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SC decision on comparability analysis in TP cases
By D P Sengupta
Apr 28, 2023

TRANSFER Pricing legislation was adopted in India in the year 2001 through the Finance Bill 2001 incorporating sections 92 to 92 F. The provision relating to reference to a specialist Transfer Pricing Officer (TPO) was introduced by the Finance Act, 2002 through a government amendment. The first few years went for organising the administration, putting in place a Directorate and allocating jurisdictions and work to the officials. Effectively, cases involving TP adjustments started to be decided since around 2004. Ever since, litigations involving transfer pricing issues have exploded and within a decade, India already had the third maximum transfer pricing adjustments as per OECD statistics.

Our website ', contains the database of almost all the decided cases in this area. If we search for total TP cases, it shows the total number at 6712 out of which 952 cases are shown to be decided by High Courts and 135 cases by the Supreme Court and the balance 5625 cases were obviously decided by the ITAT. Everyday some 3-4 new TP cases are reported. Thus, most of the decisions are from the ITAT. This is only natural as under the current scheme of assessment, with the Dispute Resolution Panel coming into play at the first stage of formulation of the assessment order itself, the Tribunal is effectively the first appellate authority in respect of transfer pricing issues.

Under the appellate process of the ITA, an appeal will lie to the High Court on a 'substantial question of law.' What is a substantial question of law is however not defined either in the Act or in section 100 of the CPC that applies in appellate proceedings before the High Courts, per section 260A (7) of the ITA. We may recall that even though the Income Tax Act does give appellate jurisdiction to the Supreme Court under section 261 of the Act, an appeal from the order of the High Court is available subject to the condition that the High Court certifies it to be a fit case to be heard considering the importance of the matter in public interest. Such cases are rare though.

But, apart from the normal appellate process, the Supreme Court can grant a special leave to appeal from any order passed by any court or tribunal under Article 136 of the Constitution. This provision is liberally used both by the taxpayers and the tax department. The power of the Supreme Court to grant special leave of appeal is not subject to any fetters and is completely at the discretion of the Court. Generally, the Supreme Court will not grant special leave, unless it is shown that exceptional and special circumstances exist; that substantial and grave injustice has been done and that the case in question presents features of sufficient gravity to warrant a review of the decision appealed against.

It is in this light that we need to consider the fact that the Supreme Court has rendered 136 decisions in TP cases as per our database. Although most of the SLPs are dismissed by the SC, there have also been many important cases decided by the SC as a result of such appeals by special leave. In the TP cases too, it is observed that the SC has in many instances condoned delay and admitted SLPs filed mainly by the Revenue and in some cases by the taxpayers as well. Prima-facie, this will indicate that some important legal issues are involved in these cases. It is in this context that a recent Supreme Court decision has created some concerns with the prediction that TP disputes will increase even further as a result of the said decision.

The Supreme Court decision was rendered in a batch of about 142 cases, led by SAP Labs India Private Ltd - 2023-TII-01-SC-TP and was from the orders of various High Courts and more particularly from the order of the Karnataka High Court dismissing the appeal filed by the Revenue by relying on its earlier order rendered in the case of PCIT v Softbrands India (P) Ltd in 2018 - 2018-TII-54-HC-KAR-TP.

It will therefore be instructive to first study the decision rendered by the Karnataka High Court in the aforesaid case. At the outset, we may note that the High Court went to great length in justifying the stand it took and perhaps in an attempt to reduce litigation, following the said decision, it had dismissed 68 appeals in one go.

This was a case of a subsidiary of a foreign company rendering software support services to its multinational parent. TP adjustments were made by the tax department rejecting the CUP method initially adopted by the taxpayer and following the TNMM and also rejecting some comparables selected by the taxpayer and adding some of their own. When the matter reached the Tribunal, it rejected 3 of the comparables adopted by the TPO and applied a related party turnover of 15%. Aggrieved, the Revenue filed appeal before the High Court suggesting the substantial question of law as to whether the ITAT was right in rejecting 3 comparables by following its earlier order and whether the ITAT was justified in fixing the Related Party Transaction at 15% of the total turnover and deleting two comparables without going into specific facts and without adducing the basis for arriving 15% cut off RPT filter.

