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HC ruling gives a clear picture to MNCs
November, 10th 2006

A recent Delhi high court ruling in the case of Sony India has backed India's Transfer Pricing regulations and given more clarity to multinationals to toe a common line for all their cross-border transactions.

Foremost, the court upheld an instruction of the Central Board of Direct Taxes (CBDT) issued in May 2003. As per this CBDT instruction, all international transactions above Rs 5 crore can be referred by the assessing officer to the transfer pricing officer (TPO).

This, however, was challenged by Sony India in whose case the TPO (after examining the overseas transactions on the basis of the arms length method) recommended adding Rs 42.4 crore to the company's income for 2001-02.

"Significantly, the court also upheld that the assessing officer can even refer transactions below the Rs 5 crore limit to the TPO if he is convinced," said Vispi T Patel, head, transfer pricing, RSM & Co. Two months ago, the financial limit of referring overseas transactions to the TPO was raised to Rs 15 crore.

The Delhi high court ruling also confirms the legal position that the order of the TPO is not binding on the assessing officer. This will give one more opportunity to all multinationals to defend their case (before the assessing officer) if the TPO suggested any revision in the transfer pricing. "Also, the court clarified that the assessing officer must consider all materials placed before him (other than the TPOs order) in computing the arms length price of the overseas transactions,"Patel said.

Other pertinent issues surrounding TP norms will soon be taken by the income tax appellate tribunal. The tribunal has decided to set up a special five member bench for hearing the first ever big case on transfer pricing (TP) issue.

The case, pertaining to Aztec Software & Technology Services, will be heard on January 8 for three days by the ITAT bench in Bangalore.

Tax experts say Aztec's case may become a landmark as it will be the first one before a special bench of ITATthe final fact finding body for direct taxes. Sony's case surpassed the ITAT level as the company directing filed a writ petition in the high court.

Transfer pricing is the most common mechanism for allocating profits between subsidiaries of MNCs and can be used to change the tax outgo of the divisions. For instance, goods from a production division of a company may be sold to its marketing division and in such transactions, the 'transfer price' of the goods will directly impact the total profit of a division.

The government brought these transactions under the scanner by introducing transfer pricing norms under Chapter X of the I-T Act from April 1, 2002. In Aztec's case, the company was asked to pay Rs 9.15 crore tax due to adjustments made to the company's transfer pricing under Section 92C of the I-T Act for the financial year 2001-02.

Most of Aztec's contentions were upheld by the commissioner of income tax (appeals) in his 189-page order passed on March 31, 2006 and this created lot of confusion.

"By constituting a special bench, ITAT has taken a proactive step to clarify doubts at the initial step," said T P Ostwal, a CA, specialising in international tax issues.

Essentially, ITATs special bench will consider four key issues. The first whether it is a legal requirement under Chapter X of the I-T Act that the assessing officer should prima facie demonstrate that there is tax avoidance before invoking the relevant provisions. And if so, what is the degree of proof required to be brought on record by him?

The second issue will be whether, before making a reference to the transfer pricing officer, is it a condition precedent that the assessing officer shall provide an opportunity of being heard.

Third issue will be if the approval granted by the commissioner of income tax under section 92CA(1) justifiable? If so, can it be called in question in appeal on the ground that it was accorded without due diligence or application of mind? Fourth issue is what is the legal effect of instruction no 2 of 2003 issued by CBDT on transfer pricing proceedings? Till the case is decided, no bench of the ITAT will take up any transfer pricing issues.

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