A REFERENCE MADE BY THE AO (Assessing Officer) TO THE TPO (Transfer Pricing Officer) UNDER SECTION 92 CA IS PROPER EVEN IF NO NOTICE TO THE ASSESSEE IS GIVEN.
The assessing officer may, refer the computation of the arm’s length price in relation to international transaction to the TPO if he considers it necessary or expedient to do so, with the previous approval of the Commissioner.
Sec 92 CA specifies the procedure to be followed when such a reference is made, as also the powers and duties of the TPO. Sub-sections (1) to (3) lay down the course of action that must be taken by the TPO, which includes the serving of a notice to the assessee, providing a proper opportunity of being heard, taking into consideration the evidence and relevant materials and passing a written order. Therefore, the AO is to compute the total income of the assessee having regard to the arm’s length price determined by the TPO.[2]
Meaning of necessary or expedient:
According to Shorter Oxford English Dictionary, the word “necessary” means indispensable, requisite, and needful. Similarly, the word “expedient” means advantageous; fit, proper, or suitable to the circumstances of the case; those who help forward or conduces to an end; a means to an end.[3]
Therefore, where the AO thinks it indispensable and advantageous to help forward in the case, then he may refer the computation of the arm’s length price to the TPO. It has a very broad scope. He need not send a notice of the same to the assessee as it is not a trial, but a mere finding or investigation, and thus, the rules of natural justice do not find any relevance in the same context. The section nowhere mentions that failure to serve notice would render the procedure illegal or void or irregular.
IT IS OPEN FOR THE ASSESSING OFFICER TO DIFFER FROM THE TRANSFER PRICES DETERMINED IN THE ORDER PASSED BY THE TPO (Transfer Pricing Officer).
PASSING OF THE ORDER: After hearing the assessee and the evidence produced by him and after considering the evidence as the TPO may require on any specified points and after taking into account all relevant materials which he has gathered, the TPO shall, by order in writing determine the arm’s length price in relation to the international transaction in accordance with provisions of section 92 C (3) and send a copy of his order to the assessee.[4]
COMPUTATION OF INCOME BY AO: On receipt of the order, the Assessing Officer shall proceed to compute the total income of the assessee under section 92 C (3) having regard to the arm’s length price determined by the TPO. The use of the words ‘having regard to’ denotes that it is not incumbent or binding upon the AO to compute the arm’s length price as per the computations made by the TPO for each and every international transactions.[5]
The phrase ‘having regard to’, appearing in sec. 92 (1) and the Explanation thereto, sec. 92 (2), sec. 92 C (1), sec. 92 C (4), and in sec. 92 CA (4) (reference to TPO), has been judicially interpreted in a uniform manner by the Supreme Court and other courts.
It is well settled that where such a phrase is used, it means that the AO has to take into consideration the relevant reports, computation of factors and not that they are binding or decisive on the AO.[6]
Thus, the assessing officer can, without any restraint, legal or otherwise, freely differ from the order of Transfer Prices determined by the TPO, the same being not binding, as provided for, in the abovementioned paras.
THE TRANSFER PRICING PROVISIONS APPLY EVEN IN A CASE WHERE ADMITTEDLY THERE IS NO MOTIVE FOR AVOIDANCE OF TAX.
The intent to deceit revenue or malafide motive to avoid or reduce tax in international transaction – is immaterial. Sec. 92 has to be applied in every such case where an international transaction has taken place and the price agreed to between the two enterprises is different from the arm’s length price, whether or not there is a malafide motive.[7]
Thus, one cannot say, as a defense, that the transaction is being carried out in good faith without any motive of tax avoidance, as motive is totally irrelevant is such cases.
