Income tax – Overview Nihar Jambusaria

Nihar Jambusariajnihar@rediffmail.com

nihar.jambusaria@ril.com

SPECIFIED DOMESTIC TRANSACTION

Typical Transactions u/s.40A(2) and their

Benchmarking………………………….

ISSUES AND CASE STUDIES

INTRICACIES OF VALUE THRESHOLD INR 5 CR. Threshold of INR 5 Cr. on aggregate basis for all six limbs

Value to be adopted as per books – [Form 3CEB] Relief from documentation and ALP benchmarking Book value to be adopted even if transactions are ALP compliant

Transaction Value as per books

ALP

    

Scenario I 

Scenario II 

40 (A)(2)(b) payments 

3.00 Cr. 

3.00 Cr. 

4.00 Cr. 

Inter-unit payment by 

qualifying unit

 

1.50 Cr. 

2.25 Cr. 

1.25 Cr.

 

Total 

4.50 Cr. 

5.25 Cr. 

5.25 Cr.

A

B C

ED

Transactions Covered:

A&B = YesA&C = YesA&D = NoA&E = NoB&C = Yes

CASE STUDY – 1

Issue 1 – Direct Vs Indirect Shareholding CBDT circular - No. 6P, July 6, 1968 – (Not Binding on Taxpayer/ Applicable only to

downstream entities).

ICAI GUIDANCE NOTE – Only Direct Shareholding covered.

Need clarification in the Act or by way of a Circular whether for purposes of Section 40A(2)(b), one needs to consider only direct shareholding and not derivative or indirect shareholding

FACTS A Ltd and B Ltd are related

parties under S. 40A (2)(b) A Ltd grants loan to B Ltd at

an interest rate of 18% p.a ALP interest rate arrived after

considering the tenure, repayment terms and other terms and conditions is much lower than the interest rate charged by A ltd.

A Ltd

B Ltd

CASE STUDY – 2

Impact For A Ltd:

Presently, income transactions from related parties under S. 40A(2)(b) are not covered under Domestic TP

For B Ltd: Payment of Interest to related party covered under S.

40A(2)(b) constitutes SDT and hence B Ltd will be liable to Domestic TP

B Ltd pays interest at a rate much higher than the ALP determined.\

Tax Authority can make an adjustment to disallow the excess interest paid and ‘may’ also be exposed to penalty for non compliance of TP provisions.

FACTS A Ltd and B Ltd are related

parties under S. 40A (2)(b) A Ltd grants interest free loan

to B Ltd.

A Ltd

B Ltd

CASE STUDY – 3

Impact For A Ltd:

No notional interest income can be computed in the hands of A Ltd on the basis of ALP rate as income transactions are not covered under the purview of Domestic TP

However, if A Ltd has used interest bearing borrowed funds to give interest free loan to B Ltd, issue of disallowance of corresponding interest expenditure ‘may’ arise.

For B Ltd:

No interest is paid by B Ltd, the provisions of S. 40A(2)(b) r.w.s. 92BA are not applicable and thus B Ltd is not liable for domestic TP.

PQR Ltd

Unit A

Unit B

Unit C

FACTS:PQR Ltd. Bod includes:

Independent Directors who receive sitting fees

Promoters (directors) who receive salary, commission and sitting Fee.

CASE STUDY – 4

ISSUES

Are the payments made to Directors covered under Specified Domestic Transactions?

Methods to determine the Arm’s length Price?

BENCHMARKING OF DIRECTORS REMUNERATION

It can be benchmarked based on their work experience and qualification.

Further the remuneration paid to them is as per the limit of Companies Act.

However there is no streamlined process to benchmark the transaction.

13

DOMESTIC TP NOT RESTRICTED TO TRANSACTION WITH RESIDENTS S. 92BA excludes International Transaction from within its scope

Trigger for AE relationship different for International and Domestic TP

Illustrative examples where transactions with non-resident may be covered under Domestic TP

Remuneration paid by an Indian company to a non-resident director

Remuneration paid by a FC having PE to non resident director

Payment by Indian Co to Foreign Co. where Foreign Co. holds 20 to < 26% in Indian Co.

salary paid

Outside India

salary paid

India

CASE STUDY – 5

A Ltd

PE in India

Mr. XDirector of

A Ltd

FACTS Mr. X is director of A Ltd which has

PE in India and was deputed to work for PE in India from 1st Nov 2011.

Mr. X’s is a non-resident for FY 2011-12

Salary to Mr. X upto 1st November was paid outside India and post November salary (above 5 Cr.) was paid in India

PE is liable to tax on net basis in India and claims salary paid to Mr. X post November 2011 as deductible expenditure from its income

Issue:

Whether salary paid to Mr. X is subject to Domestic TP considering that both A Ltd and Mr. X are non-residents.

