Rahul K Mitra and Tarun Arora,
PricewaterhouseCoopers, India


oday’s dynamic business environment coupled with prevailing economic uncertainties in the globalised world has led to widespread business restructurings by Multinational Enterprises (MNEs). Some of the common factors that lead to business restructurings are changes in business opportunities, competitive pressures, market conditions, changing operating and regulatory environment, etc. Business restructurings involve re-arrangement of value chains or operations of businesses and are typically aimed at achieving operational synergies, cost savings, efficient/economical sharing of resources, etc. by MNEs. Such restructurings, apart from the business/commercial relevance, also have significant implications for MNEs from a taxation and transfer pricing viewpoint.

I. Transfer Pricing aspects in business restructurings – background
In tax and transfer pricing (TP) parlance, business restructuring refers to cross border transfer and/or redeployment of functions, assets (both tangible and intangible), and risks by MNEs between group entities operating in different jurisdictions. Business restructurings lead to changes in existing business arrangements resulting in new ‘‘cross border transactions’’ between multinational group entities with consequential effects on profit and loss potential in each country/tax jurisdiction. The restructuring itself may also be a taxable event.

sion draft focuses on the extent to which reallocation of profits pursuant to a business restructuring is consistent with the arm’s length principle and more generally how the arm’s length principle applies to business restructurings. More recently, the Australian Tax Office on June 2, 2010 has issued a draft ruling (TR 2010/D2) on application of TP provisions to business restructurings by multinational enterprises. The draft ruling (which in substance follows the OECD’s discussion draft) is one of the first examples of detailed country-specific guidance on TP aspects of business restructurings. As is evident from the above developments, the international community has awakened to the need for undertaking an objective evaluation of corporate restructuring to determine what is business driven and what is tax driven restructuring, in case that should be treated differently; and whether business-driven restructuring gives rise to a tax liability. In this respect, tax administrations are increasingly focusing attention on profit expectations, synergy effects of restructuring and the advantages of relocation, aspects that were hitherto ignored or not examined in detail.

B. Indian transfer pricing framework
Comprehensive Transfer Pricing (TP) regulations1 were introduced in India in 2001 to prevent crossborder shifting of profits by multinational enterprises from India. The Indian transfer pricing regulations aim at ensuring that the ‘‘income’’ arising from any ‘‘international transaction’’ between related parties is determined on an arm’s length basis. Currently, there are no specific provisions in the Indian tax or transfer pricing regulations dealing with business restructurings, however, the general transfer pricing regulations apply where taxable income arises in the course of any business restructuring. Although India is not an OECD member, in several landmark rulings, the Indian Courts have held that a reference to OECD commentary can certainly be made where guidance in Indian legislation is lacking. Hence, OECD Guidance on various tax issues (including TP) promulgated from time to time is often referred to by tax authorities and taxpayers alike. Similarly, international TP legislation and related developments also play a persuasive role in shaping the mindset of Indian tax authorities as well as the evolution of transfer pricing law in India.

