Compounding of Contraventions
& Transfer Pricing Developments
Prof.(Dr.) Alok Pandey, Professor (Finance) &
Member Academic Advisory Body
Lal Bahadur Shastri Institute of
Management, Delhi
Overview of Presentation
• Section 1: FEMA- A brief overview
• Section 2: Compounding of Contraventions
• Section 3: Transfer Pricing & Recent
Developments
FEMA: A Brief Overview
Section 1
Mechanism under FEMA
Passed by the
Parliament –
the Legislature
Current Account by the
Government
Act – FEMA
Rules –
Current A/C
Notifications
Notified in the
Gazette – by the
Executive
AP Dir Circulars
to APs
RegulationsCapital A/C
All aspect of Forex
transactions
by the RBI
Capital Account by
the RBI
Important sections..
• Main sections are :
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–
–
–
–
–
–
–
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Sec.2 : Definitions.
Sec.3 : Dealing in FE.
Sec.4 : Holding of FE.
Sec.5 : Current Account.
Sec.6 : Capital Account
Sec.7 : Export of Goods and Services.
Sec.8 : Realisation / repatriation of FE.
Sec.9 : Exemption from Sec.8
Sec.10(5): Declaration
Sec.10(6): Freedom to utilize forex
Sec.13 to 15 : Penal provisions
Forex Transactions…
• Types of transactions :Current A/c ; and
Capital A/c.
• Rational :
Current A/c : The transactions which are
not prohibited are permitted.
[ Sec. 5 freedom to draw FE ]
Capital A/c : The transactions which are
not permitted are restricted.
[ Sec. 6 RB, may by regulation prohibit,
restrict or regulate.
Cross Border Investments
• Foreign Direct Investments in India
• Overseas Direct Investment by Indians Abroad
Foreign Investments in India
Compounding of Contraventions
Section II
Contraventions under FEMA
• Contravention is a breach of the provisions of
the Foreign Exchange Management Act
(FEMA), 1999 and rules/ regulations/
notification/ orders/ directions/ circulars
issued there under by RBI.
Compounding of contraventions under
FEMA
• Compounding refers to the process of
voluntarily admitting the contravention,
pleading guilty and seeking redressal.
• The Reserve Bank is empowered to compound
any contraventions as defined under section
13 of FEMA, 1999 except the contravention
under section 3(a), for a specified sum after
offering an opportunity of personal hearing to
the contravener.
Compounding of Contraventions
under FEMA
• It is a voluntary process in which an individual or
a corporate seeks compounding of an admitted
contravention.
• It provides comfort to any person who
contravenes any provisions of FEMA, 1999
[except section 3(a) of the Act] by minimizing
transaction costs.
• Willful, malafide and fraudulent transactions are,
however, viewed seriously, which will not be
compounded by the Reserve Bank.
Eligibility for applying for
Compounding
• Any person who contravenes any provision of the
FEMA, 1999 [except section 3(a)] or contravenes
any rule, regulation, notification, direction or
order issued in exercise of the powers under this
Act or contravenes any condition subject to which
an authorization is issued by the Reserve Bank,
can apply for compounding to the Reserve Bank.
• Applications seeking compounding of
contraventions under section 3(a) of FEMA, 1999
may be submitted to the Directorate of
Enforcement.
When to apply for Compounding
• When a person is made aware of the
contravention of the provisions of FEMA, 1999 by
the Reserve Bank or the Foreign Investment
Promotion Board (FIPB) or any other statutory
authority or the auditors or by any other means,
she/he may apply for compounding.
• One can also make an application for
compounding, suo moto, on becoming aware of
the contravention.
Where to apply?
• The powers to compound contraventions have
been vested with the Regional Offices of
Foreign Exchange Department(FED), Reserve
Bank.
Procedure
• The form given in the annexuret o the A.P.(DIR
Series) Circular No. 56 dated June 28, 2010 issued
by the Reserve Bank of India, can be used for
applying for compounding.
