The transfer pricing concept is new to the Indian tax system. These provisions are intended to curb the mischief of avoidance of payment of tax in India either by understating the receipt or by overstating the expenses in respect of international transaction with Associates Enterprises.  As observed by the Honourable Supreme Court in Morgan Stanley’s case (292 ITR 416) “The object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India”.But, where a taxpayer adopts the arm’s length price, no addition to income on account of transfer pricing provisions can be made.

However, determination of an arm’s length price and to substantiate the same with the prescribed documentation is primarily the taxpayer’s responsibility. Where the assessee discharges such onus and the data used for determining the arm’s length price is reliable and correct, there can be no intervention by the Assessing Officer.

In two recent Tribunal Judgments namely – Aztec Software & Tech Ltd (2007) 107 ITD 141 (SB) and Mentor Graphics (Noida) (P) Ltd 165 Taxman 28, it has been judicially recognised that determination of arm’s length price may not always be an easy task.

The Honourable ble Tribunal observed “it is true that “transfer pricing” is not an exact science, evaluation of transactions through which the process of determination is carried is an art where mathematical certainty is indeed not possible and some approximation cannot be ruled out, yet it has to be shown that analysis carried was “judicial” and was done after taking into account all the relevant facts and circumstances of the case”.

A careful study of the above judgments would show that if a taxpayer takes following steps for determining the arm’s length price, the rigour of transfer pricing can be avoided.

The first step is to analyse the specific characteristics of the controlled transaction, whether it relates to transfer of goods, services or intangibles.

Selection of comparables.

Thereafter, the best method of determining arm’s length price is selected as per Rule 10C (2) of Income Tax Rules. Selection of the most appropriate method is to be substantiated by suitable documentation. Thereafter, FAR analysis is carried out to identify functions, risks and assets of uncontrolled transactions.

The next step is search of comparable companies. The objective of this search is to identify independent companies involved in similar or almost similar activities.

Lastly, suitable adjustments are made and then finally arm’s length price is determined.

In the case of Mentor Graphics (supra), the assessee adopted the aforesaid procedure. The Honourable Tribunal observed “Computation of the arm’s length price is essentially a factual exercise. Each case depends on its own peculiar facts and circumstances.

In certain cases where an identical or almost similar uncontrolled transaction is available for comparison, determination of the arm’s length price is an easy task.

However, it is not so in most transactions and rarely is one able to locate an identical transaction. In such cases, the arm’s length price is determined by taking the results of a comparable transaction in comparable circumstances and making suitable adjustments for the differences” . It could not be located even by the assessee, an attempt was made to find comparable transactions as close as possible to the controlled transaction” .

Thereafter, there is nothing further for the taxpayer to establish that controlled transaction with Associate Enterprises was an arm’s length transaction.

The addition made on account of transfer pricing was thus deleted.

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