India: No Transfer Pricing Adjustment In Cases Where AE Is From High Tax Jurisdiction: Mumbai Tribunal

• Transfer pricing adjustment cannot be made in a case where the tax rate in the country of the Associated Enterprise is higher than the Indian rate and where, accordingly, establishment of tax avoidance or manipulation of prices or establishment of shifting of profits is not possible.
• Only after proper application of mind to all facts can the Assessing Officer make reference to the Transfer Pricing Officer.
• Reliance placed on Vodafone to conclude that CBDT Instruction No. 3 / 2003 is in complete violation of provisions of Income Tax Act, 1961.

Recently, the Mumbai Income Tax Appellate Tribunal (“Tribunal“) in the case of DCIT v. Tata Consultancy Services1 held that Transfer Pricing adjustment cannot be made in a case where the taxpayer enjoys benefits under the Income Tax Act, 1961 (“ITA“) or where the tax rate in the country of the Associates Enterprise is higher than the Indian rate and where, accordingly, establishment of tax avoidance or manipulation of prices or establishment of shifting of profits is not possible.

The Tribunal also held that it is only after proper application of mind to all facts and holding a prima facie belief that the Assessing Officer (“AO“) can make reference of a case related to Transfer Pricing to the Transfer Pricing Officer (“TPO“) or that the Commissioner of Income Tax (Appeals) (“CIT“) can grant approval for such a reference. It further held that the Instruction No. 3 / 2003 as issued by the Central Board of Direct Taxes (“CBDT Instruction”) detracts the AO/CIT from this obligation and is in complete violation of the provisions of the ITA.

BACKGROUND

Tata Consultancy Services (“TCS“) is a company incorporated in India. In the relevant financial year TCS has entered into a transaction with its Associated Enterprises (“AE“), M/s Tata America International Corporation Inc. (“TAIC“). TCS also enjoys certain tax benefits under Section 10A (Special provision in respect of newly established undertakings in free trade zone etc.) and Section 80HHE (Deduction in respect of profits from export of computer software, etc.) of the ITA. The AO, in the present case, referred the case to the TPO. The TPO made adjustments to the Arm’s Length Price (“ALP“) of the transaction that was incorporated by the AO in the assessment order. On appeal, the CIT deleted the additions made by the AO. Aggrieved by the order of the CIT, the department filed an appeal to the Tribunal.

ARGUMENTS ADVANCED

TCS argued that under the ITA it is the statutory duty of the AO to decide independently, whether the determination of ALP by TCS should be accepted. Similarly, it is only after proper application of mind to all the facts and holding a prima facie belief that there is a case for tax avoidance can the AO make reference to the TPO, or that the CIT can grant approval to such a reference. TCS argued that this is a statutory safeguard for the taxpayer and submitted that the CBDT Instruction detracts the AO and the CIT from the above obligation in complete violation of the statutory provisions of the principles of natural justice. TCS further argued that Transfer Pricing adjustment cannot be made in a case where the assessee enjoys benefits under the ITA or where the tax rate in the country of the Associated Enterprise is higher than the Indian rate and where, accordingly, establishment of tax avoidance or manipulation of prices or establishment of shifting of profits is not possible.

The Revenue Department on the other hand duly supporting the action of the AO sought reliance on the Coca Cola India Inc. v. ACIT2, Sony India Pvt. Ltd. v. CBDT3 and Aztec Software and Technology Services Ltd. v. ACIT4 to argue that the AO is not required to form a prior considered opinion before making a reference to the TPO and that only a prima facie opinion is necessary. The above mentioned cases also provide that the AO is not required to follow the steps enlisted the ITA, before making reference to the TPO. Further, there is no legal requirement upon the AO under the provisions of the ITA to prima facie demonstrate that there is tax avoidance before invoking the relevant provisions and that the AO is not required to prima facie demonstrate that any one or more circumstances set out in the transfer pricing provisions of the ITA are not satisfied and the taxpayer does not need to be given an opportunity of being heard before referencing it to the TPO. It was further contended that the CBDT Instruction is neither violative of the Constitution of India nor ultra-vires the ITA. Further, Aztec Software also held that Transfer Pricing provisions would still be applicable even if income is exempt from tax under the ITA.

