Finance Act 2001 introduced chapter X in the Income Tax Act , 1961

Chapter X Special provisions relating to AVOIDANCE OF TAX

Sections Particulars

92 Computation of Income from International Transaction having regard to arm’s length price

92A Meaning of Associated Enterprise

92B Meaning of International Transaction

92BA Meaning of Specified Domestic Transaction

92C Computation of arm’s length price

92CA Reference to Transfer Pricing officer

92CB Power of Board to make safe harbour rules

92CC Advance Pricing agreement

92CD Effect to advance Pricing Agreement

92D Maintenance and keeping of information and document by persons entering into an international transaction and specified domestic transaction

92E Report from an accountant to be furnished by persons entering into international transaction

92F Definitions of certain terms relevant to computation of arm’s length price

Other Relevant Rules and Forms

Rules Particulars

10A Meaning of expressions used in computation of arm’s length price

10AB Other method of determination of arm’s length price

10B Determination of arm’s length price under section 92C

10C Most appropriate method

10D Information and documents to be kept and maintained under section 92D

10E Report from an accountant to be furnished under section 92E

Forms Particulars

3CEB Report from an accountant to be furnished under section 92E relating to international transaction or a specified domestic transaction

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

(2) An international transaction or a specified domestic transaction between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred shall be determined having regard to the arm's length price

(2A) Any allowance for an expenditure or interest or allocation of any cost or expense or any income in relation to the specified domestic transaction shall be computed having regard to the arm's length price

(3) Transfer pricing is not applicable where ALP has the effect of reducing the income chargeable to tax or increasing the loss

Section 92 : Computation of Income from International Transaction having regard to arm’s length price

Ex 1: An enterprise in India sells goods to an AE in USA for Rs. 100000/- whereas ALP is Rs. 300000/-. Therefore the income of the Indian enterprise shall be determined with reference to ALP of Rs. 300000/-

Ex 2 : An enterprise in India purchases goods from an AE for Rs. 200000/- where as ALP is Rs. 70000/-. The income of the Indian enterprise shall be computed w.r.t Rs. 70000/-

Ex 3 : An Indian enterprise takes a loan from an AE in UK @ 24% whereas the market rate of interest is 11% p.a . Then in such a case the allowance of interest to Indian enterprise shall be on the basis of ALP of 11%

Ex 4 : Allocation or apportionment of costs or expenses

An AE incurs research and development of Rs. 3000000/- and Rs. 2000000/- are allocated to Indian AE . To ensure whether Indian AE is deriving benefit in line with the R&D expenditure allocated.

EXAMPLES

Section 92A : Meaning of Associated Enterprise

• An enterprise which participates , directly or indirectly or through one or more intermediaries, in the management or control or capital of the other enterprise.

• Both the enterprises have the same persons who participate directly or indirectly or through one or more intermediaries, in their management or control or capital.

The above mentioned criteria of management or control or capital is explained exhaustively in sub section (2). No other situation can be construed as triggering AE relationship.

How do you ascertain this control?????

a) Holds directly or indirectly atleast 26% of the voting power

b) Any person holds atleast 26% in each of such enterprise

c) A loan advanced not less than 51% of the book value of the total assets of the other enterprise

d) Guarantees atleast 10% of the total borrowings

e) One enterprise appoints more than half of the Board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of other enterprise

f) Directors or members as specified in point e) appointed by the same person in both the enterprises

g) the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents,etc of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights

h) ninety per cent. or more of the raw materials and consumables required for the

manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise, or by persons specified by the other enterprise, and the prices and other conditions relating to the supply are influenced by such other enterprise

Continued…

i) the goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise,

and the prices and other conditions relating thereto are influenced by such other enterprise

j) where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such

individual and relative of such individual k) where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family, or by a relative of a member of such Hindu undivided family, or jointly by such member and his relative ; or l) Enterprise holds 10% or more interest in firm, AOP and BOI. m) Any other mutual interest, as prescribed.

Case study 1

Participates in Management/

Capital/control

Intermediary

Participates in Management/capital

/control

A Ltd.

C Ltd.

D Ltd.

I Ltd.

B Ltd.

Fact : In the above example, A & B , conjointly and simultaneously , participate in the management, capital and control of C and D.

Ans : Consequently, C and D are to be construed as Associated Enterprises.

Section 92B : Meaning of International Transaction

-Between two ASSOCIATED ENTERPRISES and

- Atleast one of whom must be a NON RESIDENT

-A transaction of ………

purchase, sale , transfer , lease or use of tangible or intangible property; or

provision of services; or

capital financing including lending or borrowing or guarantee; or

any other transaction having a bearing on the profits, income, losses, or assets of such enterprises. And

shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.

- A transaction of business restructuring or re-organization ,irrespective of the fact that it has bearing on the profits, income, losses, or assets of such enterprise at the time of transaction or at any future date.