In deciding the case against the Revenue holding that no substantial question of law arose from the order of the Tribunal, the High Court went into a large conspectus of issues including the nature of the transfer pricing adjustments, the special procedure introduced in Chapter X of the IT Act for determining the same, the responsibilities cast on the taxpayers to provide information, the unchanged nature of the dispute resolution process by the Tribunal and the courts despite introduction of the TP provisions, the importance of international trade and the importance of resolving disputes on a timely manner.

The High Court pointed out that despite special provisions having been made for computation of Arm's Length Price to arrive at a fair assessment of income taxable in the hands of the Indian Resident Companies and despite special provisions in the Act and Rules for an elaborate and in-depth analysis of huge data of the comparable cases of other similarly situated Companies to arrive at a fair 'Arm's Length Price' and despite creation of Special Cells and designated Authorities under the Income Tax Act, the normal provisions for assessments of appeals in the Indian Income Tax Act about the remedial Forums or the appeal mechanisms continues to remain the same and the Income Tax Appellate Tribunal continues to be the final fact finding body under the Act even with regard to the assessments of the international transactions under the Special Chapter X and no change was made to in the provisions relating to appeal to the High Court and to the Supreme Court.

The HC also noticed that the exercise of arriving at the Arm's Length Price is essentially a matter of estimate of the fair value which the Indian Company has paid or has received from the Foreign Company and the said exercise to be undertaken by the Transfer Pricing Officer is based on the facts and figures relating to comparable cases of other entities, whose relevant data are available in public domain. The HC also noticed that as per the provisions of the Act and Rules, it is the taxpayer Company that is required to furnish its own Transfer Pricing Analysis and chosen comparables which then may or may not be agreed by the Revenue Authorities or Transfer Pricing Officer and they would introduce some more comparables rejecting the comparables given by the taxpayer applying certain filters like the Related Party Transaction (RPT) Filters, Turnover Filters, Export Earnings Filters, Employee Cost Filters, etc. to bring them within the comparable range of the cases of such comparables and generally there would be a tug of war between the taxpayer and the Revenue in this arena. (We may however note that this is a phenomenon not peculiar to India and most jurisdictions follow more or less the same process).

The High Court noted that the dispute may also be between the two parties as to whether the correct Filters have been properly applied or not or whether the most appropriate method of determination of Arm's Length Price as prescribed under the Rules has been adopted or not and several other such factors for arriving at the Arm's Length Price to make fair and reasonable Transfer Pricing Adjustments in the hands of the taxpayer.

From the above, the High Court concluded that this entire exercise of making Transfer Pricing adjustments on the basis of the comparables is nothing but a matter of estimate of a broad and fair guess-work of the Authorities based on relevant material brought before the Authorities including the Appellate Tribunal. Nonetheless the Tribunal being the final fact-finding body remains so for this Special Chapter X also and therefore, unless the Court is satisfied that a substantial question of law arises from the order of the Tribunal, the appeal under Section 260- A cannot be entertained and the exercise of fact finding or 'Arm's Length Price' determination or 'Transfer Pricing Adjustments' should be allowed to become final with a quietus at the hands of the final fact finding body, i.e. the Tribunal.

The High Court observed that its entry into the process of litigation under Section 260-A of the Act is locked with the words "Substantial questions of law" and the key to open that lock to maintain such appeal can only be the perversity of the findings of the Tribunal in these type of cases and the perversity in the findings should not only be averred by the appellant before it but, established on the basis of cogent material which was available before the Authorities below including the Tribunal and the findings arrived at by the Tribunal can be so held to be perverse within the well settled parameters for determining the same as perverse.

The High Court further noted that the phrase "substantial question of law", as occurring in the amended Section 100 of the Code of Civil Procedure is not defined therein. The High Court therefore held that the word substantial, as qualifying "question of law", means - of having substance, essential, real, of sound worth, important, or considerable. It is to be understood as something in contradistinction with - technical, of no substance or consequence, or academic merely. However, the legislature has chosen not to qualify the scope of "substantial question of law" by suffixing the words "of general importance" as has been done in many other provisions such as Section 109 of the Code or Article 133(1)(a) of the Constitution. The substantial question of law on which a second appeal shall be heard need not necessarily be a substantial question of law of general importance.

