DIRECT TAXATION

PROJECT ON:

RECENT TRANSFER PRICING REGULATION REFORMS IN INDIA

SUBMITTED BY:

Arsh Singh (19BBA006)

Nayanika Mishra(19bba028)

6TH SEMESTER

B.B.A., LL.B.

of

NATIONAL LAW UNIVERSITY, ODISHA

Under the Guidance

Of

Ms. Kaushiki Brahma

(Assistant. Professor of Law)

(Word Count: 5154 Words)

National Law University, Odisha [Direct Taxation Project]

ACKNOWLEDGMENT

Project Work is a complete learning experience with the objective to provide students with the
opportunity to synthesize knowledge and experiences from different areas of learning, and
critically applying it as well to real life situations and compile it all together.

As a matter of first importance, we want to express our sincere thanks to our subject teachers
Ms. Kaushiki Brahma for sharing their valuable thoughts for the successful completion of
project work. It was just under their direction and consistent guidance that we could finish our
project work. Their sources of information and learning were the basis of understanding the
essentials of the project.

“Gratitude is the fairest blossom which springs from the soul.”

~ HENRY WARD BEECHER

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TABLE OF CONTENTS

ABSTRACT ..............................................................................................................................- 3 -

INTRODUCTION ......................................................................................................................- 3 -

RESEARCH METHODOLOGY..................................................................................................- 5 -

TRANSFER PRICING REGIME IN INDIA..................................................................................- 6 -

THE ARM’S LENGTH PRINCIPLE ..........................................................................................- 7 -

METHODS OF TRANSFER PRICING ........................................................................................- 8 -

RECENT TRANSFER PRICING REFORMS ...............................................................................- 9 -

I. “INDIAN TAX AUTHORITIES CANNOT GRANT A REFUND OF TAXES PAID IN FOREIGN

JURISDICTIONS”...................................................................................................................- 9 -

II. BENEFIT OF MFN CLAUSE AVAILABLE FROM THE DATE WHEN A COUNTRY BECOMES A

MEMBER OF OECD ...........................................................................................................- 10 -

III. A NON-RESIDENT CAN’T BE TAXED UNDER SECTION 69 UNLESS IT IS PROVED THAT

INVESTMENTS ARE MADE OUT OF INCOME GENERATED IN INDIA .......................................- 11 -

IV. “SHORTFALL IN THE PREMIUM ON THE ISSUE OF SHARES IS NOT INCOME CHARGEABLE TO
TAX” .................................................................................................................................- 12 -

V. INCOME FROM CLOUD HOSTING AND ITS ANCILLARY SERVICES NEITHER ROYALTY NOR FTS

VI. CAN ADJUSTMENTS BASED ON THE COMPARABLE BE CHALLENGED? ........................- 13 -

VII. OTHER DEVELOPMENTS ............................................................................................- 13 -

CASE STUDY: ENGINEERING ANALYSIS CENTRE OF EXCELLENCE LTD. V. CIT ..............- 14 -

CONCLUSION .......................................................................................................................- 16 -

SUGGESTIONS ......................................................................................................................- 16 -

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ABSTRACT

For Indian businesses, the increasing rate of economic globalization has brought a plethora
of new obstacles. One further topic to consider is TRANSFER PRICING, which refers to the
price at which tangible or intangible assets are sold and services are delivered to affiliated
businesses. Transfer pricing (TP) regulations were implemented under Chapter X and Section
92F of the Income Tax Act of 1961 in order to bring the United States into compliance with
international norms. The new transfer pricing regulations are just somewhat different from the
OECD's Report on Transfer Pricing and Multinational Enterprises, which was published in
2008 and is available online. The latest modifications to the Finance Act of 2002 that have an
impact on transfer pricing are discussed in this article. Many obstacles must be overcome
before the rules may be used to calculate reasonable earnings that are fair, equitable, and
compliant with Indian law. These obstacles include: At the conclusion of the analysis, it is
identified the areas of concern that demand the attention and action of the federal government
immediately. The importance of considering transfer pricing as part of a company's long-term
planning and decision-making processes has been highlighted.

