Domestic Transfer Pricing - A complete study

7/29/2019 Domestic Transfer Pricing - A complete study

1/32

DOMESTIC TRANSFER PRICING PROVISIONS

CA .T. P. OSTWAL

10th October 2012

T.P.Ostwal & Associates 1

BOMBAYCHARTERED ACCOUNTANTS

SOCIETY


2/32

Introduction

TP was earlier limited to InternationalTransactions

The Finance Act 2012, extends the scope of TP provision to Specified Domestic

Transactions between related parties w.e.f. 1 April 2012 The SC in the case of CIT vs Glaxo Smithkline Asia Pvt Ltd [2010-195Taxman 35

(SC)] recommended introduction of domestic TP provisions

SDT previously reported/certified but onus on revenue authorities

Obligation now on taxpayer to report/ document and substantiate the arms length

nature of such transactions

Shift from generic FMV concept to focused ALP concept

These new provisions would have ramifications across industries which benefit from

the said preferential tax policies such as SEZ units, infrastructure developers or

operators, telecom services, industrial park developers, power generation or

transmission etc. Apart from this, business conglomerates having significant intra-

group dealing would be largely impacted

10th October 2012 T.P.Ostwal & Associates 2


3/32

SDT Intent of the Law

10th October 2012 T.P.Ostwal &

Associates 3


4/32


Intent of Indian TP Regulations

(International transactions)

Indian Co.

Associated

Enterprise

(AE Co.)

Shifting of Profits

Shifting of Losses

India Overseas

Tax @ 32.45% Tax @ lower rate

approx 10%

Tax Saving for the Group Loss to Indian revenue


5/32



(Domestic transactions)

Indian Co.

Tax Holiday

undertaking

Related Enterprise in

Domestic Tariff Area

(DTA)

Shifting of expenses/losses

Shifting of income/profits

India

Tax Exemption


India

Tax @32.45%


6/32




Particulars (Ordinary Situation) Co. X (SEZ) Co. Y (DTA)

Income 500 1000Income from related party 100 -

Expenses 300 800

Expense to related party - 100

Profit/ Loss 300 100

Tax rate applicable 0% 32.45%

Tax - 32.45 (100*32.45%)

Particulars (Planned Situation) Co. X (SEZ) Co. Y (DTA)

Income 500 1000

Income from related party 200 -

Expenses 300 800Expense to related party - 200

Profit/ Loss 400 -

Tax rate applicable 0% 32.45%

Tax - -

Loss toRevenue

Tax Saving

to the Group


7/32


Intent of TP Regulations


Indian Co.

Loss making

Related Enterprise

Profit making

Shifting of expenses

Shifting of income

India

Tax @ 32.45%

No tax or reduced tax due to loss

Tax @ 32.45%

Reduced tax due to

shifting of profits


India


8/32


Particulars (Ordinary Situation) Co. X (DTA) Co. Y (DTA)

Income 500 1000


Expenses 700 800


Profit/ Loss (100) 100

Tax rate applicable 32.45% 32.45%

Tax - 32.45 (100*32.45%)

Particulars (Planned Situation) Co. X (DTA) Co. Y (DTA)

Income 500 1000


Expenses 700 800


Profit/ Loss (50) 50

Tax rate applicable 32.45% 32.45%

Tax - 16.23 (50*32.45%)

Present

Loss to

Revenue*

Tax Savingto the

Group

* By shifting of income from a profit making company to a loss making company, the group could reduce its tax

liability by 16.23 for the current year, though the impact will be reversed in future years given carry forward of losses.

Intent of TP Regulations(Domestic transactions)


9/32


Section 92BA Meaning of SDT(inserted by Finance Act, 2012 w.e.f. AY 2013-14 i.e. current FY)

For the purposes of this section and sections 92, 92C, 92D and 92E, specified domestic

transaction in case of an assessee means any of the following transactions, not being aninternational transaction, namely:-

(i) any expenditure in respect of which payment has been made or is to be made to a person

referred to in section 40A(2)(b);

(ii) any transaction referred to in section 80A;

(iii) any transfer of goods or services referred to in sub-section (8) of section 80-IA;

(iv) any business transacted between the assessee and other person as referred to in section

80-IA (10);

(v) any transaction, referred to in any other section under Chapter VIA or section 10AA, towhich provisions of section 80-IA(8) or section 80-IA(10) are applicable; or

(vi) any other transaction as may be prescribed,

and where the aggregate of such transactions entered into by the assessee in the previous

year exceeds a sum offive crore rupees.


