Transfer Pricing Documentation – Country by Country Report- India landscape

Transfer Pricing Documentation – Country by Country Report- India landscape

1.       BEPS Action Plan 13 advocates Three-tiered approach to transfer pricing documentation as under:-

a)      Master file – Overview Information about MNE group categorized in 5 categories

i)                    MNE group organization Structure

ii)                   Description of MNE’ businesses

iii)                 MNE’s intangibles

iv)                 MNE’s inter-company financial Activities

v)                  MNE’ financial and tax position

b)      Local File – Containing detailed information relating to transaction between local country affiliate and associated enterprise, relevant financial information regarding said transaction, comparability analysis and selection and application of most appropriate transfer pricing method

c)       Country by country Report – Containing the following information

i)                    the aggregate information in respect of the amount of revenue, profit or loss before income-tax, amount of income-tax paid, amount of income-tax accrued, stated capital, accumulated earnings, number of employees and tangible assets not being cash or cash equivalents, with regard to each country or territory in which the group operates

ii)                   the details of each constituent entity of the group including the country or territory in which such constituent entity is incorporated or organised or established and the country or territory where it is resident

iii)                 he nature and details of the main business activity or activities of each constituent entity

2.       BEPS – Annual Submission of Transfer Pricing Documents to relevant Tax Authority

a)      Master and local File – Every constituent entity is required to submit Master and local file with tax authority of the country in which entity is operating, irrespective of Revenue of such entity.

b)      Country by Country Report – Parent entity of the group is required to file country by country report in tax jurisdiction in which such parent entity is resident, provided that annual consolidated group revenue of international group, as reflected in Consolidated Financial statement, in preceding fiscal year is not less than EUR 750 Mn.

3.       India Position

a)       India is signatory Country to the Multilateral Competent Authority agreement on exchange of country by country report.

b)      Accordingly, India is required to share the Country by Country report, furnish by parent entity in India, with other signatory Countries

c)       Accordingly Finance Act, 2016 has institutionalized the legal framework requiring the submission of country by country report by parent entity of MNE group, resident in India, to India’s Tax Authority.

d)      The content of reports and other incidental details are yet to notified through appropriate rules and guidelines

4.       India Legal Frame work

a)      Relevant Definitions – Under Section 286

i)                    Constituent Entity

·         Any separate entity of an international group that is included in the consolidated financial statement of the said group for financial reporting purposes;

·         Any Permanent establishment of separate business entity of International group

ii)                   Parent Entity - Constituent entity, of an international group holding, directly or indirectly, an interest in one or more of the other constituent entities of the international group, such that it is required to prepare Consolidated financial statement under any law for time being in force and no other constituent entity is required to prepare consolidated financial statement

iii)                 Group - includes a parent entity and all the entities in respect of which, for the reason of ownership or control, a consolidated financial statement for financial reporting purposes is required to be prepared

iv)                 International Group means any group  that includes:-

·         Two or more enterprises which are resident of different countries or territories

·         An enterprise, being a resident of one country or territory, which carries on any business through a permanent establishment in other countries or territories

b)      Amendment in Section 92D

i)                    Every Constituent entity, as defined u/s 286, is required to keep and maintain prescribed information & documents in respect of international group, as defined u/s 286. The prescribed information, to be notified through rules, must be relating to Master File and local file.  

ii)                   Every person who has entered into International transaction is required to furnish above-said prescribed information and documents to prescribed Authority. Submission of prescribed information is made mandatory irrespective of any amount of revenue

iii)                As per literal interpretation, it seems that constituent entity, which has not entered into international transaction, is only required to keep and maintain the prescribed information and documents and same is NOT required to be submitted to prescribed authority.

c)       Introduction of section 286 – Furnishing of Report in respect of International Group

Ø  The reporting requirement under this section is applicable only when consolidated group revenue as reflected in consolidated financial statement of International group for the accounting year preceding the reporting accounting year exceeds prescribed amount. This amount, to be specified in rules, must be in the range as specified is BEPS Action Plan-13

