The Hindu Business Line : Many strands to the picture

The transfer pricing legislation in India has been a talking point ever since it was introduced in 2001. With the latest development in the case of Aztec Software & Technology Services, where a Special Bench of the Income-Tax Appellate Tribunal gave a ruling in respect to questions on the validity of procedural aspects and determination of the arm’s length price (ALP) for international transactions, the issue has once again stirred up a debate within the accounti ng fraternity.

The latest ruling, coupled with the order of the Delhi HC in the case of Sony India versus CBDT, will lead the way in providing some clarity on the procedural aspects, especially with reference to the responsibility of the Assessing Officer (AO), says Hitesh Sharma, Tax Partner, Ernst & Young.

“However, some of the observations on computation of ALP and selection of methods may throw up further debate in the field of transfer pricing.”

He also points out that the Special Bench’s passing reference on limit on overall price charged to the end-customer, in case of an international transaction, goes against the basic transfer pricing principles.

“These principles ensure that a taxpayer can, based on the functional and risk profile, be an entrepreneur incurring losses in the initial years to seed the business and thereafter make substantial profits, while its Group company can be a risk-free entity earning only basic returns throughout the business cycle.”

The Tribunal has said that unless the assessee can demonstrate that past year’s data has an influence on the current year’s operations of the company, the same need not be considered while arriving at the ALP.

“This would require all taxpayers to include in their documentation the influence of prior year’s data on their present decisions.”

K.R. Girish, a practising chartered accountant and Rohan Phatarphekar, National Head of Transfer Pricing, KPMG, say the Special Bench’s decision has created more issues rather than solutions.

Analysing the ruling, they say it would have been more appropriate if the Tribunal had given its conclusion rather than remanding the matter to the AO.

“This would again go to the Transfer Pricing Officer (TPO) for a fresh assessment, which would mean that it would not solve the issue but only go through its motions. On this account, the order of the Special Bench clearly falls short of expectations.”

On the issue of whether conducting a benchmarking analysis using the transactional net margin method (TNMM) and the profitability of the US service provider is good enough to establish that the international transactions of the Indian taxpayer were at arm’s length, the Tribunal has said that the TNMM is consistent with the other methods such as cost plus and resale price methods.

“This means that the net margin of the taxpayer from controlled transactions should ideally be established by reference to the net margin earned from comparable uncontrolled transactions. Where the same is not possible, the net margins earned by independent enterprises in comparable transactions would serve as a guide.”

They add that the Tribunal had also observed that there is no justification in paying Rs 28.32 crore to Aztec US for rendering certain services for which Aztec India itself receives only Rs 25.69 crore from third-party customers. “Thus, the ALP of the international transactions cannot be accepted at the face of it, unless the taxpayer can prove it.”

Besides, the Bench observed that though Nasscom rates may be genuine data, these rates cannot be considered as comparable since neither the taxpayer nor the Revenue is aware of the exact nature of the rates.

“Further, as the provisions allow an adjustment to be made to comparable transactions, it would be very difficult to find out the differences in the transactions to enable an adjustment.”

Adoption of global practices such as OECD transfer pricing guidelines can resolve or even help avoid many transfer pricing disputes, says Samir Gandhi, Partner, Deloitte Haskins & Sells, adding that giving statutory recognition to the guidelines may be considered.

“Transfer pricing is an intense, fact-based issue and it is necessary that the Board of Taxes issues appropriate instructions covering nuances, such as comparables, methods, etc. This will lead to consistency in application and a fair and equitable approach.”

He also says transfer pricing is not an exact science and that there can be appropriate issues from the perspective of the authorities.

“However, the challenge is to administer the ALP test in a practical manner. Considering that the IT/ITES industry has become a big opportunity for India, one can consider giving certainty to the issue by prescribing safe harbour criteria for such units.”

In his view, this will help prevent litigation and compliance burden both for taxpayers and the tax authorities.

According to Indraneel Roy Choudhury, Executive Director, PricewaterhouseCoopers, the ruling has clearly put to rest any further arbitration on technical matters related to application of mind by the AO in referring transfer pricing cases to the TPO.

“In addition, it has ruled that the TPO’s order is binding on the AO, which is again in line with the recent amendment made vide the Finance Act 2007.” He adds that in essence, this ruling more or less “sets the precedent for future adjudication of transfer pricing cases on functions performed, risk assumed and assets employed - the crux of any transfer pricing law.”

Stating that the Tribunal has also dealt in considerable detail with the merits of the case with regard to the economic principles of transfer pricing and the selection and application of method for determining ALP, he says it has substantially upheld that the fundamental principles of transfer pricing for analysing international transactions have to be based on a proper analysis of functions performed, assets employed and risks assumed by the respective parties.

“However, the Bench went on to state the burden of proof to establish the ALP and to furnish relevant information squarely rests on the taxpayer.”

In his opinion, the ruling has substantially upheld the stand taken by the Department, especially with regard to the reference of a case by the AO to the TPO for adjudicating ALP. “The same was also the subject matter of the earlier decision of the Delhi High Court in the case of Sony India, wherein the matter was decided in the favour of the Tax Department.

The Tribunal has categorically followed the High Court’s decision while dealing with the matter under review.”

dmurali@thehindu.co.in

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