Presentation - Ms. Karishma Phatarphekar - Pharmaceuticals and Manufacturing - 22 March 2014

Pharma and Manufacturing

Industry – Overview and Recent

Updates

Karishma R. Phatarphekar

Partner,

Global Transfer Pricing Services

KPMG India

The Chamber of Tax Consultants

TP study course

22nd March 2014

1 © 2014 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with

KPMG International Cooperative (“KPMG International”), a Swiss entity.

All rights reserved.

Business

restructuring and

exit charges

Location

advantages

More audits,

disputes and

litigation

Increasing onus on

taxpayer

Scope of rules

expanding

More and more

complex regulation

Aggressive practices

by tax authorities

Dissatisfaction with

profit based

methods

Transfer Pricing – A proliferation in recent times....




Indian TP environment

TP Adjustment scenario at present

“Indian Revenue authorities are reckoned to be tough

globally in TP matters, with India accounting for about 70%

of all global TP disputes by volume”

(Source: Financial Express newspaper 16 July 2012)




Pharmaceutical industry - Areas of discussion..

1 Pharmaceutical Industry - Overview

Types of International Transactions

• Import of APIs

• Payment of Commission

• Clinical Trail Support Services

• Marketing Intangibles

• Contract R&D

• Royalty Payouts

• Location Savings

2

Other Pharma TP Issues 3

Comparison of Relevant Decisions 4

Key Takeaways

Way Forward 6

5




Pharmaceutical Industry - Overview





5

Typical FAR of Pharma Industry

Functions Assets Risks

– Research & Development

– Procurement

– Manufacturing – Primary &

Secondary

– Inventory Management

– Quality control

– Advertising / Marketing

– Sales

– Ordering and distribution

– Invoicing and collection

– Administrative, Financial and

Legal Matters

- Tangible Assets

(e.g Building, Plant &

Machinery, etc.)

- Intangible Assets

: Technical (Know-how)

: Marketing (Brand name)

– Market risk

– Product liability risk

– Inventory risk

– Technology risk

– Research and development

risk

– Credit risk

– Foreign exchange risk

– Manpower risk

– General business risk





CUP

• Purchase of API’s

• Sale of API’s

• Import / Export of Formulations

• Royalty for use of technology and

trademark

TNMM

• Manufacture of Formulations

• Contract R&D Services

• Clinical Trail Services

• Marketing and Promotion Services

• Contract Manufacturing Services

RPM • Distribution of API/Formulation

Transfer Pricing Methods




Import of Active Pharmaceutical Ingredients (APIs)




Pharmaceutical Industry – International Transactions

Entities Involved Functions / Risks

Overseas AE - Manufacturing and

marketing of API

- Product liability, R&D

Risk

- Processing of API

- Sale of Formulations

- Market, credit, inventory

and forex risk

Outside India

India

Indian AE

Primary

manufacturing

of APIs

Secondary

manufacturing

of FDFs

Import of Actives

Import of Active Pharmaceutical Ingredients




9


Issues

Documentation

Suggestions

• Comparability with generic API’s;

• Secret Comparables using power u/s 133(6);

• CUP analysis for import of actives / formulations. (using

CIMS data) – geographic differences, quality and grade of

APIs ignored

• Selection of right comparables;

• Carry out analysis on Customs database;

• Exclusion of companies from different geographies;

• Difference in Selling Price, Pharmacopeia;

• Re-iteration of high profits under TNMM, if applicable;

• Analysis of the customs data / relevant industry

publications.