Ø  Reporting Requirement

·         When Constituent entity, resident in India,  is not a parent entity

·         When constituent entity, resident in India, is Parent entity

Reporting requirement - When Constituent entity, resident in India, is not a parent entity

i)                    It is require to notify to prescribe Income tax Authority on or before prescribe date, details of parent entity of International group and country or territory of which said parent entity is resident

ii)                   It is required to file country by country report of International group for a reporting accounting year to prescribed tax authority in India, if parent entity is resident of country-

·         With which India does not have an agreement for exchange of Country by Country report

·         There has been systemic failure of the country and said failure has been intimated by prescribed authority to such constituent entity

Systemic failure" with respect to a country or territory means that the country or territory has an agreement with India providing for exchange of report of the nature referred to in sub-section (2), but—

   (i) in violation of the said agreement, it has suspended automatic exchange; or

  (ii) has persistently failed to automatically provide to India the report in its possession in respect of any international group having a constituent entity resident in India.

Reporting requirement - When Constituent entity, resident in India, is not a parent entity.

i)                    Every parent entity , resident in India, shall for every reporting accounting year furnish country by country report in respect of International group  to prescribed Income tax Authority on or before the due date u/s 139(1)

ii)                   Reporting requirement exemplified

S.No.	Parent Entity	Other Constituent Entity	Remarks
1.	Resident In India	Subsidiary resident of foreign Country	Parent entity is required to file country by country report to prescribed tax authority in India
2.	Resident in India	PE in foreign Country	The group is international group, as defined above. So, Parent entity is required to file country by country report to prescribed tax authority in India.
3.	Resident in India	Subsidiary in foreign Country, but treated as resident of India under POEM	Parent entity is NOT required to file country by country report to prescribed tax authority in India, as the requirement of International group is not satisfied.

REIT - Direct Tax Provisions

Real Estate Investment Trust (REIT)

Globally REIT is well developed phenomena, serving dual purpose of providing investor with alternative investment avenue, being real estate properties and providing developer or private equity fund avenues of exit, thus enabling them to utilise their existing funds in other projects.  Primarily these assets should be rent generating properties.

In line with global structure, Government has come with REIT proposal to provide Developers with an option to retrieve funds tied up in existing Completed Projects.

Post Transition to REIT Regime, following structure will evolve –

1.       A trust will be formed with Developer being sponsor of the trust

2.       For an investment made by Developer in SPV, Trust will issue its units to Developers in lieu of Investment in SPV. Thus Developers will hold units in Trust and Trust will hold investments in SPV.

3.       Post that Trust will bring IPO of units, list the units at Stock Exchange and in the process of IPO, developer will offer its units for sale.

SEBI- Real Estate Investment Regulations (REIT)

S.No.	Particular	Regulations
1.	Investment by REIT	1.       Not less than 80% of value of REIT assets shall be invested (either directly or through Holdco or SPV) in competed and Rent generating properties 2.       Not more than 20% of value of REIT assets shall be invested in specified assets. 3.       REIT shall hold at least 2 projects, either directly or through Holdco/SPV, with not more than 60% of the value of assets in one project 4.       The Word “Project” has not been defined in the Regulations 5.       A REIT shall not invest in units of other REIT.
2.	Income Criterion	1.       Not less than 51% of revenue of REIT, Holdco and SPV, other than gains arising from disposal of properties shall be , at all times from rental, leasing and letting real estate assets or any other income incidental to the leasing of such assets.
3.	IPO conditions	1.       Value of all assets owned by REIT shall not be less than 500 Cr 2.       Offer size is not less than 250 Cr 3.       Minimum Public float a)      If Post issue capital value of REIT at offer price is less than Rs. 1600 Cr, minimum 25% of units (based on post issue) shall be allotted to public b)      If post issue capital value of RETIR at offer price is Rs.1600 Cr or more, the value of units offered to public shall be at least equal to 400 Cr c)       If Post issue capital value of REIT at offer price is Rs. 4000 Cr or more Cr, minimum 10% of units (based on post issue) shall be allotted to public
4.	Income distribution	1.       Not less than 90% of net distributable cash flows of SPV be distributed to REIT or Hold Co. 2.       Holdco- 100% of cash received from SPV and 90% of cash generated by Holco on its own be distributed to REIT 3.       Not less than 90% of net distributable cash flow of REIT shall be distributed to the unit holders 4.       Above said distribution shall be made not less than once in every 6 months in financial year

