Post on 12-Feb-2016
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In domestic transactions, the under invoicing of sales and over-invoicing of expenses ordinarily will be revenue neutral in nature except in two circumstances having tax arbitrage such as where one of the related entities is
◦ Loss making or
◦ Liable to pay tax at lower rate and the profits are shifted to such entity
Transfer Pricing till A.Y. 2012-13 was applicable to Entities
having International transactions with their Associated
Enterprise
Honoring the Supreme Court ruling in case of CIT vs M/s
Glaxo Smithkline Asia (P) Limited expanded the ambit of
transfer pricing to Specified Domestic Transactions w.e.f. 1st
April,2013
Intent of Domestic TP-DTA & Tax Holiday Unit
Particulars Co.A Co.B
Taxed in India @ 0% 33%
Income from RP 150 -
Other Income 300 600
Expense to RP -
Other Expenses 300 300
Profit / Loss 150 150
Tax - 50
Total Tax for the Group
50
150
Particulars Co.A Co.B
Taxed in India @ 0% 33%
Income from RP 225 -
Other Income 300 600
Expense to RP -
Other Expenses 300 300
Profit / Loss 225 75
Tax - 25
Total Tax for the Group
Scenario 1 Scenario 2
225
25
By shifting of expenses from a tax holiday unit (Power) to a unit in the Domestic Tariff Area, the group could reduce its tax liability by 25. To avoid such cases, Domestic TP has been introduced.
Intent of Domestic TP-Domestic Tariff Area (DTA)
Particulars Co.A Co.B
Taxed in India @ 33% 33%
Income from RP 100 -
Other Income 200 400
Expense to RP -
Other Expenses 400 200
Profit / Loss (100) 100
Tax - 33
Total Tax for the Group
33
100
Particulars Co.A Co.B
Taxed in India @ 33% 33%
Income from RP 150 -
Other Income 200 400
Expense to RP -
Other Expenses 400 200
Profit / Loss (50) 50
Tax - 17
Total Tax for the Group
Scenario 1 Scenario 2
150
17
By shifting of expenses fro a loss making company to a profit making company, the group could reduce its tax liability by 16 for the current year, though the impact will be reversed in future years given carry forward of losses.
Intent of Indian Transfer Pricing (TP) Regulations
Indian Co.AssociatedEnterprise
(AE Co.)
Overseas(Tax at Lower rates, say 10%)
India(Tax @ 33%) Shifting of Losses
Tax Savings for the group -> Indian Govt. loses
ApplicabilityTransaction covered under Section
Applicability
clause (b) of sub section (2) of Section 40
Any expenditure
Sub section (6) of 80A Computing Section ( Determination of ALP)
Sub section (8) of Section 80IAProfit based deduction
Any transfer of goods or services within units – Intra Units
Sub section (10) of Section 80IAProfit based deduction
Any business transacted within closely connected entities
Chapter VIA or Section 10AAProfit based deduction
Any transaction
In any of the section Any other transactions as may be prescribed
Threshold
Shift of focus
How would you interpret the close connection ?
Fair Market Value can established using basic market evidence
Determination of Arm’s Length Price
Advance Pricing Agreements NOT applicable to specified domestic transactions
Powers shifted
Scope – Domestic Transactions
Tax holiday undertakings covering :• inter-unit transfer of goods and services
Expenditure incurred between related parties defined u/s 40AAny other transaction that may be specified
AggregateTransaction value exceeds Rs. 50 millions in a financial year (Applicable Applicable fromfromFY 2012-13)FY 2012-13)
Transactions with entities having close connection
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SDT
Inter unit transfer of goods & services by undertakings to which profit-linked
deductions apply – Sub section (8) of Section 80IA
Transactions between undertakings, to which profit-linked deductions apply,
having close connection Sub section (10) of Section 80IA
Scope of Section 92BA
Section Tax Payers covered Applicability of TP provisions on SDT aggregating a value of more than
INR50 million40A(2) Substantial Interested
PartiesExpenses or payment made or to be made.
