Rohan N. Popat

Rohan N. PopatEvolvement and Need

♣ Transfer Pricing is the setting of the price for goods and services sold between controlled/related legal entities. It is generally aimed at depicting favourable performance of a conglomerate by shifting earnings from a high tax jurisdiction to a low-tax one.

Before introduction of the provisions pertaining to the Domestic Transactions, section 40A(2)(b) well empowered the AO to disallow payments made to related persons for expenses if found excessive/unreasonable, having regard to its FMV. Similarly, sections 10AA, 80A, 80IA, 80IB etc. have also provided that if there are any transactions of purchases, sales etc. between two related persons, the AO could apply FMV and make adjustments. But these sections were vague on determination of FMV.

In year 2010, the SC of India in case of Glaxo Smithkline carved out the necessity of expeditious consideration by the MoF on extension of Transfer Pricing regulations to domestic transactions owing to increasing number of cooked transactions wherein two related entities take benefit of the tax arbitrage by shifting profits to such entity which either is loss making or liable to pay tax at a lower rate.

Introduction of the International Transfer Pricing provisions vide Finance Act, 2001 had proven to be an affirmative step towards applying breaks on colourable practices adopted by numerous entities to avoid instance of tax by adjusting transactions carried out internally.

Therefore the said provisions were mutatis mutandis made applicable to Specified Domestic Transactions [SDTs] vide the Finance Act, 2012.

Tracking the Law

Major governing provisions of this scheme are explained as follows:

The Finance Act, 2012:

  • Scope expanded to include SDT vide Section 92 which inter alia says, “…. Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to the S shall be computed having regard to the arm’s length price.“
  • SDT defined under section 92BA as “…. Any of the following transactions, not being an international transaction, namely:
    • any expenditure in respect of which payment has been made or is to be made to a person referred to in section 40A(2)(b);
    • any transaction referred to in section 80A;
    • any transfer of goods or services referred to in  section 80-IA(8);
    • any business transacted between the assessee and other person as referred to in section 80-IA(10);
    • any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which section 80-IA(8) or section 80-IA(10) are applicable;
    • any other transaction as may be prescribed.
  • These transactions will be regarded as SDT only if the aggregate value of all the transactions exceeds the threshold limit of 20 crores INR [increased from 5 crores INR vide Finance Act, 2015].
  • According to section 92C, ALP shall be determined by any of the following methods, being the most appropriate method, namely:
    • comparable uncontrolled price method;
    • resale price method;
    • cost plus method;
    • profit split method;
    • transactional net margin method;
    • such other method as may be prescribed.
  • Section 92CA empowers the AO to refer the case to the TPO with regard to the computation of ALP.
  • This chapter not to apply if by application of the same, income gets reduced or losses get increased.
  • Impact of the aforesaid provisions:
    • A common practice among the corporates enjoying tax holidays to park excess profits in tax – exempted units shall be curbed.
    • Normally, indirect or head office expenses are charged to the unit enjoying tax holiday, due to which excessive profit arises to that unit. This scenario stands taken care of.
    • The AO shall determine ALP of such transactions either himself or with the assistance of the TPO, by using one of the methods specified.
    • Allowance of expenses as well as computation of income shall be at ALP.
    • No deduction shall be allowed on the income so increased and also the income of the other entity shall not be recomputed consequently.

The Finance Act, 2013:

  • Sections 153 and 153B, inter alia, provide for the time-limits for completion of assessment and reassessment under different situations. The same get extended if a reference is made to the TPO during the course of assessment / reassessment proceedings. These limits were earlier extended by 3 months w.e.f. July, 2012. The above provisions have been further amended w.r.e.f. July, 2012, due to which the limits as just mentioned will be applicable regardless of the fact (a) whether a reference to the TPO or (b) whether the order of the TPO is made before, on or after July, 2012.
  • It was expected that the Budget this year would address some of the challenges and rationalise compliances. However, no suchr modifications were made.

