Worldwide: SKP Transfer Pricing 360˚

Last Updated: 13 September 2018
Article by SKP  

The tax courts in India have been increasingly attempting to provide clarity on recurring transfer pricing issues such as payment of royalty, functional characterization, etc. This edition of the newsletter, we bring you key findings of the Delhi High Court (HC) on long drawn issue of categorizing the taxpayer services as Knowledge Process Outsourcing (KPO) or Business Process Outsourcing (BPO) wherein the HC on the perusal of the agreement categorizes the activities of the taxpayer to be in the nature of KPO services. In the same case, on the issue of overdue outstanding receivables, the HC has distinguished delay in receivables from associated enterprise to be independent of the transaction of provision of service, requiring a separate benchmarking and compensation to the taxpayer. This ruling is alarming to all multinational enterprises, requiring them to give attention to delay in receivables from associated enterprises at the time of transfer pricing certification and documentation.

In the section for key regulatory updates in India, we bring you the recent amendments in the tax audit report from transfer pricing perspective, especially, the disclosure requirements pertaining to secondary adjustments provide tax authorities with relevant information in useful format for further analysis. On the other hand, the additional disclosure requirements enhances the role of the tax auditor requiring them to verify additional details.

The section on key judicial pronouncements outside India covers rulings in USA, the big win by IRS in the case of Altera Corporation on treatment of ESOP cost, which potentially has far reaching impact on the taxpayers in USA.

Lastly, the section on key regulatory updates outside India covers some developments in the USA on guidance issued for carrying out transfer pricing examination by IRS Officers, key statistics on Advance Pricing Agreement program introduced in Canada and changes in documentation requirements in France.

We hope you find this newsletter useful and look forward to your feedback. You can write to us at

Warm Regards, The SKP Team

A. Judicial Pronouncements

Firmenich Aromatics India Pvt Ltd1 - ITAT deletes adjustments made in respect of royalty payments and software services availed because of estimations used by the TPO to determine ALP

Facts of the case

The taxpayer was engaged in the business of manufacturing and marketing of industrial flavors, fragrances and chemical specialties. The taxpayer had paid a royalty to its Associated Enterprise (AE) for availing the technical know-how.

Furthermore, the taxpayer had made payments for the software services received from the AE. The taxpayer had also benchmarked the stated transaction using the Transactional Net Margin Method (TNMM), by aggregating it with certain other international transactions related to manufacturing.

Approach of the tax authorities

With respect to royalty payments, the Transfer Pricing Officer (TPO) alleged that the taxpayer did not derive any benefit from such payment and that only 10% of the royalty paid was justified and made transfer pricing adjustment towards balance 90%. Similarly, with respect to the payments that were made for the software services, TPO made an adjustment stating that the taxpayer had failed to demonstrate the benefit, while the latter claimed to have received. TPO used an estimated man-hour rate to determine the Arm's Length Price (ALP) and then made the transfer pricing adjustment. The Dispute Resolution Panel (DRP) upheld such adjustments.

The Ruling of the Income Tax Appellate Tribunal (ITAT)

The ITAT deleted the above transfer pricing adjustments on the following grounds:

  • TPO cannot make an ad-hoc adjustment on an estimation basis and doubt business expediency.
  • TPO is duty bound to determine ALP by using methods prescribed in the domestic law.
  • The taxpayer had paid royalty in the previous years as well, which were held to be at ALP by the tax authorities. The principle of consistency will apply.
  • Regarding the availing of software services, if the TPO wishes to rely on Comparable Uncontrolled Price (CUP) method, appropriate comparable should be brought on record to support its claim.

McKinsey Knowledge Centre India Pvt Ltd2 - Research and Information services, a KPO service and not BPO, an outstanding receivable is a separate international transaction

Facts of the case

The taxpayer has a wholly owned subsidiary of a US-based company that is engaged in the business of providing Research and Information (R&I) services and IT support services. The services with respect to the R&I comprised journalistic research, information support, domain-specific research support, analytics involving time-intensive analysis requiring expertise, as well as analytical tools and techniques.

Provision of R&I services

The taxpayer benchmarked the captioned transaction by characterizing these services as Business Process Outsourcing (BPO) services using TNMM.

Approach of the tax authorities

The TPO alleged that the services of the taxpayer should be characterized as Knowledge Process Outsourcing services (KPO). Accordingly, he rejected almost all the comparable companies that were selected by the taxpayer himself and introduced his own set of comparable companies. The DRP strongly upheld the order of the TPO.

Ruling of the ITAT

The ITAT chiefly relied on the findings of the TPO and DRP to characterize the taxpayer as KPO service provider because of the considerable expertise and skills that was involved. Furthermore, as regards the selection of comparable companies, the ITAT accepted the taxpayer's grounds that none of the companies proposed by the tax department meet the functional similarity criteria.

Ruling of the High Court

The High Court (HC) perused the master service agreement besides the invoices shared between the taxpayer and the AE and concluded on the two questions of law raised before it. They are as follows:

  • That taxpayer's functions were more akin to a KPO comprising of knowledge-based research and information services rather than BPO services (ruled in favor of the tax department);
  • That the nature of services provided by the comparable companies do not demonstrate even a degree of similarity with the services rendered by the taxpayer, and that the risk profiles were very different (ruled in favor of the taxpayer).

Interest on receivables

The HC also upheld ITAT's ruling on adjusting for non-charging of interest on outstanding receivables and rejected taxpayer's contention that sales transaction encompasses the effect of early or late realization of proceeds from AE. It was also stated that no separate benchmarking is required. The HC held that international transaction, in the nature of interest on overdue receivables, needs to be benchmarked separately and not in an aggregated manner.

Note: The transfer pricing related issues on overdue receivables was a most contentious issue until the recent past. However, the recent HC level rulings in few cases have clearly suggested that working capital adjustment is the most appropriate barometer to test the arm's length nature of excessive credit period if any (aggregated approach).

Contrary to this settled position, the above ruling in the case of McKinsey India which suggests that the notional interest on overdue receivable shall be benchmarked separately (segregated approach) may open Pandora's box for litigation in India on this issue.


1 ITA No. 2590/Mum/2017 – AY 2012-13

2 ITA No. 461/2017, ITA 526/2017, ITA 590/2017, ITA 82/2018 - AY's 2011-12 & 2012-13

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