80A(6) Enterprise claiming profit linked deductions from total income under chapter VI-A
Intra Transfer of goods and services and within the closed connected entities. ( i.e. eligible business to non eligible business)
80IASub Section (8)And (10)
Infrastructure developersTelecommunications service providersDevelopers of Industrial parksProducers or distributors of powerAn enterprise with an eligible business and close connection with any other person
The goods and services of an eligible business transferred to any other business carried on by the same taxpayer and vice-a-versa, are to meet the arm’s length test. (sub section 8) Intra Unit Transfer
a business transacted between a taxpayer carrying on an eligible business transact with a close connection, which results in more than ordinary profits to the business, is to meet the arm’s length test. (sub section 10)
Section Tax Payers covered Applicability of TP provisions on SDT aggregating a value of more than
INR50 million
80-IAB Developers of SEZs
The goods and services of an eligible business transferred to any other business carried on by the same taxpayer and vice-a-versa, are to meet the arm’s length test. (sub section 8) Intra Unit Transfer
a business transacted between a taxpayer carrying on an eligible business transact with a close connection, which results in more than ordinary profits to the business, is to meet the arm’s length test. (sub section 10)
Small Scale industry engaged in operating Cold storage plant
Industrial undertaking in industrially backward state as mentioned in VIII Schedule (ex : Jammu and Kashmir)
Multiplex theaters and convention centers
Company carrying on scientific research and development
Eligible housing projects Eligible hospitals
80-IC / 80-IE
Persons with units in specified states / north-eastern states claiming deduction
80-ID Hotels located in districts with World Heritage sites
10AA Persons with income from SEZ units
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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 : CA’s 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 * Sec 92F – Definitions does not define terms relevant for domestic TP transactions
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Intra Unit Transactions
Accountant’s Report
Tax Holiday
Assessment
FMV to ALP
1 5
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Expenses
6
To check evasion of tax through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases.
AO is expected to exercise his judgment in a reasonable and fair manner
Fair market value of the goods, services or facilities for which the payment is made, or
The legitimate needs of the business or Profession
The benefit derived by or accruing to the assesse from the expenditure
The above view is expressed by Hon’ble Guj High Court in the case of Coronation Flour Mills vs. Asst. CIT [ 2009] 314 ITR 1
Expenditure paid or to be paid to related parties will require to be at arm’s length Examples of related parties under section 40A(2)(b)Payer Receiver of Payment
Individual • Relative of individualCompany • Director of company or relative of the directorAoP/ HUF • Member of AoP / HUF or relative of such memberAny taxpayer
• Payment to a person who has substantial interest • Payment to a director / partner / member / relatives of a person
who has substantial interest • Payment to a company in which parent (more than 20% holding) has
substantial interest• Payment to a person whose director/ partner/ member has
substantial interest • Payment to a director/ partner/ member/ relatives of a person
whose director/ partner/ member has substantial interest • Payment to a person in which entities have substantial interest • Payment to a person in which my director/ partner/ member/
relatives have substantial interest • Payment to any of director/ partner/ member/ relatives
Substantial Interest means beneficial ownership of shares with at least 20% voting right or beneficial entitlement of at least 20% of the profits
Section 2(41) defines relative in relation to an individual to mean:
◦ Husband;
◦ Wife;
◦ Brother;
◦ Sister; or
◦ any lineal ascendant or descendant;
Means an enterprise –
◦ (a). Which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprises; or
◦ (b). In respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same person who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.
Section 40A(2)(b) applies to payment made to the assesse’s relative or an associate concern is liable (Substantially Interested Parties)
Section 92A applies to transaction with AE directly or indirectly or through one or more intermediaries in the management or control or capital of the other enterprise.