10/32


SDT

Inter unit transfer of goods & services by

undertakings to which profit-linked deductions

apply

Expenditure

incurredbetween

related

parties

defined under

section 40A

Transactions between undertakings, to which

profit-linked deductions apply, having close

connection

Any other

transaction

that may be

specified

Overview of Provisions of Section 92BA


11/32


Section 92BA Analysed......

Section Relevance with

provisions of

Sec 92BA

92 : Computation of income having regard to ALP

92A : Meaning of AE

92B : Meaning of International transaction

92C : Methods of computation of ALP

92CA: Reference to TPO

92CB : Safe harbour rules

92CC : Advance Pricing agreement

92CD : Effect of TP agreement

92D : Maintenance of information and documents

92E : CAs Report

92F : Definitions: Accountant, ALP, Enterprise, PE, Specified date, Transaction*

For the purpose of sec. 92, 92C, 92D and 92E

* Sec 92F Definitions does not define terms relevant for domestic TP transactions


12/32


(1) Computation of income from international transaction having regard to ALP.

(2) mutual agreement etc for allocation or apportionment or contribution to any cost or expense

shall be determined having regard to ALP.

(newly inserted)

(2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any

income in relation to specified domestic transaction shall be computed having regard to

ALP.

(3) section does not apply if the effect is reducing the income or increasing the loss.

Sec. 92 Computation of income from international transaction having

regard to ALP


13/32


The words specified domestic transaction has been inserted appropriately in various sub-sec.

(1) Any of the following methods, being most appropriate method :

(a) Comparable uncontrolled price method;

(b) Resale price method;

(c) Cost plus method; refer rule 10B

(d) Profit split method;

(e) Transactional net margin method;(f) other method of determination ofarms length price

(any method that takes in to account the price which has been charged or paid or would

have been charged or paid for same or similar uncontrolled transaction with or between

non associated enterprises)

(2) Most appropriate method as per criteria laid down in rule 10C considering FAR analysisalso.

FAR : Functions performed, Assets employed, Risks assumed [Rule 10C(2)]

Sec. 92 C Computation of ALP


14/32


The word specified domestic transaction inserted in various sub-sections.

(1) AO may refer the computation of ALP to TPO

(2) TPO to issue notice to Assessee to produce evidence in support of ALP

(2A) Any other international transaction coming to notice of TPO*

(2B) Non-furnishing ofCAs report and TPOs power*

(3) TPO shall pass the order determining ALP

(4) AO to compute total income accordingly

(7) TPOs power of summons (s.131), survey (s.133A) and collecting

information u/s 133(6)applies even in Domestic Transaction

Sec. 144C (15)(b)..Reference to DRP

AO to forward draft of proposed order to eligible assessee

eligible assessee means any person in whose case order u/s 92CA is passed

* 92CA (2A ) & (2B) do not cover specified domestic transactions and hence the TPO cannot

suo moto upon the transaction coming to his notice apply the TP provisions

Section 92CA - Reference To TPO


15/32

Profile of Industry

Profile of group

Profile of relatedparties

Transaction terms

FAR related

Economic Analysis(method selection,

comparable

benchmarking)

Forecasts,

budgets, estimates

Agreements

Invoices

Pricing relatedcorrespondence

(letters, e-mails,

fax, etc.)

Entity Related Price Related Transaction Related

The onus of proving SDT at ALP is on tax payer

Section 92D : Maintenance and keeping information and document by

persons entering into an international transaction



16/32


Section 271Penalty Implications

Sr.

No.

Type of penalty Section Penalty quantified

1 a) Failure to maintain

prescribed information/

documents

271AA 2% of transaction

value

(b) Failure to report any such

transaction or

(c) Furnish incorrectinformation

2 Failure to furnish information/

documents during assessment

u/s 92D

271G 2% of transaction

value

3 Adjustment to taxpayers

income during assessment

271(1)(c) 100% to 300% of tax

on

adjustment amount

4 Failure to furnish accountants

report u/s 92E

271BA INR 100,000


17/32

Section 40A(2) Transactions covered


Mapping to be done for the companys transactions with domestic Related Parties

Primary reliance on disclosures u/s 40A(2)(b) and Related Party Schedule

Different divisions enter into different transactions with various group companies

Broad categories of transactions likely to be covered :