THE TRANSFER PRICING PROVISIONS ARE APPLICABLE TO THE TRANSACTIONS, WHEN THE COMPANIES ARE ‘ASOCIATED ENTERPRISES’ For instance UNDER ‘INDIA-USA’ AND ‘INDIA-UK’ DTAA (Double Taxation Avoidance Agreements)
The Finance Act 2001 has substituted the old s. 92 and has inserted new ss. 92 to 92 F. These apply even to individual transactions such as payment of royalty, etc, which aren’t part of a regular business carried on between a resident and a non resident.[8]
Business may be carried on between a resident and a person who is not resident in India, and owing to the close connection between them, the course of business may be so arranged that the resident makes either no profits or less than the ordinary profits in that business. Such an arrangement would deprive the Indian revenue of the tax which would be payable by the resident. In such cases the provisions of this section are attracted and the resident may be charged in respect of the profits which he has not infact made but which he might reasonably be expected to have made had he done the business on ordinary commercial terms. Rule 11, read with rule 10, prescribes the method of determining the quantum of notional profits in respect of which, the resident may be charged under this section. Such notional profits should not be separately assessed but should be added on to the other income of the resident.[9]
In Mazagaon Docks case, the Supreme Court held that the subject of charge under section 42(2) of the 1922 Act which corresponded to this section, was the business of the resident and not the business of the non-resident. In that case, two non-resident companies, engaged in the business of plying ships, had entered into an arrangement with the resident company which was their subsidiary and was engaged in the business of ship repairing. According to the arrangement, the resident company was to repair the ships of the non-resident company without charging profits. The SC held that the dealings between the parties formed, concerted and organized activities of a business character and the non-resident companies carried on business with the resident company, and that the provisions of the sec. 42 (2) were attracted. The fact that the dealings were such as to yield no profit to the non-resident companies was held to be immaterial. That judgment of the SC would apply to cases arising under this section, and its correctness, with reference to the provisions of this section, would not be in doubt.
The language of the present section 92 is wide enough to cover a case like Mazagaon Dock. ‘The amount of profits which may reasonably be deemed to have been derived therefrom’ involves two concepts-
(a) the profits are in fact not derived by the resident from the business but are deemed, by a fiction of law, to be derived, and
(b) the amount of “deemed” or notional profits should be the amount which the residents could reasonably be expected to have made, if the course of business had not been ‘arranged’ owing to the close connection between the parties and the dealings had been on terms dictated by normal commercial considerations.
Rulings with respect to colourable devices-
The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authorities to unravel the device and to determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by probing into the “substance of the transaction”. This principle applies alike to cases in which the legal relation is recorded in a formal document, and to cases where it has to be gathered from evidence- oral and documentary- and conduct of the parties to the transaction.[10]
It is well recognized that in revenue cases regard must be had to the substance of the transaction rather than to its mere form.[11]
Transfer pricing provisions apply only to transactions between associated enterprises.
The term “associated enterprise” is defined in sec. 92 A. It is a relative concept, ie, an ‘enterprise’ is an “associated enterprise” only when it is viewed in relation to another enterprise. Sub-sec (1) of sec 92 A provides that an associated enterprise is one-
(a) which participates directly or indirectly, or through one or more intermediates, in the management or control or capital of the other enterprise; or ,
(b) in respect of which one or more persons who participate directly or indirectly or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.
The term “enterprise”[12] has been defined in s. 922 F (iii), and it includes “permanent establishment”[13] of a person.
Sec.92 A (2) enlists certain situations, which, if in existence at any time during the previous year, result in the deeming of two enterprises to be associated enterprises.
These conditions are-
(h) 90% or more of the raw materials and consumables required for the manufacturing or processing of goods or articles carried out by one enterprise, are supplied by the other or by persons specified by the other, and the prices and other conditions relating to the supply are influenced by such other enterprise;
(i) the goods or articles manufactured or processes by one enterprise, are sold to the other enterprise or to persons specified by the other enterprise, and the price and other conditions relating thereto are influenced by such other enterprise.
Similar provisions are in DTAA between India-UK (Article 10) and India-USA (Article 9):
Associated enterprises-
(1) where (a) an enterprise of a contracting state participates directly or indirectly in the management, control or capital of an enterprise of the other contracting state, or
(b) the same persons participate directly or in directly in the management, control, or capital of an enterprise of a contracting state,
and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.
(2) where a contracting state includes in the profits of an enterprise of that state - and taxes accordingly – profits on which an enterprise of the other contracting state has been charged to tax in that other state and the profits so included are profits which would have accrued to the enterprise of the first-mentioned state if the conditions made between the two enterprises had been those which would have been made between independent enterprises, then that other state shall make an appropriate adjustment to the amount of the tax charged therein on those profits.
