Specified Domestic Transactions – Overview of Transfer Pricing implications

The related party transactions have always been under the close scanner of the Tax Authorities. Owing to the inherent nature of such transactions it is believed that such transactions are by far the most convenient way of shifting profits and accordingly subjected to detailed scrutiny by the Tax Authorities. The international transactions have been under Chapter X of Income Tax Act, 1961 (‘Act’) – Transfer Pricing provisions since 2001, considering the related party transactions being one of the tools for profit shifting even certain domestic transactions were brought under the Chapter X of the Act through Finance Act 2012.

Section 92BA of the Act provides as under:

For the purposes of this section and sections 92, 92C, 92D and 92E, “specified domestic transaction” in case of an assessee means any of the following transactions, not being an international transaction, namely:-

(i) [***]

(ii) any transaction referred to in section 80A;

(iii) any transfer of goods or services referred to in sub-section (8) of section 80-IA;

(iv) any business transacted between the assessee and other person as referred to in sub-section (10) of section 80-IA;

(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; or

(va) any business transacted between the persons referred to in sub-section (6) of section 115BAB;

(vi) any other transaction as may be prescribed, and where the aggregate of such transactions entered into by the assessee in the previous year exceeds a sum of twenty crore rupees.

Section 80A(6) of the Act provides as under:

Notwithstanding anything to the contrary contained in section 10A or section 10AA or section 10B or section 10BA or in any provisions of this Chapter under the heading “C.—Deductions in respect of certain incomes”, where any goods or services held for the purposes of the undertaking or unit or enterprise or eligible business are transferred to any other business carried on by the assessee or where any goods or services held for the purposes of any other business carried on by the assessee are transferred to the undertaking or unit or enterprise or eligible business and, the consideration, if any, for such transfer as recorded in the accounts of the undertaking or unit or enterprise or eligible business does not correspond to the market value of such goods or services as on the date of the transfer, then, for the purposes of any deduction under this Chapter, the profits and gains of such undertaking or unit or enterprise or eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods or services as on that date.

Explanation.—For the purposes of this sub-section, the expression “market value”,—

(i) in relation to any goods or services sold or supplied, means the price that such goods or services would fetch if these were sold by the undertaking or unit or enterprise or eligible business in the open market, subject to statutory or regulatory restrictions, if any;

(ii) in relation to any goods or services acquired, means the price that such goods or services would cost if these were acquired by the undertaking or unit or enterprise or eligible business from the open market, subject to statutory or regulatory restrictions, if any;

(iii) in relation to any goods or services sold, supplied or acquired means the arm’s length price as defined in clause (ii) of section 92F of such goods or services, if it is a specified domestic transaction referred to in section 92BA.

The relevant extract from the provisions of Section 80-IA has been provided as under:

(8) Where any goods or services held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods or services held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods or services as on the date of the transfer, then, for the purposes of the deduction under this section, the profits and gains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods or services as on that date :

Provided that where, in the opinion of the Assessing Officer, the computation of the profits and gains of the eligible business in the manner hereinbefore specified presents exceptional difficulties, the Assessing Officer may compute such profits and gains on such reasonable basis as he may deem fit.

Explanation.—For the purposes of this sub-section, “market value”, in relation to any goods or services, means—

(i) the price that such goods or services would ordinarily fetch in the open market; or

(ii) the arm’s length price as defined in clause (ii) of section 92F, where the transfer of such goods or services is a specified domestic transaction referred to in section 92BA.

            ………..

(10) Where it appears to the Assessing Officer that, owing to the close connection between the assessee carrying on the eligible business to which this section applies and any other person, or for any other reason, the course of business between them is so arranged that the business transacted between them produces to the assessee more than the ordinary profits which might be expected to arise in such eligible business, the Assessing Officer shall, in computing the profits and gains of such eligible business for the purposes of the deduction under this section, take the amount of profits as may be reasonably deemed to have been derived therefrom:

Provided that in case the aforesaid arrangement involves a specified domestic transaction referred to in section 92BA, the amount of profits from such transaction shall be determined having regard to arm’s length price as defined in clause (ii) of section 92F.”

The extract from the provisions of Section 115BAB has been provided as under:

(6) Where it appears to the Assessing Officer that, owing to the close connection between the person to which this section applies and any other person, or for any other reason, the course of business between them is so arranged that the business transacted between them produces to the person more than the ordinary profits which might be expected to arise in such business, the Assessing Officer shall, in computing the profits and gains of such business for the purposes of this section, take the amount of profits as may be reasonably deemed to have been derived therefrom:

Provided that in case the aforesaid arrangement involves a specified domestic transaction referred to in section 92BA, the amount of profits from such transaction shall be determined having regard to arm’s length price as defined in clause (ii) of section 92F:

Provided further that the amount, being profits in excess of the amount of the profits determined by the Assessing Officer, shall be deemed to be the income of the person.

