1.These Tax Appeals under Section 260A of the
Income Tax Act, 1961 (for short ‘the Act,
1961’) are at the instance of the Revenue and
are directed against the orders passed by the
Income Tax Appellate Tribunal, Ahmedabad ‘D’
Bench, Ahmedabad (for short ‘the Tribunal’).
2.Tax Appeal No. 751 of 2019 is arising out of
the order of the Tribunal dated 12.02.2019 in
ITA No. 2276/AHD/2013 for A.Y. 200809.
3.Tax Appeal Nos. 752 of 2019 and 753 of 2019
are arising out of the common order of the
Tribunal dated 12.02.2019 for A.Y. 200708
in
ITA No. 760/AHD/2012 filed by the revenue and
ITA No. 874/AHD/2012 filed by the assessee.
4.Since common issues are arising in these
appeals, the same were heard analogously and
are being disposed of by this common order.
For the sake of convenience, Tax Appeal No.
753 of 2019 is treated as the lead matter.
5. The revenue has proposed the following three
questions of law as substantial questions of
law for the consideration of this Court so
far as Tax Appeal Nos. 752 of 2019 and 753 of
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2019 are concerned, which pertains to A.Y.
200708:
(a) Whether in the facts and
circumstances of the case, the learned
ITAT has erred in law and on facts in
deleting the upward adjustment of
Rs.2,78,02,502/made
by the AO/TPO and
confirmed by CIT (A) on account of
Transfer Pricing adjustments in respect
of international transactions of sale of
chemical products by the assessee to its
Associated Enterprises (Aes)?
(b) Whether in the facts and
circumstances of the case, the learned
ITAT has erred in law and on facts in
rejecting the TPO’s approach of
rejecting the Transactional Net Margin
Method (TNMM) and adopting Comparable
Uncontrolled Price (CUP) Method as Most
Appropriate Method (MAM)?
(c) Whether in the facts and
circumstances of the case, the learned
ITAT has erred in law and on facts in
allowing following appropriate
adjustments claimed by the assessee for
material differences in contractual
term, underlying commercial
circumstances, functions, risk and other
economic factors between assessee’s
transactions with AEs visàvis
assessee’s transactions with non AEs
while applying the Comparable
Uncontrolled Price (CUP) method:
vi. Adjustment on account of business
volumes difference.
vii. Adjustment for advance payment
received from AE.
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viii. Adjustment for marking and
selling expenses not required to be
incurred for AE sales visàvis
non AE
sales.
ix. Adjustment for credit risk not
required to be borne by the assessee for
AE sales visàvis
non AE sales.
x. Adjustment for interest free ECB loan
received from AE?
6. Brief facts of the case are as under:
6.1. It appears from the material on record
that the respondent – assessee filed his
return of income for A.Y. 200708
on
05.11.2007 declaring the income at
Rs.99,43,677/.
The case of the assessee
was selected for scrutiny assessment and
a notice under Section 143(2) and 142 (1)
of the Act, 1961 were issued.
6.2. The Assessing Officer referred the case to
the Transfer Pricing Officer (TPO) under
Section 92CA(1) of the Act, 1961. The TPO
passed an order dated 19.10.2010 under
Section 92CA (3) of the Act, 1961
determining the total transfer pricing
adjustment of Rs.3,91,40,456/by
discarding the Transactional Net Margin
Method (TNMM) and adopted Comparable
Uncontrolled Price (CUP) method as Most
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Appropriate Method (MAM) by the assessee
in respect of the international
transactions.
6.3. On the basis of the order passed by the
TPO, the Assessing Officer adopted the
upward transfer pricing calculated by the
TPO and passed the assessment order.
6.4. The Assessing Officer adopted the CUP
method as Most Appropriate Method (MAM),
due to following reasons as recorded by
the Tribunal in the impugned order:
“5. The material facts and circumstances
of the case are like this. The assessee
company is a wholly owned subsidiary of
EW Limited, Mauritiusa
group entity of
Gulbrandsen Inc, USA and Gulbrandsen EU
Limited UK inasmuch as the shareholders
of EW Limited, i.e. Peter Gulbrandsen
and Donald Gulbrandsen, are also
majority shareholders of Gulbrandsen
Inc, USA and Gulbrandsen EU Limited UK.
The assessee is engaged in the
manufacturing of chemicals for its
divergent industrial customers, its
product range includes Aluminium
Chloride Anhydrous (ANH), Meno N Butyl
Trichloride (MBTC), Stannic Chloride
(TTC), Dibutyl Tin Oxide (DBTO)/ Dibutyl
Tin Tin Dilaurate (DBTAA) and Tri Chloro
Benzene and these products are supplied
to the industries including
petrochemical industry, pharmaceutical
and chemical intermediate users. The
assessee has also sold these products to
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its AEs, namely Gulbrandsen Chemicals
Inc, USA, and Gulbrandsen EU Limited,
UK. During the course of assessment
proceedings, the matter regarding
ascertainment of arm’s length price was
referred to the Transfer Pricing
Officer. The Transfer Pricing Officer
noticed that the assessee had, deviating
from the stand taken in the earlier
years in which internal CUP method was
adopted for benchmarking the sale to the
AEs, computed the arm’s length price of
these transactions on the basis of
Transactional Net Margin Method (TNMM).
In effect thus, the assessee moved, in
the current year, from internal CUP to
TNMM. This, however, did not find favour
with the TPO. The TPO was of the view,
for the detailed reasons set out in his
order, that, given the facts of the
case, the internal CUP was the most
appropriate method and it has been used
all along in the earlier years. The
reasoning adopted by the TPO was like
this. It was noted that the assessee had
sold 40% of its products to the
associated enterprises, and earned
margin of PBIT/Cost at 2.07%, as against
the sale of 70% of its products in the
immediately preceding year and earning
margin of PBIT/Cost at 3.26%.
The TPO
computed the total cost per kg for each
type of chemicals and compared it with
average sale rate to AEs so as to
compute the GP/Cost (%) and noted that
“the assessee has charged very nominal
margin to the AEs”. Coming to the
Internal TNMM adopted by the assessee
and the TPO’s view that the basis of
allocating the overheads was not clear,
it was explained by the assessee that
revenue and expenses have been allocated
on actual basis wherever these are
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directly allocable, and wherever these
are not directly allocable, the
allocation has been done on the basis of
appropriate allocation key such as
ration of sales quantity, sales revenue,
total revenue. It was also explained
that the segmental details have been
reconciled with entity level audited
accounts. The assessee further submitted
that “in case if in your view there are
any inappropriate cost allocations, we
would appreciate if you can kindly let
us know which cost allocations are not
appropriate and why these are not
appropriate so that we can accordingly
clarify and explain on those aspects”.
While the TPO did not have any specific
comment on this request, he simply
rejected the explanation of assessee as
“not accepted”. It was also explained to
the TPO that the CUP method is not
really appropriate to the facts of this
case as the assessee has long term
business arrangements with the AEs,
whereas there are no such long term
arrangements with non AEs and that the
contractual, economic, commercial,
functional and risk profile differences,
between the AE transactions visàvis
non AE transactions, make the comparison
of prices irrelevant. The attention was
invited to the fact that, as also stated
in OECD Guidelines for Multinational
Enterprises and Tax Administrators,
application of CUP method “requires high
degree of comparability not only in the
products sold and services provided but
also in the economic circumstances in
which the respective AE and non AE
transactions take place”. It was thus
submitted that the economic
circumstances in which sales have taken
place with the AEs are not at all
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comparable with the economic
circumstances in which non AE sales have
taken place. It was also explained that
the AEs, to which the assessee has sold
the products, are resellers whereas non
AEs are end consumers, and that while
these AEs are located in US and UK, the
non AE customers are in Asia and Middle
East. Emphasis thus was placed on the
fact that the geographical location of
markets was different and the comparison
was thus inappropriate. It was also
highlighted that the volume of sales to
the AEs was substantially higher than
sales to non AEs. The attention was also
invited to the fact that while AEs make,
on an average, 17 months advance payment
for the purchases while non AEs are
extended 6090
days credit period. It
was thus contended that there was no
credit risk to AE sales. The assessee
further pointed out that the AEs also
reimburse the assessee the basic
research and development costs with 110%
mark up under long term business
arrangement, over and above the sale
price, and that the assessee has also
benefited from interest free ECB loans
from the AEs. None of these submissions
impressed the TPO. The TPO noted the
objections of the assessee for the
application of Internal CUP but rejected
the same mainly on the ground that
“since 200304,
the assessee company has
been using internal CUP as the most
appropriate method” and “the assessee
company has shifted from internal CUP
method to internal TNMM without giving
any appropriate reasons. So the
contention of the assessee is rejected”.
As regards the justification of TNMM on
the ground that the volume of sales to
the AEs is several times higher than the
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sale to non AEs, the TPO observed that
“it means that the assessee has sold
huge volume to AEs at a lower rate and
shifted the huge profits from India to
other countries” and, therefore, “the
contention of the assessee is not
acceptable”. As regards the credit
period and advance payments, the TPO
observed, on a superficial note again,
“contention of the assessee is
considered but is not acceptable because
in USA and UK market, the price of TTC,
MBTC and DBTC are higher than non AE
price rate”. As regards guaranteed
purchase of 50% production, the TPO
observed that “it is seen that the
assessee has been earning profits only
from the non AE transactions (and) at
least 50% guaranteed selling to AEs mean
that the assessee is making loss and
shifting the profits from India to other
countries”. On reimbursement of R&D
costs also, the Assessing Officer did
only observe, in rather general terms,
that the plea is “not acceptable because
the assessee has sold the products to
its AEs at very lower rate and shifted
the profits from India to outside India”
The same was the comment in respect of
interest free ECB loans from the AEs. As
for the need of adjustment on account of
various factors, the TPO simply observed
that “the assessee has charged very
nominal margin to its AEs (and)
therefore, there is no any issue for any
adjustment”. He then proceeded to make
the adjustment by observing as follows:
10. Computation of Arm’s Length Price
Product Sales to AE
Quantity
(kgs)
Sales to
AE: Avg.
rate
Sales to
nonAE
Uncontrolled
price rate
Difference Adjustment
TTC 113800 227 253 26 2958800
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MBTC 351036 371.41 465.18 93.77 32316646
DBTO 56852 351.84 409.27 57.43 3265010
Total Transfer Pricing Adjustment Rs.3,91,40,456/6.5.
Being aggrieved by the upward Arm’s Length
Price adjustment (ALP) made by the
Assessing Officer on the basis of the
order passed by the TPO, the assessee
carried the matter in appeal before the
CIT (A).
