Tag Archives: base erosion

Units enjoying Tax holiday not immune to TP Adjustments: Delhi Tax Tribunal

The Tax Tribunal Bench in Delhi has held in the case of Headstrong Services Private Limited that even units which enjoy Tax holiday can be subjected to Transfer Pricing (‘TP’) adjustments, rejecting ‘no base erosion’ argument put forward on behalf of the Taxpayer.

The Delhi bench refused to follow the ruling of the co-ordinate Mumbai Bench  rendered in the case of Tata Consultancy services, wherein it was held that the TP provisions are not applicable to Tax holiday units. The Delhi bench ruled that it was bound to follow the earlier ruling given by the Special Tribunal Bench in Aztec’s case, which upheld applicability of TP provisions even to Tax payers enjoying a Tax holiday.

Certain other issues decided by the Tribunal are briefly re-capitulated below:

Use of Past year’s data and future projection

The Tribunal also rejected the use of past years’ data as well as future projections for computation of the Transaction Net Margin (‘TNM’) of the Tax payer.

Alternate TP defense using revenue distribution ratio as a ‘CUP’

An interesting alternate defense was raised on behalf of the Taxpayer – that of using revenue distribution ratio as a Comparable Uncontrolled Price (CUP). It was contended that 80% of the revenues which were earned by the Associate Enterprise was shared with the Taxpayer, as against Tax Payer sharing only 77.50% of its Revenues with other third parties, in respect of certain other service contracts.  The Tribunal held that such a comparison was not valid and further  the distribution ratio did not constitute a CUP.

Exclusion of foreign exchange fluctuations in margin computation

The Tribunal ruled that forex fluctuation impacts both the Taxpayer as well as the comparable companies selected for TNM analysis and therefore there was no reason to make any adjustment for the same.

Right of Taxpayer to challenge comparable companies for the first time before Tribunal

The Tribunal upheld the right of the Taxpayer to challenge certain comparable companies for the first time before the Tribunal. The earlier ruling of Special Bench in the case of Quark Systems was followed. However, instead of deciding on the comparability or otherwise of these companies, the issue was restored to lower authorities for their consideration.

On Comparables’ selection

The Tribunal accepted Taxpayer’s argument that companies like Wipro, Infosys which own IPRs and have significant R&D expenses are not comparable to that of Taxpayer. Further, companies which are engaged in software product development were also held non-comparable to the Taxpayer, which was a service provider.

No TP adjustment sans base erosion: ITAT Mumbai

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.