ricing) material/itf2014/yogesh thar.pdf · mr. thar was a member of managing committee of the...

Current issues in Transfer Pricing (including Domestic Transfer Pricing)

18th International Tax & Finance Conference, 2014 1


2 18th International Tax & Finance Conference, 2014

CA Yogesh Thar

Mr. Yogesh A. Thar is currently a partner of M/s Bansi S. Mehta & Co., a leading firm of Chartered Accountants in Mumbai. He is a Fellow member of Institute of the Chartered Accountants of India. He has a rich blend of experience in income tax and service tax.

In his work experience of 30 years, he has acquired specialisation in the areas of corporate taxation, taxation of non-residents and foreign companies, business mergers, acquisitions and restructuring and business valuations.

He started his career with M/s. S. V. Ghatalia & Co., Chartered Accountants, as a newly qualified Chartered Accountant in 1984. He then practiced for nearly a decade as a sole proprietor and as a partner in M/s. R. S. Kadakia & Co., Chartered Accountants, before joining Bansi S. Mehta & Co. in 1997.

He has to his credit authorship of several books and articles on direct tax and double taxation avoidance agreements published mainly by Taxman, The Chamber of Income Tax Consultants and the Bombay Chartered Accountants’ Society. His recent contribution is a book on “Domestic Transfer Pricing” published by CCH which he has co-authored with his partner Ms. Anjali Agrawal.

He was a visiting faculty at the Narsee Monjee Institute of Management Studies during the period 1992 to 1997. He served as joint editor of the Bombay Chartered Accountants Society’s publication – The Referencer-cum-Diary from 1997 to 2008.

Mr. Thar was a Member of Managing Committee of the Income-tax Appellate Tribunal Bar Association, Mumbai during 2010 and 2011 and is presently a Member of the Taxation Committee of the Bombay Chartered Accountants’ Society and a Member of the Direct Tax Committee of the Chamber of Tax Consultants.




CA Yogesh Thar

1. Introduction 1.1. Transactions between related parties have always been looked at by the Income-

tax Department with an arched eyebrow. The Income Tax Act, 1961 (“the Act”) contains various provisions, which govern the transactions between related parties. In respect of certain cross border transactions between related parties, the Act requires that such transactions should be at arm’s length and it also provides for a mechanism to determine the arm’s length price of such transactions. The Act further requires the Indian party to such cross-border transactions to maintain proper documents and information in support of such cross-border transactions, so as to assist the Income-tax Department in ascertaining the arm’s length price of such transactions. Where the actual price of such cross-border transactions is not at arm’s length, the Act provides for an adjustment of the income of the tax-payer to the extent of such difference between the actual price and the arm’s length price, so as to bring the income under the Indian tax net. These are referred to as the International Transfer Pricing Regulations (ITP). These provisions are contained in Chapter X of the Act.

1.2. The purpose behind such provisions is to check evasion of tax by multinational companies by shifting the profits earned by them in India to other jurisdictions which are subject to lower tax. The Board Circular No. 14/2001 dated December 12, 2001 (2001) 252 ITR (St.) 65 refers to the then new transfer pricing provisions as “New legislation to curb tax avoidance by abuse of transfer pricing”. It says that the basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions thereby eroding the country’s tax base.

1.3. Similar to the foregoing provisions, the Act contains certain other provisions providing for certain disallowances/adjustments to the income of the tax-payer, in cases of transactions between resident taxpayers related to each other – section 40A(2), section 80IA(8), section 80IA(10), etc. The Act was amended by the Finance Act, 2012 with effect from the Assessment Year 2013-14 to provide for a mechanism to determine the fair market value even in such cases. The amendment has been brought in Chapter X of the Act whereby the applicability of the international transfer pricing provisions has been extended to certain domestic transactions between related parties referred to as the ‘Specified Domestic Transactions’. Corresponding amendments have also been brought in the specific sections of the Act – i.e. sections 40A(2), 80IA(8) and 80IA(10). Thus, with effect from the Financial Year 2012-13, Specified Domestic Transactions have been subjected to the transfer pricing provisions, which hitherto, were applicable only to international transactions and accordingly, a new concept of ‘Domestic Transfer Pricing’ (DTP) has been introduced in India. However, the



DTP provisions would not impact small assessees, since a monetary limit of ` 5 crores has been set in respect of the specified domestic transactions for the DTP provisions to apply.

1.4. Pursuant to the foregoing amendment, an assessee who undertakes specified domestic transactions during a financial year, aggregating in value by more than ` 5 crores, would require to comply with the following:

• ensure that the value of such transactions is at arm’s length price having regard to the methods prescribed under the Act;

• maintain and keep information and documents in relation to such transactions as statutorily required;

• obtain and file an accountant’s report in respect of such transactions along with his return of income.

1.5. Genesis of DTP provisions is the decision of the Supreme Court in the case of CIT v. Glaxo Smithkline Asia P. Ltd. (2010) 195 Taxman 35 (SC). The Apex Court gave suggestions, in order to “reduce litigation” to consider amendments in the law with a view to:

• Make it compulsory for the taxpayer to maintain books and documentation on the lines of Rule 10D;

• Obtain audit report from a CA;

• Reflect the transactions between related entities at arm’s length price;

• Apply the generally accepted methods specified in TP regulations.

