TPO, DRP, ALP!
Published on Thu, Sep 15,2011 | 15:55, Updated at Thu, Sep 15 at 18:23Source : Moneycontrol.com
By: Sunil Lala- ED; Devang Shah- Manager & Zeel Jambuwala- Executive, KPMG
Globalisation has made it possible for a multinational enterprise to achieve high levels of integration and the ability to have centralised functions. This has resulted in many multinational enterprises offering centralised services such as legal, accounting, financial management, data processing, etc. from one or several regional centres to group companies. To have a just and equitable distribution of these centralised costs, the multinationals enter into Cost Contribution Agreement (CCAs). It is seen MNCs find significant business advantage to share the costs and risks of developing, producing, or obtaining assets, services, or rights under a CCA.
A CCA is a framework agreed amongst enterprises to share such costs and risks and to determine the nature and extent of the interests of each participant in the result of the activity of developing, producing, or obtaining those assets, services, or rights.
Challenges surrounding CCA and Transfer Pricing Authorities
Admittedly, payment to Associated Enterprises (AEs) under CCA is a vexed issue and gaining popularity with Transfer Pricing Officers (TPO) for Transfer Pricing adjustments. Under such CCA arrangement, amongst other tax issues, there has been an uncertainty as to how cost should be allocated between AEs using suitable allocation keys, which is invariably challenged by the TPO. The Revenue Authorities (i.e., AO / TPO) have been making disallowances / adjustments in respect of the payments made by the Indian entity to the AEs under CCA on the grounds that they are (a) excessive as compared to the benefit which it has received under CCA; or (b) not necessary in view of the business activities / resources available; or (c) not correctly allocated amongst AEs.
In such a backdrop, the Hon’ble Income-tax Appellate Tribunal, Mumbai bench has recently delivered an important decision, in the case of Dresser Rand India Private Limited providing the needed clarity on this issue and also commenting adversely on the actions of the Revenue Authorities.
Dresser-Rand India Private Limited (DRIPL) availed certain services from its Associated Enterprise – Dresser-Rand USA, under a CCA jointly entered into with other group entities. It made payments towards the same as per the allocation keys, based on Head count of employees and Sales proportion.
The TPO determined the Arm’s Length Price (ALP) to be ‘NIL’ and disallowed the entire amount paid towards CCA on the premise that no real services were in effect availed by the Assessee, considering (a) the resources already available with the Assessee, (b) the profitability and expenses ratio trend and (c) the fact that no such payment was made towards CCA in prior years. Further, the ALP of the supervision services offered to AE on discount was also rejected by the TPO and the entire amount of discount was disallowed.
Further to the TPO’s conclusion, the Assessing Officer (‘AO’) in the Draft Assessment Order disallowed the same under Section 37(1), Section 40A(2)(b) and Section 40(a)(i) of the Income-tax Act, 1961 (Act).
The Dispute Resolution Panel (DRP) confirmed the Draft Assessment Order, without deliberating on the merits of the matter and failed to appreciate the voluminous underlying evidences filed by DRIPL evidencing the procurement of services.
In turn, the AO passed the Final Assessment Order giving effect to the DRP’s Order, confirming the upward Transfer Pricing adjustment.
Key Observations and Conclusions of the Hon’ble Mumbai Tribunal
• Powers of TPO
The Tribunal categorically observed that while evaluating the ALP of expenditure, it is wholly irrelevant as to whether the Assessee benefits from it or not; the real question which is to be determined by the TPO in such cases is whether the price of the services is what an independent party would have paid. It is only elementary that how an Assessee conducts his business is entirely his prerogative and it is not for the revenue authorities to decide what is necessary for an Assessee and what is not. It also observed that the fact that the AE gave same services to the assessee in the preceding years without consideration is also not relevant. Thus, the Tribunal held that the TPO had not only gone much beyond his powers in questioning the commercial wisdom of the Assessee’s decision to take benefit of expertise of Dresser Rand USA but also beyond the powers of the AO.
• Duty of DRP
The Tribunal, defining the role of the DRP, observed that it is not open for the DRP to reject the objections of the Assessee in a summary manner without properly analysing the objections of the Assessee and dealing with the evidences filed by the Assessee. [It is pertinent to note that the Tribunal did not set-aside the matter to the file of the lower authorities for re-adjudication, but decided the matter on merits and deleted the addition].
• ALP – Cost Contribution
Basis of Allocation: The Tribunal accepted the allocation keys of (i) Ratio of sales proportion (ii) Employees head count, adopted by the Assessee on the Cost Contribution and rejected the allocation keys suggested by the TPO i.e. (i) Ratio of actual services (ii) Employee Cost, on the ground that there is no objective way in which use of services can be measured and that even in common practices, cost are shared in accordance with some objective criteria like sales proportion and number of employees.
Method adopted: The Tribunal upheld the Transactional Net Margin Method (TNMM) adopted by the Assessee, observing the fact that the revenue authorities had neither made any effort to disregard the TNMM method nor to show which other prescribed method would be more appropriate for determination of ALP for payments made under CCA. (The TNMM method compares the net profitability of a transaction, or group or aggregation of transactions, to that of another transaction, group or aggregation.)
• ALP - Discount to AE with respect to supervision services rendered
The Tribunal observed that since the revenue did not reject the TNMM method adopted, the question of adopting CUP (comparable uncontrolled price) does not arise. Even under CUP, it is not necessary that sales must take place under same price since there can always be variations for the same product or services on the grounds like quantum of business, risk factors etc. It further observed that when Assessee is dealing with an AE, there are no commercial risks, no marketing costs and there could be several other factors, including the fact that the Assessee could indeed go to many important customers, a normal discount is well justified while computing ALP for transaction offering discounts to the AE. Thus, the Tribunal held that unless the AO demonstrates that the discount so allowed would not have been allowed in an arm’s length situation, no ALP adjustment should be made in respect of the same since the material factor is not the discount being granted to the AE but the discount being granted at ALP.
• Cost Contribution (without mark up) - No disallowance under Section 40A(2)(b) of the Act
The Tribunal held that since the payment made to the AE under a CCA without any mark-up is held to be at ALP, it cannot be said that the amount paid is excessive or unreasonable vis-ŕ-vis services rendered by the AE.
• Cost Contribution - No disallowance under Section 40(a)(i) of the Act
Relying on the judgment of the Apex Court in case of GE India Technology Centre Pvt. Ltd v. CIT, 327 ITR 456, the Tribunal observed that the vicarious tax withholding liability cannot be invoked unless the primary tax liability of the recipient is established. Further, the Tribunal observed that the services availed under the CCA cannot be taxed as ‘Fees for included services’ under Article 12(4) of India-US DTAA since the services prima facie do not satisfy the ‘make available’ criterion of Article 12(4)(b) of the DTAA.
This is a welcome decision for multinationals and is fairly pragmatic, keeping in perspective the true spirit and objectivity surrounding the CCA. The same is expected to bring substantial and due relief to the taxpayers during their Transfer Pricing proceedings and to cast a responsibility on the Revenue Authorities to be more vigilant and to pass better speaking Orders, lucidly detailing the reasons for coming to a particular conclusion in the Orders. Summing up, such decisions will reinforce the confidence of multinationals to get justice for genuine and legitimate transactions at the end of the day!