Finance Bill, 2012Applicability of Transfer pricing regulation on

Domestic related party transactions

Applicability of Transfer pricing regulation on

Domestic related party transactions

The Union budget 2012 (“UB”) has extended the gamut

of transfer pricing regulation to domestic firms. Therefore,

transfer pricing regulation will be applicable to specified

domestic transactions that these firms get into with their

sister company from same group.

The Supreme Court in the case of CIT Vs Glaxo SmithKline

Asia (P) Ltd, in its order has, after examining the

complications which arise in cases where fair market value

is to be assigned to transactions between domestic related

parties, has suggested that Ministry of Finance should

consider appropriate provision to make Transfer Pricing

regulations applicable to certain related party domestic

transactions.

The tax law, as it stands today, empowers the tax office to:

Disallow unreasonable expenditure incurred among

domestic group companies (or expressed as related

party transactions), under section 40A(2)(b); and

Empowers tax department to re-compute the income of

a tax payer eligible for certain tax incentives based on

fair market value, under section 10AA/80IA/80IB/80IC.

However, the law does not provide any method to

determine reasonableness of expenditure or fair market

value to re-compute the income of such transactions.

Objective of amendment

The application and extension of transfer pricing

regulations to domestic transactions would provide

objectivity in determination of income from domestic

related party transactions and determination

reasonableness of expenditure between related domestic

parties. It will create legally enforceable obligation on

assesses to maintain proper documentation. However,

extending the transfer pricing requirements to all domestic

transactions will lead to increase in compliance burden on

all assessees which may not be desirable.

Applicability of amendment

Accordingly the Finance Bill proposes to extend the

applicability of the transfer pricing provisions to all the

above referred domestic transactions i.e.

Taxpayers operating in Special Economic Zones (under

Section 10AA of ITA);

Taxpayers having domestic transactions with certain

related parties [under Section 40A(2) of ITA]; and

Taxpayers claiming deductions for undertaking

specified business activities [under Section 80A, 80- IA

etc of ITA].

The tax authorities can recompute the income (based on

fair market value) under these sections, of the

undertaking to which profit linked deduction is provided if

there are transactions with the related parties or other

undertakings of the same entity. The transfer pricing

provisions in respect of domestic transaction are

applicable to transactions that will exceed threshold of Rs

5 crore.

Under the proposed amendments the transfer pricing

officer will also examine payments made to directors and

computation of income and allocation of expenses

between related party undertakings claiming tax holiday.

Whilst on one hand the proposals increases the

compliance burden of the tax payer and, on the other, tax

authorities do not allow the tax payer to obtain certainty

as the tax payer is not entitled for APA on domestic

transactions.

This amendment will take effect from April 1, 2013 and

will, accordingly, apply in relation to the assessment year

2013-14 and subsequent assessment years.

Impact of Amendment

These new domestic transfer pricing provisions would have

ramifications across industries which benefit from the said

preferential tax policies such as SEZ units, infrastructure

developers or operators, telecom services, industrial park

developers, power generation or transmission etc. Apart

from this, business conglomerates having significant intra-

group dealing would be largely impacted. The IT industry

which gets tax incentives under Section 10AA will come

under this ambit as they also transact with their units that

are not a part of such schemes (such as STPI units). There

is now a requirement to maintain documentation to prove

arms length pricing, however, for those who are able to

demonstrate business being conducted on an arms-length

basis, these provisions will not harm them.

DOMESTIC WORRIES

* Arm’s length pricing of domestic related party transactions;

* Five transfer pricing methods for determining arm’s length

price;

* Entities claiming tax holiday with super-normal profits to

comply with TP laws;

* Taxpayers to maintain mandatory documentation for related

party transactions;

* Taxpayers will have to file Form 3CEB along with their tax

return;

* Domestic transactions to be assessed by transfer pricing

officer instead of assessing officer.

Conclusion

These amended transfer pricing regulations will not be limited

to just the large groups any more. Many mid-sized groups,

partnership firms, Hindu Undivided Families (HUFs) and even

individuals in smaller cities will now have to adhere to the TP

rules. This will lead to an increase in the administrative and

compliance burden for the taxpayer in respect of such

transactions and a focused examination by the tax authorities.

Contact details:

S.P.Nagrath & Co.,

A-380 , Defence colony , New Delhi -110024

Email - rashi@spnagrath.com/ nandita@spnagrath.com