• The same can also be downloaded from the
Reserve Bank’s website.
• Further the documents as mentioned in A.P.(DIR)
circular nos. 57 and 20 dated December 13, 2011
and August 12, 2013 respectively should also be
submitted along with the application.
Fee for Compounding
• The application in the prescribed format along
with necessary documents and a demand
draft for Rs. 5000/- (Rupees five thousand
only) drawn in favour of the “Reserve Bank of
India” should be sent to the Reserve Bank of
India while sending the request for
compounding.
What RBI does with the Application?
• The Reserve Bank makes a scrutiny of the
application to verify whether the required details
and documents furnished by the applicant are
prima-facie in order.
• Applications with incomplete details or where the
contravention is not admitted will be returned to
the applicant.
• On the admission of applications, the Reserve
Bank will examine and decide if the contravention
is technical, material or sensitive in nature.
Types of Contraventions
• Technical.
• Material.
• Sensitive.
What are Sensitive Contraventions?
• The contraventions, prima facie, involving
money laundering, national and security
concerns involving serious infringement of the
regulatory framework, etc., are sensitive
contraventions.
• When the issues involved are sensitive /
serious in nature they need to be referred to
the Directorate of Enforcement (DOE/DRI).
What are Technical Contraventions?
• Whenever a contravention is identified by the
Reserve Bank or brought to its notice by the
entity involved in contravention by way of a
reference other than through the prescribed
application for compounding, the Bank will
decide if a contravention is technical and/or
minor in nature and, as such, can be dealt with by
way of an administrative/ cautionary advice.
What are Material Contraventions?
• Material contraventions are those which are
required to be compounded for which the
necessary compounding procedure has to be
followed.
RBI decides on Nature of
Contravention
• Whether contravention under the Foreign Exchange
Management Act (FEMA) is to be treated as technical
and/ or minor or serious would be decided by the
Reserve Bank on the merits of the case. The application
will be disposed of keeping in view the procedure
notified in this regard.
• Persons who have contravened the provisions of FEMA
should not take upon themselves suo moto, or on the
basis of external advice to decide whether a particular
contravention is technical or minor in nature and,
hence, no compounding application need be submitted
to the Reserve Bank.
Apply to avoid getting penalised
• If such applications for compounding are not
made, the person concerned shall expose
himself/herself to such action under the
provisions of FEMA as the authorities may deem
appropriate.
• The persons concerned should, therefore, in their
own interest submit their applications for
compounding of contravention under FEMA to
the Reserve Bank at the earliest opportunity.
The Hearing by RBI
• Personal appearance is not mandatory and
the applicant may inform his preference of
appearing/not appearing in writing to
Compounding Authority (CA).
• Another person may be authorised by the
applicant to attend the personal hearing on
his behalf but only with proper written
authority.
Qualifications of person appearing on
behalf of Applicant
• It has to be ensured that the person appearing
on behalf of the applicant is conversant with
the nature of contravention and the related
matters.
• The Reserve Bank encourages the applicant to
appear directly for the personal hearing rather
than being represented/ accompanied by legal
experts/consultants, etc. as the compounding
is only for admitted contraventions.
Conclusion of Compounding
• The Compounding Authority passes an order
indicating details of the contravention and the
provisions of FEMA, 1999 that have been
contravened.
• The sum payable for compounding the
contravention is indicated in the compounding
order.
• The contravention is compounded by payment
of the penalty imposed.
Payment of Compounding Charges
• The amount should be paid within 15 days
from the date of the order by way of a
demand draft drawn on "Reserve Bank of
India" and payable at the Regional office
which has issued the compounding order and
at Mumbai if the order is issued by CEFA (Cell
for Effective Implementation of FEMA) ,
Mumbai.
Completion of Process
• On realization of the sum for which
contravention is compounded, a certificate
shall be issued by the Reserve Bank indicating
that the applicant has complied with the order
passed by the Compounding Authority.
Completion of Process
• There cannot be a second adjudication by any
authority on the contravention compounded.
