tp including sdt and dtaa

Transfer Pricing including Domestic Transfer Pricing and DTAAICSI Students’ Study Circle Meeting - October 18, 2015

Presented by: Sandeep Jhunjhunwala

WHAT CAN YOU EXPECT IN THIS PRESENTATION

Overview of the Transfer Pricing provisions

Tax Treaty - Insights

Transfer Pricing & Tax Treaty

Open House & Discussions

2 | ICSI Students’ Study Circle Meeting

Transfer Pricing in the news

TP IN THE NEWS


Overview of Transfer Pricing Regulations


TRANSFER PRICING IN INDIA - BACKGROUND

Prior to April 1, 2001

Basic provisions existed but were rarely applied

Expert Group set up in November 1999 to study global transfer pricing practices

April 1, 2001 onwards

Sections 92 to 92F of the Act read with Rules 10A to 10T referred to as framework of Indian TP legislation

Largely based on the OECD Transfer Pricing Guidelines

Comprehensive legislation introduced in Union Budget 2001

Detailed Rules providing guidance for application of the legislation framed

One way effect - TP adjustments cannot reduce tax computed on income as in books

Mandatory TP documentation and Form 3CEB filing

Administrative guidelines for audit - Recent CBDT direction to field officers

Is still in evolving stage- taxpayers seek clarity on various matters


CONCEPT OF TRANSFER PRICING

Section 92(1) - Transfer Pricing refers to pricing of international transactions between two associated enterprises (AEs)

A price between unrelated parties is known as the Arm’s Length Price (ALP)

Due to special relationship between related parties, transfer price may be different than the price that would have been agreed between unrelated parties

International transactions– Tangibles

Intangibles

– Services

– Capital Financing

– Business structuring

Independent Entity

Resident

Associated Enterprise

Resident


APPLICABILITY

The provisions of Sections 92 to 92F of the Act are applicable only if:

There are two or more enterprises (defined in Sec 92F)

The enterprises are Associated enterprises (defined in Sec 92A)

The enterprises enter into a transaction (defined in Sec 92F)

The transaction is an international transaction/ deemed international transaction/ specified domestic transaction (defined in Sec 92B/ 92BA)

Consequences of these provisions:

Computation of income/ expenses having regard to the Arm’s length price [Section 92(1)]

Maintenance of prescribed documentation (Section 92D & Rule 10D)

Obtaining Accountant’s report under Form 3CEB (Section 92E)

To ensure compliance with the arm’s length principle; stiff penalties prescribed for non-compliances (Section 271, 271AA, 271BA, 271G etc)

The revenue/ profits generated by a company should be attributable to Functions performed, Assets deployed and Risks assumed in its business operations


INTERNATIONAL TRANSACTION (SEC 92B)

Transactions between two or more associated enterprises, either or both of whom are non-residents

Transaction relates to:

Purchase, sale or lease of tangible/ intangible property; or

Provision of services; or

Lending or borrowing money (capital financing); or

Any other transaction of business restructuring or reorganization irrespective of the fact of having a bearing on the profits, income, losses or assets of such enterprises; or

Mutual agreements/ arrangements for allocation or apportionment of, or any contribution to, any cost or expense incurred/ to be incurred in connection with a benefit, service or facility provided/ to be provided to any one or more of such enterprise.

Transaction includes arrangement, understanding or action in concert:

whether formal or in writing

whether intended to be enforceable with legal proceedings or not

Transaction also includes number of closely linked transactions [Rule 10A(d)]


SPECIFIED DOMESTIC TRANSACTIONS (SEC 92BA)

SDTIf aggregate exceeds

INR 20 crore in a year

(applicable from FY 2012-13)

Inter unit transfer of goods & services by tax holiday undertakings to which profit-linked deductions apply

Expenditure incurred between

related parties defined under Section 40A of

the Act

Any other transaction that may be

specified

Transactions between tax holiday undertakings to which profit-linked deductions apply, having close connection

SDT provisions would impact industries which benefit from the preferential tax policies such as SEZ units, infrastructure developers or operators, telecom services, industrial park developers, power generation etc


DEEMED INTERNATIONAL TRANSACTION [SEC 92B(2)]

Parent Company 3rd Party

Subsidiary

Prior agreement

Services

Parent Company 3rd Party

SubsidiaryServices

Determination of terms

An unrelated company (3rd Party) is deemed to be an associated enterprise of a company (A) and subject to transfer pricing regulations if:

– a prior agreement exists between A's AE and 3rd party in relation to services rendered by A to the 3rd party

An unrelated company (3rd Party) is deemed to be an associated enterprise of a company (A) and subject to transfer pricing regulations if:

– terms of transaction are determined in substance by A’s AE and 3rd party

Recently amended to clarify that third party can be a resident or non-resident India


ASSOCIATED ENTERPRISES (SEC 92A)

Direct or indirect participation (through one or more intermediaries) in management or control or capital

A

C

B

A

C

B E

Both A and B are associated enterprises of C

D and E are also associated enterprises of C since they have a common ultimate parent (A)

D


DEEMED ASSOCIATED ENTERPRISES [SEC 92A(2)]

1. >= 26 percent direct / indirect holding by enterprise

OR

2. By same person in each enterprise

3. Loan >= 51 percent of total assets

4. Guarantees >= 10 percent of debt

5. >10 percent interest in Firm / AOP / BOI

6. Appointment > 50 percent of Directors/ one or more Executive Director by an enterprise

OR

7. Appointment by same person in each enterpriseS

8. 100 percent dependence on use of intangibles for manufacture/ processing/ business

9. Direct/ indirect supply of >= 90

percent raw materials under influenced prices and conditions

10.Sale under influenced prices and conditions

11. One enterprise controlled by an individual and the other by himself or his relative or jointly

12. One enterprise controlled by HUF and the other by itself, a member or his relative or jointly

Equity Holding Management Activities Control

ARM'S LENGTH PRICE (ALP)

Determination of ALP using one of the prescribed methods

Whether you arrive at a single

price?The price thus determined is the ALP, mostly not possible

The arithmetic mean of such prices or a price which varies from such arithmetic mean by

+/-3 percent (tolerance band) is the ALP

Yes

Price applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions

No


ALP - origin in the Contract Law - to arrange an equitable agreement that will stand up to legal scrutiny, even though the parties involved may have shared interests - Based on the separate entity approach

PRESCRIBED METHODS


Rule 10AB/ 10B - Prescribed by CBDT

Transactional Net Margin

Method (TNMM)

Profit Split Method (PSM)

Cost Plus Method (CPM)

Resale Price Method (RPM)

Comparable Uncontrolled Price (CUP)

Traditional Transaction Methods Transactional Profit Methods Other Method

OECD prefers traditional transaction methods over transactional methods [Chapter III, 3.49]

TNMM (and CUP) rules the roost

Indian rules prescribe no guidance/ hierarchy - legal view is to follow chronological order

Any other method prescribed by the Central Board of Direct Taxes (CBDT) - Rule 10AB

Appropriateness of the method considered based on functional analysis


TRANSFER PRICING METHODS - IN GENERAL

CUP Method compares prices charged or paid

RPM compares gross margins

CPM compares profit mark-ups on costs

PSM refers to the total profits from transactions and splits them among the parties based on the level of contribution

TNMM analyses net profit in relation to an appropriate base such as costs, sales or assets

Other method [Rule 10AB] - "Any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.”

Methods Comparability requirements

Benchmarking Remarks

CUP Very High Prices Very difficult to apply asvery high degree ofcomparability required

RPM High Gross Profit margins

Difficult to apply as highdegree of comparabilityrequired

CPM High Profit mark-ups on costs

PSM Medium Operating Profit margins

Complex Method,thinly used

TNMM Medium Operating Profit margins

Most commonly usedmethod


TRANSFER PRICING METHODS - IN GENERAL

CUP used for transactions involving homogeneous products (eg traded commodities), interest rate charged on a loan, royalty payments, franchise fees or license fees

RPM used for distributors ie when goods purchased from related parties and sold to independent parties

CPM used in cases involving manufacture, assembly or production of tangible products or services that are sold / provided to related parties

PSM is appropriate where both parties to the transaction make unique and valuable contributions or where the transaction involves highly integrated operations for which a one sided approach would not be appropriate

TNMM - Applicable for any type of transaction and often used to supplement analysis under other methods, most frequently used method in India

Rule - 10AB, provides for applying any other method that gives better picture of ALP of such transactions - Intangible assets, IPRs, Technical know-how, R&D services


COMPARABLES

All methods require comparables

Transfer price is set/ defended using data from comparable transactions

Comparable transaction should be independent and similar to tested transactions

Factors for judging comparability (Rule 10C(2)):

Nature of transactions undertaken (ie type of goods, services etc)

Company functions

Risks assumed

Contractual terms (ie similar credit terms)

Economic and market conditions


DOCUMENTATION

Profile of industryProfile of group Profile of Indian entityProfile of associated enterprises

Transaction termsFunctional analysis (FAR related)Economic analysis (method selection, comparable benchmarking)Forecasts, budgets, estimates

