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Transfer Pricing

Transfer Pricing. Specified Domestic Transactions. Study Circle Baroda Branch of WIRC 14 th May 2013. Agenda. Introduction Transfer Pricing in India Background Snapshot of Indian Regulation Specified Domestic Transactions Related Party Transactions & Eligible Units Case Studies

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Transfer Pricing

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  1. Transfer Pricing Specified Domestic Transactions Study Circle Baroda Branch of WIRC 14th May 2013

  2. Agenda • Introduction • Transfer Pricing in India • Background • Snapshot of Indian Regulation • Specified Domestic Transactions • Related Party Transactions & Eligible Units • Case Studies • TP Methods and Documentations • Procedures & Penalties

  3. Introduction

  4. Transfer Pricing - Background • Since liberalization – Companies from developed or developing countries • Collaborations with Indian entities by MNEs • Setting up 100% subsidiaries in India • Backdoor transfer of Profits • Indian Government was losing revenue in form of Tax • Finance Act, 2001 has introduced Transfer Pricing with effect from Assessment Year 2002-03

  5. Tax Avoidance - International India Co. A Co. B Dubai Tax Heaven Co. B is 100% sub. Of Co. A Co. A Sells at Rs. 100 to B Co. B Sells at Rs. 120 to Co. C Profit by B is Rs. 20 (Tax Free) Maximum tax to Co. A of Rs. 3.5 USA Co. C

  6. Tax Avoidance - Domestic Tax Avoidance Unit – 1 (Gujarat) Unit – 2 (Baddi) • Unit -1 Manufactures radiators sells to Unit – 2 in Knocked Down Condition for Rs. 100 • Unit -2 Assembles and sells to customers for Rs. 120 • Profit of Unit – 2 is tax free u/s 80IB. • Company pays tax only on profit of Rs. 10 under Unit -1.

  7. Transfer Pricing in India

  8. Transfer Pricing Litigation in India

  9. Snapshot of Indian Regulation • Transfer Pricing introduced from AY 2002-03 for international transactions • Extended to Specified Domestic Transactions [SDT] from AY 2013-14 • Sections 92 to 92F amended to include reference to SDT • However, similar amendments to Rules 10 to 10E yet to be carried out • Methodology to compute ALP is primarily provided in Rules • It is expected that appropriate amendments would be carried out in Rules to apply broadly same methods and principles to SDT as well • Discussion in this presentation is primarily based on ALP computation mechanism applicable to ‘international transactions’ assuming that the same would be applied to SDT

  10. Snapshot of TP Provision

  11. SDT - Background • Decision of the Appex Court in the case of GlaxoSmithkline Asia (P) Ltd [236 CTR 113] • The H’ble Supreme Court while deciding on the issue of section 40A(2) made some of the important observations as under: • The present Transfer Pricing Regulations does not apply to domestic transactions. CBDT should examine possibility of extending TP provisions to such transactions

  12. SDT - Background • In domestic transactions, under-invoicing and over-invoicing will be revenue neutral, except in two circumstances: • where one of the related entities is loss making or • where one of the related entities is liable to pay tax at a lower rate and the profits are shifted to such entity • Concept of ALP is preferred over FMV to test the reasonableness of the controlled or related party transactions.

  13. Specified Domestic Transactions • Section – 92BA is inserted with effect from 01-04-2013, defines “Specified Domestic Transactions”. Under SDT these transactions are covered • Expenditure under transactions with Related Party [Section- 40A(2)(b)] • Any Transactions referred in Section – 80A • Any transfer of goods or services referred to u/s 80IA(2) • Any business transaction with person as referred u/s 80IA(10) • Any transactions under for claiming deductions under chapter – VIA or 10AA where Section – 80IA(8) /(10) is applicable • Other transaction as may be prescribed.

  14. Related Party Transaction

  15. 40A(2) – Payments to related Parties • Only expense side is covered and i.e. only revenue expenditure and not items of income. • In case of transactions between two related parties of goods and services, only the purchaser is to comply and not the seller • Definition of related party is restrictive compared to Associated Enterprise • Multi-fold issues in identification of related parties

  16. 40A(2)(b) – Definition of Related party Individual Assessee • Husband / Wife • Lineal ascendants • descendants • Sister • Assessee • Where Assessee has substantial Interest • Brother

  17. 40A(2)(b) – Definition of Related party Relatives Tax Payer = Company, HUF, Firm, AOP b(v) Other Director / Partner/ member b(v) Relatives All companies where such individual is director / partner / member b(iv) Relatives Relatives Director / Partner/ member b(vi) b(ii) b(iii) b(v) b(iv) >20% Director / Partner/ member Company / Firm / HUF / AOP Individual >20% b(vi) b(ii) b(iii) >20% >20% >20% b(iv) b(iv) Tax Payer Company Person Person >20% b(vi) Person

  18. 40A(2)(b) – Definition of Related party Relatives Tax Payer = Company, HUF, Firm, AOP b(v) Other Director / Partner/ member b(v) Relatives All companies where such individual is director / partner / member b(iv) Relatives Relatives Director / Partner/ member b(vi) b(ii) b(iii) b(v) b(iv) >20% Director / Partner/ member Company / Firm / HUF / AOP Individual >20% b(vi) b(ii) b(iii) >20% >20% >20% b(iv) b(iv) Tax Payer Company Person Person >20% b(vi) >20% >20% Person Company / entity

  19. 40A(2)(b) – Issues Tax Payer = Company, HUF, Firm, AOP Relatives Individual 15% 15% Tax Payer

