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Understanding Transfer Pricing With Latest Case Laws Part 2

TG Team 13 Nov 2011 4,761 Views 0 comment Print Income Tax | Articles, Featured

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CA Manish Agarwal

Author has Earlier written Part -I of Article on Understanding Transfer Pricing With Latest Case Laws and has now come with Part -2 of the same with some more case laws.

Now a days, during transfer pricing assessment , the TPO are coming with unique ideas like valuation of intangibles , corporate guarantees, ratings provided by CRISIL etc. this all leads to corporate in a mysterious situation. Below are the summarized form of the latest judicial pronouncements on transfer pricing which will help corporate in better benchmarking of their international transactions with their foreign associate enterprises.

Bangalore ITAT in the case of Tally Solutions decided that there is nothing in s.92CA that requires the AO to first form a “considered opinion” before making a reference to the TPO. It is sufficient if he forms a prima facie opinion that it is necessary and expedient to make such a reference. The making of the reference is a step in the collection of material for making the assessment and does not visit the assessee with civil consequences. There is a safeguard of seeking prior approval of the CIT. Moreover, by virtue of CBDT’s Instruction No.3 of 2003 dated 20.5.2003 it is mandatory for the AO to refer cases with aggregate value of international transactions more than Rs.5 crores to the TPO The argument that the “Excess Earning Method” adopted by the TPO is not a prescribed method is not acceptable. A sale of IPR is not a routine transaction involving regular purchase and sale. There are no comparables available. The “Excess Earning Method” is an established method of valuation which is upheld by the U.S Courts in the context of software products. The “Excess Earning Method” method supplements the CUP method and is used to arrive at the CUP price i.e. the price at which the assessee would have sold in an uncontrolled condition.

In the case of CIT v Rakhra Technologies ( P) Ltd 243 CTR 505 it was held that in the absence of any perversity in the finding of the Tribunal in the selection of a different set of comparables for determination of ALP and re-computation of ratio of operating profit/total cost at 21.97% as against 35.26% adopted by TPO, no interference is warranted. The High court further upheld the decision of the Tribunal of allowing depreciation on administrative assets for determining the operating profits while computing the ALP. (A.Y.2005‐06).

In the case of Diageo India Pvt. Ltd v ACIT 47 SOT 252 it was decided that If one enterprise controls the decision making of the other or if the decision making of two or more enterprises are controlled by same person, these enterprises are required to be treated as ‘associated enterprises’. Though the expression used in the statute is ‘participation in control or management or capital’, essentially all these three ingredients refer to de facto control on decision making. The argument, based on Quark Systems 38 SOT 307 (SB), that exceptionally high and low profit making comparables are required to be excluded from the list of TNMM comparables is not acceptable. Merely because an assessee has made high profit or high loss is not sufficient ground for exclusion if there is no lack of functional comparability. While there is some merit in excluding comparables at the top end of the range and at the bottom end of the range as done in the US Transfer Pricing Regulations, this cannot be adopted as a practice in the absence of any provisions to this effect in the Indian TP regulations. (Benefit of +/‐ 5% adjustment as directed in UE Trade Corporation 44 SOT 457 to be given); The adjustment made by the TPO with regard to the advertisement expenditure incurred by the assessee was without jurisdiction because the AO had not made any reference on this issue to the TPO. As the reference to the TPO is transaction specific and not enterprise specific, the TPO Officer has no power to go into a matter which has not been referred to him by the AO. Even the CBDT Instructions are clear on this (3i Infotech Ltd 136 TTJ 641 followed)( A.Y.2006‐07).

The expression “shall” has been used in rule 10B (4) which makes it abundantly clear that only current year data of an uncontrolled transaction is to be used for the purpose of comparability while examining the international transactions with AE s , unless the case is covered by the proviso i.e. if the data of preceding two years reveals facts which could have an influence on the determination of transfer price. Assessee company being engaged in producing semiconductor integrated circuits is a complex product requiring skilled workforce. TPO was justified in treating it as high end service provider for the purpose of selection of comparables. The fact that the assessee’s role is only 2 to 3 percent of the overall operations performed by the group is not at all relevant for deciding whether it is high end performer or low end performer. Assessee having submitted a TP report every year by using different filters for selecting comparables are commensurate to the result declared by it . TPO was justified in rejecting the same and selecting new comparables by applying quantitative as well as qualitative filters. Tolerance band provided in the proviso to section 92C(2) is not to be construed as a standard deduction. If the arithmetic mean of comparables falls with in range of said tolerance band , no adjustment is required , if it exceeds then the ultimate adjustment is not required to be computed after reducing the arithmetic mean by 5 percent.( A.Ys 2003‐04 , 2004‐05, 2006‐07). Refer, ST Microelectronics (P) Ltd v CIT 61 DTR 1.

