Introduction
1. A taxing statute is an ongoing Act. Its construction requires continuous updation to accommodate changes in business dynamics emerging from the borderless world. The statute should be forward looking. In this closely networked world, tax laws should keep pace with business mechanics; capital movement and digital economy. Technological advancement has resulted in the steep rise of seamless international transactions. Taxation of these transactions has emerged as a global concern. Indian law has thus geared up to prescribe new tax mechanism by adopting some of the international tax practices. This write-up deals with two such proposed insertions by Finance Bill, 2017 [discussed in Parts A and B respectively].
Part A – Interest Deduction
2. Concept of Thin Capitalisation
Thin Capitalisation connotes a capital structure consisting of a larger proportion of debt as compared to equity. A debt would entail a finance cost or interest. Such interest payouts when claimed as a deduction, results in shrinking of taxable profits. Excessive debt funding entailing corresponding interest costs could strip off the earning which leads to loss of revenue for the exchequer. Such high leveraged capital structures which were sometimes a commercial need, became a modus operandi for tax avoidance for many. At a group level, the level of debt was multiplied through intra-group financing. International survey of the affiliates with high interest-to-income ratios in higher tax rate countries, the interest-to-income ratio was 29% in 2011 which exceeded the average interest-to-income ratio of 10% [Source: Measuring and Monitoring BEPS – Action Plan 11].
3. Prevalent approach of Indian Legislature
In India, the Government adopted a ‘pro-investment’ policy. There was no legislation in the income-tax statute to counter Thin Capitalisation. On the contrary interest payments made by Indian companies to a non-resident was subject to a discounted tax withholding of 5% [under section 194LC] as compared to higher rates prescribed under section 195 and a corresponding tax rate of 20% under section 115A. The dividend payouts were subject to 15% (exclusive of surcharge and cess) tax on distribution with such dividends being wholly exempt in the hands of the shareholders. Further, a non-resident could claim credit on the DDT paid in India by resorting to underlying tax credit method [although litigative]. Judicially, the Indian Courts and Tribunals did not have the teeth to deter Thin Capitalisation practice. The Bombay High Court’s verdict in DIT v. Besix Kier Dabhol SA (2012) 26 taxmann.com 169 (Bom.)
was an evidence of judiciary’s inability to stop Thin Capitalisation practice. In this case, the assessee argued that in the absence of any specific Thin Capitalisation rules in India, the Revenue cannot disallow the interest payment on debt capital after having observed the abnormal Thin Capitalisation ratio of 248:1. The Bombay High Court adjudged that no disallowance could be made in the absence of Thin Capitalisation rules.
4. International Developments
Internationally, many countries sought to discourage a skewed capital resulting in excessive interest outflow and consequent profit erosion. The Organisation for Economic Co-operation and Development (OECD) released final reports on the Base Erosion and Profit Shifting (BEPS) Action Plan. This OECD initiative is endorsed by the G20 countries to usher in standardisation in global tax rules. As a member of the G20 and an active participant of the BEPS project, Indian legislature has been keen on effective implementation of BEPS Action Plan. It is likely that various recommendations the BEPS Action Plans may be implemented through amendments to the Indian domestic tax law or India tax treaties. A start was already made by introduction of equalisation levy and Country-by-Country Reporting (CbCR) in the transfer pricing spectrum in the last budget. Walking in the same direction, the Indian legislature now seeks to introduce provisions to counter Thin capitalisation.
5. Budget 2017
Finance Bill, 2017 proposes to introduce section 94B into the statute dealing with limitation on interest deduction in certain cases. The proposed section 94B reads as under:
“94B. (1) Notwithstanding anything contained in this Act, where an Indian company, or a permanent establishment of a foreign company in India, being the borrower, pays interest or similar consideration 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, 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):
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.
(2) For the purposes of sub-section (1), the excess interest shall mean an amount of total interest paid or payable in excess of thirty per cent 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.
(3) Nothing contained in sub-section (1) shall apply to an Indian company or a permanent establishment of a foreign company which is engaged in the business of banking or insurance.
(4) 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 sub-section (2):
Provided that no interest expenditure shall be carried forward under this sub-section for more than eight assessment years immediately succeeding the assessment year for which the excess interest expenditure was first computed.
