Maximizing Benefits With Section 40a(2)(b) 6 Essential Insights On Mastering Domestic Transfer Pricing In The Gst Era

Section 40A(2)(b): Powerful Insights on Domestic Transfer Pricing in the GST Era

The landscape of domestic transfer pricing in India has been evolving, particularly in the context of the Goods and Services Tax (GST) regime. As businesses navigate the complexities of GST compliance and inter-unit transactions, several key legal developments have shaped the approach to transfer pricing, especially with respect to Section 40A(2)(b) of the Income Tax Act.

i. Changes in Specified Domestic Transactions and Section 40A(2)(b)

Prior to 1 July 2017, Section 92BA(i) of the Income Tax Act required that “specified domestic transactions” include “any expenditure in respect of which payment has been made or is to be made to a person referred to in Section 40A(2)(b).” However, with the Finance Act of 2017, this provision was deleted, effectively removing Section 40A(2)(b) payments from the category of specified domestic transactions.

This change signifies that payments made to related parties under Section 40A(2)(b) are no longer automatically subject to transfer pricing scrutiny as part of specified domestic transactions. The deletion of this provision aligns with the principle that when a provision is repealed, it is considered as though it never existed. This was clearly established by the Supreme Court in KOHLAPUR CANESUGAR WORKS LTD. v. UNION OF INDIA (AIR 2000 SC 811), affirming that the omission of a provision from the statute means it has no legal effect.

This position was recently reaffirmed in the case of GOLDBRICKS INFRASTRUCTURE PVT LTD v. ASST. COMMISSIONER OF INCOME TAX (2024-VIL-1794-ITAT-RPR), where it was held that payments under Section 40A(2)(b) no longer fall under the purview of specified domestic transactions for transfer pricing purposes.

ii. Profitability Variations Across Units in the GST Era

In the context of GST, where businesses maintain state-wise trial balances for tax purposes, a common concern arises: can the Income Tax Authorities adjust domestic transfer pricing based on the lower profitability shown by certain units? The answer is nuanced. In many cases, businesses operating in different states may show varying levels of profitability due to factors such as depreciation, operational costs, and capital expenditures.

In GST-compliant environments, businesses are now maintaining detailed records of transactions on a state-wise basis. However, merely showing lower profits does not give tax authorities the authority to adjust transfer pricing. As per several court rulings, the mere fact of low profitability is not enough to reject the profits reported in the books of account. Other reasons for lower profitability include:

  • Higher depreciation from investments in new technologies
  • Increased expenses related to labor, fuel, power, etc.

For tax authorities to make an addition to the taxable income, they must establish that there are discrepancies in the accounts. The Assessing Officer (AO) must either:

  1. Identify specific discrepancies in the books of account
  2. Reject the books under Section 145 of the Income Tax Act
  3. Provide clear evidence of underreporting or overreporting of revenue
  4. Show instances of bogus or excessive expense claims, such as inflated labor costs or depreciation.

These principles were reinforced in several judgments, including CIT v. Poonam Rani (5 Taxmann.com 76, Delhi), CIT v. Mohd Umer (101 ITR 525, Patna), and most recently in A.C.I.T. v. M/s PRAG INDUSTRIES (INDIA) PVT LTD (2024-VIL-1788-ITAT-LCK).

Key Insights for Businesses in the GST Era:

  • Section 40A(2)(b) Payments: Payments made to related parties are no longer considered specified domestic transactions under the Income Tax Act following the repeal of Section 92BA(i).
  • Profitability Variations: Low profitability across different units does not automatically trigger transfer pricing adjustments. Businesses should consider legitimate reasons for variations, such as higher depreciation or increased operating costs.
  • GST State-wise Trial Balance: With the requirement for businesses to maintain state-wise trial balances under GST, tax authorities may examine these records for discrepancies. However, adjustments can only be made with sufficient evidence of underreporting or overreporting.

Conclusion

The changes in domestic transfer pricing regulations, especially in the context of GST compliance, highlight the need for businesses to maintain accurate and detailed records. By understanding the implications of Section 40A(2)(b) and the evolving interpretation of specified domestic transactions, businesses can avoid unnecessary adjustments and penalties. Proper documentation, alignment with the arm’s length principle, and careful consideration of state-wise tax records will ensure compliance and mitigate risks in the current regulatory environment.

For businesses looking to navigate these complexities, it is crucial to stay updated on the latest rulings and interpretations of the law to ensure both Income Tax and GST compliance.

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