THE TRIBUNAL, OR THE ASSISTANT COMMISSIONER OF INCOME TAX, AS THE CASE MAY BE, WILL BE JUSTIFIED IN APPLYING THE TRANSFER PRICING PROVISIONS TO THE TRANSACTION OF PROVIDING SAMPLES[14] TO THE COMPANY INCORPORATED OUTSIDE INDIA.
This will be a perfect case of tax evasion wherein the company gives a substantial amount of its products as ‘samples’, free of cost to another company incorporated outside India. Thus, the same being a colourable device, can be charged with income tax, and the value of samples would be considered, as it would amount to a transaction in the light of the provisions of the Income Tax Act and recent judgments.
Sample, is defined in P. Ramanatha Aiyar’s, The Law Lexicon, as a small quantity of commodity exhibited. A relatively small quantity of material or an individual object from which the quality of the mass or group or species, etc which it represents may be inferred.[15]
In the case of The Asstt CIT vs. National Lamination Industries & Ors[16] on 5th June 2007, this principle was upheld that “A person invoking an exception or an exemption provision to relieve himself of the tax liability must establish clearly that he is covered by the said provision. In case of doubt or ambiguity benefit of it must go to the state.”
THE TRANSFER PRICING ADJUSTMENT COME WITHIN THE PURVIEW OF SECTION 5 OF THE INCOME TAX ACT, 1961.
The transfer pricing provisions is the ‘means’, and the scope of total income under section 5 is the ‘end’.
Section 5 of the Act of 1961 lays down the scope of total income:
Sec 5 (1)- Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which-
(a) is received or deemed to be received in India in such year by such person; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year; or
(c) accrues or arises to him outside India during year.
The definition of total income in Sec 5 is ‘subject to the provisions of this Act.’ The result is that while income cannot be taxed, generally speaking, unless it falls within sec 5, it is not necessarily to be taxed because it falls within this section; any other section may operate to save from taxation income which is within the purview of this section.[17]
This section does not cover exhaustive list of all the provisions. For example, agricultural income is exempted from tax. The Transfer Pricing Provisions come within the purview of Section 5, thus the assessee will be charged for the transactions, without any exemption, and all colourable devices can, at any stage be unveiled to give effect to the same.
[1] Warren Laboratories (P.) Ltd vs. Dy. CIT, [2005]3 SOT 638 (Mum).
[2] The law and practice of Income Tax, Kanga, Vyas and Palkhivala, at pg 1536.
[3] Taxman’s Direct Taxes Law & Practice, by Singhania, at pg 1206.
[4] Taxman’s Direct Taxes Law & Practice, by Singhania, at pg 1207.
[5] [Juggilal Kamlapat Bankers vs. WTO], (1984) 145 ITR 485 (SC).
[6] The law and practice of Income Tax, Kanga, Vyas and Palkhivala, at pg 1537.
[7] Para 508.1 - 4d, at pg 1198, Taxman’s Direct Taxes Law & Practice, by Singhania
[8] The law and practice of income tax, by Kanga, Vyas & Palkhivala, at pg 1524.
[9] Mazagaon Dock v. CIT 34 ITR 368 (SC); AIR 1958 SC 861.
[10] CIT vs. B.M. Kharwar [1969] 72 ITR 603 (SC).
[11] Kikabhai Premchand vs. CIT, (1953) 24 ITR 506, Para 525.1, pg 1211, Taxman’s Direct Taxes, Law & Practice, by Singhania
[12] ACIT vs. Indian Cooperative 134 ITR 208
[13] 92 F (iii a), CIT vs. Vishakhapatnam Port Trust 144 ITR 146.
[14] Warren Laboratories (P.) Ltd vs. Dy. CIT, [2005]3 SOT 638 (Mum).
[15] [Sec. 415, ill. (c), IPC]; [Sec. 17, Sale of Goods Act.]
[16] (2007) 109 ITD 181 (Ahd.); Manu/IB/508/2007.
[17] [CIT vs. Khambaty 159 ITR 203] (sec 64 doesn’t override sec 5); [CIT vs. Nippon 233 ITR 158].
