Recent Judicial Decisions & Developments in Transfer Pricing in India

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1 Recent Judicial Decisions & Developments in Transfer Pricing in India Presented at International Tax Conference, Mumbai 5 th Dec 2009 By Ms Alpana Saksena Indian Revenue Service Commissioner Income Tax (International Tax Appeals) Mumbai, India

2 A quick look at judicial hierarchy in India valid up to 30 th Sept 2009 Transfer Pricing Officer All TP orders originate from here & get merged in the Main assessment order passed by Assessing Officer Appeal to Each big city has one Each province has one Commissioner Appeals Income Tax Appellate Tribunal Legal issues High Court Supreme Court of India (National Apex Court) 2

3 Recent Decisions What do Indian Courts Say 3

4 TP Rules vs Capital Gains Provisions Canoro Resources Ltd, 313 ITR 2 (AAR) Apr 09 Computation of Capital Gain u/sec 45(3) where a capital asset is transferred by a person to a partnership firm as his capital contribution For computing capital gains, the value of asset recorded in books of firm on the date of transfer shall be deemed to be the full value of consideration received/ accrued Is it an International Transaction u/92b? 4

5 TP Rules vs Capital Gains Provisions Canoro Resources Ltd, 313 ITR 2 (AAR) Apr 09 Before AAR Is transfer of participating interest by Co. An international transaction between AEs Held Yes Its value be determined per Indian TP Provisions And not as per mode prescribed in Sec 45(3) Sec 45(3) does not distinguish between residents & non- residents TP Provisions would apply 5

6 Substantive Issues Income exempt Would TP Provisions apply? Should tax avoidance be demonstrated Controversy rages till date 6

7 Income Exempt.. u/s 10A/10B Would TP Provisions apply Aztec Software 07 Phillips Software 08 MSS India 09 Yes NO Yes Further held that A special larger bench decision (Aztec Software and Technology Services) prevails over the divisional bench decision (Philips Software Centre). 7

8 Substantive Issues Comparability Analysis & Adjustments Use of methods..so much to learn.. 8

9 On Comparability Analysis Aztec Software Jul 2007 Bangalore (SB) ITAT Mentor Graphics Nov 2007 Delhi ITAT Ranbaxy Labs Jan 2008 Delhi ITAT E Gain June 2008 Pune ITAT Sony India (P) Ltd Sept 2008 Delhi ITAT Phillips Software Sept 2008 Bangalore ITAT 9

10 Comparability Analysis..it was held Proper FAR analysis very important valid reasons should exist for rejecting method adopted by taxpayer Comparison not possible if Differences between comparables & tested party very material Comparables show extraordinary results Transfer pricing Not an exact Science 10

11 Comparability Analysis Parameters Skoda Auto India 30 SOT 319, Mar 2009 Pune ITAT Business model important for comparison Internal Controlled CUPs cannot be used Certain key adjustments emphasized For high costs of startups phases Difference in product cycles Impact of import duties Taxpayer not expected to arrange information not available in public domain Reasonable approximations justified in absence of information in public domain 11

12 Comparability Analysis..TNMM UCB India (P.) Ltd 30 SOT 95, Feb 2009 Mumbai ITAT Issue 1. How to benchmark? Transaction wise profits or entity level margins? (segmental profits vs combined profits?) Held TNMM to be applied transaction wise Margins at entity level only allowed when class of transactions exist..meaning all transactions are of the same type, same class and of similar variety, and the enterprise has no dissimilar transaction Taxpayer had imported branded APIs 12

13 Comparability Analysis..TNMM UCB India (P.) Ltd 30 SOT 95, Feb 2009 Mumbai ITAT Issue 2. When Can Revenue apply CUP Held Only when there is strict product comparability FAR analysis of comparables mandatory Branded products not comparable with duplicated ones Adjustment required for differences in Quality purity, potency, brand of products Matter set aside for fresh adjudication 13

