SECONDARY ADJUSTMENTS IN TRANSFER PRICING
Introduction:
The Finance Act, 2017 has introduced the concept of secondary adjustment on Transfer Pricing (TP) Adjustments by a new section 92CE- “Secondary adjustments in certain cases”. Further, Finance Act, 2019 has brought certain amendments in the provisions of secondary adjustments. Before understanding the provisions of secondary adjustments, it is important to understand certain terms which will guide us in grasping the entire concept.
What is Primary and Secondary adjustments?
Sub-Section (3) of Section 92CE gives definition of various terms used in relation to this topic. Sub-section (3) also defines the term ‘Primary Adjustment’ and ‘Secondary Adjustment’ as below:
Primary Adjustments
Primary Adjustment to a transfer price means the determination of 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 assessee. Section 92 provides that any income arising from an international transaction shall be computed having regard to the arm’s length price. The manner of determination of arm’s length price is given in section 92C. Primary adjustment denotes any adjustment in the price charged for such international transaction in accordance with the arms’ length price (ALP).
For example: X Limited exported goods to Y Limited (Associated Enterprises) at Rs. 50 crores for which the A.O. determines the ALP at Rs. 60 crores. Hence, an adjustment of Rs. 10 crores shall be made in the total income of X Limited by the A.O. X Limited shall pay tax accordingly on such additional income and also penalty as prescribed under section 270A, 271AA & 271G.
Secondary Adjustments:
Secondary Adjustments means an adjustment in the books of accounts of the assessee and its associated enterprise to reflect that the actual allocation of profits between the assessee and its associated enterprise are consistent with the transfer price determined as a result of primary adjustment, thereby removing the imbalance between cash account and actual profit of the assessee.
In the above example, it is given that X Limited exported goods to Y Limited at Rs. 50 crores thereby resulting an inflow of Rs. 50 crores from the associated enterprise Y Limited. However, the ALP of the same is Rs. 60 crores. It means that if the transaction would have been executed in uncontrolled conditions, X Limited would have received Rs. 60 crores. Therefore, the excess money (differential amount) of Rs. 10 crore shall be repatriated by Y Limited (AE) back to India within a specified time period so that actual assets of X Limited could match with actual revenue from the aforesaid transaction. If the amount is not repatriated within the prescribed time limit, the excess money shall be treated as advance to associated enterprise and notional interest on the excess money shall be booked as income of the X Limited.
What is ‘Excess Money’?
Excess Money means the difference between the ALP determined in the primary adjustment and the price at which the international transaction has actually been undertaken.
Cases where secondary adjustment is required to be made:
According to Section 92CE(1), the assessee shall make a secondary adjustment, where the primary adjustment to transfer price has been made:
- Either suo motu by the assessee in the return of income or
- By the Assessing Officer during the assessment proceedings and accepted by the assessee or
- In accordance with Advance Pricing Agreement (APA) entered into by the assessee under section 92CC on or after 01-04-2017 or
- In accordance with the Safe Harbour Rules under section 92CB or
- Arising as a result of resolution of an assessment by way of the Mutual Agreement Procedure (MAP) under an agreement entered into under section 90 or section 90A for avoidance of double taxation.
In respect of 3rd case, it is provided that secondary adjustment shall be made if primary adjustment has been made on the basis of APA entered into on or after 01-04-2017. Suppose, an assessee entered into an APA on 10-04-2016 in respect of a period of 5 years starting from 01-04-2016 to 31-03-2021. Actual price charged by the assessee in the international transaction is Rs. 20 crores whereas ALP in accordance of APA is Rs. 25 crores for A.Y. 2020-21. Thus, there will be an adjustment of Rs. 5 crores to the income of the assessee. However, secondary adjustment to his income shall not be made as the APA has been entered before 01-04-2017.
Cases where secondary adjustment is not mandatory:
Proviso to sub-section (1) of section 92CE states that secondary adjustment is not required to be made in the following two cases:
- Where the amount of primary adjustment made in any previous year is not more than Rs. 1 crore or
- Where the primary adjustment is made in respect of assessment year 2016-17 or any earlier assessment year
Effect of Secondary Adjustments:
Sub-section (2) of section 92CE provides that the excess money receivable from the AE as a result of primary adjustment should be repatriated by the AE to the assessee in India within the prescribed time period. If the excess money is not so repatriated, the amount shall be deemed to be an advance money by the assessee to such AE and the interest on such advance, shall be computed in such manner as may be prescribed.
Thus, the excess money shall be treated as “Loans & Advances” in the books of the assessee and he will be required to book notional interest income on such advances till the excess money is repatriated into India. The time period for repatriation and the rate of interest has been prescribed in the Rule 10CB of Income Tax Rules. Rule- 10CB prescribes that the time limit for repatriation of excess money shall be on or before 90 days from the relevant date.
