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Transfer Pricing Section 92 of Income Tax Act,1961

CA Final Course Paper 7 Direct Tax Laws , Chapter 16

CA. Vijay Iyer

CA. Nitin Narang

Background

Multinational Enterprises (MNE) carry out business in multiple countries

Tax rates vary from country to country

MNE may be able to reduce tax cost by moving profits from high tax to low tax jurisdictions

Tax authorities want to prevent the illegitimate shifting of profits and want to protect their tax base

Legislative framework necessary to define appropriate tax base

Intent behind introduction of Transfer Pricing (TP) provisions in India

Growth of investments by multinationals in India

Increase in cross border transactions of multinational enterprises in India

Potential risk of erosion of India’s tax base

Need for a statutory framework to examine intra-group cross-border transactions

Concepts in Transfer Pricing

• The price charged in a transaction between unrelated parties Arm’s Length Price

• The price charged in a transaction between two associated enterprise Transfer Price

• Transaction between two unrelated parties

Uncontrolled Transaction

• Transaction between two associated enterprises or related parties Controlled Transaction

Concept of TP

Transactions

Independent entity

Associated enterprise

Taxpayer

Transfer price

Arm’s length price

Independent entity

Applicability

TP Provisions contained in Section 92 to 92F of the Act TP Provisions apply to Transactions (defined in Sec 92F);

Transactions between two or more Enterprises (defined in Sec 92F);

The enterprises are Associated Enterprises (AEs) (defined in Sec 92A);

The transaction is an International Transaction (defined in Sec 92B).

Effective 1 April 2012, TP provisions shall also apply to specified domestic transactions (SDT) (defined in Sec 92BA)

Compliance Requirements

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

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

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

To ensure compliance with the arm’s length principle, stiff Penalties have been prescribed (Sections 271AA, 271BA, 271G, 271(1)(c))

Legislative Provisions

Section 92(1) – Any income arising from an international transaction shall be computed having regard to the arm’s length price

Explanation - the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm’s length price

Section 92(3) – The provisions are not intended to be applied in case determination of

arm’s length price reduces the income chargeable to tax or increases the loss as the case may be

International Transaction (Section 92B)

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

Transaction relates to: Purchase, sale or lease of tangible or intangible property; or

Provision of services; or

Lending or borrowing money; or

Any other transaction having a bearing on the profits, income, losses or assets of the enterprises; or

Mutual agreements or arrangements for allocation or apportionment of, or any contribution to, any cost or expense incurred

► Purchase, Sale, Transfer, Lease /Use of property/article/ product/ thing

► Includes Building, Vehicle, machinery etc.

► Purchase, Sale, Transfer, Lease /Use of IP

► Includes Transfer of ownership/use of rights/other commercial right

Intangible Property Tangible Property

► Long/short term borrowing/ lending

► Guarantee ► Purchase/Sale

Securities ► Advances/recei

vables, Payments/any debt etc

Capital Financing

► Market Research/ Development

► Technical Service

► Scientific Research

► Legal/ Accounting Service etc.

Provision of Services

► Transaction of Business restructuring/reorganization with AE irrespective of bearing profit/income/loss or assets – at the time of transaction/future date

Business Restructuring

International Transaction (Section 92B)

Definition of Intangible Clarified Marketing

Technology

Artistic

Data Processing

Engineering

Customer

Trademarks, Trade Names, Brand Names , Logos

Copyrights, Literary work, Musical Compositions, Maps, Engravings

Software Copyrights, Proprietary software, Automated databases, Integrated circuit Masks & Masters

Industrial Design ,Product Patent ,Trade Secrets , Engineering Drawings , Blueprints , Proprietary Documentation

Customer Lists , Customer Contracts, Customer Relationship, Open Purchase Orders

Process Patents , Patent Applications, Technical Documentation, Technical know-how

Contract Favourable Supplier Contracts, License agreements , Franchise agreements , non-compete agreements

Definition of Intangible Clarified

Human Capital Trained, Organised workforce, Employment agreements, Union Contracts

Location` Leasehold interest, Mineral exploitation rights, Easements, Air rights, Water rights

Goodwill Institutional / Professional Practice / Celebrity goodwill, Personal goodwill of professional, General business going concern value

Similar Similar item deriving its value from its intellectual content

Others Methods, Programmes, Systems, Procedures, Campaigns, Surveys, Studies, Forecasts, Estimates etc.

