Location savings from low-cost bases are not taxable, says tax tribunal

MUMBAI: The Mumbai bench of the tax tribunal has clarified that additional tax liability cannot be claimed from competitive industries in the name of location savings arising out of the country’s low-cost manufacturing base. The ruling may benefit pharmaceutical, auto, IT and IT-enabled companies, among others, that are engaged in similar disputes.

The Mumbai bench of the Income Tax Appellate Tribunal recently ruled in favour of the Indian subsidiary of US drug maker Watson Pharma, which had challenged an adjustment made by the tax authorities. The transfer pricing official had held that the company ought to add the location savings to the margins earned by competitor companies to calculate the tax liability.

When a multinational company saves costs by relocating facilities from a high-cost jurisdiction to a low-cost one, it is considered location saving under transfer pricing rulings. Watson’s Indian unit, which manufactures products for associate enterprises, contended that its profit margin was 15.66 per cent compared with the mean of 11.90 per cent of seven rival companies and within the ± 5 per cent benchmark and therefore it had conformed to arm’s length pricing.

The tribunal held that the company operates in a competitive market and it does not have exclusive access to factors that may result in location-specific advantages. As a result, there is no super profit that arises and there is no unique advantage to Watson Pharma over its competitors.

“The decision pivots its verdict on an intricate economic principle of having a competitive advantage, in other words, the “bargaining power” to negotiate a share in location savings,” said Karishma Phatarphekar, partner, global transfer pricing services at KPMG in India. “It covers a lot of ground on the technical arguments related to the issue of location savings and may address litigation for a number of such other multinationals in dispute for this issue.”

The tribunal also observed that the revenue authorities were unable to substantiate the adjustments made — either from the presentday scenario or any authenticated and globally material — and had based their computation on a method not ascribed by the provisions of the law.

“The tribunal has provided much-needed clarity in this aspect and this ruling concurs with the Guidance on Transfer Pricing Aspects of Intangibles which is part of Base Erosion and Profit Shifting Project provided by the OECD and G20, that where local market comparables are available, specific adjustment for location saving is not required,” said Kunal Gandhi, partner of tax & forensic consulting firm US Gandhi & Co.

The tribunal’s ruling comes as the Narendra Modi government promotes a non-adversarial tax regime, seeking to provide more confidence to foreign companies investing in the country as it pushes the Make in India initiative.