Import of Active Pharmaceutical Ingredients





• Whether the patents for the products have

expired

• Independent reports on differentiation in quality

• Selling price and market share analysis

• Evaluate internal CUPs if any upfront

• Quantify other adjustments – R&D, quality and

other support

• Comparison of the transfer price over the past 5

years – whether increased or decreased

• Understand the policy of the group to price the

API's whether standard cost plus

Imports is generally a high value item and therefore the

department is eyeing this closely so need to be extremely

proactive and detailed

• Meeting with markets team to understand

other competitors similar products and their

procurement strategy

• Whether any licensing agreement executed

earlier

• Why TNMM is the most appropriate method –

make aggregation rationale more conclusive

• Request for quality reports, data and

information on generic comparables proposed

to be utilized by the TPO very strongly and

explicitly

Analysis for APIs where external CUP not favourable




Payment of Commission






Entities Involved Functions

Overseas AE

- Marketing outside

India of products

manufactured by

Indian AE -

canvasser

- Manufacturing of

formulations

- Distribution of products in

and outside India directly

to the customer

Payment of

Commission

Outside India

India

Indian AE






Issues

Documentary

Suggestions

• Evaluation of commission transaction separately required

as the same is not closely connected to other transactions;

• If no direct documentary evidence to demonstrate, services

rendered could be disallowed;

• Commission percentage more than 3-5% scrutinized;

• Documentary evidences like copy of agreement, marketing

material, letters from overseas AE, CA Certificate / Bank

Realization Certificates, etc. should be maintained;

• Demonstrate tangible benefits;

• Demonstrate that marketing in India is routine and not non-

routine

Documentary evidence very crucial




Clinical Trial Support Services






Entities Involved Functions / Risks

Overseas AE - Manufacturing

- Marketing

- Primary R&D

including clinical

trials

- Co-ordinates with

hospital and CROs

- payment to hospitals /

CROs

Outside India

India

Indian AE

Clinical trail

services

Hospitals /

CROs






Issues

Documentary

Suggestions

• High mark up comparables selected by TPO without carrying

out appropriate FAR as to whether Indian AE does actual

clinical trials or only acts as coordinator;

• Difficulties arise in identifying appropriate comparable

companies

• Charges mark-up even on pass through cost

• Role may vary from mere facilitation/co-ordination v/s

responsibility for the completion of the trials;

• Risk associated with failure of product development primarily

assumed by AE;

• Service being procured from a third party – pass through

cost;

• Demonstrate pass through cost is pure reimbursement

Demonstrate the functional dissimilarity of comparables




Marketing Intangibles






Trade Intangibles


• Trade intangibles are all commercial intangibles (other than

marketing intangibles)

• Created through R&D activities and expenditure that the

developer seeks to recover over the life of the IP

• Include patents, know-how, designs, and models that are used for

the production of a good or provision of a service, as well as

intangible rights that are themselves business assets transferred

to customers or used in the operation of a business

• These are typically created through marketing activities or

developed over time through customer relationships (goodwill)

• Include trademarks and trade names that aid in the commercial

exploitation of a product or service, customer lists, distribution

channels, and unique names, symbols, or pictures that have a

promotional value for the product concerned

V/s






Issues

Documentary

Suggestions

• Determining the ALP

• More than 1 party contribute to the IP – what should be the arms

length share of each party

• Advertisement, Marketing and Promotion expenses (AMP)

construed as marketing intangible

• Indian distributor, even if not the “legal owner”, held to be the local

“developer” of trademark and hence should not pay royalty and /

or recover the AMP

• TPO’s adopt cost plus mark-up assuming more than normal AMP

to be reimbursed at mark-up of 10-15%

• Well drafted agreements and documenting business strategy;

• Demonstrate the tangible benefits and economic substance;

• Demonstrate that marketing in India is routine and not towards

promoting the brand;

• Policy to recover non routine expenditure as reimbursement




LG Electronics : Special Bench decision to deal

with legal issues not factual issues

Indian company, engaged in manufacturing of Electronic

goods in India , is a subsidiary of a Foreign Company

Indian Company incurs AMP expenses for marketing the

goods produced in India

Indian company has incurred AMP expenses which

exceeds the Bright Line limit

Excess AMP expenses incurred by the Indian Company

is perceived to enhance the brand value of Foreign

Company

Indian tax authorities have contended that AMP

expenditure incurred by a taxpayer at a level that exceeds

the “bright line” is to be reimbursed by the foreign AE with

a mark-up

Brand

Creation /

Marketing

Intangible

Indian Company

Foreign Company

Excessive

AMP

Expenses

Owner of

Brand

In India

Outside

India

Judicial Precedent

• Incurring of AMP expenses by the assessee towards brand legally owned by the foreign AE

constituted a 'transaction' subject to TP provisions;

