Sharing insights. News Alert 20 March, Key amendments in TP Regulations by the Union Budget Introduction of Advance Pricing Agreement

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1 Sharing insights News Alert 20 March, 2012 Key amendments in TP Regulations by the Union Budget 2012 The Finance Minister presented the Finance Bill 2012 (Finance Bill) in the Parliament on 16 March, 2012 proposing significant amendments in the transfer pricing (TP) regulations. In recent times, taxpayers in India have been confronted with large scale litigation in TP. Conflicting judicial rulings have made TP an area of major concern for the taxpayers. The Finance Minister has proposed the introduction of Advance Pricing Agreement (APA) with a view to provide greater certainty to the investors. Furthermore, the Finance Bill provides clarification on certain long debated issues which may limit the ongoing litigation on such issues. The scope of TP regulations has also been broadened by including specified domestic transactions within the purview of transfer pricing regulations. The key amendments proposed in the Finance Bill are discussed below: Introduction of Advance Pricing Agreement With a view to address the large scale litigation in TP, the Government has introduced APA in the Finance Bill with effect from July 1, The Finance Minister mentioned in the speech that introduction of APA can significantly bring down TP litigation and provide tax certainty to foreign investors. An APA is an arrangement between the taxpayer and the tax authority made prior to actual transactions, with a view to solve potential taxation disputes in a cooperative manner. The taxpayer and tax authority mutually agree on the transfer pricing methodology to be applied over a certain future period of time. An APA seeks to determine an appropriate set of criteria for the computation of the transfer 1

2 price, which may include the TP method to be applied, characteristics of comparables to be used, adjustments to be made to the taxpayer s results for a fair comparison with comparables, critical assumptions as to future events, etc. The Central Board of Direct Taxes (CBDT), with the approval of the central government, has been empowered to enter into an APA with any taxpayer undertaking international transactions to determine the arm s length price or specifying the manner in which arm s length price shall be determined. The APA so entered shall be binding on the taxpayer and the tax authorities in respect of the transaction covered under the agreement. Such agreement shall be valid for a period not exceeding five years. The CBDT is yet to frame detailed rules/guidelines for APA. The framework introduced in the budget does not mention whether the APA would be unilateral or bilateral. Though the Finance Bill is silent on this aspect, it is expected, as per deliberations made by senior revenue officials in various public forums, both in India and abroad, that the APA programme should cover both unilateral and bilateral APAs. Further clarity is awaited in this regard. Application of TP to specified domestic transactions Until now, Indian TP regulations were applicable only to international transactions entered into with associated enterprises. Considering the suggestions made by the Supreme Court in the cases of Glaxo SmithKline Asia (P) Ltd. 1, the application of transfer pricing regulations has been proposed to be extended to specified domestic related party transactions as well. In this case, the Supreme Court observed that it needs to be considered whether transfer pricing regulations should be applied to domestic transactions in cases where such transactions are not revenue neutral and have an impact on the tax base. Specified domestic transactions essentially include expenditure in respect of which payment has been made or is to be made to a person referred in section 40A(2)(b) of the Act, and 1 CIT v. Glaxo SmithKline Asia (P) Ltd. [2010-TII-02-SC-LB-TP] transactions referred in sections 80A, 80-IA(8) and 80-IA(10), Chapter VI-A, and section 10AA of the Income Tax Act, 1961 (the Act). Accordingly, the taxpayer would be required to undertake annual TP compliance in respect of the specified domestic transactions. This amendment will take effect from 1 April, 2013 and will, accordingly, apply in relation to the assessment year (AY) (corresponding to the Financial Year ) and subsequent years. It has been proposed to widen the meaning of related persons as provided in section 40A of the Act to include fellow related parties (where single person has substantial interest in two companies). Furthermore, a proviso has been inserted in section 40A(2)(a) of the Act to provide that no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA of the Act, if such transaction is undertaken at arm s length price as defined in clause (ii) of section 92F. Scope of international transactions The existing definition of international transaction was worded broadly and did not provide specific details of the nature and type of transactions covered. This resulted in disputes over inclusion of certain transactions within the ambit of TP. One such example is the case of Four Soft Ltd. 2, where the Hyderabad Tribunal accepted the contentions of the taxpayer that provision of a corporate guarantee does not fall within the ambit of an international transaction. This judgment was contrary to the international guidance on the issue. To avoid such instances, an explanation has been added to the definition of international transactions providing an indicative list of transactions covered under the term international transaction including the purchase, sale, transfer, lease or use of intangible property, business restructuring, etc. The intention is to 2 Four Soft Ltd v. DCIT [TS-518-ITAT-2011(Hyd)] 2

