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DOMESTIC TRANSFER PRICING PROVISIONS CA .T. P. OSTWAL

INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA RAIPUR BRANCH. DOMESTIC TRANSFER PRICING PROVISIONS CA .T. P. OSTWAL. Introduction. TP was earlier limited to ‘International Transactions’

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DOMESTIC TRANSFER PRICING PROVISIONS CA .T. P. OSTWAL

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  1. INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA RAIPUR BRANCH DOMESTIC TRANSFER PRICING PROVISIONSCA .T. P. OSTWAL T.P.Ostwal & Associates

  2. Introduction • TP was earlier limited to ‘International Transactions’ • The Finance Act 2012, extends the scope of TP provision to ‘Specified Domestic Transactions’ between related parties w.e.f. 1 April 2012 • The SC in the case of CIT vsGlaxoSmithkline Asia Pvt Ltd [2010-195Taxman 35 (SC)] recommended introduction of domestic TP provisions • SDT previously reported/certified but onus on revenue authorities • Obligation now on taxpayer to report/ document and substantiate the arm’s length nature of such transactions • Shift from generic FMV concept to focused ALP concept • These new provisions would have ramifications across industries which benefit from the said preferential tax policies such as SEZ units, infrastructure developers or operators, telecom services, industrial park developers, power generation or transmission etc. Apart from this, business conglomerates having significant intra-group dealing would be largely impacted T.P.Ostwal & Associates

  3. SDT – Intent of the Law • Bringing in objectivity in the interpretation and governance – introduction of ALP mechanism • Doing away with tax arbitrage abuse that stems from differential tax rate, tax holiday/benefits availed by undertaking and presence of accumulated losses • Protecting the revenue of the Indian Government T.P.Ostwal & Associates

  4. Intent of Indian TP Regulations (International transactions) Shifting of Profits India Overseas Associated Enterprise (AE Co.) Indian Co. Tax @ 33.99% Tax @ lower rate approx 10% Shifting of Losses Tax Saving for the Group – Loss to Indian revenue T.P.Ostwal & Associates

  5. Intent of Indian TP Regulations… (Domestic transactions) India India Shifting of expenses/losses Indian Co. Tax Holiday undertaking Related Enterprise in Domestic Tariff Area (DTA) Tax @ 33.99% Tax Exempt Unit *However, MAT @ 20 % applicable as per sec 115JB Shifting of income/profits Tax Saving for the Group – Loss to Indian revenue T.P.Ostwal & Associates

  6. Intent of Indian TP Regulations…(Domestic transactions) Loss to Revenue – Tax Saving to the Group * By shifting of income from a profit making company to a SEZ (Tax exempt Unit), the group could reduce its tax liability from 33.99% to 20% on the profits shifted since though the profits of SEZ are otherwise exempt but they would attract MAT liability as per sec.115JB. T.P.Ostwal & Associates

  7. Intent of TP Regulations… (Domestic transactions) Shifting of expenses India India Indian Co. Loss making Related Enterprise Profit making Maximum Tax @ 33.99% Reduced tax due to shifting of profits Tax @ 32.45% No tax or reduced tax due to loss Shifting of income Tax Saving for the Group – Loss to Indian revenue T.P.Ostwal & Associates

  8. Intent of TP Regulations…(Domestic transactions) Present Loss to Revenue* – Tax Saving to the Group * By shifting of income from a profit making company to a loss making company, the group could reduce its tax liability by 16.995 for the current year, though the impact will be reversed in future years given carry forward of losses. T.P.Ostwal & Associates

