transfer pricing specified domestic transactions study circle baroda branch of wirc 14 th may 2013
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• 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
Agenda
• 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
Transfer Pricing - Background
S.P. Rs. 120
Profit Rs. 20
Tax 0%
Tax Avoidance - International
Co. A
Co. C
India
Co. B
S.P. Rs. 100
Cost Rs. 90
Tax @ 35%
Dubai
USA 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 Heaven
S.P. Rs. 120
Profit Rs. 20
Tax 0%
Tax Avoidance - Domestic
Unit – 1 (Gujarat)
Unit – 2(Baddi)
S.P. Rs. 100
Cost Rs. 90
Tax @ 35%
• 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.
Tax Avoidance
For Assessment
Year
Number ofTransfer Pricingaudits
completed
Number of cases
adjusted
Percentage ofadjustment
cases
AdjustmentAmount
(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
Transfer Pricing Litigation in India
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
92Computation 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
• 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 over-invoicing 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.
SDT - Background
• 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.
Specified Domestic Transactions
• 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) – Payments to related Parties
40A(2)(b) – Definition of Related party
Individual Assessee
Assessee
Husband / Wife
Sister
Brother
Where Assessee
has substantial
Interest
Lineal ascendantsdescendant
s
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
Tax Payer = Company, HUF, Firm, AOP
Tax Payer
Director / Partner/ member
Relatives
b(ii)
b(ii)
Individual
Relatives
b(iii)
b(iii)
>20%
Company / Firm / HUF / AOP
>20%
Director / Partner/ member
Relatives
Company
>20%b(iv)
b(iv)
b(iv)
b(iv)
All companies where such individual is
director / partner / member
b(v)
Other Director / Partner/ member
Relatives
Person
b(v)
b(v)
>20%
PersonPerson
b(vi)
b(vi)
b(vi)
>20%
>20%
40A(2)(b) – Definition of Related party
Tax Payer = Company, HUF, Firm, AOP
Tax Payer
Director / Partner/ member
Relatives
b(ii)
b(ii)
Individual
Relatives
b(iii)
b(iii)
>20%
Company / Firm / HUF / AOP
>20%
Director / Partner/ member
Relatives
Company
>20%b(iv)
b(iv)
b(iv)
b(iv)
All companies where such individual is
director / partner / member
b(v)
Other Director / Partner/ member
Relatives
Person
b(v)
b(v)
>20%
PersonPerson
b(vi)
b(vi)
b(vi)
>20%
>20%
>20%
Company / entity
>20%
40A(2)(b) – Issues
Tax Payer = Company, HUF, Firm, AOP
Tax Payer10%
Company / Firm / HUF / AOP
Director / Partner/ member
Relatives
Company
10%
10%10%
10%
10%
40A(2)(b) – Issues
• Whether sub-subsidiary and ultimate parent company is relative?
Co. A
Co. B Co. C
Co. X Co. Y
Transaction
Relative?
A & B Yes
A & C Yes
A & X No
A & Y No
B & C Yes
B & Y No
C & X No
X & Y No
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) 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 • Onus on tax authorities as well
• 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
Threshold Limit & Coverage
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 AgreementProject management fees
• Benchmarking • Cost Benefit Analysis
Allocation of Expenses between Units
• Covered by SDT?• Benchmarking
Definition of related party • Direct V/s Indirect relationship
Capital Expenditure • Covered by SDT?
Sales of goods and services
• Comparability
Challenges
• 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
Posers
• The tax provisions and it impact on Economy
Economy and Tax Provisions
Incentivize
Encourage
RegulateTax
Subsidize
• 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
Case - 1Germany
India
XYZ Inc.USA
YZ Ltd.Subsidiary
X Ltd Z Ltd (10AA)
90% 25%
A Ltd Y Ltd
90%15%
20%
• 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
Case - 2
India
A Ltd.
USA
B Inc.Interest Free
Loan
C Ltd D Ltd (10AA)
E Ltd (10AA)
Inte
rest
Fre
e
Loan
Inte
rest
Fre
e
Loan
- Loan at 18%- ALP 11%
Corporate Guarantee (fees at 0.25% is
charged)
Corporate Guarantee (No fees is charged)
• 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
Case - 3
C Ltd.
