Latest Developments in Transfer Pricing

Transcription

1 Latest Developments in Transfer Pricing Bombay Chartered Accountant s Society October 11, 2017 Vispi T. Patel Vispi T. Patel & Associates

2 Transfer Pricing (TP) Indian Perspective

3 TP Regulations in India Section 92 Any income arising from an international transaction shall be computed having regard to arm s length price

4 TP Regulation in India Income under any head is covered under the ambit of TPR Section 4 Income must be chargeable to tax Preconditions: Two or more associated enterprises Enter into an international transaction Specified Domestic Transaction (w.e.f. AY ) Consequence: Income/ Expenditure to be computed having regard to the arm s length price

5 Vodafone India Services Limited (WP No. 871 of 2014) (Bombay HC) Facts of the case: Vodafone India (the assessee) issued 2,89,224 equity shares of the FV of INR 10 each on a premium of INR 8,509 / share to its holding company in accordance with the valuation methodology prescribed by the GOI The assessee, out of abundant caution, disclosed this transaction (i.e. the issuance of shares) as an international transaction in Form 3CEB The AO / TPO valued each equity share at INR 53,775 and made an adjustment of INR 45,256 per share (amounting to INR crores), by treating the shortfall in premium as income

6 Vodafone India (Contd...) Vodafone India (Assessee) Issue of shares reported as International Transaction, only out of abundant caution AO / TPO TP addition (INR 1308 crs) on shortfall in the premium on shares, treating it as income Dispute Resolution Panel DRP considered the issue of jurisdiction and rejected the same Bombay High Court Directed the DRP to decide on the preliminary jurisdictional issue raised by the assessee Bombay High Court Issue of shares at a premium does not give rise to any income from an admitted international transaction, thus, there exists no occasion to apply Chapter X of the Act

7 Vodafone India (Contd...) Observations, Analysis and Decision: The word income as defined in Section 2(24) of the Act, though an inclusive definition, cannot include capital receipts unless specified, as in Section 2(24)(vi) of the Act Capital gains chargeable to tax under Section 45 of the Act are defined to be income The amounts received on issue of share capital including the premium were undoubtedly on capital account Due to absent express legislation; no amount received, accrued or arising on capital account transaction can be subjected to tax as income

8 Vodafone India (Contd...) Chapter X of the Act is a machinery provision to arrive at the ALP of a transaction between AEs The substantive charging provisions are found in Sections 4, 5 (Scope of income), 15 (Salaries), 22 (Income from house property), 28 (Profits and gains of business), 45 (Capital gain) and 56 (Income from other Sources) of the Act An income arising from an international transaction must satisfy the test of income under the Act and find its home in one of the above heads i.e. charging provisions, as Chapter X is only a machinery provision to compute the chargeable income at ALP

9 Vodafone India (Contd...) Machinery section cannot be read de-hors the charging section, relying on the observations of the Supreme Court in CIT v. B. C. Srinivas Shetty 128 ITR 294 HC concluded that the issue of shares at a premium by the assessee to its holding company does not give rise to any income from an admitted international transaction Thus, there was no occasion to apply Chapter X of the Act. HC quashed all the orders of the Revenue authorities i.e. AO/ TPO/ DRP, as being without jurisdiction, null and void

10 Vodafone India (Effect) The Bombay HC passed a similar judgment in the case of Shell India Markets Pvt. Ltd. (Shell) v. ACIT et al., Writ Petition 1205 of 2013, except that Shell did not disclose the issuance of equity shares to its non-resident associated enterprise as an international transaction in Form 3CEB Further, the CBDT vide Instruction No. 02/2015, dated 29 January 2015 has notified that it has accepted the decision of Vodafone IV and has directed that the ratio decidendi of the judgment must be adhered to by the field officers in all cases where this issue is involved CBDT issued Instruction No. 3/ 2016 requiring the AO dispose off the objections raised by the assessee on jurisdictional issue, before making any reference to the TPO

11 Reference to TPO Instruction No. 3/2016 CBDT notified Instruction no. 3/2016 which has replaced Instruction no. 15 of 2015, and clarified that the AO is not empowered to conduct transfer pricing assessments If reference is made in following cases, AO must record his satisfaction whether there is (potential) income which is being affected by ALP determination and take approval of PCIT/ CIT: Report u/s 92E not filed and AO discovers IT or SDT IT or SDT not been disclosed in report u/s 92E & AO discovers the same Assessee claims that the transaction does not affect income

