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TMI Blog2007 (7) TMI 50X X X X Extracts X X X X X X X X Extracts X X X X ..... 92CA(1) justiciable ? If so, can it be called in question in appeal on the ground that it was accorded without due diligence or application of mind ? 4. What is the legal effect of Instruction No. 3 of 2003 issued by the Central Board of Direct Taxes on transfer pricing proceedings ?" 2 At the suggestion of learned counsel for the intervener and with the mutual consent of the parties, the aforesaid questions were permitted to be modified and certain additional questions were also allowed to be raised. Hence, the revised questions to be adjudicated by the present Bench are these "1. Whether it is a legal requirement under the provisions contained in Chapter X of the Income-tax Act, 1961 that the Assessing Officer should prima facie demonstrate that there is tax avoidance before invoking the relevant provisions ? 2. Whether it is a legal requirement under the provisions contained in Chapter X of the Income-tax Act, 1961 that the Assessing Officer should prima facie demonstrate that any one or more of the circumstances set out in clauses (a), (b), (c) and/or (d) of sub-section (3) of section 92C of the said Act are satisfied in the case of any assessee, before his case is referre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... losses are not overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country's tax base." 4 Accordingly, legislative changes through the Finance Acts, 2001 and 2002 were made. It was provided in section 92(1) that income arising from international transactions between associated enterprises shall be computed having regard to the arm's length price. In other words, results under contractual obligation of parties, notwithstanding, the authorities will examine whether there is scope to make adjustments, by fixing arm's length price in respect of goods, services, etc., provided to or by an associated enterprise (AE). The price charged or paid in an international transaction by an associated enterprise is called the "controlled price". The price fixed between two independent concerns relating to a similar transaction carried in a similar cir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . It response to the same, the representative of the assessee attended the office of the Assessing Officer and made the same objections which were raised before the TPO. Apart from the said objections, it was also submitted by the assessee that the order of the TPO was erroneous for two reasons, namely, (i) the TPO was required to determine the ALP only and could not make adjustment; and (ii) the order lacks jurisdiction since the Commissioner's approval had not been obtained before referring the computation of the ALP to the TPO. The Assessing Officer was not convinced with the objections filed by the assessee. The Assessing Officer also observed that the permission of the Commissioner had already been obtained before making a reference to the TPO and the same was on record. According to him, there is no provision in the Act for furnishing the copy of the approval of the Commissioner of Income-tax to the assessee. Consequently, the adjustments amounting to Rs. 18,18,16,843 were made by the Assessing Officer under section 92C(4) read with section 92CA(4) of the Act vide order dated March 30, 2005. 7 The said order of the Assessing Officer was challenged before the Commissioner of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n following grounds vide letter dated July 25, 2005 (1) The reasons for making a reference under section 92CA of the Income-tax Act, 1961, has not been furnished till date, in spite of specific request for the same. This non-furnishing of the reasons militates against the decision of the Supreme Court in GKN Driveshafts (India) Ltd. v. ITO [2003] 259 ITR 19 and renders the assessment invalid. (2) A reference purportedly under section 92CA is incorrect. The assessment year involved is 2002-03 and the relevant previous year is from April 1, 2001, to March 31, 2002, whereas the provisions of section 92CA was brought into the Income-tax Act by the Finance Act of 2002 with effect from June 1, 2002. Section 42 of the Finance Act, 2002 specifically mentions that section 92CA has been inserted with effect from June 1, 2002. Reading of section 92CA(1) makes it clear that it applies to transactions entered in any previous year, thereby meaning that it applies to transactions which are entered after the insertion of section and does not apply to transactions entered into prior to the insertion of section 92CA. Reliance is placed on the Supreme Court judgments, i.e., Karimtharuvi Tea Estate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The following portion of the Notes on Clauses to the Finance Bill, 2001 also shows the said intent of the Legislature ([2001] 248 ITR (St.) 1,133) : "The new section further provides that where during the course of any proceeding for the assessment of income the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that the price charged in the international transaction has not been determined in accordance with sub-sections (1) and (2) or information and documents relating to the international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D, and the rules made in this behalf or the information or data used in computation of the arm's length price is not reliable or correct or the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine, after giving an opportunity of being heard to the assessee, the arm's length price in relation to the said trans action in accordance wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m's length price in accordance with the rules, and to substantiate the same with the prescribed documentation. Where such onus is discharged by the assessee and the data used for determining the arm's length price is reliable and correct there can be no intervention by the Assessing Officer. This is made clear by sub-section (3) of section 92C which provides that the Assessing Officer may intervene only if he is, on the basis of material or information or document in his possession, of the opinion that the price charged in the international transaction has not been determined in accordance with sub-sections (1) and (2) or information and documents relating to the international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub section (1) of section 92D and the rules made thereunder; or the information or data used in computation of the -arm's length price is not reliable or correct; or the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D. If any one of such circumstances exists, the Assessing Of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are special provisions. Both the provisions intend to curb the avoidance of tax through payment to related parties. Being special provisions, the provisions of Chapter X can be invoked only under the specific circumstances, i.e., avoidance of tax through specific transfer pricing mechanism qua international transactions with associate enterprises. In view of the above discussion, it was held by him that provisions of Chapter X of the Act could not be invoked by the Assessing Officer unless it is shown that there is avoidance of tax by the assessee through the transfer pricing mechanism. 13 Secondly, it was held by him that before embarking on any determination of the ALP, the Assessing authority has to pass through the process as prescribed under clauses (a) to (d) of sub-section (3) of section 92C of the Act not only where the assessing authority does it himself but also where a reference to the TPO is made by the Assessing Officer. 