Transfer Pricing – Updates

MCS
 Transfer Pricing: A Fiscal Challenge

• At the OECD, economists have indicated that nearly 60% of world

trade occurs between different arms of multinational companies.
• In today’s fiscal situation, it would be unthinkable for revenue
authorities to pass up such a large fiscal opportunity.
• TP is an area where revenue interests have to balance art with
science.
• Though most of us would like to make transfer pricing as close to a
scientific endeavour as possible, in practice this may be difficult.
• Any company will always have unique characteristics, which, if
ignored, could place it at a disadvantage compared with others.
• Consequently, we have to ensure that a simplistic approach to transfer
pricing does not create the unintended consequence of taking away a
level playing field in some industries.

Source: Govind Sankaranarayanan, “Transfer Pricing…..”, MINT, July 5, 2010

G.Sankaranarayanan, CFO of Tata Capital Ltd.
Top Five Pharma Companies in India and their Selective
Financials

RANK COMPANY No. of Sales PAT (Rs. Cash/Bank

Subsidiaries (Rs. Crores) Balance
Crores) (Rs.
Crores)
1 GlaxoSmithKline* 99 1,795.00 547 154

2 Dr. Reddy Lab 68 5,212.00 438 745

3 Ranbaxy Labs* 57 6,776.00 786 437

4 Aurobindo 31 2,562.00 238 282

5 Glenmark 22 2,013.00 632 156

* Year-ended March 2007 and for others March 2008

Source: Business World, February 03-09, 2009

 Ministry steps in to reduce TP Disputes

• Hue and cry by Corporate India over huge TP orders

• The Finance Ministry directive to CBDT to put in place a
framework for an Advance Pricing Agreement (APA)
Mechanism
• The CBDT to constitute a panel and put up draft rules
• The Board is working to get the mechanism running by
April 1, 2012.

Source: Subramanian, N Sundaresha, “Ministry steps…..”, BS, December 6, 2011

 Cash-strapped Government and Demand for Tax

• The ghost of TP to haunt MNCs doing business in India

and Indian companies with a big presence abroad.
• Cash-strapped government (See Pranab Mukherjee’s face
– Disinvestment Talk – Budgetary Deficit – Increase in
demand from all quarters for funds – Tax Orders –
Current Budget)
• The Finance Ministry wants to collect Rs. 5.85 lakh crore
in direct taxes by March 2012 (a 30% more than last FY)
• Consultants estimate – Taxman is planning to raise Rs.
80,000 crore from TP adjustment orders to make good on
its direct tax shortfall for the FY.
• Companies and advisors are, however, not in the mood to
put up the money without getting into lengthy litigation.
Source: Subramanian, N Sundaresha and Santosh Tiwari, “Ministry steps…..”, BS, November 18, 2011
 Current Anomalies (January 2011)

• Viewpoint of Consultants of MNCs or MNCs

themselves
• The taxman has a 43-month window after a tax year is over
to come up with adjustments on TP.
• October 2011 – IT Department raised adjustments
amounting to thousands of crores for transactions
completed in financial year 2007-08.
• Multinational Corporations claim– Huge uncertainty,
skewing of our budgets and hitting out investment plans.
 About APA

• A binding contract between the revenue

department and a taxpayer by which the
department agrees not to seek a TP adjustment for
a transaction if the taxpayer files the tax return for
a year consistent with the agreed TP method.
• The mechanism is designed to resolve actual or
potential TP disputes in a cooperative manner, as
an alternative to getting into lengthy legal
disputes.
• The Direct Taxes Bill had proposed a maximum
validity of five years for such agreements.
 APA

• Safe harbour rules for the APA to function well.

• The department clearly comes up with benchmarks on
different transactions .
• Individual companies can apply for pricing agreements
based on these provisions.
• APA may be unilateral or bilateral or multilateral.
• APAs are popular in Australia, US and Japan and are
used widely by companies in dispute resolution.
• E&Y Survey: The satisfaction level with APAs as a
controversy management tool was very high and 90 per
cent of users were likely to use it again.
 Advance Pricing Agreement (APA)

• Advantages for Companies

• Resolution of uncertainty on a prospective basis
• Prevention of double taxation
• Avoidance of Penalties and litigation costs
• Lower compliance costs
• Development of a cooperative relationship with the tax
authorities
• Difficulties in getting the refunds and by APA, one
knows in advance

Source: Subramanian, N Sundaresha, “Ministry steps…..”, BS, December 6, 2011

 Advance Pricing Agreement (APA)

• Advantages for Government

• Increase in foreign direct investment as a result of more
certainty around TP matters
• Reduced administration and enforcement costs
• Removal of disputes, litigation time and costs
• Experience helps with future improvements in regulations.