B Ltd
80%
100%A Ltd
(Assessee)
Mr. X
Mr. Y
Mr. Z
Mrs. Y
Mr. F
D Ltd
10%
10%
10%
15%
Directors of A Ltd. Son of Mr.
Z
15%
YF (Partnership Firm)
50%
50%
Purchase of Raw
Material
Purchase of
Finished Goods
Consultancy Fees
Methods
Comparable
Uncontrolled Price Method
Resale Price
Method
Cost Plus Method
Profit Split Method
Transactional Net Margin Method
Transfer Pricing Methods
Methods
Comparable
Uncontrolled Price Method
Resale Price
Method
Cost Plus Method
Profit Split Method
Transactional Net Margin Method
Any Other Method (Rule 10AB)
Transfer Pricing Methods
• 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
Most Appropriate Method (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
Selection of MAM
Comparability Analysis
Selection of Tested Party
Selection of Most Appropriate Method
Selection of Profit Level Indicator
Benchmarking
Stages of Economic Analysis
Selection of Tested Party
Comparability Analysis
Selection of Tested Party & Comparability Analysis
• 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
Selection of MAM
• Comparable Uncontrolled Price Method (CUP)
• Resale Price Method (RPM)• Cost Plus Method (CPM)
Price based Methods
• Profit Split Method (PSM)• Transactional Net Margin Method
(TNMM)
Profit based
Methods
• Any other method which takes into account price charged or paid between uncontrolled parties considering all relevant facts
Other
Classification of Methods
• Functions• Assets• Risks
• Comparability
• Method Selection
• Benchmarking
• Covered entities
• Covered Transactions
• Company• Group• Industry
Background
Information
Transactional
Information
Functional Analysis
Economic Analysis
Documentation Areas
What are the Documentation Requirements?
Entity Related Price RelatedTransaction
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
Documents to be maintained
Purchase/ sale of raw material
• 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
Remuneration to Directors
• Qualification• Work Experience & Profile• Minutes of Meeting
authorizing the director’s remuneration
• Data from HR firms for Directors in the same line of business
Corporate cost sharing
• Nature of expenses• Auditor’s certificate
allocating the expenses
• Basis of allocation between the companies
• Proof of usage (rendering) of services
• Cost benefit analysis
Indicative Documentation
Transaction entered
Documents to be maintained
Rent paid toward use of premises
• 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)
Reimbursement ofexpenses
• Nature of expenses with detailed break-up
• Reason of expense incurred for
•Employee details• Actual invoices of the
expense
Interest on loan (non-financial services company)
• Basis of determination of interest rate
• Interest Rate Card for the period of loan
• Loan agreement• Basis on which the
interest rate is pegged above standard rate
Sr. No.
Compliance Timeline Relevant Provision
1.Filing Accountants Report along with Tax Return, Maintenance of Documentation
30 Nov. 2013Section – 92E r.w. Section –
139(1)
2.Limitation for Initiating transfer pricing
audit by the tax administration30 Sep. 2014 Proviso to Section – 143(2)(ii)
3.Limitation for completing transfer pricing
audit31 Jan. 2017
Section – 92CA(3) r.w. Second Proviso to Section – 153(1)
4.Limitation for Completing regular
assessment
31 Mar. 2017If 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 ³ Rs. 1,00,000)31 Mar. 2020 Section – 149(1)(b)
7.Date till which documentation is required
to be maintained31 Mar. 2021
Section – 92D and Rule – 10D(5)
Transfer Pricing Compliance Timeline – Illustration for March 2013
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 information or documents as required under 92D(3)
2% of value of transaction for each such failure
271G
Penalties
Audit ProcessFile tax return and Accountant’s Report (30th November)
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)
Based on results of above mentioned procedure assessing officer passes the order
TP Audit
Notice to be issues by the TPO - TPO calls for supporting documents and evidence
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
DRP Mechanism- Finance Act 2009
Appeal Procedure
Appeal to Commissioner of Income Tax
Passes an order
Income Tax Appellate Tribunal
High Court - only on matters related to law
Supreme Court
Constitutional Bench
Thank You
Prashant Kotecha
Office: +91 265 3086467Mobile: +91 98251 53981Email: prashant.kotecha@kcmehta.com
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