In terms of FEMA, 1999, where a
contravention has been compounded, no
proceeding or further proceeding, as the case
may be, can be initiated or continued, as the
case may be, against the person committing
such contravention under that section, in
respect of the contravention compounded.
Non Payment of Compounding
Charges
• In case of non-payment of the amount
indicated in the compounding order within 15
days of the order, it will be treated as if the
applicant has not made any compounding
application to the Reserve Bank and the other
provisions of FEMA, 1999 regarding
contraventions will apply. Such cases will be
referred to the Directorate of Enforcement for
necessary action
Appeal against the order of the
Compounding Authority
• As compounding is based on voluntary
admissions and disclosures, there is no
provision under the Compounding Rules for
an appeal against the order of the
Compounding Authority or for a request for
reduction of amount compounded or
extension of period for payment of penalty.
Timeframe for completing the
compounding process
• The compounding process is normally
completed within 180 days from the date of
receipt of the application complete in all
aspects, by the Reserve Bank.
Penalties
• Penalty up to thrice the sum involved in such
contravention where such amount is
quantifiable, or
• Up to two lakh rupees where the amount is
not quantifiable, and where such
contravention is a continuing one, further
penalty which may extend to five thousand
rupees for every day after the first day during
which the contravention continues.
Penalties
• Any currency, security or any other money or
property in respect of which the contravention
has taken place shall be confiscated to the
Central Government and further direct that
the foreign exchange holdings, if any, of the
persons committing the contraventions or any
part thereof, shall be brought back into India
or shall be retained outside India in
accordance with the directions made in this
behalf.
Transfer Pricing: Recent
Developments
Section III
Transfer Pricing
Regulations
Transfer Pricing
• Transfer pricing is one of the most important
issues in international tax.
• Transfer pricing happens whenever two
companies that are part of the same
multinational group trade with each other: when
a India-based subidiary of Coca-Cola, for
example, buys something from a French-based
subsidiary of Coca-Cola.
• When the parties establish a price for the
transaction, this is transfer pricing.
The Arm’s Length principle: Unrelated
Parties
• If two unrelated companies trade with each
other, a market price for the transaction will
generally result.
• This is known as “arms-length” trading,
because it is the product of genuine
negotiation in a market.
• This arm’s length price is usually considered
to be acceptable for tax purposes.
Arm’s Length Principle: Related Parties
• But when two related companies trade with
each other, they may wish to artificially distort
the price at which the trade is recorded, to
minimise the overall tax bill.
• This might, for example, help it record as
much of its profit as possible in a tax haven
with low or zero taxes.
Case
• A company called India MNC Ltd., which
produces a type of food product in India, then
processes it and sells the finished product in
the United States.
• India MNC Ltd. does this via three
subsidiaries: India MNC Ltd. (in India), Haven
Inc. (in a tax haven, with zero taxes) and
America Inc. (in the United States).
Case
• Now Inc. sells the produce to Haven Inc. at an
artificially low price, resulting in India MNC
Ltd. having artificially low profits – and
consequently an artificially low tax bill in
India.
• Then Haven Inc. sells the product to America
Inc. at a very high price – almost as high as the
final retail price at which America Inc. sells the
processed product.
Case
• As a result, America Inc. also has artificially
low profitability, and an artificially low tax bill
in America.
• By contrast, however, Haven Inc. has bought
at a very low price, and sold at a very high
price, artificially creating very high profits.
However, it is located in a tax haven – so it
pays no taxes on those profits.
International Transaction
• Transaction between two or more associated
companies situated in different countries in
terms of a property that is tangible or
intangible, a service offered by the company,
or any form of lending of money, etc.
• It is compulsory that at least one of the
participants involved in the transaction is a
non-resident of India.
Transaction between NRIs
• However, a transaction that has been carried
out by two non-resident Indians, where one of
them possesses a permanent setup in India
and whose income is taxable from India, such
a type of transaction is also considered as
‘International Transaction.’
