Specific Domestic Transactions. Documentation & Audit Report Requirements Key concern Areas. 22 November 2013

Transcription

1 Specific Domestic Transactions Documentation & Audit Report Requirements Key concern Areas 22 November 2013

2 Agenda Requirements at glace Key issues relating to applicability to various entities Transactions covered under Specified Domestic Transactions (SDT) Documentation & other administrative aspects 2

3 Requirements at glance 3

4 Documentary requirements TP Documentation Maintenance of documentation similar to international transactions including description of the ownership structure profile of the multinational group broad description of the business nature and terms (incl. prices) of international transactions description of the functions performed, risks assumed and assets employed record of economic and market analyses, forecasts, budgets etc. record of uncontrolled transactions description of the methods considered details of adjustments supportive documents under 10D (2). 4

5 Documentary requirements TP Documentation Functional Analysis (Activities & Risk Analysis) Arm s Length Comparables Searches Characterization of the Entity(ies) Transfer Pricing Methodology(ies) (CUP, Cost Plus & Other Methods) Determination of Transfer Price Diamond 5

6 Documentation requirements - Accountant s Report The accountant s report (Revised Form 3CEB) requires - Details of associated enterprises, including name, address & PAN Nature of relationship & business activity of AEs Furnishing of factual information relating to the specified domestic transaction entered into; The arm s length price determined by the assessee and the method applied in such determination; An opinion as to whether the prescribed documentation has been maintained; The disclosures have been verified and the same is True and Correct. 6

7 Accountant s Report in Form 3CEB Clauses relevant to SDT Part A to Form 3CEB Clause 9 Aggregate Value of specified domestic transactions as per books of account Part C to Form 3CEB Clause 21 disclosure of PAN of the AE in addition to other disclosures Clause 22 - disclosure of expenditure for payment made / to be made to person referred to in Sec 40A(2)(b) Clause 23A disclosure of inter-unit transactions (in the nature of sale by the eligible business/ unit of the taxpayer) as referred to in S. 80A(6), 80-IA(8) or 10AA Clause 23B disclosure of inter-unit transactions (in the nature of purchase by the eligible business/ unit of the taxpayer) as referred to in S. 80A(6), 80-IA(8) or 10AA Clause 24 disclosure of business transacted with closely connected person (which has resulted in more than ordinary profits to an eligible business/ unit of the taxpayer) as referred to in S. 80-IA(10) or 10AA Clause 25 disclosure of any other transaction not covered in the above clauses [residual clause] 7

8 Key issues relating to applicability to various entities 8

9 Whether Indirect shareholding covered u/s. 40A(2)(b)(iv)? Company A Whether under SDT? 100% Company B 100% Company D 100% Company C 100% Company E Whether under SDT? Section 40A(2)(b)(iv) - a company, firm, association of persons or Hindu undivided family having a substantial interest in the business or profession of the assessee... or any other company carrying on business or profession in which the first mentioned company has substantial interest Explanation. For the purposes of this sub-section, a person shall be deemed to have a substantial interest in a business or profession, if, (a) in a case where the business or profession is carried on by a company, such person is, at any time during the previous year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) carrying not less than twenty per cent of the voting power; 9

10 Whether Indirect shareholding covered u/s. 40A(2)(b)(iv)? Reference to Memorandum to the Finance Bill 2012 (Page 24): In view of the circumstances which were present in the case before the Supreme Court, there is a need to expand the definition of related parties for purpose of section 40A to cover cases of companies which have the same parent company. It is further proposed to amend the meaning of related persons as provided in section 40A to include companies having the same holding company. Revised Guidance Note issued by ICAI (Para 4A. 16) Hence, the emphasis is on covering the real owner of the shares and not the nominal owner. This proposition is also supported by legal jurisprudence which states that in a multi-tier structure, a parent cannot be regarded as the beneficial owner of shares in a downstream subsidiary merely because it owns the shares of the intermediate subsidiary companies. Consequently, in a situation where A Ltd. holds 50% in B Ltd. and B Ltd. holds 50% in C Ltd., under ordinary circumstances, A Ltd. cannot be regarded as having beneficial interest in C Ltd. In other words, for purposes of Section 40A(2)(b), it may be appropriate to consider only direct shareholding and not derivative or indirect shareholding. Support also from certain Supreme Court decisions as well as various international guidance 10