ORDER

The Tribunal ruling in favor of TCS held that the AO erred, in not examining the issue of Transfer Pricing himself and that the AO and the CIT failed to apply their mind to the Transfer Pricing Report filed by TCS. The AO and the CIT did not discharge necessary judicial functions conferred on them under the ITA. Further, the approval of the CIT for reference to the TPO on a proper application of mind to the relevant facts and circumstances is also a condition precedent and a necessary safeguard for the statutory right of the assessee and this has to be performed not in a mechanical manner.5 The Tribunal also upheld the argument of TCS that Transfer Pricing adjustment cannot be made in a case where the assessee enjoys benefits under the ITA, or where the tax rate in the country of the AE is higher than the Indian rate and where, accordingly, establishment of tax avoidance or manipulation of prices or establishment of shifting of profits is not possible.

In coming to the conclusion the Tribunal held that it is trite law that that in a case where the income derived from an international transaction is exempt from tax in India because of the provisions of the ITA, it cannot be held that because of an arrangement between the taxpayer and the Associated Enterprise, any income taxable in India had been under reported6. Further, it has been held that where a taxpayers profits was exempt under the ITA and the Associated Enterprises were not situated in tax havens, but in the US, where the tax rates were at par with India, or may be more than that; there was no case that the taxpayer would benefit by shifting profits outside India7. The Tribunal also discussed the intent of introducing the Transfer Pricing Provisions under the ITA by citing a plethora of cases8. It held that since the basic intention behind introducing the Transfer Pricing provisions in the ITA is to prevent shifting of profits outside India, and the taxpayer was claiming benefits under the ITA the Transfer Provisions ought not to be applied to the taxpayer. Further, shifting of profits to another jurisdiction would have been justified if the rate of tax in the US (jurisdiction of the AE) was lower to that in India. Since that was not the case, there could be no motive for the TCS to shift income.

In terms of the reliance placed by the department on the above-mentioned cases, the argument of the AO was struck down by the Tribunal. It upheld that reliance placed by TCS on Vodafone India Services P Ltd. vs. Union of India9 (“Vodafone”). In Vodafone, the Mumbai High Court has held that the decision in the case of Aztec Software Technology & Services and Sony India Pvt. Ltd. is not applicable in view of the amendment brought in 2007. It was held that the CBDT Instruction detracts from the provisions of law and necessary hearing is required to be given to the assessee in accordance with the principles of natural justice before a reference is made to the AO after the amendment in the year 2007.

In the case of Coca Cola India Pvt. Ltd. an appeal was preferred against the order of the Punjab & Haryana High Court before the Supreme Court of India. The Supreme Court, in its judgment directed that the authorities below should decide the matter afresh, uninfluenced by any of the observations made in the High Court judgment. Hence, the Tribunal also held this case inapplicable to present facts.

ANALYSIS

The essential point that the Tribunal re-iterates is the fact that in case where the tax rate in the jurisdiction of the AE is higher than in India, transfer pricing provisions should not apply. No doubt this judgment comes as a relief for AEs set-up in jurisdictions where the tax rate is higher than in India. Transfer pricing has become a bane in India. The object and intent of the transfer pricing provisions is to prevent avoidance on tax. In situations where the transaction is with a high tax jurisdiction, there is no scope for any such avoidance. In such cases, any transfer pricing adjustment only leads to unnecessary litigation. It should be borne in mind that India has the most number of transfer pricing litigation – the total transfer pricing adjustments made in FY 2013-14 relating to FY 2009-10 stood at a whopping USD 7148.62 million.10 This only goes on to establish that the intent based approach to see whether there is an actual avoidance taken by the Tribunal has been diluted over a period of time. The approach taken by the Tribunal is a pragmatic one to actually ascertain whether there is tax avoidance or a possibility of tax avoidance in the first place prior to there having been any transfer pricing scrutiny / adjustments.