1.6. The above suggestions have been duly carried out by the legislature. The Explanatory Memorandum (“EM”) clearly recognises the suggestions of the Supreme Court. It talks about extending the TP provisions “for the purposes of section 40A, Chapter VI-A and section 10AA”. The EM states the objective to amend the Act is to provide applicability of transfer pricing regulations to domestic transaction “for the purposes of” computation of income, disallowance of expenses etc. “as required under provisions of sections 40A, 80-IA, 10AA, 80A, sections where reference is made to section 80-IA, or to transactions as may be prescribed by the Board…”.

1.7. The fundamental propositions that emerge out of this analysis are:

(a) DTP provisions are computation provisions and are neither charging provisions nor disallowance provisions;

(b) DTP provisions have limited applicability to specified provisions of the Act;

(c) DTP provisions, in addition to governing computation, impose administrative obligation of maintaining documentations and getting accounts audited.

1.8. In the light of the above, is there a need to amend the law to clarify that:

(a) The word “expenditure” in section 92BA(i) should not include “capital expenditure” and hence depreciation cannot be disallowed by invoking this provision;



(b) The provisions of section 92BA(i) are not applicable to determine cost of acquisition of an asset for computing capital gains when the asset is transferred;

(c) This provision will not apply to, say, interest paid to related party which is allowable u/s. 24 of the Act?

1.9. The purpose of both ITP and DTP regulations are similar to the extent that both require determination of whether a transaction has been entered into based on arm’s length principles or not. These are computation provisions, assisting in determination of the amount of income chargeable to tax, without going into the questions of the very chargeability of an income or deductibility of expenditure claimed by the assessee in the first instance.

1.10. However, “international transaction” and “specified domestic transactions” are two mutually exclusive concepts. Section 92BA, which defines the expression “specified domestic transactions”, clearly excludes “international transactions” from the scope of the term specified domestic transactions. Hence, a single transaction would not be subject to both ITP and DTP regulations. Further, the word “domestic” in the expression “specified domestic transactions” is a bit misleading, since a specified domestic transactions may be a transaction within the domestic territory of India or it may also be a cross-border transaction between parties who are not associated enterprises but are covered within the scope of the specific sections included in various clauses of section 92BA. For example, take a transaction of payment of an expenditure by an Indian company to its foreign shareholder holding, say, 25% shares in the said Indian company. Since the shareholding is less than 26%, the parties will not be related as associated enterprises within the meaning of section 92A. However, since the shareholding of more than 20% amounts to “substantial interest” within the meaning of section 40A(2)1, the transaction will qualify as a SDT.

1.11. Both ITP and DTP regulations have been surrounded by various contentious issues. In this paper, we will see some of the recent issues relating to these regulations. There are posers for the participants to discuss in the groups.

Part A – International Transfer Pricing Issues:

2. Equity infusion transactions:2.1. Recently, the tax department has passed orders proposing huge transfer pricing

adjustments in cases of certain inbound equity infusions. In cases where Indian Companies have issued shares to their sole parent foreign company at face value, it has been alleged by the tax department that such issue was at a price much lower than its fair value. Accordingly, they have treated the alleged shortfall in the value of the shares as a deemed loan by the Indian company to its foreign holding company and has added notional interest on it to the total income of the Indian Companies by invoking the provisions of Chapter X.

1. Explanation to section 40A(2) defines “substantial interest” for the purposes of that section.



2.2. As if this was not enough, the tax department has also assessed the difference between the fair value and the face value as the income of the Indian Company.

2.3. Similarly, even in cases of outbound equity infusions, cases have arisen where share application money paid by a company to its foreign subsidiary for allotment of shares has been treated as an advance given by the Indian company to the foreign company, pending allotment of the shares and accordingly, notional interest income is added to the total income of the Indian Company by invoking the provisions of Chapter X.

2.4. Here again, the tax department has not stopped at that. In a case where the foreign subsidiary was in losses and the Indian parent infused equity at face value, the TP department has made a TP adjustment to the value of the share investment and the AO has treated the difference as the income of the Indian Company.

2.5. Now, the definition of the expression “international transaction” in the Explanation to section 92B has been amended by the Finance Act, 2012 with retrospective effect from 1-4-2002 to include capital financing transactions. The relevant sub-clause reads as under :

“(c) capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business;”

2.6. Similarly, clause (e) of the said Explanation provides that “a transaction of business restructuring or reorganisation, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date;” shall also be deemed to be an international transaction.

2.7. Hence, post amendment, transactions like purchase and sale of shares, lending of money, etc. have now been included in the definition of ‘international transaction’. Similarly, transactions involving business reorganisation with an associated enterprise is deemed to be an ‘international transaction’.