The High Court then observed that the process of determination of Arm's Length Price, necessarily considers the comparable cases of other similarly situated or nearly similarly situated Corporate Entities whose data are in public domain or on the Data Bases like Prowess and Capital Line Data Base etc and No Substantial Question of Law Arises in these Cases.

The High Court added that such a dispute essentially is the pairing and matching such comparables with the Transfer Pricing Analysis of the profit margins given by the taxpayer itself during the course of determination of such Arm's Length Price.

Analysing the arguments of the parties, the High Court observed that these were that either wrong Filters have been applied or Filters have been wrongly applied, particularly qua Turnover Filter giving a far too wide or narrower range of comparables or even though comparable Entities were functionally different entities from the Entities in the list of Departmental comparables, as against the comparables sought to be provided by the taxpayers but the Revenue Department generally insists on their inclusion to get high profit ratio leading to higher Transfer Pricing adjustments, whereas the taxpayer would like to keep the comparables in a narrower range to justify its Transfer Pricing Analysis and profits declared. (In TP parlance, this is known as cherry picking).

In sum and substance, such an exercise having been undertaken by the tax authorities may have resulted not only in high pitched Transfer Pricing Adjustments in the declared profits but a flood of such appeals goes before the Tribunal itself where finally the inclusion or exclusion of comparables is determined by the Tribunal on due analysis giving its own reasons.

As for the contention raised that different views taken by the Tribunal by different Benches at different places and hence the appeals under Section 260-A of the Act deserve to be entertained and admitted for laying down certain Guidelines about the Filters or Most Appropriate Method to be adopted for determination of the 'Arm's length price', the High Court took the view that the same does not fall within the parameters of the substantial question of law adding that none of the sides was able to point out any perversity in the Orders of the Appellate Tribunal in this regard.

The High Court added that it cannot be expected to undertake the exercise of comparison of the comparables itself which is essentially a fact-finding exercise. Neither sufficient Data nor factual information nor any technical expertise is available with the High Court to undertake any such fact-finding exercise in these appeals under Section 260-A of the Act.

Otherwise, if the High Court takes the path of making such a comparative analysis and pronounces upon the questions as to which Filter is good and which comparable is really comparable case or not, it will drag the High Courts into a whirlpool of such Data analysis defeating the very purpose and purport of the provisions of Section 260-A of the Act.

The High Court then went into issues of the importance of international trade, earning of foreign exchange and need for speedy resolution of disputes. It held that huge quantum of borderless Trade and International Transactions earning lot of Foreign Exchange and revenues for India through international Corporate s and Trade with them has a big interface with the Dispute Resolution of such cases in the Tax Administration Department as well as the Judiciary.

The High Court observed that the procedure of assessment under Chapter X relating to international transactions is already a lengthy one and involves multiple Authorities of the Department. A huge, cumbersome and tenacious exercise of Transfer Pricing Analysis has to be undertaken by the Corporate Entities who have to comply with the various provisions of the Act and Rules with a huge Data Bank and in the first instance they have to satisfy that the profits or the income from transactions declared by them is at 'Arm's length' which analysis is invariably put to test and inquiry by the Authorities of the Department and through the process of Transfer Pricing Officer (TPO) and Dispute Resolution Panel (DRP) and the Tribunal at various stages, the taxpayer has a cumbersome task of compliance and it has to satisfy the Authorities that what has been declared by them is true and fair disclosure and much of the Transfer Pricing Adjustments is not required but the Tax Authorities have their own view on the other side and the effort on the part of the Revenue Authorities is always to extract more and more revenue. This process of making huge Transfer Pricing Adjustments results in multi- layer litigation at multiple fora. After the lengthy process of the same, the matter reaches the Tribunal which also takes its own time to decide such appeals. In the course of this dispute resolution, much has already been lost in the form of time, man-hours and money, besides giving an adverse picture of the sluggish Dispute Resolution process through these channels. "If appeals under Section 260-A of the Act were to be lightly entertained by High Court against the findings of the Tribunal, without putting it to a strict scrutiny of the existence of the substantial questions of law, it is likely to open the floodgates for this litigation to spill over on the dockets of the High Courts and up to the Supreme Court, where such further delay may further cause serious damage to the demand of expeditious judicial dispensation in such cases."

In that view of the matter, the High Court dismissed the appeals. The disaffected parties thereupon filed SLP before the Supreme Court, which was then admitted by the Supreme Court.