14 1. Priority of methods Choice of Methods MSS India (Pune ITAT) 32 SOT 132 (May 09) ITAT approved OECD Hierarchy 2.Can Revenue reject methods? CPM & CUP vs TNMM) Only when inconsistencies /factual errors found in taxpayers choice No rejection on grounds of complexity Internal uncontrolled comparables in use of CPM & valid CUPs if not faulted, are sufficient Immaterial what profits earned if transaction is at ALP 14

15 Choice of Profit Level Indicator.Cash Profit /Sales? Schefenacker Motherson Del ITAT June 2009 Taxpayer set up new plant -applied TNMM Issue : Is cash profit /Sales an acceptable PLI (cash profit is operating profit without depreciation) ITAT Held Yes if circumstances justify TP law does not prohibit it higher depreciation on new assets can distort profits especially if there is excess, unused capacity This PLI can equalise difference in use of assets by taxpayer & comparables Guidance Note on TP issued by CA institute also referred 15

16 Substantive Issues Documentation & Natural Justice 16

17 Calling for Documentation.. Cargill India (P) Ltd Feb 2008, Delhi ITAT TPO cannot mechanically call for All information specified in TP rules Has to specify particular rule applicable To taxpayers case Penalty also cannot be levied for late submission of documents If Taxpayer prevented by reasonable cause 17

18 Natural Justice. Personal /oral hearing Moser Baer (316 ITR 1)Dec 19, 2008, Delhi H C Issue Should oral hearing be granted even when not demanded? Held Yes, & also to allow opportunity to inspect material available with TPO To file further material or evidence if need be to seek a personal hearing in the matter HCL 09, Supreme Court Matter can also be referred to DRP 18

19 Substantive Issues Reopening of assessments of earlier years 19

20 Reopening of case Sec 147 TP Coca Cola 309 ITR 194 Punjab & Haryana(Dec 2008) Issue Can TPO s Order be used to reopen assessments of preceding yrs. Held by High Court Yes - Revenue could use TPO's findings to form opinion that income had "escaped" assessment & to re-assess such income Even of periods prior to TP legislation TPOs order can be used to reopen earlier cases 20

21 Substantive Issues Reserve Bank of India Permission vs Arms Length Price 21

22 RBI Permission vs ALP Coca Cola 309 ITR 194Punjab & Haryana(Dec 2008) ITAT dismissed contention of taxpayer that according to permission granted by RBI under FERA Taxpayer could not charge more than particular price, ITAT held that such RBI permission Will not override TP Provisions If so then what happens to Rule 10B (2) 22

23 RBI Permisssion vs ALP Rule 10B(4) Coca Cola 309 ITR 194Punjab & Haryana(Dec 2008) Food for thought Attention invited to Rule 10B(2)(d) This Rule states that for purposes of Rule 10B (1) comparability of an international transaction with an uncontrolled transaction shall be judged with reference to : (d)..the laws and Government orders in force, If taxpayer forbidden by RBI to charge beyond a certain price Then how will ALP be determined? Is RBI permission Government law 23

24 Substantive Issues Burden of Proof 24

25 Burden of Proof. Initial cases Aztec Software Center Bangalore ITAT July 2007 Ranbaxy Labs Ltd Delhi ITAT Jan 2008 Phillips Software Center, Bangalore ITAT Sept

26 Burden of Proof.When on Revenue MSS India Pune ITAT & UCB India (Mum ITAT) Revenue can reject taxpayer s method When it can demonstrate fallacies therein To prove appropriateness of its own method selected on touchstone of factors set out in rule 10C(2) & cogent material and sound reasoning. If CUP method applied Documentation and data has to be made available...& Strict comparability demonstrated When can Revenue alter method adopted by taxpayer? 26

27 Burden of Proof.When on taxpayer UCB India (P.) Ltd 30 SOT 95, Feb 2009 Mumbai ITAT Taxpayer required to show appropriateness of method by furnishing adequate records & data, irrespective of whether they were statutorily required or not. AEs abroad to give proper support to subsidiaries for furnishing data on comparables AEs to support subsidiary in documentation 27

28 Substantive Issues Contemporaneous data 28

29 Contemporaneous data. Aztec Software Center Bangalore ITAT July 2007 Mentor Graphics Delhi ITAT Nov 2007 Phillips Software Center, Bangalore ITAT Sept

