An interesting makeover in 2012 to the Indian Transfer Pricing regulations is bringing specified domestic transactions (SDT) within its ambit (new Section 92BA) — transactions between resident specified persons/ closely connected persons, whose aggregate value exceeds Rs 5 crore during a financial year.

Now, even an SDT should adhere to the arm’s length principle from FY 2012-13. Transfer pricing will extend to many mid-size groups, partnership firms, Hindu Undivided Families, and even individuals.

Payment of remuneration to key managerial personnel (KMP), including stock options or ESOPs: Many assessees are bound to face issues in justifying KMP payments, as this is subjective. The KMP payments of a particular company may not be comparable to a peer company, even if both are same size. The managerial personnel may differ in terms of qualification, experience, and so on.

One way of benchmarking this transaction may be to consider the replacement cost of the KMP — and the Human Resources department records may be helpful in this.

In the case of ESOPs for key managerial personnel, the terms and conditions of issue to other employees and KMPs could act as a basis to justify the arm’s length principle.

Outsourcing by a Special Economic Zone (SEZ) unit to a non-SEZ unit of the taxpayer: In this case, the rates charged by the non-SEZ unit to the SEZ unit can be compared with the rates charged to third-party customers; or the profit earned by the non-SEZ unit can be compared with the profit earned by the non-SEZ unit from services rendered to third-party customers; or the profit earned by the non-SEZ unit can be compared with the profit earned by third-party companies in rendering similar services using external databases. The development of intellectual property by the units may add to the complexity.

Sharing of premises and utilities with a related person: SDT will be applicable to the person incurring expenditure in the form of payment for rent and utilities. The rent paid may be compared with the prevailing rent for a similar property in the area.

The rent and utilities may be benchmarked from the perspective of the receiving entity, if such data is available. The following transactions between related parties will also be examined under the arm’s length concept:

payments of corporate guarantee charges within the group;

sharing of common costs such as administration, management, and human resources;

financing , including utilisation of cash pools or group borrowings and lending with incurrence of interest expense.

The companies absorbing the costs are required to pass the ‘benefit test’ and justify the economic rationale for it. Determination of arm’s length principle, a methodical exercise based on analysis of data, may prove challenging due to inadequate comparable data under uncontrolled conditions (that is, dealings with independent parities).

When dealing with the new legislation, companies are advised to clearly instruct officials to track covered transactions, and maintain supporting documents. All personnel concerned should be given extensive training, and a documentation matrix as reference.

As SDT is not covered under the Advance Pricing Agreement scheme, even if the taxpayer obtains an APA for international transactions, mandatory TP compliances may still be needed for its SDT (TP documentation and accountant’s certificate).

Vaishali Mane is Director and Hitesh Pandey is Manager, Transfer Pricing, Grant Thornton India LLP

Published on March 31, 2013