The tax authorities had disallowed deductions for purported administrative services paid for by Akzo Nobel India to a group company in Singapore. The Income Tax Appellate Tribunal upheld the assessment in a Judgement issued in February 2022. An appeal was then filed by Akzo Nobel India with the High Court. Judgement of the High Court The High Court dismissed the Appeal of Akzo Nobel India and upheld the judgement of the Income Tax Appellate Tribunal. Excerpt “…this Court finds that all the three authorities below have given concurrent findings of fact that the Appellant had failed to furnish evidence to demonstrate that administrative services were actually rendered by the AE and the assessee had received such services. In fact, the ITAT has noted in the impugned order “….On a specific query made by the Bench to demonstrate the receipt of services from AE through cogent evidence, including, any communication with the AE, learned counsel for the assessee expressed his inability to furnish any evidence and repeated his submission to restore the matter back to the Assessing Officer for enabling the assessee to furnish evidence, if any.” (…) “Further , this Court in Principal Commissioner of Income Tax-6 vs. Make My Trip India (P) Ltd., (2017) 87 taxmann.com 284 (Delhi) has held that difference of opinion between the parties, as to the appropriateness of one or the other methods to calculate arm’s length price, cannot per se be a ground for intereference and the appropriateness of the method unless shown to be contrary to the Rules specially 10B and 10C are hardly issues that ought to be gone into under Section 260A of the Act.” “Consequently, this Court is of the view that no substantial question of law arises for consideration in the present appeal and the same is accordingly dismissed.” ...

Arm’s length range limited to interquartile range. (i) The facts are the same as in Example 2, except in this case there are some product and functional differences between the four uncontrolled comparables and USSub. However, the data is insufficiently complete to determine the effect of the differences. Applying the resale price method to the four uncontrolled comparables, and making adjustments to the uncontrolled comparables pursuant to § 1.482-1(d)(2), the district director derives the following results: Uncontrolled comparable Result (price) 1 $42.00 2 44.00 3 45.00 4 47.50 (ii) It cannot be established in this case that all material differences are likely to have been identified and reliable adjustments made for those differences. Accordingly, if the resale price method is determined to be the best method pursuant to § 1.482-1(c), the arm’s length range for the controlled transaction must be established pursuant to paragraph (e)(2)(iii)(B) of this section. In this case, the district director uses the interquartile range to determine the arm’s length range, which is the range from $43 to $46.25. If USSub’s price falls outside this range, the district director may make an allocation. In this case that allocation would be to the median of the results, or $44.50 ...

Selection of comparables. (i) To evaluate the arm’s length result of a controlled transaction between USSub, the United States taxpayer under review, and FP, its foreign parent, the district director considers applying the resale price method. The district director identifies ten potential uncontrolled transactions. The distributors in all ten uncontrolled transactions purchase and resell similar products and perform similar functions to those of USSub. (ii) Data with respect to three of the uncontrolled transactions is very limited, and although some material differences can be identified and adjusted for, the level of comparability of these three uncontrolled comparables is significantly lower than that of the other seven. Further, of those seven, adjustments for the identified material differences can be reliably made for only four of the uncontrolled transactions. Therefore, pursuant to § 1.482-1(e)(2)(ii) only these four uncontrolled comparables may be used to establish an arm’s length range ...

Sierra Spain Shopping Centers Services S.L.U. is part of a multinational group that manages shopping centres. Sierra Spain had deducted expenses for services rendered from a related party in Portugal. According to Sierra Spain, the services were related to strategic management and marketing. The tax authorities considered the expenses non-deductible and issued an assessment of additional taxable income. With respect to the strategic business management services, the tax authorities found that there was no contract between the parties. In addition, the authorities found the justification for the actual provision of services was insufficient. With regard to the marketing services, these were contracted by the Portugal-based entity to an external supplier and subsequently re-invoiced to the related parties receiving the service in Portugal, Brazil and Spain. The tax authorities considered that these services were shareholder costs and therefore not deductible in Sierra Spain. Sierra Spain appealed to the Tax Court, which upheld the assessment of the tax authorities. An appeal was then lodged with the National Court. Judgement of the Court The Court dismissed Sierra’s appeal regarding fees for management services, but ruled in favour of Sierra regarding fees for marketing services. According to the Court, Sierra had not provided sufficient supporting documentation for the management services. The Court considered that the invoices submitted were too general and that the description of the services in the invoices referred to an intercompany agreement that had not been provided. In addition, the Court considered that the internal correspondence submitted as evidence of the services provided only supported the existence of habitual and ordinary relations between the employees of the Spanish and Portuguese companies. Therefore, the requirements laid down in the Spanish legislation to support the deductibility of the management services had not been met. With regard to the expenses for marketing services, the Court stated. “Both the general purpose of the market studies (as described, for example, on p. 16 of the contested decision) and their content, in which the references to the activity carried on in Spain are of significant relevance, support the claimant’s assertion that the marketing services at issue would be subsumed under paragraph 7.14 of the OECD Guidelines, as intra-group services (specifically, as marketing assistance), and not under point 7.9 as shareholder costs (p. 31 of the complaint). Consequently, given the reality of the service, its relation to the Appellant’s activity and the utility or advantage it brings or may bring to its recipient, the deductibility of the expense incurred in 2008 for this specific item must be accepted. In order to consider the latter to be established, that is to say, that we are dealing with shareholder costs which would benefit the group and not the appellant, it is necessary to provide a statement of reasons and a greater effort of argument than that made in the present case by the Tax Inspectorate and by the contested decision. Thus, the reasons given by the tax authorities are not sufficient to establish that the basic and essential premise underlying the concept of shareholder costs is met, that is to say, that we are dealing with an activity for which the appellant entity has no need and which, therefore, it would not be prepared to pay if it were dealing with independent undertakings.” Click here for English translation Click here for other translation ...

