Specified Domestic Transactions: Section 92BA Transfer Pricing — Compliance, Documentation & Benchmarking Guide

Legislative Background: Why Domestic Transactions Were Brought Under Transfer Pricing

Prior to the Finance Act, 2012, India’s transfer pricing provisions applied exclusively to international transactions between associated enterprises. Domestic transactions between related parties were governed solely by Section 40A(2), which gave the Assessing Officer the power to disallow expenditure that was considered “excessive or unreasonable” having regard to the fair market value of goods, services, or facilities. However, Section 40A(2) lacked the structured benchmarking framework, documentation requirements, and specialised officer (TPO) that the transfer pricing regime provided.

The introduction of SDTs was driven by two policy objectives:

First, preventing profit shifting within India. Companies with tax-exempt units (SEZ units claiming Section 10AA deduction, infrastructure companies claiming Section 80-IA deduction) could shift profits from taxable units to exempt units through artificial transfer pricing. For example, an infrastructure company with a Section 80-IA eligible power plant could sell power to its own manufacturing unit at an inflated price, shifting profits to the tax-exempt power unit. Section 92BA(iii), read with Section 80-IA(8), addressed this by requiring such inter-unit transfers to be priced at arm’s length.

Second, bringing rigour to related party expenditure scrutiny. Section 40A(2) gave the Assessing Officer wide discretion without a structured methodology. By bringing such transactions under the transfer pricing framework, the legislature ensured that the same comparability analysis, documentation requirements, and appellate safeguards that applied to international transactions would also apply to domestic related party transactions.

Categories of Specified Domestic Transactions

Category 1: Section 40A(2)(b) Expenditure

Section 92BA(i) covers any expenditure in respect of which payment has been made or is to be made to a person referred to in Section 40A(2)(b). The covered persons include:

(i) Any relative of the assessee (as defined in the Explanation to Section 40A(2));

(ii) Any director of the company, or any relative of the director;

(iii) Any partner of the firm, or any relative of the partner;

(iv) Any member of the HUF, or any relative of the member;

(v) Any individual who has a substantial interest in the business or profession of the assessee, or any relative of such individual;

(vi) A company, firm, AOP, or HUF having a substantial interest in the business of the assessee or any director, partner, or member of which has a substantial interest in the business of the assessee;

(vii) A company, firm, AOP, or HUF of which the assessee holds a substantial interest, or a director, partner, or member of which holds a substantial interest.

“Substantial interest” means beneficial ownership of not less than 20% of the equity shares or voting power (for a company) or entitlement to not less than 20% of the profits (for a firm, AOP, or HUF).

Common examples of Section 40A(2)(b) expenditure that qualify as SDTs include: rent paid to directors or their relatives, salary paid to directors (where the aggregate with other SDTs exceeds Rs. 20 crore), consultancy fees paid to a company in which a director holds 20% or more, purchase of goods from a partnership firm in which the company’s director is a partner, and interest on loans from persons with substantial interest.

Category 2: Section 80-IA(8) Inter-Unit Transfers

Section 92BA(iii) covers any transfer of goods or services referred to in sub-section (8) of Section 80-IA. Section 80-IA(8) provides that where any goods or services held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods or services held for the purposes of any other business are transferred to the eligible business, then the consideration for such transfer shall correspond to the market value of such goods or services.

This provision targets the artificial inflation of profits in the eligible undertaking through non-arm’s length inter-unit transfer pricing. For example, if a company operates both a power plant (eligible for Section 80-IA deduction) and a manufacturing unit, and the power plant supplies electricity to the manufacturing unit at a price higher than the market rate, the excess profit in the power plant reduces taxable income through the Section 80-IA deduction.

The “market value” for Section 80-IA(8) purposes is now determined using the transfer pricing methodology — the arm’s length price under Section 92C, using the most appropriate method. This brings rigour and predictability to what was previously a subjective “market value” determination by the Assessing Officer.