11 Substantial interest - consider aggregate shareholding? Mr. X Relative of Mr. X SDT not applicable in any of these examples Director X Company A Director Y Company A (Assessee) However, once any one director of a company holds shares more than 20% in other company, all other directors of that company will be considered as related parties irrespective of their shareholdings Whether under SDT? Company B Assessee 8% Relative Z of Y 11

12 Inter unit transactions between 2 eligible units covered? S. 80IA(8) states as follows :- Where any goods or services held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods or services held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods or services as on the date of the transfer, Accordingly, Sec. 80IA(8) requires that transfer of goods and services between the eligible business and any other business (which includes eligible or non-eligible business) of the taxpayer shall be at market value / Arm s Length Price. Reference to Memorandum to the Finance Bill 2012 (Page 24): Therefore, the transfer pricing regulations need to be extended to the transactions entered into by domestic related parties or by an undertaking with other undertakings of the same entity for the purposes of section 40A, Chapter VI-A and section 10AA. Does this mean reporting the transaction twice!!?? 12

13 Close Connection u/s. 80IA(10) Who all are covered? Sec 80IA(10) Where it appears to the Assessing Officer that, owing to the close connection between the assessee carrying on the eligible business to which this section applies and any other person, or... Currently, the Income tax Act does not define the term close connection nor there are any specific judicial precedents on the definition of the term close connection However, references can be found in - Erstwhile provisions of Section 92 of the Act Explanatory Circular No. 14 on provisions relating to Finance Act, 2001 Erstwhile Section 42(2) of the Income Tax Act, 1922; Supreme Court decision in case of Mazagaon Dock Ltd. v. CIT (1958) 34 ITR 368; Proposed GAAR Regulations Australian & US tax laws For the purpose of harmonious interpretation of Section 92BA(iv) r.w.s. 80IA(10), the Associated Enterprise relationship as defined under Section 92A of the Act may be considered i.e. the wider meaning. 13

14 Other notable cases Once other provisions of SDT are applicable to any of the assessee, it needs to be examined for the purpose of SDT, irrespective of whether The assessee is paying tax under normal computation of taxable profits or under section 115JB on Minimum Alternative Tax (MAT) profits; The assessee eligible to claim the relevant deductions, actually claims the deduction in computing taxable income or not; In case of Life Insurance (not General Insurance) & other businesses where presumptive tax is applicable like Section 44AE, 44AF, 44BB, 44BBA, 115VA, etc., these sections override provisions contained in Section 28 to 43B of the Act and hence SDT may not be applicable to same. However, considering the provisions of SDT (Chapter X) also being special provisions, all eligible transactions in such businesses need to be disclosed in form 3CEB along with appropriate note about presumptive taxation. 14

15 Transactions covered under SDT 15

16 Purchase of Land & Capex for deduction u/s 35AD A peculiar type of Capital Expenditure as no depreciation claimed so should it be covered as a SDT? Two prerequisite conditions for application of SDT under section 92BA(i) 1. there should be an expenditure 2. payment has been made or to be made Even if depreciation is not claimed on purchased Land, the same has bearing on the capital gains computation at the time of subsequent sale - accordingly the assessee will be taking the deduction / claiming the expenditure of amount paid / to be paid for the purchase of land, even though at the later date of sale of land. Accordingly, Entire value of purchase of land needs to be disclosed in the year of purchase Purchase of capital asset from a domestic related party claimed as deduction u/s 35AD also covered similar to other capital expenditures as explicitly mentioned in Para 4A.11 of the Guidance Note issued by ICAI (August 2013 revision) These provisions are also applicable to expenditures which are in capital in nature and fully claimed as deduction under other provisions(eg Sec 35(2AB), 35 or 35AD) since any expenditure is covered under the scope of sec 40A (2)(b). 16

17 International Transactions not with AEs (26% criteria) Section 92BA For the purposes of this section, "specified domestic transaction" in case of an assessee means any of the following transactions, not being an international transaction, namely: (i) any expenditure in respect of which payment has been made or is to be made to a person referred to in clause (b) of sub-section (2) of section 40A;. Meaning of International transaction As defined u/s 92B OR As used in common parlance Transactions with foreign entities with shareholding between 20% to 26% to be covered? Revised Guidance Note issued by ICAI (Para 4A. 14) For example, where an Indian company purchases goods from a US company in which it has a 23% equity stake (substantial interest), such an expenditure transaction will not qualify as an international transaction amongst associated enterprises, but will qualify as a specified domestic transaction and thus subjected to arms length price requirements, transfer pricing documentation, accountant s report, etc. 17 Is it the intention of the legislation??

