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1. Domestic transactions - Transfer Pricing  Inspired by – Apex court ruling – Glaxo Smithkline (2010) 195 Taxman 35 (SC): we are of the view that certain.

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Presentation on theme: "1. Domestic transactions - Transfer Pricing  Inspired by – Apex court ruling – Glaxo Smithkline (2010) 195 Taxman 35 (SC): we are of the view that certain."— Presentation transcript:

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2 Domestic transactions - Transfer Pricing  Inspired by – Apex court ruling – Glaxo Smithkline (2010) 195 Taxman 35 (SC): we are of the view that certain provisions of the Act, like section 40A(2) and section 80- IA(10), need to be amended empowering the Assessing Officer to make adjustments to the income declared by the assessee having regard to the fair market value of the transactions between the related parties. The Assessing Officer may thereafter apply any of the generally accepted methods of determination of arm’s length price, including the methods provided under Transfer Pricing Regulations. However, in a number of matters, we find that, many a times, the Assessing Officer is constrained by non-maintenance of relevant documents by the taxpayers as, currently, there is no specific requirement for maintenance of documents or getting specific transfer pricing audit done by the taxpayers in respect of domestic transactions between the related parties. The suggestions which need consideration are whether the law should be amended to make it compulsory for the taxpayer to maintain books of account and other documents on the lines prescribed under rule 10D of the Income-tax Rules in respect of such domestic transactions and whether the taxpayer should obtain an audit report from his Chartered Accountant so that the taxpayer maintains proper documents and requisite books of account reflecting the transactions between related entities as at arm’s length price based on generally accepted methods specified under the Transfer Pricing Regulations” we are of the view that certain provisions of the Act, like section 40A(2) and section 80- IA(10), need to be amended empowering the Assessing Officer to make adjustments to the income declared by the assessee having regard to the fair market value of the transactions between the related parties. The Assessing Officer may thereafter apply any of the generally accepted methods of determination of arm’s length price, including the methods provided under Transfer Pricing Regulations. However, in a number of matters, we find that, many a times, the Assessing Officer is constrained by non-maintenance of relevant documents by the taxpayers as, currently, there is no specific requirement for maintenance of documents or getting specific transfer pricing audit done by the taxpayers in respect of domestic transactions between the related parties. The suggestions which need consideration are whether the law should be amended to make it compulsory for the taxpayer to maintain books of account and other documents on the lines prescribed under rule 10D of the Income-tax Rules in respect of such domestic transactions and whether the taxpayer should obtain an audit report from his Chartered Accountant so that the taxpayer maintains proper documents and requisite books of account reflecting the transactions between related entities as at arm’s length price based on generally accepted methods specified under the Transfer Pricing Regulations” 2

3 Domestic transactions - Transfer Pricing  May lead to economic double taxation  Inline with some tax jurisdictions like Australia, Thailand, Denmark etc., Thailand, Denmark etc.,  Increase in compliance burden 3

4 Domestic transactions -Transfer Pricing  New sub.sec (2A) to sec.92 “(2A) Any allowance for an expenditure or interest or allocation of “(2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to the specified any cost or expense or any income in relation to the specified domestic transaction shall be computed having regard to the domestic transaction shall be computed having regard to the arm’s length price.” w.e.f 1 st Apr ‘13 arm’s length price.” w.e.f 1 st Apr ‘13  Specified domestic transaction means “92BA. For the purposes of this section and sections 92, 92C, 92D “92BA. For the purposes of this section and sections 92, 92C, 92D and 92E, “specified domestic transaction” in case of an assessee and 92E, “specified domestic transaction” in case of an assessee means any of the following transactions, not being an means any of the following transactions, not being an international transaction, namely:— international transaction, namely:— 4

5 Domestic transactions-Transfer Pricing  Specified domestic transaction means : (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; (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; (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; (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 sub-section (10) of section 80-IA; (iv) any business transacted between the assessee and other person as referred to in sub-section (10) of section 80-IA; 5

6 Domestic transactions-Transfer Pricing  Specified domestic transaction means : (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 and where the aggregate of such transactions entered into by the assessee in the previous year exceeds a sum of five crore rupees.” - assessee in the previous year exceeds a sum of five crore rupees.” - w.e.f. 1 st Apr 2013 w.e.f. 1 st Apr

7 Domestic transactions -Transfer Pricing  S.10AA  S.40A(2)(b) – FMV vs. ALP  S.80A - Scope of deductions & FMV for inter business transfers transfers  S.80IA (8) – Eligible business Vs. Other business  S. 80IA (10) - Eligible assessee Vs. Other person  S.80IAB(3), 80IB(13),80IC (7), 80ID (5), 80IE (6) 7

