TRANSFER PRICING CASES

1. CASTLETON INVESTMENT LTD, IN RE [TS-607-AAR-2012]

BRIEF:

 The provisions pertaining to transfer pricing and filing of return of

income are applicable even if the income (capital gains) is not liable to tax.
 Even a foreign company would be covered under the minimum alternate tax (MAT)
provisions of the Income-tax Act, 1961 (the Act).

FACTS:

Castleton Investment Ltd (the applicant), a company incorporated in Mauritius, holds

shares in an Indian listed company (Indian company). The applicant proposes to transfer
its investment in the Indian company at fair value to an associated enterprise in Singapore
(Singapore AE), through an off-market transaction. The applicant, the Indian company
and the Singapore AE are all part of the same group.

KEY ISSUES:

1. Will transfer pricing (TP) provisions be applicable, even if the transfer of

shares by the applicant to Singapore AE is not taxable in India?
2. Will the MAT provisions under section 115JB of the Act be applicable to the
applicant?

HELD:

Issue 1: Applicability of TP provisions:

Section 92 of the Act reads as “Any income arising from an international

transaction shall be computed having regard to the arms-length price.” Going by the
general meaning and by the defined meaning of “income” under the Act and also from a
reading of sections 92A to 92C of the Act, there is no need to restrict the scope of the
expression “income” appearing in section 92 of the Act. Even if section 92 to sections
92F of the Act are machinery provisions, capital gains cannot be determined without
resorting to them. Only on determining whether capital gains have arisen, would the
question of its chargeability arise. The question of chargeability to tax would arise
only at a later stage. Therefore, whether ultimately the gain or income is taxable in the
country or not, sections 92 to 92F of the Act would apply if the transaction is one coming
within those provisions.

Thus, Applicability of section 92 of the Act does not depend on the chargeability under
the Act. Where there is no liability, the purpose of undertaking a TP exercise is not a
question that would affect the operation of a statutory provision.

Issue 2: Applicability of MAT provisions

The term ‘company’ as referred to in section 115JB of the Act would not limit its
applicability to domestic companies. In view of the above, the AAR ruled that the
provisions of section 115JB of the Act are prima facie applicable to ‘every company’
and the definition of a company under the Act includes a foreign company. Further, the
fact that the foreign company had no permanent establishment in India makes no
difference to the applicability of MAT provisions.

2. BAUSCH & LOMB INCORPORATED V. CIR, 933 F.2D 1084

FACTS:

Commissioner of Internal Revenue appealed from an order of the United States Tax
Court, rejecting Commissioner's reallocation of income between parent corporation and
its wholly owned Irish subsidiary, and redetermining taxpayers' income tax liability for
certain tax years. The Court of Appeals, Mahoney, Circuit Judge, held that: (1) transfer
price parent paid its subsidiary for soft contact lenses and royalty rate subsidiary paid
parent for use of its manufacturing technology and related intangibles had independent
significance and, thus, the two factors were properly examined separately, and (2) Tax
Court did not commit clear error in valuing transfer price or royalty rate.

Affirmed.

PRINCIPLES LAID DOWN:

There are three methods to deal with transfers of tangible property between commonly
controlled entities: 1) The comparable uncontrolled price method relies upon the price
prevailing in comparable sales between entities that are not members of the same control
group; 2) The resale price method starts with the price which the buyer in the controlled
sale is anticipated to charge upon resale to an entity outside the control group; that resale
price is then reduced by the profit markup of a comparable uncontrolled buyer/reseller.;
3) The cost plus method adds to the cost of producing the subject property a markup equal
to the profit percentage of a comparable uncontrolled seller. These methods must be
applied sequentially. That is, “[i]f there are comparable uncontrolled sales ..., the
comparable uncontrolled price method must be utilized because it is the method likely to
result in the most accurate estimate of an arm's-length price....”

Uncontrolled sales are considered comparable to controlled sales if the physical

property and circumstances involved in the uncontrolled sales are identical to the
physical property and circumstances involved in the controlled sales, or if such
properties and circumstances are so nearly identical that any differences either have no
effect on price or such differences can be reflected by a reasonable number of
adjustments to the price of uncontrolled sales. For this purpose, differences can be
reflected by adjusting prices only where such differences have a definite and reasonably
ascertainable effect on price.

