The Chamber of Tax Consultants

Presentation by

Yogesh Thar April 29, 2016

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Case Studies on Domestic Transfer Pricing w.r.t section 80A/80IA/10AA including its bench marking

Genesis of Transfer Pricing (“TP”) provisions

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The genesis of TP provisions is from the decision of the Supreme Court in the case of CIT v. Glaxo Smithkline Asia P. Ltd. (2010) 195 Taxman 35 (SC).

The Apex Court gave suggestions, in order to “reduce litigation” to consider amendments in the law with a view to: Make it compulsory for the tax payer to maintain books and documentation on the lines of

Rule 10D; Obtain audit report from a Chartered Accountant (“CA”); Reflect the transactions between related entities at arms’ length price; Apply the generally accepted methods specified in TP regulations

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The Finance Act, 2012 amended the Income Tax Act, 1961 (“the Act”), to provide for a mechanism to determine fair market value in cases of transactions between resident taxpayers which are related to each other :

Specified Domestic Transactions (“SDT”) defined as any of the following transaction(s), which are not international transactions (i.e. transactions where either one or both the parties to the transaction are non-residents) Payments to related parties as defined under section 40A(2)(b) ; Any transaction referred to in section 80A ; Any transfer of goods/services referred to in section 80IA(8) ; Any business transaction referred to in section 80IA(10) ; Any transaction under Chapter VI-A or u/s 10AA – to which provisions of section 80IA (8) or section

80IA (10) apply ; Any other transaction as may be prescribed

And the aggregate exceeds Rs. 20 crores

Domestic TP Applicability

The Finance Act, 2012 amended provisions of Chapter VI-A, for computing profits of units/business claiming deduction under Chapter VI-A, where such units have entered into specified domestic transaction (“SDT”).

The provisions so amended/inserted are : Explanation to section 80A(6) ; Explanation to section 80-IA(8) ; and Proviso to section 80-IA(10) ;

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Applicability of SDT provisions to Chapter VI-A provisions

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Section Taxpayers covered

10AA Persons with income from SEZ units

80-IA Infrastructure developers

80-IAB Developers of SEZ

80-IB Small scale industry engaged in operating Cold storage plant ;Industrial undertaking in Industrially backward state as mentioned in VIII Schedule (ex: Jammu and Kashmir ) Company carrying on scientific research and development ;Eligible hospitals ;Eligible housing projects

80-IC Undertakings or enterprises in certain special category States

80-ID Business of hotels and convention centers in specified area

80-IE undertakings in North-Eastern States

80LA Offshore Banking units and International Financial Services Centre

Eligible business covered

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Section 80-A(6) provides for substitution of market value of goods and services in place of their recorded values, in case of internal transfer of goods and services between eligible units claiming deduction and other units of the assessee

In order to apply this provision, the conditions to be satisfied : There should be either of the following transfers :

o Transfer of goods and services, from eligible unit to any other business carried on by the assessee ;

o Transfer of goods and services, from other businesses of the assessee to the eligible unit

The consideration for transfer does not correspond to market value of goods and services on the date of transfer

Applicability of section 80-A(6)

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Co A Ltd

Tax holiday unit Other unit

Co ATax holiday

unit

Co B

Other unit

80-IA(8) 80-IA(10)

Goods and services

Sale of goods at 120 ;

Arms Length Price (“ALP”) of goods is Rs.100 ;

Thus, deduction u/s 80-IA would be computed considering only Rs.100/- as Selling Price

Operating Margin: 40% (Extraordinary Profits) ;

ALP: 10% ;

Thus, deduction u/s 80-IA(10) would be computed considering margin of 10%

Close connection

Converse- Not True – section 92(3)

Transactions covered u/s 80-IA(8) and 80-IA(10)

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Co A Ltd

Tax holiday units (2)

Other units (7)

Facts :

The assessee is engaged in manufacturing and trading of yarn , hosiery goods and knitted cloth ;

The assessee claimed deduction u/s 80IC for 2 units out of 9 different units ;

Various administrative expenses including remuneration of directors was debited in the HO Accounts and none of the expenses was allocated to the tax-holiday units ;

No re-allocation of expenses was made in any of earlier years ;

The assessee maintained separate books of accounts for each unit and for the Head Office

Issue :

Allocation of common expenditure to eligible units ;

Whether provisions of section 80-IA(8) and 80-IA(10) are applicable

Case Study-1

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Issues for consideration:a. Whether the common costs would need to be allocated to the eligible unit?

