Overview of transfer pricing
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  • 1. Transfer Pricing Section 92 of Income Tax Act,1961 CA Final Course Paper 7 Direct Tax Laws , Chapter 16 CA. Vijay Iyer CA. Nitin Narang
  • 2. Background Multinational Enterprises (MNE) carry out business in multiple countries Tax rates vary from country to country MNE may be able to reduce tax cost by moving profits from high tax to low tax jurisdictions Tax authorities want to prevent the illegitimate shifting of profits and want to protect their tax base Legislative framework necessary to define appropriate tax base
  • 3. Intent behind introduction of Transfer Pricing (TP) provisions in India Growth of investments by multinationals in India Increase in cross border transactions of multinational enterprises in India Potential risk of erosion of India’s tax base Need for a statutory framework to examine intra-group crossborder transactions
  • 4. Concepts in Transfer Pricing Arm’s Length Price • The price charged in a transaction between unrelated parties Transfer Price • The price charged in a transaction between two associated enterprise Uncontrolled Transaction • Transaction between two unrelated parties Controlled Transaction • Transaction between two associated enterprises or related parties
  • 5. Concept of TP Associated enterprise Independent entity Transactions Taxpayer Transfer price Independent entity Arm’s length price
  • 6. Applicability  TP Provisions contained in Section 92 to 92F of the Act  TP Provisions apply to Transactions (defined in Sec 92F);  Transactions between two or more Enterprises (defined in Sec 92F);  The enterprises are Associated Enterprises (AEs) (defined in Sec 92A);  The transaction is an International Transaction (defined in Sec 92B).  Effective 1 April 2012, TP provisions shall also apply to specified domestic transactions (SDT) (defined in Sec 92BA)
  • 7. Compliance Requirements  Computation of income/ allowance of expenses having regard to the Arm’s length price [Section 92]  Maintenance of prescribed Documentation (Section 92D & Rule 10D)  Obtaining of Accountant’s report (under Form 3CEB) (Section 92E)  To ensure compliance with the arm’s length principle, stiff Penalties have been prescribed (Sections 271AA, 271BA, 271G, 271(1)(c))
  • 8. Legislative Provisions  Section 92(1) – Any income arising from an international transaction shall be computed having regard to the arm’s length price Explanation - the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm’s length price  Section 92(3) – The provisions are not intended to be applied in case determination of arm’s length price reduces the income chargeable to tax or increases the loss as the case may be
  • 9. International Transaction (Section 92B)  Transactions between two or more AEs, either or both of whom are non-residents  Transaction relates to:  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 the enterprises; or  Mutual agreements or arrangements for allocation or apportionment of, or any contribution to, any cost or expense incurred
  • 10. International Transaction (Section 92B) Intangible Property Tangible Property ► ► Purchase, Sale, Transfer, Lease /Use of property/article/ product/ thing Includes Building, Vehicle, machinery etc. ► ► Purchase, Sale, Transfer, Lease /Use of IP Includes Transfer of ownership/use of rights/other commercial right Capital Financing ► ► ► ► Long/short term borrowing/ lending Guarantee Purchase/Sale Securities Advances/recei vables, Payments/any debt etc Provision of Services ► ► ► ► Market Research/ Development Technical Service Scientific Research Legal/ Accounting Service etc. Business Restructuring ► Transaction of Business restructuring/reorg anization with AE irrespective of bearing profit/income/loss or assets – at the time of transaction/future date
  • 11. Definition of Intangible Clarified Marketing Trademarks, Trade Names, Brand Names , Logos Technology Process Patents , Patent Applications, Technical Documentation, Technical know-how Artistic Copyrights, Literary work, Musical Compositions, Maps, Engravings Data Processing Software Copyrights, Proprietary software, Automated databases, Integrated circuit Masks & Masters Engineering Industrial Design ,Product Patent ,Trade Secrets , Engineering Drawings , Blueprints , Proprietary Documentation Customer Customer Lists , Customer Contracts, Customer Relationship, Open Purchase Orders
  • 12. Definition of Intangible Clarified Contract Favourable Supplier Contracts, License agreements , Franchise agreements , non-compete agreements Human Capital Trained, Organised workforce, Employment agreements, Union Contracts Location` Leasehold interest, Mineral exploitation rights, Easements, Air rights, Water rights Goodwill Institutional / Professional Practice / Celebrity goodwill, Personal goodwill of professional, General business going concern value Similar Similar item deriving its value from its intellectual content Others Methods, Programmes, Systems, Procedures, Campaigns, Surveys, Studies, Forecasts, Estimates etc.