  9. Section 92BA – Meaning of SDT (inserted by Finance Act, 2012 w.e.f. AY 2013-14 i.e. current FY) • For the purposes of this section and sections 92, 92C, 92D and 92E, “specified domestic transaction” in case of an assessee means any of the following transactions, not being an international transaction, namely:- • any expenditure in respect of which payment has been made or is to be made to a person referred to in section 40A(2)(b); • any transaction referred to in section 80A; • any transfer of goods or services referred to in sub-section (8) of section 80-IA; • any business transacted between the assessee and other person as referred to in section 80-IA (10); • any transaction, referred to in any other section under Chapter VIA or section 10AA, to which provisions of section 80-IA(8) or section 80-IA(10) are applicable; or • 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. T.P.Ostwal & Associates

  10. Overview of Provisions of Section 92BA Inter unit transfer of goods & services by undertakings to which profit-linked deductions apply SDT Expenditure incurred between related parties defined under section 40A Any other transaction that may be specified Transactions between undertakings, to which profit-linked deductions apply, having close connection T.P.Ostwal & Associates

  11. Overview of Provisions of Section 92BA • S. 10AA uses the term close connection. • S. 40A(2)(b) uses the term Related party. • S. 80IA (8) inter unit. • S. 80IA (10) uses the term close connection. • S. 92A uses the term Associated Enterprises. • No guidance or limited guidanceon the meaning of close connection • s T.P.Ostwal & Associates

  12. Overview of Provisions of Section 92BA • S 42 (2) of ITA 1922,”Where a person not resident or not ordinarily resident in the taxable territories carries on business with a person resident in the taxable territories, and it appears to the Income-tax Officer that owing to the close connection between such persons the course of business is so arranged that the business done by the resident person with the person not resident or not ordinarily resident produces to the resident either no profits or less than the ordinary profits which might be expected to arise in that business, .the profits derived therefrom, or which may reasonably be deemed to have been derived therefrom, shall be chargeable to income-tax in the name of the resident person who shall be deemed to be, for all the purposes of this Act, the assessee in respect of such income-tax.“ • [1958] 34 ITR 368 (SC)SUPREME COURT OF INDIA • Mazagaon Dock Ltd.vs. C.I.T. Excess Profits Tax T.P.Ostwal & Associates

  13. Section 92BA Analysed...... For the purpose of sec. 92, 92C, 92D and 92E * Sec 92F – Definitions does not define terms relevant for domestic TP transactions T.P.Ostwal & Associates

  14. Sec. 92 – Computation of income from international transaction having regard to ALP (1) Computation of income from international transaction having regard to ALP. (2) mutual agreement etc for allocation or apportionment or contribution to any cost or expense shall be determined having regard to ALP. (newly inserted) (2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to specified domestic transaction shall be computed having regard to ALP. (3) section does not apply if the effect is reducing the income or increasing the loss. T.P.Ostwal & Associates

  15. Sec. 92 C – Computation of ALP • The words “specified domestic transaction” has been inserted appropriately in various sub-sec. • (1) Any of the following methods, being most appropriate method : • (a) Comparable uncontrolled price method; • (b) Resale price method; • (c) Cost plus method; • (d) Profit split method; • (e) Transactional net margin method; • (f) other method of determination of arm’s length price • (any method that takes in to account the price which has been charged or paid or would have been charged or paid for same or similar uncontrolled transaction with or between non – associated enterprises) • (2) Most appropriate method as per criteria laid down in rule 10C considering FAR analysis also. • FAR : Functions performed, Assets employed, Risks assumed [Rule 10C(2)] • For the A.Y. 2013-14, the Government has notified a tolerance range of 3% u/s 92C for specified domestic transactions vide notification dated April 15, 2013. However, for wholesale traders, the range has been notified as 1% only. refer rule 10B T.P.Ostwal & Associates

