Volume 3, Issue 22

6th Dec, 2010

Tax Alert
Bangalore Tribunal upholds disallowance of management fees in the absence of commensurate benefits

Payment of “Management Fees” or “Corporate fees” to the group “Head Office” or support service provider entity has been a much debated issue worldwide, with the tax/transfer pricing authorities scrutinising the payments and the corresponding economic benefit in greater details, and often disallowing the payment on the ground that it is merely a profit extraction tool and it lacks commercial expediency.

Given the proportion of cases where a transfer pricing adjustment has been made in respect of management fees, several taxpayers seem to have considered the adjustment as fait-accompli and have been accepting such transfer pricing adjustments. While the tax officers are invariably known for their pro-revenue approach, payment of management fees is indeed a sensitive issue and the onus of proving the bona-fides of the management fee payments is on the taxpayer.

The Bangalore Tribunal recently upheld1 the disallowance of management fees where it considered that this onus was not appropriately discharged by the taxpayer.

Key Facts of the Case

  • The taxpayer (Gemplus India) is a wholly owned subsidiary of a French company Gemplus France.
  • The regional headquarters are in Singapore (Gemplus Singapore).
  • Gemplus India paid around INR 14.5 million (USD 300,000) as management fees to Gemplus Singapore
  • The key terms of the management services agreement entered into between Gemplus India and Gemplus Singapore were as under:
    • Gemplus Singapore provides services in respect of marketing and sales, customer service, finance, accounting and administration and legal support.
    • Gemplus Singapore charges Gemplus India based on the time spent by its personnel (subject to a cap of USD 300,000).
  • The taxpayer used TNM Method to benchmark the arm’s length price of payment of management fees.
  • The first level transfer pricing officer, as well as the appellate officer held that the management fee was not at arm’s length on the ground that the taxpayer did not demonstrate the rendition of services by Gemplus Singapore or receipt of benefits by it pursuant to the management services agreement. Accordingly, the entire management fee paid by Gemplus India to Gemplus Singapore was disallowed.
  • Aggrieved by the order of the above authorities, the taxpayer appealed before the Tribunal

Contentions of the Taxpayer before the Tribunal:

  • The taxpayer had employed only few personnel in India, and all technical expertise was provided by Gemplus Singapore.
  • Services rendered by Gemplus Singapore were exclusively for the business carried on by the taxpayer in India.
  • Achieving the sales turnover by the taxpayer during the relevant year would not have been possible without availing the management services from Gemplus Singapore.
  • The taxpayer also relied on the OECD Guidelines which have highlighted the fact that management services may be rendered by an overseas affiliate to the taxpayer in an arm’s length scenario.

Contentions of the Tax Authorities before the Tribunal:

  • The comparable companies selected by the taxpayer (for applying the TNM Method) had not paid any management fees.
  • TNM Method itself was not the most appropriate method for benchmarking the arm’s length nature of payment of management fees.
  • As regards the training rendered by Gemplus Singapore to the employees of Gemplus India, the charge from Gemplus Singapore was more than the course fee charged by a primary management institution in the country. Further, as against the number of employees trained (6), certificates for only 2 persons were submitted by the taxpayer.
  • The explanation provided by the taxpayer for payment towards customer support services provided to it was vague.
  • The taxpayer did not provide any evidence of rendition of finance and accounting as well as legal services by Gemplus Singapore.
  • The taxpayer had already incurred separate head-wise expenses for professional and consultancy services.
  • The overall cost had been apportioned by Gemplus Singapore for various group entities on a mutually agreed basis, and not on the basis of services rendered to each entity. The management fee was independent of the volume and quality of service rendered to the taxpayer.

Ruling of the Tribunal:

  • It is important to note that the payment terms provided for in the agreement were independent of actual services rendered by Gemplus Singapore to the taxpayer.
  • The cost charged to the taxpayer was based on a mutually agreed basis and not on the basis of actual services rendered.
  • The taxpayer did not furnish any details as regards the services rendered by Gemplus Singapore.
  • The taxpayer did not furnish details of benefits received by it commensurate with the payment of management fees to Gemplus Singapore.

Based on above, the Tribunal held that the transfer pricing officer and the appellate officer were justified in disallowing the entire management fees payments by the taxpayer to its overseas affiliate.

Our Comments:

In one of our earlier tax alerts last year, we had highlighted the increasing occurrences of disallowances being made in cases involving payment of management fees by Indian taxpayers to overseas affiliates.

In cases involving payment of management fees to overseas affiliates, it is imperative to maintain robust documentation justifying the services rendered by the overseas affiliate, benefits received by the Indian entity, and the arm’s length nature of the charge. It is also pertinent to note that broad and vague explanations relating to the management services rendered by the overseas affiliates and benefit received by the Indian taxpayer etc. would not stand the test of audit by the Indian authorities, who insist on specific instances of services rendered and benefits received with respect to management fees, along with detailed calculation of amounts charged to the Indian entity and justification of arm’s length nature of amounts charged.

As regards justification of services rendered and benefits received, while there is no straight-jacket formula laid down for the best possible documentation, a strong documentation would essentially be contemporaneous documentation which is maintained at the time of actual receipt of services. The documentation would include several internal records and documentation like notes, memos, e-mail exchanges, reports, processes documents etc. Further, the quality as well as adequacy of documentation should be reviewed at regular intervals; in addition to the final review and sign-off at the year end.

If such contemporaneous documentation is maintained by the taxpayer, even if there is a disallowance made by the lower level tax authorities, there is a very strong case for allowing the management fee payments before the higher (appellate) authorities.

1 - Gemplus India Pvt. Ltd. vs ACIT Circle 11(4), Bangalore. ITA No. 352 / Bang / 09