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Domestic Transfer Pricing

Domestic Transfer Pricing. India Transfer Pricing Issues 6 February 2014. Transfer Pricing Journey. Content. Introduction and Overview of Provisions Analysis of Provisions Documentation and filings Impact on tax payers Key issues and analysis Case studies Way Forward.

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Domestic Transfer Pricing

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  1. Domestic Transfer Pricing India Transfer Pricing Issues 6 February 2014

  2. Transfer Pricing Journey

  3. Content • Introduction and Overview of Provisions • Analysis of Provisions • Documentation and filings • Impact on tax payers • Key issues and analysis • Case studies • Way Forward

  4. Domestic Transfer Pricing • Introduction and Overview of Provisions • Analysis of Provisions • Impact on Taxpayers • Way Forward

  5. Introduction and overview of provisions Amendments in Finance Bill 2012

  6. Introduction – Pre Finance Act, 2012

  7. Domestic TP – Applicability • Allowance for expenditure or allocation of cost or expense or any income in relation to SDT to be computed having regard to Arm’s Length Price (ALP) • Applicable from FY 2012-13 onwards • SDT defined as any of the following transaction(s), which are not international transactions (i.e. transactions where either one or both the parties to the transaction are non-residents) • Payments to related parties as defined under section 40A(2)(b) • Tax holiday related transactions (eligible business) • Any transaction referred to in section 80A • Any transfer of goods/services referred to in section 80IA(8) • Any business transaction referred to in section 80IA(10) • Any transaction under Chapter VI-A or u/s 10AA – to which provisions of section 80IA (8) or section 80IA (10) apply • Any other transaction as may be prescribed

  8. Domestic TP – Applicability • Concept of ALP applicable for determining taxable income arising from international transactions introduced in 2001, now extended to SDT • 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 • Methods for computing ALP same as international transfer pricing. • Rule 10AB applicable to SDT for FY 2012-13 onwards. • Monetary threshold of INR 5 Crore provided for applicability of the provisions • TP provisions applicable to international transactions are largely applicable to SDT as well. • Tax holiday denial to adjusted income, if SDT TP adjustment results in enhancement of total income • Taxpayer cannot apply TP to SDT so as to reduce total income that is subject to tax

  9. Methods for computing ALP • SDT with related parties shall be undertaken at ALP • ALP is required to be computed using any of the following methods being the most appropriate method • Comparable uncontrolled price method • Resale price method • Cost plus method • Profit split method • Transactional net margin method • Such other method as may be prescribed by the Board - method prescribed in May 2012 by inserting Rule 10AB • Rules provide guidance on application of the methods and factors to be considered in selecting the most appropriate method

  10. Analysis of provisions

  11. Section 40A(2)(b) – Related person Director (+) Relative Relative >20% Holding company Company Director/ Partner/ Member Individual >20% >20% Co/ Firm/ HUF/ AOP >20% Firm/ HUF/ AOP Partner/Member (+) Relative Assessee Director/ Partner/ Member (+) Relative >20% Co/ Firm/ HUF/ AOP Director (+) Relative >20% “Relative” in relation to an individual, means the husband, wife, brother or sister or any lineal ascendant or descendant of that individual Co/ Firm/ HUF/ AOP

  12. Section 40A(2) – Payments to related parties • Payments by taxpayers* to certain specified persons are covered within the ambit of section 40A(2) • The following persons are regarded as ‘specified persons’ • Directors of the taxpayer company or any relative of such directors • Individuals having Substantial Interest in the business of taxpayer company or any relative of such individual • Persons having a Substantial Interest in the business of the taxpayer company • Directors of the entities having Substantial Interest in the business of the taxpayer company or any relatives of such directors • Any company having the same holding company (which holds a SI) as that of the taxpayer company • A company of which a director has a SI in the business of the taxpayer company, any director of such company or any relative of such director • Persons/entities in which taxpayer company/its directors/ their relatives have a SI

  13. Section 40A(2) – Payments to related parties • A person shall be regarded as having a Substantial Interest in a business if at any time during the previous year • Such person is the beneficial owner of shares carrying not less than 20% of the voting power (in case of a company) • Such person is beneficially entitled to not less than 20% of the profits of such business (in any other case) • Beneficial ownership • Term not defined but can be understood as a person who ultimately enjoys the income/asset and also controls it • While a registered shareholder may generally be presumed to be the beneficial owner, under certain circumstances, an indirect shareholder could be regarded as beneficial owner • Need not be in existence for the entire year but is sufficient if it is in existence for only part of the year

