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1. As per s. 92 to 92F of the Income Tax Act, 1961 ('the Act'), any income arising from the 'International Transactions' or 'Specified Domestic Transactions' between the two 'Associated Enterprises' (AE) shall be computed having regarded to Arm's Length Price (ALP) of the transaction. If the transactions with AEs are not at the ALP, necessary adjustments are required to be made to the income declared by the assessee.
Recently, s. 92CE has been introduced in the Finance Bill, 2017 bringing a major change in the provisions relating to Transfer Pricing (TP). Until now, the TP provisions required certain adjustments to the income of the assessee as a result of which income and tax thereon were enhanced. With the introduction of s. 92CE, the Legislature has made it mandatory to bring these adjustments into the books of account of assessee as well as its AE to reflect consistency in the actual allocation of profits between the assessee and it's AE pursuant to the adjustments on account of ALP. Attempt is also made to ensure that the enhancement in the income also results in the cash inflow for the assessee.
Analysis of provisions of s. 92CE of the Act
2. For easy understanding and discussion, these provisions so introduced in the Finance Bill are reproduced below:
"92CE. (1) Where a primary adjustment to transfer price,—
Provided that nothing contained in this section shall apply, if,-
(2) Where, as a result of primary adjustment to the transfer price, there is an increase in the total income or reduction in the loss, as the case may be, of the assessee, the excess money which is available with its associated enterprise, if not repatriated to India within the time as may be prescribed, shall be deemed to be an advance made by the assessee to such associated enterprise and the interest on such advance, shall be computed in such manner as may be prescribed.
(3) For the purposes of this section,—
As per the above provisions,
As per the memorandum to the Finance Bill, provisions of secondary adjustments are internationally recognized methods to align the economic benefit of transactions with arm's length position.
The Secondary Adjustment has been proposed to be made in the books of account of the assessee in 5 specific instances, namely, where primary adjustment to TP :
Further, as per s. 92CE(2), as a result of primary adjustment, if there is an increase in the total income or reduction in the loss of the assessee, excess money which is available with its AE will have to be repatriated to India and to the extent it is not repatriated, it shall be deemed to be an advance made by the assessee to the AE on which interest will have to be calculated.
This means that if adjustments are made by the assessee suo motu in the return or made by the Assessing Officer in the order passed by him or in any other instances as explained above, the books of account of assessee will have to be aligned with such adjustments to reflect increase in profits and corresponding receivables from the AE. The secondary adjustment is not required, if the adjustments are disputed by the assessee.
To avoid difficulties, it has also been provided that the said provisions relating to secondary adjustments would not be applicable, if -
The manner in which the new provision is worded may have far-reaching implications and may also increase litigation.
Some of the issues which may arise out of these provisions are discussed below:
Treatment of Secondary Adjustments as the advance to the AE - Consequences of Interest
3. As per s. 92CE, if the amount, in respect of which secondary adjustments are made, is not received or repatriated to India, it shall be deemed to be an advance given by the assessee to its AE and the consequential interest will have to be computed on the same.
For example, the company PQR Ltd has purchased certain materials from its AE situated abroad at a price of Rs. 10 crores in respect of which the ALP is determined at Rs. 7 crores. This would result in the adjustment of Rs. 3 crores to the income of the assessee, i.e., PQR Ltd. If this adjustment is accepted by the company, the amount of Rs. 3 crores will have to be accounted for in the books of PQR Ltd. and the corresponding advance will have to be shown in the name of its AE.
The immediate consequence which would arise is that the secondary adjustment would result into consequential TP adjustments towards interest income from its AE and the interest income may have to be computed on the basis of the ALP. Moreover, until the amount is repatriated to India, the advances will continue to be reflected in the Balance Sheet of the assessee at the year-end and the same may have to be re-instated at the prevailing foreign exchange rates.
Secondary adjustment also in the books of AE
4. Further, the definition of 'Secondary Adjustment' u/s. 92CE(3)(v) prescribes adjustments in the books of account of the assessee as well as its AE.
Thus, the said provision mandates that the adjustments also have to be made in the books of the AE. The requirement of the section to amend the books of AE seems practically difficult task and may cause unintended hardships to the AE. This is because neither the assessee nor the Tax department may have control over the books of the AE which is located in the foreign tax jurisdiction. Under these circumstances, these provisions may be difficult to be fully implemented.
Constructive distribution of dividend and applicability of s. 2(22)(e)
5. If these transactions are treated as advances given to the AE, the provisions of s. 2(22)(e) of the Act may get attracted. As per s. 2(22)(e) of the Act, any loan or advances made by the company to the shareholder having beneficial interest of more than 10% of the voting power of the assessee-company or to such entity where such shareholder is having substantial interest would be treated as dividend in the hands of the shareholder to the extent of accumulated profits of the company. If such shareholder is the AE of the assessee, the consequences of treatment of advance would follow in the hands of such AE. In such scenario, there would be a fear of these transactions being treated as dividends in the hands of AE.
