Transcript Presentation on Specified Domestic Transactions
In domestic transactions, the under invoicing of sales and over-invoicing of expenses ordinarily will be revenue neutral in nature except in two circumstances having tax arbitrage such as where one of the related entities is ◦ Loss making or ◦ Liable to pay tax at lower rate and the profits are shifted to such entity
Transfer Pricing till A.Y. 2012-13 was applicable to Entities having International transactions with their Associated Enterprise Honoring the Supreme Court ruling in case of CIT vs M/s Glaxo Smithkline Asia (P) Limited expanded the ambit of transfer pricing to Specified Domestic Transactions w.e.f. 1 st April,2013
Intent of Domestic TP-DTA & Tax Holiday Unit
Scenario 1 Scenario 2
Particulars Co.A
Co.B
Particulars Co.A Co.B
Taxed in India @ 0% 33% Income from RP 150 Other Income 300 600 Expense to RP 150 Other Expenses 300 300 Profit / Loss 150 150 Tax Total Tax for the Group 50 50 Taxed in India @ 0% 33% Income from RP 225 Other Income 300 600 Expense to RP 225 Other Expenses 300 300 Profit / Loss 225 75 Tax Total Tax for the Group 25 25
By shifting of expenses from a tax holiday unit (Power) to a unit in the Domestic Tariff Area, the group could reduce its tax liability by 25. To avoid such cases, Domestic TP has been introduced.
Intent of Domestic TP-Domestic Tariff Area (DTA)
Scenario 1
Particulars Co.A Co.B
Scenario 2
Particulars Co.A Co.B
Taxed in India @ 33% 33% Income from RP 100 Other Income 200 400 Expense to RP 100 Other Expenses 400 200 Profit / Loss (100) 100 Tax Total Tax for the Group 33 33 Taxed in India @ 33% 33% Income from RP 150 Other Income 200 400 Expense to RP 150 Other Expenses 400 200 Profit / Loss (50) 50 Tax Total Tax for the Group 17 17
By shifting of expenses fro a loss making company to a profit making company, the group could reduce its tax liability by 16 for the current year, though the impact will be reversed in future years given carry forward of losses.
Intent of Indian Transfer Pricing (TP) Regulations
Indian Co.
Associated Enterprise (AE Co.) India (Tax @ 33%) Shifting of Losses Overseas (Tax at Lower rates, say 10%)
Tax Savings for the group -> Indian Govt. loses
Applicability
Transaction covered under Section Applicability clause (b) of sub section (2) of Section 40 Sub section (6) of 80A Sub section (8) of Section 80IA Profit based deduction Sub section (10) of Section 80IA Profit based deduction Chapter VIA or Section 10AA Profit based deduction In any of the section Any expenditure Computing Section ( Determination of ALP) Any transfer of goods or services within units – Intra Units Any business transacted within connected entities closely Any transaction Any other transactions as may be prescribed
Threshold Shift of focus How would you interpret the close connection ?
Fair Market Value can established using basic market evidence Determination of Arm’s Length Price Advance Pricing Agreements NOT applicable to specified domestic transactions
Scope – Domestic Transactions
Tax holiday undertakings covering : • inter-unit transfer of goods and services Transactions with entities having close connection Expenditure incurred between related parties defined u/s 40A Any other transaction that may be specified Aggregate Transaction value exceeds Rs. 50 millions in a financial year (
Applicable from FY 2012-13)
Scope of Section 92BA
Inter unit transfer of goods & services by undertakings to which profit-linked deductions apply – Sub section (8) of Section 80IA Expenditure incurred between related parties defined under section 40A SDT Transactions between undertakings, to which profit-linked deductions apply, having close connection Sub section (10) of Section 80IA
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Any other transaction that may be specified
Section 40A(2) Tax Payers covered Substantial Parties Interested Applicability of TP provisions on SDT aggregating a value of more than INR50 million Expenses or payment made or to be made.
80A(6) 80IA Sub Section (8) And (10) Enterprise claiming profit linked deductions from total income under chapter VI-A
Infrastructure developers
Telecommunications service providers
Developers of Industrial parks
Producers or distributors of power An enterprise with an eligible business and close connection with any other person Intra Transfer of goods and services and within the closed connected entities. ( i.e.
eligible business to non eligible business) The goods and services of an eligible business transferred to any other business carried on by the same taxpayer a-versa, are to meet the and vice arm’s length test.
