Tax arbitrage by pptfiles


									   In  domestic  transactions,  the  under  invoicing  of  sales  and 
    over-invoicing  of  expenses  ordinarily  will  be  revenue 
    neutral  in  nature  except  in  two  circumstances  having  tax 
    arbitrage such as where one of the related entities is

    ◦ Loss making or

    ◦ Liable to pay tax at lower rate and the profits are shifted 
      to such entity
   Transfer  Pricing  till  A.Y.  2012-13  was  applicable  to  Entities 

    having  International  transactions  with  their  Associated 


   Honoring  the  Supreme  Court  ruling  in  case  of  CIT  vs  M/s 

    Glaxo  Smithkline  Asia  (P)  Limited  expanded  the  ambit  of 

    transfer pricing to Specified Domestic Transactions w.e.f. 1st 

       Intent of Domestic TP-DTA & Tax Holiday Unit
       Scenario 1                                     Scenario 2

 Particulars         Co.A   Co.B                Particulars         Co.A   Co.B

 Taxed in India @     0%     33%                Taxed in India @    0%      33%

 Income from RP      150         -              Income from RP      225         -

 Other Income        300     600                Other Income        300     600

 Expense to RP        -      150                Expense to RP        -

 Other Expenses      300     300                Other Expenses      300     300

 Profit / Loss       150     150                Profit / Loss       225     75

 Tax                  -          50             Tax                  -          25

 Total Tax for the
                                                Total Tax for the          25
 Group                                          Group

By   shifting of expenses             from a tax holiday unit (Power) to a unit
in the Domestic Tariff Area, the group could reduce its tax liability by
25. To avoid such cases, Domestic TP has been introduced.
     Intent of Domestic TP-Domestic Tariff Area (DTA)
          Scenario 1                                  Scenario 2

    Particulars         Co.A    Co.B            Particulars         Co.A   Co.B

    Taxed in India @    33%      33%            Taxed in India @    33%     33%

    Income from RP      100          -          Income from RP      150         -

    Other Income        200      400            Other Income        200     400

    Expense to RP        -       100            Expense to RP        -

    Other Expenses      400      200            Other Expenses      400     200

    Profit / Loss       (100)    100            Profit / Loss       (50)        50

    Tax                   -          33         Tax                   -         17

    Total Tax for the
                                                Total Tax for the          17
    Group                                       Group

By shifting of expenses fro a loss making company to a profit making company,
the group could reduce its tax liability by 16 for the current year, though the impact
will be reversed in future years given carry forward of losses.
Intent of Indian Transfer Pricing (TP) Regulations

         Indian Co.                  Enterprise 
                                      (AE Co.)

   India                                           Overseas
   (Tax @ 33%)                                     (Tax at Lower 
                      Shifting of 
                                                   rates, say 10%)

       Tax Savings for the group -> Indian Govt. loses
  Applicability
Transaction covered under          Applicability

clause (b) of sub section (2) of   Any expenditure
Section 40

Sub section (6) of 80A             Computing Section
                                   ( Determination of ALP)
Sub section (8) of Section 80IA    Any transfer of goods or services
Profit based deduction             within units – Intra Units
Sub section (10) of Section 80IA   Any business transacted within closely
Profit based deduction             connected entities
Chapter VIA or Section 10AA        Any transaction
Profit based deduction
In any of the section              Any other transactions as may be
   Threshold

   Shift of focus

   How would you interpret the close connection ?

   Fair Market Value can established using basic market evidence

   Determination of Arm’s Length Price

   Advance  Pricing  Agreements NOT  applicable  to  specified 
    domestic transactions
Scope – Domestic Transactions

Tax holiday
undertakings covering :
• inter-unit transfer of
goods and services         Aggregate
Transactions with          value exceeds
entities having close      Rs. 50 millions
connection                 in a financial
Expenditure incurred       from
between related parties    FY 2012-13)
defined u/s 40A

Any other transaction
that may be specified
Scope of Section 92BA
Inter unit transfer of goods & services by
   undertakings to which profit-linked
  deductions apply – Sub section (8) of
               Section 80IA


 Transactions between undertakings, to
  which profit-linked deductions apply,
having close connection Sub section (10)
             of Section 80IA
Section      Tax Payers covered           Applicability of TP provisions on SDT
                                           aggregating a value of more than
                                                      INR50 million
40A(2)     Substantial   Interested      Expenses or payment made or to be made.