While it is not specific to the transactional net margin method, the issue of the use of non-transactional third party data is in practice more acute when applying this method due to the heavy reliance on external comparables. The problem arises because there are often insufficient public data to allow for third party net profit indicators to be determined at transactional level. This is why there needs to be sufficient comparability between the controlled transaction and the comparable uncontrolled transactions. Given that often the only data available for the third parties are company-wide data, the functions performed by the third party in its total operations must be closely aligned to those functions performed by the tested party with respect to its controlled transactions in order to allow the former to be used to determine an arm’s length outcome for the latter. The overall objective is to determine a level of segmentation that provides reliable comparables for the controlled transaction, based on the facts and circumstances of the particular case. In case it is impossible in practice to achieve the transactional level set out as the ideal by these Guidelines, it is still important to try to find the most reliable comparables as discussed at paragraph 3.2, through making suitable adjustments based on the evidence that is available ...

Application of any arm’s length method requires information on uncontrolled transactions that may not be available at the time of the controlled transactions. This may make it particularly difficult for taxpayers that attempt to apply the transactional net margin method at the time of the controlled transactions (although use of multiple year data as discussed in paragraphs 3.75-3.79 may mitigate this concern). In addition, taxpayers may not have access to enough specific information on the profits attributable to comparable uncontrolled transactions to make a valid application of the method. It also may be difficult to ascertain revenue and operating expenses related to the controlled transactions to establish the net profit indicator used as the profit measure for the transactions. Tax administrators may have more information available to them from examinations of other taxpayers. See paragraph 3.36 for a discussion of information available to tax administrators that may not be disclosed to the taxpayer, and paragraphs 3.67-3.79 for a discussion of timing issues ...

In the specific circumstances of the COVID-19 pandemic, the application of more than one transfer pricing method may be useful to corroborate the arm’s length price of a controlled transaction. In this context, it is important to note that the arm’s length principle does not require the application of more than one method and that the use of more than one method should follow the guidance in paragraphs 2.2 and 2.12 of the OECD TPG ...

Where possible, and on a temporary basis during the pandemic, tax authorities that otherwise use the price-setting approach could consider allowing taxpayers, for those controlled transactions affected by the pandemic, to take into account information that becomes available after the close of the taxable year in filing their returns (where legally permissible and properly described in the transfer pricing documentation). Tax administrations could provide flexibility to allow amendments to FY 2020 tax returns such that transfer prices are set on an arm’s length basis and using available information. Also given the potential for double taxation that may arise as a result of unilateral adjustments, consideration may be given by tax administrations to: Provide for flexibility in the allowance of “compensating adjustments” to be made before the tax return is filed, where it is legally permissible, in order to allow for any available contemporaneous information to be better evaluated by taxpayers and tax administrations such that arm’s length prices can be reliably established12; or Ensure access to the MAP, or to some alternative applicable procedure, where the issue could be addressed between the respective tax administrations and early certainty could be obtained, to avoid double taxation, noting that through MAP or alternative procedures tax administrations can address issues in a non-adversarial proceeding, often achieving a negotiated settlement in the interests of all parties. 12 Paragraphs 4.38 and 4.39 of Chapter IV of the OECD TPG ...

The OECD TPG describe two approaches to identify and collect data required to undertake a transfer pricing analysis. The first is a “price-setting,” i.e. an ex-ante approach, which uses historical data updated to reflect any change in economic conditions through the date of the contract. The second is an “outcome-testing” approach, which may incorporate information that becomes available after the close of the taxable year to determine arm’s length conditions and report results on the taxable year to determine arm’s length conditions and report results on the tax return. According to the OECD TPG, both approaches, or a combination of these approaches, are found among OECD member countries.11 11 Paragraph 3.71 of Chapter III of the OECD TPG ...

