Facts
·
India company has overseas subsidiary companies
and there may arise requirement wherein customer execution requires the
involvement of both Indian company & overseas company. In such cases, the customer
will receive an invoice from one of the group companies. Consequently, there is a requirement to raise
intercompany invoices, where one group companies’ invoice to another group
company who is raising final invoice to customers.
·
To prevent profit shifting to jurisdictions with
lower tax rates, governments worldwide have mandated inter-company transactions
to be conducted at arm's length.
·
Further, as per Indian companies act, there is
need to take audit committee approval
before executing any intercompany transaction and record that intercompany transactions
are at arm’s length. In this regard, a certificate from a chartered accountant
is also required who confirms that intercompany transactions are at arm’s
length.
·
Given below how to compute arm’s length price at
different scenarios for an intercompany transaction.
Purchase order received by
Indian entity
(applicable only when tax rates are
lower in overseas country as compared to India)
·
When purchase order is received by Indian
entity, overseas entity must cross charge its expenses for services provided to
the Indian entity by way of inter company invoice.
·
The overseas company should include mark up on its
cost portion in their intercompany invoice. To determine the markup %, we
require to follow the below process:
(a)
As per India Income tax laws, there is safe
harbor rule of 20%, (only for IT Service) which means for any transactions
(“Specified Transactions”) where overseas inter company is involved, Indian
entity should earn operating profit (“OP”) of 20%
(b)
OP means revenue of specified transactions minus
Operating Cost
(c)
Operating cost means direct cost for the
specified transactions plus allocated indirect cost (which can be based on
revenue or head count).
(d)
Now first we compute OP without considering any
inter company cost. Then we compute how much additional cost will lead to OP/OC
of 20% in India and that additional cost will become revenue for overseas group
company.
(e)
To
illustrate, consider the below example: Purchase Order received from USA for
USD 1000, where one employee work from USA and another from India. Order
received at India.
(i)
Cost of India resource is 100 & USA resource
is 300.
(ii)
Allocated India indirect cost is 30 and USA is
60.
(iii)
Below table provides the situation before any intercompany
invoice
|
Entity |
India |
Overseas/USA |
Final |
|
Revenue |
1000 |
|
1000 |
|
Less: Cost |
100 |
300 |
400 |
|
Less: Inter Co Cost |
|
|
|
|
Less: Overhead |
30 |
60 |
90 |
|
OC |
130 |
360 |
490 |
|
OP |
870 |
(360) |
510 |
|
OP/OC |
669% |
NA |
104% |
(iv)
Now the same table with Inter company invoice
with India OP/OC of 20%
|
Entity |
India |
Overseas/USA |
Final |
|
Revenue |
1000 |
700 |
1000 |
|
Less: Cost |
100 |
300 |
400 |
|
Less: Inter Co Cost |
700 |
|
|
|
Less: Overhead |
30 |
60 |
90 |
|
OC |
830 |
360 |
490 |
|
OP |
170 |
340 |
510 |
|
OP/OC |
20.48% |
94.44% |
104% |
·
In the
captioned example 700 computed to arrive in India OC/OP of 20%+ which is as per
safe harbor rule. However, its essential
to compare that overseas entity charges to the non-related customers for the
similar service to ensure arm’s length pricing.
Purchase order received by overseas
entity
·
When purchase order is received by overseas
entity, Indian entity requires to cross charge its expenses for providing
service to the Indian entity by way of inter company invoice.
·
As explained above Indian entity should invoice
with minimum 20% mark up on their OC.
(a)
To
Illustrate consider the below example: Purchase Order received from USA
for USD 1000 where one employee work from USA and another from India. Order
is received at USA
(b)
Cost of India resource is 100 & USA resource
is 300.
(c)
Allocated India indirect cost is 30 and USA is 60.
·
Below table provides the situation before
raising inter company invoice
|
Entity |
India |
Overseas/USA |
Final |
|
Revenue |
|
1000 |
1000 |
|
Less: Cost |
100 |
300 |
400 |
|
Less: Inter Co Cost |
|
|
|
|
Less: Overhead |
30 |
60 |
90 |
|
OC |
130 |
360 |
490 |
|
OP |
(130) |
640 |
510 |
|
OP/OC |
|
177% |
104% |
·
Now the same table with Inter company invoice
with India OP/OC of 20%
|
Entity |
India |
Overseas/USA |
Final |
|
Revenue |
156 |
1000 |
1000 |
|
Less: Cost |
100 |
300 |
400 |
|
Less: Inter Co Cost |
|
156 |
|
|
Less: Overhead |
30 |
60 |
90 |
|
OC |
130 |
516 |
490 |
|
OP |
26 |
484 |
510 |
|
OP/OC |
20 |
93.89% |
104% |
·
In the captioned example 156 computed to arrive
India OC/OP of 20%+, adhering to safe harbour rule. Again it’s Crucial to compare the Indian entity charges to the non related
customers for the similar service to ensure arms length pricing.
Challenges in the above model
·
When the OP/OC of the entire project is less
that 20% then its impossible to keep 20% mark up in India as in such situation
overseas entity is doing inter company
transaction as loss.
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