AAR: Income not chargeable to tax are also covered under TP provisions

Recent ruling by Advance Ruling Authority (‘AAR’), dated August 14, 2012, in case of Castleton Investment Limited [A.A.R. No.999 of 2010] came as a surprise to many stake holders on applicability of transfer pricing.

Though the ruling was on other issues as well but this write-up is limited to the issue pertaining to applicability of transfer pricing provision in India.

The Applicant, M/s Castleton Investment Limited of Mauritius (‘CIL’), raised a question that if the transfer of shares by the applicant to its associated enterprise is not taxable, whether the provisions of section 92 to section 92F of the Act relating to transfer pricing would be applicable? In response to the same AAR observed that the applicability of section 92 does not depend on the chargeability under the Act. The only saving grace is that the judgement is only applicable in on that applicant and on that transaction for which it is sought.

Facts of the Case

Glaxo Smithlkine Pharmaceuticals Limited (GSKPL) is a company incorporated in India. The applicant had acquired 600,000 shares in it in the year 1993. It also acquired 1,680,170 shares in Burroughs Wellcome (India) Limited (‘BWL’) in the year 1996. GSKPL and BWL merged.  In the year 2004, the applicant received in lieu of the shares held by it in BWL, shares in GSKPL. These shares were held as investment in the books of CIL. As a part of reorganization, CIL propose to transfer shares held in GSKPL to its associated enterprise, Glaxo Smithlkine (Pte) Limited.

On transfer of shares, AAR observed that any capital gain arising from such transfer would not be taxable in India.

Question

Whether the provisions of section 92 to section 92F of the Act relating to transfer pricing would be applicable?

Observation of AAR

It is not material that the gain or income is taxable in the country or not, section 92 to 92F would apply if the transaction is one coming within those provisions. In case, where there is no liability what would be the purpose of undertaking a transfer pricing exercise is not a question that would affect the operation or rigour of a statutory provision on its plain word. There is nothing to show in transfer pricing provisions that the expression ‘income’ has to be given a restricted meaning and the applicability of section 92 does not depend on the chargeability under the Act. 

Comment

This ruling of AAR will only going to create confusion in the minds of taxpayer and consultant. It is quite strange to observe that AAR has disregarded its earlier ruling in the case of Praxair Pacific and Vanenburg Group BV. A view that transfer pricing provisions are applicable even on those transactions wherein income is not taxable in India, is like a shaft without arrowhead. 

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In case if you have any query on transfer pricing related issues, please feel free to write to us at gaurav@jgarg.com

Best Regards

CA Gaurav Garg

JGarg Economic Advisors

www.jgarg.com

Mumbai ITAT: RPM preferred over TNMM to compute ALP in case of distributor of finished goods

In its recent judgment dated April 25, 2012, Mumbai Bench of Income Tax Appellate Tribunal (‘Mumbai ITAT’) in case of ITO vs. L’oreal India P. Ltd. [ITA No.5423/Mum/2009] upheld resale price method (‘RPM’) as the most appropriate method for computing arm’s length price ('ALP') of the transaction wherein the taxpayer in India was involved in purchase and resale of the finished goods.

 Facts of the case:

The taxpayer is a 100% subsidiary company of L’Oreal SA France and is engaged in the business of manufacturing and distribution of cosmetics and beauty products. During the year under review the taxpayer imported finished goods from its associated enterprises (‘AEs’) and resells it to independent parties. For the purpose of computation of the ALP, the taxpayer considered RPM as the most appropriate method.

During the course of transfer pricing audit, the transfer pricing officer (‘TPO’) rejected RPM as the most appropriate method and considered transactional net margin method (‘TNMM’) as the most appropriate method on the following grounds:

• The appellant is consistently incurring losses in India and hence the pricing policy is not at arm’s length.
• Gross margin in case of comparable cases cannot be relied upon because of product differences of comparable companies.
• The degree of similarity in the functions performed, assets employed and risks assumed between the taxpayer and the comparable companies identified by the appellant is not sufficient for the application of RPM but is sufficient for application of TNMM.
• Adjustment of the margin/profits of the appellant is not permissible under rule 10B.
• The taxpayer has incurred huge expenses on selling and distribution and hence there is a substantial value addition to the goods sold.


 Accordingly, the TPO suggested an addition equal to INR 4.90 cr.


Observation of CIT(A):
Against the above order of the assessing officer/ transfer pricing officer, the taxpayer appealed before Commissioner of Income-tax Appeals (‘CIT(A)’). The CIT(A) ordered in favor of the taxpayer on the basis of following:


• As per OECD guidelines RPM is easiest method to determine ALP where the reseller does not add substantially to the value of the product.
• RPM is based on the similarity of functions performed by the taxpayer and not similarity of product distributed.
• The contention of the TPO that the comparable companies selected by the appellant for the distribution segment should not be allowed on the ground of product differentiation cannot be accepted because the TPO has itself selected comparable companies for manufacturing segment from the category of FMCG products that are used for personal consumption.
• The losses incurred by the taxpayer are on account of business strategy of the taxpayer and can also be attributed to the initial years of the distribution segment. 
The TPO has erred in relating the losses to the transfer pricing policy of the taxpayer.
• The profit margin earned by the AE need to be considered for an all-round approach in transfer pricing.  The fact that the taxpayer was incurring losses and its AEs were earning low profits establishes that there is no motive on the part of the taxpayer to transfer profits to its AEs.