  • 13. Do the following transactions need to be benchmarked? Purchase of fixed assets Transfer of shares in an Indian company to a non resident External Commercial borrowing Free-of cost services availed by Indian company Payment for use of intangibles such as royalty Reimbursement of expenses
  • 14. Associated Enterprise
  • 15. Meaning of Associated enterprises (Section 92A) A Both A and B are associated enterprises of C B C A B C D E D and E are also associated enterprises of C since they have a common ultimate parent (A) Direct or indirect participation (through one or more intermediaries) in management, control or capital
  • 16. Meaning of Associated Enterprises (Section 92A(2) Capital Management Activities Control 26% direct or indirect holding by the enterprise Appointment of more than half of the directors Supply of >90% of the raw materials Common control By the same person in both enterprises One or more executive directors Wholly dependent on the intangibles provided Control by relative of jointly Loan >= 51% of total assets Appointed by the same person in both enterprises Sales under influenced prices and conditions Control by HUF and other member of HUF / relative Guarantee >= 10% of borrowings
  • 17. Deemed Associated Enterprises - Sec 92B(2) Prior agreement Prior agreement A’s Parent A’s Parent 3rd party A Determination of terms A’s Parent A 3rd party A transaction with an unrelated company (3rd party) is deemed to be a transaction with an associated enterprise and subject to transfer pricing regulations if a prior agreement exists between A’s AE and 3rd party in relation to services rendered by A to the 3rd party; or terms of transaction are determined in substance by A’s AE and 3rd party
  • 18. Determination of arm’s length price
  • 19. Arm’s length price Price applied or proposed to be applied in a transaction between persons other than AEs, in uncontrolled conditions Determination of arm’s length prices using one of the Prescribed methods Yes The price thus determined is the arm’s length price Whether you arrive at a single price ? No The arithmetic mean of such prices, read with sec 92C(2) (i.e. not exceeding the tolerance range (which has an upper ceiling of 3%) of the transfer price)
  • 20. Prescribed Transfer Pricing Methods OECD Transfer Pricing Methods Traditional Transaction Methods Comparable Uncontrolled Price  Resale Price Method Cost Plus Method Transactional Profit Methods Profit Split Method Transactional Net Margin Method Other Methods New Method New method has been prescribed by the Central Board of Direct Taxes - Any method that takes into account the price that has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances considering all the facts, shall be regarded as one of the recognized methods for determining the Arm’s Length Price
  • 21. Comparable Uncontrolled Price Method (“CUP Method”) CUP entials comparison of PRICE of comparable uncontrolled transaction with the controlled transaction • Identify comparable transactions • Adjust the price of such transactions to account for differences between the controlled transaction and the uncontrolled transaction • The adjusted uncontrolled price is the arm’s length price Controlled transaction A Inc. (USA) $10 A Ltd. (India) Uncontrolled transaction B Inc. (USA) $11 C Ltd. (India)
  • 22. Resale Price Method (“RPM”) RPM entails comparison of Gross Margin on resale of goods purchased from an associated enterprise • Identify comparable transactions / companies • Determine gross margin (Gross Profit / Sales) of the uncontrolled transactions / companies • Adjust the gross margin for differences in functions, assets and risks between the comparable transactions and the controlled transaction • Determine the arm’s length price of the controlled transaction based on the adjusted gross margin on comparable transactions Controlled transaction A Inc. (USA) Uncontrolled transaction B Inc. (USA) $10 A Ltd. (India) $12 Customers C Ltd. (India) GM 25% Customers
  • 23. Resale Price Method (“RPM”)  Gross Margin of Comparable transaction is 25%  Applying Resale Price Method  Sale Price of A Ltd. (A) - $ 12  Applying the arm’s length gross margin of 25% (B) -$3  Arm’s length price of the related party purchase transaction (A-B) -$9  Related Party Transaction Price - $ 10
