latest developments in transfer pricing · 2017-10-17 · vodafone india services limited (wp no....

Latest Developments inTransfer Pricing

Vispi T. Patel

Vispi T. Patel & Associates

Bombay Chartered Accountant’s Society

October 11, 2017

Transfer Pricing (TP) –Indian Perspective

TP Regulations in India – Section 92

Any income

arising from

an international transaction

shall be computed

having regard to

arm’s length price

TP Regulation in India

Income under any head is covered under the

ambit of TPR

Section 4 – Income must be chargeable to tax

Preconditions:

Two or more associated enterprises

Enter into an international transaction

Specified Domestic Transaction (w.e.f. AY

2013-14)

Consequence:

Income/ Expenditure to be computed having

regard to the arm’s length price

Vodafone India Services Limited(WP No. 871 of 2014) (Bombay HC)

Facts of the case:

Vodafone India (the assessee) issued 2,89,224 equity shares of the

FV of INR 10 each on a premium of INR 8,509 / share to its holding

company in accordance with the valuation methodology prescribed

by the GOI

The assessee, out of abundant caution, disclosed this transaction

(i.e. the issuance of shares) as an “international transaction” in

Form 3CEB

The AO / TPO valued each equity share at INR 53,775 and made

an adjustment of INR 45,256 per share (amounting to INR

1308.91 crores), by treating the shortfall in premium as income

Vodafone India (Assessee) AO / TPO

Bombay High CourtDispute Resolution Panel

Issue of shares reported as International Transaction,

only out of abundant caution

TP addition (INR 1308 crs) on

shortfall in the premium on shares, treating it as income

Directed the DRP to decide on the preliminary jurisdictional issue raised by the assessee

DRP considered the issue of jurisdiction and rejected the same

Bombay High Court

Issue of shares at a premium does not give rise to any income from an admitted international transaction, thus, there exists no occasion to apply Chapter X of

the Act

Vodafone India (Contd...)

Vodafone India (Contd...) Observations, Analysis and Decision:

The word income as defined in Section 2(24) of the

Act, though an inclusive definition, cannot include

capital receipts unless specified, as in Section

2(24)(vi) of the Act

Capital gains chargeable to tax under Section 45 of

the Act are defined to be income

The amounts received on issue of share capital

including the premium were undoubtedly on capital

account

Due to absent express legislation; no amount

received, accrued or arising on capital account

transaction can be subjected to tax as income


Chapter X of the Act is a machinery provision to arrive at

the ALP of a transaction between AEs

The substantive charging provisions are found in Sections

4, 5 (Scope of income), 15 (Salaries), 22 (Income from

house property), 28 (Profits and gains of business), 45

(Capital gain) and 56 (Income from other Sources) of the

Act

An income arising from an international transaction must

satisfy the test of income under the Act and find its home

in one of the above heads i.e. charging provisions, as

Chapter X is only a machinery provision to compute the

chargeable income at ALP


Machinery section cannot be read de-hors the charging

section, relying on the observations of the Supreme Court

in CIT v. B. C. Srinivas Shetty 128 ITR 294

HC concluded that the issue of shares at a premium by the

assessee to its holding company does not give rise to any

income from an admitted international transaction

Thus, there was no occasion to apply Chapter X of the Act.

HC quashed all the orders of the Revenue authorities i.e.

