Directors' Salaries under I-T scanner in New Transfer Pricing Rules

With transfer pricing being extended to domestic transactions in the Finance Act, 2012, as well under section 92BA of the Income Tax Act, 1961, directors’ salaries have also come under scanner. Due to the absence of data points for comparison of their remuneration, companies might have to take the help of third-party research on director salaries and it is difficult task. Directors that are shareholders will also face more problems.

Transfer pricing is a commercial transactions between different parts of the groups and one party transfering to the other goods, services or technology for a price. Now, directors’ salaries are also covered under this. Till now, this was restricted to international transfers but certain domestic transactions have now been covered.

Human resource experts said third-party information providers such as human resource (HR) consultants would be in demand. E Balaji, an independent HR expert, explained that all allowances, salaries and sitting fees for directors would need to be disclosed to the income tax (I-T) department under the new rules.

However, he added, it might not be possible for companies to make disclosures of fees in an arm’s length clause unless there is a benchmark. “Companies may have to engage independent third-party service providers to give data on remuneration practices, which can then be presented to I-T if there is any query.” 

Section 92BA(i) of the Act specifically states: "Any expenditure in respect of which payment has been made or is to be made to a person referred to in clause (B) of sub-section (2) of section 40A shall be considered as transaction for the purpose of Section 92, 92C, 92D and 92E of the Act." It had said the related parties covered under that section of the Act includes the directors of a company as well.

Additional disclosures would mean the documentation process will be lengthier and more cumbersome. In terms of the disclosures required from companies, information on perks and all other details of remuneration will have be provided to the I-T department. The human resource head of a financial services firm said the department has indicated that separate teams would have to be set up by companies to look into matters of director salaries and pay package.

The benchmarking exercise is undertaken with respect to remuneration to the directors, which in general terms, is expected to be carried out qualitatively on the basis of factors such as qualifications and work experience. This could, however, lead to some discrepancies. Rakesh Nangia, managing partner of Nangia and Co Chartered Accountants, opined it would involve an individual’s judgment and discretion, which is bound to result in transfer pricing adjustments and consequent litigation.

Determining the arm's length price is expected to be an area of contention. Sanjay Tolia, partner, Price Waterhouse & Co, said in the tranfer pricing certificate to be filed by the due date of filing return of income, the disclosure would essentially be the book value of the director remuneration and its arm's length price (ALP), along with the method used for determining the ALP.

He explained if a director was also a substantial shareholder (holding more than 20 per cent), then a range of remuneration payable across comparable companies could in addition be relied upon to prove ALP of the director’s fees. These could be sourced from publicly available financial statements of comparable companies (to the extent disclosed), or from an HR firm or recruitment agency.

Tax experts say this clause has caused documentation work to increase and directors with a shareholding in the company will face problems. Samir Gandhi, tax partner with Deloitte, a tax consultancy firm, added companies will have to set up a remuneration committee as well.

“The intention of the I-T department is to cover a wider ambit, but what it entails for companies is an enormous obligation to now maintain documentation and also bring salaries under arms length which will be difficult,” said Rohan Kishore Phatarphekar, partner KPMG in India.

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