Time limit for repatriation and rate of interest: Rule 10CB
Time limit of 90 days has been prescribed for repatriation of excess money or part thereof under Rule 10CB read with section 92CE (2)
|
Primary Adjustments |
Time Limit for Repatriation |
Interest chargeable on excess money not repatriated |
|
Suo Motu by the assessee in his return of income |
On or before 90 days from the due date of filing return u/s 139(1) |
From the due date of filing return u/s 139(1) till the amount is repatriated |
|
In case the assessee exercises option as per Safe Harbour Rules |
On or before 90 days from the due date of filing return u/s 139(1) |
From the due date of filing return u/s 139(1) till the amount is repatriated |
|
On the basis of APA entered by the assessee:
|
On or before 90 days from the due date of filing return u/s 139(1) |
From the due date of filing return u/s 139(1) till the amount is repatriated |
|
On the basis of APA entered by the assessee:
|
On or before 90 days from the end of the month in which the APA has been entered into. |
From the end of the month in which the APA has been entered into by the assessee |
|
On the basis of order of Assessing Officer or the appellate authority where the order has been accepted by the assessee |
On or before 90 days from the date of order of assessing officer or the appellate authority |
From the date of order of assessing officer or appellate authority |
|
On the basis of resolution arrived by way of Mutual Agreement Procedure (MAP) under DTAA u/s 90 or 90A of the Act |
On or before 90 days from the date of giving effect by the assessing officer to the resolution so arrived by way of MAP |
From the date of giving effect by the Assessing Officer under rule 44H to the resolution |
Note: The interest calculation will not be made after the expiry of 90 days from the relevant date. The benefit of 90 days is not available for calculation of interest amount. If the excess money is not repatriated within 90 days, the interest shall be computed straightaway from the relevant date and not after giving effect of 90 days.
Applicable rate of interest:
|
Denomination of International Transaction |
Applicable rate of interest |
|
Where the international transaction is denominated in the Indian Rupee |
One-year marginal cost of fund lending rate of SBI as on 1st April of the relevant previous year plus 3.25% |
|
Where the international transaction is denominated in the foreign currency |
Six-month London Interbank Offered Rate (LIBOR) as on 30th September of the relevant previous year plus 3% |
Amendments by Finance Act, 2019:
The practical application of the provisions of section 92CE was posing serious concerns as it is quite difficult for the assessee to repatriate the excess money within prescribed time period from foreign AEs in many cases due to prevailing laws in the country of such foreign AE. Further, accounting issues also arise as how to account for the deemed loans in the books of foreign counterpart and the manner of reporting in consolidated financial statements.
To remove such difficulties, amendments have been made in the Income Tax Act by Finance Act, 2019 wherein the Indian entity has been given an option to repatriate excess money from any other non-resident AE of the Indian entity or to pay additional tax on such excess money at the rates as prescribed. If the assessee chooses to opt for any of these options, the excess money shall not be deemed to be advances to foreign entity and no notional interest shall be payable thereon. The following two options have been given by the Finance Act, 2019:
- Explanation to section 92CE (2): The assessee has been given an option that the excess money or part thereof may be repatriated from any of the associated enterprises of the assessee which is not a resident of India. Thus, if there is any difficulty in repatriation of excess money from the foreign AE concerned, the taxpayer may get excess money repatriated from any other non-resident AE of the taxpayer.
- Sub-section (2A) of section 92CE: The assessee has been given another option in case the excess money is not repatriated within the prescribed time period of 90 days. He may at his option, pay additional income-tax @ 18% + applicable surcharge & cess on such excess money or part thereof.
Following points are to be noted in respect of option allowed under sub-section (2A) of section 92E:
(a) Tax paid @ 18% (plus surcharge & Cess) shall be treate as a final payment of tax towards the excess money or part thereof not repatriated. [Section 92CE(2B)]
(b) No credit shall be allowed for tax paid on the excess money or part thereof to the assessee or any other person. [Section 92CE(2B)]
(c) No deduction under any other provisions of the Income Tax Act shall be allowed to the assessee in respect of tax paid on the excess money or part thereof. Thus, the assessee cannot claim the tax so paid as revenue expenditure under section 37 of the Act. [Section 92CE(2C)]
(d) If the assessee opts to pay additional tax u/s 92CE(2A), he will not be required to make secondary adjustment and compute imputed/ notional interest under sub-section (2) of section 92CE from the date of payment of such tax. [Section 92CE(2D)]
Reporting of Secondary adjustments in Form 3CD:
- Clause 30A of the Form 3CD requires the reporting for secondary adjustments made in pursuance to section 92CE. Clause 30A requires reporting of whether primary adjustment to transfer price, as referred to in section 92CE (1), has been ‘made’ during the previous year. The primary adjustment made during the previous year may not necessarily relate to the previous year under consideration under the audit report. It suggests that each and every primary adjustment made in the relevant financial year needs to be disclosed in the audit report.
- According to Implementation Guide by ICAI, primary adjustments totalling less than Rs. 1 crore, which do not invoke secondary adjustments should also be reported under clause 30A(a)(i)
- Further, the Implementation Guide also suggests that the tax auditor should report the imputed interest till the end of the previous year for which the tax audit report is furnished.