  14. Section 40A(2) – Payments to related parties • General scope of Section 40A(2) • Applicable to taxpayers making the payment/ incurring expenditure and not to recipients of such income • Expenditure should be towards ‘goods’, ‘services’ or ‘facilities’ • Generally, following payments may be covered: • Payment towards purchase of raw materials, services, use of asset • Payment towards sharing of common premises/facilities • Payment of interest on loan • Payment of managerial remuneration, salary, bonus etc to directors

  15. Tax holiday eligible business • 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 accounts of eligible business does not correspond to market value of such goods/services • In such cases, tax authorities/ taxpayer required to recompute tax holiday claim by reference to ALPof such goods/services • Applies to all tax holiday claims under Chapter VI-A/ Section 10AA

  16. Tax holiday eligible business General scope of Section 80A(6)/ 80IA(8) • Covers transfer of goods/ services held by “eligible business” to another business or vice versa • Existence of two or more separate businesses of the same taxpayer • Transfer of goods/ services between the businesses • Once threshold is satisfied, inter-unit transfer price may be need to be determined by hypothesizing the businesses as separate & distinct enterprises for determining ALP Other units Tax holiday units Inter unit transfers (goods and services etc.) Not correspond to market value

  17. Tax holiday eligible business General scope of Section 80IA(10) • Tax officer empowered to re-compute tax holiday profits if: • more than “ordinary profits” have arisen in the eligible business due to transactions between closely connected persons or for other reasons • Provides for only “one way” adjustment i.e. only adverse adjustment at the discretion of the tax officer • Tax officer may invoke the provision in case of SDT on the basis of ALP determination Tax holiday company Business transacted (wider than transfer of goods and services) Other persons More than ordinary profits earned by tax holiday unit

  18. Documentation and Filing

  19. Domestic TP – Documentation Transaction related Supporting documents Entity related Price related • Official publications, reports by Government, institutions of repute, Stock exchanges • Financial statements • Profile of industry • Profile of group • Profile of unit of the entity claiming tax holiday • Profile of related parties • Transaction terms • Functional analysis (functions, assets and risks) • Economic analysis (method selection, comparable, benchmarking) • Forecasts, budgets • Agreements • Invoices • Pricing related correspondence (letters, emails etc) • Documentation to be contemporaneous • Due date for maintenance of documentation for FY 2012-13 is November 30, 2013

  20. Domestic TP – Filing of Form 3CEB • All taxpayers to whom the provisions apply required to e-file a Form 3CEB certified by a CA • For FY 2012-13, the due date of filing Form 3CEB is Nov 30, 2013 • Requirement to e-file the certified form • TP documentation forms the basis for certification of Form 3CEB

  21. Domestic TP – Penal provisions • Adjustment related penalty not leviable where taxpayer has acted in ‘good faith’ and exercised ‘due diligence’ • TP documentation serves as a good basis to demonstrate good faith and due diligence

  22. Impact on taxpayers

  23. Implications • Related party payments likely to be subject to detailed scrutiny to assess whether payments are consistent with ALP • Adjustments could lead to economic double taxation in the absence of correlative relief • Intra-enterprise arrangements may be reviewed to assess reasonableness of tax holiday eligible profits • Profit levels of tax holiday eligible taxpayers may be evaluated to assess whether more than ordinary profits are derived on account of dealings with closely connected persons • Documentation/ compliance and reporting obligation on taxpayer

  24. Key issues and analysis

  25. Applicability of domestic transfer pricing provisions – Section 40A(2)(b)

  26. Direct v Indirect Ownership Direct Ownership Indirect Ownership • Whether Section 40A(2)(b) covers only direct ownership? • The terms used in section is ‘beneficial ownership’ • Certain other section specifically use the term ‘directly or indirectly’ • Accordingly, it should be interpreted to cover only direct ownership unless there is an evidence to demonstrate that such enterprise is only a nominee/ agent

  27. Revenue v Capital Expenditure Whether capital expenditure covered • Section 40A(2) applies to the case of goods, services or facilities for which taxpayer has made payment. Accordingly, scope is restricted to items of revenue nature which are taken into consideration in computing business income • The provisions apply to payment made for an ‘expenditure incurred’. ‘Depreciation’ on capital asset is not an expenditure but an amortization • The FAQ issued by ICAI in respect of tax audit also provides that ‘capital expenditure’ should not be reported in 40A(2) disclosure • Separate provisions (section 43) contained in the income-tax law, empowering AO to restate the cost of acquisition of depreciable asset • However, given the penal provisions advisable to make disclosure of such interpretation as part of TP documentation Better view seems to be that the provisions would not capture a capital expenditure