  16. Section 92CA - Reference To TPO • The word “specified domestic transaction” inserted in various sub-sections. • (1) AO may refer the computation of ALP to TPO • (2) TPO to issue notice to Assessee to produce evidence in support of ALP • (2A) Any other international transaction coming to notice of TPO* • (2B) Non-furnishing of CA’s report and TPO’s power * • (3) TPO shall pass the order determining ALP • (4) AO to compute total income accordingly • (7) TPO’s power of summons (s.131), survey (s.133A) and collecting • information u/s 133(6)applies even in Domestic Transaction Sec. 144C (15)(b)…..Reference to DRP • AO to forward draft of proposed order to eligible assessee • eligible assessee means – any person in whose case order u/s 92CA is passed • * 92CA(2A ) & (2B)do not cover specified domestic transactions and hence the TPO cannot suo moto upon the transaction coming to his notice apply the TP provisions T.P.Ostwal & Associates

  17. Section 92D : Maintenance and keeping information and document by persons entering into an international transaction/ SDT Section 92CC : Advance pricing agreement The Provisions of Advance pricing agreement are not made applicable to Specified Domestic Transactions. Entity Related Price Related Transaction Related • Agreements • Invoices • Pricing related correspondence (letters, e-mails, fax, etc.) • Transaction terms • FAR related • Economic Analysis (method selection, comparable benchmarking) • Forecasts, budgets, estimates • Profile of Industry • Profile of group • Profile of related parties • The onus of proving SDT at ALP is on tax payer T.P.Ostwal & Associates

  18. Section 271 –Penalty Implications T.P.Ostwal & Associates

  19. Relationship can exists any timeduring the year Sec 40A (2)(b) – Related Party T.P.Ostwal & Associates

  20. Type of transactions covered (illustrations for payments made by a Company) … • Case 2 - To an individual who has substantial interest in the business or profession of the taxpayer or relative of such individual – Section 40A(2)(b)(iii) Case 1 - Director or any relative of the Director of the taxpayer – Section 40A(2)(b)(ii) Assessee (Taxpayer) Assessee (Taxpayer) Director Director Substantial interest >20% Relative Mr. A Mr. D Mr. C Mr. A Mr. D Mr. C Relative Relative Covered transactions Holding Structure T.P.Ostwal & Associates

  21. Type of transactions covered (illustrations for payments made by a Company) … • Case 4 – Any other company carrying on business in which the first mentioned company has substantial interest – Section 40A(2)(b)(iv) Case 3 – To a Company having substantial interest in the business of the taxpayer or any director of such company or relative of the director – Section 40A(2)(b)(iv) Mr. D Assessee (Taxpayer) C Ltd Director Substantial interest >20% Assessee (Taxpayer) A Ltd Relative Substantial interest >20% Substantial interest >20% Substantial interest >20% Mr. C A Ltd B Ltd Covered transactions Holding Structure T.P.Ostwal & Associates

  22. Type of transactions covered (illustrations for payments made by a Company) … Case 5 – To a Company of which a director has a substantial interest in the business of the taxpayer or any director of such company or relative of the director – Section 40A(2)(b)(v) B Ltd Director Director Substantial interest >20% Assessee (Taxpayer) Mr. A Mr. C Relative Mr. D Covered transactions Holding Structure T.P.Ostwal & Associates

  23. Type of transactions covered (illustrations for payments made by a Company)… Case 6 – To a Company in which the taxpayer has substantial interest in the business of the company – Section 40A(2)(b)(vi)(B) • Case 7 – Any director or relative of the director of taxpayer having substantial interest in that person– Section 40A(2)(b)(vi)(B) Substantial interest >20% Assessee (Taxpayer) Mr C A Ltd Director Assessee (Taxpayer) Substantial interest >20% Relative B Ltd Substantial interest >20% Mr B D Ltd Covered transactions Holding Structure T.P.Ostwal & Associates

  24. A B Type of transactions covered (illustrations for payments made by a Company)… Transaction Covered A & B  A & C  A & D  A & E  B & C  D & E  C & D  D & E  C D E T.P.Ostwal & Associates

