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									     RAJKOT BRANCH OF WIRC OF ICAI




Overview of Transfer Pricing Regulation




               Presented by :
              CA Brijen Sampat
                                          1
PRESENTATION OUTLINE
 Introduction


 Indian transfer pricing regulation – A bird’s
  eye view

 Key issues – A macro perspective




                                                  2
INTRODUCTION
CONCEPT :
 Enterprise choose to deal with its group
  entities in preference to a non group entity
  for gaining the benefit of group synergy

 Pricing between associated enterprise(AEs)
  with respect to transfer of goods, services,
  know how

                                                 3
INTRODUCTION
RELAVANCE :
 Revenue Authorities :
 Obtain fair share of revenue in respect of
  economic activities carried within its
  jurisdiction
 Management:
   Decision making, group’s performance
  evaluation, fair profit of an enterprise, etc

                                                  4
5
   INDIAN TRANSFER PRICING
REGULATION : A BIRD’S EYE VIEW
 Chapter X –Special provision relating to
  avoidance of tax (prior to 1.4.2002 – section 92)

 Pre TPR provisions – Section 40A(2), Section
  10A/B , Section 80 IA

 Based on Raj Narain committee – Finance Act
  2001 incorporated detailed TP provisions in
  INCOME TAX ACT,1961

 CBDT has set up new post of Director General ,
  International Tax
                                                      6
Indian situations & TP regulation
 Increasing MNC activity – Inbound & sourcing

 Inbound – key sectors : IT, Pharma, chemicals,
  services, telecom , etc

 Sourcing – illustrative applicability :
  BPO activity , global sourcing base for various
  products

 Accelerating trend of Indian companies setting up
  bases abroad
                                                      7
TPR – Developments since
Finance Act , 2001

 1st APRIL 2001   Section 92 to 92F introduced



  21st AUGUST     Rules 10A to 10E notified –
       2001          Documents prescribed


  23rd AUGUST
                     Circular No 12 issued
       2001


                                                 8
TPR – Developments since
Finance Act , 2001

 December 2001    Circular No 14 issued
                  ( Explanatory nature)


                 Guidance note issued by
   April 2002             ICAI



   May 2002      Finance Act 2002 notified


                                             9
Key Operative Provisions :
Section 92          Income arising from an
                    international transaction to be
                    computed with regard to ALP
Section 92A/B/F r/w Meaning & Definition
Rule 10A
Section 92C r/w     Computation of ALP
Rules 10B/C
Section 92CA        Reference to Transfer pricing
                    officer (TPO)
Section 92D/E r/w   Maintenance & keeping of
Rules 10D/E         information & documents ,
                    Accountant's Report
                                                      10
Applicability of TPR :
             22 Basic Conditions
                 BASIC CONDITIONS


 There should be an international transaction


 Such a transaction should be between two
  or more associated enterprises (AEs) of
  which at least one should be a non resident


                                                 11
    IMPORTANT MEANINGS &
        DEFINITIONS :
Section 92A            Associated Enterprise
Section 92B          International Transaction
Section 92C         Computation of Arm’s length
                              price
Section 92F ( i )          Accountant
Section 92F (ii)     Arm’s length price ( ALP)



                                                  12
    IMPORTANT MEANINGS &
        DEFINITIONS :
Section 92F (iii)           Enterprise

Section 92F ( iiia)   Permanent establishment

Section 92F ( iv)         Specified date

Section 92F (v)             Transaction



                                                13
  Section 92: Charging Section

 Any income arising from an international transaction shall
  be computed having regard to ALP

 In computing such income , any allowance for expense or
  interest shall be determined having regard to ALP

 ARRANGEMENT FOR ALLOCATION OR
  CONTRIBUTION FOR COST OR EXPENSES

 NON APPLICABILTY OF SECTION - when ALP has
  the effect of reducing income or increasing loss on the
  basis of entries made in books of accounts

                                                               14
Section 92A : Associated Enterprise
 An Enterprise
 which directly or        DIRECT   INDIRECT
 indirectly                              A
 participate in             A            M
 Management or              M            C
 Control or Capital                      C
                            C
 (M C C) of the             C            I
 other Enterprise                       M
                            B           C
                                        C
 ( Section 92A (1)(a) )
                                        B     15
Section 92A : Associated Enterprise
 AEs in which one        COMMON M C C
 or more persons
 participate, directly         A
 or indirectly,
 in M C C of more
 than one Enterprise

(section 92A( 1 )(b) )    B        C

                                          16
Section 92A (2) : Deemed Associated
Enterprise
1. Holding of shares carrying 26% or more
   voting powers
2. Common ownership- Holding of shares
   carrying 26% or more voting powers in
   more than one enterprises
3. Advance of loan not less than 51% of the
   total assets of the borrowing company
4. Guarantees not less than10% of the total
   borrowings on behalf of the borrower
                                              17
 Section 92A (2) : Deemed Associated
 Enterprise ……...