80A(6)     Enterprise claiming profit    Intra Transfer of goods and services and
           linked deductions from        within the closed connected entities. ( i.e.
           total income under chapter    eligible business to non eligible business)
80IA       ØInfrastructure developers    The goods and services of an eligible
Sub        ØTelecommunications           business transferred to any other business
Section    service providers             carried on by the same taxpayer and vice-a
(8)        ØDevelopers of Industrial     -versa, are to meet the arm’s length test. (sub
And (10)   parks                         section 8) Intra Unit Transfer
           ØProducers or distributors
           of power                      a business transacted between a taxpayer
           An enterprise with an         carrying on an eligible business transact
           eligible business and close   with a close connection, which results in
           connection with any other     more than ordinary profits to the business, is
           person                        to meet the arm’s length test. (sub section
Section             Tax Payers covered             Applicability of TP provisions on SDT
                                                     aggregating a value of more than
                                                                INR50 million
80-IAB    Developers of SEZs
          ØSmall Scale industry engaged in
            operating Cold storage plant
          ØIndustrial undertaking in               The goods and services of an
            industrially backward state as         eligible business transferred to any
            mentioned in VIII Schedule (ex :       other business carried on by the
            Jammu and Kashmir)                     same taxpayer and vice-a-versa,
                                                   are to meet the arm’s length test.
          § Multiplex theaters and convention
                                                   (sub section 8) Intra Unit Transfer
          § Company carrying on scientific
            research and development               a business transacted between a
          § Eligible housing projects              taxpayer carrying on an eligible
          § Eligible hospitals
                                                   business transact with a close
                                                   connection, which results in more
80-IC /   Persons with units in specified states   than ordinary profits to the
80-IE     / north-eastern states claiming          business, is to meet the arm’s
          deduction                                length test. (sub section 10)
80-ID     Hotels located in districts with World
          Heritage sites
10AA      Persons with income from SEZ units
                              Section 92BA Analysed......
                                     For the purpose of sec. 92, 92C, 92D and 92E

  Section                                                                     Relevance
                                                                              provisions of
                                                                              Sec 92BA
  92    : Computation of income having regard to ALP                                ü
  92A : Meaning of AE                                                               r
  92B : Meaning of International transaction                                        r
  92C : Methods of computation of ALP                                               ü
  92CA: Reference to TPO                                                            ü
  92CB : Safe harbour rules                                                         r
  92CC : Advance Pricing agreement                                                  r
  92CD : Effect of TP agreement                                                     r
  92D : Maintenance of information and documents                                    ü
  92E : CA’s Report                                                                 ü
  92F : Definitions: Accountant, ALP, Enterprise, PE, Specified date,               r
* Sec 92F – Definitions does not define terms relevant for domestic TP transactions
                   Intra Unit Transactions    Tax Holiday

                                     4       FMV to ALP

           1                             5



   To check evasion of tax through  excessive  or 
    unreasonable payments to relatives and associate 
    concerns  and  should  not  be  applied  in  a  manner 
    which will cause hardship in bona fide cases.

   AO  is expected to exercise his  judgment  in  a 
    reasonable and fair manner 
   Fair  market  value  of  the  goods,  services  or  facilities  for 
    which the payment is made, or

   The legitimate needs of the business or Profession

   The  benefit  derived  by  or  accruing  to  the  assesse  from  the 

   The  above  view  is  expressed  by  Hon’ble  Guj  High  Court  in 
    the case of Coronation Flour Mills vs. Asst. CIT [ 2009] 314 
    ITR 1
   Expenditure paid or to be paid to related parties will require to be at arm’s length
   Examples of related parties under section 40A(2)(b)
Payer          Receiver of Payment

Individual     • Relative of individual
Company        • Director of company or relative of the director
AoP/ HUF       • Member of AoP / HUF or relative of such member
Any            • Payment to a person who has substantial interest 
taxpayer       • Payment to a director / partner / member / relatives of a person 
                 who has substantial interest 
               • Payment to a company in which parent (more than 20% holding) has 
                 substantial interest
               • Payment to a person whose director/ partner/ member  has 
                 substantial interest 
               • Payment to a director/ partner/ member/ relatives of a person
                 whose director/ partner/ member has substantial interest 
               • Payment to a person in which entities have substantial interest 
               • Payment to a person in which my director/ partner/ member/
                 relatives have substantial interest 
               • Payment to any of director/ partner/ member/ relatives