A. International developments
On January 1, 2008, Germany amended its tax act and introduced rules to prevent an untaxed transfer of profit potential from the country as a result of business restructurings. As per this new tax law, Germany views a business restructuring as a transfer package which consists of assets, risks and/or functions which are transferred across borders within a multinational group. For valuation of such transfer package, business opportunity, i.e. the profit potential of the combined assets, risks and/or functions of the transfer package, have to be factored into the same. In September 2008, the Organisation for Economic Co-operation and Development (OECD) released its discussion draft on transfer pricing aspects of business restructuring for public comments. The discus08/10 Transfer Pricing Forum BNA ISSN 2043-0760


Where local intangibles are found to be in existence and have been transferred by the Indian taxpayer to a foreign related party consequent to the restructuring. An Indian Company (ICo) is a wholly owned subsidiary of a Foreign Company (FCo). etc. Issue One Are there any specific tax regulations on business restructurings (in terms of moving activities) in India? There are no specific tax regulations in India on business restructurings. etc. Issue Three Does India impute a compensation/exit charge upon business conversion. understanding or action in concert (whether formal or in writing or whether intended to be enforceable by legal proceeding or not6). even though there are no specific provisions or legal precedents on business restructuring. in view of the wide import of the general provisions in the Indian tax law. and if yes.2 Further. Over the years. income also includes any capital gains arising from transfer of a capital asset. on-ground functional analysis.4 The term ‘‘transaction’’ under the law has been defined to include: s Any transaction having a bearing on the profits. Thus. or even if there is mere flight of functions without any transfer of intangibles attached to the functions? III. transfer of profit potential. customer base. shifting of activities/functions. applicability of tax/ transfer pricing regulations to the transactions/ arrangements involving transfer/redeployment of functions/assets/risks is an issue that needs close and in-depth technical analysis. The Indian transfer pricing provisions prescribe that any income arising from an international transaction shall be computed having regard to the arm’s length price. a vast distribution network. Such compensation as well as the pricing arrangements in the post structuring scenario would need to take into account while formulating the business model of the changed ‘‘limited risk distributor’’ profile of the Indian entity. ICo transfers some/all of the aforementioned valuable intangibles to FCo and also agrees to discontinue such intangible creating marketing functions/activities on its own account. in order to examine the application of such provisions in the Indian context. The extent. in the restructured scenario. the Indian taxpayer needs to be compensated on an arm’s length basis for such transfer of intangibles. V. ICo has developed significant valuable intangibles viz. IV. between related enterprises.II. though ICo would continue to resell/distribute the group’s products in India. development of the local brand (for which it incurred significant expenditure in the past). In such a situation. etc. ICo operates as a full-fledged marketing distributor for the group’s products in India and has an exclusive right to sell in the Indian market. the framework is broad enough to cover such arrangements within its ambit and also give tax authorities the ability to examine and question business restructuring. while evaluating the applicability of Indian transfer pricing provisions to restructurings. This situation is analysed in the following example. assets and/or risks covered by such regulations? Unlike the German tax law. Thus.3The definition of ‘‘capital asset’’ under the domestic tax law is very wide and includes property of every kind. transfer pricing or intangible property regulations? Are arrangements involving cross-border redeployment of functions. then are business restructurings covered by general. it is important to examine whether the Indian taxpayer has developed/owns any valuable intangibles. It also includes any sum. Transfer Pricing aspects of business restructurings – Indian perspective In the background of some of these developments. contractual rights. The determination of valuable intangibles needs to be undertaken based on a detailed evaluation of the business value chain and drivers. As part of the group restructuring. under an agreement for not carrying out any activity in relation to any business. the scheme of the Indian tax and transfer pricing regulations is discussed below. terms of contracts/ arrangements. The term ‘‘income’’ is defined very broadly under the domestic tax law and it includes any profits or gains. Indian transfer pricing or tax regulations do not contain specific provisions in relation to business restructuring or related concepts like cost of corporate opportunities. etc. this paper discusses various issues pertaining to transfer pricing and business restructuring under the existing Indian tax laws and transfer pricing regulations. Transfer of functions along with valuable intangibles The Indian transfer pricing regulations. transfer of the valuable marketing/distribution related intangibles by ICo to FCo would require an arm’s length compensation to be received by ICo. methodology and basis for arriving at the arm’s length compensation would need to be determined based on the facts and circumstances of the case. However. then the precise nature/value of such intangibles as well as the economic interest of the Indian entity in such intangibles needs to be determined. income. s 08/10 Transfer Pricing Forum BNA ISSN 2043-0760 2 . whether received or receivable. only when there is transfer of intangibles (say marketing intangibles in the form of customer list. might impliedly require an arm’s length compensation/exit charge to be earned by the Indian taxpayer for transfer of functions along with transfer of asset (whether tangible or valuable intangible). distribution network. the intangible creating activities as well as the key strategic decision making functions in relation to the Indian distribution operations would not be undertaken by ICo. Issue Two If not. ICo is converted to a limited risk distributor and accordingly. examination of the business realities. say from a full risk marketing distributor to limited/low risk distributor or agent. Accordingly. however. A. including issues on valuation where required. losses or assets of such enterprises5. if not expressly. Accordingly.) along with flight of functions. and An arrangement.

