Compounding of Contraventions & Transfer Pricing Developments

1. Compounding of Contraventions & Transfer Pricing Developments Prof.(Dr.) Alok Pandey, Professor (Finance) & Member Academic Advisory Body LalBahadurShastri Institute of Management, Delhi

2. Overview of Presentation • Section 1: FEMA- A brief overview • Section 2: Compounding of Contraventions • Section 3: Transfer Pricing & Recent Developments

3. FEMA: A Brief Overview Section 1

4. Rules – Current A/C Notifications Regulations- Capital A/C Mechanism under FEMA Passed by the Parliament – the Legislature Current Account by the Government Act – FEMA AP Dir Circulars to APs Notified in the Gazette – by the Executive All aspect of Forex transactions by the RBI Capital Account by the RBI

5. Important sections.. • Main sections are : • Sec.2 : Definitions. • Sec.3 : Dealing in FE. • Sec.4 : Holding of FE. • Sec.5 : Current Account. • Sec.6 : Capital Account • Sec.7 : Export of Goods and Services. • Sec.8 : Realisation / repatriation of FE. • Sec.9 : Exemption from Sec.8 • Sec.10(5): Declaration • Sec.10(6): Freedom to utilize forex • Sec.13 to 15 : Penal provisions

6. Forex Transactions… • Types of transactions :- Current A/c ; and Capital A/c. • Rational : Current A/c : The transactions which are not prohibited are permitted. [ Sec. 5 freedom to draw FE ] Capital A/c : The transactions which are not permitted are restricted. [ Sec. 6 RB, may by regulation prohibit, restrict or regulate.

7. Cross Border Investments • Foreign Direct Investments in India • Overseas Direct Investment by Indians Abroad

8. Foreign Investments in India

9. Compounding of Contraventions Section II

10. Contraventions under FEMA • Contravention is a breach of the provisions of the Foreign Exchange Management Act (FEMA), 1999 and rules/ regulations/ notification/ orders/ directions/ circulars issued there under by RBI.

11. Compounding of contraventions under FEMA • Compounding refers to the process of voluntarily admitting the contravention, pleading guilty and seeking redressal. • The Reserve Bank is empowered to compound any contraventions as defined under section 13 of FEMA, 1999 except the contravention under section 3(a), for a specified sum after offering an opportunity of personal hearing to the contravener.

12. Compounding of Contraventions under FEMA • It is a voluntary process in which an individual or a corporate seeks compounding of an admitted contravention. • It provides comfort to any person who contravenes any provisions of FEMA, 1999 [except section 3(a) of the Act] by minimizing transaction costs. • Willful, malafideand fraudulent transactions are, however, viewed seriously, which will not be compounded by the Reserve Bank.

13. Eligibility for applying for Compounding • Any person who contravenes any provision of the FEMA, 1999 [except section 3(a)] or contravenes any rule, regulation, notification, direction or order issued in exercise of the powers under this Act or contravenes any condition subject to which an authorization is issued by the Reserve Bank, can apply for compounding to the Reserve Bank. • Applications seeking compounding of contraventions under section 3(a) of FEMA, 1999 may be submitted to the Directorate of Enforcement.

14. When to apply for Compounding • When a person is made aware of the contravention of the provisions of FEMA, 1999 by the Reserve Bank or the Foreign Investment Promotion Board (FIPB) or any other statutory authority or the auditors or by any other means, she/he may apply for compounding. • One can also make an application for compounding, suo moto, on becoming aware of the contravention.

15. Where to apply? • The powers to compound contraventions have been vested with the Regional Offices of Foreign Exchange Department(FED), Reserve Bank.

16. Procedure • The form given in the annexuret o the A.P.(DIR Series) Circular No. 56 dated June 28, 2010 issued by the Reserve Bank of India, can be used for applying for compounding. • The same can also be downloaded from the Reserve Bank’s website. • Further the documents as mentioned in A.P.(DIR) circular nos. 57 and 20 dated December 13, 2011 and August 12, 2013 respectively should also be submitted along with the application.

