Direct Tax Proposals 2012 : TRANSFER PRICING

                                              Understanding

Direct Tax

                         Proposals

Transfer Pricing

    International Transaction RE-defined

Existing Act

Proposed  Changes (w.r.e.f. 01-04-2002)

ü International transaction” means a ü transaction between two or more ü associated enterprises, ü either or both of whom are non-residents, ü in the nature of ü purchase, sale or lease of tangible or intangible property, or ü provision of services, or ü lending or borrowing money, or ü any other transaction “having a bearing on the profits, income, losses” or “assets” of such enterprises, and ü shall include a mutual agreement or arrangement between two or more associated enterprises ü for the allocation or apportionment of, or any contribution to, ü any cost or expense incurred or ü to be incurred in connection with a benefit, service ü or facility provided or to be provided to any one or more of such enterprises

International Transaction Shall include       Capital financing, ü Any type of long-term or short-term borrowing, ü lending or guarantee, ü purchase or sale of marketable securities or ü any type of advance, payments or deferred payment or ü receivable or any other debt arising during the course of business;       Provision of services : ü Market research, market development, marketing management, ü administration, technical service, ü Repairs, design, consultation, agency, scientific research, legal or accounting service.. ü Business restructuring or reorganisation, ü entered into by an enterprise with an associated enterprise, ü “Irrespective of the fact that“ ü it has “bearing on the profit, income, losses or assets” of such enterprises at the time of the transaction or at any future date;       ‘Intangible property’ shall include : ü Marketing related intangible assets, such as, trademarks, trade names, brand names, logos; ü Technology related intangible assets, such as, process patents, patent applications, technical documentation such as laboratory notebooks, technical know-how; ü Artistic related intangible assets, such as, literary works and copyrights, musical compositions, copyrights, maps, engravings; ü Data processing related intangible assets, such as, proprietary computer software, software copyrights, automated databases, and integrated circuit masks and masters; ü Engineering related intangible assets, such as, industrial design, product patents, trade secrets, engineering drawing and schematics, blueprints, proprietary documentation; ü Customer related intangible assets, such as, customer lists, customer contracts, customer relationship, open purchase orders; ü Contract related intangible assets, such as, favourable supplier, contracts, licence agreements, franchise agreements, non-compete agreements; ü Human capital related intangible assets, such as, trained and organised work force, employment agreements, union contracts; ü Location related intangible assets, such as, leasehold interest, mineral exploitation rights, easements, air rights, water rights; ü Goodwill related intangible assets, such as, institutional goodwill, professional practice goodwill, personal goodwill of professional, celebrity goodwill, general business going concern value; ü Methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data; ü Any other similar item that derives its value from its intellectual content rather than its physical attributes.’

Comment:

v Below mentioned decisions is seems to be overruled by the amendments:

v ITAT Hyderabad in Four Soft Ltd vs. DCIT 62 DTR 308 had held that “Corporate Guarantee” provided by assessee to its Subsidiary company is not covered in the definition of International Transaction. Vide retrospective amendment; “Corporate Guarantee” will now covered in the definition of International Transaction.   

v ITAT Pune in Patni Computers vs. DCIT 60 DTR 113 had held that Delayed payment from associated enterprises is not covered under the definition on International Transaction. The amendment is going to overrule the said decision.

v Delhi HC in “Maruti Suzuki vs. ACIT “ had discussed in detail, the effect of Marketing intangible in Transfer Pricing regulations vis a vis International Transaction.

v Definition of International Transaction now Redefined & brings clarity on its scope. Capital Financing, Provision of services & Intangibles are the broad categories, through which International Transactions has been defined.    

Extract of Memorandum:

“ The definition by its concise nature does not mention all the nature and details of transactions, taking benefit of which large number of International Transactions are not being reported by taxpayers in transfer pricing audit report. In the definition, the term “intangible property” is included. Still, due to lack of clarity in respect of scope of intangible property, the taxpayer has not reported several such transactions.

Certain judicial authorities have taken a view that in cases of transactions of business restructuring etc. where even if there is an international transaction Transfer Pricing provisions would not be applicable if it does not have bearing on profits or loss of current year or impact on profit and loss account is not determinable under normal computation provisions other than transfer pricing regulations. The present scheme of Transfer pricing provisions does not require that international transaction should have bearing on profits or income of current year.

Therefore, there is a need to amend the definition of international transaction in order to clarify the true scope of the meaning of the term. “international transaction” and to clarify the term “intangible property” used in the definition.”

