Transfer Pricing Theory & Practice CA Hari Om Jindal October 7, 2017

Transfer Pricing Theory & Practice CA Hari Om Jindal (hojindal@yahoo.co.in) October 7, 2017 Nothing in this paper should be construed or treated as legal advice. Whilst we endeavor to ensure that the information in this paper is correct, we do not warrant its completeness or accuracy. To the maximum extent permitted by applicable law we exclude all representations, warranties and conditions relating to this paper (including, without limitation, any warranties implied by law of satisfactory quality, fitness for purpose and/or the use of reasonable care and skill). 1

What is Income Tax? Income-tax is one of the most important sources of revenue for every Government of the world. In India also, it is one of the most important sources of revenue for the Government. Indian Income-tax Act, 1961 [hereinafter referred to as the Act ] is the Central Act under which income tax is levied and it is one of the most complicated and frequently amended statutes. Under the Act, every person has to pay Income Tax, if his income exceeds the specified limit. 2

Taxation Principles in India All Revenue receipts are taxable unless exempt under any provisions of law All Capital receipts are not taxable unless specifically covered under any provision of law (section 45) Only real income is taxable and notional or hypothetical incomes are not taxable unless there are specific provisions to the contrary, like income from house property, transfer pricing etc.. Any income cannot be taxed twice unless there are specific provisions under the law Any expense cannot be allowed twice unless there are specific provisions under the law. 3

Anti-Tax Avoidance Provisions These provisions fall into two broad categories: Transaction based provisions: Certain provisions are applicable to all taxpayers. These provisions are made to deal with specific transactions where the chances of tax evasion or avoidance are more. (like section 50C) Relationship based provisions: Certain provisions are applicable only when the transactions are between the close relatives and associated concerns. (like section 40A(2) and transfer pricing) 4

Transfer Mis-Pricing - Reasons Transfer pricing manipulation can affect the tax liability of individual or group of persons/entities. There are various reasons for TP manipulations. Some of the reasons are given below: Transfer of profits from high tax jurisdiction to low tax jurisdiction - To minimise taxes Transfer of capital from one country to other - To circumvent foreign exchange laws Transfer of profits from taxable entity to exempt/low tax entity within same jurisdiction - To minimise taxes Transfer of property/goods/services below fair market price to relatives and associates within same jurisdiction - To minimise taxes 5

Transfer Pricing in India Before the amendment of the Act w.e.f. 1st April, 2002, section 92 was the only section dealing specifically with cross border transactions. This provision was of a general nature and limited in scope. Hence, the Finance Act, 2001, has substituted the existing section 92 of the Act by new sections 92 and 92A to 92F (Chapter X) w.e.f. assessment year 2002-03. Though there were few provisions which were applicable to domestic transactions between relatives and associates, however, these were also of limited in scope. Based on recommendation of the Supreme Court in the case of CIT v. Glaxo Smithkline Asia (P.) Ltd. [2010] 195 Taxman 35 (SC), it was, therefore, felt necessary to amend the Act. Hence, the law was amended by the Finance Act 2012 with effect from 1st April, 2013. Therefore, the detailed provisions are made which are applicable to both international and domestic TP. 6

Is Transfer Pricing A Big Issue Number of TP Audits Completed Transfer-pricing Adjustments 2004-2015 Number of % of Amount of Adjustment Adjustment Adjustment (in Cases Cases Rs.Crore) Financial Year 2004-05 1,061 239 23 1,220 2005-06 1,501 337 22 2,287 2006-07 1,768 471 27 3,432 2007-08 219 84 39 1,614 2008-09 1,726 670 39 6,140 2009-10 1,830 813 44 10,908 2010-11 2,301 1,138 49 23,237 2011-12 2,638 1,343 52 44,531 White paper on Black Money, India (May 2012) 2012-13 Press Release Ministry of Finance July 2013 70,016 2013-14 59,600 2014-15 46,465 7

Transfer Pricing - Five Steps Approach Step One: Whether TP provisions are applicable: In the first step, it has to be decided; whether transfer pricing provisions are applicable to an enterprise? Step Two: Computational Provisions Transfer Pricing Methods; If the jurisdictional provisions are applicable, it has to be decided; whether the transaction is done at arm s length price? Various methods have been prescribed for computation. Computation has to be done based on comparability analysis. Step Three; Audit and Assessment; In the third step, the revenue may like to judge the accuracy of the value determined by taxpayer. Step Four; Dispute Resolution Mechanism; In the fourth step, if any adjustment is made or penalties are imposed by revenue authorities, the taxpayer may like to contest the same before appellate authorities. Step Five (optional); Dispute Resolution - Preventive Provisions; If the jurisdictional provisions are applicable, instead of going through normal computational and audit provisions, the taxpayer may also opt for preventive measures. 8

Step One: Whether TP provisions are applicable International TP In the first step, it has to be decided; whether international transfer pricing provisions are applicable to an enterprise? Following points are relevant to understand jurisdictional provisions: There should be a transaction Transactions should be between two or more associated enterprises One or more enterprise should be a non resident The transaction should have a bearing on the profits, income, losses or assets of such enterprise The motive of tax avoidance is relevant but not conclusive. 9

Step One: Whether TP provisions are applicable International TP There should be a transaction Most of the commercial transactions of sale purchase services are covered. However there are disputes in respect of certain transactions Issue of share capital Guarantee Continuing outstanding balance Advertisement Marketing & Promotion Exp. Inter group services 10

Step One: Whether TP provisions are applicable International TP Transactions should be between two or more associated enterprises 92A. (1) For the purposes of this section and sections 92, 92B, 92C, 92D, 92E and 92F, "associated enterprise", in relation to another enterprise, means an enterprise (a) which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise; or (b) in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise. 11

Step One: Whether TP provisions are applicable International TP Transactions should be between two or more associated enterprises 12 92A(2) For the purposes of sub-section (1), two enterprises shall be deemed to be associated enterprises if, at any time during the previous year, (a) one enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in the other enterprise; or (b) any person or enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in each of such enterprises; or (c) a loan advanced by one enterprise to the other enterprise constitutes not less than fifty-one per cent of the book value of the total assets of the other enterprise; or (d) one enterprise guarantees not less than ten per cent of the total borrowings of the other enterprise; or (e) more than half of the board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of one enterprise, are appointed by the other enterprise; or

Step One: Whether TP provisions are applicable International TP Transactions should be between two or more associated enterprises (f) more than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board, of each of the two enterprises are appointed by the same person or persons; or (g) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights; or (h) ninety per cent or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise; or 13

Step One: Whether TP provisions are applicable International TP Transactions should be between two or more associated enterprises 14 (i) the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprise; or (j) where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual; or (k) where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family or by a relative of a member of such Hindu undivided family or jointly by such member and his relative; or (l) where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than ten per cent interest in such firm, association of persons or body of individuals; or (m) there exists between the two enterprises, any relationship of mutual interest, as may be prescribed.