14 Thirdly, it was held by the Commissioner of Income-tax (Appeals) that jurisdiction under section 92C/92CA can be invoked only where there is sufficient material/information/documents in the possession of the Assessing Officer on the basis of whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity. It involves application of mind by the Commissioner of Income-tax to find out whether the Assessing Officer has complied with the relevant provisions or not. Therefore, the courts can interfere in appropriate cases. Reliance was placed on various cases * U. P. Financial Corporation v. Joint CIT [2006] 280 ITR 100 (All). * Yum Restaurants India P. Ltd. v. CIT [2005] 278 ITR 401 (Delhi); * Central Warehousing Corporation v. Secretary, Department of Revenue [2005] 277 ITR 452 (Delhi) * West Bengal State Co-operative Bank Ltd. v. Joint CIT [2004] 267 ITR 345 (Cal) * Peerless General Finance and Investment Co. Ltd. v. Deputy CIT [1999] 236 ITR 671 (Cal) 18 It was also held that previous approval of higher authority is an internal matter of the Department since it does not decide the rights of the assessee. Therefore, an opportunity by such authority is not required. But it does not preclude the Assessing Officer to do so before forming an opinion and before sending the proposal to higher authority. Reliance was placed on the jurisdictional High Court judgment in the case of Rishabchand Bhansali v. Deputy CIT (Investigation) [2004] 267 ITR 577 (Karn). 19 In view of the legal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ails contained in report in Form No. 3CEB. After going through the said form, the Commissioner of Income-tax (Appeals) observed that only the following information can be gathered by the Assessing Officer: * the nature of relationship of assessee with the associate enterprises, * brief description of the business carried out by the associate enterprises, * the nature of the services rendered and the payment made for such services, * the method used for determining the ALP, * why the method used was the most appropriate method. 22 In view of the above, he posed the question whether such information was sufficient to invoke the provisions of section 92C(3) for computing the ALP other than that declared by the assessee. According to the Commissioner of Income-tax (Appeals), the requirements of section 92C(3) could not be met unless the Assessing Officer further examine the facts and evidences himself since the report of the auditor did not contain any other information or detail on the basis of the which Assessing Officer could differ from the findings of the auditor. Therefore, the direction contained in the instruction of the Board to the effect that the Assessing Officer can ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Legislature either in section 92C or section 92CA or any other section in Chapter X of the Act nowhere says that the Assessing Officer is required to demonstrate the avoidance of tax before invoking the jurisdiction under section 92C/92CA of the Act. According to him, if the language of the Act is clear and unambiguous then resort cannot be made to the aids to the interpretation. Consequently, it was argued by him that the headings or marginal notes as well as the speech of the Finance Minister, Notes on Clauses or the Board's circulars cannot be considered in interpreting/construing the provisions enacted by the Legislature if the language employed by the Legislature is plain and unambiguous. Proceeding further, it is submitted that the Revenue is not disputing the decisions of the apex court relied on by the Commissioner of Income-tax (Appeals). According to the Revenue, those decisions are distinguishable since the court itself has ruled that in those very cases the reference to external aids was made in order to resolve the controversy arising out of the ambiguity in law. Reliance has been placed on a number of decisions of the apex court and other High Courts mentioned in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9 In the case of Gurudevdatta VKSSS Maryadit v. State of Maharashtra, AIR 2001 SC 1980, their Lordships of the apex court held as under (head note) "It is a cardinal principle of interpretation of statute that the words of a statute must be understood in their natural, ordinary or popular sense and construed according to their grammatical meaning, unless such construction leads to some absurdity or unless there is some thing in the context or in the object of the statute to suggest to the contrary. The golden rule is that the words of a statute must prima facie be given their ordinary meaning. It is yet another rule of construction that when the words of the statute are clear, plain and unambiguous, then the courts are bound to give effect to that meaning irrespective of consequences. It is said that the words themselves best declare the intention of the law giver. The courts have adhered to the principle that effort should be made to give meaning to each and every word used by the Legislature and it is not a sound principle of construction to brush aside words in a statute as being inapposite surpluses if they can have a proper application in circumstances conceivable within the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the construction to be put on a particular provision makes a consistent enactment of the whole statute." 32 The above judgments made it clear beyond doubt that courts are not required to look into the object or intention of the Legislature by resorting to aids to interpretation where the language of the provision is clear and unambiguous. Consequently, the meaning of each word used by the Legislature is to be given its plain and natural meaning and no word should be ignored while interpreting a provision of a statute. 33 Let us now consider the relevant provisions contained in Chapter X of the Act relating to transfer pricing. Section 92 mandates that "any income arising from an international transaction between two or more associated enterprises shall be computed having regard to the arm's length price". Section 92A defines the term "associated enterprise" while section 92B defines the term "international transaction". Section 92C provides that the ALP in relation to an international transaction shall be determined by any of the methods specified therein, being the most appropriate method, shall be applied in the manner as may be prescribed. The proviso to sub-section (2) p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m's length price, in the manner as may be prescribed Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent. of such arithmetical mean. (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that- (a) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm's length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued und ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e under sub-section (2), or as soon thereafter as may be, after hearing such evidence as the assessee may produce, including any information or documents referred to in sub-section (3) of section 92D and after considering such evidence as the Transfer Pricing Officer may require of any specified points and after taking into account all relevant materials which he has gathered, the Transfer Pricing Officer shall, by order in writing, determine the arm's length price in relation to the international transaction in accordance with sub-section (3) of section 92C and send a copy of his order to the Assessing Officer and to the assessee. (4) 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 having regard to the arm's length price determined under sub-section (3) by the Transfer Pricing Officer. (5) With a view to rectifying any mistake apparent from the record, the Transfer Pricing Officer may amend any order passed by him under sub-section (3), and the provisions of section 154 shall, so far as may be, apply accordingly. (6) Where any amendment is made by the Transfer Pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nal notes or the Finance Minister's speech or the Notes on Clauses etc. Reference can be made to the judgment of the Supreme Court in the case of Frick India Ltd. v. Union of India, AIR 1990 SC 689 wherein at page 693, it was held as under: "It is well-settled that the headings prefixed to sections or entries cannot control the plain words of the provision; they cannot also be referred to for the purpose of construing the provision when the words used in the provision are clear and unambiguous; nor can they be used to cutting down the plain meaning of the words in the provision. Only in the case of ambiguity or doubt the heading or sub heading may be referred to as an aid in construing the provision but even in such a case it could not be used for cutting down the wide application of the clear words used in the provision." 