2.8. It may appear that even such transactions would now be subject to transfer pricing adjustments. However, transfer pricing provisions are governed by section 92(1) of the Act which provides that any ‘income’ arising from an ‘international transaction’ shall be computed having regard to the arm’s length price. Hence, section 92(1) applies only in cases where there is any income arising from an international transaction. In other words, for the purpose of applicability of the provisions of 92(1), the basic requirement is that an ‘income’ should arise, in accordance with any charging provisions under the Act, in the hands of the assessee from an international transaction. Unlike other provisions under the Act [such as, section 9(1), section 61, section 64, etc.], where income is deemed to arise or be included in the total income of an assessee, the above-quoted provision deals with only income which is ‘arising’ to an assessee. If there is no charge on any receipt under any provision of the Act (for example section 9, section 17, section 56 etc.), can the TP provisions suo moto give rise to a



charge under section 92(1) of the Act is a matter that needs to be discussed and a consensus arrived at.

2.9. The view that TP provisions by themselves are only computation provisions and they do not create a charge where there is none under the charging provisions of the Act is supported by the rulings of the Authority of Advance Rulings in the following decisions:

- Dana Corpn., In re (186 Taxman 187);

- Goodyear Tyre and Rubber Company (AAR Nos. 1006 and 1031 of 2010);

- Amiantit International Holding Ltd, In re, (189 Taxman 149).

2.10. Posers:

a. Can allotment of shares by a company fall within the purview of the amended definition of “international transaction”? Can “allotment” be regarded as “purchase or sale”? Whether it can be regarded as a “business restructuring or reorganisation”?

b. Assuming such allotment is “international transaction”, is such allotment a taxing event under any of the provisions of the Act? Is section 92 a charging provision or is it a computation provision? Can there be a charge under section 92 when there is none under the other provisions of the Act?

c. Even if such transactions are regarded as ‘international transaction’, would such transactions be required to satisfy the test of arm’s length price in view of the language used in section 92(1) and would such transactions be required to be reported in Form 3CEB?

d. The purpose of Chapter X is to curb tax avoidance. Is there any sort of tax avoidance even if the shares are issued at face value which is much lower than the fair value?

e. If the issuer company has more than one shareholder instead of one sole-shareholder, will the view differ in any way if: (i) It is a rights issue and all subscribe? (ii) It is a rights issue and some of the shareholders subscribe only to the extent of their entitlements? (iii) It is a rights issue and some of them subscribe in excess of their entitlement while some do not subscribe? (iv) It is a rights issue and some of them renounce their entitlement partly or wholly in favour of the other(s)? (v) It is a preferential allotment to one or more of the existing shareholder? (vi) It is a preferential allotment to a new person?

f. What should be the acceptable measure of fair value for the purposes of Transfer Pricing Regulations in all the above cases: (a) Value which is certified as DCF value for FEMA purposes; (b) Value as determined under rule 11UA; (c) Any other method?



g. Will the view in any of the above situations differ if the shares are issued by the Indian company to the foreign entity at a price higher than the fair value?

h. Whether payment of share application money be regarded as an ‘international transaction’?

i. Would the position be different if the shares are not allotted even after the statutory period for allotment of shares against the share application money has lapsed?

j. If say such shares are allotted by the foreign company at a value much higher than its book value, would the difference be regarded as an income of the Indian company under the transfer pricing regulations?

k. Would the position be different, if instead of allotment, the shares of a company with a lower book value are purchased by an Indian company from another foreign company at a higher value?

3. Business transfer transactions between Indian wings of foreign companies:3.1. Under section 92(1), transfer pricing provisions apply to ‘international

transactions’. The said expression is defined under section 92B(1) to essentially mean a transaction between two or more associated enterprises, either or both of whom are non-residents. However, sub-section (2) of section 92B deems certain transactions between even two non-associated enterprises to be ‘international transaction’, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise.

3.2. Recently, in cases where there have been global transactions between two unrelated overseas corporate entities, the Income-tax Department has sought to apply sub-section (2) of section 92B to the transactions entered into between their Indian wings and treat the same as “international transaction”. As per the Income-tax Department, such transactions between the Indian wings are bound to be influenced by the prior global agreement entered into by their foreign holding companies and accordingly, such transactions are covered under sub-section (2) of section 92B.

3.3. Now, section 92B(2) is a deeming provision, which needs to be construed strictly. For the said section to apply, the following conditions must be satisfied:

a. There has to be an agreement between an enterprise and a third party;

b. There has to be a prior agreement between such enterprise’s AE and the third party;

c. The terms of the relevant transaction are determined in substance between the third party and the AE.

3.4. As would be observed, the second condition is that the prior agreement should be between the same third party and the AE of the assessee. However, in the



given case, the agreement exists between two AEs (foreign holding companies) of the two Indian parties. Merely because such Indian parties are subsidiaries of the foreign companies, transactions entered into by the holding companies cannot be imposed on them. It is settled law that holding-subsidiary relationship is a creature of statute and therefore, must be given credence in absence of a provision to the contrary. Corporate veil of an entity cannot be ordinarily pierced unless the transaction is regarded as sham/non-genuine.

3.5. Posers:

a. Can section 92B(2) can be invoked where none of the Indian parties is a party to the global agreement entered into between the global companies?

b. Would the position be different if one or both the Indian parties were a signatory to the global agreement or the foreign companies are signatory to the Indian agreement?

c. Can mere existence of a prior global agreement imply that the terms of the Indian agreement are determined based on the global agreement?

d. Can the corporate veil of the Indian subsidiaries be pierced to make global agreement entered into between their foreign holding companies applicable to them?

e. Can the doctrine of substance over form be applied to arrive at a conclusion that the transaction between the Indian entities was in substance a transaction between their foreign holding companies? Would even in that case, TP provisions apply considering that the foreign holding companies are not associated enterprise inter se?