On perusal of the same, it is clear that the transactions discussed above (discussed in detail later) and exceeding the threshold of Twenty crores in aggregate shall be subject to TP provisions. One may note that the sub-clause (i) which was in relation to the related party transactions u/s 40A(2)(b) was omitted vide Finance Act 2017 and basis the various judicial precedents it may be reasonable to consider that the said provisions had been omitted since it’s inception without having any saving clause in the amendment. The ruling of Texport Overseas Private Limited by the Karnataka High Court supports the view that the said provisions have been omitted since its inception and accordingly shall not be subject to TP provisions under the Act, however, the possibility of litigation in this regard cannot be ruled out especially at the first level i.e. AO/TPO. It may also be noted that the same does not restrict to AO to examine the same under the other provisions of the Act.

Let’s now discuss in detail clause by clause the applicability of transfer pricing provisions in respect to specified domestic transactions (‘SDT’).

Clause	Provisions	Understanding*
ii	any transaction referred to in section 80A	On perusal of the sub-section 6 of 80A, it may be noted that the transaction undertaken by unit/undertaking/eligible business with other units/undertaking/eligible business for which consideration shall be in accordance with fair market value/ arm’s length price as per provisions of the Act. Accordingly, such transactions shall be in the ambit of SDT. It may be noted that the transaction has to be undertaken by the eligible unit/ business of the assessee i.e. the one for which the assessee is claiming the deduction/ exemption with the other business (can be eligible or not) to fall within the ambit of this clause. (Refer Note 1 too)
iii	any transfer of goods or services referred to in sub-section (8) of section 80-IA	The said clause is in relation to the inter-unit transfer of goods or services by the eligible business of assessee to its other business of same assessee i.e. different unit/ undertaking and the value of the same shall be determined considering the market value. The said provisions are similar to 80A(6) discussed in the clause above. (Refer note 1 too)
iv	any business transacted between the assessee and other person as referred to in sub-section (10) of section 80-IA	The said clause is in relation to the transactions undertaken between assessee carrying on eligible business with person having a close connection with such assessee and where such transaction is resulting in more than ordinary profits to the assessee. Now here it may be noted that the ambit of the person with whom the transaction is undertaken is quite wide as it does not say about the associated enterprises only but any person with whom there is a close connection. The term close connection has not been defined under the Act and accordingly, any person considered as having significant influence/ control or relation may be characterized as a person with a close connection (conservative approach). Further, it may be noted that the transactions covered are the ones which are resulting in more than ordinary profits to the assessee. (Refer note 1 and 2)
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	The said clause basically covers all the transactions of nature discussed in clauses iii and iv above where the assessee is undertaking eligible business subject to deduction under Chapter VI-A or 10AA. (Refer note 1 and 2)
va	any business transacted between the persons referred to in sub-section (6) of section 115BAB	This has been new insertion u/s 92BA and is in relation to the manufacturing entities recently established and claiming the benefit of 15% tax rate. The said provisions are similar to clause iv discussed above and shall apply if the transactions have been undertaken with person having close connection and resulting in more than ordinary profits. (Refer note 1 and 2)
vi	any other transaction as may be prescribed	Residual clause and currently there has been no transaction specified under this clause

*The aggregate of the transactions covered under provision of Section 92BA shall exceed INR 20 crores for Chapter X to apply.

Notes

1. There has been a lot of debate around the transactions between the Head office or corporate office with the eligible business and the allocation of general overheads shall be within the ambit of SDT or not. It may be noted that the activities which does not qualify as business activity or services that are not marketable in nature may not qualify as transactions subject to SDT, accordingly, the TP provisions may not apply. For example, the general accounting, payroll or HR functions may not be core functions of business accordingly not subject to TP. However, this being a fact specific exercise has to be seen on case to case basis. Conservatively, the transaction undertaken with person having close connection and allocated to eligible business may be benchmarked and reported.

Further, non-applicability of TP to certain transaction does not mean they are outside the ambit of allocation of such charges to eligible business while determining profitability of the said business. Therefore, the cost allocation should be based on reasonable allocation basis and supported by robust documentation.

2. The transactions covered u/s 80-IA(10) are the ones that satisfy the following conditions:

a. Transaction undertaken with person having close connection with the assessee; and

b. Transaction results in more than ordinary profits

Accordingly, if the above two conditions are not satisfied then such transactions may not fall within the ambit of SDT, however, considering the penal consequences of non-reporting, practically, the companies eligible for deduction are maintaining the TP documentation to support the transactions have not resulted in more than ordinary profits and reporting the same in Form 3CEB on conservative basis.

3. The concept of more than ordinary profit is not same as the concept of arm’s length price. It may be reasonable to say that the arm’s length price may denote that the transactions have been undertaken at value which is similar to the value, had it been undertaken between independent parties. The transactions undertaken at value different than arm’s length price may not necessarily means that the transactions result in more than ordinary profits. There may be other factors contributing to higher profits and if the assessee can substantiate the same, then the same may not be under the ambit of SDT.

The same has been depicted through a diagram below:

FAQs

1. Whether the international transactions are considered for the purpose of threshold?

No, the transaction falling u/s 92BA are only aggregated to evaluate the 20 crores threshold and all international transactions shall be ignored for the computation of threshold or applicability of SDT provisions.

