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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 - PowerPoint PPT Presentation
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Transfer Pricing Specified Domestic Transactions Study Circle Baroda Branch of WIRC 14 th May 2013
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Page 1: Transfer Pricing

Transfer PricingSpecified Domestic Transactions

Study CircleBaroda Branch of WIRC14th May 2013

Page 2: Transfer Pricing

• 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

Agenda

Page 3: Transfer Pricing

Introduction

Page 4: Transfer Pricing

• 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

Transfer Pricing - Background

Page 5: Transfer Pricing

S.P. Rs. 120Profit Rs. 20Tax 0%

Tax Avoidance - International

Co. A

Co. C

India

Co. B

S.P. Rs. 100Cost Rs. 90Tax @ 35%

Dubai

USA Co. B is 100% sub. Of Co. ACo. A Sells at Rs. 100 to BCo. B Sells at Rs. 120 to Co. CProfit by B is Rs. 20 (Tax Free)Maximum tax to Co. A of Rs. 3.5

Tax Heaven

Page 6: Transfer Pricing

S.P. Rs. 120Profit Rs. 20Tax 0%

Tax Avoidance - Domestic

Unit – 1 (Gujarat)

Unit – 2(Baddi)

S.P. Rs. 100Cost Rs. 90Tax @ 35%

• 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.

Tax Avoidance

Page 7: Transfer Pricing

7

Transfer Pricing in India

Page 8: Transfer Pricing

For Assessment

Year

Number ofTransfer Pricingaudits

completed

Number of cases

adjusted

Percentage ofadjustment

cases

AdjustmentAmount

(INR Crores)

2002-03 1,081 238 22% 1,373

2003-04 1,501 345 23% 2,575

2004-05 1,768 477 27% 3,861

2005-06 1,479 370 25% 4,950

2006-07 1,717 1,019 59% 9,743

2007-08 2,102 1,089 52% 24,000

2008-09 2,589 1,338 52% 44,500

Transfer Pricing Litigation in India

Page 9: Transfer Pricing

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

Page 10: Transfer Pricing

Snapshot of TP Provision92 Computation of income from international transaction

having regard to arm’s length price92A Associated Enterprise92B International Transaction

92BA Meaning of Specified Domestic Transactions92C Computation of Arm’s Length Price

92CA Reference to Transfer Pricing Officer92CB Safe Harbour Rules

92CC & 92CD Advance Pricing Agreement

92D Maintenance of information and documents92E Report from Accountant to be filed

92F Definitions of certain terms relevant to computation of arm’s length price

Page 11: Transfer Pricing

• Decision of the Appex Court in the case of Glaxo Smithkline 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

SDT - Background

Page 12: Transfer Pricing

– 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.

SDT - Background

Page 13: Transfer Pricing

• 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.

Specified Domestic Transactions

Page 14: Transfer Pricing

Related Party Transaction

Page 15: Transfer Pricing

• 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

40A(2) – Payments to related Parties

Page 16: Transfer Pricing

40A(2)(b) – Definition of Related party

Individual Assessee

Assessee

Husband / Wife

Sister

Brother

Where Assessee

has substantial

Interest

Lineal ascendantsdescendant

s

Whether these are related?1. Brother or Sister of

spouse2. Lineal ascendants –

descendants of the spouse

3. Brother or Sister of Parents

4. Lineal A-D of brother or sister of parents

5. And spouse of all of the above

6. HUF of the Assessee or his relative

Page 17: Transfer Pricing

40A(2)(b) – Definition of Related party

Tax Payer = Company, HUF, Firm, AOP

Tax Payer

Director / Partner/ member

Relatives

b(ii)

b(ii)Individual

Relatives

b(iii)

b(iii)

>20%

Company / Firm / HUF / AOP

>20%

Director / Partner/ member

Relatives

Company

>20%b(iv)

b(iv)

b(iv)

b(iv)