• Upholds use of Bright Line Test for determining cost / value of such transactions:

• Under IT Act, it is legal ownership of brand that is recognized - Special Bench Majority View

• Matter on the quantification set aside to re-look at comparables and appropriate cost base




Judicial Precedent

BMW India Pvt. Ltd.- Delhi Tribunal

The Delhi Tribunal observed that:

BMW India though not a licensed manufacturer is fully responsible for sales promotion, full utilization of market

potential, providing customer service and for establishment of efficient distribution network and therefore the

functions far exceed the functions performed by a routine distributor.

The ITAT held that it was necessary for the assessee as a distributor to incur expenditure on sales promotion

and advertising but rejected assessees stand that incurring AMP expenditure is not an international

transaction by relying on LG’s ruling.

The ITAT observed that when the margins earned by the assessee were compared to those earned by the

comparables, it could be concluded that the assessee was sufficiently compensated for excess AMP

expenditure in terms of high profit margin,

The ITAT further observed that rewarding a distributor by way of price adjustment is well recognized and

well accepted remuneration model and that the department cannot insist in the absence of any

provision under the Act that the mode of compensation to the assessee by the foreign AE necessarily

be in the form of direct compensation.




Casio India Co. Pvt Ltd – Delhi Tribunal The Indian co. is a wholly owned subsidiary of Casio

Japan. The Indian company is a full fledged distributor of

watches and consumer information and other related

products in India.

The TPO made an adjustment for excess AMP expense

relying on SB ruling in case of LG.

The CIT(A) deleted the addition holding that AMP

expense have been incurred as part of its distribution

function and the benefit accruing to the AE was only

incidental.

The revenue was in appeal before the ITAT. While the

assessee relied on ruling in case of BMW, since it was a

distributor and the margins earned by the company

higher than that of comparables.

However the ITAT in this case, held that SB ruling in LG

not only applies to a manufacturer, but also extends to a

distributor whether he is bearing full risk or least risk.

ITAT thus set aside CIT(A) order and restored the matter

to the AO/TPO to decide afresh in conformity with LG SB

ruling

Indian Company

Indian co.

Consumer

Outside

India

India

Judicial Precedent

Import of Goods

Distribution

Almost similar facts to BMW but set aside for deciding the matter afresh




Contract R&D





Contract R&D

Issues

• High mark up comparables selected by TPO without carrying out

appropriate FAR as to whether Indian AE does actual R&D

activities or only acts as facilitator;

• Indian R&D Centre considered to be the economic Owner of IP -

use of high cost plus mark ups or profit split method

• TPO’s allege that majority of valuable & Unique IP are generated

due to work undertaken in India

• Prone to high litigation due to lack of clarity – prone to subjective

interpretation;

Documentary

Suggestions

• Robust FAR to justify captive R&D activities

• Primary onus on taxpayer to demonstrate remuneration on cost

plus mark-up

• Reliance can be placed on clarification by CBDT vide Circular

No.06 /2013 dated 29th June, 2013 stating 3 broad categories

based on FAR i.e. Entrepreneurial, Contract R&D and Cost-

sharing arrangements




Guidelines for

identifying the

characterization

of R&D Centre

Parameters

Funding/ Assets

Risk Profile

Outcome of Research

Foreign Entity

Performs Economically Significant Functions

Economically significant functions’ to include critical functions such as

conceptualization and design of the product and providing strategic direction and

framework

Provides funds/ capital Significant assets & intangibles

Strategic decisions for Core Functions & Monitoring on regular

basis

Economically Significant Risks

Legal & economic owner of resultant IP

Indian Entity

Performs work assigned by foreign entity

Receives remuneration for the services

performed

Operates under direct supervision and actual

control

No Economically Significant realised Risks

No ownership of resultant IP

Functions

Supervision & Control

Entrepreneurial R&D Contract R&D Cost Sharing Arrangements of R&D

Favo

ura

ble

An

aly

sis

Unfavourable Analysis

Contract Research

Services

Note: In the case of a foreign principal being located in a country/ territory widely perceived as a low or no tax jurisdiction, it

will be presumed that the foreign principal is not controlling the risk. However, the Indian Development Centre may rebut

this presumption to the satisfaction of the revenue authorities.





