing the services and where multiple entities are involved in the transaction. In such circumstances only PSM can be the MAM. If the PSM is not correctly applied, then the remedy is to correct the same and not reject the method itself.  The 'key value drivers' have been identified based on a detailed functional analysis. Each of the value drivers is determined to be equally important for the global operations of the Group; hence, each driver has been given equal weightage.  While applying the PSM, especially in a scenario wherein the functions performed or services rendered are unique in nature and comparables are not available easily for determining the manner in which profit has to be split, reliance has to be placed on some other indicia such as costs for determining how the residual profit must be allocated. This approach is supported by OECD Guidelines, UN's Practical Manual on Transfer Pricing for Developing Countries (UN TP Manual) as well as US Treasury Regulations.  The taxpayer is the joint entrepreneur in the business and not a low risk captive unit, and even if the costs incurred by an entrepreneur can be identified, the return attributable cannot be ascertained by applying the TNNM and comparing it with other independent comparables/ entrepreneurs. The Group's core asset is the global network that connects overseas entities to the 'Point of Supply' and in which all the group entities have invested heavily.  The taxpayer had furnished before the TPO detailed reasons/ explanation for losses being made by the EQUANT Group at the global level.  The PSM was not applied as per the exact requirements of the Income-tax Act, 1961 (the Act) read with Income-tax Rules, 1962 (the Rules) to the extent that residual profits allocation was not benchmarked with uncontrolled transactions. The taxpayer further submitted that nowhere in the world, benchmarking of residual profits for allocation is required. The taxpayer relied on various commentaries and referred to the decision of Asendas (India) Pvt. Ltd. 2 .  The taxpayer relied on Rule 10AB of the Rules, which was introduced w.e.f. 1 April 2012, giving the taxpayer a choice to adopt any other method. The taxpayer contended that this rule is retroactive, as it is procedural in nature. Tribunal’s ruling  In the present case, a transaction passes through a number of AEs and various parties which make a contribution to the transaction, share the revenues that arise as a consequence to such contribution. Each of Group entities deploys necessary assets and functions required for the transaction and contribute to the global network. Thus, the nature of the taxpayer’s group operations is integrated, interconnected and interdependent.  The Tribunal agreed with the taxpayer’s contention that the TNMM cannot be used for benchmarking _______________ 2 Asendas (India) Pvt. Ltd. v. DCIT (ITA No.1736/Mad/2011)
  3. 3. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. returns earned by the number of complex entities/entrepreneurs, where each make valuable unique contributions. The TPO, while adopting the TNMM, considered four comparables wherein the operating profit at the entity level was taken for the purpose of benchmarking the entity level profits of the taxpayer. The TNMM does not contemplate benchmarking at the entity level but at a transactional level.  The Tribunal noted that the taxpayer’s argument of TNMM not being applicable where there are commercial losses, cannot be accepted as a general rule. The decision as to what is the MAM does not depend on the factor as to whether a taxpayer has a loss or profits.  No doubt, the ALP has to be determined with reference to the Indian TP regulations only. At the same time, guidance can be taken from the OECD commentaries, the UN guidelines and other such literature.  Presence or use of unique intangibles is not necessary for adopting the PSM. When the transaction involves contributions of multiple entities and are integrated and interrelated and they cannot be separately evaluated for the purpose of determining ALP of any one transaction, the PSM is the MAM.  The Tribunal rejected the tax department’s contention that the residual PSM cannot be applied as reliable external market data necessary for the same were not available. In this regards, the Tribunal held that basic routine rate of returns were determined by the taxpayer based on external benchmarking.  The Tribunal also noted that though the Rules suggest that for application of the PSM, benchmarking should be done with external uncontrolled transactions, it is an impossibility in this case. Taking guidance from various international guidance and literature, the allocation can be done based on how much each independent enterprise might have contributed. The relative contribution has to be determined, based on key value drivers. Any benchmarking at this stage may not be practicable as comparables having similar, multiple, interrelated and integrated transactions, would be difficult to find. The Tribunal noted that a harmonious interpretation of the provisions is required to make the Rules workable. Based thereon, the Tribunal upheld the allocation of residual profits is to be done on the basis of contribution made by each entity.  The Tribunal accepted the following submissions of the taxpayer.  It is an admitted fact that as per Rule 10B(1)(d) of the Rules, India prescribes that a taxpayer can adopt either a contribution PSM; or a residual PSM, however, in a manner that whether or not an taxpayer adopts a contribution PSM or a residual PSM, the profits, would need to be split amongst the various AEs, who are parties to the transactions in question, on the basis of reliable external market data, which indicates how unrelated parties would have split such profits in similar circumstances. In other words, as per Rule 10B(l)(d) of the Rules, a contribution or residual PSM would need to be supplemented by a comparable PSM.  The PSM so prescribed in India is quite unique, as compared to both the OECD and the UN TP guidelines, as both provide flexibility to the taxpayer to adopt any of the following sub-methods under the overall PSM, namely contribution PSM, residual PSM or comparable PSM.  Prescription to mandatorily use comparable PSM to split entrepreneurial profits, by the Indian TP regulations, actually would make the PSM virtually redundant in most cases, since, it is not possible to obtain reliable market data on third party behavior in the matter of splitting profits.  The Comparable PSM is rarely used internationally in view of lack of reliable external data with respect to third party behavior to split profits; and OECD and UN clearly give taxpayers an option to adopt anyone of the three sub-methods under the overall PSM, without requiring the contribution and residual PSMs to mandatorily pass through comparable PSM. Thus, such compulsory mandate would render the entire mechanism of PSM unworkable in India, even in the most deserving of cases.