INTRODUCTION

The Indian economy's increasing rate of globalization has put a number of difficult concerns
on the agenda of Indian enterprises today. The following are some of them: The Indian financial
and capital markets have been deregulated, making them accessible to both foreign lenders and
borrowers. Companies that were formerly limited to their local markets are now exposed to the
highly competitive international market, putting increasing pressure on profit margins.

Furthermore, Indian businesses are rapidly growing into global firms having subsidiaries and
affiliates in a number of locations throughout the globe. Indian and worldwide multinational
companies confront major difficulties setting pricing for products, services, and technology
that are sold between their related businesses in various nations. The process of setting these
internal prices within an organization is referred to as "Transfer Pricing." After analyzing the
impact of associated enterprises' transfer pricing practices on tax receipts, the Indian
government enacted detailed transfer pricing legislation. These laws are an important step

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forward in the country's attempts to combat tax evasion.1We're talking about the prices of
"controlled transactions" between cross-border affiliated firms when we talk about transfer
pricing (AE). Because intra-group transactions between AEs are not impacted by market
forces, they may occur under conditions that differ from those that apply when we talk about
independent firms. The monies are parked in AEs located in tax havens, primarily for tax
minimization purposes.

The phrase "transfer pricing" describes the monetary value attached to the transfer of products,
services, and technology between related companies, as well as the monetary value tied to the
transfer of goods, services, and technology between unrelated parties who share ownership or
control. The Income Tax Act of 1961 codifies the regulations governing transfer pricing and
its implementation in India.2 In India, 'international transactions' between "related firms," as
well as income produced from 'international transactions' between "affiliated enterprises," must
be evaluated using the "arm's-length pricing" approach. In order to be considered reasonable,
any provision for expenses or interest arising from a foreign transaction must be determined in
proportion to the arm's-length price.

India's Income-tax Act was amended in 2001 to add provisions for transfer pricing. According
to the OECD, these regulations were generally in accordance with their transfer pricing
recommendations. Indian transfer pricing audits have been plagued by a number of issues and
difficulties during the last 15 years. Many issues and lengthy litigation have arisen as a result
of the transfer pricing legislation's implementation. The tax authorities have recently launched
a number of initiatives aimed at reducing the amount of complaints about transfer pricing. An
APA scheme has been implemented and Safe Harbour clauses have been included in bilateral
tax treaties to address transfer pricing issues, among other reasons. Amo Due to these efforts,
the number of audit cases and the number of audit disputes have both dropped. Transfer pricing
tax administration may now concentrate on high-risk scenarios while providing a sufficient
level of assurance to low-risk taxpayers The new method aims to improve the accuracy of
transfer pricing audits while reducing tax uncertainty and the length of litigation.

1
Suveera Gill, ‘The Indian Response to Transfer Pricing’, (2011) SSRN, <
https://www.academia.edu/26695675/The_Indian_Response_to_Transfer_Pricing> as accessed 1st April 2022.
2
Naina Bhardwaj, ‘Transfer Pricing Regulations in India. India Briefing’, (2021) < https://www.india-
briefing.com/news/transfer-pricing-regulations-in-india-india-briefing-news-23396.html/> as accessed 1st April
2022.

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RESEARCH METHODOLOGY

RESEARCH OBJECTIVES

Through the present research, the author aims to fulfil following objectives:

▪ To understand the concept of Transfer Pricing in Indian context.

▪ To comprehend the legal complexities involved in the process.
▪ To understand the Recent developments through various Judicial Decisions.
▪ To find out the Recent changes in International Tax and Transfer Pricing laws in India.

RESEARCH QUESTIONS

Through the present research work, the author aims to answer the following questions:

▪ What are the latest Developments in the field of Transfer Pricing?

