Secondary Adjustment in Transfer Pricing in Budget 2017

The Finance Bill 2017 has brought the concept of Secondary Adjustment into Transfer Pricing kitty by proposing a new Section 92 CE, with effect from Assessment Year 2018-19.

In the recent ruling in the case of PMP Auto Components Pvt. Ltd. [TS-263-ITAT-2014(Mum)-TP], the Mumbai ITAT, ruled in favour of the taxpayer reconfirming that the Secondary adjustment is not permissible as per the existing Transfer pricing provisions of the Income Tax Act.

Secondary Adjustment in nutshell:

In transfer pricing jargon, a Secondary Adjustment is a supplementary adjustment proposed by TPO, pursuant to the primary TP adjustment.

Explaining the Secondary Adjustment via an Example:

An Indian company sells certain products to its Associated Enterprise for INR 100, whereas the Arm's Length Price (ALP) of such transaction is INR 150. The TPO will confirm an upward adjustment (Primary adjustment) of INR 50, the difference between the Selling price INR 100 and the ALP INR 150, which is taxed in the hands of Indian company - A.  Subsequently, for the purpose of Secondary adjustment, it would be deemed that the AE owes INR 50 to Indian company (the difference between ALP and actual transfer price), which will be deemed to be a Loan or an Advance by Indian company to its AE. As a consequence, an interest would be imputed on such Loan or Advance and an Adjustment (Secondary adjustment) would be carried out in the hands of the Indian company.

Proposed amendment in the budget and analysis:

The proposed section 92CE of the IT Act permits secondary adjustment to the following primary adjustments:

• Suo moto TP adjustment by the taxpayer in its return of income;
• adjustment made by ITA and accepted by the taxpayer;
• TP adjustment, in terms of an Advance Pricing Agreement;
• TP adjustment made as per safe harbour rules;
• TP adjustment arising as a result of resolution under Mutual Agreement Procedure

The transactions, where underlying primary TP adjustment does not exceed INR 1 Crore or which are entered up to AY 2016-17 have been kept outside the ambit of secondary adjustment.

Further, the said deeming fiction is a provision whereby, if as a result of the Primary adjustment, there is an increase in the total income or reduction in loss of the taxpayer, the excess money (i.e. the difference between ALP and the Transfer price) which is available with the AE, and not repatriated to India within the prescribed time, is deemed to be an advance made by the taxpayer to such AE on which an interest would be attributed in accordance with the prescribed methodology.   

The rationale behind the Secondary adjustment is to reflect the total allocation of profits between the taxpayer and its AE are consistent with the transfer price determined as a result of the primary adjustment, thereby removing the imbalance between cash account and actual profit of the taxpayer.

Author’s Views:

Once the proposed changes in the Finance Bill are enacted, and section 92CE is inserted, it is expected to be followed up by introduction of new rules to prescribe for the time limit for repatriation of money into India and prescribing the manner for imputing interest on the deemed Loan or Advance.

About the Author: Mr. Arun Dongre BCom, ACA, MIMA. Working in a Consulting Firm, leading the Transfer Pricing Team.