Domestic Transfer Pricing

Transcription

1 Domestic Transfer Pricing September 15, 2012 CA Darpan Mehta

2 Agenda 1 Domestic TP Transactions 2 Case Study 3 Way Forward Slide 2

3 Transactions Slide 3

4 Intent of Indian Transfer Pricing (TP) Regulations Shifting of Profits Indian Co. Associated Enterprise (AE Co.) India 33%) Shifting of Losses Tax savings for the group -> Indian Govt. loses Overseas (Tax at lower rates, say 10%) Slide 4

5 Intent of Domestic TP Domestic Tariff Area (DTA) Scenario 1 Scenario 2 Particulars Co.A Co.B Taxed in 33% 33% Income from RP Other Income Particulars Co.A Co.B Taxed in 33% 33% Income from RP Other Income Expense to RP Expense to RP Other Expenses Profit/Loss (100) 100 Tax - 33 Total Tax for the Group Other Expenses Profit/Loss (50) 50 Tax - 17 Total Tax for the Group By shifting of expenses from a loss making company to a profit making company, the group could reduce its tax liability by 16 for the current year, though the impact will be reversed in future years given carry forward of losses. To avoid such cases and even though there is no erosion of tax base, Domestic TP has been introduced. Slide 5

6 Intent of Domestic TP DTA & Tax Holiday Unit Scenario 1 Scenario 2 Particulars Power DTA Taxed in India@ 0% 33% Income from RP Particulars Power DTA Taxed in India@ 0% 33% Income from RP Other Income Expense to RP - Other Expenses Profit/Loss Tax - 50 Total Tax for the Group Other Income Expense to RP Other Expenses Profit/Loss Tax - 25 Total Tax for the Group By shifting of expenses from a tax holiday unit(power ) to a unit in the Domestic Tariff Area, the group could reduce its tax liability by 25. To avoid such cases, Domestic TP has been introduced. Slide 6

7 Scope Domestic Transactions Tax holiday undertakings covering: inter-unit transfer of goods and services transactions with entities having close connection Expenditure incurred between related parties defined u/s 40A Aggregate transaction value exceeds Rs 50 million in a financial year (Applicable for FY ) Any other transaction that may be specified Slide 7

8 Scope of Domestic TP 1. Section 40A(2) Disallowance of expenditure in excess of arm's length price for transactions between related parties. 2. Section 10AA (SEZ Units) Explained later Any Transfer of goods and services between eligible unit and non-eligible unit - whether at market value? Transactions with entities having close connection whether earning ordinary profits? Slide 8

9 40A(2)(b) Transactions - Persons covered Company X s payments to the following persons are covered: - Company Z having 20% or more voting power in X; - any other company in which Company Z has 20% or more voting power; - a company in which X has 20% or more voting power; - any company of which a director has 20% or more voting power in X; - any company in which a director of X has 20% or more voting power; - any director of X or of Company Z, or to any relative of such director; & - any individual having 20% or more voting power in X or any relative of such individual. Relationship can exist at any time during the year Slide 9

10 Section 40A(2) Transactions covered Mapping to be done for the company s transactions with domestic RPs Primary reliance on disclosures u/s 40A(2)(b) and Related Party Schedule Different divisions enter into different transactions with various group companies Broad categories of transactions likely to be covered : Purchase of goods and services Payment of interest Payment of royalty charges Slide 10

11 Illustration Section 40A(2)(b) A Transactions covered? A & B Yes A & C Yes B C A & D No A & E No B & C Yes* D E D & E No *Post Budget 2012 amendment under section 40A Slide 11

12 Issues and Challenges 40A(2)(b) Scope - Direct vs Indirect ownership - Capital vs Revenue expenditure; Is depreciation an expenditure? Applies to which head of income? - Income from business or profession; and - Income from other sources Director remuneration Corresponding adjustments [Second proviso to Section 92C(4)] Availability of APA Slide 12

13 Illustration Tax holiday undertakings Transactions covered? A Z X & Y Y & Z Yes No X Tax holiday undertaking Y DTA undertaking X & Z Yes, if Z is closely connected to A Requirement to justify that goods and services transactions are at arm s length price (ALP) Requirement that profits of undertaking are ordinary profits having regard to ALP Slide 13

14 Issues and Challenges Sec 80-IA Sec 80 IA (8) Sec 80- IA (10) Inter unit transaction of goods or services Business transacted with any other person generates more than ordinary profits Owing to either close connection or any other reason Transfer at market value Ordinary profit Onus of tax payer Primary onus on taxpayer Onus on tax authorities Overlap with Sec 80A(6); of no material consequence No guidance on meaning of Close connection? Aligning Ordinary profits with ALP Significant impact on non-charging of services/costs to undertaking Relevant to consider Existing judicial precedents Slide 14

15 Penalty Sr. No. Type of penalty Section Penalty quantified (a) Failure to maintain prescribed information/ documents (b) Failure to report any such transaction or (c) Furnish incorrect information Failure to furnish information/ documents during assessment u/s 92D Adjustment to taxpayer s income during assessment Failure to furnish accountant s report u/s 92E 271AA 271G 271(1)(c) 2% of transaction value 2% of transaction value 2% of transaction value 100% to 300% of tax on adjustment amount 271BA INR 100,000 Slide 15