Royalty payouts




Charging a royalty or licensing fee within a MNE for the use of valuable

know-how, technology processes, trade names, or other intangible property,

have faced stringent tax scrutiny in pharma industry.

Tax authorities are challenging the royalty rate, comparables and arm’s

length price as determined by the taxpayer.

Historically India has been a technology importing country.

With the advent of MNCs, royalties were increasingly viewed as cash

repatriation tools – tax shield on royalty payments plus credit of withholding

tax in receiving country.


Royalty Payouts





Royalty Payouts

Issues

Documentary

Suggestions

• Satisfy ‘Benefits test’, justify royalty in a loss situation

• Need to establish direct correlation with sales/ profitability

• Whether royalty is embedded in price paid

• Approvals received by RBI not acceptable as external CUP

• Aggregation approach under TNMM – Challenged and general lack

of availability of comparables.

• Transaction specific approach has been adopted by revenue –

Outright rejection of rationale for payment. ALP held to be NIL.

• Non acceptance of foreign comparable / databases.

• Tangible/Strategic benefits received and quantification

• Demonstrate dependence of business on the intangibles

• License agreement, quotations of comparable independent recipient

• Uniqueness of intangible, market where it is used, rights of taxpayer

to receive upgrades

• geographic restrictions - export based on the licensed technology.




Various payment models

Normal Royalty streams Percentage on sales or profit, per unit royalty, lump sum payment etc.

Package Pricing Amount included in transfer price of goods, no separate royalty payment.

Industrial franchise arrangements Franchise fee paid by licensee to licensor for entire business format including

production process, marketing strategies, etc.

Others Separate royalty fees for trademark / trade name and technology.


Royalty Payouts




EKL Appliances Ltd. – Delhi High Court (2012)

(ITA Nos. 1068/2011 & ITA Nos. 1070/2011)]

Taxpayer engaged in the business of manufacturing and trading of refrigerators, washing

machines etc.

For FYs 2001-02 and 2002-03 the TPO disallowed the transaction of payment of royalty to

AE, whereas accepting all other international transactions to be at arm’s length.

Revenue’s Allegations

Taxpayer has been incurring losses year after year. Royalty payments did not result in profits from operations

Increase in turnover did not result in any profit to the taxpayer.

The continuous losses incurred showed that the taxpayer did not benefit in any way from the royalty payment. Thus payment of royalty to the AE is not justified.

Taxpayer’s arguments

The allowance of royalty depends on the utility of the brand name and the technical knowhow in respect of which the payment is made and not on the profitability of the paying entity.

Royalty payment is a legitimate expenditure and non-payment of the same would have had serious implications for the taxpayer’s business.

There were profits at the gross level and the losses at the net level were due to significant increases in the operating expenses.

Due to availability of the brand name there was substantial increase in the turnover otherwise there would have been more losses.




EKL Appliances Ltd. continued

CIT(A) Ruling

It was imperative for the taxpayer to upgrade its technology due to market dynamics.

There were profits at the gross level and the losses at the net level were due to increase in

operating costs. The losses show significant reduction after technical up gradation.

The TPO disregarded the business and commercial realities of the business of the

taxpayer and acted in a mechanical manner ignoring the economic circumstances

surrounding the transaction. TPO cannot question the judgment of the taxpayer as to how it

should conduct its business.

Royalty payment was incurred for genuine business purposes and should have been

allowed even if the taxpayer had suffered continuous losses in the business.

Tribunal Ruling

Tribunal agreed with CIT(A) that the royalty payment was justified and the TPO was wrong

in disallowing the same.




