Tuesday 13 August 2013

UNDERSTANDING TRANSFER PRICING WITH LATEST CASE LAWS: PART-III.

I have my pleasure to publishing today the 3000th post at taxbymanish.  For this I am thankful to all the Tax & Finance professional and also tax students, who has shown interest at taxbymanish and keep me motivated to reach the milestone within such a short period of two year only. I will keep my promise to provide you keep updated with tax knowledge.

We had earlier discuss in detail about the concepts of Transfer pricing along with various case laws earlier in part –I & Part - II. In case you want to refer, the part –I & II, please click on the link below:

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Details
Link
1
TP Part 1
2
TP Part 2

 

Over a period of time, there are number of judgements comes from various levels of courts from different locations of India and hence it is very important to know the same for the correct treatment of Transfer pricing:

·         In the case of Delphi TVS Diesel Systems Ltd. v. Assistant CIT, it was held that TNMM is not applicable when comparison of transaction is possible.

 

·         In the case of Hindustan Unilever Ltd. v. Additional CIT (Mumbai) it was held that benchmarking is required to be done only for transactions with international related parties and not on entire turnover.

 

·         In the case of Deputy CIT v. Hellosoft India Pvt. Ltd, it was held that Loss-making companies and companies having super normal profits not to be considered as comparables for TNMM.

 

·         Net profit margin realised from transaction with associated enterprises cannot be taken as comparable. Refer, Tecnimont ICB P. Ltd. v. Additional CIT.

 

·         Difference arose in calculation of cost due to the fact that TPO took the cost relating to charter hire activity as 50 percent of total cost whereas the assessee took the actual cost relating to the charter hire activity. Cost plus method can be applied only by taking the actual cost of the activity. Once the figures used in the calculation made by the TPO are replaced by actual figures, the payment made by the assessee is at ALP and, therefore, no adjustment is called for. Refer, Reliance Industries Ltd v. Addl. CIT.

 

·         Bangalore ITAT in the case of Trilogy E-Business Software India v. DCIT, held that TPO is entitled to collect information under section 133(6), however if it is used against the assessee, assessee should be given an opportunity, since comparables cannot be ignored on ground of abnormal profits/losses if they are functionally comparable.

 

·         Chennai ITAT in the case of Ascendas (India) Pvt. Ltd v. DCIT (Chennai), explains the  Law on valuation of shares of a closely held company.

 

·         In the case of CIT v . CA Computer Associates India P. Ltd, it was held that No reduction to be made because of failure of customers to pay for product.

 

·         List of comparable companies relied on by assessee rejected by Transfer Pricing Officer without stating any reason is not allowed. Refer, Assistant CIT v. SRA Systems Ltd.

 

·         The “Bright Line test” can be applied to determine whether AMP expenses incurred by assessee are excessive and for the benefit of the brand owner- Adjustment in relation to advertisement, marketing, and sale promotion expenses incurred by assessee for creating or improving, marketing intangible for and on behalf of foreign AE is permissible. Expenses in connection with sales which do not lead to brand promotion cannot be brought within ambit of ‘advertisement, marketing and promotion expenses’. Correct approach under TNMM is to consider operating profit from each international transaction in relation to total cost or sales or capital employed ,etc of such international transaction and not net profit , total costs sales , capital employed of assessee as a whole on entity level. (S. 92B , Rule 10A, 10B ). Refer, L.G. Electronics India Pvt. Ltd v. .ACIT.

 

·         Chennai ITAT in the case of ACIT v. Handy Waterbase India (P.) Ltd held that the Assessee is engaged in sale and export of pasteurized crab meat. The Assessee entered in to international transactions with its associated enterprise and showed sale price at Rs 24 Crores. TPO on reference made by the Assessing Officer , fixed arm’s length price of goods at Rs 18 Crores. Assessing Officer opined that receipts of assessee from sales to AE was in excess of arm’s length price and such excess was nothing but income from other sources . The Assessing Officer relying on provisions of section 10B(7) read with section 80IA (8) and 80(IA)(10) added excessive receipts to income of assessee. On appeal Commissioner (Appeals) deleted the addition. On appeal by revenue , the Tribunal held that,where sale price realised from AE was much higher than ALP fixed by TPO and there was no recommendation by TPO for making any adjustment, Assessing Officer was not at all required to make any adjustment in ALP. Accordingly the appeal of revenue was dismissed

 