37 Reference can also be made to the d of the Supreme Court in the case of CIT v. Ahmedbhai Umarbhai and Co. [1950] 18 ITR 472; AIR 1950 SC 134 wherein at page 141, it was observed as under (page 487) ".....marginal notes in an Indian statute, as in an Act of Parliament cannot be referred to for the purpose of construing the statute ..." 38 Similar view was t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has over riding effect over the provisions contained in Chapter IV-D, i.e., sections 28 to 44DA only. Hence, the provisions of section 40A(2) would not and can not override the provisions contained in Chapter X of the Act. Even otherwise, if there are different provisions over the same subject then in law the specific provisions would prevail. So, even assuming that the provisions of section 40A are attracted, these are the general provisions applicable to all transactions while the provisions of Chapter X are specific provisions relating to international transactions only. Therefore, the provisions of Chapter X which are more specific would apply to the present case. 42 At one stage of hearing, learned counsel for the assessee has also submitted before us that income of the assessee is exempt under section 10A of the Act and, therefore, the overpricing or underpricing of an international transaction would not affect the computation of income. This argument is without force in view of the specific provisions contained in the first proviso to sub-section (4) of section 92C wherein it has been clearly stated that no deduction under section 10A/10AA or section 10B or under Chapter V ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essing Officer acquires jurisdiction to redetermine or recompute the ALP if he is satisfied on the basis of material or information in his possession that the circumstances mentioned in sub-section (3) of section 92C of the Act exist. Once such jurisdiction is acquired then the Assessing Officer can refer the matter to compute the ALP to the TPO under section 92CA(1) of the Act if he forms an opinion that it is necessary or expedient to do so. According to him, such reference can only be made if he acquires the jurisdiction under section 92C(3) of the Act. Therefore, in the absence of acquiring such jurisdiction, the Assessing Officer cannot refer the matter to the TPO under section 92CA(1) of the Act. This argument is based on the principle "what cannot be done directly, cannot be done indirectly". Reliance has been placed on the judgment of the hon'ble Supreme Court in the case of CIT v. Paharpur Cooling Towers P. Ltd. [1996] 219 ITR 618, in support of the above proposition. Particular reliance was placed on the following observations of their Lordships at page 627. "Section 245E which. . . . empowers the Commission to reopen any completed proceedings connected with the case bef ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r of computation of the ALP to the TPO. Proceeding further, it submitted that the provisions of sub-section (4) of section 92C of the have been incorporated in section 92CA by virtue of the provisions of sub-section (4) of section 92CA of the Act. Had it been the intention of the Legislature as contended by learned senior counsel for the intervener, then the Legislature would have provided specifically in section 92CA of the Act. According to him, the decision of the hon'ble Supreme Court was rendered in a different context and the same cannot be applied in deciding this issue. In fact, according to him, the issue is squarely covered by the decision of the hon'ble Delhi High Court in the case of Sony India P. Ltd. v. CBDT [2007] 288 ITR 52 where the proposed question has been answered in the negative vide paragraph 20 of the judgment and there is no judgment to the contrary. 49 Rival submissions of the parties have been considered carefully. After giving our deep thoughts to the submissions of the parties, we are of the view that the Assessing Officer is not required to demonstrate the existence of the circumstances set out in clauses (a) to (d) of sub-section (3) of section 92C o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... both the sections are quite distinct as procedure to be followed in the sections is different. In the above sub-section 92CA(1), there is no reference to section 92C(3). Moreover, it is mandatory for the TPO to determine the arm's length price in accordance with sub-section (3) of section 92C. If the above section to be applied by the TPO under section 92CA(3) at the prescribed stage, there is no question of applying the same provision at the stage of making reference. What purpose would be served by applying the same provision again and again. Therefore, on a plain and clear language of statutory provision, we do not find any force in the claim of the assessee. It would be sufficient for invoking the provisions of section 92CA(1) if it is shown that there existed circumstances which prompted the Assessing Officer to consider it necessary or expedient to refer the computation of the ALP to the TPO. Once it is shown that there existed circumstances on the basis of which the Assessing Officer could consider it necessary or expedient, the matter ends. The Commissioner of Income-tax (Appeals) has emphasized on the words "the said international transaction under section 92C". These wor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ber 27, 1976, in the course of which, a number of documents were seized. At that point of time, the assessments for the assessment years 1970-71 to 1974-75 had been completed but the assessment proceedings for the assessment year 1975-76 were pending. On June 24, 1977, the assessee approached the Settlement Commission with an application under section 245C of the Act, wherein against col. 5, the assessment year 1975-76 and any other proceedings that may be decided by the Settlement Commission was mentioned while against col. 8 regarding particulars of matters to be settled, the assessee stated assessment of total income for the assessment year 1975- 76 and any other matter that may be decided by the Settlement Commission. The application of the assessee was forwarded to the Commissioner of Income-tax for his report under section 245D(1) of the Act. In his report dated July 6, 1977, the Commissioner stated that he has no objection to the application for settlement, being processed in respect of the assessment year 1975-76. Thereafter, the Settlement Commission admitted the application of the assessee vide order dated July 21, 1977. Before the Settlement Commission, the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mplated by the Legislature. Accordingly, the said judgment, in our opinion, cannot be applied to the present case. 54 In view of the above discussion, we answer question No. 2 in the negative, i.e., in favour of the Revenue and against the assessee. Contrary views expressed by the learned Commissioner of Income-tax (Appeals) are, therefore, erroneous and cannot be sustained. 55 Questions Nos. 3 to 6 are being considered together since these are interrelated in connection with the interpretation of section 92CA(1) of the Act. These questions read as under "3. Whether the Assessing Officer is required to record his opinion/reason before seeking the previous approval of the Commissioner under section 92CA(1) of the Income-tax Act, 1961 ? 4. Whether before making a reference to the Transfer Pricing Officer under section 92CA(1) read with section 92C(3) of the Income-tax Act, 1961, is it a condition precedent that the Assessing Officer shall provide to the assessee an opportunity of being heard? 