6.6. However, CIT (A) confirmed the order
passed by the Assessing Officer observing
that, ‘regardless of merits into
adjustments made by the appellant, the
fact remains that adjustment to make
control and uncontrolled transactions
comparable were possible in appellant’s
case. It was also observed that, “further,
it is an accepted position that CUP is a
superior method to other methods, if
available.” The CIT (A) relying upon the
decision of the Tribunal in case of Serdia
Pharmaceuticals India Pvt. Ltd. v. ACIT by
Mumbai ITAT reported in (2011) 44 SOT 391
(Mum.) and held that the adjustments were
possible but same were rejected on the
merits including in respect of volume
discount, credit terms, marketing and
selling function and consequent costs,
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credit risk, reimbursement of R & D costs,
interest from ECB loan and all such
factors. As the TPO observed that there is
a huge difference between the sale price
of Meno N Butyl Trichloride i.e. MBTC to
its USA based AE and UK based AE, inasmuch
as the same product was sold to USA based
AE for Rs.412.95 and to UK based AE for
Rs.370.13. According to the CIT (A) such
difference indicated that sales to USA
based AE was much above the ALP. The CIT
(A) therefore, observed that, ‘the
appellant has not explained the vast
difference between the prices charged for
the same chemical from two AEs in the same
period.’ And therefore, ‘the adjustment
claimed by the appellant and the
calculation done by the appellant to
arrive at ALP after adjustments is not
acceptable’ and ‘determination by the TPO
of ALP of transactions to be average sale
price to nonAEs
over the year, without
carrying out adjustments is upheld’. The
CIT (A) however, reduced the ALP
adjustment to Rs.2,78,02,502/by
observing as under:
“3.3.2 Appellant’s contentions in
para 3.2.2 of its submissions regarding
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mistakes in quantification of transfer
pricing addition under CUP method by
Id. TPO are now taken up. It is pointed
out by the appellant that for the
products MBTC and DBTO, TPO compared
consolidated average price for both the
AEs with nonAE
average price. Each
sale transaction to the AEs constituted
a separate international transaction,
arm’s length price of which was
required to be determined in accordance
with Section 92 of the I.T. Act. The
Comparable Uncontrolled Price (CUP) for
each of the 4 chemicals was determined
by the TPO to be the average sale price
charged by appellant to nonAEs.
Each
transaction of sale of chemicals to the
AEs needed to be benchmarked with
reference to the CUP and if the CUP
exceeded the sale price to AE for a
particular transaction, only then
transfer pricing adjustment was
warranted. TPO’s approach in working
out adjustment on the basis of
consolidated average sale price for
both AEs for MBTC & DBTO was therefore
erroneous; AEwise
aggregation of
transactions for each chemical for the
purpose of benchmarking and working out
transfer pricing adjustment is however
acceptable in this case, since it does
not result into an outcome different
from transactionwise
benchmarking.
Thus, only AEwise
segregation of sale
transactions for each chemical needs to
be done. Appellant’s submissions in
respect of DBTA sale also have merit
and are accepted. Accordingly, transfer
pricing adjustment of Rs.2,78,02,502/worked
out by the appellant is directed
to be substituted in place of
adjustment of Rs.3,91,40,456/worked
out by TPO subject to verification by
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the AO of arithmetical correctness of
the working done by the appellant.”
6.7. The assessee being aggrieved and
dissatisfied by the order passed by the
CIT (A) carried appeal before the
Tribunal, whereas, the Revenue also filed
a crossappeal
for the reduction of ALP
adjustment made by the CIT (A). The
Tribunal considered the question as to
which is the most appropriate method for
ascertainment of Arm’s Length Price in the
facts of the case. The Tribunal considered
the well established principle that as
long as it is reasonably possible to apply
direct method of ascertaining the Arm’s
Length Price of a transaction, such a
direct method will have an edge over
application of an indirect method of
ascertaining the Arm’s Length Price. The
Tribunal relied upon the decision of the
coordinate Bench of the Tribunal in case
of ACIT v. MSS India Ltd. reported in
(2009) 32 SOT 132 (Pune) and Serdia
Pharmaceuticals India Pvt. Ltd. (supra)
and has observed as under:
“…Going by this principle, all other
things being equal, a direct method like
Comparable Uncontrolled Price (CUP)
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method will have an edge over an
indirect method like Transactional Net
Margin Method (TNMM). That does not, and
cannot, however mean that whatever be
the fact situation, CUP is always a
preferred method because of one of the
essential prerequisite for application
of any method of ascertaining the ALP is
the inputs necessary for that purpose.
Whatever may be inherent edge of the
direct methods of determining arm’s
length price of an international
transaction over indirect methods of
determining the arm’s length price of
international transactions, selection of
the most appropriate method for
determining arm’s length price under the
transfer pricing provisions, in a
particular fact situation, is not an
academic exercise which can be decided
de hors the peculiar facts of that
situation, and, therefore, there cannot
be any straightjacket
formulas holding
application of a particular method in
case of a particular type of product or
service. While rule 10B(1) of the Income
Tax Rules 1962, provides that arm’s
length price in relation to an
international transaction shall be
determined by any of the methods, “being
the most appropriate method”, set out
therein, Rule 10 C(1) provides the
mechanism for selecting the most
appropriate method “which is best suited
to the facts and circumstances of each
particular transaction” and “which
provides the most reliable measure of
arm’s length price of the international
transaction”. Rule 10C(2) further
provides that in selecting the most
appropriate method as specified in rule
10C(1), certain factors are to be taken
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into account:
(a) the nature and class of the
international transaction;
(b) the class or classes of associated
enterprises entering into the
transaction and the functions performed
by them taking into account assets
employed or to be employed and risks
assumed by such enterprises;
(c) the availability, coverage and
reliability of data necessary for
application of the method;
(d) the degree of comparability existing
between the international transaction
and the uncontrolled transaction and
between the enterprises entering into
such transactions; (e) the extent to
which reliable and accurate adjustments
can be made to account for differences,
if any, between the international
transaction and the comparable
uncontrolled transaction or between the
enterprises entering into such
transactions;
(f) the nature, extent and reliability
of assumptions required to be made in
application of a method
[Emphasis, by underlining, supplied by
us]
10.What is clear from the above analysis
is that a method of determining arm’s
length price, to be held as a ‘most
appropriate method’ (MAM), should be, as
provided in rule 10C(1), a method “which
is best suited to the facts and
circumstances of each particular
transaction” and a method and “which
provides the most reliable measure of
arm’s length price of the international
transaction”. Under rule 10C(2)(c), “the
availability, coverage and reliability
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of data necessary for application of the
method” is one of the crucial factors
determining suitability of a method of
determination of arm’s length price in a
particular fact situation. Similarly, it
is also important to determine whether
accurate adjustments can be made for the
differences between the international
transactions and the comparable
uncontrolled transactions, and unless
such adjustments can be made the related
method cannot be said to be most
appropriate method. We have already seen
as to how, in the CIT(A)’s analysis,
suitable adjustments could not be made
even though in his opening observations
in the operative portion of the order,
he stated that suitable adjustments can
indeed be made. The inability to make
suitable adjustments, therefore, does
take the method outside the ambit of
most appropriate method. Quite clearly,
therefore, unless suitable reliable data
inputs necessary for application of a
particular method, as CUP in this case,
are available, CUP method cannot be said
to be most appropriate methods on the
facts of this case. Let us, therefore,
first examine whether sufficient inputs
were indeed available.
11. At the outset, it is important to
note that what has been relied upon by
the TPO is Internal CUP data but then
rather than taking the comparable
uncontrolled price of the transaction,
the TPO has compared average of intraAE
transactions and independent
transactions. This approach, though in
the case of application of Cost Plus
Method, has been rejected by a
coordinate bench of this Tribunal in the
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case of ACIT Vs Tara Ultimo Pvt Ltd
[(2012) 143 TTJ 91 (Mum)], though the
same reasoning will be equally
applicable in respect of the CUP as well
as the computation mechanism, in that
respect, is materially similar. In this
case, speaking through one of us (i.e.
the Vice President), the coordinate
bench had observed as follows:
The way this rule works, the benchmark
gross profit is to be applied on each
transaction with the AEs , while, for
computing the benchmark, one could take
into account a series of same or similar
transactions. In other words, while
setting the benchmark, one can take into
account several transactions with
unrelated enterprise on what can be
termed as ‘global basis’, essentially in
respect of same or similar property or
services though, the benchmark so
arrived at cannot be applied on the
global basis i.e. the average of gross
profit earned from same or similar
transactions with AEs. The application
of CPM has to be on transaction basis
rather than on global basis, and this
fundamental scheme of cost plus method
is also evident from the plain wordings
of Rule 10 B as well. Any other view of
the matter will result in incongruities.
For example, if our average mark up to
unrelated enterprises is 20 per cent.
and we charge a markup
of 2 per cent in
one transaction with AE and 38 per cent
in another transaction with the AE, both
these transactions, by applying the mark
up on global basis, will meet the test
of ALP whereas in the first case, the
mark up charged is certainly not a markup
resulting in an ALP. In this
particular case, for example, the normal
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mark up in transactions with has been
computed at 16.31 per cent. and the
average of mark up on sales to AEs
having been taken at 17.08 per cent.
entire sales to AEs has been taken at
ALP, but, the mark up in the many cases
is clearly less than benchmark. To give
one example, at page 221 of the paperbook,
margin of 14.15 per cent (4
invoices), 13.95 per cent. 13.81 per
cent. 14 per cent (4 invoices), 14.14
per cent (2 invoices), and 14.16 per
cent is given by assessee’s own
computation, and, on the same page, on
one invoice, the assessee has shown a
margin as high as 27 per cent. The cost
plus method, therefore, has not been
correctly applied. In any case, one of
the most important input, i.e. diamond,
has been imported at a price for which
no ALP documentation is available and
the price of imports have been taken
into account in computation of costs as
well. The costs of inputs have not been
verified either. No efforts are made to
show that the terms of sale to the AEs
and all other relevant factors are
materially similar visavis
the
transactions with independent
enterprises. The CPM is applied by
comparing gross profit on sales, whereas
the method requires comparison of mark
up on costs on transactions with AEs
visavis
mark up on costs on
transactions with non AEs [Emphasis, by
underlining, supplied by us now]
12. It is also important to note that
the TPO has justified application of
internal CUP on the basis of deviations
in prices at which products are sold to
different AEs and, by implication, using
one intra AE price to bench the other
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intra AE price. That is wholly
incorrect. It is well settled in law
that it is only an uncontrolled price
which can be compared with controlled
price and used for any benchmarking.
This position has been well summarized
in a coordinate bench decision in the
case of Sabic Innovative Plastic India
(P.) Ltd. v. Dy. CIT [2013] 59 SOT
138/35 taxmann.com 177 (Ahd.), and we
are in considered agreement with the
same.
13. When comparing the prices of
products sold in intra AE transactions
visàvis
independent transactions, it
is not sufficient to compare the prices
de hors the economic circumstances in
which the respective AE and non AE
transactions take place. This principle
is beyond any doubt or controversy. In
the OECD Guidelines for Multinational
Enterprises and Tax Administrators, it
is clearly stated that application of
CUP method “requires high degree of
comparability not only in the products
sold and services provided but also in
the economic circumstances in which the
respective AE and non AE transactions
take place”. In the UN Transfer Pricing
Manual, it is observed that “degree of
comparability between controlled and
uncontrolled transactions is typically
determined on the basis of a number of
attributes of the transactions or
parties that could materially affect
prices or profits and the adjustment
that can be made to account for
differences” and then it is observed
that “these attributes, which are
usually referred to as the five
comparability factors, include: (i)
Characteristics of the property or
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service transferred; (ii) Functions
performed by the parties taking into
account assets employed and risks
assumed, in short referred to as the
“functional analysis” (iii) Contractual
terms; (iv) Economic circumstances; and
(v) Business strategies pursued”.
Clearly, therefore, the significant
variations in economic circumstances and
contractual terms can take seemingly
comparable transactions outside the
ambit of comparability.”
