1_18 - Baroda ICAI

Report
Transfer Pricing
Specified Domestic Transactions
Study Circle
Baroda Branch of WIRC
14th May 2013
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
Introduction
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 2002-03
Tax Avoidance - International
India
Co. A
Co. B
S.P. Rs. 100
S.P. Rs. 120
Cost Rs. 90
Profit Rs. 20
Tax @ 35%
Tax 0%
USA
Co. C
Dubai
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
Tax Avoidance - Domestic
Tax Avoidance
Unit – 1
(Gujarat)
Unit – 2
(Baddi)
S.P. Rs. 100
S.P. Rs. 120
Cost Rs. 90
Profit Rs. 20
Tax @ 35%
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.
Transfer Pricing in India
Transfer Pricing Litigation in India
For Assessment
Year
Number of
Number of cases
Percentage of
Transfer Pricing
adjusted
adjustment cases
audits completed
Adjustment
Amount
(INR Crores)
2002-03
1,081
238
22%
1,373
2003-04
1,501
345
23%
2,575
2004-05
1,768
477
27%
3,861
2005-06
1,479
370
25%
4,950
2006-07
1,717
1,019
59%
9,743
2007-08
2,102
1,089
52%
24,000
2008-09
2,589
1,338
52%
44,500
Snapshot of Indian Regulation
• Transfer Pricing introduced from AY 2002-03 for international
transactions
– Extended to Specified Domestic Transactions [SDT] from AY 2013-14
• 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
Snapshot of TP Provision
92
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
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
SDT - Background
– In domestic transactions, under-invoicing and overinvoicing 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.
Specified Domestic Transactions
• Section – 92BA is inserted with effect from 01-04-2013, 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.
Related Party Transaction
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
40A(2)(b) – Definition of Related party
Individual Assessee
Husband
/ Wife
Lineal
ascendants
descendants
Sister
Assessee
Where
Assessee has
substantial
Interest
Brother
Whether these are related?
1. Brother or Sister of spouse
2. Lineal ascendants –
descendants of the spouse
3. Brother or Sister of Parents
4. Lineal A-D of brother or
sister of parents
5. And spouse of all of the
above
6. HUF of the Assessee or his
relative
40A(2)(b) – Definition of Related party
Relatives
Tax Payer = Company, HUF, Firm, AOP
b(v)
Other Director /
Partner/ member
b(v)
Relatives
b(vi)
b(ii)
>20%
Relatives
b(iii)
Director / Partner/
member
>20% b(vi)
Person
Person
b(ii)
All companies
where such
individual is
director / partner
/ member
b(v)
Director / Partner/
member
Company / Firm /
HUF / AOP
>20%
b(iv)
Tax Payer
b(vi)
b(iv)
b(iv)
Individual
b(iii)
Relatives
>20%
Person
>20%
b(iv)
>20%
Company
40A(2)(b) – Definition of Related party
Relatives
Tax Payer = Company, HUF, Firm, AOP
b(v)
Other Director /
Partner/ member
b(v)
Relatives
b(vi)
b(ii)
>20%
Relatives
b(iii)
Director / Partner/
member
>20% b(vi)
Person
Person
b(ii)
All companies
where such
individual is
director / partner
/ member
b(v)
b(iv)
Director / Partner/
member
b(iv)
Company / Firm /
HUF / AOP
Individual
b(iii)
Relatives
>20%
b(iv)
Tax Payer
b(vi)
b(iv)
>20%
Company
>20%
Person
>20%
>20%
>20%
Company / entity
40A(2)(b) – Issues
Tax Payer = Company, HUF, Firm, AOP
Relatives
15%
Tax Payer
Individual
15%
40A(2)(b) – Issues
Tax Payer = Company, HUF, Firm, AOP
Company
10%
10%
Relatives
10%
Director / Partner/
member
10%
Tax Payer
10%
Company / Firm /
HUF / AOP
10%
40A(2)(b) – Issues
• Whether sub-subsidiary and ultimate parent company is relative?
Co. A
Co. B
Co. X
Co. C
Co. Y
Transaction
A&B
A&C
A&X
Relative?
Yes
Yes
No
A&Y
B&C
B&Y
No
Yes
No
C&X
No
X&Y
No
Eligible Units / Undertaking
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
?????
SDT – Tax Holiday Units
80IA(8)
Inter-unit transaction of goods or
services
80IA(10)
•
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
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
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
• Benchmarking
• Cost Benefit Analysis
Allocation of Expenses between • Covered by SDT?