5. Is the approval granted by the Commissioner under section 92CA(1) justiciable ? If so, can it be called in question in appeal on the ground that it was accorded without due diligence or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cie opinion on the basis of material/information that it is necessary or expedient to refer the computation of the ALP to the TPO. 58 However, it was further submitted by him that the decision of the hon'ble Delhi High Court to the effect that no opportunity is required to be given to the assessee before making such reference is contrary to the later judgment of the apex court in the case of Rajesh Kumar [2006] 287 ITR 91. It was submitted by him that the apex court was concerned with the interpretation of the provisions of section 142(2A) of the Act, which provides that having regard to the nature and complexity of the accounts of the assessee and the interests of the Revenue if the Assessing Officer is of the opinion that it is necessary to do, he may, with the previous approval of the Chief Commissioner of Income-tax or the Commissioner of Income-tax, direct the assessee to get the accounts audited by an accountant nominated by the Chief Commissioner of Income-tax/Commissioner of Income-tax. He drew our attention to the relevant observations of their Lordships to the effect that (i) where an authority, be it administrative or quasi-judicial, adjudicates on a dispute and if its ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tions may cause hardships to the taxpayers. Therefore, it is submitted that the principles of natural justice must be complied with. Hence, it has been finally contended that recording of reasons and providing of an opportunity to the assessee before referring the matter to the TPO are conditions precedent which must be complied with and failure of which would render such proceedings as bad in law. 59 Proceeding further, it has been submitted that grant of approval under section 92CA is also not mechanical and, therefore, the same should be done having regard to the materials on record. According to him, the learned Commissioner of Income-tax can correct the Assessing Officer if the Assessing Officer has not exercised the discretion correctly. Hence, it is pleaded that separate opportunity must also be provided by the learned Commissioner of Income-tax before granting the approval so that the assessee may point out the shortcomings in the reasons recorded by the Assessing Officer. He distinguished the decision of the hon'ble Karnataka High Court in the case of Rishabchand Bhansali [2004] 267 ITR 577, relied upon by the Revenue by submitting that the court proceeded on the footing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... always challenge the action of the Assessing Officer if it contravenes the requirement of the relevant provisions. In such cases, the appellate authorities can ignore such circular and correct the mistakes committed .by the tax authorities. Reliance is placed on various decisions; Kerala Financial Corporation v. CIT [1994] 210 ITR 129 (SC), CWT v. Balbhadradas Bangur [1984] 148 ITR 149 (Cal) ; Paper Products Ltd. v. CCE [2001] 247 ITR 128 (SC) and CST v. Indra Industries [2001] 248 1TR 338. In view of the same, it has been argued that Instruction No. 3 is binding so long as it is benevolent, i.e., no reference can be made where the aggregate value of the transactions does not exceed Rs. 5 crores. However, where the aggregate value exceeds Rs. 5 crores, the reference to the TPO can be made subject to the conditions specified in the provisions and principles of natural justice. In no case, the Central Board of Direct Taxes circular can take away the requirement of the relevant provisions. 62 Mr. Pradeep, learned counsel for the assessee has adopted the arguments of Mr. Poddar. However, it has been submitted by him that where there is non-compliance with the provisions of section 92 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aring in section 142(2A) is absent in section 92CA. According to him, there is no internal remedy against the direction under section 142(2A) while under section 92CA, the assessee can always demonstrate before the TPO that such transactions are at the arm's length. Further, the assessee has another opportunity before the Assessing Officer under section 92CA(4) as well as another remedy under section 144A of the Act. Further, the assessee has also external remedy by way of appellate proceeding and in fact, it availed of such benefit before the learned Commissioner of Income-tax (Appeals). Thus, it cannot be said that civil consequences ensue. Consequently, the ratio laid down by the apex court in the case of Rajesh Kumar [2006] 287 ITR 91 cannot be applied in the present case. Lastly, it is submitted that a decision is an authority for what it decides and it is neither desirable nor permissible to read the observations from a judgment divorced from the context Reference is made to various decisions Vinay Extraction P. Ltd. v. Vijay Khanna [2004] 271 ITR 450 (Guj)), Ajanta Pharma Ltd. v. Asst. CIT [2004] 267 ITR 200 (Bom), V. Jaganmohan Rao v. CIT/EPT [1970] 75 TTR 373 (SC) (Referen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... x Act, 1961 are judicial proceedings in view of the provisions of section 136 of the Act, as held by the apex court in the case of Rajesh Kumar [2006] 287 ITR 91, (iii) the action or orders of such authorities are amenable to. judicial review. The above legal position is not disputed even by the Revenue. In this background, we proceed now to consider the issues raised in the proposed questions. 68 We are required to construe the provisions of section 92CA(1) of the Act. Therefore, it would be appropriate, even at the cost of repetition, to repro duce the provisions of section 92CA(1) as under: "Where any person, being the assessee, has entered into an inter national 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 Commissioner, refer the computation of the arm's length price in relation to the said international transaction under section 92C to the Transfer Pricing Officer." 69 A perusal of the above provision clearly shows that the Assessing Officer has to exercise his power in the circumstances mentioned therein, i.e., by the words "necessary or expedient". The dictionary meaning ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , therefore, should not be read as "necessary and expedient" as done by the learned Commissioner of Income-tax (Appeals) which can lead to a different meaning. The procedure to determine the ALP in section 92CA is different from the one provided in section 92C. Under section 92C, the Assessing Officer has himself to determine the ALP whereas under section 92CA, he can refer the matter to the TPO. There is nothing in the section to suggest that the Assessing Officer should hear the assessee or record reasons before making reference to the TPO. There is further nothing in the section to suggest that the Assessing Officer should ask the assessee whether he should himself proceed to determine the ALP or should involve the TPO for this purpose. It is no doubt true that the assessment under the Income-tax Act is quasi-judicial and principles of natural justice are applicable. But it cannot follow that every step taken by the Assessing Officer must satisfy principles of natural justice or must be "judicial" in character. It has to be accepted that the Assessing Officer has to play a dual role. He is also an adjudicator and assessor while remaining the Assessing Officer; a quasi-judicial a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee has not understated the income etc. etc. a purpose quite similar to purpose of section 92CA(1). The plain language of the provision does not support any of the arguments taken by learned counsel for the intervener or the assessee. The question of issuing notice to the assessee, hearing him or recording reasons before making reference to the TPO for computation of the ALP does not arise. The reference is a step in the collection of material which might be useful for making assessment. No violation of any civil rights of the assessee is involved here. Mere reference does not tantamount to any adverse assessment or use of adverse material. As per the statutory provision, the TPO is required to provide opportunity of being heard to the assessee in the process of