Workshop on Basics in Transfer Pricing. Domestic Transfer Pricing By

Transcription

1 Workshop on Basics in Transfer Pricing Domestic Transfer Pricing By CA Praveen Ranka

2 Introduction

3 SDT The Intent The Finance Act, 2012 extended applicability of transfer pricing provisions to Specified Domestic Transactions ('SDT') with effect from Assessment Year The Memorandum to Finance Act 2012 explains that the coverage of TP has been expanded based on suggestions of the SC in the case of CIT v Glaxo SmithKline Asia (P) Ltd. (236 CTR 113). Tax laws may have to be amended in order for domestic transactions between related parties to be brought within the ambit of the Indian transfer pricing provisions. Aim is to remove complications in arriving at Fair Market Value ( FMV ) for applying provisions of the ITA as mandated by S.40A(2) and S. 80IA(10). CIT v Glaxo SmithKline Asia (P) Ltd. Appropriate provisions to be made in law to make TP regulations applicable to such related party domestic transactions. AO to apply any of the generally accepted methods of determination of arm s length price (ALP) and AO s constraint of relevant documents can also be removed by making it compulsory for the taxpayer to maintain such documents and obtain audit report from Chartered Accountant. 3

4 Object of SDT Payments to related parties u/s 40A(2)(b) Profit linked tax holiday units Other transactions to be notified Inter unit transactions Transactions with outsiders Discourage excessive payments to associates Should not lead to shifting of excessive profits to qualifying units Should be at ALP 4

5 What are SDT? Specified Domestic Transactions Any expenditure in respect of which payment has been made or is to be made to a person referred in clause (b) of subsection 2 of 40A Any transaction referred to in section 80A Any transfer of goods or services referred to in subsection (8) of section 80-IA Any business transacted between assessee and other person as referred to in subsection (10) of section 80- IA Any transaction referred to in any other section under Chapter VIA or section 10AA to which subsection (8) or (10) of section 80-IA applies Any other transaction as may be prescribed Where the aggregate value of these Specified Domestic Transactions exceeds Rs.5 crore, it will require the assessee to apply transfer pricing regulations to demonstrate that the transactions are at arm s length. 5

6 SDT not restricted to transaction with residents S. 92 BA excludes international transaction from within its scope Trigger for AE relationship different for international and domestic transfer pricing Illustrative example where transactions with non-residents may be covered under SDT: Remuneration paid by an Indian Company to a non-resident director Remuneration paid by a Foreign Company having PE to non resident director Payment by Indian company to Foreign Company, where the Foreign Company holds more than 20% and less than 26% in the Indian Company. (Guidance Note issued by ICAI also approves this view) 6

7 Intricacies of value threshold INR 5 Crores Threshold limit of INR 5 crores to be taken on an aggregated basis for all six limbs of SDT. Book value of the transactions to be considered for threshold limit even if transactions are ALP compliant. Transaction Value as per books (in cr.) ALP (in cr.) Value as per books (in cr.) ALP (in cr.) 40A(2)(b) payments Inter-unit Allocations Total Reporting Requirement Not Required Required Other Issues: Transactions between two qualifying units to be counted once or twice? Evaluate exclusion of expenditure disallowed (say for TDS default). Evaluate exclusion of expenditure of a disallowable nature Consistent with method of accounting in relation to taxes and levies 7

8 Applicability of transfer pricing regulations to SDT Section Provisions Applicability of SDT 92 Computation of Income having regard to Arm s Length Price Yes 92A Meaning of Associated Enterprise No 92B Meaning of International Transaction No 92C Methods of Computation of Arm s Length Price Yes 92CA Reference to Transfer Pricing Officer Yes 92CB Safe Harbor Rules Yes 92CC Advance Pricing Agreement No 92CD Effect of Advance Pricing Agreement No 92D Maintenance of Information and Documents Yes 92E Accountant s Report Yes 92F Definitions of certain terms relevant to Computation of Arm s Length Price, etc. 144C Dispute Resolution Panel Yes Yes 8

