We all know that, every assessee as per section 208 of Income Tax Act, 1961 (“Act”), is required to pay income tax during a financial year in every case where the amount of such tax payable is ten thousand rupees or more. Such a tax is called as an advance tax. Failure to remit advance tax in accordance with the provisions laid down vide Section 208, ibid shall attract interest as per Section 234B and Section 234C.

The objective of this article is to highlight few instances/issues which are to be considered while arriving the amount on which interest has to be calculated under sections 234B and 234C of the Act. Before going to deal with such issues, in the best interest of the readers, we have referred the statutory provisions of Section 234B and 234C hereunder.

Section 234B - Interest for defaults in payment of advance tax:

234B(1) Subject to the other provisions of this section, where, in any financial year, an assessee who is liable to pay advance tax under section 208 has failed to pay such tax or, where the advance tax paid by such assessee under the provisions of section 210 is less than 90% of the assessed tax, the assessee shall be liable to pay simple interest at the rate of 1% for every month or part of a month comprised in the period from the 1st day of April next following such financial year to the date of determination of total income under section 143(1) and where a regular assessment is made, to the date of such regular assessment, on an amount equal to the assessed tax or, as the case may be, on the amount by which the advance tax paid as aforesaid falls short of the assessed tax.

234C- Interest for deferment of advance tax:

Interest is payable u/s 234C if an assessee has not paid Advance Tax or underestimated installments of advance tax on the basis specified in 234C(1)(a), 234C(1)(b) which will be calculated on Tax on Returned Income.

Food for Thought:

1. Assessed Tax vs Tax on Returned Income:
2. From the above provisions, it is clear that Section 234B speaks about Assessed Tax whereas 234C deals with tax on returned income.
3. Hence 234B interest should be calculated based on Assessed Tax which is assessed as per section 143(1) or as per regular assessment (CIT v. Tulsyan NEC Ltd. [2011] (SC)). However, 234C interest to be calculated based on returned income.
4. So, in-spite of change in tax as per returned income and assessed income, there will be no change in 234C interest but there can be change in 234B interest.

Example: If the Return of Income filed by stating the Taxable Income of Rs. 250 crores which is Assessed by the AO by arriving Assessed Income as Rs. 275 crores then 234B interest to be calculated on assessed tax of Rs.275 crores where as 234C should be calculated on tax on returned income of Rs. 250 crores only.

B. Returned Income: is it Original Return / Revised Return or something else:

1. 234C refers to tax on returned income. However, 234C does not stressed on whether the income which has to be calculated should be based on the original return or revised return or any other document.

2. However, once a revised return was filed (within due date) then it will substitutes the original return hence Income as per Revised Return can be considered as Returned Income, the returned income referred to in section 234C means the total income declared in the return of income furnished by the assessee validly for the relevant assessment year. Accordingly, Income declared in Revised computation which is filed after the due date cannot be treated as Returned Income for the purpose of section 234C.

3. In South Eastern Coalfields Ltd Vs Jt. CIT (2003) 260 ITR (AT) 1 (Nag) it was held that "revised computation of income" filed before the assessing officer after the time-limit prescribed in section 139(5) cannot be treated as returned income of the assessee for the purpose of levy of interest under section 234C.

C. Tax Deducted at Source vs Tax Deductible at Source:

1. It is to be noted that in 234B interest, tax deducted at source is to be reduced from assessed tax, where as in 234C interest actual tax deductible at source is to be reduced from tax on returned income i.e., even though tax deducted at source is less than the tax deductible at source, assessee can reduce higher amount while calculating interest u/s 234C. (same treatment for TCS also)

Example: M/s Cash Rich Ltd is having Fixed Deposits of Rs.750 crores during the F.Y.14-15 which will yield interest of Rs.71,81,87,600/- during the same financial year. Ideally Banker should have deduct TDS u/s 194A of Rs.7,18,18,760/- i.e., tax deductible at source is Rs.7,18,18,760/- however banker has deducted tds u/s 194A only Rs.5,25,00,000/- i.e., actual tax deducted is Rs.5,25,00,000/‑

In this case even though actual tds deducted was Rs.5,25,00,000/-, while arriving interest u/s 234C we can consider Rs.7,18,18,760/- to reduce from tax on returned income, where as for interest u/s 234B Rs.5,25,00,000/- should only consider while reducing from assessed tax.

2. However, we have come across situations where few books on direct taxes and ready reckoners, it was suggested that actual tax deducted should only be considered for both 234B and 234C.

3. Whereas the Act is very clear that for calculation of interest under Section 234C, the tax deductible has to be considered. Hence, in our opinion the tax deductible has to be considered instead of actual tax deducted for the purpose of interest u/s 234C.