  25. Thus for Company A payments to following persons are covered T.P.Ostwal & Associates

  26. Tax burden, if transaction not at ALP Y Ltd. (non-tax holiday) X Ltd. (non-tax holiday) Disallowance of ` 20 to Y Ltd [40A(2)(b)] Sale at 120 v/s ALP i.e. 100 Double Adjustment Tax holiday on 20 not allowed to X Ltd – [80IA(10)] (more than ordinary profits) Disallowance of 20 to Y Ltd - [40A(2)(b)] X Ltd. (tax holiday) Y Ltd. (non-tax holiday) Sale at 120 v/s ALP i.e. 100 Inefficient pricing structure – reduced tax holiday benefit since sale price is lower than ALP X Ltd. (tax holiday) Y Ltd. (non-tax holiday) Sale at ` 80 v/s ALP i.e. ` 100 T.P.Ostwal & Associates

  27. Section 80IA (8) & 80IA (10) – Deduction in respect of profits and gains from industrial undertaking or enterprise engaged in infrastructure development, etc. T.P.Ostwal & Associates

  28. Illustration T.P.Ostwal & Associates

  29. Other Sections under Chapter VI-A......to which s. 80-IA(8) or (10) are applicable T.P.Ostwal & Associates

  30. ALP FMV Implication post - budget 2012 for SDT Six methods prescribed for computing ALP No method prescribed for computing FMV Contemporaneous documentation required to be maintained No documentation required to be maintained Accountant’s report signed by a CA to be filed Other than reporting in tax audit report, no statutory compliance Assessment done by the TPO Assessment done by the AO T.P.Ostwal & Associates

  31. Points for Consideration • Whether the threshold limit of Rs. 5 crore applies to the aggregate amount under all the relevant sections taken together OR under each section separately i.e. 40A(2), 80A, 80-IA(8), 80-IA(10), 10AA etc. ? • Whether payment for capital expenditure Or expenditure capitalized is also covered ? • Whether the provisions will apply in case the payer’s income is chargeable to tax under the head ‘Income from other sources’, because section 58(2) says –The provisions of section 40A shall, so far as may be, apply in computing the income chargeable under the head “Income from other sources” as they apply in computing the income chargeable under the head “Profits and gains of business or profession” ? • Whether new provision applies to - • Public Charitable Trust paying remuneration to related persons. • Co-operative Societies • Social Clubs • having a business undertaking • Transfer pricing provisions are not applicable in case where income is not chargeable to tax at all. • Correlative adjustments - if excessive or unreasonable expenses are disallowed in the hands of tax payer at time of the assessment then corresponding adjustment to the income of the recipient will not be allowed in the hands of recipient of income. Hence, it would lead to double taxation in India. T.P.Ostwal & Associates

  32. Challenges T.P.Ostwal & Associates

  33. Filling Form 3CEB CBDT has issued a notification dated 10 June 2013 notifying the rules and certificate for reporting specified domestic transactions. The existing rules have been amended to include specified domestic transactions. Further Form 3CEB has been amended to include Part C which contains reporting of specified domestic transactions undertaken by the assessee. Accordingly every assessee who has entered into specified domestic transactions will now have to obtain the auditors report in Form 3CEB and file the same with the Income Tax Department. The amended rules comes into effect from 1 April 2013. T.P.Ostwal & Associates

  34. Annexures to Form 3CEB T.P.Ostwal & Associates

  35. Annexures to Form 3CEB (contd)… T.P.Ostwal & Associates

  36. Annexures to Form 3CEB (contd)… T.P.Ostwal & Associates

  37. Annexures to Form 3CEB (contd)… T.P.Ostwal & Associates

  38. Annexures to Form 3CEB (contd)… T.P.Ostwal & Associates

  39. Annexures to Form 3CEB (contd)… T.P.Ostwal & Associates

  40. Importance of TP Documentation • Legal requirement [Sec. 92D read with Rule 10D] • Helps taxpayer in discharge of “burden of proof” that transactions are at arm’s length • Captures relevant aspects of price determination mechanism in controlled transactions • Economically significant • Functions • Assets • Risk • Other relevant factors (such as ‘business strategies’, ‘special circumstances’, etc.) • Facilitate TP audit and evaluation by tax authorities • A good defense against TP litigation • Greater the complexity and unusualness of the case, more importance is attached to documentation. • Cost, time and efforts involved vis-à-vis likely benefits and importance need to be evaluated T.P.Ostwal & Associates

  41. Pre transaction-Planning Stage TP Documentation • Quote from updated OECD TP Guidelines [page 182, para 5.3]: “Each taxpayer should endeavor to determine transfer pricing for tax purposes in accordance with the arms length principle, based upon information reasonably available at the time of the determination. Thus, a taxpayer ordinarily should give consideration to whether its transfer pricing is appropriate for tax purposes before the pricing is established. For example, it would be reasonable for a taxpayer to have made a determination regarding whether comparable data from uncontrolled transactions are available. The taxpayer also could be expected to examine, based on information reasonably available, whether the conditions used to establish transfer pricing in prior years have changed, if those conditions are to be used to determine transfer pricing for the current year.” T.P.Ostwal & Associates

  42. Pre transaction-Planning Stage TP Documentation • Helps in demonstrating: • Taxpayer applied ‘prudent business management principle’ in establishing transfer price • Efforts undertaken to comply with arms length principle • Information on which transfer price is based (such as External/Internal information relied on etc.) • Factors taken into account (such as proposed business model: captive or entrepreneur or contracted service provider, forecast, budgeting, etc.) • Most appropriate method considered for ALP determination. • Achieving the requirement of “contemporaneous documentation” T.P.Ostwal & Associates

  43. Post Transaction TP Documentation / review • Requirement of Law • Assist in identifying deviations in pre transaction facts and post transaction facts and in gathering justifications for deviations, if any. • Updation of data (financial or otherwise) of tested party as well as comparable uncontrolled transactions. • Provides opportunity for self adjustment in transfer price • Avoid penal consequences T.P.Ostwal & Associates

  44. Indian Rules on TP Documentation… Information and documents to be kept and maintained under section 92D(Rule 10D of Income Tax rules) 10D.    (1) Every person who has entered into an international transaction / SDT shall keep and maintain the following information and documents, namely:— T.P.Ostwal & Associates

  45. …Rule 10D of Income Tax Rules T.P.Ostwal & Associates

  46. …Rule 10D of Income Tax Rules T.P.Ostwal & Associates

  47. …Rule 10D of Income Tax Rules The above documentation shall be supported by the reports and documents specified in Rule 10D(3) T.P.Ostwal & Associates

  48. Rule 10D-Documentation Requirements Entity related Price related Transaction related -Contemporaneous documentation requirement- Rule 10D Documentation to be retained for 8 years No specific documentation requirement if the value of international transaction / SDT * is less than one crore rupees * Section 92D refers to documentation as prescribed by Rule 10D, however there has not been corresponding amendment in Rule 10D with respect to providing relief from documentation requirement where value of SDT does not exceed 1 crore as is available in case of international transactions. However going by legislative intent such relief should also be available in case of SDT as well. -Profile of industry -Transaction terms -Agreements -Profile of group -Functional Analysis -Invoices -Profile of India entity ( function, assets and risks) -Pricing related correspondence -Profile of associated enterprises -Economic analysis (letters, emails etc) (method selection, comparable benchmarking) -Forecasts, budgets, estimates T.P.Ostwal & Associates

  49. TRANSFER PRICING DOCUMENTATION Documentation Best Practices Master File Transaction File TP Study TP Certification TP Assessment Characterisation & Analysis General Agreement & Invoices Assumptions Representation Related Policy Related FAR Related Benchmarking Notes Litigation Support Pricing Related Justification Undertaking & Representations T.P.Ostwal & Associates

  50. TRANSFER PRICING DOCUMENTATION Documentation Best Practices – Master File THE GROUP THE TAXPAYER T.P.Ostwal & Associates

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