(sub section 8) Intra Unit Transfer a business transacted between a taxpayer carrying on an eligible business transact with a close connection , which results in more than ordinary profits to the business, is to meet the arm’s length test. (sub section 10)
Section 80-IAB 80-IC / 80-IE 80-ID 10AA Tax Payers covered Applicability of TP provisions on SDT aggregating a value of more than INR50 million Developers of SEZs
Small Scale industry engaged in operating Cold storage plant
Industrial undertaking in industrially backward state as mentioned in VIII Schedule (ex : Jammu and Kashmir)
Multiplex theaters and convention centers
Company carrying on scientific research and development Eligible housing projects Eligible hospitals Persons with units in specified states / north-eastern states claiming deduction Hotels located in districts with World Heritage sites The goods and services of an eligible business transferred to any other business carried on by the same taxpayer are to meet the and vice-a-versa, arm’s length test.
(sub section 8) Intra Unit Transfer a business transacted between a taxpayer carrying on an eligible business transact with a close connection , which results in more than ordinary profits business, is to meet the to the arm’s length test. (sub section 10) Persons with income from SEZ units
Section 92BA Analysed......
For the purpose of sec. 92, 92C, 92D and 92E
Section
92 : Computation of income having regard to ALP
Relevance with provisions of Sec 92BA
92A : Meaning of AE 92B : Meaning of International transaction 92C : Methods of computation of ALP 92CA: Reference to TPO 92CB : Safe harbour rules 92CC : Advance Pricing agreement 92CD : Effect of TP agreement 92D : Maintenance of information and documents 92E : CA’s Report 92F : Definitions: Accountant, ALP, Enterprise, PE, Specified date, Transaction *
* Sec 92F – Definitions does not define terms relevant for domestic TP transactions
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Expenses
1 2
Intra Unit Transactions
3 4 5
Tax Holiday FMV to ALP
6
Assessment Accountant’s Report
Identify the type of the transaction covered under SDT Classification of transaction covered under SDT (i.e.40A(2)(b), Intra Group goods and services, Within Closely connected entities) Compliance of Section 92D with Rule 10D. ( Maintenance of Documentation which includes Transfer Study report, MAM, PLI, Tested Party, Manner of determination of ALP) Legal Compliance before due date of Filing return of Income
To
check evasion of tax
through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases.
AO is
expected to exercise
reasonable and fair manner his judgment in a
Fair market value of the goods, services or facilities for which the payment is made, or The legitimate needs of the business or Profession The benefit derived by or accruing to the assesse from the expenditure The above view is expressed by Hon’ble Guj High Court in the case of Coronation Flour Mills vs. Asst. CIT [ 2009] 314 ITR 1
Expenditure paid or to be paid to related parties will require to be at arm’s length Examples of related parties under section 40A(2)(b)
Payer Receiver of Payment
Individual Company AoP/ HUF Any taxpayer • • • • • • • • • • • Relative of individual Director of company or relative of the director Member of AoP / HUF or relative of such member Payment Payment
to a person
who has substantial interest
to a director / partner / member / relatives of a person
who has substantial interest Payment
to a company in which parent
substantial interest (more than 20% holding) has Payment
to a person whose director/ partner/ member
substantial interest has Payment
to a director/ partner/ member/ relatives of a person whose director/ partner/ member
has substantial interest Payment Payment
relatives
Payment
to a person in which entities
have substantial interest
to a person in which my director/ partner/ member/
have substantial interest
to any of director/ partner/ member/ relatives Substantial Interest means beneficial ownership of shares with at least 20% voting right or beneficial entitlement of at least 20% of the profits
Section 2(41)
defines relative in relation to an individual to mean: ◦ Husband; ◦ Wife; ◦ Brother; ◦ Sister; or ◦ any lineal ascendant or descendant;
Means an enterprise – ◦ (a). Which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprises; or ◦ (b). In respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same person who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.
Section 40A(2)(b) applies to payment made to the assesse’s relative or an associate concern is liable (
Substantially Interested Parties
)
Section 92A applies to transaction with AE directly or indirectly or through one or more intermediaries in the management or control or capital of the other enterprise.
