In 2013, India witnessed unprecedented TP litigation with adjustments to the tune of $13.3 billion being made in the eighth round of TP audits concluded on January 31, 2013, relevant to FY 2008-09. The focus has been broadened on issues like share valuation, marketing/brand intangibles, location savings, etc. In the case of share valuation, the revenue authorities alleged instances of grossly undervalued share investments made by MNEs in their Indian associated enterprises (AEs). Taxpayers have contended that the issue of shares as well as premium on shares are capital transactions as per the provisions of the Income-tax Act, 1961, and TP provisions should not be applied to capital receipts, which are not taxable under the Act. But the revenue authorities rejected this by observing that the transaction of issue of shares to an AE would amount to an international transaction, relying on retrospective amendment to Section 92B of the Act. The revenue authorities added the difference in the valuation of shares to be income without specifying any reasons. They have also treated such undervaluation of the shares as loan and calculated notional interest on the same when such secondary adjustment is not mandated by the Act.
In respect of marketing intangibles, the revenue authorities have focused on the development of foreign brands/intangibles in India, with the local Indian entity bearing expenses related to such development. It has been alleged that expenses incurred by an entity on advertising, marketing and promotion expenditures (AMP) typically result in an enhancement of the value of the brand/trademark belonging to the overseas AE and, so, appropriate compensation for such AMP expenses is required to be made by the AE.
For determining excess AMP spend by the Indian licensee manufacturer/distributor, the revenue authorities have been comparing the licensees AMP spend with the AMP spend of manufacturers/distributors which had been identified by the licensee as comparables for net margin comparability. The so determined excess AMP is presumed by the revenue to be a service provided to the foreign owner of the brand when the Indian licensee taxpayer could itself be the beneficiary of the excess AMP spend.
In the IT sector, the revenue authorities have alleged that MNEs are taking advantage of low costs in India to develop patented services or products that are sent to overseas parent firms as low-value routine work. Indian taxpayers providing captive R&D services have been operating as contract service providers deemed to be providing routine services without employing valuable assets or bearing significant risks, and have been typically remunerated with a mark-up on total costs and the foreign AE is entitled to the intangible related returns and a large part of the location savings, if any. The revenue authorities have, in some cases, classified these services as high value and have sought to apply the profit split method (PSM) for performing a TP adjustment. The basis of the adjustment assumed that the R&D centre performed non-routine functions and contributed to the creation of unique intellectual property, which, in turn, got transferred to the foreign affiliates without appropriate compensation.
For India to continue to attract FDI, clear guidance in the form of detailed legislation on TP laws as well as their practical implementation based on global best practices will facilitate proactive and efficient tax planning by MNEs in India. It should be acknowledged that randomly resorting to high pitched adjustments may be a temporary solution, but the same adversely affects Indias reputation as a favourable investment jurisdiction.
The APA programme will go a long way in providing certainty.
The author is head, transfer pricing, KPMG India, Global Transfer Pricing Services. Views are personal