  • 24. Cost Plus Method Cost Plus Method entails comparison of Gross Margin on supply of goods or services to an associated enterprise • Identify comparable transactions / companies • Determine gross margin (Gross Profit / Cost of Goods/Services Sold) of the uncontrolled transactions / companies • Adjust the gross margin for differences in functions, assets and risks between the comparable transactions and the controlled transaction • Determine the arm’s length price of the controlled transaction based on the adjusted gross margin on comparable transactions Controlled transaction Uncontrolled transaction Third Party Supplier Suppliers $10 A Ltd. (India) $12 A Inc. (USA) C Ltd. (India) GM 25% Customers
  • 25. Cost Plus Method  Gross Margin of Comparable transaction is 25%  Applying Cost Plus Method  Cost of Goods Sold of A Ltd. (A) - $ 10  Applying the arm’s length gross margin of 25% (B) - $ 2.5  Arm’s length price of the related party purchase transaction (A+B) - $ 12.5  Related Party Transaction Price - $ 12
  • 26. Transactional Net Margin Method (“TNMM Method”) Comparison of Net Profit comparable uncontrolled transaction / companies with the net margin of the controlled transaction Net margin may be computed with reference to cost, sales or any other relevant profit level indicator • Identify comparable transactions / companies • Adjust the price of such transactions to account for differences between the controlled transaction and the uncontrolled transaction • Determine the arm’s length price for the related party transaction on the basis of the adjusted net margin of the uncontrolled transactions Controlled transaction A Inc. (USA) Uncontrolled transaction B Inc. (USA) $60 A Ltd. (India) C Ltd. (India) $100 Customers Net Profit / Sales = 4% Customers Net Profit / Sales = 5%
  • 27. Transactional Net Margin Method  Net Margin of Comparable transaction is 5%  Applying TNMM Method  Sales of A Ltd. (A) - $ 100  Applying the arm’s length net margin of 5% (B) -$5  Net Margin of A Ltd.  Total Costs of A Ltd.  Related party transaction cost (C) - $ 60  Unrelated party costs (D) - $ 36  Arm’s length price of the related party purchase transaction (A-D-B) - $59  Related Party Transaction Price - $ 60
  • 28. Profit Split Method Controlled transaction Splitting the profit from the whole transactions between various related parties based on their relative contribution. • • Identify comparable transactions for every related party involved in the transaction (i.e. transactions comparable to A Inc., A BV and A Ltd. ) Determine net profit earned by comparable companies A Inc. (USA) A BV (Netherlands) know-how know-how A Ltd. (India) (developed know-how) Customers
  • 29. Profit Split Method Controlled transaction • • Attribute profits to each related party involved i.e. A Inc, A BV and A Ltd. Allocate the super normal-profit / loss to each related party involved (i.e. A Inc., A BV and A Ltd.) on the basis of their relative contribution • Relative value of the know-how developed by A Inc., A BV and A Ltd. A Inc. (USA) A BV (Netherlands) know-how know-how A Ltd. (India) (developed know-how) Customers
  • 30. Sixth Method-Rule 10AB • Where the application of the five specific methods is not possible due to difficulties in obtaining comparable data or due to uniqueness of transactions • Intangibles or business transfers, transfer of unlisted shares, sale of fixed assets, revenue allocation/splitting, guarantees provided and received, etc. • Examples of application: • Third party quotations • Valuation reports • Commercial & economic models
  • 31. Most appropriate method ► Rule 10C (1) – Method which provides the most reliable measure of an arm’s length price in relation to an international transaction or a Specified Domestic Transaction ► Most reliable measure would depend on availability of comparable data ► Comparable data is more likely to be available for benchmarking an entity that is relatively less complex ► For a complex entity that has intangibles and multiple operations, it is very difficult to find a true comparable. ► Gross margin of manufacturing comparable companies may not be possible to decipher from Schedule VI Profit and Loss Account and hence Cost Plus is usually very difficult to apply in practice
  • 32. Comparables ► All methods require comparables ► Transfer price is set/ defended using data from comparable transactions ► Comparable transaction should be independent and similar to tested transactions ► Factors for judging comparability (Rule 10C(2)):      nature of transactions undertaken (i.e. type of goods, services etc.) company functions risks assumed contractual terms (i.e. similar credit terms) economic and market conditions
  • 33. Case Studies
  • 34. Case Study 1 A Inc. USA (owns intangibles and is complex) Sale of tablets 100kgs at Rs 90/kg 10kgs at Rs 100/kg A India Third parties in India Which method applies to this transaction and why?