Category 3: Section 80-IA(10) Transactions with Close Connection

Section 92BA(iv) covers any business transacted between the assessee and other persons as referred to in Section 80-IA(10). Section 80-IA(10) provides that where it appears to the Assessing Officer that, owing to the close connection between the assessee and any other person, or for any other reason, the course of business between them is so arranged that the business transacted between them produces to the assessee more than the ordinary profits that might be expected to arise in such business, the Assessing Officer may compute the profits on a reasonable basis.

This is a broad provision that covers arrangements designed to artificially inflate the profits of the eligible undertaking through transactions with closely connected persons. The “close connection” is not defined and gives the Assessing Officer wider latitude than the “associated enterprise” definition under Section 92A.

Category 4: Chapter VI-A and Section 10AA Transactions

Section 92BA(v) covers any transaction referred to in any other section under Chapter VI-A or Section 10AA to which provisions of sub-section (8) or (10) of Section 80-IA are applicable. This is a sweep-up provision that extends the SDT framework to all profit-linked deductions where cross-subsidisation between eligible and non-eligible businesses is possible.

Deductions covered include Section 80-IAB (SEZ developers), Section 80-IB (certain undertakings), Section 80-IC (certain states), and Section 10AA (SEZ units). Each of these sections contains provisions similar to Section 80-IA(8) and (10) for determining the profits of the eligible undertaking at arm’s length.

The Rs. 20 Crore Threshold

The SDT provisions apply only where the aggregate value of specified domestic transactions during the previous year exceeds Rs. 20 crore. This is a critical threshold that determines whether the full transfer pricing compliance machinery — documentation, Form 3CEB, and TPO reference — is triggered.

Important points regarding the threshold:

Aggregation: The Rs. 20 crore threshold applies to the aggregate of all specified domestic transactions, not each transaction individually. A company with Section 40A(2)(b) expenditure of Rs. 15 crore and Section 80-IA(8) inter-unit transfers of Rs. 8 crore has aggregate SDTs of Rs. 23 crore, exceeding the threshold.

Both sides of the transaction: The threshold is tested for the assessee. If Company A pays Rs. 25 crore to its director’s relative company (Company B) for services, the SDT provisions apply to Company A (the payer). Whether Company B has SDTs exceeding Rs. 20 crore depends on its own aggregate transactions.

Exclusion of international transactions: International transactions are not included in the aggregate for determining the SDT threshold. They are separately governed by the international transaction provisions of Sections 92 to 92F.

Documentation and Compliance Requirements

Maintenance of Documentation Under Rule 10D

Once the Rs. 20 crore threshold is crossed, the assessee must maintain contemporaneous documentation under Section 92D read with Rule 10D for specified domestic transactions. The documentation requirements are identical to those for international transactions — functional analysis, comparability analysis, method selection, and arm’s length price determination.

However, there are practical differences in documenting SDTs compared to international transactions:

Comparability pool: For SDTs, the comparable set is restricted to domestic comparables. This is conceptually simpler than international transactions where the question of geographic comparability arises.

Functional analysis: For Section 40A(2)(b) expenditure, the functional analysis focuses on the nature of the service or goods provided by the related party and whether the price paid is consistent with what would be paid to an independent party for the same service or goods.

Inter-unit transfers: For Section 80-IA(8) transactions, the benchmarking involves comparing the inter-unit transfer price with the market price at which the same goods or services are available from independent parties. Where the company has both third-party and related-party transactions for the same goods/services, the CUP method is the most appropriate.

Form 3CEB — Part B

Form 3CEB has two parts: Part A for international transactions and Part B for specified domestic transactions. Part B requires the Chartered Accountant to certify the particulars of each specified domestic transaction, the method used for determining ALP, and the arm’s length price determined. The format mirrors Part A but applies to the SDT categories. The due date for filing Form 3CEB (including Part B) is 31st October of the assessment year, consistent with the transfer pricing audit timeline.

