2. Agenda Transfer Pricing – Concept Domestic Transactions - What Has Changed Specified Domestic Transactions Key TP Audit Issues Way Forward 2 Copyrights with S.Goyal & Associates

3. Transfer Pricing - Concept  What is Transfer Pricing? Transfer Pricing (TP) is a mechanism for the pricing of goods and services between related entities: Tangible Goods Intangible Goods – trademarks, trade-names, patents Services – management, engineering, after-sales services  TP mechanism provides the conceptual framework for pricing intercompany transactions and ensuring an appropriate allocation of income between the various tax jurisdictions (usually) in which a multinational company operates.  Any international transaction undertaken between associated enterprises would be subject to transfer pricing regulations and the transfer price charged/paid should be at arm’s length.  Specified Domestic transactions included in the scope of TP w.e.f. FY 2012- 13 (Finance Bill 2012) 3 Copyrights with S.Goyal & Associates

4. Arm’s Length Principle  As per Section 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.”  Basic Principle:  Prices set for a transaction  between related parties  should  for tax purposes  be derived from prices  which would have been applied by unrelated parties  in similar transactions under similar conditions in the open market. 4 Copyrights with S.Goyal & Associates

5. What Has Changed

6. Budget 2012 – Scope Of Transfer Pricing Regulations Expanded  Income Tax Act, 1961 (‘IT Act’) already contain provisions to curb claim of excess expenditure / re-compute the income on transactions between related parties  Section 40A(2) disallows excess / unreasonable expenses between related parties  Section 80IA(8) / 80IA(10) – Tax officer empowered to re-compute the income of eligible undertaking based on fair market value if transactions with related parties or other undertakings of same entity is not as per market value  Scope of TP regulations expanded to include ‘specified domestic transactions’ (‘SDT’)  Expenses or payments made to domestic related persons as specified in Section 40(A)(2)(b)  Transactions between undertakings of same taxpayer or transactions by taxpayer with closely connected persons for the purpose of Chapter VI-A (which includes tax holiday provisions like 80IA) and Section 10AA 6 Copyrights with S.Goyal & Associates

7. Budget 2012 – Scope Of Transfer Pricing Regulations Expanded  SDT regime applicable from FY 2012-13 where value of SDTs in aggregate exceeds INR 5 crores annually  Preparation of Form No 3CEB and TP study report mandatory even for the Specified Domestic Transactions – hence onus of identifying and reporting all covered transactions on the tax payers  Non-compliance with reporting requirements would now result in onerous additional penalties  Rationale of applicability of TP regulations to domestic transactions  Objectivity of determining income and reasonable expenditure between related parties 7 TP regulations now applicable to SDT Preparation of Form No. 3CEB and TP study report mandatory TP regulations now applicable to SDT Preparation of Form No. 3CEB and TP study report mandatory Copyrights with S.Goyal & Associates

8. Section 92BA defines ‘Specified Domestic Transactions’ as any of the following transactions, not being an international transaction: 1. Any expenditure in respect of which payment has been made or to be made to a specified person [section 40A(2)(b)]; 2. Any transaction referred to in section 80A; 3. Any transfer of goods or services referred to in sub-section (8) of section 80- IA; 4. Any business transacted between the taxpayer and other person as referred to in sub-section (10) of section 80-IA; 5. 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 6. Any other transaction as may be prescribed 8 What are Specified Domestic Transactions ? Copyrights with S.Goyal & Associates

9. Applicability  Applicable where aggregate amount of exceeds INR 5 crores (approximately USD 1 million) in a year. For instance - Rent payment of INR 2.5 crore has been made to a sister concern and a remuneration of INR 1.5 crore paid to Managing Director. In this case the aggregate of transaction is below INR 5 crore; hence TP provisions will not be applicable. Suppose Rent of INR 4 crore is paid to sister concern and MD’s Remuneration is INR 1.5 crore. Here the aggregate value of transactions will exceed INR 5 crore and both transactions will become specified domestic transaction.  Applicable from Financial Year (FY) 2012-13 onwards  Last date for filing Form 3CEB and preparation of Transfer Pricing Report is November 30,2013 9 Copyrights with S.Goyal & Associates

10. [Section 40A(2)(b)]

11. 11 Section 40A(2)(b) – only expenditure covered The Section:  Refers only to ‘expenditure’ incurred in payments made or to be made to persons specified under Section 40A(2)(b)  Does not refer to any ‘income’  Expenditure by one group entity is income for another group entity - arms length analysis may consider both transacting parties  Only the entity incurring the expense will need to complete the prescribed compliances. Capital expenditure and Availing of free services – debatable Copyrights with S.Goyal & Associates

12. Who are the specified persons - Section 40A(2)(b) Section 40A(2)(b) - list of persons/ entities to be treated as related parties/ specified persons  Specified persons having substantial interest ( i.e. more than 20% voting power or share in profits) in taxpayer’s business and vice-versa covered  Scope expanded to include sister concerns Illustrative list of entities/ persons that may be included for a corporate taxpayer (not an exhaustive list) - if the relationship exists AT ANY TIME DURING THE YEAR: a)those holding 20% or more equity in the tax payer; b)companies whose 20% or more shares are held by such a company that holds more than 20% equity in the tax payer; c)those companies in which the tax payer holds 20% or more equity; d)Directors of tax payer company, and relatives of such Directors; e)Directors of companies in category (a) above; and relatives of such Directors; f)If an individual holds 20% or more equity in the tax payer, then relatives of such an individual; all other companies where such individual is a Director; all other Directors of such a company, and relatives of all such Directors; etc 12 Copyrights with S.Goyal & Associates

13. Illustration: Payments by ABC Ltd to the following persons will be covered, if the relationship exists at any time during the previous year, where: 1.Any company in which ABC Ltd has 20% or more voting rights, 2.A company, XYZ Ltd, has 20% or more voting power in ABC Ltd, 3.A company in which above-mentioned XYZ Ltd has 20% or more voting power, 4.Any company of which a director has 20% or more voting rights in ABC Ltd, 5.Any company in which a director of ABC Ltd has 20% or more voting rights, 6.Any Director of ABC Ltd or XYZ Ltd and his/her relative, 7.Any Individual having 20% or more voting rights in ABC Ltd or any relative of such individual Further, related party also includes a company having the same parent company. 13 Copyrights with S.Goyal & Associates

14. 14 Section 40 A(2)(b) – Illustrative chart Assesee Company Company 20% Director Relative Individual Relative All Directors of such Company 20% AOPs in which individual is a Member All Members of such AOP Firms in which individual is Partner All Partners of such Firm HUFs in which individual is a Member All Members of such HUF Firm AOP HUF 20% Relative 20% Relative Partner 20% Member Director Relative BOI Relative Member 20% All Members of such BOI BOIs in which individual is a Member 20% Relative Company AOP Firm Companies in which individual is a Director 20% Circular No. 6-P, dated 6 July 1968 refers to direct and indirect relationship “Relative” - in relation to an individual, the husband, wife, brother or sister or any lineal ascendant or descendant of that individual Copyrights with S.Goyal & Associates

15. 15 Indirect interest illustrated Coverage - Substantial direct and indirect interest? Transactions between sister concerns now covered Direct Interest Indirect Interest X X1 X2 X X1 X2 X3 X4 X5 X6 X7 X8 X3 X4 X5 X6 X7 X8 Copyrights with S.Goyal & Associates

16. 16 Specified persons under Section 40A(2)(b)… Section 40A(2)(b) – amounts paid / payable by assessee company (say ABC Ltd) to:… i.directors of ABC Ltd. ii.any relative* of any director of ABC Ltd. * As per section 2(41) of the Act, relative in relation to an individual, means the husband, wife, brother, or sister or any lineal ascendant or descendant of that individual ABC Ltd Director Relative Copyrights with S.Goyal & Associates

