1. Specified Domestic Transactions
Transfer Pricing
Specified Domestic Transactions
Study Circle
Baroda Branch of WIRC
14th May 2013

2. Agenda Introduction Transfer Pricing in India
Background
Snapshot of Indian Regulation
Specified Domestic Transactions
Related Party Transactions & Eligible Units
Case Studies
TP Methods and Documentations
Procedures & Penalties

3. Introduction

4. Transfer Pricing - Background
Since liberalization – Companies from developed or developing countries
Collaborations with Indian entities by MNEs
Setting up 100% subsidiaries in India
Backdoor transfer of Profits
Indian Government was losing revenue in form of Tax
Finance Act, 2001 has introduced Transfer Pricing with effect from Assessment Year

5. Tax Avoidance - International
India
Co. A
Co. B
Dubai
S.P. Rs. 100
Cost Rs. 90
35%
S.P. Rs. 120
Profit Rs. 20
Tax 0%
Tax Heaven
Co. B is 100% sub. Of Co. A
Co. A Sells at Rs. 100 to B
Co. B Sells at Rs. 120 to Co. C
Profit by B is Rs. 20 (Tax Free)
Maximum tax to Co. A of Rs. 3.5
USA
Co. C

6. Tax Avoidance - Domestic
Unit – 1
(Gujarat)
Unit – 2
(Baddi)
S.P. Rs. 100
Cost Rs. 90
35%
S.P. Rs. 120
Profit Rs. 20
Tax 0%
Unit -1 Manufactures radiators sells to Unit – 2 in Knocked Down Condition for Rs. 100
Unit -2 Assembles and sells to customers for Rs. 120
Profit of Unit – 2 is tax free u/s 80IB.
Company pays tax only on profit of Rs. 10 under Unit -1.

7. Transfer Pricing in India

8. Transfer Pricing Litigation in India
For Assessment
Year
Number of
Transfer Pricing
audits completed
Number of cases
adjusted
Percentage of
adjustment cases
Adjustment
Amount
(INR Crores)
1,081
238
22%
1,373
1,501
345
23%
2,575
1,768
477
27%
3,861
1,479
370
25%
4,950
1,717
1,019
59%
9,743
2,102
1,089
52%
24,000
2,589
1,338
44,500

9. Snapshot of Indian Regulation
Transfer Pricing introduced from AY for international transactions
Extended to Specified Domestic Transactions [SDT] from AY
Sections 92 to 92F amended to include reference to SDT
However, similar amendments to Rules 10 to 10E yet to be carried out
Methodology to compute ALP is primarily provided in Rules
It is expected that appropriate amendments would be carried out in Rules to apply broadly same methods and principles to SDT as well
Discussion in this presentation is primarily based on ALP computation mechanism applicable to ‘international transactions’ assuming that the same would be applied to SDT

10. Snapshot of TP Provision92
Computation of income from international transaction having regard to arm’s length price
92A
Associated Enterprise
92B
International Transaction
92BA
Meaning of Specified Domestic Transactions
92C
Computation of Arm’s Length Price
92CA
Reference to Transfer Pricing Officer
92CB
Safe Harbour Rules
92CC & 92CD
Advance Pricing Agreement
92D
Maintenance of information and documents
92E
Report from Accountant to be filed
92F
Definitions of certain terms relevant to computation of arm’s length price

11. SDT - Background
Decision of the Appex Court in the case of Glaxo Smithkline Asia (P) Ltd [236 CTR 113]
The H’ble Supreme Court while deciding on the issue of section 40A(2) made some of the important observations as under:
The present Transfer Pricing Regulations does not apply to domestic transactions. CBDT should examine possibility of extending TP provisions to such transactions

12. SDT - Background
In domestic transactions, under-invoicing and over- invoicing will be revenue neutral, except in two circumstances:
where one of the related entities is loss making or
where one of the related entities is liable to pay tax at a lower rate and the profits are shifted to such entity
Concept of ALP is preferred over FMV to test the reasonableness of the controlled or related party transactions.

13. Specified Domestic Transactions
Section – 92BA is inserted with effect from , defines “Specified Domestic Transactions”. Under SDT these transactions are covered
Expenditure under transactions with Related Party [Section- 40A(2)(b)]
Any Transactions referred in Section – 80A
Any transfer of goods or services referred to u/s 80IA(2)
Any business transaction with person as referred u/s 80IA(10)
Any transactions under for claiming deductions under chapter – VIA or 10AA where Section – 80IA(8) /(10) is applicable
Other transaction as may be prescribed.