it may be possible to take a position that the transaction does not require a compensation. in the absence of taxable income. in the backdrop of the transfer pricing framework discussed in detail earlier. that in case of transfer of certain self-developed intangibles. or giving up a right to carry out any activity (in substance) with an active benefit to a group concern. In such a case. However. The need for compensation in such circumstances would have to be determined based on an evaluation of various factual parameters including. ICo does not own any other significant valuable intangibles in relation to the distribution operations. an Indian distributor has an exclusive right to sell the group’s products in the Indian market.g. ICo does not own any other significant valuable intangibles in relation to the distribution operations. ICo also agrees to discontinue the distribution function/activities. if compensation would be expected between independent parties dealing at arm’s length in comparable circumstances. it may be pos- sible to take a stand. thus requiring payment of compensation on its movement in the course of a business conversion? Movements of an assembled workforce as part of business conversions either involving ‘‘transfer of a bundle of intangibles’’ or arrangements for ‘‘not undertaking an activity/function’’ might require an arm’s length value of workforce-in-place to be included in the valuation of the total bundle of assets (including contractual rights. copyrights. there is no precedent on this issue and each case would need detailed evaluation/examination depending on the facts and circumstances of such case. Transfer of functions/risks without transfer of specific intangibles attached to the functions The Indian law does not deal in specific with the implications arising from transfer of functions and/or profit potential. a technical/legal position could possibly be taken that such movement of workforce does not attract capital gains on transfer of intangibles. the Indian regulations do not contain a specific inclusion of ‘‘workforce-in-place’’ as an intangible. ICo extinguishes/terminates this exclusive right in favor of the ‘‘principal’’ who may now appoint additional distributors in India. the Indian transfer pricing regulations could be argued to be inapplicable. In restructurings involving mere transfer of functions/risks that do not include transfer of specified property. though not defined in the TP regulations. in common parlance. dealer’s network. Example 1: ICo. In such situations. customer list. the alternative options realistically available to ICo. franchises or any other business or commercial rights of similar nature. the extent of ‘‘investment’’ of the ICo in such functions. ICo ceases to carry out distribution function/activities for the principal. the early/premature termination of ICo’s exclusive rights under the distribution agreement/arrangement with the ‘‘principal’’ would require an arm’s length compensation to be received by ICo.9 This requirement has the effect of treating an assembled workforce as an intangible asset under the US regulations. The word property under the law has very wide amplitude and covers tangibles. the definition of intangibles. Example 2: An Indian distributor is engaged in selling the group’s products in the Indian market.8 VI. In the Indian context. includes assets which are capable of being separately identified. However. trademarks. The Indian transfer pricing regulations extend to transactions involving transfer of intangibles. Unlike the US regulations. it may be important to note the following scheme of the tax/transfer pricing provisions: s Income is defined to include any capital gain arising from transfer of a capital asset. whether specific benefits (if any) passed on by ICo to the principal as a result of the restructuring would require a compensation in third party situations. This situation is anlaysed in the examples below. Issue Four Does India recognise ‘‘workforce-in-place’’ to itself constitute an intangible.B. Further. Accordingly. As part of a restructuring. intangibles. Further. the present definition of intangibles in the Indian Tax Act may not be broad enough to cover the mere movement of workforce between group concerns. no specific definition of an intangible is provided in the Indian transfer pricing regulations. FORUM ISSN 2043-0760 . has been defined elsewhere in the Act. Having discussed the issue of compensation payable at the time of business conversion under the normal principles of transfer pricing. Therefore. s 3 08/10 Copyright 2010 by The Bureau of National Affairs. patents. based on judicial precedents7. licenses. etc. The US regulations provide that skilled workforce made available to a related party through a cost sharing arrangement constitutes a distinct asset that must be compensated separately through a buy-in payment. objectively valued and capable of producing future economic benefits. any rights that are assignable or are capable of specific