9 SDT Process Flow Identification of Specified Domestic Transaction Determination of ALP Voluntary Adjustments in Return (if any) FAR Analysis Selection of most appropriate method Documentation, return filing and Form 3CEB filing Identification of comparable transactions Establishing comparability, adjustment for differences Assessment and Appellate Proceedings 9

10 SDTs - Payments to related parties [Sec 40A(2)(b)]

11 Section 40A(2)(b) only expenditure covered Refers only to expenditure incurred in payments made or to be made to persons specified under Section 40A(2)(b) Transactions not subject to SDT (Illustrative) : Grant of interest free loan to an associate Corporate guarantee on behalf of subsidiaries Sale of goods at less than FMV Allowing use of trade mark or know-how or common services by group entities at NIL or nominal charge Only the entity incurring the expense will need to comply with the prescribed regulations. However, the following issues need consideration: Direct vs. Indirect Holding Aggregated holding vs. Individual holding Are capital expenditure transactions covered? Director s remuneration Benchmarking issues 11

12 Section 40A(2)(b) chart of related parties Relative Relative Relative Relative Relative All Directors of such Company All Partners of such Firm All Members of such AOP All Members of such HUF All Members of such BOI Relative Companies in which individual is a Director Firms in which individual is Partner AOPs in which individual is a Member HUFs in which individual is a Member BOIs in which individual is a Member Director 20% Relative Relative Relative Relative Relative Relative Company Partner Member Member Member 20% Director Individual 20% 20% 20% Firm AOP HUF 20% 20% 20% BOI 20% Company Assesee Company Company AOP 20% Firm Circular No. 6-P, dated 6 July 1968 refers to direct and indirect relationship Relative - in relation to an individual, the husband, wife, brother or sister or any lineal ascendant or descendant of that individual 12

13 Direct Vs. Indirect Holding View 1 Indirect holding to be considered Explanation to Section 40A(2)(b): beneficial owner vs owner/shareholder CBDT Circular No. 6P dated 6 July 1968 refers to the words directly or indirectly Intent of SDT Curbing tax erosion : determination of reasonableness of payment made to related parties View 2 Only direct holding to be considered Beneficial owner Indicative of legal ownership in most cases Harmonious interpretation of beneficial owner u/s 40A(2)(b) and u/s 79 Definition of associated enterprise u/s 92A uses the expression directly or indirectly and through one or more intermediaries - Such language not used in Section 40A(2)(b) Circular (especially those in conflict with Act) not binding- Act is supreme. Further, Circular refers to only inclusion of persons in whose business or profession the taxpayer has a substantial interest directly or indirectly. Thus, even if applicable, limited applicability to downstream entities? The expression beneficial owner needs to be construed in contrast to legal owner and not the nominal owner. Revised Guidance Note on Report under Section 92E issued by the ICAI in August 2013 also seems to support this view. 13

14 Indirect interest illustrated Related parties as mentioned u/s 40A(2)(b) X Transactions between sister concerns now covered Direct Interest Indirect Interest X1 X X2 Coverage - Substantial direct and indirect interest? - X1 X2 Debatable Issue X3 X4 X3 X4 X5 X6 X7 X8 X5 X6 X7 X8 14

15 Shareholding u/s 40(A)(2) Aggregate or Individual?? Situation : A,B C and D are directors of A Co. who also hold 10% each of share capital each in B Ltd. Issue : whether B Ltd. can be regarded as related party to A Ltd. since directors of A Ltd. hold more than 20% in aggregate in B Ltd. though each individual director does not hold more than 20% Possible arguments: S.40A(2) refers to expenditure in respect of which payment has been or is to be made to any person referred to in s. 40A(2)(b). Each of the relationship described in items (i) to (vi) are with reference to an individual person which is supported by use of articles a or any while describing the relationship. Wherever legislative intent is to cover aggregate interest, it has specified so in the provision. For instance, o s. 47(xiii)/(xiv) - 51% shareholding in the company in an aggregate form and o s shares of a company not less than 51% beneficially held by persons. Accordingly, for the purpose of substantial ownership aggregate interest should not be considered 15

