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C h a l l e n g e U s

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BMR & Associates LLP

Privileged & confidential

Specified Domestic TransactionsBudget 2012

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Agenda

3

Transfer Pricing - Concept

Domestic Transactions - What Has Changed

Specified Domestic Transactions

Key TP Audit Issues

Way Forward

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Transfer PricingConcepts

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What is Transfer Pricing?

5

Transfer Pricing (TP) is a mechanism for the pricing of goods and services between related entities Tangible Goods Intangible Goods – trademarks, trade-names, patents Services – management, engineering, after-sales services

TP mechanism provides the conceptual framework for pricing intercompany transactions and ensuring an appropriate allocation of income between the various tax jurisdictions (usually) in which a multinational company operates.

TP for tax purposes is governed by local jurisdictional authorities.

More than 50 countries have issued formal rules regulating transfer pricing practices.

The regulations, in most instances, are accompanied by documentation requirements and penalty provisions for non-compliance.

TP Regulations introduced in India in FY 2001-02 for International Transactions.

Specified Domestic transactions included in the scope of TP w.e.f. FY 2012-13 (Finance Bill 2012)

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Domestic TransactionsWhat has changed

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Budget 2012 – Scope Of Transfer Pricing Regulations Expanded

7

Income Tax Act, 1961 (‘IT Act’) already contain provisions to curb claim of excess expenditure / re-compute the income on transactions between related parties Section 40A(2) disallows excess / unreasonable expenses between related parties Section 80IA(8) / 80IA(10) – Tax officer empowered to re-compute the income of eligible

undertaking based on fair market value if transactions with related parties or other undertakings of same entity is not as per market value

Scope of Transfer Pricing (‘TP’) regulations expanded to include ‘specified domestic transactions’ (‘SDT’) if aggregated value of such transactions exceeds INR 5 crs during the year

‘Specified domestic transactions’ cover: Expenses or payments made to domestic related persons as specified in Section 40(A)(2)(b) Transactions between undertakings of same taxpayer or transactions by taxpayer with

closely connected persons for purpose of Chapter VI-A (which includes 80-IA) and Section 10AA

Rationale of applicability of TP regulations to domestic transactions Objectivity of determining income and reasonable expenditure between related parties

TP regulations now applicable to SDT Preparation of Form No. 3CEB and TP study report mandatory

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any expenditure in respect of which payment has been made or to be made to a specified person [section 40A(2)(b)];

any transaction 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 taxpayer and other person as referred to in sub-section (10) of section 80-IA;

any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable; or

any other transaction as may be prescribed

Applicability

Applicable where aggregate amount of exceeds INR 5 crores (approximately USD 1 million) in a year.

Applicable from Financial Year (FY) 2012-13 onwards

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Who are the specified persons - Section 40A(2)(b)

Section 40A(2)(b) - 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

Illustrative list of entities/ persons that may be included for a corporate taxpayer (not an exhaustive list):

a) those holding 20% or more equity in the tax payer;

b) companies whose 20% or more shares are held by such a company that holds more than 20% equity in

the tax payer;

c) those companies in which the tax payer holds 20% or more equity;

d) Directors of tax payer company, and relatives of such Directors;

e) Directors of companies in category (a) above; and relatives of such Directors;

f) If an individual holds 20% or more equity in the tax payer, then relatives of such an individual; all other

companies where such individual is a Director; all other Directors of such a company, and relatives of all

such Directors; etc

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Related parties as mentioned u/s 40A(2)(b)

Coverage - Substantial direct

and indirect interest?

Transactions between sister concerns now

covered

Direct Interest

Indirect Interest

X

X1 X2

X

X1 X2

X3 X4

X5 X6 X7 X8

X3 X4

X5 X6 X7 X8

Indirect interest illustrated

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Tax holiday unit Other unit

Sub-section (8) of section 80-IA (and similar such provisions in 10AA and Chapter VI-A)

Inter unit transfers (goods and services etc.)

