Related Party acting as Conduit for ultimately transacting with Independent third party - Indian Transfer Pricing Perspective

Related Party acting as "Conduit" for ultimately transacting with Independent third party

There might be various situations where it is more preferable to the Indian entity to involve a Related Party to conduct a certain transaction / arrangement with Independent third party. These cases are usually seen where there is a regulatory requirement in a particular jurisdiction; or cases where it is more feasible to conduct the transactions through the related party considering various prevailing economic and commercial factors. In such cases, the related party merely acts as a conduit between the Indian Entity and the Independent Third Party.

A question might very well arise as to if Related Party / Associated Entity ('AE') is involved in such transactions to be ultimately paid / executed with the Independent third party, how the same transaction can be viewed by the Indian Tax Authorities? Following are some of the specific questions that might arise in such cases:

1. The transactions made with the AE acting as merely conduit, can it be treated as an International Transaction i.e. can Tax authorities allege that any amount paid to the AE in the course to be paid to Independent third party, to be treated as loan to the AE?
2. If the AE is not remunerated for acting as a mere conduit, can there be any implications from Indian Transfer Pricing perspective?
3. What if the amount paid to Independent third party is refunded back by such third party to the AE and back to the Indian entity? Can Tax authority has a strong footing for the question no.1?
4. How the case can be justified before the Tax / appellate authorities that the same transaction is done merely out of administrative convenience?

Recently we have certain judgements from the Hon'ble Bombay High Court and the Hon'ble Mumbai Tax Tribual ('ITAT'), in case of KSS Limited (K Sera Sera Productions). The said case law can be accessed via this link. 

To give a brief background on the same, 

• KSS Limited ('KSSL') is engaged in production and distribution of films.
• KSSL was to purchase rights of three Hollywood films from Independent third party - City Gate; for distribution of the same rights in India. 
• As per KSSL, it had contacted Citi Gate for the same but Citi Gate would not have dealt directly with KSSL, and hence it had involved its AE located in similar jurisdiction as that of Citi Gate.

The Transaction was structured as under 

• KSSL would enter into agreement with its AE for purchase of rights from the AE, which the AE in turn would enter into an agreement with Citi Gate
• KSSL would pay the necessary amounts to AE, and AE in turn would pay the amount to Citi Gate 
• The rights were to be passed by Citi Gate to the AE, which were to be further passed on to KSSL by the AE.

However the engagement did not fructify, and Citi Gate had to refund the amount to the AE and AE had to pay back the amount to KSSL. In this factual backdrop, we will analyse the questions as mentioned above and the decisions passed by the Appellate Authorities.

The transactions made with the AE acting as merely conduit, can it be treated as an International Transaction i.e. can Tax authorities allege that any amount paid to the AE in the course to be paid to Independent third party, to be treated as loan to the AE?

In the current case, the TPO had held the amount to be loan to the AE. However, before the appellate procedures, KSSL was able to prove the following;

• KSSL entered into an agreement with the AE. The very next day, the AE entered into an Agreement with Citi Gate.
• The amount advanced by KSSL to the AE was immediately paid by the AE to Citi Gate
• When the arrangement did not work out, the amount paid to Citi Gate was refunded to KSSL through the AE.
• KSSL was able to substantiate the above claims on the basis of documentary evidences i.e. bank statements, copy of agreements, etc.
• Finally it was observed by the Tax appellate Authorities that the amount was not retained anytime by the AE, and hence it did not result in diversion of income of KSSL.
• Accordingly the appellate authorities held that such arrangement / transaction did not give rise to International Transaction and is out of purview of Section 92B(2) of the Income Tax Act, 1961 

If the AE is not remunerated for acting as a mere conduit, can there be any implications from Indian Transfer Pricing perspective?

As the Indian entity is not incurring any expenses to be paid to the AE, there should be no adverse impact from Indian transfer Pricing perspective. 

However in the AEs jurisdiction, the tax authorities might view the said arrangement differently. There can be a claim by the tax authorities that AE should have been remunerated for the co-ordination services, etc. It will be quite important in each cases to relook the facts of each case and to substantiate that AE is not involved in performing any major activities by the AE.

What if the amount paid to Independent third party is refunded back by such third party to the AE and back to the Indian entity? Can Tax authority has a strong footing for the question no.1?

As discussed in the case above, if there is no time gap in the refund of the amount by third party and subsequent payment by the AE, the taxpayer should not face any problem as such.

How the case can be justified before the Tax / appellate authorities that the same transaction is done merely out of administrative convenience?

In each and every case, it has to be clearly identified whether for such arrangements, the AE is provided any services. These might include low value added services such as communicating with third party, follow ups, collection from customers, handling the procurement of goods in case of purchase of tangibles from third parties, etc.. As per the case discussed above, considering the transaction mentioned for purchase of rights for distribution, it is a quite unique case, and hence for other cases, a detailed evaluation will have to be carried out.; and accordingly arrangements have to be planned out to comply from Transfer Pricing provision of both the Jurisdictions.

Trust this might have helped to gain insights. Let me know your queries / feed back in the comments section below.