Source: Subramanian, N Sundaresha, “Ministry steps…..”, BS, December 6, 2011

 Key Dispute Areas

• IT/Telecom – Margins of captive, R&D facilities

• Pharma – IPR, Supply Chain
• FMCG – Royalty payments and advertising spends on
global brands
• Banks – Support facilities/BPO operations
• Others – Pricing of Imports, cross-border lending,
corporate guarantees.

Source: Subramanian, N Sundaresha and Santosh Tiwari, “Ministry steps…..”, BS, November 18, 2011
 Assocham for fundamental reforms in TP norms
• Radical changes are underway with the Direct Taxes
Code (DTC)
• No formal mechanism for mediation under the law at
present.
• The TP disputes in India have so far involved officers and
taxpayers, locking horns on complex economic concepts
relating to creation of intangibles, location savings and
benefits commensurate with payments.
• A sizeable number of disputes arise solely on the ground of
comparability or benchmarking analyses.
• Authorities should adopt the concept of inter-quartile range
and median as better and more robust statistical tools,
instead of arithmetic mean which produces biased results.

Source: “Assocham………..”, BS, December 2, 2011

 CBDT Version

• More references would have come on TP from the

Assessing Officers (AOs) this year and that is why more
notices have been going to companies.
• Notices are directly proportional to the references on
transfer pricing tax dues calculations.
• The law empowers officials to conduct an inquiry or
investigation while determining pricing and even raise
further claims on issues that may come up during such a
process.

Source: Subramanian, N Sundaresha and Santosh Tiwari, “Ministry steps…..”, BS, November 18, 2011
 Corporates’ Viewpoint

• Ambiguity in the provisions is leading to unreasonable

demands and lengthy disputes.
• There are no set criteria for various costs. In such a
situation, any time the government can say “I don’t agree
with your treatment.”
• When the government needs money, it will say so.
• A vicious cycle created by the stress on tax collections due
to the huge refunds issued in 2011.
• Companies spend a lot and appoint big consulting firms, but
even they get into trouble because there is no consistency.
• Even companies consciously want to keep away from
trouble can’t do it.

Source: Subramanian, N Sundaresha and Santosh Tiwari, “Ministry steps…..”, BS, November 18, 2011
 Safe Harbour Provisions

• CBDT Member: The Rules will apply to all sectors,

such as IT, BPO, ITeS, auto, garments, wrist watches
and liquor, that involve international transactions
between two related companies.
• We are discussing what should be the ideal harbour
rate.
• The problem is that in the IT sector alone, margins
vary between 5 per cent and 75 per cent and they
change every six months.
• Hence, CBDT is in a fix over the application of one
safe harbour rate to all sectors.
Source: Beniwal, Vrishti, “CBDT panel finds hole in TP tax rate”, BS, January 26, 2010
 Habouring Many Views

• A CBDT panel has estimated there is variance in margins of companies that would
come under the ambit.
• Experts argue that a lower rate should not be a problem, as it evens out in the long
run. (Growth rate in a given sector in the beginning and maturity stage – Applicability
for a given company too)
• The industry is of the view that the rate should be based on the average margins of
the industry.
• Consultants – Instead of a range, there should be one single rate for safe harbour
with the flexibility of minor adjustment of 2.5% on either side.
• The government wants to keep the rate higher to avoid any kind of revenue loss.
 Demands for Transfer Pricing (of Revenue Authorities)

• Rs. 3,500 crore in 2007-08

• Rs. 10,000 crore in 2009-10
• September 2011 – Figure put at about Rs. 22,000 crore
• 2011-12, consultants estimate the taxman plan to raise Rs.
80,000 crore from TP adjustment orders.

Source: Beniwal, Vrishti, “CBDT panel finds hole in TP tax rate”, BS, January 26, 2010
 Under Tax Scanner and Impact

• Distinction between “Tax Planning” and “Tax Avoidance”

• IT Heavyweights like IBM, Accenture and Capgemini
• Assumingly indulging in under-reporting revenues (in India)
by shifting profits using transfer pricing.
• TP adjustments are being disputed in various appellate forums
and hence have not attained finality.
• Such news tend to question “corporate integrity” and
“governance of significant investors”.
• International tax media has severely criticized India for its
handling of TP disputes, labelling it as amongst the most
“difficult tax jurisdictions”.
• MNCs are at logger heads with Indian Revenue authorities

