Transfer Pricing compliances, Litigation update and Dispute resolution. - CA Mithilesh

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1 Transfer Pricing compliances, Litigation update and Dispute resolution - CA Mithilesh

2 Overview Concept and Rationale of TP Applicability International Transaction Meaning of Associated Enterprise Specified Domestic Transaction Arm s Length Price Prescribed Transfer Pricing Methods Tolerance Band to determine the arm s length price Transfer Pricing Documentation Accountant s report TP Penalties Advance Pricing Agreement Safe Harbour Rules Summary of recent key developments Page 2

3 Transfer Pricing Adjustments (INR in Crores) Page 3 Source: Annual Report issued by the Ministry of Finance (FY & FY ) (Using conversion rates as on 31st March of respective years)

4 TP references and adjustments Source: Annual Report ( ) Ministry of Finance (Budget Division) Page 4

5 DRP Filing - Status Source: Annual Report ( ) Ministry of Finance (Budget Division) Page 5

6 Concept of transfer pricing Page 6

7 Concept of of Transfer Pricing (TP) Associated enterprise Independent entity International transactions - goods - services - intangibles - loans - guarantees Taxpayer Taxpayer Transfer price Arm s length price Page 7

8 Applicability The provisions of Section 92 to 92F of the Act are applicable only if: There are two or more enterprises (defined in Sec 92F); and The enterprises are AEs (defined in Sec 92A); and The enterprises enter into a transaction (defined in Sec 92F); and The transaction is an International transaction (defined in Sec 92B). Further w.e.f. 1 April 2012, TP provisions shall also apply to specified domestic transactions (SDTs) (defined in Sec 92BA) Consequences of these provisions: Computation of income/ allowance of expenses having regard to the Arm s length price [Section 92] Maintenance of prescribed Documentation (Section 92D & Rule 10D) Obtaining of Accountant s report (under Form 3CEB) (Section 92E) To ensure compliance with the arm s length principle, stiff Penalties have been prescribed Page 8

9 Applicability (contd.) Section 92(1) Any income arising from an international transaction shall be computed having regard to the arm s length price Explanation - the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm s length price Section 92(3) The provisions are not intended to be applied in case determination of arm s length price reduces the income chargeable to tax or increases the loss as the case may be Page 9

10 International transaction (Sec 92B) Transactions between two or more AEs, either or both of whom are nonresidents Transaction relates to: Purchase, sale or lease of tangible or intangible property; or Provision of services; or Lending or borrowing money; or Any other transaction having a bearing on the profits, income, losses or assets of the enterprises; or Mutual agreements or arrangements for allocation or apportionment of, or any contribution to, any cost or expense incurred; or Business restructuring or reorganization irrespective of fact that it has bearing on the profit, income, losses or assets As per Section 92F(V): transaction includes an arrangement, understanding or action in concert (A) whether or not such arrangement, understanding or action is formal or in writing: or (B) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceeding. Page 10

11 Enhanced definition of International transaction (w.e.f. 1 April 2002) International Transaction Tangible Property Intangible Property Capital Financing Provision of Services Business Restructuring Purchase, Sale, Transfer, Lease /Use of property/article/ product/ thing Includes Building, Vehicle, machinery etc. Purchase, Sale, Transfer, Lease /Use of IP Includes Transfer of ownership/use of rights/other commercial right Long/short term borrowing/ lending Guarantee Purchase/Sale Securities Advances/recei vables, Payments/any debt etc Market Research/ Development Technical Service Scientific Research Legal/Accountin g Service etc. Transaction of Business restructuring/reorg anization with AE irrespective of bearing profit/income/loss or assets at the time of transaction/future date Page 11

12 Definition of Intangible Clarified Marketing Trademarks, Trade Names, Brand Names, Logos Technology Process Patents, Patent Applications, Technical Documentation, Technical know-how Artistic Copyrights, Literary work, Musical Compositions, Maps, Engravings Data Processing Software Copyrights, Proprietary software, Automated databases, Integrated circuit Masks & Masters Engineering Industrial Design, Product Patent, Trade Secrets, Engineering Drawings, Blueprints, Proprietary Documentation Customer Customer Lists, Customer Contracts, Customer Relationship, Open Purchase Orders Page 12

13 Definition of Intangible Clarified (contd.) Contract Favourable Supplier Contracts, License agreements, Franchise agreements, non-compete agreements Human Capital Trained & Organised work force, Employment agreements, Union Contracts Location Leasehold interest, Mineral exploitation rights, Easements, Air rights, Water rights Goodwill Institutional / Professional Practice / Celebrity goodwill, Personal goodwill of professional, General business going concern value Similar Similar Item deriving its value from its Intellectual content rather than its physical attributes Others Methods, Programmes, Systems, Procedures, Campaigns, Surveys, Studies, Forecasts, Estimates, Customer Lists or Technical data Page 13

14 Concept of Associated Enterprises Page 14

15 Meaning of Associated enterprises (Sec 92A) A B C Both A and B are associated enterprises of C Direct or indirect participation (through one or more intermediaries) in management, control or capital A B C D E D and E are also associated enterprises of C since they have a common ultimate parent (A) Page 15

16 Deemed Associated enterprises (Sec 92A(2)) Holding Management Activities Control 1. >= 26% direct / indirect holding by enterprise OR 2. By same person in each enterprise 3. Loan >= 51% of Total Assets 4. Guarantees > = 10% of debt 5. > 10% interest in Firm / AOP / BOI 6. Appointment > 50% of Directors / one or more Executive Director by an enterprise OR 7. Appointment by same person in each enterprise % dependence on use of intangibles for manufacture / processing / business 9. Direct / indirect supply of > = 90% Raw Materials under influenced prices and conditions 10. Sale under influenced prices and conditions 11. One enterprise controlled by an individual and the other by himself or his relative or jointly 12. One enterprise controlled by HUF and the other by - a member of HUF - his relative or - Jointly by member and relative Page 16

17 Concept of Deemed International Transaction Page 17

18 Deemed international transaction- Sec 92B(2) A s Parent Prior agreement A 3rd party An transaction with an unrelated company (3 rd party) is deemed to be an international transaction and subject to transfer pricing regulations if Determination of terms A s Parent 3rd party a prior agreement exists between A s AE and 3rd party in relation to services rendered by A to the 3rd party; or A terms of transaction are determined in substance by A s AE and 3rd party Page 18

19 Definition of "deemed international transaction" amended The definition of "deemed international transaction" provides that a transaction of an enterprise with a third party shall be deemed to be an international transaction with the Associated Enterprise (AE) if there exists a prior agreement in relation to the said transaction or the terms of the said transaction are determined in substance between the AE and the third party. [Section 92B(2)] There had been an ambiguity as to whether 'deemed international transactions' would cover a case where both the contracting entities are Indian residents Hyderabad Tribunal in the case of Swarnandhra IJMII Integrated Township Development Co. P. Ltd vs. DCIT [TS-762-ITAT-2012(HYD)-TP] held that deeming fiction of section 92B(2) does not cover transactions between two Indian entities. Similar position taken in Kodak India Pvt Ltd (155 TTJ 69) Mum ITAT and Vodafone India Services Pvt Ltd (262 CTR 133) (Bom HC) Clarification provided by Finance Act 2014 that deemed international transactions would also cover cases where both the contracting parties are residents The amendment will take effect from 1 April 2014 Page 19