EKL Appliances Ltd. continued

High court ruling

It is not for the Revenue authorities to dictate to the taxpayer as to how he should conduct his

business and what expenditure should be incurred.

It is not necessary for the taxpayer to show that any legitimate expenditure incurred by him

was also incurred out of necessity or

that the expenditure incurred by him for the purpose of business has actually resulted in profit

or income.

Taxpayer only needs to show that the expenditure should have been incurred “wholly and

exclusively” for the purpose of business.

Whether or not to enter into the transaction is for the taxpayer to decide. Quantum of expenditure

can be examined by the TPO but he has no authority to disallow the expenditure on the ground

that the taxpayer has suffered continuous losses.

High Court also relied on the OECD Guidelines - Tax administrations should not disregard and

restructure the transactions as actually undertaken by the taxpayer except

where the economic substance of a transaction differs from its form; and

where the form and substance of the transaction are the same but arrangements made in

relation to the transaction, differ from those which would have been adopted by independent

enterprises behaving in a commercially rational manner.




Location Savings





Location Savings - Meaning

OECD

Location Savings (LS) derived by an MNE group that relocates

activities to a place where costs are lower than in location where

activities were initially performed

UN

General Parlance

LS are net costs savings that an MNE realizes as a result of relocation

of operations from a high cost jurisdiction to a low-cost jurisdiction

Net ‘Cost savings’ realized by an MNC as a result of relocating

manufacturing functions / production / operation sites from a ‘high

cost’ to ‘low cost’ jurisdiction to obtain competitive advantage





Location Savings

Typical cost savings include savings pertaining to:

• Labour costs;

• Raw material costs;

• Rent and property taxes;

• Training costs

• Infrastructure costs and

• Incentives including tax exemptions

Most low cost locations are in the ‘Developing World’ (e.g.- India, China,

Malaysia etc.)

Location savings = Input cost in a high cost region – Input cost in a low cost region





Location Savings

Issues

Documentary

Suggestions

• Quantification and allocation of “location savings”

• Attribution i.e. who is the rightful owner of additional profits from

location savings, the parent company or the overseas subsidiary

(‘AE’) or both

• Existence and allocation of “location savings” depends upon the

bargaining power of the parties

• Bargaining Power highly subjective - depends upon factors like

economic or beneficial ownership, uniqueness and monopoly power

• Benchmark industry cost structure changes rapidly due to shift of

manufacturing activity to low cost locations

• Approaches to allocation of location savings :

- Facts and circumstances based approach

- Indirect approach considering location dis-savings

• LS advantage passed onto end customers to survive stiff

competition





Location Savings – Recent Case Law

GAP Intl Sourcing

(India) Pvt. Ltd

• Location savings is reflected in the profitability earned by

comparables

• News Paper report cannot partake the character of

comparable data

• Location savings arise to industry as a whole

• LS advantage could be passed to end-customers to survive

stiff competition

GAP International Sourcing has rejected the applicability of “Location Savings” to the

particular case in a competitive situation (where the location advantages are passed onto

customers), however, it has not rejected the concept of “Location Savings”.




Other Pharma TP Issues




Pharmaceutical Industry – Other Pharma TP issues

Other Issues

Product Analysis vis-à-vis basket of products approach

• Most Enterprises in Pharma Industry use basket of product approach for TP

analysis and benchmarking using TNMM

• Product portfolio is a mix of established products and the products with future

potential

• Parent companies invest significant time and resources to generate new product

lines

• General Industry trend to promote complete mixture of products across different

therapeutic segments

• Tax authorities ignore the business rationale to aggregate the transactions and

require each international transaction to be benchmarked separately.





Other Issues

Drugs Prices Control Order (DPCO)

• In India, end consumer prices of several drugs are governed by DPCO

• Price control under the DPCO may cause product margins of pharmaceutical

companies to come under pressure

• Where the pricing of raw material inputs procured from AE’s is sought to be

reviewed by the application of profit based transfer pricing methods, the

identification of comparable companies entails challenges

• Ignoring the effect of DPCO on pricing of drugs, tax authorities have been

attributing the lower profits /losses to poor transfer pricing policies of the

taxpayers.