17. Fee for Compounding • The application in the prescribed format along with necessary documents and a demand draft for Rs. 5000/- (Rupees five thousand only) drawn in favour of the “Reserve Bank of India” should be sent to the Reserve Bank of India while sending the request for compounding.

18. What RBI does with the Application? • The Reserve Bank makes a scrutiny of the application to verify whether the required details and documents furnished by the applicant are prima-facie in order. • Applications with incomplete details or where the contravention is not admitted will be returned to the applicant. • On the admission of applications, the Reserve Bank will examine and decide if the contravention is technical, material or sensitive in nature.

19. Types of Contraventions • Technical. • Material. • Sensitive.

20. What are Sensitive Contraventions? • The contraventions, prima facie, involving money laundering, national and security concerns involving serious infringement of the regulatory framework, etc., are sensitive contraventions. • When the issues involved are sensitive / serious in nature they need to be referred to the Directorate of Enforcement (DOE/DRI).

21. What are Technical Contraventions? • Whenever a contravention is identified by the Reserve Bank or brought to its notice by the entity involved in contravention by way of a reference other than through the prescribed application for compounding, the Bank will decide if a contravention is technical and/or minor in nature and, as such, can be dealt with by way of an administrative/ cautionary advice.

22. What are Material Contraventions? • Material contraventions are those which are required to be compounded for which the necessary compounding procedure has to be followed.

23. RBI decides on Nature of Contravention • Whether contravention under the Foreign Exchange Management Act (FEMA) is to be treated as technical and/ or minor or serious would be decided by the Reserve Bank on the merits of the case. The application will be disposed of keeping in view the procedure notified in this regard. • Persons who have contravened the provisions of FEMA should not take upon themselves suo moto, or on the basis of external advice to decide whether a particular contravention is technical or minor in nature and, hence, no compounding application need be submitted to the Reserve Bank.

24. Apply to avoid getting penalised • If such applications for compounding are not made, the person concerned shall expose himself/herself to such action under the provisions of FEMA as the authorities may deem appropriate. • The persons concerned should, therefore, in their own interest submit their applications for compounding of contravention under FEMA to the Reserve Bank at the earliest opportunity.

25. The Hearing by RBI • Personal appearance is not mandatory and the applicant may inform his preference of appearing/not appearing in writing to Compounding Authority (CA). • Another person may be authorised by the applicant to attend the personal hearing on his behalf but only with proper written authority.

26. Qualifications of person appearing on behalf of Applicant • It has to be ensured that the person appearing on behalf of the applicant is conversant with the nature of contravention and the related matters. • The Reserve Bank encourages the applicant to appear directly for the personal hearing rather than being represented/ accompanied by legal experts/consultants, etc. as the compounding is only for admitted contraventions.

27. Conclusion of Compounding • The Compounding Authority passes an order indicating details of the contravention and the provisions of FEMA, 1999 that have been contravened. • The sum payable for compounding the contravention is indicated in the compounding order. • The contravention is compounded by payment of the penalty imposed.

28. Payment of Compounding Charges • The amount should be paid within 15 days from the date of the order by way of a demand draft drawn on "Reserve Bank of India" and payable at the Regional office which has issued the compounding order and at Mumbai if the order is issued by CEFA (Cell for Effective Implementation of FEMA) , Mumbai.

29. Completion of Process • On realization of the sum for which contravention is compounded, a certificate shall be issued by the Reserve Bank indicating that the applicant has complied with the order passed by the Compounding Authority.

30. Completion of Process • There cannot be a second adjudication by any authority on the contravention compounded. In terms of FEMA, 1999, where a contravention has been compounded, no proceeding or further proceeding, as the case may be, can be initiated or continued, as the case may be, against the person committing such contravention under that section, in respect of the contravention compounded.