Deeming provision- Section 92B(2)

Ex:

X in India Associated Enterprise

Z in UKUnrelated party

Y in AustraliaAssociated Enterprise

Y holds 35% shares of X

Transaction betn X & Z

A transaction between X India & Z UK shall be deemed to be a transaction between associated enterprises if in relation to that transaction-

i. There exists a prior agreement between the Z UK and the Y Australia; OR

ii. The terms of the relevant transaction are determined in substance between Z UK and the Y Australia.

Case study 2

A Inc. – US Co.

D Ltd.

B Inc. – US Co.

C Ltd.

Associated enterprise

Indian subsidiary Branch, a Permanent establishment

Transaction

The above transaction has even though originated , executed and concluded within India, shall be an international transaction as it is between two associated enterprises and one of the party is a non resident.

Even when a transaction is between two non resident associated enterprises, the transfer pricing provisions shall apply if the income Is taxable as per the provisions of the Income Tax act, 1961

Reason behind application and extension of scope of transfer pricing regulations to

specified domestic transactions

CIT Vs Glaxo Smithkline Asia (P) Ltd. – Supreme Court

The assessee did not have any employee other than a company secretary and all administrative services relating to marketing, finance, HR etc were provided by Glaxo Smith Kline Consumer Healthcare Ltd (“GSKCH”) pursuant to an agreement under which the assessee agreed to reimburse the costs incurred by GSKCH for providing the various services plus 5%. The costs towards services provided to the assessee were allocated on the basis suggested by a firm of CAs. The AO disallowed a part of the charges reimbursed on the ground that they were excessive and not for business purposes which was upheld by the CIT (A). However, the Tribunal deleted the disallowance on the ground that there was no provision to disallow expenditure on the ground that it was excessive or unreasonable unless the case of the assessee fell within the scope of s. 40A (2).

Held that:

No interference is called for as the entire exercise is a revenue neutral exercise, if it is between unrelated parties.

The larger issue is whether Transfer Pricing Regulations should be limited to cross-border transactions or whether the Transfer Pricing Regulations be extended to domestic transactions. In domestic transactions, the under-invoicing of sales and over-invoicing of expenses ordinarily will be revenue neutral in nature, except in two circumstances having tax arbitrage such as where one of the related entities is (i) loss making or (ii) liable to pay tax at a lower rate and the profits are shifted to such entity;

the question of extending Transfer Pricing regulations to domestic transactions require expeditious consideration by the Ministry of Finance and the CBDT may also consider issuing appropriate instructions in that regard.

Section 92BA – Meaning of Specified Domestic Transaction

i. Any expenditure in respect of which payment has been made or is to be made to person referred to in Section 40A(2) clause (b)

ii. Any transaction referred to in section 80A

iii. Any transfer of goods or services from eligible business referred to in sections 80IA, 80IAB, 80IB,80IC, 80ID , 80IE & 10AA to other business for a value which is less than the market value thereby affecting profits and leading to tax erosion

iv. More than ordinary profits are earned by the assessee in eligible business to due close connection between such assessee and any other person

v. any transaction, referred to in any other section under Chapter VI-A to which similar provisions of section 80IA(8) & 80IA(10) are applicable.

vi. Any other transaction as may be prescribed

AND where the aggregate of such transactions exceeds 5 CRORES

Explanation : For the purpose of sub section 8 of section 80IA, “market value” in relation to any goods or services means-

a. The price that such goods or services would ordinarily fetch in the open market; or

b. The arm’s length price as defined in section 92F, where transfer of such goods or services is a specified domestic transaction referred to in section 92BA.

Section 92C : Computation of Arms Length Price

• FAR analysis : Functions performed, Assets employed and Risks assumed

• Determination of the MOST APPROPRIATE method

• Six methods :

1. Comparable uncontrolled price method

2. Resale price method

3. Cost plus method

4. Profit split method

5. Transactional net margin method

6. such other method as may be prescribed by the Board

Arithmetical mean of all the prices ,

if more than price is determined by the most appropriate method

Example 1 :

International transaction at Rs. 157 Price as determined by most appropriate

method :

Price 1 : Rs. 170

Price 2 : Rs. 160

Price 3 : Rs. 150

Price 4 : Rs. 140

Arithmetic mean : Rs. 155 3% of actual transaction price : Rs. 4.71 As the variation between ALP and

actual transaction price is less than 3% , Rs. 157 shall be the arm’s length price.

Example 2 :

International transaction at Rs. 145 Price as determined by most appropriate

method :Price 1 : Rs. 180Price 2 : Rs. 170Price 3 : Rs. 140Price 4 : Rs. 130

Arithmetic mean : Rs. 155

3% of actual transaction price : Rs. 4.35 As the variation between ALP and

actual transaction price is more than 3% , Rs. 155 shall be the arm’s length price.

