Transfer Pricing News

published on 31 July 2023 | Reading time approx. 4 minutes

Important Judicial Rulings on Transfer Pricing Matters

1. Hon’ble Chennai Tax Tribunal accepts arm’s length price of ‘management and marketing service fee’ as ‘NIL’, in the absence of any substantial documentary evidence presented by the taxpayer to prove actual receipt of services:

In another significant ruling of the Chennai Income Tax Appellate Tribunal (‘ITAT’) in the case of International Flavours & Fragrances India Pvt. Ltd. [IT(TP)A No. 58/CHNY/2018], the ITAT accepted the stand of the tax authorities in holding the arm’s length price (‘ALP’) of ‘receipt of management and marketing support service fee’ as NIL. This ruling follows a similar judgment in by the Hon’ble Chennai ITAT in the case of AB Mauri India Pvt. Ltd. [IT(TP)A No’s.84 to 86/CHNY/2018 & ITA No’s.3315 to 3317/CHNY/2018].

As per the facts of the subject case, the taxpayer had availed management services, information technology (IT) services, and marketing services from its Associated Enterprise (‘AE’), for which a service fee was allocated to the taxpayer along with a profit markup. During the assessment proceedings, the tax authorities determined the ALP of management and marketing support service fee’ as NIL, however, accepted the service fee payable towards IT services.

As the case came before the Hon’ble ITAT, it was noted that the taxpayer has been availing similar services in the past, but it has not paid any fee to the AE for these services in earlier years. Further, as a part of its fact-finding exercise, ITAT analysed the details of the service-related documentation maintained by the taxpayer, and found it to be related to earlier years, vague, and noted that the important details encompassing the receipt of any actual services were non-existent.

The said ruling again becomes significant, especially in the case of taxpayers who usually don’t have an internal policy in place to document the evidence for actual receipt of such intra-group services and cost allocation attached to such services, and they simply rely only on the existence of an inter-company service agreement and documenting only invoices received from the AE’s.

2. Hon’ble Kolkata Tax Tribunal upholds capacity utilization related adjustment in the taxpayer’s case, being the initial year of its business operations:

In a recent ruling on the issue of allowing capacity under-utilisation adjustment, Hon’ble Kolkata ITAT in the case of Kyocera CTC Precision Tools Pvt. Ltd., [ITA No. 233/Kol/2022], the ITAT rejected the stand of the tax authorities in not allowing the claim of the taxpayer to make a capacity under-utilisation adjustment to its operating profit, which was done with an intention to have proper comparability for transfer pricing purposes.

As per the facts of the subject case, the year under consideration was the first full year of the taxpayer’s manufacturing activity, which was engaged in the manufacturing of auto components. In respect of capacity utilisation of the taxpayer during the relevant year, it operated at a capacity of 34 per cent as compared to 73 per cent by the industry. To arrive at the industry average for capacity utilisation, the taxpayer relied on automotive industry reports sourced from publications by the Reserve Bank of India (‘RBI’) and the Federation of Indian Chamber of Commerce & Industry (‘FICCI’).

Further, during the assessment proceedings, the tax officer rejected the claim of the capacity under-utilisation adjustment made by the taxpayer, however, the claim of the taxpayer was in turn accepted by the Commissioner of Income Tax (Appeals) (‘CIT-A’) during the first appellate proceedings.

As the matter came up before the Hon’ble Kolkata ITAT, the ITAT acknowledged that the taxpayer has adequately demonstrated the computation of the adjustment arrived at towards capacity utilisation and accordingly upheld the decision of Hon’ble CIT-A in the taxpayer’s favour.

Thus, in essence, the ruling recognises the important fact of the start-up phase in the case of taxpayers, wherein the operations can be in losses, however, the fact that during the initial years, the fixed costs may remain unabsorbed due to capacity under-utilisation, the same is required to be adjusted for transfer pricing analysis.

3. Hon’ble Supreme Court dismisses Departmental Appeal on the issue of profit attribution to a Permanent Establishment, holding it to be a factual question:

There has been a recent decision by the Hon’ble Supreme Court in the case of Travelport Inc. and others [Civil Appeal Nos. 6511-6518/2010 and others], which will have important ramifications for the issue and controversy surrounding the attribution of profits in the case of a Permanent Establishment (‘PE’) of a foreign enterprise in India.

As per the facts of the subject case, the taxpayer entities were based outside of India and were in the business of electronic global distribution services to Airlines through a “Computerized Reservation System” (‘CRS’), for which the taxpayer entities earned an amount of Euro/ USD 3 from the Airlines. In respect of the same, and to market and distribute the CRS services to travel agents in India, the taxpayers appointed Indian entities and entered into distribution agreements with them and paid an amount ranging from Euro/ USD 1 to Euro/ USD 1.8.

During the assessment proceedings, the tax authorities concluded that the taxpayers had a PE in India and determined that the entire Income of Euro/ USD 3 received by the taxpayers is taxable in India.

However, during the appellate proceedings before the Hon’ble ITAT, and based on available facts of the case, the ITAT observed that the host of the activities was being performed in USA/ Europe, and activities in India were only minuscule in nature. Therefore, as regards to attribution of profits to the PE, the ITAT concurred that based on the functions performed, assets used and risks (‘FAR’) analysis, 15 per cent of the total revenue was the income accruing or arising in India, which worked out to 0.45 cents.

Further, the ITAT observed that even payment made to the distribution agents was much more in some cases, and therefore no further income was taxable in India. The said ruling of the ITAT was challenged by the Tax Department before the Hon’ble Delhi High Court, however, the appeals were dismissed by observing that no question of Law arose from the said ITAT rulings.

When the matter finally reached the Hon’ble Supreme Court, the Hon’ble Court held that the issue of what proportion of profits arose or accrued in India is essentially dependent on the facts of the case. Therefore, as the orders of the ITAT were reasonable, and based on the proper fact-finding exercise, no further interference is called upon on the order of lower appellate authorities.

The said ruling again becomes significant, especially in the case of taxpayers who have constituted their PE in India, and the criticality of a proper FAR analysis of the arrangement to justify that a reasonable profit has been attributed to such PE.

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