Key Takeaways: Common Issues in Transfer Pricing Issues relating to Transactions and Specified Items Issues relating to Comparable and Assesments Issues arising pursuant to Covid-19

1. Practical Issues in Transfer Pricing
CA Jugal Gala

2. Research
Credits
Thirumal V

3. Legends used in the Presentation
AE Associated Enterprises
ALP Arm’s Length Price
AMP Advertisement, Marketing and Promotion
BLT Bright Line Test
MNE Multinational Enterprises
OECD Organisation for Economic Cooperation and Development
TP Transfer Pricing

4. Presentation Schema
Transfer Pricing
Common Issues in
Transfer Pricing
Transactions
Comparables
Treatment of
Specified Items
Assessment
Reporting COVID-19 Miscellaneous

5. Transfer Pricing (TP)
The rationale for transfer pricing is to ensure that transactions among associated
enterprises (AEs) or related parties happen at an arm's length price to ensure a fair share
of tax for the country which has been the prime contributor to the transaction
The ultimate objective of the ‘transfer pricing’ legislation is to ensure that the tax base
is protected in the country of source, which has rightly and predominantly
participated in enabling the transaction
The provisions of transfer pricing law shall apply to both international transactions and
specified domestic transactions
Various methods have been suggested to determine the arm's length price and
documentation required has also been prescribed by the legislation.
Chapter X of the Income-tax Act contains Transfer Pricing provisions in India

6. Common Issues in TP
Foreign AEs are typically not accepted as tested party
Indian TP laws typically does not allow for adjustments to tested party but only to comparables.
There is lack of clarity & guidance with respect to adjustments to a transfer price
Tax authorities use secret comparables for transfer pricing audits. Though the absence of access to
secret is an impediment for the assessee, tax authorities are not precluded from exercising this
right in the interest of the revenue.
Benchmarking analysis of intra-company services viz. management support service, business
support services, etc. proves to be complex issue considering the lack of guidance in the legislation

7. Transactions

8. What is the nature of taxability of costs incurred
by Indian company reimbursed by foreign AE?
Would it form part of operational cost?
As reimbursements do not relate to the expenses incurred for the company, such expenses are not
included as part of operational cost
However, if such amount is material and involves additional efforts for Indian Entity to carry out such
work, then there needs to be a profit element for the Indian Entity
The Indian company has to maintain proper records to prove that it relates to reimbursement and there
is no profit element involved.
Costs reimbursed by related parties are generally at cost to cost. This could relate to costs backed by third
party bills, say an airline bill relating to travel cost.
Reimbursements relate to an Indian company incurring expenses on behalf of the related entities and
then the related entities returning the amounts, on a cost basis, to the Indian companies.

9. What is the position in the case of interest free
loans given by an Indian entity to a foreign AE?
Also, whether guarantees provided to AE,
without any fee, could fall under the same
league?
Loan advanced to a foreign Associated Enterprise would attract interest, even if no interest is
actually charged.
The loan given to a foreign entity needs to be charged at respective interest rate relevant to the
currency in which the loan was given.
However, there could be cases where there is a genuine case of business advance being held by
the Associated Enterprise.
If there is a genuine transaction and it could be proved the balances and the period for which it
is maintained is as per business norms, then it could be argued in favour of the assessee.
Documentation will play a vital part in such circumstances.
The above rationale may not apply for guarantees given in favour of associated enterprises.
Since providing guarantee involves taking risk and cost, guarantees provided to associated
enterprises without a fee shall call for tax adjustments.

10. Comparables

11. Whether segmental revenue needs to be
considered while selecting comparables?
ALP needs to be arrived for an international transaction rather than the whole company.
Thus, the concept of segmental revenue gains importance. If the transaction covers the overall
operations of the company, then it could be compared as whole, else segmental revenue needs
to be considered.
In the cases of segmental results of a company engaged in diverse activities it is a common
experience that in many such results, certain expenditures, particularly relating to interest and
head office, are generally not allocated.
In such cases it is advocated that when direct comparables are available, there is no requirement
to consider segmented results.
For benchmarking process, functional comparability would be the primary criterion.
In case of multiple businesses, direct comparables are to be considered.
If they are not available, then segmental results could be relied on as the last option.

