Transfer Pricing – Part 2 – Compliance and Assessment Procedures

Introduction: Transfer Pricing compliance and assessment procedures is crucial for businesses engaged in international transactions. Sections 92C, 92CA, 144C, and others of the Income Tax Act, 1961 outline various aspects, from the determination of Arm’s Length Price (ALP) to Dispute Resolution Panel (DRP) mechanisms.

Transfer Pricing

Section 92C(3): Powers of AO to determine ALP

Section 92C(3) of the Income Tax Act, 1961 (the Act), concerns the determination of the ALP in international transactions. According to this provision, if, during the assessment proceedings, the AO possesses material, information, or documents indicating the following:

• The price charged or paid in an international transaction has not been determined in accordance with subsections (1) and (2).
• Any information and document relating to an international transaction have not been maintained by the assessee as per the provisions of section 92D(1) and the rules made in this regard.
• The information or data used in the computation of the arm’s length price is not reliable or correct.
• The assessee has failed to furnish any information or document required by a notice issued under section 92D(3) within the specified time.

In such cases, the AO is empowered to determine the ALP based on the available material, information, or document. However, before proceeding with such determination, the AO must afford the assessee an opportunity to explain why the ALP should not be determined on this basis.

Section 92CA: Reference to Transfer Pricing Officer (TPO)

AO has the authority to refer the computation of ALP of an international or specified domestic transaction (SDT) to the TPO. However, this discretion is not extended to the assessee. Before making such a reference, the AO must obtain prior approval from the Principal Commissioner of Income-tax (PCIT)/Commissioner of Income-tax (CIT).

Upon receiving a notice from the TPO, the assessee is obligated to produce any evidence supporting their computation of ALP on a specified date. Additionally, the TPO is empowered to determine the ALP of transactions not referred by the AO, including those identified during proceedings or those for which the assessee failed to furnish a report under section 92E.

Following the assessment of evidence and material gathered, the TPO issues an order determining the ALP, copies of which are sent to both the AO and the assessee. This order must be issued at least 60 days before the expiry of the time limit for assessment under section 153 or section 153B.

The order of the TPO holds binding authority over the AO, who must compute the taxable income in line with the ALP determined by the TPO. Furthermore, the TPO retains the power to rectify their order under section 154 in the event of any apparent mistakes, and the AO must adjust the assessment order accordingly.

Note: When a case is referred to TPO, the period for completing the assessment shall be extended additionally by 12 months.

As per section 92C(4) no deduction u/s 10AA or Chapter VI-A would be allowed in respect of the additional income computed by the AO having regard to the ALP determined by him.

Dispute Resolution Panel (DRP)

Section 144C of the Act, introduces DRP mechanism, primarily aimed at resolving disputes arising from draft assessment orders concerning transfer pricing and specified domestic transactions. Here’s a concise breakdown of its key provisions:

Section 144C(1): Mandates that the AO must provide the eligible assessee with a draft of the proposed assessment order if any proposed variation is deemed prejudicial to the assessee’s interests.

Section 144C(2): Grants the assessee the opportunity to either accept the proposed variations or lodge objections within a stipulated timeframe of 30 days from receiving the draft order.

Section 144C(3): Specifies that if the assessee accepts the proposed variations or fails to raise objections within the prescribed period, the AO proceeds to finalize the assessment based on the draft order.

Section 144C(4): Imposes a time constraint on the AO to issue the assessment order within one month from the conclusion of the acceptance period or the expiration of the objection filing deadline.

Section 144C(12): The DRP shall pass an order within nine months from the end of the month in which the draft assessment order was forwarded to it by the assessing officer. The order passed by the DRP shall be binding on the assessing officer.

If the assessee is aggrieved by the order passed by the DRP, he can file an appeal before the Income Tax Appellate Tribunal (ITAT) within sixty days from the date of receipt of the order.

All directives issued by the DRP are legally binding upon the AO, with no further avenue for appeal against such directives. However, in cases where an assessee has initiated an appeal before the ITAT, the AO retains the right to file cross objections in response to the same before the ITAT.

This section underscores the importance of providing the assessee with a fair hearing before finalizing any adverse assessment orders, with the overarching goal of mitigating litigation in transfer pricing matters. It’s worth noting that these provisions have been effective since the AY 2011-12 onwards.

What is Advance Pricing Agreements (APA) Section 92CC?

APA provision allows taxpayers to enter into an agreement with the Income Tax Authority to determine the ALP or specify the method for determining the ALP for international transactions for a maximum period of 5 consecutive years and 4 preceding previous years (rollback provisions).

With the endorsement of the Central Government, the Central Board of Direct Taxes (CBDT) has the authority to establish an APA with any entity, outlining the determination of the ALP or specifying the method by which the ALP is to be determined for an international transaction intended to be undertaken by said entity. This pertains to income as described in section 9(1)(i), or delineating the approach through which such income is to be ascribed, reasonably attributable to activities conducted in India by or on behalf of the aforementioned entity, which is a non-resident.

The terms of the APA shall supersede the provisions outlined in section 92C (pertaining to the computation of the ALP using the most appropriate method) or section 92CA (pertaining to reference to the TPO) which are typically applicable for determining the ALP.

The APA, once established, holds binding authority over:

• The individual involved in the transaction covered by the APA.
• The PCIT or CIT and the subordinate income-tax authorities under their jurisdiction, regarding the individual and transaction.