Variation between ALP and the actual transactional value of the international transaction or specified domestic transaction is less than or equal to 3% of the actual transactional value

Actual transactional value deemed to be ALP

Variation between ALP and the actual transactional value of the international transaction or specified domestic transaction is greater than 3% of the actual transactional value

ALP shall be as determined by the most appropriate method

Section 92C continued…

Where the assessing officer may proceed to determine the arm’s length price in accordance with section 92C(1) & (2)

(a) Price charged in international transaction or specified domestic transaction has not been determined under section 92C(1) & (2)

(b) Any information and document have not been kept and maintained by the assessee in accordance with section 92D(1) and rules made in this behalf.

(c) The information or data used in the computation of arm’s length price is not reliable or correct.

(d) The assessee has failed to furnish within the specified time, any information or document which he was required to furnish by a notice issued under section 92D(3)

An opportunity of being heard , to show cause prior to initiating the computation under section 92C(3)

Section 92C continued…

Two proviso s to section 92C(4) after determination of ALP by the assessing officer

No deduction shall be allowed under section 10AA or under Chapter VIA in respect any amount of adjustment so made.

That income of one associated enterprise shall not be recomputed merely by reason of one adjustment made in the case of the other associated enterprise on determination of arm’s length price by the assessing officer.

Section 92C continued…

B Inc

A Ltd.

Provides know-how27% equity

Royalty payment

Example :

B Inc holds 27% equity shares of A Ltd. B Inc provides knowhow to A Ltd. for which A Ltd. pays a royalty of Rs. 100 lacs to B Inc. A Ltd. deducts TDS of Rs. 25.75 and remits Rs. 74.25 to B Inc. A Ltd. files its return of Income of Rs. 300 lacs after claiming expenditure of Rs. 100 lacs on royalty. B Inc also files return of Income in India as under :

Royalty payment 100.00 lacs

Tax as per sec 115A 25.75 lacs

Less : TDS 25.75 lacs

Tax payable nil

The AO on the basis of information available with him determines the ALP of royalty to be Rs. 40 lacs.

TAX IMPLICATIONS ??????

TAX IMPLICATIONS….

• A Ltd and B Inc. are associated enterprise as per Section 92A.

• Since B Inc is a non resident and is providing know-how to A Ltd. for which royalty is being paid, there is an INTERNATIONAL TRANSACTION as per section 92B.

• Section 92C empowers the Assessing officer to determine the taxable income of A Ltd. on the basis of information in his possession on the basis of arms length price of Rs 40 lacs.

• The assessing officer will accordingly assess the income of A Ltd. at Rs 360 lacs after disallowing the royalty of Rs 60 lacs.

• As per Explanation 7 to section 271(1)(c), Rs 60 lacs is deemed as concealed income on which penalty for concealment of income shall be levied.

• As per the first provision to section 92C(4), deduction under section 10AA or Chapter 10AA or under Chapter VI-A otherwise allowable to A Ltd. shall not increase on account of additions of Rs 60 lacs.

• As per second provision to section 92C(4) , B Inc cannot claim that its income should be Rs 40 lacs instead of Rs 100 lacs and cannot claim refund of TDS of Rs 15.45 lacs.

FAR ANALYSIS

It focuses on three aspects i.e. Functions Performed , Assets Employed & Risk

Assumed

Analysis of functions performed

1. Design and development of a product

2. Sourcing of materials

3. Manufacturing

4. Warehousing

5. Sales and distribution

6. Technical services

7. Conceptualization and specifications of services performed

8. Customer support

Analysis of Assets employed

1. Whether the assets are owned or leased

2. Whether activity is capital or labour intensive

3. Presence or absence of intangibles

Analysis of risks assumed

Nature of risks Particulars

1. Financial risk a. Capital contribution

b. Method of funding

c. Funding of losses

d. Bad debts

2. Product risk a. Design and development of product

b. Up-gradation of product

c. After sale services

d. Risks associated with R&D

e. Product liability risk

f. Intellectual property risk if any

3. Market risk a. Development of market including advertisement and product promotion etc.

b. Business volume risk

c. Assured sales risk

d. Fluctuations in demand and prices

e. Credit and collection risk

Rule 10B : Determination of arm's length price under section 92C

Comparable uncontrolled price method

resale price method

cost plus method

Any other method as provided

in rule 10AB transactional

net margin method

profit split method

Comparable uncontrolled price method

Step 1 : Determine the price charged or paid for the property transferred or services provided in a comparable uncontrolled transaction

Step 2 : Such price is adjusted to account for the functional differences between the international transaction and the comparable uncontrolled transaction which could effect the price in the open market

There are two types of CUP :

----Internal CUP

----External CUP

Step 3 : Such adjusted price is the arms length price.

Example on CUP:

A Ltd. B Ltd.

30 % equity shares

Sales price per unit to C Ltd : 3000

Less : Differences to be adjusted

1. On account of freight & insurance 550

2. On account of warranty cost 250

3. On account of bulk order discount 20

Arms length price 2180

Price charged from B Ltd. 10000 * 2000 2,00,00,000

Arms length price 10000 * 2180 2,18,00,000

Increase in income by 18,00,000

A Ltd. supplies 10000 CD writers to B Ltd. at Rs. 2000/unitA Ltd. supplies 100 CD writers to C Ltd. at Rs. 3000/unit

Sale to C Ltd. is CIF. Sale to B Ltd. is FOB. C&F = Rs. 550/unitSales to C Ltd. backed by warranty. No warranty to B Ltd.