6.8. After considering the aforesaid
principles, the Tribunal applied the same
to the facts of the case, as under:
“14. We have noted huge and crucial
variations in payment terms of the
transactions with the AEs visavi
transactions with non AEs. The CIT(A)
has rejected the adjustments in this
respect on account of irrelevant factors
such as assessee claiming only 8%
adjustment in the financial year 200506,
as against 20% adjustment sought in
this year, even though the transactions
were under the same agreement. That is
immaterial. What is material is that
there is huge difference in the payment
terms. The CIT(A) has also noted the
deviations in the advance payment terms
of 120 days under the agreement and the
actual advance payment of 17 months on
average. He has also noted that in three
invoices on nonAEs
the credit period
was 60 days but then he declines to
treat these evidence as support for the
claim that in all cases similar credits
were given. However, what is clear that
there is clearly significant variation
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in payment terms. As a matter of fact,
at page 29, learned CIT(A) himself notes
that “as per the agreement, advance
payment was to facilitate appellant’s
purchases, working capital etc which, in
turn, ensured uninterrupted supply to
the AE”. He does accept that he was
given analysis sheet showing 17 months
advance payment but rejects it as
agreement refers to only 120 days
advance payment. That does not belittle
the fact that whatever may have been
payment terms under the intra AE
agreement, the payment was actually
received substantially in advance. The
question we must ask ourselves is that
whether such substantial advance
payments, which ensure availability of
working capital to the assessee, can be
compared with normal business
transactions allowing, on the contrary,
credit period to the customers. The
answer is clearly in negative as the
economic circumstances in which these
two sets of transactions operate are
substantially different. The very
character of these transactions is
different.
15. It is also important to bear in
mind the undisputed fact that the AE had
an obligation to buy at least 50% of its
products and the assessee was reseller
rather than an end user. These
contractual terms and the difference in
functions also seriously affect the
comparability. The reasons given by the
CIT(A) for rejecting these variations
are wholly superficial and devoid of any
legally sustainable merits. The
variations in quantities between the AEs
and the non AEs cannot be ignored
either. There is no dispute that there
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is huge variations in quantities sold to
the AEs visàvis
the quantities sold to
the nonAEs
but the CIT(A) has rejected
the plea on the basis that “there is no
consistent pattern or correlation
between the volume and sale prices” and
that “there is no reference to any
volume discount in the agreement”. That
is again a superficial approach. Whether
there is a mention of the volume
discount or not or whether there is
always a direct relation between the
prices and volumes, the fact remains
that the transactions with such huge
variations, as in this case, cannot be
considered to be comparable transactions
and that is the consistent approach in
benchmarking analysis. The scale of
transactions is an important economic
factor affecting the comparability. We
have also noted that the AEs have
reimbursed R&D costs, with mark up, to
the assessee. The AEs have also given
interest free ECB loans. These are also
equally important factors. When we take
the transactions with the AEs in the
light of these surrounding economic and
contractual realities, in our considered
view, the transactions with non AEs, on
the facts of this case and as a whole,
are not comparable at all. We cannot
consider the price of the product in
isolation with all these factors, and
that is the reason why the comparability
under CUP ceases to be relevant as these
factors are clearly missing in non AE
transactions. We have also noted that
Rule10 B(1)(a)(ii) itself provides that
“such price is adjusted to account for
differences, if any, between the
international transaction and the
comparable uncontrolled transactions or
between the enterprises entering into
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such transactions, which could
materially affect the price in the open
market” but then while CIT(A) uphold the
application of CUP method on the ground
that adjustments can indeed be made, he
rejects the adjustments on merits. That
is clearly incongruous. When he admits
that no adjustments can be made on
merits, the very foundation of his
decision to uphold application of CUP
method ceases to hold good. In any case,
having perused the material on record,
we are of the considered view that
accurate adjustments cannot be made to
nullify the impact of absolutely
fundamental variations in the terms of
the intra AE and non AE transactions,
and since accurate adjustments cannot be
made, for this reason alone, CUP method
ceases to be workable on the facts of
this case. The contradiction in the
approach is also evident from the fact
that the CIT(A) has upheld application
of CUP method on the sole basis that
accurate adjustments can be made to take
care of variations in the intra AE and
independent transactions but then one of
the points made before us, in the
written submissions, is that “if total
adjustment of 36% claimed in those years
was allowed, prices would come down to
such unrealistic levels that one of the
international transaction, including
sales to non AEs, were made anywhere
neat them”. Clearly, there is no meeting
ground between these diametrically
opposed stands by the authorities. As
regards the decision of coordinate bench
in the case of Serdia Pharmaceuticals
(supra), that was a case in which no
dispute was raised with respect to the
comparables cases except on account of
quality for which suitable adjustment
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was allowed. This precedent, therefore,
does not offer any help to the case of
the revenue.
16. A lot of emphasis has been placed on
the fact that the assessee on its own
was using the Internal CUP method in
past, and, there was, thus, no good
reason to deviate from the same. It is
for this main reason that the
application of TNMM has been declined by
the authorities below. Nothing, however,
turns on this plea. What is before us is
the question as to which method is most
appropriate method for ascertaining the
arm’s length in the present year. We do
not see how this question is to be
adjudicated simply on the basis of what
has been accepted by the assessee, on
his own, as the most appropriate method
in the earlier years. Such a choice of
method in the earlier years, in our
humble understanding, cannot act as an
estoppel against the assessee. In our
considered view, the decision as to what
is the most appropriate method on the
facts of this case is to be taken in the
light of the facts and material on
record before us in the present year.
The past conduct of the assessee, with
regard to the selection of the most
appropriate method for ascertaining
arm’s length price for the present
assessment year, is not really decisive.
We, therefore, reject this plea of the
revenue authorities as well.”
6.9. The Tribunal thereafter referred to the
decision of the Coordinate Bench relied on
behalf of the assessee in the case of DCIT
v. Dishman Pharmaceuticals & Chemicals
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Ltd. reported in 45 SOT 37 (2011),
wherein, the Tribunal considering the
factors relating to the determination of
Most Appropriate Method for computing ALP
adjustments and came to the conclusion
that CUP method cannot be applied in each
and every case. The Tribunal, therefore,
in the facts of the case, held as under:
“19. In view of the above discussions
and following the consistent view
being taken by the coordinate benches,
in our considered view, the
application of CUP method was indeed
not justified on the facts of the
present case. The intra AE
transactions, on the facts of this
case, were so fundamentally different
in character in economic circumstances
and contractual terms, that these
cannot be compared with the
independent transactions entered into
by the assessee. We, therefore, reject
the stand of the authorities below on
this issue.
20. We have noted that the assessee
has applied TNMM by comparing the
profits on transactions with AEs and
the non AEs and no specific defects
have been pointed out in the
allocation of costs in the segmental
accounts which are duly reconciled
with entity level consolidated
accounts. We have also noted that
dealing with the Internal TNMM adopted
by the assessee the TPO had expressed
the view that the basis of allocating
the overheads was not clear, in
response to which it was explained by
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the assessee that revenue and expenses
have been allocated on actual basis
wherever these are directly allocable,
and wherever these are not directly
allocable, the allocation has been
done on the basis of appropriate
allocation key such as ration of sales
quantity, sales revenue, total
revenue. It was also explained that
the segmental details have been
reconciled with entity level audited
accounts. The assessee had further
submitted that “in case if in your
view there are any inappropriate cost
allocations, we would appreciate if
you can kindly let us know which cost
allocations are not appropriate and
why these are not appropriate so that
we can accordingly clarify and explain
on those aspects”. We have noted that
the TPO did not have any specific
comment on this request and he simply
rejected the explanation of assessee
as “not accepted”. In appeal also, no
specific adjustments were suggested to
the allocations made in the segmental
accounts and the discussions were
confined to generalities. In these
circumstances, we see no reasons to
disturb the internal TNMM adopted by
the assessee. We, therefore, delete
the impugned ALP adjustment of Rs
2,78,02,502.”
6.1. Learned Standing Counsel appearing for the
revenue Mr. Varun K. Patel submitted that the
Tribunal has committed an error in law and on
facts in rejecting the approach of the TPO of
adopting Comparable Uncontrolled Price (CUP)
method as Most Appropriate Method (MAM) and
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further erred in allowing various adjustments
claimed by the assessee for material
differences in contractual term, underlying
commercial circumstances, functions, risk and
other economic factors between the
transactions of assessee with AEs visàvis
the transactions of the assessee with nonAEs
while applying the CUP method as under:
i. Adjustment on account of business
volumes difference.
ii. Adjustment for advance payment received
from AE.
iii. Adjustment for making and selling
expenses not required to be incurred for
AE sales visàvis
non AE sales.
iv. Adjustment for credit risk not required
to be borne by the assessee for AE sales
visàvis
non AE sales.
v. Adjustment for interest free ECB loan
received from AE.
6.2. Mr. Varun Patel further submitted that,
Indian Transfer Pricing Regulations as well
as OECD guidelines state that the
transactional profit method should ideally be
applied on a transaction to transaction
basis, but in appropriate situation
transactions may be grouped or aggregated. It
was submitted that, the relevant controlled
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transactions may best be aggregated if it is
impractical to analyze all profits of each
individual transactions or if such
transactions are so interrelated
that this
is the most reliable means of benchmarking
the outcome of the transaction against the
arm’s length outcome. Reference was made to
Rule 10A (d) of the Income Tax Rules, 1962
(for short ‘the Rules’), wherein, it is
defined that “transaction” includes a number
of closely linked transactions. It was
therefore submitted that if the appropriate
method adopted by the assessee by applying
TNMM is to be given any credence then in case
of any enterprise all its international
transaction would be closely interlinked
because all the transaction of an enterprise
in one way or the other are connected to the
overall operation and objective of the
company, and the basis of comparability and
analysis on a transaction to transaction
basis would lose its meaning.
6.3. It was further submitted that by following
the TNMM and by clubbing all the
international transactions for all the
products, the assessee has failed to follow
the Letter and Intent of TNMM as described in
law.
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6.4. Learned advocate for the Revenue, in support
of his submission referred to the decision of
the ITAT Ahmedabad ‘D’ Bench in case of
Effective Teleservices (P.) Ltd. v. Deputy
Commissioner of Income Tax reported in
(2019) 19 taxman.com 98 (AhmedabadTrib.).
He
relied upon the following observations made
by the Tribunal as under:
“6. We have heard the rival contentions
of both the parties and perused the
materials available on record. At the
outset we note that similar issue related
to internal CUP method was raised in
assessee’s own appeal in Effective
Teleservices (P.) Ltd. v. Asstt. CIT
(2019) 90 taxman.com 390 (Hyd.Trib.)
where issue was decided in favour of
assessee by the ITAT vide order dated 16012018
by observing as under:
“10. We have given thoughtful
consideration to the orders of the
authorities below. We find that the
assessee is eligible for tax holiday u/s.
10A of the Act, therefore, we do not find
any merit in holding that the assessee
manipulated the prices and shifted the
profits to the overseas jurisdiction for
avoiding taxes in India. Moreover, the
taxes rates in the USA are higher than
the tax rates prevailing in India.
Moreover, the AE of the appellant company
has incurred losses in providing end to
end services to third parties. If the
assessee had directly undertaken
contracts with the third parties in USA,
it would also have incurred operating
losses as against operating profits
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earned while undertaking transactions
with AEs.
11. We find that the appellant company
has earned average hourly rate from its
AE business at Rs. 274.39 per hour. As
against the same, the average hourly rate
from Non AE business was Rs. 108.82 per
hour. Thus, the average hourly rate
earned from AE business was more than Non
AE business. The only reason for
rejecting the assessee’s contention is
that the pricing mechanism in case of AE
as well as Non AEs was different;
therefore, CUP is not applicable. In our
considered opinion, merely because
pricing mechanism is different, internal
CUP should not have been rejected.
12. We find that the TPO has mentioned in
the order that the risk profile of AE and
non AE is entirely different. In our
considered opinion, reasonable accurate
adjustment cannot be made for such risk
differences and if the risk adjustment is
made, the same would further reduce the
average hourly rate charged from AE which
is, as mentioned elsewhere, lower than
the average hourly rate charged from AE.
Therefore, in our understanding of the
facts, internal CUP should have been
accepted as most appropriate method.”