5   Appointment of more than half of the BOD or
    members of the governing board or appointment
    of one or more executive directors or members

6   Common appointments

7 Total dependence on an enterprise possessing
  exclusive rights for manufacturing or processing
  of goods or articles or carrying on business using
  know how, patents, copyrights, trade marks,
  licenses, franchise , etc
                                                       18
Section 92A (2) : Deemed Associated
Enterprise ……...

8  Dependence , up to 90% or more for the
   raw materials & consumables , on another
   enterprise
9 Influence on prices for goods or articles
   manufactured or processed & sold to an
   enterprise
10 One individual ( or his/ her relative jointly
   or separately) controlling two different
   enterprises
                                                   19
Section 92A (2) : Deemed Associated
Enterprise    ……...
11.One HUF (or member or relative of
   member jointly or separately) controlling
   different enterprises

12. Enterprise holding not less than 10%
    interest in firm / AOP / BOI

13. Relationship of mutual interest as may be
    prescribed
                                                20
     Section 92B:International Transaction
     Means transaction between two or more AE ,
      either or both of whom are non residents, in the
      nature of :
1.    Sale of products
2.    Purchase of products
3.    Provision of services
4.    Lending or borrowing
5.    Cost sharing arrangements
6.    Leasing & hiring of assets,etc

                                                         21
Other Definitions u/s 92F :
92F( i )     Accountant     As per sec 288(2)

92F( ii )    ALP            Price in uncontrolled condition
                            other than for AE
92F( iii )   Enterprise     Person (including PE of such
                            person)
92F( iiia ) Permanent       Fixed place of business through
            establishment   which business is wholly or
                            partly carried on
92F( iv )    Specified date Due date as per section 139(1)
                            explanation 2
92F( v )     Transaction    Arrangement,understanding or
                            action in concert
                                                              22
Other Definition in Rule 10A :

10A (a) Uncontrolled Transaction between
        transaction enterprises other than AE,
                     whether resident or non
                     resident
10A (b) Property     Includes goods,articles or
                     things & intangible property
10A (c) Services     Includes financial services
10A (d) transaction   Includes a number of closely
                      linked transaction

                                                     23
Section 92C :Computation of ALP
 ALP shall be determined having regard
     to :
1.   Nature of transaction or class of
     transaction
2.   Class of associated enterprise
3.   Functions performed
4.   Other relevant factors as may be
     prescribed by CBDT

                                          24
Methods for Computation of ALP
1.   Comparable uncontrolled price (CUP)
2.   Resale price method (RPM)
3.   Cost plus method (CPM)
4.   Profit split method (PSM)
5.   Transactional net margin method (TNMM)
6.   Such other method as may be prescribed by the
     Board
    ALP shall be most appropriate method (MAP)
     out of the above

                                                 25
        Division of ALP based on :
         Transaction methods    Other methods /
                                   transactional profit
                                   methods :

         CUP     RPM     CPM

                                  PSM          TNMM


INTER          EXTER
 NAL            NAL

                                                          26
Comparable Uncontrolled Price : CUP
      Method …Rule 10B(a)
Where the price charged for goods, services or property
transferred in a controlled transaction is compared to a
CUT ( comparable uncontrolled transaction )


 CUT is                                     Adjusted
identified                                  Price of
                                           CUT is ALP
              CUT is adjusted to a/c
                For differences in
                    IT & CUT


                                                           27
Types of transactions considered appropriate for
adoption of CUP method

 Transfer of goods
 Provision for services
 Intangibles
 Loans,provision of finance


   This method is particularly good where an independent
    Enterprise Sells the same product or service as sold
            between two Associated enterprises


                                                           28
          Resale Price Method : RPM
                 Rule 10B(b)
Where price @ which goods/property purchased or services
obtained from AE is resold to unrelated party is identified.