Purchase ofgoods and

services

Payment

of interest

Paymentof

royaltycharges


18/32


Sec 40A (2)(b) Related Party

Sr.No Payer / assessee Payee

(i) Individual Any relative

[defined in sec. 2(41) to mean husband, wife, brother, sister, lineal ascendant or

descendant]

* Definition of Relative u/s 56(2) not relevant

(ii) Company any director or relative of such director

Firm (includes LLP)

any partner or relative of such partner

AOP any member or relative of such member

HUF any member or relative of such member

(iii) Any Assessee any individual having substantial interest in the assessees business or relative of

such individual

(iv) Any assessee a Company, Firm, AOP, HUF having substantial

interest in the assessees business

orany director, partner, member

orrelative of such director, partner or member

or (newly inserted)

any other company carrying on business or profession in which the first mentioned

company has substantial interest.

X Ltd. (subsidiary co)A Ltd. (holding co)Y Ltd. (subsidiary co)

Relationship can exists

any t imeduring the year


19/32

Type of transactions covered (illustrations for payments made by a

Company)


Case 1 - Director or any relative of theDirector of the taxpayer Section

40A(2)(b)(ii)

Mr. A Mr. C

Assessee

(Taxpayer)

Mr. D

Director

Relative

Covered transactions

Case 2 - To an individual who hassubstantial interest in the business or

profession of the taxpayer or relative of

such individual Section 40A(2)(b)(iii)

Mr. A Mr. C

Assessee

(Taxpayer)

Mr. DRelative

Substantialinterest>20%

Relative

Holding Structure


20/32


Company)


Case 3 To a Company having substantialinterest in the business of the taxpayer or

any director of such company or relative of

the director Section 40A(2)(b)(iv)

A Ltd

Mr. C

Assessee

(Taxpayer)

Mr. D

Relative

Director


Case 4 Any other company carrying onbusiness in which the first mentioned

company has substantial interest Section

40A(2)(b)(iv)

C Ltd

B Ltd

Assessee

(Taxpayer)

A Ltd


Holding Structure

Substantial

interest >20%

Substantial interest >20%



21/32


Company)


Case 5 To a Company of which a director has a substantial interest in the business of the taxpayeror any director of such company or relative of the director Section 40A(2)(b)(v)

Mr. A

Mr. C

Assessee

(Taxpayer)

B Ltd

Director


Holding Structure

Substantial

interest >20%

Mr. D

Rela

tive


22/32


Company)


Case 6 To a Company in which thetaxpayer has substantial interest in the

business of the company Section

40A(2)(b)(vi)(B)

B Ltd

Assessee

(Taxpayer)


Case 7 Any director or relative of thedirector of taxpayer having substantial

interest in that person Section

40A(2)(b)(vi)(B)

Mr C

Mr B

Assessee

(Taxpayer)

A LtdSubstantial interest >20%

Holding Structure

Substantial

interest>20%

Relative

D LtdSubstantial interest >20%


23/32


Company)


B

A

C

D E

Transaction Covered

A & B

A & C

A & D

A & E

B & C

D & E

C & D

D & E


24/32


Thus for Company A payments to following persons are covered

1

Company B having 20% or more voting power in A;

any other company in which Company B has 20% or more voting power;

2

a company in which A has 20% or more voting power;

any company of which a director has 20% or more voting power in A;

any company in which a director of A has 20% or more voting power;

3

any director of A or of Company B or to any relative of such director; &

any individual having 20% or more voting power in A or any relative of such

individual.


25/32

Tax burden, if transaction not at ALP


X Ltd.

(non-tax

holiday)

Disallowance of` 20 to Y Ltd[40A(2)(b)]

Y Ltd.

(non-tax

holiday)

Sale at 120 v/sALP i.e. 100

X Ltd.

(tax holiday)

Y Ltd.

(non-tax

holiday)

Sale at 120 v/sALP i.e. 100 Double Adjustment

Tax holiday on 20 not allowed to X Ltd

[80IA(10)] (more than ordinary profits)

Disallowance of 20 to Y Ltd -

[40A(2)(b)]

X Ltd.

(tax holiday)

Y Ltd.

(non-tax

holiday)

Sale at`80 v/sALP i.e.`100

Inefficient pricing structure reduced tax

holiday benefit since sale price is lower

than ALP


26/32

Section 80IA (8) & 80IA (10) Deduction in respect of profits and gainsfrom industrial undertaking or enterprise engaged in infrastructuredevelopment, etc.