6.1 Similarly, the identical issue
related to internal TNMM method was also
raised in assessee’s own appeal of
assessment year 200910
in Effective
Teleservices (P.) Ltd. (supra) where
issue was decided in favour of assessee
by the ITAT vide order dated 16012018
by observing as under:
“13. For the sake of completeness of the
adjudication, rejection of internal TNMM
analysis undertaken by the appellant
during the course of transfer pricing
assessment should not have been rejected.
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We find that the appellant company has
provided identical services to AE as well
as non AEs and functions performed,
assets used and risks assumed in AE as
well as non AE business were similar.
Therefore, in our considered opinion,
even internal TNMM can be considered as
most appropriate method. We find that the
operating margin of the appellant from
the AE segment was derived at 30.90% and
the operating margins in the non AE
segment was derived at Rs. 74.92%.
14. The TPO rejected the internal TNMM
analysis on the basis that as the
appellant has made operating loss in non
AE business, the transactions with non
AEs are not at independent rates and they
have been undertaken only to increase
capacity utilization. The total turnover
of Non AE segment of Rs. 5.67 lacs as
against the turnover of Rs. 1909.60 lacs
in the case of international transactions
with AE. The ld. CIT(A) confirmed the
rejection by holding that the turnover of
the third party segment is very much less
compared to that with AE. The ld. CIT(A)
further held that the appellant has not
proved the allocation of the common cost
between AE and non AEs and whether they
are scientific and at arm’s length. We
find that the TPO has nowhere disputed
the common cost allocation made by the
appellant. We also find that the ld.
CIT(A) has also never raised any doubt on
the allocation. Insofar as the difference
in the turnover, we find that the
Tribunal Delhi Bench in the case of
Lummus Technology Heat Transfer BV Vs.
DCIT 42 taxmann.com 342 has held as
under:5.
Rule 10B(l)(e) of the Income Tax
Rules, which deals with the Transactional
Net Margin Method, provides requires that
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“the net profit margin realised by the
enterprise (i.e. the assessee) from an
international transaction entered into
with an associated enterprise is computed
in relation to costs incurred or sales
effected or assets employed or to be
employed by the enterprise or having
regard to any other relevant base” is
compared with ” the net profit margin
realised by the enterprise ( i.e. the
assessee) or by an unrelated enterprise
from a comparable uncontrolled
transaction or a number of such
transactions is computed having regard to
the same base” of
course, subject to
comparability adjustments which could
affect the amount of net profit margin in
uncontrolled conditions. It is not at all
necessary, as the authorities below seem
to suggest, that such net profit
computations, in the case of internal
comparables (i.e. assessee’s transactions
with independent enterprise), are based
on the audited books of accounts or the
books of accounts regularly maintained by
the assessee. hi our considered view, all
that is necessary for the purpose of
computing arm’s length price, under TNMM
on the basis of internal comparables, is
computation of net profit margin, subject
to comparability adjustments affecting
net profit margin of uncontrolled
transactions, on the same parameters for
the transactions with AEs as well as Non
AEs, i.e. independent enterprises, and as
long as the net profits earned from the
controlled transactions are the same or
higher than the net profits earned on
uncontrolled transactions, no ALP
adjustments are warranted. It is not at
all necessary that such a computation
should be based on segmental accounts in
the books of accounts regularly
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maintained by the assessee and subjected
to audit. We are, therefore, of the view
that the authorities below were in error
in rejecting the segmental results on the
ground that the segmental accounts were
not audited and that these segmental
accounts were not maintained in the
normal course of business. As regards
vague generalizations by the TPO to the
effect that these accounts are
manipulated, that allocation basis of
expenses is unfair and that these
accounts conceal true profitability, we
find that these observations are too
sweeping and generalized the observations
to have any merits. In any event, learned
counsel for the assessee has
painstakingly taken us through the
segmental accounts, pointed out the basis
of allocation of the expenses. We have
noted that the allocation of expense is
on the man hour basis, which is quite
fair and reasonable, and that every
person has to punch in hours on a
specific project. We have also noted that
all these details and expense allocation
basis were also before the TPO and even
then, no specific defects were pointed
out by the TPO. Taking into account all
these factors, as also entirety of the
case, we are of the considered view that
the TPO indeed erred in rejecting the
segmental accounts and thus declining to
accept the internal comparable. We are
also of the view that the size of the
uncontrolled transaction or transactions
being smaller, by itself, does not make
these transactions incomparable with the
transactions in controlled conditions.
Size of the comparable does matter in
entity level comparison because scale of
operations substantially vary and so does
the underlying profitability factor, but
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in a transaction level comparison within
the same entity, mere difference in size
of the uncontrolled transactions does not
render the transaction incomparable. If
the size of uncontrolled transaction is
too big, it may call for an adjustment
for volume business. If the size of the
uncontrolled transaction is too small, it
may provoke an inquiry by the TPO to
ensure that it is not a contrived
transaction outside the normal course of
business or with regard to other
significant factors surrounding smallness
of such transaction. However, in our
considered view, in none of these cases,
a comparable can be rejected on the basis
of its size per se. In this view of the
matter, the authorities below were
clearly in error in rejecting the
internal comparable, i.e. profitability
of assessee’s transactions with non AEs,
on the ground that the volume of business
with non AEs was too small visavis
business with AEs. In view of these
discussions, as also bearing in mind
entirety of the case, the assessee was
quite justified in adopting internal TNMM
and comparing the profit earned on its
transactions with AEs with profit earned
with nonAEs.
Accordingly, the ALP
adjustment of Rs. 2,72,42,940/deserves
to be deleted. We order so. The assessee
gets the relief accordingly. 15. The
Tribunal Hyderabad Bench in the case of
NTT Data Global Delivery Services
Limited. 63 taxmann.com 92 had taken a
similar view and followed the findings
given in the case of Lummus Technology
Heat Transfer BV (supra).”
6.2 Respectfully following the same we
are of the view that assessee rightly
benchmarked the transaction by choosing
the internal CUP method as most
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appropriate method and alternatively also
rightly benchmarked the internal TNMM
method as most appropriate method to
determine the ALP. Accordingly, the
appeal of the assessee is allowed.”
6.5. It was also submitted that the Tribunal has
failed to consider that the assessee has not
taken into account very important factor for
determination of the ALP on the basis of the
determination of the price in different
geographies as compared to sale of products
to associate enterprise of the assessee, then
nonassociated
enterprises of the assessee
situated in the different parts of the world.
It was submitted that, nonAE
situated in
nondeveloped
countries or charge at a lesser
price in the sale of products to AE situated
in countries, viz. USA which are developed
countries. The difference on this account
needs to be considered, which has not been
taken into account by the assessee. It was
further submitted that, in economics,
Purchasing Power Parity (PPP) is a condition
between countries where an amount of money
has the same purchasing power in different
countries. Considering the PPP, instead of
making any reduction in NonAE
price due to
adjustments, the assessee was required to
increase the NonAE
price which is not being
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taken into account for the purposes of
calculation of ALP.
6.6. It was therefore submitted that, the ALP of
sales to the AE in respect of ANH and MBTC
are benchmarked using CUP as Most Appropriate
Method by the TPO.
6.7. It was further submitted that, the assessee
has failed to discharge the onus by carrying
out the benchmarking in using the most
appropriate method and in such scenario; the
benchmarking carried out by the TPO
represents the best possible approach.
7.1. On the other hand, learned Senior Advocate
Mr. S.N. Soparkar assisted by learned
advocate Mr. B.S. Soparkar submitted that,
the questions of law proposed by the revenue
are in realm of questions of facts and as the
Tribunal being the final fact finding
authority has arrived at a conclusion on the
basis of the material produced before it that
the TNMM applied by the assessee is the Most
Appropriate Method (MAM) for the purpose of
computation of ALP, and therefore, no
interference is required to be made in the
findings given by the Tribunal.
7.2. It was further submitted by the learned
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Senior Advocate appearing for the assessee –
respondent that the Tribunal on the facts of
the present case has held that the assessee
has applied TNMM by comparing the profits on
transactions with the AE and the NonAEs
and
no specific defects have been pointed out in
the allocation of costs in the segmental
accounts which are duly reconciled with
entity level consolidated accounts, and in
such circumstances, the method adopted by the
assessee was considered as Most Appropriated
Method. It was also submitted that the
Tribunal has also given a finding that the
application of CUP method was not justified
on the facts of the present case, as the
intra AE transactions were fundamentally
different in character in economic
circumstances and contractual terms and these
cannot be compared with the independent
transactions entered into by the assessee.
7.3. It was therefore submitted that, the
difference of opinion between the Tribunal
and that of CIT (A) and TPO as to
appropriateness of one or other methods
cannot perse
be a ground for interference
because appropriateness of the method unless
shown by the contrary to Rules, specially
Rule 10B and 10C of the Rules, the same
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cannot be considered as substantial question
of law under Section 260A of the Act, 1961.
In support of his submissions, learned Senior
Advocate placed reliance upon the decision of
the Delhi High Court in the case of
Principal Commissioner of IncomeTax6
v.
Make My Trip India (P.) Ltd. reported in
(2017) 399 ITR 297 (Delhi).
7.4. Learned Senior Advocate further relied upon
the decision of the Coordinate Bench of this
Court in the case of Principal Commissioner
of Incometax,
Gandhinagar v. Tudor India
(P.) Ltd. reported in (2019) 11 taxman.com
450 (Gujarat) to submit that the entire
scheme of the transfer pricing has been
considered by this court and as such the
Tribunal has come to the conclusion on the
basis of the material on record as per the
provision for the transfer pricing in the
act,1961. It was therefore submitted that no
interference is required to be made in the
impugned order of the Tribunal as no
substantial question of law arises there
from.
8. Having heard the learned advocates appearing
for the receptive parties and having gone
through the material on record, it appears
from the facts of the case that the Tribunal
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considering the material on record has given
the finding of fact that the TNMM applied by
the assessee is the correct method and the
application of CUP method was not justified,
in view of the fact that intra AE transactions
were fundamentally different in character in
economic circumstances and contractual terms
and these cannot be compared with the
independent transactions entered into by the
assessee.
9. The Tribunal has further discarded the view of
the TPO dealing with the internal TNMM adopted
by the assessee with regard to the basis of
allocating the overrates being not clear, by
observing that the revenue and expenses have
been allocated on actual basis wherever the
same were directly allocable and wherever the
same were not directly allocable, allocation
was made on the basis of the appropriate
allocation key such as ratio of sales
quantity, sales revenue and total revenue. The
Tribunal also found that the segmental details
have been reconciled with entity level audited
accounts. It was also found that the TPO did
not have any objection with regard to the
allocation made by the assessee, but
explanation given by the assessee was simply
rejected as “not accepted”. The CIT (A) also
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did not refer to any flow to the allocations
made in the segmental accounts and discussed
the issue on generalities only. In such
circumstances, the Tribunal after considering
in detail the facts of the case as stated in
paras14
and 15 of the impugned order
reproduced hereinabove, has come to the
conclusion that the internal TNMM adopted by
the assessee is just and proper.
10. In decision of Principal Commissioner of
Incometax,
Gandhinagar v. Tudor India (P.)
Ltd. (supra) this Court has considered the
entire scheme of the transfer pricing and has
observed as under:
“11. The Karnataka High Court, in the case of
Pr. Commissioner of Income Tax, Bangalore & Ors.
vs. Softbrands India P. Ltd., reported in (2018)
406 ITR 513 had the occasion to consider the
special provisions relating to the Avoidance of
Tax in ChapterX
of the Act comprising of
Sections 92 to 94B
with regard to the
assessment to be done for the computation of
income from international transactions on the
principles of “Arm’s Length Price” (ALP) and the
relevant Rules for computation of such income
under the aforesaid provisions of ChapterX
in
the form of Rule 10A
to 10E
in the Income Tax
Rules, 1962. We may quote the relevant portion
of the judgment;
“Perspective of International Trade and
Transactions:
4. With the ever increasing international
Trade and transactions, particularly, in the
Software Industries and Bangalore, being the
Silicon Valley of India where many big,
small and medium size Software Industries
have their Offices and Units in this
Software Industry, and Bengaluru is a hub of
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this Service Industry and essentially the
Indian Companies have business linkages with
large Companies spread worldwide
particularly in the Western Hemisphere of
the Globe.