Do the following transactions need to be benchmarked?

Purchase of fixed assets

Transfer of shares in an Indian company to a non resident

External Commercial borrowing

Free-of cost services availed by Indian company

Payment for use of intangibles such as royalty

Reimbursement of expenses

Associated Enterprise

Meaning of Associated enterprises (Section 92A)

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

Meaning of Associated Enterprises (Section 92A(2)

Capital Management Activities Control

26% direct or indirect holding by the enterprise

Appointment of more than half of the directors

Supply of >90% of the raw materials

Common control

By the same person in both enterprises

One or more executive directors

Wholly dependent on the intangibles provided

Control by relative of jointly

Loan >= 51% of total assets

Appointed by the same person in both enterprises

Sales under influenced prices and conditions

Control by HUF and other member of HUF / relative

Guarantee >= 10% of borrowings

Deemed Associated Enterprises - Sec 92B(2)

A transaction with an unrelated company (3rd party) is deemed to be a transaction with an associated enterprise 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; or terms of transaction are determined in substance by A’s AE and 3rd party

A’s Parent 3rd party

A

Prior agreement

A’s Parent 3rd party

A

Determination of terms

A’s Parent

Prior agreement

Determination of arm’s length price

Arm’s length price

Determination of arm’s length prices using one of the Prescribed methods

Whether you arrive at a single

price ?

The price thus determined is the arm’s length price

The arithmetic mean of such prices, read with sec 92C(2)

(i.e. not exceeding the

tolerance range (which has an upper ceiling of 3%) of the

transfer price)

Yes

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

No

Prescribed Transfer Pricing Methods

New method has been prescribed by the Central Board of Direct Taxes - Any method that takes into account the price that 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 facts, shall be regarded as one of the recognized methods for determining the Arm’s Length Price

New Method Transactional Net Margin

Method

Profit Split Method

Cost Plus Method

Resale Price

Method

Comparable Uncontrolled

Price

Traditional Transaction Methods Transactional Profit Methods Other Methods

OECD Transfer Pricing Methods

Comparable Uncontrolled Price Method (“CUP Method”)

CUP entials comparison of PRICE of comparable uncontrolled transaction with the controlled transaction • Identify comparable transactions • Adjust the price of such

transactions to account for differences between the controlled transaction and the uncontrolled transaction

• The adjusted uncontrolled price is the arm’s length price

A Inc. (USA)

A Ltd. (India)

C Ltd. (India)

B Inc. (USA)

Controlled transaction

Uncontrolled transaction

$10 $11

Resale Price Method (“RPM”) RPM entails comparison of Gross Margin on resale of goods purchased from an associated enterprise • Identify comparable transactions /

companies • Determine gross margin (Gross Profit /

Sales) of the uncontrolled transactions / companies

• Adjust the gross margin for differences in functions, assets and risks between the comparable transactions and the controlled transaction

• Determine the arm’s length price of the controlled transaction based on the adjusted gross margin on comparable transactions

A Inc. (USA)

A Ltd. (India)

C Ltd. (India)

B Inc. (USA)



$10

Customers Customers

$12 GM 25%

Resale Price Method (“RPM”) Gross Margin of Comparable transaction is 25%

Applying Resale Price Method Sale Price of A Ltd. (A) - $ 12

Applying the arm’s length

gross margin of 25% (B) - $ 3

Arm’s length price of the related

party purchase transaction (A-B) - $ 9

Related Party Transaction Price - $ 10

Cost Plus Method Cost Plus Method entails comparison of Gross Margin on supply of goods or services to an associated enterprise • Identify comparable transactions /

companies • Determine gross margin (Gross Profit / Cost

of Goods/Services Sold) of the uncontrolled transactions / companies

• Adjust the gross margin for differences in functions, assets and risks between the comparable transactions and the controlled transaction

