The Financial Minister (FM) presented her second Union Budget on 1st February, 2020 amidst a lot of expectations from stakeholders of the Indian economy. India has been experiencing an economic slowdown which by many has been attributed to Government's unprecedented measures such as demonetisation and Good and Service tax (GST) regime.
The global arena watched this Budget closely to comprehend its interplay with India Inc. and explore ways to partner with one of the prospective fast growing economies of the world. This government has always laid emphasis on the importance of ease of doing business to put India at par with global developed economics.
In the first union budget of the new decade, the FM introduced some welcoming tax measures in her tax proposals including abolishing Dividend Distribution Tax, increasing tax holiday eligibility for start-ups, expanding term 'business connection' as a significant step towards taxation of digital economy etc. This article focuses on the key transfer pricing proposals laid down in this budget.
- Certainty for profit allocation to Permanent Establishments (PE)
One of the most litigated transfer pricing matters in India is the establishment of PE and the consequent profit allocation to the said PE. The uncertainty surrounding the taxability of profits in the hands of PE in India has led to prevalence of diverse methodologies followed by tax authorities as well as the taxpayers.
In order to provide certainty in this aspect, it is proposed that with effect from financial year (FY) 2020-21, the two dispute avoidance mechanisms namely Safe Harbour Rule (SHR) and Advance Pricing Agreements (APA) would be amended to include determination of income attributable to a PE in India. The benefit of APA also rolls back to four preceding years.
Vide its draft report issued in relation to profit attribution to PE, the Central Board of Direct Taxes ('CBDT') had indicates its preference for a formula based approach in contrast to allocation basis the Function, Asset and Risk (FAR) profile of the PE. The public comments submitted for this draft report clearly indicated the reservation of the fraternity in accepting the said formulary approach.
MNEs have welcomed this proposal of the Government, however the detailed rules governing these amendments have to be carefully contemplated, since the allocation of income/profits to PE is extremely subjective. Therefore, it will be vital for the taxpayers to assess the methodologies suggested for such allocation before evaluating whether to opt for SHR or APA.
- Proposal in relation to objections filed before Dispute Resolution Panel (DRP)
Currently, taxpayers can file their objections before the DRP against the draft assessment order issued by an assessing officer (AO) only in case where the AO proposes any variation in the income or loss returned which is prejudicial to the interest of such taxpayer.
In other words, the AO wasn't legally bound to issue a draft order in matters were the income or loss of the taxpayer weren't altered, however there were prejudicial directions on other matters such as Function, Asset and Risk (FAR) profile of the taxpayer and its resultant economic characterization. In such cases the taxpayers were unable to approach the DRP with its objections.
In its effort to make the dispute resolution more effective, the provisions of Section 144C has been amended to instruct the AO to issue draft order even in cases the income or losses of the taxpayer are unaltered, Thereby, allowing the taxpayer to file its objections before the DRP against the draft order in any matter that is prejudicial to its interest.
Over the years, many taxpayers have experienced that the directions issued by the DRP have non-speaking for which they have received considerably flaking from the tax tribunal. Furthermore, certain taxpayers at ground level didn't prefer this route largely because the directions of the DRP weren't appealable by the revenue authorities before the ITAT which led to these directions being mere reaffirmation of the adjustments proposed in AO order.
In light of the above fact, the only relief this amendment may bring to the taxpayer would be to emerge as a fast route to an appeal before Income tax Appellate Tribunal (ITAT) since the DRP is bound to pass its directions within 9 months from the date of application filed.
Further, this budget extends the applicability of DRP provisions to an eligible assessee being a non-resident not being a company or a foreign company.
- Exclusion of Permanent Establishment of a non-resident Bank for limiting interest deductions
To address the issue of Base Erosion and Profit Shifting (BEPS), OECD introduced Action Plan 4 for limiting interest deductions. India in line with the recommendations of the said Action Plan, introduced Section 94B in 2017 wherein the deduction on interest payments exceeding one crore rupees by Indian company, or a permanent establishment (PE) of a foreign company to its Associated Enterprise (AE) was capped to 30 per cent. of its earnings before interest, taxes, depreciation and amortization (EBITDA) or interest paid or payable to AE, whichever is less.
Debt issued by branch of a foreign bank was attracted under the above provisions of interest limitation since branch of the foreign company in India is a non-resident in India and deemed to be AE if during the previous year a loan advanced by one enterprise to the other enterprise is at 50 per cent. or more of the book value of the total assets of the other enterprise.
To honour the representations received by many taxpayers, Union Budget 2020 proposes that with effect from FY 2020-21 provisions of interest limitation would not apply to interest paid in respect of a debt issued by a lender which is a PE of a non-resident, being a person engaged in the business of banking, in India.
- Penalty for false or omitted entry
Penalty to the tune of aggregate value of the amount of false or omitted entry that is relevant to relevant for the computation of taxpayer's total income has been introduced.
The false entries have been explained to include use or intention to use forged or falsified documents such as a false invoice or a false piece of documentary evidence. Further it has been explained to be an invoice in respect of supply or receipt of goods or services or both issued by the person or any other person without actual supply or receipt of such goods; or invoice in respect of supply or receipt of goods or services or both to or from a person who does not exist.
From a transfer pricing perspective, this penalty provision may be extended to inter-company payments such as management cross charges which in past have scrutinized by revenue authorities to evidence the benefits received from such services warranting payments.
At this moment this is just an interpretation of the above penalty introduced and the practicality of the same remains to emerge over time when authorities actually start levying the same. However, as an abundant caution, stake holding taxpayers require to maintain adequate documentation and support evidence to substantiate rationale behind such cross charges.
While the Budget did touch upon different issues in the TP arena, majority of them were only clarificatory or cursory in nature. TP fraternity was eagerly expecting reintroduction of SHR provisions which would have brought much sought out certainty for Small and Medium taxpayers. Further, measures such as adoption of inter-quartile range instead of the current 35th-65th percentile or moderation of applicability of Master File applicability would have put India at par with other economies having TP regulations in force and may have furthered promote ease of doing business in India.