5. The implementation of the Tax laws in
this field in a smooth, clear and quick
manner is of utmost importance to build an
image of an efficient Tax Administration
both at Departmental level and in Judicial
Courts so that the economic activity in such
borderless trade thrives and enures to the
benefit of the Indian economy at large and
Software Industry in particular.
While the special provisions have been made
for computation of ‘Arm’s Length Price’ to
arrive at a fair assessment of income
taxable in the hands of the Indian Resident
Companies and these special provisions also
provide for an elaborate and indepth
analysis of huge data of the comparable
cases of other similarly situated Companies
to arrive at a fair ‘Arm’s Length Price’ and
for that, Special Cells and designated
Authorities have been created under the
Income Tax Act, 1961, but still retaining
the normal provisions for assessments of
appeals in the Indian Income Tax Act about
the remedial Forums or the appeal mechanisms
and the Income Tax Appellate Tribunal
constituted under Section 253 of the Act
continues to be the final fact finding body
under the Act even with regard to the
assessments of the international
transactions under the Special Chapter X as
aforesaid and the appeal to the
Constitutional Courts as provided in Section
260A
to High Court and Section 261 to the
Hon’ble Supreme Court are applicable to
these special assessments under Chapter X as
well. “
12. In para11
of the judgment, the Hon’ble
Court diluted upon the following three
questions;
“[I] The analysis of the provisions relating to
the Transfer Pricing/ determination of the
‘Arm’s Length Price’;
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[II] The Scheme of procedure of assessment and
appeals to the Tribunal and High Court/Supreme
Court.
[III] The scope of interference by High Court
under Section 260A
of the Act in these type of
cases. “
13. The Court, thereafter, expressed its prima
facie opinion as regards the transfer pricing
adjustments.
“Prima Facie Opinion:
15. We are of the considered opinion that
this entire exercise of making Transfer
Pricing Adjustments on the basis of the
comparables is nothing but a matter of
estimate of a broad and fair guesswork
of
the Authorities based on relevant material
brought before the Authorities including the
Appellate Tribunal, but nonetheless the
Tribunal being the final fact finding body
remains so for this Special Chapter X also
and therefore, unless this Court is
satisfied that a substantial question of
law is arising from the order of the
Tribunal, the appeal under Section 260A
cannot be entertained at the instance by
either the Revenue or the Assessee and the
exercise of fact finding or ‘Arm’s Length
Price’ determination or ‘Transfer Pricing
Adjustments’ should be allowed to become
final with a quietus at the hands of the
final fact finding body, i.e. the Tribunal.”
14. The Court, thereafter, undertook a
comparative analysis of Section 260A
of the
Act, 1961, Section 100 and Section 103 of the
CPC and proceeded to observe as under:
“16. We would analyze the provisions of
Section 260A
of the Act in a little more
detail but we are of the firm opinion that
the entry into the High Court under Section
260A
of the Act is locked with the words
“Substantial questions of law” and the key
to open that lock to maintain such appeal
can only be the perversity of the findings
of the Tribunal in these type of cases and
the perversity in the findings not only
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averred by the appellant before this Court
but, established on the basis of cogent
material which was available before the
Authorities below including the Tribunal and
the findings arrived at by the Tribunal can
be so held to be perverse within the well
settled parameters for determining the same
as perverse. It is not allowed to either of
the parties, i.e. the Assessee or the
Revenue to invoke the jurisdiction of this
Court under Section 260A
of the Act merely
because the Tribunal comes to reverse or
modify the findings given by the lower
Authority, viz. Transfer Pricing Officer
(TPO) or Dispute Resolution Panel (DRP)
which comprises of three Commissioners and
the Revenue or the assessee may feel
dissatisfied, because of the reversal or
modification of such findings by the
Tribunal resulting in leaving out of certain
comparables or adding on of certain
comparables for determining the ‘Arm’s
Length Price’ in the hands of the Assessee
Company.
17. Unless such perversity in the findings
of the Tribunal is established we are of the
opinion that the appeals under Section 260A
of the Act cannot and should not be
entertained at the instance of either of the
parties and the present cases before us, we
find that the Tribunal has given cogent
reasons and detailed findings upon
discussing each case of comparable corporate
properly and therefore, we find ourselves
unable to call such findings of the Tribunal
perverse in any manner so as to require our
interference under Section 260A
of the Act.
18. We now take up the analysis of Section
260A
of the Act which we have already said
is in pari materia with Sections 100 and 103
of the Civil Procedure Code.
19. The said provisions are quoted below for
ready reference and comparison.
Section 260A
of the Income Tax Act, 1961
reads as under:
“260A Appeal
to High Court:
(1) An appeal shall lie to the High Court
from every order passed in appeal by the
Appellate Tribunal [before the date of
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establishment of the National Tax
Tribunal], if the High Court is satisfied
that the case involves a substantial
question of law.
(2) [The [Principal Chief Commissioner or]
Chief Commissioner or the [Principal
Commissioner or] Commissioner or an
assessee aggrieved by any order passed by
the Appellate Tribunal may file an appeal
to the
High Court and such appeal under this subsection
shall be]
(a) filed within one hundred and twenty
days from the date on which the order
appealed against is [received by the
assessee or the [Principal Chief
Commissioner or] Chief Commissioner or
[Principal Commissioner or] Commissioner];
(b) [*******]
(c) in the form of a memorandum or appeal
precisely stating therein the substantial
question of law Involved.
[(2A) The High Court may admit an appeal
after the expiry of the period of one
hundred and twenty days referred to in
Clause (a) of subsection
(2), if it is
satisfied that there was sufficient cause
for not filing the same
within that period.]
(3) Where the High Court is satisfied that
a substantial question of law is involved
in any case, it shall formulate that
question.
(4) The appeal shall be heard only on the
question so formulated, and the
respondents shall, at the hearing of the
appeal, be allowed to argue that the case
does not involve such question:
Provided that nothing in this subsection
shall be deemed to take away or abridge
the power of the Court to hear, for
reasons to be recorded, the appeal on any
other substantial question of law not
formulated by it, if it is satisfied that
the case involves such question.
(5) The High Court shall decide the
question of law so formulated and deliver
such judgment thereon containing the
grounds on which such decision is founded
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and may award such cost as it deems fit.
(6) The High Court may determine any issue
which (
a) has not been determined by the
Appellate Tribunal;
or
(b) has been wrongly determined by the
Appellate Tribunal, by reason of a
decision on such question of law as is
referred to in subsection
(1).
[(7) Save as otherwise provided in this
Act, the provisions of the Code of Civil
Procedure, 1908 (5 of 1908), relating to
appeals to the High Court shall, as far as
may be, apply in the case of appeals under
this Section.]
Sections 100 and 103 of the Code of Civil
Procedure, 1908 read thus:
“Section 100 Second
Appeal.
(1) Save as otherwise expressly provided
in the body of this Code or by any other
law for the time being in force, an appeal
shall lie to the High Court from every
decree passed in appeal by any Court
subordinate to the High Court, if the High
Court is satisfied that the case involves
a substantial question of law.
(2) An appeal may lie under this section
from an appellate decree passed exparte.
(3) In an appeal under this section, the
memorandum of appeal shall precisely state
the substantial question of law involved
in the appeal.
(4) Where the High Court is satisfied that
a substantial question of law is involved
in any case, it shall formulate the
question.
(5) The appeal shall be heard on the
question so formulated and the respondent
shall, at the hearing of the appeal, be
allowed to argue that the case does not
involve such question:
Provided that nothing in this subsection
shall be deemed to take away or abridge
the power of the Court to hear, for
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reasons to be recorded, the appeal on any
other substantial question of law, not
formulated by it, if it is satisfied that
the case involves such question.”
Section 103 Power
of High Court to
determine issues of fact In
any second appeal, the High Court may,
if the evidence on the record is
sufficient, determine any issue necessary
for the disposal of the appeal, (
a) which has not been determined by the
lower Appellate Court or both by the Court
of first instance and the lower Appellate
Court, or
(b) which has been wrongly determined by
such Court or Courts by reason of a
decision on such question of law as is
referred to in section 100.”
What is a Substantial Question of Law?
20. From a bare comparison of the provisions
quoted above and as discussed in various
judgments of the Constitutional Courts,
which we will refer in brief herein below,
it is clear that the Scheme of both Section
260A
in Income Tax Act, 1961 and Section
100 r/w. Section 103 of the Code of Civil
Procedure are in pari materia and in same
terms.
21. The existence of a substantial question
of law is sine qua non for maintaining an
appeal before the High Court. While the
appeal to High Court under Section 260A
of
the Act may be a First appeal in the sense
from the order of final fact finding by the
Tribunal under the Income Tax Act, whereas
the Second Appeal on substantial question
of law before High Court under Section 100
would lie against the Judgment and Decree of
the first Appellate Court disposing of an
appeal against the Judgment and Decree of a
Trial Court, but nonetheless it is the third
round of consideration at the level of the
High Court, where the facts and law both
have been screened, discussed and analyzed
by the Authorities or the Courts below and
therefore the tenor and color of the words
“substantial question of law” in both these
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enactments remains the same.
22. The High Court has power to not only
formulate the substantial questions of law
and rather it has the duty to do so and can
also frame additional substantial questions
of law at a later stage, if such a
substantial question of law is involved in
the appeal before it under these provisions
and the appeal should be heard and decided
only on such substantial questions of law
after allowing the parties to address their
arguments on the same. The extended power
given to the High Courts to decide even an
issue under Subsection
(6) of Section 260A
of the Income Tax Act, which is in pari
materia with Section 103 of the Civil
Procedure Code and which says that the High
Courts may determine any issue which (a)has
not been determined by the Tribunal or (b)
has been wrongly determined by the Tribunal,
can be so determined by the High Court, only
if the High Court comes to the conclusion
that ‘by reason of the decision on
substantial question of law rendered by it’,
such a determination of issue of fact also
would be necessary and incidental to the
answer given by it to the substantial
question of law arising and formulated by
it.
23. The argument raised by the learned
counsel for the Respondent Assessee before
us by making a disjuncted reading of Clause
(a) and Clause (b) of SubSection
(6) of
Section 260A
of the Income Tax Act, 1961 to
submit that the High Court can touch upon
the issues of facts also in an appeal under
this provision bereft of substantial
question of law, is a misconceived argument.
24. In our opinion, both the Clause (a) and
Clause (b) of SubSection
(6) of Section
260A
of the Act are circumscribed by the
words ‘by reason of the decision on such
question of law as is referred to in Subsection
(1)’. Therefore, even if an issue
which has not been determined by the
Tribunal, which was required to be so
determined in terms of the answer to the
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substantial question of law given by the
High Court, such an issue not determined by
the Tribunal could also be decided by the
High Court with reference to Clause (a) and
more so, if such an issue has been wrongly
decided according to the answer given by the
High Court to such a substantial question of
law, then also the High Court can set it
right to fall in line with the answer given
by the High Court to such a substantial
question of law raised before it and
determined by it in terms of Clause (b)
thereof.