14. Related Party Transaction

15. 40A(2) – Payments to related Parties
Only expense side is covered and i.e. only revenue expenditure and not items of income.
In case of transactions between two related parties of goods and services, only the purchaser is to comply and not the seller
Definition of related party is restrictive compared to Associated Enterprise
Multi-fold issues in identification of related parties

16. 40A(2)(b) – Definition of Related party
Individual Assessee
Husband / Wife
Whether these are related?
Brother or Sister of spouse
Lineal ascendants – descendants of the spouse
Brother or Sister of Parents
Lineal A-D of brother or sister of parents
And spouse of all of the above
HUF of the Assessee or his relative
Lineal ascendants
descendants
Sister
Assessee
Where Assessee has substantial Interest
Brother

17. 40A(2)(b) – Definition of Related party
Tax Payer
Director / Partner/ member
Relatives
b(ii)
Individual
b(iii)
>20%
Company / Firm / HUF / AOP
Company
b(iv)
All companies where such individual is director / partner / member
b(v)
Other Director / Partner/ member
Person
b(vi)
Tax Payer = Company, HUF, Firm, AOP

18. 40A(2)(b) – Definition of Related party
Tax Payer
Director / Partner/ member
Relatives
b(ii)
Individual
b(iii)
>20%
Company / Firm / HUF / AOP
Company
b(iv)
All companies where such individual is director / partner / member
b(v)
Other Director / Partner/ member
Person
b(vi)
Tax Payer = Company, HUF, Firm, AOP
>20%
>20%
Company / entity

19. 40A(2)(b) – Issues Tax Payer Tax Payer = Company, HUF, Firm, AOP 15%
Relatives
Individual
15%
15%
Tax Payer

20. 40A(2)(b) – Issues Tax Payer Tax Payer = Company, HUF, Firm, AOP 10%
Relatives
Director / Partner/ member
Company / Firm / HUF / AOP
10%
10%
10%
Tax Payer

21. 40A(2)(b) – Issues
Whether sub-subsidiary and ultimate parent company is relative?
Transaction
Relative?
A & B
Yes
A & C
A & X No
A & Y
B & C
B & Y
C & X
X & Y
Co. A
Co. B
Co. C
Co. X
Co. Y

22. Eligible Units / Undertaking

23. SDT – Tax Holiday Units Section
Nature of Undertakings / units affected by SDT
80IA
Undertaking engaged in
Development and maintaining of infrastructure
Generation / Transmission of Power
Reconstruction / revival of Power Generating plants
80IB
Undertakings located / engaged in
Notified industrially backward districts
Scientific research & development
Refining mineral oil / generation of natural gas
Operating cold chain facility for agricultural produce, etc
80IC
Undertaking located in notified Centre / Parks / Areas in
Sikkim, Himachal Pradesh / Uttaranchal
North-Eastern states
80ID
Undertaking engaged in business of Hotel / Convention centers in specified areas / districts
80IE
Undertaking in North-Eastern States
10AA
Undertakings having a unit in SEZ
35AD
?????

24. SDT – Tax Holiday Units 80IA(8) 80IA(10)
Inter-unit transaction of goods or services
Business 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 payer
Onus on tax authorities as well

25. Threshold Limit & Coverage
Domestic Transfer Pricing is applicable only where value of SDT exceeds INR 5 Crore.
Important points need to be considered while considering the threshold limit
Value of International transactions to be excluded
Expense transactions covered in respect of 40A(2)(b)
All transactions covered in respect of Chapter VI or 10AA transactions
Aggregate amount of all transactions should be considered
Once Exceeded 5 crore, all transactions whether significant or not are covered

26. Challenges Transactions / Issues Challenges
Salary / Remuneration to Partners / Directors
Benchmarking
Whether limits prescribed under Sec – 40(b) or Schedule XIII of Companies Act can be considered
Transfer of Land
Valuation as per “Jantri” can be considered?
Joint Development Agreement
Project management fees
Cost Benefit Analysis
Allocation of Expenses between Units
Covered by SDT?
Definition of related party
Direct V/s Indirect relationship
Capital Expenditure
Sales of goods and services
Comparability

27. Posers
Whether parties not engaged in business and profession is covered by the provisions of 40A(2)(b)?
Whether following shall be covered –
Public Charitable Trust paying remuneration to related persons
Trusts created by the companies
Co-operative societies
Social Clubs having business undertaking
Expenses disallowed under other provisions of the act say 40A(3) – whether covered by SDT?

28. Posers
In respect of 40A(2)(b) the Law envisages a Corporate Tax Payer to know
Whether the individual holding 20% interest is director in other company
Identify all directors of the Company of which such individual is a director
Relatives of all such directors
Further it also envisages to identify the Company or the entity where relative of any director of the Assessee company holds 20% voting rights.