20 Definition of "deemed international transaction amended Foreign Co India Co (AE of FCo) Global MSA for Provision of IT Services SOW/ PO pursuant to MSA Outside India India Unrelated Customer Facts: Foreign Co is a US based global IT Services Co. FCo undertakes marketing activities. FCo and its affiliates (including India Co) enters into Global MSAs with potential customers for provision of IT services. MSA provides the broad terms and conditions under which customers and FCo s affiliates may enter into local SOWs In case customer entity in India requires IT services in India, a separate SOW is entered into with India Co with price and service level separately agreed. Terms of the SOW are substantially determined based on the MSA Such transaction would be covered under the amended provision Page 20

21 Domestic Transfer Pricing Page 21

22 Specified Domestic Transaction Sec 92(2A) Scope of TP provisions expended w.e.f. AY by including SDT if aggregate value of such transaction exceeds INR 50 Million ( INR 5 Crores) [Finance Bill 2015 has proposed to increase this threshold to INR 20 Crores] Applicability of TP regulations (including procedural and penalty provisions) to specified transactions between domestic related parties and payments made to related parties. Section 92BA - Specified Domestic Transactions in case of an Assessee means any of the following transactions, not being an international transaction, namely - Page 22 i. Any expenditure in respect of which payment is made or to be made to a person u/s 40A(2)(b); ii. Any transaction referred u/s 80A; iii. Any transfer of goods/services u/s 80-IA; iv. Any business transaction u/s 80-IA(10); v. Any transaction under Chapter VI-A or u/s 10AA to which provisions of Sec 80-IA (8) or (10) applies; or vi. Any other transaction as may be prescribed.

23 Specified Domestic Transaction Sec 92(2A) (contd.) Meaning of related party of domestic transaction u/s 40A(2)(b) to include companies having same holding company. All provisions applicable for determination of ALP for international transactions would apply in case of SDT also. Also penal provisions applicable to international transactions would apply to SDT Remuneration to Key Managerial Personnel also covered under SDT Page 23

24 AS-18 Related parties vs 40A(2)(b) Related Party Holding, Subsidiary, Fellow Subsidiaries Associate, Joint venture or Other party whose associate or joint venture is the reporting entity Individuals having control or significant influence over the reporting entity and their relatives Key Management Personnel or their relatives As Per AS- 18 As Per 40A(2)(b) As per Co s Act Yes Yes. Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Page 24 Transfer Pricing Updates

25 AS-18 Related parties vs 40A(2)(b) Related Party Directors and their relatives of the entity where such entity has substantial interest in the reporting enterprise Fellow Associates, i.e., the Investing party has substantial interest in the reporting enterprise as well as in other company All directors of a company where any director of such company has substantial interest in the reporting enterprise and their relatives As Per AS-18 As Per 40A(2)(b) No Yes No Yes No Yes Yes As per companies Act Page 25 Transfer Pricing Updates

26 Indirect Holding Whether Covered u/s 40A(2)(b)? As in the case of section 92A(2)(a) and (b) (which defines the term associated enterprise for the purposes of international transactions) the phrase directly or indirectly is not used in Section 40A(2)(b). Explanation to Section 40A(2) deems a person to have substantial interest if such person is beneficial owner of shares carrying not less than twenty per cent of voting power. The expression beneficial owner needs to be construed in contrast to legal owner and not in the context of determining indirect ownership of shares. For purposes of Section 40A(2)(b), it may be appropriate to consider only direct shareholding and not derivative or indirect shareholding. Page 26 Transfer Pricing Updates

27 Capital Expenditure - Whether Covered u/s 40A(2)? A close reading of section 40A(2)(a) of the Act reveals that the section applies to the payments for goods, services or facilities for which taxpayer has made payment. Thus, it emerges that the section covers only revenue expenditure; Ahmedabad bench of ITAT in the case of Fag Bearing India Ltd. vs. DCIT [2011] 12 ITR 395 (Ahd) wherein ITAT has endorsed the view that capital expenditure is not covered within the ambit of section 40A(2) of the Act. Depreciation is an allowance and not expenditure. Thus, it is not covered by section 92BA/ 40A(2)(a) of the Act which covers expenditure. In this regard, reference is drawn to the decision of the Supreme Court ( SC ) in the case of Nectar Beverages (P) Ltd. vs. DCIT [2009] 314 ITR 314 (SC) and to the decision of Ahmedabad special bench of Income Tax Appellate Tribunal ( ITAT ) in the case of Vishnu Anant Mahajan vs. ACIT [2012] 147 TTJ 142 (Ahd SB) wherein it was held that depreciation is an allowance and not an expenditure; Page 27 Transfer Pricing Updates

28 Benchmarking Directors Remuneration: Companies needs to benchmark the remuneration paid to any director, including a full-time director. Challenge: It may be difficult to objectively benchmark these payments, as comparable instances of other taxpayers payments to their directors would also be a controlled transactions. The following documentation could be considered as an evidence of arm s length nature of transaction: Remuneration within the limits prescribed under the Companies Act; Shareholders and Board approval; Qualifications, experience, Market Profile and prior salary of the directors (in earlier employment). Aggregation under TNMM method: Alternatively, it may be argued that if any entity is remunerated on cost plus mark-up basis/ constantly good margins, the directors remunerations need not be separately benchmarked and aggregated under the Transactional Net Margin Method analysis at the entity level. Page 28

29 Arm s length price Price applied or proposed to be applied in a transaction between persons other than AEs, in uncontrolled conditions Determination of arm s length prices using one of the Prescribed methods Yes Whether you arrive at a single price? No Earlier: The arithmetic mean of such prices, read with sec 92C(2) The price thus determined is the arm s length price +1% (upper ceiling) for wholesale traders; and + 3% (upper ceiling) in all other cases Replaced in current finance Act with a range (to be defined) and mean to apply only in case of inadequate comparables Page 29

30 Prescribed Transfer Pricing Methods Traditional Transaction Methods Transactional Profit Methods Other Methods Comparable Uncontrolled Price Resale Price Method Cost Plus Method Profit Split Method Transactional Net Margin Method Other method as provided in Rule 10AB Tax payer may apply any of the above methods that is considered most appropriate for a transaction. There is no preference of one method over another Page 30 TP Law in India An overview

31 Comparables All methods require comparables Transfer price is set/ defended using data from comparable companies Comparable company should be independent and similar to an associated enterprise. Comparability Criteria (Rule 10C(2)): nature of transactions undertaken (i.e. type of good, service etc.) company functions risks assumed contractual terms (i.e. similar credit terms) economic and market conditions Slide 31 Transfer Pricing

32 Comparable Uncontrolled Price Method -Rule 10B(1)(a) The price charged or paid for property transferred or services provided in a comparable uncontrolled transaction or a number of such transactions are identified. Such price is adjusted for differences, if any, between the international transaction/sdt and the comparable uncontrollable transactions or between the enterprises entering into such transactions, which could materially affect the price in open market. The adjusted price arrived above is to be taken as the arm's length price. Slide 32 Transfer Pricing

33 Comparable Uncontrolled Price Method Internal CUP Related party - B Manufacturer A Non-related party External CUP Non-related party A Non-related party B Slide 33 Transfer Pricing

34 Resale Price Method- Rule 10B(1)(b) Compares the resale gross margin earned by associated enterprise with the resale gross margin earned by comparable independent distributors An arms length gross margin should be sufficient for a reseller to cover its operating expenses and make an appropriate operating profit (in light of its functions and risks) Preferred method for a distributor buying purely finished goods from a group company without any value addition (if no CUP available) Group Manufacturer (Hong Kong) $75 $100 Related Distributor (India) Unrelated Distributors Slide 34 Transfer Pricing

35 Resale Price Method Identification of resale price by tested party Resale price reduced by normal gross profit with reference to uncontrolled transaction(s) Such price reduced by expenses incurred (customs duty etc.) in purchase of the product/ services. This price may be adjusted to account for functional and other differences if any Adjusted price arrived above taken to be arm s length price Slide 35 Transfer Pricing