ITAT Delhi in the case of DCIT vs. Leroy Somer & Controls (India) (P) Ltd held that though no transfer pricing adjustment was made, the AO levied penalty u/s 271G of Rs. 22 lakhs (2% of the value of international transactions) on the ground that the assessee had not furnished the documents prescribed under Rule 10D r.w.s. 92D(3). This was deleted by the CIT (A).

Norway Court of Appeal held in the case of Dell Products vs. Tax East that the assessee, a company registered in the Netherlands but resident in Ireland for tax purposes appointed Dell AS, a Norwegian company, as its “commissionaire” for sales to customers in Norway. Dell AS entered into agreements in its own name and its acts (under the commission agreement and Commission Act) did not bind the principal. The assessee claimed that it was not taxable in Norway in respect of the products sold through Dell AS on the ground that Dell AS was not its “Dependent Agent Permanent Establishment” (DAPE) under Article 5(5) of the Norway-Ireland DTAA on the ground that (a) the agent had no authority to enter into contracts “in the name of the assessee” and legally bind the assessee and (b) the agent was not a “dependent” agent. However, the income-tax department took the view that Dell AS constituted a PE under Article 5(5) of the DTAA and that 60 percent of Dell Products’ net profit on sales in Norway was attributable to the PE. This was confirmed by the Oslo District Court.

Delhi High Court in the case of Oracle India (P) Limited decided that payment of royalty by assessee company to its US based holding company is not hit by the provisions of section 92 in the absence of any comparable case on record to determine the ordinary profit in similar business and the price fixed has been accepted as ALP by the TPO. Payment of royalty being a business expenditure which is incurred wholly and exclusively for the purpose of business of the assessee ,it is to be allowed as business expenditure.( A.Y. 1999‐2000 TO 2001‐02)

Mumbai Tribunal held the following in the case of Fulford India Limited : TPO having computed the ALP by applying CUP method as against TNMM adopted by the assessee and rejecting the objections raised by the assessee on the ground that all those objections were considered by the TPO in earlier years. The assessee having raised various submissions before the Tribunal which need verification at the level of the AO/TPO matter restored for fresh verification as per law.( A.Y. 2006‐07).

In the case of Siva Industries & Holdings Ltd Chennai tribunal held that in case of grant of loan by assessee to its foreign subsidiary in foreign currency out of its own funds . For determining ALP ,it is the international LIBOR rate that would apply and not the domestic prime lending rate , and assessee charging interest at a rate higher than the labor rate , no addition can be made on this count.( A.Y. 2006‐07)

The assessee, engaged in providing support and advisory services to BP group companies, entered into international transactions with its AEs pursuant to which it made payments for “business support services”. The assessee adopted the TNMM and claimed that the transactions were at ALP on the basis that its profit rate compared favourably with the comparables. In the list of comparables were two entities which had suffered a loss. There were also two other companies with high profit margin. The TPO excluded the loss making companies from the comparables on the ground that they were having a different “functional & product profile” as compared to the assessee. In appeal, the CIT (A) held that the loss making concerns could not be excluded. He also upheld the alternate argument that if the loss making companies were excluded, the high profit companies also had to be excluded. Refer BP Services India (P) Limited, Mumbai ITAT.

