The Delhi Tax Tribunal recently pronounced two decisions touching upon varied facets of transfer pricing.

The first decision in the case of Ranbaxy focuses upon fundamental principles of an arms length analysis such as choice of tested party, principles of aggregation and comparability analysis. On the other hand, the ruling in the case of Cargill provides guidance on documentation requirements and conditions for levy of transfer pricing related penalties.

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Ranbaxy Laboratories Ltd.

Facts
The taxpayer, Ranbaxy Laboratories Ltd, is an Indian multinational company undertaking the business of manufacture and sale of pharmaceutical products. During the relevant financial year, the taxpayer had entered into certain international transactions i.e., transfer of goods and services with its overseas affiliates spread over a number of countries. To demonstrate the arms length nature of the international transactions entered into by the taxpayer, Transactional Net Margin Method (TNMM) was adopted as the most appropriate method. On the ground that Indian entity was more complex of the transacting entities; the taxpayer chose overseas entity as the tested party. An administrative circular requires that all international transactions with aggregate value in excess of Rs 50 million must be referred by the Assessing Officer (AO) to the Transfer Pricing Officer (TPO) for determination of arms length price. However, inspite of the fact that the aggregate value of such transactions exceeded Rs 50 Million, no reference was made to the TPO. After preliminary enquiries, AO held such transactions to be at arms length and accepted taxpayers declarations. However, the Commissioner of Income-tax (CIT) initiated an inquiry under section 263 (Section 263 confers revisionary power on the CIT ) of the Income-tax Act, 1961 (Act), holding that the assessment was erroneous and prejudicial to Revenues interest. The primary objections raised by CIT were as follows: The case was not referred by the AO to the TPO as required by the Circular (Instruction No. 3) dated May 20, 2003 of Central Board of Direct Taxes (CBDT). The taxpayer had taken overseas affiliates as the tested parties when reliable data for comparison in respect of taxpayer was available in India. The taxpayer compared the mean of the profit margins of the tested parties with the mean profit margin of identified comparables. In view of the CIT, such an approach was not in consonance with Rule 10B of the Income-tax Rules, 1962(Rules).

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Sanjiv Malhotra Ashutosh Mohan Rastogi Deepraj Singh Aurora Devendra Gulati

Tribunal Ruling
Choice of tested party
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As a general rule, the choice of tested party is contingent upon level of complexity of the transacting entities based on FAR analysis and availability of reliable data. The Tribunal ruled that both US regulations and the OECD guidelines ( Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 1995) emphasized that the tested party should be such that the arms length price could be verified using the most reliable data. Hence, the complexity of transacting entities was only one factor to be kept in mind while determining the choice of tested party. Another equally important factor was the availability and reliability of data. Thus, where the overseas affiliate was chosen as the tested party, the relevant data should either be in public domain or furnished to the tax administration for validation of transfer prices. The Tribunal, giving specific finding held that the transfer pricing documentation did not provide basic details of international transactions such as description, quantity and volume of the goods transferred. No computations for margins of identified comparables and tested party were provided. Similarly, no details in respect of business profile, composition of total cost and turnover for the overseas comparable companies were furnished. Accordingly, the overseas entity could not be accepted as the tested party since the criterion of data availability was not met. Principles of aggregation Furthermore, the Tribunal noted that the taxpayer clubbed the overseas affiliates and compared their mean profit margin with the mean profit margin of all comparable companies. For aggregating transactions in this manner, reliance was placed on Rule 10A(d) of the Income Tax Rules (Rules) by which transaction includes number of closely linked transactions. In this regard, the Tribunal has laid down the following principles: Drawing upon the OECD Guidelines, the ideal situation of comparing was transaction by transaction basis. However, grouping of all the transactions was justified where they could not be evaluated adequately on an individual basis. On the facts of the case, the Tribunal rejected the aggregation approach adopted by the taxpayer giving the following reasons: The taxpayer had entered into transactions with overseas affiliates in different countries. The international transactions included not only sale of pharmaceutical products but other transactions such as transfer of know how and technology, sharing of expenses etc. The overseas affiliates situated in different geographical locations operated under different market conditions and economic realities. Evidence was available to prove that while some made huge losses others were making profits. Thus, profitability of entities with different market and economic conditions could not be analysed together. There was substantial variation in the operating margins of the overseas affiliates (42.17 percent to 11.22 percent). It was held that since in the given case, no convincing reasoning was put forth by the taxpayer to demonstrate closely linked nature of different transactions, aggregation approach could not be accepted.