36 Cost Plus Method Rule 10B(1)(c) Compares the gross profit on costs the associated enterprise earns with the gross profit on costs earned by comparable independent companies Preferred method for: manufacturer supplying semi-finished goods company providing services Manufacturer A (Indian) Cost + 40% Related Manufacturer B (US) US Market Slide 36 Transfer Pricing

37 Cost Plus Method Identification of direct and indirect costs of production incurred in tested party transactions Identification of normal gross profit with reference to uncontrolled transaction(s) Normal gross profit adjusted to account for functional and other differences if any Adjusted gross profit added to total costs identified in step 1 Sum arrived above is taken to be arm s length price Slide 37 Transfer Pricing

38 Profit Split Method-Rule 10B(1)(d) Appropriate for transactions which are not capable of being evaluated separately Calculates the combined operating profit resulting from a whole inter-company transaction based on the relative value of each associated enterprise's contribution to the operating profit The contribution made by each party is determined on the basis of a division of functions performed, valued, if possible using external comparable data Applicable for analyzing tangible, intangible or services issues Slide 38 Transfer Pricing

39 Profit Split Method Determination of combined net profit of the associated enterprises arising out of international transaction Evaluation of relative contributions by each enterprise on the basis of functions performed, risks assumed and assets employed Splitting of combined net profit amongst enterprises in proportion to their relative contributions Profit thus apportioned to the tested party is used to arrive at the arm s length price Slide 39 Transfer Pricing

40 Transactional Net Margin Method-Rule 10B(1)(e) Examines net operating profit from transactions as a percentage of a certain base (can use different bases i.e. costs, turnover, etc) in respect of similar parties Ideally, operating margin should be compared to operating margin earned by same enterprise on uncontrolled transaction Can compare to comparable transactions between independent parties Applicable for any type of transaction and often used to supplement analysis under other methods Most frequently used method in India, due to lack of availability of comparable uncontrolled prices and gross margin data required for application of the comparable uncontrolled price method/ cost plus method/ resale price method Slide 40 Transfer Pricing

41 Transactional Net Margin Method Computation of net profit as a percentage of a certain base realised from the international transaction. Computation of net profit realized by the tested party or an unrelated enterprise in a comparable uncontrolled transaction Net profit from uncontrolled transaction adjusted to account for differences if any The net profit thus established is taken into account to arrive at an arm s length price for the international transaction Slide 41 Transfer Pricing

42 Other Method :Notification No 18 of 2012 (Rule 10AB) Other Method or the sixth method allows the use of any method which takes into account: (i) the price which has been charged or paid or (ii) would have been charged or paid for the same or similar uncontrolled transactions, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts. The various data which may possibly be used for comparability purposes could be: (a) Third party quotations; (b) Valuation reports; (c) Tender/Bid documents; (d) Documents relating to the negotiations; (e) Standard rate cards; (f) Commercial & economic business models; etc. Slide 42 Transfer Pricing

43 Comparables All methods require comparables Transfer price is set/ defended using data from comparable transactions Comparable transaction should be independent and similar to tested transactions Factors for judging comparability (Rule 10C(2)): nature of transactions undertaken (i.e. type of goods, services etc.) company functions risks assumed contractual terms (i.e. similar credit terms) economic and market conditions Page 43

44 92 C(2) Tolerance Range reduced: Notification 23/09/2014 The Central Government notified that where the variation between the arm s length price determined under section 92C and the price at which the international transaction or specified domestic transaction has actually been undertaken does not exceed: 1% of the latter (TP) for wholesale traders (Explained) and 3% of the latter (TP) in all other cases, The price at which the international transaction or specified domestic transaction has actually been undertaken shall be deemed to be the arm s length price for assessment year Page 44 Transfer Pricing Updates

45 Tolerance band : Tweaked with non tolerance Position prior to proposed amendments Particulars to to Transfer price ALP (Arithmetic mean) Permissible Range (5% of 120) TP adjustment Arguably, 14 ( ) Arguably, 20 Position post amendments by Finance Bill, 2012 Particulars to to onwards Transfer price ALP Permissible range % (upper ceiling) for wholesale traders; and + 3% (upper ceiling) in all other cases TP adjustment 20 (no benefit of ± 5% band) 20 (if assessment pending as of ) 20 Remarks Concluded assessment not to be subject to rectification reassessment Page 45

46 Introduction of range concept Range concept followed internationally; also propounded by OECD Use of inter-quartile range is amongst the globally accepted best practice and also closer to economic realities wherein prices, and or margins, are compared to those within a range and not at to a particular point. In order to align the transfer pricing regulations in India with the international best practices, "range" concept is proposed to be introduced for determination of arm's length price. However, arithmetic mean concept will continue to apply where number of comparable is inadequate Relevant excerpts from the FM s speech In order to align Transfer Pricing regulations in India with the best available practices, I propose to introduce range concept for determination of arm s length price. However, the arithmetic mean concept will continue to apply where number of comparable is inadequate. The relevant data is under analysis and appropriate rules will be prescribed Page 46

47 CBDT Draft Rules - Range & Multiple Year Data Budget 2014 made an announcement that range concept would be introduced, where there are adequate number of comparables for determination of ALP Consequently, section 92C(2) was amended to prescribe for manner, in which the arm s length basis of the international or domestic transactions will be undertaken In light of the above announcements, the CBDT on May 21, 2015, announced draft rules on the application of range concept and use of multiple year data These draft rules, when finalised, would be applicable for international transaction or domestic transaction undertaken on or after April 1, (i.e. from Assessment Year ) Page 47

48 Range Concept applicability & Methodology Method Only under TNMM, RPM or CPM Comparables Minimum 9 Period PLI Computation Range Weighted average of 3 year data of each company to construct the data set (In certain circumstances, data of 2 years could be used out of the 3 years) Numerator and denominator of the chosen PLI to be aggregated for all the years for every comparable Data Points lying within 40 th and 60 th percentile off the data set If the transfer price of the tested party falls outside the range computed, the median of the range would be taken as ALP and adjustment to transfer price shall be made. Page 48

49 Illustration highlighting difference between the arithmetic mean concept and the range concept Name of the company Operating Margin A Limited -5.08% B Limited 6.51% C Limited 8.67% D Limited 18.08% E Limited 27.99% Tested Party 5.00% Arithmetic mean 13.23% Highest Observed Value 27.99% Upper Quartile* 23.04% Median** 8.67% Lower Quartile*** 0.72% Lowest Observed Value -5.08% No of observations (n) 5.00 Interquartile range (Upper Quartile Lower Quartile) 0.72% % * Upper quartile = [3/4 *(n+1)] th data value in the data set = 4.5 = average of 4th and 5th observation ** Median = [1/2 *(n+1) th data value in the data set = 3 = 3rd observation *** Lower Quartile = [1/4 *(n+1)] th data value in the data set = 1.5 = average of 1st and 2nd observation As evident from the above illustration, range concept is expected to provide greater flexibility to the taxpayers in respect of setting of transfer price as compared to the existing arithmetic mean approach Page 49

50 Understanding with an example..!!! Comparable Companies Weighted average of comparable companies (Scenario 1) Weighted average of comparable companies (Scenario 2) Weighted average of comparable companies (Scenario 3) Weighted average of comparable companies (Scenario 4) % % % % % -2.00% -2.00% % % 10.00% 10.00% 5.00% % 15.00% 12.00% 15.00% % 15.50% 19.00% 25.00% % 18.00% 25.00% 28.00% % 23.00% 32.00% 32.00% % 24.00% 34.00% 36.00% % 30.00% 36.50% 63.00% Page 50

