India: Benefit Test Documentation – a Transfer Pricing requirement for Intra-Group support services

published on 30 March 2023 | reading time approx. 5 minutes

Multinational Enterprise Group (MNE) generally centralizes various commonly required services across the group. These services commonly include management, administrative, marketing, legal, accounting, IT, human resource and other corporate services. Such Intra-Group support services (IGS) confer various commercial benefits in terms of economies of scale, standardization, control, cost optimization, avoiding duplicative efforts, and also allow group entities to concentrate on core activities.

In contrast, the Indian Tax Authorities view IGS as a mechanism of profit shifting claiming that these service arrangements can be implemented in an MNE scenario without proving the actual need/ existence of such services. The tax authorities have questioned the need for such IGS, when Indian entity is in relevant business for several years and has employed experienced team for undertaking activities that are also subject matter of IGS. These apprehensions have been the genesis of a prolonged controversy and several judicial rulings have laid down principles to evaluate appropriateness of IGS and charges therefor.

Benefit Test Approach for IGS transactions

In terms of the OECD^{^[1]} TP Guidelines, Benefit Test is applied to ascertain the actual rendition of services. It requires that the services rendered should provide economic or commercial value to the service recipient to enhance or maintain its business position and for which an independent enterprise would be either willing to pay or would perform such activity in-house for itself.

Indian transfer pricing regulations do not provide specific guidelines either on the application of Benefit Test analysis or prescribe documentation to be maintained. In context of IGS, Indian judiciary has generally opined that the tax authorities could not decide what was necessary for a taxpayer and what was not. It is also observed that the requirement of services should be judged from the viewpoint of the taxpayer as a businessman.

In the case of Gemplus India [TS-100-ITAT-2010(Bang)], Hon'ble Bangalore Tribunal did not allow management fee paid by taxpayer for IGS, in absence of any documentary evidence maintained by the taxpayer to prove the receipt of services and the amount of service fee charged to the taxpayer. In the case of Volvo India (P.) Ltd. [TS-993-ITAT-2016(Bang)-TP] as well, Hon’ble Bangalore Tribunal pointed out that onus lies on the taxpayer to prove that the services are actually rendered by the associated enterprise (AE) and failure by the taxpayer to discharge the onus can be presumed that the taxpayer had no evidence to establish that services of management support are rendered by its AE.

Over a period, certain tests have evolved for taxpayers to substantiate IGS, as below:

Receipt Test - the services have been actually received;
Need Test - the taxpayer was in need of these services and would have otherwise availed them from an independent party; and
Benefit Test - there are tangible or intangible benefits derived in the form of economic or commercial value from the receipt of services like improved operations, upskilling of employees, etc.

In the case of Adcock Ingram Ltd. (TS-57-ITAT-2018(Bang)-TP), Hon’ble Bangalore Tribunal observed that the 'benefit' to be identified from the taxpayer's viewpoint, could be potential, reasonable, foreseeable, may not be quantifiable in money alone, and may be strategic, but could not be incidental. The benefit also could not have qualifications such as "substantial", "direct" and "tangible" because these qualifications were not given in section 92(2) of the Act. There are several non-monetary terms other than profitability, like usefulness, enhancement in value, sustainability and enhancement of business interest, which were required to be seen while judging the benefit test.

The above judgement has relied on Hon’ble Delhi High Court observations in the case of EKL Appliances Ltd (345 ITR 241) that the revenue authorities cannot dictate the taxpayer as to how to conduct his business, nor tell the taxpayer what expenditure they can incur. It is also not necessary to show the necessity of the expense and whether it results in profit or income either in the same year or in any subsequent years. The only condition to allow a deduction is that the expenditure should have been Incurred ‘wholly and exclusively’ for the purpose of business.

Application of Benefit Test principles by Indian Judicial precedents

Indian judiciary has dealt with varied aspects of application of Benefit test, while adjudicating matters in relation to IGS. There are a plethora of rulings both against and in favour of the taxpayer.

Certain tax rulings that had ruled against the Taxpayer, it was observed that the copy of inter-company agreement and emails submitted by the Taxpayer were not sufficient. In this regards, the Indian judiciary had made following observations:

In relation to Agreement:

genuineness of the Agreement was challenged as pages not serially numbered, signed by all parties and legally registered
old agreement did not consider the updated capabilities of the Taxpayer and no proof was provided that AE had the capacity to provide such services
adequate evidence was not submitted to show that services were received under certain heads viz. Finance, Human resources, taxation, marketing etc.
taxpayer itself had qualified experienced officers and there was no proof of how the services were actually provided

In relation to emails:

emails containing reports, setting of targets for the taxpayer etc. were assumed as a shareholder activity
emails were general in nature and did not establish actual receipt of services
email relating to training did not contain details regarding trainers, their specialization, request made by taxpayer for training, cost incurred by the AE
email regarding cancellation of training, car bookings, conference call invites, random email exchange which were not self-explanatory were not considered as evidence of service provided
emails relating to services to be provided by third party vendor to the taxpayer or bearing names of certain projects undertaken by the Taxpayer did not explain the role of the AE and were thus not considered relevant.

In relation to IGS service charge:

Details of service wise budgeted cost allocation, number of recipients, turnover of recipients etc. not provided by Taxpayer
It was observed that agreement containing allocation keys fixed on the basis of sales without any reference to actual services rendered and their technical specification and application of cost-plus markup even if no services are rendered, would not exist in an independent party scenario
Some other factors going against taxpayer were that the taxpayer never tried to verify the correctness of cost allocation and failed to substantiate the high monthly IGS charge without any supporting evidence like technical specification of services rendered by its AE, personnel deployed for said purposes and other evidence including correspondence between parties.

In respect of tax rulings in favour of the Taxpayer, the Taxpayer furnished documents showing benefits in the nature of saving of interest cost, access to emails server, access to export market, access to various software licenses etc. It also submitted month wise allocation of budgeted costs and share of taxpayer along with working of actual expenditure incurred by the AE duly certified by the management / independent auditors. In certain cases, Taxpayer also submitted exhaustive chart demonstrating description of services, explanation on the type of services received, how these services have been received, in what manner and to what extent the benefits have been derived by the taxpayer and references of the exhaustive evidences.

Conclusion

Thus, there is a considerable guidance available on what aspects support the benchmarking of IGS and which factors do not support. Hence, onus of proof lies on the taxpayer to justify the Benefit Test. Although there is no straight jacket formula to determine the documentation requirements, yet it is strongly recommended that MNEs maintain robust benefit test documentation justifying nature, need and utility of services with appropriate evidences for benefits received and costs incurred for rendering of services, as their defence strategy during assessment proceedings and for any litigation in the future and should not solely rely on broadly worded agreements or email communications that do not throw adequate light on actual IGS rendered.

[1] Organisation for Economic Co-operation and Development is an international organisation and has published OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 (OECD TP Guidelines) providing guidance on the application of the “arm’s length principle”.