Increasing participation of multinational groups in economic activities in India has given rise to new and complex issue emerging from transactions entered into between two or more enterprise belonging to same group. Hence there was a need to introduce a uniform and internationally accepted mechanism of determining reasonable, fair and equitable profits and tax in India in case of such multinational enterprises. Accordingly the financial act, 2001 introduced law of transfer pricing in India through section 92A to 92Fof the Indian Income Tax Act which guides computation of transfer price and suggests detailed documentation procedures. Transfer pricing regulation (TPR) is applicable to all enterprises that enter into an ‘International Transaction’ with an ‘Association Enterprise’. Therefore generally it applies to all cross boarders transactions entered into between associated enterprises. The main aim and objective is to reach at the comparable price as available to any unrelated party in open market conditions as known as the Arm’s Length Price (ALP).
Before proceeding further we should first look into the concept of ‘Associated Enterprise’ because the whole concept mentioned above is based on this term only.
IDENTIFYING ASSOCIATED ENTERPRISES (AE)
There are large numbers of methods through which associated enterprise can be identified but the basic criteria to determine associated enterprise is through participation in management, control on capital (ownership) of one enterprise by other enterprise. The participation may be direct or indirect or through one or more intermediaries. The scope of associated enterprise is very much wide and hence the concept of control adopted in the legislation extends not only to control through holding shares or voting power or the power to appoint the management of an enterprise but it is also determined through debt, blood relationship, and control over various components of the business activities performed by the taxpayers such as control over, raw materials, sale and intangibles.
A very short example to understand the whole concept of associated enterprise, for instance if enterprise B is managed, controlled or owned either directly or through an intermediary by A, then enterprise B is said to be an associated enterprise of enterprise A. It is mandatory for all the taxpayers, without exception to obtain an independent accountants report in respect of all International Transactions between associated enterprises or specific domestic transactions. The report has to be furnished by the due date of the tax return filling (i.e. on or before 30th November). The form of the report has been prescribed.
RULES REGARDNG INTERNATIONAL TRANSACTIONS
An international transaction is essentially a cross border transaction between associated enterprise if any sort of property whether tangible, or in the provisions of services, lending of money etc. At least one of the parties of the transaction should be non-resident entering into one or more of the following transactions.
- Purchase, sale or lease of tangible or intangible property
- Provisions of services
- Lending or borrowing of money
- Any transactions having a bearing on profits, income, losses or assets.
- Mutual agreement between associated enterprises for allocation/appointment of any cost contribution or expense.
ARMS LENGTH PRICE: A DETERMINING FACTOR
In accordance with internationally accepted principles, the transfer pricing regulation have provided that any income arising from an international transaction between associated enterprise shall be computed having regard to the arm’s length price.
The Arm’s length price is to be determined by any one of the prescribed methods. The tax payer can select the most appropriate methods to be applied to any given transaction, but such selection has to be made by taking into account the factors prescribed in the transfer pricing regulations with a view to allow a degree of flexibility in adopting the arm’s length price, a variance allowance of 5% have been provided under the transfer pricing regulation.
The prescribed method for determining it is as follows:-
- Comparable uncontrolled price method (CUPM)
- Resale price method (RPM)
- Cost plus method (CPM)
- Profit split method (PSM)
- Transactional net margin method (TNMM)
The Authority for Advance Rulings (AAR) has delivered a ruling in the case of Venenuburg Group B. V. and Dana Corporation, wherein it was held that the provisions relating to determination of the arm’s – length price are machinery provisions which would not apply in the absence of liability to pay tax, and accordingly, a taxpayer would not be required to comply with the transfer pricing regulations in respect of income that is not chargeable to the tax in India. The arm’s length price principle applies to loans an interest charges. However at present, there are no rules that specifically deal with thin capitalization and no set permissible debt – to – equity ratios in the Act or the transfer pricing code. However the Indian Government has put forward a proposal for a new direct tax code that will replace the existing Income tax act.
DOCUMENTATION & BURDEN OF PROOF
The provisions contained in Transfer pricing regulation are exhaustive as far as the maintenance of documentation is concerned this includes background information on the commercial environment and should be retained for a minimum of 8 years.
Now as we talk about the burden of proof, then we can see that the primary onus of proof is on the tax payer to determine an arm’s length price in accordance with the transfer pricing regulations and substantiate the same with the prescribed documentation. Where such onus is discharged by the taxpayer and the data used for determining the arm’s length price is reliable and correct there can be no intervention by the tax officer.
In the case, where the tax officer is of the view that:-
- Price charged in the international transaction has not been determined in accordance with the methods prescribed
- Or information and documents relating to the international transaction have not been kept and maintained by the assesse in accordance with the transfer pricing regulation,
- Or the information or the data used in computation of arm’s length price is not reliable or correct.
- Or the assesse has failed to furnish any information or document which he was required to furnish under transfer pricing regulations.
From the above discussion it is very much clear that the tax officer can reject the arm’s length price adopted by the assesse and hence he can further determine the arm’s length price in accordance with the transfer pricing regulation. For this purpose he would further transfer the matter further to a Transfer Pricing Officer (TPO), (a special post for valuation of Arm’s length price) after hearing the arguments of the tax payers. Transfer pricing officer is also responsible for adjustment to reported income of the tax payers and hence can also levy penalties.
Penalties have been provided as a distinctive for non-compliance with procedural requirements are as follows:-
- Penalty for concealment of income- 100 to 300% on tax evaded
- Failure to maintain/ furnish prescribed documentation- 2% of the value of the international transaction.
