The Chamber of Tax Consultants Case Studies on Domestic Transfer Pricing w.r.t section 80A/80IA/10AA including its bench marking Presentation by Yogesh Thar April 29, 2016 1
Genesis of Transfer Pricing ( TP ) provisions The genesis of TP provisions is from the decision of the Supreme Court in the case of CIT v. Glaxo Smithkline Asia P. Ltd. (2010) 195 Taxman 35 (SC). The Apex Court gave suggestions, in order to reduce litigation to consider amendments in the law with a view to: Make it compulsory for the tax payer to maintain books and documentation on the lines of Rule 10D; Obtain audit report from a Chartered Accountant ( CA ); Reflect the transactions between related entities at arms length price; Apply the generally accepted methods specified in TP regulations 2
Domestic TP Applicability The Finance Act, 2012 amended the Income Tax Act, 1961 ( the Act ), to provide for a mechanism to determine fair market value in cases of transactions between resident taxpayers which are related to each other : Specified Domestic Transactions ( SDT ) defined as any of the following transaction(s), which are not international transactions (i.e. transactions where either one or both the parties to the transaction are non-residents) Payments to related parties as defined under section 40A(2)(b) ; Any transaction referred to in section 80A ; Any transfer of goods/services referred to in section 80IA(8) ; Any business transaction referred to in section 80IA(10) ; Any transaction under Chapter VI-A or u/s 10AA to which provisions of section 80IA (8) or section 80IA (10) apply ; Any other transaction as may be prescribed And the aggregate exceeds Rs. 20 crores 3
Applicability of SDT provisions to Chapter VI-A provisions The Finance Act, 2012 amended provisions of Chapter VI-A, for computing profits of units/business claiming deduction under Chapter VI-A, where such units have entered into specified domestic transaction ( SDT ). The provisions so amended/inserted are : Explanation to section 80A(6) ; Explanation to section 80-IA(8) ; and Proviso to section 80-IA(10) ; 4
Eligible business covered Section 10AA 80-IA 80-IAB Persons with income from SEZ units Infrastructure developers Developers of SEZ Taxpayers covered 80-IB Small scale industry engaged in operating Cold storage plant ; Industrial undertaking in Industrially backward state as mentioned in VIII Schedule (ex: Jammu and Kashmir ) Company carrying on scientific research and development ; Eligible hospitals ; Eligible housing projects 80-IC 80-ID 80-IE 80LA Undertakings or enterprises in certain special category States Business of hotels and convention centers in specified area undertakings in North-Eastern States Offshore Banking units and International Financial Services Centre 5
Applicability of section 80-A(6) Section 80-A(6) provides for substitution of market value of goods and services in place of their recorded values, in case of internal transfer of goods and services between eligible units claiming deduction and other units of the assessee In order to apply this provision, the conditions to be satisfied : There should be either of the following transfers : o o Transfer of goods and services, from eligible unit to any other business carried on by the assessee ; Transfer of goods and services, from other businesses of the assessee to the eligible unit The consideration for transfer does not correspond to market value of goods and services on the date of transfer 6
7 Transactions covered u/s 80-IA(8) and 80-IA(10) 80-IA(8) 80-IA(10) Co A Ltd Tax holiday unit Goods and services Other unit Co A Tax holiday unit Close connection Co B Other unit Sale of goods at 120 ; Arms Length Price ( ALP ) of goods is Rs.100 ; Thus, deduction u/s 80-IA would be computed considering only Rs.100/- as Selling Price Operating Margin: 40% (Extraordinary Profits) ; ALP: 10% ; Converse- Not True section 92(3) Thus, deduction u/s 80-IA(10) would be computed considering margin of 10%
Case Study-1 Issue : Tax holiday units (2) Co A Ltd Other units (7) Allocation of common expenditure to eligible units ; Whether provisions of section 80-IA(8) and 80-IA(10) are applicable Facts : The assessee is engaged in manufacturing and trading of yarn, hosiery goods and knitted cloth ; The assessee claimed deduction u/s 80IC for 2 units out of 9 different units ; Various administrative expenses including remuneration of directors was debited in the HO Accounts and none of the expenses was allocated to the tax-holiday units ; No re-allocation of expenses was made in any of earlier years ; The assessee maintained separate books of accounts for each unit and for the Head Office 8