3.6. Besides, as per the language used in section 92B(2), the deeming provision in the said sub-section applies only “for the purposes of sub-section (1)”. As per sub-section (1), “international transaction” means a transaction between two or more associated enterprises, either or both of whom are non-residents. Hence, the key ingredient for a transaction to be regarded as an international transaction is that either one or both the parties to the transaction must be a non-resident entity. In the case of CIT v. Glaxo Smithkline Asia (P) Ltd. (95 Taxman 35), the Apex Court has held that the transfer pricing provisions, as they stand, cannot apply to a transaction between two residents.

3.7. The Finance Bill, 2014 seeks to amend the provisions of section 92B(2) so as to provide that where in respect of a transaction entered into by an enterprise with a person other than an associated enterprise, there exists a prior agreement in relation to the relevant transaction between the other person and the AE or, where the terms of the relevant transactions are determined in substance between such other person and the AE, and either the enterprise or the AE or both of them are non-residents, then such transaction shall be deemed to be an international transaction whether or not such other person is a non-resident. This amendment is to take effect from AY 2015-16.



3.8. Posers:

a. Whether under sub-section (2) of section 92B, even transactions between two non-associated can be regarded as an “international transaction” if both the parties are Indian residents?

b. Can the independent existence of the Indian residents be ignored and the transactioned be regarded to be entered into by the foreign companies?

c. What is the effect of the amendment proposed by Finance Bill, 2014 and can it be contended by the tax department that such amendment is merely curative and hence (or for any other reason) would apply retrospectively even for earlier transactions?

Part B – Domestic Transfer Pricing Issues

4. Threshold of ` 5 crores4.1. Section 92BA defines “SDT” to mean certain types of transactions “where the

aggregate of such transactions entered into by the assessee in the previous year exceeds a sum of `5 crores.

4.2. Consider a case of a company getting converted into a LLP with effect from, say, October 1, 2014. It borrowed monies from a party covered under section 40A(2). Interest cost for the period April 1, 2014 to September 30, 2014 is ` 1.5 crores and for the period October 1, 2014 to March 31, 2015 is ` 4.5 crores. There are no other transactions falling under any of the clauses of section 92BA.

4.3. A question that the groups may discuss is as to whether for determining the applicability of the provisions of Chapter X, should the aggregate interest expense of the two periods should be considered or whether the interest expense of the two periods on a stand-alone basis should be considered.

5. Common Cost allocation5.1. Specified Domestic Transactions as defined under section 92BA, inter alia,

refers to transactions covered under section 80IA(8) of the Act, which deals with determination of profits of an eligible unit/business of the assessee in cases where there are inter-unit transfers. The said section provides that the profits of an eligible business shall be determined based on the market value of the goods and services, where such goods or services have been ‘transferred’ by such unit to ‘any other business’ or vice versa and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods or services as on the date of the transfer. After the introduction of the DTP regulations, now the market values of such goods and services have to be determined based on their arm’s length values as defined under section 92F(ii).

5.2. Questions have arisen as to whether the said provision would apply even to overhead expenses, which are incurred by the assesse not for any particular business but for the overall conduct of all its businesses. These expenses could be in the nature of general administrative expenses or research, marketing



and finance expenses. Indeed, under the ITP scenario, allocation of head office expenses, research expenses, etc. between various group companies of a multinational group has been a very litigative issue. However, under section 92BA r.w.s. 80IA(8)., the transfer pricing provisions have been applied to a particular unit of the assessee, whose profit is to be determined based on arm’s length principles only in certain specified scenarios, the same being:

a. There should be inter-unit ‘transfer’ of goods or services;

b. Such transfer should be any other ‘business’ of the assesse; and

c. Such transfer should be at a consideration that does not correspond to the market value.

5.3. In case of common expenses, such as managerial remuneration, it may be noticed, that the managerial services are not ‘transferred’ by any one unit of the assessee to another unit. Further, though managerial services would qualify as “services”, the same cannot be regarded as another “business” of the assessee. Hence, it may not be strictly covered under section 80IA(8), implying that such common cost need not be allocated to the eligible unit on an arm’s length basis.

5.4. However, attention may be brought to sub-section (5) of section 80IA, which requires that the profits of the undertaking claiming deduction under section 80IA should be computed as if the undertaking is the only source of income of the assessee. In view of this provision, Courts have held that the essence of the phrase ‘as if such eligible business was the only source of income’ used in the said sub-section (5) is that the expenses of the business, whether direct or indirect; project-specific or common expenses, had to be considered and allocated for computation of the profits and gains of an eligible business2.

5.5. Posers:

a. Whether the common costs would need to be allocated to the eligible unit?

b. If yes, whether such allocation would need to be determined based on the arms’ length principles and the transfer pricing methods contained in Chapter X of the Act;

c. Whether any mark-up needs to be added to the common costs while allocating it to the eligible unit?

d. An assessee is carrying out only one manufacturing business that is eligible for deduction under section 80IC. Hence, it carries out both manufacturing and selling and distribution activity as a part of one single business. Whether such manufacturing and distribution business needs to be segregated and a notional transfer of goods from the manufacturing business to the selling business needs to be assumed for determining the profits of the manufacturing business?

