Introduction In order to derive synergies and reduction of costs, the Multinationals companies started the practice of common shared center or one affiliate provides services on a central basis to several other affiliates. The agreements may be formulated amount group entities to jointly develop, produce or obtain rights, assets or services. Each participant shall bear the cost of such expenditure on a pro rata basis i.e. subject to the benefits received. Such arrangements tend to involve research and development, advertising, marketing and promotion (‘AMP’), centralized management services, information and technology, administration etc. The Indian tax law treats that arrangement or transaction as an International Transaction by virtue of section 92B of Income-tax, Act, 1961. As per section 92B(1), ‘’international transaction’’ means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of the enterprises. However, moot questions which to be answered can be categorized as under-
- Whether the benefit actually received from intra group services?
- What shall be the allocation key to attribute the cost for such benefit or how to determine the economic and commercial value of such service?
- Whether such intra group service is a part of shareholder/stewardship activity?
- Whether service recipient needs such service and is not duplicate?
OECD Guidelines On 05th October 2015, the Organization for economic co-operation and development released its final report 2015 report under its action plan on base erosion and profit shifting (‘BEPS’). The chapter of the report provides guidance specifically in relation to intangibles and their exploitation between the groups. The focus of the approach laid out in report is centric to an extent of economic value derived. Consequently, the functional analysis should identify the intangibles and the manner in which they create value to the organization. The demarcation needs to be done between soft or hard intangible, routine or non-routine and trade or marketing intangibles. Also, the owner needs to be identified within a MNE group, which is ultimately entitled to share the returns or profits out of the intangibles exploited within a group. Although, the legal owner of the group may receive the returns but there could be instances where other group members may have performed functions, taken risks or utilized its assets. Thus, the approach for such allocation and risks should be associated with the development, enhancement, maintenance, protection and exploitation of intangibles. The allocation of such intangible invite challenges like comparability, impact of income on a group, year in which investment is done vis-à-vis year in which return is yielded, economic ownership etc. The Action plan 10 instructs countries to develop transfer-pricing rules to provide protection against common types of base eroding payments like management fees and head office charges. The plan has laid out guidelines for identifying low value intra group services; allocation keys, benefit test and standard 5 percent mark up. Determining an arm’s length charge Once, it is established that intra group service has been rendered or benefit is derived, the next step shall be to substantiate if it’s at arms length. This means that the charge for intra group services should be that would have been charged in an uncontrolled scenario. There can be a case where exclusively an agreement is maintained between associated enterprises for specific set of services and thus, consideration is pre determined. Such direct method can be adopted by an enterprise where it also provides services to independent party and also, it shall be convenient to substantiate before tax authorities. However, this method shall not serve a purpose if services rendered to a independent enterprise is subjective or occasional. In such cases, groups may find cost allocation or apportionment methodology convenient. This methodology may require some degree of estimation or approximation or subjectivity and thus, it may not be acceptable by the tax authorities. Such indirect method should be sensitive to the accounting principles, cost allocation; benefits derived and reasonably correspond to the benefits derived. Consequently, it could arise to a situation of double taxation, as it is difficult to determine the cost incurred if compensation not adequately identified. Basis on the facts and circumstances of the case, the method should be appropriately applied for benchmarking. The OECD guidelines (Chapters I, II and III) propose Controlled Uncontrolled Price Method (CUPM) or Cost Plus Method for pricing intra-group services. It states that CUP method shall be most appropriate in a case where comparable services are availed or provided in either of the country. A cost plus method shall be appropriate in absence of CUPM and nature of services, risk involved and assets owned are comparable to those undertaken by independent enterprises. Consequently, in absence of above two methods, other transactional profits method may apply subject to the facts of a transaction. Interplay between section 37(1) and intra group services The revenue determines the arm’s length value of any such service as NIL and accordingly makes adjustment. One of the landmark judgments in this issue is Dressar Rand. In the case, the ITAT has clearly stated that it is the prerogative of the assesse to conduct business. It is not open for the revenue officers to question the commercial wisdom of the assesse. Its laid out that Transfer Pricing Officer exceeded the powers of the Assessing Officer. The Bench stated it is immaterial whether the such service fulfills the benefit test as its already allowed as an expense u/s 37(1) of the Act. The only question left to the TPO is to determine the arm’s length value of the transaction i.e. how much an independent person should have paid in case of availing such services. Similarly, whether such services are availed in the previous year is irrelevant. Any expenditure needs to fulfill the following requirements in order to qualify expenditure u/s 37(1) (a) it is not capital expenditure; (b) it is not personal expenditure; and (c) it should be expended wholly and exclusively for the purpose of business. Thus, any expenditure, which has been incurred, needs to be seen in a real sense that it is actually spent and not for the purpose of earning income. The section or the Act, nowhere curtails the assesse from incurring any amount in his commercial sense for the purpose of the business. It has been rightly said in the ruling that “The Assessing Officer cannot question the reasonableness by putting himself in the arm-chair of the businessman and assume status or character of the assessee.” The law has been settled and it shall be pertinent to quote extract from CIT v. Chandulal Keshavlal & Co., Petlad, [1960] 38 ITR 601- “In deciding whether a payment of money is a deductible expenditure one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading. If the payment or expenditure is incurred for the purpose of the trade of the assessee it does not matter that the payment may inure to the benefit of a third party (Usher's Wiltshire Brewery Ltd. v. Bruce [6 Tax Cas 399]. Another test is whether the transaction is properly entered into as a part of the assessee's legitimate commercial undertaking in order to facilitate the carrying on of its business; and it is immaterial that a third party also benefits thereby (Eastern Investments Ltd. v. CIT [(1951)SCR594]. But in every case it is a question of fact whether the expenditure was expended wholly and exclusively for the purpose of trade or business of the assessee. In the present case the finding is that it was laid out for the purpose of the assessee's business and there is evidence to support this finding.” Going forward and keeping in view of the overall tax scenario, it shall be essential for the company to maintain robust documentation factoring functions performed, risk assumed, benefits availed, assets owned, economic ownership vs legal ownership, cost allocation keys. Any adjustment towards intra group services shall be driven by such key factors. Also, the OECD guidelines on base erosion has focused on development, enhancement, maintenance, protection and exploitation of intangibles
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