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Inadequacy of data in Statutory Certificate (Form 3CEB) The Tribunal noted that no details on overseas enterprises or transactions undertaken (such as name of goods transferred, their specific characteristics, quantity etc) required to examine correctness of transfer pricing were available in statutory certificate (Form 3CEB). In view of absence of qualitative and quantitative information of such fundamental importance, the Tribunal held that AO should have prima facie rejected such audit report as non-compliant with Indian transfer pricing regulations or should have raised pertinent questions relating to transfer pricing. Applicability of TNMM

Relying on OECD Guidelines, the taxpayer argued that details of individual transactions with overseas affiliates were not relevant while applying TNMM. The Tribunal reiterated its observations in the Mentor Graphics case that even while applying TNMM, a FAR analysis was critically important. Use of Internal CUP The taxpayer admitted that similar transactions were undertaken by the taxpayer with independent parties. However, such transactions were not relied upon for benchmarking due to difference in risk profiles. In this regard, the Tribunal held: As per Rule 10B(2)(c), the contractual terms should have been called for and examined by the AO to determine the extent to which the risk differential affected the prices. The possibility of making appropriate adjustments for risk differential should also have been explored.

Comparability analysis The Tribunal held that for the purpose of benchmarking, the characteristics of the products or services had to be considered first. Thereafter, functions performed, assets utilized or risk assumed would have to be analysed. On the facts of the case, it was observed that in the transfer pricing documentation, the taxpayer had failed to provide information on characteristics of the property transferred. Accordingly, taxpayers comparability analysis could not be accepted as correct. Moreover, the Tribunal also held that geographical region was another important factor to be considered while benchmarking. The taxpayer had transferred goods/services to its overseas affiliates spread over different geographic regions. However, the comparables chosen were not from the same countries where the overseas affiliates (tested parties) were situated. Hence, taxpayers analysis was also defective on this count. It was noted that no information had been provided to examine whether the comparables chosen were also using a brand name. Comparability adjustments Following earlier decisions in Aztec and Mentor Graphics, the Tribunal reiterated the importance of making comparability adjustments where required.

Get BMR insights on two most relevant decisions: Aztec | Mentor Graphics
Reference to Transfer Pricing Officer On procedural issues, the Tribunal categorically held that the AO did not have discretion in referring a case to the TPO where the aggregate value of international transaction exceeded Rs 50 Million. Non-reference of a case where the aggregate value of international transactions exceeds the prescribed limit is not merely a procedural error. Moreover, non-reference to TPO justified invoking of Commissioners powers under section 263 of the Act. Reference to OECD Commentary The Tribunal has held that while the OECD Guidelines may be relied upon, they cannot be applied universally without considering the facts and circumstances of each case. Similarly, reliance should not be placed on the OECD Guidelines on a selective basis which can defeat the purpose of these guidelines.

BMR Comments and Analysis

In summary, though the key question in the case was whether there was a rightful exercise of revisionary power by CIT under section 263 of the Act; the Tribunal has made many observations in relation to choice of tested party and quality of documentation to be maintained. This decision assumes importance as it articulates expectations with regard to the documentation standards and strict compliance requirements for FORM 3CEB. From a documentation perspective, such stringency may mean that it would be very difficult to use foreign entities as the tested party. It also suggests bias towards usage of Indian comparables. The Tribunal has made far reaching observations on compliances for statutory certification in Form 3CEB thereby suggesting an onerous requirement. Identification of tested party is a fact-based exercise and no complete set of requirements can be articulated. Having India as the tested party, more often than not, means departure from global transfer pricing documentation and analysis, which, normally is not the preferred route for most multinational companies. Top

Cargill India Pvt. Ltd.

Facts
Cargill India Pvt. Ltd., an Indian company engaged in trading of agricultural products undertook international transactions with its Associated Enterprise (AE). The case was referred by the AO to the TPO for determination of the arms length price. Thereafter, the TPO issued notices requiring the taxpayer to furnish the following information:

i. ii. iii. iv.

Any evidence and/or material relied upon by taxpayer in support of computation of arms length price; Financial statements of the taxpayer, copies of audit report (Form 3CA) and the tax audit report; Statement of computation of income ; and Information and documents maintained as prescribed under section 92D of the Act read with Rule 10D Rules.

Despite furnishing of information, the TPO ruled that the taxpayer had not complied with the documentation requirements since vital information (such as comparables used to benchmark international transactions, functional details of comparables and accept reject matrix) required for computation of the arms length price had not been provided on a timely basis. Hence, the TPO concluded that there was a sufficient ground for initiation of proceedings for documentation related penalties. The AO and CIT(A) upheld the arguments of the TPO for levying penalty. Thus, the taxpayer appealed before the Tribunal, seeking relief against the order of CIT(A).