51 Proposed Range Vs Arithmetic Mean Description (Scenario 1) (Scenario 2) (Scenario 3) (Scenario 4) Tested party margin assumed (A) 13.00% 13.00% 13.00% 13.00% Proposed Range (B) 12.00% % 15.00% % 12.00%-25.00% 15.00%-18.00% Median of Range 12.50% 15.50% 19.00% 25.00% Arithmetic Mean (C) 15.56% 13.28% 17.00% 17.11% Tested Party margin (Considering tolerance band of 3%) Whether tested party margin falls within range (40%- 60%) Whether tested party margins (using he tolerance band) is at ALP (applying AM concept) 16.39% 16.39% 16.39% 16.39% Yes No Yes No Yes Yes No No Adjustment NIL Range Concept- Adjustment of 2.50% (15.50% %) AM concept- NIL Range Concept- NIL AMP Concept- 4.00% (17.00% %) Range Concept % (25.00% %) AM Concept- 4.11% (17.11% %) Page 51

52 Proposed Range Vs Inter-quartile Range Description (Scenario 1) (Scenario 2) (Scenario 3) (Scenario 4) Tested party margin assumed 13.00% 13.00% 13.00% 13.00% Proposed Range 12.00% % 15.00% % 12.00%-25.00% 15.00%-18.00% Inter- quartile Range 11.50% % 10.00% % 10.00% % 5.00% % Whether tested party margin falls within range (40%- 60%) Whether tested party margin falls within inter-quartile range Yes No Yes No Yes Yes Yes Yes Page 52

53 Use of Multiple Year data Multiple year data allowed only where determination of ALP is done using TNMM, RPM or CPM. Data would comprise of three years including the current year. Data of 2 years also permitted in case of non-availability of data for 3 years for following reasons: q q q Data of the current year of the comparables not be available by the due date; A comparable fails to clear a quantitative* filter in any one year; and Comparable commenced operations only in the last two years or closed down operations during the current year. Data of the current year can be used during the transfer pricing audit by both the taxpayer and the department, if it becomes available at the time of audit. *The draft rules in the present form are silent on the definition of quantitative filter. Further there is no reference to any qualitative filter. Page 53

54 Permissible Tolerance Band to determine arm s length price Range benefit is no more available as a standard deduction Amendments in Finance Act (No. 2) 2009 to be applicable to all AY pending after 1 Oct 2009 The ±5% variation allowed in determining ALP has been capped to a limit of + 1% for wholesale traders and + 3% in all other cases from 1 April 2013 Tolerance band now substituted going forward by range concept Page 54

55 TP Documentation & Penalties Page 55

56 Transfer Pricing Documentation A detailed list of mandatory documents are given in Rule 10D(1) of the Rules. Ownership Structure Profile of multinational group Business description/ Profile of industry Entity Related Nature and terms (including price) of international transactions Description of functions performed, risk assumed and assets employed (functional analysis) Records of economic and market analysis (economic analysis) Record of budgets, forecasts, financial estimates Any other record of analysis (if, any) to evaluate comparability of international transaction with uncontrolled transaction(s) Description of method considered with reasons of rejection of other methods Details of transfer pricing adjustment(s) made (if, any) Price Related Any other information e.g. data, documents like invoices, agreements, price related correspondence etc. Transaction Related Page 56

57 Transfer Pricing Documentation (contd.) Detailed documentation not required in case aggregate transaction value is less than INR 1 Crore List of supporting documents are also provided in the law Contemporaneous data requirements Documents to be retained for a fixed period from end of the assessment year Need to obtain Accountant s report (under Form 3CEB) to be filed along with the return of income Page 57

58 Accountant s report (Form 3CEB) - Rule 10E Obtained by every tax payer filing a return in India and having international transaction or SDT To be filed by due date for filing return of income Essentially comments on the following: whether the tax payer has maintained the transfer pricing documentation as required by the legislation, whether as per the transfer pricing documentation the prices of international transactions are at arm s length, and certifies the value of the international transactions as per the books of account and as per the transfer pricing documentation are true and correct Page 58

59 Revised Form 3CEB Revised Form 3CEB has been bifurcated into following 3 parts: q q q Part A: Details of taxpayer Part B: Details of International Transactions Part C: Details of Specified Domestic Transactions Part A Details of taxpayer Taxpayer is required to mention its nature of business in point No. 4 of Part A of Form 3CEB. Codes for nature of business to be filled in as per instruction for filing Form ITR 6. This code may be considered by the tax office while allowing range benefit (i.e. for wholesale traders range of 1 percent is applicable) Aggregate value of international transactions and SDT as per book of account to be specified in clause 8 and 9 of Part A respectively Page 59

60 Revised Form 3CEB Part B: Details of International Transactions Clause 15 of the new Form requires disclosure regarding transactions in the nature of guarantee. Details like name of AE, nature of guarantee agreement, currency and compensation/fee charges are to be disclosed in addition to method used for determining ALP Clause 16 deals with international transaction of purchase and sale of marketable securities, issue and buyback of equity shares, optionally convertible/ partially convertible/ compulsorily convertible debentures/ preference shares Clause 18 deals with international transactions relating to business restructuring and reorganization Clause 19 deals with any other transaction including a transaction which has a bearing on profits, income, losses or assets of the assessee Clause 20 requires disclosure about deemed international transactions Part C: Details of Specified Domestic Transactions Clause 22 deals with expenditures for which payment made to persons specified u/s 40A(2)(b) Clause 23 deals with inter-unit transfer of goods and services u/s 80A(6), 80IA(8) or 10AA. Sub-clause A deals with transfer by eligible unit/business undertaking to other units while sub-clause B deals with acquisition of goods/ services by such eligible unit/business undertaking from other businesses carried on by the assessee Clause 24 deals with business transacted as specified u/s 80-IA(10) and Sec. 10AA. Clause 25 deals with any residual SDT Page 60

61 TP Penalties Page 61

62 TP Penalties-Section 271 Default Post-inquiry adjustment (deemed concealment of income) à u/s 271(1)(c) Failure to maintain information or documents / Fails to report transactions / Maintains or furnishes an incorrect information or documents à u/s 271AA Failure to furnish information or documents à u/s 271G Failure to furnish accountants report à u/s 271BA Penalty % of tax on the adjusted amount 2% of the transaction value 2% of the transaction value Rs 100,000 Page 62

63 Empowering the TPO to levy penalty under section 271G The existing provisions of section 271G of the Act provide that if any person who has entered into an international transaction or specified domestic transaction fails to furnish any such document or information as required by sub-section (3) of section 92D, then such person shall be liable to a penalty up to 2% of the value of international transactions (or specified domestic transaction) which may be levied by the Assessing Officer or the Commissioner (Appeals). Given that determination of ALP in several cases is done by TPOs, TPOs are now empowered to levy penalty under section 271G for failure to furnish information/ documentation. The amendment came into effect from 1 October Need to be mindful of the 30 days time limit for submission of information/ documents during the course of transfer pricing audits Page 63

64 Penalty provisions [section 270A] - Finance Act 2016 Penalty in case of under-reporting or misreporting of income Existing Penalty Provisions under Section 271(1) (c) % of tax on transfer pricing adjustment, in absence of good faith and due diligence Proposed Penalty Provisions under Section 270A No penalty, where transfer pricing documentation maintained, transaction declared and material facts disclosed Penalty at 50% of tax on transfer pricing adjustment, where transfer pricing documentation not maintained Penalty at 200% of tax on transfer pricing adjustment, where the TP adjustment is in consequence of not reporting an international transaction Note: Other penalties for non-maintenance of documentation, failure to report a transaction, furnishing incorrect information or documents, failure to furnish accountant s report or requested documentation will continue to apply Page 64

