2016 (12) TMI 236 - AT - Income Tax

Distribution Partners (DPs) - treated as deemed AEs u/s 92A(2)(i) - TPA - Held that - Given the fact that the assessee s exports through the distribution part constitutes less than 5% of its entire exports, and less than 6% of its entire sales, Northstar is certainly not in a position to exercise any dominant influence, over the assessee. The assessee s decision to accept the terms set out by Northstar, even if that be so, may be justified on account of commercial expediencies or warranted by business exigencies or may simply be compulsion of this somewhat unique and complex business model, but it cannot, by any stretch of logic, be on account of dominant influence of Northstar as a customer. It may even be a sound business strategy to accept a rather passive and back seat role, if one can term it that way, in day to day decision making under this business model, but cannot be on account of dominant influence that Northstar exercises on buying of products from the assessee. The influence of Northstar, given the scale of business through Norrthstar as a distribution part, is too modest to make it a dominant influence in the nature of control. In this view of the matter, as also bearing in mind the earlier discussions on the issue, the assessee and Northstar can not be treated as associated enterprises under section 92 A. We uphold the plea of the assessee. Once the assessee and Northstar are held to be independent enterprise, outside the scope of Section 92A, the very basis of ALP adjustments ceases to hold good in law. The impugned ALP adjustment of ₹ 2,51,91,556 must stand deleted for this short reason alone - Decided in favour of assessee

Summary

Issues Involved:
1. Determination of whether Distribution Partners (DPs) are deemed Associated Enterprises (AEs) under Section 92A(2)(i) of the Income Tax Act, 1961.
2. Validity of Arm's Length Price (ALP) adjustments based on the association between the assessee and Northstar.

Issue-wise Detailed Analysis:

1. Determination of whether Distribution Partners (DPs) are deemed Associated Enterprises (AEs) under Section 92A(2)(i) of the Income Tax Act, 1961:

The core issue in this appeal revolves around whether the Distribution Partners (DPs), specifically Northstar and Actavis, can be deemed as Associated Enterprises (AEs) under Section 92A(2)(i) of the Income Tax Act, 1961. The Transfer Pricing Officer (TPO) relied on the findings of the Settlement Commission for the assessment years 2006-07 to 2010-11, which held that the assessee and its DPs were AEs. The Settlement Commission's decision was based on the statement of the assessee's CFO that selling prices were determined exclusively by the DPs, indicating substantial control over the assessee's operations. The TPO adopted this reasoning, leading to the conclusion that the DPs influenced the prices and other conditions of sale, thereby fulfilling the criteria under Section 92A(2)(i).

However, the Tribunal noted that the decisions of the Settlement Commission do not constitute a binding precedent. The Tribunal emphasized that Section 92A(1) and (2) must be read together. Section 92A(1) lays down the principle that for two enterprises to be considered AEs, one must participate in the management, control, or capital of the other. Section 92A(2) provides specific situations where this participation is deemed to exist. The Tribunal found that the mere influence on prices by the DPs, without a significant degree of control over the assessee's operations, does not satisfy the mandate of Section 92A(1).

The Tribunal further discussed the importance of "control" in determining AE status. It highlighted that control could be de facto, arising from commercial relationships, but must be significant enough to influence the other enterprise's operations. In this case, the assessee's exports through Northstar constituted less than 5% of its total sales, indicating that Northstar did not have a dominant influence over the assessee. Therefore, the Tribunal concluded that Northstar and the assessee could not be considered AEs under Section 92A.

2. Validity of Arm's Length Price (ALP) adjustments based on the association between the assessee and Northstar:

Given the Tribunal's conclusion that Northstar and the assessee are not AEs, the basis for ALP adjustments under the Transfer Pricing provisions ceases to exist. The Tribunal noted that once the relationship between the assessee and Northstar is outside the scope of Section 92A, any ALP adjustments related to transactions with Northstar are rendered academic and infructuous. Consequently, the ALP adjustment of ?2,51,91,556 was deleted.

Conclusion:

The Tribunal allowed the appeal, holding that the assessee and Northstar could not be treated as AEs under Section 92A. This decision rendered the ALP adjustments moot, leading to the deletion of the impugned ALP adjustment. The Tribunal also suggested that the apparent omission of a threshold for the application of Section 92A(2)(i) in the statute calls for reconsideration to avoid similar litigation in the future.