Indian Union Budget 2017 - Transfer Pricing update

Published on February 23, 2017

• Thin capitalization rules introduced limiting deduction of interest for loans taken from Associated Enterprises (AEs). Fallout of OECB BEPS Action Plan 4.
• Secondary adjustment introduced providing that if a primary arm’s length price adjustment is not repatriated by the AE, then it will be deemed as an advance and notional interest would be computed.
• Domestic Transfer Pricing provisions applicable only for transactions with related parties availing profit linked deductions.

Thin Capitalization Rules

• Thin Capitalization norms have been introduced for the first time in the domain of Transfer Pricing in line with the Organisation for Economic Co-operation and Development’s (”OECD”) Project for Base Erosion and Profit Shifting (”BEPS”) to limit excess interest deduction by multi-national entities [Action Plan 4].
• In keeping pace with the implementation of BEPS project, Action Plan 4 ”Limiting Base Erosion Involving Interest Deductions and Other Financial Payments” recommendations have been proposed to be assimilated into Income Tax Act through Section 94B Income Tax Act.
• As per the new provision, interest paid by an Indian taxpayer to a non-resident AE can only be deducted from its business income up to an amount of 30% of its earnings before interest, taxes, depreciation and amortization (EBITDA).
• Further, the provision shall also apply in cases where debt is borrowed from an unrelated lender and where the AE has provided an implicit or explicit guarantee to the lender for the debt or has deposited funds with the lender to secure the debt.
• The provisions allow for carry forward of disallowed interest expense to succeeding eight assessment years and deduction against the business income to the extent of the maximum allowable interest expenditure (i.e. 30% as mentioned above).
• The above provision is applicable only where the interest expenditure exceeds INR 10 Million per Financial Year. Further, banking and insurance businesses are excluded from the applicability of the said provisions.
• The provisions will apply from Financial Year 2017-18 (starting on 1 April 2017) onwards (i.e. from Assessment Year 2018-19).
   

Secondary Adjustment under Transfer Pricing

• The concept of ”Secondary Adjustment” is introduced through insertion of new Section 92CE Income Tax Act.
• It provides for an additional adjustment, where there is an increase in the total income or reduction in the loss, for the following cases where any primary adjustment in transfer prices:
  › has been made (suo moto) by the assessee; or
  › has been made by tax officer and has been accepted by the assessee; or
  › is determined by an advance pricing agreement entered by the assessee; or
  › has been made as per the safe harbor rules; or
  › is arising out of mutual agreement procedure.
  › The excess money which is available with the AE (as per the findings in the primary adjustment), if not repatriated to India within a time as may be prescribed, shall be deemed to be an advance made by the taxpayer to such AE and the interest on such advance, shall be computed as the income of the taxpayer.
• Such secondary adjustment shall not be made if the amount of primary adjustment made in the case of a taxpayer in any financial year does not exceed INR 10 Million and also in cases of primary adjustment in respect of the Assessment Years before 2017-18.
• The provisions will apply from Financial Year 2017-18 (starting on 1 April 2017) onwards (i.e. from Assessment Year 2018-19). There is no clarification about the application of the amendment for Financial Year 2016-17.
• The rules relating to interest rates to be applied and the time period to be considered for secondary adjustment would be prescribed in due course. Based on the present provision, it appears that if the amount equivalent to the primary adjustment is not recovered from the AE, interest amount on the adjustment amount would have to be considered as deemed income of the assessee on perpetuity basis.
• In our opinion, the applicability clause ”primary adjustment made by the assessing officer and accepted by the assessee” needs to be clarified further, whether an appeal filed by the assessee against the assessing officer’s primary adjustment, would be sufficient for exclusion from the application of the said provision to the taxpayer.
   

Applicability of Domestic Transfer Pricing Provisions

• The existing provision of Section 92BA Income Tax Act which defines the meaning of Specified Domestic Transactions (”SDT”) has been amended.
• The scope of domestic transfer pricing thus stands curtailed and would apply only to transactions entered with related parties which are enjoying specified profit-linked deductions, such as eligible Special Economic Zone entities, etc.
• Considering that the above change is proposed under the heading of ”Ease of Doing Business”, these provisions are effective retrospective from 1 April 2016 i.e. for FY 2016-17 (Assessment Year 2017-18).
• The reduced scope of domestic transfer pricing means a very positive relief from documentation and reporting requirements.