Tax Insights
from India Tax & Regulatory Services
www.pwc.in
CBDT issues revised and updated guidance for implementation of TP provisions
October 19, 2015
In brief
The Central Board of Direct Taxes (CBDT) has issued Instruction No. 15 of 2015 on 16 October 2015.
This instruction (new instruction) replaces Instruction No. 3 of 2003 which had been issued by CBDT on 20 May 2003 (old instruction). The old instruction had been issued to provide guidance to Transfer Pricing Officers (TPO) and Assessing Officers (AO) to operationalise the transfer pricing provisions and to ensure procedural uniformity. However, due to a number of legislative, procedural and structural changes carried out over the last few years, the old instruction is being now replaced with the new one to provide updated and adequate guidance in relation to international transactions. The new instruction mentions that similar guidance is also under consideration by CBDT for specified domestic transactions.
In detail
The guidelines contained in the new instruction are either:
1. similar to the ones in the old instruction; or 2. have simply been updated
based on the current relevant provisions of the Income-tax Act, 1961 (the Act) and the Income-tax Rules, 1962 (the Rules); or 3. are entirely new, i.e., did
not exist in the old instruction or are a
modified version of the old instruction, and are also not explicitly provided either in the Act or in the Rules as they stand as of current date.
In this news alert, we have focused on the third category of changes made in the new instruction [i.e., as stated in
point 3. above]. These changes have been summarized below:
There is now no
requirement of selecting or referring a case for transfer pricing scrutiny on the basis of the value of international
transaction(s), because transfer pricing cases are now being selected for scrutiny on the basis of risk parameters. The only exception to this would be in a case where the AO comes to know that the taxpayer has entered into an international
transaction(s), but has either not filed an
Accountant's Report (AR) under section 92E of the Act, or not declared the transaction(s) in its AR. In such a case, irrespective of the value of international transactions, the AO may
refer the matter to the TPO after giving an opportunity of being heard to the taxpayer. It may be noted that the new instruction specifically mentions that this guidance would also apply in case of specified domestic transactions.
Where an AR has been filed by a taxpayer, the AO can (as he could earlier), on the basis of details provided in the AR, arrive at a prima facie belief that a reference to the TPO is necessary. However, in a few situations, before making a reference to the TPO1 or determining arm’s length price (ALP) on his own2, the AO must, as a jurisdictional requirement,
1 Under section 92CA(1) of the Act
2 Under section 92C(3) of the Act
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record his satisfaction (after giving an opportunity of being heard to the taxpayer) that there is an income or a potential of an income arising and / or being affected on the determination of ALP. These situations are as follows:
a) where the taxpayer has not filed an AR, or has not declared one or more international transactions in the AR, but the
international
transaction(s) come to the notice of the AO, or b) where the taxpayer has
declared the international transaction(s) in the AR filed by it, but has made certain qualifying remarks to the effect that the said transaction(s) are not international transactions, or they do not impact the income of the taxpayer.
If no objection is raised by the taxpayer to applicability of Chapter X (sections 92 to 92F) of the Act, then the AO’s view would be sufficient before making a reference to the TPO. However, where any objection is raised by the taxpayer on the applicability of Chapter X of the Act, then such objections should be considered and specifically dealt with.
If a TPO is the rank of an Additional / Joint
Commissioner of Income-Tax (CIT), then he shall obtain approval of the jurisdictional CIT (TP) before passing the TP assessment order. On the other hand, if a TPO is the rank of a Deputy/ Assistant CIT, then he shall obtain the approval of the jurisdictional Additional/ Joint CIT before passing the TP assessment order.
The jurisdictional CIT (TP) would assign a limited number of important and complex cases, not exceeding 50, to the Additional/ Joint CIT (TPOs) working in the same jurisdiction.
Appropriate guidelines shall be framed for selection of such important and complex cases.
The takeaways
Risk based selection of cases for TP audits (from ‘quantity’
to ‘quality’)
Selection of cases for transfer pricing scrutiny on the basis risk parameters is not an on-ground reality as yet. However, the fact that this has been explicitly stated in the new instruction indicates that the next round of selection of cases is likely to be risk based.
So far, selection of cases based on a monetary threshold has led to a significant number of cases being selected for TP audits. As a result, the focus had shifted from a quality investigation to quantity investigations, the repercussions of which were evident in
cumbersome audits, both for taxpayers and revenue authorities.
Therefore, introduction of risk based scrutiny is a very rational step taken by the Indian
Government which will certainly streamline the TP audit process.
With such an enormous dispute resolution burden, coupled with growing pendency of cases and already strained Revenue resources, risk based selection of cases for TP audits was
undoubtedly called for. Revenue authorities will now hopefully spend less time and costs on too many audits, and end up doing justice to audits which are in fact
‘worth it’. Further, valuable time of the judiciary will be effectively spent on ‘meaningful’ cases, and the Government will in fact be able to collect ‘real’ revenues.
