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ITAT clears the air over transfer pricing
October, 10th 2008

The method adopted by a company to arrive at a transfer price is valid unless the tax officer can prove that the company had manipulated the price to shift profits outside India, the Income-Tax Appellate Tribunal (ITAT) has ruled. The tribunal has also observed that the transfer pricing officer (TPO) should have sufficient ground to suspect the shift in profits before invoking the transfer pricing rules.

Transfer pricing rules are meant to prevent a loss in revenues arising from related party transactions. Since more than 60% of the global transactions are between related parties, most developed countries have laid down stringent transfer pricing rules. India incorporated transfer pricing rules in the Income-tax Act in 2001. While putting the onus of proving the companys wrongdoing on the transfer pricing officer, ITAT quashed an order issued against Philips Software Centre, a captive software development company, on the ground that the order did not conform with the law. The tribunal also held that the primary objective of transfer pricing rules is to prevent profits from being shifted outside India.

According to ITAT, the tax officer should not have applied the transfer pricing rules to Philips Software as the company claimed exemption under Section 10-A of the Income-Tax Act. Under the section, companies can claim tax benefits on their software exports. Moreover, the transfer pricing officer did not explain to the company the reasons for invoking provisions of transfer pricing rules and hence the action cannot be construed as valid.

ITAT said the transfer pricing officer has to explain the reasons for rejecting a companys transfer pricing study and method. It concluded that the officer cannot reject the route used for arriving at the arms-length price, an income-tax jargon for market price, unless it is proved insufficient or invalid.

Philips Software Centre, which renders services to its overseas associated enterprises, had conducted a study to substantiate the arms-length price of its international transactions for assessment year 2003-04 by using the cost plus method (CPM) and supplementing it with the transactional net margin method (TNMM).

The TPO had rejected the transfer pricing study conducted by Philips and the method that was used in carrying out the research and replaced them with the TNMM method. The tax official, however, did not give any reason for rejecting the study. ITAT observed that the companys method for arriving at arms length price conformed to the transfer pricing rules.

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