overview on transfer pricing

OVERVIEW ON TRANSFER PRICING

Transactions between two or more enterprises belonging to the same multinational group have created a new and complex issue as a result of the increasing participation of multinational groups in economic activities in the country.

To provide a detailed statutory framework that can lead to the computation of reasonable, fair and equitable profits and taxes in India, the government has incorporated various acts that take into account various aspects in this regard.

The Finance Act of 2001 replaced section 92 with a new section and added new sections 92A to 92F to the Income-tax Act, relating to the computation of income from an international transaction in relation to the arm’s length price, the meaning of associated enterprise, and the meaning of information and documents by persons entering into international transactions.

Specified Domestic Transactions:

Form No. 3CEB as specified by Rule 10E to be provided for international transactions by an accountant pursuant to Section 92E. In the case of Specified Domestic Transactions, however, no such form has been specified separately.

The contents of this Guidance Note (insofar as they apply to Specified Domestic Transactions) are based on the current provisions of the Income Tax Act of 1961 and the Income Tax Rules of 1962. The contents of this Guidance Note may need to be evaluated, and an addendum or separate or amended Guidance Note may be required. In the while, the contents of this chapter (Specified Domestic Transactions) should only be used as a source of information.

For the purposes of section 40A, Chapter VI-A, and section 10AA of the Finance Act of 2012, transfer pricing laws have been expanded to encompass transactions conducted into with domestic related parties or by an undertaking with other undertakings of the same entity. Domestic transfer pricing rules implemented since Assessment Year 2013-14.

All compliance requirements, such as transfer pricing documents and an accountant’s report, apply equally to specified domestic transactions as they do to international transactions between companies.

Definition

Specified Domestic Transaction (SDT) is defined in Section 92BA and is subject to TP restrictions. Section 92BA is as follows.

“Specified domestic transaction” in the case of an Assesse means any of the following transactions, which are not international transactions, for the purposes of this section and sections 92, 92C, 92D, and 92E:

• Any expenditure for which payment has been made or will be paid to a person listed in clause (b) of section 40A’s sub-section (2).
• business undertaken between the Assessee and a third party as defined in section 80-IA, sub-section (10)
• Any transaction referred to in any other section of Chapter VI-A or section 10AA that is subject to the provisions of section 80-IA sub-section (8) or sub-section (10)
• Transaction that falls under section 80A.
• Any transfer of goods or services as defined in section 80-IA, subsection (8).
• other transaction that may be deemed necessary
• where the Assessee’s aggregate of such transactions in the previous year exceeds a sum of 5 crore.

Threshold Limit:

The above-mentioned transactions shall be considered SDT only if the total amount of all of the above-mentioned transactions surpasses the threshold limit of 5 crore. Only if the total value of all transactions exceeds the threshold of 5 crore will all transactions covered by the six limbs as indicated above be considered SDT.

If the threshold limit is exceeded, the taxpayer will be forced to comply with TP rules for all transactions, regardless of how little or insignificant the value of transactions under one of the limbs may be. As a result, each limb of the definition has no internal threshold.

Expenditure for payments given to the people mentioned in section 40A(2) (b).

‘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;’ is defined in section 92BA(i).

Section 40A(2)(a) specifies:

“Where the Assessee incurs any expenditure for which payment has been or will be made to any person referred to in clause (b) of this subsection, and the Assessing Officer believes that such expenditure is excessive or unreasonable in light of the fair market value of the goods, services, or facilities for which payment is made or the legitimate needs of the business or prostitution”

w.e.f. 1-4-2013, added the following proviso to sub-section (2) (a) of section 40A  the Finance Act, 2012:

“Provided that no disallowance shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm’s length price as defined in clause (ii) of section 92F, on account of any expenditure being excessive or unreasonable in light of the fair market value.”

Expenditure transactions, for example, would be covered in the scope of this section (illustrative only):

• Expenditure on goods purchased.
• Any Expenditure on service procurement.
• Interest payment expenditure.
• Expenses for salaries, training services, and marketing.
• Any Expenditure on physical and intangible property purchases.
• Commission, sitting fees, and director’s remuneration
• Charges for a group.
• Expenditure for reimbursement.
• Guarantee the payment of fees.

This provision only affects the expenditure side of the equation; it has no bearing on the beneficiaries of such payments. As a result, only the individuals or businesses that incur such expenses would be subject to SDT under this section and would be required to comply with the relevant transfer pricing compliances.

Under this provision, persons/entities receiving such income will not be subject to SDT and will not be required to comply with related transfer pricing compliances.

Provision 40A (2) (b) establishes the list of those who are covered by this section.

The following is the text of Section 40A (2) (b).

The individuals mentioned in clause (a) are as follows:

• if the Assessee is a person – any of the Assessee’s relatives
• Any director of the company, firm, association of persons, or Hindu un-divided family, or any relative of such director, partner, or member, if the Assessee is a company, firm, association of persons, or Hindu un-divided family.
• Any person with a significant interest in the Assessee’s company or profession, or a relative of that person.
• a company, firm, association of persons, or Hindu undivided family with a substantial interest in the Assessee’s business or profession, or any director, partner, or member of such company, firm, organisation, or family, or any relative of such director, partner, or member [or any other company carrying on business or profession in which the first mentioned company has significant interest].
• a company, firm, association of persons, or Hindu undivided family in which a director, partner, or member, as the case may be, has a substantial interest in the Assessee’s business or profession; or any director, partner, or member of such company, firm, association, or family, or any relative of such director, partner, or member; or any director, partner, or member of such company, firm, association, or family.
• Anyone who runs a business or works in a profession.

