This blog takes a brief look at the meaning of intra group services and how to minimize the risk of transfer pricing upward adjustment in relation to this.
Services provided by one entity within a Multinational Enterprise Group (MNE) to other entities within the same group are referred to as “Intra Group Services (IGS).
In this age of globalization and cutthroat competition, nearly every MNE must arrange for a wide range of required services, viz., HR, Accounting, Payroll, IT Support, Finance etc., to be available for group entities.
MNE typically centralizes the commonly required services across the group for several commercial benefits including cost optimization, economies of sales, centralization and standardization, and avoiding duplicacy and saving manpower to focus on core activities and operations. These services are, in the majority of cases, rendered by the parent company or a service centre company.
But while MNEs see intra group service transactions as ways to simplify operations and gain commercial benefits, tax authorities see service transactions as simple means of shifting profits into jurisdictions with low or no taxes. IGS tend to draw a lot of scrutiny from tax authorities. If the Transfer Pricing Officer (TPO) concludes that the entity would not have paid any amount for similar services to an independent third-party entity, TPO will conclude the Arm’s Length Price (ALP) of the transaction as ‘Nil’ thereby increasing the transfer pricing adjustment.
Transfer Pricing Adjustment is defined to mean the determination of the transfer price in accordance with the arm’s length principle resulting in an increase in the total income or reduction in the loss as the case may be.
Indian tax laws do not have specific legislation in relation to IGS, so reliance is placed on the guidance provided in Organization for Economic Co-operation and Development (OECD) – Transfer Pricing Guidelines Chapter VII – Special Considerations for Intra Group Services.
There are two main issues in determining the ALP of intra group services,
We will discuss both the issues briefly below:
With reference to OECD 2017 guidelines, a benefit test is applied to ascertain whether the services have been provided and if those were required. This can be determined by considering whether an independent enterprise, in similar circumstances, would have been willing to pay for the activity if performed for it by an independent enterprise or would have performed the activity in-house for itself. If the independent enterprise is not willing to pay the price for the said services, the activity typically should not be considered as Intra Group Services.
There are certain types of services which can never pass the benefits test. For eg., Shareholder activities, like admin costs for a parent company or shareholder meetings, are excluded because group entities don’t need them to do main operations. Services that are duplicated fail to qualify, as well. If a parent company, for example, performs the accounting function for its subsidiaries around the world, but one subsidiary has its own accounting department, then the subsidiary doesn’t need the parent company’s service. This duplication would not qualify as an intercompany service, because the subsidiary wouldn’t be willing to pay for a service it already does. Companies that benefit from services incidentally would also be disqualified.
Once it is determined that an intra group service has been rendered, it is necessary to determine the amount of charge, if any, is in accordance with the arm’s length principle.
For eg, IT support costs incurred by the parent company on behalf of the entire group shall be allocated between the group companies availing the services based on appropriate allocation keys. In the said example, number of users or number of logins per each entity can be considered as an allocation key.
Action 10 of OECD has specifically distinguished between low value-added services and other services and has provided a simplified approach to the determination of ALP. The simplified approach to the determination of arm’s length charges provides that the service provider shall apply a mark-up equal to 5% of the relevant cost. The mark-up under the simplified approach does not need to be justified by a benchmarking study and will have to be applied consistently across all jurisdictions.
Example of low value-added services include staffing, recruitment or general services of administrative or clerical nature.
Indian tax authorities have intensified scrutiny on intra group services as these are widely viewed as a profit shifting way by revenue department. It is strongly recommended that MNEs maintain robust benefit test documentation justifying nature, need and receipt of services with appropriate evidence for benefits received and costs incurred for rendering services, as their strategy during dispute proceedings and for any litigation in the future and should not solely rely on broadly worded agreements or email communications that do not provide enough evidence of actual IGS rendered. Thus, proper documentation is essential in proving the provision or receipt of IGS. The need to maintain proper contemporaneous documents is vital and cannot be ignored.
Taxpayers are recommended and encouraged to maintain the following illustrative list of documents and working:
We at UJA support clients in minimizing the risk of upward adjustments by recommending maintaining a strong robust contemporaneous documentation right from preparing TP study report and performing TP audit in Form 3CEB. With over 28 years of experience and a diverse team of 170+ experts across 11 offices, we’ve helped over 1,000 clients, from SMEs to MNCs, achieve their goals. With expertise in accounting, audit and advisory services, we are here to guide your business forward.