Step One: Whether TP provisions are applicable Domestic TP New scheme is applicable only to Specified Domestic Transactions (SDT). If any transaction is covered both under SDT and international transaction then provision applicable to international transaction will only be applicable. Scope of transactions under International TP is more than Domestic TP Aggregate book value of SDT should exceed Rs. 5 crore during the relevant financial year (20 cr. from AY 2016-17). For this purpose the amount have to be taken as recorded in the books of account. There is no such threshold in case of International TP. Methods of computation are same Audit and Assessment procedure are same Dispute resolution procedure are same 15

16 Step One: Whether TP provisions are applicable Domestic TP Section 92BA contains the list of SDT. This section was inserted by the Finance Act, 2012, w.e.f. 1-4-2013. It specifically includes following six categories of transactions: 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; (removed w.e.f. AY2017-18) any transaction referred to in section 80A; any transfer of goods or services referred to in sub-section (8) of section 80-IA; any business transacted between the assessee and other person as referred to in sub-section (10) of section 80-IA; any transaction, referred to in any other section under Chapter Vl-A or section 10AA, to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable; or any other transaction as may be prescribed,

Domestic TP Section 40A(2) 40A(2)(a) 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. 17

Domestic TP Section 40A(2) The expenditure should be incurred in a business or profession The payment is to be made to the assessee s relative or an associate concern The reasonableness of any expenditure is to be judged having regarded to: Fair market value of the goods, services or facilities for which the payment is made, (Fair Market Value Theory) or The legitimate needs of the business or profession, (Business Need Theory) or The benefit derived by or accruing to the assessee from the expenditure (Business Benefit Theory). If covered under SDT then the payments have to be at arm s length price 18

Domestic TP Section 40A(2) There are three approaches to judge the allowability of expenditure under the head business and profession When the payment is not covered u/s 40A(2) General principles of deduction When the payment is covered u/s 40A(2) but not covered under SDT three principles without any method of computation When the payment is covered u/s 40A(2) and also covered SDT - ALP principles with specified methods of computation (Not applicable from AY2017-18) 19

O. P. Jindal Global University Domestic TP Remuneration to Promoter Directors Name Company Name Designation Salary (Rs.mn) 1 Naveen Jindal Jindal Steel & Power Chairman & MD 734.2 2 Kalanithi Maran Sun TV Chairman 570.1 3 Kavery Maran Sun TV Executive Director 570.1 4 Kumar Mangalam Birla[1] Aditya Birla Group Group Chairman 471.1 5 Pawan Munjal Hero Motocorp MD & CEO 344.7 6 Brijmohan Lall Munjal Hero Motocorp Chairman 344.4

Domestic TP Section 80 IA (8) Section 80 IA (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.] 21

Domestic TP Section 80 IA (8) There should be transfer of goods or service from one business of the assessee to other business of the same assessee. In this case the owner of the business should be same. This provision does not get attracted where one of the businesses is owned by associate or relative of owner. In that case section 80-IA(10) may be get attracted. One of business should not be eligible business for deduction u/s 80-IA of the Act. For example, if transfer of goods or services is between two businesses of the same assessee and both are eligible for deduction u/s 80 IA then this subsection will not be applicable. One of the businesses should be non eligible business. 22

Domestic TP Section 80 IA (8) The consideration for transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods or services. For the purposes of this sub-section, market value, in relation to any goods or services, means the price that such goods or services would ordinarily fetch in the open market. However, no specific method to determine fair market value in such related transactions is provided. If transaction comes within the mischief of specified domestic transaction referred to in section 92CA then market value means ALP as per in clause (ii) of section 92F. This provision is applicable w. e. f. 1.04.2013 i.e. assessment year 2013-14. If market value of ALP determination proves to be exceptional difficult, further discretion is also given to AO to compute profits and gains of the eligible business on such reasonable basis as he may deem fit. 23

Domestic TP 80 IA (10) Section 80 IA (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. 24

Domestic TP - Challenge ahead Section 80-IA(10) covers business transactions undertaken by a taxpayer claiming tax holiday with other entities having close connection with the taxpayer. The term close connection has not been expressly defined in the Act. There is no tax arbitrage in case of payment to professional directors and where both the entities are taxable (not availing any tax benefit). It will be very difficult to get comparables of salary payment to promoter directors. Only artificial rules based on profits/turnover can solve the problem. There should be some provision to mitigate the effect of double taxation 25

Domestic TP Recent Developments 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, is also covered within the scope of SDTs. However, there is no tax arbitrage in most of the cases covered within the scope of payments made to a person referred to in clause (b) of sub-section (2) of section 40A. When the first batch of cases under SDTs relating to FY 2012-13 were scrutinized recently, the Government realized that most of the transactions referred to in section 40A(2) does to involve any tax arbitrage. Therefore, vide Finance Act 2017, Government of India has amended the Act by providing that expenditure in respect of which payment has been made by the assessee to a person referred to in under section 40A(2)(b) are to be excluded from the scope of section 92BA of the Act. 26

27 Domestic TP Six reasons why adjustments should not be made u/s 40A(2) 1. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country s tax base [CBDT (Circular No. 12/2001, DATED 23-8-2001)]. But there is no base erosion in most of the case covered under section 40A(2)(b), except few cases, as both the parties are liable for Indian taxation. 2. In the case of adjustments made under international transactions, the taxpayer can approach competent authorities of respected countries to get relief from double taxation; however, there is no such remedial provision under domestic law. Though in other cases, there are specific provisions like taxation of partner's profit from partnership firm. 3. The heading of Chapter X also clearly indicates that it contains "special provisions relating to avoidance of tax". The object of Chapter X of the Act is not to tax any notional income but to ensure that the real income is brought to tax under the Act. However, adjustments made in most of the cases covered under section 40A(2)(b) would result in double taxation.

28 Domestic TP Six reasons why adjustments should not be made u/s 40A(2) 4. Tax arbitrage is the only reason which prompted observations in CIT v. Glaxo Smithkline Asia (P.) Ltd. [2010] 195 Taxman 35 (SC). However, there is no tax arbitrage in most of the cases covered within the scope of payments made to a person referred to in clause (b) of sub-section (2) of section 40A. 5. An income cannot be taxed twice unless there are specific provisions under the law. Bombay High Court in the case of Vodafone India Services (P.) Ltd. v. Union of India [2014] 50 taxmann.com 300 (Bombay) held that chapter X (transfer pricing) has no charging provision. Transfer pricing provisions are computational provisions and not substantive provisions. Therefore, there is no specific provision to tax the same income twice in the hand of two different entities. However, adjustments made in most of the cases covered under section 40A(2)(b) would result in double taxation, which is again against the fundamental principles of taxation. 6. In the Finance Act 2017, Government of India has amended the Act by providing that expenditure in respect of which payment has been made by the assessee to a person referred to in under section 40A(2)(b) are to be excluded from the scope of section 92BA of the Act. This was done to reduce the compliance burden of taxpayers. The intention of the Government is clear that transactions referred to in section 40A(2)(b) does not required ALP determination. Therefore, the amendment should be applied retrospectively. Allied Motors (P.) Ltd. v. CIT [1997] 224 ITR 677/91 Taxman 205 (SC) and CIT v. Alom Extrusions Ltd. [2009] 319 ITR 306/185 Taxman 416 (SC)

Avoidance of tax Is a condition precedent for invoking TP provisions? 29 Circular 6-P dated 6th July, 1968 - Para 74 of said circular reads as under: 74. It may be noted that the new provision is applicable to all categories of expenditure incurred in businesses and professions, including expenditure on purchase of raw materials, stores or goods, salaries to employees and also other expenditure on professional services, or by way of brokerage, commission, interest, etc. Where payment for any expenditure is found to have been made to a relative or associate concern falling within the specified categories, it will be necessary for the Income-tax Officer to scrutinise the reasonableness of the expenditure with reference to the criteria mentioned in the section. The Income-tax Officer is expected to exercise his judgment in a reasonable and fair manner. It should be borne in mind that the provision is meant to check evasion of tax through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases.