determination of the ALP. Besides, with respect, the assessee cannot be asked to have a choice whether in his case the ALP should be determined by the Assessing Officer or by the TPO. 75 Having made the above observations, we must add that the Assessing Officer cannot make a reference for some ulterior motive or for the sake of mere pleasure or in a mechanical manner. The Assessing Officer should have some material with him ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... il rights of the assessee or related to matters involving final disposal of the issue and do not relate to some interim order or to a step in the process of the assessment. There it was not the question whether the Assessing Officer should himself determine the ALP or should get help from the TPO. Those matters related to transfer of cases from one station to another or initiation of reassessments or acquisition proceedings. Thus, reopening of the closed assessments or matters involving civil rights of the assessee cannot be compared with a situation where the Assessing Officer has merely to decide whether he should himself determine the ALP or it would be "necessary or expedient" to get it determined from the TPO. There is no vested right with the assessee to force the Revenue to follow a particular course and not the other alternative. 78 The case of Rajesh Kumar v. Deputy CIT [2006] 287 ITR 91 (SC), strongly relied upon by learned counsel for the assessee has already been discussed earlier. The case has no application here. We state again the following basis for the decision. In the first place, their Lordships of the Supreme Court has referred the matter to a larger Bench, for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re more than one transaction with an associated enterprise or there are transactions with more than one associated enterprises the aggregate value of which exceeds Rs. 5 crores, the transactions should be referred to the TPO. Before making reference to the TPO, the Assessing Officer has to seek approval of the Commissioner/Director as contemplated under the Act. Under the provisions of section 92CA reference is in relation to the international transaction. Hence, all transactions have to be explicitly mentioned in the letter of reference. Since the case will be selected for scrutiny before making reference to the TPO, the Assessing Officer may proceed to examine other aspects of the case during pendency of assessment proceedings but await the report of the TPO on the value of international transaction before making final assessment. The threshold limit of Rs. 5 crores will be reviewed depending upon the workload of the TPOs. The work relating to selection of cases for scrutiny and reference to TPO on the above basis in respect of pending returns filed for the assessment year 2002-03 should be completed by June 30, 2003." 82 It is not in dispute that the abovesaid circular was is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act." 85 Therefore, when the provisions of section 92CA(1) are read with Circular of Central Board of Direct Taxes (Instruction No. 3) dated May 20, 2003, ([2003] 261 ITR (St.) 51), it becomes "necessary" for the Assessing Officer to refer the question of determination of transfer pricing of international transactions to the TPO. He has no discretion in the matter in the light of limit fixed by the Board. The Assessing Officer has only to look at the aggregate value of international transactions disclosed by the assessee in the audit report and then follows directions of the Central Board of Direct Taxes. The Assessing Officer, therefore, is left with a very limited role under section 92CA(1). Likewise, while granting approval to the action of the Assessing Officer, the Commissioner has only to see whether the aggregate value of international transaction is more than Rs. 5 crores or not. If it is more, he has also to grant approval in the light of the directions of the Central Board of Direct Taxes. These directions are mandatory and binding on the Assessing Officer and the Commissioner. The fact that directions are not binding on the assessee or courts is immaterial. The relevant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thereafter proceed to amend the order of assessment in conformity with such order of the Transfer Pricing Officer". According to Shri Poddar, sub-section (6) clearly suggest that order of the TPO even under sub-section (3) of section 92CA is binding on the Assessing Officer. Otherwise sub-section (6) would have no meaning if in the assessment order the arm's length price has not been taken as deter mined by the TPO. The question of amending such assessment order in conformity with order of TPO cannot arise. Thus, sub-section (6) would have no meaning or operation. He argued that as per settled law, all the sub-sections, i.e., sub-sections (4), (5) and (6) of section 92CA are to be read together and harmoniously and should be interpreted in a rational manner to advance the purpose of the provision. If under sub-section (6), the Transfer Pricing Officer has to amend his assessment order in conformity with amended order of the TPO, the original assessment is also required to be made in conformity with the arm's length price determined under sub-section (3). 92 When attention of Shri Poddar was drawn to the decision of the Delhi High Court in the case of Sony India P. Ltd. [2007 288 I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d interpretation of the Privy Council of the words "having regard to" in CIT v. Williamson Diamonds Ltd. [1959] 35 ITR 290. The Privy Council had held (page 297) "The form of the words used no doubt lends itself to the suggestion that regard should be paid only to the two matters mentioned, but it appears to their Lordships that it is impossible to arrive at a conclusion as to reasonableness by considering the two matters mentioned isolated from other relevant factors. Moreover, the statute does not say 'having regard only' to losses previously incurred by the company and to the smallness of the profits made. No answer, which can be said to be in any measure adequate, can be given to the question of 'unreasonableness' by considering these two matters alone. Their Lordships are of the opinion that the statute by the words used, while making sure that 'losses and smallness of profit' are never lost sight of, requires all matters relevant to the question of unreasonableness to be considered. Capital losses, if established, would be one of them." 95 Their Lordships of the Delhi High Court further concluded as under (page 69) "In view of the settled legal position, we are of the view ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntrary observations of the learned Commissioner of Income-tax (Appeals) in the impugned order. 97 As far as the decision of the Supreme Court in the case of Rajesh Kumar v. Deputy CIT [2006] 287 ITR 91 is concerned on which strong reliance was placed, their Lordships, as already noted, have observed that the expression "having regard to" in this context assumes some significance. An opinion must be formed strictly in terms of the factors enumerated therein. The expression indicates that in exercising the power regard must be had also to the factors enumerated therein together with all factors relevant for exercise of that power. 98 Their Lordships further quoted the following extracts from two decisions of the Supreme Court in the above report: (i) India Cement Ltd. v. Union of India [1990] 4 5CC 356 "The meaning of the expression 'having regard to' is well-settled. It indicates that in exercising the power, regard must be had also to the factors enumerated together with all factors relevant for exercise of that power." (emphasis' supplied) (ii) Delhi Farming and Construction P. Ltd. v. CIT [2003] 260 ITR 561 (SC) "The words 'having regard to' used in the section do not restr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s, we hold that prior to substitution of sub-section (4) by a new sub-section, the order of the TPO was not binding on the Assessing Officer. 