AO/ TPO/ DRP, as being without jurisdiction, null and void

Vodafone India (Effect)

The Bombay HC passed a similar judgment in the case of

Shell India Markets Pvt. Ltd. (Shell) v. ACIT et al., Writ

Petition 1205 of 2013, except that Shell did not disclose the

issuance of equity shares to its non-resident associated

enterprise as an international transaction in Form 3CEB

Further, the CBDT vide Instruction No. 02/2015, dated 29

January 2015 has notified that it has accepted the decision of

Vodafone IV and has directed that the ratio decidendi of the

judgment must be adhered to by the field officers in all cases

where this issue is involved

CBDT issued Instruction No. 3/ 2016 requiring the AO dispose

off the objections raised by the assessee on jurisdictional

issue, before making any reference to the TPO

Reference to TPO – Instruction No. 3/2016

CBDT notified Instruction no. 3/2016 which has replaced

Instruction no. 15 of 2015, and clarified that the AO is not

empowered to conduct transfer pricing assessments

If reference is made in following cases, AO must record his

satisfaction whether there is (potential) income which is

being affected by ALP determination and take approval of

PCIT/ CIT:

Report u/s 92E not filed and AO discovers IT or SDT

IT or SDT not been disclosed in report u/s 92E & AO

discovers the same

Assessee claims that the transaction does not affect

income

Case selected under TP risk

parameter

If AO becomes aware of an international transaction not disclosed in Form No.

3CEB

Case selected under non-TP

risk parameter

AO must record his satisfaction that there is an income or a potential of an

income arising

Obtain approval

of PCIT or CIT

TP adjustment in an earlier

year has been set-aside by the

ITAT, High Court or

Supreme Court

If TP adjustment of INR 10 crores or more in earlier year,

is upheld by higher authorities or pending in

appeal

Transaction discovered during search or seizure

operations

Reference to TPO

Reference to TPO – Instruction No. 3/2016

BNT Global Private Limited (ITA No. 4111/Mum/2016)

Facts of the case ITAT held that

• Assessee company received share capital and share premium from NRI shareholder-cum-director

• The assessee filed return of income but failed to file Form No. 3CEB

• The AO during assessment took a view 3CEB was required. Although no adjustment to income was done, penalty was levied under section 271BA

• CIT(A) upheld penalty

• It is mandatory to furnish a report for a person entering into an international transaction

• ITAT distinguished Vodafone decision stating that it had filed Form 3CEB and HC had ruled that no adjustment should be made to arm’s length price

• In instant case, AO has not made any adjustment to ALP but levied penalty for failure to comply

• Relied on Tribunal ruling in case of IL & FS Maritime (Pre Vodafone case)

Whether if no income is arising from a transaction, it can still be considered to be an international transaction? Can sec. 92B be read devoid

of sec. 92(1)?

Kolkata ITAT (SB) Instrumentarium Corporation

Outside India

India

Instrumentarium / Assessee

Interest-free loan Deemed interest

Datex Ohmeda (WOS of assessee)

Instrumentarium (Contd.)

Revenue is entitled to make TP adjustment in respect of

interest-free loan advanced by an assessee (a non-resident) to

its Indian subsidiary;

Rejects stand that case is covered by exclusion u/s 92(3) (TP-

adjustment shall not apply if income reduced or loss

increased;

As per Sec 92(3) income to be computed based on entries in

books and "there is thus no scope at all for taking into

account the impact on taxes for the subsequent year";

Rejects argument that "if an altogether new income is

brought to tax in the hands of the assessee, as a result of ALP

adjustment, corresponding deduction is required to be given

to the Indian AE“

In a situation in which result or consequence of an ALP

adjustment is erosion of domestic tax base, the provisions of

the transfer pricing cannot be invoked

Facts of the case:

Instrumentarium / Assessee entered into an agreement, duly

approved by the RBI, to advance an interest free loan to Datex

India (its WOS)

AO disputed the ALP of the interest income earned by the

assessee from India and brought to tax the same in the hands

of the assessee

The assessee claimed that for a variety of reasons including

the issue of base erosion of Indian tax base, no adjustment

should be made on the said transaction.