Avoidance of tax Is a condition precedent for invoking TP provisions? CBDT (Circular No. 12/2001, DATED 23-8-2001), explains the objective in following manner: The new provision is intended to ensure that profits taxable in India are not understated (or losses are not overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country s tax base. The new section 92 is, therefore, not intended to be applied in cases where the adoption of the ALP determined under the regulations would result in a decrease in the overall tax incidence in India in respect of the parties involved in the international transaction. 30

Step Two: Computational Provisions Transfer Pricing Methods Second step has been discussed in two parts. If the jurisdictional provisions are applicable and transaction is an international transaction, it has to be decided; whether the transaction is done at arm s length price? Various methods have been discussed in this part. Comparability analysis is discussed in next part. : Comparable Uncontrolled Price Method (CUP Method) Cost Plus Method (CPM) Resale Price Method(RPM) Transactional Net Margin Method (TNM Method) Profit Split Method (PSM) Other Method Most Appropriate Method (MAM ) 31

Step Two: Computational Provisions Comparability Analysis Single or Multiple Transactions Single or Multiple Year Data for Comparison Selection of Tested Party Internal or External Comparables FAR Analysis Use of quantitative and qualitative filters Comparability adjustments Safe Harbour Rules Taxpayer and AE Income/Loss Adjustments 32

Step Three; Audit and Assessment In the third step, the revenue may like to judge the accuracy of the value determined by taxpayer. Following points are relevant to understand audit and assessment provisions: Audit and Return Filing Burden of Proof Documentation Requirement Assessment by AO Audit by TPO Objection before DRP Penalties and Prosecution Provisions 33

Step Four; Dispute Resolution Mechanism In the fourth step, if any adjustment is made or penalties are imposed by revenue authorities, the taxpayer may like to contest the same before appellate authorities. Following points are relevant to understand various options before taxpayer: Rectification u/s 154 Revisions u/s 263/264 Appeal before CIT(A) Appeal before ITAT Appeal before High Court Appeal/SLP before Supreme Court Writ Options are limited When MAP option can be availed? 34

Step Five (optional); Dispute Resolution Preventive Provisions If the jurisdictional provisions are applicable and the transaction is an international transaction, instead of going through normal computational and audit provisions, the taxpayer may also opt for preventive measures. Following points are relevant to understand preventive options available with the taxpayer: Authority for Advance Ruling (AAR) Advance pricing Agreements Safe harbour rules 35

Selection of Method Section 92C provides that the ALP in relation to an international transaction shall be determined by the most appropriate method ( MAM ). MAM can be any of the following six methods: Comparable Uncontrolled Price Method (CUP) Resale Price Method (RPM) Cost Plus Method (CPM) Profit Split Method (PSM) Transactional Net Margin Method (TNMM) Other Method 36

Priority of methods One of the foremost question, which arises while calculating ALP of IT, is the choice of method. Neither Indian TP provisions nor OECD guidelines provide hierarchy of methods. It all depends on the facts and circumstances of the case. Nevertheless, where all the factors remain same then the choice of the method should be as below: First choice should be CUP Method Second choice should be RPM and CPM Third choice should be TNM method PSM can be used only in unique cases 37

Most Preferred Method in India A study on most preferred method for determination of arm s length price has revealed that the transactional net margin method (TNMM) was the most appropriate method for determination of arm s length price. The status of most preferred method in India during F.Y. 2006-07 is depicted as under: TNMM 72% CUP 19% CPM 06% RPM 03% PSM 0.1% Source: Mr. Prakash Chandra s (DG International Taxation) presentation during FIT Mumbai Conference 2008 38

Most Preferred Method in USA In USA also, the primary transfer pricing method used for transfers of both tangible and intangible property in APAs executed in 2014 was the comparable profits method/transactional net margin method (CPM/TNMM). CPM/TNMM 78% CUP Method 10% Residual Profit Split Method 8% All Other TPMs 4% 39

Most Preferred Method in UK In UK also the primary transfer pricing method used for transfers of both tangible and intangible property in APAs executed since inception was the transactional net margin method. TNMM 50% Profit Split Method 18% CUP Method 13% CPM 13% RPM 6% 40

Comparability Methods What is Comparable Comment Here, product similarity is more important than CUP Similar Transaction functional similarity. RPM Gross Profit Margin Here functional similarity with that of controlled transactions is more important than product similarity. CPM PSM TNM method Gross Profit Margin See comment Net Profit Margin Here functional similarity with that of controlled transactions is more important than product similarity. This method may require comparable at one or two level depending on the type of PSM is used i.e. Residual Profit Split Method or as Transactional Profit Split Method. Here broad functional similarity with that of controlled transactions is more important than product similarity. 41

CUP Method In this method, similar transaction (internal or external) has to be identified for the purpose of comparison. Here, product similarity is more important than functional similarity. 42

Resale Price Method This method compares the gross profit margin earned in the controlled transaction to gross profit margins earned in similar uncontrolled transactions (internal or external). Here functional similarity with that of controlled transactions is more important than product similarity. 43

Cost Plus Method This method also compares the gross profit margin earned in the controlled transaction to gross profit margins earned in similar uncontrolled transactions (internal or external). Here functional similarity with that of controlled transactions is more important than product similarity. 44

Profit Split Method This method may require comparable at one or two level depending on the type of PSM is used i.e. Residual Profit Split Method or as Transactional Profit Split Method. Combined net profit in the first instance, be partially allocated to each enterprise so as to provide it with a basic return appropriate for the type of international transaction in which it is engaged, with reference to market returns achieved for similar types of transactions by independent enterprises and then the relative contribution made by each of the associated enterprises to the earning of such combined net profit, is then evaluated on the basis of reliable external market data. 45

TNM Method This method compares net profit indicators (such as profit margins) between independent and associated enterprises. Here broad functional similarity with that of controlled transactions is more important than product similarity. 46

Other Method Recently, new rule 10AB has been inserted w. e.f. Assessment year 2012-13. This rule provides: "Other method of determination of arm's length price. It says: For the purposes of clause (f) of sub-section (1) of section 92C, the other method for determination of the arm's' length price in relation to an international transaction shall be any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts." 47

TNMM - Manner of computation 48 Sub-rule (1) of rule 10B lays down the manner in which the ALP in relation to an international transaction must be computed, for various methods. As per rule 10B(1)(e), the computation under TNM method have to be made in the following manner: Net profit margin of actual international transaction with appropriate base to be computed (Actual margin); Net profit margin from uncontrolled transaction (internal or external transaction) to be computed with same base (Comparable margin); Adjustments based on FAR analysis to be made to net profit margin from uncontrolled transaction (Comparable adjusted margin); Comparable adjusted margin is compared with actual margin; Comparable adjusted margin is adopted instead of actual margin for computing ALP.

What should be Profit Level Indicator (PLI) As per rule 10B(1)(e), the computation under TNMM have to be made in the following manner: The net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base. The rule provides for four bases for calculation of PLI. These are: Net profit margin/cost Net profit margin/sales Net profit margin/assets employed Net profit margin/any other relevant base Hence the taxpayer or department can also use any other relevant base apart from three specific bases. But the numerator in all cases should be net profit margin. It is also important to note that there should be some positive correlation between the net profit margin and appropriate base. It s not that denominator can be anything. 49

Segment Computation Single Segment Calculation of PLI Total Revenue as per audited accounts 847,101,677 Less: Non operating income 73,659,360 Operating revenue as per audited accounts 773,442,317 Calculation of Operating Cost Total Cost as per audited accounts 780,887,720 Less: Non operating cost Finance charges 10,539,394 Provision for doubtful advances 6,246,306 Provision for doubtful trade receivables 7,136,049 Loss on fixed assets sold 7,337,639 Provision for impairment of investments 573,685 Net loss on foreign currency transactions and translations 631,718 Total non operating cost 32,464,791 Operating Cost 748,422,929 Net Profit 25,019,388 OP/OC 3% 50

