India: Notional interest on “deemed advances” involving related parties

India: Notional interest on “deemed advances”

The Central Board of Direct Taxes (CBDT) released guidance concerning the computation of “notional interest” on amounts deemed to be advances made by the taxpayer to a related party. The advances are deemed to exist when the taxpayer does not repatriate and offer to tax in India, amounts of taxable profits (or reductions in losses) that flow from transfer pricing adjustments that are assigned to a related party.

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Background

The Finance Act, 2017, introduced provisions into Indian tax law relating to “secondary adjustments”—that is, adjustments made in the taxpayer’s (and a related party’s) books reflecting the actual allocations of profits between the taxpayer and a related party. These provisions are used in determining that such adjustments are consistent with the transfer price resulting from a “primary adjustment” (based on the arm’s length price). 

A primary adjustment refers to an adjustment to the transfer price resulting from, for example, an adjustment pursuant to an assessment determined by the Assessing Officer; under an advance pricing agreement (APA); under the safe harbour rules; or by way of a mutual agreement procedure.

The provisions further provide that when there is an “enhancement” of taxable profits (or a reduction in losses) due to transfer pricing adjustments charged the related party, the additional amount receivable from the related party is to be repatriated by the taxpayer and offered for tax in India. If this amount is not received and repatriated by the taxpayer, then notional interest on the outstanding amount receivable from the related party—deemed to be an advance—is to be offered for tax in India as income of the taxpayer.

Notional interest

The CBDT guidance explains the manner for computing the notional interest on amounts that are deemed to be advances to related parties. There is a new provision (rule 10CB) added to the income tax regulations (rules) in India that explains the computation and addresses the timing for repatriation, as well as the rate of interest. 

KPMG observation

The rules concerning the secondary adjustment will apply from FY 2016-17. The prescribed notional interest mechanism is viewed as being in line with the recent revised ratios for outbound loans under the safe harbour rules. 

 

Read a June 2017 report [PDF 281 KB] prepared by the KPMG member firm in India

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