65 TP Assessment Experience

66 Assessment Procedure 1 TPO U/s 92CA the AO may refer determination of ALP to the TPO, with prior approval of Commissioner would then notify the taxpayer to produce evidence supporting transfer price as arm s 2length AO would proceed to compute income of the taxpayer in conformity with ALP determined by the 4TPO and pass a draft order TPO would determine ALP by passing an order based on information gathered from the assessee/ other sources and 3intimate the AO & taxpayer

67 Revised time limit for completion of assessment, reassessment and re-computation FA 2016 To finalize proceedings more expeditiously as digitization of processes has enhanced its efficiency (Amendment to section 153(1)) Reduction in time limit of assessment by 3 months (i.e. from 24 months to 21 months), consequently impacting time limit for completion of TP assessment Basis the revised timeline for assessment, timelines and due dates for TP compliance, assessment shall (illustratively) be as below: Page 67 Particulars Timelines in Calendar Year 2016 Timelines in Calendar Year 2017 TP assessment order 31 October 2016 (AY ) Draft AO order 31 December 2016 (AY ) DRP directions 31 December 2016 (AY ) TP Compliance 30 November 2016 (AY ) 31 October 2017 (AY ) 31 December 2017 (AY ) 30 September 2017 (AY ) 30 November 2017 (AY )

68 Revised time limit for completion of assessment, reassessment and re-computation Extension of time limit to TPO u/s 92CA(3A) in certain cases Existing Time Limit TPO to pass order sixty days prior to the date on which the limitation for making assessment expires Proposed Time Limit If time available to the TPO for making an order is less than sixty days, in case where assessment proceedings are stayed by any court or a reference for exchange of information has been made by the competent authority then such remaining period shall be extended to sixty days Consequent to the above extended period, if the period of limitation provided u/s 153 which is available to the Tax authority is less than sixty days, such remaining period shall be extended to sixty days and the aforesaid period of limitation shall be deemed to be extended accordingly Recently Delhi Tribunal in case of Honda Trading Corporation, Japan held that TPO has to pass order sixty days prior to the date on which the limitation for making assessment expires Page 68

69 Assessment Experience Whether any method or combination of any two or more methods can be adopted for determining ALP? Tested Party Internal Comparable or External Comparable Aggregation of transactions or transactions by transaction approach Database for locating comparable Number of uncontrolled transactions for comparability analysis Weightage to be assigned for characterisation of product or service in different methods Slide 69 Transfer Pricing

70 Assessment Experience Contractual Terms Comparability Analysis: Single year vs Multiple Year data Financial period (Different financial year end) Related Party Transactions Secret Comparable (Use of 133(6) information) Exclusion of loss makers Inclusion of Super Profit making Companies Significance of Brand Turnover Criteria Customs Valuation Slide 70 Transfer Pricing

71 Recent TP Controversies Slide 71 Transfer Pricing

72 Adjustments/controversy Share issue transaction Transfer pricing adjustment on issue of shares transaction by an Indian company to its overseas parent company followed in the case of Shell (INR 15,000 crores) and Vodafone (INR 8,500 crores) TPOs in audit cycle for AY have scrutinized share issue transaction and made adjustments The Bombay High Court in the recent ruling of Vodafone has held that no income had arisen from the issue of shares, and hence, transfer pricing adjustment on such transaction was not valid. Subsequent to this ruling, the CBDT has directed the Revenue Officers to adhere to the principles of the Vodafone case with regard to the share issue transaction and not categorize shortfall in premium as income of Indian company. However, secondary adjustments with regard to imputed interest on shortfall in receipt of premium may still be made Page 72

73 Issuance of shares Controversy Issue of shares to overseas parent have been scrutinized even though not an international transaction and twin-fold adjustments were made Adjustments made in cases where value of shares derived from DCF valuation was more than price at which shares were issued. Such excess was characterised as Deemed Loans advanced to the AEs Secondary adjustments were also made i.e. notional interest should have been earned by the Indian Co. on such Deemed Loans Conservative Position adopted by taxpayers: TP provisions should apply only in relation to income arising from an international transaction. In the absence of income bearing international transactions, which affect the profitability of the entity, the transaction should not be subject to TP regulations. However, in terms of the explicit requirement in electronic Form 3CEB to disclose the transaction of issue of share capital, it shall be disclosed in order to mitigate any penal provisions. (Basis of position taken to be disclosed in notes to Form 3CEB filed separately with the AO). Page 73 Key TP Issues

74 Issuance of shares Jurisprudence Recently, Hon ble Bombay HC held chapter X is not applicable on issue of share capital. It was held Chapter-X is not a complete code but a machinery provision to arrive at ALP. The Union Cabinet, chaired by the Prime Minister Shri Narendra Modi, in a major decision, has decided to accept the order of the Hon ble High Court of Bombay in the case of Vodafone India Services Private Limited (VISPL) dated Entire controversy has been put to rest formally since CBDT has issued an internal circular instructing the tax department to not appeal before Supreme Court against Delhi High Court Order Page 74 Key TP Issues

75 Delhi High Court Ruling on Advertisement, Marketing and Promotion Expenses The Delhi High Court (HC) has issued landmark ruling on the issue of transfer pricing (TP) adjustment on account of excessive Advertisement, Marketing and Promotion expenses (AMP) incurred by Indian MNCs, leading to benefit for brand owners The HC while observing that AMP may be an international transaction, has concluded that the compensation for AMP expenses may be included or subsumed in the low purchase price of goods imported from overseas AE or lower/ no charge of royalty paid The HC has held that AMP expenses can be benchmarked by way of an aggregated / bundled analysis with other transactions as long as the comparables selected appropriately reflect the aggregated functions Page 75

76 Adjustments/controversy (cont d ) IT/ ITES companies Technology companies (IT/ITeS) continue to be targets for large adjustments Characterization of a taxpayer as risk taking software developer Notices issued in relation to Circular 6 (and erstwhile Circular 3) for contract R&D centers Arm s length margin not necessarily aligned with safe harbour, though margin computation aligned with safe harbour procedures Guarantee fee Guarantee provided by Indian parent on behalf of its foreign subsidiaries is considered as service rendered and is scrutinized in detail. Adjustments are usually made in case there is no guarantee fee charge by the Indian parent Outstanding AE balances Outstanding AE balances deemed as loan given to AEs and adjustments proposed for notional interest Royalty and Intra Group services (management fee) Royalty/ management fee/ intra-group services subject to need test, services test, benefit test, Evidence test and Computational test Combined TNMM rejected and in most of the cases, ALP determined at Nil by applying CUP Page 76

77 Adjustments/controversy (cont d ) Location savings Location savings is the new wave of concern for MNEs operating or setting up operations in low-cost jurisdictions such as India Savings attributable to shifting of operations to India being split between Indian and foreign operations and adjustment made on the same Revenue Authorities have used research articles available in the public domain to arrive at cost savings in India (due to location) and made adjustment. Other Issues Economic adjustments Working capital adjustment granted on selective basis Other economic adjustments such as capacity adjustment, risk adjustment, adjustment for abnormal costs, treating foreign exchange as operating in nature, etc. not being granted Leveraging on media statements/information available in public domain to challenge functional characterization of taxpayer In some cases, relief granted by ITAT is not being followed in subsequent years by TPOs/ DRP Page 77

