Profits chargeable to tax.

95

The provision of section 38(1)(a) shall apply in computing the income of an assessee under section 92, as they apply in computing the income of an assessee under the head “Profits and gains of business or profession”

Explanation

Section Summary:

Section 95 of the new income tax law clarifies how the provisions of Section 38(1)(a) apply when computing income under Section 92. Section 92 deals with the computation of income from international transactions or specified domestic transactions, ensuring that such transactions are priced at arm's length (i.e., as if they were conducted between unrelated parties). Section 38(1)(a) pertains to deductions allowed for expenses incurred wholly and exclusively for business purposes. This section ensures that the same principles for deducting business expenses apply when computing income under Section 92.

Key Changes:

• Integration of Section 38(1)(a) with Section 92: Previously, Section 38(1)(a) applied to general business income computations. Now, it explicitly applies to income computed under Section 92, ensuring consistency in expense deductions for international or specified domestic transactions.
• Alignment with Arm’s Length Principle: This change reinforces the arm’s length principle by ensuring that allowable deductions are treated uniformly, whether for domestic or cross-border transactions.

Practical Implications:

• For Businesses Engaged in International Transactions: Businesses must ensure that expenses claimed under Section 38(1)(a) are consistent with the arm’s length principle when computing income under Section 92. This means expenses must be justifiable and directly related to the business.
• Compliance Burden: Taxpayers must maintain detailed documentation to substantiate that expenses claimed are wholly and exclusively for business purposes, especially in cross-border transactions.
• Impact on Transfer Pricing Adjustments: If transfer pricing adjustments are made under Section 92, the deductibility of related expenses under Section 38(1)(a) must also be reviewed to ensure compliance.

Critical Concepts:

• Section 38(1)(a): Allows deductions for expenses incurred wholly and exclusively for business purposes. These expenses must be directly related to the business and not personal or capital in nature.
• Section 92: Governs the computation of income from international transactions or specified domestic transactions, ensuring they are priced at arm’s length.
• Arm’s Length Principle: Requires that transactions between related parties be conducted as if they were between unrelated parties, ensuring fair pricing and compliance with tax laws.

Compliance Steps:

1. Document Expenses: Maintain detailed records of all expenses claimed under Section 38(1)(a), ensuring they are wholly and exclusively for business purposes.
2. Align with Transfer Pricing Documentation: Ensure that expenses related to international or specified domestic transactions are consistent with transfer pricing documentation and the arm’s length principle.
3. Review Transfer Pricing Adjustments: If adjustments are made under Section 92, reassess the deductibility of related expenses under Section 38(1)(a) to ensure compliance.

Example:

A company in India purchases raw materials from its subsidiary in Germany. The transaction is subject to transfer pricing rules under Section 92. The company incurs transportation costs for importing the materials, which it claims as a deduction under Section 38(1)(a). Under Section 95, the company must ensure that the transportation costs are:

• Wholly and exclusively for business purposes.
• Consistent with the arm’s length principle (i.e., the costs are reasonable and comparable to what an unrelated party would charge).

If the transfer pricing officer adjusts the transaction value under Section 92, the company must also review the deductibility of the transportation costs under Section 38(1)(a) to ensure they remain compliant.

This section ensures uniformity in expense deductions across domestic and international transactions, reinforcing the arm’s length principle in transfer pricing.