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Specified Domestic Transactions
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Budget 2012
Agenda
Transfer Pricing - Concept
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Domestic Transactions - What Has Changed
Specified Domestic Transactions
Key TP Audit Issues
Way Forward
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Transfer Pricing
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Concepts
What is Transfer Pricing?
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
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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TP mechanism provides the conceptual framework for pricing intercompany transactions
Domestic Transactions
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What has changed
Budget 2012 – Scope Of Transfer Pricing Regulations
Expanded
Income Tax Act, 1961 (‘IT Act’) already contain provisions to curb claim of excess
expenditure / re-compute the income on transactions between related parties
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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 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
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Specified Domestic Transactions
Specified Domestic Transactions
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 business transacted between the taxpayer and other person as referred to in subsection (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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any transfer of goods or services referred to in sub-section (8) of section 80-IA;
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
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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profits) in taxpayer’s business and vice-versa covered
Indirect interest illustrated
Related parties as mentioned u/s 40A(2)(b)
Direct Interest
X1
X2
Indirect Interest
X
Coverage Substantial direct
and indirect
interest?
X1
X2
X3
X5
X4
X6
X7
X3
X8
X5
X4
X6
X7
X8
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Transactions
between sister
concerns now
covered
X
Tax Holiday - Transfer Pricing Test
Sub-section (8) of section 80-IA (and similar such provisions in 10AA and Chapter VI-A)
Inter unit transfers (goods and services etc.)
Tax holiday unit
Other unit
Sub-section (10) of section 80-IA (and similar such provisions in 10AA and Chapter VI-A
Tax holiday
company
Business transacted (wider than transfer of goods or
services)
Other person
having close
connection
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
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Not corresponding to market value (adherence to ALP proposed)
Section
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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Tax Holiday beneficiaries impacted by Domestic TP
X Ltd.
X Ltd.
X Ltd.
(non-tax holiday)
(non-tax holiday)
(non-tax holiday)
Sale at 120
v/s ALP
(ie 100)
Y Ltd.
(non-tax
holiday)
Disallowance of
INR 20
[40A(2)(b)]
Sale at 120
v/s ALP
(100)
Sale at 80
v/s ALP
(100)
Y Ltd.
Y Ltd.
(tax holiday)
(tax holiday)
Double
Disallowance
INR 40
[40A(2)(b) and
excessive profit]
Inefficient pricing
structure – Reduced
tax holiday benefit
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Possible Tax Leakages – If ALP Not Followed (Illustrations)
Penalties
Penalty
In 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
Maintenance of contemporaneous and robust documentation is the key to avoid penalties
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Default
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Way Forward
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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

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TP Regime in India and the approach to be
adopted
Transfer Pricing Documentation – Sec 92D / Rule 10D
Price related
Profile of industry
Transaction terms
Agreements
Profile of group
Functional analysis
Invoices
(functions, assets and risks)
Profile of taxpayer
Pricing related
Economic analysis (method
Profile of associated
correspondence
selection, comparable
enterprises
(letters, emails etc)
benchmarking)
Contemporaneous documentation
requirement
Forecasts,
budgets,– Rule 10D
estimates
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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Transaction related
Entity related
Accountants Report – Sec 92E / Rule 10E
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”
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.
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
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To be obtained by every person entering
into a specified domestic transaction
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
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”
Prescribed Methods
Traditional Transaction Method
CUP Method &
Sixth Method
RPM Method
CPLM Method
Transactional Profit Method
PSM Method
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Where more than one ALP is determined, the arithmetic mean of such prices is taken to be the ALP
TNMM Method
No hierarchy or preference of methods prescribed under the Act
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Methods
CUP and
Sixth
Method
RPM
Product
Comparability
Very High
High
Functional
Comparability
Approach
Remarks
Medium
Prices are
benchmarked
Very difficult to apply as very
high degree of comparability
required
Medium
GPM (on sales)
benchmarked
Difficult to apply as high
degree of comparability
required
Difficult to apply as high
degree of comparability
required
CPLM
High
High
GPM (on costs)
benchmarked
PSM
Medium
Very High
Profit Margins
TNMM
Medium
Very High
Net Profit Margins
Complex Method, sparingly
used
Most commonly used
Method
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Summary of Methods
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BMR Approach
Transfer Pricing Process
Stage 5
Stage 4
Stage 2
Stage 3
Pre-project
planning
• Preparation
of project
plan
Functional
analysis Information
gathering
• Interviews
• Questionnaires
Comparable
data /
Industry
Analysis
• Search strategy
• Discussions with • Access to local &
global database
Management
• Analysis of
• Characterisation
internal
of each entity
comparables
• Judicious
• Agreement
identification of
reviews
arm’s length
range
Economic
Analysis
• Understand
existing costing
mechanism
• Determination of
billing
methodology
Issuance of
Transfer Pricing
Documentation
• Consultation with
management
• Finalization of
Transfer pricing
documentation
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Stage 1
TP Documentation Methodology
3
4
Documentation
2
Functional Analysis
Economic Analysis/
Benchmarking
5
Accountant’s Report
This exercise will assist in meeting the taxpayer’s requirements from a TP perspective
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1
Information Gathering
TP Documentation Methodology – Detailed steps
STEP 1 – Information Gathering
 Industry profile
 Taxpayer‘s profile
 AE’s profile
Price Related
 Transaction terms, forecasts and budget
estimates
 Market Profile
 Functional analysis – functions performed,
assets used & risk assumed
 Economic Analysis - method selection &
benchmarking
Sequential progression
Transaction Related
 Agreements
 Invoices
 Pricing related
correspondence –
letters, e-mails,
etc.
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Entity Related
TP Documentation Methodology – detailed steps (contd...)
STEP 2 – Functional Analysis
 Functional analysis based on information gathered in Step 1
 Audit of the functions performed, assets utilised and risks assumed by Taxpayer for the specified
 Conduct interviews with company management and business personnel to understand the business/
strategic objectives from a TP perspective
 Document the functional analysis
 STEP 3 – Economic Analysis/ Benchmarking
 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
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domestic transactions being tested
TP Documentation Methodology – detailed steps (contd...)
STEP 4 – Documentation
 Preparation of draft TP Documentation that incorporates findings resulting from the above mentioned
steps
 Incorporate Taxpayer‘s review comments and issue the final TP Documentation
 Timelines: Usually 6-8 weeks from the date of receiving required information
STEP 5 – Accountant’s Report by a Chartered Accountant Firm
 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
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 Discuss these findings with Taxpayer to ensure factual consistency
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