• Determine the arm’s length price of the controlled transaction based on the adjusted gross margin on comparable transactions

Third Party

Supplier

A Ltd. (India)

C Ltd. (India)

Suppliers



$10

A Inc. (USA) Customers

$12 GM 25%

Cost Plus Method Gross Margin of Comparable transaction is 25%

Applying Cost Plus Method Cost of Goods Sold of A Ltd. (A) - $ 10


gross margin of 25% (B) - $ 2.5


party purchase transaction (A+B) - $ 12.5


Transactional Net Margin Method (“TNMM Method”)

Comparison of Net Profit comparable uncontrolled transaction / companies with the net margin of the controlled transaction Net margin may be computed with reference to cost, sales or any other relevant profit level indicator • Identify comparable transactions / companies • Adjust the price of such transactions to

account for differences between the controlled transaction and the uncontrolled transaction

• Determine the arm’s length price for the related party transaction on the basis of the adjusted net margin of the uncontrolled transactions

A Inc. (USA)

A Ltd. (India)

C Ltd. (India)

B Inc. (USA)



Customers Customers

Net Profit / Sales =

4%

Net Profit / Sales =

5%

$100

$60

Transactional Net Margin Method

Net Margin of Comparable transaction is 5% Applying TNMM Method

Sales of A Ltd. (A) - $ 100


net margin of 5% (B) - $ 5

Net Margin of A Ltd.

Total Costs of A Ltd. Related party transaction cost (C) - $ 60

Unrelated party costs (D) - $ 36


party purchase transaction (A-D-B) - $59


Profit Split Method

Splitting the profit from the whole transactions between various related parties based on their relative contribution. • Identify comparable transactions for

every related party involved in the transaction (i.e. transactions comparable to A Inc., A BV and A Ltd. )

• Determine net profit earned by comparable companies

A Inc. (USA)

A Ltd. (India)

(developed know-how)


know-how

A BV (Netherlands)

Customers

know-how

Profit Split Method

A Inc. (USA)

A Ltd. (India)

(developed know-how)


know-how

A BV (Netherlands)

Customers

know-how

• Allocate the super normal-profit / loss to each related party involved (i.e. A Inc., A BV and A Ltd.) on the basis of their relative contribution

• Relative value of the know-how developed by A Inc., A BV and A Ltd.

• Attribute profits to each related party involved i.e. A Inc, A BV and A Ltd.

Sixth Method-Rule 10AB • Where the application of the five specific methods is not possible due

to difficulties in obtaining comparable data or due to uniqueness of transactions

• Intangibles or business transfers, transfer of unlisted shares, sale of fixed assets, revenue allocation/splitting, guarantees provided and received, etc.

• Examples of application:

• Third party quotations

• Valuation reports

• Commercial & economic models

Most appropriate method ► Rule 10C (1) – Method which provides the most reliable measure of an

arm’s length price in relation to an international transaction or a Specified Domestic Transaction

► Most reliable measure would depend on availability of comparable data ► Comparable data is more likely to be available for benchmarking an entity that is

relatively less complex ► For a complex entity that has intangibles and multiple operations, it is very difficult to

find a true comparable. ► Gross margin of manufacturing comparable companies may not be possible to

decipher from Schedule VI Profit and Loss Account and hence Cost Plus is usually very difficult to apply in practice

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 (i.e. type of goods, services etc.) company functions risks assumed contractual terms (i.e. similar credit terms) economic and market conditions

Case Studies

Case Study 1

A India Third parties in India

10kgs at Rs 100/kg

A Inc. USA (owns intangibles and is complex)

100kgs at Rs 90/kg

Sale of tablets

Which method applies to this transaction and why?