D. Few Instances where 234B & 234C is not liable to be paid:

1. As evident from the provisions of Section 234B, every assessee who is liable to pay advance tax has paid less than 90% of assessed tax is required to pay interest under Section 234B. However, there are certain instances where interest is not required to be paid even that 90% of assessed tax was not paid by assessee.

2. The pre requisite for levy interest under Section 234B, 234C are “Assessee should liable to pay Advance Tax under Section 208 of Act”. Hence, it is clear that the provisions of 234B, 234C shall come into play only when the assessee fits into the ambit of Section 208 of Act. (Jt. CIT v. Rolta India Ltd. [2011] (SC))

3. Hence, in a case where the assessee is not falling under the ambit of Section 208 i.e., not liable to pay Advance Tax, then in-spite of failing to pay 90% of assessed tax or there is a deferment in installments paid, assessee is not liable for interest u/s 234B, 234C.

Few examples of such Privileged Assessee:

1. a) An individual resident in India, who does not have any income chargeable under the head "Profits and gains of business or profession"; and is of the age of 60 years or more at any time during the previous year;
2. b) Assessee whose tax payable as mentioned in section 208 of Act is less than Rs 10,000/-;
3. c) Assessee covered under section 44AD (but not assessee u/s 44AE);
4. d) I. Assessee whose total income comprises of Salary income from which tax at source is to be deducted (DIT v. Maersk Co. Ltd. [2011]) and
5. Non Resident Assessee whose income is subject to tax deduction at source (DIT v. Jacabs Civil Incorporated/Mitsubishi Corporation [2010])

•          for both these cases irrespective of fact that the TDS was deducted or not assessee not liable to pay interest u/s 234 B,234C.

E. Amendments made in Finance Act,2015

In sec.234B

1. sub-section (2A) is inserted to provide that, where an application u/s. 245C (1) for any assessment year has been made, Assessee shall be liable to pay simple interest at the rate of 1% for every month or part of a month comprised in the period commencing on the 1st day of April of such assessment year and ending on the date of making such application, on the additional amount of income-tax referred to in that sub-section.

Where as a result of an order of the Settlement Commission u/s. 245D (4) for any assessment year, the amount of total income disclosed in the application u/s.245C (1) is increased, the assessee shall be liable to pay simple interest at the rate of 1% for every month or part of a month comprised in the period commencing on the 1st day of April of such assessment year and ending on the date of such order, on the amount by which the tax on the total income determined on the basis of such order exceeds the tax on the total income disclosed in the application filed u/s. 245C(1)

2. Sub-section (3) is inserted to provide that the period for which the interest is to be computed will begin from the 1st day of April next following the financial year and end on the date of determination of total income u/s. 147 or sec. 153A.

Conclusion: Apparently even though it seems to be similar factors for calculating the interest u/s 234B and 234C there are differences in factors that are to be taken for calculating referred interests such as Assessed Tax vs Tax on Returned Income, Tax Deducted vs Tax Deductible which will impact on outcome of interest amount.

This article is contributed by Partners of SBS and Company LLP - Chartered Accountant Company. You can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

The role of trade agreements, either free trade or preferential trade has contributed a lot to the international trade. India has also entered various agreements with various countries in order to reduce the tariff based barriers between the contracting parties. The objective of this article is to throw light on the various agreements where India is party, so that the exporters and importers can take advantage of the same.

These agreements boost the confidence of the Indian exporters and place them ahead in the competition while dealing with the signatory parties. For example, a person located in country ‘A’ has an option to import certain goods say, computers either from India or country ‘B’. If import is made from country ‘B’ the import duties shall be 20%. However, if the same goods are imported from India, the import duty for the person located in country ‘A’ is 0%, since India and country ‘A’ has entered an agreement.

Further, these agreements also attract investments from other non-signatory countries. For example, consider two countries ‘P’ and ‘India’ having an agreement. Country ‘P’ has high infrastructure cost and large domestic market. The companies located in country ‘R’ may decide to invest in country ‘P’ to cater to its domestic market. However, if India offers better business environment and it is having an agreement with country ‘P’, ‘R’ may decide to invest in India to cater to the needs of ‘P’.

Hence, the agreements entered by India with other foreign countries contribute a lot to the exports and also safeguards the domestic manufactures from paying high import duties. The agreements generally aim at reducing or granting complete exemption from import duty when goods are imported to India from other signatory countries.

As far as the India is concerned, the agreements entered with other countries to participate in International Trade can be represented as under, for easy understanding:

As represented above, the agreements entered by India with various countries can be grouped under two main buckets namely Unilateral and Bilateral or Multilateral, which we shall understand in the following paragraphs.