  28. Section 40A(2) would apply Covers payment for expenditure incurred ALP which has effect of reducing chargeable income or increase in loss is to be ignored Tax authority can not impute any notional expense/ income in the hands of the taxpayer For eg: receipt of services/ guarantee/ use of facilities without payment not covered Actual v Notional Expenditure Whether notional taxation would apply ? Non tax-holiday entities Tax holiday unit/ entities • Section 80IA(8)/ 80IA(10) would apply • Inter unit transfer of goods and services should correspond to market value and transaction with assessee claiming tax holiday should not result in more than ordinary profit • Imputation of notional income/ expenses by tax authorities possible

  29. Possible Tax Inefficiency X Ltd. (non-tax holiday) X Ltd. (non-tax holiday) X Ltd. (non-tax holiday) Sale at 120 v/s ALP (ie 100) Sale at 120 v/s ALP (100) Sale at 80 v/s ALP (100) Y Ltd. (non-tax holiday) Y Ltd. (tax holiday) Y Ltd. (tax holiday) Disallowance of INR 20 [40A(2)(b)] Double DisallowanceINR 40 [40A(2)(b) and excessive profit] Inefficient pricing structure – Reduced tax holiday benefit 29

  30. Key Analysis Q 1. What is the impact of transactions specified under s. 92BA being covered by Domestic TP Provides method for computing FMV. Transfer the onus to taxpayer to determine the FMV Q 2. Whether exclusion of ‘International Transactions’ from scope of SDT implies that all transactions with non-residents are outside the scope of SDT No, there could be an SDT which may be cross border and either or both parties to the transaction could be non-resident. - remuneration paid to foreign Directors - ICO may make payment to FCO which holds 21% in ICO - FCO may have PE in India in respect of which, FCO may pay service fees to the director who has specific technical skills

  31. Key Analysis Q 3. Is a business covered under s. 35AD covered by Domestic TP provisions considering that provisions of s. 80A(6) and s. 80-IA(10) are as equally applicable to s. 35AD? Section 92BA defines certain SDTs within the coverage of the section. In respect of profit linked incentive deduction it refers to a taxpayer claiming deduction under Chapter VI-A and s. 10AA. S. 92BA does not, however, contain any reference to a taxpayer who is entitled to investment linked incentive deduction under s. 35AD. Q 4. Is transfer between two eligible units covered under SDT specially where both units enjoy same tax holiday Section 80IA(8) coves transaction from one eligible units to other business units. Hence, transactions between two eligible units are also covered. Where eligible units enjoys different tax holiday (say u/s 80IC) then transactions may be planned. Where same tax holiday are available, for compliance purpose, one should report under SDT.

  32. Key Analysis Q 5. Payment made to directors? How director’s remuneration need to be benchmarked – how to established that payment made to directors are at ALP

  33. Case Study

  34. Case study 1 & 2 Case 1 • A Ltd and B Ltd are related parties • A Ltd has advanced interest free loan to B Ltd. Case 2 • A Ltd has advanced interest free loan to B Ltd. • B Ltd has used that loan for its undertaking eligible for tax holiday A Ltd Interest free loan Tax Holiday B Ltd Use for tax holiday units

  35. Case study 3 & 4 Case 3 • A Ltd hold 100% in B Ltd which in turn hold 100% in D Ltd • Whether A Ltd and D Ltd are related party Case 4 • A Ltd hold 100% in B Ltd and C Ltd. • Whether B Ltd and C Ltd. are related party • Whether D Ltd and E Ltd. are related party A Ltd 100% 100% B Ltd C Ltd 100% 100% D Ltd E Ltd

  36. Case study 5 Case 5 • A, B, C, D are directors in A Ltd • A, B, C, D are holds 10% each in B Ltd. • Whether A Ltd and B Ltd are related party. Directors A B C D 10% 10% 10% 10% B Ltd A Ltd

  37. Way Forward

  38. Four Step action plan 1 2 Identifying SDTs Understand implications • Identify inter company Transactions/ arrangements that would be covered within the ambit of Domestic TP provisions • Map the transactions and document the current policy of pricing/allocation • Review the agreements/documents in support of the current inter company pricing/allocations • Analyze whether the current pricing policy of the group are in line with the arm’s length principle • Technical assessment of the arrangements to evaluate applicability of SDT provisions and possible approach for establishing ALP for the arrangements where SDT applies 4 3 Compliance requirements Impact assessment • Maintain prescribed TP documentation as stipulated under Rule 10D of the ITL within the prescribed due date (Nov 30, 2013 for FY 2012-13 transactions) • Obtain and file Form 3CEB with the tax authorities (Nov 30, 2013 for FY 2012-13 transactions) • Undertake Functional analysis of the identified transactions • Undertake a bench marking analysis

  39. Questions?

  40. Thank you

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