12 Reference to TPO Instruction No. 3/2016 Case selected under TP risk parameter AO must record his satisfaction that there is an income or a potential of an income arising Obtain approval of PCIT or CIT Case selected under non-tp risk parameter TP adjustment in an earlier year has been set-aside by the ITAT, High Court or Supreme Court If AO becomes aware of an international transaction not disclosed in Form No. 3CEB If TP adjustment of INR 10 crores or more in earlier year, is upheld by higher authorities or pending in appeal Transaction discovered during search or seizure operations Reference to TPO

13 BNT Global Private Limited (ITA No. 4111/Mum/2016) Facts of the case Assessee company received share capital and share premium from NRI shareholder-cum-director ITAT held that It is mandatory to furnish a report for a person entering into an international transaction The assessee filed return of income but failed to file Form No. 3CEB The AO during assessment took a view 3CEB was required. Although no adjustment to income was done, penalty was levied under section 271BA CIT(A) upheld penalty ITAT distinguished Vodafone decision stating that it had filed Form 3CEB and HC had ruled that no adjustment should be made to arm s length price In instant case, AO has not made any adjustment to ALP but levied penalty for failure to comply Relied on Tribunal ruling in case of IL & FS Maritime (Pre Vodafone case) Whether if no income is arising from a transaction, it can still be considered to be an international transaction? Can sec. 92B be read devoid of sec. 92(1)?

14 Kolkata ITAT (SB) Instrumentarium Corporation Instrumentarium / Assessee Interest-free loan Deemed interest Outside India India Datex Ohmeda (WOS of assessee)

15 Instrumentarium (Contd.) Revenue is entitled to make TP adjustment in respect of interest-free loan advanced by an assessee (a non-resident) to its Indian subsidiary; Rejects stand that case is covered by exclusion u/s 92(3) (TPadjustment shall not apply if income reduced or loss increased; As per Sec 92(3) income to be computed based on entries in books and "there is thus no scope at all for taking into account the impact on taxes for the subsequent year"; Rejects argument that "if an altogether new income is brought to tax in the hands of the assessee, as a result of ALP adjustment, corresponding deduction is required to be given to the Indian AE In a situation in which result or consequence of an ALP adjustment is erosion of domestic tax base, the provisions of the transfer pricing cannot be invoked

16 Facts of the case: Instrumentarium (Contd.) Instrumentarium / Assessee entered into an agreement, duly approved by the RBI, to advance an interest free loan to Datex India (its WOS) AO disputed the ALP of the interest income earned by the assessee from India and brought to tax the same in the hands of the assessee The assessee claimed that for a variety of reasons including the issue of base erosion of Indian tax base, no adjustment should be made on the said transaction. AO proceeded to treat Datex India as a representative assessee and proceeded to finalize the assessment under section 144 r.w.s. 147 of the Act

17 Instrumentarium (Contd.) Contentions of the assessee before ITAT: In a situation in which result or consequence of an ALP adjustment is erosion of domestic tax base, the provisions of the transfer pricing cannot be invoked The assessee pointed out that if the computation of interest is imputed to the loan, the net result will be: a withholding tax of 10% on the interest payable, a statutory reduction or deductibility of the said expenses which will allow benefit of 36.75% tax to the appellant company, and a resultant base erosion of 26.75% to the Indian revenue.

18 Instrumentarium (Contd.) Key observations of the ITAT: Section 92(3) requires an impact on profits or losses for the year and it does not discuss the impact on taxes for the subsequent years. Tax administration cannot be expected to have clairvoyance of whether or not Indian AE will actually make sufficient profits in the next eight assessment years which will subsume the losses incurred by the assessee by the AE"; Rejects assessee s reliance on Australian law to support base erosion argument Rejects reliance on SC's Morgan Stanley ruling to buttress claim that adequate profits taxed in India Further rejects 'business expediency' and 'shareholder service' argument of assessee

19 Thin Capitalisation (Interest deduction u/s 94B)

20 What is thin capitalisation? Thin Capitalisation Thin Capitalisation means having highly disproportionate debt capital in comparison to equity capital Companies tend to borrow in high-tax jurisdictions to avail higher tax deductions Why debt over equity? No stamp duty required for infusion of debt capital, unlike equity capital In most countries, dividends are subjected to economic double taxation, whereas interest is not; on the contrary interest is taxeffective Easy and tax effective repatriation of borrowed funds as compared to capital infusion Debt is more flexible; it can be converted into equity, when required Debt can be borrowed in foreign currency to avoid currency fluctuation risk

