Expenses incurred by Indian entity for setting up its overseas subsidiary (pre-incorporation expenses) cannot be relegated as "international transaction" and shall consider being a "shareholder activity"
Facts of the case
New Delhi Television Ltd. ("the taxpayer") is engaged in the business of Television, News Broadcasting to its two channels namely NDTV 24x7 and NDTV India. During the financial year 2006-07, the taxpayer assisted its overseas subsidiary i.e. NDTV Net Works Plc. [associated enterprise ("AE")] to set up its business operations in England. For this purpose, the taxpayer incurred certain expenditure prior to incorporation of its overseas subsidiary, as a part of its plan to diversify into various domains of the media. These expenses were subsequently reimbursed to the taxpayer at cost by the AE. The taxpayer also rendered certain management services to its AE post incorporation, towards which the taxpayer again did not charge any markup.
During the course of transfer pricing ("TP") assessment, the TP Officer ("TPO") spurned the taxpayer's contention of treating its activities as "shareholder activity" and proceeds to benchmark both the transactions under the head "management services". Accordingly, he proceeded and made an upward adjustment. At the appellate proceedings, the Commissioner of Income Tax (Appeals) upheld the order passed by the TPO to the extent of levying mark-up on the services rendered post incorporation of the AE.
Aggrieved with the same, both taxpayer and revenue decided to move to the Income Tax Appellant Tribunal ["the ITAT"/ the Tribunal"].
Tribunal's Ruling
1. On Pre-Incorporation Expenses
The ITAT, in relation to taxpayer's contention of considering its expenditure incurred prior to incorporation of its AE as "shareholder's activity", relied on OECD TP Guidelines which define the term 'shareholder activity' as "an activity which is performed by a Member of an MNE group (usually the parent company or a regional holding company) solely because of its ownership interest in one or more other group members i.e. in its capacity as a shareholder".
The ITAT held that the taxpayer had incurred expenses solely because of its ownership interest and is different transaction from the one of provision of managerial services after incorporation. Thence classifying it as a shareholder activity, the tribunal upheld the action of taxpayer of not charging any mark-up on reimbursement of expenses incurred before AE come into existence.
2. On Post-Incorporation Expenses
The ITAT clarified that the expenditure incurred by the taxpayer before incorporation of its AE cannot be a deciding factor to determine the arm's length price of international transaction between the taxpayer and its AE post incorporation. Accordingly, the ITAT held that the reimbursement of other managerial costs by the AE to the taxpayer, post its incorporation, is considered to be the serviced rendered by the taxpayer and thus, should be subjected to an arm's length mark-up. The Tribunal further observed that the taxpayer itself has worked out the arm's length margin of 12.29% in its TP report.
Nangia's Take
The Indian TP regulations do not have any specific guidelines for identification and treatment of consideration paid/received for shareholder activity or of any other nature. The instant case, however, specifically brings out a distinctive feature between "shareholder activities" & "services provided under normal course of business" and with additional mark-up policy in the former case.
Source: New Delhi Television Limited vs. ACIT [TS-613-ITAT-2016-(DEL)-TP]
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