Judicial reading of transfer pricing provisions

The Income tax department has created a special cell to deal with foreign companies and international transactions entered. The above cell has the position of Transfer Pricing Officers (TPOs) who are authorised to decide transfer pricing issues.

Where the TPO is not satisfied about the margin of profit charged or received by an Indian assessee from its transaction with foreign enterprises, he can make an adjustment in the taxable income of the Indian enterprise.

According to instruction number 3/2003 dated May 20, 2003 issued by the Central Board of Direct Taxes (CBDT), it is mandatory for an Assessing officer (AO) to refer transfer pricing matters to the TPO in all cases where the aggregate value of international transaction in that year exceeds Rs 5 crore. If reference to TPO is not made, the assessment could be declared as bad in law.

Transfer pricing provisions are intended to regulate the profit margins of Indian parties on their transactions with foreign parties. The law requires that the cross-border transactions should be at arm's length price (ALP). For this purpose, the margins of the Indian party need to be compared with the margins charged on similar transactions by other enterprises.

For the purpose of this comparison, an Indian taxpayer has a choice to either treat himself as a "tested party" or to treat its associated enterprises (AEs) (parties with whom the Indian assessee has made international transactions) as the "tested party". Thereafter, in order to determine the ALP, the margin of the tested party is compared with the margin charged by other enterprises who are also involved in similar business.

In case of Ranbaxy Laboratories versus Addl CIT [2008] (299 ITR 175), the Indian assessee elected to treat its 17 AEs as tested parties. Then the average of margins of all the 17 parties was compared with the margins of some other foreign pharmaceuticals companies.

However, the Honourable ITAT held that: "The taxpayer is wrong in selecting overseas AEs as tested party for purposes of comparison to apply TP regulaions...if a taxpayer wishes to take foreign AEs as the tested party and compared the margin with the foreign comparables, then it must ensure that it is such an entity for which relevant data for comparison is available in public domain or is furnished to tax administration."

The Honourable Tribunal also held that separate transactions should not be aggregated to arrive at an average if they are of different companies in different countries.

It is also important that the audit report furnished by Ranbaxy was found incomplete as the same did not contain details like:

a. Specific characteristics of the transactions
b. Evidence that Functional, Asset and Risk (FAR) analysis was carried out.
c. Specific details of International transactions carried out with the 17 AEs.
d. Other Details

Ranbaxy's case lays down the judicial thinking that unless the required documents are maintained by an assessee and are provided to the AO for verification, the assessment would be bad in law and could be reopened according to the provisions contained in the Act.

It is clear that a mere certificate from a Chartered Accountant does not suffice. It is also clear that reliance on foreign companies' data for the purpose of comparison may not be acceptable to India.

agar@bol.net.in