Burning Issues on secondary adjustments:
|
Issue |
Resolution |
What is the effective date of application of provisions of section 92CE? |
Memorandum to the Finance Bill 2017 states as under: “This amendment will take effect from 1st April, 2018 and will, accordingly, apply in relation to the assessment year 2018-19 and subsequent years” But when we read section proviso to section 92CE (1), it provides that no secondary adjustment is to be made in respect of AY 2016-17 or earlier. This means to say that secondary adjustments shall be made for A.Y. 2017-18 and onwards. This is resulting into a confusion over the effective date of application of section 92CE. To clarify this, suppose due date of filing return of income for AY 2017-18 is 30-11-2017. As per the Rule 10CB, the assessee has to bring back excess money within 90 days from due date u/s 139(1) i.e. 28-02-2018. If he fails to do so, notional interest income shall be computed for the period 30-11-2017 to 31-03-2018. Obviously, this notional interest income shall be taxed only in the A.Y. 2018-19. This view further gets strengthened from the amendment in Form 3CD wherein disclosure requirement regarding secondary adjustments is incorporated in clause 30A from A.Y. 2018-19. |
Whether the limit of Rs. 1 crore is applicable per associated enterprise-wise or aggregate of the primary adjustments made for all the AEs for that previous year? |
The words “made in any previous year” in the proviso to section 92CE (1) suggests that the limit of Rs. 1 crore is cumulatively for international transactions entered with all the AEs of an assessee. |
Whether section 92CE is applicable to deemed international transaction u/s 92B (2)? |
Section 92B (2) covers the deemed international transactions entered into by an enterprise with a person other than associated enterprise. Now a question arises whether secondary adjustment u/s 92CE is required in the case of deemed international transaction as in this case an enterprise is entering into a transaction with a person other than associated enterprise. To answer this question, we will look into definition of “International Transaction” and “Associated Enterprises” as per section 92CE. International Transaction: Explanation to Rule 10CB states that “International Transaction” shall have the same meaning as assigned to in section 92B of the Act. Thus, in accordance with this explanation, international transaction would cover cases given u/s 92B (1) as well as 92B (2) i.e. deemed international transaction. So, a view can be taken that the provisions of section 92CE(2) are applicable on deemed international transaction u/s 92B (2) of the Act. But another view prevails as we read the definition of “Associated Enterprises” as given in 92CE (3) which states that “Associated Enterprise” shall have the same meaning assigned to it in sub-section (1) and sub-section (2) of section 92A. Section 92CE (2) makes it clear that the excess money which is available with associated enterprise on account of primary adjustments needs to be repatriated within the prescribed time limit otherwise it shall be deemed to be an advance made by the assessee to such associated enterprise. There is no reference of any ‘person other than associated enterprise’ in this sub-section. Further, the term ‘Associated Enterprise’ has been intentionally defined by the law. Therefore, it can be interpreted that applicability of section 92CE is to be restricted only to the international transactions other than deemed international transactions. A clarity on this issue will come on the basis of any future rulings by the appellate bodies. |
Whether the Indian Income Tax Authorities have jurisdiction over foreign AEs to make adjustments in their books? |
Secondary adjustments cast a responsibility upon the Indian entity and its foreign AE to repatriate the excess money into India within 90 days. It is however questionable as to how Indian tax authorities ask a non-resident AE to make adjustment in its books of accounts. Further, it would be difficult for AE to repatriate money to India on account of secondary adjustment as the income tax laws or any other relevant laws in such country may not allow it to repatriate money back to India. Also, the AE would have paid tax on such amount in its home country which would lead to double taxation. |
Can secondary adjustment lead to application of section 2(22)(e) |
According to section 92CE (2), if the excess money is not repatriated within the prescribed time limit, such excess money shall be deemed to be an advance by the assessee to its associated enterprise. It is to be noted that section 2(22)(e) of the Act covers the case of deemed dividend where a company (other than a company in which public is substantially interested) makes an advance or loan to shareholder holding not less than 10% of voting power. In such cases, such loan or advance is treated as dividend and taxed accordingly. Therefore, the applicability of deeming fiction of section 92CE(2) might also attract applicable of another deeming fiction under section 2(22)(e). This issue needs a clarity. |
Implication of section 92CE with regard to FEMA |
Whether mere passing an accounting entry depicting receivable from foreign AEs to comply with section 92CE of the Income Tax Act would result in contravention of FEMA or not has to be examined. |
Conclusion:
Determination of Arm's length price in case of international transactions has seen a lot of litigations due to differential views of the Revenue which also attract huge amount of penalties under various provisions of the Income Tax Act, 1961. The introduction of section 92CE has further added burden upon the assessees for repatriation of excess money arising out of difference in ALP and price actually charged in an international transaction. Therefore, the taxpayers should be more cautious while entering into international transactions and determining ALP thereof so as to avoid corresponding secondary adjustments leading to outflow of notional interest on deemed advances to foreign AEs. There are many issues which are yet to be answered by the Government and which needs clarity including the difficulties resulting from statutory restrictions in repatriation of excess money by associated enterprises located outside India.