    Substantial Interest means beneficial ownership of shares with at least 20% voting
                right or beneficial entitlement of at least 20% of the profits
    Section 2(41) defines relative in relation to an individual to mean:

    ◦ Husband;

    ◦ Wife;

    ◦ Brother;

    ◦ Sister; or 

    ◦ any lineal ascendant or descendant;
   Means an enterprise –

    ◦ (a). Which participates, directly or indirectly, or through one 
     or  more  intermediaries,  in  the  management  or  control  or 
     capital of the other enterprises; or

    ◦ (b).  In  respect  of  which  one  or  more  persons  who 
     participate,  directly  or  indirectly,  or  through  one  or  more 
     intermediaries,  in  its  management  or  control  or  capital,  are 
     the  same  person  who  participate,  directly  or  indirectly,  or 
     through  one or more  intermediaries,  in the management  or 
     control or capital of the other enterprise. 
   Section 40A(2)(b) applies to payment made to the 
    assesse’s  relative  or  an  associate  concern  is  liable 
    (Substantially Interested Parties)

   Section 92A applies to transaction with AE directly 
    or indirectly or through one or more intermediaries 
    in  the  management  or  control  or  capital  of  the 
    other enterprise.

    A       A & B              ü

            A & C               ü

            A & D               r
B       C
            A & E                r

            B & C                ü

            D & E               r

            C & D               r
D       E   B & E               r

   Domestic  Transfer  Pricing  usher  shift  from  generic  ‘Fair  Market  Value’ 
    concept to Arm’s Length Pricing 

    Characteristic      Fair Market Value                  Arm’s Length Pricing

                        The  price  which  goods  or  A  price  which  is  applied  in  a 
    Definition          services  would  have  fetched  transaction  in  uncontrolled 
                        or cost in the open market      conditions

    Computation         No  specific  mechanism            Most  appropriate  method  out 
    Mechanism           provided in law                    of five prescribed methods

                        Any market pricing point can  Arithmetic     mean       of 
    Transaction Value   be  treated  as  fair  market  comparable  prices  treated  as 
                        value                          arm’s length price

                        One  comparable  may  be 
                                                           Require  bigger  sample  size 
    Sample Size         sufficient  to  establish  fair 
                                                           for establishing arm’s length
                        market value

                        No  deviation  permitted  from  Deviation  of  plus  /  minus 
                        fair market value               three percent is permitted
    “Arm’s length price” means a price which is applied or proposed to be applied 
     in a transaction in uncontrolled conditions
    Arm’s Length price is determined using the Most Appropriate Method :
    Methods                                Comparability

    Comparable Uncontrolled Price Method   ‘Price’ of the transactions

                                           ‘Gross margin’ of company reselling products / 
    Resale Price Method
                                           services to unrelated parties

                                           ‘Gross margin’ of company selling manufactured 
    Cost Plus Method
                                           products / services to related parties

                                           ‘Splits profits’ between parties to transactions 
    Profit Split Method
                                           based on economic parameters
                                           ‘Net Profit margin’ (Operating Profit) of ‘Tested 
    Transactional Net Margin Method

    If more than one comparable price is obtained using above methods, then the 
     arm’s length price would be ‘Arithmetic Mean’ of comparable prices

    ◦ Deviation of plus / minus five percent is permitted from arm’s length price
  Methods for Determination of ALP 
Price applied in a transaction between independent enterprises in 
uncontrolled conditions
To  be  determined  by  applying  the  Most  Appropriate  Method, 
being one of the following five methods
    Comparable Uncontrolled Price (CUP) Method        Traditional
    Resale Price Method (RPM)                           methods
    Cost Plus Method (CPM)
    Profit Split Method (PSM)                         Transactional
    Transactional Net Margin Method (TNMM)              methods

