Presentation Transcript

1. Presentation onSpecified Domestic TransactionsCA Hiren D ShahAhmedabad Email: hirenindia@hotmail.com

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
3. Impact of Domestic Transfer Pricing
4. Intent of Indian TP Regulations (International transactions) Shifting of Profits India Overseas Associated Enterprise (AE Co.) Indian Co. Tax @ 32.45% Tax @ lower rate approx 10% Shifting of Losses Tax Saving for the Group – Loss to Indian revenue
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 Exemption Tax @32.45% Shifting of income/profits Tax Saving for the Group – Loss to Indian revenue
6. Intent of Domestic TP–Domestic Tariff Area (DTA) Scenario 1 Scenario 2 Particulars Co.A Co.B Particulars Co.A Co.B Taxed in India @ 33% 33% Taxed in India @ 33% 33% Sales to RP 150 - Sales to RP 100 - Other Income 200 400 Other Income 200 400 Purchases from RP - 100 150 Purchases from RP - Other Expenses 400 200 Other Expenses 400 200 Profit/Loss (50) 50 Profit/Loss (100) 100 Tax - 17 Tax - 33 Total Tax for the Total Tax for the 33 17 Group Group By shifting of expenses from a loss making company to a profit making company, the group could reduce its tax liability by 16.
7. Intent of Domestic TP–DTA & Tax Holiday Unit Scenario 1 Scenario 2 Particulars Power DTA Particulars Power DTA Taxed in India@ 0% 33% Taxed in India@ 0% 33% Sales to RP 225 - Sales to RP 150 - Other Income 300 600 Other Income 300 600 150 225 Purchases from RP - Purchases from RP - Other Expenses 300 300 Other Expenses 300 300 Profit/Loss 225 75 Profit/Loss 150 150 Tax - 25 Tax - 50 Total Tax for the Total Tax for the 25 50 Group Group 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 was introduced.
8. TP REGULATIONS TO APPLY TO CERTAIN SPECIFIED DOMESTIC TRANSACTIONS [NEW SECTION 92BA] TP provisions would now be applicable to the followingDomestic transactions as well: Any expenditure u/s 40A(2)(b); Any transactions referred to in S. 80A Transaction referred u/s 80IA(8) and 80IA(10); Transaction referred under S.10AA or Any others as maybe prescribed TP Regulations (procedural and penal) would be applicable if the aggregate value of all specified domestic transactions exceeds INR 5 crores annually.
9. CONCEPT OF ARM’S LENGTH PRICE (ALP) Concept of ALP applicable for determining taxable income arising from international transaction introduced in 2001, now extended to SDTs ALP defined to mean a price which is applied or proposed to be applied in a transaction between persons other than AEs, in uncontrolled conditions Comparability and FAR fundamental to the concept of ALP Comparison of conditions in a controlled transactions with conditions in transactions between uncontrolled enterprises Compensation usually reflects functions performed (taking into account assets used and risks assumed) ALP concept usually relevant for transactions between “separate enterprises”; may need to be applied by analogy to SDT involving inter-unit transfer of goods/ services
10. 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
11. Fair Market Value vs. Arm’s Length Price Domestic Transfer Pricing usher shift from generic ‘Fair Market Value’ concept to Arm’s Length Pricing
12. 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
13. Methods for Determination of ALP Price applied in a transaction between independent enterprises in uncontrolled conditions To be determined by applying the Most Appropriate Method, being one of the following five methods Comparable Uncontrolled Price (CUP) Method Resale Price Method (RPM) Cost Plus Method (CPM) Profit Split Method (PSM) Transactional Net Margin Method (TNMM) In case, more than one price is determined by MAM: Apply Arithmetic mean Range of +3% of the arithmetic mean Traditional transaction methods Transactional profit methods
14. FILING OF FORM 3CEB All taxpayers to whom the provisions apply are required to file Form 3CEB certified by a CA For FY 2012-13, the due date of filing Form 3CEB is 30 November, 2013 Requirement to file physical copy of the certified form No provision for filing electronic copy TP documentation forms the basis for certification of Form 3CEB Certificate contains details such as Compliance by taxpayer with the TP documentation requirements Nature/ Quantum of transactions and method used to determine ALP Aimed at assisting tax officers in assessment proceedings
15. Steps
16. PENAL PROVISIONS Adjustment related penalty not leviable where taxpayer has acted in ‘good faith’ and exercised ‘due diligence’
17. KEY PROVISIONS OF SDT S. 40A(2) S. 80A(6) S. 80IA(8) S. 80IA (10)
18. Meaning of Specified Domestic Transaction Means
19. Legislature intention behind insertion of Section 40A(2) 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. AO is expected to exercise his judgment in a reasonable and fair manner
20. Reasonableness of expenses to be judges having regards to Fair market value of the goods, services or facilities for which the payment is made, or The legitimate needs of the business or Profession The benefit derived by or accruing to the assesse from the expenditure The above view is expressed by Hon’bleGuj High Court in the case of Coronation Flour Mills vs. Asst. CIT [ 2009] 314 ITR 1
21. SECTION 40A(2)(b) Any Transactions with the following persons will be covered within the purview of Domestic Transfer Pricing: A Company, firm, AOP or HUF holding substantial interest in the business or profession of the Assessee or any other company in which the first mentioned company has substantial interest; Any Company in which Assessee has substantial interest in the business or profession of such company; Individual holding substantial interest in the business and profession of the assessee or any relative of such individual; and Any Director of the company or partner of the firm or member of HUF or any of their relative holding substantial interest in the business or profession of the assessee
22. SECTION 40A(2)(b) ‘Substantial Interest’ is defined as: in case of company, any person who is the beneficial owner of shares carrying not less than 20% of the voting power; and In other case, any person who is beneficially entitled to not less than 20% of profits of such business or profession. The term Beneficial owner of shares is no where defined in the Act. Black’s Law dictionary: A beneficial owner is “one recognized in equity as the owner of something because use and title belongs to that person, even though legal title belongs to someone else.”