Taxation Aspects- REIT

The taxation aspects are covered for following entities

1.       Sponsors

2.       Special Purpose vehicle (SPV)

3.       REIT

4.       Investor

1.       Sponsors

a)      Capital gains on Exchange of shares of SPV with units of REIT

i)                    Such exchange will not attract Capital gains- exempt u/s 47(xvii)

ii)                   The cost of shares of SPV will be taken as cost of units of REIT (For computing capital gains, in future, if any)- u/s 49(2AC)

iii)                 U/s 2(42A)(hc),the holding period of units of RIET will include holding period of shares of SPV.

iv)                 Tenure of long term asset -Section 2(42A) is amended to provide that for security listed on stock exchange, holding of 12 month is required to classify them as long term capital asset. Security is defined as per section 2(h) of Securities Contract Regulation Act as under:-

i)        shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate

ii)       Derivative

iii)     Units or any other instrument issued by any collective investment scheme to the investor in such scheme

From said definition of Security, it is not aptly clear that whether UNITS of REIT will be covered under existing definition or needs amendment.

If UNITS of REIT are not covered above, the holding period of same will be 36 months or more to be classified as Long term capital asset.

b)      Capital gain on sale of units on the floor of stock exchange (STT is paid)

i)                    If units are long term capital asset, then capital gain arising thereon will be exempt from tax u/s 10(38).

ii)                   If units are short term capital assets, then capital gain will be subject to tax @ 15% u/s 111A

2.       SPV

a)      SPV will be subject to corporate tax under Normal Provisions of Income Tax Act or MAT, as applicable.

b)      There will not be any TDS requirement on Interest paid on money borrowed from REIT.

c)       SPV is exempted from DDT on Dividend paid to RIET, provided REIT hold entire equity share capital of SPV, u/s 115O(7)

d)      In case SPV has bought forward losses, then such bough forward losses will lapse u/s 79, when REIT becomes the shareholder of SPV, instead of Sponsors.

3.       REIT & Investor

Under Income Tax Act, for REIT taxation, a pass through Mechanism is adopted, whereby income is made exempt in the hands of REIT and same is taxable in the hands of Investor. The taxation of different types of income is tabulated as under

S.No.	Income	REIT Taxation	Investor’s taxation
1.	Dividend from SPV	Exempt from tax u/s 10(23FC)	Exempt from Tax u/s 10(23FD)
2.	Interest From SPV	Exempt from tax u/s 10(23FC)	Taxable u/s 115UA
3.	Rental Income from properties directly owned by REIT	Exempt from tax u/s 10(23FCA)	Taxable u/s 115UA
4	Interest, other than from SPV	Taxable @ 30%	Exempt u/s 10(23FD)
5.	Short Term Capital gain (STCG) on sale of property	Taxable @ 30%, other than STCG on listed shares traded on stock exchange, which are taxable @ 15% u/s 111A	Exempt u/s 10(23FD)
6.	Long Term Capital gain (LTCG) on sale of property	Taxable @ 20% u/s 112, other than LTCG on listed shares traded on stock exchange, which are exempt u/s 10(38	Exempt u/s 10(23FD)
7.	Sale of units of REIT on stock exchange	Not Applicable	Long Term capital Gain exempt u/s 10(38) and short term capital gain taxable @ 15% u/s 111A

Important Point – The dividend paid by SPV is exempt in entire chain

a)      Neither subject to DDT at SPV level

b)      Not taxable in the hands of REIT

c)       Not taxable in the hands of Investor.

