THE FINDINGS OF INCOME TAX APPELLATE TRIBUNAL ON ‘ARM’S LENGTH PRICE’ IS SUBJECT TO JUDICIAL REVIEW

[Mr. M. GOVINDARAJAN]

Arm’s Length Price

Section 92F(ii) of  Income Tax Act, 1961 (‘Act’ for short) defines the expression ‘Arm’s Length Price’ (‘ALP’ for short) as the price applied or proposed to be applied when two unrelated persons enter into a transaction between persons other than associated enterprises in uncontrolled conditions.  This is helpful to determine a fair value of a product.  Special provisions have been made for computation of ALP to arrive at a fair assessment of income taxable in the hands of the Indian Resident Companies and these special provisions also provide for an elaborate and in-depth analysis of huge data of the comparable cases of other similarly situated Companies to arrive at a fair ALP.  The scheme of transfer pricing/arm’s length price is to be determined under Chapter X of the Act more particularly Sections 92, 92A to 92CA, 92D, 92E and 92F and Rules 10A to 10E of the Income Tax Rules, 1962.

Computation of ALP

Section 92C of the Act provides that in relation to an international transaction or specified domestic transaction shall be determined by any of the following 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, namely-

• comparable uncontrolled price method;
• resale price method;
• cost plus method;
• profit split method;
•  transactional net margin method;
• such other method as may be prescribed by the Board.

Before choosing any of the above methods, the following procedure should be followed-

• Identify the international transaction/specified domestic transaction.
• Identify an uncontrolled transaction.
• Compare the international/specified domestic transaction with uncontrolled transactions on the basis of guidelines in Rule 10B(2) an situation mentioned in 10B(3).
• Ascertain most appropriate method by taking into account the factors discussed in Rule 10C which states that the method to be selected shall be the one best suited to the facts and circumstances of each international/specified domestic transaction and that which provides the more reliable measure of the arm’s length price.
• Finally determine the arm’s length price by applying the most appropriate method chosen.

Reference to Transfer Pricing Officer

Section 92CA of the Act provides that where any person, being the assessee, has entered into an international transaction or specified domestic transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the Principal Commissioner or Commissioner, refer the computation of the arm's length price in relation to the said   transaction to the Transfer Pricing Officer.  The Transfer Pricing Officer after observing due formalities determine the arms’ length price in relation to the above said transaction.

Section 92CA(4) of the Act provides that on receipt of the order under sub-section (3), the Assessing Officer shall proceed to compute the total income of the assessee under sub-section (4) of section 92C in conformity with the arm's length price as so determined by the Transfer Pricing Officer.

Issue

Appeal may be filed by the assessee against the order of Assessing Officer before the Income Tax Appellate Tribunal (‘Tribunal’ for short).   The issue to be discussed in this article is as to whether the findings of the Tribunal in relation to transfer pricing dispute attain finality or not.

Final fact authority

In PR. COMMISSIONER OF INCOME TAX AND ASSISTANT COMMISSIONER OF INCOME TAX VERSUS M/S. SOFTBRANDS INDIA P. LTD. - 2018 (6) TMI 1327 - KARNATAKA HIGH COURT, the Karnataka High Court observed that the dispute essentially before them is the pairing and matching such comparables with the Transfer Pricing Analysis of the profit margins given by the Assessee himself during the course of determination of such ALP.  The High Court cannot be expected to undertake the exercise of comparison of the comparables itself which is essentially a fact finding exercise.  Neither the sufficient Data nor factual information nor any technical expertise is available with the High Court to undertake any such fact finding exercise in the said appeals under Section 260-A of the Act. This Court is only concerned with the question of law and that too a substantial one, which has a well defined connotations as explained above and findings of facts arrived at by the Tribunal in these type of assessments like any other type of assessments in other regular assessment provisions of the Act, viz. Sections 143, 147 etc., are final and are binding on this Court.   The High Court cannot disturb those findings of fact under Section 260-A of the Act, unless such findings are ex-facie perverse and unsustainable and exhibit a total non- application of mind by the Tribunal to the relevant facts of the case and evidence before the Tribunal. 

The Karnataka High Court held that the Income Tax Tribunal is the final and highest fact finding body under the Act. It is manned by Expert Members (Judicial Members are selected from District Judges or Advocates and Accountant Members selected from practicing Chartered Accountants or persons of CIT level in the Department).   In the case before the High Court, the pick of comparables, short-listing of them, applying of filters, etc., are all fact finding exercises and therefore the final Orders passed by the Tribunal are binding on the lower Authorities of the Department as well as High Court.

Tribunal’s order subject to judicial review

The Supreme Court held that the findings of the Tribunal in relation to arm’s length price is not final and subject to judicial review by High Court in SAP LABS INDIA PRIVATE LIMITED VERSUS INCOME TAX OFFICER, CIRCLE 6, BANGALORE - 2023 (4) TMI 859 - SUPREME COURT  decided on 19.04.2023.