Unilateral Tariff Preferences:

Unilateral tariff preferences benefits or concessions flow from one country to another country and there shall be no reciprocity. There are two types of unilateral tariff preferences namely ‘Generalized System of Preference’ (for brevity ‘GSP’) and ‘Duty Free Tariff Preference Scheme’ for Least Developed Countries.

Generalized System of Preference - GSP:

The GSP is a commercial policy instrument aimed towards development. The objective of GSP is to offer the developing countries a more preferential tariff compared to the developed countries. For example, an importer in New Zealand buys material from India, by virtue of GSP with New Zealand Government, such material might attract lower customs duty in New Zealand when compared with same import from United States of America.

As of now, Australia, Canada, EU, Iceland, Japan, New Zealand, Norway, Russian Federation, Belarus, Kazakhstan, Switzerland, Turkey and United States of America extend GSPs. The Indian exporters shall submit Certificate of Origin (for brevity ‘CoO’) issued by designated authorities to the importer, so that the importer can avail such reduced tariff or exemption as per the concerned GSP.

Duty Free Tariff Preference (DFTP) for Least Developed Countries:

One of the obligations from the sixth Ministerial Conference of WTO, also known as WTO Hong Kong Ministerial Conference (MC6) was to provide duty free tariff preferences for least developed countries. In order to stand up to this obligation, the Department of Commerce, India now provides duty free/preferential access to 98.2% of tariff lines. India has 31 least developed countries as beneficiaries to this scheme.

Bilateral or Multilateral Agreements:

Free Trade Agreements (for brevity ‘FTA’) and Preferential Trade Agreements (for brevity ‘PTA’) are either in form of ‘bilateral agreements’ where only India and counterpart alone entered into an agreement or in the form of ‘multilateral agreements’ where India and group of countries enter into an agreement. As on date, 619 notifications of RTA/FTAs had been received by WTO, where 413 RTA/FTAs are in force and there are 28 PTA’s.

Free Trade Agreements - FTA:

In terms of WTO, FTAs are defined as reciprocal trade agreements between two or more signatory countries. That is to say, in FTAs tariff on items covering substantial bilateral trade are eliminated between As on November, 2015 Source: https://www.wto.org/

the signing countries, however the countries maintains an individual tariff structure when dealing with non-singing countries. Under FTAs the signing countries agrees on a list of goods called as negative list for which the FTA shall not be applicable. Except such goods mentioned in the negative list, all other goods can be freely traded between the signing countries. As on date India has entered 10 FTAs as per Para 2.103 of Handbook of Procedures. India is in the process of negotiating another 18 FTAs.

List of FTAs signed by India are:

1. India – Srilanka FTA;
2. Agreement on South Asia Free Trade Agreement (SAFTA);
3. Revised Agreement of Cooperation between Government of India and Nepal to control unauthorised trade;
4. India – Bhutan Agreement on Trade Commerce or Transit;
5. India – Thailand FTA – Early Harvest Scheme;
6. India - Singapore Comprehensive Economic Cooperation Agreement (CECA)
7. India - ASEAN CECA (Goods, Services and Investment)
8. India - South Korea Comprehensive Economic Partnership Agreement (CEPA)
9. India - Japan CEPA
10. India - Malaysia CECA

EHS/EH P:

Early Harvest Scheme/Early Harvest Programme is a forerunner to FTA between two trading partners. This is to help the two trading countries to identify certain products for tariff liberalization pending the conclusion of FTA negotiation. EHS has been used as a mechanism to build greater confidence amongst trading partners to prepare them for even bigger economic engagement.

CECA & CEPA:

Comprehensive Economic Co-operation Agreement (for brevity ‘CECA’) and Comprehensive Economic Partnership Agreement (for brevity ‘CEPA’) describes agreements which consists of an integrated package on goods, services and investments along with other areas including IPR.

EHS/EHP, CECA & CEPA are grouped under FTA. Preferential Trade Agreements - PTA:

Under PTAs, two or more partners agree to reduce tariffs on agreed number of products, generally called positive list. Hence, PTAs do not cover substantial trade as like in FTAs. As of Feb 2016, India has entered 6 PTAs as per Para 2.103 of Handbook of Procedures.

List of PTAs signed by India are:

1. Asia Pacific Trade Agreement (APTA)
2. Global System of Trade Preferences (GSTP)
3. India - Afghanistan PTA
4. India - MERCOSUR PTA
5. India - Chile PTA
6. SAARC Preferential Trading Arrangement (SAPTA)

Global System of Trade Preference - GSTP:

GSTP is entered between developing countries to exchange tariff concession to limited products. India provides tariff concessions to selective products imported from 54 countries subject to submission of CoO issued by the concerned authorities in exporting country. The goods originating from participating countries and CoO issued should comply with Customs Tariff (Determination of Origin of Goods under the Agreement on Global System of Trade Preferences among Developing Countries) Rules, 1989.