The assessee, engaged in the business of manufacture and export of studded diamond and gold jewellery, imported & exported diamonds and exported jewellery to associated enterprises. For transfer pricing purposes, the ALP of the imported & exported diamonds was evaluated using the “Comparable Uncontrolled Price” (CUP) method while the exports of jewelry was evaluated using the “Cost Plus Method” (CPM). The TPO & AO rejected both methods on the ground that adequate material to support it was not available and instead adopted the TNMM and made an adjustment. On appeal, the CIT(A) upheld the adoption of CPM on the imports & exports of diamonds on the ground that total cost details were maintained and the average margin earned from AE transactions was higher than that earned from non AE transactions. However, he did not deal with the ALV on export of jewellery. On appeal by the department, HELD reversing the CIT(A). Refer, ACIT vs. Tara Ultimo Private Limited .

In the case of CIT vs Nestle India Limited 337 ITR 103 it was held that business expenditure disallowed for excessive or unreasonable payments for remuneration/royalty paid to subsidiaries for technical assistance . Finding that such assistance essential for business and that expenditure not excessive or unreasonable hence section 92 does not apply to royalty which is not part of regular business between resident and non-resident

When assessee showed the price charged was with in 5 % variation of ALP , no addition was required to be made.( Asst Year 2006‐07). Refer, Capgemini India ( P) Ltd v Addl CIT. 46 SOT 195 ( Mumbai) (Trib).

Delhi Tribunal held in the case of NIT Limited that In view of the fact that annual reports / data base extracts of three companies which were selected as comparable cases were not available earlier in the public domain and having regard to the fact that these documents are essential for determining ALP these additional evidences are admitted for consideration : TPO is directed to make a fresh transfer pricing order by taking in to account database of said companies now submitted and also to decide as to whether all the comparables selected by the assessee are proper comparables for the purpose of determining ALP after considering the relevant parameters.( Asst year 2005‐06).

Adjustment of 5 % is not applicable if a single price is determined by the assessee . Circular no 12 dated 23‐8‐2001 does not apply to the case under consideration as theprice variation is more than 5 % .( Asst Year 2004‐05). Refer, ADP (P) ltd v Dy CIT 57 DTR 310 ( Hyd) ( Trib).

Mumbai Tribunal held in the case of Teva India (P) Ltd v Dy CIT 57 DTR 212 that Exact nature of the business needs to be taken in to consideration vis –a –vis the nature of business activity carried on by other parties so as to ascertain whether the said parties can be selected as comparable cases for transfer pricing analysis ; Four companies included by the assessee company , there was no justifiable reason to select the same as comparables; however , exclusion of companies showing supernormal profits as compared to other comparable is fully justified.( Asst Year 2004‐05).

Pune Tribunal held the following in the case of Bringtons Carpets Asia (P) Ltd v Dy CIT 57 DTR 121 assessee having cited six comparables, TPO /AO was not justified in rejecting the same and applying domestic transactions of the assessee when the AO/TPO has accepted said six external comparables in the subsequent assessment year and there is similarity of facts in both the years, further the assessee is entitled to economic adjustments in the circumstances of under capacity utilization of the company, matter is set a side for examining the issue de novo. (Asst Year 2006‐07)

Each transaction of sale made by the assessee to its AE in UK being a separate transaction and there being no subsisting agreement between the assessee and the AE from beginning in 1996 , proviso to rule 10(4) is not applicable to the facts of the case and therefore , assessee was required to maintain documents as per rule 10D . Cases relied upon by the TPO not being comparable cases, matter is restored to the AO to obtain data of comparable cases so as to come to an informed decision as to whether the price charged by the assessee from its AE is arm’s length or not.(A.Y. 2006‐07 ). Refer Delhi Tribunal decision in the case of Airtech (P) Ltd v Dy CIT 57 DTR 169.

Mumbai ITAT in the case of RBS Equities India Ltd decided that the assessee adopted the TNMM to determine the ALP in respect of the broking transactions entered into with its affiliates. The AO & TPO held that the assessee ought to have adopted the CUP method and made an adjustment of Rs. 1.10 crores. This was accepted by the assessee. The AO levied penalty under Explanation 1 to s. 271(1)(c) on the ground that the assessee had filed inaccurate particulars of income. This was deleted by the CIT (A).

Without ascertaining the quality and size of precious stones as sold to Associated Enterprise as compared to other enterprises, the Assessing Officer could not have made any adjustment on account of quality, and therefore, the addition made by Assessing officer on account of ALP was liable to be deleted.(Assst Year 2005‐56). Refer, ITO v Kanchan Tara Exports 138 TTJ 592 (JP) (Trib).

