Article discusses about Meaning of specified domestic transaction, Nature of Transaction, Brief description of the transaction, Methods of computation of arm’s length price, Penalty under section 271(1)(c) & Illustration.
The provisions of transfer pricing are designed to keep a check on the practice of reducing the tax liability by entering into transactions at prices higher/lower than market prices with one or more associated entity.
As per section 92 when any specified domestic transaction is carried out between associated enterprises, the said transaction should be carried out at arm’s length price. In other words, income arising or allowance of any expenses to an entity resulting from specified domestic transactions with associated enterprise should be computed by having regard to arm’s length price of such transaction.
The provisions of section 92 will apply only if the aggregate value of specified domestic transactions entered into by the taxpayer during the year exceeds Rs. 20Cr.
E.g., Essem Ltd. took services of one of its group company, an associated enterprise enjoying tax holiday. The transaction is a specified domestic transaction). Essem Ltd. paid Rs. 28,40,00,000 for the said service to the group company. The arm’s length price of such service is Rs. 17,00,00,000.
In this case it can be observed that while computing its taxable income Essem Ltd. will claim deduction of Rs. 28,40,00,000 in respect of service charges paid to its associated entity.
The arm’s length price, i.e., the fair value of the service is Rs. 17,00,00,000 but by paying higher charges, Essem Ltd. claimed a higher deduction and reduced its profit by Rs. 11,40,00,000. In this case the provisions of section 92 will be applicable and the income of Essem Ltd. will be recomputed by taking into account the arm’s length price of the specified domestic transaction. In other words, the taxable income of Essem Ltd. will have to be computed by allowing deduction of only Rs. 17,00,00,000 on account of service charges instead of the actually paid amount of Rs. 28,40,00,000.
Suppose in the above example, the transaction is not a specified domestic transaction, then the provisions of section 92 will not apply.
Meaning of specified domestic transaction
For the above purpose, specified domestic transaction means any of the following transactions which is not an international transaction:
|Nature of Transaction||Brief description of the transaction|
|(i) 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.||Section 40A(2)(b) gives list of entities which are treated as related entities of a taxpayer, inter-alia, any relative of an individual taxpayer, director in the case of a company, a partner in the case of a partnership firm, etc.|
|(ii) Any transaction referred to in section 80A.||As per section 80A(6) when a taxpayer claiming deduction under various sections, inter-alia, sections 80-IA, 80-IAB, 80-IB, 80-IC, 80-ID, 80-IE etc., carries certain transactions with its associated entities, these transactions should be carried out at fair market value. So, if a transaction is covered under section 80A, then it will be treated as a specified domestic transaction.|
|(iii) Any transfer of goods or services referred to in sub-section (8) of section 80-IA.|
Section 80-IA provides for deductions in respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development, telecommunication services, power generation, etc.
Section 80-IA(8) covers inter-unit transfer of goods and services by an entity claiming deduction under section 80-IA.
|(iv) Any business transacted between the taxpayer and other person as referred to in sub-section (10) of section 80-IA.|
Section 80-IA provides for deductions in respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development, telecommunication services,power generation, etc.
A taxpayer claiming deduction under section 80-IA may enter into business transaction with other person with whom he has close connection. The transaction may be arranged in such a manner that the profit earned by the taxpayer from such transaction is more than the normal profit. By doing so the profit of other entity is diverted to the taxpayer and in tune the taxpayer will not pay tax on the profit so diverted (because he will claim deduction under section 80IA of higher profit). Such type of transactions are covered under section 80-IA(10).
|(v) any 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 are applicable.|
Section 10AA provides for exemption in respect of income generated by a unit located in Special Economic Zone.
Under Chapter VI-A there are various sections under which the taxpayer can claim deduction. Only those sections of Chapter VI-A are relevant to which the provisions of section 80-IA(8) and (10) are applicable.
