Domestic Transfer Pricing Ameya Kunte 20 March 2015 ameya.kunte@taxsutra.com
Contents Background why domestic TP? SC observations in Glaxo ruling Amendments by Finance Act, 2012 Domestic TP Framework SDT and International Transaction Related party payments u/s 40A(2) Case studies Compliance provisions Penalty Arm s length under Companies law and Cost Accounting records 2
Need for Coverage Scenario 1 Particulars Co. A Co. B Taxed in India @ 33% 33% Sales to RP 100 - Other Income 200 400 Purchases from RP - 100 Other Expenses 400 200 Profit/Loss (100) 100 Tax - 33 Scenario 2 Particulars Co. A Co. B Taxed in India @ 33% 33% Sales to RP 150 - Other Income 200 400 Purchases from RP - 150 Other Expenses 400 200 Profit/Loss (50) 50 Tax - 17 Domestic Transactions resulting in tax base erosion/deferral Use of loss making units and tax holiday entities 3
Domestic Transfer pricing new? Disallowance of excessive / unreasonable expenditure u/s 40A(2)(b) Fair value Legitimate needs of the business Benefits test Conditions u/s 80IA (8)/(10) in case of tax holiday units Ordinary profits 4
Domestic Transfer pricing new? Immovable property transfers u/s 50C / 43CA and Sec 56 Use of stamp duty valuation / fair valuation Cost of acquisition of depreciable assets where higher cost is used with the objective of reduction of tax liability explanation to Sec 43(1) Value of any benefit or perquisite derived from exercise of business or profession Sec 28(iv) 5
SC observations in Glaxo ruling SC ruling of July 2010 Domestic transactions between related entities will not be revenue neutral if Profit shifted from profitable entity to loss-making entity Tax arbitrage on transactions between related units due to difference in tax rates E.g. shifting of profits from non-sez unit to SEZ unit SC recommends amendments to provisions like Sec 40A (2) and Sec 80IA(10) to empower AO to make adjustments to the income having regard to the fair market value of the transactions between the related parties 6
SC observations in Glaxo ruling The AO may thereafter apply any of the generally accepted methods of determination of arm's length price, including the methods provided under Transfer Pricing Regulations One of the suggestions which needs consideration is whether the law should be amended to make it compulsory for the taxpayer to maintain Books of Accounts and other documents in line with Rule 10D and whether the assessee should be required to obtain an audit report from CA 7
Amendments by Finance Act, 2012 Finance Act, 2012 introduced TP provisions to specified domestic transactions (SDT) Memorandum to Finance Bill: Proposals in line with SC decision in Glaxo Smithkline [TS-47-SC-2010-TP] Objectives as per Memorandum Bring in objectivity in determination of income/reasonableness of expenditure arising from domestic related party transaction Legally enforceable obligation on assessee to maintain documentation Monetary threshold of aggregate transactions of Rs. 5 Cr for avoiding unnecessary compliance & administrative burden 8
Domestic TP - Framework Applicability Implications Undertakings to which incentive deductions are provided (e.g. 10AA, 80-IA, 80-IB), covering: inter-unit transfer of goods and services; and transactions between entities having close connection Expenditure for which payment made to related parties defined u/s 40A(2) Aggregate transaction value exceeds Rs. 5 / 20 Cr in a financial year These transactions have to be undertaken at arm s length price by selecting most appropriate method Maintain contemporaneous documentation Report transaction in the Accountant s Report Any other transaction that may be specified Penalty of 2% on transactions value each for failure to report / maintain or furnishing documentation 9
SDT Value threshold SDT provisions applicable only if aggregate of all SDT during relevant previous year exceeds Rs 5 cr (upto FY 2014-2015) Finance Bill 2015 proposes to increase the value-threshold from Rs 5 cr to Rs 20 cr Memorandum on Finance Bill 2015 In order to address the issue of compliance cost in case of small businesses on account of low threshold of five crores rupees, it is proposed to amend section 92BA to provide that the aggregate of specified transactions entered into by the assessee in the previous year should exceed a sum of twenty crore rupees for such transaction to be treated as specified domestic transaction. This amendment will take effect from 1st April, 2016 and will, accordingly, apply in relation to the assessment year 2016-17 and subsequent assessment years. 10
SDT Definition Sec.92BA Transactions covered: Expenditure in respect of which payment has been made or is to be made to a person covered u/s 40A(2)(b); Any transaction referred to in Sec. 80A inter-unit transfers; Any transfer of goods or services referred in Sec 80IA(8) inter-unit transfer; Any business transacted between the assessee and other person referred in 80-IA(10) Transactions between connected persons; Any transaction, referred in Chapter VIA or Sec 10AA, to which provisions of Sec. 80-IA(8) or (10) apply; and Any other transaction as may be prescribed 11
