We are pleased to release a Tax Alert which summarizes a recent decision of the Mumbai Income-Tax Appellate Tribunal (ITAT) in the case of Deloitte Consulting India Pvt Ltd (Taxpayer) [TS-148-ITAT-2014(Mum)-TP] on levy of penalty in the case of a transfer pricing (TP) adjustment. The Taxpayer, an Indian company, had entered into a Master Service Agreement (MSA) with its Associated Enterprise (AE), Deloitte Consulting (DC), a limited partnership registered in New York. The Taxpayer was engaged by its AE to provide software development services. The AE was responsible for undertaking marketing activities and entering into consulting contracts with customers in the US. During the Financial Year (FY) 2003-04 and FY 2004-05, the Taxpayer was allocated marketing costs by the AE to the extent relatable to its operations. The Taxpayer was entitled to claim a tax
holiday on the profits derived from the export of software development services for the relevant years. Subsequent to commencement of the audit proceedings for the relevant years, the Taxpayer filed a revised tax return and voluntarily performed a TP adjustment by not claiming the allocated marketing costs as a tax deduction and claimed tax holiday on the enhanced total income. The Tax Authority disregarded the revised tax return and thereafter made a TP adjustment by disallowing the claim made in the original return for the marketing costs and denied tax holiday on the enhanced income arising from the TP adjustment. The Tax Authority also levied penalty at 100% of the tax liability arising from the TP adjustment on grounds that the Taxpayer had concealed true particulars of income/ furnished inaccurate particulars of income. The TP adjustment and levy of penalty was upheld by the First Appellate Authority.
The ITAT upheld the TP adjustment and the levy of penalty. The ITAT observed that the revised tax return filed by the Taxpayer to reverse its claim of marketing expense was filed after initiation of TP audit proceedings in anticipation of a TP adjustment. Further, the revised tax return was not accompanied by a revised TP Accountant’s Report (Form 3CEB). Thus, the revised tax return was held invalid as it was not ”voluntary,” a prerequisite for filing a revised tax return. The ITAT also observed that protection from levy of penalty may be claimed in case of a TP adjustment only in bona fide cases where the arm’s length price (ALP) has been determined in good faith and due diligence.
Indian TP regulations contain stringent penalty provisions that are most often directed toward providing disincentives for noncompliance, where the compliance at issue may relate to timely preparation and maintenance of documentation, reporting and disclosure of international transactions or furnishing of necessary information and documentation during an audit. In the context of a TP adjustment, the adjusted income is deemed to represent income in which particulars have been concealed or inaccurate particulars have been furnished on which it is generally imposable. Protection from levy of penalty in such cases is available if the taxpayer is able to demonstrate that he has determined the ALP for the international transaction in accordance with the provisions of the TP regulations, in good faith and with due diligence.
This ruling outlines some key aspects that need to be considered by taxpayers while preparing their TP documentation and in defending their TP positions before Tax Authorities so they are able to meet the standards for penalty protection prescribed in the tax law. The ruling also suggests taxpayers may need to consider, in appropriate circumstances, filing a revised Form 3CEB to report/ disclose their international transactions when there is a change in their tax return filing position.
holiday on the profits derived from the export of software development services for the relevant years. Subsequent to commencement of the audit proceedings for the relevant years, the Taxpayer filed a revised tax return and voluntarily performed a TP adjustment by not claiming the allocated marketing costs as a tax deduction and claimed tax holiday on the enhanced total income. The Tax Authority disregarded the revised tax return and thereafter made a TP adjustment by disallowing the claim made in the original return for the marketing costs and denied tax holiday on the enhanced income arising from the TP adjustment. The Tax Authority also levied penalty at 100% of the tax liability arising from the TP adjustment on grounds that the Taxpayer had concealed true particulars of income/ furnished inaccurate particulars of income. The TP adjustment and levy of penalty was upheld by the First Appellate Authority.
The ITAT upheld the TP adjustment and the levy of penalty. The ITAT observed that the revised tax return filed by the Taxpayer to reverse its claim of marketing expense was filed after initiation of TP audit proceedings in anticipation of a TP adjustment. Further, the revised tax return was not accompanied by a revised TP Accountant’s Report (Form 3CEB). Thus, the revised tax return was held invalid as it was not ”voluntary,” a prerequisite for filing a revised tax return. The ITAT also observed that protection from levy of penalty may be claimed in case of a TP adjustment only in bona fide cases where the arm’s length price (ALP) has been determined in good faith and due diligence.
Indian TP regulations contain stringent penalty provisions that are most often directed toward providing disincentives for noncompliance, where the compliance at issue may relate to timely preparation and maintenance of documentation, reporting and disclosure of international transactions or furnishing of necessary information and documentation during an audit. In the context of a TP adjustment, the adjusted income is deemed to represent income in which particulars have been concealed or inaccurate particulars have been furnished on which it is generally imposable. Protection from levy of penalty in such cases is available if the taxpayer is able to demonstrate that he has determined the ALP for the international transaction in accordance with the provisions of the TP regulations, in good faith and with due diligence.
This ruling outlines some key aspects that need to be considered by taxpayers while preparing their TP documentation and in defending their TP positions before Tax Authorities so they are able to meet the standards for penalty protection prescribed in the tax law. The ruling also suggests taxpayers may need to consider, in appropriate circumstances, filing a revised Form 3CEB to report/ disclose their international transactions when there is a change in their tax return filing position.
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