performance. Inc. etc. Transfer is defined to include sale. to encompass know-how. However. The terms of contract between ICo and the ‘‘principal’’ were such that ICo was to undertake distribution for a long term. for the purposes of depreciation allowance. s s Intangibles. ICo’s arrangement with the ‘‘principal’’ is such that it does not have any specific ‘‘rights’’ in relation to carrying out such distribution operations. the computation mechanism for capital gains income would fail. etc. As part of a restructuring. other assets and liabilities associated with performing particular functions). Capital asset is defined to include property of any kind held by a taxpayer. thus extinguishing the chances of taxation. since the cost of acquisition of the same cannot be ascertained. e. exchange or relinquishment of the capital asset or extinguishment of any rights in a capital asset. however. The issue that requires careful examination in such situations is whether cessation/ transfer of the performance of a function by an Indian taxpayer has any bearing on the income and profit/ loss of the Indian entity and whether the transfer/ cessation qualifies as a taxable event/transaction (either by virtue of it being transfer of a capital asset or an implied agreement/arrangement for not carrying out any activity). the possibility of imputation of an exit charge/ compensation in restructurings involving only transfer of functions and/or risks (without any intangibles) cannot be ruled out.

s Industry dynamics. VII. This would also involve examination of the fact as to what are the alternatives available with the Indian entity (in terms of economically utilising its workforce) in the event transfer is originating as a result of transfer of the activity/function being carried out by such personnel prior to the restructuring. Under the Indian tax laws.e. Hence. skilled resources is critical to the operations and success of a business. it can be commercially rational from an Article 9 perspective for an MNE group to restructure in order to obtain tax savings. which has been incorporated in the majority of the tax treaties signed by India. analysis of the business value chain. Once the commercial substance of the transaction i. placement of the employees on the business value chain. by reason of those conditions. have accrued to one of the enterprises. without having any other commercial justification or rationale? Based on the available common law precedents. which is expected to introduce a general anti–avoidance rule (GAAR) that would empower tax authorities to disregard/recharacterise a transaction that lacks commercial rationale/prudence. Also it would need to be evaluated that in similar circumstances. had the transaction been executed between independent parties. which differ from those. it would need to be carefully analysed that by agreeing to surrender its rights under the employment contracts and shifting valuable profit generating resources. Hence. which would be made between independent enterprises. the position under Indian tax laws is in consonance with the following position adopted by the OECD in its discussion draft on business restructurings: ‘‘as long as functions. ‘‘tax avoidance’’ and ‘‘tax evasion’’. would independent parties be agreeable to a payment/service fee for giving up/providing value generating skilled resources. the courts/tax authorities cannot question the commercial motives behind a transaction. have not so accrued. Issue Five Does India disregard business restructuring. which the tax authorities were hitherto not directly authorised to do under the existing Indian transfer pricing/tax rules. an inference can be drawn that courts in India have drawn a distinction between the two concepts. assets and/or risks are actually transferred. The natural corollary of the above provisions would be that the powers of the tax authorities under the TP regulations are comparatively limited and at least surely do not extend to a review of the commercial justification for the taxpayer’s transaction. and 08/10 Transfer Pricing Forum BNA ISSN 2043-0760 the Indian TP regulations. Since the authorities ought not to judge the commercial rationale of a transaction. the tax authorities or the courts cannot be judgmental of the commercial decisions of the taxpayer and substitute their decision by what in their wisdom is commercially more prudent. but. the conformity of the contractual arrangements/ documentation with the reality has been demonstrated. the Indian Finance Minister tabled a new direct tax code (DTC). etc. once GAAR is enacted. The upshot of the above discussion is that even if a restructuring is motivated solely by tax savings it may not be disregarded so long as the structure of the transaction mirrors the reality and is not sham. Issue Six Do the Indian tax authorities view risks as only transferring with the relevant people/risk managers? What do the Indian tax authorities place more reliance on. it may not be open to them to price the transactions