Transfer Pricing Judgements
Transfer Pricing Judgements

    TRANSFER PRICING JUDGEMENTS

    When two or more associated enterprises companies enter into a joint contract during an international transaction in order to allocate a particular cost incurred in relation with a profit, service or facility presented by any one or all of the companies, such a cost shall be calculated taking into account the arm’s length price of the particular assistance, service, or facility, as applicable.

    Recently Bombay High Court dismissed a plea by British telecom giant Vodafone's Indian arm against the income-tax department and clarified that transfer pricing authorities have the jurisdiction to investigate suo moto any cross-border transactions. The court said that the company has the option to go for an alternative remedy.

    Recently there have been many judgements at various appellate levels in the vastly dynamic field of Transfer Pricing. I would be covering some of the recent Transfer Pricing Judgements which could impact our understanding of the regulations in India.

    Delhi ITAT (SB)- L.G. Electronics (I) P. Ltd. (TS- 11- ITAT- 2013 (DEL)- TP) :
    Advertisement Marketing and Promotion (AMP) expenses were incurred by L.G. India in India. L.G. was paying towards Royalty to L.G. (Korea) @1%.

    ITAT held that the assessee was promoting brand owned by AE on its behalf by incurring excessive AMP expenses. It held that that AMP constituted an ‘International Transaction’ even though no payment was made to L.G. Korea or any associated enterprise. Non payment of consideration does not make TP provisions inapplicable. It also held that LG Korea benefited from brand promotion in India. So a reasonable profit percentage was assumed on the brand promotion expenses incurred in India and TP adjustment was made.

    Some other conclusions were as follows:
    a. Use of Bright Line Test (used in USA) for determining cost / value of such transactions was upheld
    b. DRP as well as AO were right in applying the spirit of the 'cost plus method'
    c. Non applicability if any of the recognised methods in TPO/ DRP orders does not make the entire proceedings void.
    d. Selling Expenses which do not lead to brand promotion cannot be brought within the ambit of AMP for determining cost / value of the International Transaction.

    Please also note that Finance Act 2012 has inserted explanation to Sec 92B retrospectively to amend the definition of international transaction to include market research, market development, marketing management, administration, technical service, repairs, design, consultation, agency, scientific research, legal or accounting service.

    Delhi ITAT- Cotton Naturals (I) P. Ltd. (TS- 33- ITAT- 2013 (DEL)- TP)
    The TPO had held that LIBOR (London Inter Bank Offer Rate) was not proper rate while deciding interest rate on receivables. The TPO adopted domestic rate while determining ALP and made TP adjustment.

    The Delhi ITAT held that domestic prime lending rate is not applicable where loan is advanced to foreign subsidiary in foreign currency. It also held that LIBOR could be used as a reference rate to determine the borrowing rate/ lending rate.

    In fact Mumbai ITAT in Hinduja Global Solutions Ltd. (TS- 147- ITAT- 2013 (Mum)- TP) has also upheld LIBOR for lending to subsidiary in USA.

    Mumbai ITAT- Aurion Pro Solutions Ltd. (TS- 75- ITAT- 2013 (Mum)- TP)
    The Mumbai ITAT has held that the Tested Party would always be always the taxpayer & not AE, as effect of the transaction on the income of the ‘assessee’ is relevant.

    Delhi ITAT- GAP International Sourcing (I) P. Ltd. (TS- 667- ITAT- 2012 (Del)- TP)
    GAP India was a wholly owned subsidiary of GAP USA. GAP India used to facilitate sourcing of apparel merchandise from India. GAP India charged at Cost plus 15% for its low cost services from India. The TPO rejected the cost plus model on the alleged ground that it created a supply chain and human intangibles in India and generated location savings in India which have not been factored into its remuneration model.

    The ITAT held that the Assessee was wrongly categorized as risk bearing agent for AE. There was nothing on record to show that assessee developed substantial human resources intangibles. The employees were merely following instructions provided by GAP USA and no decision making or entrepreneurial role was embedded in the work profile. Cost plus method was accepted by the ITAT.