Segment Computation Multiple Segments As per published a/cs Operating Income only Trading Incom Service Incom Remarks INC OME Sale Income 76,982,341 76,982,341 76,982,341 Service Income Reimursements 8,480,453 Reimbursements ignored Service Income 32,859,328 32,859,328 32,859,328 Other Income - Interest Income 94,701 Non operating income Foreign Exchange Gain 4,728,522 4,728,522 3,313,977 1,414,546 Revenue ratio T OT A L 118, 322, 122 114,570,191 80,296,318 34,273,873 EXPENDITURE Cost of Sales 54,421,186 54,419,583 54,419,583 Operating Expenses Cost of Spares & Consumables 5,136,409 5,136,409 5,136,409 Actual accounting Cost of Consumable Tools 3,956,127 3,956,127 3,956,127 Actual accounting Personnel Expenses 11,574,797 Eng. Expenses 6,290,258 6,290,258 Actual accounting Accounts and sales 5,284,539 3,703,660 1,580,879 Revenue ratio Administration Expenses Reimursements 8,480,453 Reimbursements ignored Other Expenses 6,196,163 6,196,163 4,342,570 1,853,593 Revenue ratio Provision for Doubtful Debts 2,380,988 Non operative & only with Non AE Liquidated Damages 2,799,000 Non operative & only with Non AE Depreciation 600,049 600,049 420,543 179,506 Revenue ratio TOTAL 95,545,172 81,883,128 62,886,356 18,996,772 Op er ating p r ofit 22, 776, 950 32,687,063 17,409,962 15,277,101 Operating profit margin 19.25% 28.53% 21.68% 44.57% 51

Audit and Return Filing (1) Taxpayer enters into international transaction. Taxpayer has to get TP study prepared for determination of ALP of international transactions before the specified date. It can be prepared by assessee himself or can engage some tax consultant/ca etc. Taxpayer has to get TP Report in Form No. 3CEB from an Accountant before the specified date. (30 th November) Taxpayer has to file the TP Report (electronically from AY 2013-14). 52

Audit and Return Filing (2) The statement of particulars given in the Annexure to Form No. 3CEB contains twenty five clauses. The accountant/ca has to report; whether the particulars furnished in Form No. 3CEB are true and correct. Under the TP provisions, the primary onus is on the taxpayer to determine an ALP in accordance with the rules, and to substantiate the same with the prescribed documentation. Where such onus is discharged by the assessee and the data used for determining the ALP is reliable and correct, there can be no intervention by the AO. CA has to give an opinion as to whether the prescribed documentation has been maintained. Except expressing opinion on documentation, no comments are required from CA. The TP report comprises three types of informations: 53 Whether the Auditor(s) have examined the accounts and records relating to the international transactions entered into by the assessee. Whether, in his opinion, proper information and documents, as are prescribed, have been kept by the assessee. Whether, in his opinion and to the best of information and according to the explanations given to him, the particulars given in the Annexure are true and correct.

Audit and Return Filing (3) What is difference between TP study and Form 3CEB? Whether it is mandatory to determine ALP based on external comparables? What is the right time to prepare TP study? Whether it can be modified at the time of assessment or appeal? Whether TP study and form 3CEB can be filed during assessment if taxpayer forget to file before? 54

Transfer Pricing Documentation(1) (1) International transaction specific information I. the nature and terms (including prices) of international transactions entered into with each associated enterprise, details of property transferred or services provided and the quantum and the value of each such transaction or class of such transaction; II. III. a description of the functions performed, risks assumed and assets employed or to be employed by the assessee and by the associated enterprises involved in the international transaction; a record of the economic and market analyses, forecasts, budgets or any other financial estimates prepared by the assessee for the business as a whole and for each division or product separately, which may have a bearing on the international transactions entered into by the assessee 55

Transfer Pricing Documentation (2) (2) Enterprise and group specific information I. a description of the ownership structure of the assessee enterprise with details of shares or other ownership interest held therein by other enterprises; II. a profile of the multinational group of which the assessee enterprise is a part along with the name, address, legal status and country of tax residence of each of the enterprises comprised in the group with whom international transactions have been entered into by the assessee, and ownership linkages among them; III. a broad description of the business of the assessee and the industry in which the assessee operates, and of the business of the associated enterprises with whom the assessee has transacted; 56

Transfer Pricing Documentation (3) (3) ALP computation specific information I. a record of uncontrolled transactions taken into account for analysing their comparability with the international transactions entered into, including a record of the nature, terms and conditions relating to any uncontrolled transaction with third parties which may be of relevance to the pricing of the international transaction; II. a record of the analysis performed to evaluate comparability of uncontrolled transactions with the relevant interna tional transaction; III. a description of the methods considered for determining the ALP in relation to each international transac tion or class of transaction, the method selected as the MAM along with explanations as to why such method was so selected, and how such method was applied in each case; IV. a record of the actual working carried out for determining the ALP, including details of the comparable data and financial information used in applying the most appropriate method, and adjustments, if any, which were made to account for differences between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions; 57

Transfer Pricing Documentation (4) (3) ALP computation specific information V. the assumptions, policies and price negotiations, if any, which have critically affected the determination of the ALP; VI. details of the adjustments, if any, made to transfer prices to align them with ALPs determined under these rules and consequent adjustment made to the total income for tax purposes; (4) Other informations I. any other information, data or document, including information or data relating to the associated enterprise, which may be relevant for determination of the ALP. 58

Transfer Pricing Documentation (5) Further, under sub-rule (3) of rule 10D, the information shall be supported by authentic documents, which may include the following: official publications, reports, studies and data bases from the Government of the country of residence of the associated enterprise, or of any other country; reports of market research studies carried out and technical publications brought out by institutions of national or international repute; price publications including stock exchange and commod ity market quotations; published accounts and financial statements relating to the business affairs of the associated enterprises; agreements and contracts entered into with associated enterprises or with unrelated enterprises in respect of transac tions similar to the international transactions; letters and other correspondence documenting any terms negotiated between the assessee and the associated enterprises; documents normally issued in connection with various transactions under the accounting practices followed. 59

When reference can be made to TPO? (1) (A) Position of law upto 15.10.2015 Earlier, it was mandatory on part of AO to make reference to TPO for determination of ALP wherever aggregate value of international transactions exceeds Rs. 5 crores (The limit has been increased to Rs. 15 crores from 2005-06 onwards.). However, now this value based reference has been done away with and only risk based reference will be made. 60

When reference can be made to TPO? (2) (B) Position of law from 16.10.2015 Normal Provision In the following circumstances, it is mandatory for the AO to refer the case to TPO: 1. Under CASS: If the reason or one of the reasons for selection of a case for scrutiny is a TP risk parameter [under CASS] 2. Compulsory manual selection; Under the compulsory manual selection system (in accordance with the CBDT's annual instructions in this regard] i.e. Cases involving addition in an earlier assessment year on the issue of transfer pricing in excess of Rs. 10 crore or more on a substantial and recurring question of law or fact which is either confirmed in appeal or is pending before an appellate authority. 3. Search and seizure or survey; where search and seizure or survey operations have been carried out under the provisions of the Income-tax Act and findings regarding transfer pricing issues in respect of international transactions or specified domestic transactions or both have been recorded by the Investigation Wing or the AO. There is no monetary limit under this guidance 4. Where no 3CEB filed: where the AO comes to know that the taxpayer has entered into international transactions or specified domestic transactions or both but the taxpayer has not filed the Accountant's report under section 92E at all. 4. Where some transactions are not disclosed in 3CEB; where the AO comes to know that the taxpayer has entered into international transactions or specified domestic transactions or both but the taxpayer has not shown some of the transaction in the Accountant's report under section 92E. 5. Set aside cases: A case involving a transfer pricing adjustment in an earlier assessment year that has been fully or partially set-aside by the ITAT, High Court or Supreme Court on the issue of the said adjustment shall invariably be referred to the TPO for determination of the ALP. Here also the amount of adjustment is not important. 61