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B
A
C
D E
Transaction Covered
A & B
A & C
A & D
A & E
B & C
D & E
C & D
B & E
Domestic Transfer Pricing usher shift from generic ‘Fair Market Value’ concept to Arm’s Length Pricing
Characteristic Fair Market Value Arm’s Length Pricing
DefinitionThe price which goods or services would have fetched or cost in the open market
A price which is applied in a transaction in uncontrolled conditions
Computation Mechanism
No specific mechanism provided in law
Most appropriate method out of five prescribed methods
Transaction ValueAny market pricing point can be treated as fair market value
Arithmetic mean of comparable prices treated as arm’s length price
Sample SizeOne comparable may be sufficient to establish fair market value
Require bigger sample size for establishing arm’s length
Deviation No deviation permitted from fair market value
Deviation of plus / minus three percent is permitted
“Arm’s length price” means a price which is applied or proposed to be applied in a transaction in uncontrolled conditions
Arm’s Length price is determined using the Most Appropriate Method :
If more than one comparable price is obtained using above methods, then the arm’s length price would be ‘Arithmetic Mean’ of comparable prices
◦ Deviation of plus / minus five percent is permitted from arm’s length price
Methods Comparability
Comparable Uncontrolled Price Method ‘Price’ of the transactions
Resale Price Method ‘Gross margin’ of company reselling products / services to unrelated parties
Cost Plus Method ‘Gross margin’ of company selling manufactured products / services to related parties
Profit Split Method ‘Splits profits’ between parties to transactions based on economic parameters
Transactional Net Margin Method ‘Net Profit margin’ (Operating Profit) of ‘Tested Party’
Methods for Determination of ALP Price applied in a transaction between independent enterprises in uncontrolled conditionsTo be determined by applying the Most Appropriate Method, being one of the following five methods
Comparable Uncontrolled Price (CUP) MethodResale Price Method (RPM)Cost Plus Method (CPM)Profit Split Method (PSM)Transactional Net Margin Method (TNMM)
In case, more than one price is determined by MAM:Apply Arithmetic meanRange of + 5% of the arithmetic mean
Traditional transaction methods
Transactional profit
methods
Section Nature of Undertakings covered80IA Undertakings engaged in
•Developing, operating and maintaining, developing and operating and maintaining infrastructure facilities•Generation/ transmission or distribution of power•Reconstruction/ revival of power generating plants
80IB Undertakings located/ engaged in•Industrially backward districts as notified;•Scientific research & development•Refining of mineral oil/ commercial production of natural gas•Operating cold chain facility for agricultural produce•Processing, preservation and packing of meat/ meat products or poultry/ marine/ dairy products•Operating and maintaining a hospital of specified capacity
80IC Undertaking located in notified Centre/ Parks/ Areas in•Sikkim•Himachal Pradesh/ Uttaranchal•North- Eastern states
80ID Undertaking engaged in business of hotel/ convention centre in specified areas/ districts
10AA Undertakings having a Special Economic Zone unit
anti-abuse provision brought to check the excessive tax holiday claims
Generic framework of ‘More than ordinary profit’ was provided in law to compute the excessive tax holiday claims
To plug the loophole, it is now proposed to compute more than ordinary profits through the ‘arm’s length price’ mechanism
Issues◦ Eligible business will have to justify the ALP of the transactions
between the eligible unit/ business and any other person having close connection
◦ The term “Close Connection” not defined◦ Burden of the proving the “close connection” between the assessee
and other party is on TPOImpact ◦ Loss of tax holiday claim in excess of arm’s length profits ◦ No corresponding adjustment allowed for other party for adjustments
made, if any, by the TPO for transactions falling under this category
Industries operating in SEZs
Infrastructure Developers
Infrastructure Operator
Telecom Services
Industrial Park Developers
Power Generations or Transmission
Interest free Loans to Group Companies Sub section 8 of Section 80IA
Granting of Corporate Guarantees/ Performance Guarantees by Parent Company to its subsidiaries Sub section 8 of Section 80IA
Intra-group purchase/ sell/ service transactions Sub section 8 of Section 80IA
Payment made to key personnel e.g. transaction with Directors/CFO/CEO etc.. Section 40A(2)(b)
Payment made to key personnel of Group Companies. Section 40A(2)(b)
Payment made to relative of key personnel of the assessee/group companies. Section 40A(2)(b)
Commission to relatives of the directors/ partners
Salary paid to the relatives of the directors/Partners
Remuneration to the directors
Extra Purchase Price and Interest foregone to relatives
Good sold at lower than market price if bona fide
Higher Purchase Price than rates prevailing in the market
Interest paid to sister concerns at rate higher than normal rates
Hire Charges of Machinery or Rent paid for use of Immovable property
Maintenance of detailed TP Documentation, as specified in rule 10D demonstrating compliance with the ALP
Filing an Accountants’ report (Form 3CEB), certified by a Chartered Accountant with tax authorities containing details of specified domestic transactions
Default Nature of penaltyIn case of a post-inquiry adjustment, there is deemed to be a concealment of income
100-300% of tax on the adjusted amount
Failure to maintain documents 2% of the value of each international transaction or specified domestic transaction
Failure to furnish documents 2% of the value of each international transaction or specified domestic transaction
Failure to report a transaction in accountants report
2% of the value of each international transaction or specified domestic transaction
Maintaining or furnishing incorrect information or documents
2% of the value of each international transaction or specified domestic transaction
However, penalty for concealment of income shall not be levied if the taxpayer demonstrates that price charged or paid has been determined in ‘good faith’ and
with ‘due diligence’
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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?