All companies where such individual is

director / partner / member

b(v)

Other Director / Partner/ member

Relatives

Person

b(v)

b(v)

>20%

PersonPerson

b(vi)

b(vi)

b(vi)

>20%

>20%

Page 18: Transfer Pricing

40A(2)(b) – Definition of Related party

Tax Payer = Company, HUF, Firm, AOP

Tax Payer

Director / Partner/ member

Relatives

b(ii)

b(ii)Individual

Relatives

b(iii)

b(iii)

>20%

Company / Firm / HUF / AOP

>20%

Director / Partner/ member

Relatives

Company

>20%b(iv)

b(iv)

b(iv)

b(iv)

All companies where such individual is

director / partner / member

b(v)

Other Director / Partner/ member

Relatives

Person

b(v)

b(v)

>20%

PersonPerson

b(vi)

b(vi)

b(vi)

>20%

>20%

>20%Company /

entity>20%

Page 19: Transfer Pricing

40A(2)(b) – Issues

Tax Payer = Company, HUF, Firm, AOP

Tax Payer

IndividualRelatives

15%15%

Page 20: Transfer Pricing

40A(2)(b) – Issues

Tax Payer = Company, HUF, Firm, AOP

Tax Payer10%

Company / Firm / HUF / AOP

Director / Partner/ member

Relatives

Company

10%

10%10%

10%10%

Page 21: Transfer Pricing

40A(2)(b) – Issues

• Whether sub-subsidiary and ultimate parent company is relative?

Co. A

Co. B Co. C

Co. X Co. Y

Transaction

Relative?

A & B YesA & C YesA & X NoA & Y NoB & C YesB & Y NoC & X NoX & Y No

Page 22: Transfer Pricing

Eligible Units / Undertaking

Page 23: Transfer Pricing

SDT – Tax Holiday Units Section Nature of Undertakings / units affected by SDT80IA Undertaking engaged in

• Development and maintaining of infrastructure • Generation / Transmission of Power• Reconstruction / revival of Power Generating plants

80IB Undertakings located / engaged in• Notified industrially backward districts• Scientific research & development• Refining mineral oil / generation of natural gas• Operating cold chain facility for agricultural produce, etc

80IC Undertaking located in notified Centre / Parks / Areas in• Sikkim, Himachal Pradesh / Uttaranchal• North-Eastern states

80ID Undertaking engaged in business of Hotel / Convention centers in specified areas / districts

80IE Undertaking in North-Eastern States10AA Undertakings having a unit in SEZ35AD ?????

Page 24: Transfer Pricing

SDT – Tax Holiday Units 80IA(8) 80IA(10)Inter-unit transaction of goods or services

• Business transacted with any person generates more than ordinary profits

• Owing to either close connection or any other reason

Applicable where transfer is not at market value

Applicable to tax holiday units earning more than ordinary profit

Onus on tax payer • Onus on tax authorities as well

Page 25: Transfer Pricing

• 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

Threshold Limit & Coverage

Page 26: Transfer Pricing

Transactions / Issues ChallengesSalary / Remuneration to Partners / Directors

• Benchmarking• Whether limits prescribed under Sec –

40(b) or Schedule XIII of Companies Act can be considered

Transfer of Land • Valuation as per “Jantri” can be considered?

Joint Development AgreementProject management fees

• Benchmarking • Cost Benefit Analysis

Allocation of Expenses between Units

• Covered by SDT?• Benchmarking

Definition of related party • Direct V/s Indirect relationshipCapital Expenditure • Covered by SDT?Sales of goods and services

• Comparability

Challenges

Page 27: Transfer Pricing

• 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?

Posers

Page 28: Transfer Pricing

• 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.