When reference can be made to TPO? (3) (C) Position of law APA Cases The assessee shall furnish an annual compliance report to Director General of Incometax (International Taxation) for each year covered in the agreement. The annual compliance report shall be in Form 3CEF. The TPO is required to carry out the Compliance Audit of the Advance Pricing Agreements (APAs) entered into by the Board and the taxpayers in accordance with Rule 10P of the Income-tax Rules. In this case, the TPO is bound by the terms and conditions specified in the APA agreement with the assessee. There is no role of AO. (D) Position of law Safe Harbour Cases The TPO is also required to play an important role in respect of Safe Harbour provisions. Where the Assessing officer doubts the valid exercise of the option for the safe harbour by an assessee, he shall make a reference to the Transfer Pricing Officer for determination of the eligibility of the assessee or the international transaction or both for the purposes of the safe harbour. No reference shall be made by an Assessing Officer after expiry of a period of two months from the end of the month in which Form 3CEFA is received by him. Whenever a reference is made to the TPO under sub-rule (4) or sub-rule (10) of Rule 10TE of the Income-tax Rules, the TPO has to carefully examine all the facts and circumstances of the taxpayer's exercise of an option for Safe Harbour and pass an order in writing as mandated in sub-rule (6) or sub-rule (11) of the said Rule, respectively. 62

When reference can be made to TPO? (4) General Points 1. If a case has been selected for scrutiny on a TP risk parameter pertaining to international transactions only, then the international transactions shall alone be referred to the TPO; 2. If a case has been selected for scrutiny on a TP risk parameter pertaining to specified domestic transactions only, then the specified domestic transactions shall alone be referred to the TPO; and 3. If a case has been selected for scrutiny on the basis of TP risk parameters pertaining to both international transactions and specified domestic transactions, then the international transactions and the specified domestic transactions shall together be referred to the TPO. 4. It has further been provided that, since international transactions may be benchmarked together at the entity level due to the inter-linkages amongst them, if a case has been selected for scrutiny on a TP risk parameter pertaining to one or more international transactions, then all the international transactions entered into by the taxpayer - except those about which the AO has decided not to make a reference shall be referred to the TPO. 5. It has also been provided that though AO has the power under section 92C to determine the ALP of international transactions or specified domestic transactions, determination of ALP should not be carried out at all by the AO in a case where reference is not made to the TPO. However, in such cases, the AO must record in the body of the assessment order that due to the Board's instruction on this matter, the transfer pricing issue has not been examined at all. What does it mean for the taxpayer? Uncertainty for six year? Or Whether Jurisdiction u/s 263 or Reassessment u/s 147 or Rectification u/s 154 possible 63

When reference can be made to TPO? (5) General Points 6. There may be situation where the taxpayer has declared the international transactions or specified domestic transactions in the Accountant's report filed under section 92E of the Act but has made certain qualifying remarks to the effect that the said transactions are not international transactions or specified domestic transactions or they do not impact the income of the taxpayer. 7. There may also be a situation where the AO comes to know that the taxpayer has entered into international transactions or specified domestic transactions or both but the taxpayer has not disclosed the said transactions in the Accountant's report filed and also objected to the applicability of Chapter X. 8. There may also be a situation where the taxpayer has not filed the Accountant's report under section 92E of the Act but the international transactions or specified domestic transactions undertaken by it come to the notice of the AO, however the taxpayer objected to the applicability of Chapter X. 9. In substance, in any of the cases where the assessee objected to the applicability of Chapter X, the AO must consider the taxpayer's objections and pass a speaking order so as to comply with the principles of natural justice. 10. If the AO decides in the said order that the transaction in question needs to be referred to the TPO, he should make a reference after obtaining the approval of the PCIT or CIT. However, where the AO is satisfied with the reply of assessee, it is not mandatory to refer the case to TPO. If the case is not so referred, then, as per CBDT instruction, it would not be possible for the TPO to determine ALP of such transactions. 64

When reference can be made to TPO? (6) Reference in case of undisputed transactions In respect of international transactions which are reported in form 3CEB without any qualifying remark, the AO can arrive at a prima facie belief on the basis of these details whether a reference to the TPO is necessary. No detailed enquiries are needed at this stage and the AO should not embark upon scrutinizing the correctness or otherwise of the price of the international transaction at this stage. There is nothing in section 92CA to suggest that the AO should hear the assessee or record reasons before making a reference to the TPO nor is there anything to suggest that the AO should ask the assessee whether he should himself proceed to determine the arm's length price or should involve the TPO for this purpose. Before making a reference to the TPO, the AO has to seek the approval of the Principal Commissioner or Commissioner as provided in the Act. The provisions of Section 92CA of the Act, inter-alia, refer to the international transaction. Hence, all international transactions, in relation to which a reference to the TPO is considered necessary, have to be explicitly mentioned in the letter through which the reference is being mode. Valuation done by TPO is binding on AO and CIT has no power to review valuation done by TPO u/s 263. 65

When reference can be made to TPO? (7) Reference in case of disputed transactions In respect of international transactions which are (i) either not reported in form 3CEB or (ii) reported with any qualifying remark, or (iii) no form 3CEB is filed, the AO must. as a jurisdictional requirement record his satisfaction that there is an income or a potential of an income arising and/or being affected on determination of the ALP of on international transaction before he proceeds to determine the ALP under Section 92C of the Act or to refer the matter to the TPO. The AO must provide an opportunity of being heard to the taxpayer before recording his satisfaction or otherwise Before making a reference to the TPO, the AO has to seek the approval of the Principal Commissioner or Commissioner as provided in the Act. The provisions of Section 92CA of the Act, inter-alia, refer to the international transaction. Hence, all international transactions, in relation to which a reference to the TPO is considered necessary, have to be explicitly mentioned in the letter through which the reference is being mode. Valuation done by TPO is binding on AO and CIT has no power to review valuation done by TPO u/s 263. 66

When reference can be made to TPO? (8) Whether AO can make reference to TPO in respect of an AY of which no assessment is pending? No [Maximize Learning (P.) Ltd. v. Asstt. CIT[ 2015 ] 54 taxmann.com 234 (Pune - Trib.)] 67

Reassessment (1) (A) When a case can be selected for TP scrutiny u/s 147 1. International transactions were reported in form 3CEB. The AO neither determined ALP himself/herself nor had made a reference to TPO. Therefore the AO wants to reopen the case u/s 147, based on following grounds; a) Where adjustments are made by TPO in respect of other AY and based on this report, the AO feel that there is escapement of income in the relevant year also. Up to 4 years: In view of a line of precedent of the Supreme Court, it is a settled principle of law that the reopening of an assessment on the basis of information which is disclosed in the course of assessment proceedings for a subsequent assessment year is permissible. Therefore, the reopening of the assessment within a period of four years on the basis of the order of assessment for other year would constitute tangible material on the basis of which the assessment could be reopened. [Rabo India Finance Ltd. v. Dy. CIT [2013] 34 taxmann.com 228 (Bombay) and Coca Cola India Inc. v. Asstt. CIT [2009] 177 Taxman 103/309 ITR 194/221 CTR (Punj. & Har.) 225] Beyond 4 years: Where an assessment is sought to be reopened beyond a period of four years, the proviso to Section 147 stipulates as a jurisdictional requirement that there must be a failure on the part of the assessee to disclose fully and truly all material facts necessary for his assessment for that Assessment Year. Therefore, the reopening of the assessment after a period of four years on the basis of the order of assessment for other year would not be deemed as a failure on the part of the assessee to disclose fully and truly all material facts necessary for his assessment for that Assessment Year. [Rabo India Finance Ltd. v. Dy. CIT [2012] 27 taxmann.com 163 (Bom.)] 68