(5) For the purposes of this section, the expressions––
(i) “Associated enterprise” shall have the meaning assigned to it in sub-section (1) and sub-section (2) of section 92A;
(ii) “Debt” means any loan, financial instrument, finance lease, financial derivative, or any arrangement that gives rise to interest, discounts or other finance charges that are deductible in the computation of income chargeable under the head “Profits and gains of business or profession”;
(iii) “Permanent establishment” includes a fixed place of business through which the business of the enterprise is wholly or partly carried on.”
6. One can discern the objective of this provision from the memorandum to Finance Bill, 2017 which explains the legislative intent in the following manner:
Limitation of interest deduction in certain cases
A company is typically financed or capitalised through a mixture of debt and equity. The way a company is capitalised often has a significant impact on the amount of profit it reports for tax purposes as the tax legislations of countries typically allow a deduction for interest paid or payable in arriving at the profit for tax purposes while the dividend paid on equity contribution is not deductible. Therefore, the higher the level of debt in a company, and thus the amount of interest it pays, the lower will be its taxable profit. For this reason, debt is often a more tax efficient method of finance than equity. Multinational groups are often able to structure their financing arrangements to maximise these benefits. For this reason, country’s tax administrations often introduce rules that place a limit on the amount of interest that can be deducted in computing a company’s profit for tax purposes. Such rules are designed to counter cross-border shifting of profit through excessive interest payments, and thus aim to protect a country’s tax base.
Under the initiative of the G-20 countries, the Organization for Economic Co-operation and Development (OECD) in its Base Erosion and Profit Shifting (BEPS) project had taken up the issue of base erosion and profit shifting by way of excess interest deductions by the MNEs in Action Plan 4. The OECD has recommended several measures in its final report to address this issue.
In view of the above, it is proposed to insert a new section 94B, in line with the recommendations of OECD BEPS Action Plan 4, to provide that interest expenses claimed by an entity to its associated enterprises shall be restricted to 30% of its earnings before interest, taxes, depreciation and amortization (EBITDA) or interest paid or payable to associated enterprise, whichever is less.
…..
In order to target only large interest payments, it is proposed to provide for a threshold of interest expenditure of one crore rupees exceeding which the provision would be applicable.
It is further proposed to exclude Banks and Insurance business from the ambit of the said provisions keeping in view of special nature of these businesses.”
7. The introduction of section 94B finds its roots in BEPS Action Plan 4
The objective of Action Plan 4 is to capture large interest payments to associated enterprises. It seeks to counter cross-border shifting of profit through excessive interest payments and to protect a country’s tax base. It is thus an anti-abuse provision. This is possibly the reason why the section is proposed to be placed in Chapter X of the Act which deals with Special Provisions Relating to Avoidance of Tax.
Meaning & scope of interest and similar consideration
8. Sub-section (1) of section 94B deals with payment of interest or similar consideration which is ‘deductible’ in computing income chargeable under the head ‘Profits and gains from business or profession’. The section does not define ‘interest’. In the absence of section specific definition one could rely on the definition of the term ‘interest’ in section 2(28A) which reads as under:
“(28A) “interest” means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised”.
9. The definition can be bisected as under –
a. Interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation); or
b. Any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised.
10. Thus, the payment could be interest, service fees or any other charges. The payment variants do not matter. The emphasis is on the purpose of payment. It must be a liability arising ‘in respect of’ any debt/ borrowing to qualify as interest. The ambit of section 2(28A) is thus wide. The legislature now proposes to envelope interest and ‘similar consideration’ within its ambit. One may have to thus await the interpretation of this loosely worded phrase. One wonders whether any payment could be visualised which is outside the ambit of interest but is in relation to borrowings?
11. There is one more attribute attached to such interest payment. They should be deductible against income under the head ‘Profits and gains from business or profession’. This would mean that any interest payment which is otherwise not deductible under Chapter IV-D of the Act would not be covered herein. For instance, section 36(1)(iii) stipulates that interest payment pertaining to debt incurred for purchase of assets ought to be capitalised till the date the asset is put to use. A disallowance under section 36(1)(iii) [through the mandate of capitalsation] would automatically exclude such interest from section 94B.
