AO not justified in adjustment to a international transaction whose arm’s length character is accepted by Transfer Pricing Officer (TPO)

The Delhi bench of the Income-tax Appellate Tribunal (the Tribunal), in the case of Oracle India (P) Ltd. V. ACIT (2009-TIOL-540-ITAT-DEL) (the taxpayer) held that section 40A(2) of the Income-tax Act, 1961 (the Act) overrides the provisions relating to computation of business income only and thus in relation to international transactions, the specific provisions embodied in Chapter X (section 92 – 92F) shall override the general provisions embodied in section 40A of the Act. Hence, once the Transfer Pricing Officer (TPO) accepts the arm’s length character of any international transaction, the Assessing Officer (AO) could not make an adjustment in relation to that transaction under section 40A(2) of the Act.

Facts of the Case

• The taxpayer paid royalty to its parent company – Oracle Corporation, USA for duplication and distribution of software.
• The TPO did not make any adjustment in respect of payment of royalty.
• However, the AO made an addition under section 40A(2)(b) of the Act on the grounds that the said section overrides other provisions of the Act.
• The Commissioner of Income-tax (Appeals) [CIT(A)] confirmed disallowance of INR 180 million relating to royalty paid to the parent company.

Taxpayer’s Contentions

• CIT(A) erroneously confirmed the disallowance of royalty payment and held that the provisions of Section 40A(2) of the Act override the provisions relating to transfer pricing under Chapter X of the Act.
• The CIT(A) erroneously held that fixing royalty with reference to the Indian Published Price (IPP) of the software vis-à-vis the actual sales price was unreasonable despite the fact that the payment of royalty at rates up to 30 percent of IPP was allowed under automatic approval by the Reserve Bank of India.
• CIT(A) confirmed disallowance of royalty payment and disregarded the TPO’s order under section 92CA(3) of the Act which upheld royalty payment to be at arm’s length.
• CIT(A) erroneously held that the arm’s length consideration as determined by the TPO was not in accordance with the provision of section 92C(1) of the Act.
• CIT(A) disregarded provisions of section 92CA(4) of the Act which requires the AO to compute the total income of the taxpayer having regard to the arm’s length price determined by the TPO.

Tribunal’s ruling

• In relation to the Assessment Years (AY) 1999-2000, 2000-01, 200 1-02, as regards royalty payments, the Tribunal had ruled in favour of the taxpayer by holding that the provisions of section 92 of the Act (pre – enactment of detailed Transfer Pricing legislation) could not be invoked as the tax authorities had failed to demonstrate that the profits earned by the taxpayer were less than ordinary profit.
• Further, in relation to AY 2002-03 also, the TPO had accepted the arm’s length character of the international transaction of payment of royalty.
• Also, the special bench of Bangalore Tribunal in the case of Aztec Software Technology Services Ltd. v. CIT [2007] 107 ITD 141 (Bang) has held that section 40A(2) of the Act has an overriding effect over the provisions relating to the computation of income under the head “Profits and Gains of business or profession” and not over the transfer pricing provisions embodied in Chapter X of the Act. The Transfer Pricing provisions, being specific provisions designed to ensure arm’s length compliance, would prevail over other general provisions of the Act like section 40A of the Act.
• Considering the above, the CIT(A) was not justified in disallowing the royalty payment by invoking the provisions of section 40A(2) of the Act.
• The AO should determine the income of the taxpayer in accordance with the order of the TPO.

Our Comments

Relying on the principle that specific provisions of the Act should prevail over the general provisions of the Act, the Tribunal has held that transfer pricing provisions, being specific to international transactions between associated enterprises, should prevail over section 40A(2) of the Act (being general provision applicable to all transactions).

The above principle should also apply to cases where AO himself examines the international transactions without a reference to the TPO under section 92CA of the Act.

Accordingly, in all cases, the computation of arm’s length price of international transactions between associated enterprises should be with reference to the specific transfer pricing provisions and not with reference to the general provisions of the Act.