Reassessment (2) b) Where no such evidence of escapement is available with AO but he feel that determination ALP is required to find out escapement of income in the relevant year. It is well settled that the AO has power to reopen the assessment provided there is "tangible material" to come to the conclusion that income has escaped assessment. Therefore, the reason of determination of the Arm's Length Price, for reopening the assessment, was not a reason at all. [CIT v. Cheil Communications India (P.) Ltd. [2013] 33 taxmann.com 170 (Delhi)] 2. International transactions are not reported in form 3CEB. Therefore the AO wants to reopen the case u/s 147. Section 147 of the Act, provides for reopening of the cases of the previous years, if any income chargeable to tax has escaped assessment. Explanation to this section provides certain circumstances where it will be deemed that income has escaped assessments. It has been provided that in all cases where it is found that an international transaction has not been reported either by non-filing of report or otherwise by not including such transaction in the report mentioned in section 92E then such non-reporting would be considered as a case of deemed escapement of income and such a case can be reopened under section 147 of the Act. (effective from 1st July, 2012) 69

Assessment by AO (1) Where reference is made to TPO ALP of the international transactions have to be taken as determined by the TPO Have to follow the DRP directions, if any against draft order CIT, u/s 263, cannot revise that part of order which is subject to DRP directions or is based on order of TPO. CIT can revise only that part of order which is decided exclusively by AO and which is not litigated before DRP. AO can not reopen the case u/s 147 which is based on TPO or DRP order AO can not rectify that part of order which is based on TPO order. Only TPO can rectify that part of order. 70

Assessment by AO (2) Where no reference is made to TPO AO cannot determine ALP of international transactions, where reference to TPO is not made and AO have to specifically mentioned that TP matter is not investigated by him CIT can revise AO order u/s 263? Where the reference to TPO is mandatory, however no such reference is made by AO, the CIT can ask to refer the case to TPO. [Ranbaxy Laboratories Ltd. v. CIT [2011] 16 taxmann.com 418 (Delhi)] 71

No Estoppels Against Provision of Law Modification in benchmarking method, comparable etc. during assessment and appeal The taxing authorities exercise quasi-judicial powers and in doing so, they must act in a fair and not a partisan manner. Although it is a part of their duty to ensure that no tax which is legitimately due from an assessee should remain unrecovered, they must also at the same time not act in a manner as might indicate that scales are weighed against the assessee. If some wrong comparable is chosen or wrong method is applied, there is no estoppels under the provisions in pointing out the defect even before higher authorities. The Income-tax Appellate Tribunal is a fact-finding body and, therefore, has to take into account all the relevant material and determine the question as per the statutory regulations. When substantial justice and technical considerations are pitted against each other, the cause of substantial justice deserves to be preferred. [Dy. CIT v. Quark Systems (P.) Ltd. [2010] 38 SOT 307/4 ITR (Trib.) 606/132 TTJ 1 (Chd.)(SB) and CIT v. Quark Systems India (P.) Ltd. [2011] 11 taxmann.com 427 (Punj. & Har.)] 72

Principle of Natural Justice (1) One of the fundamental principles of assessment is; the Rule of Audi alteram Partem which means hear the other side or that no man shall be condemned unheard. Rules of "natural justice" are not embodied rules. The phrase "natural justice" is also not capable of a precise definition. The underlying principle of natural justice, evolved under the common law, is to check arbitrary exercise of power by the State or its functionaries. Therefore, the principle implies a duty to act fairly, i.e. fair play in action. As observed by Supreme Court in A.K. Kraipak v. Union of India [1969] 2 SCC 262, the aim of rules of natural justice is to secure justice or to put it negatively to prevent miscarriage of justice. These rules can operate only in areas not covered by any law validly made. They do not supplant the law but supplement it. (Also see ITO v. Madnani Engg. Works Ltd. [1979] 118 ITR 1 (SC) ) 73

Principle of natural justice (2) Therefore a fair hearing postulates making known to the other side the evidence being relied upon in support of the notice. There can be three situations: A statutory provision specifically or by necessary implication provide the opportunity of being heard before any adverse order against the taxpayer A statutory provision either specifically or by necessary implication excludes the application of principles of natural justice A statutory provision is silent on the application of principles of natural justice Under the first situation, the opportunity of being heard is specifically provided, hence no dispute. In the second case, as the statutory provision specifically or by necessary implication excludes the application of principles of natural justice, the court would not ignore the legislative mandate. In the third situation, the requirement of giving reasonable opportunity of being heard before an order is made, is generally read into the provisions of a statute, particularly when the order has adverse civil consequences for the party affected. The principle will hold good irrespective of whether the power conferred on a statutory body or ITAT is administrative or quasi-judicial. 74

Time barred assessment are null and void Time-barring assessment does not come within the purview of mistake, defect or omission referred in section 292B of the Income-tax Act, 1961. This is not a procedural mistake which can be rectified by taking recourse of section 292B of the I.T. Act. Also, stay of the demand have to be given even the issue on merit is still pending in appellant proceedings. [P.K. Ramachandran v. State of Kerala and another, JT. 1997 (8) S.C. 189 and Vijay Television (P.) Ltd. v. DRP [2014] 46 taxmann.com 100 (Madras)] 75

Receipt of reference from AO Issue of first notice to the taxpayer Issue of final show cause notice to the taxpayer Audit by TPO(1) Journey before TPO Completion of audit and final TP order with DIT/CIT(TP) approval Completion of assessment and issue of draft assessment order (draft order only if there are TP adjustments) On receipt of draft assessment order, the assessee has two options. Where the assessee intimates its acceptance of the variations to the AO within the period of 30 days, or does not reply within the prescribed period of 30 days, then in both the situations, the AO have to pass the final assessment order with the proposed variation suggested in the draft assessment order. The AO must pass the assessment order within one month from the end of the month in which the acceptance is re ceived or the period for filing of objection expires. In this case, the assessee can file appeal before CIT(A). Where the assessee intimates its reservations against the proposed variations to the AO within the period of 30 days, then the assessee can file its objection to DRP. In this case the AO can pass the assessment order only after receipt of directions from the DRP In this case, the assessee can file appeal against the order of AO directly before ITAT. No direction shall be issued by the panel after nine months from the end of the month in which the draft order is forwarded to the eligible assessee. It must be noted that the time-limit must be reckoned from the date on which the AO forwards the draft order to the eligible assessee and not from the date on which the eligible assessee receives the draft order. 76

Audit by TPO(2) First Notice by TPO The first notice can require the following information and documents:- Copy of Form No. 3CEB. Complete set of audited final accounts & auditor's report. Copy of tax audit report. Copy of computation of total income. Copies of information & documents maintained under section 920 (I) of Income-tax Act read with rules 100(1) & (3) of Income-tax Rules, along with a copy of transfer pricing study report. Global transfer pricing policy of associated enterprises. Copy of assessment order for the last assessment year. Copy of transfer pricing order for the last assessment year. Copies of CIT (Appeals) and ITAT for earlier years involving adjudication of transfer Copies of ground of appeal and statement of facts in respect of appeals, if any, field against the last year assessment order. If any associated enterprise is filling its tax return in India, a copy of the return along with details of its assessment. 77