Authorized Person
• Any person who has involved in an
international transaction in the previous year
shall submit the report in Form 3CEB through
a Chartered Accountant, duly verified and
certified by him, on or before the date ( i.e.
30th September ( of every year) ) prescribed
by the authority, furnishing all the required
details .
C Transfers to X
Cost to C
SP of X
Tax Rate for C
Tax Rate for X
Impact of TP
S-I
S-2
S-3
S-4
S-5
200
280
300
400
500
100
100
100
100
100
300
300
300
300
300
20%
60%
SP
Cost
PBT
Tax
PAT
SP
Cost
PBT
Tax
PAT
C
200
100
100
20
80
C
400
100
300
60
240
S-1
X
300
200
100
60
40
Total
500
300
200
80
120
S-4
X
300
400
-100
C
280
100
180
36
144
Total
700
500
200
60
240
S-2
X
300
280
20
12
8
Total
580
380
200
48
152
C
500
100
400
80
320
C
300
100
200
40
160
S-5
X
300
500
-200
S-3
X
300
300
0
0
0
Total
600
400
200
40
160
Total
800
600
200
80
320
Transactions
Internal
External
(Within the country)
(outside the country)
Inter Company
Revenue Profit
Capital Gain
Royalty
Intra Company
Inter Comapny
Control System
Non-Related:
cost centres
Profit/Dividend/Royalty
revenue centres
Forex Fluctuations
profit/Investment centre
Accounting
Related
Profit/Dividend/Royalty
Transfer Pricing
Forex/Accounting
Intra Company
Control Systems
Forex Fluctuations
Accounting
Transfer Pricing
Transfer Price: What and Why?
• TP means the value or price at which transactions
take place amongst related parties.
• TP are the prices at which an enterprise transfers
physical goods and intangible property and provides
services to associated enterprises
• TP gain significance because these can be used by
the controlling party to their advantage to minimise
tax incidence.
Transfer Price: What and Why?
• Approximately 60% of the total transactions
across the world are between related parties.
• If the transactions are across different tax
jurisdictions, where tax rates are different,
shifting is beneficial.
Factors Affecting Transfer Pricing
• Internal factors: Performance Measurement
and Evaluation
• External Factors:
– Accounting Standard
– Income Tax
– Custom Duty
– Currency Fluctuations
– Risk of Expropriation
Transfer Price Regulations
International
• OECD formulated
“Guidelines on transfer
pricing”. They serve as
generally accepted
practices by the tax
authorities
•
•
•
•
India
The Finance Act 2001
introduced the detailed
TPR w.e.f. 1st April 2001
The Income Tax Act
AS-18
Other Relevant Acts
Accounting Standard 18
Requires disclosure of ‘any elements of the
related party transactions necessary for an
understanding of the financial statements’.
Related Parties
• Control by ownership
– 50% of the voting right
• Control over composition of board of directors
– Power to appoint or remove the directors
• Control of substantial interest
– 20% or more interest in the voting power
AS-18 and Transactions
•
•
•
•
•
•
•
•
•
Purchase and sale of goods;
Rendering or receiving services;
Agency arrangements;
Leasing arrangements;
Transfer of research and development;
Licence aggrements;
Finance
Guarantees and collaterals;
Management contracts.
Income Tax Act and TP
• Finance Act 2001 substituted the old
section of 92 of the ITA by sections 92,92A
to 92 F.
• These sections are the backbone of Indian
TPR.
• These sections define the meaning of
related parties, international transactions,
pricing methodologies etc.
TPR: Some Important Concepts
• Income/Expenses/Cost arising from an
international transaction shall be computed
having regard to arm’s length price (ALP).
• ALP provisions can be applied if it leads
to decrease in taxable income or increase
in losses.
Associate Enterprise: 92A
• Direct Control/Control through intermediary
• Holding 26% of voting power
• Advance of not less than 51% of the total assets of
borrowing company.