21 Thin Capitalisation Impact analysis Particulars Zero Debt Debt-Equity Ratio of 1:1 Zero Equity Debt ,000 Equity 1, Total Capital 1,000 1,000 1,000 PBIT Less: Interest PBT Less: 30% (approx) (A) PAT Less: 20% (approx) (B) Net profit distributed to equity shareholders Amount distributed for capital Total tax paid (A + B) Effective rate of tax (Total tax to PBIT) 44% 33% 22%

22 Limitation on interest deduction (Section 94B) Year of disallowance beginning from AY Expenditure of Interest or similar nature over INR 1 crore which is allowed as a deduction under profits and gains from business and profession Borrowed by: Indian Company/PE in India of foreign company (LLPs/ Partnerships/ trusts, etc. not covered) Borrowed from: AE of Indian company 94B(2): Excess interest (amount to be disallowed) Lower of: Total interest paid in excess of 30% of earnings before interest, taxes, depreciation and amortisation; OR Interest paid / payable to AE for the year

23 Limitation on interest deduction (Section 94B) Exception: borrower is a banking or insurance company (Whether NBFCs will be granted an exception?) Interest expenditure to the extent not wholly deducted, shall be carried forward to the following assessment year, subject to the maximum allowable expenditure as per s. 94(2) No interest shall be carried forward for more than 8 assessment years, immediately succeeding the assessment year for which such excess interest was first computed

24 Limitation on interest deduction (Section 94B) What is a debt? Debt means: any loan, financial instrument, finance lease, financial derivative, or an arrangement that gives rise to interest, discounts or other finance charges that are deductible as business expenditures a. Whether LCs will be considered as debt? b. Whether compulsorily convertible debentures which are hybrid instruments should be considered as debt? c. Whether premium on option contracts (financial derivative) would be considered as other finance charges?

25 Limitation on interest deduction (Section 94B)

26 Limitation on interest deduction (Section 94B) What is the mode of computation of EBITDA? What is implicit and explicit guarantee? Whether borrowing of real funds and availing of guarantee for borrowing could be classified in the same basket? Whether interest is to be understood, net of interest income?

27 An Illustration A Ltd. has borrowing of INR 100 crore from its overseas AE i.e. B 14% p.a. Interest paid / payable to AE is INR 14 crore EBITDA of A Ltd. for year ended is 30 crores Impact u/s 94B: Disallowance u/s 94B = Total deductible interest exceeding the 30% of EBITDA i.e. 5 crores [14 (30%*30) = 5] TP proceedings: Arm s length interest rate determined by 11% and hence, made a transfer pricing adjustment of 3 crores [(14% - 11%) * 100 crores] What would be the amount of interest allowed to be carried forward u/s 94B(4), INR 2 crores or INR 5 crores)

28 Secondary Adjustment (Sec. 92CE)

29 Secondary Adjustment Introduced by Finance Act 2017, applicable from AY Secondary adjustment as an adjustment that arises from imposing tax on a deemed basis by considering previous period s transfer pricing adjustment itself as a separate international transaction Applicable to primary adjustments exceeding one crore rupees made in respect of the AY and onwards Whether primary adjustment made to the international transaction determines additional benefit transferred to the associated enterprise on a deemed basis?

30 Secondary Adjustment CBDT Notification No. 52 /2017 dated 15 June 2017 Conditions Time Limit for repatriation of excess money If primary adjustment to transfer price has been made suo-moto by assessee in his return of income In case APA entered into by the assessee u/s. 92CD In case option exercised by the assessee as per Safe Harbour rules u/s 92CB Within 90 days from due date of filing return of income u/s. 139(1) i.e. 30th November In case assessee has entered into a Mutual Agreement Procedure under DTAA u/s. 90 or 90A In case the primary adjustment made as per the order of Assessing Officer (AO) / Appellate Authority has been accepted by the assessee From the date of order of AO/ appellate authority

31 Imputation of interest income on excess money not repatriated within time limit Currency denomination of international transaction INR Foreign currency Rate of imputation of interest income per annum 1-year marginal cost of lending rate (MCLR) of SBI as on 1 st April of relevant previous year basis points 6-month LIBOR as on 30 th September of relevant previous year basis points Whether suo-moto payment of taxes on the primary transfer pricing adjustment is not a sufficient parameter for the revenue authorities? Can income-tax department force a company to bring money into India or its role is restricted to collection of taxes on the money?