23. SECTION 40A(2)(b) Also, in respect of section 79 of the Act, typically, position is adopted when there is a change in more than 51% of ‘beneficial holding’ in a closely held company. Change in shareholding should be seen at immediate holding company level. Section 79 is not invoked where there is change in shareholding at the ultimate holding company level. Further, as per S. 92A(2), the term associated entities is clearly defined to include an enterprise holding directly or indirectlyshares carrying not less than 26% of the voting power in the other enterprise. However, under section 40 A(2)(b) of the Act, only substantial interest has been used, which is specifically defined to include that shareholder who is the beneficial owner of shares. There is no mention about the words direct or indirect holding of shares.
24. SECTION 40A(2)(b) Under normal circumstances, immediate holder of shares is regarded as beneficial owner and applicability of S.40A(2)(b) is restricted to that immediate holder of shares. The fact that immediate holder is beneficial owner of share and its rights is not constrained in any manner needs to be demonstrated by facts.
25. KEY FEATURES As per the provisions of section 92(2A) introduced by the Finance Act, 2012 – Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to the specified domestic transaction shall be computed having regard to the arm's length price However, the provisions of section 92BA specifically includes only – any expenditure in respect of which payment has been made or is to be made to a person referred to in clause (b) of sub- section (2) of section 40A
26. KEY FEATURES Accordingly, in the case of transactions as specified in S.40A(2)(b), only the entity making payment for expenditure shall be covered. The entity receiving income shall not be covered. Only the entity incurring expenses will need to complete the prescribed compliances. There is no provision regarding indirect holding of shares. Therefore a view can be taken that any transactions between Holding Company and its step down subsidiaries are not covered.
27. 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
28. Thus for Company A payments to following persons are covered
29. 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
30. Transactions covered (illustrative): Expenditure on buying goods or procurement of services; or Expenditure on salary, training services, marketing expenses, interest payments. Expenditure on purchase of tangible and intangible property, Group charges Reimbursements, Guarantee fees etc.
31. 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
32. 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
33. 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
34. 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
35. S.80A(6) & S.80 IA(8) 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 accountsof eligible business does not correspond to market value of such goods/ services In such cases, tax authorities/ taxpayer required to re-compute tax holiday claim by reference to ALP of such goods/ services
36. Overlap between 80A(6) and 80IA(8) not of much consequence Is in the nature of notional adjustments for determining profits eligible for tax holiday Applies to all tax holiday claims under Chapter VI-A/ Section 10AA Onus on tax payer to establish that goods and services transferred at market value.
37. Other Sections under Chapter VI-A......to which s. 80-IA(8) or (10) are applicable
38. Section 80IA (8) & 80IA (10) – Deduction in respect of profits and gains from industrial undertaking or enterprise engaged in infrastructure development, etc. No guidance on the meaning of close connection To align ordinary profits with arm’s length price. For example: OP/ TC of 30% considered to be at arm’s length by the TPO Under 801A(10) the AO states that the profits are more than ordinary Solution: Defend price or evaluate alternate methods (other then profit based) Impact of non-charging of services/ costs to tax holiday undertaking
39. Close connection? Particulars AS-18 40A(2)(b) 92A(2) Voting Power >50% >=20% >=26% Direct or indirect Both Direct Both holding Directors Key Managerial Directors Not covered Personnel Key Suppliers Specifically excluded Not covered More than 90% supplies
40. Comparative Analysis S. 40A(2)(b) S. 80IA(10) Substantial Interest is defined No guidance provided for under the Act Closely Connected persons SDT will not be applicable on SDT will be applicable for any any payment made to step transactions between company down subsidiaries for providing and its step down subsidiaries goods or services carrying on eligible business
41. Most Likely effected Industries.. Industries operating in SEZs Infrastructure Developers Infrastructure Operator Telecom Services Industrial Park Developers Power Generations or Transmission
42. Most Likely Transactions under Scanner of SDT Interest free Loans to Group Companies Sub section 8 of Section 80IA Granting of Corporate Guarantees/ Performance Guarantees by Parent Company to its subsidiaries Sub section 8 of Section 80IA Intra-group purchase/ sell/ service transactions Sub section 8 of Section 80IA Payment made to key personnel e.g. transaction with Directors/CFO/CEO etc.. Section 40A(2)(b) Payment made to key personnel of Group Companies. Section 40A(2)(b) Payment made to relative of key personnel of the assessee/group companies. Section 40A(2)(b)
43. Critical Issues…….. Provisions applicable only to expenditure where payment is made or to be made Does this include capital expenditure? – Section 40A(2)(b) Does this include transactions without consideration? – Section 80IA(8) & 80IA(10) 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?