30 Held Contemporaneous data. Data to be used should pertain to year of transaction only not for other years Dissenting Note in Phillips Case Preceding year s data could be used When data for relevant financial Year Was not available at time of TP Study 30

31 Contemporaneous data.rule 10B(4) Honeywell Automation Pune ITAT (Feb 2009) Under the proviso to Rule 10B(4) no scope to consider data for a subsequent year. Customer Service 30 SOT 486 Del ITAT (Mar 2009) Even TPO not justified in using prior years data without assigning any reasons for such deviations Use of subsequent years data not permitted 31

32 Substantive Issues Making of Adjustments Calculation of Operating Profits 32

33 Calculation of operating Profits Honeywell Automation Pune ITAT (Feb 2009) Does provision for future losses debited in books constitute operating expense? Held - laying down Parameters for calculating OP all receipts/ expenses should have nexus with Operating Profit Has to be ascertained if future profit / loss Has nexus with current year s income Matter remanded for reexamination by TPO 33

34 Substantive Issues Penalties for TP adjustments 34

35 Penalties for TP adjustments Vertex Customer Services Del ITAT (Sept 2009) Taxpayer adjusts Operating Profit by excluding provision for doubtful debts towards sums due from the parent company. Labeling it as extraordinary costs TPO disagrees, taxpayer accepts Held Issue debatable, two opinions possible 35 Penalty not justified

36 Substantive Issues TP Provisions & DTAAs 36

37 Canada DTAA Art 24 vs TP Provisions Canoro Resources Ltd, 313 ITR 2 (AAR) Apr 09 Sec 92B defines International Transaction makes distinction between enterprises on basis of residential status, (not nationality) Would apply to Indian as well as Foreign nationals Art 24 refers to discrimination Between Nationals of both Contracting states Held.TP Provisions not in conflict with Art 24 37

38 Netherlands DTAA Art 3(d) vs TP Rules Sun Chemicals 180 ITD 311 Mum ITAT (Jun 08) Art 3(d) defines Tax provides that tax for the benefit of DTAA shall not include any amount which was payable in respect of any default or omission in relation to the taxes to which the convention applied or which represents a penalty imposed relating to those taxes 38

39 Netherlands DTAA Art 3(d) vs TP Rules Sun Chemicals 180 ITD 311 Mum ITAT (Jun 08) Taxpayer sells shares & reports only sale in 3CEB Acquisition of shares had not been reported AO denied benefit of DTAA to the assessee, holding such non reporting as default u/s 92C Held - default or omission relating to TP sections 92 to 92F are not covered by the default or omission contemplated in article 3(d) of DTAA Benefit of DTAA to be allowed 39

40 Recent Developments in Transfer Pricing In India

41 Recent Developments Finance Act (No 2), 2009 Safe Harbour Provisions Sec 92CB CBDT to formulate safe harbour rules To provide circumstances in which Income-tax authorities shall accept the transfer price declared by the assessee. 41

42 Finance Act (No 2), 2009 Recent Developments Sec 144C Dispute Resolution Panel CBDT would constitute a Panel of three CITs to provide alternate dispute resolution mechanism To eligible assessees being any person in whose case the Assessing Officer proposes to make variation to income returned after 1/10/09 (which is prejudicial to such person) in consequence of TPOs order u/s 92CA OR any foreign company 42

43 Direct Taxes Code Recent Developments On the ANVIL APAs GAAR AEs Penalties APAs Five yr validity, binding on taxpayer & revenue unless law or facts change GAAR - General Anti Avoidance Rules (concept of Impermissible avoidance arrangements) If entered to avoid tax or not at Arms Length form over substance to be seen 43

44 Direct Taxes Code AEs Recent Developments Audit Trigger AEs shareholding relationship (proposed reduction from 26% to 10%) Audit Trigger risk based On the ANVIL Penalties Penalties to be rationalized reductions proposed On Failure to maintain documentation On Tax adjustment 44

45 THANK YOU 45