prpri Secondary Adjustment: An exploration of path less traversed with a dash of GST Secondary Adjustment: An exploration of path less traversed with a dash of GST

‘The oranges upon the trees in California are not acquired wealth until they are picked, not even at that stage until they are packed, and not even at that stage until they are transported to the place where demand exists and until they are put where the consumer can use them. These stages, upto the point where wealth reached fruition, may be shared in by different territorial authorities.’

The aforementioned paragraph brings out the essence of the conflict between the states (residence and source states) over the right to taxation.

A multinational enterprise (MNE) may have entities setup in various countries, each performing a specific function. When there are dealings between entities forming part of the same group (Associated Enterprises or AEs), transactions may be structured in a manner that the majority of the profits of the group are taxed in the country where the tax rates are minimal, thereby reducing the tax cost for the group as a whole. Thus, the price at which transactions take place between entities forming part of a group (i.e. Transfer Price (TP)) gains relevance.

The Organization for Economic Co-operation and Development (OECD) guidelines for determining the Arm’s Length Price (ALP i.e. the price at which the transaction would occur between unrelated parties, everything else remaining constant) of transactions between related entities are based on the premise that the profits of a MNE must be allocated amongst the respective states in proportion to the assets used, risks assumed and functions performed.

Secondary adjustment under Indian TP rules

The introduction of provisions relating to secondary adjustment in the Indian TP rules is a step in the direction of evolving the Indian TP landscape in line with international best practices.

In cases where the underlying transaction is held not to be at arm’s length, an adjustment to taxable income is made to align the transfer price with the arm’s length price (ALP) which is known as primary adjustment.

Thus, a cash benefit accumulates from the non-arm’s length pricing of the underlying primary transaction (i.e. the other AE has effectively retained such excess/differential funds)

Section 92CE was introduced to tackle this cash benefit and ensure that such excess funds are repatriated to India. It, inter alia, provides that the assessee shall be required to carry out secondary adjustment in certain scenarios if the excess money (difference between ALP and the actual transfer price) is not repatriated into India within a prescribed time limit.

The secondary adjustment contemplated in this provision involves deeming the excess money that is not repatriated into India within the prescribed limit as an advance to the AE and an interest would be imputed on such advance. This will result an adjustment/addition to income in the hands of the assessee on account of such interest. The interest would be so imputed till the

Alternatively, the assessee has an option to pay additional income-tax at the rate of 18% on such excess money or part thereof. In such a case, the calculation of interest, as mentioned above, will only be done till the date of payment of additional income-tax.

It appears that the interest imputation will happen year-on-year till the excess money is repatriated to India. Considering such a scenario, assesses may prefer opting to pay tax @18% rather than having to deal with the adjustment on account of interest every year till the excess money is repatriated into India

The tax so paid shall be the final payment of tax and no credit shall be allowed in respect of the amount of tax so paid.

Example – An Indian Company, I Co, sells certain products to its associated enterprise (AE), F Co, for ₹ 1,000, whereas the arm’s length price (ALP) of such sale transaction is ₹ 1,500. Given the difference between the transfer price (₹ 1,000) and the ALP (₹ 1,500), an upward (primary) TP adjustment will be carried out to the extent of INR 500, which will be added to the taxable income of I Co.  Subsequently, for the purpose of carrying out secondary adjustment, it would be deemed as if F Co. owes ₹ 500 to the I Co. (being the difference between ALP and actual transfer price), which will be deemed to be a loan or an advance by I Co to F Co. Interest as per the prescribed method would be imputed on such advance of ₹500 in the hands of I Co. Alternatively, the assessee has an option of paying tax @ 18% on ₹500.

 However, the secondary adjustment is not required to be made if the amount of primary adjustment made in any previous year does not exceed one crore rupees.

Aspects worth deliberating upon – Income Tax

1. Suo-motu adjustments may be discouraged –With the primary adjustments made suo-motu by the taxpayer in their return of income being subject to secondary adjustment, taxpayer may be discouraged to carry out such adjustments on their own accord and thereby resulting in a loss of revenue at the self-assessment stage.

2. Disputed Primary Adjustment-The intention to execute secondary adjustment may only be in respect of such primary TP adjustments which have attained finality.  However, the language of the section in 92CE(1)(ii) leaves room for another interpretation, though literal. Does this mean that a primary adjustment that is disputed before judicial fora falls completely outside the ambit of secondary adjustment or is the secondary adjustment merely postponed till the time the dispute on primary TP adjustment is finally adjudicated (and not further litigated by taxpayer)? Clarity from the legislature on this front would be much appreciated.

