While deciding in favour of the Revenue department, the Ahmedabad Income Tax Appellate Tribunal recently ruled in the case of Pino Bisazza Glass Pvt Ltd that product comparison is an essential element and should be preferred over ‘functional similarity’ for determining arm’s length price under the Transactional Net Margin Method (TNMM). Holding that the transfer pricing officer had rightly rejected the comparables selected by the taxpayer, the tribunal observed that without first establishing the proximity of the products it was difficult to treat the companies as ‘comparables’. Interestingly, the Mumbai tribunal in the recent case of Diageo India Pvt Ltd held that product similarity was not relevant, as that criteria would make TNMM impractical. Further, the Organisation for Economic Cooperation and Development’s guidelines too hold that while prices are likely to be affected by differences in products, net profit indicators are less adversely affected.

Share premium catches taxman's eye

In the case of Northgate Technologies Ltd, the transfer pricing officer/ first appellate authority had treated the share premium paid by the taxpayer in an investment in an overseas subsidiary as a loan to the subsidiary. The Revenue argued that unless price paid as premium to subsidiaries is justified in an arm’s length situation, it should be treated as ‘nil’ under the Comparable Uncontrolled Price method as no independent party would pay such a huge premium without basis. The adjudicating Hyderabad Income Tax Appellate Tribunal observed that the Revenue’s main contention was the taxpayer’s failure to furnish analysis supporting the high premium paid. Accordingly, it remanded the matter back to the assessing officer, directing the taxpayer to furnish the supporting evidence. While the question remains whether the re-characterisation of a transaction is appropriate, in the current era of TP with an expanded definition of “international transaction”, this ruling reiterates the importance of valuation and robust documentation to support the arm’s length nature of capital transactions.

Contract manufacture outside TDS net

The Supreme Court in the case of Silver Oak Laboratories Pvt Ltd recently held that the amendment to section 194C of the Income-Tax Act, 1961 will apply only from October 1, 2009, and not retrospectively. The amendment under Finance Act 2009 excluded “contract in the nature of contract manufacturing arrangement” from the definition of “work” with effect from October 1 that year. Typically, under a contract manufacturing arrangement, the vendor manufactures a product by procuring the raw material according to customer specifications and supplies the product after levying the applicable excise duty or sales tax. On delivery, the property title passes to the customer. It may be noted that even before the amendment the predominant judicial view was that contract manufacture is a sale transaction and not a ‘works contract’, and hence outside the scope of section 194C.

The correct profit of the branch office

Recently, in the case of Wellinx Inc, the Hyderabad Income Tax Appellate Tribunal ruled on the exclusion of payments received by an Indian branch office from its US head office. Considering Article 7(3) of the India-US tax treaty, the tribunal held that when services by the Indian branch office were outsourced “commercial” activities, they would be included as its profits. However, if it carried out non-commercial activities on specific instructions from the head office, then the payments would be excluded from its profits. While the tribunal’s distinction between commercial and non-commercial services does not find specific reference in the treaty or the OECD Report on Profit Attribution, it may have perhaps intended to identify whether there are “dealings” between the branch and head offices.

— EY

Published on July 21, 2013