2. Index
Introduction 1
Case Law: CIT vs GlaxoSmithKline
Asia (P) Ltd.
2
Compliance Requirement 3
Documentation Required 4
Common Transactions of STD with
related parties
5
Section 40A(2)- Transaction
covered
7
Section 80A- Transactions covered 12
Section 80IA (8) & 80IA (10) 14
Difference between FMV and ALP 16
Penalties 19
Going Forward 22
3. Introduction
The Finance Act 2012 extended the scope of Transfer Pricing provision to “Specified Domestic
Transactions” (SDT).The provision apply from the financial year 2012-13 onward if the aggregate
value of the transaction exceed INR 50Million in the relevant financial year.
SDT includes payment to related parties, inter-unit transfer of goods or services of profit-linked
tax holding-eligible units, transactions of profit-linked tax holding-eligible units with other parties
and any other transactions that may be notified by the CBDT.
By extending TP provision to SDT, pricing of these transactions will need to be determined with
regard to arm’s length principles using method prescribed under TP regulation.
TP regulation will now applicable to all taxpayers including Individuals, Hindu Undivided Families
(HUFs).
The risk of tax arbitrage abuse by opportune taxpayers may arise due to presence of
accumulated losses or differential tax rates. This risk is amplified in view of the increased tax
stimulus provided in recent years to entities operating in special economic zones, infrastructure
sector or economically backward areas. The new domestic TP provisions would have significant
anti-abuse effects to redress any such non-arm's length pricing of domestic transactions.
Page 1
4. Case Law
Page 2
What made Finance Minister to Introduce Transfer Pricing Provisions is
respect of Domestic Transactions?
While dealing with the issue whether the assessee company and its service provider
are related companies in terms of Section 40A (2), Hon’ble SC in CIT vs.
GlaxoSmithKline Asia (P) Ltd. (SLP 18121/2007) had observed “The larger issue is
whether Transfer Pricing Regulations should be limited to cross-border transactions or
whether the Transfer Pricing Regulations be extended to domestic transactions. 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 (i) loss making or (ii) liable to
pay tax at a lower rate and the profits are shifted to such entity. The CBDT should
examine whether Transfer Pricing Regulations can be applied to domestic
transactions between related parties u/s 40A(2) by making amendments to the Act.
The AO can be empowered to make adjustments to the income declared by the
assessee having regard to the fair market value of the transactions between the
related parties and can apply any of the generally accepted methods of
determination of arm’s length price, including the methods provided under Transfer
Pricing Regulations.”
SC further mentioned “Though the Court normally does not make recommendations
or suggestions, in order to reduce litigation occurring in complicated matters, the
question of extending Transfer Pricing regulations to domestic transactions require
expeditious consideration by the Ministry of Finance and the CBDT may also
consider issuing appropriate instructions in that regard.”
The above remarks of the SC had laid the foundation for Domestic Transfer Pricing
(DTP) law in India, which was also affirmed in the memorandum explaining the
Finance Bill 2012.
6. Page 4
Documentations Required
Profile of
Industry
Profile of
Group
Profile of
Indian
entity
Profile of AEs
Entity Related Price Related
• Transaction
terms
• Functional
Analysis
(functions, assets
and risks)
• Economic
Analysis (method
selection,
Comparable
benchmarking)
• Forecasts,
budgets,
estimates
Agreements
Pricing
related
corresponden
ce
(letters, e-
mails,
fax, etc.)
Transaction
Related
7. Page 5
Common Transactions of SDT
with related parties
Purchase/lease of movable and immovable property
Centralised Corporate Services - Strategy, Marketing, Design & Engineering, HR, accounting, finance
Common management personnel like common MD, CEO.