17. 17 …Specified persons under Section 40A(2)(b)… …Section 40A(2)(b) - amounts paid / payable by ABC Ltd to:… iii.individuals owning 20% or more equity** in ABC Ltd. iv.any relative of the aforesaid individual. ** Circular No. 6-P, dated 6 July 1968 refers to direct and indirect relationship ABC Ltd Individual Relative Copyrights with S.Goyal & Associates

18. 18 …Specified persons under Section 40A(2)(b)… v.a company (say X1), firm, association of persons or Hindu undivided family owning 20% or more equity in ABC Ltd. vi.any company (say X2) in which the aforesaid company (mentioned in point (v)) owns 20% or more equity. vii.any director, partner or member of the aforesaid company (X1), firm, association of persons or Hindu undivided family (mentioned in point (v)). viii.any relative of the aforesaid director, partner or member (mentioned in point (vii)). …Section 40A(2)(b) - amounts paid / payable by ABC Ltd to:… Relative Partner Director Member ABC Ltd X1 X2 20% Firm AOP HUF 20% BOI 20% Copyrights with S.Goyal & Associates

19. 19 …Specified persons under Section 40A(2)(b)… ix.a company (say X3), firm, association of persons or Hindu undivided family of which any director, partner or member owns 20% or more equity in ABC Ltd. x.any director, partner or member of the aforesaid company (X3), firm, association of persons or Hindu undivided family (mentioned in point (ix)). xi.any relative of the aforesaid director, partner or member (mentioned in point (x)). Individual X3 All Directors of X3 AOPs in which individual is a Member All Members of such AOP Firms in which individual is Partner All Partners of such Firm HUFs in which individual is a Member All Members of such HUF All Members of such BOI BOIs in which individual is a Member Relative ABC Ltd 20% ….Section 40A(2)(b) - amounts paid / payable by ABC Ltd to:… Copyrights with S.Goyal & Associates

20. …Specified persons under Section 40A(2)(b) 20 xii.any person (including a Company – say X4) carrying on business or profession in which ABC Ltd owns 20% or more equity. xiii.any person (including a Company – say X4) carrying on business or profession in which any director of ABC Ltd owns 20% or more equity. xiv.any person (including a Company – say X4) carrying on business or profession in which any relative of any director of ABC Ltd owns 20% or more equity. Director Relative X4 20% AOP Firm 20% ABC Ltd 20% ….Section 40A(2)(b) - amounts paid / payable by ABC Ltd to: Copyrights with S.Goyal & Associates

21. Tax Holiday - Transfer Pricing Test 21 Not corresponding to market value (adherence to ALP proposed) More than ordinary profits earned by business unit claiming deduction (adherence to ALP proposed) Transactions to be reported in Accountant’s Report (Form 3CEB) and arms’ length nature to be substantiated in the TP Documentation Tax holiday unit Other unit Sub-section (8) of section 80-IA (and similar such provisions in 10AA and Chapter VI-A) Inter unit transfers (goods and services etc.) Other person having close connection Tax holiday company Business transacted (wider than transfer of goods or services) Sub-section (10) of section 80-IA (and similar such provisions in 10AA and Chapter VI-A Copyrights with S.Goyal & Associates

22. 22 Tax Holiday beneficiaries impacted by Domestic TP SectionNature of undertaking covered 80IAUndertakings engaged in  Developing, operating and maintaining, developing and operating and maintaining infrastructure facilities  Generation/ transmission or distribution of power  Reconstruction / revival of power generating plants 80IBUndertakings located/ engaged in  Industrially backward districts as notified  Scientific research and development  Refining mineral oil / commercial production of natural gas  Operating cold chain facility for agricultural produce  Processing, preservation and packing of meat / meat products or poultry / marine/dairy products  Operating and maintaining a hospital of specified capacity 80ICUndertaking located in notified Centre/ Parks/ Areas in  Sikkim  Himachal Pradesh/ Uttaranchal  North –Eastern states 80IDUndertaking engaged in business of hotel / convention centre in specified areas/ districts 10AAUndertakings having a Special Economic Zone unit Copyrights with S.Goyal & Associates