Reference to TPO

Under Section 92CA, the Assessing Officer may refer the computation of ALP in respect of specified domestic transactions to the TPO, following the same procedure as for international transactions. The TPO’s order is binding on the Assessing Officer. In practice, references to TPO for SDTs are less frequent than for international transactions, but they do occur — particularly for high-value inter-unit transfers in infrastructure and power companies claiming Section 80-IA deductions.

Benchmarking Specified Domestic Transactions

Method Selection for Section 40A(2)(b) Transactions

For expenditure under Section 40A(2)(b), the method selection depends on the nature of the transaction:

Comparable Uncontrolled Price (CUP): Where the assessee pays for goods or services that are also procured from independent parties, the CUP method provides the most direct comparison. For example, if a company rents office space from a director’s relative at Rs. 150 per square foot, and comparable independent properties in the same area are rented at Rs. 120-130 per square foot, the CUP method directly establishes the arm’s length range.

Transaction Net Margin Method (TNMM): Where the transaction involves unique services (such as management consultancy or technical services from a related entity) and no direct CUP is available, TNMM may be applied by benchmarking the service provider’s net profit margin against comparable independent service providers.

Cost Plus Method (CPM): For transactions involving provision of services on a cost-recovery or cost-plus basis, the CPM is appropriate. The arm’s length mark-up is determined by reference to comparable independent service arrangements.

Method Selection for Section 80-IA(8) Inter-Unit Transfers

For inter-unit transfers, the CUP method is almost always the most appropriate, as the “market value” referred to in Section 80-IA(8) directly corresponds to the CUP concept. Where the company sells the same product to third parties and transfers it to its own units, the third-party price (adjusted for quantity discounts, payment terms, and delivery costs) is the internal CUP.

Where no direct CUP is available — for example, where the power plant supplies electricity exclusively to the manufacturing unit — external benchmarks such as the state electricity board’s industrial tariff rates, CERC/SERC tariff orders, or power exchange prices may be used as the arm’s length benchmark.

Key Litigation Issues in SDTs

Deletion of Section 92BA(i) — Finance Act, 2017

The Finance Act, 2017 omitted clause (i) of Section 92BA with effect from 1st April 2017 (AY 2017-18). This means that expenditure under Section 40A(2)(b) is no longer a specified domestic transaction from AY 2017-18 onwards. However, transactions under Section 80-IA(8), 80-IA(10), and other Chapter VI-A/Section 10AA provisions continue to be SDTs.

This omission significantly reduced the SDT compliance burden for many companies, as Section 40A(2)(b) expenditure was the most common category of SDTs. Companies that exceeded the Rs. 20 crore threshold solely on account of Section 40A(2)(b) expenditure are no longer required to maintain TP documentation or file Form 3CEB Part B (unless they have other categories of SDTs exceeding Rs. 20 crore).

For assessment years prior to AY 2017-18, SDT proceedings relating to Section 40A(2)(b) expenditure continue to be litigated. The key issues include the reasonableness of the expenditure, the selection of comparables, and whether the Assessing Officer can make a disallowance under both Section 40A(2) and the SDT/transfer pricing framework.

Interplay Between Section 40A(2) and Transfer Pricing

For years where Section 92BA(i) was in force, a question arose whether the Assessing Officer could make a disallowance under Section 40A(2) independently of the transfer pricing determination. The ITAT and High Courts have held that where a transaction is classified as an SDT and referred to the TPO, the arm’s length price determined through the transfer pricing framework supersedes the Section 40A(2) disallowance. The Assessing Officer cannot make an independent disallowance under Section 40A(2) in addition to the TP adjustment — this would amount to double disallowance.

Threshold Computation Disputes

Several disputes have arisen regarding the computation of the Rs. 20 crore threshold — whether it includes transactions at both ends (payments made and received), whether notional transactions (such as deemed interest on interest-free loans) are included, and whether transactions that are not actually claimed as deductions should be counted. The prevailing view is that the threshold is computed based on the aggregate value of transactions as defined in Section 92BA, regardless of whether the transaction results in a deduction claim.