Procedure for claiming concessions & exemptions under the above agreements – General:

The basic customs duty charged under Section 12 of the Customs Act, 1961 is exempted or reduced by virtue of FTAs or PTAs. It is to be noted that other customs duties like countervailing duties are not covered under FTAs or PTAs. Further, a corresponding notification has to be issued under customs law to operationalize the promises made under FTAs or PTAs. The person intending to export or import as per the FTAs or PTAs has to satisfy the conditions mentioned in such notifications along with any rules made thereunder. The essential pre-requisite in order to avail the concessions or exemptions, is the Certificate of Origin (for brevity ‘CoO’).

The general procedure in order to avail the concession and exemptions prescribed under the FTAs/PTAs is prescribed as under. Let us a take an example of Indian manufacturer who intends to import goods from Srilanka under the India – Sri Lanka Free Trade Agreement (for brevity ‘ISLFTA’).

In order to import goods which are specified in the above agreement, the importer has to approach an exporter located in Sri Lanka, obtain CoO issued by the designated Sri Lankan authorities from such exporter, submit the CoO to the customs authorities and claim such exemption or reduced duty as place in the ISLFTA.

In the same way, if an exporter located in India wants to export specified goods in the ISLFTA, the Indian exporter has to obtain CoO from the designated authorities and pass it on to the Sri Lankan buyer, wherein such person can claim the reduced import duty or exemption as per ISLFTA.

This article is contributed by Partners of SBS and Company LLP - Chartered Accountant Company. You can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

Brief about ICDS:

The Finance Act (No.2) 2014 provides in Section 145(2)that the Central Government may notify in the Official Gazette from time to time Income Computation and Disclosure Standards(ICDS) to be followed by any class of assessee or in respect of any class of income.

In exercise of the powers conferred by Section 145(2) of the Income Tax Act, 1961 the Central Government has notified ICDS vide notification dated 31-3-2015. These notified ICDS are required to be followed by all assessee's following the mercantile system of accounting for the purpose of computation of income chargeable to income-tax under the head "Profits and Gains of Business or Profession" or "Income from Other Sources". ICDS is not applicable for assessee who are not required to maintain books of accounts as per the Income Tax Act, 1961.

In case of any conflict between The Income Tax Act, 1961 & ICDS, the provisions of the Act will be prevail.

Words and expressions used and not defined in ICDS but defined in the Act shall have the meaning respectively assigned to them in the Act.

ICDS-III:

ICDS-III shall be applied separately to each construction contract. However, where ever it is necessary, ICDS-III should be applied to the separately identifiable components of a Single Contract (Segmentation of Contract) or to a group of contracts (Combination of Contracts) to reflect the substance of a contract or group of contracts.

When a contract covers a number of assets, the construction of each asset should be treated as a separate construction contract when separate proposals have been submitted for each asset and each asset is subject to separate negotiation. It provides that contractor and customer able to accept or reject that part of contract relating to each asset and cost and revenue of each asset can be identified, such contracts should be treated as separate construction contract.

Where a contract provide for the construction of an additional asset at the option of the customer or is amended to include the construction of an additional asset, the construction of additional asset should be treated as a separate construction contract when the asset differs significantly in design, technology or function from the asset or assets covered by the original contractor the price of the asset is negotiated without having regard to the original contract price.

A group of contracts should be treated as a single construction contract when the group contracts is negotiated as a single package and contracts are so closely interrelated that they are part of single project with an overall profit margin. These contracts are performed concurrently or in a continuous sequence.

Contract for the purpose of this standard includes the following:

1. Construction of an asset or combination of assets
2. Contract for rendering services which are directly related to (i) above.

• Contracts of demolition or destruction of assets in connection to (i) above.

Note:- Taxpayer's who compute their taxable income on presumptive basis i.e 44AD etc are not required to maintain books of accounts for tax purposes if they claim their income in accordance with the provisions of section (i.e., 8% in case of 44AD). As a result ICDS may not be applicable as they are not following mercantile system of accounting.

Contract revenue: It shall be recognized when there is a reasonable ground of certainty for collection of amount which includes the following:

If any amount, in any year during the period of contract was written off due to uncertainty in collection, the same should be SHOWN AS AN EXPENSE, not by way of adjusting to contract revenue. (Finance Act,

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2015- Section 36(1)(vii))

Contract costs: Shall include the following:

1. Costs which are directly related and attributed to contract;
2. Other costs specifically charged under T&C of contracts;

• Allocated BORROWED COSTS as per ICDS on BORROWED COSTS.