16 Capital expenditure covered under the scope of S. 40 (A)(2)? View 1 Capital expenditure is neither to be benchmarked nor reported Section 92BA(i) covers any expenditure in respect of which payment has been made. However, Section 92(2A) applicable in case of expenditure for which an allowance is claimed. Depreciation is a deduction granted to offset the decrease in value of a capital asset through wear and tear and does not constitute an allowance for expenditure. View upheld by SC in the case of Nectar Beverages P. Ltd. (182 Taxman 319) and followed in various Appellate Authorities. Interpretation of CBDT Notification No. 41 dated 10 June 2013 in the context of definition of the term associated enterprise for the purposes of Rule 10A suggests that Section 92BA is not only restricted to determining the covered persons but is also reflective of the transactions to be covered Revised ICAI Guidance Note on Section 92E - TP provisions applicable to expenditures which are in nature of capital and fully claimed as deduction (eg section 35AD) In case of capital expenditure, except for specific instances of allowance in cases such as under Section 35AD, no upfront allowance is permitted. Hence, transfer pricing provisions ought not to apply. CBDT s Circular No.35 dated clarifies that Sec.40(A)(3) has no applicability to payments made to purchase of capital asset. Similar analogy can be drawn for Sec. 40(A)(2) 16

17 Capital expenditure covered under the scope of S. 40 (A)(2)? (contd..) View 2 To be benchmarked & reported A view exists that incase of depreciation, while the deduction is entirely not allowed upfront but allowed in parts over of the years Depreciation is claimed as a deduction in the computation and hence, affects taxability Whether TP provision triggered? In certain cases such as Section 35D, even capital expenditure is deductible. Recently issued Guidance Note of the ICAI specifically includes expenditure on purchase of tangible and intangible property in ambit of Section 40A(2)(a) transactions Stringent penal provisions for non-compliance with TP provisions - Sections 92BA and 92E should be read de hors Section 92(2A) i.e. regardless of applicability of Section 92(2A), reporting benchmarking provisions triggered Possibility of opting for View 3 i.e. to report but not to benchmark the transaction? 17

18 Case Study - 1 A Ltd X Ltd Loan given Y Ltd Facts: Interest 18% where ALP is 11% X Ltd and Y Ltd are Indian companies and related parties under s 40A(2)(b). X Ltd has given loan to Y Ltd on which Y Ltd pays 18% p.a. The ALP interest rate considering the tenure, repayment terms, collateral offered, etc. of the loan is determined at 11%. This rate of interest is also considered to be fair rate required to be paid by a borrower who is similarly placed. There is no explanation offered for payment at higher rate. X Ltd and Y Ltd are not entitled to any profit linked tax holiday. Interest paid by Y Ltd exceeds Rs. 5 Cr. 18

19 Case Study - 2 H Ltd A Ltd S1 Inc. S2 `Ltd S3 `Ltd Facts: Outside India India H Ltd is an Indian company. S1 Inc. is a foreign subsidiary. S2 Ltd and S3 Ltd are Indian subsidiaries. H Ltd owns valuable brand XYZ and is not eligible for any profit linked tax holiday. The subsidiaries are engaged in manufacturing and distribution of diverse products under brand name of XYZ. The subsidiaries pay royalty to H Ltd for use of brand name. S2 Ltd pays royalty of Rs. 4 Cr and S3 Ltd pays royalty of Rs. 7 Cr to H Ltd. Both S2 Ltd and S3 Ltd are not entitled to any profit linked tax holiday. 19

20 Managerial Remuneration Payment to directors including inter alia remuneration, sitting fees, commission, perquisites etc., are covered under SDT provisions To clarify, a director includes any director of a company, regardless of the nature of directorship Challenge Applying any of the transfer pricing methods to director payments poses a challenge since payments vary across companies and depend on a combination of factors. These factors include role, functions and qualification of a particular directror, each company s ability and capacity to pay specific business needs of each company and cannot be compared or bechmarked. Furthermore, the payments by any company to its directors cannot be compared to payments made by any other company to its directors, since payments to directors by any company are always controlled related party transactions and SDT provisions pre-suppose he use of uncontrolled transactions to establish comparability. The Delhi HC in the case of Shriram Pistons Ltd held that director payment approved by company law board shall be reasonable under 40A(2)(b). How to substantiate payments made to directors of Private Limited Co. 20

