Tribunal rules that transactions must be assessed separately

International transactions must be assessed separately for transfer pricing, a tribunal in Kolkata has ruled. The hearing found for the taxpayer Development Consultants Private Limited which had appealed against a transfer pricing officer’s assessment which had aggregated a group of transactions. The Kolkata Income-tax Appellate Tribunal addressed several issues of aggregation of transactions, tested party and safe harbor for area of transfer pricing. Among other factors, the tribunal upheld that each category of international transactions must be benchmarked separately and should not be aggregated. (Kolkata pictured)

Adjudicating on the concept of tested party, it held that tested party should be the least complex of the controlled taxpayers. A benchmarking exercise using foreign comparables is acceptable, if the tested party in a controlled transaction is the least complex of the parties to a transaction.

The tribunal also provided a beneficial interpretation on the availability of the safe harbour +/- 5% variance and allowed it as a standard deduction, if the margins from the controlled transaction were to fall outside the range.

The important aspects of the case are:

Aggregation of international transactions

During the course of the assessment, the TPO had computed the net profit margin of the taxpayer on an aggregate basis (combining various domestic and international transactions). The assessee contended that to arrive at the most precise approximation, one should compute the arm’s length price on a transaction-by-transaction basis. This was upheld by the tribunal as the assessee had different international transactions with various associated enterprises.

Typically international transactions should be evaluated on transaction by transaction basis and aggregation would be best suited only in circumstances where such transactions are inextricably linked.

Tested party is the least complex entity

The tribunal affirmed that in order to select the most appropriate method for determining the arm’s length price, it is necessary to select the tested party which will be least complex of the controlled taxpayers engaged in the transaction and will not own valuable intangible property or unique assets that distinguish it from potential uncontrolled comparables. Also, a benchmarking exercise using foreign comparables is acceptable if the tested party in a controlled transaction is the least complex of the parties to a transaction. It may be noted that the OECD guidelines also support the selection of the least complex party as the tested party.

As the Indian transfer pricing legislation does not discuss the concept of tested party, the assessee placed reliance and referred to the US regulations issued by the Internal Revenue Service to support its arguments. Interestingly, the tribunal has accepted such a position.

Benefit of +/- 5%

The Indian regulations provide a relief to assessee that any price within +/- 5% of the arm’s length price would be deemed to be at arm’s length. However, in cases where assessees were falling outside the said range, such relief was not extended by the revenue.

The tribunal confirmed the availability of relief to assessee on account of safe harbour +/- 5% variance. It implicitly extended benefit to be allowed as a standard deduction even, as the margins from the controlled transaction fell outside the said arm’s length range. The tribunal concluded that the transfer pricing adjustment should be restricted to 95% of the arm’s length price as determined in the transfer pricing study conducted by the taxpayer. The revenue authorities do not currently agree with the tribunal’s view and are unlikely to allow the 5% benefit as a standard deduction, if the margin of the taxpayer falls outside the arm’s length range.

This is a judgment where the ruling was based on overall principles of equity rather than applying verbatim by law. One needs to see how the courts are going to view such judgments as the judiciary would only go as per the law and no further. Nevertheless, this judgment once again brings in the fact that in this area one is going to see more litigation until a high court ruling is pronounced.

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