Posers

Page 29: Transfer Pricing

• 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

Posers

Page 30: Transfer Pricing

• The tax provisions and it impact on Economy

Economy and Tax Provisions

Incentivize

Encourage

RegulateTax

Subsidize

Page 31: Transfer Pricing

Case Studies

Page 32: Transfer Pricing

• 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

Case - 1

Page 33: Transfer Pricing

Case - 1Germany

India

XYZ Inc.USA

YZ Ltd.Subsidiary

X Ltd Z Ltd (10AA)

90% 25%

A Ltd Y Ltd

90%15%

20%

Page 34: Transfer Pricing

• 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

Case - 2

Page 35: Transfer Pricing

Case - 2

India

A Ltd.USA

B Inc.Interest Free

Loan

C Ltd D Ltd (10AA)

E Ltd (10AA)

Inte

rest

Fre

e Lo

an

Inte

rest

Fre

e Lo

an- Loan at 18%- ALP 11%

Corporate Guarantee (fees at 0.25% is

charged)

Corporate Guarantee (No fees is charged)

Page 36: Transfer Pricing

• 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

Case - 3

Page 37: Transfer Pricing

Case - 3C Ltd.

B Ltd

80%

100%A Ltd

(Assessee)

Mr. X

Mr. Y

Mr. Z

Mrs. Y Mr. F

D Ltd

10%

10%

10%

15%

Directors of A Ltd. Son of Mr.

Z

15%

YF (Partnership Firm)

50%

50%

Purchase of Raw

Material

Purchase of

Finished Goods

Consultancy Fees

Page 38: Transfer Pricing

Transfer Pricing Methods

Page 39: Transfer Pricing

Methods

Comparable

Uncontrolled Price Method

Resale Price

Method

Cost Plus Method

Profit Split Method

Transactional Net Margin Method

Transfer Pricing Methods

Page 40: Transfer Pricing

Methods

Comparable

Uncontrolled Price Method

Resale Price

Method

Cost Plus Method

Profit Split Method

Transactional Net Margin Method

Any Other Method (Rule 10AB)

Transfer Pricing Methods

Page 41: Transfer Pricing

• 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

Most Appropriate Method (MAM)

Page 42: Transfer Pricing

• 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 MAM

Page 43: Transfer Pricing

Comparability Analysis

Selection of Tested Party

Selection of Most Appropriate Method

Selection of Profit Level Indicator

Benchmarking

Stages of Economic Analysis

Page 44: Transfer Pricing

Selection of Tested Party

Comparability Analysis

Selection of Tested Party & Comparability Analysis

• 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 MAM

Page 45: Transfer Pricing

• Comparable Uncontrolled Price Method (CUP)

• Resale Price Method (RPM)• Cost Plus Method (CPM)

Price based

Methods

• Profit Split Method (PSM)• Transactional Net Margin Method

(TNMM)

Profit based

Methods• Any other method which takes into

account price charged or paid between uncontrolled parties considering all relevant facts

Other

Classification of Methods

Page 46: Transfer Pricing

Documentation

Page 47: Transfer Pricing

• Functions• Assets• Risks

• Comparability• Method Selection• Benchmarking

• Covered entities

• Covered Transactions

• Company• Group• Industry

Background

Information

Transactional

Information

Functional Analysis

Economic Analysis

Documentation Areas

Page 48: Transfer Pricing

What are the Documentation Requirements?

Entity Related Price Related Transaction Related

Profile of Group Terms of Transaction Agreements

Profile of Indian Entity Functional Analysis (FAR) Invoices

Profile of Associated Enterprises

Economic Analysis (Method Selection, comparables

benchmarking)

Price Mechanism, other pricing related

documents

Profile of Industry Forecasts, Budgets, Estimates

Correspondences (letters, emails, etc.)