32 An Illustration Initial Year Revenue from software development services Overseas Ltd. (AE of India Ltd.) India Ltd. PLI of India Ltd. = 15% Comparable uncontrolled transactions = 24% TPO made an adjustment for the difference between the profit margin on sales of INR 100 crores Later Year TP adjustment continues Overseas Ltd. does not pay the amount of TP adjustment to India Ltd. TPO makes a secondary TP adjustment

33 Preliminary Issues on Secondary Adjustment Whether laws of other countries may allow free repatriation of money? i.e. Effect under FEMA Would lead to double taxation Effect of treatment under MAT / in the books of accounts maintained in India prepared as per Companies Act, 2013 Whether interest income is a one time levy or will apply on a year to year basis until the amount related to the primary adjustment is brought into India? Is there a contradiction for agreements between competent authorities in the case of Bilateral APAs or MAPs In case assessee goes for appeal before ITAT / High court / Supreme court, at what stage secondary adjustment to be made? Whether secondary adjustment leads to discrimination under DTAA?

34 Advance Pricing Agreement & Revised Safe Harbour Rules

35 Advance Pricing Agreements (APA) APA mechanism introduced in 2012 and Roll-back in 2014 Salient Features To provide assurance of certainty and unanimity in transfer pricing approach Valid upto five subsequent years and four previous years Binding on tax authorities as well as taxpayers unless there is a change in the law or facts of the case Pre consultation process (anonymous application option)

36 APA (Contd ) Statistics as per CBDT Press Release dated 6 October 2017 Unilateral Bilateral No. of Applications made in five years No. of Agreements Signed More than 800 applications (about 85% are Unilateral) with UK and 5 with Japan

37 APA (Contd ) Important points to be considered: Each year Annual Compliance Report in Form No. 3CEF needs to be filed before DGIT (IT) The APA can be cancelled/revised if critical assumptions are violated or conditions are not met If the Compliance Audit results in a finding that the assessee has failed to comply with the terms of the agreement, the agreement can be cancelled Non filing of Compliance Report or the report contains material errors, it may result in cancellation of the agreement

38 Safe Harbour Rules Safe Harbour (SH) Provisions were Introduced by Finance Act, 2009, however, CBDT released SH rules in September 2013 In June 2017, CBDT revised the SH rules w.e.f. 1 April 2017, decreasing the SH margins and the included low value adding intra group services as one of the eligible international transactions Revised SH margins shall be applicable from the AY for three consecutive years Eligible assessee has the right to exercise the option under either sub-rule (2) or sub-rule (2A) of Rule 10TD, whichever is beneficial

39 Safe Harbour Rules (Contd ) Eligible International Transaction (EIT) Safe Harbour Rules Old Revised [Rule 10TD (2)] [Rule 10TD (2A)] Provision of software development services (other than contract R&D) and ITES 20 % or more (EIT INR 500 crores) 22 % or more (EIT > INR 500 crores) 17 % or more of OE (EIT INR 100 crores) 18 % or more of OE (EIT > INR 100 crores) Employee Cost to OP to OC Operating % Provision of knowledge process outsourcing services 25 % or more (No Threshold) Cost < 40 % 40 % and 60 % 18 % or more 21 % or more 60 % 24 % or more

40 Safe Harbour Rules (Contd ) Eligible International Transaction (EIT) Provision of contract R&D services wholly or partly relating to software development and generic pharmaceutical drugs Manufacture and export of core and non-core auto components Safe Harbour Rules Old Revised [Rule 10TD (2)] [Rule 10TD (2A)] 30 % or more (software development) 24 % or more 29 % or more (EIT INR 200 crores) (generic pharmaceutical drugs) 12 % or more (core auto components) 8.5 % or more (non-core auto components) Providing corporate guarantee (other than comfort letter, performance guarantee, etc.) 2 % p.a. or more (EIT INR 100 crores) 1.75 % p.a. or more (EIT > INR 100 crores) 1 % p.a. or more (No Threshold)