    TP regulations for Domestic Companies

Existing Act

Proposed  Changes

ü Provisions of Transfer Pricing are ü Applicable for ü International Transaction between  ü associated enterprises, ü either or both of whom are non-residents

v  TP Regulations will also Applicable to “Specified Domestic Transactions” between related parties, if v  “Exceeds INR 5 crore” in Aggregate during the previous year  Section 40A(2) ü Disallowance on account of any expenditure ü being excessive or unreasonable ü having regard to the Fair Market Value, ü shall be made in respect of a “Specified Domestic Transaction” ü If such transaction is ü NOT at Arm’s Length Price as per 92 F. Related Party includes “Companies” having ‘same Parent Company’  Section 80-IA(8) ü Transfer of Goods or Services between related entities ü Is Not at ALP & Due to which ü More than ordinary profit arises  Section 10AA ü Transaction between Entities ü Located in SEZ. ü If Not at ALP.

Comment:

v Supreme Court in the case of CIT Vs. Glaxo Smith Kline Asia (P) Ltd., in its order has, after examining the complications which arise in cases where fair market value is to be assigned to transactions between domestic related parties, suggested that Ministry of Finance should consider appropriate provisions in law to make transfer pricing regulations applicable to such related party domestic transactions. Hence, this amendment.

v Earlier, TP regulations applicable for ‘International Transactions’ only, but through this amendment, ‘Specified Domestic Transaction’ will also be under TP net.

v Litigations will Rise in line with Present Transfer Pricing litigations, due to difference in calculation of ALP.

v Compliance Burden on the assessee which includes documentation, audits, calculations of ALP  and more particularly, satisfy the TPO , that Transactions are at ALP.    

v Entities claiming Tax Holidays in section 80-IA & 10AA, and earning extraordinary profit have to comply with TP regulations.

v Transactions exceeding INR 5 crore, will falls in TP net.   

Extract of Memorandum

“ The application and extension of scope of transfer pricing regulations to domestic transactions would provide objectivity in determination of income from domestic related party transactions and determination of reasonableness of expenditure between related domestic parties. It will create legally enforceable obligation on assessees to maintain proper documentation. However, extending the transfer pricing requirements to all domestic transactions will lead to increase in compliance burden on all assessees which may not be desirable.

Therefore, the transfer pricing regulations need to be extended to the transactions entered into by domestic related parties or by an undertaking with other undertakings of the same entity for the purposes of section 40A, Chapter VI-A and section 10AA.

The concerns of administrative and compliance burden are addressed by restricting its applicability to the transactions, which exceed a monetary threshold of Rs. 5 crores in aggregate during the year. In view of the circumstances which were present in the case before the Supreme Court, there is a need to expand the definition of related parties for purpose of section 40A to cover cases of companies which have the same parent company.”

    Verification of International Transaction not reported by Assessee & Reopening

Existing Act	Proposed  Changes (w.r.e.f. 01-06-2002)
ü U/s 92C, AO, ü  if he considers it necessary or expedient to do so, ü may with the previous approval of CIT ü Refer the matter of determination of ALP in respect of an international transaction to the Transfer Pricing Officer (TPO). ü TPO is competent to exercise all powers that are available to the Assessing Officer u/s 92C (3) for determination of ALP and consequent adjustment. v  As per section 92E, v  Assessee has an obligation to file v  Audit Report before AO v  containing details of v  all international transactions during the year	ü TPO can Determine ü ALP of an International transaction ü noticed by him in the course of proceedings before him, ü “even if “ ü the said transaction ‘was not referred to him’ by AO, ü provided that ü such international transaction ü “was not reported by the taxpayer” in the Audit report u/s 92E Will take effect retrospectively from 1st June, 2002. v  Due to retrospectively of the amendment v  no reopening of any proceeding would be undertaken v  Only on account of this amendment. v  W.e.f. 01-07-2012
ü  A concluded proceedings ü  Can be reopened, ü  if any income chargeable to tax has escaped assessment	ü  Where it is found that an international transaction ü  has not been reported ü  either by non-filing of report or otherwise ü  then such non-reporting would be considered ü  as a case of deemed escapement of income ü  and such a case can be reopened under section 147 of the Act.

Comment:

v Through this amendment, govt is seems to curb malpractices in TP regulations. Stricter rules will force the taxpayers to be more transparent while reporting the International Transaction.

v Concluded Assesseement will not be reopened only due to this amendment is a beneficial clarification. 

v Reopening upto 4 years on account of non disclosure of International Transaction gives the department much needed authority to catch such type of unreported transactions.

