Tax Authorities Crack Down

In an effort to curb tax avoidance, the government has introduced several sections in the Income Tax Act that focus on transfer pricing and related party transactions.

Transfer Pricing and Section 141 of the Act

Section 141 of the act gives the tax authorities the power to tax non-residents on income reasonably expected to accrue to residents with whom they have close relationships. This is based on arm’s length conditions, where a resident is deemed to be an agent of the non-resident.

However, in practice, the tax authorities have tended to use sections 140 and 140A for transfer pricing audits instead.

Income Obtainable on Demand

Section 29(1) and (2) of the act deals with income obtainable on demand. Gross income from interest, discounts, rent, royalties, pensions, annuities, or other periodical payments is only taxable when received. However, if the income can be obtained on demand, it will be taxed even if not received.

For instance, if a taxpayer is due to receive interest and the payer is ready and able to pay, but the taxpayer chooses not to receive it yet, section 29 may be invoked to assess the income.
Section 29(3), (4), and (5) introduces further provisions applying to related parties.

In a loan or other arrangement between related persons, the ability to control/dictate the timing of payment can lead to manipulation for a tax advantage.

As an anti-avoidance measure, these sections deem interest on loans between related parties as obtainable on demand when due to be paid, making it taxable in that year.
Employment income, interest, discounts, premiums, rent, royalties, pensions, annuities, and other income arising between related parties is also deemed to be obtainable on demand in the following year.

Employment Income and Living Accommodation

Section 32(3)(A) of the act deals with the ascertainment of value of living accommodation for a director of a controlled company.

The defined value of the living accommodation is compared to 30% of the gross employment income under section 13(1)(a).
However, if the director is not employed in a managerial or technical capacity and holds more than 5% of the ordinary share capital of the company, he will be assessable on the full defined value of the living accommodation.

Interest Expense Deductibility

Section 33(4) and (5) of the act deals with the deductibility of interest expense when “due to be paid”.

Interest payable for a basis period is only deductible when it becomes due to be paid, and must be related back to the year of assessment for which it is payable.

Shareholder Continuity Rules

Sections 44(5A) to (5D) of the act relate to shareholder continuity rules. These rules were meant to disregard unabsorbed losses and capital allowances brought forward where there was a substantial change in shareholding during a basis period.

However, these rules have been suspended or deferred as they only apply to dormant companies.

Capital Allowances

Paragraphs 38 to 40, schedule 3, and income tax rules relating to disposals subject to control deal with the calculation of capital allowances where qualifying assets are transferred between related parties under common control, or where one party controls the other.

The mischief here is that the disposal price may be artificially inflated to increase the claim for capital allowances by the acquirer or deflated to lead to a bigger balancing allowance.

Tax Authorities Crack Down on Transfer Pricing and Related Party Transactions