Introduction
The revenue authorities have been given powers under various provisions of the Act to assess the income and taxability of the income earned by the taxpayers, in some cases even to search and survey the business of the taxpayer, however, taxpayers have complete authority to decide the business and it is left to the taxpayer to take business decisions, the income tax authorities have no rights to question the commercial wisdom the taxpayer pertaining to their business.
Revenue intruding the business decisions of taxpayer
The Income tax authorities have complete jurisdiction to travel around in assessing the business of taxpayers concerning income earned and its applicability of tax, the decisions of business per se lies with the taxpayers and the tax authorities have no power to interfere in such matters.
When any taxpayer’s case is referred to the Transfer Pricing Officer (‘TPO’) by the Assessing officer, it is the duty of the TPO to determine the Arm’s length price of the transaction. Since the Assessing officer has already tested the genuineness and validity of the business transaction.
However, in the case of Dresser-Rand India (P.) Ltd.[1] (‘Assessee’), Assessee had incurred expenses towards cost contribution allocation by its holding company, the Ld. Transfer Pricing Officer (‘TPO’) contended there were no real services availed by the Assessee from its holding company, under the cost contribution arrangement (‘CCA’), and hence the payment, under the said arrangement, was not a genuine expenditure incurred for the purposes of business of the Assessee and held that the arm’s length price (‘ALP’) of services availed by the Assessee is determined to be NIL. Since, as per the TPO, Assessee is not required to appoint / avail services from patent company, since it had the capability to appoint a local vendor/ experts/ professionals to perform the shared services agreed under the agreement, the TPO is of the view that such services are just made up for increasing expenses and did not even constitute a service. When the ALP is determined to be NIL (Zero), such expenses shall be adjusted (added back) to the business profits and offer to tax.
The Hon’ble ITAT Mumbai held that it is irrelevant to analyse the benefit derived by the Assessee from the CCA rather the TPO should determine the ALP of the service, when an independent enterprise would have paid for the same and it is left to the wisdom of the Assessee to decide on the business.
Further, the tax authorities have their views of regarding services performed between associated enterprises (‘AE’) , where they argue that the services performed by the AE are worthless when the said service could have been performed on their own and when the taxpayer has capability to perform any service or task on its own by using its own manpower or resources, if the same services are availed form the AE’s, such services are said to have been availed just to inflate the expenses. However, in the case of Schneider Electric India (P.) Ltd [2], the Hon’ble Tribunal held that the revenue has no authority to interfere in deciding the worthiness of the service and its benefits.
The TPO cannot surpass its jurisdiction by judging the commercial expediency of service availed by the taxpayer from its related party
Often the taxpayers are questioned to demonstrate the need for availing the service from its related party (‘Associated enterprise’ or ‘AE’) and asked to prove the benefit out of the cost incurred, when there is a huge cost incurred by the taxpayer, the Assessing officers and Transfer pricing officers are worried about the amount of expenses booked in the books of accounts and claimed as deduction while computing total income. However, the taxpayers are not restricted from availing services from its AE, unless they have underlying agreement to support the transaction and documents/ evidence to prove the expense was genuinely incurred in connection to business.
It was held in the case of EKL Appliances Ltd[3][4] that the TPO is not allowed to question the judgement of the taxpayer as to how it conducts its business and question the need for availing any service or otherwise in incurring such expenses. Further, the Hon’ble Hogh court held that it the businessman to decide the business in terms of choosing the party with whom it transacts, take steps to meet the market expectations and strive for competition, it is not the domain of the TPO or Tax authority to interfere in business expediencies and should only determine the expenses are incurred as per provisions of law.
Disallowances of expenses and Adjustments to taxable income
The taxpayers suffer Transfer Pricing adjustment when erroneous decisions are taken by the revenue authorities, revenue authorities target the expenses or payments made to AE’s, since this is the area where they can project their views in disallowance of expenses in terms of taxpayers. The TPO proceeds to judges the taxpayers capability in terms of carrying out the work on its own, by using its own resources or employee, at times there situations where the taxpayers do have the ability to employ its own employees or local resources to accomplish a work and might be no necessity to engage a non-resident AE to avail such services, in the view of the TPO, when such services are locally available or the employees of taxpayers are capable of carrying out such service, it shall be abnormal to avail such service form a non-resident AE, in such situation, TPO shall question the purpose of such service and the benefit to the taxpayer from such expenses in order to determine the existence of service.
Conclusion
When there exits an underlying agreement for a service and such service involves efforts regardless of value, performing the service as required under the agreement and accomplishing the needs of the taxpayer is the sufficient evidence to prove the existence of service. However, a similar ground can be seen in the case of Goodyear India Ltd.[5] , the tribunal held that the TPO is limited to carrying out the Transfer Pricing analysis and ALP of the transaction and not to decide if the service exist or beneficial to the taxpayer. There are cases where the complete or no benefit shall flow to the taxpayer for the expenses incurred, say for example, payment of Advocate fees and the result of the case is a failure, we can’t say that the expenses did not exist or incurred, since the taxpayer did not benefit out of the advocate fees. Accordingly, many business expenses may not reap adequate benefit to the taxpayer and such expenses cannot be held to be disallowed or non-existing. A similar footing can be seen in the Goodyear India Ltd case (Supra).
Way forward
Service agreement should be executed between parties to establish the relationship and scope of work agreed between them, proper documentation of the intercompany and intra group transaction is necessary to substantiate the existence of service. The maintenance of documentary evidence not only helps the taxpayers in compliance but also to save themselves in terms of tax and transfer pricing litigations.
[1] Dresser-Rand India (P.) Ltd. Vs. ACIT Range – 6(2), Mumbai, IT APPEAL NO. 8753 (MUM.) OF 2010
[2] Schneider Electric India (P.) Ltd. V. DCIT, Vadodara, IT APPEAL NO. 209 (AHD.) OF 2015
[3] EKL Appliances Ltd. [TS-206-HC-2012 (Del.)-TP] (para 18)
[4] Metalsa India (P.) Ltd. V. DCIT IT Appeal No. 449 (Delhi) of 2019
[5] Goodyear India Ltd. V. DCIT, Delhi, IT APPEAL NOS. 346 & 1451 (DELHI) OF 2022
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