3. 1 Crore threshold as per 92CE(1) –

a. Per Adjustment vs Per previous year – The limit of 1 crore is to be computed on an aggregate basis for a previous year and not on a per adjustment basis. This is clear from the words “in any previous year” used in the proviso to 92CE(1)

b. Per AE vs Aggregate of all primary adjustments made with all AEs during the previous year-There are two possible interpretations in this regard. The definition of secondary adjustment as per 92CE(3)(v) contains the words adjustment in the books of account of the assessee and its associated enterprise”. Going by the definition, a view is that the limit of 1 crore is to be considered with respect to each AE. However, the words “in any previous year” in the proviso to 92CE(1) indicate that all primary adjustments w.r.t. all AEs during the previous year have to be aggregated and tested against the limit of 1 crore

4. Economic Double Taxation –The interest that is imputed on the advance in the hands of Indian taxpayer may not be tax deductible in the overseas jurisdiction where the foreign AE is based.

5. Corresponding Adjustment –The corresponding adjustment as contemplated under Article 9(2) of the OECD model commentary, is available only in respect of the primary adjustment, provided there is an enabling provision under the Treaty and countries agree under a Mutual Agreement Procedure (MAP). However, corresponding adjustment would not be available to the foreign AE in respect of the secondary adjustment carried out in the hands of the Indian taxpayer.

6. Lack of clarity on the treatment of imputed interest – There provision of 92CE  is silent on the aspect of whether there needs to be an entry in the books of account in respect of the interest that is imputed on such deemed advance or the same is only to be considered in the return of income.

Another aspect worth considering is whether the imputed interest in the hands of the taxpayer will cast a withholding obligation on the AE and if so, whether this imputed interest will be further subject to the Arm’s Length test in order to avail the beneficial rate under the treaty.

7. Do Indian Income Tax authorities have the jurisdiction to mandate adjustments in the books of foreign AEs?Going by the language of the section in general and the specific definition of secondary adjustment in 92CE(3)(v), it appears that the provision is binding on the Indian taxpayer as well as the foreign AE. Whether it is within the competence of the Indian Income Tax authorities to bind an overseas enterprise to make an adjustment in its books of accounts is questionable.

8. Constructive loan vis-à-vis constructive dividend –As per the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, secondary adjustment may take the form of constructive dividends, constructive equity contributions, or constructive loans.

Therefore, an interpretation could be that the objective of bringing in the concept of secondary adjustment in the Indian TP legislation was to recover the amount of Dividend Distribution Tax (DDT) as the same amount would have been available as accumulated profits for distribution as dividend had it been repatriated and the Government would have received DDT.

Considering the example discussed above, I Co is required to pass necessary entry in the books of account so that the profits of I Co are reflected in accordance with the arm’s length principle. Thus, even for the purpose of books of account the profits would increase to ₹ 1,500 (instead of ₹ 1,000) with corresponding amount shown as receivable from the foreign AE. Accordingly, ‘accumulated profit’ for the purpose of Section 2(22) i.e. dividend would be ₹ 1,500 (instead of ₹ 1,000) and in case of distribution of dividend or ultimately at the time of liquidation, DDT would be payable on ₹ 1,500 (instead of ₹ 1,000).

Thus, it can be said that though the book adjustment doesn’t directly trigger any constructive dividends, it certainly enhances the value of dividend whenever declared in future. With DDT being abolished by Finance Act, 2020, the objective and functionality of the secondary adjustment provision is well worth deliberation.

9. Interplay between Secondary Adjustment u/s 92CE and Deemed Dividend u/s 2(22)(e) – While section 92CE deems the excess money, if not repatriated within the prescribed time, as an advance to the foreign AE by the Indian taxpayer, section 2(22)(e)of the I.T.Act,1961 provides that if a company(other than a company in which public is substantially interested) makes an advance or loan to shareholder beneficially holding more than 10% stake, such loan or advance will be deemed a ‘dividend’.

 There could be a situation where these two independent deeming provisions apply if the excess money (i.e. ₹ 500 in the above example) is not repatriated to India within the prescribed time. Clarity on this aspect would be much appreciated.

Import and Export between related parties – Customs & GST perspective

Custom Duty is levied under Customs Act, 1962 on the event of import or export of goods.  While GST is levied and collected on supply of goods or services for a consideration in the course or furtherance of business.