In case, more than one price is determined by MAM:
    Apply Arithmetic mean
    Range of + 5% of the arithmetic mean 
Section   Nature of Undertakings covered
80IA      Undertakings engaged in
          •Developing,  operating  and  maintaining,  developing  and  operating 
          and maintaining infrastructure facilities
          •Generation/ transmission or distribution of power
          •Reconstruction/ revival of power generating plants  
80IB      Undertakings located/ engaged in
          •Industrially backward districts as notified;
          •Scientific research & development
          •Refining of mineral oil/ commercial production of natural gas
          •Operating cold chain facility for agricultural produce
          •Processing,  preservation  and  packing  of  meat/  meat  products  or 
          poultry/ marine/ dairy products
          •Operating and maintaining a hospital of specified capacity
80IC      Undertaking located in notified Centre/ Parks/ Areas in
          •Himachal Pradesh/ Uttaranchal
          •North- Eastern states
80ID      Undertaking  engaged  in  business  of  hotel/  convention  centre  in 
          specified areas/ districts
10AA      Undertakings having a Special Economic Zone unit
 anti-abuse provision  brought  to  check  the  excessive  tax  holiday 
 Generic  framework  of ‘More than ordinary profit’ was  provided  in 
  law to compute the excessive tax holiday claims
 To  plug  the  loophole,  it  is  now  proposed  to  compute  more  than 
  ordinary profits through the ‘arm’s length price’ mechanism
    ◦ Eligible  business  will  have  to  justify  the  ALP  of  the  transactions 
      between  the  eligible  unit/  business  and  any  other  person  having 
      close connection
    ◦ The term “Close Connection” not defined
    ◦ Burden  of  the  proving  the  “close  connection”  between  the  assessee 
      and other party is on TPO
    ◦ Loss of tax holiday claim in excess of arm’s length profits 
    ◦ No corresponding adjustment allowed for other party for adjustments 
      made, if any, by the TPO for transactions falling under this category
   Industries operating in SEZs

   Infrastructure Developers

   Infrastructure Operator

   Telecom Services

   Industrial Park Developers

   Power Generations or Transmission
   Interest free Loans to Group Companies Sub section 8 of
    Section 80IA

   Granting of Corporate Guarantees/ Performance Guarantees by 
    Parent Company to its subsidiaries Sub section 8 of Section

   Intra-group purchase/ sell/ service transactions Sub section 8 of
    Section 80IA

   Payment made to key personnel e.g. transaction with 
    Directors/CFO/CEO etc.. Section 40A(2)(b)

   Payment made to key personnel of Group Companies. Section 

   Payment made to relative of key personnel of the assessee/group 
    companies. Section 40A(2)(b)
   Commission to relatives of the directors/ partners

   Salary paid to the relatives of the directors/Partners

   Remuneration to the directors

   Extra Purchase Price and Interest foregone to relatives

   Good sold at lower than market price if bona fide

   Higher Purchase Price than rates prevailing in the

   Interest paid to sister concerns at rate higher than
    normal rates

   Hire Charges of Machinery or Rent paid for use of
    Immovable property
   Maintenance of detailed TP Documentation,
    as specified in rule 10D demonstrating
    compliance with the ALP

   Filing an Accountants’ report (Form 3CEB),
    certified by a Chartered Accountant with tax
    authorities containing details of specified
    domestic transactions
Default                               Nature of penalty
In  case  of  a  post-inquiry  100-300% of tax on the adjusted amount
adjustment,  there  is  deemed  to 
be a concealment of income
Failure to maintain documents         2%  of  the  value  of  each  international 
                                      transaction  or  specified  domestic 
Failure to furnish documents          2%  of  the  value  of  each  international 
                                      transaction  or  specified  domestic 
Failure  to  report  a  transaction  in  2%  of  the  value  of  each  international 
accountants report                       transaction  or  specified  domestic 
Maintaining  or  furnishing           2%  of  the  value  of  each  international 
incorrect   information  or           transaction  or  specified  domestic 
documents                             transaction
  However, penalty   for concealment of income shall not be levied   if the taxpayer
 demonstrates that   price charged or paid has been determined in    ‘good faith’ and
                                 with ‘due diligence’
       Type of payments/                            Challenges
• Salary and Bonuses paid to the    • Benchmarking?
  partners                          • Whether the limit as mentioned in 
                                      section 40 (b) would be the ALP?

• Remuneration paid to the          • Benchmarking?
  Directors                         • Whether the limit as mentioned in 
                                      Schedule XIII would be the ALP?

                                    • Rules defined by Local Authorities 
• Transfer of land                    (Jantri) as ALP?

• Joint Development agreements      • Benchmarking?

• Project management fees           • Benchmarking?

