H P Agrawal: Standard rules not the only method to calculate arm's length for TP

Transfer Pricing (TP) provisions were introduced in India by the Finance Act 2001. The TP provisions were introduced with an intent to protect India’s right to collect a fair share of tax in respect of cross border transactions. In simpler terms, TP provisions were introduced to ensure that an international transaction between two associated enterprises is made at an arm’s length price (ALP) so that both the countries involved get a proper share of profits in their respective jurisdiction. In order to determine the ALP, various methods have been prescribed which are based on OECD guidelines and international transfer pricing practices.

Income-tax rules originally prescribed five methods for determining the ALP. Rule 10B specifically provides that value of an international transaction has to be determined by any of the said five methods.

However, sometimes the nature of transaction is such that none of the methods prescribed in law are appropriate to determine ALP. Then, in such a situation, how will the ALP be calculated? In this context, reference may be made to the recent case of Ascendas India Pvt Ltd. wherein the Chennai Bench of the Income-tax Appellate Tribunal (ITAT) has analysed the issue threadbare. Under the facts of the case, Ascendas India Pvt Ltd (AIPL), the taxpayer sold some shares to its associated enterprise. The taxpayer determined the share valuation on the basis of CCI Guidelines.

The Transfer Pricing Officer (TPO) rejected the CCI guidelines valuation.

The Hon’ble Tribunal observed that by the very nature of the transactions, none of the methods appear at the first blush appropriate for a TP analysis. Resale Price Method cannot be applied since the shares sold by the Assessee were in turn not sold to anybody else. Cost Plus Method cannot be applied since the assessee had made no value addition to any item.

Original cost per share was only its face value and the cost incurred, which resulted in increase of its intrinsic value, cannot be correctly ascertained. Neither Profit Split Method nor Transactional Net Marginal Method can be used. Similarly placed companies doing similar share transactions are hard to find.

The Tribunal finally held “ it appears that following one of the methods mentioned in (a) to (f) [ of section 92C(1)] are mandatory. However, in our opinion, the purpose of enactment of Chapter X, is to benchmark an international transaction with the Fair Market Value of such transaction, so as to ensure that there are no profit transfers between parties in different jurisdictions effectually circumventing taxes. Thus, purpose of transfer pricing rules, is to verify whether the prices at which an international transaction has been carried out is comparable with the market value of the underlying asset or commodity or service.

It may be true that difficulties might arise in ascertaining the fair market value, but such difficulties should not be a reason for not adapting the rules and methods prescribed in this regard. This might require some subtle adjustments in the methodology prescribed for evaluation of an international transaction.

A water-tight attitude of interpretation of the prescribed methods will defeat the very purpose of enactment of transfer pricing rules and regulations and also detrimentally affect the effective and fair administration of an international tax regime. That interpretation of the word ‘shall’ need not always be mandatory and could also be read as “may”, is a rule laid down by the Gujarat High Court in the case of CIT v. Gujarat Oil & Allied Industries.”

Having held so, the Tribunal considered the DCF Method as an appropriate method for valuation of shares to determine ALP on transfer of shares for the purpose of transfer pricing.

The Hon’ble Tribunal has rightly given a harmonious interpretation of the Transfer Pricing Rules keeping in view the objectives of Transfer Pricing. Therefore, where an assessee is stuck with a transaction, ALP of which cannot be determined by any of the methods prescribed by the Rules, fair market value of the transaction may be determined by applying some logical and reasonable basis of valuation.

 

H P Agrawal / Alok Gupta
e-mail: hp.agrawal@sskmin.com,
a.gupta@sskmin.com