31. Non Payment of Compounding Charges • In case of non-payment of the amount indicated in the compounding order within 15 days of the order, it will be treated as if the applicant has not made any compounding application to the Reserve Bank and the other provisions of FEMA, 1999 regarding contraventions will apply. Such cases will be referred to the Directorate of Enforcement for necessary action

32. Appeal against the order of the Compounding Authority • As compounding is based on voluntary admissions and disclosures, there is no provision under the Compounding Rules for an appeal against the order of the Compounding Authority or for a request for reduction of amount compounded or extension of period for payment of penalty.

33. Timeframe for completing the compounding process • The compounding process is normally completed within 180 days from the date of receipt of the application complete in all aspects, by the Reserve Bank.

34. Penalties • Penalty up to thrice the sum involved in such contravention where such amount is quantifiable, or • Up to two lakh rupees where the amount is not quantifiable, and where such contravention is a continuing one, further penalty which may extend to five thousand rupees for every day after the first day during which the contravention continues.

35. Penalties • Any currency, security or any other money or property in respect of which the contravention has taken place shall be confiscated to the Central Government and further direct that the foreign exchange holdings, if any, of the persons committing the contraventions or any part thereof, shall be brought back into India or shall be retained outside India in accordance with the directions made in this behalf.

36. Transfer Pricing: Recent Developments Section III

37. Transfer PricingRegulations

38. Transfer Pricing • Transfer pricing is one of the most important issues in international tax. • Transfer pricing happens whenever two companies that are part of the same multinational group trade with each other: when a India-based subidiary of Coca-Cola, for example, buys something from a French-based subsidiary of Coca-Cola. • When the parties establish a price for the transaction, this is transfer pricing.

39. The Arm’s Length principle: Unrelated Parties • If two unrelated companies trade with each other, a market price for the transaction will generally result. • This is known as “arms-length” trading, because it is the product of genuine negotiation in a market.  • This arm’s length price is usually considered to be acceptable for tax purposes.

40. Arm’s Length Principle: Related Parties • But when two related companies trade with each other, they may wish to artificially distort the price at which the trade is recorded, to minimise the overall tax bill. • This might, for example, help it record as much of its profit as possible in a tax haven with low or zero taxes.

41. Case • A company called India MNC Ltd., which produces a type of food product in India, then processes it and sells the finished product in the United States. • India MNC Ltd. does  this  via three subsidiaries: India MNC Ltd. (in India), Haven Inc. (in a tax haven, with zero taxes) and America Inc. (in the United States).

42. Case • Now Inc. sells the produce to Haven Inc. at an artificially low price, resulting in India MNC Ltd. having artificially low profits – and consequently an artificially low tax bill in India. • Then Haven Inc. sells the product to America Inc. at a very high price – almost as high as the final retail price at which America Inc. sells the processed product.

43. Case • As a result, America Inc. also has artificially low profitability, and an artificially low tax bill in America. • By contrast, however, Haven Inc. has bought at a very low price, and sold at a very high price, artificially creating very high profits. However, it is located in a tax haven – so it pays no taxes on those profits.

44. International Transaction • Transaction between two or more associated companies situated in different countries in terms of a property that is tangible or intangible, a service offered by the company, or any form of lending of money, etc. • It is compulsory that at least one of the participants involved in the transaction is a non-resident of India.

45. Transaction between NRIs • However, a transaction that has been carried out by two non-resident Indians, where one of them possesses a permanent setup in India and whose income is taxable from India, such a type of transaction is also considered as ‘International Transaction.’

46. Authorized Person • Any person who has involved in an international transaction in the previous year shall submit the report in Form 3CEB through a Chartered Accountant, duly verified and certified by him, on or before the date ( i.e. 30th September ( of every year) ) prescribed by the authority, furnishing all the required details .

50. Transfer Price: What and Why? • TP means the value or price at which transactions take place amongst related parties. • TP are the prices at which an enterprise transfers physical goods and intangible property and provides services to associated enterprises • TP gain significance because these can be used by the controlling party to their advantage to minimise tax incidence.