ITAT: refer matters to TPO only if specialist is needed
It has been a matter of dispute between income tax authorities and tax payers that whether regular assessing officer is required to analyse returns before referring a case to a transfer pricing officer (TPO). Various judicial and quasi-judicial bodies have passed several orders on this issue. Some verdicts may conflict with other rulings, but then that is the way the income tax orders the world over have been, especially the judgements on transfer pricing (TP) issues.
In a recent order involving Tata Consultancy Services (TCS), the Income Tax Appellate Tribunal (ITAT) held that the assessing officer should apply his/her mind before referring the matter to TPO. The assessing officer should refer the matter to TPO only if a specialist is needed in dealing with cross-border transactions.
For the uninitiated, transfer pricing rules were put in place in India in 2001.The income tax department describes transfer pricing as follows: “Transfer pricing generally refers to prices of transactions between associated enterprises which may take place under conditions differing from those taking place between independent enterprises. It refers to the value attached to transfers of goods, services and technology between related entities. It also refers to the value attached to transfers between unrelated parties which are controlled by a common entity.”
Transfer pricing is an essential component of international trade and therefore judicial orders on cross-border transactions are keenly observed by global tax regimes. In India alone, tax demands based on transfer pricing assessment run into thousands of crores of rupees. The figure was more than Rs 70,000 crore in the last financial year.
Many issues related to transfer pricing crop up time and again. The latest order by ITAT in Mumbai in the case of TCS deals with the issue of whether a regular assessing officer should apply his/her mind on issues related to cross-border transactions before referring the matter to the TPO. The tribunal ruled that the officer is required by law to apply his/her mind under section 92 CA of the Income Tax Act before referring the cross-border transactions to TPO.
The ITAT order also said that the transfer pricing assessment cannot be made in a case where the assessee enjoys tax benefits under section 10A / 80HHE. The ITAT also held that the assessing officer cannot make such a reference to TPO if the tax rate in the country of the associated enterprise is higher than the Indian rate. In such situations it is not possible to establish tax avoidance or manipulation of prices or establishment of shifting of profits. In short, the regular assessing officer should have a reasonable suspicion that revenue has escaped the tax net in the cross-border transaction if he has to refer the matter to a TPO.
Regarding the applicability of transfer pricing provisions, the ITAT explained that the ITAT special bench ruling in Aztec Software & Technology Services, wherein it was held that transfer pricing provisions are applicable even if income is exempt u/s 10A/10B, stands overridden by jurisdictional high court ruling in Vodafone India case.
The tribunal also lays down law on assessing officer’s statutory duty in independently analysing transfer pricing transactions before making reference to TPO. “The AO erred in not himself examining the issue of TP and with the approval of the CIT made a reference to the TPO u/s 92CA(1) of the Act,” the ITAT observed
The ITAT pointed out that the CIT (A) failed to apply his mind to the return filed by the assessee, or to any other material or information or document furnished. The TPO made an adjustment, which was incorporated by the assessing officer in the assessment order. Thereby, the assessing officer as well as the CIT (A) did not discharge necessary respective judicial functions conferred on them under sections 92C and 92CA of the Act. The ITAT held that application of mind to the relevant facts and circumstances is a statutory necessity for the assessing officer. It is mandatory and a statutory safeguard for assessee’s right and cannot be performed in a mechanical manner.
The ITAT relied on the Supreme Court ruling in Johari Lal and jurisdictional high court ruling in German Remedies to support its conclusion.
The ITAT also made a reference to CBDT instruction 3/2003. It said the instruction detracts AO/CIT from the above obligation. This instruction is in complete violation of the statutory provisions of the Act and necessary hearing is required to be given to the assessee in accordance with principles of natural justice. The tribunal relied on Bombay High Court ruling in Vodafone India.
Here it should be mentioned that the CBDT circular 3/ 2003 which allows automatic reference to the TP officer if the value of international transaction is Rs 5 crore or more was challenged before the Delhi High Court. The latter held that the instruction was consistent with statutory objective and not ultra vires to the Act. The court, however, had observed that the circular would act as a guidance to the assessing officer while deciding whether to refer the matter to the transfer pricing officer or not.
Relying on the case of CIT vs Amedius, the ITAT held that it is primarily AO’s duty to compute arm’s length price (ALP) and only where AO requires ALP to be computed by an expert can a reference be made to TPO.
The ITAT order in the TCS case was delivered a few days before the CBDT issued a notification for setting up grievance cells across I-T offices in India. According to the notification, the grievance cells will be headed by three high-ranking income tax officers. The major responsibility of the grievance cells is, among other things, to examine whether there is non-application of mind or even gross negligence on the part of the officials responsible for the assessment. If the cell concludes that an unreasonable and high-pitched assessment has been made, a report will be sent to the principal chief commissioner of income tax, who will take suitable administrative measures to curtail litigation.