Various scenarios and their tax treatment is tabulated below:

Case Tax Treatment
Taxpayer in India has imported goods from its AE Custom Duty is applicable and it will be subject to verification under Special Valuation Branch (SVB). The custom authorities would check for under-valuation so that they can collect higher custom duty by enhancing value while Transfer Pricing authorities would be worried about over valuation so that they can reduce the expenditure claimed by Taxpayer in India.
Taxpayer in India has received a service from its AE This transaction would be regarded as import of service subject to place of supply provisions.  The taxpayer in India would pay GST under Reverse Charge.  The GST authorities would check for under-valuation while the Income Tax authorities would check for over valuation.
Taxpayer in India has Exported goods to its AE Most of the exports are not liable to custom duty as indirect taxes are consumption based taxes.  GST is also not applicable on export of goods.  In addition to this, a refund can be claimed of taxes paid on inputs and input services used for such export goods.
Taxpayer in India has provided a service to its AE No implications under Customs law.  GST is also not applicable on export of service subject to five conditions.  In addition to this, a refund can be claimed of taxes paid on inputs and input services used for such export of services.

In addition to the above, it is pertinent to note that related person transactions are subject to valuation rules framed under CGST Rules, 2017.  Rule 28 of CGST Rules, 2017 provides the following order to value a transaction between related persons:

a. The open market value of such supply.

b. If the open market value is not available, be the value of supply of goods or services of like kind and quality.

c. Finally, if the other methods are not applicable, then the value shall be in the following order:

Cost of the supply plus 10% mark-up[Rule 30] or

– By other reasonable means[Best Judgement Method – Rule 31].

Transfer Pricing Adjustments – Aspects worth deliberating upon – Customs & GST

1. Primary/Secondary adjustment is not a supply – The term supply is not defined under the GST law.  However, in general sense, it is an activity carried out by one person for another for something in return. Taking a que from the above, any such adjustment would not qualify to be a supply and hence there should not be any GST implications on primary adjustments.

2. Transfer Pricing authorities have increased the value of goods or service supplied to AE – In such cases, the value of goods or services exported outside India will be enhanced.  The issue which arises is whether such increased price can be adopted for claiming a higher refund as export turnover would enhance resulting in higher refund.  The authors are of the opinion that this needs to be clarified by CBIC as GST and Custom authorities look to lower the value of export.

3. Transfer Pricing authorities have decreased the value of goods or service supplied by AE to the Indian Taxpayer – In such cases, the Indian taxpayer would have already paid custom duty on import of goods and GST on import of service.  If the TP authorities reduce the value as they believe that the value is enhanced to claim higher expenditure in India.  In such cases, can a refund be claimed of custom duty/GST which is already paid on the value at which import was made?  This remains doubtful as the valuation mechanism under direct and indirect taxes are not necessarily aligned.

4. GST applicability on interest received/receivable/offered to tax in case of secondary adjustment – Income Tax Act, 1961 deems such adjustment as a loan.  It is pertinent to note that interest earned on loans or advances is exempted from GST under notification number 12/2017 dated 20.6.2017.


1. (excerpts from a report on double taxation submitted to League of Nations in early 1920s)

2. Secondary adjustment means an adjustment in the books of account of the assessee and its associated enterprise to reflect that the actual allocation of profits between the assessee and its associated enterprise are consistent with the transfer price determined as a result of primary adjustment, thereby removing the imbalance between cash account and actual profit of the assessee.

3. Where the primary adjustment to transfer price, has been made:

1. Suo motu by the assessee in the return of income, or

2. Made by the Assessing Officer and accepted by the assessee; or

3. Is determined by an advance pricing agreement entered into by him under section 92CC of the Act; or

4. Is made as per safe harbour rules prescribed under section 92CB of the Act; or

5. Is arising as a result of resolution of an assessment through mutual agreement procedure under an agreement entered into under section 90 or 90A of the Act.

4. Open market value means the full value of money excluding taxes under GST laws, payable by a person to obtain such supply at the time when supply being valued is made, provided such supply is between unrelated persons and price is the sole consideration for such supply.

 5. Supply of like kind & quality means any other supply made under similar circumstances, which is same or closely or substantially resembles in respect of characteristics, quality, quantity, functionality, reputation to the supply being valued

 Co Author- Nitin Nahar CA, LLB

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Company: NDJ and Associates
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