IndexIntroduction 1Case Law: CIT vs GlaxoSmithKlineAsia (P) Ltd.2Compliance Requirement 3Documentation Required 4Common Transactions of STD withrelated parties5Section 40A(2)- Transactioncovered7Section 80A- Transactions covered 12Section 80IA (8) & 80IA (10) 14Difference between FMV and ALP 16Penalties 19Going Forward 22
IntroductionThe Finance Act 2012 extended the scope of Transfer Pricing provision to “Specified DomesticTransactions” (SDT).The provision apply from the financial year 2012-13 onward if the aggregatevalue of the transaction exceed INR 50Million in the relevant financial year.SDT includes payment to related parties, inter-unit transfer of goods or services of profit-linkedtax holding-eligible units, transactions of profit-linked tax holding-eligible units with other partiesand any other transactions that may be notified by the CBDT.By extending TP provision to SDT, pricing of these transactions will need to be determined withregard to arm’s length principles using method prescribed under TP regulation.TP regulation will now applicable to all taxpayers including Individuals, Hindu Undivided Families(HUFs).The risk of tax arbitrage abuse by opportune taxpayers may arise due to presence ofaccumulated losses or differential tax rates. This risk is amplified in view of the increased taxstimulus provided in recent years to entities operating in special economic zones, infrastructuresector or economically backward areas. The new domestic TP provisions would have significantanti-abuse effects to redress any such non-arms length pricing of domestic transactions.Page 1
Case LawPage 2What made Finance Minister to Introduce Transfer Pricing Provisions isrespect of Domestic Transactions?While dealing with the issue whether the assessee company and its service providerare related companies in terms of Section 40A (2), Hon’ble SC in CIT vs.GlaxoSmithKline Asia (P) Ltd. (SLP 18121/2007) had observed “The larger issue iswhether Transfer Pricing Regulations should be limited to cross-border transactions orwhether the Transfer Pricing Regulations be extended to domestic transactions. Indomestic transactions, the under-invoicing of sales and over-invoicing of expensesordinarily will be revenue neutral in nature, except in two circumstances having taxarbitrage such as where one of the related entities is (i) loss making or (ii) liable topay tax at a lower rate and the profits are shifted to such entity. The CBDT shouldexamine whether Transfer Pricing Regulations can be applied to domestictransactions between related parties u/s 40A(2) by making amendments to the Act.The AO can be empowered to make adjustments to the income declared by theassessee having regard to the fair market value of the transactions between therelated parties and can apply any of the generally accepted methods ofdetermination of arm’s length price, including the methods provided under TransferPricing Regulations.”SC further mentioned “Though the Court normally does not make recommendationsor suggestions, in order to reduce litigation occurring in complicated matters, thequestion of extending Transfer Pricing regulations to domestic transactions requireexpeditious consideration by the Ministry of Finance and the CBDT may alsoconsider issuing appropriate instructions in that regard.”The above remarks of the SC had laid the foundation for Domestic Transfer Pricing(DTP) law in India, which was also affirmed in the memorandum explaining theFinance Bill 2012.
