There is no requirement to establish tax evasion before initiation of proceedings for determination of arms length price.
Taxation of multinational corporations (MNCs) is assuming greater and importance because of the opening up of the Indian economy and the entry of large transnationals into the Indian market. The ability of transnational corporations to allocate profits to sister concerns outside the Indian jurisdiction by controlling prices in group transactions has become a matter of great concern.
Profits taxable in India should not be understated by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in similar circumstances.
Legislative changes were brought about through the Finance Acts 2001 and 2002. The Central Board of Direct Taxes (CBDT) has explained in Circulars 12 and 14 that the basic intention of the new transfer pricing regulation is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the countrys tax base.
Section 92 of the Income-Tax Act 1961 lays down the Rule for computation of the arms length price in respect of international transactions between associated enterprises. Elaborate machinery is prescribed under Section 92CA for determining the correct price. In fact, Chapter X lays down special provisions relating to tax avoidance. The Memorandum of the Finance Bill 2001 stated that Chapter X was introduced as a measure to curb tax avoidance.
Transfer pricing officers (TPOs) have come on the field and are functioning in major cities. The assessing officer (AO) can refer a case to the TPO after forming an opinion that it is expedient to do so. The TPO will examine the arms length price (ALP) and recommend to the AO the modus operandi for fixing the ALP. The approval of the Commissioner of Income-Tax (CIT) is required for this purpose.
In a landmark ruling on transfer pricing regulations and the fixation of ALP, a Full Bench of the Income-tax Appellate Tribunal (ITAT), in the Aztec Software and Technology Services Ltd vs ACIT (294 ITR AT 32 Bangalore, SB) case, considered the question whether it is a legal requirement under Chapter X of the I-T Act that the AO should prima facie demonstrate that there is tax avoidance before resorting to Section 92CA.
The Special Bench of five Members held that courts are not required to look into the object or intention of the legislature by resorting to aids to interpretation when the language of the provision is clear and unambiguous.
It is for the AO to form an opinion that circumstances exist making it necessary to refer the matter to the TPO.
The question of tax avoidance is not to be established by following mandatory provisions. It is not necessary for the AO to demonstrate the avoidance of tax before invoking these provisions. Observed the Special Bench: We are not required to find the intent of the legislature by referring to the Budget Speech of the Finance Minister, Notes on Clauses, Circulars etc., when the language of the statute is clear and unambiguous. Headings or Marginal Notes do not control a provision where plain and unambiguous language has been used by the legislature.
According to the Special Bench, there is no such requirement of establishing tax evasion before initiation of proceedings for determination of ALP.
Section 40A provides for disallowance of excessive or unreasonable expenditure in matters concerning transactions between sister units.
The Special Bench ruled that Chapter X is not governed by Section 40A. It also held that the availability of exemption under Section 10A will not bar the applicability of Sections 92C and 92CA of the Act. It is for the assessee to substantiate the most appropriate method by proper documentation. The burden of proof about the correctness of the price charged to associate enterprises is on the assessee.
This ruling of the Special Bench of the Appellate Tribunal will have far-reaching consequences in the application and interpretation of the transfer pricing law. At one sweep, the Special Bench has brushed aside the Finance Minsters speech, Notes on Clauses and the Memorandum explaining the provisions of the law as not relevant in deciding the question whether attempt at tax evasion or avoidance should be proved before invoking Chapter X.
Even the exemption provision for newly established undertakings in free trade zones will have to be disregarded when it comes to a question of applying the TP law.
Naturally, the Special Bench has ruffled the feathers of tax jurists and the ruling is now the subject matter of intense controversy.
T. C. A. Ramanujam (The author is a former Chief Commissioner of Income-Tax.)