▪ Whether sale of Computer Software through EULA taxable as Royalty?
▪ What is the Arm’s length Principle and how is it determined?

RESEARCH METHOD

The research methodology used by the author is doctrinal in nature. The author has referred to
various books, article, blogs and journals etc. Along with this, author has also referred to
various statutes and rules etc.

STATEMENT OF PROBLEM

Transfer pricing regulations provide a framework to MNCs to adopt internal pricing policies
that are market driven and not influenced by the relationship within the organisation. The
primary objective of all tax authorities across the globe in enforcing transfer pricing policies is
to ensure that MNC entities within their respective jurisdictions do not under report income in
that jurisdiction.

All this, by no means, undermines the need to reform the existing transfer pricing legislation
in India. Additional guidelines and rules helping to resolve the uncertain tax climate will be a
welcome change and will certainly aid in improving compliance and indeed tax revenues. But
the issue of recovering black money is distinct from creating a better discipline in the transfer
pricing laws. It is time to recognise this difference and treat the two problems in their own
respective rights with no overlap in interpretation or enforcement.

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TRANSFER PRICING REGIME IN INDIA

Corporations that engage in international transactions with an affiliated firm must document
those transactions using the required form and have them reviewed by a certified public
accountant. Rule 10D and Section 92D of the Information Technology Act (IT Act) require the
retention of contemporaneous data on entities, prices, and transactions, respectively. After all
the documentation has been received, the Assessing Officer will choose cases for further
investigation and review.

Over time, the auditing standards have developed, changing from monetary levels to risk
assessments. In the beginning, the monetary threshold was set at 50 million Indian rupees, but
it was later increased to 150 million rupees. The Central Board of Direct Taxation (CBDT)
issued Instruction No.6 of 2014 using an automatic selection process known as the CASS,
which was developed by the Central Bureau of Direct Taxation. If a taxpayer had previously
been subject to a TP adjustment of more than INR 100 million, the selection of cases for TP
audits was compelled by this Instruction, which was effective immediately. TARC's Tax
Administration Reform Commission (TARC) recommended that TP audits be chosen based on
"risk criteria" rather than the amount of money involved, and the CBDT published new
guidelines in October 2015 to reflect this suggestion. The assessing officer has the authority to
refer an audit matter to the Transfer Pricing Officer (TPO) for consideration. It is true that the
Income Tax Act permits an Assessing Officer (AO) to refer a matter to the Taxpayer's Advocate
if he considers it is essential and expedient, but Instruction No. 3 in 2003 made the referral
mandatory when an international transaction exceeds INR 50 million.3 Later, an agreement on
a price of INR 150 million was reached. A revised set of instructions was then released by the
CBDT, which mandated that all cases selected based on TP risk indicators be submitted to a
TP officer for additional review.4

The TPO is responsible for determining the Arm's Length Price (ALP). The AO receives an
order from the TPO, which he follows to the letter, calculating the assessee's total income in
accordance with the ALP before delivering the drafted order to the assessee for examination
and commenting. Within 30 days of receiving draught orders, assessors must either accept them

3
Central Board of Direct Taxation (2014)
4
Central Board of Direct Taxation (2015)

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or file objections with the Dispute Resolution Panel (DRP) for assessment and discussion.
Alternatively, he has 30 days from the date of receipt of the final order to file an appeal with
the Commissioner of Income Tax (CIT) (Appeals). Prior to June 1st, 2016, transfer pricing
cases were subject to a three-year assessment term cap; however, this limit has been decreased
to 33 months.5

There are two avenues available to the assessee for appealing his or her decision. Two appeals
were made, one to the CIT(A) and the other to the DRP, both of which were filed in opposition
to the final decision. The alternate dispute settlement system established by the Finance Act of
2009 was employed in an attempt to expedite the process of settling disputes (DRP). The
Revenue Department would not be able to contest the DRP until 2012 at the earliest.