3. EU DU PONT DE NEMOURS V. US 608 F.2D 445 (FED. CIR. 1979)

FACTS:

Du Pont de Nemours, the American chemical concern, created a wholly-owned Swiss

marketing and sales subsidiary for foreign sales of Du Pont International S.A. (DISA).
Most of the Du Pont chemical products marketed abroad were first sold by Du Pont to
DISA, which then arranged for resale to the ultimate consumer through independent
distributors. The profits on these Du Pont sales were divided for income tax purposes
between plaintiff and DISA via the mechanism of the prices plaintiff charged DISA. For
1959 and 1960 the Commissioner of Internal Revenue, acting under section 482 of the
Internal Revenue Code which gives him authority to reallocate profits among commonly
controlled enterprises, found these divisions of profits economically unrealistic as giving
DISA too great a share. Accordingly, he reallocated a substantial part of DISA's income
to taxpayer, thus increasing the latter's taxes for 1959 and 1960 by considerable sums.
The additional taxes were paid and this refund suit was brought in due course. Du Pont
assails the Service's reallocation, urging that the prices plaintiff charged DISA were valid
under the Treasury regulations implementing section 482.

Held, that taxpayer has failed to demonstrate that, under the regulation it invokes and
must invoke, it is entitled to any refund of taxes.

PRINCIPLES:

Applicability of Resale Price Method- The resale price method reconstructs a fair arm's
length market price by discounting the controlled reseller's selling price by the gross
profit margin (or markup percentage) rates of comparable uncontrolled dealers. Thus, if
DISA's gross profit margin for resale was 35% and the prevailing margin for comparable
uncontrolled resellers was 25%, the Commissioner could reallocate 10% of DISA's gross
income. But the vital prerequisite for applying the resale price method is the existence of
substantially comparable uncontrolled resellers. This method requires determination of
the "most similar" resale or resales, considering the type of property, reseller's functions,
use of any intangibles, and similarity of geographic markets.

Cited cases: Woodward Governor Co. v. Commissioner, 55 T.C. 56, 65 (1970) (resale
price method applicable only when evidence shows uncontrolled purchases and resales by
same or similar reseller); American Terrazzo Strip Co. v. Commissioner, 56 T.C. 961,
972-73 (1971) (uncontrolled sales must be comparable in terms of similar goods and
circumstances of sale); Edwards v. Commissioner, 67 T.C. 224, 236 (1976) (rejecting use
of industry gross profit statistic when no evidence that such sales were comparable to
taxpayer).

4. AZTEC SOFTWARE AND TECHNOLOGY V. ACIT 2007 107 ITD 141 BANG

Ratio: There is no requirement of establishment of "tax evasion" before initiation of

proceedings for determination of Arm's length price.

Method of determining arm’s length price: Computation of arm's length price is

essentially a factual exercise. Each case depends on its own peculiar facts and
circumstances. In certain cases where identical or almost similar uncontrolled transaction
is available for comparison; determination of Arm's Length Price is an easy task.
However, it is not so in most of transactions and rarely one is able to locate an identical
transaction. In such cases Arm's Length Price is determined by taking results of a
comparable transaction in comparable circumstances and make suitable adjustments for
the differences. The Legislature in India, in order to take true income of taxpayer, has
prescribed certain universally accepted methodologies to compute arm's length price
under the IT Act read with the IT Rules. Thus whatever methodology is chosen for the
purpose of determination of arm's length price under Section 92C, these criteria, as
specified in the Act and the Rules have to form a basis of judging the comparability. Thus
there should be a proper analysis of such transactions with respect to, the functions
performed, the assets employed and the risk assumed by the respective parties with
reference to the transaction in question. This can be termed as functional, asset, risk
analysis, i.e., FAR analysis. All the three ingredients of FAR have direct bearing on the
pricing of products/services. The provision also provides scope for carrying out
adjustments in cases where there are some differences or variations to make two
transactions commercially comparable, for the purpose of benchmarking. In other words,
an uncontrolled transaction selected for benchmarking should be adjusted by employing
certain techniques like FAR analysis, to be selected on its peculiar factual matrix, for the
purpose of enabling comparison of the same with a controlled international transaction so
that the differences or variations are ironed out or minimized. The underlying principle
being that only likes can be compared with like. The adjustments are suggested to achieve
the object of testing and trying to see if both the parties or/and the transactions are similar
or nearly similar. At times even after adjustments, the transaction/s or parties sought to be
compared may not be identical or there might not be a possibility of adjustment. This is a
very subjective exercise and fact based. The selection of the most appropriate method
(MAM) is based on the nature of transaction, the availability of relevant data and the
possibility of making appropriate adjustments. The burden is on the assessee to select the
most appropriate method (MAM). This decision of selecting MAM is to be substantiated
by the assessee by an appropriate documentation as well as by substantiating why a
particular method is considered best suited to the facts and circumstances of the
international transaction and as to how it provides the most reliable result of the ALP.
Rule 10C(2) of the IT Rules lays down the factors to be considered in selection of MAM.
Hence, while making the selection of the transfer pricing method, one would be required
to evaluate each method vis-a -vis the a factors / parameters prescribed in Rule 10C(2).