No guidance on the meaning of close connection To align ordinary profits with arms length price. For example:

OP/ TC of 30% considered to be at arms length by the TPO

Under 801A(10) the AO states that the profits are more than ordinary

Solution: Defend price or evaluate alternate methods (other then profit based)

Impact of non-charging of services/ costs to tax holiday undertaking10th October 2012 T.P.Ostwal & Associates 26

80IA (8) 80IA (10)

Inter-unit transaction of goods or services Business transacted with any person generates more than

ordinary profits

Owing to either close connection or any other reason

Applicable where transfer is not at market value Applicable to tax holiday units earning more than ordinary

profit

Onus on tax payer Primary onus on taxpayer

Onus on tax authorities as well

ALP of 5 comparable companies OP/TC Mark-up of the tax holiday entity

OP/TC

Arithmetic mean = 15% 30%


27/32


80-IA Income from Infrastructure, Telecommunication, Industrial Park & Power sector etc.

80-IAB Income of an undertaking or enterprise engaged in development of SEZ

80-IB Income from certain Industrial undertaking and Housing Projects etc.

80-IC Income from certain Industrial undertaking set up in Sikkim, HP...etc.

80-ID Income from hotels etc in Delhi, Faridabad and other specified districts.

80-IE Income from eligible business undertaking in North Eastern States

Other Sections under Chapter VI-A......to which s. 80-IA(8) or (10) are

applicable


28/32

FMV ALP

No method prescribed for

computing FMV

Six methods prescribed for

computing ALP

No documentation required to be

maintained

Contemporaneous documentation

required to be maintained

Other than reporting in tax audit

report, no statutory compliance

Accountants report signed by a CA

to be filed

Assessment done by the AO Assessment done by the TPO

Implication post - budget 2012 for SDT



29/32


Points for Consideration Whether the threshold limit of Rs. 5 crore applies to the aggregate amount under all the

relevant sections taken together OR under each section separately i.e. 40A(2), 80A, 80-IA(8),

80-IA(10), 10AA etc. ?

Whether payment for capital expenditure Or expenditure capitalized is also covered ?

Whether the provisions will apply in case the payers income is chargeable to tax under the

head Income from other sources, because section 58(2) says The provisions of section

40A shall, so far as may be, apply in computing the income chargeable under the head

Income from other sources as they apply in computing the income chargeable under the

head Profits and gains of business orprofession ?

Whether new provision applies to -

Public Charitable Trust paying remuneration to related persons.

Co-operative Societies

Social Clubs

having a business undertaking

Transfer pricing provisions are not applicable in case where income is not chargeable totax at all.

Correlative adjustments - if excessive or unreasonable expenses are disallowed in the hands

of tax payer at time of the assessment then corresponding adjustment to the income of the

recipient will not be allowed in the hands of recipient of income. Hence, it would lead to double

taxation in India.


30/32

Challenges


Type of payments/ transactions Challenges

Salary and Bonuses paid to the partners

Remuneration paid to the Directors

Transfer of land

Joint Development agreements

Project management fees

Allocation of expenses between the

same taxpayer having an eligible unit

and non-eligible unit

Definition of Related Party

Benchmarking?

Whether the limit as mentioned in section 40 (b)

would be the ALP?

Benchmarking?

Whether the limit as mentioned in Schedule XIII

would be the ALP?

Whether the rates mentioned in the ready

reckoner be considered as ALP?

Benchmarking?

Benchmarking?

Whether these allocation would be SDT Sec 80-

IA(10)?

Directly v/s Indirectly


31/32

Going Forward


To Identify and map the relationship between domestic related parties specified u/s

40A(2)(b)

Identify and map the SDT

Revisit the pricing mechanism applied by the company for SDT applying the most

appropriate prescribed methods

To implement TP regulations in FY 2011-12 itself although not statutorily required so that

systems can be improved for FY 2012-13. To note that variations in profits of tax holiday

units for FY 2013 compared to FY 2012 may raise concerns from tax officers.

Availability of APA

The onus of proving SDT at ALP is on the tax payer


32/32

THANK YOU

T. P. Ostwal & AssociatesCHARTERED ACCOUNTANTS

4th Floor, Bharat House,

104 Mumbai Samachar Marg,

fort, MUMBAI-400001.

Tel No.: +91-22-40693900

Fax No.: +91-22-40693999Mobile:+919004660107

Email: [email protected]

T.P.Ostwal & Associates 32

Domestic Transfer Pricing - A complete study

Documents