Case Study 1 (Answers)

Most Appropriate Method would depend on the availability of comparable data

If comparable prices for ‘identical’ tablets is available then CUP may be applied (with minor adjustments)

If gross margin of comparable distribution companies is available, RPM may be used

Cost Plus may not be appropriate method for benchmarking an intangible-owning complex entity

If gross margin of comparable distribution companies is not available, TNMM may be the only method that could be applied since PSM applies only where intangibles are owned by the Indian entity and the foreign AE

Case Study 2

XYZ India

XYZ UK

XYZ Netherlands (Licensor of technology)

XYZ UK, XYZ Netherlands and XYZ India are associated enterprises

Which method can be applied to this transaction? Can CUP be applied?

Royalty - 3% of gross sales

Royalty - 8% of net sales


Transaction between XYZ US and XYZ Netherlands is a controlled transaction and therefore is not an arm’s length price

Comparison of transaction between XYZ US and XYZ Netherlands with the controlled transaction between XYZ India and XYZ Netherlands is not appropriate

If XYZ US was an unrelated party to XYZ Netherlands, comparison of the royalty rates may have been possible after adjusting for the difference in the base (CUP method)

If CUP is not possible to apply, then TNMM may be applied as the most appropriate method

Case Study 3

X Ltd India

X Inc USA

Which method can be applied to this transaction? How would you defend TP for X Ltd India

Third parties in USA

XYZ Inc, USA (Group Company)

Third parties in India

100 kgs at Rs 90/kg

100 kgs at Rs 90/kg

1000 kgs at Rs 80/kg

90 kgs at Rs 100/kg


X Inc. has supplied to third parties in the US at $80/kg while it has supplied to X India at $90/kg

Quantity supplied to third parties is 10 times more than the quantity supplied to X India and hence a direct comparison of the prices may not appropriate

Appropriate adjustment for volume discount to be offered to a substantial customer may be required before comparison with the controlled transaction

Where such comparison is not possible, RPM or TNMM may be applied depending upon the available comparable data (Refer Case Study 1)

Case Study 4

ABC India (duplication and

distribution)

ABC Inc., USA

Which method can be applied to the transactions?

Can royalty be disallowed to the extent of bad debts as it is based on net sales?

--------------------------------------------------------------------- Outside India

India

Import of master copy of software for duplication

and resale

Royalty payments for distribution

based on net sales

Customers in India


Selection of the most appropriate method would depend on available comparables

If comparable software duplicators and distributors are identified and their Royalty rates are available in the public domain, CUP may be an appropriate method

In the absence of CUP data, RPM and TNMM may be explored

Since the functions of ABC are not merely distribution, RPM may be applied only if a perfect comparable is identified

In the absence of comparable data for RPM, TNMM may be applied as the most appropriate method

Case Study 5

XYZ India

XYZ USA ► XYZ India sells wipers to

XYZ USA. Similar wipers are purchased by XYZ USA from third parties in China

► CUP method applied by XYZ India

► Transfer Pricing Officer disregarded CUP on the basis that conditions prevailing in the market are not similar

► How would you defend the case?

Third parties in China


If the wipers purchased from China and India are identical, CUP may be the most appropriate method

Chinese and Indian economies may be similar and therefore, the Chinese suppliers price may be a suitable benchmark

For the purchaser (XYZ US) it does not matter where is purchases from (related or unrelated party) so long as the same wiper is supplied by both

Therefore, the uncontrolled transaction would serve as a basis for determining the price of the transaction between XYZ US and XYZ India

Case Study 6

ABC India

(entrepreneur and developer of patents)

ABC USA Sale of registered

patents

Which method applies to this transaction and why?