GP margin of CUT is reduced from such resale price to
arrived at ALP


              10     A         12     AE          15   xyz



                                      13.50 (-)
   NORMAL GP           15 (-) 10%
                         =13.50        EXPS
                                                       ALP
 as per CUT is 10%
                                                               29
Types of transactions considered appropriate for
adoption of RPM method

 Distribution of finished products or other
  goods involving no or little value addition

 Where the entity performs basic sales ,
  marketing & distribution functions

 Where goods are further processed or
  incorporated into other products

                                                   30
        Cost Plus Method : CPM (C+)
                Rule 10B( c )
Direct & indirect cost of production in respect of goods/services
sold to AE is identified , to which normal GP mark up in CUT
is added to arrive @ ALP



   DC 10
                      A
                                       GP
   ID 05                              10%
      ---       STRUCTURE             CUT               ALP
   TC 15
     ==
                     AE
                                 (To consider fn
                                  & other diff. )              31
Types of transactions considered appropriate for
adoption of CPM method
                                         Subsidiary or
 Provision of services                   peripheral
 Contract manufacturing
 Joint facility arrangement
 Transfer of semi finished goods
 Long term buying & selling arrangements




                                                         32
           Profit Split Method : PSM
                  Rule 10B (d)
1. PSM applied when there is transfer of unique intangibles
2. Multiple IT so interrelated that they can not be evaluated
   separately for the purpose of determining ALP
                          Combined NP
                            of AEs
                              15

         A                                                  AE
         9                                                   6

          Relative contribution of each AE to be identified based on:
                              Functions performed
                       Assets employed or to be employed
                                Risk assumed
                         Reliable external market data                  33
Types of transactions considered appropriate for
adoption of PSM
  Integrated services provided by more than
   one enterprise
  Transfer of unique intangibles
  Multiple inter related transactions , which
   cannot be separately evaluated




The profit should be split on an economically valid basis
That reflects the functions & risks of each of the parties
                                                             34
         Transaction Net Margin Method : TNMM
                      Rule 10B (e)

•NP margin in IT with AE established based on cost incurred
  sales effected, assets employed, etc
• NP margin in CUT is calculated based on the same criteria
• NP margin in CUT situations is adjusted to factor open market issues
• NP margin of AE transaction established/ compared with CUT NP



            A                10%                AE


            X                 8%                  Y

                 ALP shall be based on 8%margin
                                                                     35
Types of transactions considered appropriate for
adoption of TNMM

 Provision of services
 Distribution of finished products where
  resale price method cannot be adequately
  applied
 Transfer of semi finished goods


In India,in majority cases, method selection process would
lead to selection of TNMM as MAM, due to Non Availability
of requisite data for other methods.

                                                         36
         Computation Related Documents

       Degree of Similarity Required Under Various Methods:


Methods to   PRODUCT   FUNCTIONS   RESOURCES   RISKS   COMPLEXITY
 be used
CUP                                             
               
CPLM/RPM                                       

TNMM                                          

PSM                                                     




                                                                    37
        Computation Related Documents

       Degree of Similarity Required Under Various Methods
      (Contd.):

          • CUP - High comparability of Products and Risks.
          • CPLM and RPM – High comparability of Functions and Risks.

          • TNMM – High Comparability of Risk and Resources. Functions also important.

          • PSM – Exceptionally used in complex cases, such as presence of intangibles.



In India, in majority cases, method selection process would lead to
selection of TNMM as MAM, due to Non Availability of requisite
data in other methods.


                                                                                          38
 Most appropriated method ( MAM) for ALP
 Factors for Selection of MAM [Rule 10C R.W. S. 92C]:



  Rule 10C provides for following factors for selecting MAM:

  •Nature of International Transaction
  • Class of Associated Enterprise
    (e.g. Distributor, Contract Mfgr. Etc.)
  • Functions Performed, Assets Employed, Risks Assumed.
  • Availability, Coverage and Reliability of Data
  • Extent to Which Reliable and Accurate ,Adjustments Can Be Made.
  • Nature, Extent and Reliability of Assumptions Required.




Most Appropriate Method must be Reliable Measure of ALP
                                                                      39
40
41
Reference to Transfer Pricing Officer ( TPO)
(Section 92CA):

 AO (with CIT prior approval ) may refer
  computation to TPO

 TPO : Authorized JCIT / DCIT / ACIT


 Binding nature of his direction to AO


 ALP computed by Assessee (+/-) 5% of price
  determined by AO – NO adjustment (Circular no
  12/2001 dated 23-08-2001)
                                                  42
Power of Board to make safe harbour
rules (Section 92CB)
 The determination of arm’s length price
  under section 92C or section 92CA shall be
  subject to safe harbour rules.

 The Board may, for the purposes of sub-section
  (1), make rules for safe harbour.

 Explanation.—For the purposes of this section,
  ―safe harbour‖ means circumstances in which the
  income-tax authorities shall accept the transfer
  price declared by the assessee.                  43
Documentation :–
Section 92D r.w Rule 10D
 Every person who has entered into an international transaction
  shall keep and maintain prescribed information and documents.
  (S.92D(1) ).

 Prescribed the period for which such information and documents is
  required to be kept and maintained is 8 years.[S.92D(2), Rule
  10D(5)].