            

Observation of Mumbai ITAT:

Against the order of CIT(A), the AO appealed before the Mumbai ITAT  and ITAT uphold the order of CIT(A) and considered RPM as the appropriate method for computing ALP for import of finished goods from AEs.

Our Comments:               

This case is quite important from the perspective of creating robust documentation wherein the taxpayer is into losses. In this case though RPM is accepted as the most appropriate method for the purpose of computation of ALP, but something which needs appreciation is the justification of losses in India. The taxpayer was able to do so by sharing the profit margin earned by the AEs and also by co-relating the losses with business strategy. 

Happy Reading

CA Gaurav Garg

CA Vineeta Goyal

JGarg Economic Advisors Pvt. Ltd.

New Delhi, India

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(M) +91 98-999-94934

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Delhi ITAT: Information regarding secret data used by the tax department should be shared with the taxpayer

In the case of Adobe Systems India Pvt. Ltd. vs. JCIT (ITA No.5693, Del, 2011), Delhi Bench of the Income Tax Appellate Tribunal observed that in case tax authorities uses some information or data, in respect of which information is not available in public domain (secret data), for the purpose of computation of the arm's length price in such case such information/ data should be supplied to the taxpayer for his objection or examination. The absence of such opportunity violates the fundamental principle of natural justice. 

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CA Gaurav Garg

Abhishek Agarwal

JGarg Economic Advisors Pvt. Ltd.

New Delhi, India

(M) +91  98-999-94934

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 (E) gaurav@jgarg.com

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Mumbai ITAT: Taxpayer should charge interest on loan given to non resident AEs

In its recent judgment in the case of M/s Tata Autocomp Systems Ltd. vs. ACIT Mumbai bench of Income Tax Appellate Tribunal (‘Mumbai ITAT’) observed that the lending or borrowing money between two associated enterprises comes within the ambit of international transaction and taxpayer should charge interest from its non resident associated enterprise.

Facts of the case:

The taxpayer is a company, involved in the manufacturing of indoor plastic, rendering engineering services, supply chain management services and administrative support for joint venture companies. In order to have better supply chain management and relationship with the customer in Europe, the taxpayer established a manufacturing company TACO Kunstsofftechnik GMBH (‘TKT’) in Germany. During the year under review, in order to assist TKT during start-up phase and because of commercial expediency, the taxpayer granted the interest free loan to TKT.

The case was referred to the transfer pricing officer (‘TPO’). The TPO rejected the interest free pricing of the transaction and re-computed the arm’s length price by considering lending rate equal to 10.25 % based on loans received by the taxpayer from Indian banks. The taxpayer took an alternative stand before the TPO, without prejudice to the its stand of interest free loan, that even if interest isto be charged on the interest free loan provided by the Assessee to TKT, the same should berestricted to 4.15% which is the rate specified in the benchmarking exercise conducted by theassessee for ascertaining the arm's length interest rate.

The taxpayer filed an appeal before the Dispute Resolution Panel (‘DRP’) against the order of the TPO. On review of the appeal, The DRP upheld the order of TPO but arrived at 12% rate ofinterest and directed the AO to recalculate the adjustment adopting rate of interest at 12% perannum instead of the calculation at 10.25% in the TPO's order.

Against the directions issued by the DRP, the taxpayer filed an appeal with the ITAT. The observation of the same are given below

Observations of Mumbai ITAT:

• Interest free loan extended to the associated concerns as at arm's length lending or borrowing money between two associated enterprises comes within the ambit of international transaction and whether the same is at arm’s length price has to be considered.
• The fact that the loan has the RBI's approval does not put a seal of approval on the true character of the transaction from the perspective of transfer pricing regulation as the substance of the transaction has to be judged as to whether the transaction is at arm’s length or not.
• Relying upon the judgment in the cases of DCIT v. M/s Tech Mahindra Ltd.(Mumbai Tribunal) and M/s Siva Industries & Holdings Ltd. v. ACIT ( (Chennai Tribunal), the tribunal ruled that the claim of the taxpayer to adopt EURIBOR rate as stated before the TPO is reasonable and deserves to be accepted. And also observed that the rate of interest to be used for benchmarking shall be the rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate.

Our Comments:

Judgement is in line with the well recognised arm’s length principle and also reinforces the pricing principle that for foreign currency loan one should not consider Indian currency loan rate. 

Happy Reading

CA Gaurav Garg

CA Parul Mittal

JGarg Economic Advisors Pvt. Ltd.

New Delhi, India

+91 98999 94934

+91 11470 94934

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