Sold for Rs. 50 crores based on valuation report from independent valuer


A valuer’s report based on generally accepted valuation methodology is a reasonable estimate of how third parties may value intangibles when such intangibles are sold to unrelated parties

Therefore the valuer’s report provides a computation of arm’s length price

Since the arm’s length price determination is based on methods that may be applied by third parties to determine their transaction prices in uncontrolled transactions, such determination would fall under the Sixth Method under the Indian TP Rules

Domestic TP

Introduction – Pre Finance Act, 2012

Tax Authority empowered to disallow payments to “related parties” which are “excessive” or “unreasonable”

In case of inter-unit transfer of goods/services, tax holiday profits to be determined based on Fair Market Value (FMV) of goods/ services

Tax Authority empowered to re-compute tax holiday eligible profit if undertaking makes more than ordinary profits as a result of arrangements with closely connected persons or otherwise

No specific methodology prescribed for disallowance/ tax holiday profit adjustment

Introduction – Finance Act, 2012

TP provisions extended to certain Specified Domestic Transactions(SDTs) with effect from Financial Year 2012-13

Seeks to create legally enforceable obligation on taxpayers to maintain proper documentation

Is intended to provide objectivity in determining reasonableness of expenditure and income eligible for tax holiday

Monetary threshold of INR 50 Million (approx. USD 900,000) provided for applicability of the provisions

Allowance for expenditure or allocation of cost or expense or any income in relation to SDT to be computed having regard to Arm’s Length Price (ALP)

Definition of SDT

Payments to related parties as defined under section 40A(2)(b) Tax holiday related transactions (eligible business) Any transaction referred to in section 80A Any transfer of goods/services referred to in section 80IA(8) Any business transaction referred to in section 80IA(10) Any transaction under Chapter VI-A or u/s 10AA – to which provisions of section 80IA (8) or section 80IA (10) apply Any other transaction as may be prescribed

Domestic TP – Applicability Taxpayer cannot apply TP to SDT so as to reduce total income that is subject to tax

Monetary threshold of INR 50M to be computed based on aggregate of payments and receipts to which the provisions apply during a FY

Definition of the term “related parties” for the purposes of expense disallowance expanded to cover entities which have common beneficial ownership

TP provisions applicable to international transactions are largely applicable to SDT as well, with the exception of Advance Pricing Agreement (APA) provisions

Eligible business covered

Section Tax payers covered Deduction

10AA Persons with income from Special Economic Zone (SEZ) units

100% for the first 5 years 50% for the next 5 years 50% of the profits or amount credited to SEZ re - investment reserve, whichever is less for next 5 years

80 - IA Infrastructure developers 100% for a period of 10/15 years out of 15/20 years, as the case may be, from the date of commencement of operation

80 - IA Telecommunication service providers

100% for a period of 5 years 30% for the next 5 years out of 15 years from the date of commencement of operations

80 - IA Developers of Industrial park 100% for a period of 10 years out of 15 years from the date of commencement of operations

80 - IA Producers or distributors of power

100% for a period of 10 years out of 15 years from the date of commencement of operations

80 - IAB Developers of SEZ 100% for a period of 10 years out of 15 years from the date of commencement of operations

80 - IB Small scale industry engaged in operating Cold storage plant

30% of profits for the first 10 years

80 - IB Industrial undertaking in Industrially backward state as mentioned in VIII Schedule (ex: Jammu and Kashmir )

100% of profits for 5 years and 30% for the next 5 years

80 - IB Multiplex theaters and convention centre

50% for the first 5 years

Eligible business covered (contd…)

Secti on

Tax payers covered Deduction

80 - IB Company carrying on scientific research and development

100% of profits for first 10 years

80 - IB Eligible housing projects 100% of profits from such business

80 - IB Eligible hospitals 100% of profits for first 5 years

80 - IC/ 80 - IE

Persons with units in North - eastern states claiming deduction

100% for a period of first 10 years

80 - ID Hotels located in districts having World Heritage site

100% of profits for first 5 years of commencement of business

Section 40A(2) – Payments to related parties

Payments by taxpayers to certain specified persons covered within the ambit of section 40A(2)

Where the taxpayer/assessee is a company, following persons regarded as ‘specified persons’