·         Chennai ITAT in the case of SL Lumax Ltd. v. ACIT, held that Assessee, engaged in auto components manufacturing and sale, had international transactions with four Associated Enterprises (AE). International transactions comprised of import of raw materials, import of machinery and payment for royalty and technical assistance. The Assessing officer divided total operating cost between material cost relatable to AEs and cost relatable to non-AEs, which included both material cost as well as other costs. Thus, Assessing officer deducted from operating cost, only material cost relatable to purchases from AEs and not operating cost attributable to such material cost. It was held that if along with material cost paid to AEs, operational cost attributable to such cost was also considered, then amount considered by TPO as ALP of AE purchases, would have gone up significantly, and hence work out of ALP of purchases from non-AEs had been erroneously done. Matter remanded back.

 

·         Bangalore ITAT in the case of Lenovo India P. Ltd. v. ACIT, held that Where similar transactions with associated enterprises for subsequent years have been accepted by TPO without any ALP adjustment, he should adopt TP analysis conducted by assessee for relevant assessment year also to be at ALP. Revenue could not be permitted to take a different approach in the relevant assessment year. Matter Remanded back..

 

·         In the case of Wills Processing Services (India) P. Ltd. It was held that Information relied upon by Transfer Pricing Officer is not available in public domain. Secret information not to be used against assessee. No uniformity in rejection of assessee’s comparables and selection of comparables by Transfer Pricing Officer. Proper and appropriate functions, assets and risk analysis required to be done. Transfer Pricing Officer and Dispute Resolution Panel to deal with assessee’s objections and discuss them in order. Matter remanded.

 

·         Mumbai ITAT in the case of Dresser- Rand India (P.) v. Addl.CIT, held that assessee rendered similar service to both domestic customers and AEs abroad, but granted discount of 10% only to AE abroad. According to TPO price of services rendered was not at ALP and thus, he made upward adjustment in ALP to the extent of discount allowed. It was held that in independent business situation granting of discount is a normal occurrence and unless AO demonstrates that discount so allowed would not have been allowed in an arm’s length situation, ALP adjustment could not be made in respect of the same. It was therefore held that since there was nothing on record to show to even suggest that discount in question was not arm’s length discount, or that discount had not been allowed under any other situations, adjustment made by revenue was set aside.

 

·         Petitioner participated in the proceedings before TPO and has remedy to move before the DRP as well as appeal before the Tribunal hence  writ petition was held to be not maintainable . (Art 226, Constitution of India). Refer, Hindalco Industries Ltd  v. Add.CIT.

 

·         While computing Arms length price  profit should be considered without deduction of depreciation. Refer, Qual Core Logic Ltd  v. Dy.CIT

 

·         Mumbai ITAT held that A “controlled transaction” can never be regarded as “comparable” even if at ALP. Refer, Tecnimont ICB Private Limited v. ACIT.

 

·          Mumbai ITAT in the case of Deloitte Consulting India (P.) Ltd.v. DCIT held that reference to TPO does not give presumption that the payment is allowable under section 37.

 

·         Average of percentage of expenditure incurred by 17 pharmaceutical companies on advertisement and marketing and no analysis as to type of drug, nature of market, period of advertisement. Mumbai ITAT held not to be TNMM as per provisions of the Act. Refer, ACIT v. Genom Biotech (P.) Ltd.

 

·         In the case of Tata Autocomp Systems Ltd v. ACIT, it was held that interest free loan to international sister concern comes under the ambit of transfer pricing.

 

·         Mumbai High court in the case of CIT v. CA Computer Associates India Pvt. Ltd, held that Royalty allowable even in respect of unpaid sales.

 

·         Operating margin being within the range of 5% of the arithmetic mean of the operating margin of such comparable companies, same has to be accepted as ALP. Refer, Caryle India Advisors (P) Ltd. v. ACIT.

 

·         TPO has no authority to disallow the payment for the purpose of business, on the ground that the assessee has suffered continuous losses. [S. 37(I)]. Refer, CIT v. EKL Appliances Ltd.

 

·         Bangalore ITAT held that Expression “shall” used in Rule 10B(4), makes it clear that only current year’s data is to be used. Refer, Dy. CIT v. Deloitte Consulting India P. Ltd.

 

·         Bangalore ITAT in the case of Kodiak Networks (India) Pvt. Ltd v. ACIT, held that Information cannot be used against the assessee without giving an opportunity.