2. Nitco Tiles Ltd.v. Deputy Commissioner of Income-tax [2009] 30 SOT 474 (MUM.);KewalKairan Clothing Ltd, Mumbai v. Assessee ITA No.44/Mum/2009; Controla & Switchgear Co Ltd v. Deputy Commissioner Of Income Tax; Nahar Spinning Mills Ltd. v. Joint Commissioner of Income-tax, Range VII, Ludhiana [2012] 54 SOT 134 (CHD)(URO):[2012] 25 taxmann.com 342 (Chd.); Synco Industries Ltd. v. Assessing Officer of Income-tax [2002] 254 ITR 608 (Bom)



5.6. Difficulties could arise also where different entities of a group that are related to each other under section 40A(2) have arranged their affairs in such a manner that some employees and some resources are jointly used and each entity raises debit note on the other towards sharing of costs every month based on certain fixed criteria – like number of staff, turnover, etc. Since the charges are essentially towards sharing of costs, companies would like to contend that the inter-company charge is reasonable having regard to ALP as determined under CUP method. However, the point that is being missed is that the basis of sharing should really meet the arm’s length principle because if such basis is not scientific, then, the condition in section 40A(2) that the expenditure should be reasonable having regard to not only the ALP but also to the legitimate needs of the business and benefits derived therefrom may come under a challenge.

6. Real Estate Transactions6.1. Section 40A(2) of the Act provides for disallowance of expenses in respect of

transactions entered into between certain specified parties where the expenditure incurred by the assessee is regarded as excessive or unreasonable having regard to the following:

– the fair market value of the goods, services or facilities for which the payment is made; or

– the legitimate needs of the business or profession of the assessee; or

– the benefits derived by or accruing to him therefrom.

6.2. The said provision applies only in respect of any ‘expenditure’ incurred by an assessee, which is claimed as deduction by it. Further, the said three conditions are separated by the conjunction ‘or’, which indicates that all the three circumstances need not exist simultaneously and that these requirements are independent and alternative to each other.

6.3. In respect of the first condition that the expenditure incurred should be at fair market value, the Finance Act, 2012 has inserted a new proviso to section 40A(2)(a) with effect from assessment year 2013-14, which reads as under:

“Provided that no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm’s length price as defined in clause (ii) of section 92F.”

6.4. This amendment is consequential to the introduction of the DTP regulations in the Act. Hence, post amendment, the reasonableness of an expenditure in respect of a specified domestic transaction needs to be ascertained based on the transfer pricing methods prescribed in Chapter X of the Act. Further, the assessee also needs to maintain proper documents to demonstrate that the transactions are entered into on arm’s length basis.

6.5. Now, construction activity in real estate sector generally stretches over more than one financial year. Accordingly, as per the generally accepted accounting norms, the construction companies follow either percentage completion method



or project completion method. In both the cases, the construction expenses are initially carried forward under the head “Construction Work-in Progress”. Now, in cases where the transactions for payment of construction related expenditure are undertaken with a related party, and the expenses are debited to CWIP and not claimed as expense in the year in which the same is incurred, question arise as to whether section 40A(2) would apply in the year of incurrence. If a view is taken that section 40A(2) would not apply in the year of incurrence of expenditure on the ground that such expenditure has not been claimed as deduction in that year, question would then arise as to whether section 40A(2) would apply in the subsequent year in which it is taken to the profit and loss account.

6.6. The Mumbai Bench of the Income Tax Tribunal has held in Savala Associates v. ITO (35 SOT 148) and Unique Enterprise v. ITO (ITA No. 5109/M/2008), that where the assessee has not claimed any expenditure and carried to CWIP, question of disallowance u/s. 40(a)(ia) does not arise.

6.7. Posers:

a. Where expenditure incurred on construction is debited to CWIP and not claimed as expenditure, whether the provisions of section 40A(2) would get triggered to disallow excessive expenditure?

b. Alternatively, would section 40A(2) be triggered to adjust the CWIP or be triggered in subsequent years in which such CWIP is actually claimed as expenditure?

6.8. Where construction costs are paid by an entity which is the real estate owner to a related entity which is a developer for construction of property on its land, such costs would be required to be determined based on arm’s length principles. Similarly, where project management services or marketing services relating to real estate projects are outsourced to a related party, the fees for such activities need to be determined based on arm’s length principles.

6.9. However, where there is a joint development agreement under which the developer gets from the owner a licence to enter on the property for the purposes of developing the property and in consideration thereof the developer is granted rights to own and sell a portion of the constructed area. In such cases, the real estate owner records in its books of account only the sales of the area that is agreed to be his share with little costs debited against it. On the other hand the developer debits all costs of construction, whether related to his area or to the area relating to the owner’s share and record sales only relating to his area.

6.10. In substance, the owner has parted with a portion of his land in consideration of his getting rights over certain constructed area. On the other hand, the developer has carried out construction on the land belonging to the owner and in consideration of his carrying out construction, he gets the rights to own and sell a part of the constructed area. But on the face of the profit and loss account of either of the parties, there is no debit of any expense that has resulted in a payment to a related party. Ostensibly, the transaction of area sharing between



the related parties does not come under scrutiny for testing the reasonableness under section 40A(2). Is this correct?

