domestic transfer pricing - a complete study
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DOMESTIC TRANSFER PRICING PROVISIONS
CA .T. P. OSTWAL
10th October 2012
T.P.Ostwal & Associates 1
BOMBAYCHARTERED ACCOUNTANTS
SOCIETY
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Introduction
TP was earlier limited to InternationalTransactions
The Finance Act 2012, extends the scope of TP provision to Specified Domestic
Transactions between related parties w.e.f. 1 April 2012 The SC in the case of CIT vs Glaxo Smithkline Asia Pvt Ltd [2010-195Taxman 35
(SC)] recommended introduction of domestic TP provisions
SDT previously reported/certified but onus on revenue authorities
Obligation now on taxpayer to report/ document and substantiate the arms length
nature of such transactions
Shift from generic FMV concept to focused ALP concept
These new provisions would have ramifications across industries which benefit from
the said preferential tax policies such as SEZ units, infrastructure developers or
operators, telecom services, industrial park developers, power generation or
transmission etc. Apart from this, business conglomerates having significant intra-
group dealing would be largely impacted
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SDT Intent of the Law
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Associates 3
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Intent of Indian TP Regulations
(International transactions)
Indian Co.
Associated
Enterprise
(AE Co.)
Shifting of Profits
Shifting of Losses
India Overseas
Tax @ 32.45% Tax @ lower rate
approx 10%
Tax Saving for the Group Loss to Indian revenue
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Intent of Indian TP Regulations
(Domestic transactions)
Indian Co.
Tax Holiday
undertaking
Related Enterprise in
Domestic Tariff Area
(DTA)
Shifting of expenses/losses
Shifting of income/profits
India
Tax Exemption
Tax Saving for the Group Loss to Indian revenue
India
Tax @32.45%
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Intent of Indian TP Regulations
(Domestic transactions)
Particulars (Ordinary Situation) Co. X (SEZ) Co. Y (DTA)
Income 500 1000Income from related party 100 -
Expenses 300 800
Expense to related party - 100
Profit/ Loss 300 100
Tax rate applicable 0% 32.45%
Tax - 32.45 (100*32.45%)
Particulars (Planned Situation) Co. X (SEZ) Co. Y (DTA)
Income 500 1000
Income from related party 200 -
Expenses 300 800Expense to related party - 200
Profit/ Loss 400 -
Tax rate applicable 0% 32.45%
Tax - -
Loss toRevenue
Tax Saving
to the Group
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Intent of TP Regulations
(Domestic transactions)
Indian Co.
Loss making
Related Enterprise
Profit making
Shifting of expenses
Shifting of income
India
Tax @ 32.45%
No tax or reduced tax due to loss
Tax @ 32.45%
Reduced tax due to
shifting of profits
Tax Saving for the Group Loss to Indian revenue
India
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Particulars (Ordinary Situation) Co. X (DTA) Co. Y (DTA)
Income 500 1000
Income from related party 100 -
Expenses 700 800
Expense to related party - 100
Profit/ Loss (100) 100
Tax rate applicable 32.45% 32.45%
Tax - 32.45 (100*32.45%)
Particulars (Planned Situation) Co. X (DTA) Co. Y (DTA)
Income 500 1000
Income from related party 150 -
Expenses 700 800
Expense to related party - 150
Profit/ Loss (50) 50
Tax rate applicable 32.45% 32.45%
Tax - 16.23 (50*32.45%)
Present
Loss to
Revenue*
Tax Savingto the
Group
* By shifting of income from a profit making company to a loss making company, the group could reduce its tax
liability by 16.23 for the current year, though the impact will be reversed in future years given carry forward of losses.
Intent of TP Regulations(Domestic transactions)
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Section 92BA Meaning of SDT(inserted by Finance Act, 2012 w.e.f. AY 2013-14 i.e. current FY)
For the purposes of this section and sections 92, 92C, 92D and 92E, specified domestic
transaction in case of an assessee means any of the following transactions, not being aninternational transaction, namely:-
(i) any expenditure in respect of which payment has been made or is to be made to a person
referred to in section 40A(2)(b);
(ii) any transaction referred to in section 80A;
(iii) any transfer of goods or services referred to in sub-section (8) of section 80-IA;
(iv) any business transacted between the assessee and other person as referred to in section
80-IA (10);
(v) any transaction, referred to in any other section under Chapter VIA or section 10AA, towhich provisions of section 80-IA(8) or section 80-IA(10) are applicable; or
(vi) any other transaction as may be prescribed,
and where the aggregate of such transactions entered into by the assessee in the previous
year exceeds a sum offive crore rupees.
