Presentation on Specified Domestic Transactions

1. Presentation onSpecified Domestic Transactions CA Hiren D Shah Ahmedabad Email: hirenindia@hotmail.com

2. Applicability.. Section 92BA • Transfer Pricing until now was applicable to Companies having cross border transactions with their Associated Enterprise • Honoring the Supreme Court ruling in case of CIT vs M/s GlaxoSmithkline Asia (P) Limited expanded the ambit of transfer pricing to Specified Domestic Transactions w.e.f. 1st April,2013

3. Introduction of Domestic Transfer Pricing • Transfer Pricing (“TP”) was earlier limited to ‘International Transactions’ • TP provision will now apply to ‘Specified Domestic Transactions’ • Expenditure for which payment is made or to be made to domestic related parties • Tax Holiday / Deductions claimed by the assessee • Transfer of goods or services between various businesses of same assessee • More than ordinary profits derived from transactions with closely connected persons • TP provisions to apply if the aggregate of ‘Specified Domestic Transactions’ exceeds five crores • Shift of focus from generic ‘Fair Market Value’ concept to ‘Arm’s Length Price’ • Fair Market Value can established using basic market evidence • Arm’s Length Price can be determined by use of five prescribed methods • Advance Pricing Agreements NOT applicable to specified domestic transactions • Assessing officer’s powers shifted to Transfer Pricing Officer (‘TPO’)

4. Tax Arbitrage… • In domestic transactions, the under invoicing of sales and over-invoicing of expenses ordinarily will be revenue neutral in nature except in two circumstances having tax arbitrage such as where one of the related entities is • Loss making or • Liable to pay tax at lower rate and the profits are shifted to such entity

5. Intent of Indian Transfer Pricing (TP) Regulations Indian Co. Associated Enterprise (AE Co.) India (Tax @ 33%) Overseas (Tax at Lower rates, say 10%) Shifting of Losses Tax Savings for the group -> Indian Govt. loses

6. Intent of Domestic TP-Domestic Tariff Area (DTA) Scenario 1 Scenario 2 100 150 17 33 By shifting of expenses fro a loss making company to a profit making company, the group could reduce its tax liability by 16 for the current year, though the impact will be reversed in future years given carry forward of losses. To avoid such cases and even though there is no erosion of tax base, Domestic TP has been introduced.

7. Intent of Domestic TP-DTA & Tax Holiday Unit Scenario 1 Scenario 2 150 225 25 50 By shifting of expenses from a tax holiday unit (Power) to a unit in the Domestic Tariff Area, the group could reduce its tax liability by 25. To avoid such cases, Domestic TP has been introduced.

8. Excessive Profits of Tax Holiday Units • This is an anti-abuse provision brought to check the excessive tax holiday claims • Generic framework of ‘More than ordinary profit’ was provided in law to compute the excessive tax holiday claims • Various tribunal rulings in favor of taxpayers virtually made this clause redundant • To plug the loophole, it is now proposed to compute more than ordinary profits through the ‘arm’s length price’ mechanism • Impact/ Issues • The assessee carrying on the eligible business will have to justify the ALP of the transactions between the eligible unit/ business and any other person with whom the assessee has close connection • The term “Close Connection” under section 80IA(10) not defined • Burden of the proving the “close connection” between the assessee and other party is on TPO • Loss of tax holiday claim in excess of arm’s length profits • No corresponding adjustment allowed for other party for adjustments made, if any, by the TPO for transactions falling under this category

9. Scope – Domestic Transactions Aggregate Transaction value exceeds Rs. 50 millions in a financial year (Applicable for FY 2012-13 • Tax holiday undertakings covering : • inter-unit transfer of goods and services • transactions with entities having close connection Expenditure incurred between related parties defined u/s 40A Any other transaction that may be specified

10. Tax Holiday Beneficiaries Impacted by Domestic Transfer Pricing

11. Impact of Domestic Transfer Pricing

12. What is Arm’s Length Pricing? • “Arm’s length price” means a price which is applied or proposed to be applied in a transaction in uncontrolled conditions • Arm’s Length price is determined using the Most Appropriate Method : • If more than one comparable price is obtained using above methods, then the arm’s length price would be ‘Arithmetic Mean’ of comparable prices • Deviation of plus / minus three percent is permitted from arm’s length price

13. Fair Market Value vs. Arm’s Length Price • Domestic Transfer Pricing usher shift from generic ‘Fair Market Value’ concept to Arm’s Length Pricing

14. Expenditure Between Related Parties • Expenditure paid or to be paid to related parties will require to be at arm’s length • Examples of related parties under section 40A(2)(b) Substantial Interest means beneficial ownership of shares with at least 20% voting right or beneficial entitlement of at least 20% of the profits

15. Expenditure Between Related Parties • Section 2(41) defines relative in relation to an individual to mean: • Husband; • Wife; • Brother; • Sister; or • any lineal ascendant or descendant; • Proviso inserted in section 40A(2)(i) to the effect that disallowance shall not be made if the specified domestic transactions are at arm’s length price • Provisions applicable only to expenditure where payment is made or to be made • Does this include capital expenditure? • Does this include transactions without consideration? • Excessive discounts not covered • 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?

16. Section – 92A ( AE) • Means an enterprise – • (a). Which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprises; or • (b). In respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same person who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.

17. Most likely Transaction under scanner of the TPO would be… • Interest free Loans to group Companies • Granting of Corporate Guarantees / Performance Guarantee by Parent Company to its Subsidiaries • Intra-group purchase/sell/ service transactions • Payment made to key personnel of the assesse e.g. Directors/CEO/CFO • Payment made to key personnel of the group Companies • Payment made to relatives of key personnel of the assesse/ group companies

18. Comparable in case of Director Remuneration • For Royalty payments it has held in the decision of Oracle India Pvt Ltd vs. ACIT, some weightage was attributed by the Delhi Bench of the ITAT to the earlier RBI norms governing remittance of royalties in the computation of ALP • In SGS India Pvt Ltd vs. ACIT 292 ITR 93(Bom), it was held that some importance needs to be given in a case where the RBI had allowed the remittance of research and development expenditure considering its disallowance by the assessing officer. • Similarly Can one rely on the remuneration guidelines under schedule XIII of the Companies Act to determine Director Remuneration at Arms’ length Price?

19. Probable Issues…….. • 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 Depreciate comes under the ambit of Domestic Transfer Pricing?

20. Probable Issues…….. • 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

21. Documentation Entity Related Price Related Transaction Related • Transaction terms • Functional Analysis (functions, assets and risks) • Economic Analysis (method selection, comparable benchmarking) • Forecasts, budgets, estimates • Profile of Industry • Profile of group • Profile of Indian entity • Profile of AEs • Agreements • Invoices • Pricing related correspondence (letters, e-mails, fax, etc.)

22. Penalties However, penalty for concealment of income shall not be levied if the taxpayer demonstrates that price charged or paid has been determined in ‘good faith’ and with ‘due diligence’

23. Thank You