12. What is the position of law regarding loss-making
comparable companies?
In the case of Sabic Innovative Plastics India (P.) Ltd. vs. Deputy Commissioner of Income-tax, Circle
2(1)(1), Vadodara [2019] 104 taxmann.com 162 (Ahmedabad - Trib.) it was held that when losses are
continuously incurred by a company for three consecutive years, two years preceding and current year,
then that comparable can be excluded from comparable list
And, in the case of Bobst India (P.) Ltd. vs. Deputy Commissioner of Income-tax, Circle 1 (1), Pune
[2015] 63 taxmann.com 339 (Pune - Trib.) it was held that persistent loss making means continuous loss
making for more than 3 years; company which earned profit in one of last three years could not be
considered as loss making entity so as to exclude same from comparability analysis
It can be concluded that only a persistent loss-making can be
considered as a bad comparable and excluded.
And for a company to be persistent loss-making, it
must have incurred losses in at least 3 consecutive
years including the previous year concerned.

13. Whether it can be held that if companies are
earning super normal profits, could they be
not considered?
if the loss making companies are excluded for the purpose of comparability, then companies with
super normal profits needs to be excluded and vice versa
However, if such abnormal profits is due to extraordinary events such merger and acquisition
the company can be excluded from comparables
Courts have held that occurrence of profits and losses are part and parcel of business and thus it
could not form part of filter criterion. Both loss making and super normal profit-making
companies are to be considered as comparable companies.
There are cases where even operating profits more than 50% are being considered by the Transfer
Pricing Officer as comparable in the benchmarking process.
Although loss making companies are removed, super normal profit-making companies remain in
the list of comparables and push the ALP higher.
Though Transfer Pricing Officer rejects companies having losses, there is reluctance in rejecting
companies having super normal profits.

14. How to factor for working capital adjustments
while determining ALP?
Working capital adjustment is factored while determining ALP to provide the benefit of time value of money
Working capital adjustment between the tested party and the comparables results in difference being adjusted in profits
• For example, the assessee could be receiving funds in advance from its overseas parent (AE)
while a comparable company would be paying in advance and offering credit to its customers.
• In this case comparing the margins without factoring for the working capital adjustments will
not be prudent.
The process of working capital adjustment relates to identifying the level of
working capital employed and the cost of deploying such working capital.
Difference in the levels of working capital adjustment as appropriate to a base
reflecting interest rate is considered.
The Courts have upheld working capital adjustments in various cases.

15. Treatment of Specified Items

16. Whether comparability analysis is to be
performed by including “one time
expenditure” under operating costs?
Generally normal expenditure needs to be included under operating costs. If there is any one
time expenditure, they shall not be included under operating costs.
For concluding whether expenditure is normal or not, the type of business in which the
assessee is operating is important.
In the case of Polartech India (P.) Ltd. vs. Assistant Commissioner of Income-tax [2013] 40
taxmann.com 81 (Hyderabad - Trib.), it was held that management fees paid towards setting
up of new factory would not constitute operational expenses and same should be excluded
while computing operating profits of assessee in determining profit level indicator (PLI)
The nature of cost considering the nature of business needs to be analysed to confirm whether
a cost should be classified as operating cost or otherwise.

17. Whether foreign exchange gain or loss would
form part of operating revenue or cost while
analysing comparable financial information?
In the case of export oriented businesses or business relying on imports, foreign exchange
gain or loss is an unavoidable transaction.
The concern under such situations is whether such gain or loss is an integral part of operating
income or expenditure while analysing the financial information of comparable companies.
Various judgements have held that foreign exchange fluctuation was to be treated as an item
of operating nature both for assessee company and comparable companies.
Foreign exchange are considered as part of operational income by the Transfer Pricing Officer
in assessment orders and the same rationale shall apply for foreign exchange losses.
However, due considerations needs to be given to the nature of business, whether it is
predominantly engaged in import or export of goods and services.

