DOMESTIC TRANSFER PRICING PROVISIONS CA .T. P. OSTWAL

1. INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA RAJKOT BRANCH DOMESTIC TRANSFER PRICING PROVISIONSCA .T. P. OSTWAL T.P.Ostwal & Associates

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 vs Glaxo Smithkline 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 T.P.Ostwal & Associates

3. SDT – Intent of the Law Bringing in objectivity in the interpretation and governance – introduction of ALP mechanism Doing away with tax arbitrage abuse that stems from differential tax rate, tax holiday/benefits availed by undertaking and presence of accumulated losses Protecting the revenue of the Indian Government T.P.Ostwal & Associates

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 T.P.Ostwal & Associates

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 T.P.Ostwal & Associates

6. Intent of Indian TP Regulations… (Domestic transactions) Loss to Revenue – Tax Saving to the Group T.P.Ostwal & Associates

7. Intent of TP Regulations… (Domestic transactions) Shifting of expenses India India Indian Co. Loss making Related Enterprise Profit making Tax @ 32.45% Reduced tax due to shifting of profits Tax @ 32.45% No tax or reduced tax due to loss Shifting of income Tax Saving for the Group – Loss to Indian revenue T.P.Ostwal & Associates

8. Intent of TP Regulations…(Domestic transactions) Present Loss to Revenue* – Tax Saving to the Group * By shifting of income from a profit making company to a loss making company, the group could reduce its tax liability by 16.23 for the current year, though the impact will be reversed in future years given carry forward of losses. T.P.Ostwal & Associates

9. Section 92BA – Meaning of SDT (inserted by Finance Act, 2012 w.e.f. AY 2013-14 i.e. current FY) For the purposes of this section and sections 92, 92C, 92D and 92E, “specified domestic transaction” in case of an assessee means any of the following transactions, not being an international transaction, namely:- any expenditure in respect of which payment has been made or is to be made to a person referred to in section 40A(2)(b); any transaction referred to in section 80A; any transfer of goods or services referred to in sub-section (8) of section 80-IA; any business transacted between the assessee and other person as referred to in section 80-IA (10); any transaction, referred to in any other section under Chapter VIA or section 10AA, to which provisions of section 80-IA(8) or section 80-IA(10) are applicable; or any other transaction as may be prescribed, and where the aggregate of such transactions entered into by the assessee in the previous year exceeds a sum of five crore rupees. T.P.Ostwal & Associates

10. Overview of Provisions of Section 92BA Inter unit transfer of goods & services by undertakings to which profit-linked deductions apply SDT Expenditure incurred between related parties defined under section 40A Any other transaction that may be specified Transactions between undertakings, to which profit-linked deductions apply, having close connection T.P.Ostwal & Associates

11. S. 10AA uses the term close connection. • S. 40A(2)(b) uses the term Related party. • S. 80IA (8) inter unit. • S. 80IA (10) uses the term close connection. • S. 92A uses the term Associated Enterprises. • No guidance or limited guidanceon the meaning of close connection • s T.P.Ostwal & Associates

12. S 42 (2) of ITA 1922,”Where a person not resident or not ordinarily resident in the taxable territories carries on business with a person resident in the taxable territories, and it appears to the Income-tax Officer that owing to the close connection between such persons the course of business is so arranged that the business done by the resident person with the person not resident or not ordinarily resident produces to the resident either no profits or less than the ordinary profits which might be expected to arise in that business, .the profits derived therefrom, or which may reasonably be deemed to have been derived therefrom, shall be chargeable to income-tax in the name of the resident person who shall be deemed to be, for all the purposes of this Act, the assessee in respect of such income-tax.“ • [1958] 34 ITR 368 (SC)SUPREME COURT OF INDIA • Mazagaon Dock Ltd.vs. C.I.T. Excess Profits Tax T.P.Ostwal & Associates

13. Section 92BA Analysed...... For the purpose of sec. 92, 92C, 92D and 92E * Sec 92F – Definitions does not define terms relevant for domestic TP transactions T.P.Ostwal & Associates

14. Sec. 92 – Computation of income from international transaction having regard to ALP (1) Computation of income from international transaction having regard to ALP. (2) mutual agreement etc for allocation or apportionment or contribution to any cost or expense shall be determined having regard to ALP. (newly inserted) (2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to specified domestic transaction shall be computed having regard to ALP. (3) section does not apply if the effect is reducing the income or increasing the loss. T.P.Ostwal & Associates

15. Sec. 92 C – Computation of ALP The words “specified domestic transaction” has been inserted appropriately in various sub-sec. (1) Any of the following methods, being most appropriate method : (a) Comparable uncontrolled price method; (b) Resale price method; (c) Cost plus method; refer rule 10B (d) Profit split method; (e) Transactional net margin method; (f) other method of determination of arm’s length price (any method that takes in to account the price which has been charged or paid or would have been charged or paid for same or similar uncontrolled transaction with or between non – associated enterprises) (2) Most appropriate method as per criteria laid down in rule 10C considering FAR analysis also. FAR : Functions performed, Assets employed, Risks assumed [Rule 10C(2)] T.P.Ostwal & Associates