Audit by TPO(3) First Notice by TPO Details of all international transactions along with segment-wise break-up of such transactions. Copies of relevant agreements in respect of international transactions. Details of transactions with associated enterprises relating to transfer of tangible or intangible goods or provision of services without any consideration, along with reasons therefore. Details of transfer pricing adjustments, if any, offered in the tax return. Details of transactions with third parties in India or outside India along with their comparability with international transact ions. Details of Corporate Guarantee given/taken on behalf of the AE. Details of Expenditure on advertising. Details of changes in shareholding structure, whether directly or indirectly. Fact Sheet (duly filled). It required earlier year GP/NP comparison etc. Soft copies of all these documents. You are requested to comply with the terms of this notice by attending office on.at 10:00 am either in person or through a representative duly authorized in writing in this behalf. Please note that in case of non compliance, the arm' s length price for' international transactions' shall be determined u/s. 92CA(3) of the I.T. Act on merits on the basis of material on record. 78

Audit by TPO(4) Hearing before TPO TPO generally asked for updated TP study based on current data of comparables of relevant PY Modification in benchmarking method, comparable etc. during assessment and appeal is possible Data about foreign AE are generally not asked unless the tested party is foreign AE or PSM is selected as best method or some foreign comparable are taken. If taxpayer failed to provide the relevant data, TPO also have to make search for the comparables and he/she can not make adjustment on ad hoc basis. However, penalty for non maintenance can also be levied. 79

Audit by TPO(5) TPO s Power Where the transactions are reported by assessee in the report furnished under section 92E Before amendment made by the Finance Act, 2011, w. e. f. 1st June, 2011, it was the settled position of law that the TPO cannot, under section 92CA(3), determine the ALP in relation to an international transaction not referred to him by the AO under section 92CA(1). If during the course of proceedings before him, it is found that there are certain other transactions; which have not been referred to him by the AO, he will have to take up the matter with the AO so that a fresh reference is received with regard to such transactions. It may be noted that the reference to the TPO is transaction and enterprise specific. But it was the general practice to refer all the transactions reported in the report to TPO. After section 92CA has been amended by the Finance Act, 2011 w. e. f. 1st June, 2011 it has been specifically provided that the jurisdiction of the TPO shall extend to the determination of the ALP in respect of other international transactions, which are noticed by him subsequently, in the course of proceedings before him even the same is not referred by AO. 80

Audit by TPO(6) TPO s Power Where the transactions are not reported by assessee in the report furnished under section 92E, even the transaction is covered under the scope of international transaction. If the proceedings are closed on or before 30th June 2012 then the TPO have no power to determine ALP of such transactions even the transaction is international transaction. However, where the proceedings are open as on 1st July, 2012, (for assessment year 2002-03 and onward) then the TPO is empowered to determine Arm's Length Price of an international transaction noticed by him in the course of proceedings before him, even if the said transaction was not referred to him by the AO. This amendment is important because sometimes taxpayer forget to report some of transactions in form 3CEB. 81

Audit by TPO(7) Rectification u/s 154 Section 154 of the Income-tax Act empowers an income-tax authority, referred to in section 116, to rectify any mistake apparent from the record in the orders passed by them. An order of rectification can be made within a period of four years from the date of the passing of the order sought to be rectified. AO is also one of the authorities referred to in section 116. Hence, AO can rectify the assessment order. However, where the ALP is determined by AO based on TPO report, which is binding on the AO, the AO cannot rectify the assessment order so as to overrule the TPO determination of ALP. Nevertheless, the provisions of section 92CA permit rectification/amendment by TPO also. Section 92CA(5) provides that with a view to rectifying any mistake apparent from the record, the TPO may amend any order passed by him and the provisions of section 154 shall apply. Section 92CA(6) provides that where any amendment is made by the TPO under sub-section (5), he shall send a copy of his order to the AO who shall thereafter proceed to amend the order of assessment in conformity with such order of the TPO. But the scope u/s 154 read with section 92CA(5) is limited to apparent error. 82

Audit by TPO(8) Principle of res judicata and consistency Principle of res judicata simply means that previous years decisions are binding on the authorities. It means a thing adjudicated should not be again litigated. But this principle is not applicable to income-tax proceedings. However, consistency is always the hallmark to maintain judicial discipline, even the principle of res judicata is not applicable to any proceeding under the Act. The main question to decide the issue is to see whether the previous decision is wrong on the facts of case or as per the provisions of law or the law is changed or facts are different from the previous years. If not, then it will not be right to disturb the existing situation. If two views are possible then also it is not recommendable to take a different stand if the AO opines that the other view is better unless the view taken is erroneous as per fact and law. There are three reasons for change of view in the next year: I. Facts in the current year have changed as compared to previous years II. Position of law is changed either due to change of law or due to decision of Court III. Previous case of assessee was decided wrongly as per the facts and position of law. 83

Dispute Resolution Panel (1) In order to address the concerns of the multinational companies and to provide mechanism for speedy disposal of their cases, so as to attain finality, section 144C was inserted under the Act with effect from 1st October, 2009 to facilitate expeditious resolution of disputes. The term Dispute Resolution Panel means a collegium comprising of three Commissioners of Income-tax constituted by the Board for this purpose. In the beginning the judiciary was very optimistic about the new dispute resolution mechanism. But, in the very first year of operation, judiciary started losing faith when the first batch of DRP orders came before it. The Finance Act 2012 has, further diminished the practical utility of this institution by providing appeal option to department against its order. In few cases even appeal has already been filed by the department. The very purpose for which these institutions were created have been vanished. The only advantage to go for DRP is automatic stay of demand, as there is no final assessment order, which is not available in case of appeal to CIT (A). By force, the taxpayers have to opt for DRP as the stakes are high. Otherwise in its current form, CIT (A) seems to be better option than DRP. 84

Dispute Resolution Panel (2) How many DRP Panels are constituted by the Government? Seven (3 at Mumbai and 2 each at Delhi and Bengaluru) Whether jurisdictional Commissioner can be nominated as a member of the DRP No [Hyundai Heavy Industries Ltd. v. Union of India [2011] 12 taxmann.com 309/201 Taxman 237 (Uttarakhand)] Who can opt for DRP route? If the AO proposes to make, on or after 1-10-2009, any variation in the income or loss returned by an eligible assessee which is prejudicial to the interest of that assessee, the AO must, in the first instance, forward a draft of the proposed assessment order to the eligible assessee. The term eligible assessee means (i) any person in whose case the any variation in the income or loss returned by an eligible asses see which is prejudicial to the interest of that assessee arises as a consequence of the order of the TPO under section 92CA(3) of the Act, and (ii) any foreign company. 85

Dispute Resolution Panel (3) Whether DRP route is optional? As per section 144C(2)/(3) DRP is optional and the assessee can avail the exiting appeal procedure also instead of DRP. However, once the option of filing an objection against the draft assessment order before the DRP has been exercised, the assessee cannot withdraw the objection and opt for the normal channel of filing an appeal before the CIT (Appeals). What are the powers of DRP? The panel has powers to confirm, reduce or to enhance the variations proposed in the draft order. However, the panel shall not (i) set aside any proposed variations, or (ii) issue any direction for further enquiry and for passing of the assessment order. If the members of the panel differ in opinion on any point, the point shall be decided according to the opinion of the majority of the members. No direction prejudicial to the interest of the assessee shall be issued unless an opportunity of being heard is given to the assessee. No direction prejudicial to the interest of the revenue shall be issued unless an opportunity of being heard is given to the AO. 86