The Finance Act of 2012, on the other hand, made changes to Section 253(2A) of the
Information Technology Act of 1984. If an objection is made after July 1, 2012, the Principal
Commissioner or Commissioner of Internal Revenue may initiate an appeal with the Income
Tax Appellate Tribunal against the DRP's decision (ITAT). When it comes to deciding on
appeals, the Income Tax Act affords the two dispute resolution organisations varying amounts
of time to do so. In accordance with Sections 250(6A) and 254, the CIT(A) or ITAT shall, to
the extent practicable, respond to appeals within a reasonable time. An entire year has passed
since the conclusion of the fiscal year in which an appeal for the CIT is filed has been
completed. As a result, the ITAT has a four-year statute of limitations for filing an appeal.
While this is true in general, Section 144(C)(12) requires that no directive be provided by the
DRP after nine months have gone since it was sent to an eligible assessee in conjunction with
the draught order in order to comply with the law.

The Act therefore only applies to DRP, in spite of the fact that it has a date attached to it. The
ITAT is the final and conclusive authority in this case. Any legal appeals are considered by the
High Court, which then refers the case to the Supreme Court for consideration.

THE ARM’S LENGTH PRINCIPLE

Different nations have vastly differing tax rates. Since countries with high tax rates have an
incentive to relocate their money into countries with lower tax rates, multinational firms have

5
Government of India Act 1961, S. 32.

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an incentive to do so. Profit shifting is possible when a parent company gives financial or
advisory services to its subsidiaries or a manufacturing branch distributes completed items to
a distribution branch. A network may be used to offer services from one linked business to
another. Consequently, the quantity of profit earned and the amount of tax paid at the end of
the day are subject to the influence of multinational corporations. With this in mind, tax
administrations (which are part of the OECD) have adopted the arm's length principle (Article
9 of the OECD Model Convention). In accordance with the legislation, all regulated
transactions must be conducted at market prices.

Companies that are connected in some manner must agree to the same terms and conditions as
non-related organizations for similar transactions while engaged in regulated activities in order
to conform to the arm's length principle. When the terms and circumstances are in line with
this fundamental idea, it is said to be "at arm's length.".6

METHODS OF TRANSFER PRICING

If you are doing business with a company in India, you may comply with the country's tax
requirements by using multiple transfer pricing methodologies to calculate an appropriate arm's
length price (ALP) for both international and some domestic transactions between affiliated
firms.

CUP Method: Comparing the price paid in a regulated transaction to the price paid in an
unregulated transaction between comparable independent parties under similar conditions is
known as the "Comparable Uncontrolled Price (CUP) approach. A CUP can make use of
comparable transactions that are both internal and external to the organisation.7

Transactional Net Margin Method: There are several ways to determine whether or not a
transaction is at arm's length. To establish whether or whether transactions involving related
parties were carried out on an arm's length basis, it analyses the operating and net margin of
different firms

6
Abhishek Sharma, ‘Understanding Transfer Pricing Regulations in India’, (2021) Tax Guru, <
https://taxguru.in/income-tax/understanding-transfer-pricing-regulations-india.html> as accessed 4th April 2022.
7
‘Comparable Uncontrolled Price Method for Transfer Pricing’, (2021) Au-Partners, < https://au-
partners.com/en/blog/comparable-uncontrolled-price-method-for-transfer-pricing> as accessed 4th April 2022.

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Profit Split Method: There are instances when the transactions of a corporation are so
intertwined that it is difficult to distinguish between them. In order to evaluate these types of
regulated transactions, the Profit Split Method is employed as it calculates what proportion of
earnings independent firms would have realized as a result of their participation.8

OTHER METHOD: Rule 10AB, a new rule, which is comparable to the CUP Method, has been
added to compare the real price of an uncontrolled transaction with the price quoted in the
transaction. Transactions involving a third party are permitted under the new rule. According
to this guideline, the price that would have been charged or paid in an uncontrolled transaction
should be utilised as a starting point. According to the OECD Guidelines, the alternative
technique allows for some degree of flexibility in selecting between the five steps required for
computing ALP, with the first step being the most straightforward.