The difficulty posed by the delayed availability of contemporaneous data on comparable companies or transactions may have been exacerbated by the COVID-19 pandemic. Taxpayers and tax administrations should be mindful that determining a reliable arm’s length outcome requires flexibility and the exercise of good judgment.10 Difficult transfer pricing issues that arise as a result of the COVID-19 pandemic could give rise to a large number of mutual agreement procedure (“MAP”) disputes that could severely strain the resources of tax administrations. As such, tax administrations are encouraged to keep these complexities in mind when performing risk assessments, evaluating transfer pricing positions on audits and considering the support and documentation taxpayers provide that might demonstrate reasonable efforts and care when trying to comply with the arm’s length principle. Taxpayers should undertake reasonable and appropriate due diligence in evaluating the likely effects of the COVID-19 pandemic and in implementing appropriate changes in their transfer prices. MNE groups should document the best available market evidence currently available, which may be in the form of internal comparables, external comparables, or other relevant evidence of the economic impact of the COVID-19 pandemic (see paragraph 11), including its effects on the level of demand for goods and services, and on production and supply chains in particular sectors of the economy. 10 Paragraphs 1.13 and 2.74 of Chapter I and Chapter II of the OECD TPG ...

The discussion below provides several pragmatic approaches to this issue. Tax administrations could consider these pragmatic approaches in an attempt to minimise disputes where taxpayers are making good faith efforts to determine arm’s length prices in the context of the information deficiencies associated with the COVID-19 pandemic. However, these approaches would not be appropriate in cases where taxpayers seek to use the circumstances attached to the COVID-19 pandemic to manipulate their pricing strategies in a way that is inconsistent with the arm’s length principle ...

Data from independent comparable transactions or companies from other time periods, such as average returns in preceding years, may not provide a sufficiently reliable benchmark for the current period without considering the specific impact of the pandemic on the controlled transactions under review ...

As the economic circumstances caused by the pandemic are continuing and evolving over time, taxpayers may encounter difficulties in determining arm’s length conditions due to the lag in time between the occurrence of controlled transactions and the availability of information regarding contemporaneous uncontrolled transactions ...

While it is not specific to the transactional net margin method, the issue of the use of non-transactional third party data is in practice more acute when applying this method due to the heavy reliance on external comparables. The problem arises because there are often insufficient public data to allow for third party net profit indicators to be determined at transactional level. This is why there needs to be sufficient comparability between the controlled transaction and the comparable uncontrolled transactions. Given that often the only data available for the third parties are company-wide data, the functions performed by the third party in its total operations must be closely aligned to those functions performed by the tested party with respect to its controlled transactions in order to allow the former to be used to determine an arm’s length outcome for the latter. The overall objective is to determine a level of segmentation that provides reliable comparables for the controlled transaction, based on the facts and circumstances of the particular case. In case it is impossible in practice to achieve the transactional level set out as the ideal by these Guidelines, it is still important to try to find the most reliable comparables as discussed at paragraph 3.2, through making suitable adjustments based on the evidence that is available ...

Application of any arm’s length method requires information on uncontrolled transactions that may not be available at the time of the controlled transactions. This may make it particularly difficult for taxpayers that attempt to apply the transactional net margin method at the time of the controlled transactions (although use of multiple year data as discussed in paragraphs 3.75-3.79 may mitigate this concern). In addition, taxpayers may not have access to enough specific information on the profits attributable to comparable uncontrolled transactions to make a valid application of the method. It also may be difficult to ascertain revenue and operating expenses related to the controlled transactions to establish the net profit indicator used as the profit measure for the transactions. Tax administrators may have more information available to them from examinations of other taxpayers. See paragraph 3.36 for a discussion of information available to tax administrators that may not be disclosed to the taxpayer, and paragraphs 3.67-3.79 for a discussion of timing issues ...

Herbalife International India is a subsidiary of HLI Inc., USA. It is engaged in the business of dealing in weight management, food and dietary supplements and personal care products. The return of income for the assessment year 2006-07 was filed declaring Nil income. The Indian company had paid royalties and management fees to its US parent and sought to justify the consideration paid to be at arm’s length. In the transfer pricing documentation the Transactional Net Margin Method (TNMM) had been selected as the most appropriate method for the purpose of bench marking the transactions. The case was selected for scrutiny by the tax authorities and following an audit, deductions for administrative services were denied and royalty payments were reduced. Disagreeing with the assessment Herbalife filed an appeal. Decision of the Income Tax Appellate Tribunal The Tax Appellate Tribunal dismissed the appeal of Herbalife and upheld the tax assessment. Excerpts “The appellant had not filed any additional evidences to prove the administrative services/technical knowhow are actually received by the appellant and thus the assessee company had failed to discharge this onus of proving this aspect. Therefore, even as per the provisions of Indian Evidence Act, the presumption can be drawn that the assessee has no evidence to prove this aspect. Therefore, the AO/TPO was justified in adopting the ALP in respect of payment of administrative services and royalty at Nil. Thus, the grounds of appeal in ground Nos. 2 to 7 are dismissed. In respect of the other grounds of appeal, since we held that there was no proof of receipt of administrative services as well as technical knowhow which is used in the process of manufacturing activity, the question of bundling of transaction or aggregating all other transactions does not arise.” “Thus all the grounds of appeal relating to the royalty and administrative services have been dismissed. Then the only ground of appeal that survives is ground IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 relating to uphold of disallowance on account of doubtful advance written off of Rs.1,20,16,395/-. The brief facts surrounding this addition are as under:” ...