18 Other notable transactions covered under SDT Transaction of slump sale the aggregate value of the slump sale required to be disclosed even if values of individual assets are determinable Expenditure incurred for deduction under head of account income from other sources specific mention in the ICAI Guidance Note for application of section 40A even if such expenditure is disallowed under section 14A Purchase of shares / other securities similar to any other capital expenditure initial subscription of the shares excluded Prepaid expenses only the expenditure accrued during the year is to be reported in Form 3CEB and accordingly benchmarked. Guarantee fee payable to the guarantor specifically noted in the ICAI Guidance Note 18

19 Other notable transactions covered under SDT Expenditure which are not claimed as deduction /allowance on account of nonwithholding of tax, exempt entities etc. no specific exclusion for such expenditure Reimbursement of expenses specifically noted in the ICAI Guidance Note Allocation of common overhead costs like interest, administration, HR, accounting by Head Office Nature of the transactions Whether to be allocated? Whether markup to be charged? Stewardship activities No Not applicable Common / Third party costs Yes No Service provided Yes Yes 19

20 Benchmarking related aspects Benchmarking of directors remuneration Limits provided under the Companies Act 1956 / Companies Bill 2013 may be used for benchmarking purposes in addition to application of TNMM More than ordinary profits in case of section 80IA(10) If ALP of eligible unit fits within 3% range from transfer price, then it may be construed as ordinary profits else consider higher price / profits of any external comparable or even upper quartile Taxation of notional income in the hands of related parties Interest income on account of interest free loans / Guarantee fees on account of charge-free guarantee However, application of SDT may lead to allocation of notional expenses in eligible unit in order to reduce the quantum of deduction e.g. interest free loan given by eligible unit to ineligible unit Allocation of costs in eligible & non eligible units Non allocation of certain costs to eligible unit may attract provisions of section 80IA(10) for overstating the profits of eligible unit 20

21 Transactions NOT covered under SDT Loans / advances / inter corporate deposits these are not in the nature of expenditure even interest income arising from such transaction is out of purview of SDT Trade / Cash discounts (provided not separately recorded in the books) to be excluded considering part of sales transactions rather than expenditure Dividend not an expenditure as is in the nature of appropriation of profits 21

22 Documentation & Other Administrative aspects 22

23 Aggregate value of SDT under clause 9 Particularly important keeping in mind threshold of Rs. 5 crores Amounts recorded in the books of account as per the Companies Act to be considered Only the amounts of transactions recorded in the books of account of the taxpayer need to be considered for computing the limit of Rs. 5 crores (e.g. non charging of guarantee fees) Suo moto adjustments offered by the assessee in its return of income should be appropriately disclosed under relevant clauses of Form No. 3CEB but need not be considered for disclosure in clause 9 of Form 3CEB. Transactions between two eligible units need to be disclosed in both clauses 23A & 23B of Form 3CEB, however, need to be counted only once for the purpose of computing aggregate value of SDT under clause 9. Value of all SDT should be considered, whether or not expenses are deductible or not Outstanding balances of transactions covered? 23

24 Other expected concerns Identification of transactions relating to allocation of cost amongst eligible & non eligible units & consequently the amount of disclosure in Form 3CEB Differences in transactions covered under section 40A(2)(b) as per Tax Audit Report & as per Form 3CEB Identification of transactions covered under section 80IA(10) owing to the close connection between assessee s eligible business & other person How to document non-applicability of SDT Related parties not covered u/s 40A(2)(b) Aggregate of transactions below threshold of Rs. 5 crores 24

25 Other administrative aspects Regulations require maintaining one Transfer Pricing Documentation & one Form 3CEB for International Transactions as well as Specified Domestic Transactions However, two different sets / annexures of functional & economic analysis can be maintained in respect of International Transactions and Specified Domestic Transactions There is no provision for joint signing of Form No. 3CEB. Also the online Form No. 3CEB has to be signed by one chartered accountant using his or her digital signature 25

26