These costs will be reduced by incidental income(Income which is supplementary to the costs), if any. But, income or revenue shall not comprise, if it is in the nature of:

Interest;

Dividend;

Capital gains.

Those costs* which are spent for securing a contract shall also be recognized if:

1. They are separately identified;
2. If it is more likely than not to secure a contract. (Probable).

*If those costs are recognized as an expense in that particular year when they were incurred, then they are not included in contract costs when it is obtained.

Contract costs related to future activity shall be recognized as an asset by showing as the amount due from customer.

Contract costs exclude the following:

1. Costs related to future activity;
2. Payments to sub – contractors as an advance for work to be done.

Recognition of contract costs & revenue: Shall be recognized by way of stage of completion of contract. Stage of completion of contract: Shall be determined by any of the following ways:

1. Cost to cost method;
2. Survey method;

• Valuation through valuer - physical proportion of work done.

Change in estimates: For cost to cost method – Cumulative cost is to be applied. If any change in estimates on a reasonable ground, that estimates are to be used for determining the percentage of completion of contract.

Transitional pro visions: Contract costs & revenue which are commenced on or before 31st March, 2015 but not completed by the said date, shall be recognized as per this ICDS. The amount of contract revenue, contract costs or expected loss if any, recognised for the said contract for any previous year commencing on or before 01/04/2014 shall be taken into consideration for recognising revenue and cost of the said contract for the previous year commencing 01/04/2015.

Disclosure requirements as per this standard:

Type of contract;

Contract revenue & costs recognized for the respective period; Method used for determining stage of completion of contract; The amount of advances received;

The amount of retentions;

Some Issues:‑

Recognition of Retention Money:- AS-7 is silent on treatment of retention money. Various Judicial

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pronouncements held that retention money accrues only at the time of completion of conditions attached as per the relevant contract. To nullify these judgements ICDS provides for recognition of retention money on Percentage of Completion Method basis. However, this is contrary to the concept of prudence and hence will not recorded in the books of accounts.

If subsequently the amount is not recoverable, taxpayer can't claim this amount as bad debt since the amount is not recorded in the books. To claim non recovery of debt as bad debt it should have been written off in the books of accounts. Since debt was not recorded in the books the question of written off doesn't arise.

To overcome this difficulty Finance Act, 2015 amended section 36(1)(vii) by inserting second proviso with effect from AY 2016-17. It provides that if debt or part thereof has been offered as income in compliance with ICDS and the debt or part becomes irrecoverable it would be allowed as a bad debt deeming that such debt or part thereof been written off as irrecoverable in accounts.

Initial Period of Recognition of Revenue:- AS-7 provides that revenue shall not be recognized during the early stages of contract. What is meant by “early stage” is not clearly defined. To provide certainty ICDS provides that contract revenue and contract cost should not be recognised till the contract reaches 25% stage of completion.

Recognition of Expected Losses:‑

ICDS provides that expected losses from the contract are allowed to be recognised as per percentage of completion method. This is contrary to the concept of prudence. Also it would conflict with the provisions of section 28 which provides for allowances of losses in computing the business income. As per AS-7 expected losses to be recognised in full.

This article is contributed by Partners of SBS and Company LLP - Chartered Accountant Company. You can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

OECD is an international economic organisation of 34 countries, founded in 1961 to stimulate economic progress and world trade. It is a forum of countries describing themselves as committed to democracy and the market economy, providing a platform to compare policy experiences, seeking answers to common problems, identify good practices and coordinate domestic and international policies of its members.

The G20 is made up of the finance ministers and central bank governors of 19 countries: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States of America.

The remaining seat is held by the European Union, which is represented by the rotating Council presidency and the European Central Bank.

India not a member of OECD, but actively engaged in taxation work of OECD. Since 2006, India been accorded the status of “Participant” / “Observer”of OECD and G20 countries working on equal footing on the BEPS project. Recommendations under BEPS Project made on basis of consensus arrived by 34 OECD Countries and 8 non-OECD G20 countries

India as an non-OECD G20 country, is an active participant in the BEPS project. As member of “Bureau Plus”, participated in the decision making process. India obliged to act on BEPS recommendations. We Can expect BEPS related changes as early in the forthcoming 2016 Budget.

What is BEPS?

The term Base Erosion and Profit Shifting (BEPS) refers to tax avoidance strategies which, by exploiting gaps and mismatches in tax rules, shift profits of Multinational Enterprise (‘MNE’) Groups to low or no tax locations where there is little or no real activity.