- Penalty for non-furnishing of accountants report- INR 1,00,000 is fixed
On the other hand the above penalties can be avoided if the tax payer proves that there was reasonable cause for such failures.
DOMESTIC TRANSFER PRICING
Before the concept of domestic transfer pricing there existed transfer pricing. The scope of transfer pricing was enlarged for widening the scope of section 40A (2), and transfer pricing regulations is applied to this concept. After implementation of this concept from 1st April 2013 under section 40 (2) of income tax act, 1961 in case of any transaction with a related party, the assessing officer can disallow the expenditure while computing income from business or profession which is in his opinion is excessive or unreasonable having regard to the:
- Fair market value of goods,
Under this provision there is no- mechanism to re-compute the income received from a related part, in case the assessing officer is of the opinion that such income is low considering the market value, since this section focuses on Expenditure. In order to address this issue, the provisions of transfer pricing are being amended to extend the scope to ‘Specified Domestic Transactions’ by amending section 92 of the act. Further specified domestic transaction have been defined in a new section 92BA as following transactions where the aggregate of such transactions entered into by the assesse in a year exceeds Rs. 5 crore.
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 determining reasonableness of expenditure between related domestic parties. It will create legally enforceable obligation on assesse to maintain proper documentation. However, extending the transfer pricing requirements to all domestic transactions will lead to increase in compliance burden on all assesse which may not be desirable.
Following table shows the sections and transactions covered there under:-
|40A||Any payment made or to be made in respect of expenditure incurred to persons specified in section 40A (2) (b)|
|80A||Any transaction in relation to transfer of goods of services from eligible business to non-eligible business, vice versa.|
|80IA(8)||Any business transaction in relation to transfer of any goods or services between units of the assesse i.e. inter units transfers|
|80IA(10)||Any business transaction between the assesse (covered under 80IA) and his associated entries|
|80-IB, 80-IC, 80ID, 80-IE and 10AA||Any business transaction entered between the assesse who is eligible for 8IB, 80IC, 80ID & 10AA and associated entries or inter unit transfer between the eligible business if the assesse and his non- eligible business|
Accordingly corresponding amendment is been made in the procedural laws of transfer pricing to cover domestic transaction i.e.
- Section 92C for computation of arm’s length price by the method prescribed
- Section 92D maintains and keeping of information and documents,
- Section 92E obtaining report from charted accountant in respect of specified domestic transactions,
- Section 92CA being reference to the transfer pricing officer,
- Penal provisions of section 271(1), Explanation 7 regarding concealment
- Section 271 AA penalty for failure to keep and maintain information and
- Section 271G for penalty for failure to furnish information or document
The Hon’ble Supreme court while deciding on the issue of section 40A (2) in CIT v. Glaxo Smithkline Asia (P) ltd case made some of the important observations and based on those observation of Supreme Court, the Finance Act, 2012 has extended the applicability of the transfer pricing provisions for specified domestic related party transactions. The Supreme Court observed that the present transfer pricing regulations does not apply to domestic transactions. The main advantage of implementing domestic transfer pricing is that under domestic transaction under invoicing and over invoicing will be revenue neutral, except in two circumstances:
- Where one of the related is loss making, or
- Where one of the related entities is liable to pay tax at the lower rate and the profits are shifted to such entity.
The question of extending transfer pricing regulation to domestic transactions requires expeditious considerations by the tax authorities and hence empowers the tax officer to:
- Disallow unreasonable expenditure incurred among domestic group companies (or expressed as related party transactions), under section 40A (2) (b) and
- Empower tax department to re-compute the income of a tax payer eligible for certain tax incentives based in fair market value, under section 10AA/80IA/80IC.
The central board of direct taxes should examine whether transfer pricing regulations be extended to domestic transaction by making amendments to the act. Therefore law can be hence forth amended to mandate the taxpayer to comply with rule 10D. Assessing officer can be empowered to make adjustments to value of the transactions between the related parties based on methods of determinations of arm’s length price, and hence forth based on the above observation of Hon’ble Supreme Court The finance act,2012 has extended the applicability of the transfer pricing provisions for specified domestic related transactions.
Following were the observations made by the government:-
- Presently, there is no method prescribed to determine reasonableness of expenditure to re compute the income in related party transactions.
- There is need to provide objectivity in determination of income and determination of reasonableness of expenditure in domestic related party transactions.
There is need to create legally enforceable obligation on assesse to maintain proper documentation.
The new domestic transfer pricing provisions would have very strict impact across industries which benefit from the said preferential tax policies such as special economic zone (SEZ) units, infrastructure developers or operators, telecom services, industrial park developers, power generation or transmission etc. Apart from this, business 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. There is now a requirement to maintain documentation to prove arm’s length pricing, however for those who are able to demonstrate business being conducted on an arm’s length basis, these provisions will not harm or affect them.
The amended transfer pricing regulations will not be limited to just the large groups any more. Many mid-sized groups, partnership firms, Hindu undivided firm (HUF’s) 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 focused examination by the tax authorities.
 A scheme of Advance Ruling has been introduced in the Act in order to provide the facility to non – residents and certain categories of residents. of ascertaining their income tax liability, planning their income tax affairs well in advance and avoiding long drawn and expensive litigation, an authority for advance Ruling has accordingly been construed.
 Provided that the implementation of the new Direct Tax Code is not deferred by the Government.
 The act or practice of stating the price of a good on an invoice as being less than the price actually paid. It occurs if the importers / exporters wish to reduce a tariff or if a buyer/ seller wish to reduce their profits so as to pay less in taxes.
 The provision of an invoice that reports the price as higher than it is actually.