Indian finance act of 2012 with effect from financial year 2013-14, introduced a new tax law compliance requirement in relation to transaction between group companies. According to which two domestic companies under the same management or under common control ( Associated enterprises) do transaction aggregating five crore rupees in a year, is required to comply with the following;-
(a)Ensure the value of transaction is at arms – length price as per the method prescribe by income tax act 1961, b) maintain and keep information and documents in relating to such transaction as statutorily required, c) obtain and file an accountant’s report in respect of such transaction along with return of Income.
This amendment to the income tax act was caused to be made in accordance of Supreme court judgement , in CIT Vs Glaxo Smith Kline Asia Pvt Ltd.(2010)195 Taxman 35 SC. In this judgement, Supreme court addressed the issue whether transfer pricing regulation should be limited to cross border transaction, or that to be extended to domestic transaction as well. Supreme Court noticed that even in certain domestic transaction, the under invoicing of sale and over invoicing of expenses in certain circumstance create tax arbitrage. For example-by under invoicing of sale and over invoicing of expenses they could save tax a) if one of the related company is loss making, and other is profit making concern, b) if the tax rates are different from two related units, on account of different status and if profit is diverted to towards the unit of lower side of arbitrage, for example;- sale of goods and services from a non special economic zone(SEZ) areas,(Taxable unit ) to SEZ unit(non taxable unit),at a price below the market price so that taxable division will have less profit taxable, and non taxable division will have a higher profit exemption. Citing these two instances, Supreme Court has suggested making amendments to income tax act incorporating domestic transfer pricing provisions.
The amendment made to income tax act by finance act 2012 is based on the recommendation of Supreme Court. The finance act 2012 introduced section 92BA , 40 A, 80 A, , 10 AA , 80 IA etc to the income tax Act
Based on this amendment transaction between two related domestic parties ( it could e companies, individuals, firm ) if they transact each other should ensure that, the transaction is at arms length price. The method of arms length price determination are same as that applicable to international transaction between associated enterprises.
Internationally countries like UK, Malaysia, Ireland, Peru, Hong Kong, Norway and Russia had similar provisions in their tax laws. The new amendment to the Income tax act is definitely create additional tax revenue. However, the implementation of the same will definitely open up another window for litigation and friction between tax officers and assesses; unless we have more standardization and better approved processes in determination of arms length price. Arms length price determination should not be left at whims and fancies of the tax officers.
By: Rajesh Vellakkat