Section 80-IA(8) and (10) have already has been discussed above.
|(vi) Any other transaction as may be prescribed||No other transaction prescribed as yet by CBDT under this clause.|
The above transactions will be treated as the specified domestic transaction only if the aggregate value of these transactions entered into by the taxpayer during the year exceeds Rs. 20 Cr.
Methods of computation of arm’s length price
As discussed earlier, a taxpayer should carry out specified domestic transactions at arm’s length price. Arm’s length price is to be determined by applying any of the following methods:
Penalty under section 271(1)(c)
Many times a taxpayer may try to reduce tax liability by concealing his income or by furnishing inaccurate particulars of his income. In such a case, by virtue of section 271(1)(c), the taxpayer shall be liable to pay penalty for concealing his income or for furnishing inaccurate particulars of his income.
Section 271(1)(c) provides that if the taxpayer has concealed his income or has furnished inaccurate particulars of his income, then he shall be liable to pay penalty which could be 100% to 300% of the taxes evaded.
As per Explanation 7 to section 271(1)(c), in the case of a taxpayer who has entered into a specified domestic transaction, any amount added or disallowed in computing the total income under section 92C(4), shall be deemed to represent the income in respect of which particulars have been concealed or inaccurate particulars have been furnished. However, such penalty would not be attracted if the taxpayer proves to the satisfaction of the tax authorities that the price charged or paid in such transaction was computed in accordance with the provisions contained in section 92C (*) and in the manner prescribed therein, in good faith and with due diligence.
(*) Section 92C deals with methods of computation of arm’s length price.
In other words, in case of specified domestic transaction if following conditions are satisfied, then penalty under section 271(1)(c) can be levied :
In the above case, income that has increased on account of arm’s length price will be treated as concealed income or income in respect of which the taxpayer has furnished inaccurate particulars and penalty under section 271(1)(c) will be levied at 100% to 300% of tax evaded or sought to be evaded due to such transaction.
However, no penalty will be levied if the taxpayer proves to the satisfaction of the tax authorities that :
Essem Ltd., an Indian company, is the subsidiary company of Shyamal Ltd. an Indian company. Essem Ltd. has purchased goods from Shyamal Ltd. @ Rs. 84 per unit. The same goods are purchased from unrelated entities @ Rs. 80 per unit.
Check the applicability of the transfer pricing provisions in the above case and advise the company on penalty provisions, if any, which could be initiated against it by the tax authorities (you may assume that the quantum of transactions exceeds Rs. 20 Cr. in aggregate).
The relationship of holding and subsidiary company is covered under section 40A(2)(b) and the quantum of transaction exceeds Rs. 20 Cr., hence, the transaction of purchase/sale of goods carried between these companies will constitute a specified domestic transaction.
In case of specified domestic transactions, if following conditions are satisfied, then penalty under section 271(1 )(c) can be levied :
In this case, Essem Ltd. has purchased goods from unrelated parties @ Rs. 80 per unit but the same are purchased from Shyamal Ltd. (related entity) @ Rs. 84 per unit. Hence, it can be observed that Essem Ltd. has purchased goods at a higher price. The higher price of Rs. 4 per unit will be disallowed and the tax authority will re-compute the profit of the company by allowing purchase price at Rs. 80 per unit.
Vide Explanation 7 to section 271(1)(c) the amount so added or disallowed, shall be deemed to represent the income in respect of which particulars have been concealed or inaccurate particulars have been furnished and penalty of not less than 100% but not exceeding 300% of the tax sought to be evaded can be levied.
In the above case no penalty will be levied if Essem Ltd. justifies the higher price being charged by its holding company and also satisfies the other conditions specified in this regard. Suppose goods were purchased from Shyamal Ltd. on credit basis whereas goods purchased from other party were on advance payment and, hence, Shyamal Ltd. charged a higher price of Rs. 4 to incorporate the effect of credit period.
In this case, if Essem Ltd. demonstrates the following than penalty will not be levied: