Domestic Transfer Pricing

1. Domestic Transfer Pricing By CA MANOJ KUMAR C/O MANOJ KUMAR MITTAL & CO. CHARTERED ACCOUTANTS Ph No. 9810764620

2. Relevant Provision of the Income Tax Act-Chapter X

4. Relevant Circular and notification-Circular NO. 6-P, Dated 6-7-1968 and circular NO. 4-P[LXXVI-65], dated 7-6-1968 • For related Party, reference is to • 40A(2)(b)-Related Party • AS-18 • Section 92A-Associates Parties

5. Domestic Transfer Pricing • This is introduced by the Finance Act, 2012 on the guidance of the SC in Glaxo Smithline 236 CTR 113(SC) • The purpose of introduction • To avoid tax arbitrage • for determination of income between related enterprises • for determination of income between related party transaction • for eliminating discrenatiorypower of AO in calculating FMV and to compute ALP on scientific basis through proper documentation.

6. Concept of Transfer Pricing • Difference between price and transfer Price • Price means the price at which transaction takes places between party • Transfer Pricing means the price at which the transaction takes places between two related enterprises. • Due to special relationship between related enterprises, the transfer price may be different from price for any transaction. • Arm’s Length Price(Sec 92F(ii))- It means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions;

7. Transfer Pricing Arm’ Length Price Related Party Independent Party Domestic Transaction *Goods *Services *Intangibles *Loans Resident Resident

8. Domestic Transfer Pricing from 01.04.2013 • Specified Domestic Transaction (not being international transaction) will be subject to transfer pricing at par with the norms applicable to International transaction.(Sec 92(2) • In respect of Specified Domestic Transaction, an allowance for an expenditure or allocation of any cost or expense or income shall be computed as per ALP and however, no computation shall be made which result in reducing income or increasing loss. Sec 92(2A) or 92(3) • MAT liability will continue as per books.

9. Domestic Transfer pricing regulation Sec-92BA-Meaning of Specified Domestic Transaction-Scope of the section i) any expenditure for which payment made or to be made to a person covered u/s 40(A)(2)(b) ii) Any transfer of goods and services between eligible units and non eligible unit of two associate of an undertaking -(80)(IA)(8) iii) Any business transaction with entities having close Connection-80(IA)(10) iv) Any other transaction as may be specified.

10. Specified Domestic Transaction

13. The above provision will be applicable if the aggregate of such transaction exceeds Rs 5.00 Cr. • If Entity A sells goods to entity B for Rs. 3.00 cr and entity B sell goods to entity A for 2.5 cr the question is whether it will be applicable. Yes • Whether notional income principle will be applicable for clause 80(IA)(8) or (10)-NO • A pays rent of Rs. 4 crores to B ltd and pays interest on loan of Rs, 1.5 crores to C, as the aggregate of tranaction exceeds Rs. 5 Cr, it will be covered.

14. Fair Market Value vs. Arm’s Length Price

18. Definition of Relatives-Sec 2(41) Relative means • -Husband • -Wife • Brother • Sister • Any lineal ascendant or descendent • Circular 6P of 1968

19. Case Study-1-Payment to director or relative of director of the company- 40A2b(ii) X ltd(assessee) C-Relative of director-Y Y-Director X LTD

21. Case Study-II-payment to person having substantial interest in the business or any relative of such perosn40 A 2b(iii) A Related Transaction Related Party X LTD A has substantial interest in X ltd X and A and X and Y are related person Y, relative of A

23. Case Study-III-payment to company, firm, HUF or AOP or any director , partner of member thereof or any relative of director , partner or member -40A2b(iv) • D ltd has substantial interest in X ltd • X and D, X and Y, X and C are related person. D Ltd X LTD Y, Director of D LTD C –Relative of Y

25. Illustration – Section 40A(2)(b)(iv) A B C D E A & B--------- Yes A & C--------- Yes A & D--------- No A & E---------- No B & C---------- Yes D & E----------- No Transactions covered ? *Post Budget 2012 amendment under section 40A

26. Case Study –IV-Payment to company, HUF, Firm or AOP of which director, partner or member has substantial interest in assessee or any other director, partner or member of such co. firm or AOP or relative of thereof -40A2bv A X Ltd A has substantial interest in X ltd X and A, X and Y, X and Z and X and C are related person Director in Y ltd C relative of Z Z director in Y ltd

28. Case Study V-Payment to a person in whom assessee or any relative of assessee has substantial interest-40Ab (vi)A A C - relative of A Y Ltd A is an assessee , C is relative of A C substantial interest in Y ltd A and Y, Y and C are related person.

29. Case Study VI-Payment to a person in whom the assessee being co.,firm, HUF or AOP has a substantial interest or any director, partner or member there of or any relative of them-40A2bvi B Y, Director of X Ltd X LTD H ltd C has substantial interest in H ltd or Y has substantial interest in H ltd X and H, X and Y, X and C are related person C relative of Y

31. Brief Background ► Relevant extracts of the Departmental Circular - Circular NO. 6-P, Dated 6-7-1968 and circular NO. 4-P[LXXVI-65], dated 7-6-1968 ►It may be noted that the new provision is applicable to all categories of expenditure incurred in businesses and professions, including expenditure on purchase of raw materials, stores or goods, salaries to employees and also other expenditure on professional services, or by way of brokerage, commission, interest, etc. ► Where payment for any expenditure is found to have been made to a relative or associate concern falling within the specified categories, it will be necessary for the Income-tax Officer to scrutinize the reasonableness of the expenditure with reference to the criteria mentioned in the section. ► The Income-tax Officer is expected to exercise his judgment in a reasonable and fair manner. It should be borne in mind that the provision is meant to check evasion of tax through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases.

32. Any transaction referred in Sec 80A Sec 80(A)(6) refers to internal transaction between units/undertaking of the assessee in respect of goods and services. Hence, it applies to both income and expenses.

33. Sec 80 IA(8)-Deduction in respect of profit and gain • Where the goods and services are transferred from eligible business to any other business or vice versa, • The consideration for transfer as recorded in the books of eligible business does not correspond to the market value • The AO, then for the purpose of deduction, may compute the profit and gain according to the market value of such goods and services • Explanation inserted by finance Act, 2012 Market Price means the ALP in case of transaction covered under domestic transfer pricing u/s 92BA.

34. 80 IA-(10)- • That Where it appears to the AO that because of close connection between assessee carrying on eligible business and any other business or or for any other reason , any business transacted between them produces abnormal profit to the assessee, then AO may take the profit of the eligible business what can be reasonable derived from this business. • Proviso inserted by Finance Act, 2012, That if the business transacted between them is covered by SDT, then the will compute the profit as per ALP.

35. Sec 10AA As per this section, any unit located in SEZ area and is engaged in providing any goods or services is exempt from tax.

36. XYZ Ltd Power Production Sugar Production Cloth Production

37. Case Study • There is a company XYZ Ltd which has a three unit, one deals in production of sugar, another garments and one in generation of power. The power is supplied for the production of sugar and cloth. If any shortage comes in the production of power. The power is purchased from state Electricity Board. The power unit is tax free unit. • The power is purchased for production of cloth and sugar at Rs. 5 per unit. However, the rate of state electricity board is 4 per unit. Hence, the profit of power unit is being enhanced which is tax free and other unit is being reduced, • Similarly, there are certain common expenditure which as per accepted accounting principle is being should be divided into three unit but all the expenses are divided into cloth and sugar unit so as to reduce their profit.

38. Close Connection • A ltd provides loan to B Ltd which is more than 50% of its total assets • The manufacture or processing of goods or articles or business carried on by the a assessee is wholly dependent on knowhow, trade mark or any kind of data, documentation provided by other enterprises. • A ltd supplies more than 90% of the raw material to B Ltd for its manufacturing operation. • 90% of the goods produced by A Ltd is sold to B Ltd and this is B ltd who determines the price of the goods.

