In a recent decision rendered in the case of Tata Consultancy Services, the Tax Tribunal has held that a Transfer Pricing adjustment was not warranted in situations where Tax avoidance / Profit shifting is not possible, such as in cases where the Indian company is enjoying Tax holiday or the foreign associated enterprise is located in a high-tax jurisdiction.

The Tribunal also held that a mechanical reference to the Transfer Pricing Officer was improper and the Assessing Officer ought to have applied his mind to the Transfer Pricing report filed by the Taxpayer and given an opportunity of hearing to the Taxpayer, before referring the case to Transfer Pricing Officer.

The other issues that were decided in the aforesaid appeal in favor of Taxpayer were allowing the deduction for State Taxes paid in US, allowing capitalization of software expenses to escape dis-allowance under section 40(a) for non-deduction of Taxes and allowing deduction under section 10A, even though 80HHE relief was claimed in earlier years.

Our Comment

The Tribunal has dealt with two forms of base erosion arguments on the same footing:

(a) That there cannot be any motive to shift profits where the Indian Taxpayer is enjoying a Tax holiday and

(b) Where the Tax rate in the foreign country is higher, again, there cannot be any motive for shifting profits

In cases where the Taxpayer in India is enjoying an undisputed Tax holiday  benefit, the logic that there is no motive to avoid Tax is quite unexceptionable. As regards the argument relating to the foreign associated enterprise being located in a ‘high-tax’ jurisdiction is concerned, in our view, the head-line tax rate per se cannot be a factor to determine if there exists a motive or incentive to shift profits, as what would be relevant is the effective tax rate of the foreign enterprise.  In this context, the other aspect of the ruling on providing an opportunity for hearing to the assessee before a reference to the TPO becomes relevant, as the said opportunity could be used by the Taxpayer to demonstrate the effective tax impact of the Transaction in both jurisdictions.