Warranty cost = Rs. 250/unit Bulk trade discount to B Ltd. Rs 20/unit

Resale price method

Step 1 : The price at which the property purchased or services obtained by the enterprise from an associated enterprise are sold to an unrelated enterprise is first determined

Step 2 : Such resale price is reduced by normal gross profit margin accruing to the enterprise from the purchase and resale of similar goods in a comparable uncontrolled transaction. If there is no comparable uncontrolled transaction, then take gross profit of unrelated person from purchase and resale of similar goods

Step 3 : Reduce the expenses incurred by the enterprise in connection with such purchase

Step 4 : Adjust the price so arrived in step 3 to the extent of functional differences Step 5 : The adjusted price arrived at Step 4 is the ALP.

Example on RSP method

A Ltd. B Ltd.

C Ltd.

purchases

Re sales

30% equity

B Ltd. holds 30 % equity shares of A Ltd. A Ltd. imports 1000 towels from B Ltd. at a price of Rs. 2900/unit. And then

These are sold to C Ltd at Rs. 3000/unit. A Ltd. bought similar products from D Ltd. and sold to E Ltd. at 12 % gross

Profit on salesB Ltd. offers a quantity discount of Rs. 10/unit to A Ltd. whereas D Ltd.

Does not offer such discount.Freight at Rs. 10/unit and customs incurred at Rs. 25/unit

in case of purchase from B Ltd.

Ans :

Arms length price is as under:

Resale price of goods purchased from B ltd. 3000

Less: normal gross profit at 12% 360

Less: expenses connected with freight & customs duty 35

Less: quantity discount allowed by B ltd. 10

Arms length price 2595

Price paid to B ltd. 1000* 2900 29,00,000

Arms length price 1000* 2595 25,95,000

Increase in income of A ltd. 3,05,000

Cost plus method

Step 1: Determine the direct and indirect costs of production in respect of property transferred or services provided to an associated enterprise

Step 2 : Determine the normal gross profit mark up to such costs which will arise from transfer of similar goods or services to an unrelated enterprise or in a comparable uncontrollable transaction.

Step 3: The normal gross profit mark up determined In Step 2 should be adjusted to account for the functional differences if any

Step 4: The cost arrived in step 1 shall be increased by such adjusted profit mark up as arrived at in step 3

Step5 : The sum so arrived at is the arms length price.

Example on cost plus method

B Ltd. A Ltd 35% equity

A Ltd. holds 35% shares in B Ltd.B Ltd. develops software and provides consultancy services for customers

Onsite as well as offsite.B Ltd. during the year billed A Ltd. for 100 man-hours at Rs. 2000/man hour.

The total cost for executing this work amounted to Rs. 175000.However B Ltd. Billed C Ltd. at the rate of Rs. 3000/man hour for same level of

Manpower and earned a gross profit of 50 % on its cost.

• Thus the transactions of B Ltd. with A ltd. and C Ltd. are comparable subject to following differences to which value in terms of gross profit % is assigned in order to arrive at an adjusted gross profit margin.

Particulars % of normal profits

Technology support extended by A ltd. to B Ltd. (not in case of C Ltd.)

Quantity discount

No risk in case of services rendered to A ltd.

One month credit to A Ltd. unlike to C Ltd.

20%

10%

10%

3%

Calculation of arms length price

Price charged to C Ltd. 3000

Gross profit mark up in case of C Ltd. 50%

Less: Functional differences

1. Technology support (20% of 50%) 10%

2. Quantity discount (10% of 50%) 5%

3. Risk factor (10% of 50%) 5%

30%

Add : Cost of credit period 1.5%

Arms length gross profit 31.5%

Total cost 1,75,000

Arms length income(175000*31.5% +175000) 2,30,125

Profit split method

Applicable in transactions involving transfer of unique intangibles or in multiple transactions which are so interrelated that they cannot be evaluated separately for the purpose of determining ALP.

Step 1 : The combined net profit of the associated enterprise arising from the transaction in which they are engaged, is determined

Step 2 : The relative contribution made by each of the AEs is evaluated on the basis of FAR analysis and on the basis of relative external market data which indicates how much contribution would be evaluated by unrelated enterprise performing comparable functions in similar circumstances

Step 3 : The combined net profit is then split amongst the enterprises in proportion to their relative contributions, as evaluated in step 2

Step 4 : The profit so apportioned is at arms length price.

Residual Analysis approach : In the first stage, each AE is allocated an Arm’s length remuneration for its non unique contributions to the controlled transactions based on any of the four methods I.E CUP, RPM, CPM or TNMM.

While the residual net profit remaining after such allocation may be allocated in proportion to their relative contribution, based on analysis of facts and circumstances.