78 Dispute Resolution Page 78

79 Traditional dispute resolution mechanism Supreme Court 3 to 8 years Around 2L crores locked in appeals Most tax disputes are dealt with under the traditional dispute resolution avenues High Court ITAT 2 to 5 years 1 to 3 years Substantial period of time taken at each level of dispute resolution forum At times, pro-tax revenue approach perceived at lower levels Drawbacks of prolonged litigation: Huge tax compliance costs (time + money) CIT(A) 1 to 2 years Uncertainty Lack of investor confidence Distorts Governmental budgeting AO 0.5 to 2 years Need for robust, effective and speedy ADR mechanisms Biggest drawback It could take upto years to achieve certainty in tax position Page 79

80 Dispute Resolution Panel The AO to provide draft order to assessee, in case any adjustment is proposed. TPO s order Show cause notice The assessee has to file the objections within 30 days of receipt of the draft order; Directions of the DRP to be issued within 9 months of the end of month draft order forwarded to Assessee; The directions issued by the DRP Panel are appealable in the ITAT by the Assessee. The department can appeal against the DRP directions for objections filed after 1 July Page 80 No response AO s order CIT(A) ITAT AO s draft order Appeal Within 30 days of receipt of draft order File Objections with DRP DRP Order AO Order Within 9 Months from end of the month in which draft order was forwarded to Assessee

81 Concerns on domestic tax law appeal process Time consuming and several tiers of appellate proceedings Appeal by tax authorities in case of favorable resolution at lower levels Build up of cases at Tribunal level; factual nature of issues results in matter being remanded back for relook; unscientific approach is being adopted at tribunal level being fresh and complex issue Uncertainty on eventual outcome and impact on financial statements Risk of economic double taxation, if matter is decided against the taxpayer Recent experiences with DRP not very encouraging Parameter Domestic Litigation APA Time Certainty Frequency Around 10 years to resolve disputes Dispute resolution in one year does not guarantee acceptance of positions in subsequent years Annual audits and necessity to pursue litigation every year Finalization of Unilateral APAs may take around months 5 year binding agreement with the Indian government (& foreign tax administration, wherever applicable) Could be 9 years considering roll back One time exercise can get a 5 year agreement and it can be renewed with lesser effort Page 81

82 ADR mechanism AAR Settlement Comm. DRP ADR mechanism APA MAP Safe Harbour Page 82

83 Advance Pricing Agreement ( APA ) Sec 92CC/CD CBDT empowered, with effect from 1 July 2012 to enter into APA with any person in relation to an international transaction for determination of ALP As per method referred in S. 92C or Any other method with such adjustments or variations as may be necessary/expedient The agreement shall be valid for period not exceeding five consecutive years APA is binding on the concerned person and on the tax authorities provided there is no change in law or no change in facts having a bearing on the agreement Roll back provision introduced for upto four years preceding the first year of the APA. Detailed rollback rules notified on March 14, 2015 Page 83

84 APA - Sec 92CC/CD (contd.) With approval of Central Government, APA can be regarded as void ab initio (as if the agreement was never entered into) if obtained by fraud or misrepresentation of facts CBDT given the powers to prescribe a scheme specifying the manner, form, procedure and any other matters in respect of APA Taxpayer to furnish modified return, limited to the impact of APA, within 3 months of date of APA, including for years for which assessments have been completed. Taxpayer may be disentitled to claim the impact of APA in the event of delay in submission of modified return Pre-filing consultation made optional Page 84

85 Types of APA Indian Taxpayer Unilateral APA (UAPA) Agreement between the tax payer and the APA Authority of the domestic country Indian APA Authority Types of APA Bilateral APA (BAPA) Agreement between the tax payer and two foreign tax authorities Multilateral APA (MAPA) Agreement between the tax payer and multiple foreign tax authorities Indian APA Authority/ CA Tax Treaty Partner Indian Taxpayer Foreign Taxpayer Draft 11 May for 2016 discussion only Page 85

86 APA Overview Any person who has undertaken or who is contemplating to undertake an international transaction can apply for an APA Pre-filing consultation mandatory to determine scope of APA, identify issues, determine suitability and discuss broad terms of the APA Anonymous filing permitted but it shall not bind the applicant or the CBDT to enter into an agreement Application can be made after pre-filing consultation and can be for unilateral, bilateral or multilateral APAs. Withdrawal and amendment to application permitted Fees varies in accordance with value of international transaction Value of international transaction in respect of which APA is proposed Filing fees (INR Million) Less than INR 1 billion 1 INR 1-2 billion 1.5 More than INR 2 billion 2 Draft for discussion only Page 86 Page 6

87 APA Overview of the process Pre-filing APA request Evaluation and negotiation Agreement Execution and monitoring Unilateral vs bilateral Pre-filing meeting (anonymous?) Pricing study and strategy Industry overview Supply chain overview FAR analysis Proposed economic analysis Field work (functional interviews, review financial statements) Government-togovernment process Position papers face to face meetings Critical assumptions Annual report, record-keeping Audit Revocation, cancellation or revision Renewal Proposed term Drafting and concluding APAs Draft 11 May for 2016 discussion only Page 87

88 APA Benefit & Risk analysis Benefits Concerns around domestic tax law process Provides certainty and enhances predictability Proactively avoids TP controversy Discussion at the right level Solution to complex/ difficult TP issues Eliminates/reduces risk of economic double taxation Can reduce compliance cost Roll back option for past 4 years (resolving litigation for upto 9 years) Risks Time consuming exercise especially with BAPA and MAPAs Taxpayers may be asked to provide detailed information on transactions that is normally not required in a normal audit Confidentiality of information submitted not clear 11 May 2016 Page 88

89 APA Pros and Cons Benefits Proactively avoids TP controversy - Provides certainty and enhances predictability Discussion at the right level Solution to complex/ difficult TP issues Eliminates/reduces risk of economic double taxation Can reduce compliance cost Concerns around domestic tax law process - Preferred means of controversy management after MAP Risks Strain on resources for taxpayers personnel and expenses May not provide certainty in case of a unilateral APA or if an APA involves unreliable prediction on market conditions without adequate critical assumptions Fairly detailed forms/ information request during pre-filing and application stage - normally not required in an audit Confidentiality of information submitted not clear May not always result in the desired outcome Page 89

90 Numbers The CBDT has so far signed 16 APAs of which 15 are unilateral and one bilateral with Japan. First unilateral rollback APA signed with a US MNC The 16 APAs signed relate to various sectors like telecommunication, oil exploration, pharmaceuticals, Filed finance/banking, FY Unilateral software APA Bilateral development APA Total services and Signed ITeS. Applications Applications (till date) NA NA NA 6 Total Page 90

91 APA Roll back of APA FY FY FY FY FY FY FY FY FY APA Rollback Negotiation initiation To make APA applicable from FY , APA application has to be filed before March 31, 2015 Maximum APA duration for prospective years Page 91

92 Rollback Provisions clarified Type of international transaction covered: Same international transaction implies that the transaction in the rollback year has to be of same nature and undertaken with the same AE(s), as proposed to be undertaken in the future years and in respect of which agreement has been reached. Rollback provisions would apply only if the FAR analysis of the rollback year does not differ materially from the FAR validated for the purpose of reaching an agreement in respect of international transactions to be undertaken in the future years for which the agreement applies. materially will be interpreted consistently with its ordinary definition and in a manner that a material change of facts and circumstances would be understood as a change which could reasonably have resulted in an agreement with significantly different terms and conditions. Choice of years The applicant does not have the option to choose the years for which it wants to apply for rollback. The applicant has to either apply for all the four years or not apply at all subject to exception if covered international transaction(s) did not exist in a rollback year or there is some disqualification in a rollback year. Recent TP Updates

