Finance Act, 2012 has extended transfer pricing provisions to certain specified domestic transactions. This followed the Supreme Court’s decision in the CIT vs. Glaxo Smithkline case, where it had examined the complications that arise when fair market value is assigned to transactions between domestic related parties; the apex court had suggested that the Finance Ministry should consider applying transfer pricing provisions to such transactions.
Specified domestic transactions include payments to specified related parties, inter-unit transfer of goods or services of profit-linked tax holiday-eligible units, transactions of profit-linked tax holiday-eligible units with other parties, and any other transactions that may be notified. By extending transfer pricing provisions, the pricing of these transactions will have to be determined using prescribed arm’s length principles.
The provisions are applicable from FY2012–13. The existing transfer pricing provisions applicable to international cross-border transactions regarding documentation, filing of accountant’s report, and penal consequences for non-compliance are applicable to specified domestic transactions too.
The key aspects of the provisions for specified domestic transactions are:
Allowance for expenditure or allocation of any cost, expense or income in relation to specified domestic transactions will be computed on the basis of the arm’s length price;
Taxpayers cannot apply transfer pricing provisions to specified domestic transactions if it reduces the taxable income;
Monetary threshold of Rs 5 crore is applicable for the trigger, which is computed based on the aggregate of payments and receipts to which the provisions apply;
The provisions relating to Advance Pricing Agreements are not applicable to specified domestic transactions.
With the introduction of transfer pricing provisions to specified domestic transactions, related-party payments may be subject to detailed scrutiny, to assess whether they are consistent with arm’s length principles. Intra-enterprise arrangements may also be reviewed to assess the reasonableness of tax holiday profits, and this, in turn, would impact the extent of profits eligible for tax holiday. As such transactions will be scrutinised by specialised officers, taxpayers should take care to adhere to the compliances. As FY2012-13 is the first year when transfer pricing provisions apply to specified domestic transactions, the due date for documentation and filing of the accountant’s report is November 30, 2013.
The extension of transfer pricing provisions to domestic transactions is aimed at providing objectivity in the determination of income from domestic related-party transactions and the reasonableness of expenditure between them. Although the due date is November 30, 2013, it would be useful for taxpayers to analyse the provisions in advance, and adopt a four-step approach.
Identify inter-company transactions/ arrangements subject to provisions for specified domestic transactions;
Analyse current pricing policies and practices, and evaluate the applicability of the provisions;
Undertake impact assessment through a functional analysis and benchmarking exercise;
Adhere to the compliances within the due date.
Taxpayers should complete the first three steps by March 31, 2013, so as to be prepared to make the necessary changes to agreements or pricing policies.
Vijay Iyer is Partner and Transfer Pricing Leader, Ernst & Young