  20. 40A(2)(b) – Issues Tax Payer = Company, HUF, Firm, AOP Company 10% 10% 10% Relatives Company / Firm / HUF / AOP Director / Partner/ member 10% 10% 10% Tax Payer

  21. 40A(2)(b) – Issues • Whether sub-subsidiary and ultimate parent company is relative? Co. A Co. B Co. C Co. X Co. Y

  22. Eligible Units / Undertaking

  23. SDT – Tax Holiday Units

  24. SDT – Tax Holiday Units

  25. Threshold Limit & Coverage • Domestic Transfer Pricing is applicable only where value of SDT exceeds INR 5 Crore. • Important points need to be considered while considering the threshold limit • Value of International transactions to be excluded • Expense transactions covered in respect of 40A(2)(b) • All transactions covered in respect of Chapter VI or 10AA transactions • Aggregate amount of all transactions should be considered • Once Exceeded 5 crore, all transactions whether significant or not are covered

  26. Challenges

  27. Posers • Whether parties not engaged in business and profession is covered by the provisions of 40A(2)(b)? • Whether following shall be covered – • Public Charitable Trust paying remuneration to related persons • Trusts created by the companies • Co-operative societies • Social Clubs having business undertaking • Expenses disallowed under other provisions of the act say 40A(3) – whether covered by SDT?

  28. Posers • In respect of 40A(2)(b) the Law envisages a Corporate Tax Payer to know • Whether the individual holding 20% interest is director in other company • Identify all directors of the Company of which such individual is a director • Relatives of all such directors • Further it also envisages to identify the Company or the entity where relative of any director of the Assessee company holds 20% voting rights.

  29. Posers • For calculating 20% interest, preference shares or other securities having voting rights to be considered. • Preference Shareholders where voting rights are vested under the provisions of Companies Act as consequences of default by Assessee Company. • Corresponding Credit for tax neutrality or to avoid double taxation • Small value transactions

  30. Economy and Tax Provisions • The tax provisions and it impact on Economy • Incentivize • Subsidize • Encourage • Regulate • Tax

  31. Case Studies

  32. Case - 1 • XYZ Inc, USA is engaged in manufacturing of wide range of Automotive engineering products • YZ Ltd. Germany is engaged in R&D and manufacturing of Bearings • X Ltd. is manufacturing TYPE A bearings • Y Ltd. is manufacturing TYPE B bearings • Z Ltd. is manufacturing Clutches – 10AA unit • A Ltd. is provided technical services

  33. Case - 1 Germany USA YZ Ltd. XYZ Inc. Subsidiary India 15% 90% 25% 90% 20% X Ltd Z Ltd (10AA) A Ltd Y Ltd

  34. Case - 2 • A Ltd. is an Indian company • B Inc., USA is 100% subsidiary of A Ltd. • C Ltd is an Indian Company, 100% sub. of A Ltd. • D Ltd and E Ltd (10AA eligible) are Indian Companies, 100% sub of A Ltd. • A Ltd granted interest free loans to B C and D • A Ltd granted loan to E Ltd at 18% p.a. interest

  35. Case - 2 USA B Inc. A Ltd. Interest Free Loan Corporate Guarantee (fees at 0.25% is charged) India • Loan at 18% • ALP 11% Interest Free Loan Interest Free Loan Corporate Guarantee (No fees is charged) C Ltd D Ltd (10AA) E Ltd (10AA)

  36. Case - 3 • A Ltd, B Ltd, C Ltd, and D Ltd are Indian companies • C Ltd holds 80% shares of B Ltd. • B Ltd holds 100% shares of A Ltd • X, Y, Z are the directors of A Ltd. Holds 10% share of D Ltd. • Mrs. Y holds 15% and Mr. F son of Z holds 15% of D Ltd. • FY is P’ship firm of Mrs. Y and Mr. F

  37. Case - 3 C Ltd. Directors of A Ltd. Son of Mr. Z Mr. F Mrs. Y Mr. Z Mr. X Mr. Y Purchase of Finished Goods 80% 15% 10% 10% 10% 15% B Ltd 100% D Ltd A Ltd (Assessee) Purchase of Raw Material 50% 50% YF (Partnership Firm) Consultancy Fees

  38. Transfer Pricing Methods

  39. Transfer Pricing Methods

  40. Transfer Pricing Methods

  41. Most Appropriate Method (MAM) • ITA does not provide any specific hierarchy of methods • It insists on applying the ‘Most Appropriate Method’ (MAM) • MAM means a Method • Which is best suited to facts and circumstances of transaction • Which is the most reliable measure of an arm’s length price

  42. Selection of MAM • MAM is to be determined considering – • Nature and class of transaction • Functions, assets and risks undertaken assessee and other party • Degree of comparability between underlying transaction and uncontrolled transactions • Extent to which reliable and accurate adjustments can be made to account for differences, if any • Availability, coverage and reliability of data necessary for application of method • Nature, extend and reliability of assumptions required to be made in application of method

  43. Stages of Economic Analysis

  44. Selection of MAM • MAM is to be determined considering – • Nature and class of transaction • Functions, assets and risks undertaken assessee and other party • Degree of comparability between underlying transaction and uncontrolled transactions • Extent to which reliable and accurate adjustments can be made to account for differences, if any • Availability, coverage and reliability of data necessary for application of method • Nature, extend and reliability of assumptions required to be made in application of method Selection of Tested Party Comparability Analysis Selection of Tested Party & Comparability Analysis

  45. Classification of Methods

  46. Documentation

  47. Documentation Areas

  48. What are the Documentation Requirements?

  49. Indicative Documentation

  50. Indicative Documentation

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