AO proceeded to treat Datex India as a representative assessee

and proceeded to finalize the assessment under section 144

r.w.s. 147 of the Act


Contentions of the assessee before ITAT:

In a situation in which result or consequence of an ALP

adjustment is erosion of domestic tax base, the provisions

of the transfer pricing cannot be invoked

The assessee pointed out that if the computation of interest

is imputed to the loan, the net result will be:

a withholding tax of 10% on the interest payable,

a statutory reduction or deductibility of the said

expenses which will allow benefit of 36.75% tax to the

appellant company, and

a resultant base erosion of 26.75% to the Indian revenue.


Key observations of the ITAT:

Section 92(3) requires an impact on profits or losses for the

year and it does not discuss the impact on taxes for the

subsequent years.

“Tax administration cannot be expected to have clairvoyance

of whether or not Indian AE will actually make sufficient

profits in the next eight assessment years which will

subsume the losses incurred by the assessee by the AE";

Rejects assessee’s reliance on Australian law to support base

erosion argument

Rejects reliance on SC's Morgan Stanley ruling to buttress

claim that adequate profits taxed in India

Further rejects 'business expediency' and 'shareholder

service' argument of assessee


Thin Capitalisation (Interest deduction u/s

94B)

What is thin capitalisation?

Thin Capitalisation means having highly disproportionate debt capital in comparison to equity capital

Companies tend to borrow in high-tax jurisdictions to avail higher tax deductions

Why debt over equity?

No stamp duty required for infusion of debt capital, unlike equity capital

In most countries, dividends are subjected to economic double taxation, whereas interest is not; on the contrary interest is tax-effective

Easy and tax effective repatriation of borrowed funds as compared to capital infusion

Debt is more flexible; it can be converted into equity, when required

Debt can be borrowed in foreign currency to avoid currency fluctuation risk

Thin Capitalisation

Thin Capitalisation – Impact analysis

Particulars Zero DebtDebt-Equity Ratio of 1:1

Zero Equity

Debt 0 500 1,000

Equity 1,000 500 0

Total Capital 1,000 1,000 1,000

PBIT 200 200 200

Less: Interest (Assumed @10%) 0 -50 -100

PBT 200 150 100

Less: Tax @ 30% (approx) (A) -60 -45 -30

PAT 140 105 70

Less: DDT @ 20% (approx) (B) -28 -21 -14

Net profit distributed to equity shareholders

112 84 56

Amount distributed for capital 112 134 156

Total tax paid (A + B) 88 66 44

Effective rate of tax (Total tax to PBIT) 44% 33% 22%

Year of disallowance beginning from AY 2018-19

Expenditure of Interest or similar nature over INR 1

crore which is allowed as a deduction under ‘profits

and gains from business and profession’

Borrowed by: Indian Company/PE in India of foreign

company (LLPs/ Partnerships/ trusts, etc. not

covered)

Borrowed from: AE of Indian company

• Lower of:• Total interest paid in excess of 30% of earnings before

interest, taxes, depreciation and amortisation; OR• Interest paid / payable to AE for the year

94B(2): Excess interest

(amount to be disallowed)

Limitation on interest deduction (Section 94B)


Exception: borrower is a banking or insurance

company (Whether NBFCs will be granted an

exception?)

Interest expenditure to the extent not wholly

deducted, shall be carried forward to the following

assessment year, subject to the maximum allowable

expenditure as per s. 94(2)

No interest shall be carried forward for more than 8

assessment years, immediately succeeding the

assessment year for which such excess interest was

first computed


What is a debt?

Debt means:

any loan, financial instrument, finance lease, financial derivative, or an arrangement that gives rise to

interest, discounts or other finance charges that are deductible as business expenditures

a. Whether LCs will be considered as debt?b. Whether compulsorily convertible

debentures which are hybrid instruments should be considered as debt?

c. Whether premium on option contracts (financial derivative) would be considered as ‘other finance charges’?


What is the mode of computation of EBITDA?

What is implicit and explicit guarantee?

Whether borrowing of real funds and availing of guarantee for borrowing could be classified in the same basket?

Whether interest is to be understood, net of interest income?

