If a foreign company does not have a liability to pay tax, the income-tax department cannot apply transfer pricing provisions on it. Giving relief to the Netherlands-based Vanenburg Group BV, Authority for Advance Rulings (AAR) has ruled that transfer pricing provisions will not apply in its case as it was not liable to pay tax in India.

Vanenburg Group, which had transferred the entire shareholding of its Indian subsidiary Cordys R&D (India) Pvt Ltd to its Cordys Holdings BV (Netherlands), had sought a ruling from the AAR on whether the transfer would attract capital gains tax and the transfer pricing provisions under Sections 92-92F of the Income-Tax Act, 1961.

The AAR, in its ruling, said capital gains arising out of Cordys (India)s holding to Cordys (Netherlands) would not attract tax under Article 13(5) of the India-Netherlands double taxation avoidance agreement. The authority held that the provisions under Section 92-92F of the Income-Tax Act, 1961, are machinery provisions and will not apply where there was absence of liability to pay tax. The provisions are aimed at preventing avoidance of tax by devices such as arms length pricing and computation of income in certain cases in relation to international transactions.

This is the first ruling on an important question whether transfer pricing rules will apply in a situation where underlying transaction is exempt from taxation under the relevant treaty. The ruling gives an important guidance of the fact that transfer pricing provisions, being machinery provisions, would not be applicable where substantively there is no tax liability under basic principle, BSR & Co partner Sudhir Kapadia said.

The issue of applicability of transfer pricing provisions has always been a matter of debate and there had been no precedents on the issue. The ruling lays down the principle that transfer pricing provisions will not apply in absence of tax liability. While the ruling will not be binding in other cases, it is likely to have a persuasive value. Also, the AAR has termed the provisions as machinery provisions to ascertain the arms length nature of international transactions and it can be inferred that these are not charging provisions.