• Directors of the taxpayer company or any relative of such directors • Individuals having Substantial Interest (SI) in the business of taxpayer company or

any relative of such individual • Persons having a SI in the business of the taxpayer company • Directors of the entities having SI in the business of the taxpayer company or any

relatives of such directors • Any company having the same holding company (which holds a SI) as that of the

taxpayer company • A company of which a director has a SI in the business of the taxpayer company, any

director of such company or any relative of such director • Persons/entities in which taxpayer company/its directors/ their relatives have a SI

Payments by an individual, firm, AOP and HUF to certain specified persons are also covered within the ambit of section 40A(2)


A person shall be regarded as having a SI in a business if at any time during the previous year • Such person is the beneficial owner of shares carrying not less

than 20% of the voting power (in case of a company) • Such person is beneficially entitled to not less than 20% of the

profits of such business (in any other case)

Beneficial ownership

• Term not defined but can be understood as a person who ultimately enjoys the income/asset and also controls it

• Need not be in existence for the entire year but is sufficient if it is in existence for only part of the year


General scope of Section 40A(2) •Applicable to taxpayers making the payment/incurring expenditure and not to recipients of such income •Can ALP testing of recipient be relied upon to support arm’s length nature of expense?

•No correlative relief for recipient if payer subject to a TP adjustment •If no payment is made or payment is less than ALP, cannot be considered as “excessive/ unreasonable”

•Expenditure should be towards ‘goods’, ‘services’ or ‘facilities’ •Capital expenditure, depreciation outside the purview of section 40A(2) •Generally, following payments may be covered: •Payment towards purchase of raw materials, services, use of asset •Payment towards sharing of common premises/facilities •Payment of interest on loan •Payment of managerial remuneration, salary, bonus etc to directors

Payments to related parties – Illustration

Any payment towards expenditure by ACo to its own directors

as remuneration, salary, bonus etc

ACo to XCo

ACo to directors of XCo

ACo to Relatives of directors of A Co and X Co

ACo to BCo

Any payment towards expenditure by XCo to ACo/BCo

Beneficial Share holding

>20%

A Co (Indian company)

B Co (Indian company)

X Co (Indian company)

Beneficial Share holding

>20%

Tax holiday eligible business

SDT provisions apply to business transactions/transfers referred to in section 80A, 80IA(8), 80IA(10), 10AA, Chapter VI-A provisions

Section 80A(6) and Section 80IA(8) require adjustment to tax holiday profits where

• Goods and services of eligible business are transferred to any other business carried on by the same taxpayer and vice versa

• Consideration for such transfer as recorded in the accounts of eligible business does not correspond to market value of such goods/services

• In such cases, tax authorities/ taxpayer required to recompute tax holiday claim by reference to ALP of such goods/services

Overlap between 80A(6) and 80IA(8) not of much consequence

Applies to all tax holiday claims under Chapter VI-A/ Section 10AA


General scope of Section 80A(6)/ 80IA(8) Covers transfer of goods/ services held by “eligible business” to

another business or vice versa Existence of two or more separate businesses of the same

taxpayer

Transfer of goods/ services between the businesses

Does not contemplate an artificial or hypothetical segregation of profits between tax holiday unit and the rest of the enterprise

Once threshold is satisfied, inter-unit transfer price may be need to be determined by hypothesizing the businesses as separate & distinct enterprises for determining ALP

Provides for a “two-way” adjustment (both favorable as well as adverse) and is a mandatory provision

Is in the nature of notional adjustments for determining profits eligible for tax holiday


General scope of Section 80IA(10) Tax officer empowered to re-compute tax holiday profits if:

more than “ordinary profits” have arisen in the eligible business due to transactions between closely connected persons or for other reasons

Provides for only “one way” adjustment i.e. only adverse adjustment at the discretion of the tax officer

Is in the nature of notional adjustment for determining profits eligible for tax holiday

Tax officer may invoke the provision in case of SDT on the basis of ALP determination Onus still on tax officer to establish that the course of business

was arranged to produce more than ordinary profits?