29. Posers
For calculating 20% interest, preference shares or other securities having voting rights to be considered.
Preference Shareholders where voting rights are vested under the provisions of Companies Act as consequences of default by Assessee Company.
Corresponding Credit for tax neutrality or to avoid double taxation
Small value transactions

30. Economy and Tax Provisions
The tax provisions and it impact on Economy
Incentivize
Subsidize
Encourage
Tax
Regulate

31. Case Studies

32. Case - 1
XYZ Inc, USA is engaged in manufacturing of wide range of Automotive engineering products
YZ Ltd. Germany is engaged in R&D and manufacturing of Bearings
X Ltd. is manufacturing TYPE A bearings
Y Ltd. is manufacturing TYPE B bearings
Z Ltd. is manufacturing Clutches – 10AA unit
A Ltd. is provided technical services

33. Case - 1 Germany USA XYZ Inc. YZ Ltd. India X Ltd A Ltd Y Ltd
Subsidiary
India
15%
90%
90%
25%
20%
X Ltd
Z Ltd (10AA)
A Ltd
Y Ltd

34. Case - 2 A Ltd. is an Indian company
B Inc., USA is 100% subsidiary of A Ltd.
C Ltd is an Indian Company, 100% sub. of A Ltd.
D Ltd and E Ltd (10AA eligible) are Indian Companies, 100% sub of A Ltd.
A Ltd granted interest free loans to B C and D
A Ltd granted loan to E Ltd at 18% p.a. interest

35. Corporate Guarantee (fees at 0.25% is charged)
Case - 2
USA
A Ltd.
B Inc.
Interest Free Loan
Corporate Guarantee (fees at 0.25% is charged)
India
Loan at 18%
ALP 11%
Interest Free Loan
Interest Free Loan
Corporate Guarantee
(No fees is charged)
C Ltd
D Ltd (10AA)
E Ltd (10AA)

36. Case - 3 A Ltd, B Ltd, C Ltd, and D Ltd are Indian companies
C Ltd holds 80% shares of B Ltd.
B Ltd holds 100% shares of A Ltd
X, Y, Z are the directors of A Ltd. Holds 10% share of D Ltd.
Mrs. Y holds 15% and Mr. F son of Z holds 15% of D Ltd.
FY is P’ship firm of Mrs. Y and Mr. F

37. Case - 3 C Ltd. Mr. X Mr. Y Mr. Z Mrs. Y Mr. F B Ltd D Ltd A Ltd
Directors of A Ltd.
Son of Mr. Z
Mr. X
Mr. Y
Mr. Z
Mrs. Y
Mr. F
Purchase of Finished Goods
80%
10%
10%
10%
15%
15%
B Ltd
100%
D Ltd
A Ltd
(Assessee)
Purchase of Raw Material
50%
50%
YF (Partnership Firm)
Consultancy Fees

38. Transfer Pricing Methods

39. Transfer Pricing Methods
Comparable Uncontrolled Price Method
Resale Price Method
Cost Plus Method
Profit Split Method
Transactional Net Margin Method

40. Transfer Pricing Methods
Comparable Uncontrolled Price Method
Resale Price Method
Cost Plus Method
Profit Split Method
Transactional Net Margin Method
Any Other Method (Rule 10AB)

41. Most Appropriate Method (MAM)
ITA does not provide any specific hierarchy of methods
It insists on applying the ‘Most Appropriate Method’ (MAM)
MAM means a Method
Which is best suited to facts and circumstances of transaction
Which is the most reliable measure of an arm’s length price

42. Selection of MAM MAM is to be determined considering –
Nature and class of transaction
Functions, assets and risks undertaken assessee and other party
Degree of comparability between underlying transaction and uncontrolled transactions
Extent to which reliable and accurate adjustments can be made to account for differences, if any
Availability, coverage and reliability of data necessary for application of method
Nature, extend and reliability of assumptions required to be made in application of method

43. Stages of Economic Analysis
Comparability Analysis
Selection of Tested Party
Selection of Most Appropriate Method
Selection of Profit Level Indicator
Benchmarking

44. Selection of MAM MAM is to be determined considering –
Nature and class of transaction
Functions, assets and risks undertaken assessee and other party
Degree of comparability between underlying transaction and uncontrolled transactions
Extent to which reliable and accurate adjustments can be made to account for differences, if any
Availability, coverage and reliability of data necessary for application of method
Nature, extend and reliability of assumptions required to be made in application of method
Selection of Tested Party
Comparability Analysis
Selection of Tested Party & Comparability Analysis

