Worldwide: Transfer Pricing 360˚

Last Updated: 23 August 2018
Article by SKP  


Higher courts will only adjudicate on 'substantial question of law'

Watson Pharma Pvt Ltd 1- The taxpayer carried out Research and Development (R&D) activities in India for supporting the manufacturing functions of the Associated Enterprise (AE) outside India. Citing the reason for savings in average costs for R&D in India, the Transfer Pricing Officer (TPO) proposed adjustments for location-specific advantage. Before the Income Tax Appellate Tribunal (ITAT), it was observed that the taxpayer, as well as the comparables, operate in a perfectly competitive market and hence the taxpayer did not enjoy any exclusive or unique factors that may result in location savings, as against its competitors. Furthermore, the revenue authorities were not able to substantiate the adjustments in the year under consideration or based on any authenticated global material. In addition to this, placing reliance on the guidance of Transfer Pricing Aspects of Intangibles issued by the OECD, which states that where local market comparables are available, specific adjustment for location saving is not required, the ITAT ruled in favor of the taxpayer. Relying on the observations of the ITAT, the Bombay High Court (HC) also dismissed the appeal of the Revenue starting that this issue does not give rise to a substantial question of law.

Softbrands India Pvt Ltd 2- In this case, the dispute was in relation to the selection of comparables companies and the application of filters. The Karnataka HC has ruled that the ITAT is the final fact-finding authority and if there is no unreasonableness in the ITAT order in findings of the fact, it will not qualify to be a "substantial question of law," hence not appealable before the HC. The HC categorically explained the provisions relating to the determination of arm's length price and how the ITAT is the final fact-finding body. Furthermore, the HC referred to Section 100 and 103 of the code of civil procedure that reiterates the principles of Section 260A and stated that:

"While dealing with these appeals..., we cannot disturb those findings of fact..., unless such findings are ex- facie perverse and unsustainable and exhibit a total non-application of mind by the Tribunal to the relevant facts of the case and evidence before the Tribunal."

Excess AMP as Against the Comparables does not Always Result in Brand Promotion

Soni Mobile Communications 3 - The taxpayer was engaged in distribution, marketing and post-sales services. The taxpayer purchased mobile handsets and spares at a resale price minus basis and the pricing of the products is regulated in a way that ensures the taxpayer earns an arm's length return. The AE owned commercial / marketing intangibles and was involved in complex product development, manufacturing & brand development. During the assessment proceedings. The TPO noticed that the taxpayer had incurred huge expenditure on Advertising, Marketing and Promotion (AMP). The TPO held that the expenditure was to promote the brand name which is beneficially owned by the AE, thereby creating a local marketing intangible for the AE. The TPO held that this warrants a compensation from the AE drawing support from Section 92F(v). The TPO, adopting the bright-line test, observed that the ratio of AMP/ sales was higher as against comparables and held that the excess expenditure of the taxpayer was on account of brand building in India and proposed an adjustment with a 15% markup. The Dispute Resolution Panel (DRP) upheld the view of the TPO but reduced the markup to 12%.

Furthermore, even the ITAT accepted treating AMP as an international transaction. However, the HC in this case, along with others, had remanded the matter after rejecting the application of the bright-line test. One of the many relevant findings of the HC was that "the bright line test has no statutory mandate and a broad- brush approach is not mandated or prescribed." After that, the ITAT, based on the HC directions, re-examined the FAR of the taxpayer including the AMP expenses. The ITAT observed that the compensation model of the taxpayer is structured in such a manner that it had earned margins, even after considering AMP expense, which was higher than the average margins of the comparables. Considering the fact that the AEs are responsible for the core marketing, and that the taxpayer was in its first year of business in India, incurring AMP in the domestic market could not have added any value to the brand name. Accordingly, the ITAT deleted the adjustment.