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SDT
Inter unit transfer of goods & services by
undertakings to which profit-linked deductions
apply
Expenditure
incurredbetween
related
parties
defined under
section 40A
Transactions between undertakings, to which
profit-linked deductions apply, having close
connection
Any other
transaction
that may be
specified
Overview of Provisions of Section 92BA
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Section 92BA Analysed......
Section Relevance with
provisions of
Sec 92BA
92 : Computation of income having regard to ALP
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 : CAs Report
92F : Definitions: Accountant, ALP, Enterprise, PE, Specified date, Transaction*
For the purpose of sec. 92, 92C, 92D and 92E
* Sec 92F Definitions does not define terms relevant for domestic TP transactions
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(1) Computation of income from international transaction having regard to ALP.
(2) mutual agreement etc for allocation or apportionment or contribution to any cost or expense
shall be determined having regard to ALP.
(newly inserted)
(2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any
income in relation to specified domestic transaction shall be computed having regard to
ALP.
(3) section does not apply if the effect is reducing the income or increasing the loss.
Sec. 92 Computation of income from international transaction having
regard to ALP
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The words specified domestic transaction has been inserted appropriately in various sub-sec.
(1) Any of the following methods, being most appropriate method :
(a) Comparable uncontrolled price method;
(b) Resale price method;
(c) Cost plus method; refer rule 10B
(d) Profit split method;
(e) Transactional net margin method;(f) other method of determination ofarms length price
(any method that takes in to account the price which has been charged or paid or would
have been charged or paid for same or similar uncontrolled transaction with or between
non associated enterprises)
(2) Most appropriate method as per criteria laid down in rule 10C considering FAR analysisalso.
FAR : Functions performed, Assets employed, Risks assumed [Rule 10C(2)]
Sec. 92 C Computation of ALP
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The word specified domestic transaction inserted in various sub-sections.
(1) AO may refer the computation of ALP to TPO
(2) TPO to issue notice to Assessee to produce evidence in support of ALP
(2A) Any other international transaction coming to notice of TPO*
(2B) Non-furnishing ofCAs report and TPOs power*
(3) TPO shall pass the order determining ALP
(4) AO to compute total income accordingly
(7) TPOs power of summons (s.131), survey (s.133A) and collecting
information u/s 133(6)applies even in Domestic Transaction
Sec. 144C (15)(b)..Reference to DRP
AO to forward draft of proposed order to eligible assessee
eligible assessee means any person in whose case order u/s 92CA is passed
* 92CA (2A ) & (2B) do not cover specified domestic transactions and hence the TPO cannot
suo moto upon the transaction coming to his notice apply the TP provisions
Section 92CA - Reference To TPO
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Profile of Industry
Profile of group
Profile of relatedparties
Transaction terms
FAR related
Economic Analysis(method selection,
comparable
benchmarking)
Forecasts,
budgets, estimates
Agreements
Invoices
Pricing relatedcorrespondence
(letters, e-mails,
fax, etc.)
Entity Related Price Related Transaction Related
The onus of proving SDT at ALP is on tax payer
Section 92D : Maintenance and keeping information and document by
persons entering into an international transaction
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Section 271Penalty Implications
Sr.
No.
