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Benefit Test - Really required in Transfer Pricing?
By Partho Dasgupta Partner BDO India LLP

Merk case is yet again an important judgement on the non -core intercompany services such as Management charges, technical know-how etc.

It is no doubt in the Transfer price domain this is very contentious issue and the position of the revenue is pretty consistent in disallowing the same services under the pretext of ( a) benefit of services (b) rendition of services (c) following these two reasons the method to be applied. We have analysed in the following document.

In the recent Ruling of Merck Limited v/s DCIT (ITA No. 1946/Mum/2014), it has been observed that one of the transaction the Merk has entered into with its associated enterprise is of availing technical consultancy services. The Transfer Pricing officer has considered the transaction as NIL and thereby making Arm’s Length Price adjustment in respect of the entire amount paid by the Assessee to its associated enterprise. The stand of the TPO has been upheld by the DRP. The DRP mentioned (i) based on the documents produced by the Assessee like e-mails/ correspondences/ documents relating to conference, etc. the DRP cannot persuade to reach any unimpeachable evidence in support of actual receipt of service. (ii) when the Assessee habitually reimburses actual amounts for specific services rendered by the AE on a cost-to-cost basis, no reason for making a provision for lump-sum amount for certain services (like technical consultancy) which is not backed up with reliable evidence. (iii) The transaction yielded no actual services rendered by the AE to the Assessee and hence no ALP could be attributed to the Assessee.

ITAT while pronouncing its judgement has considered the above mentioned points

Rendition of services - How rendering/ receiving of non-core services can be substantiated:

Based on the Merck (supra) case, ITAT observed that the Assessee has sufficient material on record to show that the Assessee was under the agreement and entitled to receive a package of services as and when required. The e-mails and other documentary evidence can be valid proof for the provision of the services. Even if the services are too general, the tax authorities cannot hold the reason that the services has not been rendered at all.

Based on that it is advisable to have an agreement in place for the non-core bundled services. Secondly, there should be enough evidences in place the way services been rendered. However it may happen that for a particular financial year, it may render any one service out of the bundles services. This specific service needs to be backed up properly with enough documentary evidence including a separate arrangement/ agreement during the start of such particular service and followed up with enough detailed documents as evidence that the service has actually been rendered.

Benefit Test – Really required in Transfer Pricing:

Whether intra group services has been rendered or not, it has to be understood that such activity is providing any ‘economic or commercial value’ to enhance commercial position of a company [refer OECD guidelines under chapter VII (Point B.1 para 7.6)]. However, the Indian tax authorities are tending towards misrepresenting such economic / commercial values with ‘benefit received by a taxpayer’. As per the ITAT Ruling in Merck case, benefit test does not has too much relevance in the arm’s length price ascertainment and that it is totally irrelevant as to whether a taxpayer receives any benefit from such transaction. Even more it can be highlighted that the role of the transfer pricing officer is to ascertain that the arms’ length price determined by the taxpayer is correct or not by application of the most appropriate method. So the question of whether the transaction entered into by the taxpayer only for the benefit is irrelevant and beyond the role of the transfer pricing officer as it is purely a business/ commercial decision. While pronouncing this judgement, a reference has been made to the judgment of AWB India – where the concept of commercial expedient has been discussed along with if the agreement is sham or not.

Though as per the OECD, mere statement for example “management fee” should not be treated as prima facie evidence that such service has been rendered. At the same time, absence of payments or contractual agreement does not automatically lead to the conclusion that no intra-group services have been rendered [refer OECD guidelines under chapter VII (Point B.1 para 7.18)]. Based on the above and the mind-set of the Indian tax authorities, it is best for the taxpayers to keep enough documentary evidence substantiating the fact that the actual non-core service has been rendered through a transaction.

Benchmarking of transaction (non-core services):

The Transfer Pricing regulation in India [Section 92C(1) of the Income-tax Act] provides for six methods for determination of arm’s length price of an ‘international transaction’, out of which one of the method is to be applied. Under the Transfer Pricing regulations contained in sections 92 to 92F of the Act, the mandate of the Transfer Pricing Officer is to determine the arm’s length price of the international transaction. The mandate of the TPO is thereby limited to application of any of the five prescribed methods as the most appropriate method.

It has been observed that in some rulings that for transactions like royalty payment and management charges, the Assessee has applied Comparable Uncontrolled Price (CUP) Method with backup of FEMA Rules for royalty remittance, Government approvals like payment of royalty. These backup evidences though questioned by the tax officers at the lower level but considered valid by the higher level authorities. However, in absence of the data for justifying the transaction under CUP Method, can other methods like Cost Plus or TNMM be considered to be the most appropriate method, is a matter of question before the tax authorities.

The author is a Direct Tax Partner with BDO India LLP.

Views expreseed herein are personal .


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