Scope of ‘debt’
12. Sub-section (1) deals with issue of debt by the associated enterprise and corresponding borrowal by the Indian company or permanent establishment of foreign company in India. The two complementary and corresponding actions must co-exist to trigger section 94B. The term ‘debt’ has been defined by sub-section (5) to mean any loan, financial instrument, finance lease, financial derivative, or any arrangement that gives rise to interest, discounts or other finance charges that are deductible in the computation of income chargeable under the head “Profits and gains of business or profession”. The opening portion of the definition appears to focus on various forms of availing debt – i.e., loan, financial instrument (like debentures), finance lease or derivative. However, the latter portion makes the ambit of ‘debt’ extremely wide to cover any arrangement giving rise to interest or discount or finance charges which are deductible against business income. Would this mean that transaction such as lease rentals are also covered within the section? It seeks to cover every arrangement that ‘gives rise’ to finance charges. One may have to read ‘gives rise to’ as ‘proximate nexus’ to respect the spirit of the section.
Quantification of disallowance
13. The closing portion of sub-section (1) deals with computation of interest disallowance. It states that interest shall not qualify as a deduction in computation of business income to the extent it arises from excess interest as specified in sub-section (2). The section requires identification of interest which arises from excess interest. The language is inelegant. It is difficult to comprehend how an interest can arise from interest? The possible intent was to carve out interest to the extent of being excessive as explained by sub-section (2). However, a literal reading of the section appears to have some fallacies.
14. Sub-section (2) defines excess interest in an exhaustive manner to mean an amount of total interest paid or payable in excess of 30% 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. In other words one has to compare 30% of EBIDTA with interest paid or payable for the previous year. The lower of the two has to be derived. Any interest paid or payable in excess of such derived number is excess interest. The section uses the term ‘earnings’ which is more a financial terminology. An appropriate definition of this term would negate any ambiguities or multiplicity in interpretations. For instance, should extraordinary items in the financial statement be considered? What about income from discontinuing operations or exceptional items? Clarity in this regard would be a welcome clarification.
15. Sub-section (2) interestingly only captures ‘interest’. Payment which may fall within the realm of ‘similar consideration’ [as provided in sub-section (1)] appears to be missing. This appears to be an omission which could possibly be corrected in the Finance Act. It is important to note that 30% threshold is applied only to the profits of the relevant year. Accumulated profits of the earlier years are not to be factored for such computation. However, the section
remains silent on the computation in the event of loss.
Expensive proviso to sub-section (1)
16. Proviso to sub-section (1) creates a deeming fiction. It deals with guarantee arrangements by associated enterprises. It visualises a situation where debt is issued by a third party or independent lender and the associated enterprise provides guarantee to such debt. In such a situation the law deems that the said loan (although issued by lender in reality) is deemed to have been issued by the associated enterprise. The first question is whether sub-section (1) covers deemed issue of loans by associated enterprises. Should the use of ‘issued’ in sub-section (1) be interpreted to include ‘deemed to be issued’? It is also interesting to ponder as to why has a substantive deeming provision of this nature couched in a proviso? However, having regard to the scheme of the section, it appears that deemed issue of debt is also covered within sub-section (1).
17. The proviso requires certain specific action to be undertaken by the associated enterprise. It states that an associated enterprise should provide guarantee to such lender or deposits a corresponding and matching amount of funds with the lender. The tenor of proviso appears to suggest that the guarantee provided to or deposit kept with the lender should be an amount equal to the debt availed. Can this mean that a debt borrowed from a lender which is partially (or substantially) guaranteed by associated enterprise is outside the ambit of section 94B? Although this does not seem to be the legislative intent, the language appears to fall short of the objective sought to be acheived.
18. The deeming fiction only appears to have focused only on the debt aspect and not on interest. To elucidate, the proviso states that a debt guaranteed is deemed to be debt issued. Whereas a corresponding deeming provision to state that interest corresponding to such deemed debt is also an interest deemed to be paid or payable to associated enterprise is missing. It is a trite to state that the deeming provision should be given its full effect. In the absence of a deeming provision in the context of interest, this canon of taxation fails. One may recollect the verdict of Bombay High Court in
CIT v. ACE Builders (P) Ltd (2006) 281 ITR 210 (Bombay) wherein it was held that the legal fiction created in section 50 is to deem capital gains as short-term capital gains and not to deem an asset as short-term capital asset. It cannot therefore be said that section 50 converts long-term capital asset into short-term capital asset. The same sentiments are applicable in the present case as well.
