India’s High Court (HC) of Delhi, in the case of M/s Cushman & Wakefield India Private Limited (the Taxpayer), has ruled on the transfer pricing aspects of payments made for certain intra group services.
The Taxpayer had received certain liaison and coordination services from its Associated Enterprises (AEs) for which the AEs charged the Taxpayer actual costs, allocated based on an allocation key. The Transfer Pricing Officer (TPO) disallowed the payment on grounds that the Taxpayer did not establish the arm’s length nature of the same. Since the AEs charged only the actual costs without adding a profit element, the Taxpayer argued that it was not required to benchmark the transaction. The Taxpayer was of the view that determination of the arm’s length price (ALP) in this case would only have the effect of reducing the tax incidence in India, which is not permitted under the provisions of Section 92(3) of the Income-tax Act, 1961 (the Act). The taxpayer’s contention was earlier affirmed by the Income Tax Appellate Tribunal (ITAT).
The HC rejected the Taxpayer’s contention that no benchmarking is required where the AEs have only recovered costs without charging any mark up. The HC ruled that even though the transaction involves only a recovery of cost, as the transaction is between two AEs, it is necessary to test whether an uncontrolled entity for the same or comparable services charges an amount less than or equal to or more than what was charged to the Taxpayer by the AEs. Application of Section 92(3), which does not permit application of ALP if it has the effect of reducing tax incidence, cannot be inferred merely because the AEs recover costs without a mark-up. A comprehensive transfer pricing (TP) analysis is required to test the appropriateness of the costs that are allocated as well as for determining applicability of Section 92(3). The HC also observed that while examining whether an independent entity would have paid for such services, the Tax Authorities cannot question the commercial judgment of the Taxpayer.
The HC thereafter remanded the matter back to the Tax Authority for a re-determination of the ALP for the transaction.
The TP analysis and documentation of intercompany services is among the most complex and burdensome areas of TP compliance, and can represent a significant compliance risk for multinational companies having operations in India. In the absence of prescriptive guidance in the Indian TP rules regarding intra-group services, the guidance contained in Chapter VII of the OECD TP Guidelines regarding special considerations for intragroup services is often relied upon by the Tax Authority as well as by taxpayers. A core concept of the Guidelines is that a charge to affiliates must provide a specifically identified benefit. Thus a benefit test is required to substantiate the non-general benefits received by a related party due to the services for which it is receiving an intercompany charge.
The HC’s observation that the role of the TPO is to examine whether an independent entity would have paid for such services implicitly seems to recognize the need to consider the benefits test while determining the ALP for intra-group services.The HC’s observation that the TPO cannot question the commercial wisdom or reasoning for providing the services is welcome as it seeks to respect the business judgment of a taxpayer. The HC’s view that a comprehensive TP analysis is necessary before determining applicability of Section 92(3) may result in increasing the compliance burdens for taxpayers especially where certain low-value/ routine services are charged at cost.
Taxpayers need to consider the impact of this ruling on the TP analysis and compliance obligations for intercompany service transactions.
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