• Allocation of expenses between  • Whether these allocation would be SDT 
  the same taxpayer having an         – Sec 80-IA(10)? 
  eligible unit and non-eligible unit

• Definition of Related Party       • Directly v/s Indirectly

•   Transfer  pricing  provisions  are  not  applicable  in  case  where  income  is  not   
    chargeable to tax at all.
     [Amiantit International Holding Ltd., (2010) 322 ITR 678 (AAR)]

2.  Provisions of section 40A(2) are not applicable to a co-operative society.
      [CIT vs. Manjara Shetkari Sahakari Sakhar Karkhana Ltd.(2008) 301 ITR 191

3. Payment made by holding co. to subsidiary co. is not covered u/s 40A(2)(b), as the 
     relationship  does  not  fall  under  sub-clause  (ii)  nor  under  sub-clause  (iv)  of  sec. 
     [CIT vs. V.S.Dempo & Co. (P) Ltd. (2011) 336 ITR 209 (Bom.)
     Note: In this decision, clause (vi) of s. 40A(2)(b) was not considered.

4. When  a  person  commits  an  offence  by  not  maintaining  the  books  of  accounts  as 
       contemplated  by  section  44AA,  the  offence  is  complete.  After  that  there  can  be  no 
       possibility  of  any  offence  as  contemplated  by  section  44AB  and  therefore,  the 
       imposition of penalty is erroneous.
         [Surajmal Parasmal Todi vs. CIT (1996) 222 ITR 691 (Gauhati)]
              Note  :  This  decision  may  be  helpful  in  the  context  of  sections  271AA,  271G  and 

5.    Correlative  adjustments  -  if  excessive  or  unreasonable  expenses  are  disallowed  in 
     the hands of tax payer at time of the assessment then corresponding adjustment to 
     the  income  of  the  recipient  will  not  be  allowed  in  the  hands  of  recipient  of  income. 
     Hence, it would lead to double taxation in India.
    Provisions  applicable  only  to expenditure  where payment is
     made or to be made
    ◦ Does this include capital expenditure? – Section 40A(2)(b)
    ◦ Does  this  include  transactions  without  consideration?  – 
     Section 80IA(8) & 80IA(10)
    ◦ Does threshold apply to the amount recorded in the Books of 
     Account or Amount determine as per ALP?
    Whether Government approval u/s 295, 297 of the Companies 
     Act would be relevant? 
    Whether  close  connection  would  be  interpreted  to  mean  the 
     criteria  mentioned  in  section  92A(2)  or  40A(2)(b) 
     (Inconsistency regarding definition of related parties
   Does  the  limit  of  INR  50  million  apply  qua  transaction  or 
    aggregate of all transactions ?

   If  aggregate  of  International  and  Domestic  transaction 
    exceeds  INR  50  million,  but  the  International  Transactions 
    are below INR 10 million, Do we need to maintain documents 
    prescribe under Rule 10D? ( Reference Rule 10D(2)

   Would  claim  of  Depreciate  comes  under  the  ambit  of 
    Domestic Transfer Pricing?
   How are SDT defined?

    ◦ The  following  transactions  with  the  aggregate  value 
      exceeding INR 50 million are covered

      Expenditure for which payment is made or to be made to 
       specified domestic parties

      Transfer  of  goods  or  services  to/from  eligible  business  ( 
       tax  holiday)  from/to  other  business  (  non-tax  holiday 

      Business  transactions  between  eligible  business  (  tax 
       holiday  unit)  and  other  person(s)  producing  more  than 
       ordinary profits owing to close connection

   Which tax payers covered under SDT?

    ◦ Any  tax  payer  incurring  any  expenditure  with  specified 
      Domestic  related  parties  are  required  to  comply  the 
   How do you define specified domestic related party?

    ◦ The domestic related party will inter alia include a director, a 
      relative  of  the  director,  a  person  having  substantial  interest 
      in  the  tax  payer  (  carrying  not  less  than  20%  of  the  voting 
      power)  and fellow  related  parties  where  a single  person  has 
      substantial interest in two tax payers 

   Which are the illustrative list of SDT?

    ◦ Transaction between the specified persons and also between 
      the  inter-unit  transactions  of  taxpayers    would  be  covered 
      e.g. normal operating transactions, allocation of costs, etc…
   What are the compliance requirements for tax payers that 
    have SDT?

    Tax payer that have specified Domestic Transaction would 
    need to do the following:

       Identify the nature of Transactions

       Maintain requisite information and documents as 

       Obtain and furnish a prescribed report from an 
        accountant in Form 3CEB
   Applicability of OECD TP guidelines

   Advance Pricing Arrangement

   Benefit of range

   Rule 10D and Form 3CEB requires modification to

    harmonise their applicability in relation to inter-units pricing

    and reporting of domestic transactions

   Corresponding adjustment

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