Carry forward of excess interest
19. Sub-section (4) deals with the carry forward of interest which is not wholly deductible (against business income) in a particular year. The sub-section provides an opportunity to carry forward such non-deductible interest against business income of subsequent years. Proviso to sub-section (4) ushers in 8 year cap for which such carry forward is permitted. On a year-on-year basis, one has to adhere to the restriction that the total interest in one particular year cannot be claimed beyond the extent outlined in sub-section (2). In other words, interest brought forward from earlier years cannot exceed the limits stipulated in sub-section (2) [i.e., computation of excess interest]. Sub-section (4) facilitates seamless movement of excess interest to subsequent years to facilitate a claim in those years subject to the ‘extent’ or ‘limits’ prescribed in sub-section (2). Similar to the flaw in sub-section (2), it appears that there is omission of carry forward of excess ‘similar consideration’ [as referred to in sub-section (1)].
20. A collective reading of sub-sections (1), (2) and (4) indicates that section 94B deals with restriction on payment of interest to associated enterprise. Such interest paid or payable can be claimed to a maximum extent of 30% of EBIDTA or actual payment whichever is less [sub-section (2)]. In a year, there could be two portions of interest that are examined for claim of deduction. The first one being the interest paid or payable for the previous year and the latter is the carried forward excess interest [in accordance with sub-section (4)]. The claim of current year interest and carried forward interest should independently pass the test of sub-section (2). The limits outlined in sub-section (2) should therefore be separately applied to both the current year interest and carried forward interest. It is important to note that there is no explicit mention in the section that current year interest along with carried forward interest together should not exceed the limits of sub-section (2). However, this could be a matter of litigation unless a clarification is provided in the section or by appropriate notification by the Central Board of Direct Taxes.
Relaxation for a few
21. Sub-section (1) absolves payments of interest or similar consideration not exceeding one crore rupees from the spectrum of section 94B. However, the relaxation lies in limbo since it is not clarified as to when should this threshold be examined? To elucidate, should one crore be reckoned per borrowing or per year or per lender? This assumes utmost importance because payments made to a particular associated enterprise (lender) may be below one crore in one year but may exceed in the subsequent years or when viewed cumulatively, the threshold may be breached. In such a circumstance, would the Revenue adopt a ‘look back’ approach to disallow on retrospective basis? These questions are currently glaring to the taxpayer.
22. Apart from the above mentioned threshold, there is relaxation given to companies engaged in business of banking and insurance. The reason for such relaxation has been special nature of business. It remains to be seen whether only banks and insurance companies per se are excluded or the other players operating in these segments can also be absolved [for instance, leasing companies, NBFC(s)]?
PART B – SECONDARY ADJUSTMENT
23. Transfer pricing adjustments have echoed in every boardroom of a company whose transactions cross the borders of this country. The focus has always been on the taxpayer in India who has transacted with its associated enterprise. The target is to achieve an arm’s length price. What is the corresponding effect in the associated enterprise’s books; what is the treatment therein of the impugned transaction – these questions were not questionable (albeit, the tax assessments are seldom settled without these details).
24. The Organisation for Economic Co-operation and Development (“OECD”) has observed in its commentary on Article 9 of the model treaty convention that sovereign countries can opt for secondary adjustments, if permissible under their domestic tax laws. Internationally, the practice of secondary adjustment has been accepted by various nations. Whilst the approaches to secondary adjustments by individual countries vary, they have now emerged as an internationally recognised method in transfer pricing regime. In order to align the transfer pricing provisions in line with OECD transfer pricing guidelines and international best practices, new section 92CE is proposed.
25. Finance Bill, 2017 proposes a new section 92CE into the statute. The law proposes to mandate a ‘secondary adjustment’ in addition to the primary adjustment (which was hitherto understood as the transfer pricing adjustment). The analysis would now go one step deeper. The provision is more invasive and would require an ongoing strategic approach at the group-level.
26. Section 92CE reads as under:
’92CE. (1) 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, the assessee shall make a secondary adjustment:
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.
(2) Where, as a result of primary adjustment to the transfer price, there is an increase in the total income or reduction in the loss, as the case may be, of the assessee, the excess money which is available with its associated enterprise, if not repatriated to India within the time as may be prescribed, shall be deemed to be an advance made by the assessee to such associated enterprise and the interest on such advance, shall be computed in such manner as may be prescribed.
(3) For the purposes of this section,–
(i) “Associated enterprise” shall have the meaning assigned to it in sub-section (1) and sub-section (2) of section 92A;
(ii) “Arm’s length price” shall have the meaning assigned to it in clause (ii) of section 92F;
(iii) “Excess money” means the difference between the arm’s length price determined in primary adjustment and the price at which the international transaction has actually been undertaken;
(iv) “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;
(v) “Secondary adjustment” means an adjustment in the books of account 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.