  • 35. Case Study 1 (Answers)  Most Appropriate Method would depend on the availability of comparable data  If comparable prices for ‘identical’ tablets is available then CUP may be applied (with minor adjustments)  If gross margin of comparable distribution companies is available, RPM may be used  Cost Plus may not be appropriate method for benchmarking an intangible-owning complex entity  If gross margin of comparable distribution companies is not available, TNMM may be the only method that could be applied since PSM applies only where intangibles are owned by the Indian entity and the foreign AE
  • 36. Case Study 2 XYZ UK Royalty - 3% of gross sales XYZ Netherlands (Licensor of technology) XYZ India Royalty - 8% of net sales XYZ UK, XYZ Netherlands and XYZ India are associated enterprises Which method can be applied to this transaction? Can CUP be applied?
  • 37. Case Study 2 (Answers)  Transaction between XYZ US and XYZ Netherlands is a controlled transaction and therefore is not an arm’s length price  Comparison of transaction between XYZ US and XYZ Netherlands with the controlled transaction between XYZ India and XYZ Netherlands is not appropriate  If XYZ US was an unrelated party to XYZ Netherlands, comparison of the royalty rates may have been possible after adjusting for the difference in the base (CUP method)  If CUP is not possible to apply, then TNMM may be applied as the most appropriate method
  • 38. Case Study 3 1000 kgs at Rs 80/kg Third parties in USA X Inc USA 100 kgs at Rs 90/kg X Ltd India 100 kgs at Rs 90/kg XYZ Inc, USA (Group Company) 90 kgs at Rs 100/kg Third parties in India Which method can be applied to this transaction? How would you defend TP for X Ltd India
  • 39. Case Study 3 (Answers)  X Inc. has supplied to third parties in the US at $80/kg while it has supplied to X India at $90/kg  Quantity supplied to third parties is 10 times more than the quantity supplied to X India and hence a direct comparison of the prices may not appropriate  Appropriate adjustment for volume discount to be offered to a substantial customer may be required before comparison with the controlled transaction  Where such comparison is not possible, RPM or TNMM may be applied depending upon the available comparable data (Refer Case Study 1)
  • 40. Case Study 4 ABC Inc., USA Outside India Import of master copy of software for duplication and resale Royalty payments for distribution based on net sales --------------------------------------------------------------------India ABC India (duplication and distribution) Which method can be applied to the transactions? Can royalty be disallowed to the extent of bad debts as it is based on net sales? Customers in India
  • 41. Case Study 4 (Answers)  Selection of the most appropriate method would depend on available comparables  If comparable software duplicators and distributors are identified and their Royalty rates are available in the public domain, CUP may be an appropriate method  In the absence of CUP data, RPM and TNMM may be explored  Since the functions of ABC are not merely distribution, RPM may be applied only if a perfect comparable is identified  In the absence of comparable data for RPM, TNMM may be applied as the most appropriate method
  • 42. Case Study 5 ► XYZ India sells wipers to XYZ USA. Similar wipers are purchased by XYZ USA from third parties in China ► CUP method applied by XYZ India ► Transfer Pricing Officer disregarded CUP on the basis that conditions prevailing in the market are not similar ► How would you defend the case? XYZ USA XYZ India Third parties in China
  • 43. Case Study 5 (Answers)  If the wipers purchased from China and India are identical, CUP may be the most appropriate method  Chinese and Indian economies may be similar and therefore, the Chinese suppliers price may be a suitable benchmark  For the purchaser (XYZ US) it does not matter where is purchases from (related or unrelated party) so long as the same wiper is supplied by both  Therefore, the uncontrolled transaction would serve as a basis for determining the price of the transaction between XYZ US and XYZ India
  • 44. Case Study 6 ABC USA Sold for Rs. 50 crores based on valuation report from independent valuer Sale of registered patents ABC India (entrepreneur and developer of patents) Which method applies to this transaction and why?
