The most ignored transaction from the transfer pricing perspective is the reimbursement of expenses. However, with the increasing complexity of modern business, it is important for us to properly understand the transaction relating to reimbursement of expenses and understand its benchmarking from an Indian Transfer Pricing perspective.
Before starting with the issue of reimbursement of expenses under transfer pricing, it is first important to clarify what exactly is a reimbursement. The first point to note is that the term ‘reimbursement’ is not defined anywhere in the Income Tax Act so we have to understand the meaning of reimbursement as used in the common parlance. Generally, when one party incurs an expense on behalf of other party, that other party is liable to reimburse the first party for the expenses already incurred by the first party. From dictionary meaning[1] , it is “the act of paying back money to somebody which they have spent or lost.” Therefore, based on the above, we can conclude that reimbursement is neither the income nor the expense for the party who has incurred on behalf of the other party. From a transfer pricing perspective, the transaction of reimbursement is a back to back arrangement between the taxpayer and its associated enterprise(s) where the expenditure incurred by party on behalf of the is generally reimbursed on cost to cost basis without adding any mark-up by the other party.
Now, one may assume that since there is no question of income or expense and that the transaction is merely due to the administrative convenience and therefore should not be under scrutiny by the income tax department. Yes, usually such transactions do not come into scrutiny since there is no shifting of profits involved. However, in case of reimbursement received by Indian entity, it becomes important to find that whether it is just a pass-through cost (inbound reimbursement/third party cost). Because these are usually considered as payment received for services by Indian entity. Therefore, it plays a defensive role in case the matter goes for scrutiny. If, third party render services and no substantial value is made or major risk is assumed by the taxpayer in relation to third party services then no mark- up is required on reimbursement received and that pass-through cost is not required to include in cost base.
In the case of Ness Technologies (India) Private Limited [TS-980-ITAT-2019(Mum)-TP], lower level transfer pricing authorities have raised objections and have warranted a mark-up on the reimbursement received by the taxpayer on account of delay in receiving payments and also questioned the service element in the transaction. In the instant case, the assessee contended to the ITAT that these expenses were incurred only for administrative convenience and does not involve any service element. On producing the relevant debit notes raised by assessee on its AE, and subsequent debit notes raised by AE on final customers, the ITAT accepted assessee’s contention and deleted the TP adjustment raised by way of mark-up on reimbursement received by the taxpayer.
In another case of Cheil communications India Private Limited [ITA No. 712/Del/2010], the assessee (an advertisement agency) incurred significant amount on behalf of its AE’s customers for the placement of their ads various platforms (print media/ TV media/ outdoor) which were subsequently reimbursed to the assessee by its customers on cost to cost basis. The TPO was of the opinion that since the assessee is providing agency functions by facilitating AE’s customers to place their ads and also assuming the risk in case of non-payment by AE’s customers, it should a charge a mark-up for the same. Although the adjustment on account of mark-up on this reimbursement was rejected by CIT (A), the revenue department filed case in ITAT. ITAT, in this case as well, rejected the contention of the revenue department. The tribunal observed that the third parties (Print media/ TV media/ outdoor media) raised invoice in the name of the final customers and the final liability to pay to these third parties lies with the customers of AE. Tribunal concluded that assessee is not performing agency function but is only facilitating the transaction and also that the assessee is not bearing any credit risk. Therefore, ITAT upheld the decision of CIT (A) and rejected the revenue’s claim.
Although the contentions of the lower tax authorities/ revenue department for adding markup on reimbursement received/ receivable by the assessee were continuously declined by the Tribunal, these cases tells us a lot about the department’s view on the reimbursement of expenses received/receivable by the Indian taxpayer.
Now another question to ponder over is that if there is no shifting of profits in the transaction of reimbursement of expenses, is there a need to benchmark the transaction or whether the assessee needs to ensure proper documentation for the transaction? In the case of Cushman & Wakefield India Pvt. Ltd. [TS- 218-HC-2015 (Del)-TP], assessee entered into international transactions with its AEs which include reimbursement of expenses which were charged by AE without any mark-up from assessee. Assessee contended that since reimbursement was charged without markup, the transaction does not require benchmarking. However, HC rejected the contention of the assessee and stated that irrespective of the fact that whether markup has been charged on reimbursement or not, benchmarking analysis needs to be performed. The Court also emphasised that it is equally vital to proof that the reimbursement is caused due to “business need” and is “wholly and exclusively” connected with the assessee’s business for which the assessee needs to ensure proper documentation so as to make the expense deductible during computation of income.
However, in an interesting case of Seagram Manufacturing Private Limited [TS-157-ITAT-2016(Del)-TP] ITAT included the reimbursement received from foreign AE in operating revenue as well as in operating expenses thereby confirming the TP adjustment made by TPO. The assessee, in order to promote sale of its AE in India, provided need-based marketing support services to its AE. Assessee hired third party agencies for the services and recovered the cost of marketing as a reimbursement on a cost to cost basis from its AE without any mark-up. TPO pressed on the point that since assessee had shown the amount received from AE as operating revenue (as received from its AE) it should also be shown as operating cost (as incurred for providing marketing services) which resulted in a TP adjustment for the assessee. ITAT upholding the decision of TPO, noted that since assessee had included the reimbursement amount in income, it should also be included in cost to nullify the differences in the cost incurred by assessee on marketing support services even if the assessee is not assuming any significant risk.
Concluding the case laws, we can say that whether mark-up on reimbursement to be charged from the AE or not will depend on the functions performed, assets employed & risks assumed in connection with the reimbursement. In case there is any service element in the transaction, or presence of any significant risk assumed by the Indian assessee, the assessee should charge a mark-up from its AE to avoid unreasonable dispute with the tax authorities.
Also, the inclusion of reimbursement in the operating revenue and operating cost would depend upon how the reimbursement is shown in the books of accounts. In case the reimbursement received from AE is shown under revenue, it gives a hint to the department that it is the income of the assessee, and corresponding expense incurred in respect of this revenue should be considered as a part of operating cost which increases the base of PLI, reduces the margin of assessee and leading to an increase in the transfer pricing adjustment by the Indian tax authorities.
Other factors on which the treatment of reimbursement of expenses may depend are as follows:
- Whether such cost is ancillary or reflects core business activity – In case the cost incurred by the assessee reflects core business then mark-up should be charged by the entity.
- Standard Practice followed in industry – if there is practice of cost to cost recovery then mark-up may not be required.
There is no hard and fast rule to determine the taxability of reimbursement transaction in India. The only solution is to document the records which reflects the purposes of transacting parties, purpose and nature of the expense incurred.
References of case laws used:
Cushman and Wakefield (India) Pvt Ltd (TS -766-SC-2017-TP), (TS-150-HC-2014(DEL)-TP
JT International Private limited – TS-611-ITAT-2011(Del)
Ness Technologies India Private Limited -TS- 980-ITAT-2019(MUM)
Cheil communications India Pvt. Ltd.- TS-87-ITAT-2010(Del)
Seagram manufacturing private limited – TS-157-ITAT-2016(Del)
Monster.com India Private Limited. – TS-256-ITAT-2019(HYD)
Four Soft Limited -https://indiankanoon.org/doc/172126650/
[1] https://www.oxfordlearnersdictionaries.com/definition/english/reimbursement?q=Reimbursement
(Article is been Jointly contributed by CA Raghav Gupta and Ms Shreya Jain.)
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