The first question that comes to mind is that what is Location
Savings? The answer to this is very simple; when a Multinational
Enterprise (MNE) saves costs by relocating facilities from a
high-cost jurisdiction to a low-cost one, it is considered location
saving under transfer pricing terminology. From a business and
strategic point of view a MNE is perfectly justified in its
decision to relocate. One may ask why should there be an issue at
all as the jurisdiction where the operations are located say for
eg. India would stand to gain in terms of taxes?
The tax authorities in India claim that the Indian enterprise
should additionally be compensated for the location savings that
the MNE would have had by relocating their operations to India.
The Mumbai Tribunal in the case of Watson Pharma (P.)
Ltd. v DCIT  54taxmann.com88 recently had an occasion to adjudicate upon
this controversial issue.
The facts of the case were that taxpayer was engaged in
provision of contract manufacturing and contract Research and
Development (R&D) services to its Associated Enterprises (AEs).
The taxpayer adopted Transactional Net Margin Method (TNMM) and
selected Indian comparable companies for benchmarking its
international transactions with its AEs to substantiate the
arm's length nature of these transactions.
The TPO while making addition on account of choice of
comparables also contended that the taxpayer's AEs enjoyed
locational advantage on account of lower costs in India by shifting
contract manufacturing and contract R&D activities to the
taxpayer in India vis-ŕ-vis undertaking the same in the US.
Further, relying on research paper / articles, the TPO held that
there is approximately 40% and 50% cost reduction in India to the
AEs on contract manufacturing and contract R&D activities
respectively. Based on this analysis, the TPO computed the overall
cost savings to AEs from these activities in India and attributed
50% of such savings to the taxpayer on the ground that such
arrangement was mutually beneficial for the AEs and the taxpayer.
The TPO accordingly proposed an adjustment for location savings
which adjustment was confirmed by the DRP.
The Tribunal ruled in favour of the assessee. Amongst other
reasons, the ITAT relied heavily on the ruling of the Delhi
Tribunal in the case of GAP International Sourcing India Pvt.
Ltd. vs. ACIT (2012) 149 TTJ 437 and held that when local
Indian comparables which are operating in similar economic
circumstances as that of the taxpayer are considered for
benchmarking, any benefit (if at all) on account of location
savings would have already got embedded in the operating margins of
the comparable companies. Since the taxpayer's operating margin
is higher than the arm's length margin based on such local
comparables, specific adjustment for location savings is not
required. While holding this position, the Tribunal also observed
that G20 countries have given their consensus to the above view in
OECD Guidance in Intangibles and India is part of G20
The Tribunal disregarded the contention of the TPO that in the
absence of the various details regarding AEs (such as cost of
manufacturing in the US and ultimate selling price by them to the
distributors), it could be assumed that location savings arise to
the AEs. The Tribunal held that the financial results of the AEs
are not relevant for determining the arm's length margin of the
taxpayer. The Tribunal also observed that the reliance placed by
the TPO on research papers for computation of location savings is
ad hoc, based on assumptions and cannot be accepted. The
Tribunal observed that the research papers were only web based
articles and were not accepted by any forum.
This ruling comes at a time when the Government is trying to
promote a non-adversarial tax regime and would benefit
pharmaceutical, auto, IT and IT-enabled companies, among others,
that are engaged in similar disputes.
Originally published July 16, 2015
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
Cummins Inc. is a foreign company, rendering services in respect of desktop/laptop software license and internet mail facilities to its Indian associated enterprises, i.e. CIL and CSSL which were paying IT charges provided by the taxpayer.
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).