Case Study-1 Issues for consideration: a. Whether the common costs would need to be allocated to the eligible unit? b. If yes, whether such allocation would need to be determined based on the arms length principles and the transfer pricing methods contained in Chapter X of the Act; c. An assessee is carrying out only one manufacturing business that is eligible for deduction under section 80IC. Hence, it carries out both manufacturing and selling and distribution activity as a part of one single business. Whether such manufacturing and distribution business needs to be segregated and a notional transfer of goods from the manufacturing business to the selling business needs to be assumed for determine the profits of the manufacturing business? d. Basis of allocation of common cost whether meets the arm s length principle 9
Case Study-2 Facts : ABC Ltd. is a public listed company engaged in the business of manufacturing consumer durables ; ABC Ltd Eligible unit -80IC It has a subsidiary which imports certain chemicals and supplies the same to ABC Ltd; Sell @Rs.105 One of the several manufacturing units is in Himachal Pradesh which enjoys 100% tax holiday u/s 80-IC ; Subsidiary Sell @Rs.115 3rd party The subsidiary also imports and sells the same chemicals to third parties in India ; Issue : from the point of view of deduction u/s. 80IC, the price charged by the subsidiary is less than the market price and consequently, the profits of the 80IC unit is inflated by Rs. 10 (i.e. the difference between the supply price to third parties of Rs. 115 and the supply price to the assessee of Rs. 105). Assume that the subsidiary imports a Chemical X at a landed cost of Rs.100/kg., it sells the same to ABC Ltd. at Rs.105/ kg and it sells to 3rd party in India at Rs.115/ kg, Assume that all other terms and conditions, being same Despite purchase at Rs.105 from subsidiary, if profits of 80-IC undertaking is less than the profits of other undertakings, which will prevail? 10
Case Study-3 Co PQR Ltd Facts : PQR is engaged in the manufacturing of various products through various units including one unit eligible for 80-IC deduction ; Eligible unit Other unit PQR Ltd purchases various stores and spares parts required for all units at one place, which is then used by other units as per their requirement ; Inter-unit of transfer of stores and spares Queries : Whether use of store and spares by several units would be covered u/s 80-IA(8) of the Act? If yes, what would be the ALP? 11
Case Study-4 80-IC eligible unit Co XYZ Ltd Other unit Transfer of Fixed Assets from /to eligible unit Facts : XYZ has set up at a Unit, in the state of Sikkim, which is enjoying a tax holiday, say under the provisions of section 80-IC the Act ; The company has transferred fixed assets to/ from the eligible unit from/ to the non-eligible units of the Company Queries : Whether such transfer of Fixed assets falls within the definition of SDTs? If yes, market value of such transfer is to be established by applying arms length principles under Chapter X? Method to applied for determining ALP? 12
Case Study-5 Power unit Co ABC Ltd Transfer of power (Eligible Unit) to Manufacturing Unit (Non-Eligible). Manufacturing unit Facts : Power Unit (PU) transfers power to Manufacturing unit (MU) ; Transfer recorded in the books of accounts of PU and MU at standard cost (say Rs 3/- per unit) ALP of power is Rs 6/- per unit. Queries : What would be the basis for computing deduction under section 80-IA? a. Rs 3/-p.u.; or b. Rs 6/- p.u. [Sec 80IA(8) r.w.s 92(3)] 13
Case Study-6 Captive Coal Mine Co ABC Ltd Transfer of coal to power plant Power Generation Unit Facts : Coal mine allotted solely for captive consumption for power generation; Profits from power generation eligible for 80IA Queries : Whether transferring coal amounts to transfer of goods held for the purpose of non eligible business to eligible business? Effect of TISCO s ruling in 48 ITR 123 (SC) 14
Other issues Applicability of SDT provisions in case of Loss making eligible units In case of an undertaking availing tax holiday incurs losses, tax holidays continue to be applicable, however, tax holiday claimed is NIL ; Possibility of shifting profits is absent ; Losses are c/fd and set-off against future profits or set-off against other profits Allocation of interest expenses Availing interest bearing loan for setting up eligible and other unit ; Non-allocation of interest costs to all units ; Funds lying of separate accounts of non-eligible units used for settle expenses of eligible units ; Notional interest on borrowed funds in case of inter-unit financing ; Borrowings at entity level, disbursements to units out of both borrowed funds and own funds, whether interest cost is to be apportioned; 15
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