RECENT TRANSFER PRICING REFORMS

Transfer pricing conflicts have been the subject of many court judgments, and as a result,
important legal concepts have been developed.

INDIAN TAX AUTHORITIES CANNOT GRANT A REFUND OF TAXES PAID IN

FOREIGN JURISDICTIONS

In the judgement delivered by the Mumbai Tribunal in the recent case of Bank of India v. ACIT9
it was held that the tax credit schemes, as evident from the international tax literature and model
convention commentaries, do not envisage any situation in which the excess foreign tax credit
can result in a tax refund to the taxpayers from the exchequer of residence jurisdictions.

All the methods of eliminating double taxation, i.e., exemption method, credit method or hybrid
method, restrict the liability to tax in the source jurisdiction. The relief sought in the instant
case goes well beyond that and would result in a refund of taxes by India, and what is being
termed as a refund is not even paid to the Indian exchequer.

8
‘The Profit Split Method with Example’, (2017) Transfer Pricing India, <
https://transferpricingasia.com/2017/04/11/profit-split-method-with-example/> as accessed 4th April 2022.
9
Bank of India v. ACIT [2021] 125 taxmann 155 (Mumbai- Trib.).

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Wherever tax credits exceed the tax liability, at best a carry forward or back of excess tax credit
can be given when permitted by the domestic law, or at best when not restricted by the domestic
law.

BENEFIT OF MFN CLAUSE AVAILABLE FROM THE DATE WHEN A COUNTRY

BECOMES A MEMBER OF OECD

In the case of Concentrix Services Netherlands B.V. v. Income Tax Officer10 Because of this,
it is said, India's reduced withholding tax rate would only be accessible to countries who were
member countries of the Organization for Economic Co-operation and Development (OECD)
prior to the time when India signed into this agreement with these countries. Slovenia,
Lithuania, and Columbia, to name a few, were not OECD members when the DTAAs with
India were finalized. This means that Clause IV(2) of the protocol attached to the topic DTAA
is invalid.

It was found that the concept of parity is present in both the subject DTAA and any subsequent
DTAAs that were signed after it, according to Delhi High Court's ruling on a petition filed by
the United States of America. Withholding tax rates and conventions may be used to achieve
parity in terms of dividends, interest, royalties, fees for technical services, or payments for the
use of equipment, among other things.

A third country must be an OECD member in order for India to benefit from the concept of
parity when it enters into a DTAA. India should have confined its withholding tax rate on
subject remittances to a lower rate or a more restricted scope than the rate or scope established
in the subject DTAA, which was signed with the third state.

The same withholding tax rate or scope must be applied to the subject DTAA once the
aforementioned requirements are met, and that date will be the date on which the DTAA
between India and a third State enters into effect.

Therefore, the beneficial withholding tax rate of 5% in India-Slovenia DTAA will apply from
the date when Slovenia became an OECD member, i.e., from August 2010. However, India –
Slovenia DTAA came into force in February 2005.

10
Concentrix Services Netherlands B.V. v. Income Tax Officer (TDS) [2021] 127 taxmann 43 (Delhi).

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A NON-RESIDENT CAN ’T BE TAXED UNDER SECTION 69 UNLESS IT IS PROVED

THAT INVESTMENTS ARE MADE OUT OF INCOME GENERATED IN INDIA

In the case of ITO v. Rajeev Suresh Ghai11, the assessee was an Indian national but a resident
of the UAE. The taxing rights under Article 12 belong to the residence jurisdiction. Even if the
rights can at best go to the source jurisdiction, by no stretch of logic, an unexplained investment
could be taxed in India, which is neither residence nor source jurisdiction but is an investment
jurisdiction.

Thus, unexplained investments could be taxed in India under section 69 only if it can be proved
that the assessee made the unexplained investments out of his incomes earned in India.