• Guarantees not less than 10% on behalf of borrower
• Appointment of more than 50% of the BoD
• Dependence for 90% or more of the total raw
material or other consumables
International Transactions: 92B
• Transaction between two or more AE of which
either both or anyone is a non-resident.
• Transactions:
– Purchase/Sale/Lease
– Provision of service
– Lending or borrowing
Arm’s Length Price
• Price which two independent firms would
agree on.
• Price which is generally charged in a
transaction between persons other than
associated enterprises.
Arm’s Length Price: 92C
•
•
•
•
Comparable uncontrolled price method
Resale price method
Cost plus method
Profit split method
Comparable uncontrolled price
method
• CUP method compares the price transferred in
a controlled transaction to the price charged
in a comparable un-controlled transaction.
• CUP method is the most direct and reliable
way to apply the arm’s length principle.
Resale price method
• The resale price method begins with the price
at which a product is resold to an independent
enterprise (IE)by an associate enterprise.
– X sold to AE at Rs. 1000 (profit: 300)
– AE sold to an IE at Rs. 2000
• (profit of Rs. 500 for relevant IE)
– Arms length price = 2000 - 500 = 1500
Profit Split Method
• PSM is used when transactions are interrelated and is not possible to evaluate
separately.
• PSM first identifies the profit to be split for the
AE. The profit so determined is split between
the AE on the basis of the functions
performed/assets/CE
Cost Plus Method
• In CP method, first the cost incurred is
determined. An appropriate cost plus mark-up
is then added to the cost to arrive at an
appropriate profit. The resultant figure is the
arm’s length price.
Some Transactions subject to ALP
• Purchase at little or no
cost.
• Payment for services
never rendered.
• Sales below MP/
Purchase above MP
• Interest free
borrowings
• Exchanging property
• Selling of real estate at
a price different from
MP
• Use of trade names or
patents at exorbitant
rates even after their
expiry.
Some Cases
• Kinetic Honda Motors
– Collaborator: Honda Motor Co. Ltd Japan and
their Subsidiary Honda Trading Corpn. Japan
• Hero Honda Motors Ltd.
– Parent: Honda Motor Co. Ltd Japan and their
Subsidiary Honda Trading Corpn. Japan
Some Cases
• Peico Electronics & Electricals Ltd.
– Parent: Phillips Netherlands and its subsidiaries
• Asea Brown Boveri
– Parent: ABB Switzerland and its subsidiaries
• Videocon Group
– Collaborators: Toshiba Co., Mitsubishi Co
Latest Developments in Transfer
Pricing
APA Introduced in India
• The concept of Advance Pricing Agreement
(APA) has been introduced in India
• The Central Board of Direct Taxes has recently
notified advance pricing agreements scheme.
• Given the numerous transfer pricing cases in
dispute, introduction of APAs is expected to
considerably alleviate the uncertainty
regarding arm’s length pricing of international
transactions.
APA
• Advance Pricing Agreement (APA) provisions
were introduced in the Income-tax Act, 1961
(Act) w.e.f. 1 July 2012.
• The rules in respect of the APA scheme have
been notified by the Central Board of Direct
Taxes (CBDT) by way of insertion of Rule 10F
to Rule 10T and Rule 44GA in the Income-tax
Rules, 1962 (Rules).
APA Explained
• Agreement between a tax payer and tax
authority determining the transfer pricing
methodology for pricing the tax payer’s
international transactions for future years.
• The methodology is to be applied for a certain
period of time based on the fulfillment of
certain terms and conditions (called critical
assumptions).
Types of APAs
• Unilateral APA
• Bilateral APA (BAPA)
• Multilateral APA (MAPA)
Unilateral APA
• Involves only the tax payer and the tax
uthority of the country where the tax payer is
located.
Bilateral APA
• Involves the tax payer, associated enterprise
(AE) of the tax payer in the foreign country, tax
authority of the country where the tax payer is
located, and the foreign tax authority.
Multilateral APA
• Involves the tax payer, two or more AEs of the
tax payer in different foreign countries, tax
authority of the country where the tax payer is
located, and the tax authorities of AEs.