• Rules defined by Local Authorities (Jantri) as ALP?
• Benchmarking?
• Benchmarking?
• Whether these allocation would be SDT – Sec 80-IA(10)?
• Directly v/s Indirectly
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1. Transfer pricing provisions are not applicable in case where income is not chargeable to tax at all.
[Amiantit International Holding Ltd., (2010) 322 ITR 678 (AAR)]
2. Provisions of section 40A(2) are not applicable to a co-operative society. [CIT vs. Manjara Shetkari Sahakari Sakhar Karkhana Ltd.(2008) 301 ITR 191 (Bom.)]
3. Payment made by holding co. to subsidiary co. is not covered u/s 40A(2)(b), as the relationship does not fall under sub-clause (ii) nor under sub-clause (iv) of sec. 40A(2)(b).
[CIT vs. V.S.Dempo & Co. (P) Ltd. (2011) 336 ITR 209 (Bom.) Note: In this decision, clause (vi) of s. 40A(2)(b) was not considered.
4. When a person commits an offence by not maintaining the books of accounts as contemplated by section 44AA, the offence is complete. After that there can be no possibility of any offence as contemplated by section 44AB and therefore, the imposition of penalty is erroneous.
[Surajmal Parasmal Todi vs. CIT (1996) 222 ITR 691 (Gauhati)] Note : This decision may be helpful in the context of sections 271AA, 271G and
271BA.
5. 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.
Provisions applicable only to expenditure where payment is made or to be made
◦ Does this include capital expenditure? – Section 40A(2)(b)◦ Does this include transactions without consideration? –
Section 80IA(8) & 80IA(10)◦ Does threshold apply to the amount recorded in the Books of
Account or Amount determine as per ALP? Whether Government approval u/s 295, 297 of the Companies
Act would be relevant? Whether close connection would be interpreted to mean the
criteria mentioned in section 92A(2) or 40A(2)(b) (Inconsistency regarding definition of related parties
Does the limit of INR 50 million apply qua transaction or aggregate of all transactions ?
If aggregate of International and Domestic transaction exceeds INR 50 million, but the International Transactions are below INR 10 million, Do we need to maintain documents prescribe under Rule 10D? ( Reference Rule 10D(2)
Would claim of Depreciate comes under the ambit of Domestic Transfer Pricing?
How are SDT defined?
◦ The following transactions with the aggregate value exceeding INR 50 million are covered Expenditure for which payment is made or to be made to
specified domestic parties Transfer of goods or services to/from eligible business
( tax holiday) from/to other business ( non-tax holiday undertaking)
Business transactions between eligible business ( tax holiday unit) and other person(s) producing more than ordinary profits owing to close connection
Which tax payers covered under SDT?
◦ Any tax payer incurring any expenditure with specified Domestic related parties are required to comply the regulation
How do you define specified domestic related party?
◦ The domestic related party will inter alia include a director, a relative of the director, a person having substantial interest in the tax payer ( carrying not less than 20% of the voting power) and fellow related parties where a single person has substantial interest in two tax payers
Which are the illustrative list of SDT?
◦ Transaction between the specified persons and also between the inter-unit transactions of taxpayers would be covered e.g. normal operating transactions, allocation of costs, etc…
What are the compliance requirements for tax payers that have SDT?
Tax payer that have specified Domestic Transaction would need to do the following:
Identify the nature of Transactions
Maintain requisite information and documents as prescribed
Obtain and furnish a prescribed report from an accountant in Form 3CEB
Applicability of OECD TP guidelines
Advance Pricing Arrangement
Benefit of range
Rule 10D and Form 3CEB requires modification to
harmonise their applicability in relation to inter-units pricing
and reporting of domestic transactions
Corresponding adjustment