A Ltd. has borrowing of INR 100 crore from its overseas AE i.e. B Ltd. @ 14% p.a.

Interest paid / payable to AE is INR 14 crore

EBITDA of A Ltd. for year ended 31.03.2017 is 30 crores

Impact u/s 94B:

Disallowance u/s 94B = Total deductible interest exceeding the 30% of EBITDA i.e. 5 crores [14 – (30%*30) = 5]

TP proceedings:

Arm’s length interest rate determined by TPO @ 11% and hence, made a transfer pricing adjustment of 3 crores [(14% - 11%) * 100 crores]

An Illustration

What would be the amount of interest allowed to be carried forward u/s 94B(4), INR 2 crores or INR 5 crores)

Secondary Adjustment (Sec. 92CE)

Secondary Adjustment

Introduced by Finance Act 2017, applicable from AY 2018-19

“Secondary adjustment” as an adjustment that arises from

imposing tax on a deemed basis by considering previous

period’s transfer pricing adjustment itself as a separate

international transaction

Applicable to primary adjustments exceeding one crore rupees

made in respect of the AY 2017-18 and onwards

Whether primary adjustment made to the international transaction

determines additional benefit transferred to the associated enterprise on

a deemed basis?

Conditions

Time Limit for

repatriation of excess

money

If primary adjustment to transfer price has been

made suo-moto by assessee in his return of income

Within 90 days from due

date of filing return of

income u/s. 139(1) i.e.

30th November

In case APA entered into by the assessee u/s. 92CD

In case option exercised by the assessee as per Safe

Harbour rules u/s 92CB

In case assessee has entered into a Mutual

Agreement Procedure under DTAA u/s. 90 or 90A

In case the primary adjustment made as per the

order of Assessing Officer (AO) / Appellate

Authority has been accepted by the assessee

From the date of order of

AO/ appellate authority

Secondary AdjustmentCBDT Notification No. 52 /2017 dated 15 June 2017

Currencydenomination of

international transaction

Rate of imputation of interest income per annum

INR1-year marginal cost of lending rate

(MCLR) of SBI as on 1st April of relevant previous year + 325 basis points

Foreign currency 6-month LIBOR as on 30th September of

relevant previous year + 300 basis points

Imputation of interest income on excess money not repatriated within time limit

Whether suo-moto payment of taxes on the primary transfer pricing adjustment is not a sufficient parameter for the revenue authorities?

Can income-tax department force a company to bring money into India or its role is restricted to collection of taxes on the money?

An Illustration

Overseas Ltd. (AE of India Ltd.)

India Ltd.

Revenue from software

development services

• PLI of India Ltd. = 15%

• Comparable uncontrolled transactions = 24%

• TPO made an adjustment for the difference between the profit margin on sales of INR 100 crores

Initial Year

• TP adjustment continues• Overseas Ltd. does not pay the amount of TP adjustment to India Ltd.• TPO makes a secondary TP adjustment

Later Year

Whether laws of other countries may allow freerepatriation of money? i.e. Effect under FEMA

Would lead to double taxation

Effect of treatment under MAT / in the books of accountsmaintained in India prepared as per Companies Act, 2013

Whether interest income is a one time levy or will apply ona year to year basis until the amount related to the primaryadjustment is brought into India?

Is there a contradiction for agreements betweencompetent authorities in the case of Bilateral APAs orMAPs

In case assessee goes for appeal before ITAT / High court /Supreme court, at what stage secondary adjustment to bemade?

Whether secondary adjustment leads to discrimination

under DTAA?