Other person having close connection

Tax holiday company

Business transacted (wider than transfer of goods or services)

Sub-section (10) of section 80-IA (and similar such provisions in 10AA and Chapter VI-A

Not corresponding to market value (adherence to ALP proposed)

More than ordinary profits earned by business unit claiming deduction (adherence to ALP proposed)

Transactions to be reported in Accountant’s Report and arms’ length nature to be substantiated in the TP Documentation

Tax Holiday - Transfer Pricing Test

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Tax Holiday beneficiaries impacted by Domestic TPSection Nature of undertaking 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 and development Refining 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 Sikkim 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

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Possible Tax Leakages – If ALP Not Followed (Illustrations)

X Ltd.(non-tax holiday)

Y Ltd.(non-tax holiday)

Sale at 120 v/s ALP (ie 100)

Disallowance of INR 20

[40A(2)(b)]


Y Ltd.(tax holiday)

Sale at 120 v/s ALP

(100)

Double Disallowance

INR 40[40A(2)(b) and

excessive profit]


Y Ltd.(tax holiday)

Sale at 80 v/s ALP

(100)

Inefficient pricing structure – Reduced tax holiday benefit

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Penalties

Default PenaltyIn case of a post-inquiry adjustment, there is deemed to be a concealment of income

100-300% of tax on the adjusted amount

Failure to maintain documents 2% of the value of each international transaction or specified domestic transaction

Failure to furnish documents 2% of the value of each international transaction or 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 international transaction or specified domestic transaction

Maintaining or furnishing incorrect information or documents

2% of the value of each international transaction or specified domestic transaction

15

Maintenance of contemporaneous and robust documentation is the key to avoid penalties

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Privileged & confidential For discussion purposes only

Way Forward

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Next Steps

Immediate Identification of:

covered entities and persons covered transactions

Review of the pricing mechanism for the covered transactions Planning for corrective steps to be taken:

Functions, Assets and Risk (FAR)analysis Economic Analysis including Benchmarking for price setting

Ongoing Review of existing transaction for change in facts and circumstances Examining any new transactions and reviewing the pricing mechanism for such transaction

Year end compliance Preparation of Transfer Pricing Documentation (TP Report):

Covered persons Covered transactions Nature and quantum of transactions Arm’s length pricing of all such transactions using Prescribed methods

Filing of Accountant’s Report in [Form No. 3CEB] within the prescribed time limit i.e. 30th November of the relevant assessment year

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TP Regime in India and the approach to be adopted

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Transfer Pricing Documentation – Sec 92D / Rule 10D

19

Profile of industry

Profile of group

Profile of taxpayer

Profile of associated enterprises

Transaction terms

Functional analysis (functions, assets and risks)

Economic analysis (method selection, comparable benchmarking)

Forecasts, budgets, estimates

Agreements

Invoices

Pricing related correspondence (letters, emails etc)

Entity related Price related Transaction related

Contemporaneous documentation requirement – Rule 10D

Documentation to be retained for 9 years

No specific documentation requirement if the value of specified transactions is less than one crore rupees.

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Accountants Report – Sec 92E / Rule 10E

20

To be obtained by every person entering into a specified domestic transaction

To be filed by the due date for filing return of income (no e-filing)

Opinion whether prescribed documents have been maintained the particulars in the report are “true and correct”

Review is limited to specified domestic transaction conducted by assessee

Relevant annexures and appendices be attached

Inputs: Related party ledgers extracts Related party Schedule under AS-18 Sample Invoices/ Vouchers / DN / CN Relevant intra-group agreements CUP information

Form No. 3CEB

[See rule 10E]

Report from an accountant to be furnished under section 92E relating to international transaction(s)

1. We have examined the accounts and records of ENTITY NAME AND POSTAL ADDRESS - PAN No. relating to the international transactions entered into by the assessee during the previous year ending on 31st March 2012.

2. In our opinion proper information and documents as are prescribed have been kept by the assessee in respect of the international transaction (s) entered into so far as appears from our examination of the records of the assessee.