Page 3Compliance RequirementComplianceRequirement• Preparation of Transfer PricingDocumentation (TP Report)• Accountant’s Report in Form3CEB• Transfer Pricing Assessment
Page 5Common Transactions of SDTwith related parties Purchase/lease of movable and immovable property Centralised Corporate Services - Strategy, Marketing, Design & Engineering, HR, accounting, finance Common management personnel like common MD, CEO. Use of common facilities and Infrastructure - space, equipment, Payment to Managing Director / Directors Use of brand name or trademarks Reimbursement of expenses Group Restructuring Purchase of Goods / Provision of services - Domestic Procurement Company
Page 6Applicability of Provisions“specified domestic transaction” in case of an assessee means any of thefollowing transactions, not being an international transaction, namely:-anyexpenditure in respectof whichpaymenthas beenmade or isto bemade to apersonreferred toin section40A(2)(b);anytransaction referredto insection80A;anytransfer ofgoods orservicesreferred toin sub-section (8)of section80-IA;anybusinesstransactedbetweentheassesseeand otherperson asreferred toin section80-IA (10);anytransaction,referred to inany othersection underChapter VIAor section10AA, towhichprovisions ofsection 80-IA(8) orsection 80-IA(10) areapplicable;any othertransaction as maybeprescribed,and where the aggregate of such transactions entered into by the assessee in the previous yearexceeds a sum of five crore rupees (approximately US $1 million)Tax Holiday undertakings
Section 40A(2)– Transactions coveredPage 7Section 40A override the other provisions of the act relating to computation ofincome under “Profit & Gains of Business or Profession”. As per sub section (2),any expenditure by way of payment to the persons [mentioned in sub clause(b)], is liable to be disallowed in computing business profit to the extent suchexpenditure is considered to be excessive or unreasonable having regard tofair market value of goods, services, facilities etc. However, no disallowanceshall be made if the transaction (Specified Domestic Transaction) has beenmade at arm’s length price. Sub clause (b) of sub section (2) covers the varioussituations mentioned below wherein the two persons are related parties.Section 40A(2)(b) of the Act - list of persons/ entities to be treated as relatedparties/ specified persons• Specified persons having substantial interest ( i.e. more than 20% voting poweror share in profits) in taxpayer’s business and vice-versa covered• Scope expanded to include sister concerns
Page 8Section 40A(2)Type of transactions covered (illustrations for payments made by a Company) …Case 1 - Director or any relative of theDirector of the taxpayer – Section40A(2)(b)(ii)Mr. PMr. RAssessee(Taxpayer)Mr. QDirectorRelativeCovered transactionsCase 2 - To an individual who hassubstantial interest in the business orprofession of the taxpayer or relative ofsuch individual – Section 40A(2)(b)(iii)Mr. PMr. RAssessee(Taxpayer)Mr. QRelativeRelativeHolding Structure
Page 9Section 40A(2)Type of transactions covered (illustrations for payments made by a Company) …Case 3 – To a Company havingsubstantial interest in the business of thetaxpayer or any director of such companyor relative of the director – Section40A(2)(b)(iv)ABCLtdMr. QAssessee(Taxpayer)Mr. PRelativeCovered transactionsCase 4 – Any other company carrying onbusiness in which the first mentionedcompany has substantial interest – Section40A(2)(b)(iv)XVYLtdPORLtdAssessee(Taxpayer)ABCLtdSubstantialinterest>20%Holding StructureSubstantialinterest>20%Substantial interest >20%Substantialinterest>20%
Page 10Section 40A(2)Type of transactions covered (illustrations for payments made by aCompany) …Case 5 – To a Company of which adirector has a substantial interest inthe business of the taxpayer or anydirector of such company or relativeof the director – Section 40A(2)(b)(v)Mr. PMr. QAssessee(Taxpayer)ABC LtdDirectorCovered transactionsHolding StructureSubstantialinterest>20%Mr. RRelative
Page 11Section 40A(2)Type of transactions covered (illustrations for payments made by aCompany) …Case 6 – To a Company in whichthe taxpayer has substantialinterest in the business of thecompany – Section40A(2)(b)(vi)(B)ABCLtdAssessee(Taxpayer)Covered transactionsCase 7 – Any director or relative of the director oftaxpayer having substantial interest in thatperson– Section 40A(2)(b)(vi)(B)Mr. PMr. QAssessee(Taxpayer)ABCLtdSubstantial interest >20%Holding StructureSubstantialinterest>20%RelativePQRLtdSubstantial interest >20%
Section 80A– Transactions coveredPage 12Section 80A (6) refers tointernal transactionsbetween various units /undertakings of theassessee in respect ofgoods or services. Thisclause covers anytransactions of goods orservices and hence thistransaction will beapplicable to income aswell as expenditure.
Transactions of Tax Holiday undertakingsPage 13a) Any transfer of goods or services referred to in section 80-IA(8)b) Any business transacted between the assessee and other person asreferred to in section 80-IA(10)c) Any transaction, referred to in any other section under Chapter VI-A orsection 10AA, to which section 80-IA(8) or section 80-IA(10) are applicable;It is a common practice among companies / groups enjoying tax holidayperiod to park excess profits in tax-exempt units / businesses. To curb the same,the relevant clauses had been inserted in the domestic transfer pricing law.Now AO is empowered to make adjustments if it appears that ‘more thanordinary profits were earned by tax exempt businesses/units owing to its ‘closeconnection with transacting parties.
