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1. Amendment of section 90
The Finance Bill (No. 2) 2009
proposes to replace the existing Section 90 with a new section 90. The new
section 90 is substantially the same as earlier section 90 except that the
proposed amendment seeks to empower the Central Government to enter into an
agreement with the Government of any country outside India or a specified
territory outside India, inter alia, for avoidance of double taxation of
income. For this purpose, the Central Government may, by notification in the
Official Gazette, make such provisions as may be necessary for implementing
the said Agreement and would also notify the specified territory outside
India.
Earlier, the Central
Government was empowered to enter into an agreement only with foreign
countries and after the amendment it shall be empowered to enter into such an
agreement with any specified territory outside India.
Media reports indicate that
the Government is set to track the unaccounted wealth stashed away by Indians
in tax havens, with the proposed double-taxation avoidance treaties, or a Tax
Information Exchange Agreement, with what it describes as ‘non-sovereign’
jurisdictions.
According to one estimate,
over trillion dollars (roughly the size of our GDP) may be lying in
undisclosed, offshore bank accounts held by Indians. Jersey, Isle of Man and
Guernsey, which also falls in this category, are dependent on the British
Crown. Despite the ‘non-sovereign’ tag, these territories have complete
autonomy over their internal affairs and certain external affairs.
Although the Finance Bill
does not specifically say so, such specified territories outside India could
also include special administrative regions and non-self governing
territories. Hong Kong and Macau are Special Administrative Regions of the
People’s Republic of China, while tax havens, such as British Virgin Islands
and Cayman Islands, are non-self governing territories though they have
attributes of sovereignty including control over monetary policy.
Double-taxation treaties are
essentially agreements between two countries that seek to eliminate the
double-taxation of income or gains arising in one country and paid to
residents or companies of the other country. The idea is to ensure that the
same income is not taxed twice. But such pacts need concurrence of both
countries. Alternatively, India is also looking at a Tax Information Exchange
Agreement with non-sovereign nations. The trigger for such a move is to get
information on Indians who could be holding illegal accounts in some of these
countries.
Indians featured in the list
of account holders with LGT Bank in Liechtenstein, a tax haven bordering
Switzerland and Austria. The government secured the list of Indians having
unreported bank accounts and sent over 50 notices asking why action should not
be taken under the Indian Income-Tax Act against these account holders. A copy
of the list was also sent to Enforcement Directorate, which is probing the
flight of capital from India.
The tax havens have attracted
the attention of political establishments in Europe and the US. The new-found
focus on wealth stashed away from these countries to offshore banks was partly
driven by the ongoing recession that compelled the fiscal managers to look for
extra resources.
The concern over the impact
of tax havens on the European and the US economies was also voiced at the last
G-20 meet held in London. US President Barack Obama also raised the issue at
every forum that discussed the global financial crisis.
It is a moot point whether
such Tax Heavens would be willing to enter into such agreements with India,
which will adversely impact their economies.
2. Proposed changes to the
transfer pricing provisions
The recent transfer pricing
audits have resulted in significant tax demands and long drawn time consuming
litigation and uncertainty. The proposed measures in the Finance Bill, 2009
attempt to reduce the hardship of going through the present appellate process
and reduce litigation cost, administrative burden and bring in certainty for
tax matters.
3. Some of the proposals
have been discussed below
i) Determination of the arm’s
length price shall now be subject to the “safe harbour rules”. The Central
Board of Direct Taxes (CBDT) is empowered to formulate safe harbour rules i.e.
to provide the circumstances in which the revenue authorities shall accept the
transfer price declared by the tax-payer.
ii) The ‘Safe Harbour’ rules
have been proposed with an objective of reducing the impact of judgemental
errors in determining the transfer price. The Finance Bill has proposed to
introduce a new section 92CB in the Act, which deals with the ‘safe harbour’
rules. The administrative procedure and conditions for availing the benefits
of the ‘safe harbour’ rules would be separately notified by the Central Board
of Direct Taxes (‘CBDT’).
iii) The new provisions
define ‘safe harbour’ to mean ‘certain circumstances in which the Revenue
Authorities shall accept the transfer price as declared by the tax-payer’.
iv) Safe Harbour rules will
help achieve the objectives of compliance relief, administrative simplicity
and certainty for tax-payers and tax administrators.
4. Concept of Safe Harbour
i) Safe harbour rules in
transfer pricing are to reduce uncertainty and administrative cost involved in
the application of the arm’s length principle. The rules provide the
circumstances in which the tax authorities will automatically accept transfer
prices. The administrative requirement of safe harbour may vary from a relief
from obligation to comply with a country’s transfer pricing regulations to the
obligation to comply with various procedural rules. However, safe harbours
have limitations as they may not be in adherence of the arm’s length
principle. Further, there is a possibility of negative impact on the tax
revenues of counties adopting safe harbour as well as on the countries whose
enterprises have transactions with such countries.
ii) The OECD guidelines
suggest the use of certain provisions under which taxpayer could follow a
simple set of rules, whereby the transfer price would automatically be
accepted by the tax authorities. To seek the advantages of safe harbour
certain countries like Australia and Mexico have introduced such rules known
as “safe harbours” for certain service providers.
iii) In Australia, for
instance, an enterprise rendering services can be said to meet arm’s length
standard, if it has earned 7.5% margin over its cost, subject to certain
parameters.
iv) Similarly, Mexico has
also released a “Presidential Tax relief Decree in October 2003”, to provide
“Maquiladoras” a substantial tax exemption based on a formula applied. The
contract manufacturer must declare a minimum taxable profit representing the
greater of 6.5% of total costs and expenses (cost base) or 6.9% of
manufacturer’s assets (asset base) used in the manufacturing operation.
v) At present, there are no
specific safe harbour rules in India. However, proviso to s 92C(2) provides
that the tax officer shall not make any adjustment to the arm’s length price
determined by taxpayer, if such price is up to 5% less or 5% more than the
price determined by the tax officer. This 5% range can be considered as a safe
harbour.
