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The applicability of transfer pricing provisions was earlier limited to cross-border transactions. The Supreme Court in the case of Glaxo Smithkline Asia made some important observations, especially on the need for a robust tax mechanism to address pricing between group companies. Subsequently, Finance Act 2012 extended transfer pricing provisions to specified domestic transactions (SDT) with effect from April 1, 2013.
An Insight
Now, transactions between domestic group entities or persons should be reported/ documented and benchmarked accordingly.
However, taxpayers should follow the compliance procedures under SDT only if the aggregate value crosses Rs 5 crore in a financial year. To determine this threshold, all transactions with specified domestic related parties on the expenditure side should be taken into account. However, if the taxpayer or taxpayer’s unit(s) is enjoying certain tax benefits then, apart from expenditure, income should also be counted.
According to regulations, taxpayers should maintain documentation for SDT, including benchmarking relevant transactions by selecting the appropriate method and undertaking functional and economic analysis. Taxpayers should capture the SDT in Form No. 3CEB, to be filed with tax returns. Comprehensive documentation is needed to both justify the pricing during assessment and for mitigating the risk of penalty if tax authorities do not accept the price.
The Central Board of Direct Taxes has notified the new Form No. 3CEB to assist the taxpayer in reporting and filing SDT as well as international transactions. Taxpayers should provide details such as name, address, PAN (Permanent Account Number) of the related party, description of transactions along with the amount and methodology used to benchmark the SDT in the new Form No. 3CEB.
Taxpayers with SDT will get additional time — they have to file the tax return and Form No. 3CEB by November 30, instead of September 30. Moreover, revenue authorities too will get additional time to complete the assessments involving SDT. Non-compliance with the requirements could attract penalties ranging from 2 per cent to 4 per cent of the SDT value, besides leading to double taxation within the group.
Clarity and Burden
As the arm’s length price concept for SDT transactions has now been defined, there will be clarity on the transaction rate/ price; earlier, under Section 40A(2) the test for excessive or unreasonable expenditure was quite subjective. The onus earlier was on tax authorities to prove that the transaction was not at a correct price, which now has been shifted to the taxpayer.
By applying transfer pricing provisions to SDT, tax authorities will also check the possible shift of profits from high-tax entities/ units to low- or zero-tax entities/ units in SEZ (special economic zones), infrastructure companies and so on. There will also be a check on shifting profits from a profit-making entity to one with accumulated losses to reduce the combined tax obligation for the group.
Compliance burden would increase for taxpayers in terms of documentation, filing of Form No. 3CEB, pricing, scrutiny assessment and so on. On the other hand, determination of the arm’s length nature will be more structured. The Tax Department will also need to deploy additional skilled resources to understand and assess entities with SDT.
Open Issues
Any new law will initially not be completely clear to the taxpayer, The Government should provide clear guidance on the application of transfer pricing to SDT, including how to interpret terms such as “close connection”, how to report transactions without consideration, how to benchmark transactions such as directors’ remuneration or sitting fees, and so on. Given the ongoing litigation over transfer pricing for international transactions, taxpayers should be careful when benchmarking and preparing documentation for transactions such as transfer of capital assets, common cost apportionments, managerial remunerations, inter-unit transfers and discounts or transactions under the cash pooling system.
Guidance would be welcome on whether co-relative adjustment would be allowed where transfer pricing adjustment is made to a group company, and whether advance pricing agreements would cover SDT.
After the introduction of transfer pricing regulations for SDT, the burden of proof for justifying the price has been shifted to the taxpayer where there is payment to related parties. Compliance burden has increased, especially for business groups with multiple entities and a variety of inter-company transactions. As the deadline for filing tax return for FY 2012-13 is fast approaching, it is time to pay attention to the compliance exercise. A proactive, rather than reactive approach is called for.
Pramod Joshi is Senior Director and Ashish Apte is Manager, Deloitte Haskins & Sells
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