6.11. Posers:

a. Does the area sharing arrangement between the parties in a development agreement that are related to each other under section 40A(2) come under the purview of section 40A(2) or not? Is there any “expenditure” incurred by either of the parties, in respect of which any “payment” is made to a related party so as to get covered within the scope of section 40A(2)? If yes, in whose hands would section 40A(2) apply, the owner or the developer?

b. What would be the most appropriate method for determining its arm’s length price?

7. Corresponding Adjustments in 40A(2)7.1. The SC in CIT v. Glaxo Smithkline Asia P. Ltd. (2010) 195 Taxman 35, on the facts

of that case, refused to interfere “as the entire exercise is revenue neutral” and accordingly dismissed the SLP filed by the Revenue.

Is there, therefore, any need to amend the law so as to provide that:

(i) The provisions of section 40A(2) should apply only where there is a tax arbitrage; and/or

(ii) Provisions should be made for allowing ‘corresponding adjustments’ in the hands of the other assessee?

(iii) Alternatively, is there a case to argue that even if the payment to a related party is excessive having regard to the ALP, the excess cannot be disallowed if the recipient entity is paying full tax on its income.

8. Directors’ Remuneration8.1. Whether Companies Act provisions / approval is valid benchmark? Consider, inter

alia, CBDT circular 6P .

8.2. If ‘no’, then how to administer DTP requirement for directors’ remuneration?

• CUP can’t apply because all are “controlled” transactions;

• Other methods are clearly NA;

• Any documentation to fit into the sixth method will be artificial and avoidable.

8.3. When the remuneration committee / shareholders have approved the directors’ remuneration and the interested director has not participated in the relevant resolution, is there any case to apply the disallowance provision at all?

9. Partner’s Remuneration9.1. Whether the limits prescribed u/s. 40(b) should be considered valid even for DTP

compliance? Is that not an in built TP provision?



9.2. If ‘no’, same questions as for directors’ remuneration will have to be answered.

10. Passing of entries in the books of eligible undertakings – whether necessary10.1. Section 80IA(8) requires, “for the purposes of the deduction under this section,

the profits and gains of eligible business shall be computed as if the transfer…had been made at the market value…”

10.2. Thus, the assessee need not pass any entry in the books of account to notionally account for such transfer. Sometimes, the assessee passes the entries at some standard cost for internal reporting and this does not reflect market price. In such cases, for the limited purposes of making computation of deduction, the market value based computation is made and return is filed accordingly. Indeed, the fiction of law requires the computation to be at market value.

10.3. Where no entry is passed for such inter unit transfers, or where entries passed are at some standard costs, invariably the profits computed based on market value will be different. Thus, the “income computed on the basis of entries passed in the books of account” would be different than the income computed based on the mandatory requirement of section 80IA(8), i.e. based on market price.

10.4. Till now, there has been no problem in implementing section 80IA in such cases. Now, Section 92(3) says that TP chapter shall not apply where the chapter has the effect of reducing the income or increasing the loss “computed on the basis of the entries made in the books of account”. Does it mean that in such cases, the ALP is not to be considered for computing the deduction? In such a case, can it be contended that the original concept of market value (i.e. open market price) continues to apply in view of clause (i) to the Explanation to section 80IA(8) and the TP chapter is not applicable?

11. Concept of “close connection” or “any other reason” – AO’s judgement – such subjective criteria can’t be imposed on the assessee and auditors for reporting11.1. Invoking section 80IA(10) is a prerogative of the AO. The AO can recompute the

profits eligible for tax holiday if the tax payer having business with another party of “close connection” earns more than ordinary profits because of such “close connection” or “for any other reason”.

11.2. Now, a transaction between such persons is regarded as a SDT.

11.3. Consequently, in view of the proviso to section 80IA(10) read along with section 92(2A), the profits from such SDT are to be computed having regard to ALP.

11.4. The section does not provide for any objective criteria to decide whether there is any “close connection” between two parties doing business with each other. Also, “any other reason” is a term that is subjective and which reflects the legislative intent of providing freedom to the AO to examine all facts and circumstances of the case and decide. For example, an unrelated person who has lived with the assessee as a paying guest for several years and for whom he develops affection may be covered under “close connection”. At the same time two brothers



separated from each other may run independent companies which may do business with each other, but the “close connection”, in substance, is absent.

11.5. Now, the new law casts the onus on the assessee and the auditors to identify and report such transactions! It is impossible to comply with such a requirement unless, like section 40A(2) or section 92A there are objective criteria to determine the persons having “close connection”. Also, cases of “any other reason” can never be imagined by the assessee or the auditors for reporting.

11.6. Participants may discuss how such reporting should be done if there is no amendment / clarification on this.

12. A Case Study ABC Ltd. is a public listed company engaged in the business of manufacturing certain

consumer durables. It has a subsidiary which imports certain chemicals and supplies the same to ABC Ltd. These chemicals are used by ABC Limited in its manufacturing units. One of the several manufacturing units is in Himachal Pradesh which enjoys 100% tax holiday under section 80IC. The subsidiary also imports and sells the same chemicals to third parties in India.

