Clarification to prevent erosion of Indian tax base through Transfer Pricing adjustments in hands of Foreign Companies


Overseas AEs may decide either not to charge any consideration; or charge moderate consideration, which may otherwise be less than the market driven or arm’s length price (ALP).

Any receipt of interest, fees or royalty on such loans, services and licenses respectively, would attract income tax in the hands of the overseas AEs in India @ 10% under Indian domestic tax laws and/ or tax treaties, where the overseas AEs do not have permanent establishments in India.

On the other hand, any payment of such consideration would obtain tax breaks in the hands of the Indian taxpayers @ 30%, through deduction or allowance while computing business profits.

Thus, in other words, the Indian taxpayers, either by not paying any such consideration; or paying any consideration less than the arm’s length price, the Indian exchequer would have only benefitted in the form of tax savings @ 20% thereof. This is generally referred to as the “base erosion” theory or concept.

In the background of identical facts, a TP adjustment was made by the Indian Revenue in the hands of a foreign company in the case of Instrumentarium Corporation Ltd v ADIT [2016] 49 ITR(T) 589 (Kolkata – Trib), by disregarding the concept of “base erosion”. The TP adjustment ultimately reached the Hon’ble Income Tax Appellate Tribunal (the Tribunal) for resolution. Being a matter having nationwide ramification, the erstwhile

Hon’ble President of the Tribunal had constituted a Special Bench of the Tribunal in Kolkata in 2009 for deciding the matter. The case was finally heard and disposed of by the Special Bench of the Tribunal in the month of July, 2016, by dealing with the matters arising in the hands of the aforesaid assessee and another intervener.

The Special Bench had decided the issue in favour of the Revenue, by disregarding the concept of “base erosion”.

Incidentally, while doing so, the Special Bench had seemingly misinterpreted the provisions of section 92(3) of the Income-tax Act, 1961 (the Act) read with Circular No. 14 of 2001 issued by the Central Board of Direct Taxes (CBDT) in the year 2001 to explain the newly introduced provisions of TP (Circular).

Section 92(3) of the Act reads as under (inserted the context, wherever required):

“The provisions of this section shall not apply in a case where the computation of income under sub-section (1) or sub-section (2A) or the determination of the allowance for any expense or interest under sub-section (1) or sub-section (2A), or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2) or subsection (2A) (all these subsections provides for determination of value of international transaction at arm’s length price), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction or specified domestic transaction was entered into.”

Though it is not very explicitly coming out from the above mentioned provisions of section 92(3) of the Act, the Central Board of Direct Taxes (CBDT) at paragraph 55.5 of the said Circular explained as under:

“The new provision is intended to ensure that profits taxable in India are not understated (or losses are not overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country’s tax base. The new section 92 is, therefore, not intended to be applied in cases where the adoption of the arm’s length price determined under the regulation would result in a decrease in the overall tax incidence in India in respect of the parties involved in the international transactions.”

The Revenue Officers and the Special Bench of the Tribunal have actually applied TP provisions in a reverse manner, which again, defeats the whole purpose of introducing TP. You may note that the concept of “base erosion”, under identical circumstances, has been approved by the Australian Tax Office (ATO) vide one of its rulings, being equivalent to circulars issued by the CBDT. However, the Special Bench of the Tribunal had refused to be persuaded by the ruling of the ATO on grounds, not appealing to logic.

The main logic applied by the Special Bench of the Tribunal in taking the aforesaid view, is that since the Indian TP regulations do not contain the provisions of compensatory downward adjustment in the hands of the paying company upon a TP adjustment being made in the hands of the payee company, by virtue of the restrictions contained in section 92(3) of the Income-tax Act, 1961 (Act) as in the aforesaid cases, the concept of “base erosion” could not be applied in the context of Indian TP provisions.

The aforesaid ruling of the Special Bench of the Tribunal is likely to have far reaching negative tax consequences in the hands of several foreign companies in India, who might not have charged either any consideration of the above nature; or charged less than arm’s length consideration, from their Indian AEs, under a bona fide and correct belief that by not charging such consideration, the Indian exchequer was not getting impacted in any way, being the very object of introducing TP regulations in India.

Further, if the said interpretation of the Special Bench of the Tribunal is to be accepted, then all foreign companies would, most likely, start charging interests, royalties and fees from their Indian AEs, even under situations, where, for various commercial reasons, they would not have charged so, as a result of which, the Government exchequer would be actually losing to the extent of 20% of all such charges, in the form of income tax, being a reverse form of “base erosion”, which one finds difficult to comprehend. This will significantly erode the tax base of India, which perhaps could be only the country in the world to be applying the provisions of TP to its disadvantage.

In the case of Cummins Inc. v. ADIT [2016] 73 207 (Pune), the assessee had provided services to the Indian entities and had received charges in respect of desktop/laptop software licence and internet mail and had determined the value of transactions by allocating cost based on cost estimates. However, the TPO did not accept the same and made the adjustment. The Pune Tribunal held that where the assessee is a foreign company and is a recipient of internet mail charges and desktop /laptop service charges from the Indian entities and in case the assessee have to charge higher amounts from the Indian entities, then the same would result in reduction of overall tax base of India. In such circumstances, the Indian Transfer Pricing provisions are not to be applied.

The Pune Tribunal observed that during the subsequent Assessment Years, the DRP and the AO have not made any similar adjustment in the hands of assessee on account of internet mail service charges and desktop/laptop service charges though identical international transactions were carried out in those years.

The said intention of the TP provisions is also clear from the introduction of section 92CE providing for secondary adjustment vide Finance Act, 2017 wherein it is provided that “where, as a result of primary adjustment to the transfer price, there is an increase in the total income or reduction in the loss, as the case may be, of the assessee, the excess money which is available with its associated enterprise, if not repatriated to India within the time as may be prescribed, shall be deemed to be an advance made by the assessee to such associated enterprise and the interest on such advance, shall be computed in such manner as may be prescribed.”

The above clearly demonstrates that intention of the TP provisions is to bring back excess money eroded from India rather than allowing foreign companies to take excess money out of India. If upward TP adjustment in the hands of the foreign company is sustained, as per the provisions of section 92CE, foreign company is required to bring money, however, since they have earned this income they will be required to remit this money out of India, this will create an absurd situation, not intended by the law.


Considering the above, we request you to clarify either by making necessary amendments in the provisions of section 92 of the Act; or by issuance of a circular, ideally being the latter, to prevent the unintended application of the TP provisions of India in the manner, as aforesaid; and also obviate the hardship faced by foreign companies in India.

Source-  ICAI Pre-Budget Memorandum–2018 (Direct Taxes and International Tax)

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June 2021