Example on Profit split method

ZMC Ltd. Singapore

Crest Ltd. USA

Amco Ltd. India

27 % equity

32% equity

Crest Ltd. USA received an order from Trium Ltd. USA for developing a software in which all the above three entities integrally contributed. A consideration of $ 50000 was received by Crest Ltd.

Crest paid $10000 to ZMC Ltd. and $12000 to Amco Ltd.

A profit of $10000 is earned. Amco India incurred a cost of $9500

On the basis of FAR, relative contribution of each of them is as follows:

Amco Ltd - 50%

ZMC Ltd. - 20%

Crest Ltd. - 30%

Arms length price under profit split method

Price charged by Crest Ltd. $ 50000

Amco Ltd. India ‘s share of revenue $ 12000

ZMC Ltd. singapore’ s share $ 10000

Crest Ltd. USA ‘s share $ 28000

Combined total profits $ 10000

Evaluation of relative contribution:Amco Ltd - 50% $ 5000ZMC Ltd. - 20% $ 2000Crest Ltd. - 30% $ 3000Total cost of Amco Ltd. $ 9500

Income of Amco Ltd. India arms length price $ 14500Actual revenue of Amco Ltd. $ 12000Increased income $ 2500

Transactional net margin method

Step 1 : The net profit margin realized by the enterprise is computed in relation to costs incurred or sales effected or assets employed or any other base

Step 2 : Net profit margin realized by the enterprise or an unrelated enterprise from a comparable uncontrolled transaction is computed

Step 3 : Net profit margin ascertained in step 2 is adjusted for functional differences Step 4 : net profit margin so adjusted is taken into account to arrive at an arms length price

Example on transaction net margin method:

Hindustan lever exports shampoos to Unilever UK, an AE & earns a net profit of 10% on sales

Sales are Rs. 10000 crores and net profit Rs. 1000 crores

Procter and gamble exports shampoos and earns a net profit of 15% . 2% of net profit is mainly due to sale to European countries

Therefore , adjusted net profit Is 13% , when applied to sales 1300 crores.

Addition of 300 crores to income.

The comparability of international transaction with uncontrolled transaction shall be judged with reference to the following:

• Specific characteristics of the property transferred or services

• Functions performed, assets employed or risks assumed

• contractual terms whether they are formal or in writing

• Conditions prevailing in the markets , geographical location, size of the market, laws and government orders in force, costs of factors of production, overall economic development, level of competition, wholesale or retail level markets

An uncontrolled transaction shall be said to comparable when :

1. None of the differences material enough present affecting the price or cost charged or profits

2. reasonable accurate adjustments can be made to eliminate material differences

Data for comparison should be taken specifically of the year concerned

or at the max two years prior to that.

Rule 10C : Most appropriate method

Factors to be considered:

1. Nature and class of transactions

2. Class or classes of AEs

3. FAR analysis

4. Availability, coverage and reliability of data necessary for application of the method

5. Degree of comparability between actual transaction and transaction between uncontrolled conditions.

6. Extent to which reliable and approximately accurate adjustments can be made

7. Nature and extent of assumptions required to be made

Section 92CA : Reference to Transfer pricing officer(1) Assessing officer , with previous approval of commissioner , refer the computation of ALP in relation to an international transaction or specified domestic transaction to TPO , if it considers it necessary and expedient.

(2) The TPO to serve notice on the assessee requiring him to produce all the evidence.

(2A)Where any other international transaction (other than referred in (1) above) , comes to the notice of the TPO during the course of the proceedings before him, the provisions of this chaptershall also apply.

(2B)The TPO will have power to challenge the computation of ALP of those transactions which have not been mentioned in the report furnished under section 92E.

(3) Determination of ALP by TPO and he will send a copy to the AO

(3A)An order under sub section 3 to be made at any time before sixty days prior to the date on which the period of limitation in section 153 or 153B expires

(4)The AO shall compute the total income in conformity with the ALP so determined

(5)Mistake apparent from records- 154 by TPO

(6)Re computation by AO under sub section 5

(7)TPO can exercise powers of summoning or calling for the details for the purpose of inquiry and investigation under section 131(1) and 133(6)

Objections to the order Of TPO

Accept the draft order

File objectionsWithin 30 days from The date of receipt

Of draft order from AOTo dispute resolution

Panel.

Appeal before CIT(Appeals) after

obtaining Final order from AO

By keeping silent Against the draft

Order.

Section 144C : Dispute Resolution Panel

• DRP – Collegium of three commissioners

• Eligible assessee – One who has suffered transfer pricing adjustment in the order passed by the TPO and any foreign company.