  • 45. Case Study 6 (Answers)  A valuer’s report based on generally accepted valuation methodology is a reasonable estimate of how third parties may value intangibles when such intangibles are sold to unrelated parties  Therefore the valuer’s report provides a computation of arm’s length price  Since the arm’s length price determination is based on methods that may be applied by third parties to determine their transaction prices in uncontrolled transactions, such determination would fall under the Sixth Method under the Indian TP Rules
  • 46. Domestic TP
  • 47. Introduction – Pre Finance Act, 2012 Tax Authority empowered to disallow payments to “related parties” which are “excessive” or “unreasonable” In case of inter-unit transfer of goods/services, tax holiday profits to be determined based on Fair Market Value (FMV) of goods/ services Tax Authority empowered to re-compute tax holiday eligible profit if undertaking makes more than ordinary profits as a result of arrangements with closely connected persons or otherwise No specific methodology prescribed for disallowance/ tax holiday profit adjustment
  • 48. Introduction – Finance Act, 2012 TP provisions extended to certain Specified Domestic Transactions(SDTs) with effect from Financial Year 2012-13 Seeks to create legally enforceable obligation on taxpayers to maintain proper documentation Is intended to provide objectivity in determining reasonableness of expenditure and income eligible for tax holiday Monetary threshold of INR 50 Million (approx. USD 900,000) provided for applicability of the provisions Allowance for expenditure or allocation of cost or expense or any income in relation to SDT to be computed having regard to Arm’s Length Price (ALP)
  • 49. Definition of SDT Payments to related parties as defined under section 40A(2)(b) Tax holiday related transactions (eligible business) Any transaction referred to in section 80A Any transfer of goods/services referred to in section 80IA(8) Any business transaction referred to in section 80IA(10) Any transaction under Chapter VI-A or u/s 10AA – to which provisions of section 80IA (8) or section 80IA (10) apply Any other transaction as may be prescribed
  • 50. Domestic TP – Applicability Taxpayer cannot apply TP to SDT so as to reduce total income that is subject to tax Monetary threshold of INR 50M to be computed based on aggregate of payments and receipts to which the provisions apply during a FY Definition of the term “related parties” for the purposes of expense disallowance expanded to cover entities which have common beneficial ownership TP provisions applicable to international transactions are largely applicable to SDT as well, with the exception of Advance Pricing Agreement (APA) provisions
  • 51. Eligible business covered Section Tax payers covered Deduction 10AA Persons with income from Special Economic Zone (SEZ) units 100% for the first 5 years 50% for the next 5 years 50% of the profits or amount credited to SEZ re -investment reserve, whichever is less for next 5 years 80 -IA Infrastructure developers 100% for a period of 10/15 years out of 15/20 years, as the case may be, from the date of commencement of operation 80 -IA Telecommunication service providers 100% for a period of 5 years 30% for the next 5 years out of 15 years from the date of commencement of operations 80 -IA Developers of Industrial park 100% for a period of 10 years out of 15 years from the date of commencement of operations 80 -IA Producers or distributors of power 100% for a period of 10 years out of 15 years from the date of commencement of operations 80 -IAB Developers of SEZ 100% for a period of 10 years out of 15 years from the date of commencement of operations 80 -IB Small scale industry engaged in operating Cold storage plant 30% of profits for the first 10 years 80 -IB Industrial undertaking in Industrially backward state as mentioned in VIII Schedule (ex: Jammu and Kashmir ) 100% of profits for 5 years and 30% for the next 5 years 80 -IB Multiplex theaters and convention centre 50% for the first 5 years
  • 52. Eligible business covered (contd…) Secti on Tax payers covered Deduction 80 -IB Company carrying on scientific research and development 100% of profits for first 10 years 80 -IB Eligible housing projects 100% of profits from such business 80 -IB Eligible hospitals 100% of profits for first 5 years 80 -IC/ 80 -IE Persons with units in North-eastern states claiming deduction 100% for a period of first 10 years 80 -ID Hotels located in districts having World Heritage site 100% of profits for first 5 years of commencement of business