Extract of Memorandum:

“ This audit report is the primary document with the Assessing Officer, which contains the details of international transactions undertaken by the taxpayer. If the assessee does not report such a transaction in the report furnished under section 92E then the Assessing Officer would normally not be aware of such an International Transaction so as to make a reference to the Transfer Pricing Officer. The Transfer Pricing Officer may notice such a transaction subsequently during the course of proceeding before him. In absence of specific power, the determination of Arm’s Length Price by the Transfer Pricing Officer would be open to challenge even though the basis of such an action is non-reporting of transaction by the taxpayer at first instance.

If an international transaction is not reported by the assessee, such transaction never gets benchmarked against arm’s length principle. It is, therefore, imperative that non-reporting of international transactions should lead to a presumption of escapement of income.”

    Determination of Arm’s Length Price

Existing Act	Proposed  Changes (w.r.e.f. 01-04-2002)
First Provisio Section 92C(2)       where more than one price is determined       by application of most appropriate method,       the Arms length price (ALP) shall be taken       to be the ‘Arithmetic mean’ of such prices. Second Provisio Section 92C(2) ·         In case variation of ‘Transaction price’ ·         from the arithmetic mean ·         is within the “Tolerance range of 5%”, ·         No adjustment was required to be made to transaction value. ·         Till 31st March 2011.	·         In case variation of ‘Transaction price’ ·         is within the “Tolerance range of 5%”, ·         No adjustment was required to be made to transaction value.       5% Tolerance Band was not a standard Deduction. ·         No Re-opening of ·         already completed assessments or proceedings ·         due to this retrospective amendment       Second proviso to section 92C       shall also be applicable to all proceedings       Which were pending as on ‘01.10.2009’.       Retrospective effect from 1st October, 2009.
·         As per Proviso to 92C (2) ·         Central Government may ·         notify a percentage and ·         if variation between the ALP & Transaction price ·         is within the notified percentage of transaction price, ·         no adjustment shall be made to the transaction price	Notified percentage determined as 3% for determination of arms length price. w.e.f.  AY 2013-14

Comment:

v Various Court had held that Amendment made by Finance Act 2009 is not applicable for pending assessments as on that date and amendment is applicable only from AY 2010-11. Few of them are

           Kuber Tobacco Products (P) Ltd. v. Dy. CIT  117 ITD 273 (Delhi)(SB)

            ITO v. Ekta Promoter s(P) Ltd. 113 ITD 719 (Delhi)(SB)

           iPolicy Network Pvt. Ltd. v. ITO 59 DTR 209 (Delhi)(Trib).

As it has been clarified in the amendment that changes made by FA 2009 is applicable for all proceedings pending on 01-10-2009 and accordingly nullifies the above judgements.

v Tolerance band of 5% provided in the section shall be taken as Standard deduction as per  

          Genysis Integrating Systems vs. DCIT (Bang ITAT)

          TNT India Ltd vs. ACIT 45 SOT 471 (Bang ITAT)

    Tolerance band of 5% given in the section shall not be taken as Standard deduction as per  

          ST Micro electronics vs. CIT 61 DTR 1  [ Delhi ITAT ]

          DCIT vs. Deloitte Consulting India (p) Ltd 61 DTR 101 (Hyd ITAT)

     

     To bring clarity in the law, this amendment is proposed by Finance bill 2012.

Extract of Memorandum:

“Disputes arose regarding the interpretation of the proviso. Whether the tolerance band is a standard deduction or not, in case variation of ALP and transaction value exceeded the tolerance band. Different courts interpreted it differently. In order to bring more clarity and resolving the controversy the proviso was substituted by Finance Act (No.2), 2009.

The substituted proviso not only made clear the intent that 5% tolerance band is not a standard deduction but also changed the base of determination of the allowable band, linked it to the transaction price instead of the earlier base of Arithmetic mean. The amendment clarified the ambiguity about applicability of 5% tolerance band, not being a standard deduction.”