B D A C E
Transaction Covered A & B A & C A & D A & E B & C D & E C & D B & E 22
Domestic Transfer Pricing usher shift from generic ‘Fair Market Value’ concept to Arm’s Length Pricing
Characteristic
Definition Computation Mechanism Transaction Value Sample Size Deviation
Fair Market Value Arm’s Length Pricing
The price which goods or services would have fetched or cost in the open market A price which is applied in a transaction in uncontrolled conditions No specific provided in law mechanism Most appropriate method out of five prescribed methods Any market pricing point can be treated as fair market value Arithmetic mean of comparable prices treated as arm’s length price One comparable market value may be sufficient to establish fair Require bigger sample size for establishing arm’s length No deviation permitted from fair market value Deviation of plus / minus three percent is permitted
“Arm’s length price” means a price which is applied or proposed to be applied in a transaction in uncontrolled conditions Arm’s Length price is determined using the Most Appropriate Method :
Methods Comparability
Comparable Uncontrolled Price Method ‘Price’ of the transactions Resale Price Method Cost Plus Method Profit Split Method Transactional Net Margin Method ‘Gross margin’ of company reselling products / services to unrelated parties ‘Gross margin’ of company selling manufactured products / services to related parties ‘Splits profits’ between parties to transactions based on economic parameters ‘Net Profit margin’ (Operating Profit) of ‘Tested Party’ If more than one comparable price is obtained using above methods, then the arm’s length price would be ‘Arithmetic Mean’ of comparable prices ◦ Deviation of plus / minus five percent is permitted from arm’s length price
Methods for Determination of ALP
Price applied in a transaction between independent enterprises in uncontrolled conditions To be determined by applying the Most Appropriate Method, being one of the following five methods Comparable Uncontrolled Price (CUP) Method Resale Price Method (RPM)
Traditional transaction methods
Cost Plus Method (CPM) Profit Split Method (PSM) Transactional Net Margin Method (TNMM)
Transactional profit methods
In case, more than one price is determined by MAM: Apply Arithmetic mean Range of + 5% of the arithmetic mean
Section Nature of Undertakings covered
80IA 80IB 80IC 80ID 10AA Undertakings 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 Undertakings located/ engaged in • Industrially backward districts as notified; • Scientific research & development • Refining of 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 Undertaking located in notified Centre/ Parks/ Areas in • Sikkim • Himachal Pradesh/ Uttaranchal • North- Eastern states Undertaking engaged in business of hotel/ convention centre in specified areas/ districts Undertakings having a Special Economic Zone unit
anti-abuse provision
claims brought to check the excessive tax holiday Generic framework of
‘More than ordinary profit’
law to compute the excessive tax holiday claims was provided in To plug the loophole, it is now proposed to compute more than ordinary profits through the ‘arm’s length price’ mechanism
Issues
◦ Eligible business will have to justify the ALP of the transactions between the eligible unit/ business and any other person having
close connection
◦ The term “Close Connection” not defined ◦ ◦ ◦ Burden of the proving the “close connection” between the assessee and other party is on TPO
Impact
Loss of tax holiday claim in excess of arm’s length profits No corresponding adjustment allowed for other party for adjustments made, if any, by the TPO for transactions falling under this category
Industries operating in SEZs Infrastructure Developers Infrastructure Operator Telecom Services Industrial Park Developers Power Generations or Transmission
Interest free Loans to Group Companies Sub section 8 of
Section 80IA
Granting of Corporate Guarantees/ Performance Guarantees by Parent Company to its subsidiaries Sub section 8 of Section
80IA
Intra-group purchase/ sell/ service transactions Sub section 8 of
Section 80IA
Payment made to key personnel e.g. transaction with Directors/CFO/CEO etc.. Section 40A(2)(b) Payment made to key personnel of Group Companies. Section
40A(2)(b)
Payment made to relative of key personnel of the assessee/group companies. Section 40A(2)(b)
Commission to relatives of the directors/ partners
Salary paid to the relatives of the directors/Partners
Remuneration to the directors
Extra Purchase Price and Interest foregone to relatives
Good sold at lower than market price if bona fide
Higher Purchase Price than rates prevailing in the market
Interest paid to sister concerns at rate higher than normal rates
Hire Charges of Machinery or Rent paid for use of Immovable property
Maintenance of detailed TP Documentation, as specified in rule 10D demonstrating compliance with the ALP
Filing an Accountants’ report (Form 3CEB), certified by a Chartered Accountant with tax authorities containing details of specified domestic transactions
Default
In case of a post-inquiry adjustment, there is deemed to be a concealment of income Failure to maintain documents
Nature of penalty
100-300% of tax on the adjusted amount Failure to furnish documents Failure to report a transaction in accountants report Maintaining incorrect documents or furnishing information or 2% of the value of each international transaction or specified domestic transaction 2% of the value of each international transaction or specified domestic transaction 2% of the value of each international transaction or specified domestic transaction 2% of the value of each international transaction transaction or specified domestic
However, penalty for concealment of income shall not be levied if the taxpayer demonstrates that price charged or paid has been determined in ‘good faith’ and with ‘due diligence’
• •
Type of payments/
partners Directors
transactions
Salary and Bonuses paid to the Remuneration paid to the
Challenges
• • 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?