While determining arm’s length price, it is profit as per books of account that has to be considered for computing net margin of assessee and not adjusted book profits. ( Asst Year 2006‐ 07). Refer, Geodis Overseas (P) Ltd v Dy CIT 45 SOT 375 (Delhi )(Trib).

The AO had accepted the license fees for the month of February and March , 2003 to be at arm’s length . However the steep increase given from the beginning of the year with retrospective effect has not been accepted .CIT (A) has accepted the computation made by the assessee, based on the comparable as well as department has accepted the method of computation for the asst year 2004‐05. The Tribunal restored the matter to the file of AO for re working of the transfer pricing adjustments using TNMM on the basis of facts and figures available for asst year 2003‐04 in respect of the comparable selected by the assessee.( Asst Year 2003‐04). Refer, Asst CIT v NCG Net work (India ) (P ) Ltd 56 DTR 1 (Mumbai) (Trib).

Provision for import duty made by the assessee which has been reversed in the immediately succeeding year being merely a book entry , is to be excluded for working out the operating profit ratio for computation of ALP (Asst year 2005‐06 & 2006‐07). Refer, Sony India (P) Ltd v Addl CIT 56 DTR 156 ( Delhi) (Trib).

Transfer Pricing Officer having excluded the loss making companies from the list of comparables in the transfer pricing analysis , one company which showed the super profits is also to be excluded as it is engaged in software product company. Where as the assessee is engaged in rendering soft ware development services in OP/TC of the assessee is with the safe harbor range of + 5 percent , no adjustment is warranted on account of difference in ALP of the international transaction. (Asst Year 2006‐07). Refer, Sapient Corporation ( P) Ltd v Dy CIT 56 DTR 465 ( Delhi ) (Trib).

ITAT Delhi held the following in the case of Yum Restaurants(India) Pvt. Ltd From the list of comparables provided by the assessee (after excluding persistent loss‐making companies), the TPO rejected some other loss‐making companies & determined the ALP applying the TNMM and made an adjustment of Rs. 2.28 crores. The Tribunal dismissing the appeal held that : Merely because a company is showing losses, it does not lose its status of comparable if the other criteria depict its status as a comparable because the declaration of loss is an incident of business which is at par with profit. The FAR Analysis of a company indicated the avowed objective of the company and the tools that it sought to employ to achieve that objective but it was the financial result which decided whether that company has been successfully in achieving the objective or not. The TPO held that if the assessee’s contention based on FAR analysis only is accepted then the process of choosing comparable will not proceed beyond the matching of FAR. All types of other tests i.e. data base screening, quality and quantitative screening or use of diagnostic with ratios will be rendered meaningless and unnecessary. Comparability has been taken into consideration by the assessee on the basis of FAR analysis and “other aspects” have not been considered. TPO had looked into “other aspects” also.

ITAT Hyderabad decided the following in the case of Deloitte Consulting India Pvt. Limited The Tribunal had to consider two Transfer Pricing issues (i) whether notional interest relatable to the extended credit period allowed to the Associated Enterprises (AEs) to pay the dues can be assessed and (ii) Whether, in the absence of any agreement between the assessee and the AEs to share costs, the consultancy expenses paid to McKinsey & Co can be disallowed on the ground that it benefited the AEs as well.

ITAT Pune in the case of Patni Computer Systems Ltd held that The Tribunal had to consider two Transfer Pricing issues (i) whether notional interest relatable to the extended credit period allowed to the Associated Enterprises (AEs) to pay the dues can be assessed and (ii) Whether, in the absence of any agreement between the assessee and the AEs to share costs, the consultancy expenses paid to McKinsey & Co can be disallowed on the ground that it benefited the AEs as well.