Finance Bill 2017- Critical Analysis of Direct Tax Provisions

Finance Bill 2017- Critical analysis of Direct Tax Provisions

1.       Capital gains – Joint Development Property

a)      Finance Bill 2017, propose section 45(5A) which provide for the  time of taxability of capital gain arising on  transfer of land or building, contributed by an Individual or HUF, in Joint Development agreement.

b)      The salient features of Section 45(5A) are as under;-

i)                    Section 45(5A) supersede section 45(1), thus providing an exception that capital gains will not be chargeable in the year of Transfer.

ii)                   Capital gains will be taxable in the year in which property or part of the property under joint development gets completion certificate

iii)                 The sales consideration will be stamp duty value (of year in which property gets completion certificate) of share of property attributable to Individual or HUF and cash consideration if any.

iv)                 Thus transfer will take place in earlier year and computation and taxability will be in posterior years.

c)       Critical analysis – In case of Long term capital Gains, of which year Cost inflation index will be applicable i.e year of Transfer or Year of Computation, as Section 48 prescribe that for Calculating Indexed Cost, Cost Inflation index (CFI) of the year of Transfer be taken.  Exemplified as under:-

i)                    Cost of land Contributed in JDA – Rs. 10 lacs  (Acquired in year 2013-14, CFI - 939)

ii)                   Year of Transfer – 2017-18 (Stamp duty value – Rs. 30 lacs, CFI assumed - 1200)

iii)                 Year  of Computation & Taxability (property gets completion certificate) – 2020-21

iv)                 During 2017-18 and 2020-21, there is huge run up in inflation and as a result thereof property price and Cost inflation index also goes up substantially (by 50%)

v)                  Capital gain Computation in two scenarios are as under;-

Particulars	Units	Cases
		CFI - Year of Transfer	CFI - Year of Taxability
CFI	Nos	1200	1800
Consideration	Rs lacs	45	45
Cost	Rs lacs	10	10
Indexed Cost	Rs lacs	12.78	19.17
Capital gain	Rs lacs	32.22	25.83

vi)                 On parity principles, CFI should be taken of the year of which Stamp duty value is taken as sales consideration, otherwise assessee would be required to pay more taxes.

2.       Cost of Acquisition of share of developed Property under JDA

a)      Section 45(5A) provides that in JDA, the sales consideration for land/building transferred in JDA, will be aggregate of following two:-

i)                    Stamp duty value (of the year of Completion) of Individual’s share in Developed Property and

ii)                   Cash Consideration, if any.

b)      Propose section 49(7) provides for cost of acquisition of Individual share in developed property received in JDA. It read as under;-

“Where the capital gain arises from the transfer of a capital asset, being share in the project, in the form of land or building or both, referred to in sub-section (5A) of section 45, not being the capital asset referred to in the proviso to the said sub-section, the cost of acquisition of such asset, shall be the amount which is deemed as full value of consideration in that sub-section”

c)       The Cost of acquisition of share in developed property should be only stamp duty value taken as sales consideration earlier and should not include the cash consideration received.

d)      Illustrated

i)                    Cost of land Contributed in JDA – Rs. 5 lacs

ii)                   Stamp Duty Value of Individual share in Developed Property – Rs. 15 lacs

iii)                 Cash Consideration – Rs. 2 lacs

iv)                 Thus as per section 45(5A), the full consideration is Rs. 17 lacs

v)                  Further as per section 49(7), the cost of acquisition of Share in developed property is Rs. 17 lacs, which is not factually correct.

vi)                 The cost of acquisition of Share in Developed Property should be Rs. 15 lacs , taken as sale consideration earlier, rather than Rs. 17 lacs.

3.       Double Taxation – Interplay of Section Propose section 50CA and 56(2)(x)

a)      Section 50CA provides that on transfer of unquoted share of company, being capital asset, if sales consideration is less than FMV, to be be prescribed, then FMV shall be deemed as sales consideration

b)      Section 56(2)(x)- Among other things, said section provides that if person receives any property (Including unquoted shares in company) at value less than FMV, then excess of FMV over such value will be deemed as income of recipient of shares.

c)       Assuming the FMV as per section 50CA is on same basis, as prescribed for section 56(2)(x), then there will be double taxation of same amount in the hands of two assessee.

d)      Demonstrated

i)                    Mr. A sold unquoted shares to Mr. B at Rs. 1 lakh, at cost to him and the FMV being 1.7 lacs.

ii)                   As per section 50CA, Rs. 70,000 (1.7 lacs – 1.00 lacs) will be capital gains in the hands of Mr. A.

iii)                 As per Section 56(2)(x), same Rs. 70,000 will be taxable in the hands of Mr. B, as he paid less than FMV for acquiring the shares.