Taxpayers can also now focus their energies on high risk areas, and deploy their own risk
assessment techniques in order to strengthen their documentation and defence files such that they are able to effectively manage compliance.
However, the choice and transparency around risk
parameters would determine how this policy change would be implemented on-ground.
The introduction of risk based selection of cases for TP audits also indicates India’s intention to adopt Action 13 of the OECD’s Base Erosion and Profit Shifting project, i.e., on TP
Documentation and Country-by- Country Reporting (CbCR). This is because one of the articulated purposes of CbCR has been to assist in risk assessment.
Whatever be the driving factor, selection of cases based on risk assessment is a significant positive and in line with best practices followed globally.
Moreover, it would surely boost investor confidence, and
demonstrate India’s commitment to attracting foreign investment.
Situations in which AO must record his satisfaction before reference to TPO
The CBDT acknowledges that there could be situations where taxpayers either do not file an AR, or do not declare a transaction(s) in their AR, or declare the transaction with qualifying statements to the effect that the transaction is itself not an international transaction, or that no income arises therefrom. To address these situations, the CBDT has put the onus on the AO to put on record why he believes that the international
transaction(s) impacts, or has the potential to impact, income. This would provide the taxpayer with an additional opportunity to present its position, and may prevent occurrence of
unwarranted litigation, provided
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AOs are given sufficient guidance to implement this, as such issues have, in the past, been highly debated at higher judicial fora.
From a reading of the instruction, it is apparent that the CBDT appreciates that applicability of Chapter X (sections 92 to 92F) of the Act would come into play only where an international
transaction impacts, or has the potential to impact, income. This is undoubtedly a very rational and legally appropriate approach adopted by the CBDT, which will serve as a reminder for the tax authorities that TP is not beyond fundamentals of taxation. On an overall basis, this approach also ties in with the underlying intent of the Indian TP regulations, i.e., that of avoiding ‘erosion of tax base’ in India.
Notably, this is also in line with the High Court decision in the case of Vodafone (pronounced in October 20143), wherein the High Court had held that if an
international transaction did not give rise to income under the Act, no occasion to apply Chapter X of the Act could arise in such a case.
That the AO is required to record his satisfaction where a taxpayer has declared an international transaction in the AR with qualifying remarks, indicates that in scenarios where the taxpayer contends non-applicability of Chapter X, it may be advisable to provide a note in the AR stating the taxpayer’s position on such transactions. However, to make
3 Vodafone India Services Pvt Ltd v. UOI - WP No.871 of 2014, TS-308-HC- 2014(BOM)-TP, [2014] 50 taxmann.com 300 (Bombay), [2014] 368 ITR 1
(Bombay), [2014] 271 CTR 488 (Bombay), [2015] 228 Taxman 25 (Bombay), 2014- TII-19-HC-MUM-TP.
this workable, the online AR format would need to be modified so as to provide for notes.
The fact that the onus has been put on the AO to record why he believes that an international transaction impacts or has the potential to impact income, provides testimony to the fact that the Indian Government is putting in checks and balances to avoid arbitrary use of authority by first level assessing officers. This may also prevent taxpayers from being saddled with unnecessary adjustments and protracted litigation thereafter, at least on issues relating to applicability or otherwise of Chapter X per se.
This is yet another welcome move by the Government to invigorate the investment climate in India.
Limiting the number of cases per TPO
Limiting the number of important and complex cases handled by each TPO is undoubtedly a laudable step taken by the Indian Government, as the large number of cases being handled by TPOs with less time on hand has probably deterred them from delving into the merits of each case. This could have led to
“batch processing” of cases without proper application of mind, leading to unsustainable TP adjustments at higher judicial fora.
However, that said, 50 cases (for senior rank TPOs) may still be a large number, particularly given the fact that these 50 cases would be important/ complex in nature.
Further, even for junior rank TPOs, it would be important to prescribe a reasonable upper limit per TPO, in line with
international norms (as TPO’s counterparts in certain developed jurisdictions are known to handle far less cases on an annual basis).
Concluding thoughts
On the whole, the issuance of the new instruction reflects the Indian Government’s line of thinking and philosophy on different aspects as discussed above, and clearly reflects the political will to control the volume of disputes, better utilise the Revenue’s resources, and enhance international perception and investor confidence.
However, having said that, on- ground implementation and execution remain to be seen.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact:
Tax & Regulatory Services – Transfer Pricing
Gautam Mehra, Mumbai +91-22 6689 1154
Indraneel R Chaudhury, Bangalore +91-80 4079 6064
Tax Insights
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