Page 14Tax HolidayundertakingsSection 80IA (8) & 80IA (10) – Deduction in respect of profits andgains from industrial undertaking or enterprise engaged ininfrastructure development, etc.80IA (8) 80IA (10)Inter-unit transaction of goodsor services• Business transacted with anyperson generates more thanordinary profits• Owing to either close connectionor any other reasonApplicable where transfer isnot at market valueApplicable to tax holiday unitsearning more than ordinary profitOnus on tax payer • Primary onus on taxpayer• Onus on tax authorities as well
Page 15Tax HolidayundertakingsSection Nature of undertakings covered80IA Undertakings engaged in•Developing, operating and maintaining, developing and operatingand maintaining infrastructure facilities.•Generation/ transmission or distribution of power•Reconstruction/ revival of power generating plants80IAB Undertaking or enterprise engaged in development of SEZ80IB Undertakings located/ engaged in•Industrially backward districts as notified;•Scientific research and development•Refining of mineral oil/ commercial production of natural gas•Operating cold chain facility for agricultural produce•Processing, preservation and packing of meat/ meat products orpoultry/ marine/ dairy products•Operating and maintaining a hospital of specified capacity80IC Undertakings located in notified Centre/ Parks/ Areas in HimachalPradesh or Uttaranchal.80ID Undertaking engaged in business of hotel in the specified districthaving a World Heritage Site80IE Undertakings located in notified Centre/ Parks/ Areas in North-Eastern States.10AA Undertaking having a Special Economic Zone unit
Page 16Difference between FMV and ALPThe new provision is based on ALP as compared to the FMV in the earlier provisionCharacteristics Fair Market Value Arm’s Length PricingDefinition The price which goods or serviceswould have fetched or cost in theopen market.A price which is applied in a transactionin uncontrolled condition.ComputationMechanismNo specific mechanism provided in law Most appropriate method out of fiveprescribed methods.Transaction value Any market pricing point can betreated as fair market value.Arithmetic mean of comparable pricestreated as arm’s length price.Sample Size One comparable may be sufficient toestablish fair market valueRequire bigger sample size forestablishing arm’s lengthDeviation No deviation permitted from fairmarket valueDeviation of such percentage notexceeding 3% as notified by the CentralGovernment is permitted.
Page 17Tax HolidayundertakingsExamples :Tax burden, if transaction not at ALPXYZ Ltd.(non-tax holiday)Disallowance of ` 50 toPQR Ltd[40A(2)(b)]PQR Ltd.(non-tax holiday)Saleat`150v/sALPi.e.`100XYZ Ltd.(tax holiday)PQR Ltd.(non-tax holiday)Saleat`150v/sALPi.e.`100Double AdjustmentTax holiday on ` 50 notallowed to X Ltd – [80IA(10)](more than ordinary profits)Disallowance of ` 50 to PQRLtd -[40A(2)(b)]X Ltd.(tax holiday)Y Ltd.(non-tax holiday)Saleat`80v/sALPi.e.`100Inefficient pricing structurereduced tax holiday benefitsince sale price is lower thanALP
Page 18Prescribed MethodsTraditional TransactionMethodRPM MethodCUP MethodCPM MethodTransactional ProfitMethodTNMM MethodPSM MethodOtherMethodPricecharged orpaid/ Pricewould havebeencharged orpaid.No hierarchy or preference of methodsprescribed under the Act
Page 19PenaltiesDefault PenaltyIn case of a post-inquiry adjustment, there isdeemed to be concealment of income100-300% of tax on the adjusted amountFailure to maintain documents 2% of the value of each specified domestictransactionFailure to furnish documents 2% of the value of each specified domestictransactionFailure to furnish accountant’s report INR 100,000Failure to report a transaction inaccountant’s report2% of the value of each specified domestictransactionMaintaining or furnishing incorrectinformation or documents2% of the value of each specified domestictransaction
Page 20Going Forward•To Identify and map the relationship between domestic related partiesspecified u/s 40A(2)(b)•Identify and map the SDT•Revisit the pricing mechanism applied by the company for SDT applying themost appropriate prescribed methods• Maintaining proper documentation for the purpose of ensuring that SDT’s areat ALP.