Use of common facilities and Infrastructure - space, equipment,
Payment to Managing Director / Directors
Use of brand name or trademarks
Reimbursement of expenses
Group Restructuring
Purchase of Goods / Provision of services - Domestic Procurement Company
8. Page 6
Applicability of Provisions
“specified domestic transaction” in case of an assessee means any of the
following transactions, not being an international transaction, namely:-
any
expenditur
e in respect
of which
payment
has been
made or is
to be
made to a
person
referred to
in section
40A(2)(b);
any
transactio
n referred
to in
section
80A;
any
transfer of
goods or
services
referred to
in sub-
section (8)
of section
80-IA;
any
business
transacted
between
the
assessee
and other
person as
referred to
in section
80-IA (10);
any
transaction,
referred to in
any other
section under
Chapter VIA
or section
10AA, to
which
provisions of
section 80-
IA(8) or
section 80-
IA(10) are
applicable;
any other
transactio
n as may
be
prescribe
d,
and where the aggregate of such transactions entered into by the assessee in the previous year
exceeds a sum of five crore rupees (approximately US $1 million)
Tax Holiday undertakings
9. Section 40A(2)
– Transactions covered
Page 7
Section 40A override the other provisions of the act relating to computation of
income under “Profit & Gains of Business or Profession”. As per sub section (2),
any expenditure by way of payment to the persons [mentioned in sub clause
(b)], is liable to be disallowed in computing business profit to the extent such
expenditure is considered to be excessive or unreasonable having regard to
fair market value of goods, services, facilities etc. However, no disallowance
shall be made if the transaction (Specified Domestic Transaction) has been
made at arm’s length price. Sub clause (b) of sub section (2) covers the various
situations mentioned below wherein the two persons are related parties.
Section 40A(2)(b) of the Act - list of persons/ entities to be treated as related
parties/ specified persons
• Specified persons having substantial interest ( i.e. more than 20% voting power
or share in profits) in taxpayer’s business and vice-versa covered
• Scope expanded to include sister concerns
10. Page 8
Section 40A(2)Type of transactions covered (illustrations for payments made by a Company) …
Case 1 - Director or any relative of the
Director of the taxpayer – Section
40A(2)(b)(ii)
Mr. P
Mr. R
Assessee
(Taxpayer)
Mr. Q
Director
Relative
Covered transactions
Case 2 - To an individual who has
substantial interest in the business or
profession of the taxpayer or relative of
such individual – Section 40A(2)(b)(iii)
Mr. P
Mr. R
Assessee
(Taxpayer)
Mr. Q
Relative
Relative
Holding Structure
11. Page 9
Section 40A(2)Type of transactions covered (illustrations for payments made by a Company) …
Case 3 – To a Company having
substantial interest in the business of the
taxpayer or any director of such company
or relative of the director – Section
40A(2)(b)(iv)
ABC
Ltd
Mr. Q
Assessee
(Taxpayer)
Mr. P
Relative
Covered transactions
Case 4 – Any other company carrying on
business in which the first mentioned
company has substantial interest – Section
40A(2)(b)(iv)
XVY
Ltd
POR
Ltd
Assessee
(Taxpayer)
ABC
Ltd
Substantialinterest>20%
Holding Structure
Substantial
interest>20%
Substantial interest >20%
Substantialinterest>20%
12. Page 10
Section 40A(2)
Type of transactions covered (illustrations for payments made by a
Company) …
Case 5 – To a Company of which a
director has a substantial interest in
the business of the taxpayer or any
director of such company or relative
of the director – Section 40A(2)(b)(v)
Mr. P
Mr. Q
Assessee
(Taxpayer)
ABC Ltd
Director
Covered transactions
Holding Structure
Substantial
interest>20%
Mr. R
Relative
13. Page 11
Section 40A(2)
Type of transactions covered (illustrations for payments made by a
Company) …
Case 6 – To a Company in which
the taxpayer has substantial
interest in the business of the
company – Section
40A(2)(b)(vi)(B)
ABC
Ltd
Assessee
(Taxpayer)
Covered transactions
Case 7 – Any director or relative of the director of
taxpayer having substantial interest in that
person– Section 40A(2)(b)(vi)(B)
Mr. P
Mr. Q
Assessee
(Taxpayer)
ABC
Ltd
Substantial interest >20%
Holding Structure
Substantial
interest>20%
Relative
PQR
Ltd
Substantial interest >20%
14. Section 80A
– Transactions covered
Page 12
Section 80A (6) refers to
internal transactions
between various units /
undertakings of the
assessee in respect of
goods or services. This
clause covers any
transactions of goods or
services and hence this
transaction will be
applicable to income as
well as expenditure.
15. Transactions of Tax Holiday undertakings
Page 13
a) Any transfer of goods or services referred to in section 80-IA(8)
b) Any business transacted between the assessee and other person as
referred to in section 80-IA(10)
c) Any transaction, referred to in any other section under Chapter VI-A or
section 10AA, to which section 80-IA(8) or section 80-IA(10) are applicable;
It is a common practice among companies / groups enjoying tax holiday
period to park excess profits in tax-exempt units / businesses. To curb the same,
the relevant clauses had been inserted in the domestic transfer pricing law.