102 In the course of hearing, Shri N. K. Poddar argued that in the case of the intervener in appellate proceedings, the learned Commissioner of Income- tax (Appeals) had remitted the question of determination of transfer pricing again to the TPO. After discussion with the assessee, the TPO accepted the transactions to be arm's length transactions. However, the Department has not accepted the order of the TPO and are agitating the matter in appeal. As all the facts and circumstances of the case are not before us, we cannot express final view and accordingly leave the question to be determined by the Bench, before whom the matter is pending. Ordinarily without strong reasons, the Assessing Officer should not challenge the transfer pricing determined by the TPO and bring to naught his efforts after receipt of the reference. Our observations that it was not binding on the Assessing Officer, prior to June 1, 2007, are meant to convey that the assessee even before the Assessing Officer could file evidence and show that the arm's length price shown ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (Master Agreement - Page 1, Clause-5). 107 Then taxpayer issued work orders to Aztec-US for every client's project. The professionals under the employment of Aztec US performed the stipulated tasks based on the specifications given in the work orders. Sometimes the personnel from the taxpayer were also deployed to assist them. The payment to Aztec US was made on a cost + markup basis, The markup charged was 5 per cent, of the cost. (Master Agreement-page 4, clause 3.1) The term "cost" is, however, nowhere defined in the agreement. 108 The taxpayer had further appointed Aztec-US as its marketing agent in USA. As per the marketing agreement dated April 1, 2001, Aztec US was to perform the following functions: Deputing personnel to sell products of Aztec-India, Ensuring minimum number of orders and Ensuring prompt payment by customers. 109 The taxpayer was to compensate Aztec-US for its services by reimbursing "cost of service" with a 10 per cent. markup. During the period relevant to the assessment year under consideration the taxpayer paid a sum equal to Rs. 9,32,66,856 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es of Aztec US are used for providing onsite development services to customers. The taxpayer also pointed out as follows. "Aztec US functions as a contract service provider and operates in a risk-mitigated environment. Aztec US is insulated from entrepreneurial risks. Hence, payments to Aztec US are independent of the commercial outcome of the contracts entered into by the taxpayer with the customers. Aztec US is reimbursed the expenses plus a reasonable mark up for the functions performed. Transactions involving availing of services of Aztec US are separate and distinct from the transactions relating to services rendered by the taxpayer under the contracts with customers in U.S. Hence, these should not be compared to ascertain the transfer price." 116 The Transfer Pricing Officer, vide letter dated September 20, 2004, further required the assessee to explain/furnish the following details (a) Whether Aztec US rendered marketing support services in the period prior to April 1, 2001 ? (b) With reference to justification of sales commission to Aztec US on TNMN method, the TPO observed that "comparables" chosen were in the business of computer system design, software development etc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ut to 79 dollars per man hour. 122 After considering the submissions of the taxpayer, the TPO put her proposed the arm's length determination to the taxpayer for its objection vide TPO's letter dated November 2, 2004. The matter was fixed for final hearing. The proposal is summarized as under: (a) Certain companies included in working the average marketing expenditure did not show any such expenditure nor could have included them under other heads and hence such companies are being excluded from consideration. After exclusion of such companies, average marketing expenditure works at 2.52 per cent. as against 13.22 per cent. claimed by the taxpayer. The contention of the assessee that companies included in the list might have misclassified certain expenditure could not be accepted as no evidence was placed in support of such claim. (b) In respect of onsite services, TPO proposed the arm's length price as the amount equivalent to onsite service charges received by the assessee as per accounts ascertained at 22.3 per cent. 123 The taxpayer company filed further objections vide letter dated November 25, 2004. As per the transfer pricing study claimed to be carried by the company, t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... us companies were not required to disclose marketing expenses under separate head and hence data used by the taxpayer was reliable. In respect of onsite software development services, it was submitted that Aztec functioned as a contract service provider and such payments were not at all comparable to the revenue received by the taxpayer from its clients on account of onsite services. 127 It was also submitted that TPO was proposing to allow only Rs. 21,73,40,292 as expenditure as against Rs. 35,45,21,482 actually incurred and such disallowance of expenditure under the guise of the arm's length procedure was not warranted. Had the assessee opened a branch in the USA instead of a subsidiary, then all such expenses would have been allowable ; it was further contended. 128 After considering the submissions of the assessee, the TPO vide order dated February 21, 2005, determined the arm's length price. The TPO rejected the contention of the assessee that payments were made to Aztec US on the basis of contract and therefore could not be questioned. The TPO took into account article 9 of the OECD Model Tax Convention providing that any condition, "which differ from those which would be m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... this conclusion TPO referred to the fact that Aztec-India was billing its customer at an average rate of US$ 79 per man hour for onsite services against industry average of US$ 58-65 per hour during the same period. The TPO was of the view that on account of the above factors downwards adjustments needs to be made to the CUP or the price charged in comparable uncontrolled transaction to arrive at the arm's length price as laid down in rule 10B(1)(a). The TPO suggested the following adjustments in internal and external CUP Adjustment to internal CUP Internal CUP represents the price charged by the taxpayer to the end customers in respect of onsite software services outsourced to Aztec-US. The adjustment should account for the following differences * The return for extra functions performed by Aztec-India including administrative and sale functions in addition to the technical functions out sourced to Aztec-US. * The return for additional assets deployed by Aztec-India, in particular the trade name Aztec. * The return for all the commercial risks undertaken by Aztec-India. Even after accepting that "these factors influence the pricing in any market condition", the TPO did not m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... " amount at US$ 0.0076 million, but found that the assessee had actually paid 1.9 million US$ to its associated function. The TPO thus concluded that entire bills of annual salary of all non-software personnel of Aztec US along with a 10 per cent. markup which was quite in excess of the arm's length price were raised on the assessee. To show that the transaction was not at arm's length the TPO further took into account revenue receipts of the assessee and totals recoverable debts for the years ending March 31, 2000, and March 31, 2001. She concluded that payment of Rs. 9.62 crores by the assessee to Aztec US resulted in decrease of revenue of Rs. 8.6 crores and further resulted in out standing debts (beyond six months) at Rs. 1.13 crores. The learned TPO accordingly noted that taxpayer has justified the amount paid both for marketing and software services with common analysis. She rejected the analysis and working of the ALP of taxpayer by observing that US enterprises