Source: Butani, Mukesh, “Transfer Pricing law – Reflections & prejudices”, BS, Sept. 12, 2011
 “Reality” and TP-related Issues

• Tax issues have been keeping pace with “complexities of the

business world” or not.
• The “steep learning curve” displayed by both the Indian
Revenue authorities and taxpayers.
• “Objective reflection” on the currents state of flux.
• Indian views to align itself with “global though leadership
initiatives” – Not Encouraging
• The historical framework of Indian tax regulations has been a
“cocktail of concepts” developed by common law, UN and
OECD countries. There is desi (Indian) flavour to everything.
• Wide variance in the ground level understanding of transfer
pricing aspects, safe harbour limits

Source: Butani, Mukesh, “Transfer Pricing law – Reflections & prejudices”, BS, Sept. 12, 2011
 Pfizer in Pakistan has TP Issue

• The eight investors - two others died waiting for the

verdict - are part of a dwindling group of
shareholders who now own less than 0.5% in Pfizer
Laboratories Ltd (PLL), which is the current version
of Pfizer’s operations in Pakistan that has origins in
a manufacturing facility opened in 1961.
• Some of the shareholders who have been fighting
Pfizer in court maintain that their original holdings
are investments that their parents made in a
company called Dumex, acquired by Pfizer in 1959.

Source: Parker, Leela Ann, “Transfer Pricing at heart of Pfizer Case”, Mint, July 26, 2007
 Pfizer in Pakistan has TP Issue

• At its core, the legal battle is fairly simple.

• The shareholders allege that Pfizer has deliberately contributed
to poor results at its Pakistan operations, thus continuously
diluting the value of the minority stakeholders’ shares in an
attempt to get 100% control of the business for a lot less than
what it is worth.
• Minority shareholders alleged that Pfizer sold raw
materials at huge markups.
• They say because Pfizer took equity in return for the cash it
pumped into the struggling operation, the drug giant ended
up with a growing share of PLL at the cost of minority
investors whose equity only fell over time.

Source: Parker, Leela Ann, “Transfer Pricing at heart of Pfizer Case”, Mint, July 26, 2007
 Court ordered examination of PLL’s practices by E&Y

• Examination Report by E&Y

• Pfizer exported drug raw materials to the Pakistani unit at prices
that were, in some cases, up to 70 times those charged by
alternative providers.
• For example, the court papers show, amlodepine besylate, the
active ingredient in high-blood pressure medicine Norvasc, was
sold at $30,000 per kg while alternative sources could have
provided it for as little as $500 per kg.
• Another example was of piroxicam, used in arthritis drug
Feldene, which was allegedly imported by PLL at $8,750 per
kg, compared with $125 per kg in the market.
• Another ingredient, doxycycline, found in antibiotic
Vibramycin, was imported by PLL at $700 per kg though it
could have been purchased for $60 per kg.
 Pfizer in Pakistan has TP Issue

• Whether other suppliers could have provided the same raw

materials at the prices cited.
• A judge in Karachi agreed with the minority investors, citing
Pfizer’s treatment of them as “oppressive.”
• The ruling of the Sindh high court also ordered an independent
auditor to calculate a new valuation of PLL’s shares, taking
into consideration the “artificial losses” created by Pfizer’s
“transfer pricing.”
• A. Majeed, director and CS for Pfizer in Pakistan: “The
issues raised in your questions are all subject matter in a court
case thereby making the issues subjudice and therefore, we
cannot provide any comment at this stage.”
• Asked if an appeal was planned, Majeed simply wrote “yes.”
 Pfizer in Pakistan has TP Issue

• The minority shareholders insist that even if their battle is

about much smaller amounts, it is a matter of principle.
• “When you’re young and starting out, you invest
something for your old age and your kids,” M.A. Khan said
of his paediatrician father’s motivations in buying 100,000
shares in the late 1950s.
• He recalls his parents meeting Pfizer board members in New
York, then later entertaining company executives in their
Karachi home in the 1950s and 1960s.

