Tax Holiday undertakings – Domestic Transfer Pricing

    The transactions of a tax holiday undertakings which are to be treated as SDTs are as under:

        transfer of goods and services from one tax holiday undertaking to non tax holiday undertaking of the same tax payer or vice versa

        any business transacted with entities having close connection

        non recurring and unique transactions such as purchase of undertaking from a closely connected person

        allocation of common expenses

        guarantees and loans for the purpose of the business of tax holiday undertaking.

    Sec. 80-IA(8) and 80-IA(10) deal with inter unit transfers and transactions with connected parties respectively by a tax holiday undertaking. The purpose of these provisions is to ensure that an assessee claims tax holiday computing his profit correctly. In other words, an assessee should not be allowed to inflate profits of a tax holiday undertaking and correspondingly reduce profits of taxable units and for this purpose domestic transfer pricing provisions have been put in place. In the regular international transfer pricing if profits declared by an assessee are higher than arm’s length profits then there is no objection under the TPR. Whereas when you examine the objective of sec. 80-IA(8) and 80-IA(10) it is to restrict the profit to the level of ordinary profits if the profits declared are higher than that. Now the domestic transfer pricing provisions which are brought into the statute book are expected to promote the objective of sec. 80-IA(8) and 80-IA(10) in computing ordinary profits of the tax holiday undertaking. In other words, unlike in the case of international transfer pricing, the domestic transfer pricing provisions in the context of computing profits of tax holiday undertakings would target to restrict the profits to the level of ordinary profits. This basic difference needs to be borne in mind.

    6.1 In this backdrop let us look at the issues that may be encountered.

        Ordinary profits vs arm’s length profit:

        If profits computed as per arm’s length principle are say 15 per cent net margin on the basis of average of comparable companies and if the actual profit reported by the tax holiday undertaking is at 30 per cent, whether there arises an issue whereby assessing officer would restrict the tax holiday profit to 15 per cent and disallow the balance 15 per cent from claim of tax holiday. There is case law in this regard in the context of international transfer pricing vis-à-vis sec. 10B(7) provisions. It was held by the Courts that once profits of a tax payer who is eligible to claim tax holiday under sec.10A / 10B are established at arm’s length then the assessing officer has no legal mandate to restrict or reduce such profits under sec. 10A(7) / 10B(7) alleging that assessee inflated profits for tax holiday claim – Visual Graphics Computing Services (India) Pvt. Ltd. v. ACIT (2012) 52 SOT 172 (URO), Weston Knowledge Systems & Solutions (India) Pvt. Ltd. v. ITO (2012) 52 SOT 120 (Hyd.) (URO). It is therefore to be debated whether ratio of this case law will help the assessee when arm’s length principle is to be applied for computing ordinary profits.

        Whether loss making tax holiday undertakings have to comply with domestic transfer pricing provisions is an issue for debate

        Whether a cost allocation is a service and is required to be marked up by one undertaking to the other?