Other Issues

Distribution – start-up losses

TP Documentation to take into account the following :

• Loss analysis stating demonstrating factors triggering losses i.e. unfavourable

business decision, external / extraordinary causes,

• Variance analysis between budgeted and actual figures with regards prices and

volumes

• Countermeasures taken to cope with the loss situation

• Documentary evidence in defending losses stating not only profits of the taxpayer

but overall profitability (including other related parties in the supply chain of the

business decreased

• Consider applying for Mutual Agreement Procedure (MAP) based on taxpayer’s

position





Other Issues Entity level Comparison v/s Segment Comparison

• Rule10B(1)(e)(i) “net profit margin realised by the enterprise from an international

transaction entered into with an associated enterprise……”

• Taxpayer to maintain segmental accounts separately for transactions with AE’s and

Non-AE’s

• Expenses to be allocated between AE and Non-AE Segment using appropriate basis /

allocation keys :

- Direct Expenses : On actual basis

- Indirect Expenses : Based on allocation keys such as turnover, employee

headcount, time spent, area occupied, number of computers etc

• Adoption of segmental data upheld in the decision of UCB India Pvt Ltd v/s ACIT

(Mumbai) and Iljin Electronics India Pvt Ltd v/s ACIT (Delhi).

Real time audited segmental data preferred over unaudited segmental data by the

authorities during assessment




Pharma Industry – Comparison of Relevant Decisions




Pharmaceutical Industry – Comparison of Relevant Decisions

UCB India

GlaxoSmitkLine Inc

Serdia India

Branded products

cannot be

compared with

generics

Tax Court - Price of generic

API constitutes CUP

Federal Court of Appeal –

Overruled tax court,

importance should also be

given to commercial factors

such as the agreement

After the patent

expiry branded

product can be

compared to generic

products.

Issue

Branded V/s

Generic API

Quality Differences

Even a minor

difference in quality

will affect price,

efficacy and safety

of product.

Quality difference cited in

granulation. GMP, HSE

practices bear no

significance on import

prices.

Allowed adjustment

based on

pharmacopeia

standards.

Requirement for

authoritative quality

grading systems.




Pharmaceutical Industry – Comparison of Relevant Decisions

(contd….)

UCB India

GlaxoSmitkLine Inc

Serdia India

Rational judgment

needs to be adopted

for CUP method.

Rejection of TNMM

based on entity level

margins.

Hierarchy of methods

citing CUP as the most

preferred methods. Also in

OECD hierarchy taken into

consideration.

Transactional methods

to be preferred over

profit based methods

Issue

Priority of Methods

Final Decision

Importance of

Agreement

NA License and royalty

agreement are separate.

Need to be considered for

ALP calculation

Hidden Technical fees

needs to be supported

by agreement.

Fresh adjudication

with rejection of

TNMM and CUP

method. New TP

documentation study

to be undertaken.

Extra amount above ALP

treated as dividend.

Additional evidence

required and referred back

for fresh adjudication to

take into account the

licensing agreement

Upheld the CIT(A)

order.




Manufacturing - Areas of discussion..

1 Manufacturing Industry- Types of Manufacturer

Compensation Model 3

Typical Transfer Pricing Issues 4

Specific Transfer Pricing Issues 5

Challenges for Contract Manufacturers

Management Payouts 7

6

2 FAR Analysis




Manufacturing Industry




Manufacturing Industry – Types of Manufacturer

Functions

and risks

Toll

Manufacturer

Contract

Manufacturer

Licensed

Manufacturer

Entrepreneur

Intangibles

Sales

Inventory

Manufacturing




Manufacturing Industry – FAR Analysis

Functions Risks

Products and entities

Transactions

Forecasts/ business

plan

Business process

Asset Agreements/

terms

Financial results

Organization/ staff

Internal comparables

Characterization

Basis to search for external comparables

Planning possibilities

Forecasts/ business

plan

Risk opportunity assessment

Documentation Understanding

of business

FAR

Analysis

Inputs Outputs




Manufacturing Industry – Compensation Model

Functions Typical Compensation model

Contract / Toll

manufacturing operations

Full cost plus mark up (or)

Return for value added services plus appropriate return on

capital investments in material and finished goods inventory

Routine manufacture /

assembly activity with

licensed technology from

Group.