The treaty does not cover the taxation of income of the nature, such as ‘unexplained
investment’, and that is the end of the road. Since the said income is not even taxable under the
residuary Article 22, there cannot be any taxation of this income in the hands of the assessee
under the Indo UAE tax treaty.

INCOME FROM CLOUD HOSTING AND ITS ANCILLARY SERVICES NEITHER

ROYALTY NOR FTS

The assessee in the case of Racksapce US, Inc. v. DCIT12 was taxed in the United States. The
assessee made money through cloud services, such as cloud hosting and other ancillary services
given to Indian customers. Under Article 12 of the India-US tax treaty, the assessee submitted
a statement of income and notes that said that the cloud hosting services were not taxable as
'royalties'.The Mumbai ITAT held that the agreement between the assessee and its customer
was for providing hosting and other ancillary services to the customer and not for the use of or
leasing of any equipment.

The Data Centre and the Infrastructure therein were used to provide these services belonging
to the assessee. The customers do not have physical control or possession over the servers, and
right to operate and manage this infrastructure or servers vested solely with the assessee. The
agreement was to provide simpliciter hosting services and not give the underlying equipment

11
ITO v. Rajeev Suresh Ghai [2021] 132 taxmann 234 (Mumbai – Trib.).
12
Racksapce US, Inc. v. DCIT [2021] 124 taxmann 92 (Mumbai – Trib.).

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on hire or lease. The customer did not know any server location in the data centre, webmail,
websites, etc. To put it another way, AO and DRP were wrong to treat the money they received
from cloud hosting services as royalties under the DTAA's Explanation 2 to Section 9(1)(vi)
and Article 12(3)(b).

“ SHORTFALL IN THE PREMIUM ON THE ISSUE OF SHARES IS NOT INCOME

CHARGEABLE TO TAX

In India, a Vodafone and Shell subsidiary company granted shares to a foreign connected
company. The TPO came to the conclusion that the shares were sold at a low price. It was thus
decided to regard this deficit in premium on the issuing of shares, which was 'income
chargeable to tax in India', as transfer pricing adjustment in the Indian entity's hands. Because
of this, TPO considered the premium deficit to be a debt from the Indian subsidiary to its
international affiliated company. As a result, the considered loan's notional interest on arm's-
length pricing was billed as interest revenue through a subsequent adjustment.

To put it another way, the question before the court was whether or not there was a gap in share
value in India, and hence whether or not it was subject to taxation.

Because of this, transfer pricing clauses may only be used to update the arm's-length price and
not recharacterize a transaction, according to the High Court. It is clear that the transaction did
not generate any revenue, and therefore, there was no need for a transfer price adjustment.13

CAN AD HOC TRANSFER PRICING ADJUSTMENTS WITHOUT DUE PROCESS OF

LAW BE RETAINED?

There should be no second chance for TPOs to challenge TP modifications that were made
without due process of law by the Mumbai ITAT in the landmark case of CLSA India Pvt Ltd
v. DCIT Circle 4(1)(1).14 Despite the Bangalore ITAT's ruling to the contrary. In other cases,
the ITAT has returned the case to the tax officer, but only for the restricted purpose of checking
the margins.15

13
Vodafone [2014] 368 ITR 1 (Bombay); Shell [2015] 64 taxmann 262 (Bombay).
14
CLSA India Pvt Ltd v. DCIT Circle 4(1)(1), Mumbai [2019] 101 taxmann 388 (Mumbai – Trib).
“

15
CWT India Pvt Ltd [2019] 109 taxmann 182 (Mumbai – Trib).

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CAN ADJUSTMENTS BASED ON THE COMPARABLE BE CHALLENGED ?

In 2018, the Karnataka High Court delivered a judgment in the case of Pr Commissioner Of vs
M/S Softbrands India16 If the results are ex-facie perverse and reflect absolute non-application
of mind, they cannot be challenged in the High Court. Following this decision, more than 500
appeals were decided, and the Supreme Court is presently debating whether or not this decision
was right.