Assume that the subsidiary imports a Chemical ‘X’ at a landed cost of ` 100 per kg., it sells the same to ABC Ltd. at ` 105 per k.g. and it sells to third party manufacturers in India at ` 115 per kg. Assume that all other terms and conditions, like credit period, etc. are the same.

Till last year, the said transaction was reported in the column relating to section 40A(2) in the tax audit report. Since the price charged from the assessee was lower than the price charged by the subsidiary to third parties, the transaction was regarded as within the parameters of section 40A(2) and no additions were made.

A question that has now arisen is as to whether it can be said that from the point of view of deduction u/s. 80IC, the price charged by the subsidiary is less than the market price and consequently, the profits of the 80IC unit is inflated by ` 10 (i.e. the difference between the supply price to third parties of ` 115 and the supply price to the assessee of ` 105).

13. A final word The Transfer Pricing methodologies are prescribed for both ITP and DTP. But it

would be interesting to note that there could be several cases of transactions between domestic related parties where the DTP provisions do not apply, yet, the knowledge of the TP methodologies is now a must because under the newly introduced Companies Act, 2013 as also under the amended listing agreement, the related party transactions have to be approved by the audit committee as being on an arm’s length basis and every such transaction that is considered “material” has to be approved by the shareholders by a special resolution and in such resolution the related parties cannot vote. These requirements have partly been made applicable and a part would apply from October 1, 2014. Our experience in the field of transfer pricing under this new Company Law may be a subject matter of a separate paper next year. Till then, good bye!



International and Domestic Transfer Pricing – Some important issues

Reference Material

Expenses or payments not deductible in certain circumstances.40A. (1) The provisions of this section shall have effect notwithstanding anything to the

contrary contained in any other provision of this Act relating to the computation of income under the head “Profits and gains of business or profession”.

(2)(a) Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction:

Provided that no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm’s length price as defined in clause (ii) of section 92F.

(b) The persons referred to in clause (a) are the following, namely :—

(i) where the assessee is an individual

any relative of the assessee;

(ii) where the assessee is a company, firm, association of persons or Hindu un-divided family

any director of the company, partner of the firm, or member of the association or family, or any relative of such director, partner or member;

(iii) any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual;

(iv) a company, firm, association of persons or Hindu undivided family having a substantial interest in the business or profession of the assessee or any director, partner or member of such company, firm, association or family, or any relative of such director, partner or member or any other company carrying on business or profession in which the first mentioned company has substantial interest;

(v) a company, firm, association of persons or Hindu undivided family of which a director, partner or member, as the case may be, has a substantial interest in the business or profession of the assessee; or any director, partner or



member of such company, firm, association or family or any relative of such director, partner or member;

(vi) any person who carries on a business or profession,—

(A) where the assessee being an individual, or any relative of such assessee, has a substantial interest in the business or profession of that person; or

(B) where the assessee being a company, firm, association of persons or Hindu undivided family, or any director of such company, partner of such firm or member of the association or family, or any relative of such director, partner or member, has a substantial interest in the business or profession of that person.

Explanation.—For the purposes of this sub-section, a person shall be deemed to have a substantial interest in a business or profession, if,—

(a) in a case where the business or profession is carried on by a company, such person is, at any time during the previous year, the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) carrying not less than twenty per cent of the voting power; and

(b) in any other case, such person is, at any time during the previous year, beneficially entitled to not less than twenty per cent of the profits of such business or profession.

Deductions in respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development, etc. 80-IA.(1) Where the gross total income of an assessee includes any profits and gains

derived by an undertaking or an enterprise from any business referred to in sub-section (4) (such business being hereinafter referred to as the eligible business), there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction of an amount equal to hundred per cent of the profits and gains derived from such business for ten consecutive assessment years.

(5) Notwithstanding anything contained in any other provision of this Act, the profits and gains of an eligible business to which the provisions of sub-section (1) apply shall, for the purposes of determining the quantum of deduction under that sub-section for the assessment year immediately succeeding the initial assessment year or any subsequent assessment year, be computed as if such eligible business were the only source of income of the assessee during the previous year relevant to the initial assessment year and to every subsequent assessment year up to and including the assessment year for which the determination is to be made.

(8) Where any goods or services held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods or services held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does



not correspond to the market value of such goods or services as on the date of the transfer, then, for the purposes of the deduction under this section, the profits and gains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods or services as on that date:

Provided that where, in the opinion of the Assessing Officer, the computation of the profits and gains of the eligible business in the manner hereinbefore specified presents exceptional difficulties, the Assessing Officer may compute such profits and gains on such reasonable basis as he may deem fit.

Explanation.—For the purposes of this sub-section, “market value”, in relation to any goods or services, means—

(i) the price that such goods or services would ordinarily fetch in the open market; or

(ii) the arm’s length price as defined in clause (ii) of section 92F, where the transfer of such goods or services is a specified domestic transaction referred to in section 92BA.]