The Finance Act, 2014:

  • Introduction of the Range concept for determination of ALP introduced was long awaited.
  • It shall be allowed to use multiple years data for margin analysis of the comparables and to benchmark
  • Impact of the aforesaid provisions:
    • The focus of the Govt. can be seen to be on reducing large scaled litigation.
    • Roll back provisions have been introduced in relation to Advance Pricing Agreements, which however are not applicable for SDTs.
    • Use of multiple years data had been on the wishlist of the tax payers and trade bodies right from the very inception. Thus, it is a welcome move to align Indian regulations with the OECD Guidelines.
    • The tone and approach of the Govt. is expected to improve the confidence of both tax payers as well as investors and seems to be a Win – Win situation for the Govt. too.
    • As of now, the CBDT has issued draft scheme containing provisions for the aforesaid. This may lead to complexities, which may breed more litigation. However, the scheme is still a draft, and a turnaround is possible. A simplified approach of broadening the range would serve the purpose. In addition, in line with global best practices, if the Govt. allows use of the range in relation to all methods, it would be an extra enhancement!

The Finance Act, 2015:

  • The threshold limit of SDTs as laid down under section 92BA increased from 5 crores to 20 crores INR.
  • Impact of the aforesaid provision:
    • To spare small entities from unnecessary compliances and hassles, this was a necessary change.
    • This amendment will take a major number of assesses out of the ambit of this Chapter.
    • On the other hand, there will be bit lesser audit requirements and hence lesser opportunities for the professionals!

Compliance and Documentation

  • As per section 92D, every person entering into an SDT, shall keep and maintain such information and documents as prescribed in Rule 10D of the Income-tax Rules.
  • As per Section 92E, an assessee has to get a CA’s Report, in Form 3CEB, which shall be filed with the Dept. electronicallyon or before 30th November of the respective A.Y. This Report covers the details of related parties, nature and values of SDTs, method used to determine ALP, stand taken with regard to certain transactions not considered as SDTs, so on and so forth.
  • Penal provisions for non- compliance:
    • Section 271(1)(c): If income gets increased due to adjustment of ALP, penalty ranging from 100 to 300% of the amount of tax sought to be evaded, shall be levied.
    • Section 271AA: If any person in respect of an SDT: (a) fails to keep and maintain such information and document as required by section 92D; (b) fails to report such transaction which he is required to do so or (c) maintains or furnishes an incorrect information or document, penalty equal to 2% of the value of SDT entered into shall be levied. No penalty was levied when any transaction escaped from the Report in Form 3CEB. However this section has been amended vide Finance Act, 2012 to overcome this defect. It is notable that section 147 can be invoked even when a single SDT has not been so reported.
    • Section 271BA: If any person fails to furnish a Report as required by section 92E, penalty of 1 lakh INR shall be levied.
    • Section 271G: If a person fails to furnish information or document as referred to in section 92D, penalty equal to 2% of the value of SDT entered into shall be levied. The TPO shall be empowered to levy penalty under this section in addition to the AO and Commissioner (Appeals) vide the Finance Act, 2014.

Comparision with International Transfer Pricing 

Some of the major differences between the two are as below:

  • A key feature of the International Transfer Pricinge. Advance Pricing Agreements is absent from the scheme of Domestic Transfer Pricing.
  • Safe Harbour regime is kept restricted to International transactions only.

