Presentation on theme: "Domestic Transfer Pricing"— Presentation transcript:
1 Domestic Transfer Pricing CPE SeminaronDomestic Transfer PricingICAI- Trichur22nd June 2013CA P.V.S.S Prasad
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”
3 Domestic transactions - Transfer Pricing May lead to economic double taxationInline with some tax jurisdictions like Australia,Thailand , Denmark etc.,Increase in compliance burden
4 Domestic transactions -Transfer Pricing New sub.sec (2A) to sec.92“(2A) Any allowance for an expenditure or interest or allocation ofany cost or expense or any income in relation to the specifieddomestic transaction shall be computed having regard to thearm’s length price.” w.e.f 1st Apr ‘13Specified domestic transaction means“92BA. For the purposes of this section and sections 92, 92C, 92Dand 92E, “specified domestic transaction” in case of an assesseemeans any of the following transactions, not being aninternational transaction, namely:—
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;(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 sub-section (10) of section 80-IA;
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 theassessee in the previous year exceeds a sum of five crore rupees.” -w.e.f. 1st Apr 2013
7 Domestic transactions -Transfer Pricing S.10AAS.40A(2)(b) – FMV vs. ALPS.80A - Scope of deductions & FMV for inter businesstransfersS.80IA (8) – Eligible business Vs. Other businessS. 80IA (10) - Eligible assessee Vs. Other personS.80IAB(3), 80IB(13),80IC (7), 80ID (5), 80IE (6)
8 Domestic transactions-Transfer Pricing S.92C – computation of ALP – methodologies- alsoapply to Spec. dom. transactionsS.92CA (1)(2)&(3)- reference , service of notice & orderto be made by TPOS.92D – documentation – maintenance & productionS.92E – report from an accountant – may be a new form
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 expenditurebeing excessive or unreasonable having regard to the fair marketvalue, shall be made in respect of a specified domestic transactionreferred to in S.92BA, if such transaction is at arm’s length price asdefined in cl.(ii) of S.92F”- 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 onbusiness or profession in which the first mentioned company hassubstantial interest” shall be inserted.
10 Domestic transactions -Transfer Pricing Corresponding Amendments :S. 80A – Cl (iii) to Explanation inserted :“in relation to any goods or services sold, supplied or acquiredmeans the arm’s length price as defined in cl.(ii) of S.92F of suchgoods or services, if it is a specified domestic transaction referred toin S.92BA”is ALP synonymous with Market value ?S. 80-IA – Explanation substituted in Ss(8) :Market Value , in relation to any goods or services means –the price that such goods or services would ordinarily fetch in the open market: orthe 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
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”not clear whether ALP and FMV are the same .
12 Relationship can exists any time during the year Sec 40A (2)(b) – Related PartyRelationship can exists any time during the yearSr.NoPayer / assesseePayee(i)IndividualAny 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 directorFirm (includes LLP)any partner or relative of such partnerAOPany member or relative of such memberHUF(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 substantialinterest in the assessees businessorany director, partner, memberrelative of such director, partner or memberor (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)
13 Type of transactions covered (illustrations for payments made by a Company) … Case 1 - Director or any relative of the Director of the taxpayer – Section 40A(2)(b)(ii)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)Assessee (Taxpayer)Assessee (Taxpayer)DirectorDirectorSubstantial interest >20%RelativeMr. AMr. DMr. CMr. AMr. DMr. CRelativeRelativeCovered transactionsHolding Structure
14 Type of transactions covered (illustrations for payments made by a Company) … 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)Case 4 – Any other company carrying on business in which the first mentioned company has substantial interest – Section 40A(2)(b)(iv)Mr. DAssessee (Taxpayer)C LtdDirectorSubstantial interest >20%Assessee (Taxpayer)A LtdRelativeSubstantial interest >20%Substantial interest >20%Mr. CSubstantial interest >20%A LtdB LtdCovered transactionsHolding Structure
15 Type of transactions covered (illustrations for payments made by a Company) … 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)B LtdDirectorDirectorSubstantial interest >20%Assessee (Taxpayer)Mr. AMr. CRelativeMr. DCovered transactionsHolding Structure
16 Type of transactions covered (illustrations for payments made by a Company)… Case 6 – To a Company in which the taxpayer has substantial interest in the business of the company – Section 40A(2)(b)(vi)(B)Case 7 – Any director or relative of the director of taxpayer having substantial interest in that person– Section 40A(2)(b)(vi)(B)Assessee (Taxpayer)Substantial interest >20%A LtdMr CDirectorSubstantial interest >20%Assessee (Taxpayer)RelativeB LtdSubstantial interest >20%D LtdMr BCovered transactionsHolding Structure
17 Tax burden, if transaction not at ALP X Ltd.(non-tax holiday)Disallowance of ` 20 to Y Ltd[40A(2)(b)]Y Ltd.Sale at ` 120 v/s ALP i.e. ` 100X Ltd.(tax holiday)Y Ltd.(non-tax holiday)Sale at ` 120 v/s ALP i.e. ` 100Double AdjustmentTax 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. ` 100Inefficient 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.80IA (8)80IA (10)Inter-unit transaction of goods or servicesBusiness transacted with any person generates more than ordinary profitsOwing to either close connection or any other reasonApplicable where transfer is not at market valueApplicable to tax holiday units earning more than ordinary profitOnus on tax payerPrimary onus on taxpayerOnus on tax authorities as wellNo guidance on the meaning of close connectionTo align ordinary profits with arm’s length price. For example:OP/ TC of 30% considered to be at arm’s length by the TPOUnder 801A(10) the AO states that the profits are more than ordinarySolution: Defend price or evaluate alternate methods (other then profit based)Impact of non-charging of services/ costs to tax holiday undertakingALP of 5 comparable companies OP/TCMark-up of the tax holiday entity OP/TCArithmetic mean = 15%30%
19 Tax holiday undertaking International TP Vs. Tax holiday profitsSec 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 TPOWhether same approach is possible when domestic TP is targeted in computing ordinary profits.Domestic TP supports the approach of AO in restricting ordinary profits?