 

·         AO has made a reference to the TPO for determination of ALP, adoption of ALP suggested is sufficient compliance. Refer, Tevapharm Pvt. Ltd. v. Addl. CIT.

 

·         While Computing of Arm’s Length Price the data is to be restricted to AEP. Refer, Genesys Intergrating Systems (I) Pvt. Ltd. v. Dy. CIT.

 

·         Arm’s length price is to be done in accordance with Rule 10B. Refer, Trigent Software Ltd. v. Asst. CIT.

 

·         ITAT Kolkata held that Law on taxability of turnkey contracts for offshore & onshore supply explained and matter setaside for redetermination. Refer, Dongfang Electric Corporation v. DDIT.

 

·         Chandigarh ITAT in the case of GlaxoSmithkline Consumer Healthcare Ltd v. Addl. CIT, held that reference by the AO under section 92CA(1) is transaction based and not entity based. There may be several international transactions with the same entity, but reference made by the AO is each transaction specific i.e. only the international transaction which have been referred to by the AO after taking the approval of the Commissioner can be looked into by the TPO.

 

·         In the case of Nimbus Communications Ltd. v. Asst. CIT (Mumbai), it was held that AO cannot make addition of notional interest on overdue payments from AE.

 

·         The assessee has followed a scientific system of providing for depreciation on a more real time basis. The assessee is not providing technical depreciation influenced by Income Tax Rules. The assessee provides for more or less actual depreciation. This actual depreciation is more relevant in working out the operating profit of the assessee. Thus, no adjustment is called for in the quantum of depreciation provided by the assessee in its operating account so as to work out its operating profit for the purpose of determining the Arm’s Length Price. Refer, Lason India (P.) Ltd. v. Asst. CIT.

 

·         Where TPO rejected the filters adopted by the assessee and adopted untenable filters for arriving at the comparables. The assessee in his detailed submissions before the TPO as well as the Tribunal, brought out various factors that would justify adopting of comparables by the assessee. On appeal, the Tribunal following the decision of Genesis Integrating System India P. Ltd. (Bangalore) set- aside the matter back to the file of AO directing the TPO to allow assessee to cross examine the comparables whose replies were sought to be used against the assessee if the assessee so desires. Refer, Genesis Microchip (I) (P.) Ltd. v. Dy. CIT.

 

·         The extension of credit to the AE beyond a stipulated credit period cannot be construed as an ‘international transaction’ for the purpose of section 92B(1) so as to require adjustment for ascertaining the ALP. Therefore, the consequential addition is untenable and liable to be deleted. Refer, Patni Computer Systems Ltd. v. Dy. CIT.

 

·         ITAT Delhi in the case of Ericsson India Pvt. Ltd v. DCIT held that TPO has no power to question business purpose of transaction, rule 10B(1)(a), does not authorize disallowance of any expenditure on the ground that it was not necessary.

 

·         Chennai ITAT in the case of Siva Industries & Holdings Ltd. v. Asst. CIT held that in case of grant of loan by the 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 LIBOR rate, no addition can be made on this account.

 

·         Corporate guarantee provided by assessee to subsidiary does not fall within international transaction. Refer, Four Soft Ltd. v. Deputy CIT.

 

·         The Assessee in its TP study observed that as no external CUP was available for bench marking the transaction applied the TNMM and concluded that transaction was at arms’s length .The TPO rejected the assessee’s method considered a risk free return from the subsidiary , a notional interest at 10 percent on loan as ALP amounting to Rs 31, 51, 259. On appeal Commissioner (Appeals) also confirmed the addition. On appeal to the Tribunal , the tribunal held that neither the assessee nor TPO having examined applicability of CUP method in order to determine the ALP of the international transaction of interest –free currency loan to its subsidiary by assessee , the Tribunal restored the matter to Assessing Officer for fresh adjudication following CUP method. Refer, Aithent Technologies (P) Ltd v. ITO.

 

·         The assessee had international transactions with related and unrelated parties . The TPO has selected only four comparables and also denied the benefit of+ 5 percent sought by assessee. The adjustment made by the TPO was confirmed by the DRP. On appeal to the Tribunal , it was contended that the (1) Party having substantial related party transactions should be excluded as comparable .(2) Allocation of advertisement and sale promotion expenses based on turn over of manufacturing and trading is held to be not proper. (3) The benefit of standard deduction of plus or minus 5 percent is not taken in to consideration. (4)The adjustment can be made only in respect of transaction with Associated Enterprises instead of entire turn over ,(5) While working out the operating profit to sales margin , accurate figures as per the annual accounts of the concerned comparables should be taken .The Tribunal held that the TPO having flawed on five issues as contended by the assessee matter remanded to the Assessing Officer for deciding the matter afresh after taking in to consideration the propositions put forth by the assessee. Refer, Huntman Adavnced Materials (India) (P) Ltd v. DY.CIT.

