Hertope we are setting up to discuss the most debated concern for the Indian Tax Authorities in relatively recent times. Development of multinational trade and commerce has triggered the growth of Transfer Pricing in India. The concept of Transfer Pricing although being at the growing stage, yet its early reference is immemorial. Before going into the rulings under Transfer Pricing provisions, we need to understand the various insights of the concept.
The insights of transfer pricing rulings
Basically, the word Transfer Pricing (TP) may be interpreted as the method of ascertaining the price of goods and services transacted between controlled or related legal entities within a company. It relates to the price at which the subsidiaries of a business sell to each other.
The related legal entities referred to in this context are termed as Associated Enterprises (AEs) defined u/s 92A of the Income Tax Act, 1961. It means direct / indirect participation in the management, control or capital of an enterprise by another enterprise.
The supposed price which is to be used in this regard is called Arm’s Length Price. According to section 92F(ii) of the Income Tax Act, 1961- “arm’s length price means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.” The methods prescribed u/s 92C for determination of the arm’s length price required in every transaction between AE are mentioned below:
- Comparable uncontrolled price (CUP) method
- Resale price method (RPM)
- Cost plus method (CPM)
- Profit split method (PSM)
- Transactional net margin method (TNMM)
- Other method (applicable from FY 2011-12 onwards)
From the above definitions, we find that the concept is logical and simple. Multinational Corporations (MNCs) and big concerns tend to manipulate their profit margins intentionally as per the varying tax rates in different countries. They reduce their profits in countries where tax rates are high and vice versa. This global level manipulation for better net earnings is of great concern to the tax authorities as the governmental revenues tend to reduce in such scenarios. Keeping this in mind, the Ministry of Finance- Central Board of Direct Tax (CBDT) develops several weapons from time to time so that the manipulation can be curtailed and tax is properly ascertained on transactions between units of associated enterprises. These are called Transfer Pricing Rulings. The CBDT has also set up a Transfer Pricing Cell for conducting transfer pricing audits. The guidelines have been enclosed in the following legal vehicles:
- The Income Tax Act, 1961, sections 92 to 92F;
- Rules 10A to 10G of the Income Tax Rules, 1962;
- Circular No. 12 of August 23, 2001;
- Circular No. 14 of December 24, 2001;
- Circular No. 06/2013 dated June 29, 2013;
- Administrative Guidelines of May 20, 2003.
The Union Budget every year introduces certain changes in the TP provisions with the aim to align the Indian TP regime with the global standards.
The most significant 5 transfer pricing rulings applicable in Indian context in the FY 2015-16 may be counted down as below:
Taxpayers are required to maintain on an annual basis, detailed documentation relating to international transactions undertaken with AEs or specified domestic transactions (vide Rule 10D of the Income Tax Rules 1962). Mainly, there are two parts of such requirements-
Firstly, the mandatory documents that a taxpayer must maintain the ownership structure of the taxpayer, group profile, business overview and AEs, prescribed international transaction or specified domestic transaction details and financial forecasts. It further demands documentation of extensive TP study.
The second part of the Rules need adequate documentation which substantiates the information documented in the first part. It also contains a recommended list of supporting documents including government publication, reports, studies, etc.
International transaction below INR 10 million and specified domestic transaction below 50 million (revised vide Finance Act 2015)are relieved from such requirements.
Companies to which TP regulations are applicable are required to file their documents and tax returns on or before 30 November. Such documents must be maintained for a period of 9 years from the end of the relevant tax year.
In respect of all international transactions or specified domestic transactions, it is mandatory for all taxpayers to obtain an independent accountant’s report. This must be furnished on or before 30 November. The form (Form no. 3CEB) of the report was revised with effect from FY 2012-13 and includes new matters like corporate guarantees, the issue of shares, deemed international transactions, etc. The report requires the accountant to give an opinion on documentation compliance by the taxpayer. Moreover, it certifies the correctness of an extensive list of prescribed information.
The CBDT was empowered to formulate the safe harbour rules with a view to reduce the quantity of TP audits and lengthy disputes regarding comparability analysis under TP. The rules governing safe harbour points out the circumstances in which the authorities would accept the arm’s length price as declared by the taxpayer, without detailed analysis, if certain criteria are satisfied. The ‘eligible assesse’ along with different thresholds has been defined for transactions like- knowledge process outsourcing services, software development services, contract manufacturing of core and non-core auto components and transactions, etc. Moreover, the CBDT also notified that the rule would apply in the case of government electricity companies for specified domestic transactions. The most significant aspect being its publication in recent times which is expected to lift its low rate of response.
A remarkable step in TP rulings taken by Indian government is regarding thin capitalisation. In the corporate world, a company is said to be thinly capitalised when it has more debt than equity. There were no rules that specifically set permissible debt-to-equity ratios in any TP code. But, the Indian government intends to introduce within 2 years, the general anti-avoidance rules (GAAR) which incorporate then the concept of thin capitalisation.
The proposed regulation does not include any capital gearing ratio, unlike typical thin capitalisation regulations. Instead, it characterises debt as equity and vice versa where the arrangement among parties is:
- Not at arm’s length,
- Has less commercial substance,
- Means adopted which are not ordinarily for bona fide purposes.
The lack of capital gearing ratio allows discretion of the Revenues while it ascertains whether a given capital structure is an impermissible avoidance arrangement.
Advance pricing agreements (APAs) has to be ranked at the top of all transfer pricing rulings in 2015-16. Right from its introduction on 1st July 2012 by the Indian authorities, APA has had an overwhelming response. Approximately, 550 unilateral applications have been filed in the past three years. As of 31 March 2015, the taxpayers and the government have signed 8 unilateral APAs and 1 bilateral APA while several more upcoming signings on its verge.
It is to be noted that APA rules don’t prescribe any threshold for the application. Again, this mechanism is unavailable for specified domestic transaction. APA shall be compulsorily binding on the taxpayers and its validity shall not exceed 5 consecutive years. Based on the value of the international transaction, APA fee ranges between INR1 million to 2 million. The four phases of APA as per global standards are listed below:
- Pre-filing phase: Deals with pre-filing consultation meeting and involves no payment of fees.
- Formal submission phase: Application for APA stating the critical assumptions is made in required Filing fees are payable at this phase.
- Negotiation phase: Draft report prepared & provided to the competent authorities.
- Finalisation phase: Comments on draft APA, finalisation and effect giving to APA terms are dealt with in this phase.
As a part of APA, the taxpayer needs to prepare an annual compliance report (ACR) for every year. The ACR is to be furnished by 30 days of Income Tax Return filing or within 90 days of APA (once entered into), whichever is later.
India has thus witnessed some interesting transfer pricing developments in the FY 2015-16. Significantly, India has concluded its first bilateral APA with the Japanese within a record period of one and a half years. The rollback provision introduced in APAs has been a welcome step towards the reduction of litigation. Another major controversy regarding ‘Issue of Shares’ (whether an international transaction was covered under Indian transfer pricing rulings) was finally settled. The government decided to accept the Mumbai HC decision in favour of the taxpayers. Again, the introduction of the use of multiple-year data and the range concept (in line with global leading practices) increased the scope of transfer pricing in India. The government also announced a risk-based approach, negating the transaction-value-based methodology, for selecting the relevant cases for audit.
Hence, it will be interesting to see how the legislation acts to modify the Indian transfer pricing regulations as committed under the G20 Summit in line with the Base Erosion and Profit Shifting (BEPS) initiatives.
Source :Business Magazine
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