(2) On receipt of the draft order, the eligible assessee shall, within thirty days of the receipt by him of the draft order,— (a) file his acceptance of the variations to the Assessing Officer; or (b) file his objections, if any, to such variation with,— (i) the Dispute Resolution Panel; and (ii) the Assessing Officer.3) The Assessing Officer shall complete the assessment on the basis of the draft order, if— (a) the assessee intimates to the Assessing Officer the acceptance of the variation; or (b) no objections are received within the period specified in sub-section (2).(4) The Assessing Officer shall, notwithstanding anything contained in section 153, pass the assessment order under sub-section (3) within one month from the end of the month in which,— (a) the acceptance is received; or (b) the period of filing of objections under sub-section (2) expires. (5) The Dispute Resolution Panel shall, in a case where any objection is received under sub-section (2), issue such directions, as it thinks fit, for the guidance of the Assessing Officer to enable him to complete the assessment.

(6) The Dispute Resolution Panel shall issue the directions referred to in sub-section (5), after considering the following, namely:— (a) draft order; (b) objections filed by the assessee; (c) evidence furnished by the assessee; (d) report, if any, of the Assessing Officer, Valuation Officer or Transfer Pricing Officer or any other authority; (e) records relating to the draft order; (f) evidence collected by, or caused to be collected by, it; and (g) result of any enquiry made by, or caused to be made by, it.(7) The Dispute Resolution Panel may, before issuing any directions referred to in sub-section (5),— (a) make such further enquiry, as it thinks fit; or (b) cause any further enquiry to be made by any income-tax authority and report the result of the same to it.(8) The Dispute Resolution Panel may confirm, reduce or enhance the variations proposed in the draft order so, however, that it shall not set aside any proposed variation or issue any direction under sub-section (5) for further enquiry and passing of the assessment order.(9) If the members of the Dispute Resolution Panel differ in opinion on any point, the point shall be decided according to the opinion of the majority of the members.

(10) Every direction issued by the Dispute Resolution Panel shall be binding on the Assessing Officer.(11) No direction under sub-section (5) shall be issued unless an opportunity of being heard is given to the assessee and the Assessing Officer on such directions which are prejudicial to the interest of the assessee or the interest of the revenue, respectively.(12) No direction under sub-section (5) shall be issued after nine months from the end of the month in which the draft order is forwarded to the eligible assessee.(13) Upon receipt of the directions issued under sub-section (5), the Assessing Officer shall, in conformity with the directions, complete, notwithstanding anything to the contrary contained in section 153, the assessment without providing any further opportunity of being heard to the assessee, within one month from the end of the month in which such direction is received.(14) The Board may make rules for the purposes of the efficient functioning of the Dispute Resolution Panel and expeditious disposal of the objections filed under sub-section (2) by the eligible assessee.

Section 92CB Safe Harbour rules

The determination of arm's length price under section 92C or section 92CA shall be subject to safe harbour rules.

The Board may, for the purposes of sub-section (1), make rules for safe harbour.

CBDT has constituted Rangachary committee to notify safe harbour rules

E.g. circular No 6/2013 dated 29.06.2013 was issued to deal with development centers engaged in contract R&D services with insignificant risks

Safe Harbour means circumstances in which the income tax authorities shall accept the transfer price declared by the assessee.

Section 92D Maintenance and keeping of information and document by persons entering into international transaction or specified domestic transaction

To keep and maintain books of accounts and such information , as may be prescribed Period for which books to be maintained as prescribed by the board. To be maintained for a period of 8 years

from the end of the relevant assessment year. The assessee shall be required to submit such information as asked for within 30 days of the receipt of such notice

from the AO or CIT (Appeals). Can be further extended to 30 more days No documentation if the aggregate value of such transactions doesnot exceed 1 crore rupees

Section 92E Report from an accountant to be furnished by persons entering into international transaction [or specified domestic transaction] - due date – 30th November of the relevant assessment year

Section 92F Definitions of certain terms

Types of Information &

Documents

Enterprise wise Documents – Describing

Relations with AE, nature of

Business etc.

Transaction Specific documents

-Functional Analysis of each

Transaction,Contractual terms,

Economic,Market analysis

Computation relatedDocuments –

Methods considered, adjustments

Made to Transfer price,Assumptions,

Policies.

Section 271(1)(c) & explanation to section 271

Penalty for failure to furnish particulars of income, concealing or inaccurate furnishing in case of any amount of international or specified domestic transaction so added unless the transaction was computed under section92C and in good faith.

100% to 300% of tax sought to be evaded

Section 271AA Penalty for failure to keep and maintain information and documents

Without prejudice to 271 & 271BA,

Fails to keep & maintain under section 92D(2)

Fails to report such transaction

Maintains or furnishes incorrect information

2% of the value of each international transaction or specified domestic transaction

Section 271BA Penalty for failure to furnish report from the accountant

Form 3CEB

Rs. 100000/-

Section 271G Penalty for failure to furnish information or document as required under section 92D(3)

AO or CIT (Appeals) may direct

2% of the value of each international transaction or specified domestic transaction

Advance Pricing Agreement (only for international transactions)

Advance Pricing agreement is an agreement between a taxpayer and a taxing authority on an appropriate transfer pricing methodology for a set of transactions over a fixed period of time in future.