Preliminary Issues on Secondary Adjustment

Advance Pricing Agreement&

Revised Safe Harbour Rules

Advance Pricing Agreements (APA)

APA mechanism introduced in 2012 and Roll-back in 2014

Salient Features –

To provide assurance of certainty and unanimity in

transfer pricing approach

Valid upto five subsequent years and four previous years

Binding on tax authorities as well as taxpayers unless

there is a change in the law or facts of the case

Pre–consultation process (anonymous application option)

APA (Contd…)

Statistics as per CBDT Press Release dated 6 October 2017

Unilateral Bilateral

No. of Applications

made in five years

More than 800 applications

(about 85% are Unilateral)

No. of Agreements

Signed

164 8 with UK and

5 with Japan

APA (Contd…)

Important points to be considered:

Each year Annual Compliance Report in Form No. 3CEF

needs to be filed before DGIT (IT)

The APA can be cancelled/revised if critical assumptions

are violated or conditions are not met

If the Compliance Audit results in a finding that the

assessee has failed to comply with the terms of the

agreement, the agreement can be cancelled

Non filing of Compliance Report or the report contains

material errors, it may result in cancellation of the

agreement

Safe Harbour Rules

Safe Harbour (SH) Provisions were Introduced by Finance

Act, 2009, however, CBDT released SH rules in September

2013

In June 2017, CBDT revised the SH rules w.e.f. 1 April 2017,

decreasing the SH margins and the included low value adding

intra group services as one of the eligible international

transactions

Revised SH margins shall be applicable from the AY 2017-18

for three consecutive years

Eligible assessee has the right to exercise the option under

either sub-rule (2) or sub-rule (2A) of Rule 10TD, whichever

is beneficial

Safe Harbour Rules (Contd…)

Eligible International

Transaction (EIT)

Safe Harbour Rules

Old

[Rule 10TD (2)]

Revised

[Rule 10TD (2A)]

Provision of software

development services (other

than contract R&D) and ITES

20 % or more

(EIT INR 500 crores)

17 % or more of OE

(EIT INR 100 crores)

22 % or more

(EIT > INR 500 crores)

18 % or more of OE


Provision of knowledge

process

outsourcing services

25 % or more

(No Threshold)

Employee

Cost to

Operating

Cost

OP to OC

%

< 40 %18 % or

more

40 % and

60 %

21 % or

more

60 %24 % or

more



Transaction (EIT)

Safe Harbour Rules

Old

[Rule 10TD (2)]

Revised

[Rule 10TD (2A)]

Provision of contract R&D

services wholly or partly

relating to software

development and generic

pharmaceutical drugs

30 % or more

(software development)24 % or more

(EIT INR 200 crores)29 % or more

(generic pharmaceutical

drugs)

Manufacture and export of

core

and non-core auto

components

12 % or more

(core auto components)

8.5 % or more

(non-core auto components)

Providing corporate

guarantee (other than

comfort letter, performance

guarantee, etc.)

2 % p.a. or more

(EIT INR 100 crores) 1 % p.a. or more

(No Threshold)1.75 % p.a. or more


Safe Harbour Rules (Contd…)Eligible

international

transaction

Safe Harbour Rules

Old

[Rule 10TD (2)]

Revised

[Rule 10TD (2A)]

Interest on

advancing of intra-

group loans

SBI base rate + 150 bp

(INR Loan 50 crores)

1 year SBI MCLR + basis points

as shown below in (A) (INR Loan)

SBI base rate + 300 bp

(INR Loan > 50 crores)

6 month LIBOR + basis points as

shown below in (B) (foreign

currency Loan)

CRISIL credit rating of associated enterprise (AE)

(A) (B)

Basis

points

Basis

points

AAA to A or equivalent 175 150

BBB-, BBB or BBB+ or equivalent 325 300

BB to B or equivalent 475 450

C to D or equivalent 625 600

Credit rating not available and total loan in INR provided to all

AEs do not exceed INR 100 crores as on 31 March of the relevant

previous year

425 NA

Credit rating not available and total loan provided to all AEs do

not exceed equivalent to INR 100 crores as on 31 March of the

relevant previous year

NA 400



Transaction (EIT)

Safe Harbour Rules

Old

[Rule 10TD (2)]

Revised

[Rule 10TD (2A)]

