In generic sense, anything secondary has often been thought as a by-product or addition. Although it can a spin-off from a primary factor, essentially inheriting its qualities, it often looks to embellish an already painted landscape. In India’s case, the landscape of transfer pricing litigation has always been dynamic, and the recent introduction of secondary adjustments in the Income-tax Act 1961 (‘the Act’) has signalled an intent to keep pace with the global economic reality. With the recent press release by CBDT, secondary adjustments are on course to become an operational reality in industry practices.
With effect from AY 2018-19, secondary adjustments shall be made applicable on primary adjustments exceeding INR 1 crore made from AY 2017-18 and onwards.
What is primary adjustment?
Primary adjustment refers to increase in the total income or reduction in the loss of the assessee due to non-maintenance of arm’s length price for the transactions between the associated enterprises.
What is Secondary Adjustment?
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 because of primary adjustments, thereby removing the imbalance between cash account and actual profit of the assessee.
As per the OECD’s Transfer Pricing Guidelines, secondary adjustment can be considered as deemed dividends, constructive equity contributions, or constructive loans or advance. The Finance Act treats secondary adjustments as advances given (if not repatriated to India) to respective associated enterprise which shall suffer transfer pricing adjustment. These advances are eligible to compute interest forming part of total income of assessee.
CBDT vide Notification No. 52 of 2017 dated 15 June 2017, has introduced Rule 10CB to operationalise the incorporation of secondary adjustments in Indian transfer pricing legislation. According to Notification, the foreign AE must repatriate back the excess money with in time limit set by CBDT i.e. 90 days from the due date of filing of return under section 139(1) of the Act in order to avoid paying interest on primary adjustment. The due date depending on the circumstances in which the Indian assessee operates in.
|Sub Sections of Section 1 of Rule 10CB||Circumstances||Time limit of 90 days for repatriation of excess money|
|(i)||Assessee makes suo moto (on its own) primary adjustment in return of income||From due date of filing return i.e. 30th November u/s 139(1)|
|(ii)||Assessee accepts primary adjustment in the order||From date of Assessing officer’s or appellate authority’s order|
|(iii)||Assessee enters in to an APA u/s 92CD of the Act||From due date of filing return i.e. 30th November u/s 139(1)|
|(iv)||Assessee exercises option as per safe harbour rules||From due date of filing return i.e. 30th November u/s 139(1)|
|(v)||Agreement made under MAP under double tax treaty entered u/s 90 or 90A||From due date of filing return i.e. 30th November u/s 139(1)|
Where the time limit of 90 days for the repatriation of the excess money is not met, the rules specify a computation of interest income on such excess unrepatriated money. The rate of interest is applicable on an annual basis and is segregated as below.
|Sr. No.||Circumstances||Interest income on excess money|
|1||Where international transaction is in INR||1 year MCLR of SBI as on 1st April of relevant previous year + 325 basis points|
|2||Where international transaction is in foreign currency||6-month LIBOR as on 30th September of relevant previous year + 300 basis points|
The interest income attributed on excess money in case of the foreign AE not repatriating the money to Indian assessee within the time limit of 90 days, can be understood with the help of the following instances:
Instance 1: International transaction in INR
– Total declared income Rs. 100 crore
– Adjustment of Rs. 10 crore on the international transaction
The computation would be as follows:
|Particulars||Amount (Rs. crore)|
|Add: Primary adjustment||10|
|Add: Secondary adjustment (treat 10 crores as advance given to Associated Enterprise, if not repatriated, and impute an interest, @ approx. 11%*)* (7.75% + 3.25%)MCLR is 7.75% (as on 1st June 2017)||1.1|
|Total adjusted income||111.1|
Instance 2: International transaction is in foreign currency
– Total declared income US $ 100 crore
– Adjustment of US $ 10 crore on the international transaction
The computation would be as follows:
|Particulars||Amount (US $ in crore)|
|Add: Primary adjustment||10|
|Add: Secondary adjustment (treat 10 crores as advance given to Associated Enterprise, if not repatriated, and impute an interest, @ approx. 4.42%**)* (1.42% + 3.00%)6-monthly LIBOR rate is 1.42% (as on 1st June 2017)||0.442|
|Total adjusted income||110.442|
What are the exception to Secondary Adjustment?
The provision of Secondary Adjustment will not be applicable in the following two scenarios, i.e.
- Where primary adjustment does not cross threshold of Rs. 1 crore in any previous year, and
- Primary Adjustment made on or before Assessment Year 2016-17.
Some important facets to consider: –
Sub-clause (ii) of section (1) of Rule 10CB says that time limit of 90 days will start from date of order of Assessing office or of Appellate authority, as the case may be, if the primary adjustment as determined by aforesaid order has been accepted by the assessee. Here, the term “Accepted by the assessee” has a great significance. It is relatively difficult to determine the point when assessee is accepting the primary adjustment. For e.g. if assessee strategically decides to drop the appeal at ITAT level though assessee in principle is not accepting the primary adjustment. There should be more clarity required from department on term “accepted by assessee”.
In practical scenario, department will compel the assessee to recover the amount of primary adjustment and levy interest on primary adjustment from CIT(A) order (Subject to stay on demand grant by ITAT).
Combined reading of sub section (iii) of section 1 of Rule 10CB with sub section (2) of section 92CD, provides that due date for filing of modified return will be considered as due date of return for years covered under APA agreement. On the other hand, plain reading of section 139(1) of the Act, 1961 does not cover any such provision. In such scenario, it is very difficult to calculate limit of 90 days for recovery of excess money and consequently, the time period for interest computation.
Further, without prejudice to above, sub section (i) and (ii) of section (1) of Rule 10CB will trigger only when assessee accepts the primary addition on suo-moto or made by AO or Appellate Authority. By applying the same rationale on sub section (iii), it is clear that the 90 days limit to recover the money will start from due date of filing modified return under sub-section (1) of section 92CD of the Act.
More clarity is required on the interest calculation, mainly the period under consideration for interest on primary adjustment, i.e. after expiry of 90 days or after the due date of filing return u/s 139 (1) of the Act.
All things put together at one place, more clarity is required from the CBDT regarding the arguments made above. On reading the provisions along with other rules/section of the Act, it brings a doubt in mind regarding “Due date for filing of return” based on which the limit of 90 days is calculated and subsequently interest on primary adjustment.
Further, without prejudice to above, where a primary adjustment is computed and the same does not fulfil the above-mentioned exceptions, then it is inevitable to avoid secondary adjustment, provided the deemed advance is not settled in cash.
Following is recommended to avoid a secondary adjustment:
- Planning of transfer prices goes a long way in avoiding transfer pricing disputes
- Important to document the price setting mechanism in a transfer pricing policy document
- While a primary adjustment is foreseen, it is important to settle the adjustment in cash position.
Contributed by CA. Gaurav Mehta and Abhijit Deouskar.