• Transfer of land • Joint Development agreements • Rules defined by Local Authorities (Jantri) as ALP?
• Benchmarking?
• Project management fees • Benchmarking?
• Allocation of expenses between the same taxpayer having an eligible unit and non-eligible unit • Whether these allocation would be SDT – Sec 80-IA(10)? • Definition of Related Party • Directly v/s Indirectly 33
1. Transfer pricing provisions are not applicable in case where income is not chargeable to tax at all.
[Amiantit International Holding Ltd., (2010) 322 ITR 678 (AAR)]
2. Provisions of section 40A(2) are not applicable to a co-operative society.
[CIT vs. Manjara Shetkari Sahakari Sakhar Karkhana Ltd.(2008) 301 ITR 191 (Bom.)]
3. Payment made by holding co. to subsidiary co. is not covered u/s 40A(2)(b), as the relationship does not fall under sub-clause (ii) nor under sub-clause (iv) of sec.
40A(2)(b).
[CIT vs. V.S.Dempo & Co. (P) Ltd. (2011) 336 ITR 209 (Bom.)
Note: In this decision, clause (vi) of s. 40A(2)(b) was not considered.
4. When a person commits an offence by not maintaining the books of accounts as contemplated by section 44AA, the offence is complete. After that there can be no possibility of any offence as contemplated by section 44AB and therefore, the imposition of penalty is erroneous.
[Surajmal Parasmal Todi vs. CIT (1996) 222 ITR 691 (Gauhati)]
Note : This decision may be helpful in the context of sections 271AA, 271G and 271BA.
5. 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.
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◦ ◦ ◦ Provisions applicable only to expenditure where payment is
made or to be made
Does this include capital expenditure? – Section 40A(2)(b) Does this include transactions without consideration? –
Section 80IA(8) & 80IA(10)
Does threshold apply to the amount recorded in the Books of Account or Amount determine as per ALP?
Whether Government approval u/s 295, 297 of the Companies Act would be relevant?
Whether close connection would be interpreted to mean the criteria mentioned in section 92A(2) or 40A(2)(b) (Inconsistency regarding definition of related parties
Does the limit of INR 50 million apply qua transaction or aggregate of all transactions ?
If aggregate of International and Domestic transaction exceeds INR 50 million, but the International Transactions are below INR 10 million, Do we need to maintain documents prescribe under Rule 10D? ( Reference Rule 10D(2) Would claim of Depreciate comes under the ambit of Domestic Transfer Pricing?
How are SDT defined?
◦ The following transactions with the aggregate value exceeding INR 50 million are covered Expenditure for which payment is made or to be made to specified domestic parties Transfer of goods or services to/from eligible business ( tax holiday) from/to other business ( non-tax holiday undertaking) Business transactions between eligible business ( tax holiday unit) and other person(s) producing more than ordinary profits owing to close connection Which tax payers covered under SDT?
◦ Any tax payer incurring any expenditure with specified Domestic related parties are required to comply the regulation
How do you define specified domestic related party?
◦ The domestic related party will inter alia include a director, a relative of the director, a person having substantial interest in the tax payer ( carrying not less than 20% of the voting power) and fellow related parties where a single person has substantial interest in two tax payers Which are the illustrative list of SDT?
◦ Transaction between the specified persons and also between the inter-unit transactions of taxpayers would be covered e.g. normal operating transactions, allocation of costs, etc…
What are the compliance requirements for tax payers that have SDT?
Tax payer that have specified Domestic Transaction would need to do the following: Identify the nature of Transactions Maintain requisite information and documents as prescribed Obtain and furnish a prescribed report from an accountant in Form 3CEB
Applicability of OECD TP guidelines
Advance Pricing Arrangement
Benefit of range
Rule 10D and Form 3CEB requires modification to harmonise their applicability in relation to inter-units pricing and reporting of domestic transactions