Section 92CC & 92CD deals with it. The board with the prior approval of CG may enter into an APA with any person undertaking

an international transaction include determination of the ALP or specify the manner in which arms length price shall be

determined and that will be in line with the provisions of section 92C or any other method with such adjustments or variations as may be necessary or expedient so to do.

International transaction , which is covered under such APA shall be determined in accordance with the APA only.

APA shall be valid for 5 consecutive years APA shall be binding only on the person and the commissioner (including income tax

authorities subordinate to him ) in respect of the transactions in relation to which the agreement has been entered into

APA shall not be binding if there is any change in any laws or fact having bearing on such APA

The board may declare with the approval of Central government by a order any such agreement to be void ab initio if it finds that the agreement has been obtained by the person by fraud or misrepresentation of facts. Once the agreement has been declared void ab initio, all the provisions of the act shall apply to the person as if such APA had never been entered into

Where an application is made by the person for entering into an APA, the proceeding shall be deemed to be pending in case of the person for the purposes of the Act.

Unilateral APAIf only one tax administration

Of the tax payer Is involved in the

APA.Such APA is bindingOnly on the tax payerWho is an applicant

And the tax administration

who is the Other party of the APA.

Bilateral APAAPA binding on

The taxAdministration of the

AE and the AE Which is in

Other tax jurisdiction.Therefore it avoids Economic Double

Taxation

APA Types

IdentificationOf intra groupTransactions

FAR AnalysisIdentification Of comparableTransactions

Adjustments

Return filing

Determination Of ALP

Documentation

Selection of Most appropriate

Method

TP Assessment

Establishing Comparability ,

Adjustments

Transfer Pricing Process

Concept of SHAREHOLDER Activity

If a service is availed from one group member by another group member and such service would have been paid if availed from a third party , then such service needs to be paid for by the member availing the same to the member providing the same in the group. In addition there will be a different service which is rendered generally by a parent to its subsidiaries. This service is rendered not at the instance of the member availing such service, but rendered to all the members of the group by the parent member. This service is more of a parental obligation or an effort to maintain consistency in quality . This is onerous responsibility of a parent co. against its subsidiaries. This is more of a duty than a service otherwise rendered for a charge. This is called a “shareholder activity”

Arms length price should be determined in respect of intra group service both from the perspective of the service provider and service recipient.

Concept of Tested party

Tested party is the one who performs least complex functions and who doesnot use non routine intangible. However from a practical perspective , it may be desirable to use an entity for which comprehensive data is available as tested party though such entity is a complex functional entity.

Delhi bench of ITAT judgment :Ranbaxy laboratories (2008) 167 taxmann 306(Del)

Global Vantedge (2010) 1 ITR (Trib.) 326 (Del.)

BRIGHT LINE TEST

Special Bench Decision in the case of L.G. Electronics: (2013) 29 taxmann.com.300

FACTS :

L.G. Electronics India Private Limited (“the assessee”) obtained a right from the AE to use technical information, designs, drawings and industrial property rights for the manufacture, marketing, sale and services of agreed products, for which it agreed to pay royalty @ 1 per cent. The AE allowed the assessee to use its brand name and trademarks to products manufactured in India “without any restriction”.

LG Electronics Inc.Korea

LG Electronics India Private Limited

Royalty payment

Subsidiary

Observations :

The Transfer Pricing Officer (“TPO”) concluded that the assessee was promoting LG brand as it had incurred expenses on AMP to the tune of 3.85% of sales vis-à-vis 1.39% incurred by a comparable. Accordingly, TPO held that the assessee should have been compensated for the difference.

• Applying the Bright Line Test, the TPO held that the expenses in excess of 1.39 % of the sales are towards brand promotion of the AE and proposed a transfer pricing adjustment.

• The Dispute Resolution Panel (“DRP”) not only confirmed the approach of the TPO, but also directed to charge a mark-up of 13 % on such AMP expenses towards opportunity cost and entrepreneurial efforts.

Concept of Bright Line Test

Origin : Origin of Dispute in USA - DHL Case

There is a difference between product promotion and brand promotion. Product promotion primarily targets an increase in the demand for a particular product whereas Brand Promotion results in creation of Marketing Intangibles.

The expenditure on advertisement and brand promotion expenses which exceed the average of AMP expenses incurred by the comparable companies in India, is required to be reimbursed/ compensated by the overseas associated enterprise.

In that case , the Indian AE becomes the economic owner of the brand, the legal owner being the Foreign Enterprise.

SOME BASIC CONTROVERSIAL ISSUES??????

•Whether traditional transaction methods have precedence over transactional profit methods?

Delphi TVS Diesel Systems Ltd. v. Asstt. CIT (Chennai)(URO)

Whether when a transaction to transaction or item to item comparison is possible, that should always be preferred for determining ALP and proper adjustment can be carried to account for difference that could materially effect prices in open market of related items rather than transactional net margin method.

• Application of filters such as turnover filters , export revenue filters etc ?