In respect of AY 2006-07, the assessee entered into international transaction with its associate enterprises for a sum of Rs. 14.33 crores. The TPO applied the TNMM and determined the ALP at Rs. 15.08 crores and made an adjustment of Rs. 75 lakhs. The assessee claimed that as the said adjustment was within +/-5% of the ALP, no adjustment could be made under the proviso to s. 92C(2) as it stood pre-amendment by the F (No. 2) Act, 2009. The Department relied on Circular No.F.142/13/2010-SO (TPL) dated 30.9.2010 (Corrigendum) where the view was expressed that as the amendment came into effect from 1.10.2009, it would apply in relation to all cases in which proceedings are pending before the Transfer Pricing Officer on or after such date. HELD disagreeing with the Department’s contention. Refer, iPolicy Network Pvt Ltd vs. ITO (Delhi ITAT).

A continuing debit balance in the account of the Associated Enterprise by itself does not amount to an international transaction under section 92B in respect of which arm’s length price adjustment can be made. Even assuming that the continuing debit balances of AEs can be treated as “International Transactions” the right course of applying the CUP method would have been by comparing this not charging of interest with other cases in which other enterprises have charged the interest , in respect of over dues in respect of similar business transactions, with independent enterprises. As no exercise has been carried out addition was deleted.( Asst year 2004-05). Refer, Nimbus Communications 43 SOT 695/ 55.

The Tribunal had to consider the following transfer pricing issues: (i) Whether if two distinct services are rendered to the AE and mark-up is received for one and not for the other, the aggregate position can be considered for determining ALP, (ii) whether multi-year data can be considered, (iii) whether if loss making comparables are rejected, high profit making comparables should also be rejected? HELD by the Tribunal. Refer, Exxon Mobil Company India Pvt Ltd vs. DCIT (Mumbai ITAT).

The assessee’s appeal raised the issues whether (i) the TPO could consider financial information of comparables not available at the time of TP study, (ii) multi-year data of comparables could be considered, (iii) a turnover filter had to be applied for identification of comparable companies, (iv) an adjustment for difference in functional and risk profile of comparable companies vis-à-vis of the assessee had to be made and (v) the amendment of +/-5% variation law was retrospective. HELD by the Tribunal: Refer, Symantec software Solutions Pvt Ltd vs. ACIT, Mumbai ITAT.

ITAT Delhi held the following in the case of Sapient Corporation Pvt. Ltd. When loss making companies have been taken out from the list of comparables by the TPO, Zenith Infotech Ltd. which showed super profits should also be excluded. The fact that assessee has himself included in the list of comparables initially, cannot act as estoppel, particularly in light of the fact that the Assessing Officer had only chosen the companies which are showing profits and had rejected the other companies which showed loss (Quark System vs. Dy. CIT 38 SOT 307 (SB) followed). (A. Y. 2006-07)

ITAT Mumbai held the following in the case of DHL Express (India) Pvt. Ltd. (i) The assessee’s argument that comparables with a turnover less than 20% of the assessee’s turnover should be considered is not acceptable because it is a universal fact that there are lot of differences between large businesses and small businesses operating in the same field. In the case of small business, economies of scale are not available and they are generally less profitable. The fact that such companies were considered comparable in an earlier year is not conclusive for want of facts of that year and also because there is no res judicata; (ii) The argument that segmental results of a company engaged in diverse activities should be considered is also not acceptable because it is a common experience that in many such results certain expenditures, particularly relating to interest and head office, are generally not allocated. When direct comparables are available, there is no need to consider segmented results; (iii) In principle, should be only the operating profit of the comparables considered. Items like interest income, rent, dividend, penalty collected, rent deposits returned back, foreign exchange fluctuations and profit on sale of assets do not form part of the operational income because these items have nothing to do with the main operations of the assessee. Insurance charges would depend on the nature of insurance charges. If the insurance charges were on account of loss of some parcel or courier against which courier has made a payment of compensation then such charges would constitute operational income. (A. Y. 2006-07). See Also Adobe Systems India (ITAT Delhi) (super-normal profit companies to be excluded) & Marubeni India (ITAT Delhi) (interest on surplus & abnormal costs to be excluded) .
On a reference under section 92CA(1), TPO can suggest adjustment only in respect of the international transactions entered in to by the assessee with AEs which are referred to him for computation of ALP by the Assessing Officer. TPO cannot suo motu take cognizance of any other international transaction for suggesting adjustment in the ALP. (A. Y. 2006-07). Refer, Amadeus India (P) Ltd. vs. ACIT 52 DTR 378 (Delhi)(Trib.).