selected for comparison were in software business and there was no evidence to show that these companies were carrying on marketing functions as were rendered by Aztec-US. 134 The TPO determined the ALP in respect o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ervices Total Rs. 9,06,93,275 Rs. 9,11,23,568 Rs. 18,18,16,843 137 During the course of the assessment proceedings before the learned Commissioner of Income-tax (Appeals) the taxpayer submitted his objections against the assessment and order of the TPO. These are summarized as under (a) It is not correct to say that the taxpayer's auditor did not compute the arm length's price correctly in accordance with law. The company had conducted transfer pricing analysis and the same was submitted to the TPO vide letter dated February 16, 2004. (b) The taxpayer had identified 10 companies based in US which were businesswise comparable to Aztec-US. These companies were providing similar services and operating profit margin of these companies was com parable to the operating profit margin of Aztec-US. (c) In the transfer pricing study, the company had evaluated the applicability of all the possible methods and considered transactional net margin method (TNMM) to be the most appropriate method. (d) The arm's length price is also to be seen from the angle of tax payer having a branch in US. In such circumstances, all the expenses incurred would have been allowable. Thus, the issue under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e reimbursement could form subject matter of inter national transaction is not understandable. Not only the mark up amount but also the reimbursement amount to the associated enterprise could bear the characteristic of an international transaction in terms of section 92B(1) of the Income-tax Act. (iii) On approach and determination of the ALP by the TPO, the learned Commissioner of Income-tax (Appeals) has observed that in a nut-shell what has been done in the order of the Transfer Pricing Officer is that it has been presumed that Aztec US as respective associated enterprises had less of functions, asset deployment and risk sharing that were disproportionate to the presumed excessive payments made to them by Aztec India. Such presumed excessive payments to these associated enterprises, i.e., Aztec US have been tried to be justified by arguing that they are not in commensuration with and are disproportionately excessive to the revenue earned by the appellant from its different end customers. To justify this proposition the Transfer Pricing Officer has tried to demonstrate as to how the appellant has charged from its customers the revenue for the services rendered to them for differ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n made on the basis of order of the TPO. 140 The grounds of appeals, against the above order of the Commissioner of Income-tax (Appeals), as raised in the assessee's appeal ITA No. 584/Bang/06 are: "1. That the orders of the authorities below in so far as it is against the assessee is against the law, facts, circumstances, natural justice, equity and all other known principles of law. 2. That the total income computed and the total tax computed is hereby disputed. 3. The learned authorities below erred in holding the sum of Rs. 1.00 crore paid for termination of the lease/rent agreement as capital expenditure. The appellant submits that expenditure is revenue in nature and prays that the amount paid for termination of lease be allowed as claimed in the interest of justice. 4. That the learned authorities below have not appreciated the entire issue in the right perspective and the findings are totally against the facts emerging on record. 5. The order of the Commissioner of Income-tax (Appeals) on the issue of transfer pricing order in so far as it is against the appellant is in error. 6. The Commissioner of Income-tax (Appeals) erred in holding that ipso facto the determinat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a certain limit, refer the same to the Transfer Pricing Officer who being an expert and dealing with only such transactions, goes on to determine whether the arm's length price has been arrived at in a fair manner. The Transfer Pricing Officer thus takes over the role of the Assessing Officer when the provisions of Chapter X are involved. The Commissioner of Income-tax (Appeals) has failed to appreciate the above position. 6. The entire thrust of the appellate order has been on improper application of mind and non-determination of a clear case of tax avoidance by the Assessing Officer and also by the Administrative Commissioner before making the reference to the Transfer Pricing Officer. The learned Commissioner of Income-tax (Appeals) has failed to see that this responsibility of determination and quantification of the arm's length price has been cast on a specialised Assessing Officer called the Transfer Pricing Officer who deals exclusively with international transactions and its provisions under Chapter X. 7. The Commissioner of Income-tax (Appeals) erred in holding that the provision of Chapter X can be invoked in cases when there is a presupposition of avoidance of tax. 8. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d on the arms' length price computation of the tax payer. The taxpayer has done comparability analysis using date of "comparables" pertaining to the years 1999, 2000 and 2001 which is not permissible as per statutory requirements. Earlier year's data can be used only when such data influenced the determining of the transfer price. No claim has been made to this effect nor any material brought on record to show such influence. Hence, results of earlier years were not relevant and rule 10B (4) was not applicable. OECD guidelines also do not support the use of earlier year data as a statistical in the actual arithmetical computation of the arm's length price. Such multiple year data could be used merely when such data explains certain trends in the current year. The weighted averages of earlier years could not be used in the actual computation of ALP. It was submitted that the comparability analysis furnished by the taxpayer was thus not in accordance with the rules. The taxpayer had used non-contemporaneous data. 144 It is contended that order of the learned Commissioner of Income-tax (Appeals) striking down computation of the ALP by the TPO in respect of provision of onsite softwar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y's customers in the USA, for and on behalf of the company". (Master agreement-page 1, clause 5) 147 The taxpayer could not revise its claim changing nature of transaction from "provision of onsite software services" to "reimbursement" without revising the claim by filing revised return. The learned Commissioner of Income-tax (Appeals) also fell in error in not providing any opportunity of being heard to the TPO on this new claim. The learned Commissioner of Income-tax (Appeals) further failed to appreciate that primary "onus" of computation of the ALP was on the taxpayer and the same was not discharged. 148 The Revenue has challenged the finding of the learned Commissioner of Income-tax ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hrough Aztec US. On the contrary Aztec US earned profit of 41.65 per cent. from business dealing with the assessee. Working of this huge profit is claimed to be given at page 34/35 of the paper-book/written submission filed by the Revenue. It was accordingly submitted that it was a clear case of shifting and diversion of profit by the assessee to the US company. 