A person is deemed to have a considerable interest in a company or profession for the purposes of this section if:

• If the business or profession is carried out by a corporation, such person is the beneficial owner of shares (not shares entitled to a set rate of dividend, whether with or without a right to participate in profits) with not less than 20% voting power at any time during the previous year.
• In any other circumstance, such individual has a beneficial interest in not less than 20% of the profits of such business or profession at any time during the previous year.

Furthermore, the Finance Act 2012 extended the list of specified people in section 40A(2)(b) to include transactions between persons/companies in which another person/company has a substantial interest in both such transacting persons/companies.

The threshold for substantial interest to qualify as ‘specified people’ (important for domestic transfer pricing) is 20% or more, but the bar for ‘associated enterprises’ is 26% or more (relevant for international transfer pricing).

For instance, if an Indian company buys goods from a US company in which it owns a 23 percent equity stake (substantial interest), the purchase will not be considered an international transaction among associated enterprises, but rather a specified domestic transaction, requiring arms-length pricing, transfer pricing documentation, and accountants.

In the case of a taxpayer of corporations, the following is an illustrative (only) chart of individuals specified in Article 40A(2)(b):

Section 40A(2)(b)does not use the statement “directly or indirectly,” as it does in Section 92A(2)(a) and (b) (which define the term “associated enterprise” for the purposes of international transactions) . In this regard, however, reference should be made to the Central Board of Direct Taxes Circular number 6-P dated 6 July 1968, which explains the newly inserted provisions in section 40A(2) at the time . This circular specifies the types of people to whom payments are made under section 40A(2). It specifies that such individuals would include, among others.

Individuals in whose business or profession the taxpayer has a significant direct or indirect interest.”

Section 40A(2)(b) has a broad scope, encompassing people who are linked to the Assessee in a variety of ways. As a result, the Assessee and the accountant should carefully identify and include in the transfer price paperwork and accountant’s report all relevant expenditure transactions with all specified persons as described under section 40A(2)(b). The accountant should receive a written representation from the Assessee describing the list of persons described in section 40A(2)(b) and expenditure transactions with them in order to ensure the accuracy of such information.

Sections 80A, 80-IA, and 10AA applicable to transactions. Section 92BA expands transfer pricing provisions even further.

• the certain transaction governed by section 80A.
• Certain transfer of goods or services governed by sub-section (8) of section 80-IA.
• any business transacted between all the Assessee and any other person referred to in sub-section (10) of section 80-IA.
• Transaction referred to in any other section under Chapter VI-A or section 10AA to which provisions of sub-section (8) or sub-section (10) of section 80-IA apply.

What exactly is Section 92?

As modified by the Finance Act of 2002, any revenue emerging from an international transaction, or when the international transaction consists only of an outflow, is subject to an allowance for such expenses or interest deriving from the foreign transaction based on the arm’s length price.

The regulations, on the other hand, would not apply if the use of an arm’s length pricing results in a reduction in the overall tax incidence in India for the parties participating in the foreign transaction.

Arm’s length price: In accordance with internationally accepted principles, it has been provided that any income arising from an international transaction, as well as any outgoing like expenses or interest arising from the international transaction between associated enterprises, shall be computed with regard to the arm’s length price, which is the price that would have been charged in the transaction if it had been entered into at arm’s length.

In accordance with Rules 10A to 10C and with video S.O. 808 E dated 21.8.2001, the price of arm length shall be established by a method of Section 92C.

ONE OF THE SPECIFIED METHODS CAN BE USED TO CALCULATES THE ARM’S LENGTH.

• Price approach that is comparable but uncontrolled.
• The procedure of determining a resale price.
• Method of cost plus
• Method of splitting profits
• Net margin method for transactions.

The taxpayer can choose the most appropriate method for any given transaction, but he or she must do so while considering the different variables set forth in the Rules.

Tax Planning, Tax Avoidance, and Tax Evasion

Judicial pronouncements

• CBDT has issued a press release regarding signing of Third Protocol between India and Singapore for amending the Double Taxation Avoidance Agreement (DTAA) for the avoidance of double taxation & prevention of fiscal evasion with respect to taxes on income.
• Gujarat High Court held that a reference to the Transfer Pricing Officer(TPO) can be made only after passing a speaking order disposing of the objections raised by the assessee. In this case, the reference was made without passing such a speaking order, the reference so made was invalid. [M/s Alpha Nipon Innovatives Ltd. Vs CIT]
• Income from vacant house property – income would not be assessed under Section 23(1)(c) but under Section 23(1)(a) – Punjab And Haryana High Court in case of [Susham Singla Vs. The CIT, Patiala].
• Whether the provisions of Section 36 and Section 43-B are mutually exclusive and the Assessee is legally entitled to claim deduction of employees’ contribution to provident fund and ESI u/s 43-B as amended vide FA, 2003, even if the said deduction was not admissible u/s 36(1)(va) – Held Yes – Allahabad High Court in case of [Sagun Foundry Private Limited Vs. CIT, Kanpur].

• More read: Taxation on Income from Equity and Debt Mutual Fund

• Maintaining Transfer Pricing Documentation (including carrying out benchmarkings on Public databases);
• Transfer Pricing Planning & Advisory;
• Assistance in TP assessments and Litigations such as preparing robust TP submissions, filing of DRP objections, etc.;
• Review of Form no. 3CEB, to include detailed notes which safeguards the interest of the CA;
• Assistance in filing of Application of Advance Pricing Agreements.