The Chamber of Tax Consultants

THE CHAMBER OF TAX CONSULTANTS

3, Rewa Chambers, Ground Floor, 31, New Marine Lines, Mumbai - 400 020

lTel.: 2200 1787 / 2209 0423 lFax: 2200 2455 lE-mail:

lVisit us at: Website: http://www.citcindia.org

3rd Intensive Study Course on Transfer Pricing

(Including Domestic Transfer Pricing) – 24 Sessions – 48 Houses

Day & Date – Saturday, 6th April, 2013

Case Studies for Panel Discussion CTC TP Course 2013

1.  Case Study – AMP expenses

1.1.  SMART is a Swiss Verein which has specialised in cutting edge integrated circuit etched memory devices. It holds several patents globally and also sells its products under the brand name Smart Memory a Device Mark which is registered in 42 countries in the world.

1.2.  It invested 25.97 % equity in DUMB Pvt. Ltd. (DUMB) a company in India in May 2005, which has manufacturing and sales facilities for electronic instrumentation and devices. Apart from the equity investment it enters into a comprehensive agreement with SMART for quality control services, licence of technology for manufacture of Smart Memory devices as well as use of the Smart memory Trademark on certain other integrated circuits manufactured by DUMB, subject to quality control and supervision of SMART. All Advertising, marketing, promotion (AMP) and distribution expenses in India will have to be borne by DUMB. For all the above services DUMB will have to pay a license fee of 12 % of sales.

1.3.  DUMB, for AY 2010-11, had benchmarked its international transaction of payment of license fee by applying Transactional Net Margin Method (TNMM). Since its profitability at 25% was higher than comparables margin of 20%, it had concluded in its documentation that its international transaction was at arm’s length.

1.4.  The following figures are given

(in crores)

Assessment Year (AY) / 2006-07 / 2007-08 / 2008-09 / 2009-10 / 2010-11
Sales (INR) / 75 / 125 / 170 / 200 / 250
AMP Spend (INR) / 5 / 10 / 12 / 18 / 24
% of sales on which SMART Trademark used by DUMB / 0 / 45 / 75 / 90 / 85
Transfer Pricing Officer (TPO’s) adjustments (INR) / 24 (disallowance of AMP) + 25.5
(12 % license fee on 85% of sales)
Total proposed adjustment by TPO INR 49.5 crores

1.5.  In addition to the above, the following information is also relevant;

1.5.1.  SMART has registered its trademark in India. However, in the context of India, DUMB has modified this trademark slightly and has also registered this modified trademark as an Associated trademark in the name of SMART.

1.5.2.  SMART also charges a licence fee between 5%-12% of sales (net of excise duty and sales returns) for licensing its trademark to various jurisdictions around the world whether or not they are Associated Enterprises (AEs).

1.5.3.  In the assessment proceedings for the AY 2010-11, the TPO proposes to disallow the license fee paid and he states that at most a license fee of 5 % may be allowed based on general industry practice.

1.5.4.  The TPO has contended that since DUMB has incurred AMP expenses to enhance the brand and develop marketing intangibles for SMART, it must receive compensation from SMART, since the current AMP expenditure is more than the AMP expenditure of comparable companies, which was 4% of sales.

Please discuss the perspectives of the TPO and suggest appropriate arguments.

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2.  Case study - Management Services

2.1.  WELLDONE Inc. is based in USA and its group is in the business of providing management consultancy services namely in the field of strategic management, change management, etc. The group has been in existence for more than 75 years and rendered services throughout the globe.

2.2.  WELLDONE Inc. has set up a subsidiary in India FINE Pvt. Ltd. (FINE), in 2009. To perform services as envisaged by the group, WELLDONE Inc. renders management services to all its group entities.

2.3.  WELLDONE Inc. as part of its activities has a shared service centre, which performs a variety of central functions in the USA without which the local entities would not be able to operate in a seamless fashion as a one unit.

2.4.  The functions are performed centrally and thus, the benefits of synergy are enjoyed by all the group companies worldwide, which would not have been possible if each entity had to avail these functions independently from the third parties and since these services are group specific, outside parties would not be able to replicate the same.

2.5.  The costs of these activities are allocated to all the operating entities in the Group. Management services are provided by the WELLDONE Inc. to its group in a number of activities. These services include corporate communications, corporate finance and group reporting services like MIS, formulating group accounting policies and procedures, etc. Further, the following divisions also help in the delivery of the Management Services, namely; Group Quality Assurance, Human Resource, Information Technology, Integrated Business System, Internal Audit Services, Legal Services, etc.

2.6.  For the above services, WELLDONE Inc. charges a cost plus mark-up of three percent. Where the services are specific to a particular entity, a charge will be made to that entity based on the operating cost (including overheads) plus a mark-up of three percent. Where third party professional/consultancy costs are simply being passed on to a service receipt entity, these costs will not be subject to any further mark-up. The costs of any stewardship function or of any service specific to the running of the local corporate centre will not be charged out to service recipient entities.

2.7.  In all other cases, where services cannot be specifically identified as being provided to a particular entity, and do not relate to stewardship, the cost of providing these services is recharged to service recipient entities on an appropriate basis (head count, third party sales, area occupied, etc). As noted above, these recharges will include an arm’s length mark-up unless the recharge is simply reallocating third party costs.

2.8.  FINE, for AY 2010-11, had benchmarked its international transaction of payment of management fees by applying TNMM. Since, the operating profit margin of FINE i.e. 17 percent is more than that of the comparable companies i.e. 7 percent; the international transaction is at arm’s length.

2.9.  In the assessment proceedings for the AY 2010-11, the TPO proposes to disallow the whole of management fee paid. FINE has submitted various documents, emails, etc. which demonstrate the receipt of various management services and how it has been able to utilise these services for the benefit of its operations.

2.10.  The TPO has further contended that;

2.10.1.  When expenditure is incurred for the benefit of the group as a whole, no charging of such expenditure is required as such expenditure is not incurred in connection with any individual member of the group and the benefit of such expenditure would be available to all the members of the group.

2.10.2.  Corporate communication, internal communications, implementation of group fineness policies and group accounting policies are meant for maintaining overall control over the subsidiaries and for overall coordination.

2.10.3.  What is the tangible and substantial commercial benefit derived by paying such charges to the AE?

2.10.4.  Services might have been performed for the benefit of parent company in its role as shareholder, rather than to provide value to the subsidiaries.

Please discuss the perspectives of the TPO and suggest appropriate arguments.

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3.  Case study on adjustment due to issue of shares / subscription of shares

Please discuss the perspective as regards the adjustment made by the Transfer pricing officer on the Indian entity for;

·  Issue of shares to its parent company at below market value

·  Subscription of shares of its subsidiary at above market value

4.  Case study on locational savings

Please give your perspective on the proposed action of the Transfer pricing officer who proposes to make adjustments to the consideration received by the Indian entity for provision of research and development services to its AEs; on the basis of location specific advantages (locational savings) derived by the AEs by outsourcing their research and development work to India, over and above the return earned by the Indian entity.

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The TPO intends to attribute income to the Indian entity not only for the services provided but also for the location advantages (locational savings), on the basis that the comparable return earned by comparable companies would only compensate the Indian entity for the routine services provided, and hence, for computing the arm’s length price of the international transaction for provision of R&D services on a holistic basis there should be further revenue attributable for the location savings.

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