Persons covered u/s 40A(2) Company Director / his Relatives Hindu Undivided Family Member / his Relative Association of Persons Member / his Relative Partnership firm Partners / his Relatives Individual Relative Any individual (or his relative) who has substantial interest in the assessee s business / profession. Any company (or director), firm (or partner), AoP / HUF (or member) or their relatives who has substantial interest in the assessee s business / profession including company in which such company is holding substantial interest Any company, firm, AOP or HUF if director/partner/ member of which has substantial interest Other director/partner/ members of such entities Any person in whose business / profession, assessee or his relative has substantial interest. 12
Related party payments u/s 40A(2) Relative husband, wife, brother, sister or any lineal ascendant or descendant of the individual Substantial Interest In case of Companies 20% control on voting power In case of other entities 20% share in profits Provision cover payment and compliance required for party making payment Whether 20% threshold needs to be examined qua an individual director or qua all directors put together? 13
Case Study - Direct vs. indirect ownership Whether beneficial ownership includes direct as well as indirect shareholdings? ICAI Revised Guidance Note (2013) A A X X Y Y 14
ICAI Guidance Note Para 4A.16 However, 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. Hence, the emphasis is on covering the real owner of the shares and not the nominal owner. This proposition is also supported by legal jurisprudence which states that in a multitier structure, a parent cannot be regarded as the beneficial owner of shares in a downstream subsidiary merely because it owns the shares of the intermediate subsidiary companies. It is important to respect the fact that the entities are separate legal entities. In other words, for purposes of Section 40A(2)(b), it may be appropriate to consider only direct shareholding and not derivative or indirect shareholding. www.tp.taxsutra.com 15
International transaction vs SDT International Transaction Covers both income and expense transactions Substantial interest for international transaction - AE threshold 26% APA, Safe Harbour framework available Deemed Transaction concept applicable Specified Domestic Transaction u/s 40A(2) only expenditure is covered. u/s 80A(6)/ 80-IA(8)/80- IA(10)/section 10AA, both expense/ profits from transactions are covered Substantial interest threshold of 20% APA, Safe Harbour framework not applicable Deemed Transactions concept not applicable 16
Case Study cross border transactions Entity A (Indian Company) 23% Import (Purchase) of goods Entity B (US Company) Will this transaction qualify as International transaction or specified domestic transaction? 17
Case Study non-resident transactions Whether SDT will get triggered if both parties to the transaction are non-resident? Entity A (Foreign Company) Outside India Director of Foreign Company India Salary PE in India 18
Related party payments u/s 40A(2) Illustration on transactions covered Expenditure on buying goods Expenditure on procurement of services Expenditure on interest payments Expenditure on salary, training services, marketing expenses Expenditure on purchase of tangible and intangible property Director s remuneration, commission, sitting fees Group charges Reimbursement expenditure Guarantee fee expenditure 19
SDT applicability Trade discount- not an expenditure 40A(2) not applicable United Exports [333 ITR 549 (Del)] Grandpix [128 TTJ 60(Delhi)] Sales to sister concern/income from sister concern CIT v. Glaxo Smithkline Asia (P) Ltd [TS-47-SC-2010-TP], Udhoji Shrikrishnadas [TS-1-HC-1980(MP)-TP], A. K. Subbaraya Chetty & Sons [TS- 1-HC-1979(MAD)-TP], Durga Rice & Gen Mills [TS-446-ITAT-2012(CHANDI)], CIT v. Rajnish Ahuja [(TS-116-HC-2013(P & H))] Capital expenditure - Depreciation / investment allowance? Nectar Beverages [TS-110-SC-2009], Vishnu Anant Mahajan [TS-396-ITAT- 2012(Ahd)] (on 14A) depreciation is allowance not an expenditure Payment to partners payments covered u/s 40(b) - Yoganand Textile [202 ITR 869 (Guj)], Ganesh Factory [180 ITR 416 (P&H)] 20
Case Study - Intra group funding Situation 1 Entity A (Indian Company) Loan given Interest Paid 12 % (ALP at 8%) Tax Holiday entity Situation 2 Entity A (Indian Company) Guarantee given No fee paid (ALP at 8%) Tax Holiday entity 21
Director remuneration Benchmarking difficult - payments by other companies to their directors will represent controlled transactions. Difficulty in finding uncontrolled transactions for comparability Revenue neutrality situation Use of 6 th method for TP benchmarking 22
Relevant provisions Sec 92C and Rule 10B & 10AB Sec. 92CA(2) Sec 92D and Rule 10D Sec 92E and Rule 10E Six methods for computing ALP Safe harbour provisions applicable Reference to TPO Extended assessment timelines apply Maintenance of Contemporaneous Documentation Accountant s Report Form 3CEB in electronic form to be filed before due date 23
Reference to TPO For international transactions, AO must mandatorily refer all transactions to TPO if value exceeds Rs. 15 crores CBDT may issue suitable instruction for specified domestic transactions. TPO s powers to determine ALP of Transaction not referred by AO ( restricted to international transaction) SDT not covered Transaction not disclosed in Form 3CEB SDT not covered [Sec 92 CA (2B)] 24
Penalty Sec 271AA Sec 271BA Sec 271G 2% of transaction value for: failure to maintain prescribed documents or information. failure to report any specified domestic transaction which is required to be reported. maintaining/ furnishing incorrect information/ documents. Penalty of Rs. 1 lakh for failure to furnish accountant s report u/s 92E 2% of transaction value for failure to furnish information / documents as required u/s Sec 92D(3). Concealment penalty u/s 271(1)(c) - @ 100%- 300% of tax sought to be evaded also applicable to SDT 25