Assessee engaged in business of import of rough diamonds and selling same in local markets without value addition to goods, resale price method is most appropriate method for determining ALP with respect to AE transaction. If comparables cited by assessee were not found appropriate, fresh comparables could be searched, but method adopted was not to be rejected. Matter was set aside to Assessing Officer for disposal afresh after finding appropriate comparable and adopting resale price method. (A. Y. 2004-05). Refer, Star Diamond Group vs. Dy. CIT 44 SOT 532 (Mum.)(Trib.).

Delhi ITAT in the case of Honda Siel Cars India Ltd. vs. ACIT 129 ITD 200 decided that TPO is not concerned, nor is he competent to decide as to whether the payment under collaboration agreement was capital or revenue and on the facts and circumstances, reference to the TPO for determining ‘arm’s length price’ may not be necessary.

Transfer Pricing principles on use of multi-year data, adjustment to operating profits & +/- 5% adjustment : The assessee adopted the TNMM and claimed that (i) as its operations were for a part of the year, an adjustment to the margins on account of ‘capacity utilisation’ should be made, (ii) the pre-operative expenditure should be excluded, (iii) multi-year data should be used to determine comparables, (iv) if only one comparable is left, the entire exercise should be carried out afresh and (v) even if there was only one comparable, the +/- 5% adjustment should be made. The AO & DRP rejected the claim. On appeal to the Tribunal, HELD. Refer, Haworth (India) Pvt Ltd vs. DCIT.

Net Profit margin actually realised can only be taken as comparable when TNMM method is adopted for TP analysis. Refer, Geodis Oversweas Limited v DCIT 10 Taxmann.com 231.

Merely because transaction is with AE can’t be ground to reject it as a comparable when transaction is at arm’s length. Refer, ACIT v NGC Network India (P) Limited 10 Taxmann.com 140.

Sec 92C(2) specifies that adjustment of 5 percent is not applicable if a single price is determinded by assessee. Refer, ADP Private Limited v DCIT. 10 Taxmann.com 160.

Inclusion of non-operating income and non – exclusion of the non -operating expenses would definitely affect net margin of operating profits of comparable company. Refer, TNT India (P) Limited v ACIT, 10 Taxmann.com 161.

Where the finding of CIT(A) is based on net profit margin of the assessee company worked out by him at 6.97% on the basis of operating profits/sales, which was within +/- 5 % range of ALP, there is no reason to interfere in the order of CIT(A). refer, Osram India (P) Ltd. vs. Dy. CIT 51 DTR 297 (Delhi)(Trib.).

Though the deputation of three employees by the assessee to its US subsidiary without consideration is covered by the definition of “international transaction” under section 92B (1), it was not necessary for the Assessing Officer to determine the ALP of the said transaction as there would be erosion of tax base of India if the assessee charges the cost of deputation of employees in as much as assessee is remunerating the subsidiary on the cost–plus basis for the services and entire revenue accrues to the assessee. Jurisdiction of TPO is restricted to the transactions referred by the Assessing Officer under section 92CA(1) and therefore, TPO cannot determine the ALP in relation to an international transaction not referred to him by the Assessing Officer under section 92CA(1), further, since the conditions laid down in section 92C(3) were not satisfied the impugned addition cannot also be sustained on the premise that the Assessing Officer as determined the ALP on the basis of material or information or document in his possession. Refer, 3i Infotech Ltd. vs. Dy. CIT, 51 DTR 385 / 136 TTJ 641/ 129 ITD 422 (Mum (Trib.).

Bad debts written off cannot be factor to determine the arm’s length price of any international transaction. The Transfer Pricing Officer had exceeded his limits in following a method not authorized under the Act or Rules. Refer, C. A. Computer Associates P. Ltd. vs. Dy. CIT 8 ITR 142 (Mum.)(Trib.).

Order was passed by TPO without granting extension of time sought by the petitioner for furnishing more documents and giving an opportunity of personal hearing to it and also documents were not consider which were already on record in their right perspective the impugned order was set aside and TPO was directed to pass an order and also personnel hearing.. refer, Toyota Kirloskar Motor (P) Ltd. vs. Addl. CIT 52 DTR 393 (Kar.)(High Court).

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