Specified Domestic Transactions

Report
CA Hiren D Shah
Ahmedabad
Email: [email protected]

Transfer Pricing until now was applicable to Companies
having cross border 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. 1st April,2013
Transfer Pricing (“TP”) was earlier limited to ‘International Transactions’
 TP provision will now apply to ‘Specified Domestic Transactions’
◦ Expenditure for which payment is made or to be made to domestic related
parties
◦ Tax Holiday / Deductions claimed by the assessee
 Transfer of goods or services between various businesses of same assessee
 More than ordinary profits derived from transactions with closely connected
persons
 TP provisions to apply if the aggregate of ‘Specified Domestic Transactions’
exceeds five crores
 Shift of focus from generic ‘Fair Market Value’ concept to ‘Arm’s Length Price’
◦ Fair Market Value can established using basic market evidence
◦ Arm’s Length Price can be determined by use of five prescribed methods
 Advance Pricing Agreements NOT applicable to specified domestic transactions
 Assessing officer’s powers shifted to Transfer Pricing Officer (‘TPO’)

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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
Intent of Indian Transfer Pricing (TP) Regulations
Associated Enterprise
(AE Co.)
Indian Co.
India
(Tax @ 33%)
Shifting of Losses
Overseas
(Tax at Lower
rates, say 10%)
Tax Savings for the group -> Indian Govt. loses
Intent of Domestic TP-Domestic Tariff Area (DTA)
Scenario 1
Scenario 2
Particulars
Co.A
Co.B
Particulars
Co.A
Co.B
Taxed in India @
33%
33%
Taxed in India @
33%
33%
Income from RP
100
-
Income from RP
150
-
Other Income
200
400
Other Income
200
400
Expense to RP
-
100
Expense to RP
-
150
Other Expenses
400
200
Other Expenses
400
200
Profit / Loss
(100)
100
Profit / Loss
(50)
50
-
33
Tax
Total Tax for the
Group
33
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.
To avoid such cases and even though there is no erosion of tax base, Domestic TP
has been introduced.
Intent of Domestic TP-DTA & Tax Holiday Unit
Scenario 1
Particulars
Scenario 2
Co.A
Co.B
Particulars
Co.A
Taxed in India @
0%
Income from RP
Other Income
33%
Taxed in India @
0%
33%
150
-
Income from RP
225
-
300
600
Other Income
300
600
Expense to RP
-
150
Expense to RP
-
225
Other Expenses
300
300
Other Expenses
300
300
Profit / Loss
(150)
150
Profit / Loss
225
75
-
50
Tax
Total Tax for the
Group
50
Tax
Total Tax for the
Group
Co.B
-
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.
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This is an anti-abuse provision brought to check the excessive tax holiday claims
Generic framework of ‘More than ordinary profit’ was provided in law to compute the
excessive tax holiday claims
Various tribunal rulings in favor of taxpayers virtually made this clause redundant
To plug the loophole, it is now proposed to compute more than ordinary profits through
the ‘arm’s length price’ mechanism
Impact/ Issues
◦ The assessee carrying on the eligible business will have to justify the
ALP of the transactions between the eligible unit/ business and any
other person with whom the assessee has close connection
◦ The term “Close Connection” under section 80IA(10) not defined
◦ Burden of the proving the “close connection” between the assessee and
other party is on TPO
◦ 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
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
for FY 201213
Section
Nature of Undertakings covered
80IA
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
80IB
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
80IC
Undertaking located in notified Centre/ Parks/ Areas in
• Sikkim
• Himachal Pradesh/ Uttaranchal
• North- Eastern states
80ID
Undertaking engaged in business of hotel/ convention centre in
specified areas/ districts
10AA
Undertakings having a Special Economic Zone unit
Expenses
Transactio
n within
Company
• Expenses paid by domestic companies to related parties will be challenged
• Corresponding adjustment not permitted for disallowed expenses; will lead to double taxation
• Company with multiple units and claiming tax holiday will be questioned on inter unit transfers
• Authorities will attempt to reduce profitability of exempted unit for reducing the quantum of deduction
• Companies declaring ‘More than ordinary Profits’ for tax holiday units will loose excessive income-tax benefits
Tax Holiday
Shift of
Approach
Compliance
• Approach will shift from generic ‘Fair Market Value’ concept to Arm’s Length pricing
• Heavy Compliance burden of maintaining:
• transfer pricing documentation and
• reporting of transactions (Form 3CEB)
• Assessment / audit by specialized cell of TPO
Assessment