93 Rollback Provisions clarified ITAT order consideration: Where Appellate Tribunal has passed an order disposing of an appeal, on factual issues, the matter has already reached finality in that year. Hence, rollback not allowed for that year. If the ITAT has not decided the matter and has only set aside the order for fresh consideration of the matter by the lower authorities with full discretion at their disposal, the matter shall not be treated as one having reached finality and hence, benefit of rollback can still be given. Cancellation If the rollback provision cannot be given effect to for any of the rollback years on account of the applicant not taking the actions specified in sub-rules (2), (3), (4) or (6), the entire agreement gets vitiated and will have to be cancelled. MAP Application If MAP has been already concluded for any of the international transactions in any of the rollback year under APA, rollback provisions would not be allowed for those international transactions for that year but could be allowed for other years or for other international transactions for that year, subject to fulfilment of specified conditions in Rules 10MA and 10RA. However, if MAP request is pending for any of the rollback year under APA, upon the option exercised by the applicant, either MAP or application for roll back shall be proceeded with for such year. Recent TP Updates

94 Rollback Provisions clarified Different ALP: The ALP could be different for different years. However, the manner of determination of ALP (including choice of Method, comparability analysis and Tested Party) would be same. Compliance audit Since rollback provisions are for past years, ALP for the rollback years would be agreed after full examination of all the facts, including validation of critical assumptions. Hence, compliance audit for the rollback years would primarily be to check if the agreed price or methodology has been applied in the modified return. Withdrawal The applicant has an option to withdraw its roll back application even while maintaining the APA application for the future years. However, it is not possible to accept the rollback results without accepting the APA for the future years. Recent TP Updates

95 Rollback Provisions clarified Merger of companies: If A, B and C merge to form C and C is the APA applicant, then the agreement can only be entered into with C and only C would be eligible for the rollback provisions.. Demerger of companies: The same principle as mentioned in the previous answer, i.e., the person (company) who makes an APA application or enters into an APA would only be entitled for the rollback provisions, would continue to apply. Recent TP Updates

96 Safe Harbour Rules Rules 10TA to 10TG Meaning Safe Harbour Rules refers to determination of price margin which are acceptable to tax authorities to provide protection to taxpayers from TP scrutiny proceedings Prices established under such rules would be automatically accepted by the tax administrations that have expressly adopted such rules Applicability Rules to be applicable for a maximum period of 5 years beginning AY or the period opted by the Assessee Does not apply where the AE is located in any country or territory notified under section 94A or in a no tax or low tax country or territory Compliance The Assessee shall furnish a Form 3CEFA on or before 30 November of the first assessment year of the covered period for which it is seeking protection Arbitration Objection to Commissioner within 15 days of receipt of TPO order Commissioner shall pass its order within 2 months from the end of the month in which the objection is received by him Page 96

97 Safe Harbour Rules Rules 10TA to 10TG Eligible international transactions Provision of Software development services Circumstances If Transaction 500 crore, then Min. 20% If Transaction > 500 crore, then Min. 22% Provision of ITES If Transaction 500 crore, then Min. 20% If Transaction > 500 crore, then Min. 22% Provision of KPO Min. 25% Advancing of Intra Group Loans Provision of corporate guarantee If Loan amount 50 crore, then Min. SBI base rate bps If Loan amount > 50 crore, then Min. SBI base rate bps If Guaranteed amount 100 crore, then Min. 2% If Guaranteed amount > 100 crore and AE s credit rating (done by SEBI registered agency) is of highest safety, then Min.1.75% Contract R &D If relating to software development, then Min. 30% If relating to generic pharmaceutical drugs, then Min. 29% Manufacture and export Of core components, then Min. 12% Of non-core components, then Min. 8.5% Page 97

98 Safe Harbor rules Compliance procedure Eligible Assessee/ Eligible International transaction Safe Harbour option exercised accepted to be valid No Reference to TPO within 2 months from end of the month of receipt of Form 3CEFA (Initial FY) Form 3CEFA/ Statement of particulars to be furnished before AO* AO doubts eligibility of taxpayer/ transaction Yes Reference to TPO in case of change in facts and circumstances (in subsequent years) *ROI to be filed on or before furnishing Form 3CEFA for initial year. The due date for filing Form 3CEFA is 30 November. For subsequent years, only statement of particulars to be furnished before filing the ROI for particular year **Documents/ Information to be submitted to TPO to substantiate validity, if required TPO to determine eligibility of tax payer/ transaction within 2 months from end of the month of receipt of reference from AO** Yes TPO declares taxpayer to be eligible No Taxpayer may file objection before CIT within 15 days from receipt of order from TPO CIT to pass appropriate order within 2 months from end of month of filing of objection Page 98

99 Ind AS Page 99

100 Applicability of Ind AS On 16 February, 2015, the MCA notified the rules which lay the Ind AS roadmap: Voluntary Phase: Early adoption of Ind AS is permitted from financial year beginning on or after 1st April, Mandatory Phase I (adoption from 1st April, 2016 with comparatives for ) Listed company or Unlisted company having net worth in excess of Rs. 500 Crores or more Holding, subsidiary, joint venture or associates of these companies Mandatory Phase II (adoption from 1st April, 2017 with comparatives for ) All listed companies not covered under the mandatory phase I Non-listed companies with net worth of INR 250 Crores or more and not covered in the mandatory phase I Holding, subsidiary, joint venture or associates of these companies

101 Ind AS Impact on RPT Disclosure Definition of related party under Ind AS 24 is broader and will cover increased number of related party relationship and has clear principles of identification of related parties. If, based on the Ind AS 24 definition, one party is identified as related to the second party; the definition would treat the second party as related to the first party, by symmetry. Some of the Key differences are as follows: Ind AS 24 AS -18 Includes any director Excludes non executive directors Includes close members of family of KMP A entity discloses that terms of RPT are equivalent to those that prevail in arm s length transactions, only if such terms can be substantiated KMP remuneration disclosure to include post employment benefits Includes only relatives of KMP No such stipulation on substantiation of RPT when the same is disclosed to be on arm s length Does not have such requirement

102 Key impact of Ind AS on RPT Entities will be required to reassess the list of related parties for enhanced relationships. In the revised clause 49, definition of the term related party includes related parties according to applicable accounting standards. Entities will need to strengthen/change their reporting processes and information technology systems to map new related parties covered in Ind AS 24 and track transactions with specific related parties.

103 Ind AS impact on Transfer Pricing Analysis Impact of PLI in applying TPM s: Timing of recognition of income and expense and also balance sheet amounts can differ between Ind AS and existing accounting standards Impact on use of multiple year data: Two different sets of accounting principles could be included in the multi-year comparable data. A mix of standards in the Analysis window could cause the analysis to become less reliable Implications for APA: APAs include critical assumptions upon which their respective TPMs depend. A standard critical assumption that is often included in APAs is that the business activities, functions performed, risks assumed, assets employed, and financial accounting methods and categories of taxpayer shall remain materially the same as described in taxpayer s request for this APA. Companies considering an APA or currently in the process of negotiating an APA should consider discussing Ind-AS conversion issues with the APA team.