23. 23 Possible Tax Leakages – If ALP Not Followed (Illustrations) X Ltd. (non-tax holiday) Y Ltd. (non-tax holiday) Sale at 120 v/s ALP (ie 100) Disallowance of INR 20 [40A(2)(b)] X Ltd. (non-tax holiday) Y Ltd. (tax holiday) Sale at 120 v/s ALP (100) Double Disallowance INR 40 [40A(2)(b) and excessive profit] X Ltd. (non-tax holiday) Y Ltd. (tax holiday) Sale at 80 v/s ALP (100) Inefficient pricing structure – Reduced tax holiday benefit Copyrights with S.Goyal & Associates

24. 24 Penalties DefaultPenalty In case of a post-inquiry adjustment, there is deemed to be a concealment of income 100-300% of tax on the adjusted amount Failure to maintain documents2% of the value of each international transaction or specified domestic transaction Failure to furnish documents2% of the value of each international transaction or specified domestic transaction Failure to furnish accountant’s reportINR 100,000 Failure to report a transaction in accountant’s report 2% of the value of each international transaction or specified domestic transaction Maintaining or furnishing incorrect information or documents 2% of the value of each international transaction or specified domestic transaction Maintenance of contemporaneous and robust documentation is the key to avoid penalties Maintenance of contemporaneous and robust documentation is the key to avoid penalties Copyrights with S.Goyal & Associates

25. SDT – Non-compliance may lead to significant exposure 25 2% of Transaction Value for: a)Non-maintenance of documents b)Non-submission of documents In case of adjustment a)100% to 300% of additional tax 2% of Transaction Value for: a)Non-maintenance of documents b)Non-submission of documents In case of adjustment a)100% to 300% of additional tax Existing penalty provisions now also applicable to SDT New penalty provisions introduced for SDT & International Transactions 2% of Transaction Value for: a)Non-reporting of transaction b)For incorrect maintenance/submission of documents 2% of Transaction Value for: a)Non-reporting of transaction b)For incorrect maintenance/submission of documents Transfer Pricing addition – Tax payable thereon Copyrights with S.Goyal & Associates

26. Way Forward - Next Steps 26  Immediate  Identification of:  covered entities and persons  covered transactions  Review of the pricing mechanism for the covered transactions  Planning for corrective steps to be taken:  Functions, Assets and Risk (FAR)analysis  Economic Analysis including Benchmarking for price setting  Ongoing  Review of existing transaction for change in facts and circumstances  Examining any new transactions and reviewing the pricing mechanism for such transaction  Year end compliance - (MOST IMPORTANT)  Preparation of Transfer Pricing Documentation (TP Report):  Covered persons  Covered transactions  Nature and quantum of transactions  Arm’s length pricing of all such transactions using Prescribed methods  Filing of Accountant’s Report in [Form No. 3CEB] within the prescribed time limit i.e. 30th November of the relevant assessment year Copyrights with S.Goyal & Associates

27. 27 Transfer Pricing Documentation – Sec 92D / Rule 10D  Profile of industry  Profile of group  Profile of taxpayer  Profile of associated enterprises  Transaction terms  Functional analysis (functions, assets and risks)  Economic analysis (method selection, comparable benchmarking)  Forecasts, budgets, estimates  Agreements  Invoices  Pricing related correspondence (letters, emails etc) Entity related Price related Transaction related  Contemporaneous documentation requirement – Rule 10D  Documentation to be retained for 9 years  No specific documentation requirement if the value of specified transactions is less than one crore rupees. Copyrights with S.Goyal & Associates

