Did you know! Transactions M.2 Safe harbour rules M.3 Dispute resolution panel

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1 M Transfer pricing

2 Doing business in India 209 Did you know! India has emerged as the world s number one, along with the US, in annual solar power generation. In wind power production, when it comes to space, scope and facilities for renewable energy expansion, India ranks fourth in the world. Transactions M.2 Safe harbour rules M.3 Dispute resolution panel Transactions M.5 Advance pricing agreements (APAs) M.6 Changes in Transfer Pricing Litigation

3 210 Doing business in India Comprehensive transfer pricing regulations (TPRs) were introduced, effective 1 April 2001, with the objective to prevent MNCs from manipulating prices in intra-group transactions, e.g., by transferring Indian transfer pricing provisions are generally in line with transfer pricing guidelines for MNCs and tax administrators issued by the Organization for Economic Co-operation and Development (OECD enterprise and follow the concept of arithmetic mean as opposed to statistical measures of median/arm s length range followed internationally. Under TPRs, any international transaction (ITN) between two or more associated enterprises (including permanent establishments) must be at arm s length price (ALP). These regulations also apply to costsharing arrangements. For computation of ALP, TPRs require the application of the most appropriate among all prescribed methods. The following methods have been prescribed: Comparable uncontrolled price method Resale price method Cost plus method Transactional net margin method Any method, which takes into account the price for the same or similar uncontrolled transaction between non-associated enterprises, under similar circumstances, considering all the relevant facts. However, TPRs do not mandate a hierarchy of methods. Where more than one ALP is determined, the TPRs mandate that the arithmetic mean of such prices shall be taken to be the ALP. If the variation between the ALP and the price of ITN does not exceed a prescribed percentage of transfer price, the ITN are considered to be at arm s length. The CBDT is yet to notify the prescribed percentages as allowable variations from transfer price. However, the Finance Act 2012 has put an upper ceiling of 3% on the prescribed percentages.

4 Doing business in India 211 TPRs require taxpayers entering into ITNs to maintain prescribed documents and information and also obtain and furnish an accountant s report, which includes prescribed details related to the ITNs being carried out, to the tax authorities. The due date for year. The prescribed documents include details of the ownership structure, description of the functions performed, risks undertaken, assets used by the parties to the relevant transaction, etc. Failure to maintain the documentation required by TPRs or to furnish the report of a Chartered Accountant result in imposition of a penalty. Nature of default Failure to keep and maintain documents and information with respect to an ITN Failure to furnish the documents or information required by TPRs Failure to report any ITN, which is required to be reported; Maintenance or furnishing of any incorrect information or documents Failure to furnish the report of a Chartered Accountant mandated by TPRs Possible penalty An amount equal to 2% of the value of the ITN An amount equal to 2% of the value of the ITN for each such failure An amount equal to 2% of the value of the ITN for each such failure An amount equal to 2% of the value of the ITN for each such failure INR-100,000 According to TPRs, enterprises are considered to be associated if there is direct/indirect participation in the management, control or capital of an enterprise or by the same persons in both the enterprises. Further, TPRs suggest certain other deeming provisions, which also trigger an associated enterprise relationship. Some of the important ones among these include: Direct/indirect shareholding giving rise to 26% or more of voting power Dependence on source of raw material/consumables as well as on customers in the case of manufactured/processed goods, price and

5 212 Doing business in India Authority to appoint more than 50% of board of directors or one or more of executive directors or members of the governing board of the other enterprise Dependence on borrowings, i.e., advancing loans amounting to not less than 51% of the total assets of the enterprise or providing a guarantee amounting to not less than 10% of the total borrowings associated enterprises, either or both of whom are non-residents meaning of ITN. Accordingly, ITN now covers the following: Transactions of business restructuring or reorganization type of long-term or short borrowing or lending or provision of guarantee, etc. development, legal or accounting services Purchase, sale, transfer, lease or use of tangible property including building, plant and machinery, vehicles or any other article, product or thing Purchase, sale, transfer, lease or use of any intangible property; artistic activity, goodwill, location, or include customer list, customer contracts, methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, technical data, etc.

6 Doing business in India 213 M.2 Safe harbour rules According to the amendment of the Finance Act (No. 2) 2009, determination of ALP with respect to ITN is subject to safe harbour rules, which the CBDT is empowered to draft. Safe harbour indicates the circumstances under which tax authorities accept a transfer price declared by a taxpayer. Currently, safe harbour rules are yet to be M.3 Dispute Resolution Panel Please refer to the discussion in Para L.6.2 Finance Act 2012 has brought certain SDTs (not being ITNs) within the ambit of TPRs with effect from 1 April 2013 where the aggregate of such transactions exceeds INR 50m. The SDTs are as follows: Any expenditure incurred in favor of any domestic related party Any deductions claimed while computing taxable income, which have related party transactions Transactions with related domestic companies or units eligible for tax holiday; the amendments will primarily affect the following taxpayers: Taxpayers with income from SEZ units Developers of SEZ Infrastructure developers Developers of industrial park Telecommunication service providers

7 214 Doing business in India Producers or distributors of power mineral oil Eligible housing projects Eligible hospitals Eligible Hotels and convention centers Eligible taxpayers with units in North-eastern states M.5 Advance Pricing Arrangements (APAs) Finance Act 2012 has introduced enabling provision effective 1 July 2012 that empowers CBDT to enter into advance pricing arrangements (APAs) with taxpayers to determine the arm s length pricing (ALP) or specifying the manner in which an ALP is to be determined in relation to the ITN to be entered with the taxpayer. Some of the salient features of the provisions are as follows: entered into years An APA will be binding on Income Tax authorities, the taxpayer in respect of the transaction in relation to which the APA has been entered into An APA will be declared void if it is found to be obtained by fraud or misrepresentation of facts Taxpayers are required to modify their returns of income in accordance with the APA within three months from the end of the month of entering into the APA The AO will have to assess or reassess taxpayers in accordance with The CBDT, which has already set up a separate team under the Director General of Income Tax, International Taxation (the APA rules. The rules contain procedures for APA applications,

8 Doing business in India 215 M.6 Changes in Transfer Pricing regulation The Finance Act 2012 has made the following amendments in the transfer pricing regulations (TPRs): amended retrospectively with effect from 1 April 2002 so that the arithmetic mean of ALP will be considered to be the ALP if the difference between the arithmetic mean and the taxpayer s transfer price is greater than 5%. Further, the range is computed from the transfer price and not from the arm s length price. Effective 1 June 2002, the TPO is entitled to evaluate and determine ALP of any transaction, which comes to his notice irrespective of whether it has been disclosed in accountant s report Non furnishing of report in respect of international transaction, which the taxpayer was required to furnish will now be grounds for re-opening assessment proceedings