 

·         The assessee is engaged in the business of manufacturing of several products . It had three overseas subsidiaries , namely Vega UK, Vega US and Vega UAE. The assessee sold its products to domestic market where as marketing and distribution of its products in international markets was undertaken by Vega entities of in their specified jurisdiction. The TPO made adjustment in respect of sales made to Vega UAE on ground that Vega UAE was neither bearing any inventory risk nor credit risk and therefore it was not a distributor but only market service provider .The TPO adopted the transfer pricing on basis of operating cost /operating profit percentage of Vega UAE, Vega UK and Vega US as base. The Tribunal held that operating cost /operating profit margin depend on level of operating expenses incurred by respective Vega entities and also making business earning by respective Vega entities , if operating cost is higher in US it could not be said that profit margin of other Vega entities in different countries should be at par with profit margin of Vega US . Accordingly once the it was accepted that Vega UAE as distributor and carrying on both inventory or credit risk , TP adjustment made of the TP officer was deleted .Refer, AIA Engineering Ltd v. Addl. CIT.

 

·          The assessee is 100 % subsidiary of a foreign company and is engaged in the business of BPO/ITES. The assessee has adopted TNMM method as the most appropriate method and computed the PLI(OP/TC) at the rate of 15.76 percent on the operating cost . The TPO has determined PLI at 25.78 percent on the basis of eight comparable. Before Commissioner (Appeals) the assessee has furnished eight additional comparables . On the basis of 16 comparables the average PLI was computed at 11.01 percentage which was less than PLI shown by assessee . The Commissioner (Appeals) had excluded the results of loss making companies for the purpose of determining the average profit margin. On appeal to Tribunal ,by assessee the Tribunal held that order of Commissioner (Appeals), held to be justified . Refer, Knooh Solutions (P) Ltd v. ITO.

 

·         Price paid by assessee to its associated enterprise was higher than price paid by unrelated parties for purchase of similar goods hence adjustment made by TPO held to be justified. Refer, Vipin Enterprises v. Addl.CIT.

 

·         Assessee company which is in the business of providing buying services to associated enterprises for sourcing of garments, handicrafts, leather products etc. in India. Assessee determined ALP on ‘transaction by transaction’ basis using most appropriate method having regard to functional analysis and availability of comparable uncontrolled bench mark. TPO determined ALP by combining all transactions undertaken by assessee. Tribunal held that in assessee’s case, there were different segmental activities, which were independent of each other, they are required to be analyzed on transaction to transaction basis and not by combining all activities, hence the method adopted by the assessee is correct and up held the computation of assessee. Refer, Benetton India (P) Ltd. v. ITO.

 

·         Assessee has reimbursed only cost of one employee who is sitting in Singapore. Assessee has produced evidence in the form of emails to substantiate its case that it has actually obtained services from its group companies and justified the commercial expediency of reimbursement of cost to said concerns by relating the payment to revenue earned by it from such services, the Tribunal held that there is no justification for adjustment to the ALP in respect of the payments made by the assessee to its group concerns. The Tribunal also held that once an international transaction has been made subject of determination of ALP by the TPO, and he has found that transaction is at arms length, then it is not permissible for the Assessing Officer to reexamine that transaction and make disallowance under the normal provisions of the Act. Refer, Cushman & Wakefield India (P) Ltd v. ACIT.

 

·         Assessee has paid 3% of the net sales price, which was approved by RBI. The Tribunal has found that the assessee had sold only part of goods manufactured to its Associated enterprise and bulk sales were made to uncontrolled parties, and the Assessing Officer had failed to bring any material on record to show that payment of royalty @ 3% was not at arms length, hence disallowance of royalty was not justified. Refer, SonaOkegawa Precision Forgings Ltd. v. Addl. CIT.