  • 53. Section 40A(2) – Payments to related parties Payments by taxpayers to certain specified persons covered within the ambit of section 40A(2) Where the taxpayer/assessee is a company, following persons regarded as ‘specified persons’ • Directors of the taxpayer company or any relative of such directors • Individuals having Substantial Interest (SI) in the business of taxpayer company or any relative of such individual • Persons having a SI in the business of the taxpayer company • Directors of the entities having SI in the business of the taxpayer company or any relatives of such directors • Any company having the same holding company (which holds a SI) as that of the taxpayer company • A company of which a director has a SI in the business of the taxpayer company, any director of such company or any relative of such director • Persons/entities in which taxpayer company/its directors/ their relatives have a SI Payments by an individual, firm, AOP and HUF to certain specified persons are also covered within the ambit of section 40A(2)
  • 54. Section 40A(2) – Payments to related parties A person shall be regarded as having a SI in a business if at any time during the previous year • Such person is the beneficial owner of shares carrying not less than 20% of the voting power (in case of a company) • Such person is beneficially entitled to not less than 20% of the profits of such business (in any other case) Beneficial ownership • Term not defined but can be understood as a person who ultimately enjoys the income/asset and also controls it • Need not be in existence for the entire year but is sufficient if it is in existence for only part of the year
  • 55. Section 40A(2) – Payments to related parties General scope of Section 40A(2) • Applicable to taxpayers making the payment/incurring expenditure and not to recipients of such income •Can ALP testing of recipient be relied upon to support arm’s length nature of expense? •No correlative relief for recipient if payer subject to a TP adjustment • If no payment is made or payment is less than ALP, cannot be considered as “excessive/ unreasonable” • Expenditure should be towards ‘goods’, ‘services’ or ‘facilities’ • Capital expenditure, depreciation outside the purview of section 40A(2) • Generally, following payments may be covered: •Payment towards purchase of raw materials, services, use of asset •Payment towards sharing of common premises/facilities •Payment of interest on loan •Payment of managerial remuneration, salary, bonus etc to directors
  • 56. Payments to related parties – Illustration  Any payment towards expenditure by  ACo to its own directors as remuneration, salary, bonus etc X Co (Indian company) Beneficial Share holding >20% A Co (Indian company) Beneficial Share holding >20% B Co (Indian company)  ACo to XCo  ACo to directors of XCo  ACo to Relatives of directors of A Co and X Co  ACo to BCo  Any payment towards expenditure by  XCo to ACo/BCo
  • 57. Tax holiday eligible business SDT provisions apply to business transactions/transfers referred to in section 80A, 80IA(8), 80IA(10), 10AA, Chapter VI-A provisions Section 80A(6) and Section 80IA(8) require adjustment to tax holiday profits where • Goods and services of eligible business are transferred to any other business carried on by the same taxpayer and vice versa • Consideration for such transfer as recorded in the accounts of eligible business does not correspond to market value of such goods/services • In such cases, tax authorities/ taxpayer required to recompute tax holiday claim by reference to ALP of such goods/services Overlap between 80A(6) and 80IA(8) not of much consequence Applies to all tax holiday claims under Chapter VI-A/ Section 10AA
  • 58. Tax holiday eligible business  General scope of Section 80A(6)/ 80IA(8)  Covers transfer of goods/ services held by “eligible business” to another business or vice versa  Existence of two or more separate businesses of the same taxpayer  Transfer of goods/ services between the businesses  Does not contemplate an artificial or hypothetical segregation of profits between tax holiday unit and the rest of the enterprise  Once threshold is satisfied, inter-unit transfer price may be need to be determined by hypothesizing the businesses as separate & distinct enterprises for determining ALP  Provides for a “two-way” adjustment (both favorable as well as adverse) and is a mandatory provision  Is in the nature of notional adjustments for determining profits eligible for tax holiday
  • 59. Tax holiday eligible business  General scope of Section 80IA(10)  Tax officer empowered to re-compute tax holiday profits if:  more than “ordinary profits” have arisen in the eligible business due to transactions between closely connected persons or for other reasons  Provides for only “one way” adjustment i.e. only adverse adjustment at the discretion of the tax officer  Is in the nature of notional adjustment for determining profits eligible for tax holiday  Tax officer may invoke the provision in case of SDT on the basis of ALP determination  Onus still on tax officer to establish that the course of business was arranged to produce more than ordinary profits?