Practical Considerations

  • Granting of interest-free loans guarantees to group companies.
  • Benchmarking requirement for remuneration etc. made to Directors, Chairman, CFO etc.: It is difficult for an entity to benchmark the payment made to their key personnel. For instance, it is tough for the Reliance Industries to justify payments made to Mr. Ambani, as it is not possible to find a comparable instance and one cannot compare the above payment with those made by other business groups. Delhi HC in case of CIT vs. India Thermit Corporation [cited at ITA/350/2011] has held that when commission paid to the Director etc. was in accordance with the provisions of the Companies Act, the AO cannot make any disallowance on this account. Inspite of such rulings, this issue is litigation prone.
  • Intentional double taxation arises when one entity suffers ALP adjustment and the other entity cannot recompute its income correspondingly.
  • Difficulty in applying any particular method for computation of ALP in a non-standardized environment.
  • Whether regulatory / corporate governance approvals can be considered as an evidence of arm’s length conditions or not.
  • Avoidance of conflicts with home and host governments over tax issues and repatriation of profits.
  • Internal concerns regarding goal congruence or subsidiary management motivation.
  • Necessity of appropriate cost allocation drivers for common expenditure; reliability of the same may be questioned by the Revenue.
  • Requirement for contemporaneous documentation.
  • With the ongoing amendments in this arena, a lot of ambiguity and confusion have paved in the Industry. However, there are various vendors who provide easy to use softwares for computation of ALP and to effectively analyze comparables so as to arrive at a Benchmark Transfer Pricing system. In support of this, the Hon’ble ICAI has joint hands with such vendors for facilitating procurement of such softwares for members who can access it at reasonable rates. Even ICAI promotes the use of these softwares by sensitizing the professionals about them during seminars it conducts from time to time. Some of the widely used softwares are: OneSource, Capitaline, ACETP etc.
  • Other sources to derive comparables are internal reports, external information i.e. websites, magazines, public databases, market surveys etc. Prowess is an excellent source of database of the financial performance of Indian companies which comes in handy for this purpose.

From the Judiciary

  • Vodafone India Services Pvt. Ltd. – Bombay HC [2014]
  • Shell India Markets Pvt. Ltd. – Bombay HC [2014]
  • According to legal experts, the rulings in the Shell case follows from the HC’s decision in the Vodafone case, which had said that the transfer-pricing regulations would not be applicable if there is no income component involved in the transaction.
  • Sony Ericsson Mobile Communications India Pvt. Ltd. – Delhi HC [2015] – The bright line test has no statutory mandate and a broad-brush approach is not mandated or prescribed.
  • Wrigley India Pvt. Ltd.ITAT Delhi [2014] – To apply the Cost Plus method, there must be a comparable uncontrolled transaction.
  • EXL India Business Services Pvt. Ltd.ITAT Delhi [2014] – After the expiry of the time limit for issuance of notice under section 143(2), the AO has no jurisdiction to make a reference to the TPO. The TPO’s report cannot form the basis for reopening the assessment.

A Bird’s Eye View

  • The Finance Act, 2012 and series of amendments.
  • SDT: Meaning, Threshold.
  • Denial of tax incentives for ALP adjustments made.
  • ALP: Computation and Range concept
  • Reference to the TPO.
  • Domestic Transfer Pricing kept out of APA & Safe Harbour regime.
  • Documentation as well as CA’s Report in Form 3CEB.
  • Stringent
  • Hurdles being faced: Benchmarking transactions, Determination of Comparables, Remuneration to Key Personnel, Double Taxation.
  • Rulings: Shell, Vodafone etc.

Summing up and the Way Ahead:

  • It is well understood that Transfer Pricing can impact shareholders’ wealth as it influences distribution of income. This is why the role of specialists and auditors is becoming indispensable.
  • Amazon, Adobe, Hewlett-Packard, Microsoft and other multinationals have made headlines because of Transfer Pricing disputes amounting from tens of millions to upward of a billion dollars.
  • It is pertinent for the Govt. to bring about a clarification on all such issues so that these provisions can achieve the purpose for which they were introduced.
  • Perfect balancing required while reorganizing the businesses – Income-tax vs. Indirect taxes.
  • Need to consider a long term approach in light of the forthcoming statutes i.e. GAAR, GST.
  • In backdrop of what has been stated so far, one can fairly say that India has yet some miles to travel to reach the sweet spot.

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