41 Safe Harbour Rules (Contd ) Eligible international transaction Interest on advancing of intragroup loans Safe Harbour Rules Old Revised [Rule 10TD (2)] [Rule 10TD (2A)] SBI base rate bp 1 year SBI MCLR + basis points (INR Loan 50 crores) as shown below in (A) (INR Loan) 6 month LIBOR + basis points as SBI base rate bp shown below in (B) (foreign (INR Loan > 50 crores) currency Loan) (A) (B) CRISIL credit rating of associated enterprise (AE) Basis points Basis points AAA to A or equivalent BBB-, BBB or BBB+ or equivalent BB to B or equivalent C to D or equivalent Credit rating not available and total loan in INR provided to all AEs do not exceed INR 100 crores as on 31 March of the relevant 425 NA previous year Credit rating not available and total loan provided to all AEs do not exceed equivalent to INR 100 crores as on 31 March of the relevant previous year NA 400

42 Safe Harbour Rules (Contd ) Eligible International Transaction (EIT) Receipt of low value adding intra group Services (This concept was introduced in the BEPS Action Plan 13, wherein it has been stated that these services are activities which are not the principal business activities of the group entity providing such services) Safe Harbour Rules Old Revised [Rule 10TD (2)] [Rule 10TD (2A)] Value of EIT including a Absent markup on cost upto 5% INR 10 crores * * The following shall be required to be certified by an accountant: 1. Method of cost pooling 2. Exclusion of shareholder costs duplicate cost from the cost pool 3. Reasonableness of the allocation key used by overseas AE for allocation of cost to the Assessee

43 Safe Harbour Rules (Contd ) Procedural Aspects Eligible taxpayers must furnish a self-attested form i.e. Form No. 3CEFA, containing various details of the eligible transactions on or before the due date for filing the income tax return The Assessing Officer may make a reference to the Transfer Pricing Officer to verify the validity of option exercised by the taxpayer Various other procedural aspects have been provided by the relevant Rules

44 Master File and Country-by- Country Reporting (Draft Rules)

45 Master File and Country-by-Country Reporting (Draft Rules) Central Board of Direct Taxes (CBDT) on October 6, 2017 issued Draft Rules (Rule 10DA and 10DB) in respect of keeping, maintaining and furnishing information and documents with respect to: Country-by-Country (CbC) report and Master File In line with the BEPS Action 13, India has become a signatory to the Multilateral Competent Authority Agreement (MCAA) for the automatic exchange of CBC Report with the other signatories of the Agreement on 12 May 2016 and notified on 28 July 2017

46 Master File Applicability (Rule 10DA) Entity Consolidated Revenue of the International Group in Preceding accounting year > INR 500 crores AND As per Books of Accounts > INR 50 crores Aggregate value of International Transaction in Reporting Year OR In relation to Intangible property > INR 10 crores

47 Master File (Draft Rules) Rule 10DA - Master File Master File is an onerous documentation which Depicts sensitive information and is supposed to provide a bird s eye view of the working of the group The due date to furnish the information with respect to the Master File for FY is 31 March 2018 Furnishing of Information under Form 3CEBA

48 Country-by-Country Report (Rule 10DB) Rule 10DB CbC Report CbC report applicable to an international group having total consolidated group revenue of more than INR 5,500 crore (approx. $ 750mn) in the accounting year preceding the FY Draft notification is silent on the due date with respect to CbC report for FY , however, considering the constraint of time, the CBDT may extend the due date in line with Master File Furnishing of Report under Form 3CEBC

49 Master File and CbC Report (Draft Rules) Master File (to provide the MNE s blueprint) The group s organisation structure A description of the group s business, intangibles, intercompany financial activities and financial and tax positions Jurisdiction-wise information on global allocation of income, taxes paid/ accrued, the Country-by- Country (CbC) Report stated capital, accumulated earnings, number of employees and tangible assets Entity-wise details of main business activities which will portray the value chain of intercompany transactions

50 CbC Report (Form 3CEBC)

51 CbC Report (Form 3CEBC)

52 Master File and CbC Report - Penalty Section Section 271AA Particulars Penalty for failure to keep and maintain Master File (INR 500,000) Section 271GB Penalty for failure to furnish CbC report u/s 286(2) Penalty for nonfurnishing information asked for u/s 286(6) Inaccurate report / information a. INR 5,000 per day upto one month; or b. INR 15,000 per day beyond one month INR 5,000 per day INR 500,000 Failure continues after penalty order INR 50,000 per day NA

53 THANK YOU Vispi T. Patel Vispi T. Patel & Associates Chartered Accountants Contact no : / id : vispitpatel@vispitpatel.com