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Adjustment and Scope of Assessment – Advance Pricing Agreement

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May 5, 2021

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9 mins read

Adjustment and Scope of Assessment – Advance Pricing Agreement – Transfer Pricing – International Taxation Case Study

AB India Private Limited was incorporated under Companies Act, 2013, at Mumbai, and is a subsidiary of USA based company AB Inc. It is engaged in providing asset management software, namely, OPAC, to Indian clients. Such software can be used track all physical and digital assets; track inventories, hardware devices, software, and other software. The system also helps in asset lifecycle management.

AB India purchases 1,000 software license @ 800 per software from its holding company AB Inc., which is then distributed to Indian customers.  AB India pays license fees to AB Inc. as follows :-

Particulars Amount
Revenue collected from Indian clients [1,000 software @ 1,000] 10,00,000
Less: License fee paid to AB Inc. 8,00,000
Profit 2,00,000
Actual gross Margin earned 20%

AB India filed its income-tax return for PY 2019-20 by treating license fee of INR 8,00,000 paid to its holding company as arm’s length price.

It has computed comparable gross margin as per Resale Price Method as under :-

Particulars Amount
Revenue collected from Indian clients [1,000 software @ 1,000] 10,00,000
Less: Comparable gross profit margin [18%] 1,80,000
Arm’s Length Price of license fee 8,20,000

AB India has considered actual license fee as arm’s length price and filed its income tax return for the PY 2019-20.  The Assessing Officer has initiated scrutiny assessment for the PY 2019-20. However,  in order to buy peace , the taxpayer approached CBDT for concluding unilateral Advance Pricing Agreement.  The CBDT has determined comparable margin of 30% under Resale Price Method under the APA as on March 1, 2023. On March 20, 2023 the Assessing Officer has completed the assessment proceedings on the basis of original return filed by the taxpayer for the PY 2019-20. Now the taxpayer has filed modified return as per APA on June 1, 2023.

As a practicing Chartered Accountant, you are required to answer following questions:-

a)What would be the arm’s length price of license fee paid to AB Inc. on the basis of APA entered into with the CBDT?

b)Whether the Assessing Officer can reassess or reopen the entire income tax case for the AY 2020-21 on the basis of modified return filed by the taxpayer? Please justify the stand or action taken by the Assessing Officer.

International Taxation Services

Adjustment and Scope of Assessment – Advance Pricing Agreement – Solution:-

(a) Section 92CC of the Act empowers the Central Board of Direct Taxes (CBDT) to enter into an APA, with the approval of the Central Government, with any person for determining the Arm’s Length Price (ALP) or specifying the manner in which ALP is to be determined in relation to an international transaction which is to be entered into by that person.

Thus, once the APA is entered into, the ALP of the international transaction, which is subject matter of the APA, would be determined in accordance with such APA.

The arm’s length price of license fee shall be determined as per APA as under

Particulars Amount
Revenue collected from customers (INR 1,000 per license * 1,000 license) 10,00,000
Less :- Comparable margin determined as per APA (30% * INR 10 lakhs) 3,00,000
Arm’s Length price of license fee 7,00,000

In the present case, since the payment to non-resident AE is more than ALP determined as per the APA, an addition of Rs. 100,000 shall be made to the taxable income.

(b) In order to give effect to the APA, section 92CD provides the mechanism, including filing of modified return of income by the taxpayer and manner of completion of assessments by the Assessing Officer having regard to terms of the APA.

As per provisions of Section 92CD, the taxpayer is required to file modified return of income within 3 months from the end of the month in which APA has been entered into.

As per the existing provisions of Section 92CD(3), if the assessment or reassessment proceedings for an assessment year have been completed before the expiry of period allowed for furnishing of modified, the Assessing Officer shall, assess or reassess or recompute the total income as per APA.

However, due to the use of words “assess or reassess or recompute”, the Assessing Officer may start fresh assessment or reassessment in respect of completed assessments or reassessments of the assessees who have modified their returns of income as per APA entered into by them. The Finance Act, 2019 has amended Section 92CD(3) to provide that intention of the legislature is for Assessing Officer to merely modify the total income consequent to modification of return of income in pursuance to APA.

It has been provided that where assessment or reassessment has already been completed and modified return of income has been filed by the tax payer, the AO shall pass an order modifying the total income determined in such assessment or reassessment, having regard to and in accordance with the APA.

Accordingly, in this case, the AO cannot recompute or reassess the entire proceedings of AB India for the PY 2019-20 since he can only modify assessment order in respect of  the additions of INR 1 lakhs made in modified return.

For any queries, please write them in the Comment Section or Talk to our tax expert

Arinjay Jain

Bio of author

Arinjay is a Chartered Accountant with more than 20 years of post-qualification experience. He worked as Director, in the M&A Tax Division at KPMG in India. Presently, he is advising several MNCs in UAE on Economic Substance Regulations and impact of the UAE Corporate Tax Law on their business and clients across globe on International Tax issues . He is a well recognised Trainer of International Tax and UAE Corporate Tax. The areas of service include the following : - Advise and Compliance relating to International Tax Issues; Advise relating to UAE Corporate Tax Issues; Advise and Compliance relating to UAE Economic Substance Regulations; Advise and Compliance relating to Indian Income Tax Issues; Other connected matters from a Regulatory perspective.

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