18. Creation of provisions and reversal of such provisions forms part of majority of the financials of the
company. Creation of provision is a normal part of any business activity i.e. required in the business
operations.
Further, based on the actual incurrence of expenses, the reversal of provisions created is determined in
the subsequent years.
Therefore, both, provisions and reversal of such provisions, may be considered to be in operating nature
for the purpose of computing the operating margin of tested party and comparable companies.
In the case of Hyundai Motor India Engg. (P.) Ltd. vs. Deputy Commissioner of Income Tax, Circle-2(2),
Hyderabad [2018] 100 taxmann.com 483 (Hyderabad - Trib.) it was held that in the course of transfer
pricing proceedings, bad debts and provisions for bad debts were to be regarded as operating expenses
for purpose of computing profit and loss of comparables companies.
However, there are no judicial precedents which confirms the inclusion of other provisions viz. warranty,
etc. being routinely part of the business, in the operating cost of the company.
What will be the treatment of provisions and
reversal of such provisions in TP?

19. What is Bright line test (BLT) and its importance in
the context of Advertising Marketing and
Promotion ("AMP") expenses?
The precedent provided in the case of Maruti Suzuki India Ltd. v Additional Commissioner of Income-tax,
Transfer Pricing Office [2010] 328 ITR 210 (Delhi High Court) has created a lot of awareness around AMP
expenses.
This is generally prevalent in the case of MNCs, where a foreign company sets up its subsidiary and gives its
brand and sells the product under its brand name. In return, it collects royalty from the Indian subsidiary.
- Till these cases came up, the Indian subsidiaries were making payment under the head royalty.
- However in the case of Maruti Suzuki India Ltd mentioned supra, it was held that though the Indian
subsidiary made payments, in turn, it had created awareness for the foreign brand in the Indian soil, for
which it needs to be compensated.
- Thus, the foreign company needs to pay any amount spent more than the normal marketing
expenditure to the Indian subsidiary.
Background

20. Contd.
However, in the case of Sony Ericsson Mobile Communications India (P.) Ltd. v. Commissioner of Income-tax -III
[2015] 55 taxmann.com 240 (Delhi), it was held that where comparables adopted by assessee, with or without
making adjustments, as a bundled transaction had been accepted by TPO, it would be illogical and improper to treat
AMP expenses as a separate transaction using bright line test and that the bright line test has no statutory
mandate and in all cases costs or compensation paid for AMP expenses cannot be 'NIL’.
This view has been affirmed by the Supreme Court in the case of Commissioner of Income-tax-IV v. Haier
Appliances India (P.) Ltd. [2016] 73 taxmann.com 300 (SC).
As per the Bright Line Test, the amount of AMP expenses incurred above the
similar amount incurred by comparable is considered as non-routine AMP expense
• For example, say the Indian subsidiary spent 4% of its sales for marketing expenditure while the industry
average is 3%, then the foreign company needs to pay the Indian subsidiary the difference of 1%
considering the bright line test.
• Any amount over and above the market average would be compensated considering the bright line test.
Issue

21. Assessment

22. Can TP adjustment be made, even if the AE makes
losses?
TP Adjustment can be made even
if AE makes losses, as it is the
assessee who is the tested party
and not it’s AE and loss by
Associated Enterprises will not
change the scenario
This principle was held in Syscom
Corporation Ltd. v Assistant
Commissioner of Income- tax,
Circle - 3(3) (2014) 45 taxmann.com
89 (Mumbai - Trib.)