3. The particulars required to be furnished under section 92E are given in the Annexure to this Form. In our opinion and to the best of our information and according to the explanations given to us, the particulars given in the Annexure are true and correct.

Place : Chennai

Date : For B S R & Co.

Chartered Accountants

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Computation of Arm’s Length Price – Section 92C of the Act

21

Prescribed Methods

Traditional Transaction Method Transactional Profit Method

Determination of ALP using one of the Prescribed methods – Best suited to the facts and circumstances of each particular specified domestic transaction and Provides the most reliable measure of an arm’s length price in relation to the specified domestic

transaction shall be “Most Appropriate Method”

Where more than one ALP is determined, the arithmetic mean of such prices is taken to be the ALP

PSM MethodCPLM MethodRPM MethodCUP Method &Sixth Method TNMM Method

No hierarchy or preference of methods prescribed under the Act

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Summary of Methods

22

Methods Product Comparability

Functional Comparability Approach Remarks

CUP and Sixth

Method Very High Medium Prices are

benchmarked

Very difficult to apply as very high degree of comparability required

RPM High Medium GPM (on sales) benchmarked

Difficult to apply as high degree of comparability required

CPLM High High GPM (on costs) benchmarked

Difficult to apply as high degree of comparability required

PSM Medium Very High Profit Margins Complex Method, sparingly used

TNMM Medium Very High Net Profit Margins Most commonly used Method

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BMR Approach

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Transfer Pricing Process

24

• Preparation of project plan • Search strategy

• Access to local & global database

• Analysis of internal comparables

• Judicious identification of arm’s length range

• Understand existing costing mechanism

• Determination of billing methodology

Pre-project planning

Stage 2Stage 3

Stage 4

Functional analysis - Information gathering

Comparable data /Industry Analysis

Economic Analysis

• Interviews• Questionnaires• Discussions with

Management• Characterisation

of each entity• Agreement

reviews

Stage 5

• Consultation with management

• Finalization of Transfer pricing documentation

Issuance of Transfer Pricing Documentation

Stage 1

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TP Documentation Methodology

Information Gathering1 Functional Analysis2Economic Analysis/

Benchmarking3Documentation4 5 Accountant’s Report

This exercise will assist in meeting the taxpayer’s requirements from a TP perspective

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TP Documentation Methodology – Detailed steps

Entity Related Price Related

Industry profile

Taxpayer‘s profile

AE’s profile

Agreements Invoices Pricing related

correspondence –

letters, e-mails,

etc.

Transaction terms, forecasts and budget

estimates Market Profile Functional analysis – functions performed,

assets used & risk assumed Economic Analysis - method selection &

benchmarking

Transaction Related

Sequential progression

STEP 1 – Information Gathering

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TP Documentation Methodology – detailed steps (contd...)

Functional analysis based on information gathered in Step 1

Audit of the functions performed, assets utilised and risks assumed by Taxpayer for the specified

domestic transactions being tested

Conduct interviews with company management and business personnel to understand the

business/ strategic objectives from a TP perspective

Document the functional analysis

STEP 2 – Functional Analysis

Select the ‘most appropriate method’ based on functional interview and availability of data

Searching for comparable transactions/ companies using internal data and/ or publicly available

databases at our disposal

Apply quantitative and qualitative screens with appropriate financial adjustment to the comparables

Conclude if Taxpayer‘s related party transactions comply with the arm’s length standard

STEP 3 – Economic Analysis/ Benchmarking

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TP Documentation Methodology – detailed steps (contd...)

Preparation of draft TP Documentation that incorporates findings resulting from the above

mentioned steps

Discuss these findings with Taxpayer to ensure factual consistency

Incorporate Taxpayer‘s review comments and issue the final TP Documentation

Timelines: Usually 6-8 weeks from the date of receiving required information

STEP 4 – Documentation

Liaison with Taxpayer‘s personnel, after the close of statutory accounts to arrange for Accountant’s

Report completion in the prescribed format

Timelines: Usually 2 weeks from the date of receiving required information

STEP 5 – Accountant’s Report by a Chartered Accountant Firm

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Thank You

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