Tribunal Ruling
The key points of the Tribunal ruling are discussed: Relationship between Statutory Certification (Form 3CEB) and section 92D The Tribunal held that although the statutory certificate is not information mentioned in Rule 10D, the inter-linkage between the statutory certificate and Rule 10D is to be borne in mind. It is quite possible that some information required by the TPO under Rule 10D is already available with the Revenue in the form of the statutory certificate. Conditions for notice under section 92D(3) It was observed that the documents and information prescribed under Rule 10D are

voluminous and it would be in the rarest cases that all clauses of Rule 10D are attracted. For example, in some cases taxpayer need not maintain / furnish any analysis of functions performed, risks assumed and assets employed where there is an exactly similar uncontrolled transaction with an independent party to establish arms length nature of the transaction. Likewise, in many cases there may be no necessity to prepare economic analysis, forecasts, budgets or other financial estimates of business if such information is not required. Section 92D(3) allows AO to call for any information from the taxpayer. In this regard, the tribunal held that the word any information or document does not mean all information or documents prescribed under rule 10D. Having regard to the facts and circumstances of each case, Revenue has to see what information and documents are relevant to determine the arms length price. For determination, Revenue may rely on basic and initial information on international transactions as contained in Form 3CEB. Moreover, notice under section 92D(3) is different from other statutory notices. The consequences for non-compliance of such a notice, in the form of penalty under section 271G are quite severe. Accordingly, any notice under section 92D(3) must require the taxpayer to furnish only such information as is prescribed under Rule 10D. Moreover, having regard to the purpose of the regulations, the notice under section 92D(3) must require specific information (or documentation) and cannot call for information of a general nature. Where the notice seeks information that has already been furnished before the Revenue (such as through the Form 3CEB), there is no point in requiring the same information to be filed again and hence, such a notice would not be a valid notice under section 92D(3) read with section 271G of the Act. Similarly, where information not prescribed in Rule 10D is sought, or where information is sought in a casual and routine manner without mentioning specific information, the notice would be invalid. Legislative scheme for notices / sourcing information under the Act The taxpayer is to file preliminary or initial information on the arms length price in the form of statutory certificate. This is the information available with the Revenue before a reference is made to the TPO under section 92CA(1). The TPO is thereafter required to serve a notice under Section 92CA(2) of the Act providing the taxpayer an opportunity to furnish evidence or information supporting his computation of the arms length price. This is a mandatory requirement under the regulations. Thereafter, if more information is still required, notice under section 92CA(3) may be issued, requiring the taxpayer to furnish information on any specific points whether or not covered by Rule10D. Similarly, notices under section 92D(3) may also be issued, but these can only call for information prescribed under Rule 10D. The Tribunal held that the above steps are as envisaged by the regulations and the Revenue is expected to follow them in the prescribed sequence. Penalty under section 271G The Tribunal has laid down the following principles in respect of imposition of penalty under section 271G: Relevant factors that need to be examined are: manner in which documents are summoned; whether or not the impugned default has actually taken place; circumstances in which the default, if any, was committed; Notices issued by the TPO and the information furnished by the taxpayer from time to time.

Where the conditions for a valid notice under section 92D(3) are not met, no penalty under section 271G is leviable. On the facts of the case, since the notice issued by the Revenue

was vague and did not clearly specify the points on which information was required, the notice was held to be invalid. Accordingly, no penalty under section 271G could be levied. Where the show cause notice issued under section 271G does not mention the specific clause of Rule 10D or details of the international transaction relating to which default is committed, it would prima facie be illegal and bad in law. On the facts of the case, since the show-cause notice failed to mention specifics, the imposition of penalty was struck down. The provisions of section 273B override section 271G. Hence, no penalty can be imposed for failure to furnish documents in time if such failure is due to reasonable cause. In the given case, since Revenue failed to consider the reasonable cause (significant movement of taxpayers key finance and accounting personnel responsible for collating documents) put forth by the taxpayer, the Tribunal held that penalty was not sustainable. The provisions of Section271G are different from the provisions of section 271(1) of the Act. Hence, unlike section 271(1), for initiation of penalty proceedings under section 271G of the Act, no satisfaction of the AO was required to be recorded during the course of the assessment proceedings,

Comments
The interpretation adopted by the Tribunal in respect of documentation requirements under section 92D(3) read with Rule 10D is pragmatic, besides being in line with the intent of the legislation. The Tribunal has noted that all kinds of information mentioned in Rule 10D need not be maintained in each and every case. The nature of information that is relevant would vary depending upon the facts and circumstances of each case. The Tribunal has rightly observed that since the penalty leviable for non-compliance with requirements under section 92D(3) is onerous, its conditions must be strictly met. The notice under section 92D(3) cannot be vague and must require only information prescribed under Rule 10D. It must also specify on which particular points the information is required. This is a welcome interpretation of law that should reduce ambiguity from a compliance perspective. In summary, the Tribunal has clarified the procedural law on sourcing of information by the Revenue; and in the process clearly defined the kind of information that can be requested for each kind of notice. Top

Events BMR India Budget 2008 Analysis

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