Type of penalty Section Penalty quantified
1 a) Failure to maintain
prescribed information/
documents
271AA 2% of transaction
value
(b) Failure to report any such
transaction or
(c) Furnish incorrectinformation
2 Failure to furnish information/
documents during assessment
u/s 92D
271G 2% of transaction
value
3 Adjustment to taxpayers
income during assessment
271(1)(c) 100% to 300% of tax
on
adjustment amount
4 Failure to furnish accountants
report u/s 92E
271BA INR 100,000
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Section 40A(2) Transactions covered
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Mapping to be done for the companys transactions with domestic Related Parties
Primary reliance on disclosures u/s 40A(2)(b) and Related Party Schedule
Different divisions enter into different transactions with various group companies
Broad categories of transactions likely to be covered :
Purchase ofgoods and
services
Payment
of interest
Paymentof
royaltycharges
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Sec 40A (2)(b) Related Party
Sr.No Payer / assessee Payee
(i) Individual Any relative
[defined in sec. 2(41) to mean husband, wife, brother, sister, lineal ascendant or
descendant]
* Definition of Relative u/s 56(2) not relevant
(ii) Company any director or relative of such director
Firm (includes LLP)
any partner or relative of such partner
AOP any member or relative of such member
HUF any member or relative of such member
(iii) Any Assessee any individual having substantial interest in the assessees business or relative of
such individual
(iv) Any assessee a Company, Firm, AOP, HUF having substantial
interest in the assessees business
orany director, partner, member
orrelative of such director, partner or member
or (newly inserted)
any other company carrying on business or profession in which the first mentioned
company has substantial interest.
X Ltd. (subsidiary co)A Ltd. (holding co)Y Ltd. (subsidiary co)
Relationship can exists
any t imeduring the year
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Type of transactions covered (illustrations for payments made by a
Company)
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Case 1 - Director or any relative of theDirector of the taxpayer Section
40A(2)(b)(ii)
Mr. A Mr. C
Assessee
(Taxpayer)
Mr. D
Director
Relative
Covered transactions
Case 2 - To an individual who hassubstantial interest in the business or
profession of the taxpayer or relative of
such individual Section 40A(2)(b)(iii)
Mr. A Mr. C
Assessee
(Taxpayer)
Mr. DRelative
Substantialinterest>20%
Relative
Holding Structure
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Type of transactions covered (illustrations for payments made by a
Company)
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Case 3 To a Company having substantialinterest in the business of the taxpayer or
any director of such company or relative of
the director Section 40A(2)(b)(iv)
A Ltd
Mr. C
Assessee
(Taxpayer)
Mr. D
Relative
Director
Covered transactions
Case 4 Any other company carrying onbusiness in which the first mentioned
company has substantial interest Section
40A(2)(b)(iv)
C Ltd
B Ltd
Assessee
(Taxpayer)
A Ltd
Substantialinterest>20%
Holding Structure
Substantial
interest >20%
Substantial interest >20%
Substantialinterest>20%
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Type of transactions covered (illustrations for payments made by a
Company)
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Case 5 To a Company of which a director has a substantial interest in the business of the taxpayeror any director of such company or relative of the director Section 40A(2)(b)(v)
Mr. A
Mr. C
Assessee
(Taxpayer)
B Ltd
Director
Covered transactions
Holding Structure
Substantial
interest >20%
Mr. D
Rela
tive
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Type of transactions covered (illustrations for payments made by a
Company)
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Case 6 To a Company in which thetaxpayer has substantial interest in the
business of the company Section
40A(2)(b)(vi)(B)
B Ltd
Assessee
(Taxpayer)
Covered transactions
Case 7 Any director or relative of thedirector of taxpayer having substantial
interest in that person Section
40A(2)(b)(vi)(B)
Mr C
Mr B
Assessee
(Taxpayer)
A LtdSubstantial interest >20%
Holding Structure
Substantial
interest>20%
Relative
D LtdSubstantial interest >20%
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Type of transactions covered (illustrations for payments made by a
Company)
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B
A
C
D E
Transaction Covered
A & B
A & C
A & D
A & E
B & C
D & E
C & D
D & E
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Thus for Company A payments to following persons are covered
1
Company B having 20% or more voting power in A;
any other company in which Company B has 20% or more voting power;
2
a company in which A has 20% or more voting power;
any company of which a director has 20% or more voting power in A;
any company in which a director of A has 20% or more voting power;
3
any director of A or of Company B or to any relative of such director; &
any individual having 20% or more voting power in A or any relative of such
individual.
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Tax burden, if transaction not at ALP
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X Ltd.
(non-tax
holiday)
Disallowance of` 20 to Y Ltd[40A(2)(b)]
Y Ltd.
(non-tax
holiday)
Sale at 120 v/sALP i.e. 100
X Ltd.
(tax holiday)
Y Ltd.
(non-tax
holiday)
Sale at 120 v/sALP i.e. 100 Double Adjustment
Tax holiday on 20 not allowed to X Ltd
[80IA(10)] (more than ordinary profits)
Disallowance of 20 to Y Ltd -
[40A(2)(b)]
X Ltd.