39. Penalty

40. Assessment Timelines ► This amendment will take effect from 1st July,2012. ► The due date for completion of a TP assessments is extended by 3 months. ► The existing and the new extended period for completion of pending proceedings and subsequent proceedings under the provisions is given below :

41. Implication of GAAR on TP • As per the proposed GAAR provisions in Chapter X of the Income Tax Act ,An arrangement whose main purpose is to obtain a tax benefit and which also satisfies at least one of the four tests, can be declared as 'impermissible avoidance agreements'. • The four tests inter alia are: • The arrangement that creates rights and obligations, which are not normally created between parties dealing at arm's length; • It results in misuse or abuse of provisions of tax laws; • it lacks commercial substance or is deemed to lack commercial substance. • Is carried out in a manner , which is normally not employed for bonfide purpose. TP Implications will arise mainly if it satisfies any one of the following two tests : • The arrangement that creates rights and obligations, which are not normally created between parties dealing at arm's length • It lacks commercial substance

42. Compliance Requirements • Documentation for specified Domestic Transaction within the specified time limit • Benchmarking for the specified domestic Transaction-onus on the tax payer • Determining the arm’s length price following six method as provided in the Act • Adjustment in the price-No corresponding adjustment allowed to other party causing double taxation • Preparing TP report • Giving audit report in form 3CEB

43. International TP vs. Domestic TP • If transactions are covered under SDT provisions, disallowance u/s 40A(2)(a) may be made by the AO only when transactions are not at arm’s length. [Proviso to Sec 40A(2)(a)] • Software / databases generally used for searches- Prowess, Capitaline Plus

44. Probable Issues • Provisions applicable only to expenditure where payment is made or to be made • Does this include capital expenditure? • Does this include transactions without consideration? • Does threshold apply to the amount recorded in the Books of Account or Amount determine as per ALP? • Wide coverage and goes beyond the related parties covered under AS-18 • Whether Government approval u/s 295, 297 of the Companies Act would be relevant?

45. If aggregate of International and Domestic transaction exceeds INR 50 million, Do we need to demonstrate ALP for Domestic transaction which is otherwise below INR 50 million? • If aggregate of International and Domestic transaction exceeds INR 50 million, but the International Transactions are below INR 10 million, Do we need to maintain documents prescribe under Rule 10D? ( Reference Rule 10D(2) • Would claim of Depreciation comes under the ambit of Domestic Transfer Pricing?

46. Under which Form, report for Domestic transfer Pricing shall be given? [ Section 92BA refer Section 92E] [ Prescribed form u/s92E is Form 3CEB which refers to the report on International Transactions] Revised Form 3CEB shall be notified in order to cover Specific Domestic Transactions • Section 92A [AE and Deemed AE] deals with directly or indirectly interested vis-à-vis Section 40A(2)(b) [Specified Domestic Related Party] deals with directly interested

47. Transaction under scanner of SDT • Interest free Loans to Group Companies • Granting of Corporate Guarantees/ Performance Guarantees by Parent Company to its subsidiaries • Intra-group purchase/ sell/ service transactions • Payment made to key personnel e.g. transaction with Directors/CFO/CEO etc.. • Payment made to key personnel of Group Companies • Payment made to relative of key personnel of the assessee/group companies

48. Difficulty to establish transaction in ALP • Commission to relatives of the directors/ partners • Salary paid to the relatives of the directors/Partners • Remuneration to the directors • Extra Purchase Price and Interest foregone to relatives • Good sold at lower than market price if bona fide • Higher Purchase Price than rates prevailing in the market • Interest paid to sister concerns at rate higher than normal rates • Hire Charges of Machinery or Rent paid for use of Immovable property

49. Challenges

50. a) Transfer pricing provisions are not applicable in case where income is not chargeable to tax at all. [Amiantit International Holding Ltd., (2010) 322 ITR 678 (AAR)] b) Provisions of section 40A(2) are not applicable to a co-operative society. [CIT vs. ManjaraShetkariSahakariSakharKarkhana Ltd.(2008) 301 ITR 191 (Bom.)] d) When a person commits an offence by not maintaining the books of accounts as contemplated by section 44AA, the offence is complete. After that there can be no possibility of any offence as contemplated by section 44AB and therefore, the imposition of penalty is erroneous. [SurajmalParasmalTodi vs. CIT (1996) 222 ITR 691 (Gauhati)] Note : This decision may be helpful in the context of sections 271AA, 271G and 271BA. e) 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.