Risk free assured return in line with industry benchmarks

As a variant of the above

with significant local

marketing efforts

Receipt of compensation for marketing intangible in addition

to the above

Full fledged manufacturer

and contributing to the R&D

effort of the Group

Profit Split Method (PSM) to determine the contribution

towards routine functions and towards intangibles




Manufacturing Industry – Typical Transfer Pricing Issues

Start up phase challenges

Application of the TNMM method – Dealing with losses

Application of CUP – Comparability issues

Aggregation of transactions – Trading, Sourcing, Product Bundling

Payment towards Technical Know - How

IPR Valuation

TP Vs. Customs




Manufacturing Industry – Specific Transfer Pricing Issues

Business Restructuring

Challenges for Contract Manufacturers

Comparability Adjustments – Specific focus working capital

Payouts - Specific focus on Royalty

Imports V/s Local

Apparent transfer pricing risk

Global effective high tax rate

Potential need for ongoing capital contributions




Manufacturing Industry – Challenges for Contract

Manufacturers

Functional profile of Contract Manufacturers - Risk-free operations

Remuneration model - remunerated with a Cost Plus Mark-up with reference to third party

manufacturers Challenge

Third parties available as benchmarks are Entrepreneurial manufacturers

• Undertake full gamut of risks

• Not remunerated on “Cost Plus” basis

Solutions

Adjustments for better comparability

• Possible adjustments for working capital and Risk differential

Alternate PLIs

• Use of Return on Assets (ROA) as PLI

• Use of Return on Capital Employed (ROCE) as PLI

Safe Harbours

• As a percent of return on value of assets employed/return on total costs

• Recent safer harbours announced in India for auto manufacturing industry




Manufacturing Industry – Management Payouts

Typical forms of payouts - Royalty, Technical fee, Management fee, Guarantee fee

Primary challenge – Payouts through having economic substance are challenged in the start up

phase due to existing losses

Benchmarking - Is a challenge due to inadequate comparable data in public domain

Documentation - Under the transaction specific approach it is necessary to analyze potential

“cost-benefit” and maintain appropriate documentation to substantiate arm’s length nature of

payouts

• Cost- Benchmarking payouts of comparable companies, Basis of arriving at the value of

payouts ( Direct / Indirect Method) by the Group

• Potential Benefits - Need for obtaining service from the Group, Analysis of potential benefit

obtained by the Company and value attributable to the service

Other Regulatory Considerations - The recent relaxation of the statutory RBI / FEMA limits on

royalty and technical fee payouts increases the challenge of defending the arm’s length nature of

such transactions.




Key Takeaways

Need for proactive and robust CUP analysis.

Mere reliance on the reason of difference in quality not

sufficient for rejection of CUP

Commercial justification to be built on to source APIs

from AEs vis-à-vis third parties

Need to have a detailed licensing agreement where

trademark/brand is involved taking care of possible

imputation of royalty

Appropriate documentation of business rationale

FAR very crucial to defend the transaction and

determination of value and non-value additions




Key Takeaways

Strong and robust economic analysis with supporting

documentation along with business rationale

Cost-benefit analysis vital

Internal CUPs preferred over external CUPs

Important to characterize value added and non-value

added activities for tested party and attribution of profits

Segmented financials play key role




Way Forward

Be Proactive – not reactive - consider APA?

Adopt Coordinated and centralized approach.

Involve operational teams in tax and TP

planning and documentation process

Holistic solutions – not fragmented responses

Global awareness and vision – not myopic

Harmonize TP documentation with other

regulatory requirements




Questions & Answers

Questions

&

Answers

Documents

Presentation - Ms. Karishma Phatarphekar - Pharmaceuticals and Manufacturing - 22 March 2014