Since introduction of transfer pricing (TP) provisions almost a decade and a half back, Indian TP landscape has been constantly evolving in order to keep pace with the economic realities of the world as well as the international best practices.

The evolution of TP landscape has also seen aggressive posturing by the Indian tax authorities in the matters of TP adjustments, which is evident from the increasing litigation on TP issues across several appellate and judicial fora. The overzealous attitude of the Indian tax authorities also saw some radical and ambitious TP adjustments in the past, albeit without the express mandate of law. One such TP adjustment, which we are going to delve deeper in this article, was on account of secondary adjustments. The tax authorities' earlier attempt to carry out secondary adjustments was thwarted by the higher appellate and judicial bodies for there was no express provision under the extant TP regulations to permit such secondary adjustments.

This is no longer the position now and secondary TP adjustments are all set to become a reality very soon. Union Budget 2017 proposes to introduce a new provision in the Income-tax Act, 1961, namely section 92CE, which permits secondary adjustments in situations enumerated there under, with effect from April 1, 2018 (assessment year 2018-19).

What is secondary adjustment?
In transfer pricing parlance, a secondary adjustment, with the express sanction of law, is carried out pursuant to the primary TP adjustment. This can be better understood by way of the following illustration:
An Indian Company, I Co, sells certain products to its associated enterprise (AE), F Co, for Rs 100, whereas the arm's length price (ALP) of such sale transaction is Rs 150. Given the difference between the transfer price (Rs 100) and the ALP (Rs 150), an upward (primary) TP adjustment will be carried out to the extent of INR 50, which will be taxed in the hands of the I Co. Subsequently, for the purpose of carrying out secondary adjustment, it would be deemed as if F Co. owes Rs 50 to the I Co. (being the difference between ALP and actual transfer price), which will be deemed to be a loan or an advance by I Co to F Co. As such, an interest would be imputed on such advance and an adjustment/addition to income will be carried out in the hands of the I Co on account of such interest. This adjustment/addition on account of a notional interest is termed as secondary adjustment.

Secondary adjustment, therefore, is carried out in the following manner:
(a) making a primary adjustment;
(b) assuming/deeming a transaction based on such primary adjustment, and;
(c) Imputing a notional income to such assumed/deemed transaction.

Since, Secondary adjustment deems existence of an international transaction (of a loan or advance), its execution was not possible without the blessing under the IT Act.
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 upto financial year 2015-16 (assessment year 2016-17) have been kept outside the ambit of secondary adjustment.

Deeming fiction is introduced under the new 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 imputed in accordance with the prescribed methodology.

Secondary adjustment is defined to mean an adjustment in the books of accounts of the taxpayer and its AE to reflect that 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.

Analysis and issue

Importantly, situations where TP adjustment has either been suo moto offered in the return of income or which, after being carried out by the ITA, have been accepted by the taxpayer are included within the scope of secondary adjustment. What follows is that where TP adjustment has not been accepted by the taxpayer and is litigated before higher appellate authorities/judicial fora, carrying out secondary adjustment is not permitted. We can gather from the above that the intention to execute secondary adjustment is only in respect of such primary TP adjustments which have attained finality. The language of the section, however, leaves room for another interpretation, albeit literal, that the moment any TP adjustment is disputed by a taxpayer, it falls outside the purview of secondary adjustment. Does it mean that secondary adjustment cannot be executed at all in such cases or it is merely postponed till the time the dispute on primary TP adjustment is finally adjudicated (and not further litigated by taxpayer)? Perhaps, a clarification on this aspect by the government or a suitable amendment is needed to clear the air around it.

Further, it is also pertinent to mention that the proposed provision requires repatriation of money from AE into India within the prescribed time. It may be noted that repatriation of money into India is also subject to foreign currency regulatory laws. Assuming that the money is either not brought within the prescribed time or is not allowed to be brought into India under the extant regulatory regime, it could lead to a situation where secondary adjustments are carried out perpetually in the hands of the taxpayer. If the intention of the legislature is not to fasten the taxpayer with the perpetual burden of secondary adjustment, the proposed provision requires necessary clarification/modification.

Conclusion
Many countries in the world today permit secondary adjustment, namely, Canada, South Korea, South Africa and certain other European countries, by treating the difference between ALP and transfer prince as either deemed dividend or deemed loan or advance. OECD TP manual also provides for Secondary adjustment, however, cautions that the same should have an express legislative backing. The legislative mandate which was earlier missing, is now introduced in the Indian TP regulations. Once the proposed changes in the Finance Bill are accepted, and section 92CE is enacted, 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 advance or loan.