27.Precursor to secondary adjustment: Sub-section (1) outlines that a transfer pricing adjustment or primary adjustment is a precursor for a secondary adjustment. The term ‘primary adjustment’ has been defined in sub-section (3) to mean determination of transfer price resulting in an increase in the total income or reduction in the loss of the assessee. The section thus remains silent on a situation wherein there is no ‘increase’ in total income despite certain transfer pricing adjustment.
28. Sub-section (1) deals with five situations where the primary adjustments could happen – namely, suo motu adjustment by assessee in return of income; adjustment by assessing officer (AO) which is accepted by assessee; pricing under advance pricing arrangement; pricing under safe harbour rules; and resolution under Mutual Agreement Procedure.
29. If there is a primary adjustment on account of any of the aforementioned events, a secondary adjustment has to be made by the assessee. However, such secondary adjustment is not required if the quantum of primary adjustment [not the quantum of international transaction(s)] is less than rupees one crore in the previous year or where the primary adjustment is made before Assessment Year 2016-17. The two conditions are independent and have to be read disjunctively although the Finance Bill has used ‘and’ in between the two conditions. The use of the word ‘and’ appears to be an error and which one should expect the same to be corrected in the Finance Act.
30. Out of the five forms of primary adjustments referred to above, the second variant of primary adjustment deals with an adjustment done by the AO and which is accepted by the assessee. There could be multiple inferences from this portion of the provision. Some of the possible inferences are:
(a) It refers to only an adjustment made by AO and accepted by assessee without dispute. In other words, the said variant would fail immediately after the assessee makes an appeal before the Commissioner of Income-tax or prefers an objection before the Dispute Resolution Panel.
(b) It refers to adjustment made by AO and this fact remains unchanged even if the adjustment is disputed before the higher forum. The appellate authorities or tribunals or courts can only adjudge whether the adjustment made by AO is appropriate or otherwise. Therefore, the adjustment always remains to be the one made by AO.
(c) It refers to the adjustment made by AO which is affirmed or rejected by the higher appellate forum. However, an adjustment made over and above the AO’s adjustment [in terms of quantum or adjustment] would not be covered within the primary adjustment.
(d) It refers to adjustment made by AO which may be affirmed, rejected or enhanced. However, the order giving effect to the verdict is made by the AO. Therefore, an adjustment always continues to be one made by AO. If this proposition were to be accepted, the assessee should contest every adjustment till Supreme Court level; for acceptance at any level would trigger the secondary adjustment.
31. It may be premature to state with conviction as to which of the above would be correct. However, this appears to be a breeding ground for litigation.
32. The term ‘secondary adjustment’ is defined in clause (v) of sub-section (3) to mean an adjustment in the books of account 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. On paraphrasing, the following facets of secondary adjustment emerge:
(a) It is an adjustment in the books of account;
(b) It should be adjusted in the books of the assessee as also its associated enterprise;
(c) The objective of the adjustment is 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;
(d) It should result in removing the imbalance between cash account and actual profit of the assessee.
Condition (a) & (b)
33. The secondary adjustment is required to be made in the books of account. It is a one-off instance wherein the legislature is mandating an adjustment to be reflected in the books of account. Income-tax is a charge on total income. The gamut of taxation cannot travel beyond total income computation. Income-tax laws cannot trespass into accounting domain. Books of account can only form a base to commence the tax computation. However, it is interesting to ponder whether an income-tax adjustment should inevitably find a place in books of account? While it has always been contended that accounting cannot dictate the taxing statute, can there be a role reversal? A fair conclusion would be to say that the two complement each other.
34. Even assuming for a moment that Income-tax laws would also govern the books of account, it is unimaginable to perceive that Indian income-tax laws would be able to direct a non-resident to make an adjustment in its books of account. This would go way beyond the concept of extra-territoriality. Further, a secondary adjustment pre-supposes an existence of associated enterprise at the time of international transaction (stage I); on primary adjustment (stage II); and on secondary adjustment (stage III). However, in this dynamic business world wherein mergers, hive-offs and group restructuring are the buzz words, the associated enterprise may not exist in all the three points in time. In such a situation, the secondary adjustment cannot be carried out.