AnalysisSalary paid to Mr. X is not an International

transactions in terms of S. 92B r.w.s 92A since Mr. X is not an AE of A Ltd as defined under S. 92A

However, Mr. X is a director of A Ltd and hence it will be covered under related party as defined under S. 40A(2)(b)

PE is liable to tax in India on net basis and it can claim deduction for salary paid to Mr. X for rendering services in India

The salary cost paid to Mr. X for services rendered in India does not constitute ‘HO expenditure’ in terms of S. 44C, full deduction is available.

The payment made by PE to Mr. X will be covered under the purview of Domestic TP as payment is made to related party covered under S. 40A(2)(b)

PE will be required to benchmark the payment made to Mr. X to ALP and required to comply with all the provisions of Domestic TP,.

The fact that both A Ltd and Mr. X are non-residents is not relevant.

SDT can be applicable with / between non-residents.

CASE STUDY – 6

H Co.(Indian Co)

A Ltd (foreign subsidiar

y)

B Ltd (Indian

Subsdiary)

C Ltd (Indian

Subsidiary)

H Co. and both Indian Subsidiaries are not entitled to any profit linked tax holiday.

H Co. owns a valuable brand ‘XYZ’ which is self generated for Hold Co.

The subsidiaries companies are engaged in manufacturing and distribution of diverse products and sell their products under the brand name of ‘XYZ’.

The subsidiaries pays royalty to H Co. for use of brand name.

Foreign subsidiary has no presence in India and its not liable to tax in India.

Facts:

Issues:

Whether H Co. is liable for Domestic TP for royalties received from its subsidiaries

Whether subsidiaries are liable for Domestic TP

Applicability of Domestic TP for H. Co

Even though B Ltd and C Ltd (domestic subsidiaries)are related parties covered under 40A(2)(b), the royalty income received from subsidiaries is not covered under by the provisions of domestic TP as it covers only the payments made to related parties and not income transactions.

However, A ltd (foreign subsidiary) is an AE for H Co. Royalty Income received from A Ltd will constitutes Intl. transaction for H Co. and it is required to benchmark royalty income received

Analysis:

Applicability of Domestic TP to A Ltd

A Ltd has no presence in India and not liable to tax in India hence S. 40A(2)(b) and Domestic TP provisions are not applicable.

Applicability of Domestic TP to B Ltd & C Ltd

B Ltd and C Ltd (domestic subsidiaries)are related parties covered under 40A(2)(b), the provisions of Domestic TP will be applicable.

Royalty fees paid by B Ltd and C Ltd will be required to benchmark with ALP.

• Mr. P, Q, R & S hold 15% of voting power in Co. 1 and balance 40% are held by others

• Mr. P, Q, R & S are directors in Co. 2

P Q R S

Co. 1

Others

Co. 2

15%

15%

15%

15% 40%

Directors

CASE STUDY 7 : DETERMINING SUBSTANTIAL INTEREST

Issue:• Are Co1. and Co. 2 related parties?

Analysis: Substantial holding is required to be determined on an

individual holding basis. Preference shares holding to be excluded while

determining the substantial interest. Mr. P, Q, R & S does not hold any substantial interest (less

than 20%) individually, Co. 1 and Co. 2 are not related parties.

Issue:• Are Co1. and Co. 2 related parties?

Analysis: Substantial holding is required to be determined on an

individual holding basis. Preference shares holding to be excluded while

determining the substantial interest. Mr. P, Q, R & S does not hold any substantial interest (less

than 20%) individually, Co. 1 and Co. 2 are not related parties.

Miscellaneous IssuesIssues Possible views

What does ‘close connection’ for Section 80IA(10) mean?

- Reliance on Sec. 92A, Sec. 40A(2)(b) and AS 18?- Indirect shareholding covered?

Whether all transactions with a closely connected person included or only those resulting in more than ordinary profits?

- View 1 - All transactions to report & benchmark- View 2 - Only transactions resulting in more than

ordinary profits to report and benchmark- Whether all transactions are to be reported?

Whether TP applicable if expense not claimed?

- Transaction to be reported, not benchmarked?

Whether transactions between two eligible units (having differential exemption) covered?

- Nothing expressly stated in the provisions - ICAI Guidance Note mentions transfers between

‘eligible’ and ‘non-eligible’ business?

Are free of cost goods/ services/ loans covered?

- Should not be an issue under Section 40A(2)(b)- Tax holiday units?