AgreementsInvoicesPricing related correspondence (letters, emails etc)

Price related Transaction related

Contemporaneous documentation requirement

Documentation to be retained for 9 years from the financial year

Documentation is not required to be maintained if the aggregate value of international transactions does not exceed INR 1 crore

Entity related

Description and analysis of uncontrolled transactionsDescription and analysis of methods considered and adopted

Methodology related


ACCOUNTANT’S REPORT (FORM 3CEB) - RULE 10E

Obtained by every tax payer filing a return in India and having international transaction

To be filed by due date for filing return of income

Essentially comments :

whether the tax payer has maintained the transfer pricing documentation as required by the legislation;

whether as per the transfer pricing documentation the prices of international transactions are at arm’s length, and

certifies the value of the international transactions as per the books of account and as per the transfer pricing documentation are “true and correct”


TRANSFER PRICING & OTHER TAX LINKAGES

Common aspects required to be analyzed while preparing TP report

PE implications

International tax structure

Foreign jurisdiction lawsTreaty provisions

Customs issues Withholding tax issues

Economic substance Intangible valuations

TP Architecture

Tax Treaty - Insights


WHAT IS TAX TREATY?

What is a tax treaty?

Tax treaties are international agreements entered into between Governments for the allocation of fiscal jurisdiction so as to avoid double taxation of the same income

The purpose of the DTAA is to remove impediments to the flow of trade and investment by the elimination of international double taxation

What is the purpose of a tax treaty?

Elimination of double taxation

Clarification of fiscal situation of tax payer

Sharing of tax revenues between contracting countries

Promotion of cross border trade

Exchange of information to combat tax avoidance/ tax evasion

Section 90 of the Act empowers the Central Government to enter into tax treaties with the government of any foreign country

The provisions of the Act shall apply to the extent they are more beneficial than the provisions of the treaty


NATURE OF TAX TREATY

Types of tax systems followed

Residence based tax system

Connecting factor is "residence" Country of residence has the primary jurisdiction to tax In case of conflict "tie-breaker test"

Source based tax system

Connecting factor is "income" Country of source shall restrict its right to tax

Country of residence will give credit for tax paid in the country of source

Transfer Pricing and Tax treaty


ARTICLES OF TAX TREATY

SCOPE PROVISIONS

1. Article 1 - Personal Scope2. Article 2 - Taxes covered3. Article 29 - Entry into force4. Article 30 - Termination

ANTI-AVOIDANCE

1. Article 9 - Associated Enterprise2. Article 26 - Exchange of Information

ELIMINATION OF DOUBLE TAXATION

1. Article 23 - Elimination of double taxation

2. Article 25 - Mutual Agreement

DEFINITION PROVISIONS

1. Article 3 - General definitions2. Article 4 - Residence3. Article 5 - Permanent

Establishment

SUBSTANTIVE PROVISIONS

1. Article 6 - Immovable property2. Article 7 - Business Profits3. Article 8 - Shipping, etc4. Article 10 - Dividends5. Article 11 - Interest6. Article 12 - Royalties & TSF7. Article 13 - Capital gains8. Article 14 - Independent Personal Services9. Article 15 - Dependent Personal Services10. Article 16 - Directors11. Article 17 - Artistes & Sports persons12. Article 18 - Pensions13. Article 19 - Government service14. Article 20 - Students15. Article 21 - Other income16. Article 22 - Capital

MISCELLANEOUS PROVISIONS

1. Article 24 - Non-discrimination2. Article 27 - Diplomats3. Article 28 - Territorial Extension


ARTICLE 9 - ASSOCIATED ENTERPRISES

Article 9 confirms in a treaty situation:

the domestic right of a contracting state

to adjust the profits of an enterprise located on its territory, which is managed, held or controlled directly or indirectly by an enterprise of the other contracting state

If the conditions in their relationship differ from the conditions which would have been stipulated between independent enterprises (ie other than on arm’s length terms)


ARTICLE 27 - MUTUAL AGREEMENT PROCEDURES

If taxpayer has been subjected to tax not in accordance with provisions of the tax treaty, then MAP could be exercised

Under MAP, competent authorities from states concerned try to resolve tax issues

Article 27 provides for a machinery whereby competent authorities can interact between themselves to resolve all outstanding issues amicably

Taxpayer can take recourse to MAP even before tax has been levied

Time limit for MAP application is 3 years from date of first notification of action leading to taxation not in accordance with DTAA

The tax payer has an option to follow the decision given under MAP

OPEN HOUSE & DISCUSSIONS

THANK YOU

E: [email protected]: +91 97401 55469D: +91 80 4032 0011

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