Specified Domestic Transactions

Demystified

-By CA Yagnesh Katira

Discussion Topics

•Pre Finance Act 2012 & Glaxo smith Kline Case

•Scope of SDT provisions•Concept of ALP•Difference between FMV and ALP•Documentation requirements & Penalties•Clause wise analysis & Cases•Assessments procedure

Pre Finance Act 2012 & Glaxo smith Kline Case Tax officer empowered to disallow payments to “related

parties” which are “excessive” or “unreasonable” Tax officer empowered to re-compute tax holiday eligible

profit, if an undertaking makes more than ordinary profits as a result of arrangements with closely connected persons or otherwise.

In case of inter-unit transfer of goods or services, the tax officer/taxpayer allowed to determine tax holiday profits based on the Fair Market Value (‘FMV’) of goods/services.

No specific methodology prescribed for disallowance/tax holiday profit adjustment.

Glaxo smith Kline Case• Supreme Court Suggestions

▫ Amendment to Sections 40A(2) and 80IA(10) to empower AO to make adjustments based on ALPs.

▫ Law should be amended to make it compulsory for the taxpayer to maintain books of accounts and other documents as required under the Indian TP laws, in respect of domestic transactions which are not revenue neutral; and

▫ The taxpayer may be required to obtain an audit report from a Chartered Accountant certifying that transactions between related entities are at arm's length

Scope of Specified domestic transactions (SDT)

• Sub sec. (2A) was introduced to Sec 92 which read –

(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.

• Specified domestic transactions as per Sec 92BA –

► Payments to related parties as defined under section 40A (2) (b)► Tax holiday-related transactions (eligible business) :▫ Any transaction referred to in section 80A of the Act▫ Any transfer of goods/services referred to in section 80IA (8) of

the Act▫ Any business transaction referred to in section 80IA (10) of the

Act▫ Any transaction under Chapter VI-A or u/s 10AA of the Act to

which provisions of section 80IA (8) or section 80IA (10) apply► Any other transaction, as may be prescribed

Aggregate value of transaction to exceed INR 20 Cr

Concept of ALP• Defined to mean a price that is applied or proposed for a transaction

entered into by persons other than associated enterprises (‘AEs’) , in uncontrolled conditions

• Concept of ALP, applicable for determining taxable income arising from international transaction introduced in 2001, now extended to SDTs

• Comparability and FAR analysis (ie analysis of functions performed, assets employed and risks undertaken) fundamental to the concept of ALP:

• Comparison of conditions in controlled transactions with conditions in transactions among uncontrolled enterprises

• Compensation to reflect functions performed (taking into account assets used and risks assumed)

• Typically relevant for transactions among “separate enterprises”; may need to be applied by analogy to SDT involving the inter-unit transfer of goods/services

ALP V/s FMVArm’s length price Fair market value

• Subjective, entity specific value

• Based on actual transaction undertaken & market conditions

• Calculated following the prescribed methods only.

• Narrow concept.

• Objective, market-based value

• Based on hypothetical transactions & market conditions

• No methods have been prescribed.

• Broader concept

• FMV a better method when ALP is incapable of achieving a comparison.

• ITAT Ruling of Ascendas India upheld usage of DCF over the prescribed methods of calculating ALP

Methods for computing ALP• Computed using any of the following methods that seems to be the

most appropriate method:

▫ Comparable uncontrolled price method

▫ Resale price method

▫ Cost plus method

▫ Profit split method

▫ Transactional net margin method

▫ Other method as may be prescribed by the Central Board of Direct Taxes — method prescribed in May 2012 by inserting Rule 10AB of the Income Tax Rules (‘Rules’)

• Rules to provide guidance on the application of the listed methods and factorsto be considered while selecting the most appropriate method (Rule 10B)

Documentation Requirements

Filing of Form 3CEB• All taxpayers to whom the provisions apply required to file

• Form 3CEB, certified by a chartered accountant

• For FY 2012–13, due date of filing Form 3CEB: 30 November 2013 (to be filed online)

• TP documentation as basis for the certification of Form 3CEB

• Certificate to contain details such as:

▫ Compliance by taxpayer with TP documentation requirements

▫ Nature/Quantum of transactions and method used to determine ALP

• Aimed at assisting tax officers in assessment proceedings

Penal Provisions

Sec 40A(2)(b) Analysis

Clause (i)

Clause (ii)

Sec 40A(2)(b) Analysis

Clause (iii)

Clause (iv)

Sec 40A(2)(b) Analysis

Clause (v)

Sec 40A(2)(b) Analysis

Clause (vi)(A)

Clause (vi)(B)

Sec 40A(2)(b) Challenges

• Applicability to Capital expenditure

• Direct / Indirect Relationship (for the purpose of determining beneficial ownership to derive substantial interest)

• Benchmarking Director Remuneration

• Data sourced to understand entities / persons covered

Sec 40A(2)(b) Case

Tax Holiday undertakings80A(6), 80IA(8), 80IA(10), 10AA

SDT provisions on business transactions/transfers referred to in section 80A, 80IA (8) , 80IA (10) , 10AA, Chapter VI-A provisions of the ActSection 80A (6) and Section 80IA (8) to require adjustment to tax holidayprofits where:► Goods and services of eligible business 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 notin correspondence to the market value of such goods/services► In such cases, tax authorities/taxpayer required to re-compute tax holiday claim byreference to ALP of such goods/services► Overlap between Section 80A (6) and Section 80IA (8) not of muchconsequence► Applies to all tax holiday claims under Chapter VI-A/ Section 10AA

Tax Holiday undertakings80A(6), 80IA(8), 80IA(10), 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 among the businesses• Does not contemplate an artificial or hypothetical segregation

of profits between tax holiday unit and the rest of the enterprise

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

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

Eligible business covered

Eligible business covered

Eligible business covered

Tax Holiday undertakings80A(6), 80IA(8), 80IA(10), 10AA

Tax Holiday undertakings80A(6), 80IA(8), 80IA(10), 10AA

Close Connection ??

Examples

Applicability of Domestic TP – Inter Unit Transfer

Inter unit transfers – Interplay of eligible and non-eligible unit

Coverage of s. 80-IA(10)

Tax Burden, if transaction not at ALP – Interplay between 40A(2) & 80IA(10)

Voluntary TP adjustment in ROI

Questions???

Thank YouFor any details contact CA Yagnesh Katira on yagneshkatira@gmail.com