“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
‘Gross margin’ of company reselling products /
services to unrelated parties
Cost Plus Method
‘Gross margin’ of company selling manufactured
products / services to related parties
Profit Split Method
‘Splits profits’ between parties to transactions
based on economic parameters
Transactional Net Margin Method
‘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 three percent is permitted from arm’s length
price

Domestic Transfer Pricing usher shift from generic ‘Fair Market Value’ concept to
Arm’s Length Pricing
Characteristic
Fair Market Value
Arm’s Length Pricing
Definition
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
Computation
Mechanism
No specific mechanism
provided in law
Most appropriate method out
of five prescribed methods
Transaction Value
Any market pricing point can
be treated as fair market
value
Arithmetic mean of
comparable prices treated as
arm’s length price
Sample Size
One comparable may be
sufficient to establish fair
market value
Require bigger sample size for
establishing arm’s length
Deviation
No deviation permitted from
fair market value
Deviation of plus / minus three
percent is permitted


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
• Relative of individual
Company
• Director of company or relative of the director
AoP/ HUF
• Member of AoP / HUF or relative of such member
Any taxpayer
• Payment to a person who has substantial interest
• Payment to a director / partner / member / relatives of a person who has substantial
interest
• Payment to a company in which my parent (more than 20% holding) has substantial
interest
• Payment to a person whose director/ partner/ member has substantial interest
• Payment to a director/ partner/ member/ relatives of a person whose director/
partner/ member has substantial interest
• Payment to a person in which I have substantial interest
• Payment to a person in which my director/ partner/ member/ relatives have
substantial interest
• Payment to any of my 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:

◦
◦
◦
◦
◦
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Husband;
Wife;
Brother;
Sister; or
any lineal ascendant or descendant;
Proviso inserted in section 40A(2)(i) to the effect that disallowance shall not be made
if the specified domestic transactions are at arm’s length price
Provisions applicable only to expenditure where payment is made or to be made
◦ Does this include capital expenditure?
◦ Does this include transactions without consideration?
◦ Excessive discounts not covered


Wide coverage and goes beyond the related parties covered under AS-18
Whether Government approval u/s 295, 297 of the Companies Act would be
relevant?

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.
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Interest free Loans to group Companies
Granting of Corporate Guarantees / Performance
Guarantee by Parent Company to its Subsidiaries
Intra-group purchase/sell/ service transactions
Payment made to key personnel of the assesse
e.g. Directors/CEO/CFO
Payment made to key personnel of the group
Companies
Payment made to relatives of key personnel of
the assesse/ group companies
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For Royalty payments it has held in the decision of
Oracle India Pvt Ltd vs. ACIT, some weightage was
attributed by the Delhi Bench of the ITAT to the
earlier RBI norms governing remittance of royalties
in the computation of ALP
In SGS India Pvt Ltd vs. ACIT 292 ITR 93(Bom), it was
held that some importance needs to be given in a
case where the RBI had allowed the remittance of
research and development expenditure considering
its disallowance by the assessing officer.
Similarly Can one rely on the remuneration
guidelines under schedule XIII of the Companies Act
to determine Director Remuneration at Arms’ length
Price?
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If aggregate of International and Domestic
transaction exceeds INR 50 million, Do we
need to demonstrate ALP for Domestic
transaction which is otherwise below INR 50
million?
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?


Under which Form, report for Domestic
transfer Pricing shall be given? [ Section 92BA
refer Section 92E] [ Prescribed form u/s92E is
Form 3CEB which refers to the report on
International Transactions] Revised Form
3CEB shall be notified in order to cover
Specific Domestic Transactions
Section 92A [AE and Deemed AE] deals with
directly or indirectly interested vis-à-vis
Section 40A(2)(b) [Specified Domestic Related
Party] deals with directly interested
Entity Related
Price Related
 Profile of
Industry
 Transaction
terms
 Profile of group
 Functional
Analysis
(functions, assets
and risks)
 Profile of Indian
entity
 Profile of AEs
 Economic
Analysis (method
selection,
comparable
benchmarking)
 Forecasts,
budgets,
estimates
Transaction Related
 Agreements
 Invoices
 Pricing related
correspondence
(letters, e-mails,
fax, etc.)
Default
Nature of penalty
In case of a post-inquiry
100-300% of tax on the adjusted amount
adjustment, there is deemed to be a
concealment of income
Failure to maintain documents
2% of the value of each international
transaction or specified domestic transaction
Failure to furnish documents
2% of the value of each international
transaction or specified domestic transaction
Failure to report a transaction in
accountants 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
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’

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