Introduction
The provisions of transfer pricing are designed to keep a check on the practice of reducing the tax liability by entering into transactions at prices higher/lower than market prices with one or more associated entities.
As per section 92 when any specified domestic transaction is carried out between associated enterprises, the said transaction should be carried out at arm’s length price. In other words, income arising or allowance of any expenses to an entity resulting from specified domestic transactions with associated enterprise should be computed by having regard to arm’s length price of such transaction.
The provisions of section 92 will apply only if the aggregate value of specified domestic transactions entered into by the taxpayer during the year exceeds Rs. 20Cr.
The arm’s length price, i.e., the fair value of the service is Rs. 17,00,00,000 but by paying higher charges, Essem Ltd. claimed a higher deduction and reduced its profit by Rs. 11,40,00,000. In this case, the provisions of section 92 will be applicable and the income of Essem Ltd. will be recomputed by taking into account the arm’s length price of the specified domestic transaction. In other words, the taxable income of Essem Ltd. will have to be computed by allowing a deduction of only Rs. 17,00,00,000 on account of service charges instead of the actually paid amount of Rs. 28,40,00,000.
Suppose in the above example, the transaction is not a specified domestic transaction, then the provisions of section 92 will not apply.
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Meaning of specified domestic transaction
For the above purpose, the specified domestic transaction means any of the following transactions which is not an international transaction:
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Nature of Transaction |
Brief description of the transaction |
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(i) Any transaction referred to in section 80A. |
As per section 80A(6) when a taxpayer claiming deduction under various sections, inter-alia, sections 80-IA, 80-IAB, 80-IB, 80- IC, 80-ID, 80-IE, etc., carries certain transactions with its associated entities, these transactions should be carried out at fair market value. So, if a transaction is covered under section 80A, then it will be treated as a specified domestic transaction. |
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(ii) Any transfer of goods or services referred to in sub-section (8) of section 80- IA. |
Section 80-IA provides for deductions in respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development, telecommunication services, power generation, etc. Section 80-IA(8) covers the inter-unit transfer of goods and services by an entity claiming deduction under section 80-IA. |
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(iii) Any business transacted between the taxpayer and other people as referred to in sub-section (10) of section 80-IA. |
Section 80-IA provides for deductions in respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development, telecommunication services, power generation, etc. A taxpayer claiming deduction under section 80-IA may enter into a business transaction with other people with whom he has a close connection. The transaction may be arranged in such a manner that the profit earned by the taxpayer from such transaction is more than the normal profit. By doing so the profit of other entity is diverted to the taxpayer and in tune, the taxpayer will not pay tax on the profit so diverted (because he will claim deduction under section 80IA of higher profit). Such type of transactions is covered under section 80-IA(10). |
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(iv) any transaction referred to in any other section under Chapter VI-A or section 10AA, to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable. |
Under Chapter VI-A there are various sections under which the taxpayer can claim the deduction. Only those sections of Chapter VI-A are relevant to which the provisions of section 80-IA(8) and (10) are applicable. Section 80-IA(8) and (10) have already have been discussed above. |
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(v) Any business transacted between the persons referred to in sub-section (4) of section 115BAB |
Section 115BAB provides for a reduced tax rate of 15% in case of those domestic manufacturing companies (including electricity generation Co.) which have been incorporated on or after October 1, 2019, and whose total income is computed without claiming specified exemption, deduction, or incentive available under the Act. Sub-section (4) of section 115BAB provides that where the course of business between company and any other person is so arranged that it produces to the company more than the ordinary profits, the Assessing Officer can re-compute the profit which may be reasonably deemed to have been derived therefrom. The profit from such transaction shall be determined having regard to arm’s length price if such transaction is covered under the ambit of ‘Specified Domestic Transaction’ as defined under section 92BA. |
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(vi) Any other transaction as may be prescribed |
No other transaction prescribed as yet by CBDT under this clause. |
The above transactions will be treated as the specified domestic transaction only if the aggregate value of these transactions entered into by the taxpayer during the year exceeds Rs. 20 Cr.
Methods of computation of arm’s length price
As discussed earlier, a taxpayer should carry out specified domestic transactions at arm’s length price. Arm’s length price is to be determined by applying any of the following methods:
- Comparable Uncontrolled Price Method Resale Price Method
- Cost Plus Method
- Profit Split Method
- Transactional Net Margin Method
- Such other methods may be prescribed by the CBDT.
Penalty under section 271(1)(c)
Many times a taxpayer may try to reduce his tax liability by furnishing inaccurate particulars of his income. In such a case, by virtue of section 270A, the taxpayer shall be liable to pay a penalty for under-reporting or misreporting his income.
