Transfer Pricing Alert

BACKGROUND

As per section 92 of the Income Tax Act, 1961 (IT Act), income from international transactions shall be computed having regard to the arm’s length price (ALP). While section 92C of the IT Act prescribes methods that can be applied for determining ALP, as per section 92D of the IT Act, the taxpayer is required to maintain details of international transactions (including the method adopted for determination of ALP) in the Transfer Pricing Study Report (TPSR). Tax Officers may challenge the method adopted by the taxpayer. However, a question may arise as to whether the taxpayer can deviate from the method adopted in TPSR during an audit. In this regard, recently, the Special Bench of Mumbai Tax Tribunal¹ (Special Bench), had to examine whether taxpayers can resile from the most appropriate method (MAM) adopted in its TPSR. The Special Bench has held that there can be no impediment in switching over to the new method because the legislature stipulates that the MAM shall be applied for determining the ALP.

The Special Bench has also examined which method is most appropriate for determining ALP and whether the ALP so determined by the taxpayer was appropriate or not.

We, at BDO in India, have summarised this ruling and provided our comments on the impact of this decision hereunder:

FACTS OF THE CASE

Taxpayer, during the immediately preceding fiscal year (FY) i.e. FY 2013-14, entered into a Master Rights Agreement (MRA) wherein it purchased a Bundle of Sports Broadcasting Rights (BSB Rights) from its US-based Associated Enterprise (US AE) for USD 1,211mn.
Incidentally, the relevant BSB rights were purchased by US AE from third parties, i.e., International Sport Bodies (ISBs).
By virtue of the MRA, the taxpayer stepped into the shoes of US AE and acquired all the rights and obligations that US AE had with ISBs.
Majority of the BSB rights were acquired by entering into novation agreements with ISBs and remaining by way of sub-licensing at a discount of 9.5% of the value agreed to be paid / payable by the US AE to the ISB’S
The acquisition price was also supported by a valuation report considering Discounted Cash Flow approach.
During the year under consideration, the taxpayer claimed a deduction of INR 3,075cr (approx.) towards the ‘Purchase of the BSB Rights’.
To determine ALP, the taxpayer considered the ‘Other Method’ as the MAM. However, during the tax audit, the taxpayer argued for the adoption of the Comparable Uncontrolled Price (CUP) method as was applied by the taxpayer in the immediately preceding year.
The taxpayer contended that the CUP method is the MAM since the amount to be paid to US AE or the third parties pursuant to MRA was lesser than the amount payable by US AE to third parties by 9.5%.
The TPO for the immediately preceding year i.e. FY 2013-14 had disputed the valuation report and took a position that the valuation of BSB rights was inflated by 66.06%.
Following a similar approach, the TPO treated the valuation for FY 2013-14 to be inflated to a similar extent making a TP adjustment of INR 2,031cr (approx.).
On appeal, no relief was provided by the next appellate body (i.e., Dispute Resolution Panel).
Aggrieved, the taxpayer filed an appeal before the Mumbai Tax Tribunal.

Special Bench Ruling

The Division Bench was unable to concur with the view adopted in the taxpayer’s own case for the immediately preceding year on the benchmarking of the international transaction of ‘Purchase of Bundle of Sport Broadcasting Rights’, hence a Special Bench was constituted. The Special Bench evaluated the facts and deliberated in detail on the following questions while ruling partially in favour of the taxpayer and partially in favour of tax authorities:

First and foremost, whether the taxpayer can resile from the MAM adopted in its TPSR. In this regard, the Special Bench made the following observations:
- Technicalities of the taxpayer having selected a wrong comparable or adopted a wrong method cannot come in the way of determining the correct ALP.
- The ultimate aim of the transfer pricing exercise is to determine an accurate value of ALP. Reliance was placed on Matrix Cellular International Services Pvt. Ltd. ² Hence, there can be no estoppel to the change of a method so long as the new method is, in fact, most appropriate for determining the ALP.
- Where either the TPO rejects the taxpayer’s selection of the method or the taxpayer itself realises its mistake in the selection of the method, it is for the adjudicating authority to examine the correctness of the newly selected method as the most appropriate in the facts and circumstances of the case.
- If the Tribunal holds that the change in the method by the TPO or the taxpayer resiling from its earlier selection is correct, then there can be no impediment in switching over to the new method because the legislature stipulates that the MAM shall be applied for determining the ALP.
- This view was upheld by all three members of the Special Bench.
Second question was to determine the MAM in the transaction under consideration. Herein, the view of the Accountant Member and Judicial Member deviated from the view of the Vice President. Views of all the members are mentioned hereunder for reference:

Observations by Vice President

Comparative analysis was carried out between the CUP method and Other method wherein it was observed that the CUP method emphasises ‘price charged or paid for property transferred’. However, Other method focuses on ‘price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction’.
From the above, it was construed that the CUP method has an edge over the other method’ because it employs the transacted price exclusively over the `other method’.
CUP method envisages a greater degree of match by considering only the same property in a comparable uncontrolled transaction. However, the `other method’ gives a concession in this regard and settles with an even lesser degree of match for choosing a benchmark property;
Methods other than the above were disregarded considering that they are profit based unlike CUP and Other method which are price based.
Ambit of the ‘other method’ in contrast to the specific methods makes it a method of last resort because of its relatively lesser exactitude and meticulousness.
CUP is the MAM in the facts and circumstances of the case.

Observations by Accountant Member

Necessarily there have to be two prices for CUP to succeed.
The amount paid by the taxpayer to various sports bodies is arising out of the MRA entered between the taxpayer, US AE and third parties, that is, it is merely an obligation arising out of the MRA which was earlier to be discharged by US AE. Therefore, the agreed price paid by the taxpayer to third parties is part of a controlled transaction which is paid in terms of the contract with AE.
There is no evidence available that any independent party has purchased identical/similar sports broadcasting right at the same time. Therefore, as there are no comparable uncontrolled transaction prices available, the CUP method is not the most appropriate method.
First Valuation report furnished by the taxpayer negates the adoption of the CUP method as the MAM as it does not satisfy the test of comparability of nature and class of international transaction because of changes in the perspective related to future economic benefits. Time factors and changes in economic and market conditions in future will affect the price and hence CUP is not suitable.
Second valuation report states that the market transaction approach is more relevant and markets have changed substantially from the date ESS acquired those rights and the date at which MRA is entered in.
Accordingly, the only method that can be applied in this case is the market approach i.e., which supports the ‘other method’.
Reference was also made to the report of another expert wherein it was opined that the valuation methodology for determining ALP of the bundle of sporting rights is a ‘market approach’.
OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration 2022 advocates freedom to apply ‘other methods’ for the determination of the ALP if the method prescribed are not appropriate to the facts and circumstances of the case.
Sale of bundle of sports broadcasting rights was a unique transaction where other traditional methods fail, therefore, the MAM in this case is ‘Other method’.

Observations by Judicial Member

Prices paid by the taxpayer to various sports bodies by virtue of MRA represented only the discharge of liabilities and was a part of the controlled transaction which was paid to ISBs at the instance of the AE; It did not represent uncontrolled price/ transaction under uncontrolled conditions and hence did not constitute reliable data to undertake CUP analysis.
It is not in dispute that US AE had contracted these liabilities in prior years when the prevailing market conditions, time period etc. were materially different than the date on which the MSA was entered into with the taxpayer.
Agree with the view of the Accountant Member that MAM to benchmark the international transaction is the ‘Other Method’ and not the CUP method.

The third question was on whether the ALP determined by the taxpayer is correct.

The Vice President observed that the taxpayer had purchased BSB rights at a consideration lower than what would have been otherwise paid by US AE. Hence the AO was not justified in making the transfer pricing adjustment on the basis of the deficiencies found in the valuation report submitted by the taxpayer.

However, the Accountant Member and Judicial Member held that the MAM for determining the ALP is the ‘Other Method’. Hence by a majority decision, the matter of determining the ALP was directed to be placed before the Division Bench by adopting the ‘Other Method’ as the MAM.

BDO INDIA COMMENTS

This is a welcome ruling wherein the Special Bench has emphasised that taxpayers can also resile from the method used for ALP determination and plea for a different method during assessment proceedings, provided the method so adopted should be most appropriate.

Another interesting observation is that the acquisition of the rights at a discount of what would have been paid by the AE is not conclusive evidence for the transaction to be at arm’s length.

The ruling brings out the importance of actual delineation of the transaction, the role played by time factors and changes in economic and market conditions in the determination of the MAM.

¹Star India Private Limited v. ACIT (ITA No.7872/MUM/2019) (Mumbai)

² Pr. CIT v. Matrix Cellular International Services Pvt. Ltd. (ITA 484/2017) (Delhi High Court)

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