Source: Parker, Leela Ann, “Transfer Pricing at heart of Pfizer Case”, Mint, July 26, 2007
 Pfizer in Pakistan has TP Issue

• For the next three decades, PLL was largely profitable, declaring dividends and
bonus shares on a regular basis.
• By 1990, it reported profits of Pakistani Rs160 million, with equity amounting to
Rs. 98 per share.
• But, in 1991, the company embarked on a change in business strategy, which one of
the shareholders describes as the beginning of the downturn.
• But investors were still hopeful about the company’s prospects.
• In 1995, chartered accountant Azfar Hasnain bought 126,242 shares in PLL for his
son Zahid, then in college, at about Rs. 12.50 per share.
• Back then, about 23% of the company was held by minority shareholders, with the
rest owned by Pfizer, he said.
• For the next few years, PLL’s sales still grew steadily, at an average of 4% per year.
• But, because of the huge markup on drug ingredients—offset by money pumped in
from the parent and taken back in the form of shares—the Pakistan unit began
operating at a loss and shareholder equity shrank.
 Pfizer in Pakistan has TP Issue

• Throughout the 1990s, minority shareholders’ questions about

Pfizer’s practices were brushed off at multiple annual meetings.
• Matters came to a head in 2000 when Pfizer prevailed in
acquiring Warner-Lambert Co. for $90 billion in stock and the
two companies agreed to merge subsidiaries worldwide.
• In Pakistan, PLL was to be merged into Parke Davis & Co. Ltd,
a unit of Warner-Lambert, through a share swap ratio of 264 PLL
shares to one Parke Davis share, creating a company called
Pfizer Pakistan that could eventually be traded on exchanges in
the country.
 Pfizer in Pakistan has TP Issue
• The per-share swap value of PLL was derived based on a 2001 audit by
accounting firm KPMG.
• At least 10 minority shareholders objected to the merger, claiming that a
Rs10 share of PLL (in Pakistani rupees) had been reduced to just four paise.
• The remaining 20 or so minority shareholders-some scattered around the
world-did not pursue legal action.
• “I am surprised at how a large company can get away with it,” said
Nurallah Merchant, who inherited 50,000 shares, along with his wife. “I am
an actuary by profession so I understand these things. I was requested by
my father-in-law to get involved.”
• But the investors suffered a setback when, in 2002, the court denied their
request to stop the merger of PLL and Parke Davis.
• But, in doing so, the court also ordered Pfizer to buy them out at a
“reasonable” price.
• Along with that ruling, the court also ordered a second valuation of PLL,
this time from auditor Ernst & Young.
 Pfizer in Pakistan has TP Issue

• E&Y Report (2003) – Formed the basis of ruling in 2007 (May 21)
• “It may be argued that the financial position of PLL is a direct consequence
of the decision of its management to operate in the manner described,” the
report said, citing the inflated drug prices. “…such management decisions
have been in the interest of the majority shareholder, which is also its
principal supplier of raw materials.”
• By 2002, the E&Y report concluded, PLL’s losses amounted to more than
Rs. 930 million - equal to more than 152% of the total value of the
company.
• The court concurred that the impact of transfer pricing on both the
profitability of PLL and the valuation of minority shares was not
adequately taken into consideration at the time of the proposed merger.
• M.A. Sayeed (Served as the lead lawyer for the minority shareholders):
“Indeed, it is the first judgment of its kind considering transfer pricing
as an instrument of oppression of the minority shareholders. This
practice has been guarded against in the income-tax law of Pakistan.”
 Pfizer in Pakistan has TP Issue

• This judgment would spur the Securities and Exchange Commission of

Pakistan to initiate an investigation into the affairs of PLL.
• Minority Shareholders: All we want is “a fair price for the shares.”
• The years have taken their toll. In addition to two of the original parties to the
lawsuit dying, today, only 0.35% of PLL is held by minority shareholders.
• And for Pfizer, the merger of PLL and Parke Davis is pending the
resolution of the valuation of minority shares, notes Azfar Hasnain, who has a
power of attorney for PLL shares held by his son who is largely overseas.
• “A similar investment made in other company would be 40 to 50 times
more,” says Khan, who holds the 100,000 shares with his brother, Abbas.
“That’s the reason I am fighting for this thing. It’s a personal principle.”
 Pfizer in Pakistan has TP Issue

• A Shareholder who inherited shares: “I am surprised at how

a large company can get away with it.” “I am an actuary by
profession so I understand these things. I was requested by my
father-in-law to get involved.”
• The investors suffered a setback when, in 2002, the court
denied their request to stop the merger of PLL and Parke
Davis.
• But, in doing so, the court also ordered Pfizer to buy them
out at a “reasonable” price. Along with that ruling, the court
also ordered a second valuation of PLL, this time from
auditor Ernst & Young.
 Pfizer in Pakistan has TP Issue

• E&Y Valuation - Effect

• The court concurred that the impact of transfer pricing on both
the profitability of PLL and the valuation of minority shares
was not adequately taken into consideration at the time of the
proposed merger.