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    Transfer Pricing - Secondary Adjustment - More Ambiguity Than Clarity

    Transfer pricing provisions in India and globally seek to ensure that there is no shift of profits or funds as against the functions being performed, risks absorbed and capital deployed in a specific jurisdiction i.e.,correct allocation of taxable profits amongst tax jurisdictions. In cases where the underlying transaction was not undertaken at arm’s length, a primary adjustment is made to the taxable profits of the taxpayer to align the transfer price with the arm’s length price (“ALP”). This primary adjustment may be made by the tax payer (voluntarily) or by the tax authorities.


    Thus as per the Indian tax laws, currently, there is no concept or issue of remittance of the difference between the transaction price and the arm’s length price. There would only be a single TP adjustment that increases the taxable income of the taxpayer and Income tax would likely be required to be paid on such notional TP adjustment. In effect, the Associated Enterprise (AE) would effectively retain the excess/differential funds due to any Transfer Pricing (TP) disconnect.


    International Scenario:


    The secondary adjustment rules are an internationally recognised including the United States, Canada, France and other EU Member States, albeit in different forms/approaches. Recently, in 2016, the UK Government also sought consultation from stakeholders on whether a secondary adjustment rule should be introduced into the UK's transfer pricing legislation and if so, in what form.


    Secondary adjustments may take the form of constructive dividends, constructive equity contributions or constructive/ deemed loans. While a rule based on constructive dividends would treat the excess profits transferred to the overseas company as a deemed dividend (which may be subject to withholding tax), an equity contribution rule would treat the excess profits as deemed equity contribution.


    The OECD Transfer Pricing Guidelines for Multinational Corporations and Tax Administrations (“OECD Guidelines”) define the term secondary adjustments as “an adjustment that arises from imposing tax on a secondary transaction”. A secondary transaction is further defined as “a constructive transaction that some countries will assert under their domestic legislation after having proposed a primary adjustment in order to make the actual allocation of profits consistent with the primary adjustment”


    Indian Scenario: Union Budget 2017:


    The Indian government has introduced the concept of secondary adjustments (Sec 92 CD &CE) under the


    TP provisions. The Budget specifies that where a primary adjustment to transfer price:


    1. has been made by the Assessing Officer and accepted by the tax payer; or
      1. has been made by the tax payer suo-moto in the return; or
    • Is determined under APA/ MAP/ safe harbour

    then secondary adjustment is required to be done.


    The Union Budget specifies that the amount of difference between arm’s length price as determined and actual transaction price (referred as “excess money” = ALP in primary adjustment – actual transfer price of international transaction) is not received by the taxpayer from the AE within the prescribed time, then such excess money shall be deemed to be an advance made by the taxpayer to the AE and interest shall be computed on such advance. The time limit for repatriation to India and manner of computation of such interest including rate & method will be prescribed.


    However, the following proviso has also been supplemented to the above proposed new section:


    “Provided that nothing contained in this section shall apply, if,–


    • the amount of primary adjustment made in any previous year does not exceed one crore rupees; and


    • the primary adjustment is made in respect of an assessment year commencing on or before the 1st day of April, 2016.”


    Thus, the above proviso specifies that the new proposal would not be applicable if the amount of primary adjustment is less than Rs 1 Crore in any financial year on or before FY 2015-16.


    Questions that need answers in the form of clarification–

    There is certain ambiguity in the above mentioned provisions as follows:


    1. Applicability of threshold of Rs 1 crores for future years?
    2. Applicability of these provisions for past years (where adjustment is more than 1 crores)?
    3. Applicability of these provisions for AY 2017-18?


    1. Applicability of the above said provisions in scenarios where non filing of appeal by taxpayer pursuant to unfavourable HC/ITAT order?


    1. MAT implications and is the interest calculations on cumulative basis?


    1. How will the section impact counterparty if transfer price is not acceptable in overseas jurisdiction?


    1. Does it make any difference that there is no corresponding amendment in Section 4,5 and 9 of ITA?


    1. Does it make any difference if F Co ceases to be AE at a later date, while being AE on the date of transaction?


    1. Whether interest needs to be computed from the date of primary adjustment or when the assessment is completed?


    1. Cases where the AE also has a presence in India (say, in the form of Permanent Establishment)?


    1. Window period of getting funds into the country and the manner of computation of interest?


    As mentioned above, there is a need to have clarity on the ambiguity and already representations on this matter are being made before the CBDT/ Finance Ministry to get appropriate clarifications.

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