b. If yes, whether such allocation would need to be determined based on the arms’ length principles and the transfer pricing methods contained in Chapter X of the Act;

c. An assessee is carrying out only one manufacturing business that is eligible for deduction under section 80IC. Hence, it carries out both manufacturing and selling and distribution activity as a part of one single business. Whether such manufacturing and distribution business needs to be segregated and a notional transfer of goods from the manufacturing business to the selling business needs to be assumed for determine the profits of the manufacturing business?

d. Basis of allocation of common cost whether meets the arm’s length principle

Case Study-1

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ABC Ltd

Subsidiary

Eligible unit -80IC

Facts : ABC Ltd. is a public listed company engaged in the

business of manufacturing consumer durables ;

It has a subsidiary which imports certain chemicals and supplies the same to ABC Ltd;

One of the several manufacturing units is in Himachal Pradesh which enjoys 100% tax holiday u/s 80-IC ;

The subsidiary also imports and sells the same chemicals to third parties in India ;

Assume that the subsidiary imports a Chemical ‘X’ at a landed cost of Rs.100/kg., it sells the same to ABC Ltd. at Rs.105/ kg and it sells to 3rd party in India at Rs.115/ kg, Assume that all other terms and conditions, being same

Despite purchase at Rs.105 from subsidiary, if profits of 80-IC undertaking is less than the profits of other undertakings, which will prevail ?

Issue :

from the point of view of deduction u/s. 80IC, the price charged by the subsidiary is less than the market price and consequently, the profits of the 80IC unit is inflated by Rs. 10 (i.e. the difference between the supply price to third parties of Rs. 115 and the supply price to the assessee of Rs. 105).

3rd party

Sell @Rs.115

Sell @Rs.105

Case Study-2

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Facts : PQR is engaged in the manufacturing of various products

through various units including one unit eligible for 80-IC deduction ;

PQR Ltd purchases various stores and spares parts required for all units at one place, which is then used by other units as per their requirement ;

Queries : Whether use of store and spares by several units would be

covered u/s 80-IA(8) of the Act?

If yes, what would be the ALP?

Co PQR Ltd

Eligible unit

Other unit

Inter-unit of transfer of stores and spares

Case Study-3

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Facts : XYZ has set up at a Unit, in the state of Sikkim, which is

enjoying a tax holiday, say under the provisions of section 80-IC the Act ;

The company has transferred fixed assets to/ from the eligible unit from/ to the non-eligible units of the Company

Queries : Whether such transfer of Fixed assets falls within the

definition of SDTs?

If yes, ‘market value’ of such transfer is to be established by applying ‘arms’ length’ principles under Chapter X?

Method to applied for determining ALP?

Co XYZ Ltd

80-IC –eligible unit

Other unit

Transfer of Fixed Assets from /to eligible unit

Case Study-4

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Facts : Power Unit (PU) transfers power to Manufacturing unit

(MU) ; Transfer recorded in the books of accounts of PU and MU

at standard cost (say Rs 3/- per unit) ALP of power is Rs 6/- per unit.

Queries : What would be the basis for computing deduction under

section 80-IA?

a. Rs 3/-p.u.; orb. Rs 6/- p.u.

[Sec 80IA(8) r.w.s 92(3)]

Co ABC Ltd

Power unitManufacturing

unit

Transfer of power (Eligible Unit) to Manufacturing Unit (Non-Eligible).

Case Study-5

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Facts : Coal mine allotted solely for captive consumption for

power generation; Profits from power generation eligible for 80IA

Queries : Whether transferring coal amounts to transfer of “goods

held for the purpose of non eligible business” to eligible business?

Effect of TISCO’s ruling in 48 ITR 123 (SC)

Co ABC Ltd

Captive Coal Mine

Power Generation

UnitTransfer of coal to power plant

Case Study-6

Other issues

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Applicability of SDT provisions in case of Loss making eligible units In case of an undertaking availing tax holiday incurs losses, tax holidays continue to be

applicable, however, tax holiday claimed is “NIL”; Possibility of shifting profits is absent ; Losses are c/fd and set-off against future profits or set-off against other profits

Allocation of interest expenses Availing interest bearing loan for setting up eligible and other unit ; Non-allocation of interest costs to all units ; Funds lying of separate accounts of non-eligible units used for settle expenses of eligible units ; Notional interest on borrowed funds in case of inter-unit financing ; Borrowings at entity level, disbursements to units out of both borrowed funds and own funds,

whether interest cost is to be apportioned;

Thank You