TP compliance requirements

Transfer Pricing Documentation

► Nature and terms (including price) of international transactions

► Description of functions performed, risk assumed and assets employed (functional analysis)

► Records of economic and market analysis (economic analysis)

► Record of budgets, forecasts, financial estimates

► Any other record of analysis (if, any) to evaluate comparability of international transaction with uncontrolled transaction(s)

► Description of method considered with reasons of rejection of other methods

► Details of transfer pricing adjustment(s) made (if, any)

► Ownership Structure ► Profile of multinational group

► Business description/ Profile of industry

► Any other information e.g. data, documents like invoices, agreements, price related correspondence etc.

Entity Related

Price Related

Transaction Related

Transfer Pricing Documentation

Detailed documentation not required in case aggregate value of all international transactions does not exceed one crore rupees (five crores in case of specified domestic transactions)

List of supporting documents are also provided in the law

Contemporaneous data requirements

Documents to be retained for a fixed period from end of the assessment year

Need to obtain Accountant’s report (under Form 3CEB) to be filed along with the return of income

Accountant’s report (Form 3CEB) - Rule 10E Obtained by every tax payer filing a return in India and having international transaction or SDT

To be filed by due date for filing return of income

Essentially comments on the following: 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”

TP Penalties - Section 271 Default Penalty

Post - inquiry adjustment (deemed concealment of income) Section 271(1)(c)

100 - 300% of tax on the adjusted amount

Failure to maintain documents Fails to report transactions / Maintains or furnishes incorrect documents Section 271AA

2% of the transaction value

Failure to furnish documents Section 271G

2% of the transaction value

Failure to furnish accountants report Section 271BA

Rs 100,000

Transfer Pricing Audit Process

Transfer Pricing Calendar

Indian Financial Year (‘FY’) – 1 April to 31 March

• Due date of completion of Transfer Pricing Documentation and filing of Form 3CEB (Accountant Report)

• 30 November following the FY • Time limit for completion of assessment • 46 months from the end of the FY (i.e. 31 January 2013

for the FY 2008-09) • Retain Documentation for 8 years

Routine Audit Process

AO to determine ALP u/s 92C(3)

AO also may refer

determination of ALP to the TPO

Taxpayer to substantiate

transfer price as ALP to TPO

TPO to determine ALP by passing an

order Intimation to

taxpayer & AO

AO to compute taxable income

AO to pass Draft order

Taxpayer to file objections with

DRP* DRP to pass directions*

AO to pass final order

Appeal/ Rectification

* If the tax payer files chooses to file objections with the Dispute Resolution Panel (DRP). The taxpayer also has an option to file an appeal with the Commissioner of Income Tax (Appeals) against the final assessment order of the AO

Timelines for DRP route – A Snapshot

•34 months from end of AY

TPO to pass order


AO to pass draft order •Within 30

Days of receipt of Draft Order

Objections before DRP

•Within 9 months of Draft Order

DRP to pass directions •Within 1

month

Final AO Order passed

Timelines for CIT (A) route – A Snapshot

•34 months from end from AY

TPO to pass order


AO to pass draft order •Within 60

days of the draft order

AO passes final Order

•Within 30 days from receipt of AO Order

Appeal to CIT(A) •No time limit

CIT(A) Order

Domestic Law Dispute Resolution Process

TPO’s Order

AO’s draft order

DRP objections

DRP order AO’s Final Order Tribunal

High Court

Supreme Court

Advance Pricing Agreements

What is an APA? Finance Act, 2012 – Salient features An agreement between the Central Board of Direct

Taxes (CBDT) and any person determining the arm’s length price (ALP) or specifying the manner in which the ALP is to be

determined in relation to an international transaction Flexibility to determine arm’s length price using

unspecified method/ adjustments/variations, as necessary

Valid for the periods specified in the APA and for a maximum period of 5 consecutive years

Binding on taxpayer and tax authority, unless there is a change in law/ facts

No provision for “roll back”

Indian APA rules- Overview New rules introduced in Income-tax Rules, 1962 – Rules 10F-10T and Rule