What causes BEPS?

The interaction of domestic tax systems in cross border transactions may result in double taxation of same income / leave gaps, resulting in double non-taxation of income.BEPS strategies take advantage of these gaps between tax systems in order to achieve double non-taxation.

Impact:

Global corporate income tax (CIT) revenue losses estimated between 4% and 10% of global CIT revenues, i.e. USD 100 to 240 billion annually. Given developing countries’ greater reliance on CIT revenues, estimates of the impact on developing countries, as a percentage of GDP, are higher than for developed countries.

The Organisation for Economic Co-operation and Development (OECD) has published ‘Action Plans’ on BEPS as an initiative aimed at curbing such strategies. The Action Plans are built around three pillars viz. Coherence, Substance and Transparency. The final reports on the 15 Actions differ in timing of impact and further steps are needed. Some measures may have (almost) immediate effect in a number of countries; others require treaty based action or legislative action by countries. The OECD also has announced plans for additional work on some Actions.

Other Action points (1 is pertaining to concerns on the business involving Digital economy and the harmful tax planning’s and the solutions and 15 is pertaining to multilateral instrument relating to one common document to be signed by the countries accepting the changes that the BEPS action plans are suggesting.)

The Action points pertaining to Transfer Pricing (8-10 and 13) are of immediate impact on the global tax economies including India. In the following paragraphs, we have provided a brief overview of the Action points 8-10, transfer pricing aspects (Intangibles, risk allocation and High value Intra group transactions):

Actions 8-10 – Transfer pricing aspects:

The OECD has included its updated transfer pricing guidance in one report under Actions 8-10, covering: amended guidance on applying the arm’s length principle (revisions to section D of chapter I of the OECD Transfer Pricing Guidelines), notably providing guidance on the identification of the actual transaction undertaken, on what is meant by control of a risk, and on the circumstances in which the actual transaction undertaken may be disregarded for transfer pricing purposes.

Guidance on comparability factors in transfer pricing, including location savings, assembled workforce, and MNE group synergies (additions to chapter I of the OECD Transfer Pricing Guidelines). This guidance remains unchanged from the guidance issued as part of the 2014 report on transfer pricing for intangibles New guidance on transfer pricing for commodity transactions (additions to chapter II of the OECD Transfer Pricing Guidelines). A new version of chapter VI of the OECD Transfer Pricing Guidelines addressing intangibles, including new guidance on the return to funding activities and on hard-to -value intangibles. New guidance on low-value adding intragroup services (revisions to chapter VII of the OECD Transfer Pricing Guidelines).

An entirely new version of chapter VIII of the OECD Transfer Pricing Guidelines, covering cost contribution arrangements In addition, the Actions 8-10 package describes additional work to be conducted by the OECD to produce new guidance on the application of the transactional profit split method. The aim is to produce a discussion draft in 2016 and final guidance during the first half of 2017.

Intangibles:

The intangibles final report consists of a new version of chapter VI, which builds on the version issued in September 2014.10 The structure of the final report is the same, containing four sections providing guidance on: (i) identifying intangibles for transfer pricing purposes, including adefinition of intangibles for transfer pricing purposes; (ii) identifying and characterizing transactions involving intangibles, including the determination of which entity or entities should share in the costs and risks of intangible development and the economic returns from the intangibles; (iii) identifying types of transactions involving intangibles; and (iv) determining arm’s length conditions and pricing in cases involving intangibles, in particular addressing intangible valuation, and arm’s length conditions for hard-to-value intangibles.

The key features of the final report, and key differences from earlier reports on intangibles, are:

Guidance on which entity or entities are entitled to share in the economic return from exploiting intangibles. The final report clarifies and confirms previous work, stating that mere legal ownership of an intangible does not confer any right to the return from its exploitation. Instead, the economic return from intangibles will accrue to the entities that perform the important value creating functions of developing, enhancing, maintaining, protecting and exploiting the intangible, and that assume and manage the risk associated with those functions.

New guidance on determining the arm’s length return for providing funding for intangible development. Where the entity providing the funding exercises control over the financial risk assumed, that entity is entitled to an expected rate of return commensurate with the risk (for example, based on the rate of return that might be achieved by investing in comparable alternative investments). Where the entity does not exercise control over the financial risk, it is entitled to (no more than) a risk free return only.

Guidance on valuation methods. The final report confirms that database comparables are seldom appropriate for pricing intangible transactions, and provides guidance on the use of other valuation techniques that may be more applicable.