Before the SC, the tax department argued that that there cannot be any absolute proposition of law that against the decision of the Tribunal determining the arm's length price, there shall not be any interference by the High Court in an appeal under Section 260A of the IT Act. 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. Therefore, it is always open for the High Court to consider whether the guidelines stipulated under the Act and the Rules, while determining the arm's length price have been followed by the Tribunal or not.

On the other hand, the representatives of the taxpayers argued that once the arm's length price is determined by the Tribunal taking into consideration the relevant guidelines, the challenge to the same cannot be said to be a substantial question of law. It was submitted that a finding of fact may give rise to a substantial question of law, inter alia, in the event the findings are based on (i) no evidence; and/or (ii) while arriving at the said finding, relevant admissible evidence has not been taken into consideration or inadmissible evidence has been taken into consideration; or (iii) legal principles have not been applied in appreciating the evidence; or (iv) when the evidence has been misread.

It was reiterated that the High Courts as well as the Supreme Court have consistently held that the Tribunal being a final fact-finding authority, in the absence of demonstrated perversity in its finding, interference therewith by the High Court is not warranted.

It was further argued that in Transfer Pricing matters, some instances where a substantial question of law can arise could be whether a transaction falls within the definition of 'international transaction' at all, or whether two enterprises are 'associated enterprises' as per the definition under the IT Act or not. On the other hand, the question of comparability of two companies or selection of filters are usually question of fact, which primarily depend on the functions performed, assets employed and risks assumed by the tested party as well as comparable transactions. Unless perversity in the findings of the Tribunal is pleaded and demonstrated, by placing material on record, no substantial question of law can arise for the consideration of the High Court in such cases.

It was emphasised that over last two decades, Tribunal and various High Courts have applied the guidelines laid down in the IT Act and the Rules contributing to evolution of a process and any intervention at this stage could upset the well-steeled principles. It was also mentioned that Transfer Pricing provisions are essentially a valuation exercise involving determination of a statistical sample of comparables. Under Section 92C(2) of the IT Act, Arm's Length Price is always in a range; that it is not a science but it is an art. Moreover, in all the cases in the batch, the High Court did not find any perversity by the Tribunal in determining the ALP and none was also alleged by the tax department.

The Supreme Court then formulated the essential question that required to be answered as- whether in every case where the Tribunal determines the arm's length price, the same shall attain finality and the High Court is precluded from considering the determination of the arm's length price determined by the Tribunal, in exercise of powers under Section 260A of the Act ?

Answering the same, the Supreme Court held that while determining the arm's length price, the Tribunal has to follow the guidelines stipulated under Chapter X of the IT Act, namely, Sections 92, 92A to 92CA, 92D, 92E and 92F of the Act and Rules 10A to 10E of the Rules. Therefore, any determination of the arm's length price under Chapter X de hors the relevant provisions of the guidelines can be considered as 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.

Therefore, there cannot be any absolute proposition of law that in all cases where the Tribunal has determined the arm's length price the same is final and cannot be the subject matter of scrutiny by the High Court in an appeal under Section 260A of the IT Act. When the determination of the arm's length price is challenged before the High Court, it is always open for the High Court to consider and examine whether the arm's length price has been determined while taking into consideration the relevant guidelines under the Act and the Rules. 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 on the basis of 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 as comparable transactions or not.

In that view of the matter, the Supreme Court held that the view taken by the Karnataka High Court in the case of Softbrands India (P) Ltd. that in the transfer pricing matters, the determination of the arm's length price by the Tribunal is final and cannot be subject matter of scrutiny under Section 260A of the IT Act cannot be accepted.

The Supreme Court finally laid down that in each case, the High Court should examine whether the guidelines laid down in the Act and the Rules are followed while determining the arm's length price; 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.

Although this decision seems to be the first substantial case decided by the Supreme Court in Transfer pricing matters, it does not seem to be path breaking. The Supreme Court has only negated the extreme proposition of the Karnataka High Court that determination of ALP by the Tribunal in TP cases is final and is beyond the pale of consideration by the High Courts. In all these cases in this batch, it may still be that indeed no substantial question of law arises since there was no perversity in the orders of the Tribunal. But that will have to be decided after considering the relevant facts and the regulations.

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