Transfer Pricing is a popular term in every company for the purpose of complying with the Income Tax Act of India. In this article the two types of Transfer Pricing adjustments, primary adjustment and Secondary adjustment, will be discussed briefly.
1. What is Transfer Pricing?
The term ¨Transfer Pricing¨ refers to the price which is paid for goods or services that are transferred from one unit of an organization to its other units, which are situated in different countries (with certain exceptions) . It is basically the value which is attached to the goods or services transferred between related parties.
2. What are the different types of Transfer Pricing Adjustments?
When it comes to transfer pricing, there are namely two types of adjustments used:
2.1 Primary Adjustment
2.2 Secondary Adjustment
3. Primary adjustment under Transfer pricing
In layman’s language, primary adjustment is defined to mean the determination of the transfer price in accordance with the arm’s length principle resulting in an increase in the total income or reduction in the loss, as the case may be, of the taxpayer.
Transfer pricing provisions seek to ensure that there is fair and equitable allocation of taxable profits amongst the tax jurisdictions, so in cases where the underlying transaction is held not to be at arm’s length, primary adjustments are made in order to align the said transfer price with the arm’s length price (ALP) attained. Here, this is known as Primary Adjustment.
To understand the practical implementation of these adjustments, primary adjustment to the transfer price occurs in one of the following circumstances:
- Voluntarily made by the taxpayer in the tax return.
- Made by the tax officer and accepted by the taxpayer.
- Determined by an Advance Pricing Agreement (APA) entered into by the taxpayer under Section 92CC.
- Made as per the safe harbour rules under Section 92CB.
- Resulted from a Mutual Agreement Procedure (MAP) resolution under Section 90 or Section 90A.
4. Secondary Adjustment under Transfer Pricing
India introduced secondary adjustments in transfer pricing cases in the Finance Act 2017. Secondary adjustments are designed to ensure that the cash profits of the taxpayer are in line with the tax profits following a primary adjustment, which is an adjustment that is made to the transfer price where the price in an intercompany transaction differs from what would be expected in a transaction between unrelated third parties.
In accordance with the secondary adjustment provisions, an Indian taxpayer is required to repatriate cash equivalent to the amount of primary adjustment. If the repatriation is not made within the prescribed time, the excess amount arising as a result of the primary adjustment is deemed to be an advance made by the taxpayer to the associated party on which notional interest is charged and offered to tax in India by the Indian taxpayer.
Basically, the provisions relating to secondary adjustments are primarily introduced in order to ensure that the profit allocations between the AEs are consistent with the primary Transfer Pricing adjustments.
A “secondary adjustment” has been defined to mean an adjustment in the books of accounts of the taxpayer and its AE to reflect that the actual allocation of profits between the taxpayer and its AE are consistent with the transfer price determined as a result of primary adjustment.
Therefore, the provisions on secondary adjustment seek to target such cash or fund benefit by seeking repatriation of such excess funds lying with the Associated Enterprise. Here, any funds not repatriated by the Associated Enterprise will be termed as an “advance” given by the Assessee to the Associated Enterprise and notional interest rate, as prescribed, will be added to the Total income of the Assessee by way of a secondary adjustment (Section-92CE).
These secondary adjustments can be further understood by taking the following provisions into consideration:
4.1 Section 92CE of Income Tax Act
This sections provides that the assessee shall apply secondary adjustment where a primary adjustment to transfer price:
(i) has been made suo motu by the assessee in his return of income;
(ii) made by the Assessing Officer has been accepted by the assessee;
(iii) is determined by an advance pricing agreement entered into by the assessee under section 92CC;
(iv) is made as per the safe harbour rules framed under section 92CB; or
(v) is arising as a result of resolution of an assessment by way of the mutual agreement procedure under an agreement entered into under section 90 or section 90A for avoidance of double taxation.
Provided that nothing contained in this section shall apply, if,—
(i) the amount of primary adjustment made in any previous year does not exceed one crore rupees; and
(ii) the primary adjustment is made in respect of an assessment year commencing on or before the 1st day of April, 2016.
4.2 Rule 10CB Income Tax Rule, 1962
Rule 10CB lays down the provisions for computation of interest income pursuant to secondary adjustments. It is discussed briefly, along with the recent amendments, further in this article.