8 Domestic transactions-Transfer Pricing  S.92C – computation of ALP – methodologies- also apply to Spec. dom. transactions apply to Spec. dom. transactions  S.92CA (1)(2)&(3)- reference, service of notice & order to be made by TPO to be made by TPO  S.92D – documentation – maintenance & production  S.92E – report from an accountant – may be a new form 8

9 Domestic transactions -Transfer Pricing Corresponding Amendments :  S. 40A(2) – Proviso inserted to provide for ALP in cl(a) : “ Provided that no disallowance, on account of any expenditure “ Provided that no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction value, shall be made in respect of a specified domestic transaction referred to in S.92BA, if such transaction is at arm’s length price as referred to in S.92BA, if such transaction is at arm’s length price as defined in cl.(ii) of S.92F” defined in cl.(ii) of S.92F” - FMV different from ALP? - FMV different from ALP?  In cl.(b) (iv), after the words “ or any relative of such director, partner or member”, the words “or any other company carrying on partner or member”, the words “or any other company carrying on business or profession in which the first mentioned company has business or profession in which the first mentioned company has substantial interest” shall be inserted. substantial interest” shall be inserted. 9

10 Domestic transactions -Transfer Pricing Corresponding Amendments :  S. 80A – Cl (iii) to Explanation inserted : “in relation to any goods or services sold, supplied or acquired means the arm’s length price as defined in cl.(ii) of S.92F of such means the arm’s length price as defined in cl.(ii) of S.92F of such goods or services, if it is a specified domestic transaction referred to goods or services, if it is a specified domestic transaction referred to in S.92BA” in S.92BA” is ALP synonymous with Market value ? is ALP synonymous with Market value ?  S. 80-IA – Explanation substituted in Ss(8) : 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 cl(ii) of S.92F, where the transfer of such goods or services is a specified domestic transaction referred to in S.92BA 10

11 Domestic transactions -Transfer Pricing Corresponding Amendments :  In S.80 IA(10) - Proviso inserted : “Provided that in case the aforesaid arrangement involves a specified transaction referred to in S.92BA, the amount of profits from such transaction shall be determined having regard to arm’s length price as defined in clause (ii) of S. 92F” “Provided that in case the aforesaid arrangement involves a specified transaction referred to in S.92BA, the amount of profits from such transaction shall be determined having regard to arm’s length price as defined in clause (ii) of S. 92F” not clear whether ALP and FMV are the same. not clear whether ALP and FMV are the same. 11

12 12 Sec 40A (2)(b) – Related Party Sr.NoPayer / assessee Payee (i)Individual Any relative [defined in sec. 2(41) to mean husband, wife, brother, sister, lineal ascendant or descendant] * Definition of Relative u/s 56(2) not relevant (ii)Companyany director or relative of such director Firm (includes LLP)any partner or relative of such partner AOPany member or relative of such member HUFany member or relative of such member (iii)Any Assesseeany individual having substantial interest in the assessee’s business or relative of such individual (iv)Any assesseea Company, Firm, AOP, HUF having substantial interest in the assessees business or any director, partner, member or relative of such director, partner or member or (newly inserted) any other company carrying on business or profession in which the first mentioned company has substantial interest. X Ltd. (subsidiary co) A Ltd. (holding co) Y Ltd. (subsidiary co) Relationship can exists any time during the year

13 Type of transactions covered (illustrations for payments made by a Company) … 13 Case 1 - Director or any relative of the Director of the taxpayer – Section 40A(2)(b)(ii) Mr. A Mr. C Assessee (Taxpayer) Mr. D Director Relative Director Covered transactions Case 2 - To an individual who has substantial interest in the business or profession of the taxpayer or relative of such individual – Section 40A(2)(b)(iii) Mr. A Mr. C Assessee (Taxpayer) Mr. D Relative Substantial interest >20% Relative Holding Structure

14 Type of transactions covered (illustrations for payments made by a Company) … 14 Case 3 – To a Company having substantial interest in the business of the taxpayer or any director of such company or relative of the director – Section 40A(2)(b)(iv) A Ltd Mr. C Assessee (Taxpayer) Mr. D Relative Director Covered transactions Case 4 – Any other company carrying on business in which the first mentioned company has substantial interest – Section 40A(2)(b)(iv) C Ltd B Ltd Assessee (Taxpayer) A Ltd Substantial interest >20% Holding Structure Substantial interest >20%

15 Type of transactions covered (illustrations for payments made by a Company) … Type of transactions covered (illustrations for payments made by a Company) … 15 Case 5 – To a Company of which a director has a substantial interest in the business of the taxpayer or any director of such company or relative of the director – Section 40A(2)(b)(v) Mr. A Mr. C Assessee (Taxpayer) B Ltd Director Covered transactions Holding Structure Substantial interest >20% Mr. D Relative

