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