Effectively, the provision may act like double edged sword. The AEs will be hit hard-once due to making it obligatory for them to repay advance and secondly, due to payment of tax u/s. 2(22)(e) of the Act. If the AE is taxable in the foreign tax jurisdiction and out of reach of the tax department, the assessee may also run risk of it being treated as the representative assessee for the said AE. This can invite problems and difficulties for the assessee as well.
Impact of the adjustments on the computation of book profits for subsequent years
6. Once the provisions of s. 92CE(2) are complied with and the adjustments are introduced in the books of account for the subsequent years, certainly income for the subsequent years when the secondary adjustments are carried out would get enhanced.
This may have an impact on the computation of the book profits for the subsequent years in case of corporate entities and may impact their tax liabilities in case if the tax u/s. 115JB exceeds the tax determined under the normal provisions for that year.
As a result of the same, the assessee may have to face double taxation of the same income, once by virtue of the primary adjustments carried out in the year in which the transactions are carried out and secondly on account of MAT tax in the year when such adjustments are introduced in the books by crediting profit and loss account.
Secondary adjustment - only if primary adjustment causes change in income of assessee
7. There may be instances where the secondary adjustments may not have to be made, even if the adjustment on account of ALP is to be made.
In a case where the transactions pertain to acquisition of fixed assets by a company, undisputedly no deduction of any expenditure is claimed by the assessee. In such scenario even if the adjustments are proposed in terms of TP regulations, only the value of assets would change and there may not be any impact on the income of the company, except to the extent of depreciation claimed on the same.
In case of 'International transaction' perhaps the secondary adjustment would only arise to the extent of value of depreciation. This is because secondary adjustment specifically provides for adjustments in the books to reflect that actual allocation of profits of assessee and its AE are consistent and imbalance between cash account and actual profits is removed. Since in such case the imbalance is only to the extent of depreciation, only such amount may be introduced in the books.
However, in case of 'Specified Domestic Transactions' even the adjustment for depreciation may not have to be made. This is because the specified domestic transactions, as per s. 92BA, only cover incidence of expenditure in respect of which payment has been made or is to be made. If the transaction is not in the nature of expenditure, the TP provisions would not be applicable and no primary adjustment would arise. Admittedly, depreciation is an allowance and not expenditure and, hence, TP provisions may not arise. In such cases even no secondary adjustment is required to be carried out by the assessee.
Accounting treatment in the year adjustments
8. While incorporating the amount of primary adjustments in the books P & L A/c. may have to be credited with the said amount and the corresponding debit would have to be given in the balance sheet as an advance to the AE.
In the P & L A/c., in terms of the accounting standard followed by the company, these adjustments may have to be treated as prior period adjustments and, accordingly, may have to be given a special treatment based on the applicable accounting standards.
Repatriation of the excess amount (secondary adjustments) from AE - Implications of other laws
9. The secondary adjustments have to be brought into the books of the assessee and held as an advance made by the assessee to such AE. Several guidelines have been issued by the Govt. of India and the RBI explaining the procedure of repatriation of funds and several compliances have to be made as per the provisions of the FEMA.
One may, therefore, have to see the implications of the provisions of the FEMA and compliance with the RBI with respect to repatriation of the funds. One may also have to see the provisions relating to the indirect tax laws, more particularly with respect to possibility of allegation of under invoicing of the transaction and possible evasion of duties.
Increase in litigation possible
10. These newly introduced provisions may also increase litigation multifold. This is because these provisions would only apply if the primary adjustment to the TP has been made in five different scenarios. These scenarios would show that a need for secondary adjustments would arise if, in principle, such adjustment is either made by the assessee itself or is accepted by the assessee in accordance with the modes specified u/s. 92CE(1). Thus, consequences of secondary adjustments have to be borne by the assessee if it accepts or admits these adjustments on account of the TP regulations.
Undisputedly, if conceding to the TP adjustments would result into further hardship to the assessee and it's AE, there are greater chances that the assessee may not admit or accept such adjustments and may challenge the same in appeal. Once these adjustments are disputed by an assessee in appeal, the provisions of s. 92CE would not be applicable and the assessee would be out of the purview of these harsh provisions.
Applicability of s. 92CE - Retrospectively?
11. As explained in foregoing paras, the applicability of s. 92CE is subject to certain exceptions. The proviso to s. 92CE(1) says that the secondary adjustments may not be carried out, if:
12. There are serious concerns in the manner the said exception has been worded in the Act, more particularly due to the use of the word 'and' between the two scenarios. Since the two scenarios mentioned in the proviso to s. 92CE(1) are combined by use of 'and", it would mean that in order to fall within the exception, the case of the assessee must comply with both conditions simultaneously, i.e., primary adjustment should be less than Rs. 1 crore and it should pertain to A.Y. 2016-17 or the earlier years.
In other words, and to put it differently, secondary adjustment would still be, required if either:
If such interpretation is intended by the Legislature, it would cause immense hardships to the assessee as they would be subjected to secondary adjustments even in respect of past years and would have retrospective effect.
It is necessary that the assessee should consider various issues that arise due to introduction of the said provisions. The CBDT or the Finance Ministry should also look into clarifying the issues which may unintentionally cause hardship to the assessees.