2. Whether the transactions such as interest income, dividend, etc. be considered while evaluating the threshold?

Usually No, as the transactions in the nature of interest income, dividends are generally not related to the core business activity or the eligible business, hence, the same may not impact the taxable income of eligible undertaking/ unit. Therefore, a view may be taken that the said transaction does not lead to base erosion, and hence, the said transactions are not liable to be considered under the threshold of INR 20 crores. The said view is also supported by the Supreme Court ruling in the case of Glaxo Smithkline Asia P Ltd where the Hon’ble Supreme Court held that the transactions being revenue neutral in nature shall not be subject to disallowance. Accordingly, the said transactions may not be subject to Transfer Pricing.

However, if the said transactions are eligible for deduction under Chapter VI-A or 10AA, then the same shall be governed by the provisions of Section 92BA and accordingly subject to TP if the INR 20 crores threshold is breached.

3. Whether the compliances need to be undertaken by both parties with respect to transactions covered u/s S.92BA?

No, the assessee who is eligible for claiming the deduction/ exemption is required to undertake the TP compliances i.e. file Form 3CEB and maintain TP study to support the fair market value/ price not resulting in more than ordinary profits.

4. The assessee eligible for deduction but not claiming the same, shall be required to comply with TP provisions for SDT?

Here it is to be noted that the assessee eligible for a deduction has the option to choose between the years for deduction under relevant provisions of the Act or not. Basis the same there shall be two scenarios

a) Entity has the option to chose the year of the beginning of deduction: In such a case the entity prior to the beginning of the eligible period may not be subject to TP provisions. Once the option is exercised the entity shall fall within option b below

b) Entity does not have the option to chose the year of deduction: In such a case the entity is eligible for deduction from the first year itself and even if the entity does not claim the deduction it may be required to comply with the TP provisions as the same may impact the future deduction.

5. Whether the purchase of a capital asset from related party/entity with close connection in the ambit of SDT or not?

There may be two views in respect to the said transaction:

a) Purchase of capital asset is SDT

The capital asset amount is not charged to profit and loss accounts other than through depreciation over a period of years. Accordingly, the capital asset acquisition to be at fair market value is essential so as to avoid the depreciation charge being unreasonable.

It is well understood in the context of incentive deduction and/or amortization provisions under the Business Chapter, that the term ‘expenditure’ will include both revenue and capital expenditure. Wherever Legislature intended to exclude capital expenditure from the scope of ‘expenditure’ it has specifically provided so. Refer for example, sections like 35(1)(i), 36(1)(xii), 37(1), etc. The language used in these provisions is ‘any expenditure (not being in the nature of capital expenditure)’. Since such specific exclusion is absent in s. 92BA, it can be reasonably inferred that it includes even capital expenditure.

Now the question arises that whether the said is to be benchmarked in the year of acquisition or year of put to use when the depreciation shall be charged to P&L A/c. Considering the practical difficulty in benchmarking the same at the time of put to use since there may be cases where the asset takes time before it is put to use, therefore, the said transaction shall be benchmarked at the time of acquisition.

b) Purchase of capital asset not being SDT

It may be noted that the legislature intends to apply specific provisions to capital expenditure, it has specifically provided in the law. Refer, for instance, sections like 35(1)(v) which refers to:

“in respect of any expenditure of capital nature on scientific research…..”

Similar provisions exist where different norms for allowability of deduction of revenue and capital nature are specified. Refer for instance s. 36(1)(ix) which allows a full deduction for revenue expenses and 1/5 th for capital expenditure incurred on promoting family planning among employees. Therefore, since the transaction has not been specifically dealt u/s 92BA the capital expenditure may be outside the purview of SDT.

Now on perusal of both the arguments, a view may be taken in support of either option, however, view a) being conservative as well as more supportive of legislative intent to restrict base erosion/ profit shifting considering that the capital transactions may impact the taxable income in future years may be benchmarked and reported in Form 3CEB/TP Study. The view discussed in clause b) above may be taken as well, however, the possibility of litigation in this regard cannot be ruled out.

6. As Section 40A(2)(b) has been omitted from S. 92BA, therefore outside the purview of SDT, will the entity be required to maintain documentation to support the fair market value?

It may be noted that though the 40A(2)(b) transaction are outside the ambit of TP, the entities having substantial RPT value may consider maintaining documentation to support the Fair market value or arm’s length price as the same may be questioned by the AO during the assessment proceedings. Further, such documentation shall also provide support under other laws as well such as Good and services Tax Act 2017, Companies Act 2013, etc.

It may be further noted that this being completely voluntary exercise the same is not mandated under the Act with respect to 40A(2)(b) transactions and it is the decision of the management basis their past litigation history/experience as well as the organization governance policy in respect to related party transactions.

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Disclaimer: Nothing contained in this document is to be construed as a legal opinion/ advice or recommendation and the content is to be used strictly for educative purposes only. Further, there can be different views with respect to the matters discussed above and any decision shall be taken only after considering the provisions of the Act, judicial precedents and post detailed deliberation with your tax advisor.