  • 60. TP compliance requirements
  • 61. Transfer Pricing Documentation ► Ownership Structure ► Profile of multinational group Entity Related ► Business description/ Profile of industry ► Nature and terms (including price) of international transactions ► Description of functions performed, risk assumed and assets employed (functional analysis) ► Records of economic and market analysis (economic analysis) ► Record of budgets, forecasts, financial estimates Price Related ► Any other record of analysis (if, any) to evaluate comparability of international transaction with uncontrolled transaction(s) ► Description of method considered with reasons of rejection of other methods ► Details of transfer pricing adjustment(s) made (if, any) ► Any other information e.g. data, documents like invoices, agreements, price related correspondence etc. Transaction Related
  • 62. Transfer Pricing Documentation Detailed documentation not required in case aggregate value of all international transactions does not exceed one crore rupees (five crores in case of specified domestic transactions) List of supporting documents are also provided in the law Contemporaneous data requirements Documents to be retained for a fixed period from end of the assessment year Need to obtain Accountant’s report (under Form 3CEB) to be filed along with the return of income
  • 63. Accountant’s report (Form 3CEB) - Rule 10E Obtained by every tax payer filing a return in India and having international transaction or SDT To be filed by due date for filing return of income Essentially comments on the following: whether the tax payer has maintained the transfer pricing documentation as required by the legislation, whether as per the transfer pricing documentation the prices of international transactions are at arm’s length, and certifies the value of the international transactions as per the books of account and as per the transfer pricing documentation are “true and correct”
  • 64. TP Penalties - Section 271 Default Penalty Post - inquiry adjustment (deemed concealment of income)  Section 271(1)(c) 100 - 300% of tax on the adjusted amount Failure to maintain documents Fails to report transactions / Maintains or furnishes incorrect documents  Section 271AA 2% of the transaction value Failure to furnish documents Section 271G Failure to furnish accountants report  Section 271BA  2% of the transaction value Rs 100,000
  • 65. Transfer Pricing Audit Process
  • 66. Transfer Pricing Calendar Indian Financial Year (‘FY’) – 1 April to 31 March • Due date of completion of Transfer Pricing Documentation and filing of Form 3CEB (Accountant Report) • 30 November following the FY • Time limit for completion of assessment • 46 months from the end of the FY (i.e. 31 January 2013 for the FY 2008-09) • Retain Documentation for 8 years
  • 67. Routine Audit Process AO to determine ALP u/s 92C(3) Taxpayer to file objections with DRP* DRP to pass directions* AO also may refer determination of ALP to the TPO AO to pass Draft order AO to pass final order Taxpayer to substantiate transfer price as ALP to TPO AO to compute taxable income Appeal/ Rectification TPO to determine ALP by passing an order Intimation to taxpayer & AO * If the tax payer files chooses to file objections with the Dispute Resolution Panel (DRP). The taxpayer also has an option to file an appeal with the Commissioner of Income Tax (Appeals) against the final assessment order of the AO
  • 68. Timelines for DRP route – A Snapshot • 34 months from end of AY TPO to pass order AO to pass draft order • 36 months from end of AY • Within 30 Days of receipt of Draft Order Objections before DRP DRP to pass directions • Within 9 months of Draft Order • Within 1 month Final AO Order passed
  • 69. Timelines for CIT (A) route – A Snapshot • 34 months from end from AY TPO to pass order AO to pass draft order • 36 months from end of AY • Within 60 days of the draft order AO passes final Order Appeal to CIT(A) • Within 30 days from receipt of AO Order • No time limit CIT(A) Order
  • 70. Domestic Law Dispute Resolution Process TPO’s Order AO’s draft order DRP objections Tribunal AO’s Final Order DRP order High Court Supreme Court
  • 71. Advance Pricing Agreements
  • 72. What is an APA? Finance Act, 2012 – Salient features  An agreement between the Central Board of Direct Taxes (CBDT) and any person  determining the arm’s length price (ALP) or  specifying the manner in which the ALP is to be determined in relation to an international transaction  Flexibility to determine arm’s length price using unspecified method/ adjustments/variations, as necessary  Valid for the periods specified in the APA and for a maximum period of 5 consecutive years  Binding on taxpayer and tax authority, unless there is a change in law/ facts  No provision for “roll back”