Dispute Resolution Panel (4) Whether DRP has power of enhancement? Earlier, the power of DRP was restricted only to the issues raised in the draft assessment order and therefore it cannot enhance the income as a result of any new issue which comes to the notice of the panel during the course of proceedings before it. Hence the Finance Act 2012 inserted an Explanation w.r.e.f. 1st day of April, 2009 (assessment year 2009-10) in section 144C to clarify that the power of the DRP to enhance the variation shall include and shall always be deemed to have included the power to consider any matter arising out of the assessment proceedings relating to the draft assessment order. This power to consider any issue would be irrespective of the fact whether such matter was raised by the eligible assessee or not. Whether DRP can entertain additional evidences? A combined reading of section 144C read with Rule 4 of Income-tax (Disputes Resolution Penal) Rules, 2009, clearly show that the DRP had to take into consideration the evidence furnished by the assessee before issuing any directions. The proviso to Rule-4B Income-tax (Disputes Resolution Penal) Rules, 2009, clearly deals with additional evidence and requires that it should be separately filed along with application stating the reasons for so doing. 87

Dispute Resolution Panel (5) Time-limit for issue of directions No direction shall be issued by the panel after nine months from the end of the month in which the draft order is forwarded to the eligible assessee. It must be noted that the time-limit must be reckoned from the date on which the AO forwards the draft order to the eligible assessee and not from the date on which the eligible assessee receives the draft order. Whether DRP s directions are binding on AO? On the receipt of the directions, the AO shall complete the assessment in conformity with the directions within one month from the end of the month in which such direction is received by him. Initially the directions issued by the panel were binding on the AO only and taxpayers can go in appeal before the ITAT. The Finance Act 2012 w. e. f. 1st day of July, 2012 provides that the AO may also file an appeal before the ITAT against an order passed in pursuance of directions of the DRP.. 88

Recent Developments Risk Based Assessment Multiple Year and Range Concept for Benchmarking CBC Reporting Requirement Revision of Safe Harbour Rules Introduction of Secondary Adjustment Limitation of Interest deduction in certain cases.. 89

Risk Based Assessment Earlier, it was mandatory on part of AO to make reference to TPO for determination of ALP wherever aggregate value of international transactions exceeds Rs. 5 crores (The limit has been increased to Rs. 15 crores from 2005-06 onwards.). Now, it is based on risk parameters and in the following circumstances, it is mandatory for the AO to refer the case to TPO: (discussed in earlier slides) 90. Under CASS: Compulsory manual selection; Search and seizure or survey; Where no 3CEB filed: Where some transactions are not disclosed in 3CEB; Set aside cases:

Multiple Year and Range Concept for Benchmarking (1) Multiple year data can be used in the following manner: The multiple year data would be used only in case of determination of ALP is by TNMM, RPM or CPM; The multiple year data should comprise three years including the current year i.e. (year in which transaction has been undertaken) and its use for above mentioned methods shall be mandatory; In case of non-availability of data for 3 years for any of the following reasons: Data of the current year of the comparables may not be available on the databases at the time of filing of returns of income by taxpayers; A comparable may fail to clear a quantitative filter in any one out of the three years; and A comparable may have commenced operations only in the last two years or may have closed down operations during the current year. the use of data of two out of relevant three years shall be permitted. The data of the current year, however, can be used during the transfer pricing audit by both the taxpayer and the department if it becomes available at the time of audit... 91

Multiple Year and Range Concept for Benchmarking (2) The "Range" concept shall be used only in case the method used for determination of ALP is TNMM, RPM or CPM. Therefore, this concept would not be used under CUP method and PSM. The following steps would be required to construct the range: A minimum of 6 entities are required to be selected as comparable entities of the tested party, based on the similarity of their functions, assets and risks with that of the tested party; 3-year data of these 6 entities (or more) would be considered and the weighted average of such 3-year data of each company would be used to construct the data set. In certain circumstances, data of 2 out of 3 years could also be used. Thus, the data set or series would have a minimum of 6 data points; For calculating the weighted average, the numerator and denominator of the chosen PLI would be aggregated for all the years for every comparable entity and the margin would be computed thereafter; and The data points lying within the 35th to 65th percentile of the data set of series would constitute the range. If the transfer price of the tested party falls outside the range as constructed above, the median of the range would be taken as ALP and adjustment to transfer price shall be made. If the transfer price is within the range no adjustment shall be made. There shall not be two different data sets - one for testing and one for making adjustments. 92.

CBC Reporting Requirement The OECD report on Action 13 of BEPS Action plan provides for revised standards for transfer pricing documentation and a template for country-by-country reporting of income, earnings, taxes paid and certain measure of economic activity. India has been one of the active members of BEPS initiative and part of international consensus. It is recommended in the BEPS report that the countries should adopt a standardised approach to transfer pricing documentation. A three-tiered structure has been mandated consisting of: a master file containing standardised information relevant for all multinational enterprises (MNE) group members; a local file referring specifically to material transactions of the local taxpayer; and a country-by-country report containing certain information relating to the global allocation of the MNE's income and taxes paid together with certain indicators of the location of economic activity within the MNE group. The report mentions that taken together, these three documents (country-by-country report, master file and local file) will require taxpayers to articulate consistent transfer pricing positions and will provide tax administrations with useful information to assess transfer pricing risks. It will facilitate tax administrations to make determinations about where their resources can most effectively be deployed, and, in the event audits are called for, provide information to commence and target audit enquiries. 93.

94 Introduction of Secondary Adjustment (1) Secondary adjustment" means an adjustment in the books of accounts of the assessee and its associated enterprise to reflect that the actual allocation of profits between the assessee and its associated enterprise are consistent with the transfer price determined as a result of primary adjustment, thereby removing the imbalance between cash account and actual profit of the assessee. Now the assessee would be required to carry out secondary adjustment in case where primary adjustment is:. made suo motu by the assessee in his return of income; or made by the Assessing Officer has been accepted by the assessee; or determined by an advance pricing agreement; or made as per the safe harbour rules; or arising as a result of resolution of an assessment by way of the mutual agreement procedure.

Introduction of Secondary Adjustment (2) Where as a result of primary adjustment, there is an increase in the total income or reduction in the loss and the excess money which is available with its associated enterprise, if not repatriated to India within the prescribed time limit, shall be deemed to be an advance given by the assessee to such associated enterprise and the interest on such advance, shall be computed as the income of the assessee, in the manner as may be prescribed However, secondary adjustment will be not be carried out if the primary adjustment does not exceed INR 1 Cr. and the primary adjustment is made in respect of assessment year 2016-17 or prior assessment years.. This amendment will take effect from 1st April, 2018 and will, accordingly, apply in relation to the assessment year 2018-19 and subsequent years.. 95

Limitation of Interest deduction in certain cases A new section 94B is inserted, in line with the recommendations of OECD BEPS Action Plan 4, to provide that interest expenses claimed by an entity to its associated enterprises shall be restricted to 30% of its earnings before interest, taxes, depreciation and amortization (EBITDA) or interest paid or payable to associated enterprise, whichever is less. The provision is applicable to an Indian company, or a permanent establishment of a foreign company who pays interest to a non-resident or to a permanent establishment of a non-resident and who is an 'associated enterprise' of the borrower. Further, the debt shall be deemed to be treated as issued by an associated enterprise where it provides an implicit or explicit guarantee to the lender or deposits a corresponding and matching amount of funds with the lender. The provisions shall allow for carry forward of disallowed interest expense to eight assessment years immediately succeeding the assessment year A basic threshold of interest expenditure of one crore rupees is provided for applicability of this provision This provision is not applicable to Banks and Insurance business This provision will apply in relation to the assessment year 2018-19 and subsequent years. 96

THANKS CA Hari Om Jindal Mob. +91-9810338200 Email: hojindal@yahoo.co.in Author: Indian Transfer Pricing in relation to International Taxation (2 Vol.) 2015 Ed. Law Relating to Transfer Pricing with OECD Transfer Pricing Guidelines 2011 Ed. Business Expenditure Law and Practice 2007 & 2008 Ed. 97