Saturday, September 28, 2013

Directors' fees pose transfer pricing challenge for companies : Times of India

MUMBAI: India Inc, which has to comply with domestic transfer pricing provisions for the first time since the norms were introduced by the Finance Act, 2012, faces compliance challenges. The top-most concern is substantiating that directors' fees paid by companies are at an 'arm's length' — which refers to a true unbiased value.

The problem arises because transfer pricing provisions are based on establishing comparability. To illustrate, remuneration received by Reliance Industries chairman Mukesh Ambani is bound to be vastly different from what his counterpart at Wipro, Azim Premji, is paid. It also cannot be compared with director's remuneration paid by a medium-sized private company.

Fees payable to a director by a company depends on many factors such as the director's role and responsibility, experience, the size and area of operation of the company, performance of the company and performance of the industry (see table for examples). "Any kind of payment such as salary, commission, sitting fees, various allowances to any director - be it a comprehensive remuneration package to a chairperson or sitting fees running into a few thousand paid to an independent director — are all covered by domestic transfer pricing provisions. Benchmarking of payments to directors is not an easy task," says Sanjay Tolia, partner, PWC.





Traditionally, transfer pricing applied to international transactions entered into by a company in India with related parties, such as its foreign parent company or overseas group companies. However, the Finance Act, 2012 expanded the ambit to cover domestic transactions entered into by a company with related parties, if the aggregate of such transactions in a year is over Rs5 crore.

Domestic transfer pricing provisions cover expenditure under section 40A(2) of the I-T Act, which includes payments to 'any' directors. India Inc now has to file with the tax authorities a transfer pricing report, containing various details of both international and domestic transactions and a transfer pricing study which demonstrates arm's length pricing.

"The burden is on the company to prove that payments to its directors are at an arm's length. Thus, comprehensive documentation of the roles and responsibilities of its directors should be undertaken to substantiate that such payment is commensurate keeping in view the benefits obtained by the company," says Rajendra Nayak, partner, E&Y.

"The starting point in the documentation process could be the internal policies that are in place for fixing director's remuneration - be it policies of the remuneration committee or of an HR department for listed companies or private companies. These policies would  show that the director did not in any way influence his remuneration, which is based on independent guidelines," adds Tolia.

In addition, recourse can also be taken both by private and public companies to the provisions of the Companies Act, which lay down limits for payments to directors across various categories and also provide for individual ceiling parameters. The aggregate remuneration to all directors is restricted to 11% of the net profits of the company in a given year and that of a managing director is restricted to 5% of the net profits.

High courts in the past have held that a director's remuneration cannot be disallowed as a deduction from business profits for income tax purposes. "Remuneration which is within such limits should be accepted by the transfer pricing officers and also the government should consider this for safe harbour provisions and thus ease the compliance cost and burden," says Porus Kaka, senior advocate.

In case of promoter-directors, it may be more challenging to demonstrate that the remuneration was at an arm's length. "If a director is also a substantial shareholder (holding more than 20%), then a range of remuneration payable across comparable companies could in addition be relied upon to prove arm's length pricing of the director's fees," suggests Tolia.

For the fiscal 2012-13, which is the first year of applicability of these provisions, the deadline for transfer pricing compliance is November 30. As of now, India Inc has to live with these provisions - a 2% penalty against the transaction value is prescribed for incorrect reporting or failure to maintain transfer pricing documentation. There is an additional 2% penalty for failure to furnish documentation to the tax authorities during assessment.


 
Regards
Prarthana Jalan

Financial technologies Audit Report

MUMBAI: Just a day before Financial Technologies (FT), the MCX Group's flagship company, planned to meet its shareholders at the annual general meeting in Mumbai, its auditor Deloitte Haskins and Sells has withdrawn its audit report saying that the company's standalone and consolidated results are not to be relied upon. FT is the promoter of the National Spot Exchange (NSEL) which defaulted on 5,500 crore of payments to investors. 
On Tuesday, FT informed the BSE that it has postponed its shareholders' vote on adoption of the company's balance sheet and profit and loss accounts for the fiscal year ended March 31, 2013. FT has also put on hold the ratification of payment of interim and final dividend to shareholders and re-appointment of Deloitte as its auditor. "As per our consistent policy, we do not comment on client proprietary matters,'' a Deloitte spokesperson said to a specific query on why it took 45 days to express its reservations about FT balance sheet for FY13. 

A source close to Deloitte, however, said NSEL auditor's decision to withdraw its report prompted them to do the same on FT. In FY12, an affiliate of Ernst & Young was the auditor to NSEL and Mukesh P Shah audited it in FY13. FT said that Deloitte had to withdraw its report as the auditors of NSEL withdrew their report on September 21. The audit report was signed before NSEL payment crisis broke out. NSEL's revenues are regrouped in the FT's balance sheet. 
"It is unusual in India and anywhere that auditor has withdrawn its report after it was signed by them," said Mukund Chitale, chairman of National Advisory Committee on Accounting Standards. "Given the circumstances involving NSEL and its parent FT, the auditor's move can be termed as practical. The Standard on Accounting 560 talks about auditor's responsibility relating to subsequent events in an audit of financial statements." 

After the NSEL crisis broke out, FT, in August, used $107 million from its accounts to prepay its foreign currency and ECB loans and fund the working capital needs of its overseas ventures. "FT Group pre-paid $76 million of its foreign currency & ECB loans to various lenders and $14 million is in the process of pre-payment with respective lenders out of the total amount remitted to FTGIPL, being the SPV for investments in overseas ventures. 

The balance $10 million is kept for working capital for its overseas stock exchanges. With regards to remittance of $10 million to FTSPL, being SPV for investments at the Singapore Mercantile Exchange, was for maintaining the minimum capital adequacy as required," FT said. 

Meanwhile, on Tuesday, NSEL stared at the sixth straight default. Details on NSEL website showed that the exchange had received just 11.28 crore until Monday against the 174 crore it required towards payments to investors.

 
Regards
Prarthana Jalan

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