'Business Dependency' for determining AE relationship under section 92A(2)g

Magic Software Enterprises India Pvt Ltd 4 - The taxpayer was a subsidiary of an Israel company. A group company sold its business, along with its rights and access to an existing customer base, to an independent entity. Thereafter, the independent entity incorporated a new company in the Netherlands with whom the taxpayer had entered into an agreement for the provision of software services. The TPO, during the proceedings, observed that the service provided by the taxpayer was on the platform owned by the other party, and without the platform, the taxpayer would not be able to perform its services. Accordingly, referring to Section 92A(2)(g), the TPO held that the taxpayer is 'wholly dependent' upon the use of know-how, patents, copyrights trademarks, etc. owned by the recipient party and that party should be considered to be an AE. The taxpayer submitted that the services to this party constituted only 20% of the total turnover and it also provides services to other AEs and trades in software licenses in the local market making it "not wholly dependent" on the platform of the recipient entity. It also stated that it is a general industry practice to share platforms on which the software is to be developed and it cannot be held that the service is dependent on that platform. The CIT(A) agreed with the view of the taxpayer and stated that there was no AE relationship under Section 92A created. Furthermore, ITAT also upheld this view and directed the CIT(A) to pass a speaking order with a direction that the independent party cannot be considered to be an AE purely on account of the use of the platform belonging to the customer.


Hong Kong

On 4 July 2018, the Legislative Council enacted the Base Erosion and Profit Shifting (BEPS) and Transfer Pricing Bill. The key provisions of the new transfer pricing regime are as follows:

  1. Implementation of the arm's length principle for related-party transactions.
  2. Related party transaction is exempted from the new rules if the transaction is:

    • Domestic in nature;
    • Does not give rise to an actual tax difference; and
    • Not utilized for tax avoidance purposes.
  3. Introduction of Documentation requirements pertaining to applicability and implementation of Master File, Country-by-Country Reports and Local File based on the thresholds prescribed.
  4. Imposition of tax on taxpayers performing Development, Enhancement, Maintenance, Protection, and Exploitation of Intangibles (DEMPE) functions that contributed to any intellectual property held by an overseas related party.
  5. Introduction of the provisions relating to Permanent Establishment (PE) and guidance on how profits should be attributed to a PE.
  6. Introduction of a formal Advance Pricing Arrangement (APA) regime, including rollback provision.
  7. Introduction of a statutory dispute resolution mechanism whereby a taxpayer can present a case for a Mutual Agreement Procedure (MAP) and/or arbitration under a relevant tax treaty.
  8. Penalties and fines for noncompliance.


The Australian Tax Authority (ATO) has recently issued a Draft Schedule 2 to Practical Compliance Guideline (PCG) 2017/1 - 'ATO compliance approach to transfer pricing issues related to centralized operating models involving procurement, marketing, sales and distribution functions.' This draft guidance assists taxpayers to comply with their transfer pricing obligations, allows them to self-assess the transfer pricing risk for certain types of purchases from a related-party offshore hub and helps them understand the department's analysis of the transfer pricing arrangements. Furthermore, the ATO has also released guidance addressing ATO's compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions. It sets out specific risk indicators for related party derivative arrangements that are used to hedge or manage the economic exposure of a company or group of companies. Where the derivative is entered into with a related party, the ATO is likely to consider the arrangement as higher risk unless the terms and conditions of the related party derivative are backed out to the external market on mirror terms.


The Thai government submitted a draft of law amending the Revenue Code on transfer pricing to the National Legislative Assembly for consideration. The key changes and updates are:

The transfer pricing law will be in force for the accounting periods starting on or after 1 January 2019.

Taxpayers who pass the income threshold will need to prepare and submit an annual report disclosing the relationship between related parties and the related party transactions, regardless of whether such relationship exists throughout the entire accounting period, or whether the related parties had any intercompany transactions during the year.

OECD's Discussion Draft on Financial Transactions

The Organization for Economic Co- operation and Development (OECD) published a discussion draft on the transfer pricing aspects of financial transactions. While the draft does not yet represent a consensus position, it does aim to clarify the application of principles included in the OECD Transfer Pricing Guidelines, 2017. The draft addresses various issues relating to transfer pricing in financial transactions, viz treasury function, intra-group loans, credit ratings, cash pooling, hedging, guarantees and captive insurance. The OECD has sought feedback on the draft from the relevant stakeholders by 7 September 18.


1. ITA No. 124/Mumbai/2016 for A.Y 2009-2010

2. ITA No. 536/Karnataka/2015 c/w 537/2015 for AY 2006-2007

3. ITA No. 6410/Delhi/2012 read with High Court Ruling in ITA No. 16/Delhi/2014 of AY 2008-2

4. ITA No.1802/Pune/2013 & CO. No. 98/2014 of AY 2008-2009

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.

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