Units
• Benchmarking
Definition of related party
• Direct V/s Indirect relationship
Capital Expenditure
• Covered by SDT?
Sales of goods and services
• Comparability
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?
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.
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
Economy and Tax Provisions
• The tax provisions and it impact on Economy
Incentivize
Subsidize
Encourage
Tax
Regulate
Case Studies
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
Case - 1
Germany
USA
XYZ Inc.
YZ Ltd.
Subsidiary
India
90%
X Ltd
15%
25%
Z Ltd (10AA)
20%
A Ltd
90%
Y Ltd
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
Case - 2
USA
A Ltd.
B Inc.
Interest Free Loan
Corporate Guarantee
(fees at 0.25% is charged)
C Ltd
Interest Free Loan
Interest Free Loan
India
D Ltd (10AA)
-
Loan at 18%
ALP 11%
Corporate Guarantee
(No fees is charged)
E Ltd (10AA)
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
Case - 3
Directors of A
Ltd.
C Ltd.
Purchase of
Finished
Goods
80%
B Ltd
Son of Mr. Z
Mr. X
Mr. Y
Mr. Z
10%
10%
10%
Mrs. Y
Mr. F
15%
15%
100%
A Ltd
(Assessee)
D Ltd
Purchase of
Raw Material
50%
50%
YF (Partnership Firm)
Consultancy Fees
Transfer Pricing Methods
Transfer Pricing Methods
Comparable
Uncontrolled
Price Method
Resale Price
Method
Methods
Transactional
Net Margin
Method
Cost Plus
Method
Profit Split
Method
Transfer Pricing Methods
Comparable
Uncontrolled
Price Method
Any Other
Method
(Rule 10AB)
Resale Price
Method
Methods
Transactional
Net Margin
Method
Cost Plus
Method
Profit Split
Method
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
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
Stages of Economic Analysis
Comparability Analysis
Selection of Tested Party
Selection of Most Appropriate Method
Selection of Profit Level Indicator
Benchmarking
Selection of MAM
• MAM is to be determined considering –
Selection of
Tested Party
Comparability
Analysis
Selection of
Tested Party &
Comparability
Analysis
– 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
Classification of Methods
Price based
Methods
• Comparable Uncontrolled Price Method (CUP)
• Resale Price Method (RPM)
• Cost Plus Method (CPM)
Profit based
Methods
• Profit Split Method (PSM)
• Transactional Net Margin Method (TNMM)
Other
• Any other method which takes into account
price charged or paid between uncontrolled
parties considering all relevant facts
Documentation
Documentation Areas
• Company
• Group
• Industry
• Comparability
• Method
Selection
• Benchmarking
• Covered entities
• Covered
Transactions
Background
Information
Transactional
Information
Economic
Analysis
Functional
Analysis
• Functions
• Assets
• Risks
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,
emails, 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
Indicative Documentation
Transaction entered
Purchase/ sale of raw
material
Documents to be maintained
•
•
•
•
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
• Qualification
• Data from HR firms for
• Work Experience & Profile
Directors in the same line of
• Minutes of Meeting authorizing
business
the director’s remuneration
Corporate cost sharing • Nature of expenses
• Basis of allocation between
• Auditor’s certificate allocating
the companies
the expenses
• Proof of usage (rendering) of
services
• Cost benefit analysis
Remuneration to
Directors
Indicative Documentation
Transaction entered
Rent paid toward use
of premises
Reimbursement of
expenses
Interest on loan (nonfinancial services
company)
Documents to be maintained
• 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)
• Nature of expenses with detailed • Employee details
break-up
• Actual invoices of the
• Reason of expense incurred for
expense
• Basis of determination of
• Loan agreement
interest rate
• Basis on which the interest
• Interest Rate Card for the period
rate is pegged above standard
of loan
rate
Procedures
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  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)
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
271AA
Furnishing correct
information
2% of value of transactions for which
incorrect or no information is furnished
271AA
Failure to furnish
2% of value of transaction for each such
information or documents failure
as required under 92D(3)
271G
Audit Process
File tax return and Accountant’s Report (30th November)
DRP MechanismFinance 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 2005-06
onwards (Internal guidelines)
Appeal Procedure
Notice to be issues by the TPO - TPO calls for supporting
documents and evidence
TP Audit
Appeal to Commissioner of
Income Tax
Passes an order
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
Income Tax Appellate Tribunal
High Court - only on matters
related to law
Supreme Court
Constitutional Bench
Questions
Prashant Kotecha
Office: +91 265 3086467
Mobile: +91 98251 53981
Email: [email protected]
Thank You

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