 

·         Pune ITAT in the case of Demag Cranes & Components (India) v. Dy. CIT held that In a Transfer Pricing matter, the Tribunal had to consider whether for purposes of making adjustment under Rule 10B(1)(e)(iii) ‘working capital’ constituted a ‘difference between the international transactions and the comparable uncontrolled transactions of between the nterprises entering into such transactions’ and if so whether the said difference ‘could materially affect’ the amount of net profit margin of relevant transactions in the open market. Held by the Tribunal: Rule 10B(1)(e)(iii) provides that “the profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market“. While the “differences” are not specified, it covers “any differences” which could materially affect the amount of net profit margin. The litmus test to be applied is if the ‘difference, if any, is capable of affecting the NPM in open market? If yes, then the TPO is under statutory obligation to eliminate such differences. The revenue cannot say that difference is likely to exist in all accounts and so the demands of the assessee should be ignored. The revenue’s stand that the assessee is ineligible for any adjustments if he provides the set of comparable is not correct because under Rule 10(3) it is the duty of the AO/TPO/DRP to minimize/eliminate the difference which is likely to materially affect the price. It is the settled proposition that ‘working capital’ adjustment is an adjustment that is required to be made in TNMM. The revenue’s contention that the ‘differences’ specified should refer to only (i) the factor of demand and supply; (ii) existence of marketable intangibles i.e. brand name etc; (iii) geographical location and the like is not acceptable. Further, as the difference in the Arm’s length Operating Margin of the Comparables before and after  making the adjustment for working capital was up to 3.77%, it was material and had to be eliminated (Mentor Graphics(2007) 109 ITD 101 (Delhi), Egain Communication(2008) 118 ITD 243 (Pune) Sony India( 2008) 114 ITD 448 (Delhi) &TNT India followed). 

 

·         In a transfer pricing appeal, the Tribunal had to consider two issues: (a) what is the data to be considered by the TPO at the time of determining ALP? & (b) whether the assessee should be given an opportunity to refute the material sought to be utilized by the TPO? HELD by the Tribunal: (i) Under Rule 10D(4) the information and documents should as far as possible be contemporaneous and should exists latest by the ‘specified date’ specified in section 92F(4) i.e. the due date for filing the ROI. There is no cutoff date upto which only the information available in public domain can be taken into consideration by the TPO while making the transfer pricing adjustments and arriving at the ALP. The assessees argument that section 92D and Rule 10D is defeated if the TPO takes the data which is available in the public domain after the specified date is not acceptable. (ii) While the TPO is empowered by section 131(1) & 133(6) to call for information without informing the assessee about the process, he cannot use such information against the assessee without giving the assessee a reasonable opportunity of hearing. If the assessee seeks an opportunity to crossexamine third parties, it has to be given the opportunity (Genisys Integrating Systems followed). Refer, Kodiak Networks (India) Pvt. Ltd. v. ACIT.

 

·         Assessee was a wholly owned subsidiary of U.S. based company MTC. It entered into a support agreement with assessee for research services and corporate support services which was an international transaction. For bench marking assessee’s international transactions TPO took various companies and made additions. Before Commissioner (Appeals) the assessee submitted that comparable cases identified by TPO were not engaged in similar activities as that of assessee. It was also contended that the TPO has ignored the comparable of another subsidiary where in the business is identical. The Commissioner(Appeals) held that the TPO arbitrarily selected ‘S’ Ltd. as comparable and ignored ‘C’ Ltd as comparable. Commissioner (Appeals) further held that had ‘C’ had been considered as comparable then arithmetic mean all comparable selected by TPO and assessee would be only 11.71 percentage and applying safe harbor rules in terms of second proviso below section 92C(2), difference in price between one adopted by TPO and ALP determined by including C Ltd would be within + or 5 percent range calling for no adjustment to price adopted by assessee in respect of international transaction, accordingly the Commissioner (Appeals) deleted the addition made by the TPO. Tribunal confirmed the view of Commissioner . Refer, Dy. CIT v. Monsanto Holdings (P) Ltd.

 

·         Assessee was a British company and was part of BBC group. It had appointed an Indian company, BWIPL as its authorized agent in India under an airtime sales agreement to solicit orders for sale of advertisement airtime on channel at rates and on terms and advertising provided by assessee and pass on such orders to assessee for acceptance and confirmation. In consideration of service provided by BWIPL, it was to receive 15 percent marketing commission of advertisement revenues received by assessee from Indian advertisers. Assessee claimed that since BWIPL had been remunerated from arm’s length price no further income was taxable in India. Tribunal has accepted the contention of assessee and allowed the appeal. On appeal the High Court upheld the order of Tribunal.  Refer, Director of Income Tax v. BBC World wide.

 

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