4.3 Section 94B of Income Tax Act
Limitations on interest deduction in certain cases are mentioned under this provision.
Section 94B(1) states that wherever any expenditure is incurred, by way of interest or of similar nature exceeding one crore rupees which is deductible in computing income chargeable under the head “Profits and gains of business or profession” in respect of any debt issued by a non-resident, to an Indian company, or a permanent establishment of a foreign company in India, being the borrower, being an associated enterprise of such borrower, the interest shall not be deductible in computation of income under the said head to the extent that it arises from excess interest, as specified in sub-section (2):
[NOTE: Provided that where the debt is issued by a lender which is not associated but an associated enterprise either provides an implicit or explicit guarantee to such lender or deposits a corresponding and matching amount of funds with the lender, such debt shall be deemed to have been issued by an associated enterprise.]
Section 94B(2) For the purpose of sub section (1), the excess interest shall mean an amount of total interest paid or payable in excess of thirty percent of earnings before interest, taxes, depreciation and amortisation of the borrower in the previous year or interest paid or payable to associated enterprises for that previous year, whichever is less.
(Rs. in crores)
|Interest paid to Third parties||250|
|Interest paid to AEs(A)||150|
|30% of EBITDA||300|
|Disallowance to be lower of: |
Total Interest (250+150=400)-30% of EBITDA (300)orInterest paid or payable to AEs
Further, Clause (4) of this section provides that: Where for any assessment year, the interest expenditure is not wholly deducted against income under the head “Profits and gains of business or profession”, so much of the interest expenditure as has not been so deducted, shall be carried forward to the following assessment year or assessment years, and it shall be allowed as a deduction against the profits and gains, if any, of any business or profession carried on by it and assessable for that assessment year to the extent of maximum allowable interest expenditure in accordance with subsection (2):
[NOTE:Provided that no interest expenditure shall be carried forward under this subsection for more than eight assessment years immediately succeeding the assessment year for which the excess interest expenditure was first computed.]
5 Amendments to the Secondary Adjustment Provisions
On 30th of September, 2019 the Central Board of Direct Taxes (CBDT) in India passed a notification (REGD. NO. D. L.-33004/99) in order to amend the provisions relating to cash repatriation and calculation of notional interest under the secondary adjustment provisions that are contained in Rule 10CB of the Indian Income-tax Rules, 1962, and these changes were deemed effective from the date of release as well. This notification amends Rule 10CB in the following ways:
5.1 Cash repatriation on conclusion of APA
Prior to the notification, the provisions for cash repatriation following the conclusion of an APA were not clear and had some loopholes that were left for interpretation. Under the previous provisions, the 90-day period was calculated from the due date of filing the modified return, which allowed the taxpayer at least 180 days to repatriate the cash. With the new amendments the scenario is much more clearer:
- The period for cash repatriation, where an APA is concluded, is actually based on the due date for filing the income tax return for the year to which the transfer pricing adjustment relates.
- In addition, for years for which the APA is concluded after the filing date, the cash must be repatriated within 90 days from the end of the month in which the APA is signed.
- In case the transfer pricing adjustment relates to a year for which the filing period for the relevant return has not expired at the time the APA is signed, the cash must be repatriated within 90 days after the due date for filing the tax return for that year.
5.2 Cash repatriation following resolution under a MAP
Previously, the 90-day period for cash repatriation was calculated from the due date for filing the return, which could be ambiguous and subjected to multiple interpretations. Now, in cases where a transfer pricing adjustment is determined based on a resolution under a MAP, it is essential that the cash repatriation must be made within 90 days from the date the assessing officer issues the demand notice giving effect to the MAP resolution.
5.3 Clarification on the start date for calculating the crucial 90-days period
For years, the date from which notional interest arising from a secondary adjustment should be calculated has been interpreted by taxpayers in various ways. With this notification, it has been clarified by the CBDT that notional interest is to be calculated from the due date of cash repatriation where the taxpayer does not repatriate the full amount of cash within the required 90-day period, and not from the 91st day after that date.
5.4 Applicable Foreign Currency Exchange Rate
It has been clarified by CBDT that in order to determine the value of cross-border transactions denominated in foreign currency when calculating notional interest, the applicable exchange rate is the telegraphic transfer buying rate of the foreign currency on 31 March of the financial year in which the cross-border transactions were undertaken.