However, the APA will cease to be binding in the event of any alterations in law or facts that are relevant to the APA.

Applicable Fee for application for APA

Annual Compliance Report

The taxpayer is required to submit an annual compliance report in quadruplicate for each fiscal year covered by the agreement. This report must be provided:

– Within 30 days from the due date of filing the income tax return for that particular year, or

– Within 90 days from the date of entering into the agreement, whichever occurs later.

Compliance Audit of APA [Rule 10P]

The TPO with jurisdiction over the taxpayer shall conduct a compliance audit of the agreement for each year covered by the agreement. The compliance audit report must be provided by the TPO within six months from the conclusion of the month in which the Annual Compliance Report is received by the TPO.

Roll back in APA Scheme [Section 92CC(9A)]

The APA may establish the method for determining the ALP or specifying the approach by which the ALP is to be determined concerning an international transaction conducted by a non-resident individual, involving income as described in section 9(1)(i). Additionally, the APA may outline the method for determining said income, which is reasonably attributable to activities conducted in India by or on behalf of the aforementioned non-resident individual, for a period not exceeding four previous years preceding the first of the years for which the APA is applicable regarding the international transaction to be undertaken.

Conditions for the Application of Rollback Provisions

• The international transaction is identical to the international transaction covered by the APA (excluding the rollback provision).
• The Return of Income (ROI) for the relevant rollback year has been filed or is furnished before the due date as per section 139(1) of the Act.
• A report regarding the international transaction has been submitted as per section 92E.
• The applicant has requested the applicability of rollback provisions for all rollback years.
• The applicant has submitted an application seeking rollback.

Non-applicability of Rollback provision

The rollback provisions shall not apply if:

The determination of the ALP for the international transaction in question for the relevant year has been the subject of an appeal before the Appellate Tribunal, and the Appellate Tribunal has issued an order resolving such appeal before the agreement is signed.

OR

The application of the rollback provision results in a decrease in the total income or an increase in the loss as declared in the ROI.

Note: The applicant may furnish along with the application for advance pricing agreement, the request for rollback provision with proof of payment of an additional fee of INR 5 lakh.

Procedure for giving effect to rollback provision of an Agreement

i. Submit a modified ROI for the relevant rollback year, accompanied by evidence of payment for any additional tax liability arising due to the implementation of the rollback provision.

ii. Submit a modified return for the rollback year, along with the modified return for the initial year for which the APA has been requested in the application.

iii. Withdraw any appeal lodged by the applicant pending before the Commissioner (Appeals), Appellate Tribunal, or High Court for the rollback year, specifically concerning the issue addressed by the rollback provision for that year, to the extent covered under the APA, prior to submitting the modified return.

iv. Withdraw any appeal initiated by the AO, PCIT, or CIT pending before the Appellate Tribunal or High Court for the rollback year, pertaining to the issue addressed by the rollback provision for that year, to the extent covered under the agreement, within three months of the applicant filing the revised return.

v. Inform the DRP, Commissioner (Appeals), Appellate Tribunal, or High Court, as applicable, regarding the execution of an agreement inclusive of rollback provisions, providing a copy of the same.

Penalty for failure to comply with TP provisions

Section 270A(9): Failure to report any international transaction or deemed international transaction to which the provision of Chapter X applies would constitute ‘misreporting of income’.

Penalty: 200% of the tax payable on under-reported income.

Section 271BA: Failure to furnish a report from an accountant as required under section 92E.

Penalty: INR 1 Lakh

Section 271G: Failure to furnish information or document as required by Assessing Officer or CIT(A) u/s 92D(3) within 10 days from the date of receipt of notice or extended period not exceeding 30 days, as the case may be.

Penalty: 2% of the value.

Section 271AA: (a) Failure to keep and maintain any such document and information as required by section 92D(1)/(2); (b) Failure to report such international transaction or specified domestic transaction which is required to be reported; or (c) Maintaining or furnishing any incorrect information or document.

Penalty: 2% of the value.

Note: The penalty u/s 271AA is in addition and not in substitution of penalty u/s 271BA.

Section 94B: Limitation on Interest Deduction

Section 94B of the Act, deals with the limitation on interest deductions related to debt issued to non-resident associated enterprises. Here’s a summary of its key points:

Interest Deduction Limit: The interest expenses claimed by a company to its associated enterprises are restricted to 30% of its earnings before interest, taxes, depreciation, and amortization (EBITDA) or the interest paid or payable to associated enterprises, whichever is less.

Applicability: It applies to an Indian company or a permanent establishment of a foreign company that incurs interest expenditure exceeding ₹1 crore to its non-resident associated enterprises.

Debt Considerations: The debt is considered issued by an associated enterprise if it provides an implicit or explicit guarantee to the lender or deposits a corresponding and matching amount of funds with the lender.

Carry Forward: Disallowed interest expense can be carried forward to eight assessment years immediately succeeding the assessment year for which the disallowance was first made.

Exclusions: Banks and insurance companies are excluded from these provisions, and non-banking financial companies may also be exempted as notified by the Central Government.

This section was introduced as part of the Base Erosion and Profit Shifting (BEPS) project by the OECD to counter cross-border shifting of profit through excessive interest payments.

Conclusion: Understanding Transfer Pricing compliance and assessment procedures is essential for businesses to ensure adherence to tax regulations and mitigate risks of penalties. From ALP determination to APAs and penalty implications, thorough knowledge of these procedures is vital for smooth tax compliance and dispute resolution.