Transwitch India Pvt Ltd vs. DCIT [TS-105-ITAT 2013 (bang) – TP]Patni telecom Services Pvt Ltd vs. ACIT [ TS-102-ITAT-2013(HYD)-TP]

A high turnover company cannot be bench marked against low turnover company because size of the company makes difference in terms of economies of scale

• Internal TNMM versus external TNMM?

Birla Soft India Ltd. [2011] 44 SOT 664 (Delhi)

Held that the assessee was justified in taking internal benchmarking analysis on stand alone basis by placing on record working of operating profit margin from international transactions with AE and transactions with unrelated parties undertaken in similar functional and economic scenarios and the same should be the basis for determination of arms length price in respect of international transactions undertaken with the associated enterprise. We therefore hold the transfer pricing officer had no mandate to have recourse to external comparables when in the present case internal comparables were available which could be applied to determine the arms length price with AE. We therefore direct the AO /TPO to determine the arms length price of international transaction with AE by making internal comparisons of the net margin earned by the assessee from the international transactions with the AE and the profit earned by the assessee from international transactions with unrelated parties.

• Whether overall profit earned by both the AE’s for third party is relevant or not?

Global Vantedge (2010) 1 ITR(Trib.) 326 (Del)

It is often argued by the tax payers before the appellate authorities that overall profit earned by the tax payer and his AE abroad must be considered by the transfer pricing authorities in making any TP adjustment. In other words income assessed in the hands of tax payer in India and income assessed in the hands of AE abroad cannot be more than what is totally earned from the third parties. If this rule is not followed it obviously results in economic double taxation by taxing same income in the hands of tax payer in India and his AE abroad by virtue of TP adjustments.

Ariston Thermo India Ltd. v. DCIT

Hinduja Global Solutions v. ACIT (ITA No. 254/Mum/2013)

Held that adjustments by the tax payer due to under utilization of capacity could be made .

The tribunal rejected the department’s contention that economic adjustments can only be made on the basis of comparables.

The Mumbai Bench of the Income Tax Appellate Tribunal held that , where the lending of money was in foreign currency to its AE the domestic prime lending rate would have no applicability and the interbank rate fixed should be taken as benchmark rate for international transactions.

It, therefore held that LIBOR rate has to be adopted in the instant case.

Vijai Electricals Ltd. Vs ACIT (ITAT Hyderabad)

Perot Systems TSI vs DCIT (ITAT Delhi)

The Hyderabad Bench of the Income Tax Appellate Tribunal held that Transfer pricing provisions do not apply

• to an investment in share capital of overseas companies and

• to transactions where no income has arisen.

Held that the loans were in reality not loans but were quasi capital because the agreement shows them to be loans. The argument that loans were given interest free is not acceptable because it is not an ordinary business transaction but an international transaction between two AEs.

Section 92B defines an international transaction to mean any transaction between AEs in the nature of lending or borrowing money. Therefore in considering the arm’s length price of a loan , the rate of interest has to be considered and income on account of interest can be attributed.

Ascendas (India ) Private Limited v DCIT

The Chennai Bench of the Income tax Appellate Tribunal held that the discounted cash flow method is preferable in determining the arm’s length price for the sale of shares.

Google India Pvt. Ltd. vs DCIT (ITAT Banglore)

Held that the TPO could consider the financial information of comparable not available at the time of TP study.

Symantec Software Solutions Private Limited vs ACIT (ITAT Mumbai)

Held that super profit making companies are to be excluded from the list of comparable before making transfer pricing adjustments.

Transfer Pricing Alerts

• Interest to be charged on delayed payments from Associated Enterprises

• Role of Transfer Pricing Officer limited to determining the arm’s length price

• Corporate Guarantee with no impact on profits , income, losses or assets of a guarantor not considered international transaction.

• Share Application cannot be recharacterised as interest free loan.

• Internal CUP with adjustments preferred over TNMM.

• Adjustment for difference in capacity utilization allowed.

• Price Publications of independent organizations – acceptable CUP.

• Reimbursements of costs require arm’s length price determination.

• Tribunal strikes down arbitrary lifting of corporate veil by TPO.

Amendments vide Finance Act 2014

• Roll Back Provisions in APA w.e.f. 01/10/2014

• Power to levy Documentation penalty extended to TPO w.e.f. 01/10/2014

• Introduction of Range concept (under analysis)

• Allowability of multiple year data for benchmarking (expected to come)

• Deeming TP provisions – section 92B(2) to apply irrespective whether such independent person is a resident or not – w.e.f. 01/04/2015

SOURCES

• Income Tax Act, 1961

• Income Tax Rules

• Guidance Note on Report under Section 92E of the Income Tax Act, 1961

• Transfer Pricing provisions by CA Vinod Gupta

• Google – Search Engine

• International Taxation – A basic study by P.V.S.S Prasad and Sampath Raghunathan

CA Pankti SHAH

Membership No. 141994

Email ID : shahpankti1989@gmail.com