23. How does lower profitability of AE make difference
to the Indian entity?
Therefore, entities earning lower profit are facing problem to prove that their low margin is not
because of shifting of profits but real commercial terms depreciating ALP
Section 92 is, therefore, not intended to be applied in cases where the adoption of the arm’s
length price determined under the regulations would result in a decrease in the overall tax
incidence in India in respect of the parties involved in the international transaction.
The basic intention underlying the transfer pricing regulations is to prevent shifting out of
profits by manipulating prices charged or paid in international transactions, thereby eroding the
country’s tax base.
The argument that since AE is earning lower profits hence margin in Indian entity should be low
is not accepted

24. Whether the assessee can alter the comparables at
the time of audit?
At the time of audit, if the assessee intends to alter the data due to valid reasons, it could be considered as
appropriate.
In the case of Deputy Commissioner of Income-tax, Circle 17(1), New Delhi v MCI Com India (P) Ltd. (2012) 53
SOT 290 (Delhi)(URO),
- assessee-company which was carrying on marketing support services had entered into international transaction
with its Associated Enterprises.
- Transfer pricing study conducted by assessee was approved by Transfer Pricing Officer.
- However, before Commissioner (Appeals), the assessee contended that 4 of comparables selected by it and
accepted by Transfer Pricing Officer had to be excluded for reason that they were not functionally comparable
with assessee as they were engineering companies providing end-to-end solution and not comparable to
assessee.
- Commissioner (Appeals) was held to be justified in admitting ground of assessee.
In the case of DCIT v Quark Systems P Ltd (2010) 4 ITR 606 (Chandigarh), assessee had included a comparable which
was later noticed to be making extraordinary profit and huge turnover and hence sought to exclude. Matter was
remanded back to the Transfer Pricing Officer for providing opportunity to the assessee's contention.
Thus assessee has the right of estoppel to exclude companies selected by it. However it could well be noted that
these situations would be considered based on the facts and merits of the case.

25. Reporting

26. Can there be a belated filing of Form 3CEB
where return of income has been filed within
the due date u/s 139(1)?
Hence it can be construed that belated filing for Form 3CEB is permitted by law and the applicability
of the penalty is entirely dependent on the reasonableness of the factors behind such belated filing.
In the case of Ashok Leyland Ltd. v Deputy Commissioner of Income Tax, Large Tax Payer Unit,
Chennai (2016) 67 taxmann.com 48 (Chennai - Trib.) it was held that revised Form 3CEB submitted
during TP proceedings within one year from end of assessment year, shall be accepted.
Technically the law permits belated filing of TP report since penalty u/s 271BA applies where a
person has failed to furnish a TP report within the due date specified u/s 92E.
Can Form 3CEB be revised?
Act or Rule doesn’t specify anything but option available on portal to upload revised Form 3CEB

27. What are the issues in Country-by-Country
Reporting?
Different compliance requirements in different
jurisdictions may have significant implications in
terms of information dissemination, efforts and
resources required to ensure compliance
Though one entity may not be obligated by its
domestic regulations to prepare a Master File, it
will be saddled with the burden to prepare the
other documentations to enable its Group
entities to furnish the Master File with their tax
authorities
• As CbCR is recently introduced, assessment of CbC reports have not been initiated yet
• More issues may crop up once the department sends notices for assessment of CbCR regime

28. COVID-19

29. Issues due to COVID-19
Global economic situation has been affected by the demand, supply and liquidity shocks that Covid-19 has
inflicted.
• Many MNEs would face pressures due to the coronavirus outbreak when
renegotiating these mark-ups. This would mean the margins for Indian entities of
the MNEs could come down. There is going to be an impact on cost-plus mark-ups
that all entities charge to parent or foreign entities. This will lead to issues as the tax
authorities may not accept reduction in mark-up.
Setting of Price
Consideration
• The more diverse the effects of an economic crisis between companies, industries, or
markets, the lower the chances of finding appropriate comparable transactions and
conducting a reliable TP analysis. Benchmarking strategies may need to be revised
by targeting comparables that are closer to the tested party.
Lack of
Comparables
• The economic downturn may lead MNEs to reassess their existing intercompany
financing arrangements and to devise appropriate structures for cash and liquidity
management. The crisis and the consequent increase in risk aversion in financial
markets has led to volatile credit spreads, changes in reference interest rates, and is
likely to result in fewer debt transactions.
Pricing of
Financial
Transactions