45. Classification of Methods
Comparable Uncontrolled Price Method (CUP)
Resale Price Method (RPM)
Cost Plus Method (CPM)
Price based Methods
Profit Split Method (PSM)
Transactional Net Margin Method (TNMM)
Profit based Methods
Any other method which takes into account price charged or paid between uncontrolled parties considering all relevant facts
Other

46. Documentation

47. Background Information Transactional Information
Documentation Areas
Functions
Assets
Risks
Comparability
Method Selection
Benchmarking
Covered entities
Covered Transactions
Company
Group
Industry
Background Information
Transactional Information
Functional Analysis
Economic Analysis

48. What are the Documentation Requirements?
Entity Related
Price Related
Transaction Related
Profile of Group
Terms of Transaction
Agreements
Profile of Indian Entity
Functional Analysis (FAR)
Invoices
Profile of Associated Enterprises
Economic Analysis (Method Selection, comparables benchmarking)
Price Mechanism, other pricing related documents
Profile of Industry
Forecasts, Budgets, Estimates
Correspondences (letters, s, etc.)
Contemporaneous documentation requirement - Rule 10D Documentation to be retained for 9 years No specific documentation requirement if the value of international transactions is less than 1 crore rupees

49. Indicative Documentation
Transaction entered
Documents to be maintained
Purchase/ sale of raw material
Invoices
Purchase/ Sale order
Product details
Sale details if sold to 3rd Party
Pricing strategy
Proof of price negotiation
Quotes from competitors
Terms of payment
Remuneration to Directors
Qualification
Work Experience & Profile
Minutes of Meeting authorizing the director’s remuneration
Data from HR firms for Directors in the same line of business
Corporate cost sharing
Nature of expenses
Auditor’s certificate allocating the expenses
Basis of allocation between the companies
Proof of usage (rendering) of services
Cost benefit analysis

50. Indicative Documentation
Transaction entered
Documents to be maintained
Rent paid toward use of premises
Rent receipts
Documents suggesting the rent of the surrounding area
Rental agreement
Fair market value of the property (municipal valuation, only if higher than the actual rent paid)
Reimbursement of
expenses
Nature of expenses with detailed break-up
Reason of expense incurred for
Employee details
Actual invoices of the expense
Interest on loan (non-
financial services company)
Basis of determination of interest rate
Interest Rate Card for the period of loan
Loan agreement
Basis on which the interest rate is pegged above standard rate

51. Procedures

52. Transfer Pricing Compliance Timeline – Illustration for March 2013
Sr. No.
Compliance
Timeline
Relevant Provision 1.
Filing Accountants Report along with Tax Return, Maintenance of Documentation
30 Nov. 2013
Section – 92E r.w. Section – 139(1) 2.
Limitation for Initiating transfer pricing audit by the tax administration
30 Sep. 2014
Proviso to Section – 143(2)(ii) 3.
Limitation for completing transfer pricing audit
31 Jan. 2017
Section – 92CA(3) r.w. Second Proviso to Section – 153(1) 4.
Limitation for Completing regular assessment
31 Mar. 2017
If 144C
BY 31 May 2017
Second Proviso to Section -153(1) 5.
Limitation for Re-Assessment (where income escaped < Rs. 1,00,000)
31 Mar. 2018
Section – 149(1)(a) 6.
Limitation for Re-Assessment (where income escaped ³ Rs. 1,00,000)
31 Mar. 2020
Section – 149(1)(b) 7.
Date till which documentation is required to be maintained
31 Mar. 2021
Section – 92D and Rule – 10D(5)

53. Penalties Compliance Penalties Section
Filing of Accountants Report (specified form)
Rs. 1,00,000
271BA
Reporting SDT and Int. Transactions
2% of value of transactions not reported
271AA
Maintenance of Documentation
2% of value of transactions for which documentation is not maintained
Furnishing correct information
2% of value of transactions for which incorrect or no information is furnished
Failure to furnish information or documents as required under 92D(3)
2% of value of transaction for each such failure
271G

54. Audit Process File tax return and Accountant’s Report (30th November)
DRP Mechanism- Finance Act 2009
Reference to be made to TP Officer (‘TPO’) by the Assessing Officer (‘AO’); Compulsory Reference to be made by AO if international transactions exceed INR 1500 million for AY onwards (Internal guidelines)
Appeal Procedure
Notice to be issues by the TPO - TPO calls for supporting documents and evidence
Appeal to Commissioner of Income Tax
Passes an order
Income Tax Appellate Tribunal
High Court - only on matters related to law
Supreme Court
Constitutional Bench
TP Audit
Based on results of above mentioned procedure assessing officer passes the order
Rectification application can be made against the order of TPO for apparent mistake
Appeal can be made against the order of AO as order of TPO included within the order of the AO

55. Questions

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