Contemporaneous documentation requirement - Rule 10D Documentation to be retained for 9 years No specific documentation

requirement if the value of international transactions is less than 1 crore rupees

Page 49: Transfer Pricing

Indicative Documentation

Transaction entered

Documents to be maintained

Purchase/ sale of raw material

• Invoices• Purchase/ Sale order• Product details• Sale details if sold to 3rd

Party

• Pricing strategy• Proof of price

negotiation• Quotes from

competitors• Terms of payment

Remuneration to Directors

• Qualification• Work Experience & Profile• Minutes of Meeting

authorizing the director’s remuneration

• Data from HR firms for Directors in the same line of business

Corporate cost sharing

• Nature of expenses• Auditor’s certificate

allocating the expenses

• Basis of allocation between the companies

• Proof of usage (rendering) of services

• Cost benefit analysis

Page 50: Transfer Pricing

Indicative Documentation

Transaction entered

Documents to be maintained

Rent paid toward use of premises

• Rent receipts• Documents suggesting

the rent of the surrounding area

• Rental agreement• Fair market value of

the property (municipal valuation, only if higher than the actual rent paid)

Reimbursement ofexpenses

• Nature of expenses with detailed break-up

• Reason of expense incurred for

•Employee details• Actual invoices of the

expense

Interest on loan (non-financial services company)

• Basis of determination of interest rate

• Interest Rate Card for the period of loan

• Loan agreement• Basis on which the

interest rate is pegged above standard rate

Page 51: Transfer Pricing

Procedures

Page 52: Transfer Pricing

Sr. No. Compliance Timeline Relevant Provision

1. Filing Accountants Report along with Tax Return, Maintenance of Documentation 30 Nov. 2013 Section – 92E r.w. Section –

139(1)

2. Limitation for Initiating transfer pricing audit by the tax administration 30 Sep. 2014 Proviso to Section – 143(2)(ii)

3. Limitation for completing transfer pricing audit 31 Jan. 2017 Section – 92CA(3) r.w. Second

Proviso to Section – 153(1)

4. Limitation for Completing regular assessment

31 Mar. 2017If 144C

BY 31 May 2017

Second Proviso to Section -153(1)

5. Limitation for Re-Assessment (where income escaped < Rs. 1,00,000) 31 Mar. 2018 Section – 149(1)(a)

6. Limitation for Re-Assessment (where income escaped ³ Rs. 1,00,000) 31 Mar. 2020 Section – 149(1)(b)

7. Date till which documentation is required to be maintained 31 Mar. 2021 Section – 92D and Rule –

10D(5)

Transfer Pricing Compliance Timeline – Illustration for March 2013

Page 53: Transfer Pricing

Compliance Penalties SectionFiling of Accountants Report (specified form)

Rs. 1,00,000 271BA

Reporting SDT and Int. Transactions

2% of value of transactions not reported

271AA

Maintenance of Documentation

2% of value of transactions for which documentation is not maintained

271AA

Furnishing correct information

2% of value of transactions for which incorrect or no information is furnished

271AA

Failure to furnish information or documents as required under 92D(3)

2% of value of transaction for each such failure

271G

Penalties

Page 54: Transfer Pricing

Audit ProcessFile tax return and Accountant’s Report (30th November)

Reference to be made to TP Officer (‘TPO’) by the Assessing Officer (‘AO’); Compulsory Reference to be made by AO if international transactions exceed INR

1500 million for AY 2005-06 onwards (Internal guidelines)

Based on results of above mentioned procedure assessing officer passes the order

TP Audit

Notice to be issues by the TPO - TPO calls for supporting documents and evidence

Rectification application can be made against the

order of TPO for apparent mistake

Appeal can be made against the order of AO

as order of TPO included within the order of the

AO

DRP Mechanism- Finance Act 2009

Appeal Procedure

Appeal to Commissioner of Income Tax

Passes an order

Income Tax Appellate Tribunal

High Court - only on matters related to law

Supreme Court

Constitutional Bench

Page 55: Transfer Pricing

Questions

Page 56: Transfer Pricing

Thank You

Prashant Kotecha

Office: +91 265 3086467Mobile: +91 98251 53981Email: [email protected]


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