28. Accountants Report – Sec 92E / Rule 10E 28  To be obtained by every person entering into a specified domestic transaction  To be filed by the due date for filing return of income (no e-filing)  Opinion whether prescribed documents have been maintained the particulars in the report are “true and correct”  Review is limited to specified domestic transaction conducted by assessee  Relevant annexures and appendices be attached  Inputs: Related party ledgers extracts Related party Schedule under AS-18 Sample Invoices/ Vouchers / DN / CN Relevant intra-group agreements CUP information Form No. 3CEB [See rule 10E] Report from an accountant to be furnished under section 92E relating to international transaction(s) 1.We have examined the accounts and records of ENTITY NAME AND POSTAL ADDRESS - PAN No. relating to the international transactions entered into by the assessee during the previous year ending on 31st March 2012. 2. In our opinion proper information and documents as are prescribed have been kept by the assessee in respect of the international transaction (s) entered into so far as appears from our examination of the records of the assessee. 3. The particulars required to be furnished under section 92E are given in the Annexure to this Form. In our opinion and to the best of our information and according to the explanations given to us, the particulars given in the Annexure are true and correct. Place : New Delhi For S.Goyal & Associates Date : Chartered Accountants Copyrights with S.Goyal & Associates

29. Computation of Arm’s Length Price – Section 92C of the Act 29 Prescribed Methods Traditional Transaction Method Transactional Profit Method PSM Method CPLM Method RPM Method TNMM Method No hierarchy or preference of methods prescribed under the Act  Determination of ALP using one of the Prescribed methods -  Best suited to the facts and circumstances of each particular specified domestic transaction and  Provides the most reliable measure of an arm’s length price in relation to the specified domestic transaction shall be “Most Appropriate Method”  Where more than one ALP is determined, the arithmetic mean of such prices is taken to be the ALP CUP Method Copyrights with S.Goyal & Associates

30. 30 Summary of Methods Methods Product Comparability Functional Comparability ApproachRemarks CUPVery HighMedium Prices are benchmarked Very difficult to apply as very high degree of comparability required RPMHighMedium GPM (on sales) benchmarked Difficult to apply as high degree of comparability required CPLMHigh GPM (on costs) benchmarked Difficult to apply as high degree of comparability required PSMMediumVery HighProfit Margins Complex Method, sparingly used TNMMMediumVery HighNet Profit Margins Most commonly used Method Copyrights with S.Goyal & Associates

31. 31 Our Approach – For TP Documentation Methodology Information Gathering 1 Functional Analysis 2 Economic Analysis/ Benchmarking 3 Documentation 4 5 Accountant’s Report This exercise will assist in meeting the taxpayer’s requirements from a TP perspective Copyrights with S.Goyal & Associates

32. TP Documentation Methodology – Detailed steps 32 STEP 1 – Information Gathering Entity Related Price Related  Industry profile  Taxpayer‘s profile  AE’s profile  Agreements  Invoices  Pricing related correspondence – letters, e-mails, etc.  Transaction terms, forecasts and budget estimates  Market Profile  Functional analysis – functions performed, assets used & risk assumed  Economic Analysis - method selection & benchmarking Transaction Related Sequential progression Copyrights with S.Goyal & Associates

33. 33 TP Documentation Methodology – detailed steps (contd...)  Functional analysis based on information gathered in Step 1  Audit of the functions performed, assets utilised and risks assumed by Taxpayer for the specified domestic transactions being tested  Conduct interviews with company management and business personnel to understand the business/ strategic objectives from a TP perspective  Document the functional analysis STEP 2 – Functional Analysis  Select the ‘most appropriate method’ based on functional interview and availability of data  Searching for comparable transactions/ companies using internal data and/ or publicly available databases at our disposal  Apply quantitative and qualitative screens with appropriate financial adjustment to the comparables  Conclude if Taxpayer‘s related party transactions comply with the arm’s length standard STEP 3 – Economic Analysis/ Benchmarking Copyrights with S.Goyal & Associates

34. TP Documentation Methodology – detailed steps (contd...) 34  Preparation of draft TP Documentation that incorporates findings resulting from the above mentioned steps  Discuss these findings with Taxpayer to ensure factual consistency  Incorporate Taxpayer‘s review comments and issue the final TP Documentation  Timelines: Usually 6-8 weeks from the date of receiving required information STEP 4 – Documentation  Liaison with Taxpayer‘s personnel, after the close of statutory accounts to arrange for Accountant’s Report completion in the prescribed format  Timelines: Usually 2 weeks from the date of receiving required information STEP 5 – Accountant’s Report by a Chartered Accountant Firm Copyrights with S.Goyal & Associates

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