Transfer Pricing in India

An overview of Specified Domestic Transaction in TP Provisions

Transactions between related parties have long been suspected of being used to shift income and thereby decrease a company’s or group’s overall tax burden when operating from numerous places with varied tax regulations. Even before the idea of Specified Domestic Transaction was incorporated into Indian tax legislation, there were various additional regulations in place to prevent tax evasion through inter-company transactions between domestic companies in the same group.

The idea of Specified Domestic Transactions was added in the Income-tax Act of 1961 by Finance Act of 2012 in order to prevent tax arbitrage opportunities in transactions between domestic enterprises.

The rationale for the introduction of Specified Domestic Transaction

Transactions between two different enterprises in the same tax jurisdiction have no effect on tax authorities’ revenue base. Company A and Company B, for example, are both situated in the same tax jurisdiction. If Company A claims more than fair market value for the goods or services it provides to Company B, the drop in Company B’s income is offset by an equivalent rise in Company A’s income.

On the other side, when Company A undercharges for goods and services, the income of Company B increases by the same amount. From the perspective of tax authorities, it receives the same amount of tax regardless of who pays the tax. This is known as Revenue Neutrality, and it occurs when inter-group transactions have no impact from the perspective of tax authorities.

But the tax implications change if one of the parties to the transaction is either losing money or is required to pay taxes at a reduced rate. Profits can be purposefully moved to such entities in such instances to decrease the group’s or company’s overall tax burden.

Assume Company A and Company B are part of the same group/are significantly controlled by the same set of shareholders. Company B, on the other hand, is an eligible unit that qualifies for tax breaks under the Income-tax legislation. In such a circumstance, when delivering services to Company B, Company A can undercharge for such services, cutting its profits while raising Company B’s income by the same amount. However, because Company B is on a tax break, such gains are exempt from taxation. As a result, the overall tax paid by the group is lowered.

This is known as tax arbitrage. The word “tax arbitrage” is not defined in tax regulations. The phrase is commonly used to refer to the practice of benefitting from the variations in how income and expenditures are considered for the purpose of computing taxes. The goal of introducing transfer pricing provisions to Specified Domestic Transactions is to reduce Tax Arbitrage and ensure that tax authorities’ revenue base is not impacted by such unfair practices.

What is the definition of Specified Domestic Transaction?

According to the Act’s provisions, once a transaction is classified as a Specified Domestic Transaction, all the regulatory requirements such as transfer pricing documents, the accountant’s reports, and so on apply to it in the same way as they do to international transactions.

The term of Specified Domestic Transactions was added to the Income-tax Act of 1961 by the Finance Act of 2012^[1], to make some transactions between domestic corporations to be treated as specified domestic transactions and to make them subject to domestic transfer pricing restrictions.

The following conditions must be met in order for a transaction to be classified as a specified domestic transaction:

• The transaction should not be multinational in nature.
• The transaction should fall under one of the parts (ii) to (vi) of Section 92BA.
• The total amount of such transactions entered into by the assessee should surpass INR 20 cores (with effect from the assessment year 2016-17).

Interpretation of Specified Domestic Transaction

SDTs cover the following transactions:

• a transaction that is referred to in section 80A
• a transfer of goods or services that is stated in Section 80-IA (8)
• a business transacted between the taxpayer and any other person in Section 80-IA (10)
• any transaction mentioned in any other section of Chapter VI-A or section 10AA that is subject to the provisions of sections 80-IA (8) and 80-IA (10)
• a business transacted between the persons stated under Section 115BAB (6)

In other words, in order to be considered a specified domestic transaction, the transaction must not fall within ‘international transaction’ definition as stated in Section 92B, and the aggregate value of the transactions referred to above must exceed INR 20 Crore in the fiscal year.

Section 92BA (ii) relates to transactions referenced in Section 80A, which pertains to deductions to be made in determining total income under Chapter VI-A. The legislation’s objective was to cover just sub-section (6) of Section 80A because the other sub-sections control the magnitude of deductions and do not entail any fair pricing of transactions.

Section 80A (6) applies to some specific transactions, i.e., any goods or services that are kept for the purpose of the entity, undertaking, or eligible business are being passed on to any other business carried on by the assessee; or any goods or services that are kept for any other business carried on by the assessee are being passed to the entity, undertaking, or eligible business.

According to section 80A (6), in the scenario of all the above transactions, when the price at which such transactions are captured in the books of accounts differs from the current market value of such goods and services, then the transfer will be treated to have been done at the market value of such goods and services for the purpose of calculating the income of such unit, undertaking, or eligible business.

The phrase “market value” refers to the price that such goods and services attract in the open market. The concept of “market value” has been broadened by a commensurate change to the Finance Act of 2012 to include the arm’s length price where the transactions are governed by specified domestic transactions. Various parts of the Income-tax Act of 1961 that allow for profit-linked tax break deductions and are thus covered by section 80A (6) are Section 80-IA, 80-IAB, 80-IB, 80-IC, 80-ID, 80-IE, 80JJA, 80-JJAA, 80-LA, and 80-P.

Furthermore, in the case of Specified Domestic Transactions, the concept of market value has been broadened to include the arm’s length price. Because the regulations provide us with a threshold limit for transactions to be categorized as SDTs, where the overall total of all transactions of an enterprise does not exceed the specified threshold of Rs. 20 crores (from the AY 2016-17), such transactions will be administered by the earlier provisions of section 80A (6), and thus the Fair Market Value of such transactions shall be calculated in accordance with general principles.

Section 80-IA (8) is similar to Section 80A (6) in that it addresses the inter-unit transfer of goods & services. Section 80-IA (8) states that for the purposes of deduction under section 80-IA, if any goods or services previously held for the intent of an eligible undertaking are transferred to other business carried on by the assessee or vice versa, then such deductions will be calculated as though these transfers were made at the market value of such goods and services. In accordance with the modifications made to section 80A (6), the definition of ‘market value’ for the purposes of section 80-IA (8) has also been modified to provide that the market value shall include the arm’s length price in the case of Specified Domestic Transactions.

Section 92-BA (4) refers to transactions between the taxpayer and any other person mentioned in subsection (10) of Section 80-IA. Section 80-IA (10) applies when a transaction occurs between the assessee and any other person, such interactions result in greater than usual profits in the hands of taxpayers; and, in addition, such excessive profit is the consequence of a close connection with the other person or for any other cause. The clause gives the Assessing Officer broad authority to recalculate the value of any transactions done by the taxpayer that involve an eligible unit if it appears to him that such eligible units have generated unjustified profits. The section includes all transactions that include both income and spending.

Specified Domestic Transactions have also been established to include any transaction mentioned in any other section of Chapter VI-A or section 10AA that is subject to the provisions of sections 80-IA (8) and 80-IA (10). This sub-section appears to cover transfers between units that are eligible for profit-linked deduction and other units that likewise enjoy comparable profit-linked deductions, although under various sections.

Conclusion

To be captured by the description of Specified Domestic Transaction, the overall value of all specified transactions under varied provisions of Section 92BA must exceed INR 20 crores with effect from the Assessment year 2016-17. The mentioned threshold helps to ensure that any taxpayers with few transactions with related entities are not burdened by the transfer pricing compliance requirements. This threshold limit also ensures that the cost of compliance and administrative burden associated with such provisions does not outweigh the benefit derived from them.

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