based on a hypothetical transaction which would ordinarily be expected to exist. There is a fundamental difference between Article 9 of the OECD Model Tax Treaty. in specific industry settings (say Information Technology/IT Enabled services). Where a transaction has been found to be motivated solely by the objective of realising tax savings. Some of the critical factors to be considered in this regard from an Indian standpoint are:s Careful examination of the underlying commercial considerations viz. VIII.10 In terms of the legal basis for the above position. From an Indian transfer pricing point of view. provided the structure put in place by the taxpayer has commercial substance and is not a ‘‘sham’’. Accordingly. Incidentally. has the Indian taxpayer extended a benefit to the overseas group concern while at the same time leading to a reduction in its own profit generation. it would expressly empower the Indian tax authorities to even question the commercial rationale of a business restructuring.’’ In a recent development. reference can also be made to the provisions in India tax treaties and transfer pricing regulations. the scope of the TP regulations is relatively narrow compared to the reach of Article 9 in the tax treaty. which is driven entirely by tax savings. analysis of the loss of future and/or alternative income generation/profit potential. s Structure of the legal/employment contracts. in this regard. but for those conditions. In other words. fabricated or lacks commercial substance. 2011. examination of contractual terms or actual behaviour/ conduct of the parties? The Indian transfer pricing regulations do not contain any specific rules for determining allocation of 4 . prevalent situation in the resource market. availability. the transaction may not necessarily fall foul of law. for e. s Manpower situation e.g. Article 9 provides that if conditions are made or imposed between two related parties in their commercial or financial relations. may be included in the profits of that enterprise and taxed accordingly. On the other hand.g. prima facie.A related issue would be to examine the impact of such movement of workforce on the transferring entity’s profit generation capability and the benefits derived by the transferee entity. it is proposed that GAAR would override tax treaties. the Indian transfer pricing regulations merely require that any income arising from an international transaction between two related parties should be computed having regard to the arm’s length price. whichever is more beneficial to him. It is expected that the DTC shall replace the existing Income Tax Act with effect from April 1. then any profits which would. a taxpayer can choose to be governed by either a tax treaty or the Indian domestic tax law. etc.

If. would imply that the ‘‘significant people functions’’ must be aligned with the contractual allocation of such risks.? As there are no specific rules/provisions in the Indian tax and transfer pricing law dealing with business restructuring and extraordinary transactions. etc. reports. calculations. while evaluating a transaction. while not mandatory. Such documentation requirements equally apply to transactions undertaken by taxpayers pursuant to business restructuring Tarun Arora is a Partner in the National Transfer Pricing Practice at PricewaterhouseCoopers in India. articulating the commercial rationale underlying the business restructuring to strengthen the audit defense. decision to put the capital at risk.g. wherein a fullfledged distributor in India is stripped of its significant risks (such as inventory risk. as laid down in the OECD Transfer Pricing Guidelines (Paragraphs 1. forecasts/budgets.) capturing the financial effects of restructuring (costs and anticipated benefits) as well as an evaluation of the other options realistically available to the taxpayer. s It is important to ensure that the legal contracts (for transactions post restructuring) are in line with the on-ground realities achieved by the group after the restructuring exercise. credit risk and debtors’ risk). He can be contacted be email at : arora. the Indian transfer pricing regulations require taxpayers to maintain detailed documentation on a contemporaneous basis in respect of any international transaction/dealings with group companies in order to demonstrate compliance by the Indian taxpayer with the arm’s length standard. inventory management. Agreements. type and value of the international transactions or arrangements undertaken by the Indian taxpayer with the various associated enterprises involved in the business restructuring. It is necessary to undertake and capture an in-depth examination of the onground business realities of the Indian taxpayer. the Indian tax authorities may arrive at a prima-facie view based on the contractual terms/documentation surrounding the transaction. Where anticipated synergy gains are an important business reason for the restructuring. are: s Examine and clearly document the functions. s Identify