The taxpayer, as a market penetration strategy, incurred advertisement expenditure in India. A portion of the expenditure was reimbursed by the AE. While the taxpayer had considered the reimbursement as reducing its operating expense for the purpose of the transfer pricing analysis, the transfer pricing officer (TPO) “recharacterised” the reimbursement in a form of loan or equity from the AE and did not consider it as an operating item for the TP analysis.

Having relied on various judicial precedents, the Income Tax Appellate Tribunal (ITAT) observed that under the fiscal statutes, actual transaction, as entered into between the parties, has to be considered and the authorities have no right to rewrite the transaction unless it is held that it is sham or entered into by the parties in bad faith to avoid and/or evade taxes.

It is interesting to note that the Tribunal reaffirmed the doctrine by Lord Wright in the Duke of Westminster vs IRC (1936 19 TC 490 HL) case — “the true nature of the legal obligations arising out of a genuine transaction and nothing else is the substance.”

The Tribunal also relied upon the Supreme Court precedence in India, particularly in the Motors & General Stores (P) Ltd (66 ITR 692) and Gillanders Arbuthnot & Co (87 ITR 407) cases.

The Tribunal further noted that the above principles applicable to physical statutes are also incorporated in special regulations on transfer pricing under Rule 10B(2)(c) of the Income Tax Rules, wherein it is provided that the comparability of an international transaction with an uncontrolled transaction is to be judged with reference to the contractual terms of the transactions.

In general, loss-making companies cannot be excluded from the list of comparable companies, as incurrence of loss is part of normal business.

However, where losses are made consistently and there are other circumstances peculiar to a company to be factored in, that company may not be comparable and, hence, may need to be excluded.

While undertaking functional analysis of the uncontrolled transactions, it has to be examined whether a reasonably accurate adjustment can be made to eliminate the material effect of the differences between the transactions/entities, and in case such adjustment cannot possibly be made, then such uncontrolled comparables may have to be rejected.

For the purposes of comparison, what is to be judged is the impact of the related party transaction vis-À-vis sales and not profit since profit of an enterprise is influenced by large number of other factors.

Under the transfer pricing regulations in India, an option has been provided to a taxpayer to consider an arm’s length price (ALP) which may vary from the arithmetic mean by an amount not exceeding 5 per cent of such arithmetic mean.

This option is intended to provide marginal benefit at the choice of the taxpayer.

More Stories on : Taxation | Courts/Legal Issues | Reassessment

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page