Transfer Pricing Alert - Supreme Court reverses the decision of High Court, holds that Arm’s Length Price determined by Tribunal can be reviewed

BACKGROUND

As per Section 260A of the Income-tax Act, 1961 (IT Act), an appeal can be preferred to the High Court against an order of the Income-tax Appellate Tribunal (ITAT) only if the High Court is satisfied that the case involves a substantial question of Law.  In other words, ITAT is the final fact-finding authority. In respect of Transfer Pricing matters, a question may arise as to whether the issue relating to the determination of the Arm’s Length Price can be raised before the High Court or not. There have been many High Court decisions which have held that ITAT being the final fact-finding authority, no question of law arises as far as the determination of arm’s length price is concerned. In this regard, recently, Supreme Court¹ had to delve into this matter and held that High Court is empowered to adjudicate matters involving the determination of Arm’s Length Price.

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

FACTS OF THE CASE

The matter before the Supreme Court revolved around judgements of various High Courts² who had dismissed the appeals challenging the findings of the ITAT on ‘Transfer Pricing’ issues on the ground that the issues decided by the ITAT are questions of fact and as perversity is neither pleaded nor argued nor demonstrated by placing material to that effect, no substantial question of law arises for consideration under Section 260A of the IT Act.

Tax Authorities’ Contentions

• The Karnataka High Court in the case of Softbrands India (P) Ltd has erroneously held that the ITAT is the final fact-finding authority on determining the arms-length price.
• Under the scheme of transfer pricing, the arm’s length price is to be determined taking into consideration the guidelines stipulated under the provisions of the IT Act and the Rules. It is submitted that therefore it is always open for the High Court to consider and/or examine, whether the guidelines stipulated under the Act and the Rules, while determining the arm’s length price have been followed by the ITAT or not.
• If the arm’s length price is determined by the ITAT dehors the guidelines stipulated under the IT Act and the Rules, more particularly Rules 10A to 10E of the Rules, the determination can be said to be perverse which is always subject to scrutiny by the High Court in an appeal under Section 260A of the IT Act.

Taxpayers’ Contentions

• An appeal to the High Court from every order of ITAT can be made only if the High Court is satisfied that the case involves a substantial question of law.
• A substantial question of law can arise in a case only when a question of law is arguable, where there is room for a difference of opinion.
• A finding of fact may give rise to substantial questions of law in the event that the findings are based on:
  • No evidence; and/or
  • While arriving at the finding, relevant admissible evidence has not been taken into consideration or inadmissible evidence has been taken into consideration; or
  • Legal principles have not been applied in appreciating the evidence; or
  • When the evidence has been misread.
• Instances, where the substantial question of law can arise in transfer pricing matters, is where the issue relates to whether at all a transaction falls within the definition of ‘international transaction’ or if two enterprises are ‘associated enterprises’ as per the IT Act.
• Questions of comparability of companies or selection of filters are usually questions of fact and unless perversity in findings of the ITAT is pleaded and demonstrated by placing material on record, no substantial question of law can arise and there can be interference by the High Court.
• Transfer pricing analysis involves benchmarking controlled transactions with uncontrolled transactions (terms specifically defined in the IT Act and the Rules) and is largely a statistical exercise using a database of companies in the public domain as specifically defined in the IT Act and Rules.
• Transfer Pricing provisions are essentially a valuation exercise involving the determination of a statistical sample of comparables. Under Section 92C (2) of the IT Act, Arm’s Length Price is always in a range. It is not a science, but it is an art. SC in the case of G. L. Sulatnia and Anr³ has held that valuation is a question of fact.

SC RULING

The Supreme Court held that within the parameters of Section 260A of the IT Act in an appeal challenging the determination of the arm’s length price, it is always open for the High Court to examine in each case whether while determining the arm’s length price, the guidelines laid down under the Act and the Rules, referred to hereinabove, are followed or not and whether the determination of the arm’s length price and the findings recorded by the Tribunal while determining the arm’s length price are perverse or not. While coming to this conclusion, it made the following observations:  

• Section 92C (1) of the IT Act visualises the determination of the Arm’s Length Price by any of five enumerated methods, ‘being the most appropriate method’, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the board may prescribe.
• Rule 10B of the IT Rules prescribes the determination of arm's length price under Section 92C of the IT Act. The first step in all methods is the evaluation of differences between the international transaction undertaken with the ‘unrelated enterprise performing comparable functions’ in similar circumstances. Rule 10B of the IT Rules inter alia, provides for various methods for the determination of the arm’s length price.
• While determining the arms-length price, the Tribunal must follow the guidelines stipulated in Chapter X of the IT Act namely, Section 92, 92A to 92CA, 92D, 92E and 92F and Rules 10A to 10E of the Rules.
• Any determination of the arms-length price under Chapter X dehors to the relevant provisions of the guidelines can be considered perverse and it may be considered as a substantial question of law as perversity itself can be said to be a substantial question of law.
• Even the High Court can also examine the question of comparability of two companies or selection of filters and examine whether the same is done judiciously and based on the relevant material/evidence on record. The High Court can also examine whether the comparable transactions have been taken into consideration properly or not, i.e., to the extent non-comparable transactions are considered comparable transactions or not.
• The High Court should examine whether the guidelines laid down in the IT Act and the IT Rules are followed while determining the arm’s length price or not.

BDO IN INDIA COMMENTS

SC has held that HC is not debarred from considering an appeal against ITAT’s order relating to the determination of arms’ length price. The High Court should examine whether while determining the arm’s length price the guidelines laid down under the Act and the Rules, are followed or not and whether the findings recorded by the ITAT while determining the arm’s length price are perverse or not. While SC has set aside High Court’s order and asked High Court to examine whether the guidelines for the determination of arm’s length price are followed or not, within 9 months of the order, this decision will be helpful for all the pending matters where the determination of arm’s length price is challenged.

To ensure the maintainability of any appeal to the High Court on transfer pricing issues, the appeal should include specific evidence that the guidelines laid down under the IT Act and the IT Rules for determination of the arm’s length price have not been followed and whether the findings recorded by the Tribunal while determining the arm’s length price are perverse or not.

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