the scope. credit evaluation and debtors’ management. However. Some of the relevant factors that should be kept in mind while putting in place the necessary documentation for India (depending upon the facts and circumstances of each case). s Document the internal analysis (e.27). may not be tenable if the ‘‘significant people functions’’ corresponding to the assumption of such risks (which are claimed to have been stripped off the Indian entity) are not actually carried out by the principal from overseas. the Indian law does not contain any ‘‘special documentation requirements’’ in the case of business restructurings. Maintaining India specific comprehensive/robust documentation (on a contemporaneous basis) with respect to restructuring involving Indian operations would be critical from an audit defense perspective. while not conclusive on the characterisation. the purported risk allocation is not consistent with the distribution of control over the creation of such risks). a business restructuring. if the transaction lacks commercial substance (e. etc. including justifying the rationale for business restructuring. assets and risks of the business operations subject to restructuring. e. IX. He can be contacted be email at: rahul. Hence. s Undertake detailed functional analysis under both the pre and post restructuring business activities and document the same. post-restructuring the ‘‘limited risk distributor’’ continues to undertake critical decision making activities/responsibilities pertaining to functions.tarun@in. testing of the compensation paid/received. and attribute a higher return to the so called ‘‘limited risk distributor’’. for determining how risks are distributed. can assist in raising the quality of audit defense. expected benefits.k. e. s Maintain documentation. the tax authorities can disregard the contractual terms/arrangements and re– price the transactions in accordance with the business/commercial ‘‘Control’’. Hence.risks. s A comparison and evaluation of the profits of the Indian taxpayer before and after the restructuring.25 to 1.mitra@in. FORUM ISSN 2043-0760 .com 5 08/10 Copyright 2010 by The Bureau of National Affairs. it would be prudent to document these gains as well as the assumptions on which they are anticipated. then it would be open for the tax authorities in India to disregard such restructuring as sham.g. Issue Seven Are there any special/contemporaneous documentation/ reporting requirements for extraordinary transactions and business restructurings.g.g. s Undertake and document an economic/ comparability analysis using available comparable data reflecting arrangements between independent parties in order to determine the arm’s length pricing for the arrangements between the group enterprises as part of the business restructuring. which as per the tax authorities correctly reflects the commercial reality. discussions. In terms of allocation of risks this. in this context means the capacity to take decisions with respect to risk. However. which are the basis of the profit earning capability of such business. whether and how to manage the risk. including identification of the key value drivers of the business. Several Indian rulings in the past have generically endorsed the principle of aligning the economic substance of a transaction with its contractual terms. s Document the comparability/benchmarking analysis carried out in order to determine and demonstrate that intra group transactions post the restructuring exercise comply with the requirements of the arm’s length standard. Rahul K Mitra is a Partner and Leader of the National Transfer Pricing Practice at PricewaterhouseCoopers in India. may be crucial in justifying the revised structure/arrangements. s Consider and document the totality of the broader overall arrangements and financial impact arising from other transactions undertaken as a part of and/or consequent to the business restructuring. For example. Indian tax authorities would have regard to the factual reality which essentially implies examining who exercises control over the risks or where are the ‘‘significant people functions’’ located.

read with section 2(47) of the Act 4 Section 2(14) of the Act 5 Section 92B of the Act 6 Section 92F (v) of the Act 7 CIT v..8 NOTES 1 Sections 92 to 92F of the Indian Income Tax Act. B. 817 of 2009) Prop. Vanenburg Group B.V. Amiantit International Holdings Ltd. § 1. 10 08/10 Transfer Pricing Forum BNA ISSN 2043-0760 6 . In Re (AAR No. Dana Corporation. reg. Srinivasa Setty. In Re (289 ITR 464 AAR). In Re (AAR No. C.788 of 2008).482-7(b)(3)(viii)(Example 2) 9 The Supreme Court ruling in the case of Azadi Bachao Andolan – 263 ITR 706 (SC). the Revenue may not be permitted to question the commercial rationale for the taxpayer in transacting in any particular manner. 1962 2 Section 2(24) of the Act 3 Section 2(24). has made it clear that so long as a transaction is not a sham or prohibited by law. 1961 (‘‘Act’’) and Rule 10A to 10E of the Income Tax Rules.. 128 ITR 294 (SC).