3 clarify the meaning of international transaction and specifically cover certain transactions on which applicability of TP was being questioned by taxpayers such as provision of corporate guarantee. Furthermore, intangible property has been explained to include marketing intangible, customer related intangible, human capital intangible, location related intangible, etc. The explanation has been inserted retrospectively and shall have effect from 1 April, Arm s length range The availability of the tolerance band of 5% around arithmetic mean as a standard deduction has been a matter of TP litigation for a number of years. There are a number of judgments both in the favor of and against the issue. The Finance Bill has clarified that the tolerance band of 5% provided in the proviso to section 92C(2) of the Act is not a standard deduction for taxpayers in cases where differences between the transfer price and the arm s length price is more than 5%. Thus, as a result of the above amendment, standard deduction of 5% would not be available to the taxpayers in respect of any pending TP litigation. However, the amended provision cannot be used to assess or reassess income for an assessment year for which proceedings have been completed before 1 October, In the last Finance Act, the government amended the TP provisions to provide that in respect of the tolerance band, such percentages for different industries as may be prescribed in the Official Gazette shall be applied. Incidentally, no such percentage has yet been prescribed for Financial Year The Finance Bill proposes to further amend the tolerance band from AY Going forward, the upper limit of tolerance band would not exceed 3% of the value of international transaction. As a result, the transaction would be at arm s length if the difference between the transfer price and the arm s length price does not exceed the number as notified by CBDT, subject to an upper limit of 3%. In doing so, the internationally accepted best practice of using an inter-quartile range has not been considered. Examination by the TPO of unreported international transactions The Finance Act, 2011 had introduced a new section (2A) in section 92CA of the Act whereby the TPO was empowered to adjudicate on transactions which have not been specifically referred to by the assessing officer (AO). This amendment in effect countered the rulings of the Tribunal in various cases (Amadeus India 3, 3iInfotech 4, Diageo India 5 ) where it was held that in the absence of a reference by the Assessing Officer, the TPO cannot, on its own, take cognizance of an international transaction and propose an adjustment thereof. The Finance Bill has introduced sub-section (2B) for section 92CA of the Act empowering the TPO to determine the arm s length price (ALP) of an international transaction noticed by him during the course of proceedings, even if the taxpayer has not submitted the accountant s report in Form 3CEB. This clause empowers the TPO to scrutinise any transaction of the company which he believes to be an international transaction or specified domestic transaction. This clause has been introduced retrospectively with effect from 1 June, However, it has been mentioned that no reopening of any proceedings would be undertaken pursuant only to this proposed amendment. Penalty for non-reporting of international transactions The government has observed that non-reporting of international transaction in Form 3CEB by due date (under section 92E of the Act) carries a meager penalty of INR 0.1 million and there is no other penalty for non-reporting of international transactions, or for maintenance or furnishing of incorrect information/documents. Therefore, in order to suppress information about 3 CIT v. Amadeus India Pvt. Ltd. [TS-693-HC-2011(Del)] 4 3iInfotech v. DCIT [2011] 129 ITD 422 (Mum) 5 Diageo India Pvt. Ltd. v. DCIT [TS-507-ITAT-2011(Mum)] 3

4 international transactions, some taxpayers may not furnish the report or get the TP audit done. Considering the above, section 271-AA of the Act has been amended and penalty in respect of non-reporting of transactions has been provided at 2% of the total value of international transactions. This penalty would be in addition to penalties for non-maintenance/non-furnishing of TP documentation and will take effect from 1 July, While the tax payers were expecting respite in the existing stringent penalty regime (in line with the provisions of the Direct Taxes Code, 2010), the government has proposed to make the TP compliance penalties more stringent. Reassessment proceedings in transfer pricing cases and accordingly, in cases where some international transactions have not been reported, it can be reopened under section 147 of the Act. The proposed amendments to section 147 and section 271AA of the Act are aimed at ensuring all transactions relating to transfer pricing are reported by the taxpayer. The amendments proposed by the Finance Bill are a mixed bag for taxpayers. While introduction of APAs would be helpful in minimising disputes on TP, some of the clarificatory retrospective amendments may cause agony to taxpayers. Introduction of APA is a positive move and if implemented in a right manner will boost the confidence of the investors. However, APA may also be a long drawn process and detailed rules and regulations with timelines for completion will determine the eventual effectiveness of India s APA program. Section 147 (which provides for reopening of the cases of the previous years if any income chargeable to tax has escaped assessment) of the Act is proposed to be amended to provide that where some international transactions have not been reported in Form 3CEB, such non-reporting would be considered as a case of deemed escapement of income. This amendment will take place from 1 July 2012, 4

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