104 Companies Act 2013 TP Interplay Page 104

105 Key compliance requirements With the growing participation of investors and other stakeholders in companies, the question of transparency in deals with related parties has often been a topic of much debate and discussion. With the objective to usher increased degree of transparency in such transactions, section 188 has been introduced in the Act placing the onus on the Board of Directors to review, approve and explain such transactions to shareholders and in some cases seek their approval. The following are the key compliance requirements for related party transactions under the Act: Page 105

106 Key compliance requirements Under the Act, provisions relating to RPT are applicable to all companies. The requirements concerning RPT may be divided into the following four key parts- Identification of related parties; Identifications of transactions falling within the scope of the term RPT; Approval process; and Disclosure requirements. An elaborate approval mechanism is mandated for all related party transactions, except in case the contract or arrangement satisfies the following : It is entered in the ordinary course of business of the company; and It is at ALP. Based on our understanding, all the identified transactions are transacted in the ordinary course of its business. As per the Act,all the existing RPT entered prior to April 01, 2014 will not require fresh approval under section 188 till the expiry of the original term of such contracts. If any modification in such contract is made on or after April 01, 2014, the requirements under section 188 will have to be complied with. Page 106

107 Who are related parties? Governing section: Section 2(76) of the Act and The Companies (Meetings of Board and its Powers) Rules, 2014* Sl# Transacting Party Nature of relationship 1 Individual Is a director or director of a holding company/kmp or KMP of the holding company/their relative The director/manager of Company is accustomed to act as per his/her advice/directions/instructions 2 Firm The director or manager of Company or his/her relative is a partner 3 Private Company The director or manager of Company or their relative is a member/director in such private company 4 Public Company Director/manager of such Public Company is also a director and holds along with his/her relatives more than 2% of the paid-up share capital 5 Body Corporate Board of Directors/Managing Director/manager of such Body Corporate is accustomed to act in accordance with advice/directions/instructions of director or manager of the Company. 6 Other Companies Holding company/subsidiary company/associate company/sister concern Page 107

108 Companies Act, 2013 Related Party Governing section: Section 2(76) of the Act and The Companies (Meetings of Board and its Powers) Rules, 2014* Any person, on whose advice, etc Director/ Manager to act * Director/KMP/ their relatives ## Holding Co Body corporate whose BOD/ MD/ Manager accustomed to act on advice, etc of Director/ Manager* KMP or relative Company Subsidiary Co/ Associate Co/ Sister concern Public Co. # Member/ Director Relative of Director/ Manager # Private. Co Member/ Director Director Partner Partner Manager Partner Firm Firm * Exception for advice given in professional capacity # Director/ Manager holds more than 2% of PSC along with relatives ## Deemed Related parties as per The Companies (Meetings of Board and its Powers) Rules, 2014 Page 108

109 Companies Act, 2013 Definitions Holding Company A company of which such companies are subsidiary companies Subsidiary Company A company in which the holding company Controls the composition of the board of directors; Exercises or controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies Associate Company A company in which that other company has significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company. Significant influence means control of at least twenty percent of the total share capital, or of business decisions under an agreement; Page 109

110 Companies Act, 2013 Definitions KMP The Chief Executive Office or the managing director or the manager; The Company Secretary; The Whole-time director; The Chief Financial Officer; Such other officer as may be prescribed Relative Members of a HUF Husband and wife One person is related to the other in such manner as may be prescribed (includes father, mother, son, daughter, son s wife, daughter s husband, brother, sister ) Manager An individual who, subject to the superintendence, control and direction of the Board of Directors, has the management of the whole, or substantially the whole, of the affairs of a company, and includes a director or any other person occupying the position of a manager, by whatever name called, whether under a contract of service or not. Page 110

111 Companies Act 2013 Related Party Transactions - Definition Sale, purchase or supply of any goods or materials; Selling or otherwise disposing of, or buying, property of any kind; Leasing of property of any kind; Availing or rendering of any services; Appointment of any agent for the purchase or sale of goods, materials, services or property; Governing section: Section 188 The Companies Act, 2013 has laid down certain restrictions on the related party transactions if those transactions are not in the ordinary course of business or at arm s length. However, these restrictions are limited to specified transactions mentioned under section 188 of the Companies Act, These specified transactions are: Appointment of any related party to any office or place of profit in the company, its subsidiary company or associate company; and Underwriting the subscription of any securities or derivatives thereof, of the company.

112 Companies Act 2013 Approval Process Prior Board approval required If transaction is not at ALP or not in ordinary course of business. Shareholder s special resolution required for following transactions Particulars For specific transactions Applicable to every Company Prescribed threshold Sale, purchase or supply of any goods or materials directly or though appointment of agents Selling or otherwise disposing of, or buying, property of any kind directly or though appointment of agents Transaction value > 10% of annual turnover; or > 100 crore whichever is lower Transaction value > 10% of net worth; or > 100 crore whichever is lower Availing or rendering of any services directly or through appointment of agents Transaction value > 10% of net worth; or > 50 crore whichever is lower Leasing of property of any kind Transaction value > 10% of net worth; or > 10% of annual turnover; or > 100 crore whichever is lower Appointment of any related party to any office or place of profit in the company, its subsidiary company or associate company Underwriting the subscription of any securities or derivatives thereof, of the company Monthly remuneration > Rs 2.5 lakhs Transaction value > 1% of net worth

113 Arm s length Definition Companies Act 2013* Arm s length transaction means a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest. Transfer pricing regulations** Arm s length price means a price which is applied in a transaction between persons other than associated enterprises, in uncontrolled conditions Arm s length The Act or the Board Rules do not prescribe methodologies and approaches, which may be used to determine whether a transaction has been entered into on an arm s length basis. One may consider the following aspects in this regard: TP guidelines under the Income-tax Act, 1961, prescribe methodologies/approaches to be used for determining arms length price. In absence of specific guidance under the Act one may find methodologies/ approaches under the TP guidelines in Income Tax Act, 1961 to be useful. However, it may be noted that the objective of the TP guidelines is different from that of the Act. The purpose of the TP guidelines is to ensure that there is no tax leakage. The Act requirements aim to protect the interest of all stakeholders. Hence, one may need to factor these differences in the objective and make suitable adjustments to the methodologies/approaches for establishing the arm s length nature of the transaction. In many cases, whether the transaction is at arms length, price may be clear from the face of the transaction itself, without any further analysis. In other cases, complex analysis/valuation may be needed. In such cases, the involvement of registered valuer may help companies in demonstrating that the transaction has been entered into on arms length basis. From a common parlance perspective, it appears that to demonstrate this, a company will need to show that the existence of special relationship between the contracting parties has not affected the transaction or its critical terms, including the price, quantity and other terms and conditions governing the transaction. -

114 Ordinary course of business As mentioned above, the restrictions have been laid down on specified transactions if those transactions are not in the ordinary course of business or at arm s length. However, the Act has not defined the term ordinary course of business. It seems that the ordinary course of business will cover the usual transactions, customs and practices of a business and of a company. In this regard, guidance can be drawn from Standard of Auditing (SA) 550 Related party issued by Institute of Chartered Accountants of India (ICAI) which states that one has to see the business rationale behind the transaction to determine whether it is in the normal course of business or not. Following examples of transactions may be considered to be outside the entity s normal course of business: Complex equity transactions Transactions under contracts whose terms are changed before expiry Transactions with circular arrangements Sales transactions with unusually large discounts or returns Leasing of property/ rendering of services for no consideration Transactions with offshore entities in jurisdictions with weak corporate laws

115 RPT - Disclosure Requirements under the Act Board Report along with justification for disclosures under Section 188 Every contract or arrangement entered into under 188 (1) shall be referred to in the Board s report to the shareholders along with the justification for entering into such contract or arrangement Related Party Disclosures Registers for disclosures under section 188 Section 189 Registers Every company shall keep one or more registers giving separately the particulars of all contracts or arrangements to section 188 applies As per Rule 16(1) of the Companies (Meetings of Board and its Powers) Rules, 2014 register to be maintained in Form MBP 4.