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Fettering the discretion of the AO
April, 07th 2007
The Finance Bill, 2007 has laid down that the opinion given by the transfer pricing officer will be binding on the assessing officer, the former being an expert in matters concerning the determination of the arm's length price.

The Central Board of Direct Taxes (CBDT) seems to be increasingly concerned with effective implementation of the transfer pricing law. The Finance Act, 2001 had brought in new provisions in Chapter X of the Income-Tax Act, 1961 to deal with computation of income from international transaction having regard to the arm's length price of the transactions. The office of the Transfer Pricing Officer (TPO) under Section 92CA was created. Assessing officers (AOs) handling cases involving multinational corporations are expected to consult TPOs whenever they consider it necessary or expedient to do so.

In May 2003, the CBDT issued Instruction No.3 advising the departmental officers to take up cases for scrutiny where the aggregate value of the international transactions exceeded Rs 5 crore. This circular was challenged before the Delhi High Court on the ground that it took away the discretion of the AO by laying down a monetary limit.

The court rejected this objection. It went into the nitty-gritty of Chapter X and pointed out that Instruction No. 3 was only a guideline to the AO in matters concerning exercise of discretion conferred by the statute. It suggested that in due course a database of decisions given by the TPOs be made available to the AOs to act as a useful guide in determination of the arm's length price.

The amendment

Section 92 CA(4) of the Act requires the AO to pass an assessment order "having regard" to the arm's length price determined by the TPO. The Delhi High Court had said that the TPO's order will help the AO exercise his discretionary power in a knowledgeable and intelligible way after receiving the report of the TPO.

The Finance Bill, 2007 has amended Section 92 CA(4), laying down that the opinion given by the TPO will be binding on the AO, the TPO being an expert in matters concerning the determination of the arm's length price.

The AO will hereafter have no discretion to apply his mind to the report of the TPO. He has to compute the total income of the assessee in conformity with the arm's length price determined by the TPO. To this extent, the Delhi High Court ruling in Sony India (P) Ltd vs CBDT (157 Taxmann 125) is modified.

Audit of the transfer price by both the TPO and the AO can be time consuming. The Finance Bill has revised the time limit for making the assessment/reassessment in cases where a reference is made to the TPO. The AO will get one more year to make the assessment.

The TPO, on his part, should determine the arm's length price at least two months before the expiry of the new statutory time limit for making the assessment/reassessment. Sections 153 and 153B have been amended for this purpose.

The GSK case

The Glaxo Smithkline vs IRS case shows how the US deals with companies violating the arm's length rule. Glaxo Smithkline (GSK), a pharma major, was selling Zantac, a high-value drug, in the US. It had obtained a trademark in the US and spent huge amounts on marketing. However, research and development was undertaken by GSK, UK.

The question arose whether substantial value for the product was created in the US, by way of extensive marketing and obtaining of trademark, or in the UK, by way of research.

Where was the greater portion of the income derived? The dispute went on for 17 years. Finally, in November 2006, GSK, US and the IRS (Internal Revenue Service) of the US arrived at a settlement under which the former was to pay $3.4 billion to the latter to settle the longstanding dispute on transfer pricing.

The company had preferred a discrimination claim for $17 billion against the IRS for rejecting its request for advance pricing agreement. Under the November 2006 settlement, the counter-claim was abandoned by the company.

Advance pricing mechanism

The amendment proposed in the Finance Bill, 2007 and the GSK case should be studied in-depth. Our own TPOs will have to develop expertise in interpreting the arm's length rule. India is not a low-tax destination. For MNCs, the inducement to claim expenditure in India and shift income outside this country will always be strong. There should be rational basis for allocation of income and expenditure between transnational jurisdictions. Just withdrawing the discretion hitherto available to the AO and substituting the opinion of the TPO may not achieve the desired purpose of establishing a fair arm's length price. The advance pricing mechanism must be introduced soon.

The amendment is likely to give rise to litigation as it takes away the discretion of the AO. The Government, however, has a point. Under the wealth tax law, the report of the valuation officer is binding on the wealth tax officer. But the question may arise whether the expertise of the valuation officer can be considered to be on a par with that of the TPO.

T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)

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