(10) Where it appears to the Assessing Officer that, owing to the close connection between the assessee carrying on the eligible business to which this section applies and any other person, or for any other reason, the course of business between them is so arranged that the business transacted between them produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business, the Assessing Officer shall, in computing the profits and gains of such eligible business for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived therefrom:

Provided that in case the aforesaid arrangement involves a specified domestic transaction referred to in section 92BA, the amount of profits from such transaction shall be determined having regard to arm’s length price as defined in clause (ii) of section 92F.

CHAPTER X SPECIAL PROVISIONS RELATING TO AVOIDANCE OF TAX

Computation of income from international transaction having regard to arm’s length price92. (1) Any income arising from an international transaction shall be computed having

regard to the arm’s length price.

Explanation.—For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm’s length price.

(2) Where in an international transaction or specified domestic transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or



expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm’s length price of such benefit, service or facility, as the case may be.

(2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to the specified domestic transaction shall be computed having regard to the arm’s length price.

(3) The provisions of this section shall not apply in a case where the computation of income under sub-section (1) [or sub-section (2A) or the determination of the allowance for any expense or interest under sub-section (1) or sub-section (2A), or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2) or sub-section (2A), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction or specified domestic transaction was entered into.

Meaning of international transaction92B. (1) For the purposes of this section and sections 92, 92C, 92D and 92E, “international

transaction” means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.

(2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be a transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise.

Explanation.—For the removal of doubts, it is hereby clarified that—

(i) the expression “international transaction” shall include—

(a) the purchase, sale, transfer, lease or use of tangible property including building, transportation vehicle, machinery, equipment, tools, plant, furniture, commodity or any other article, product or thing;

(b) the purchase, sale, transfer, lease or use of intangible property, including the transfer of ownership or the provision of use of rights regarding land use, copyrights, patents, trademarks, licences, franchises, customer list, marketing channel, brand, commercial secret, know-how, industrial property right, exterior design or practical and new design or any other business or commercial rights of similar nature;



(c) capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business;

(d) provision of services, including provision of market research, market development, marketing management, administration, technical service, repairs, design, consultation, agency, scientific research, legal or accounting service;

(e) a transaction of business restructuring or reorganisation, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date;

(ii) the expression “intangible property” shall include—

(a) marketing related intangible assets, such as, trademarks, trade names, brand names, logos;

(b) technology related intangible assets, such as, process patents, patent applications, technical documentation such as laboratory notebooks, technical know-how;

(c) artistic related intangible assets, such as, literary works and copyrights, musical compositions, copyrights, maps, engravings;

(d) data processing related intangible assets, such as, proprietary computer software, software copyrights, automated databases, and integrated circuit masks and masters;

(e) engineering related intangible assets, such as, industrial design, product patents, trade secrets, engineering drawing and schematics, blueprints, proprietary documentation;

(f) customer related intangible assets, such as, customer-lists, customer contracts, customer relationship, open purchase orders;

(g) contract related intangible assets, such as, favourable supplier, contracts, licence agreements, franchise agreements, non-compete agreements;

(h) human capital related intangible assets, such as, trained and organised work force, employment agreements, union contracts;

(i) location related intangible assets, such as, leasehold interest, mineral exploitation rights, easements, air rights, water rights;

(j) goodwill related intangible assets, such as, institutional goodwill, professional practice goodwill, personal goodwill of professional, celebrity goodwill, general business going concern value;

(k) methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data;



(l) any other similar item that derives its value from its intellectual content rather than its physical attributes.]

Meaning of specified domestic transaction92BA. 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 an international transaction, namely:—

(i) any expenditure in respect of which payment has been made or is to be made to a person referred to in clause (b) of sub-section (2) of section 40A;

(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 sub-section (10) of section 80-IA;

(v) any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which provisions of sub-section (8) or sub-section (10) of section 80-IA 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 of five crore rupees.



PassionPassion is an amazing thing. A passionate person believes in the impossible. A passionate person believes they are the future history makers. A passionate person believes ‘Obstacles are for other people. They can see only opportunities.’

A passionate person believes, if they touch a double decker bus with the tip of their toe, the bus will go rolling.

A passionate person believes their idea is ‘the’ game changer.

Passionate people can love like no one can. Passionate people can live like no one else.

Ahhhh! What a wonderful feeling it is to be passionate and to be with passionate people. It makes life so so so much, worth living.

When someone asks, ‘What should I do in my life?’, the most common answer is, ‘Live your passion’.

While the answer is indeed right and perfect, there are some sides to passion that people miss to tell. Not knowing this side can be outright dangerous. While passion does get the best out of us and makes blood within our veins run with a tsunami of determination, being ready for the little dirty side of passion makes the journey even more worthwhile.

So, here are things no one tells you about passion

• You may feel worse and remorseful before you feel better.

• Your fears will be bigger than ever and you will feel alone.

• Forget about it. There are no comfort zones.

• For sometime, there will be no balance in life. Forget about holidays.

• You will meet jerks (sorry for the unparliamentary word) and you will also have to work with them.

• Everything takes longer than anticipated.

• In the end, It’s absolutely worth it. Do it. Live it. If necessary, die it.

If you can take the above in your stride, then you are indeed passionate about your idea. Go for it. Nothing else in life will give you greater meaning and satisfaction.

ricing) material/itf2014/yogesh thar.pdf · mr. thar was a member of managing committee of the...

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