25. Subsection
(6) of Section 260A
of the
Act, therefore, does not give any extended
power, beyond the parameters of the
substantial question of law to the High
Court to disturb the findings of fact given
by the Tribunal below.
26. Subsection
(7) inserted in Section 260A
of the Act by the Finance Act of 1999 with
effect from 01/06/1999 after a period of
about 8 months of substituting the new
provisions of Section 260A
to the Act as
they now stand by Finance Act of 1998, with
effect from 01/10/1998 was only to clarify
and support that the parameters of Sections
100 & 103 of the Civil Procedure Code and
other provisions of Civil Procedure Code
relating to appeals of High Court shall
apply to the appeals under Section 260A
of
the Income Tax Act also.
27. The insertion of Subsection
(7) in
Section 260A
of the Act does not give any
new or extended powers to the High Court and
the preexisting
provisions from Subsection
(1) to Subsection
(6) in Section 260A
of
the Act already had all the trappings of
Sections 100 and 103 of the Civil Procedure
Code.
Case Laws on Substantial Question of Law:
28. In the leading and the first and
foremost case on the interpretation of
Section 100 of the Code of Civil Procedure
Code, the Constitution Bench of the Hon’ble
Supreme Court in the case of Sir Chunilal V.
Mehta and Sons Limited Vs. Century Spinning
and Manufacturing Co. Limited AIR 1962 SC
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1314, held in para.6 as under:
“6. We are in general agreement with
the view taken by the Madras High Court
and we think that while the view taken
by the Bombay High Court is rather
narrow the one taken by the former High
Court of Nagpur is too wide. The proper
test for determining whether a question
of law raised in the case is
substantial would, in our opinion, be
whether it is of general public
importance or whether if directly and
substantially affects the rights of the
parties and if so whether it is either
an open question in the sense that it
is not finally settled by this Court or
by the Privy Council, or by the Federal
Court or is not free from difficulty or
calls for discussion of alternative
views. If the question is settled by
the highest Court or the general
principles to be applied in determining
the question are well settled and there
is a mere question of applying those
principles or that the plea raised is
palpably absurd the question would not
be a substantial question of law.”
29. In the case of Santosh Hazari Vs.
Purushottam Tiwari (Deceased) by LRs.,
[2001] 3 SCC 179, another Three Judges’
Bench of the Honble Supreme Court explained
the meaning of the substantial questions of
law in paras.11 and 12 in the following
manner.
“11. Even under the old Section 100 of
the Code (pre1976
amendment), a pure
finding of fact was not open to
challenge before the High Court in
second appeal. However the Law
Commission noticed a plethora of
conflicting judgments. It noted that in
dealing with second appeals, the courts
were devising and successfully adopting
several concepts such as, a mixed
question of fact and law, a legal
inference to be drawn from facts
proved, and even the point that the
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case has not been properly approached
by the courts below. This was creating
confusion in the minds of the public as
to the legitimate scope of second
appeal under Section 100 and had
burdened the High courts with an
unnecessarily large number of second
appeals. Section 100 was, therefore,
suggested to be amended so as to
provide that the right of second appeal
should be confined to cases where a
question of law is involved and such
question of law is a substantial one.
(See Statement of Objects and Reasons.)
The Select Committee to which the
Amendment Bill was referred felt that
the scope of second appeals should be
restricted so that litigations may not
drag on for a long period. Reasons, of
course, are not required to be stated
for formulating any question of law
under subsection
(4) of Section 100 of
the Code; though such reasons are to be
recorded under proviso to subsection
(5) while exercising power to hear on
any other substantial question of law,
other than the one formulated under
subsection
(4).
12. The phrase “substantial question of
law”, as occurring in the amended
substantial, as qualifying “question of
law”, means of
having substance,
essential, real, of sound worth,
important or considerable. It is to be
understood as something in
contradistinction with technical,
of
no substance or consequence, or
academic merely. However, it is clear
that the legislature has chosen not to
qualify the scope of “substantial
question of law” by suffixing the words
“of general importance” as has been
done in many other provisions such as
Section 109 of the Code or Article
133(1)(a) of the Constitution. The
substantial question of law on which a
second appeal shall be heard need not
necessarily be a substantial question
of law of general importance. In Guran
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Ditta v. T. Ram Ditta”, the phrase
“substantial question of law” as it was
employed in the last clause of the then
existing Section 110 CPC (since omitted
by the Amendment Act, 1973) came up for
consideration and their Lordships held
that it did not mean a substantial
question of general importance but a
substantial question of law which was
involved in the case as between the
parties. In Sir Chunilal V. Mehta &
Sons Ltd. v. Century Spg. And Mfg. Co.
Ltd. the Constitution Bench expressed
agreement with the following view taken
by a Full Bench of the Madras High
Court in Rimmalapudi Subba Rao v. Noony
Veeraju.”
30. In the case of Hero Vinoth (Minor) Vs.
Seshammal [2006]5 SCC 545, the Two Judges’
Bench of the Hon’ble Supreme Court following
the earlier precedents, summarises the
principles in the following manner.
The relevant portion of the said judgment at
para.24 is quoted below for ready reference:
“24. The principles relating to Section
100 CPC relevant for this case may be
summarized thus:
(i) An inference of fact from the
recitals or contents of a document is a
question of fact.
But the legal effect of the terms of a
document is a question of law.
Construction of a document involving
the application of any principle of
law, is also a question of law.
Therefore, when there is
misconstruction of a document or wrong
application of a principles of law in
construing a document, it gives rise to
a question of law.
(ii) The High Court should be satisfied
that the case involves a substantial
question of law, and not a mere
question of law. A question of law
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having a material bearing on the
decision of the case (that is, a
question, answer to which affects the
rights of parties to the suit) will be
a substantial question of law, if it is
not covered by any specific provisions
of law or settled legal principle
emerging from binding precedents, and
involves a debatable legal issue. A
substantial question of law will also
arise in a contrary situation; where
the legal position is clear, either on
account of express provisions of law or
binding precedents, but the Court below
has decided the matter, either ignoring
or acting contrary to such legal
principle. In the second type of cases,
the substantial question of law arises
not because the law is still debatable,
but because the decision rendered on a
material question, violates the settled
position of law.
(iii) The general rule is that High
Court will not interfere with the
concurrent findings of the courts
below. But it is not an absolute rule.
Some of the wellrecognised
exceptions
are where (i) the courts below have
ignored material evidence or acted on
no evidence; (ii) the courts have drawn
wrong inferences from proved facts by
applying the law erroneously; or (iii)
the courts have wrongly cast the burden
of proof. When we refer to “decision
based on no evidence”, it not only
refers to
cases where there is a total dearth of
evidence, but also refers to any case,
where the evidence, taken as a whole,
is not reasonably capable of supporting
the finding.”
31. In the case of Vijay Kumar Talwar Vs.
Commissioner of Income Tax, Delhi, [2011] 1
SCC 673, comparing the provisions of Section
260A
of the Act with Section 100 of the
Civil Procedure Code, the Hon’ble Supreme
Court held that in the absence of
demonstrated perversity in the findings of
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the Tribunal, the Court cannot interfere and
a finding of fact may give rise to a
substantial question of law, only if it is
perverse.
Paragraphs 23 and 25 of the said judgment is
quoted below for ready reference:”
23. A finding of fact may give rise to
a substantial question of law, inter
alia, in the event the findings are
based on no evidence and/or while
arriving at the said finding, relevant
admissible evidence has not been taken
into consideration or inadmissible
evidence has been taken into
consideration or legal principles have
not been applied in appreciating the
evidence, or when the evidence has been
misread. (See Madan Lal v. Gopi
Narendra Gopal Vidyarthi V. Rajat
Vidyarthi, Commr. Of Customs v. Vijay
Dasharath Patel, Metroark Ltd. v. CCE
and W.B. Electricity Regulatory
Commission v. CESC Ltd.).
25. We are of the opinion that on a
conspectus of the factual scenario,
noted above, the conclusion of the
Tribunal to the effect that the
assessee has failed to prove the source
of the cash credits cannot be said to
be perverse, giving rise to a
substantial question of law. The
Tribunal being a final factfinding
authority, in the absence of
demonstrated perversity in its finding,
interference therewith by this Court is
not warranted.”
15. The Court, thereafter, proceeded to explain
the scheme of assessment of the Transfer Pricing
Cases.
“Scheme of Assessment of the Transfer
Pricing Cases:
32. Let us briefly now discuss the Scheme of
assessment under Chapter X relating to
Transfer Pricing cases of International
Taxation under these provisions in income
arising from international transactions
which shall be computed having regard to the
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‘Arm’s Length Price’ (Sec.92).
33. Section 92A
defines an ‘Associate
Enterprise’ viz., the Company which
participates directly or indirectly, or
through one or more intermediaries, in its
Management or control or Capital of the
other Enterprise by holding more than 26% of
the share holding in such other
Enterprises and satisfy the other criterias
as stated in Section 92A
of the Act.
34. The word ‘International Transaction’ is
defined in Section 92B
of the Act.
35. The most important provision concerning
us in this batch of cases is Section 92C
of
the Act which provides for ‘Computation of
Arm’s Length Price’ and the said provision
stipulates that the ‘Arm’s Length Price’ in
relation to the international transactions
shall be determined by following any of
these methods enumerated in Section 92C
of
the Act which is considered to be the ‘Most
Appropriate Method’ by the Authorities under
the Act. The methods provided are:
Clause (a): Comparable Uncontrolled
Principles Method (CUP);
Clause (b): Resale Price Method (RP)
Clause (c): Cost Plus Method (CP)
Clause (d): Profit Split Method (PS)
Clause (e): Transactional Net Margin Method
(TNMM); and
Clause (f): such other Method as may be
prescribed by the Board.
36. It appears from the true facts of the
various cases before us and the arguments of
the learned counsels that the TNNM Method
appears to be the most popular and widely
adopted Method for determining the ‘Arm’s
length price’ in which the Operating Profit
Margin of comparable
Companies are considered by the Authorities
and applied to the cases of the Assessees to
determined the ‘Arm’s Length Price’ and make
Transfer Pricing Adjustments.
Rules 10A,
10AB,
10B,
10C
& 10CA
of the
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Income Tax Rules, 1962 prescribe the manner
for working out ‘Arm’s Length Price’ under
aforesaid prescribed Methods.
37. Section 92CA
of the Act envisages that
the Assessing Authority, if he considers
necessary or expedient so to do, he can with
the previous approval of the Principal
Commissioner, refer the computation of
‘Arm’s Length Price’ to Transfer Pricing
Officer (TPO), another Departmental
Authority only, who is supposed to have
special knowledge and training for computing
the ‘Arm’s Length Price’ in the
international transactions. The Report of
the Transfer Pricing Officer is binding on
the Assessing Authority as per Section 92CA
(4) of the Act, but where the Assessee
raises an objection against the Draft
Assessment Order of the Assessing Authority
based on such Report of the Transfer Pricing
Officer, the Assessee Company within 30 days
can either accept the said Draft Order or
file its objections before the Dispute
Resolution Panel (DRP) and the Assessing
Officer as per Section 144C
of the Act.
The said Dispute Resolution Panel comprises
of a Collegium of three Principal
Commissioners or Commissioners of Income Tax
constituted by the Board as defined in
Section 144C
(15) of the Act and it has to
comply with the principles of natural
justice by giving an opportunity of hearing
to the Assessees. The order passed by the
Assessing Authority in pursuance of the
directions of the Dispute Resolution Panel
(DRP) is directly appealable to the Income
Tax Tribunal under Section 253 (1) (d) of
the Act. Section 254 of the Act empowers the
Appellate Tribunal to pass such orders on
the appeals ‘as it thinks fit’ after giving
an opportunity of hearing to both the
parties.