 The information or documents so maintained can be called for
  within a period of 30 days from the date of receipt of notice by the
  assessee. The said period can be further extended by another 30
  days. (S. 92D(3)).

 Rule 10D(2) provides for exemption from documentation
  requirements to the assessees, whose aggregate value as recorded in
  the books of account, of international transactions entered into by
  him does not exceed Rs. 1 crore.
                                                                         44
PRESCRIBED DOCUMENTATION

• Principal Documents [Rule 10D(1)]


• Supportive Documents[Rule 10D(3)]




                                      45
Principal Documents
   ICAI’s classification of Principal
              Documents:
 • Enterprise-Wise Documents [clauses (a) to (c )
   of Rule 10D(1)]

 • Transaction-Specific Documents [clauses (d) to
   (h) of Rule 10D(1)]

 • Computation Related Documents [clauses (i) to
   (m) of Rule 10D(1)]
                                                    46
Supportive Documentation [Rule 10D(3)]

     The information and records maintained shall be
     supported, to the extent possible by authentic
     documents, e.g.:

1.   Official publications, reports and studies and databases
     from the Government of the countries of AEs.
2.   Market research studies carried out and technical
     publications brought out by institutions of national or
     international repute
    Price publications (e.g. stock market / commodity market
     quotations)

                                                                47
Supportive Documentation [Rule 10D(3)]

 Published accounts and financial statements of
  AEs
• Agreements / contracts in respect of transactions
  with unrelated parties which are comparable with
  the relevant international transactions

• Letters/other correspondences documenting any
  terms negotiated with related parties (i.e.
  Associated Enterprises)

• Documents issued for various transactions under
  the accounting practices followed
                                                      48
 ACCOUNTANT’S REPORT : Section 92E
 (Rule 10E)

 Every person who has entered into an international
  transaction shall obtain a report form an
  accountant
 Report shall be in Form 3CEB ( Rule 10E)
 Accountant to certify the contents of annexure to
  Form 3CEB as true &correct
 Furnish such report before specified date
 No requirement to furnish along with return of
  income
                                                       49
Important clauses of 3CEB
Clause 8    Transaction in respect of tangible
            property
Clause 9    Transaction in respect of intangible
            property
Clause 10   Particulars in respect of provision of
            services
Clause 11   Particulars in respect of lending or
            borrowing money
Clause 12   Particulars in respect mutual agreement
            or arrangement
Clause 13   Particulars in respect any other
            transaction
                                                      50
Penalties for non compliance of TPR
Section     Addition made in computing        100% -
271(1)(C) total income u/s 92C(4) shall be    300% of tax
explanation deemed concealed income           sought to be
7                                             evaded
Section     Failure to keep & maintain such 2% of value
271AA       information & documentation as of each
            per section 92D                 international
                                            transaction
Section     Failure to furnish accountant’s   Rs. 1 LAC
271BA       report as per section 92E
Section    Failure to furnish any             2% of the
271G       information or documents as        value of
           required u/s 92D(3)                transaction
    Reasonable Cause                          for each
       Sec 273B                               failure        51
        Some Landmark TPR rulings
Case law            Important observations




Oracle India        •The Tribunal held that transfer pricing provisions, being
                    specific in nature, override the domestic tax avoidance
                    provisions concerning related party transactions.

                    •Accordingly, if the Transfer Pricing Officer holds a
                    transaction to be at arm’s length, there can be no disallowance
                    under the pretext of excessive payment to related party under
                    the provisions of Section 40(A) of the Act

Canoro Resources,   •where it was held that the Transfer Pricing provisions, being
                    more specific override the general provisions.


                                                                                     52
           Some Landmark TPR rulings
Case law      Important observations

Vertex        •The Tribunal has affirmed that where a taxpayer has computed the arm’s
              length price as per law, in 'good faith’ and with ‘due diligence’, penalty should
              not be levied.

              • This comes as welcome relief to taxpayers subjected to arbitrary or
              procedural penalty on transfer pricing adjustments.

Cargill India •The Tribunal had favored the taxpayer holding that where penalty was levied
              for ‘non-maintenance of documentation’.

              •In this case, the Tribunal had ruled that Revenue has to call only for
              specific and relevant information and not simply ‘all information’.

              •It further held that the penalty would not be justified if the Revenue does
              not point out any specific default in complying with the documentation
              requirements and does not consider any ‘reasonable cause’ that the
              taxpayer may have resulting in the default                                          53
Revision :
 Applicability
 Charging section
 Associated Enterprise
 Deemed Associated Enterprises – Situations
 International transaction
 ALP & Methods



                                               54
Thank You




            55

								
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