Transfer Pricing (TP) provisions were introduced in Indian in 2002 as anti-avoidance regulations with an objective of protecting the tax base of India and checking the manipulation of inter company pricing by MNCs operating in India. Having achieved remarkable success in garnering huge amounts of taxes, by making transfer pricing adjustments on companies with cross-border operations in last 6-7 years, the Finance Ministry has now cast its net wider and deeper. The Finance Act 2012 has expanded the scope of TP provisions by including specified transactions between domestic related parties within the ambit of TP provisions.
Who would be affected?
The Income-tax Act (ITA) is now amended to extend applicability of the TP regulations (including procedural and penalty provisions) to specified domestic transactions between domestic related parties.
The specified domestic transactions are defined to include:
- Payments to related parties u/s 40(A)(2) - The ITA already has a limited provisions [section 40A(2)] under which the tax authorities can disallow any excess of expenses over fair market value paid by the taxpayers to its domestic related parties. However, a clear framework in this regard was missing. It is now proposed to extend the specific concept of arm’s length price instead of a fair market value to determine the value of domestic related party transactions. It is also pertinent to note that definition of related parties is comprehensive enough to include majority of the parties
- who could possibly influence the price of a transaction. E.g. in respect of companies, payments to its director(s)/director’s relative(s) or other entities in which a director or director’s relatives have substantial interest would be regarded as related parties.
- Tax Holiday units: Tax payers claiming tax holiday/tax exemption/profit linked deductions would now be subjected to transfer pricing for the following:
- ransfer of goods or services between various businesses/units belonging to the same tax payer
- More than ordinary profits derived from transactions with closely connected persons
These new 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 dealings would be largely impacted. All cost sharing arrangements between the domestic group entities, payments to managerial personnel, and inter-company purchases, sale or licensing of goods, services and properties would be covered within the ambit of specified domestic transactions.
The above provisions are applicable only if the aggregate of specified domestic transactions exceeds Rs. 50 million (approximately US$ 1 million).
What does it imply for affected tax payers?
From 1st April 2012 i.e. FY 2012-13, these entities would have to justify that their transactions, even with domestic related parties, are at arm’s length. The existing concept of “fair market value” was more of a general definition, while under the arm’s length price approach, the tax payer has to demonstrate the value of inter-company transactions by choosing one of the five prescribed methods. Additionally, these taxpayers will now have to maintain the mandatory and onerous documentation for domestic related party transactions. These taxpayers will have to obtain and file a Certificate to be issued by a Chartered Accountant in Form 3CEB along with their tax return. These transactions will be examined by a special cell of the Transfer Pricing Officers instead of Assessing Officers.
What are the consequences of non-compliance?
If the tax authorities are of the view that the transactions between domestic enterprises are not at arm’s length, they may either disallow the expenses or deny tax benefits on the excessive profits of the undertaking. This would lead to double taxation for the group as a whole. Apart from the above, the following penal consequences may also follow:
- Penalty of 2% of transaction value for failure to report the transaction in the Form 3CEB.
- Penalty of 2% of transaction value for failure to maintain documentation.
- Penalty of 2% of transaction value for failure to furnish documentation.
- Adjustments, if any, by the Transfer Pricing Officer, will attract penalties of 100 to 300% of the additional tax payable.
Our experience with the transfer pricing regime suggests that the tax authorities globally and more so in India are extremely aggressive in applying these regulations. The quantum of adjustments by the Indian tax authorities in last 7 years is approximately US$ 19 billion with US$ 9 billion being the value of adjustments made in the last round of scrutiny assessments. Apart from the above, the aggressive approach of the Government is easily comprehensible from the amendments made in the Finance Act 2012 to widen the ambit of international transactions, giving wide powers to transfer pricing officers and stringent penalties for failure to report transactions – some of these amendments are retrospective in nature to overcome certain favourable judicial precedents.
It is thus imperative now for these entities to re look their existing pricing arrangements in respect of transactions with their domestic related entities. A proper and consistent pricing policy in respect of these transactions needs to be developed and documented based on arm’s length principle. Based on our experience in dealing with transfer pricing regulations for cross border transactions, it is strongly recommended that a pricing policy/framework be developed and requisite documentation be created/maintained on an ongoing basis rather than looking at it at/after the year end.
How can SKP be of help?
- Assistance in formulating a pricing policy for all types of related party transactions, with appropriate guidelines such that it meets with commercials objective as well as complies with tax and regulatory policies.
- Guidance on maintenance of prescribed documentation required to support/substantiate the transfer price.
- Assistance in selection of most appropriate method and undertaking benchmarking analysis
- Issuance of Form 3CEB
- Assistance in developing defence strategies and files and representation for transfer pricing assessments.