    Mumbai ITAT – Capgemini India P. Ltd. (TS- 45- ITAT- 2013 (Mum)- TP)
    Capgemini India was a subsidiary of Capgemini USA. Capgemini India used to provide software programming services to its AE i.e. Capgemini USA. The Arms Length Price was determined using TNMM (Transaction Net Margin Method. In this method, net margin realized by an enterprise from an international transaction is compared with comparable uncontrolled transaction). The TPO included companies like Wipro and Infosys as comparable for computing arm’s length margin. TPO used standalone financials as against consolidated financials used by the assessee. Assessee sought for exclusion of Infosys and Wipro since they had very high turnover in compared to mid scale turnover of Capgemini India.

    The ITAT rejected the upper turnover filter. So it accepted the contention of the TPO that the concept of economy of scale is relevant for manufacturing and not for service oriented IT companies. So Infosys and TCS are comparables, which should be used for calculation of the Arms Length Price.

    It also held that only standalone financials should be considered as consolidated financials include profits from overseas jurisdictions with different geographical / marketing conditions.

    Now there have been many contradictory judgements on whether turnover filters may be applied while selecting comparables. For example, Bangalore ITAT in Trilogy E- Business Software India P. Ltd. (TS- 748- ITAT- 2012 (Bang)- TP) upheld the turnover filter of Rs. 1 Crore- Rs.200 Crores.

    However the recent judegements like Mumbai ITAT in Willis Processing India P. Lts. (TS- 49- ITAT- 2013 (Mum)- TP) have been rejecting turnover filter slabs submitted by the assessee. These judgements are similar to the Capgemini case.

    Delhi HC- EKL Appliances P. Ltd. (TS- 206- HC- 2012 (Del)- TP)
    EKL Appliances Ltd. was an Indian Company which paid a Royalty/ Brand Fee to its Swedish Associated Enterprises for the right to use the Kelvinator Brand. EKL Appliances Ltd. was making continuous losses. So The TPO held that the Royalty Payment did not benefit the assessee. The TPO held that the Arms Length Price is NIL.

    The Honourable Delhi High Court rejected the disallowance made by the TPO for royalty payment for the Kelvinator Brand. It held that the TPO can only examine the quantum of expenditure, but cannot judge the allowability as business expenditure. HC extensively relied upon OECD TP Guidelines, which discourage restructuring of legitimate business transactions.

    There are also conflicting judgements on whether Customs Data can be used in computing Arms Length Price
    Coastal Energy Pvt. Ltd. V ACIT (Chennai ITAT) held that comparable prices obtained from the Customs authorities are appropriate in computing Arms Length Price of import transactions. However Mumbai ITAT in Serdia Pharmaceuticals (india) Pvt. Ltd. and Delhi ITAT in Panasonic India Pvt. Ltd. held that prices obtained from the customs authorities were not considered as appropriate Comparable Uncontrolled Transactions (CUP)

    There is also a case of Diageo India P. Ltd., 47 SOT 252 wherein
    it was decided that if one enterprise controls the decision making of the other or if the decision making of two or more enterprises are controlled by the same person, these enterprises are required to be treated as associated enterprises. Though the expression used in the statute is ‘participation in control or management or capital’, essentially all the three ingredients refer to de facto control in decision making.

    As per a white paper released in May 2012 by Ministry of Finance, Department of Revenue, in 2011-12, Transfer Pricing Adjustments were made in 52% of all the Transfer Pricing Audits and the amount of adjustment was a mammoth Rs. 44,531 Crores. Transfer Pricing is a continuously evolving field both within India and internationally and until it becomes a settled law, it could subject us to unanticipated challenges and risks. With the introduction of domestic transfer pricing provisions to transactions between Indian entities which are associated enterprises, the coverage of the transfer pricing regulations is now wider. It is imperative that the Finance Ministry issues notifications/ circulars/ makes amendments clarifying their positions on the aforementioned issues. Any sudden negative surprises could further spoil an already vitiated investment climate in India.