  4. 4. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.  In case the requirement of mandatory adoption of comparable PSM actually renders the entire scheme or mechanism of the PSM virtually redundant and impossible to comply with, then the requirement for adoption of comparable PSM should be dispensed with, and the taxpayer should be given an option to adopt a residual or contribution PSM.  The legislature has introduced Rule 10AB by the Income Tax (Sixth Amendment) Rules, 2012 w.e.f. 1 April 2012 under the sub head ‘Other method of determination of ALP’. With regard to the CBDT Circular issued while introducing the Rule, though the note does not indicate much as to the purpose, it can be seen that the purpose and objective of introduction of this Rule is to determine the ALP, whenever the methods suggested result in practical difficulties by adopting generally accepted methods which are not specifically listed. It is a procedural provision aimed at arriving at the ALP. Based thereon, the Tribunal held that it is retroactive. When a new method is allowed, with the objective of enabling determination of the proper ALP, such a provision operates retroactively, and can be used to determine the ALP in the earlier AYs also.  The Tribunal finally remitted the matter back to the file of the Assessing Officer for fresh adjudication in line with the observations made by the Bench. Our comments The ruling provides useful guidance on the application of the PSM, a method typically applied for complex related party transactions. The Tribunal’s reference of the OECD guidelines, the UN TP manual and other international literature while holding that the allocation of residual profits can be done based on relative contributions made by various entities, adds significance to relevant international practices on the development and interpretation of transfer pricing regulations in India. The Indian TP scenario where so far there was very limited guidance on the application of the PSM, this is a welcome judgment. The ruling also highlighted an important point about the ‘Other Method’. The Tribunal held that since it is a procedural provision aimed at arriving at the ALP, it is retroactive.
  5. 5. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity“ are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity. www.kpmg.com/in Ahmedabad Commerce House V, 9th Floor, 902 & 903,Near Vodafone House,Corporate Road, Prahlad Nagar, Ahmedabad – 380 051 Tel: +91 79 4040 2200 Fax: +91 79 4040 2244 Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore 560 071 Tel: +91 80 3980 6000 Fax: +91 80 3980 6999 Chandigarh SCO 22-23 (Ist Floor) Sector 8C, Madhya Marg Chandigarh 160 009 Tel: +91 172 393 5777/781 Fax: +91 172 393 5780 Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai 600 034 Tel: +91 44 3914 5000 Fax: +91 44 3914 5999 Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana 122 002 Tel: +91 124 307 4000 Fax: +91 124 254 9101 Hyderabad 8-2-618/2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad 500 034 Tel: +91 40 3046 5000 Fax: +91 40 3046 5299 Kochi 4/F, Palal Towers M. G. Road, Ravipuram, Kochi 682 016 Tel: +91 484 302 7000 Fax: +91 484 302 7001 Kolkata Unit No. 603 – 604, 6th Floor, Tower – 1, Godrej Waterside, Sector – V, Salt Lake, Kolkata 700 091 Tel: +91 33 44034000 Fax: +91 33 44034199 Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai 400 011 Tel: +91 22 3989 6000 Fax: +91 22 3983 6000 Pune 703, Godrej Castlemaine Bund Garden Pune 411 001 Tel: +91 20 3050 4000 Fax: +91 20 3050 4010

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