Before, transfer pricing provisions were limited to International Transactions only. Since 01.04.2013, transfer pricing rules and regulations have been applied on ‘Specified Domestic Transactions’ from A.Y. 2013-14.
Now that Transfer Pricing is applicable on Specified Domestic Transactions, now the taxpayers are obliged to report/document & provide evidence of the Arm’s Length nature of such transaction.
The concept of International Transfer Pricing was there introduced sooner in other countries as compared to India. Other developing countries presented transfer pricing, such as Korea in 1998 and China in 1999, while India adopted international transfer pricing in 2001. Now the questions arise, Why is Transfer Pricing necessary? More than 100 countries have introduced International as well as Domestic Transfer Pricing Provisions.
Now we will discuss about the various concepts of Domestic Transfer Pricing
It has been clarified, that there is much difference between domestic and international controlled transactions. But what is the relevance of that difference? Well, mainly the following three points:
Tax authorities are less likely to examine carefully the transfer pricing of a domestic controlled transaction. The reason for this is that an adjustment to the terms and conditions of such a transaction at the level of one associated enterprise will be mirrored by a corresponding adjustment at the level of the other associated enterprise. And since both enterprises live in the same country or tax jurisdiction and pay taxes there, in most cases a correction will have a neutral result for the tax authorities in terms of tax revenues.
But in the case of international transfer pricing, a correction can result in additional tax revenues. To make this clearer, let us give you an example
XYZ Technology sells IT equipment to associated enterprise ABC Technology and the tax jurisdiction of both enterprises is the United Kingdom. The price for the sale is GBP 100,000 and both enterprises book this amount as revenue respectively costs of goods sold in their books. The HRMS, that is, the tax authority of the United Kingdom, takes the position that the price is not at arm’s length and should be increased with GBP 50,000. This means that the income of XYZ Technology increases by GBP 50,000 and normally corporate tax revenue also increases. However, the position of the HRMS results in that the costs of goods sold for ABC Technology increase with GBP 50,000, and normally corporate tax revenue decreases. Non-acceptance of the latter would be inconsistent with the HRMS! So, in most of the cases on balance, there is not much to win. There are cases that this doesn’t apply, for example where one of the associated enterprises has tax losses to be utilized.
Now XYZ Technology sells IT equipment to associated enterprise ABC Technology US. XYZ Technology is situated in the United Kingdom and ABF Technology US is situated in the United States. The price for the sale is GBP 100,000 and both enterprises book this amount as revenue respectively costs of goods sold in their books. The HRMS takes the position that the price is not at arm’s length, and should be increased with GBP 50,000. This means that the revenue of XYZ Technology increases by GBP 50,000 and normally corporate tax revenue also increases. This is a real gain for the HRMS. And contrary to the above example, the correction of the HRMS does not necessarily mean that the costs of goods sold for ABC Technology, US increase by the same amount. The IRS, the United States tax authorities, may have a different view on such an increase. In the worst-case scenario, this correction is not followed by the IRS and this gives birth to a new dispute. Solving such disputes takes a lot of time and costs.
The compliance requirements such as reporting of transactions in tax filings and transfer pricing documentation can be different in different countries. For domestic controlled transactions the compliance burden is generally less. In some countries, there is no documentation required for domestic transfer pricing at all.
There can be a difference in withholding taxes. Domestic transactions normally do not attract withholding tax. International transfer pricing may attract withholding tax on the basis of domestic legislation and subject to the application of dual tax treaties. Withholding taxes may apply to the payment of royalties, service charges, interest payments, and dividends. If the recipient of such payments cannot claim a credit for the withholding tax paid, that is a real cost to the company.
Before the introduction of domestic transfer pricing, tax officers were given the power to re-compute tax holiday eligible profit if undertaking makes more than ordinary profits, which results in arrangements with closely connected persons or otherwise. In the case of an inter-unit transfer of goods or services, the tax officer/taxpayer has been allowed to calculate tax holiday profits on the basis of the FMV of goods/services.
Thus, no specific methodology was prescribed for disallowance/ tax holiday profit adjustment and it was important to consider making TP provisions applicable to previously mentioned transactions.
There are two counts where tax loopholes are taken benefit of in India.
The main objective of the introduction of the domestic transfer pricing provisions in India was to deal with the tax arbitrage possibilities in India arising out of differential taxes and accumulated losses of loss-making concerns.
The separate transfer pricing code referred to in Sections 92 to 92F of the Indian Income Tax Act, 1961 (‘the Act’) applies to intra-group domestic transactions.
The Indian Transfer Pricing Code advises the taxpayers and collectors that income arising from specified domestic transactions should be computed having regard to the arm’s length price. It has been made clear that any allowance for an expenditure or interest or allotment of any cost or expense arising from a specified domestic transaction also shall be determined having regard to the arm’s-length price. The Act describes the term of the domestic transactions, the linked parties, and the price of the arm’s length.
The existing provisions under Section 92BA of the Income-tax Act, 1961, an assessee is required to comply with the transfer pricing provisions if the total of the Specified Domestic Transactions (SDT) is more than INR 20 crore during an assessment year.
A small assesse must comply with the transfer pricing provisions, which leads to an increase in the compliance burden and cost.
Therefore, it is recommended that the threshold limit of INR 20 crores needs to be revised upwards, up to INR 50 crores providing relief to the small assesse is preferred. The amendment that is proposed above will also provide a boost to the ease of doing business initiative of the government, as it will reduce compliance burden and cost of the assessee.
Finance Act 2012 enlarged the application of Indian transfer pricing regulations to specified domestic transactions, the below mentioned transactions being applicable to related domestic parties if the aggregate value of such transactions exceeds 20 crores:
Thus, Specific Domestic Transfer Pricing provisions are applicable only if one of the domestic Indian entities involved in the intercompany transaction is enjoying benefits of any tax holiday/profit linked deduction and the aggregate of such transactions are more than INR 20 crores.
According to section 92D, every person who has entered into a Specific Transfer Pricing shall keep and maintain such information and documents to prove the transactions, as prescribed in Rule 10D of the Income Tax Rules. As per Section 92E, the assessee has to take an accountant’s report, in Form 3CEB, duly signed and verified as per the provisions of the Act. The Transfer Pricing Audit Report has to be filed electronically on or before the due date of filing of Income Tax Return (on or before November 30 of the respective assessment year).
If someone doesn’t keep and maintain any such information or/and document as required by section 92D, the Assessing Officer or Commissioner (Appeals) has the power to take a penalty from that person, a sum equal to 2% of the value of each SDT entered into by such person.
Moreover, if a person fails to furnish a report from an accountant (Form 3CEB) as required by section 92E by the due date will be charged a penalty of INR 100,000. However, in case of a transfer pricing adjustment, if good faith and due diligence are absent by the taxpayer in applying the provisions and maintaining as much documentation as needed, tax authorities in India can levy a penalty of 100% – 300% of tax on the adjusted amount.
According to Section 92C, the Arm’s Length Price in relation to “Specified Domestic Transaction” can be calculated by any of the following methods, the one that you consider the most appropriate for your work.
According to Rule 10C of the Income Tax Rules, the most appropriate method will be the method that is best suited to the facts and situations of each particular transaction and provides the most reasonable measure of the transaction. These are the factors that should be taken into consideration while choosing the most appropriate method namely:
The nature and class of the international transaction.
The class or classes of related enterprises that enter into the transaction and the functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprises.
The availability, coverage, and reliability of the data necessary for the method to be applied.
The magnitude of comparability existing between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions.
The extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions.
The nature, extent and reliability of assumptions required to be made in application of a method.
The disciplinary procedure includes:
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