  • 73. Indian APA rules- Overview  New rules introduced in Income-tax Rules, 1962 – Rules 10F-10T and Rule 44GA  Rules 10F-10T contain procedures for APA applications in general; Rule 44GA contains the procedure to deal with requests for Bilateral APAs/ Multilateral APAs  Overview of the process Pre-filing ► ► ► Unilateral vs bilateral vs multilateral Pre-filing meeting (anonymous also permitted) Pricing study and strategy Evaluation and negotiation – Agreement APA request ► Industry overview ► Supply chain overview ► FAR analysis ► Proposed economic analysis ► Proposed term ► Field work (functional interviews, review financial statements) ► Government-togovernment process ► Position papers – face to face meetings ► Critical assumptions ► Drafting and concluding APAs Execution and monitoring ► Annual report, record-keeping ► Audit ► Revocation, cancellation or revision ► Renewal
  • 74. Administrative structure in India for APAs UNILATERAL Chairperson CBDT Director General of Income Tax BILATERAL / MULTILATERAL  All APAs to be approved by the Central Government  Common team at the back end for unilateral and bilateral / multilateral APAs Chairperson CBDT Competent Authority Director APA Director APA Team of Officers, economists and statisticians Team of Officers, economists and statisticians
  • 75. Key Features & Implications Feature Description Implication Taxpayer can pursue an APA for its existing intercompany transactions with India Eligibility Any person who has undertaken or is proposing to undertake an international transaction Types of APAs Framework allows unilateral, bilateral and Multilateral APAs Flexibility to choose the type of solution depending on requirements. Pre-filing application and consultation Prescribed format provided for pre-filing. Application will be followed by a meeting with the APA authority. Pre-filing on a noname or anonymous basis is also permitted This is a mandatory step in the process and will offer an opportunity to determine the scope and broad terms of the APA and identify potential issues for consideration. No timeframe proposed as of now
  • 76. Key Features & Implications Feature Filing Fee for APA Filing timeline APA application Description Implication Prescribed fee in the range of USD 18,000 to USD 37,000 depending on the value of transactions sought to be covered in the APA Filing fee kept steep to deter non serious applications The application can be filed anytime (i) before the first day of the financial year for which the application is made in respect of existing or continuing transactions; or (ii) before undertaking a proposed transaction APAs will apply prospectively for the period sought to be covered (upto five consecutive years). No past year can be covered and hence, no roll-back mechanism. Prescribed format provided requesting extensive details of the taxpayer’s business, transactions and industry. Taxpayer should be prepared to submit detailed information voluntarily. In the absence of any firewall provisions, sharing of this information by the APA authority with other departments within the tax administration cannot be ruled out
  • 77. Key Features & Implications Feature Description Implication Evaluation and negotiation APA authority is empowered to hold meetings with the applicant, request for additional information, and visit the applicant’s business premises to arrive at its final decision The process is consultative. The APA Authority and taxpayer shall prepare a proposed mutually agreed draft agreement in the end. However taxpayer would not be party to the discussions between the CAs in the bilateral process Agreement The APA authority needs to seek approval from the Central Government to enter into the APA Taxpayer may need to wait for some time for the final approval Bilateral & Multilateral APAs The CAs would negotiate the terms of the agreement. The APA process will not be initiated unless the foreign taxpayer has filed a request with the CA of his country Taxpayer would need to file an application with CA to kick off the bilateral / multilateral APA process
  • 78. Key Features & Implications Feature Description Implication Post APA compliance An Annual Compliance Report (ACR) needs to be filed for each year covered by the APA and a compliance audit would be undertaken to monitor adherence to the terms of the APA Taxpayer would need to substantiate continued satisfaction of the critical assumptions, correctness of the supporting data or information and consistency of the application of the transfer pricing method Revision, cancellation and withdrawal of APA APAs can be revised in the event of significant changes to the underlying terms of the agreement. Non compliance can lead to cancellation of an APA. A taxpayer is also free to withdraw an APA application if a mutually acceptable outcome is not reached The program is forward looking, flexible and allows for various situations that could arise
  • 79. Thank you and best of luck for your exams CA. Vijay Iyer CA. Nitin Narang