16 Comprehensive Compliance Transfer Pricing Section 301 of the Companies Act Clause 49 of Listing Agreement Corporate Governance Proposed Companies Bill Addressing the Transfer Pricing requirements helps you manage other compliances as well! Slide 16

17 Other developments - Proposed Companies Bill, 2011 What does the Bill say? Which companies qualify? What are the reporting requirements? Requires Board or, in some cases, shareholder s consent (by special resolution), if transactions not at arm s length All companies no threshold prescribed Reporting in the Board s report to the shareholders, along with justification What are the implications of nonadherence? Contract/ arrangement can be rendered void by the Board Director to indemnify company against any loss for transactions with Director s related party or authorized by him Company can recover loss from director or employee Company personnel involved can be imprisoned (in case of listed company) or fined (in case of listed / unlisted company) Slide 17

18 Case Study Slide 18

19 Case Study ABC India Ltd. ABC Ltd. is a diversified group. ABC Ltd. (Head Office) XYZ Ltd. Unit P is a power generation unit which is claiming deduction u/s 80-IA. UNIT P UNIT Q Unit R Unit Q (in Baddi) is involved in the manufacture of pharmaceutical goods. It is claiming deduction u/s 80 -IC. Unit R sells medical equipment to XYZ Ltd. (associate) and third party customers in India. It is not a Tax Holiday Unit. HO incurs expenses in the nature of research and development (R&D), corporate, marketing and interest expenses. Slide 19

20 # 1 Payments to Directors UNIT P ABC Ltd. (Head Office) Unit R XYZ Ltd. Facts ABC Ltd s board of directors include: Independent directors who receive sitting fee. Promoter (directors) who receive salary, commission and sitting fee. UNIT Q 1. Are the payments to Directors Specified Domestic Transactions? 2. If yes, discuss the approach to comply with the transfer pricing rules? Slide 20

21 # 2 Unit P (Power) UNIT P UNIT Q ABC Ltd. (Head Office) Unit R XYZ Ltd. Third party customers Facts Unit P provides power supply to Unit Q, Unit R, XYZ Ltd and third party customers in India. State Board supplies power to Rs. 4 per unit Rate charged to Unit Q, Unit R and XYZ - Rs. 3 per unit Average rate charged from third party customers Rs. 2 per unit 1. Identify the transactions which qualify as Specified Domestic Transactions. 2. What is the comparable uncontrolled price for sale of power by Unit P to related parties? 3. While calculating eligible profits for Unit P,Q and R, the management expenses have not been allocated. Is this a likely challenge from tax authorities? Slide 21

22 # 3 Unit Q (Baddi) UNIT Q Third party customers AEs (outside India) Facts Unit Q is involved in selling pharma products to its AEs, which is covered under TP provision. Taxpayer carried out a TP Study. Unit Q earned a margin (OP/TC) of 65% vis-à-vis the mean margin earned by comparable companies (41%). Refer Annexure -1 for details. No adjustment made by the TPO. Unit Q has earned higher profits than average profits earned by comparable companies. 1. Can higher profit earned by Unit Q be considered as more than ordinary profits u/s 80- IA(10)? Consequently, can the tax authorities restrict the tax holiday claim to the extent of the average profits earned by comparable companies in the light of amendments in Finance Act 2012 related to domestic transactions? 2. What is the appropriate approach for Unit Q to demonstrate that section 80- IA(10) should not apply? Slide 22

23 #3 Unit Q contd Annexure -1 Unit Q has earned a margin of 65% (OP/TC). Arithmetic mean of the margins earned by comparables is as under : Comparable Companies Operating profits/total cost (OP/TC) Company A 58% Company B -8% Company C 45% Company D 72% Company E 38% Arithmetic Mean 41% TP documentation concludes that the international transactions with AEs are at arm s length. Slide 23

24 #4 Unit Q (Baddi Unit) UNI T P ABC Ltd. (Head Office) UNI T Q Unit R XYZ Ltd. Facts Unit Q claimed deduction on the profit earned by selling goods to third party. Unit Q had earned higher profits than profits earned by other units. Earlier Unit Q was selling goods which were purchased from third party contract manufacturers and earned a profit of 59%. After manufacturing its own products, Unit Q has started earning 65%. The AO contended that Unit Q carried out manufacturing activity and transferred the goods to the marketing division in the head office and therefore should be entitled only to manufacturing profits of 6% (65% minus 59%). In the light of amendments in the Finance Act 2012 relating to domestic transactions, is the AO justified in restricting the profits to the extent of manufacturing profits alone? Slide 24

25 Way forward Slide 25

26 Way forward Transaction mapping Pricing documentation real time basis Robust documentation ordinary profits Apply learning for FY Slide 26

27 Glossary APA ALP DTA FY RP SEZ TP Advance Pricing Agreements Arm s Length Price Domestic Tariff Area Financial Year Related Party Special Economic Zone Transfer Pricing Slide 27

28 Thank You