Receipt of low value adding

intra group Services

(This concept was

introduced in the BEPS

Action Plan 13, wherein it

has been stated that these

services are activities which

are not the principal

business activities of the

group entity providing such

services)

Absent

Value of EIT including a

markup on cost upto 5%

INR 10 crores *

* The following shall be required to be certified by an accountant:

1. Method of cost pooling

2. Exclusion of shareholder costs duplicate cost from the cost pool

3. Reasonableness of the allocation key used by overseas AE for allocation

of cost to the Assessee


Procedural Aspects

Eligible taxpayers must furnish a self-attested form i.e.

Form No. 3CEFA, containing various details of the eligible

transactions on or before the due date for filing the

income tax return

The Assessing Officer may make a reference to the

Transfer Pricing Officer to verify the validity of option

exercised by the taxpayer

Various other procedural aspects have been provided by

the relevant Rules

Master File and Country-by-Country Reporting (Draft

Rules)

Master File and Country-by-Country Reporting (Draft Rules)

Central Board of Direct Taxes (CBDT) on October 6, 2017

issued Draft Rules (Rule 10DA and 10DB) in respect of

keeping, maintaining and furnishing information and

documents with respect to:

Country-by-Country (CbC) report and

Master File

In line with the BEPS Action 13, India has become a signatory

to the Multilateral Competent Authority Agreement (MCAA)

for the automatic exchange of CBC Report with the other

signatories of the Agreement on 12 May 2016 and notified on

28 July 2017

Master File Applicability (Rule 10DA)

Entity

Consolidated Revenue of the International

Group in Preceding

accounting year > INR 500 crores

Aggregate value of International

Transaction in Reporting Year

As per Books of Accounts > INR

50 crores

In relation to Intangible

property > INR 10 crores

AND

OR

Master File (Draft Rules)

Rule 10DA - Master File

Master File is an onerous documentation which Depicts

sensitive information and is supposed to provide a bird’s

eye view of the working of the group

The due date to furnish the information with respect to

the Master File for FY 2016-17 is 31 March 2018

Furnishing of Information under Form 3CEBA

Country-by-Country Report (Rule 10DB)

Rule 10DB – CbC Report

CbC report applicable to an international group having

total consolidated group revenue of more than INR 5,500

crore (approx. $ 750mn) in the accounting year preceding

the FY 2016-17

Draft notification is silent on the due date with respect to

CbC report for FY 2016-17, however, considering the

constraint of time, the CBDT may extend the due date in

line with Master File

Furnishing of Report under Form 3CEBC

Master File and CbC Report (Draft Rules)

Master File

(to provide the

MNE’s

blueprint)

The group’s organisation structure

A description of the group’s business, intangibles,

intercompany financial activities and financial

and tax positions

Country-by-

Country (CbC)

Report

Jurisdiction-wise information on global

allocation of income, taxes paid/ accrued, the

stated capital, accumulated earnings, number of

employees and tangible assets

Entity-wise details of main business activities

which will portray the value chain of inter-

company transactions

CbC Report (Form 3CEBC)

Master File and CbC Report - Penalty

Section Particulars

Section 271AA Penalty for failure to keep and maintain Master

File (INR 500,000)

Section 271GB

Penalty for failure

to furnish CbC

report u/s 286(2)

a. INR 5,000 per day upto

one month; or

b. INR 15,000 per day

beyond one month Failure continues

after penalty order

INR 50,000 per dayPenalty for non-

furnishing

information asked

for u/s 286(6)

INR 5,000 per day

Inaccurate report /

information

INR 500,000 NA

THANK YOU

Vispi T. Patel

Vispi T. Patel & Associates

Chartered Accountants

Contact no : +91 22 2288 1091/1092

+91 -98 6763 5555

Email id : [email protected]

latest developments in transfer pricing · 2017-10-17 · vodafone india services limited (wp no....

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