Guidance on hard-to-value intangibles. Where intangibles are transferred or licensed in development or where their value is highly uncertain, the tax administration is entitled to use the ex post evidence about financial outcomes to inform the determination of the arm’s length pricing arrangements, including any contingent pricing arrangements, that would have been made between independent enterprises at the time of the transaction. The taxpayer can prove the original pricing was based on reasonable forecasts taking into account all reasonably foreseeable eventualities. There are some similarities with the US ”Commensurate with Income”standard. The guidance on intangibles is effectively final, although one small section within part D on the application of the transactional profit split method for pricing intangibles transactions is likely to be revised when the OECD completes its new guidance on this transfer pricing method.

Cost contribution arrangements

The section on cost contribution arrangements (CCAs) replaces existing chapter VIII of the OECD Transfer Pricing Guidelines in it sentirety. The objective of the final report is to align the guidance on CCAs with the new guidance elsewhere in the final report on control of risk and on intangibles transactions.

The guidance contained in the final report is similar to the guidance in the discussion draft issued in April 2015.11 although some aspects have been refined in light of the OECD consultations with business representatives.

The key points contained in the final report are:

CCAs are contractual arrangements among business enterprises for sharing contributions and risks associated with the joint development, production or obtaining of intangibles, tangible assets or services, in the expectation of mutual benefit from the pooling of resources and skills.

The expectation of mutual benefit is a pre-requisite for participating in a CCA. Participants must expect to benefit from the output of the CCA, for example by being able to exploit the rights acquired or services developed in their own businesses.

Control is a pre-requisite to be considered as a participant in a CCA. Participants must have the functional capacity to exercise control over the risks taken in the CCA. This means they must be capable of making the decision to take on the initial financial risk of participation in the CCA, and must have the ongoing decision-making capacity to decide on whether or how to respond to the risks associated with the CCA.

The value of the contributions made by CCA participants must be in proportion to their reasonably anticipated benefits from the CCA. Where contributions are not in proportion to reasonably anticipated benefits, true-up payments may be required.

The value of each participant’s contribution should be determined in line with the value that would be placed on it by independent enterprises in comparable circumstances. While contributions should be measured based on value, the final report recognizes that it maybe more practical for taxpayers to compensate current contributions at cost. However, this approach may not be appropriate where the contribution of different participants differ in nature (for instance, where some participants contribute services and others provide intangibles or other assets).

Hard-to-value intangible

The final report contains a specific transfer pricing approach with respect to hard-to-value intangibles (HTVI). The guidance finalizes an earlier discussion draft released June 2015.12 HTVI are defined as intangibles or rights in intangibles for which, at the time of their transfer between associated enterprises, (i) no reliable comparables exist; and (ii) at the time the transactions was entered into, the projections of future cash flows or income expected to be derived from the transferred intangible, or the assumptions used in valuing the intangible are highly uncertain, making it difficult to predict the level of ultimate success of the intangible at the time of the transfer.

The approach is intended to ensure that tax administrations can determine in which situations the pricing arrangements with respect to a HTVI as set by the taxpayers are at arm’s length and are based on an appropriate weighting of the foreseeable developments or events that are relevant for the valuation of certain HTVI and in which situations this is not the case. Under this approach, ex post evidence provides presumptive evidence as to the existence of uncertainties at the time of the transaction, whether the taxpayer appropriately took into account reasonably foreseeable developments or events at the time of the transaction, and there liability of the information used ex ante in determining the transfer price for the transfer of such intangibles or rights in intangibles.

Such presumptive evidence may be subject to rebuttal if it can be demonstrated that it does not affect the accurate determination of the arm’s length price.

Compared to the discussion draft, the final report provides more detailed exemptions and safe harbours when a transfer does not fall within the rules on HTVI.

Risk & Capital

The final report also contains revisions to Section D of Chapter I of the OECD Transfer Pricing Guidelines following the work under Action 9 (transferring risks or allocating excessive capital) and Action 10 (clarifying circumstances to re-characterize transactions).

More specifically, the revisions include the following main guidance to consider in conducting a transfer pricing analysis:

The importance of accurately delineating the actual transactions between associated enterprises through analysing the contractual relations between the parties together with evidence of the actual conduct of the parties.

Detailed guidance on analysing risks as part of a functional analysis, including a six-step analytical framework. This framework considers the identification of the economically significant risks with specificity, the determination of contractual allocation of these risks and the functions relating to these risks.

For transfer pricing purposes, the associated enterprise assuming a risk should control the risk and have the financial capacity to assume the risk.

A capital-rich MNE group member without any other relevant economic activities (a “cash box”) that provides funding, but cannot control financial risks in relation to the funding, will attain no more than a risk-free return, or less if the transaction is commercially irrational.