5. Advantages and
Disadvantages of Safe Harbour.
a) Advantages of Safe
Harbours are as follows:
i) Compliance relief for eligible tax-payers
in determining arm’s length conditions for controlled transactions;
ii) Assurance to eligible tax-payers that they
will not be subjected to further scrutiny in connection with their transfer
prices; and
iii) Administrative relief to the tax
authorities.
b) Limitations of using Safe
Harbours are given herein below:
i) Generally not compatible with the
enforcement to transfer pricing law consistent with the arm’s length
principle;
ii) Possibility of a negative impact on the
tax revenues of countries adopting safe harbour, as well as on the countries
whose associated enterprises engage in controlled transactions with the
former;
iii) Obtaining relevant information for
establishing and monitoring safe harbour parameters may impose
administrative burdens on tax administrations; and
iv) Implementations of a safe harbour creates
uniformity issues, since there are two distinct sets of rules in the
transfer pricing area – one requiring conformity of prices with the arm’s
length principle, and another requiring conformity with a different and
simplified set of rules.
Thus, the concept of ‘safe
harbour’ suggests that the results declared by the tax-payer, who fulfils the
prescribed conditions/ circumstances, may be accepted without detailed
scrutiny. Though the proposal of ‘safe harbour’ provisions is a move in the
right direction, one would need to await for detailed guidelines on this, to
see if the desired end result is achieved.
Countries like USA, Mexico, Australia etc. have been effectively using the
‘safe harbour’ rules. It would be interesting to note how the Indian safe
harbour rules would be different from those of other countries.
The proposed amendment is
retrospective and will apply to year ended March 31, 2009.
6. Variation from the arm’s
length price - Amendment to section 92C(2)
i) The existing proviso to section 92C(2) of the
Act mandates that while determining the arm’s length price, the arithmetical
mean of the comparable uncontrolled transactions shall be considered to be the
arm’s length price. The proviso also gives an option to the tax-payer to adopt
a price, which varies by not more than 5% of the arithmetical mean, to be the
arm’s length price.
ii) In other words, in all cases where there
would be a proposed transfer pricing adjustment, the tax-payer could exercise
his option and seek to claim the benefit of the 5% variation as a ‘standard
deduction’ before applying the arm’s length principle. This interpretation of
the proviso to section 92C(2), by the tax-payers, is not being accepted by the
Indian Revenue.
iii) However, the following decisions, the
Tribunals have upheld the interpretation of the tax-payers that the proviso to
section 92C(2) provides a standard deduction of 5%.
• Development Consultants
Pvt. Ltd. vs DCIT (115 TTJ 577)(KOL),
• E-Gain Communication Pvt Ltd. vs. ITO (ITA No.1685/PN/2007) (Pune),
• Mentor Graphics (Noida) Pvt. Ltd. vs DCIT (18 SOT 76)(Delhi),
• Sony India (P) Limited vs. DCIT
(2008-TIOL-439) (Delhi)
iv) With a view to resolving
this controversy, the proviso is proposed to be amended to mean that if the
variation between the ‘price of the controlled transaction of the tax-payer’
and ‘the arm’s length price’ is not more than 5% (of the controlled
transaction of the tax-payer), the former would be deemed to be at arm’s
length.
The impact of the revised
proviso is explained as under:
|
Particulars |
Value of controlled
transfer price |
Arithmetical mean of the
Arm’s Length Price |
Adjusted ALP after 5%
variation Rs. |
TP adjustment Rs. |
|
Existing
proviso |
Sale of
Rs.100 |
Sale price
of Rs.125 |
125 x 0.95
= 118.75 |
118.75–100
= 18.75 |
|
Revised proviso (as proposed) |
Sale of
Rs. 100 |
Sale price
of Rs. 125 |
100 x 1.05
= 105 |
125 – 100
= 25 |
v) As per the above, under
the existing proviso, the tax-payer ought to get the benefit of the 5%
variation as a ‘standard deduction’ on the original ALP (i.e., the adjustment
would be done using the adjusted ALP of 118.75). However, as per the proposed
proviso, if the arm’s length price is beyond 5% of the value of the controlled
transaction, the tax-payer would be subjected to a transfer pricing adjustment
from the original arm’s length price (i.e., the ALP of 125).
In short, the proposed
amendment primarily aims to provide that the benefit of +/- 5% would not be
available as a ‘standard deduction’.
The proposed amendment would
be applicable for all transfer pricing orders passed on or after 1st October,
2009.
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