16. Section 92CA - Reference To TPO • The word “specified domestic transaction” inserted in various sub-sections. • (1) AO may refer the computation of ALP to TPO • (2) TPO to issue notice to Assessee to produce evidence in support of ALP • (2A) Any other international transaction coming to notice of TPO* • (2B) Non-furnishing of CA’s report and TPO’s power * • (3) TPO shall pass the order determining ALP • (4) AO to compute total income accordingly • (7) TPO’s power of summons (s.131), survey (s.133A) and collecting • information u/s 133(6)applies even in Domestic Transaction • Sec. 144C (15)(b)…..Reference to DRP • AO to forward draft of proposed order to eligible assessee • eligible assessee means – any person in whose case order u/s 92CA is passed • * 92CA(2A ) & (2B) do not cover specified domestic transactions and hence the TPO cannot suo moto upon the transaction coming to his notice apply the TP provisions T.P.Ostwal & Associates

17. Section 92D : Maintenance and keeping information and document by persons entering into an international transaction Entity Related Price Related Transaction Related • Agreements • Invoices • Pricing related correspondence (letters, e-mails, fax, etc.) • Transaction terms • FAR related • Economic Analysis (method selection, comparable benchmarking) • Forecasts, budgets, estimates • Profile of Industry • Profile of group • Profile of related parties • The onus of proving SDT at ALP is on tax payer T.P.Ostwal & Associates

18. Section 271 –Penalty Implications T.P.Ostwal & Associates

19. Section 40A(2) – Transactions covered • Mapping to be done for the company’s transactions with domestic Related Parties • Primary reliance on disclosures u/s 40A(2)(b) and Related Party Schedule • Different divisions enter into different transactions with various group companies • Broad categories of transactions likely to be covered : T.P.Ostwal & Associates

20. Relationship can exists any timeduring the year Sec 40A (2)(b) – Related Party T.P.Ostwal & Associates

21. 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 T.P.Ostwal & Associates

22. 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 T.P.Ostwal & Associates

23. 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 T.P.Ostwal & Associates

24. 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 T.P.Ostwal & Associates

25. 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 T.P.Ostwal & Associates

26. Thus for Company A payments to following persons are covered T.P.Ostwal & Associates

27. 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 T.P.Ostwal & Associates

28. Section 80IA (8) & 80IA (10) – Deduction in respect of profits and gains from industrial undertaking or enterprise engaged in infrastructure development, etc. T.P.Ostwal & Associates

29. T.P.Ostwal & Associates

30. Other Sections under Chapter VI-A......to which s. 80-IA(8) or (10) are applicable T.P.Ostwal & Associates

31. 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 T.P.Ostwal & Associates

32. Points for Consideration • Whether the threshold limit of Rs. 5 crore applies to the aggregate amount under all the relevant sections taken together OR under each section separately i.e. 40A(2), 80A, 80-IA(8), 80-IA(10), 10AA etc. ? • Whether payment for capital expenditure Or expenditure capitalized is also covered ? • Whether the provisions will apply in case the payer’s income is chargeable to tax under the head ‘Income from other sources’, because section 58(2) says –The provisions of section 40A shall, so far as may be, apply in computing the income chargeable under the head “Income from other sources” as they apply in computing the income chargeable under the head “Profits and gains of business or profession” ? • Whether new provision applies to - • Public Charitable Trust paying remuneration to related persons. • Co-operative Societies • Social Clubs • having a business undertaking • Transfer pricing provisions are not applicable in case where income is not chargeable to tax at all. • 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. T.P.Ostwal & Associates

33. Challenges T.P.Ostwal & Associates

34. Going Forward • To Identify and map the relationship between domestic related parties specified u/s 40A(2)(b) • Identify and map the SDT • Revisit the pricing mechanism applied by the company for SDT applying the most appropriate prescribed methods • To implement TP regulations in FY 2011-12 itself although not statutorily required so that systems can be improved for FY 2012-13. To note that variations in profits of tax holiday units for FY 2013 compared to FY 2012 may raise concerns from tax officers. • Availability of APA • The onus of proving SDT at ALP is on the tax payer T.P.Ostwal & Associates

35. T. P. Ostwal & Associates CHARTERED ACCOUNTANTS 4th Floor, Bharat House, 104 Mumbai Samachar Marg, fort, MUMBAI-400001. Tel No.: +91-22-40693900 Fax No.: +91-22-40693999 Mobile:+919004660107 Email: fca@vsnl.com Thank You T.P.Ostwal & Associates