16 Type of transactions covered (illustrations for payments made by a Company)… Type of transactions covered (illustrations for payments made by a Company)… 16 Case 6 – To a Company in which the taxpayer has substantial interest in the business of the company – Section 40A(2)(b)(vi)(B) B Ltd Assessee (Taxpayer) Covered transactions Case 7 – Any director or relative of the director of taxpayer having substantial interest in that person– Section 40A(2)(b)(vi)(B) Mr C Mr B Assessee (Taxpayer) A Ltd Substantial interest >20% Holding Structure Substantial interest >20% Director Relative D Ltd Substantial interest >20%

17 Tax burden, if transaction not at ALP 17 X Ltd. (non-tax holiday) Disallowance of ` 20 to Y Ltd [40A(2)(b)] Y Ltd. (non-tax holiday) Sale at ` 120 v/s ALP i.e. ` 100 X Ltd. (tax holiday) Y Ltd. (non-tax holiday) Sale at ` 120 v/s ALP i.e. ` 100 Double Adjustment Tax holiday on ` 20 not allowed to X Ltd – [80IA(10)] (more than ordinary profits) Disallowance of ` 20 to Y Ltd - [40A(2)(b)] X Ltd. (tax holiday) Y Ltd. (non-tax holiday) Sale at ` 80 v/s ALP i.e. ` 100 Inefficient pricing structure – reduced tax holiday benefit since sale price is lower than ALP

18 Section 80IA (8) & 80IA (10) – Deduction in respect of profits and gains from industrial undertaking or enterprise engaged in infrastructure development, etc.  No guidance on the meaning of close connection  To align ordinary profits with arm’s length price. For example:  OP/ TC of 30% considered to be at arm’s length by the TPO  Under 801A(10) the AO states that the profits are more than ordinary  Solution: Defend price or evaluate alternate methods (other then profit based)  Impact of non-charging of services/ costs to tax holiday undertaking 18 80IA (8)80IA (10) Inter-unit transaction of goods or servicesBusiness transacted with any person generates more than ordinary profits Owing to either close connection or any other reason Applicable where transfer is not at market value Applicable to tax holiday units earning more than ordinary profit Onus on tax payerPrimary onus on taxpayer Onus on tax authorities as well ALP of 5 comparable companies OP/TCMark-up of the tax holiday entity OP/TC Arithmetic mean = 15%30%

19 Tax holiday undertaking  International TP Vs. Tax holiday profits  Sec 10A(7) / 10B (7)  Case laws - Visual Graphics Computing Services (India) Pvt. Ltd vs ACIT 2012) 52 SOT 172 (URO), Weston Knowledge Systems & Solutions (India) Pvt. Ltd. vs ITO (2012) 52 SOT 120 (Hyd)(URO)  AO has no authority to reduce tax holiday claim once approved by TPO  Whether same approach is possible when domestic TP is targeted in computing ordinary profits.  Domestic TP supports the approach of AO in restricting ordinary profits? 19

20 Cost allocation  Whether corporate group expenses to be allocated? Courts held that it need not be allocated Courts held that it need not be allocated Case laws - Wipro Information Technology vs DCIT (2004) 88 TTJ(Bang) 778 ; Zandu Pharmaceuticals Works Ltd, vs CIT (2013) 213 Taxman 207 Ponds India Ltd (ITA NO. 2047/Mad/88)Case laws - Wipro Information Technology vs DCIT (2004) 88 TTJ(Bang) 778 ; Zandu Pharmaceuticals Works Ltd, vs CIT (2013) 213 Taxman 207 Ponds India Ltd (ITA NO. 2047/Mad/88) Whether every cost allocation should have a mark up?Whether every cost allocation should have a mark up? 20

21 21 Transfer Pricing Process Identification of Intra Group Transactions FAR Analysis Identification of Comparable Transactions Establishing Comparability, Adjustment for Material Differences Selection of Most Appropriate Method Determination of A L P Adjustments Documentation Return Filing TP Assessment

22 22  S. 92 F (ii) “arm’s length price” means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions” Arm’s length price

23 23 Traditional transaction methods  Comparable Uncontrolled Price Method (CUP)  Resale price method (RPM)  Cost plus method (CPM) Transactional profit methods  Profits split method (PSM)  Transactional net margin method (TNMM) Other method

24 24  New Rule 10AB inserted vide Notification No.18/2012 dated  Refers to “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” “Other Method” for determination of ALP

25 25  New Rule 10AB inserted vide Notification No.18/2012 dated  Refers to “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” “Other Method” for determination of ALP