(tax holiday)
Y Ltd.
(non-tax
holiday)
Sale at`80 v/sALP i.e.`100
Inefficient pricing structure reduced tax
holiday benefit since sale price is lower
than ALP
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Section 80IA (8) & 80IA (10) Deduction in respect of profits and gainsfrom industrial undertaking or enterprise engaged in infrastructuredevelopment, etc.
No guidance on the meaning of close connection To align ordinary profits with arms length price. For example:
OP/ TC of 30% considered to be at arms length by the TPO
Under 801A(10) the AO states that the profits are more than ordinary
Solution: Defend price or evaluate alternate methods (other then profit based)
Impact of non-charging of services/ costs to tax holiday undertaking10th October 2012 T.P.Ostwal & Associates 26
80IA (8) 80IA (10)
Inter-unit transaction of goods or services 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 Primary onus on taxpayer
Onus on tax authorities as well
ALP of 5 comparable companies OP/TC Mark-up of the tax holiday entity
OP/TC
Arithmetic mean = 15% 30%
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80-IA Income from Infrastructure, Telecommunication, Industrial Park & Power sector etc.
80-IAB Income of an undertaking or enterprise engaged in development of SEZ
80-IB Income from certain Industrial undertaking and Housing Projects etc.
80-IC Income from certain Industrial undertaking set up in Sikkim, HP...etc.
80-ID Income from hotels etc in Delhi, Faridabad and other specified districts.
80-IE Income from eligible business undertaking in North Eastern States
Other Sections under Chapter VI-A......to which s. 80-IA(8) or (10) are
applicable
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FMV ALP
No method prescribed for
computing FMV
Six methods prescribed for
computing ALP
No documentation required to be
maintained
Contemporaneous documentation
required to be maintained
Other than reporting in tax audit
report, no statutory compliance
Accountants report signed by a CA
to be filed
Assessment done by the AO Assessment done by the TPO
Implication post - budget 2012 for SDT
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Points for Consideration Whether the threshold limit of Rs. 5 crore applies to the aggregate amount under all the
relevant sections taken together OR under each section separately i.e. 40A(2), 80A, 80-IA(8),
80-IA(10), 10AA etc. ?
Whether payment for capital expenditure Or expenditure capitalized is also covered ?
Whether the provisions will apply in case the payers income is chargeable to tax under the
head Income from other sources, because section 58(2) says The provisions of section
40A shall, so far as may be, apply in computing the income chargeable under the head
Income from other sources as they apply in computing the income chargeable under the
head Profits and gains of business orprofession ?
Whether new provision applies to -
Public Charitable Trust paying remuneration to related persons.
Co-operative Societies
Social Clubs
having a business undertaking
Transfer pricing provisions are not applicable in case where income is not chargeable totax at all.
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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Challenges
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Type of payments/ transactions Challenges
Salary and Bonuses paid to the partners
Remuneration paid to the Directors
Transfer of land
Joint Development agreements
Project management fees
Allocation of expenses between the
same taxpayer having an eligible unit
and non-eligible unit
Definition of Related Party
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?
Whether the rates mentioned in the ready
reckoner be considered as ALP?
Benchmarking?
Benchmarking?
Whether these allocation would be SDT Sec 80-
IA(10)?
Directly v/s Indirectly
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Going Forward
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To Identify and map the relationship between domestic related parties specified u/s
40A(2)(b)
Identify and map the SDT
Revisit the pricing mechanism applied by the company for SDT applying the most
appropriate prescribed methods
To implement TP regulations in FY 2011-12 itself although not statutorily required so that
systems can be improved for FY 2012-13. To note that variations in profits of tax holiday
units for FY 2013 compared to FY 2012 may raise concerns from tax officers.
Availability of APA
The onus of proving SDT at ALP is on the tax payer
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THANK YOU
T. P. Ostwal & AssociatesCHARTERED ACCOUNTANTS
4th Floor, Bharat House,
104 Mumbai Samachar Marg,
fort, MUMBAI-400001.
Tel No.: +91-22-40693900
Fax No.: +91-22-40693999Mobile:+919004660107
Email: fca@vsnl.com
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