44. Critical Issues…….. Applicability of OECD TP guidelines Advance Pricing Arrangement Benefit of range Rule 10D and Form 3CEB requires modification to harmonise their applicability in relation to inter-units pricing and reporting of domestic transactions Corresponding adjustment
45. Difficult to establish Transactions at 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
46. Practical issues PracticalIssues
47. Should capital expenditure be considered under provisions of Sec 92BA? 1 DTP provisions cover payments for „any expenditures‟ – which would mean capital as well as revenue expenditure. Further, the Revised ICAI Guidance Note illustrates that purchase of tangible or intangible property qualifies as SDT. 2 Judicial precedents suggest that capital expenditure payments are not covered under section 40A(2)(b). DTP provisions intended for expenditure covered under section 40A(2)(b), capital expenditure may be excluded.
48. APA and DRP APA - No • APA framework will apply only to international transactions and not to SDT DRP - Yes • Eligible assessee as defined under Sec 144C means any person in whose case the variation of total income arises as a consequence of TPO‟s order u/s 92CA(3)
49. Case Studies PwC
50. Case Study I • Holding company receives service fees from : F Co. - INR 6 crores from ICo 1 (WOS) - INR 4 crores from ICo 2 overseas - INR 8 crores from F Co. India Implications Holding Co. Applicability of domestic TP provisions to a) Holding Co b) I Co. 1 I Co. 1 I Co. 2 c) I Co. 2 d) F Co.
51. Case Study II • Holding company makes payment for services to: F Co. - INR 2 crores - ICo 1 (WOS) - INR 2 crores - ICo 2 overseas - INR 2 crores - F Co. India Total services payment – 6 Holding Co. crores Implications Whether Domestic TP would apply to the Holding Company I Co. 1 I Co. 2
52. Case Study III Market price v/s Arm‟s length price • ICo 2 acts as a contract manufacturer for ICo 1 • ICo 1 purchases a fixed quantity of goods from FCo ICo 2 every year – assured commitment • In order to utilise entire manufacturing capacity, ICo 2 also manufactures, and sells goods to third parties • ICo 2 charges same rate for the products sold to third parties and to ICo 1 100% 100% • Prior to the amendment: Price charged to INR 100 p.u third parties arguably was considered as market ICo 1 ICo 2 Sale of goods price and since the price paid by ICo 1 correspond to market price, there has been no 40A(2)(b) challenge Sale of goods INR 100 p.u • Post amendment, whether INR 100 would be the right arm‟s length price for the purchases Third Parties made by ICo 1? • Can sale price by ICo 2 to ICo 1 be compared with sale price by ICo 2 to Third Parties on account of certain differences viz. difference in functional profile?
53. Case Study IV Deduction under section 80IC • Company A has three units: Unit A and Unit Company A B (Manufacturing units) and Head Office unit Overall Profit margin 15% • Head Office performs functions of R&D, marketing and distribution of goods produced by the manufacturing units HO • Profitability is ascertained by allocating the expenses incurred by the Head Office in an Unit - A Unit - B Tax Non- appropriate ratio between Unit A and Unit B Holiday Tax u/s 80IC Holiday • Whether the reported profitability of the tax holiday undertaking can be varied by the tax authorities on the grounds that: ― HO is separate undertaking; and Owns Brands, performs ― Costs allocable to Unit A should be R&D and marketing activities, etc charged using mark up or alternatively imputing a royalty cost?
54. Case Study - V AB Ltd. FACTS AB Ltd is involved in selling pharma products to its AEs, which are covered under TP provisions Taxpayer carried out a TP Study, AB Ltd earned a margin of 65% vis-à-vis the mean margin earned by comparable companies i.e. 41% No adjustment made by the TPO AB Ltd has earned higher profits than average profits earned by comparable companies Third party AEs outside India customers
55. Case Study VI FACTS Unit A Expenses incurred for F.Y. 12-13 for which Unit A raised Debit Note to Unit B. Unit B has not yet commenced the operation. Hence, no profit is generated for F.Y. 2012-13. It may or may not start operation in F.Y. 2013-14. Expenses incurred of Rs. 7 Crore Unit B (Power Generation Unit) Whether the nature of transaction covered under the purview of Domestic Transfer Pricing? If yes then still it be applicable under Domestic Transfer Pricing as no profit is generated by Unit B in that year to take exemption u/s 80IA(6)?
56. ISSUES Can higher profit earned by AB Ltd be considered as ‘ more than ordinary profits’ under section 80IA(10)? Can the tax authorities restrict the tax holiday claim to the extent of the average profits earned by the comparable companies in the light of amendments in Finance Act, 2012 related to domestic transactions? What is the appropriate approach for AB Ltd to demonstrate that section 80IA(10) should not apply?