Section 270A provides that penalty to be levied shall be 50% of the amount of tax payable on under-reported income. In case under-reported income is in consequence of any misreporting, the penalty shall be 200% of tax payable on under-reported income.
A person shall be deemed to have under-reported his income if:
- the income assessed is greater than the income determined in the return processed under section 143(1)(a)
- the income assessed is greater than the maximum amount not chargeable to tax, where no return of income has been furnished
- the income reassessed is greater than the income assessed or reassessed immediately before such reassessment
- the income assessed or reassessed has the effect of reducing the loss or converting such loss into income,
- the amount of deemed total income assessed or reassessed under section 115JB/115JC is greater than the deemed total income determined in the return processed under section 143(1)(a)
- the amount of deemed total income assessed as per the provisions of section 115JB/115JC is greater than the maximum amount not chargeable to tax, where no return of income has been furnished
- the amount of deemed total income reassessed as per the provisions of section 115JB/115JC is greater than the deemed total income assessed or reassessed immediately before such reassessment.
- the income assessed or reassessed has the effect of reducing the loss or converting such loss into income.
Income shall be deemed to under-reported because of misrepresentation of acts in the following cases:
- misrepresentation or suppression of facts,
- failure to record investment in the books of accounts,
- the claim of expenditure not substantiated by any evidence,
- recording of any false entry in the books of account,
- failure to record any receipt in the books of account having a bearing on total income,
- failure to record any international transaction or any transaction deemed to be an international transaction or any specified domestic transaction, to which the provision of Chapter X applies.
However, no penalty will be levied in the following cases:
- the amount of income in respect of which the assessee offers an explanation and the Assessing Officer or the Commissioner (Appeals) is satisfied that the explanation is bona fide and the assessee has disclosed all the material facts to substantiate the explanation offered
- the amount of under-reported income determined on the basis of an estimate, if the accounts are correct and complete to the satisfaction of the Assessing Officer or the Commissioner (Appeals) but the method employed is such that the income cannot properly be deduced therefrom
- the amount of under-reported income determined on the basis of an estimate, if the assessee has, on his own, estimated a lower amount of addition or disallowance on the same issue, has included such amount in the computation of his income, and has disclosed all the facts material to the addition or disallowance
- the amount of under-reported income represented by any addition made in conformity with the arm’s length price determined by the Transfer Pricing Officer, where the assessee had maintained information and documents as prescribed under section 92D, declared the international transaction under Chapter X, and, disclosed all the material facts relating to the transaction
- the amount of undisclosed income referred to in section
Illustration
Essem Ltd., an Indian company, is the subsidiary company of Shyamal Ltd. an Indian company. Essem Ltd. has purchased goods from Shyamal Ltd. @ Rs. 84 per unit. The same goods are purchased from unrelated entities at Rs. 80 per unit.
Check the applicability of the transfer pricing provisions in the above case and advise the company on penalty provisions, if any, which could be initiated against it by the tax authorities (you may assume that the quantum of transactions exceeds Rs. 20 Cr. in aggregate).
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The relationship of holding and the subsidiary company is covered under section 40A(2)(b) and the quantum of the transaction exceeds Rs. 20 Cr., hence, the transaction of purchase/sale of goods carried between these companies will constitute a specified domestic transaction.
In case of specified domestic transactions, if the following conditions are satisfied, then a penalty under section 270A can be levied :
- Taxpayer enters into any specified domestic transaction exceeding the monetary limit of Rs.20 Cr. (in aggregate).
- The said transaction is not carried out at arm’s length price.
- Tax authorities recomputed the income of the taxpayer by applying the arm’s length price.
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In this case, Essem Ltd. has purchased goods from unrelated parties @ Rs. 80 per unit but the same are purchased from Shyamal Ltd. (related entity) @ Rs. 84 per unit. Hence, it can be observed that Essem Ltd. has purchased goods at a higher price. The higher price of Rs. 4 per unit will be disallowed and the tax authority will re-compute the profit of the company by allowing the purchase price at Rs. 80 per unit.
As per section 270A, the amount so added or disallowed shall be deemed as under-reporting of income, and penalty shall be levied, which shall be 50% or 200% of tax payable on the under-reported income of the tax sought to be evaded can be levied.
In the above case, no penalty will be levied if Essem Ltd. justifies the higher price being charged by its holding company and also satisfies the other conditions specified in this regard. Suppose goods were purchased from Shyamal Ltd. on a credit basis whereas goods purchased from other parties were on advance payment and, hence, Shyamal Ltd. charged a higher price of Rs. 4 to incorporate the effect of the credit period.
In this case, if Essem Ltd. demonstrates that it had maintained information and documents as prescribed under section 92D, declared the international transaction under Chapter X, and, disclosed all the material facts relating to the transaction.