Now AO is empowered to make adjustments if it appears that ‘more than
ordinary profits' were earned by tax exempt businesses/units owing to its ‘close
connection' with transacting parties.
16. Page 14
Tax Holiday
undertakings
Section 80IA (8) & 80IA (10) – Deduction in respect of profits and
gains from industrial undertaking or enterprise engaged in
infrastructure development, etc.
80IA (8) 80IA (10)
Inter-unit transaction of goods
or services
• Business transacted with any
person generates more than
ordinary profits
• Owing to either close connection
or any other reason
Applicable where transfer is
not at market value
Applicable to tax holiday units
earning more than ordinary profit
Onus on tax payer • Primary onus on taxpayer
• Onus on tax authorities as well
17. Page 15
Tax Holiday
undertakings
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
80IAB Undertaking or enterprise engaged in development of SEZ
80IB Undertakings located/ engaged in
•Industrially backward districts as notified;
•Scientific research and 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 Undertakings located in notified Centre/ Parks/ Areas in Himachal
Pradesh or Uttaranchal.
80ID Undertaking engaged in business of hotel in the specified district
having a World Heritage Site
80IE Undertakings located in notified Centre/ Parks/ Areas in North-
Eastern States.
10AA Undertaking having a Special Economic Zone unit
18. Page 16
Difference between FMV and ALP
The new provision is based on ALP as compared to the FMV in the earlier provision
Characteristics Fair Market Value Arm’s Length Pricing
Definition The price which goods or services
would have fetched or cost in the
open market.
A price which is applied in a transaction
in uncontrolled condition.
Computation
Mechanism
No specific mechanism provided in law Most appropriate method out of five
prescribed methods.
Transaction value Any market pricing point can be
treated as fair market value.
Arithmetic mean of comparable prices
treated as arm’s length price.
Sample Size One comparable may be sufficient to
establish fair market value
Require bigger sample size for
establishing arm’s length
Deviation No deviation permitted from fair
market value
Deviation of such percentage not
exceeding 3% as notified by the Central
Government is permitted.
19. Page 17
Tax Holiday
undertakingsExamples :Tax burden, if transaction not at ALP
XYZ Ltd.
(non-tax holiday)
Disallowance of ` 50 to
PQR Ltd
[40A(2)(b)]
PQR Ltd.
(non-tax holiday)
Saleat`150
v/sALPi.e.`
100
XYZ Ltd.
(tax holiday)
PQR Ltd.
(non-tax holiday)
Saleat`
150v/sALP
i.e.`100
Double Adjustment
Tax holiday on ` 50 not
allowed to X Ltd – [80IA(10)]
(more than ordinary profits)
Disallowance of ` 50 to PQR
Ltd -
[40A(2)(b)]
X Ltd.
(tax holiday)
Y Ltd.
(non-tax holiday)
Saleat`80
v/sALPi.e.`
100
Inefficient pricing structure
reduced tax holiday benefit
since sale price is lower than
ALP
20. Page 18
Prescribed Methods
Traditional Transaction
Method
RPM Method
CUP Method
CPM Method
Transactional Profit
Method
TNMM Method
PSM Method
Other
Method
Price
charged or
paid/ Price
would have
been
charged or
paid.
No hierarchy or preference of methods
prescribed under the Act
21. Page 19
Penalties
Default Penalty
In case of a post-inquiry adjustment, there is
deemed to be concealment of income
100-300% of tax on the adjusted amount
Failure to maintain documents 2% of the value of each specified domestic
transaction
Failure to furnish documents 2% of the value of each specified domestic
transaction
Failure to furnish accountant’s report INR 100,000
Failure to report a transaction in
accountant’s report
2% of the value of each specified domestic
transaction
Maintaining or furnishing incorrect
information or documents
2% of the value of each specified domestic
transaction
22. Page 20
Going Forward
•To Identify and map the relationship between domestic related parties
specified u/s 40A(2)(b)
•Identify and map the SDT
•Revisit the pricing mechanism applied by the company for SDT applying the
most appropriate prescribed methods
• Maintaining proper documentation for the purpose of ensuring that SDT’s are
at ALP.