In another case,17 the High Court, while rejecting the appeal of the Revenue, concluded that “a
party is not barred in law from withdrawing from its list of comparables, a company, if the
same is found to have been included on account of mistake as on facts, it is not comparable.
The Transfer Pricing Mechanism requires comparability analysis to be done between like
companies and controlled and uncontrolled transactions.”

OTHER DEVELOPMENTS

➢ In the Mitsui case,18 TNMM was found to be the most suitable approach to adopt, and
the Berry ratio was used as an indication of profit level by the ITAT (PLI). There was
no serious point of law emerged, and hence the High Court denied Revenue's appeal.
The Revenue has appealed to the Supreme Court, which is now pending.

➢ The Supreme Court in the case of The Principal Commissioner of Income Tax vs M/S
S.G. Asia Holdings (India)19 The ITAT was correct in pointing out that the AO had
violated the obligatory directions set by the CBDT by not referring to the TPO.
Although the Supreme Court granted the Revenue's request for a new transfer pricing
audit, the case was overturned on appeal.

➢ the ITAT in another case20 If the FAR profile of the tested party is basic enough, it may
be taken as the tested party in international transactions.

16
Pr Commissioner Of Income Tax v. M/S Softbrands India TS-475-HC-2018(KAR)-TP. ”

17
Tata Power Solar Systems Ltd [2019] 77 taxmann 326 and Lionbridge Technologies Pvt Ltd [TS-176-HC-
“

2019(BOM)-TP].
18
Mitsui and India Pvt Ltd [TS-602-SC-2017-TP]. ”

19
The Principal Commissioner Of Income Tax vs M/S S.G. Asia Holdings (India) TS-775-SC-2019-TP.
“
20
General Motors India Pvt Limited [2013] 37 taxmann 403 (Ahmedabad – Trib).

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➢ It has also been held21 that the approach offered to a taxpayer is not an unrestricted one.
If the CUP approach is proven to be acceptable in a specific case, it should be favoured
above the other ways.

➢ There is also a precedent,22 This was denied because there was no comparison with an
uncontrolled transaction to prove that location factor had a meaningful effect on price
and profit margin on the 'location saving' adjustment made to a taxpayer's arm's length
pricing.

CASE STUDY: ENGINEERING ANALYSIS CENTRE OF EXCELLENCE LTD. VS CIT23

FACTUAL BACKGROUND

Courts in Karnataka and Delhi had two sets of appeals before the Supreme Court, which ruled
on both sets in a two-day hearing on Monday. Supreme Court also put to rest the conflicting
decisions of the Authority for Advance Rulings (AAR). A non-resident Indian corporation sells
shrink-wrapped computer software to the Appellant, who is an Indian resident in the United
States. Taxes were not deducted from payments made to the non-resident company by the
Appellant because of their nature. However, since the parties had agreed on a copyright for the
right to use the software in consideration for royalties, it was found that tax should be deducted
at source in line with Section 195 of the Act in this situation. An appeal to the Karnataka High
Court by a variety of assessors was unsuccessful. the High Court upheld the appeal relying on
its judgment in CIT v Samsung Electronics Co. Ltd. & Others24, in which it was found that the
sale of computer software contained a right or interest in Copyright, which therefore generated
royalty payments and necessitated a tax deduction at source under section 9(1)(vi) of India's
Income Tax Act. Civil appeals were brought at the Supreme Court by the Appellant and others
who felt they had been wronged. Four types of appeals were considered:

▪ Computer software acquired from a foreign non-resident provider or producer by a

resident end-user directly in their country of residence.

21
Serdia Pharmaceuticals (India) Pvt Ltd [2011] 9 taxmann 13 (Mumbai).
22
Syngenta India Ltd [2017] 77 taxmann 220 (Mumbai). ”

23
Engineering Analysis Centre of Excellence (P.) Ltd. v. CIT [2021] 125 taxmann 2 (SC).
24
CIT v Samsung Electronics Co. Ltd. & Others [(2011) 245 CTR (Kar) 481].