Arm s length - Company Law New Companies Act has introduced arm s length concept for related party transactions (RPT) Various approvals required from Board of Directors/ shareholders not applicable if the RPT entered on arm s length basis & in ordinary course of business Company not prohibited from entering into RPT which is not on arm s length basis, but Board of Directors required to give justification for every transaction Related party transactions disclosure in cost audit report under the Companies (Cost Audit Report) Rules 2011 Report requires disclosure of transfer price, normal price and basis adopted to determine normal price Non disclosure of normal price and basis amounts to incomplete information 26
Case Study Scope of Sec 92BA Can Sec 92BA invoked independent of Sec 40A(2) disallowance? 27
Case Study Work in Progress SPV (subsidiary) set up to construct a road project. SPV sub-contracts part work to holding company on EPC basis. EPC work done by the holding company shown as CWIP as the construction is not yet completed. Advances have been issued by SPV to Holding Company. Domestic TP if no deduction claimed during the year? Unique wording of Sec 80IA(10) www.tp.taxsutra.com 28
Case Study Cost allocation Should the common Head office costs be allocated between units? If yes, whether mark-up should be charged on it? 29
Case Study Inter Unit Transfer In case goods/services are transferred between 2 tax holiday units of the same entity? Will it require reporting in Form 3CEB? www.tp.taxsutra.com 30
Thank you 31
Section 40A(2) Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction. Provided 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, if such transaction is at arm s length price as defined in clause (ii) of section 92F. Slide 10 32
Section 92 Section Heading : Computation of income from international transaction having regard to arm s length price. Sec 92 (2A): Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to the specified domestic transaction shall be computed having regard to the arm s length price. Sec 92 (3) The provisions of this section shall not apply in a case where the computation of income under sub-section (1) or sub-section (2A) or the determination of the allowance for any expense or interest under sub-section (1) or sub-section (2A), or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2) or subsection (2A), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction or specified domestic transaction was entered into. 33
Section 92BA For the purposes of this section and sections 92, 92C, 92D and 92E, specified domestic transaction in case of an assessee means any of the following transactions, not being an international transaction, namely: (i) any expenditure in respect of which payment has been made or is to be made to a person referred to in clause (b) of sub-section (2) of section 40A. (ii) any transaction referred to in section 80A; (iii) any transfer of goods or services referred to in sub-section (8) of section 80-IA; (iv) any business transacted between the assessee and other person as referred to in subsection(10) of section 80-IA; (v) any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable; or (vi) any other transaction as may be prescribed, and where the aggregate of such transactions entered into by the the previous year exceeds a sum of five crore rupees. assessee in 34
Section 80IA(8) (8) Where any goods or services held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods or services held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods or services as on the date of the transfer, then, for the purposes of the deduction under this section, the profits and gains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods or services as on that date : Provided that where, in the opinion of the Assessing Officer, the computation of the profits and gains of the eligible business in the manner hereinbefore specified presents exceptional difficulties, the Assessing Officer may compute such profits and gains on such reasonable basis as he may deem fit. Explanation. For the purposes of this sub-section, market value, in relation to any goods or services, means (i) the price that such goods or services would ordinarily fetch in the open market; or (ii) the arm s length price as defined in clause (ii) of section 92F, where the transfer of such goods or services is a specified domestic transaction referred to in section 92BA.] www.tp.taxsutra.com 35
Section 80IA(10) (10) Where it appears to the Assessing Officer that, owing to the close connection between the assessee carrying on the eligible business to which this section applies and any other person, or for any other reason, the course of business between them is so arranged that the business transacted between them produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business, the Assessing Officer shall, in computing the profits and gains of such eligible business for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived therefrom: Provided that in case the aforesaid arrangement involves a specified domestic transaction referred to in section 92BA, the amount of profits from such transaction shall be determined having regard to arm s length price as defined in clause (ii) of section 92F. www.tp.taxsutra.com 36