21 Managerial Remuneration (contd ) The following alternatives could accordingly, be considered to benchmark payment to directors S.No Comparable Analysis 1 Limits prescribed under the Companies Act 1956 and/or central government approval Tax Payers could rely on judicial precedents which have held the following: - Quantum of remuneration is a business decision, influenced by business considerations and differs across companies - Remuneration paid in accordance with the Companies Act,1956 should not attract disallowance. The above should be supported by the remuneration policy of the company 2 Benchmarking from external agency Determining the cost involved in recruitment of another personnel with similar qualifications, experience levels, skill sets and operation capabilities 21

22 Issues Inter-linking of S.40A(2) (a) and S.40A(2)(b) Benchmarking of remuneration Remuneration to partners regulated by s.40(b) (Circular 636) Directors remuneration regulated under Company Law (1968 Circular 6-P) Whether limit as mentioned in Schedule XIII would be the ALP?? Payment to related parties covered under non-business heads Interest payment to related party claimed as deduction u/s 57 ; s.58 (2) extends s. 40(A)( 2) to Income from other sources. Cost of capital asset acquired from related party Payments for capital assets under business head Depreciation claimed u/s. 32 Full deduction claimed u/s. 35(1)(iv) In case of margin-based methods, should the tested party be the company to whom SDT applies or should we test margins of both entities? 22

23 SDTs units availing a tax holiday

24 Tax Holiday Eligible Businesses In addition to the payments made to persons covered under s. 40A(2)(b), it is proposed to extend the applicability of transfer pricing provisions to: I. transactions referred to in section 80A; II. III. IV. transfer of goods or services referred to in sub-section (8) of section 80-IA; business transacted between the assessee and any other persons as referred to in subsection (10) of section 80-IA; any transaction, referred to in any other section under Chapter VI-A or section I0AA,to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable. 24

25 Transfers referred to in S.80IA(8) Bare Provisions " (8) 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, then for the purposes of the deduction under this section. the profits and gains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods or services as on that date. Key observations Applies to only transfer of goods or services between eligible business and any other business of the Assessee Eligible and non-eligible businesses could be two units in the same entity (assesse) market value to be determined in relation to the goods or services emphasis on price Further, it will be applicable to expenses as well as income for the eligible assessee. 25

26 Transfers referred to in S.80IA(10) Bare Provisions 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 for any other reason, the course of business between them is so arranged that the business transacted between them produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business, the Assessing Officer shall, in computing the profits and gains of such eligible business for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived therefrom Key observations Unlike s. 40A(2)(b), s. 80-1A(I0) does not setout a clear list of persons who would be the person referred to in sub-section (10) of section 80-IA. The said provision applies to persons with whom the assessee, during the course of business arranges its transaction such that it produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business, owing to: a) a close connection between them; or b) for any other reason Emphasis on profits as against market value of goods Could cover all transactions in the course of business, not just transfer of goods or services 26

27 Section 80IA(8) and Section 80IA(10) A snapshot Sub-section (8) of section 80-IA (and similar such provisions in Chapter VI A) Tax holiday unit Inter unit transfers (goods or services) Other unit Not corresponding to market value (adherence to ALP proposed) Appropriate allocation keys to be used to allocate costs and overheads for computation of tax holiday Revenue could challenge use of ad-hoc allocation keys Sub-section (10) of section 80-IA (and similar such provisions in Chapter VI A) Tax holiday company Business transacted (wider than transfer of goods or services) Other person having close connection More than ordinary profits earned by business unit claiming deduction (adherence to ALP proposed) Corresponding provisions to the above would be covered in Chapter VI-A and Section 10AA Transactions to be reported in Accountant s Report and their arms length nature to be substantiated in the TP Report 27