    Advance Pricing Adjustments (APA)

New Section (w.e.f 01-07-2012)

ü  ‘Advance Pricing Agreement’ (APA) is an agreement between a ‘Taxpayer and a Taxing authority’ on ü  an appropriate Transfer Pricing Methodology for a ü  set of transactions over a fixed period of time in future Procedural Aspects:       The Board, may enter into an ‘APA’ with any person for determination of the Arm’s length Price or       specify the manner in which arm’s length price shall be determined,       in relation to an ‘International Transaction’ to be entered by that Person.        The “APA” will valid for a period of 5 Years.        The “APA” shall “not be binding” if there is any ‘change in law or facts’ having bearing on such APA.       The APA shall be binding only on “the person” and the Department.       The Board is empowered to prescribe a Scheme providing for the manner, form, procedure and any other matter generally in respect of the advance pricing agreement.       Board is empowered to declare APA as Void if obtained by Fraud or Misrepresentation of facts.        Where an application is made by a person for APA, proceedings shall be “Deemed to be pending” in the case of the person for the purposes of the Act like.. for making enquiries under section 133(6) of the Act.       The person entering in to such APA shall necessarily have to furnish a Modified Return within a 3 Months from the end of the month in which the said APA was entered in respect of the return of income already filed for a previous year to which the APA applies. The modified return has to reflect modification to the income only in respect of the issues arising from the APA.       Appeal before CIT (A) can be filed against the assessment or reassessment pursuant to modified return based on APA.       All the other provisions of this Act shall apply accordingly as if the modified return is a return u/s 139.

Comment:

v The APA mechanism is similar to Advance Ruling.

v Detail guidelines will be prescribed by CBDT in future.

v After getting the APA, whether assessee is required to maintain certain details as TP regulations require.

v APA will not be applicable if the govt will change the law in near future. What course of action the assessee will take in such a case is not clarified

v After Filing application for APA, it will be deemed that income tax proceedings is pending in case of assessee.

v After sharing all details with revenue authorities, if APA does work in favour of assessee, then assessee will stand nowhere as all the details are with the taxing authorities and they can proceed as they like.

v Will APA deliver the required result as promised by Finance Ministry is a matter of time as the assessee is lost confidence in DRP due to not providing requisite relief to assessee.

    Procedural Aspects

Existing Act	Proposed  Changes
Extended Time for Return Filing (139)
»        Due Date for Return Filing »        In Case of Corporate Assessee, »        Who is required to »        obtain and file »        Transfer Pricing report (u/s 92E ), »        extended to 30th Nov of assessment year	·         Applicable to” ALL Assessee” ·         W.r.e.f. AY 2012-13.
Due Date for Audit Report in case of International Transaction  (44AB)
·         Due Date for ·         furnishing tax audit report under section 44AB ·         is 30th September of Assessment Year	·         Due Date for ·         furnishing tax audit report under section 44AB ·         would be the same as Due date u/s 139 ·         W.r.e.f. AY 2012-13
Penalty Provisions
Penalty U/s 271BA ü  Penalty of INR 1,00,000 for ü  Failure to furnish Audit report u/s 92E. Penalty U/s 271AA ü  Penalty of 2% of value of International Transaction ü  Failure to keep relevant records. Penalty U/s 271G ü  Penalty of 2% of value of International Transaction ü  Failure to furnish relevant records	Penalty U/s 271AA as amended (w.e.f. 01-07-2012): ü  Penalty of 2% of value of International Transaction, ü  If the taxpayer – v  fails to maintain prescribed documents or information or; v  fails to report any international transaction which is required to be reported, or; v  maintains or furnishes any incorrect information or documents. This penalty would be in addition to penalties in section 271BA and 271G.

Comment:

Extension of Due Date of Return Filing in case of Non Corporate assessee, subjected to TP, is a welcome move, as they find more time to comply with law.

Strict penal provisions are likely to introduce so that Assessee now comply with the TP regulations without fail.

Extract of Memorandum:.

Extended ROI Date:

“ Vide the Finance Act, 2011 the due date for filing of return of income in case of corporate assesses who were required to obtain and file Transfer Pricing report (required under section 92E of the Act), was extended to 30^th November of the assessment year.

It has been noted that assesses other than companies are also faced with similar constraints of absence of sufficient contemporary data in public domain by 30^th September which is currently the due date of filing of return of income and Transfer Pricing report in their cases.”

Penal Provisions :

“ The meager penalty of Rs.1 lakh as compared to the quantum of international transactions is not an effective deterrent. There is presently no penalty for non-reporting of an international transaction in report filed under section 92E or maintenance or furnishing of incorrect information or documents. Therefore, there is need to provide effective deterrent based on transaction value to enforce compliance with Transfer pricing regulations.”