Income tax – Overview Nihar Jambusaria Typical Transactions u/s.40A(2) and their Benchmarking…………………………. Nihar Jambusaria [email protected] [email protected] ISSUES AND CASE STUDIES INTRICACIES OF VALUE THRESHOLD INR 5 CR. Threshold of INR 5 Cr. on aggregate basis for all six limbs Value to be adopted as per books – [Form 3CEB] Relief from documentation and ALP benchmarking Book value to be adopted even if transactions are ALP compliant Transaction Value as per books ALP Scenario I Scenario II 40 (A)(2)(b) payments 3.00 Cr. 3.00 Cr. 4.00 Cr. Inter-unit payment by 1.50 Cr. 2.25 Cr. 1.25 Cr. 4.50 Cr. 5.25 Cr. 5.25 Cr. qualifying unit Total CASE STUDY – 1 Transactions Covered: A&B = Yes A&C = Yes A&D = No A&E = No B&C = Yes Issue 1 – Direct Vs Indirect Shareholding CBDT circular - No. 6P, July 6, 1968 – (Not Binding on Taxpayer/ Applicable only to downstream entities). ICAI GUIDANCE NOTE – Only Direct Shareholding covered. Need clarification in the Act or by way of a Circular whether for purposes of Section 40A(2)(b), one needs to consider only direct shareholding and not derivative or indirect shareholding CASE STUDY – 2 FACTS A Ltd B Ltd A Ltd and B Ltd are related parties under S. 40A (2)(b) A Ltd grants loan to B Ltd at an interest rate of 18% p.a ALP interest rate arrived after considering the tenure, repayment terms and other terms and conditions is much lower than the interest rate charged by A ltd. Impact For A Ltd: Presently, income transactions from related parties under S. 40A(2)(b) are not covered under Domestic TP For B Ltd: Payment of Interest to related party covered under S. 40A(2)(b) constitutes SDT and hence B Ltd will be liable to Domestic TP B Ltd pays interest at a rate much higher than the ALP determined.\ Tax Authority can make an adjustment to disallow the excess interest paid and ‘may’ also be exposed to penalty for non compliance of TP provisions. CASE STUDY – 3 FACTS A Ltd B Ltd A Ltd and B Ltd are related parties under S. 40A (2)(b) A Ltd grants interest free loan to B Ltd. Impact For A Ltd: No notional interest income can be computed in the hands of A Ltd on the basis of ALP rate as income transactions are not covered under the purview of Domestic TP However, if A Ltd has used interest bearing borrowed funds to give interest free loan to B Ltd, issue of disallowance of corresponding interest expenditure ‘may’ arise. For B Ltd: No interest is paid by B Ltd, the provisions of S. 40A(2)(b) r.w.s. 92BA are not applicable and thus B Ltd is not liable for domestic TP. CASE STUDY – 4 FACTS: PQR Ltd. Bod includes: PQR Ltd Unit A Unit B Unit C Independent Directors who receive sitting fees Promoters (directors) who receive salary, commission and sitting Fee. ISSUES Are the payments made to Directors covered under Specified Domestic Transactions? Methods to determine the Arm’s length Price? BENCHMARKING OF DIRECTORS REMUNERATION It can be benchmarked based on their work experience and qualification. Further the remuneration paid to them is as per the limit of Companies Act. However there is no streamlined process to benchmark the transaction. 13 DOMESTIC TP NOT RESTRICTED TO TRANSACTION WITH RESIDENTS S. 92BA excludes International Transaction from within its scope Trigger for AE relationship different for International and Domestic TP Illustrative examples where transactions with non-resident may be covered under Domestic TP Remuneration paid by an Indian company to a non-resident director Remuneration paid by a FC having PE to non resident director Payment by Indian Co to Foreign Co. where Foreign Co. holds 20 to < 26% in Indian Co. CASE STUDY – 5 A Ltd Outside India salary paid Mr. X Director of A Ltd salary paid India PE in India FACTS Mr. X is director of A Ltd which has PE in India and was deputed to work for PE in India from 1st Nov 2011. Mr. X’s is a non-resident for FY 201112 Salary to Mr. X upto 1st November was paid outside India and post November salary (above 5 Cr.) was paid in India PE is liable to tax on net basis in India and claims salary paid to Mr. X post November 2011 as deductible expenditure from its income Issue: Whether salary paid to Mr. X is subject to Domestic TP considering that both A Ltd and Mr. X are non-residents. Analysis Salary paid to Mr. X is not an International transactions in terms of S. 92B r.w.s 92A