44GA

Rules 10F-10T contain procedures for APA applications in general; Rule 44GA contains the procedure to deal with requests for Bilateral APAs/ Multilateral APAs

Overview of the process

► Industry overview

► Supply chain overview

► FAR analysis

► Proposed economic analysis

► Proposed term

► Field work (functional interviews, review financial statements)

► Government-to-government process

► Position papers – face to face meetings

► Critical assumptions

► Drafting and concluding APAs

► Unilateral vs bilateral vs multilateral

► Pre-filing meeting (anonymous also permitted)

► Pricing study and strategy

► Annual report, record-keeping

► Audit

► Revocation, cancellation or revision

► Renewal

Execution and monitoring

Evaluation and negotiation – Agreement

APA request Pre-filing

Administrative structure in India for APAs

Director APA

Chairperson CBDT Chairperson CBDT

Team of Officers, economists and

statisticians

Team of Officers, economists and

statisticians

Director APA

Competent Authority

Director General of Income Tax

All APAs to be approved by the Central Government

Common team at the back end for unilateral and bilateral

/ multilateral APAs

UNILATERAL BILATERAL / MULTILATERAL

Key Features & Implications Feature Description Implication

Eligibility

Any person who has undertaken or is proposing to undertake an international transaction

Taxpayer can pursue an APA for its existing inter-company transactions with India

Types of APAs Framework allows unilateral, bilateral and

Multilateral APAs Flexibility to choose the type of solution depending on requirements.

Pre-filing application and consultation

Prescribed format provided for pre-filing. Application will be followed by a meeting with the APA authority. Pre-filing on a no-name or anonymous basis is also permitted

This is a mandatory step in the process and will offer an opportunity to determine the scope and broad terms of the APA and identify potential issues for consideration. No timeframe proposed as of now

Key Features & Implications

Feature Description Implication Filing Fee for APA

Prescribed fee in the range of USD 18,000 to USD 37,000 depending on the value of transactions sought to be covered in the APA

Filing fee kept steep to deter non serious applications

Filing timeline

The application can be filed anytime (i) before the first day of the financial year for which the application is made in respect of existing or continuing transactions; or (ii) before undertaking a proposed transaction

APAs will apply prospectively for the period sought to be covered (upto five consecutive years). No past year can be covered and hence, no roll-back mechanism.

APA application

Prescribed format provided requesting extensive details of the taxpayer’s business, transactions and industry.

Taxpayer should be prepared to submit detailed information voluntarily. In the absence of any firewall provisions, sharing of this information by the APA authority with other departments within the tax administration cannot be ruled out


Feature Description Implication

Evaluation and negotiation

APA authority is empowered to hold meetings with the applicant, request for additional information, and visit the applicant’s business premises to arrive at its final decision

The process is consultative. The APA Authority and taxpayer shall prepare a proposed mutually agreed draft agreement in the end. However taxpayer would not be party to the discussions between the CAs in the bilateral process

Agreement

The APA authority needs to seek approval from the Central Government to enter into the APA

Taxpayer may need to wait for some time for the final approval

Bilateral & Multilateral APAs

The CAs would negotiate the terms of the agreement. The APA process will not be initiated unless the foreign taxpayer has filed a request with the CA of his country

Taxpayer would need to file an application with CA to kick off the bilateral / multilateral APA process


Feature Description Implication

Post APA compliance

An Annual Compliance Report (ACR) needs to be filed for each year covered by the APA and a compliance audit would be undertaken to monitor adherence to the terms of the APA

Taxpayer would need to substantiate continued satisfaction of the critical assumptions, correctness of the supporting data or information and consistency of the application of the transfer pricing method

Revision, cancellation and withdrawal of APA

APAs can be revised in the event of significant changes to the underlying terms of the agreement. Non compliance can lead to cancellation of an APA. A taxpayer is also free to withdraw an APA application if a mutually acceptable outcome is not reached

The program is forward looking, flexible and allows for various situations that could arise

Thank you

and best of luck for

your exams CA. Vijay Iyer

CA. Nitin Narang