Bangalore tribunal ruling upholds transfer pricing adjustment disallowing payment of management charges
Court :Bangalore Income Tax Appellate Tribunal
Citation :Gemplus India Pvt. Ltd. (Taxpayer) [ITA No.352/ Bang/2009]
Brief : The Bangalore Income Tax Appellate Tribunal (Tribunal) has ruled on the transfer pricing aspects of management services fees paid by the Taxpayer to its regional headquarter company (associated enterprise or AE).
The Tribunal upheld the contention of the Transfer Pricing Officer (TPO) that the Taxpayer has not proved the commensurate benefits received for the service fees paid to the AE and, hence, ruled that the payment of the management services was not justified under arm’s length principles.
Background and facts- The Taxpayer, an Indian company, entered into a Management Services Agreement (MSA) with its regional headquarters and AE in Singapore. As per the terms of the agreement, the AE would provide need-based services with respect to marketing and sales support, customer service support, finance, accounting and administration support and legal support.
During the financial year (FY) 2003-04, the Taxpayer made payments towards management services and selected the Transactional Net Margin Method (TNMM) as the most appropriate method to substantiate the arm’s length nature of the payment. As per the Taxpayer, the charges for the services rendered by the AE were billed on the basis of the time spent for the services rendered to the Taxpayer with an overall cap of US$300,000 per annum. During the audit proceedings, the TPO held that the Taxpayer had not derived any specific benefit from the management services and that the payment towards management services was not justified. Being aggrieved by the TPO order, the Taxpayer preferred an appeal at the first appellate authority. The first appellate authority decided the matter in favor of the Tax Authority.
The Taxpayer appealed before the Tribunal against the first appellate authority’s order.
• The Taxpayer had achieved a commendable amount of sales turnover during the FY, which would not have been possible without the services rendered by the AE.
• The Taxpayer had only employed a handful of persons in India and all the technical expertise was provided by the AE on a need basis.
• The services were rendered exclusively for the purposes of the business carried on by it in India and there was no reason for treating the said amount outside the normal parameters of ALP.
• OECD Guidelines have contemplated similar circumstances in international transactions and have highlighted the relevance of such services rendered by the units situated in foreign countries.
• There was no material on record to show that no services were rendered and that the payments were excessive compared to analogous transactions.
• The TNMM, adopted by the Taxpayer, could not be accepted to determine the arm’s length nature of the service fees as none of the comparables identified by the Taxpayer have paid any management service fees.
• The Taxpayer has not established the necessity for availing such services from its AE.
• The Taxpayer already has qualified personnel in its service in India and the Taxpayer has already incurred expenditure for similar services.
• There was no comparison between the volume and quality and services and the amounts paid by the Taxpayer. The cost has been apportioned by the AE for different country-centres on a mutual agreed basis and not on the basis of actual services rendered.
• The MSA has been entered into before the FY and, therefore, it was not possible to contemplate the nature and volume of the services and their compensation.
The Tribunal upheld the adjustment made by the TPO and held as follows:
• It is imperative on the part of the Taxpayer to establish that the payments were made commensurate to the volume and quality of services and such costs are comparable.
• The payment terms of the MSA were independent of the nature or volume of services and, hence, the TPO was justified in making the observation that the expenses were apportioned by the AE among different country-centres on the basis of their own agreements and not on the basis of the actual services rendered to individual units.
• There were no details available on record with respect to the nature of services rendered by the AE to the Taxpayer and, hence, the TPO was justified in holding that the Taxpayer has not proved the commensurate benefits against the payment of service fees to the AE.
Comments :-In recent years, the appropriate treatment of the intercompany provision of services has become one of the critical transfer pricing issues in India. Under the arm’s length principle, a service is considered to be rendered when an activity is performed by one group member for another group member and such activity provides the respective group member with economic or commercial value to enhance its commercial position. This test, known as the benefit test, is critical to determine whether a related party would pay for an intra-group service and, therefore, whether the service provider can justify a charge for the provision of the intra-group services under arm’s length conditions.
In many cases, the Indian tax authority has applied the benefit test to contend that the services rendered by the foreign affiliate are either shareholder activities or do not provide a specific benefit to the Indian affiliate, and therefore under arm’s length conditions, do not justify a charge. The key focus areas during an audit include: (1) justifying that a benefit is anticipated to be or has been obtained from the performance of services; (2) verifying that the amount of charge is at arm’s length.
In light of the present ruling, it would be useful for multinational enterprises with Indian affiliates to review their intra-group arrangements relating to intra¬group services for India and assess the need to strengthen the documentation that would help demonstrate compliance with arm’s length principles.