The Mumbai bench of Income Tax Appellate Tribunal (ITAT) has delivered an interesting judgement in the case of Diageo India Private Limited vs Deputy Commissioner of Income Tax (ITA No. 8602/Mum/2010).
Apart from the various issues in the said appeal, one tantalising question was on the treatment of purchases made by otherwise unrelated parties (Diageo’s contract bottling unit (CBU)) from the related parties of the taxpayer (Diageo India).
It was held by the ITAT that such purchase from associated enterprises (AE) of Diageo India by the CBU, and its dependence on the AEs for supply of raw materials, makes the unrelated manufacturer and Diageo India an AE.
Therefore, the transaction between the unrelated manufacturer and the AEs of Diageo India also need to be tested for arm’s-length price and, accordingly, the adjustment made by the assessing officer (AO) was upheld.
What is interesting to observe is that the ITAT did examine the applicability of section 92A of the Income Tax Act, 1961 (the Act) and concluded that CBU, Diageo India and other group entities of Diageo India are AEs.
However, it is not clear whether, after concluding the relationship between the parties, the transaction in question was tested on the touchstone of section 92B of the act which defines international transaction. It is crucial because, in terms of section 92 of the act, it is the income arising from an international transaction that shall be computed to the arm’s-length price.
According to section 92B, at least one party to the transaction must be a non-resident. Further, sub-section (2) envisages a situation where a transaction is entered in to with a person other than an associated enterprise, if the substance of the agreement is controlled by the AE.
However, it appears that the transaction between the Diageo group entity and the CBU has been tested for arm’s-length pricing, invoking section 92B (1) because, in order to invoke section 92B (2), it needs to be conceded that the CBU was not an AE.
It is intriguing that, in the assessment proceedings of Diageo India, the international transactions between the CBU and the Diageo group entities have been tested. It is not clear why the income of Diageo India has been adjusted under section 92 if it was not an international transaction entered into by Diageo India.
The ITAT came to its conclusion through an interpretation of section 92 of the act. Sub-section (2) of section 92A is a deeming provision. A deeming provision enlarges the scope of the relevant section. Thus, sub-section (2) enlarges the scope of sub-section (1) and has included certain situations that would create a relationship between two enterprises, which is capable of influencing the transfer price.
It is a dated law that deeming fiction cannot be extended beyond the object for which it is enacted (Amarchand N Shroff [48 ITR 59 (SC)). The ITAT has interestingly observed that sub section (2) is illustrative in nature.
This judgment raises certain pertinent questions. It would be worthwhile to see the view of the High Court, in case an appeal is preferred raising a question of law, on the interplay of:
· The deemed international transaction (while dealing with an otherwise unrelated party);
· Scope of definition of AE on the one hand and;
· The scope of a transfer pricing adjustment to be made in the assessment of an Indian multinational company that has purchased goods from an independent Indian contractor that was supplied raw materials from the parent company of an Indian multinational, on the other hand.
According to the principles laid down by the ITAT in this case, it would be excruciating for Indian multinationals to optimise their cost of business in India. It will be interesting to see how multinational companies manage their relationships with original equipment manufacturers (OEM) where they are treated as independent for the purposes of Section 194C (principal to principal sale and not contract manufacturing) but related for the purposes of Section 92A of the act. It would also be circumspect to review OEMs dependent on the parent companies of Indian subsidiaries for supply of raw material and adhering to the strict quality controls.