In the above said case the Supreme Court entertained a bulk of appeals challenging the judgments of various High Courts which dismissed the appeals before it (219 appeals by Department and 5 appeals by tax payers). The Karnataka High Court held that the Tribunal is the final fact finding authority and no judicial review can be made before the High Courts.  Against this order the Revenue filed appeals before Supreme Court.

The Revenue submitted the following before the Supreme Court-

• Under the scheme of transfer pricing, the arm’s length price is to be determined taking into consideration the guidelines stipulated under the aforesaid provisions of the Act and the Rules. 
• 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 Tribunal or not.
• The Karnataka High Court in the case of ‘Softbrands India (P) Limited’ (supra) has erroneously held that the Tribunal is the final fact finding authority on determining the arm’s length price and therefore once the Tribunal determines the arm’s length price the same cannot be subject to judicial scrutiny/scrutiny in an appeal under Section 260A of the Act.
• 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 Act.
• 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 Tribunal or not.
• If the arm’s length price is determined by the Tribunal de hors the guidelines stipulated under the 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 the scrutiny by the High Court in an appeal under Section 260A of the Act.
• The view taken by the High Court of Karnataka in the case of ‘Softbrands India  (P) Limited’ (supra) is required to be corrected by this Court.

The assessees contended before the Supreme Court that-

• Once the arm’s length price is determined by the Tribunal taking into consideration the relevant guidelines, thereafter challenge to the same cannot be said to be a substantial question of law, to be considered in an appeal under Section 260A of the Act.
• Section 260A of the Act provides that an appeal shall lie to the High Court from every order of the Tribunal only if the High Court is satisfied that the case involves a substantial question of law. 
• The High Court may determine any issue which has not been determined by the Appellate Tribunal; or has been wrongly determined by the Appellate Tribunal, by reason of a decision on such question of law.
• The High Courts as well as 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. 
• Unless perversity in the findings of the Tribunal is pleaded and demonstrated, by placing material on record, no substantial question of law can arise and, therefore, there can be no interference by the High Court.
•  In all the appeals filed by the Revenue before the High Court, the primary issues raised pertained to inclusion and exclusion of a few comparables and selection of filters, which are essentially questions of fact and there is a consensus ad idem to this extent between the parties.
• In none of the appeals has the Revenue pleaded, argued, or placed any material to demonstrate perversity in the order of the Tribunal.
• The Tribunal is the final fact finding authority and all the questions decided by the Tribunal are questions of fact is too broadly stated, and as a result of this proposition, it would appear that the High Court has held that no appeal would lie to it under section 260A of the Act.
• The High Court has found that there is no perversity by the Tribunal in determining the arm’s length price and therefore no substantial question of law arises as no perversity is pleaded and demonstrated.

The Supreme Court considered the submissions made by the parties to the bulk appeals.  The Supreme Court observed that the High Court has taken the view that the determination of arm’s length price by the Tribunal shall be final against which an appeal under Section 260A of the Act is not required to be entertained.  The short question which is posed for the consideration of this Court is - ‘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?’

The Supreme Court analyzed the provisions of Section 92C of the Act and Rule 10B.  The Supreme Court observed that any determination of the arm’s length price under Chapter X de hors the relevant provisions of the guidelines, referred to hereinabove, 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 Act.  In the challenge before the High Court on the determination of arm’s length price 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?
• 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;
• 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?

Therefore the Supreme Court held that the view taken by the Karnataka High Court in the case of ‘Softbrands India (P) Limited’ (supra) 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 Act cannot be accepted.

The Supreme Court observed that High Court should examine whether the guidelines laid down in the Act and the Rules are followed while determining the arm’s length price.  Therefore the Supreme Court was of the opinion that he absolute proposition of law laid down by the Karnataka High Court in the case of ‘Softbrands India (P) Limited’ (supra) that in the matter of transfer pricing, determination of the arm’s length price by the Tribunal shall be final and cannot be subject matter of scrutiny and the High Court is precluded from examining the correctness of the determination of the arm’s length price by the Tribunal in an appeal under Section 260A of the Act on the ground that it cannot be said to be raising a substantial question of law cannot be accepted.    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.

The Supreme Court allowed all the appeals.  The Supreme Court quashed the impugned judgments of High Courts.  The Supreme Court remitted the matter to the respective High Courts to decide and dispose of the appeals afresh in light of the observations made by the Supreme Court and to examine whether in each case 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 findings recorded by the Tribunal while determining the arm’s length price are perverse or not. 

Conclusion

The Department is benefited by this order.  This ruling is likely to have a significant impact on litigation around transfer pricing issues as a large chunk of controversy in this area lies on the issues pertaining to inclusion and exclusion of comparables, selection of filters, computation of tested party margin.  This ruling will pave the way for the substantial increase of time for transfer pricing disputes to attain finality.  The taxpayers are to proactively strategize at the time of entering into an international/specific domestic transaction or latest, when they receive an adverse transfer pricing order, on whether they should focus on the domestic litigation route or also evaluate the alternative dispute resolution mechanisms such as Mutual Agreement Procedure and Advance Pricing Agreement.