In exceptional circumstances of commercial irrationality, a tax administration may disregard the actual transaction. The main question is whether the actual transaction has the commercial rationality of arrangements that would be agreed between unrelated parties under comparable economic circumstances.

With respect to risk and recharacterization, the final report contains significant changes compared to the discussion draft in December 2014.13 including the inclusion of guidance on risk as an integral part of a functional analysis, the new six-step analytical framework to analyze risk, the inclusion of a materiality threshold by considering economically significant risks with specificity, the importance of financial capacity to assume risk, which was generally ignored in the discussion draft, and elimination of the moral hazard concept.

Low value added services

The guidance on low value adding services under Action 10 finalizes an earlier discussion draft released in November 2014.14 It takes the form of a rewrite of chapter VII of the OECD Transfer Pricing Guidelines on services. The updated guidance has the stated aim of achieving a balance between appropriate charges for low value adding services and head office expenses and the need to protect the tax base of payer countries. Key features of the proposed guidance include:

A standard definition of low value-adding intra-group services as being supportive in nature, not being part of the MNE’s core business, not requiring or creating valuable intangibles and not involving significant risks.

• A list of services that would typically meet the definition. In essence the services listed are back-office services.
• An elective simplified approach to determine arm’s length charges for low value-adding services:
• - A process for determining the costs associated with low value adding services
• - Allowing general allocation keys
• - A simplified benefits test
• - A standard 5% mark-up

• Prescriptive guidance on documentation and reporting that should be prepared for the MNE to be able to apply the simplified approach.
• The ability for tax administrations to include a threshold above which the simplified approach may be denied. Further work on the threshold will be performed as part of step two mentioned below.

Implementation will take place in two steps. As step one, a large group of countries has agreed to endorse the elective simplified mechanism by 2018. The second step looks to provide comfort to other countries that the elective simplified mechanism will not lead to base-eroding payments. It will entail further work in relation to a potential threshold above which the elective simplified mechanism will not apply and other implementation issues.

Finally, the revised guidance encourages tax administrations to limit any withholding taxes on low value-adding services to the profit element in the charge only.

Profit split

One of the objectives of Action 10 was to prepare transfer pricing rules or special measures to clarify the application of transfer pricing methods, in particular profit splits, in the context of global value chains. In order to determine for which matters additional clarification would be useful, the OECD released a discussion draft in December 2014.15 That discussion draft did not include revised guidance. The final report released in respect of Actions 8-10 includes a “scope of work for guidance on the transactional profit split method” which explains, among others, that the revised and improved guidance should:

• Clarify the circumstances in which transactional profit splits are the most appropriate method for a particular case and describe what approaches can be taken to split profits in a reliable way

Take into account changes to the transfer pricing guidance in pursuit of other BEPS actions and take into account the conclusions of the Report on Addressing the Tax Challenges of the Digital Economy, developed in relation to BEPS Action 1.

Reflect further work being undertaken to develop approaches to transfer pricing in situations where the availability of comparables is limited, for example due to the specific features of a controlled transaction, and clarify how in such cases, the most appropriate method should be selected. This scope of work as included in the final report will form the basis for draft guidance to be developed by the OECD during 2016 and expected to be finalized in the first half of 2017. A discussion draft will be released for public comments and a public consultation will be held in May 2016.

Commodities

The new guidance on commodity transactions under Action 10 finalizes an earlier discussion draft released in December 2014.16 and includes additional paragraphs to be inserted immediately following paragraph 2.16 of the OECD Transfer Pricing Guidelines.

The stated aim is an improved framework for the analysis of commodity transactions from a transfer pricing perspective which should lead to greater consistency in the way that tax administrations and taxpayers determine the arm’s length price for commodity transactions and should ensure that pricing reflects value creation. The key features of the released guidance on commodity transactions include:

• Clarification of the existing guidance on the application of the comparable uncontrolled price (CUP) method to commodity transactions and the use of publicly quoted prices to apply the CUP.
• Recommendation that taxpayers document their price-setting policy for commodity transactions to assist tax authorities in conducting informed examinations.
• Guidance regarding the adoption of a deemed pricing date for controlled commodity transactions
  in the absence of evidence of the actual pricing date agreed by the parties to the transactions.

Compared to the discussion draft, the final guidance has minor changes, including a more specific list of the types of adjustments applicable when using a CUP method and clarification that the functions performed, assets used and risk assumed by other entities in the supply chain need to be compensated properly.

In our next Wiki, we would be covering exhaustively on the CBC (country by Country Reporting – Action 13) and its impact on the Indian TP regulations.

This article is contributed by Partners of SBS and Company LLP - Chartered Accountant Company. You can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.