since Mr. X is not an AE of A Ltd as defined under S. 92A However, Mr. X is a director of A Ltd and hence it will be covered under related party as defined under S. 40A(2)(b) PE is liable to tax in India on net basis and it can claim deduction for salary paid to Mr. X for rendering services in India The salary cost paid to Mr. X for services rendered in India does not constitute ‘HO expenditure’ in terms of S. 44C, full deduction is available. The payment made by PE to Mr. X will be covered under the purview of Domestic TP as payment is made to related party covered under S. 40A(2)(b) PE will be required to benchmark the payment made to Mr. X to ALP and required to comply with all the provisions of Domestic TP,. The fact that both A Ltd and Mr. X are non-residents is not relevant. SDT can be applicable with / between non-residents. CASE STUDY – 6 H Co. (Indian Co) A Ltd (foreign subsidiary) B Ltd (Indian Subsdiary) C Ltd (Indian Subsidiary) Facts: H Co. and both Indian Subsidiaries are not entitled to any profit linked tax holiday. H Co. owns a valuable brand ‘XYZ’ which is self generated for Hold Co. The subsidiaries companies are engaged in manufacturing and distribution of diverse products and sell their products under the brand name of ‘XYZ’. The subsidiaries pays royalty to H Co. for use of brand name. Foreign subsidiary has no presence in India and its not liable to tax in India. Issues: Whether H Co. is liable for Domestic TP for royalties received from its subsidiaries Whether subsidiaries are liable for Domestic TP Analysis: Applicability of Domestic TP for H. Co Even though B Ltd and C Ltd (domestic subsidiaries)are related parties covered under 40A(2)(b), the royalty income received from subsidiaries is not covered under by the provisions of domestic TP as it covers only the payments made to related parties and not income transactions. However, A ltd (foreign subsidiary) is an AE for H Co. Royalty Income received from A Ltd will constitutes Intl. transaction for H Co. and it is required to benchmark royalty income received Applicability of Domestic TP to A Ltd A Ltd has no presence in India and not liable to tax in India hence S. 40A(2)(b) and Domestic TP provisions are not applicable. Applicability of Domestic TP to B Ltd & C Ltd B Ltd and C Ltd (domestic subsidiaries)are related parties covered under 40A(2)(b), the provisions of Domestic TP will be applicable. Royalty fees paid by B Ltd and C Ltd will be required to benchmark with ALP. CASE STUDY 7 : DETERMINING SUBSTANTIAL INTEREST P Directors Co. 2 • • Q 15% R 15% Others S 15% 15% 40% Co. 1 Mr. P, Q, R & S hold 15% of voting power in Co. 1 and balance 40% are held by others Mr. P, Q, R & S are directors in Co. 2 Issue: • Are Co1. and Co. 2 related parties? Analysis: Substantial holding is required to be determined on an individual holding basis. Preference shares holding to be excluded while determining the substantial interest. Mr. P, Q, R & S does not hold any substantial interest (less than 20%) individually, Co. 1 and Co. 2 are not related parties. Issue: • Are Co1. and Co. 2 related parties? Analysis: Substantial holding is required to be determined on an individual holding basis. Preference shares holding to be excluded while determining the substantial interest. Mr. P, Q, R & S does not hold any substantial interest (less than 20%) individually, Co. 1 and Co. 2 are not related parties. Miscellaneous Issues Issues Possible views What does ‘close connection’ for Section 80IA(10) mean? - Reliance on Sec. 92A, Sec. 40A(2)(b) and AS 18? Indirect shareholding covered? Whether all transactions with a closely connected person included or only those resulting in more than ordinary profits? - View 1 - All transactions to report & benchmark View 2 - Only transactions resulting in more than ordinary profits to report and benchmark Whether all transactions are to be reported? Whether TP applicable if expense not claimed? - Transaction to be reported, not benchmarked? Whether transactions between two eligible units (having differential exemption) covered? - Nothing expressly stated in the provisions ICAI Guidance Note mentions transfers between ‘eligible’ and ‘non-eligible’ business? Are free of cost goods/ services/ loans covered? - Should not be an issue under Section 40A(2)(b) Tax holiday units?