30. Contd.
• Companies that have agreements, such as advance pricing agreements, in place with
tax authorities may need to revisit the assumptions upon which such arrangements
were based. A change in critical assumption and important factors, such as functions,
risks assumed, costs incurred for mark-ups, allowance of payments, etc. may require
the renegotiation of the agreement with the authorities.
Changes in Dispute
Avoidance
Arrangements
• The fair market value and fair value standards of valuation only consider what is
known as of the valuation date. Therefore, for valuation dates prior to the Covid-19
pandemic, forecasts would not include cash flow projections reflecting the economic
and business disruptions of the virus. Conversely, those valuation dates falling after
the pandemic must include cash flow projections that properly account for the
current and future impact of the virus.
Cash Flow
Forecasts
• Due to the global implementation of travel restrictions and lock downs, people are
now grounded in their respective homes, providing virtual advice and information. In
this respect, emails/documents or similar paper trails that can serve as
documentation of the decision makers can be archived to form the basis for making
COVID-19 related decisions. It is still in question whether mere email
correspondences would be sufficient to meet tax authority requirements as
evidence of beneficial and value-added services.
Digital
Documentation

31. Issue Impact
Loss of the assessee subject to TP Currently, as per TP rules, PLI of current year of assessee are
benchmarked with that of 3 years average of comparable
companies. Amidst this scenario, assessee company would incur
losses. Thus, considering the current year’s data of the assessee
vis-à-vis the 3 year’s data of the comparable companies would
distort the comparability analysis
Profit being below the prescribed
percentage under the safe harbour
rules
As profits would push down, assessee may not be able to opt for
provisions of safe harbour rules and hence may be subject to
normal provisions of TP assessment
Delay in finalisation of accounts due to
lockdown
Assessee may face practical difficulty to carry out transfer
pricing study because of the lack of latest year data in TP
databases. The data wouldn’t be updated because of abnormal
delay in completion of audit and publishing annual accounts.
Other Issues due to COVID-19

32. Miscellaneous

33. Miscellaneous Issues
• Excise duty being a pass through cost has to be excluded from sales
as well as costs for both assessee and comparable companies while
computing operating margins
Whether comparability analysis is to be
performed by including or excluding
excise duty from sales?
• In comparability analysis, Depreciation needs to be considered where
the depreciation charge is material is nature
Whether comparability analysis is to be
performed by including or excluding
depreciation?
• OECD guidelines do not have any binding effect on Indian Transfer
pricing laws. However these guidelines do have a persuasive value.
What is the relevance of OECD guidelines
under the Indian Transfer Pricing laws?
• Letter of comfort is an assurance about a debt, short of a legal
guarantee, given to a bank by a third party
• Since it would not result in actual outflow of cash and there is no
contingent liability on the side of the related party, it is not
considered as a transaction attracting TP provisions
Whether Letter of Comfort shall be
subject to TP?
• There can be only one method for determination of arm's length
price which shall be the most appropriate method. However, at the
time of assessment, more methods can be additionally applied to
justify the position considered in the TP report
Whether there can be a combination of
methods used for determining ALP?

34. Contd.
Whether Employee cost can be used as a filter?
• Generally functional analysis shall form the basis for conduct of economic analysis. Also filters shall
be accordingly chosen while performing benchmarking. In case employee cost forms important
criteria, the same may be adopted as an additional filter.
If application is made under safe harbor and the same is accepted, whether transfer pricing study
needs to be conducted?
• As per the safe harbor rules, the provisions of sections 92D and 92E in respect of an international
transaction shall apply irrespective of the fact that the assessee has exercised his option for safe
harbor in respect of such transaction or not.
• Thus the conduct of transfer pricing study and preparation of the report is quintessential and are
not waived off even when an assessee has opted for application of safe harbor rules.
• Adoption of safe harbour rules would not entail any TP assessment and would obviate TP
adjustments
Whether Transfer pricing law is applicable in the case of entities being taxed under presumptive basis?
• Since Chapter X is an anti-avoidance provision, there is no specific exclusion provided under law
and shall apply to all transactions which may fall within the spirit of the levy. Hence the provisions
of transfer pricing shall apply to those entities liable for taxation under presumptive basis.

35. Thank You!
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