What is Mutual Agreement Procedure
• MAP is a mechanism laid down in tax treaties
to ensure that taxation is in accordance with
the tax treaty.
• This can also be invoked when a tax payer
suffers or is likely to suffer an adverse action
during transfer pricing audit to avoid
economic double taxation.
How is APA different?
• APA can be entered into for prospective years.
• Tax payers with litigation history may opt to
file MAP in respect of pending disputes and
also opt for APA for the same transactions for
the future years as an effective dispute
resolution/avoidance strategy.
Eligibility for APA
• Any tax payer who has undertaken an
international transaction or is contemplating
to undertake an international transaction is
eligible to file for an APA.
• Any type of international transaction can be
covered in an APA.
Advantages of APA
• Removal of an audit threat (minimize rigours of
audit), and deliverance of a particular tax
outcome based on the terms of the agreement.
• Certainty with respect to tax outcome of the tax
payer’s international transactions, by agreeing in
advance the arm’s length pricing or pricing
methodology (ies) to be applied to the tax payer’s
international transactions covered by the APA
Advantages of APA
• Substantial reduction of compliance costs over
the term of the APA; and
• APA also reduces cost of administration and
also frees scarce resources.
Scope of APA
• All International transactions covered;
• Agreed transfer pricing policy;
• Determination of arm’s length price including
the transfer pricing methodology to be
applied;
• Definition of any relevant term; and Critical
assumptions and the conditions, if any, other
than that provided in the Act or the Rules.
Methodology
• Pre filing Consultation (even on no name
basis)
• Fee to be deposited
• Negotiations to be done with CBDT
• Finalized APAs to not to be in public domain.
• Other provisions of Transfer Pricing Act to
remain operational.
Methodology
• Tax payer will have to comply with all the
• provisions including maintenance of transfer
pricing documentation and filing of Form
3CEB.
• Tax authorities will continue with the audit as
per the provisions of the Act even while the
APA is under negotiation.
Methodology
• On conclusion of APA, tax payer has to revise
its return of income for the past years,
covered under APA, within three months from
the conclusion of APA.
• Tax authorities will complete/amend the audit
of revised returns in accordance with the
terms of the APA
Further
• In a move to clear ambiguities related to
retrospective amendments on transfer pricing,
the Finance Minister Arun Jaitley has
proposed to set up high level Central Board of
Direct Taxes (CBDT) committee to decide on
fresh cases arising out of the 2012
amendment of Income Tax (I-T) Act.
More Developments
• Three measures have been introduced on
transfer pricing in the Budget — “roll back”
provision in advance pricing agreements
(APAs), range concept for determining arm’s
length price and allowing multiple-year data
for comparable analysis.
‘Roll Back’
• Means, If a company and IT Dept. sign an APA
agreement right now, its (share pricing)
methodology can be applied for solving
pending cases upto last four years.
‘Range concept for Arm’s length price’
• A transfer pricing report usually produces a list of
companies proposed as comparables.
• The results are often summarised as an interquartile range.
• An interquartile range discards the results of the bottom
quarter and top quarter of the results.
• The median is the mid-point of the interquartile range. The
median will generally produce a different result to the
average of the range being considered.
• In a case where all the comparables being used are more
or less equally valid, and there is no reason why the tested
company is any better performance wise than those
comparables companies, then there is probably nothing
wrong with using the interquartile range.
OECD’s Base Erosion & Profit Sharing
Action Points
ACTION 1:Address the tax challenges of the
digital economy
ACTION 2:Neutralise the effects of hybrid
mismatch arrangements
ACTION 3:Strengthen CFC rules
ACTION 4:Limit base erosion via interest
deductions and other financial payments
ACTION 5:Counter harmful tax practices more
effectively, taking into account transparency
and substance
ACTION 6:Prevent treaty abuse
ACTION 7:Prevent the artificial avoidance of PE
status
ACTIONS 8, 9, 10:Assure that transfer pricing
outcomes are in line with value creation