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▪ Reselling products from non-resident suppliers to Indian customers as a distributor or

reseller in India.
▪ Software purchased from a non-resident vendor and sold to Indian distributors or end
users by the non-resident foreign vendor.
▪ Non-Indian providers sell integrated software and hardware to Indian distributors and
end-users. The Appellant belonged to the latter group.

ISSUE BEFORE THE COURT

“ When an Indian resident payer paid for software from foreign software suppliers, the Supreme
Court argued that such payments should be considered 'royalty' as defined in Section 9(1)(vi)
and the Double Taxation Avoidance Agreement (DTAA), and thus the payer was required to
deduct tax at source under Section 195 of the Act, as well. ”

JUDGEMENT

The Supreme Court, in a detailed judgment, held that:

➢ Only those sections of the Act that are more favourable to the assessee may be
enforced while the DTAA is in effect.

➢ To be eligible for Tax Deduction at Source under Section 195 of the Act, a non-
resident must be required to pay tax under Section 9's charging provision read with
Section 4 of the Act, as well as the DTAA's Tax Treaty Agreement. There is no need
to apply the PILCOM decision in this situation.

➢ When a computer program is used for the purpose for which it was provided, or if it is
used as a backup copy, it does not constitute infringement of copyright and does not
constitute a transfer of copyright as defined in Sections 14b(ii) and 52(1)(aa).

➢ It is important to read the EULAs as a whole in order to understand the full nature of
the agreement. According to Tata Consulting, the sale of a physical thing with an
integrated computer software qualifies as a licensed transaction.

➢ It is impossible for the Act's Explanation 4 to apply retroactively. Because the Supreme
Court agreed with the assesses in all four areas, they won.

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CONCLUSION

Transfer pricing reforms have been beneficial, however there are still concerns that need to be
dealt with. As a primary worry, more than one-third of all situations are comparable to those
of an assessee in the past. As a result, the department and taxpayers are likely to get stuck in
the same issues over and over again. The APAs were created solely for this purpose. From the
perspective of tax administration, switching from the expensive and time-consuming dispute
resolution technique to the APA mechanism would be better. Since it allows everyone involved
in financial management to more accurately predict their costs and spending, as well as their
tax obligations, the APA programme has shown to be beneficial to all parties involved in
financial management. Inter-company price disagreements can be resolved quickly and
peacefully if the Indian government and the Central Board of Trade (CBDT) are willing to be
flexible.

Further, for firms, understanding and following the regulations is much better to being
subjected to the taxman's wrath and scrutiny. Therefore, transfer pricing should be a critical
consideration in the development of a company's strategy and decision-making processes.
Preventative efforts must be made to improve the performance of the company, limit legal risk,
and lower the overall tax burden. This can be accomplished through merging and restructuring
business units. If the organisation adheres to this strategy, it will reap both immediate and long-
term rewards.

SUGGESTIONS

It takes time for a law to grow as institutions mature and precedents become more readily
available. This is true of India's transfer pricing regulations. In terms of the length of cases,
there has been some noticeable progress. The introduction of the DRP was also a factor in the
reported decrease in length. Recurring conflicts over the same issues and low success rates for
tax officials mean that the current system still needs to be reformed. It is necessary to promote
in advance price agreements in order to reduce the related expenses.

The tax agency also has a shortage of expertise in the field of transfer pricing. As a time- and
money-saving measure, a combination evaluation may be an appropriate option.

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National Law University, Odisha [Direct Taxation Project]

SUGGESTION IN LIGHT OF THE COVID-19 PANDEMIC

Covid-19 will force companies to revaluate their transfer pricing practices. Agreements
between businesses must be re-examined. It is expected that tax payers would take into account
the influence on profit margins of limited-risk distributors, contract manufacturers, and contract
R&D services providers. Despite the absence of administrative guidance, taxpayers may,
however, renegotiate the terms of their APA.

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