38. From the aforesaid Scheme of assessment
with regard to international transactions,
it is clear that the process of
determination of ‘Arm’s Length Price’ has to
be undertaken by the Expert Wing of the
Income Tax Department which is manned by
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Transfer Pricing Officer
(TPO) and at the higher level by a Collegium
of three Commissioners in the form of
Dispute Resolution Panel (DRP) whose orders
on questions of facts are appealable before
the highest fact finding body, viz., the
Appellate Tribunal.
39. The process of determination of ‘Arm’s
Length Price’ as observed above, necessarily
takes into account the comparable cases of
other similarly situated or nearly similarly
situated Corporate Entities whose data are
in public domain or on the Data Bases like
Prowess and
Capital Line Data Base etc. “
16. The Court, thereafter, proceeded to discuss
whether any substantial question of law could be
said to be involved in the matter.
“No Substantial Question of Law Arises in
these Cases:
40. The dispute essentially before us is the
pairing and matching such comparables with
the Transfer Pricing Analysis of the profit
margins given by the Assessee himself during
the course of determination of such ‘Arm’s
Length Price’.
41. The shades of arguments raised by both
the sides before us in these appeals and
most of which have been filed by the Revenue
are that either the wrong Filters have been
applied or Filters have been wrongly
applied, particularly qua Turnover Filter
giving a far too wide or narrower range of
comparables or even though comparable
Entities were functionally different
entities from the Entities in the list of
Departmental comparables, as against the
comparables sought to be provided by the
assessees but the Revenue Department
generally insists on their inclusion to get
high profit ratio leading to higher Transfer
Pricing adjustments, whereas the assessee
would like to keep the comparables in a
narrower range to justify its Transfer
Pricing Analysis and profits declared.
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42. In sum and substance, we find that such
an exercise having been undertaken by the
Authorities below may have resulted not only
in high pitched Transfer Pricing Adjustments
in the declared profits of the Assessee, but
a flood of such appeals go before the
Tribunal itself where finally the inclusion
or exclusion of comparables has been
determined by the Tribunal on due analysis
giving its own reasons.
43. The contention raised before us that in
view of some different views taken by the
Tribunal by different Benches at different
places, the present appeals under Section
260A
of the Act deserve to be entertained
and admitted by this Court for laying down
certain Guidelines about the Filters or Most
Appropriate Method to be adopted for
determination of the ‘Arm’s length price’,
does not, in our considered opinion falls
within the parameters of the substantial
question of law. None of the sides was able
to point out any perversity in the Orders of
the Appellate Tribunal in this regard.
44. This Court cannot be expected to
undertake the exercise of comparison of the
comparables itself which is essentially a
fact finding exercise. Neither the
sufficient Data nor factual informations nor
any technical expertise is available with
this Court to undertake any such fact
finding exercise in the said appeals under
Section 260A
of the Act. This Court is only
concerned with the question of law and that
too a substantial one, which has a well
defined connotations as explained above and
findings of facts arrived at by the Tribunal
in these type of assessments like any other
type of assessments in other regular
assessment provisions of the Act, viz.
Sections 143, 147 etc. are final and are
binding on this Court. While dealing with
these appeals under Section 260A
of the
Act, we cannot disturb those findings of
fact under Section 260A
of the Act, unless
such findings are exfacie perverse and
unsustainable and exhibit a total
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nonapplication of mind by the Tribunal to
the relevant facts of the case and evidence
before the Tribunal.
45. Otherwise if the High Court takes the
path of making such a comparative analysis
and pronounces upon the questions as to
which Filter is good and which comparable is
really comparable case or not, it will drag
the High Courts into a whirlpool of such
Data analysis defeating the very purpose and
purport of the provisions of Section 260A
of the Act. Therefore what we observed above
appears to us to be the sustainable view
that the key to the lock for entering into
the jurisdiction of High Court under Section
260A
of the Act is the existence of a
substantial question of law involved in the
matter. The key of exfacie
perversity of
the findings of the Tribunal duly
established with the relevant evidence and
facts. Unless it is so, no other key or for
that matter, even the inconsistent
view
taken by the Tribunal in different cases
depending upon the relevant facts available
before it cannot lead to the formation of a
substantial question of law in any
particular case to determine the aspects of
determination of ‘Arm’s Length Price’ as is
sought to be raised before us. “
17. The Court, thereafter, expressed its concern
for giving primacy to the Tribunal in the area
of fact finding.
“46. Undoubtedly, the Income Tax Tribunal is
the final and highest fact finding body
under the Act. It is manned by Expert
Members (Judicial Members are selected from
District Judges or Advocates and Accountant
Members selected from practicing Chartered
Accountants or persons of CIT level in the
Department). Therefore this quasijudicial
forum is expected and as some of the nicely
articulated Judgments and Orders from the
Tribunal would indicate, the Orders passed
by the Tribunal should normally put an end
and quietus to the findings of facts and
factual aspects of assessment. The lower
Revenue Authorities cannot be allowed to
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make it their prestige issue, if their stand
is not upheld by the Tribunal and agitate
against their Orders before the higher
Courts by resort to Section 260A
or Section
261 of the Act merely because they are
dissatisfied with the findings of facts by
the Tribunal.
47. In the case before us now, the pick of
comparables, shortlisting
of them, applying
of filters, etc., are all fact finding
exercises and therefore the final Orders
passed by the Tribunal are binding on the
lower Authorities of the Department as well
as High Court.
48. The Tribunal of course is expected to
act fairly, reasonably and rationally and
should scrupulously avoid perversity in
their Orders. It should reflect due
application of mind when they assign reasons
for returning the particular findings.
49. For instance, while dealing with
comparables or Filters, if unequals
like
Software Giant Infosys or Wipro are compared
to a newly established small size Company
engaged in Software service, it would
obviously be wrong and perverse. The very
word “comparable” means that the Group of
Entities should be in a homogeneous Group.
They should not be wildly dissimilar or
unlike or poles apart. Such wild comparisons
may result in the best judgment assessment
going haywire and directionless wild, which
may land up the findings of the Tribunal in
the realm of perversity attracting
interference under Section 260A
of the Act.
“
18. In the last, the Court concluded as under:
“The procedure of assessment under Chapter X
relating to international transactions as
indicated above is already a lengthy one and
involves multiple Authorities of the
Department. A huge, cumbersome and tenacious
exercise of Transfer Pricing Analysis has to
be undertaken by the Corporate Entities who
have to comply with the various provisions
of the Act and Rules with a huge Data Bank
and in the first instance they have to
satisfy that the profits or the income from
transactions declared by them is at ‘Arm’s
length’ which analysis is invariably put to
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test and inquiry by the Authorities of the
Department and through the process of
Transfer Pricing Officer (TPO) and Dispute
Resolution Panel (DRP) and the Tribunal at
various stages, the assessee has a
cumbersome task of compliance and it has to
satisfy the Authorities that what has been
declared by them is true and fair disclosure
and much of the Transfer Pricing
Adjustments is not required but the Tax
Authorities have their own view on the other
side and the effort on the part of the Tax
Revenue Authorities is always to extract
more and more revenue. This process of
making huge Transfer Pricing Adjustments
results in multilayer
litigation at
multiple Fora. After the lengthy process of
the same, the matter reaches the Tribunal
which also takes its own time to decide such
appeals. In the course of this dispute
resolution, much has already been lost in
the form of time, manhours
and money,
besides giving an adverse picture of the
sluggish Dispute Resolution process through
these channels. If appeals under Section
260A
of the Act were to be lightly
entertained by High Court against the
findings of the Tribunal, without putting it
to a strict scrutiny of the existence of the
substantial questions of law, it is likely
to open the floodgates
for this litigation
to spill over on the dockets of the High
Courts and up to the Supreme Court, where
such further delay may further cause serious
damage to the demand of expeditious judicial
dispensation in such cases.
Conclusion:
55. A substantial quantum of international
trade and transactions depends upon the fair
and quick judicial dispensation in such
cases. Had it been a case of substantial
question of interpretation of provisions of
Double Taxation Avoidance Treaties (DTAA),
interpretation of provisions of the Income
Tax Act or Overriding Effect of the Treaties
over the Domestic Legislations or the
questions like Treaty Shopping, Base Erosion
and Profit Shifting (BEPS), Transfer of
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Shares in Tax Havens (like in the case of
Vodafone etc.), if based on relevant facts,
such substantial questions of law could be
raised before the High Court under Section
260A
of the Act, the Courts could have
embarked upon such exercise of framing and
answering such substantial question of law.
On the other hand, the appeals of the
present tenor as to whether the comparables
have been rightly picked up or not, Filters
for arriving at the correct list of
comparables have been rightly applied or
not, do
not in our considered opinion, give rise to
any substantial question of law.
56. We are therefore of the considered
opinion that the present appeals filed by
the Revenue do not give rise to any
substantial question of law and the
suggested substantial questions of law do
not meet the requirements of Section 260A
of the Act and thus the appeals filed by the
Revenue are found to be devoid of merit and
the same are liable to be dismissed.
57. We make it clear that the same
yardsticks and parameters will have to be
applied, even if such appeals are filed by
the Assessees, because, there may be cases
where the Tribunal giving its own reasons
and findings has found certain comparables
to be good comparables to arrive at an
‘Arm’s Length Price’ in the case of the
assessees with which the assessees may not
be satisfied and have filed such appeals
before this Court. Therefore we clarify that
mere dissatisfaction with the findings of
facts arrived at by the learned Tribunal is
not at all a sufficient reason to invoke
Section 260A
of the Act before this Court.
“
19. The Delhi High Court, in the case of CIT vs.
EKL Appliances Ltd., reported in (2012) 345 ITR
241 (Delhi), in context with Section 92CA of the
Act, had observed as under:
“It seems to us that the decision taken by
the Tribunal is the right decision. The TPO
applied the CUP method while examining the
payment of brand fee/ royalty. The CUP
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method which in its expanded form is known
as “comparable uncontrolled price” method is
provided for in Rule 10B(1)(a) of the Income
Tax Rules, 1962. It is one of the methods
recognised for determining the ALP in
relation to an international transaction.
Rule 10B(1) says that for the purposes of
Section 92C(2), the ALP shall be determined
by any one of the five methods, which is
found to be the most appropriate method, and
goes on to lay down the manner of
determination of the ALP under each method.
The five methods recognized by the rule are
(i) comparable uncontrolled price method
(CUP), (ii) resale
price method, (iii) cost
plus method, (iv) profit split method and
(v) transactional net marginal method
(TNMM). The manner by which the ALP in
relation to an international transaction is
determined under CUP is prescribed in
clause (a) of the subrule
(1) of Rule 10B.
The following three steps have been
prescribed: “(
a) comparable uncontrolled price method,
by which,
(i) the price charged or paid for property
transferred or services provided in a
comparable uncontrolled transaction, or a
number of such transactions, is identified;
(ii) such price is adjusted to account for
differences, if any, between the
international transaction and the comparable
uncontrolled transactions or between the
enterprises entering into such transactions,
which could materially affect the price in
the open market;
(iii) the adjusted price arrived at under
subclause
(ii) is taken to be an arm’s
length price in respect of the property
transferred or services provided in the
international transaction;”
The Organization for Economic Cooperation
and Development (“OECD , for short) has ‟
laid down “transfer pricing guidelines” for
MultiNational
Enterprises and Tax
Administrations. These guidelines give an
introduction to the arm’s length price
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principle and explains article 9 of the OECD
Model Tax Convention. This article provides
that when conditions are made or imposed
between two associated enterprises in their
commercial or financial relations which
differ from those which would be made
between independent enterprises then any
profit which would, but for those
conditions, have accrued to one of the
enterprises, but, by reason of those
conditions, if not so accrued, may be
included in the profits of that enterprise
and taxed accordingly. By seeking to adjust
the profits in the above manner, the arm’s
length principle of pricing follows the
approach of treating the members of a multinational
enterprise group as operating as
separate entities rather than as inseparable
parts of a single unified business. After
referring to article 9 of the model
convention and stating the arm’s length
principle, the guidelines provide for
“recognition of the actual transactions
undertaken” in paragraphs 1.36 to 1.41.