20 Cost allocation Whether corporate group expenses to be allocated? Courts held that it need not be allocatedCase laws - Wipro Information Technology vs DCIT (2004) 88 TTJ(Bang) 778 ; Zandu Pharmaceuticals Works Ltd, vs CIT (2013) 213 Taxman Ponds India Ltd (ITA NO. 2047/Mad/88)Whether every cost allocation should have a mark up?
21 Transfer Pricing Process TP AssessmentIdentification ofIntra GroupTransactionsReturn FilingFAR AnalysisDocumentationIdentification ofComparableTransactionsAdjustmentsEstablishingComparability,Adjustment forMaterial DifferencesSelection ofMostAppropriateMethodDetermination ofA L P21
22 Arm’s length price 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”22
23 Traditional transaction methods Transactional profit methods Comparable Uncontrolled Price Method (CUP)Resale price method (RPM)Cost plus method (CPM)Transactional profit methodsProfits split method (PSM)Transactional net margin method (TNMM)Other method23
24 “Other Method” for determination of ALP New Rule 10AB inserted vide NotificationNo.18/2012 datedRefers to “price which has been charged orpaid, or would have been charged or paid, forthe same or similar uncontrolled transaction,with or between non-associated enterprises,under similar circumstances, considering allthe relevant facts”24
25 “Other Method” for determination of ALP New Rule 10AB inserted vide NotificationNo.18/2012 datedRefers to “price which has been charged orpaid, or would have been charged or paid, forthe same or similar uncontrolled transaction,with or between non-associated enterprises,under similar circumstances, considering allthe relevant facts”25
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 neutraltransactions- lest it would result in economicdouble taxation
27 Domestic transactions -Transfer Pricing S.92CA (2A) , (2B) & (2C) apply only to international transactions and not to SDTNon-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
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?
29 Domestic transactions -Transfer Pricing Typical SDTs:Rent paymentsIntra- group transactionsFinancial transactionsManagerial remuneration etcCorporate guaranteeEquity contributionsReimbursement of expensesCommission paid and discount allowed
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%
31 Domestic transactions -Transfer Pricing AE Vs Related Party creates dichotomyCircular 6-P dated 6th July 1968 provides – no disallowance- where there is no attempt to evade taxesSDT covers only assessee spending u/s40A(2)(b) and will not cover entity receiving payments
32 Domestic transactions -Transfer Pricing OECD TP guidelines apply to SDTs?Benefit of range available to SDTsTP adjustments for SDTs result in doubletaxation – in revenue neutral cases – hence corresponding adjustments warranted
33 DocumentationRule 10D is amended to cover SDTs – sub rule (2) applies only to international transactionsNeed based documentation good enough even for SDTsShould be contemporaneous and be in place by specified dateInitial burden lies with the assessee33
34 Section 271 –Penalty Implications Sr.No.Type of penaltySectionPenalty quantified1a) Failure to maintainprescribed information/documents271AA2% of transaction value(b) Failure to report any suchtransaction or(c) Furnish incorrectinformation2Failure to furnish information/documents during assessmentu/s 92D271G3Adjustment to taxpayer’sincome during assessment271(1)(c)100% to 300% of tax onadjustment amount4Failure to furnish accountant’sreport u/s 92E271BAINR 100,000
35 IssuesWhether 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 SocietiesSocial Clubshaving a business undertaking
36 IssuesTransfer 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.
37 Type of payments/ transactions ChallengesType of payments/ transactionsChallengesSalary and Bonuses paid to the partnersRemuneration paid to the DirectorsTransfer of landJoint Development agreementsProject management feesAllocation of expenses between the same taxpayer having an eligible unit and non-eligible unitDefinition of Related PartyBenchmarking?Whether the limit as mentioned in section 40 (b) would be the ALP?Whether the limit as mentioned in Schedule XIII would be the ALP?Whether the rates mentioned in the ready reckoner be considered as ALP?Whether these allocation would be SDT – Sec 80-IA(10)?Directly v/s Indirectly
38 New Rules & FormsForm 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.
39 Action Awaited Clarifications in line with old circular 6-P (supra) Revenue neutral transactions – avoidance of double taxation – critical