28 Tax Holiday impacted under SDT Section 80IA 80IAB 80IB Nature of undertaking covered Undertakings engaged in Developing or operating and maintaining or developing, operating and maintaining any infrastructure facilities Providing various telecom services Developing, developing and operating or maintaining and operating an industrial park Generation/ transmission or distribution of power Reconstruction / revival of power generating plants Undertakings engaged in developing a Special Economic Zone Undertakings located/ engaged in Industrially backward districts as notified Scientific research and development Refining 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 28

29 Tax Holiday impacted under SDT Section 80IC 80ID 10AA Nature of undertaking covered Undertaking located in notified Centre/ Parks/ Areas in Sikkim Himachal Pradesh/ Uttaranchal North Eastern states Undertaking engaged in business of hotel / convention centre in specified areas/ districts Undertakings being units in a Special Economic Zone 29

30 Possible Tax Leakages If ALP Not Followed (Illustrations) X Ltd. (non-tax holiday) X Ltd. (non-tax holiday) X Ltd. (non-tax holiday) Sale at 120 v/s ALP (ie 100) Sale at 120 v/s ALP (100) Sale at 80 v/s ALP (100) Y Ltd. (non-tax holiday) Y Ltd. (tax holiday) Y Ltd. (tax holiday) Disallowance for X Ltd of INR 20 [40A(2)(b)] Double Disallowance INR 40 (INR 20 for both companies) [40A(2)(b) and excessive profit] Inefficient pricing structure Reduced tax holiday benefit 30

31 Case Study 1 A Ltd X Ltd SEZ Unit A Ltd Non-SEZ Unit Facts: A Ltd is an IT software services company that has an existing non-sez unit. The Key management and marketing people and undertakes the key value add functions for the group as a whole. The SEZ unit has been recently set up which provides IT services to new customers. It houses all the delivery and project managers. It depends on the Non-SEZ unit for certain technologies and support. Contracts are obtained and signed by management located in Non-SEZ unit. A Ltd allocates all the revenue from new contracts to the SEZ unit and also allocates common costs between the two units. 31

32 Case Study 1 - Contd. Facts: A Ltd. is an Indian company engaged in diversified business. Its head office performs general management functions like accounting, HR, payroll etc. A Ltd. has 4 business units. Unit-1 of A Ltd. is engaged in providing full fledged back office / IT enabled services to other units and independent third parties. Unit-2 is engaged in insurance business. Unit-3 is engaged in telecom business. Unit-4 is engaged in infrastructure business. Unit-1 has provided ITES services to unit-2, unit-3 and unit-4 and charged at Rs. 1,200 per hour, 800 per hour and 900 per hour respectively. Unit-1 has also provided similar services to third parties at Rs. 1,000 per hour 32

33 Case Study 2 Allocation of Head office expenses A Ltd X Ltd A Ltd. Head Office (Performs general management functions) Rs. 1200/- per hour Unit - 1 Unit - 2 Unit - 3 Unit - 4 -SEZ -Back office support/ites -10AA eligible Insurance business Rs. 800/- per hour Telecom business Infrastructure business Rs. 900/- per hour Rs.1000/-per hour Third Party Insurance business 33

34 Case Study 2 - Contd. Facts: A Ltd. is an Indian company engaged in diversified business. Its head office performs general management functions like accounting, HR, payroll, etc. A Ltd has 4 business units. Unit -1 of A Ltd. is full fledged engaged in providing back office / IT enabled services to other units and independent third parties Unit -2 is engaged in insurance business. Unit -3 is engaged in telecom business Unit -4 is engaged in infrastructure business Unit-1 has provided ITES services to unit-2, unit-3 and unit-4 and charged at Rs.1,200 per hour, 800 per hour and 900 per hour respectively. Unit-1 has also provided similar services to third party at Rs. 1,000 per hour 34

35 Case Study 2- Contd. Issues: Whether head office expenses are required to by allocated between various units? If yes in what ratio? Whether domestic TP will be applicable for allocation of head office expenses and whether head office expenses are required to be allocated to various units by charging arm s length mark up as per transfer pricing provisions? Whether IT Enabled services provided by unit-1 to all other units will be covered under SDT requiring arm s length mark-up? Whether deduction u/s 10 AA of unit-1 can be reduced by applying domestic TP provisions? 35