Condition (c) & (d)
35. The secondary adjustment should reflect the actual allocation of profits between assessee and associated enterprises which is consistent with the transfer price determined as primary adjustment. It is certain that the assessee and Revenue would be at loggerhead on what constitutes actual allocation of profits. There would certainly be certain incomes and outflows which are non-allocable – can the Revenue force upon an allocation which it perceives to be actual? There could be various yardsticks for allocation – say, based on turnover, time, area, manpower. To insist on one would be re-writing the commercial arrangements between the parties. This would mean that the Revenue could now decide the content and quantum of the assessee’s books. It is believed that the secondary adjustment would negate the imbalance between cash account and actual profits of the assessee.
36. It is critical to understand that any adjustment to books of account which gets captured in financial statements would be subject to Minimum Alternate Tax (“MAT”).
Interest on deemed advance
37. Sub-section (2) deals with deemed advance. On primary adjustment, there may be an increase in the total income or reduction in the loss for the assessee. There would therefore be a difference between the actual pricing by the assessee and the pricing in primary adjustment. The differential is coined as ‘excess money’ by this section. Sub-section (2) requires repatriation of this excess money into India within prescribed timeline. In the event of failure to repatriate, such excess money is deemed to be an advance made by the assessee to such associated enterprise. Consequently, interest on such advance, shall be computed in such manner as may be prescribed.
38. The timelines for repatriation and interest computation are yet to be prescribed. It is interesting to observe as to how would the repatriation timelines be fixed for entities who do not have any compulsion to repatriate funds into India. To explain, a unit operating in a Special Economic Zone is not bound to repatriate funds into India within a fixed timeline [unlike section 10A(3) which prescribed a six month timeline]. Can section 92CE now compel such entities to repatriate excess money into India? One may also note that if the MAP proceedings prescribe a different time period, such time frame may prevail over section 92CE having regard to section 90(2). Further, the excess money is deemed to be an advance on breach of the prescribed repatriation timeline. This being the case, an interest on such advance would be computed from the date of it becoming an advance [i.e., the date of contravention when prescribed timeline is breached] or is it the date of actual international transaction? These are some of the questions to which answers are awaited in the prescribed rules/notifications.
39. Extending the interest computation aspect further, should a transfer pricing analysis be carried on such interest payments? While in terms of methods, one can fix into the sixth (or prescribed method), it remains to be seen whether interest computed in the manner prescribed would not be questioned by the Revenue authorities.
40. The deeming fiction of converting the excess money into advance could create ambiguity on whether such monies would be treated as loan for other provisions of the Act? For instance, section 2(22)(e) provides that if a closely held company makes advance to the shareholder beneficially holding more than 10% stake, such loan would be deemed as ‘dividend’ and accordingly taxable in the hands of the shareholder (and also withholding tax obligation instead of Dividend Distribution Tax). However, the appropriate view would be not to extend the deeming fiction of one provision into another.
41. As mentioned earlier, secondary adjustment can only be initiated when there is a primary adjustment. The two adjustments are inextricably linked. Secondary adjustment is actually an extension of primary adjustment. Thus, similar to primary adjustment, any variation under secondary adjustment can be made only to international transaction as defined in section 92B. The question is whether such deemed advances is a international transaction? Although one could argue that Explanation to section 92B houses ‘capital financing’, the question lingers whether a deemed advance of this nature is also covered therein? The secondary adjustment may not satisfy the pre-requisites of international transaction [viz., of income, profit, loss or assets]. Further, there is no amendment to section 2(24) [definition of income] to accommodate such adjustments as income chargeable to tax. However, this aspect has been debated for many years now in the context of primary adjustment as well. So the legacy issue of whether a transfer pricing adjustment constitutes income continues to remain.
Conclusion
42. It is imperative to gear up to the business changes across the globe. However, the philosophy of ‘ease of doing business’ cannot be given a go-by. Foreign investments are given primacy like never before. While investment should not be attracted by giving doles, they cannot be burdened by compliances and ambiguities in law. Introduction of Thin Capitalisation was only a question of time. However, ushering in of concepts should be supported by apt drafting of the section. One wonders whether an ideal debt-equity ratio should have been prescribed by section 94B? Secondary adjustment could be an international practice, but one wonders whether the proposed deeming in this section is taking us away from real income theory? Is it time for India to implement such measures when the transfer pricing litigation has substantially contributed to the heap of tax cases.