26 Objectives – Specified Domestic Transactions (SDT)  When profit getting shifted from profit making unit to a loss making unit ;  Profit shift from taxable unit to tax free unit ;  SDT is not meant to cover revenue neutral transactions- lest it would result in economic transactions- lest it would result in economic double taxation double taxation 26

27 Domestic transactions -Transfer Pricing  S.92CA (2A), (2B) & (2C) apply only to international transactions and not to SDT  Non-reference and non-reporting of SDTs are not covered by new Ss (2A) & (2B)  APA mechanism proposed u/s 92CC & CD is not available for SDTs 27

28 Domestic transactions -Transfer Pricing  If SDTs do not cross threshold INR 5 Crores, TP Documentation & Reporting not applicable ; however, original requirement to comply with market value concept of u/s 40A(2)(b) / 10AA/ 80A/ 80IA (8) & (10) still continues. ◊ then how is it a safe harbor? 28

29 Domestic transactions -Transfer Pricing Typical SDTs: Typical SDTs:  Rent payments  Intra- group transactions  Financial transactions  Managerial remuneration etc  Corporate guarantee  Equity contributions  Reimbursement of expenses  Commission paid and discount allowed 29

30 Domestic transactions -Transfer Pricing  Expenditure incurred by a resident against non-resident – though not covered as AE, as ownership and control being less than 26% voting, but may be covered as SDT if voting power is ≥20% 30

31 Domestic transactions -Transfer Pricing  AE Vs Related Party creates dichotomy  Circular 6-P dated 6 th July 1968 provides – no disallowance- where there is no attempt to evade taxes  SDT covers only assessee spending u/s 40A(2)(b) and will not cover entity receiving payments 40A(2)(b) and will not cover entity receiving payments 31

32 Domestic transactions -Transfer Pricing  OECD TP guidelines apply to SDTs?  Benefit of range available to SDTs  TP adjustments for SDTs result in double taxation – in revenue neutral cases – hence corresponding adjustments warranted taxation – in revenue neutral cases – hence corresponding adjustments warranted 32

33 33  Rule 10D is amended to cover SDTs – sub rule (2) applies only to international transactions  Need based documentation good enough even for SDTs  Should be contemporaneous and be in place by specified date  Initial burden lies with the assessee Documentation

34 34 Section 271 –Penalty Implications Sr. No. Type of penaltySectionPenalty quantified 1a) Failure to maintain prescribed information/ documents 271AA2% of transaction value (b) Failure to report any such transaction or (c) Furnish incorrect information 2Failure to furnish information/ documents during assessment u/s 92D 271G2% of transaction value 3Adjustment to taxpayer’s income during assessment 271(1)(c)100% to 300% of tax on adjustment amount 4Failure to furnish accountant’s report u/s 92E 271BAINR 100,000

35 35 Issues  Whether payment for capital expenditure Or expenditure capitalized is also covered ?  Whether the provisions will apply in case the payer’s income is chargeable to tax under the head ‘Income from other sources’, because section 58(2) says –The provisions of section 40A shall, so far as may be, apply in computing the income chargeable under the head “Income from other sources” as they apply in computing the income chargeable under the head “Profits and gains of business or profession” ?  Whether new provision applies to -  Public Charitable Trust paying remuneration to related persons.  Co-operative Societies  Social Clubs having a business undertaking

36 Issues  Transfer pricing provisions are not applicable in case where income is not chargeable to tax at all.  Correlative adjustments - if excessive or unreasonable expenses are disallowed in the hands of tax payer at time of the assessment then corresponding adjustment to the income of the recipient will not be allowed in the hands of recipient of income. Hence, it would lead to double taxation in India. 36

37 Challenges 37 Type of payments/ transactionsChallenges Salary and Bonuses paid to the partners Remuneration paid to the Directors Transfer of land Joint Development agreements Project management fees Allocation of expenses between the same taxpayer having an eligible unit and non-eligible unit Definition of Related Party Benchmarking? Whether the limit as mentioned in section 40 (b) would be the ALP? Benchmarking? Whether the limit as mentioned in Schedule XIII would be the ALP? Whether the rates mentioned in the ready reckoner be considered as ALP? Benchmarking? Whether these allocation would be SDT – Sec 80-IA(10)? Directly v/s Indirectly

38 New Rules & Forms  Form 3 CEB enlarged – Part C inserted with respect to details of specified domestic transactions.  Rule 10A – Expands AE definition when Sec.92A(1) & (2) doesn’t do so. 38

39 Action Awaited  Clarifications in line with old circular 6-P (supra)  Revenue neutral transactions – avoidance of double taxation – critical 39

40 Thank You 40


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