Paragraphs 1.36 to 1.38 are important and
are relevant to our purpose. These
paragraphs are reproduced below: ”
1.36 A tax administration’s
examination of a controlled transaction
ordinarily should be based on the
transaction actually undertaken by the
associated enterprises as it has been
structured by them, using the methods
applied by the taxpayer insofar as
these are consistent with the methods
described in Chapters II and III. In
other than exceptional cases, the tax
administration should not disregard the
actual transactions or substitute other
transactions for them. Restructuring of
legitimate business transactions would
be a wholly arbitrary exercise the
inequity of which could be compounded
by double taxation created where the
other tax administration does not share
the same views as to how the
transaction should be structured.
1.37 However, there are two particular
circumstances in which it may,
exceptionally, be both appropriate and
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legitimate for a tax administration to
consider disregarding the structure
adopted by a taxpayer in entering into
a controlled transaction. The first
circumstance arises where the economic
substance of a transaction differs from
its form. In such a case the tax
administration may disregard the
parties’ characterization of the
transaction and recharacterise
it in
accordance with its substance. An
example of this circumstance would be
an investment in an associated
enterprise in the form of interestbearing
debt when, at arm’s length,
having regard to the economic
circumstances of the borrowing company,
the investment would not be expected to
be structured in this way. In this case
it might be appropriate for a tax
administration to characterize the
investment in accordance with its
economic substance with the result that
the loan may be treated as a
subscription of capital. The second
circumstance arises where, while the
form and substance of the transaction
are the same, the arrangements made in
relation to the transaction, viewed in
their totality, differ from those which
would have been adopted by independent
enterprises behaving in a commercially
rational manner and the actual
structure practically impedes the tax
administration from determining an
appropriate transfer price. An example
of this circumstance would be a sale
under a longterm
contract, for a lump
sum payment, of unlimited entitlement
to the intellectual property rights
arising as a result of future research
for the term of the contract (as
previously indicated in paragraph
1.10). While in this case it may be
proper to respect the transaction as a
transfer of commercial property, it
would nevertheless be appropriate for a
tax administration to conform the terms
of that transfer in their entirety (and
not simply by reference to pricing) to
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those that might reasonably have been
expected had the transfer of property
been the subject of a transaction
involving independent enterprises.
Thus, in the case described above it
might be appropriate for the tax
administration, for example, to adjust
the conditions of the agreement in a
commercially rational manner as a
continuing research agreement.
1.38 In both sets of circumstances
described above, the character of the
transaction may derive from the
relationship between the parties rather
than be determined by normal commercial
conditions as may have been structured
by the taxpayer to avoid or minimize
tax. In such cases, the totality of its
terms would be the result of a
condition that would not have been made
if the parties had been engaged in
arm’s length dealings. Article 9 would
thus allow an adjustment of conditions
to reflect those which the parties
would have attained had the transaction
been structured in accordance with the
economic and commercial reality of
parties dealing at arm’s length.”
The significance of the aforesaid guidelines
lies in the fact that they recognise that
barring exceptional cases, the tax
administration should not disregard the
actual transaction or substitute other
transactions for them and the examination of
a controlled transaction should ordinarily
be based on the transaction as it has been
actually undertaken and structured by the
associated enterprises. It is of further
significance that the guidelines discourage
restructuring
of legitimate business
transactions. The reason for
characterisation of such restructuring as an
arbitrary exercise, as given in the
guidelines, is that it has the potential to
create double taxation if the other tax
administration does not share the same view
as to how the transaction should be
structured.
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Two exceptions have been allowed to the
aforesaid principle and they are (i) where
the economic substance of a transaction
differs from its form and (ii) where the
form and substance of the transaction are
the same but arrangements made in relation
to the transaction, viewed in their
totality, differ from those which would have
been adopted by independent enterprises
behaving in a commercially rational manner.
There is no reason why the OECD guidelines
should not be taken as a valid input in the
present case in judging the action of the
TPO. In fact, the CIT (Appeals) has referred
to and applied them and his decision has
been affirmed by the Tribunal. These
guidelines, in a different form, have been
recognized in the tax jurisprudence of our
country earlier. It has been held by our
courts that it is not for the revenue
authorities to dictate to the assessee as to
how he should conduct his business and it is
not for them to tell the assessee as to what
expenditure the assessee can incur. We may
refer to a few of these authorities to
elucidate the point. In Eastern Investment
Ltd. v. CIT, (1951) 20 ITR 1, it was held by
the Supreme Court that “there are usually
many ways in which a given thing can be
brought about in business circles but it is
not for the Court to decide which of them
should have been employed when the Court is
deciding a question under Section 12(2) of
the Income Tax Act”. It was further held in
this case that “it is not necessary to show
that the expenditure was a profitable one or
that in fact any profit was earned”. In CIT
v. Walchand & Co. etc., (1967) 65 ITR 381,
it was held by the Supreme Court that in
applying the test of commercial expediency
for determining whether the expenditure was
wholly and exclusively laid out for the
purpose of business, reasonableness of the
expenditure has to be judged from the point
of view of the businessman and not of the
Revenue. It was further observed that the
rule that expenditure can only be justified
if there is corresponding increase in the
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profits was erroneous. It has been
classically observed by Lord Thankerton in
Hughes v. Bank of New Zealand, (1938) 6 ITR
636 that “expenditure in the course of the
trade which is unremunerative is none the
less a proper deduction if wholly and
exclusively made for the purposes of trade.
It does not require the presence of a
receipt on the credit side to justify the
deduction of an expense”. The question
whether an expenditure can be allowed as a
deduction only if it has resulted in any
income or profits came to be considered by
the Supreme Court again in CIT v. Rajendra
Prasad Moody, (1978) 115 ITR 519, and it was
observed as under: ”
We fail to appreciate how expenditure
which is otherwise a proper expenditure
can cease to be such merely because
there is no receipt of income. Whatever
is a proper outgoing by way of
expenditure must be debited
irrespective of whether there is
receipt of income or not. That is the
plain requirement of proper accounting
and the interpretation of Section
57(iii) cannot be different. The
deduction of the expenditure cannot, in
the circumstances, be held to be
conditional upon the making
or earning of the income.”
It is noteworthy that the above observations
were made in the context of Section 57(iii)
of the Act where the language is somewhat
narrower than the language employed in
Section 37(1) of the Act. This fact is
recognised in the judgment itself. The fact
that the language employed in Section 37(1)
of the Act is broader than Section 57(iii)
of the Act makes the position stronger.
In the case of Sassoon J. David & Co. Pvt.
Ltd. v. CIT, (1979) 118 ITR 261 (SC), the
Supreme Court referred to the legislative
history and noted that when the Income Tax
Bill of 1961 was introduced, Section 37(1)
required that the expenditure should have
been incurred “wholly, necessarily and
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exclusively” for the purposes of business in
order to merit deduction. Pursuant to public
protest, the word “necessarily” was omitted
from the section.
The position emerging from the above
decisions is that it is not necessary for
the assessee to show that any legitimate
expenditure incurred by him was also
incurred out of necessity. It is also not
necessary for the assessee to show that any
expenditure incurred by him for the purpose
of business carried on by him has actually
resulted in profit or income either in the
same year or in any of the subsequent years.
The only condition is that the expenditure
should have been incurred “wholly and
exclusively” for the purpose of business and
nothing more. It is this principle that
inter alia finds expression in the OECD
guidelines, in the paragraphs which we have
quoted above.
Even Rule 10B(1)(a) does not authorise
disallowance of any expenditure on the
ground that it was not necessary or prudent
for the assessee to have incurred the same
or that in the view of the Revenue the
expenditure was unremunerative or that in
view of the continued losses suffered by the
assessee in his business, he could have
fared better had he not incurred such
expenditure. These are irrelevant
considerations for the purpose of Rule 10B.
Whether or not to enter into the transaction
is for the assessee to decide. The quantum
of expenditure can no doubt be examined by
the TPO as per law but in judging the
allowability thereof as business
expenditure, he has no authority to disallow
the entire expenditure or a part thereof on
the ground that the assessee has suffered
continuous losses. The financial health of
assessee can never be a criterion to judge
allowability of an expense; there is
certainly no authority for that. What the
TPO has done in the present case is to hold
that the assessee ought not to have entered
into the agreement to pay royalty/ brand
fee, because it has been suffering losses
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continuously. So long as the expenditure or
payment has been demonstrated to have been
incurred or laid out for the purposes of
business, it is no concern of the TPO to
disallow the same on any extraneous
reasoning. As provided in the OECD
guidelines, he is expected to examine the
international transaction as he actually
finds the same and then make suitable
adjustment but a wholesale disallowance of
the expenditure, particularly on the grounds
which have been given by the TPO is not
contemplated or authorised.
Apart from the legal position stated above,
even on merits the disallowance of the
entire brand fee/ royalty payment was not
warranted. The assessee has furnished
copious material and valid reasons as to why
it was suffering losses continuously and
these have been referred to by us earlier.
Full justification supported by facts and
figures have been given to demonstrate that
the increase in the employees cost, finance
charges, administrative expenses,
depreciation cost and capacity increase have
contributed to the continuous losses. The
comparative position over a period of 5
years from 1998 to 2003 with relevant
figures have been given before the CIT
(Appeals) and they are referred to in a
tabular form in his order in paragraph
5.5.1. In fact there are four tabular
statements furnished by the assessee before
the CIT (Appeals) in support of the reasons
for the continuous losses. There is no
material brought by the revenue either
before the CIT (Appeals) or before the
Tribunal or even before us to show that
these are incorrect figures or that even on
merits the reasons for the losses are not
genuine.
We are, therefore, unable to hold that the
Tribunal committed any error in confirming
the order of the CIT (Appeals) for both the
years deleting the disallowance of the brand
fee/ royalty payment while determining the
ALP. Accordingly, the substantial questions
of law are answered in the affirmative and
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in favour of the assessee and against the
Revenue. The appeals are accordingly
dismissed with no order as to costs.“
11. We are of the view that in view of above
dictum of law the findings of fact recorded by
the Tribunal in the impugned order cannot be
termed as perverse or contrary to the evidence
on record. The Tribunal has taken into
consideration the voluminous documentary
evidence on record for the purpose of coming
to the conclusion of adoption of TNMM by the
assessee as the Most Appropriate Method of
arriving at ALP. The Delhi High Court in the
case of Make My Trip India (P.) Ltd. (supra)
has also held that difference of opinion as to
the appropriateness of one or the other method
cannot be gone into in the appeal under
Section 260A of the Act, 1961 by observing as
under:
“5. The Court is of the opinion that
no substantial question of law
arises. The difference of opinion
between the CIT (A) and the TPO, as
to the appropriateness of one or the
other methods, cannot per se be a
ground for interference; the
appropriateness of the method unless
shown to be contrary to the Rules
specially Rules 10B and 10C, in the
opinion of the Court, are hardly
issues that ought to be gone into
under Section 260A of the Incometax
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Act.”
12.In the overall view of the matter, we are
convinced that the decision of the Tribunal is
correct and requires no interference and no
question of law much less any substantial
question of law can be said to have arisen
from the impugned order of the Tribunal. In
the result, these appeals fail and are hereby
dismissed, with no order as to costs.