4.       Section 56(2)(x) – Impediment in restructuring stated in section 47.

a)      Among other things, section 56(2)(x) provides that, if a company or firm receives any Immovable property or shares & Securities (Listed or unlisted) or other specified properties (Capital asset) at value less than FMV, then excess of FMV over such value be deemed as Income of said company or firm.

b)      Section 56(2)(x) provides its non-applicability in case  of merger and demerger, however following types of restructuring is not covered in exclusion scope of section 56(2)(x)

i)                    Transfer of capital asset by Holding to Wholly owned Subsidiary or vice versa, referred to in section 47(iv) & 47(v)

ii)                   Any transfer of Capital asset by a firm to company, referred to in section 47(xiii).

iii)                 Any transfer of capital asset by Company to LLP, referred to in section 47(xiiia)

iv)                 Any transfer of Capital asset by  sole proprietorship concern to company, referred to in section 47(xiv)

v)                  Contribution of listed shares as capital by partner in Firm at less than FMV.

c)       Typified

i)                    Holding Company is having land of Rs. 5 lacs, FMV being Rs, 50 lacs

ii)                   It transferred the same to wholly owned Subsidiary at cost, with an objective to develop real estate project in separate entity.

iii)                 The holding company is not subject to capital gain, as the said transaction does not amounts to transfer u/s 47(iv) but now u/s 56(2)(x), subsidiary will be made taxable on Income of Rs. 45 lacs, the excess of FMV over consideration paid for acquiring the land.

5.       Thin Capitalization Provision

a)      Though propose section 94B, thin capitalization rules are intended to be introduced in India.

b)      Section 94B provides as under;-

i)                    An Indian company or Permanent establishment (PE) borrow money from its foreign company, being an associated enterprise

ii)                   The amount of Interest, on said borrowing, which is eligible for deduction under computing PGBP, exceeds Rs. 1 Cr.

iii)                 In above situation, the interest eligible for deduction under PGBP will be restricted to 30% of EBITDA or actual amount of Interest, whichever is less.

iv)                 The Interest not allowed as afore-said will be carried forward to next year and such carried forward is allowed upto 8^th assessment years.

c)       The thin capitalization provisions in its current propose setting may not be able to pass the test of Non-discrimination Rule under Article 24 of OECD Model Convention of DTAA.

d)      Article 24(4) of  OECD model reiterates as under:-

“Except where the provisions of paragraph 1 of Article 9, paragraph 6 of Article 11 or paragraph 4 of Article 12 apply, interest, royalties and other disbursement paid by an enterprise of a contracting state to a resident of the other contracting state shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to resident of first-mentioned state”

e)      Let analyses the provision of article 24(4)

i)                    It prohibits the discrimination against deduction of expenditure, paid to foreign enterprise , in the hands of resident enterprise, where such deduction would have been allowable, had payment being made to other resident enterprise in similar conditions

ii)                   The said discrimination is prohibited only when same is also forbidden by Article 9.

iii)                 The OECD Commentary on Article 9 permits the application of Thin Capitalization rules in domestic legislation, provided the same does not have the effect of increasing the taxable profits of relevant domestic enterprise to more than Arm’s Length Profit.

f)       Analysis of Section 94B vis-à-vis Article 24 and Article 9

i)                    Restriction of Interest expenditure upto 30% of EBITDA, paid to Foreign associated enterprise is discrimination, whereas similar expenditure to any extent is allowed when same is paid to other domestic enterprise. – Article 24(4) will prevent such discrimination

ii)                   The criterion of restricting Interest paid to foreign associated enterprise upto 30% of EBIDTA may have effect of taxing the profit of Domestic Enterprise at more than Arm’s length level profit, as comparable enterprise may have allowable interest expenditure in excess of said 30% range.- Article 9 will prevent such taxation of profit at more than Arm’s length level

iii)                 Thus Thin Capitalization Provisions u/s 94B may not have desired impact in view of non-discrimination provision of Article 24(4).