Practical Compliance Checklist for SDTs

At Virtual Auditor, we follow a structured checklist for SDT compliance:

Step 1 — Identify related parties: Map all persons covered under Section 40A(2)(b) — directors, their relatives, persons with substantial interest, and entities in which such persons have substantial interest. Also identify eligible undertakings claiming deductions under Section 80-IA, 80-IB, 80-IC, 80-IAB, or 10AA.

Step 2 — Quantify transactions: Extract all transactions with identified related parties from the general ledger. Separately quantify inter-unit transfers for entities with eligible and non-eligible businesses. Compute the aggregate to test the Rs. 20 crore threshold.

Step 3 — Prepare documentation: If the threshold is crossed, prepare the TP Study Report covering all SDT categories. Conduct the functional analysis, select the most appropriate method, perform the comparability search, and determine the arm’s length price for each transaction category.

Step 4 — File Form 3CEB Part B: Ensure that all SDTs are reported in Part B of Form 3CEB with accurate transaction values, methods used, and arm’s length prices determined. File by 31st October of the assessment year.

Step 5 — Maintain records: Archive all supporting documents — contracts, invoices, market data, comparable search strategy, and the TP Study Report — for eight years from the end of the relevant assessment year.

Frequently Asked Questions

1. Is Section 40A(2)(b) expenditure still a specified domestic transaction?

No. The Finance Act, 2017 omitted clause (i) of Section 92BA with effect from 1st April 2017 (applicable from AY 2017-18). From AY 2017-18 onwards, expenditure under Section 40A(2)(b) is not a specified domestic transaction. However, such expenditure may still be disallowed under Section 40A(2)(a) if the Assessing Officer considers it excessive or unreasonable — but this disallowance follows the general assessment procedure, not the transfer pricing framework.

2. How is the Rs. 20 crore threshold computed?

The threshold is the aggregate value of all specified domestic transactions entered into during the previous year. All categories of SDTs are aggregated — Section 40A(2)(b) expenditure (for years where applicable), Section 80-IA(8) inter-unit transfers, Section 80-IA(10) transactions, and Chapter VI-A/Section 10AA transactions. International transactions are not included in this aggregate. If the aggregate exceeds Rs. 20 crore, TP compliance is mandatory for all SDTs, not just those exceeding the threshold individually.

3. Can the TPO make adjustments to specified domestic transactions?

Yes. Under Section 92CA, the Assessing Officer may refer the computation of ALP for SDTs to the TPO, and the TPO’s determination is binding on the Assessing Officer. The TPO follows the same procedure for SDTs as for international transactions — issuing a reference order, requiring the assessee to furnish information, conducting the comparability analysis, and determining the ALP. The assessee has the right to be heard before the TPO and to appeal the TPO’s order (as part of the assessment order) to the CIT(A) and ITAT.

4. Do Master File and CbCR requirements apply to SDTs?

No. The Master File obligation under Rule 10DA and the Country-by-Country Report obligation under Rule 10DB apply only to international groups and international transactions. SDTs do not trigger Master File or CbCR filing requirements. Only the Local File documentation under Rule 10D and Form 3CEB Part B are required for SDTs.

5. What happens if SDTs are not reported in Form 3CEB?

Failure to report SDTs in Form 3CEB Part B may attract penalty under Section 271AA(1)(b) — 2% of the value of the unreported transaction — for failure to report a transaction that was required to be reported. Additionally, if Form 3CEB is not filed at all, penalty under Section 271BA (Rs. 1,00,000) applies. Proper identification and reporting of all SDTs is therefore critical to avoiding penalty exposure.

6. How does Virtual Auditor assist with SDT compliance?

At Virtual Auditor, we provide end-to-end SDT compliance — from related party identification and transaction mapping, through documentation and benchmarking, to Form 3CEB filing and assessment defence. Our approach ensures that the arm’s length price for each SDT is determined using the most appropriate method with robust comparable data, and that the documentation meets the contemporaneous standards under Rule 10D. For companies with eligible undertakings, we pay particular attention to inter-unit transfer pricing to ensure that valuation and pricing withstands TPO scrutiny.