151 The Revenue has also objected to the stand of the assessee that only "markup portion" of the compensation, attracted application of transfer pricing provision as the rest represents third party cost incurred by the Aztec US exclusively for the benefit of the taxpayer. This argument was rejected by the learned Commissioner of Income-tax (Appeals) also. 152 It is contended by the Revenue that analysis furnished by the assessee did not satisfy the requirement of section 92C(1) and (2) and relevant rules governing the computation of the arm's length price. It is pointed out that arm's length price is to be determined by following the most appropriate method. It is pointed out that taxpayer had chosen transactional net margin method (TNMM) as most appropriate method, on the ground that the other 4 methods given under secti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... man-hours not accepted by the client or wasted the bench man-hours), Aztec India cannot be expected to pa for the unbillable hours of the service provider either. The amount debited is clearly described in the profit and loss account of Aztec India (schedule 12) as onsite service charges. Hence, this cannot be treated as payment for anything other than onsite services. Therefore, the rate of payment (billing rate) can be calculated only with reference to the onsite man-hours billed and nothing else. Every service provider incurs cost towards surplus capacity or bench. Every service provider does man-hours of work, which cannot be billed to the customer or are rejected by the customer. Billing rates are always calculated without taking these into account. 156 The most serious objection of the Revenue is that after rejecting the ALP determined by the TPO the learned Commissioner of Income-tax (Appeals) accepted the ALP of the assessee impliedly although it suffered from various defects and was unsustainable under the law. 157 In respect of marketing commission, it has been submitted that the learned Commissioner of Income-tax (Appeals) allowed relief without any discussion or reaso ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd its "open market value". Under section 7(1) of the Wealth-tax Act, the value of an asset owned by the taxpayer, is provided "to be the price which, in the opinion of the Assessing Officer, it would fetch in the open market". Under section 40A(2) of the Income-tax Act, tax authorities, in case of claim of payment to a close relative or a sister concern, are empowered to substitute for such payment the market value of goods, services or facilities provided where it is found that the payment is excessive and unreasonable. Under the above provisions and several other enactments, courts in India have laid useful guidelines to help determine the open market value of property/transaction. These guidelines for the determination of fair market value are quite well-settled. All circumstances surrounding the transaction, influencing its market value, are required to be considered. Rule to compare like with like is firmly established. However, technical terms like "controlled transaction", "uncontrolled transaction", "international transaction", etc., various methods of determination of the arm's length price, obligation of the taxpayer to maintain record of international transaction and su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aken to be the arithmetical mean of such prices, or, at the option of the asses- see, a price which may vary from the arithmetical mean by an amount not exceeding five per cent. of such arithmetical mean/' 162 Section 92(2) deals with the arm's length price as follows: "Where in an international transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, ser vice or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm's length price of such benefit, service or facility, as the case may be." 163 The transfer pricing methods prescribed in section 92C, are further described and explained in rules 10A, 10B and 10C. Though section 92C(2) specifies that the Board may prescribe certain other methods of computation of the arm's length price, no other method has been prescribed by the Central Board of Direct Taxes till date. 164 Before ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the responsibilities, risks and benefits are to be divided between the respective parties to the transactions (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.' 166 The parameters for taking a controlled transaction as "comparable' to an uncontrolled transaction are provided in sub-rule (3) of rule 10B. Sub- rule (4) of the aforesaid rule states the period for which data should be collected. These are as under "Rule10B. (3) An uncontrolled transaction shall be comparable to an international transaction, if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t appropriate method (MAM) is based on the nature of transaction, the availability of relevant data and the possibility of making appropriate adjustments. 170 The various methods are now discussed hereunder: Comparable Uncontrolled Price method (CUP) : CUP is described in rule 10B(a) as follows "(a) comparable uncontrolled price method, by which,- (i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified (ii) such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market; (iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm's length price in respect of the property transferred or ser vices provided in the international transaction ;" CUP is applied when a price is charged for a product or service. 171 This is essentially a comparison of prices charged for the property or services transferred in a controlled transaction to a price charged for prop ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled trans action, or a number of such transactions; (iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services (iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market; (v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise ;" 175 The RPM is to be applied when a property purchased or services obtained from an associated enterprise is resold to an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y agreements, long- buy and supply arrangements of provisions of services, etc. 178 This is a method, which uses the costs incurred by the supplier of the property or services in a controlled transaction. Here also as in the case of RPM benchmarking of normal gross profit margins is necessary. The cost plus markup of the supplier in a controlled transaction should ideally be established by reference to the cost plus mark up with the supplies of functional similarity earned in a comparable uncontrolled transaction. 179 The cost plus method is adopted in situations where comparable transactions are of functional similarity with that of controlled transactions. In other words, under cost plus method, there is no necessity to benchmark with such product, which is 100 per cent. identical. Products, which are functionally comparable, are good enough for benchmarking under the cost plus method. Even in this regard FAR analysis is critical in identifying functionally similar comparable transactions. 180 As in other methods, the assets employed, the functions performed, the risk assumed, the contractual terms and other differences have to be taken into account. The mark up must be measur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsactional Net Margin Method (TNMM): Rule 10B(1)(e) describes TNMM as under (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to an other relevant base (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realized by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii) (v) the net profit margin thus established is then taken int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such arithmetical mean. 188 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 Income-tax Rules lays down the factors to be considered in selection of MAM. These have been extracted in the previous paragraphs. 189 Hence, while making the selection of the transfer pricing method, one would be required to evaluate each method vis-à-vis the factors/parameters prescribed in rule 10C(2). 190 Once MAM, i.e., most appropriate method is selected, the next step is to collect the inputs for computing the arm's length price under that method. The question, arises as to who has the onus of collecting and furnishing the requisite inputs for determining the ALP. 191 To answer the above question, we find guidance from sub-section (1) of section 92 which, for a ready reference, is reproduced below "92.(1) Any income arising from an internat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rnational trans actions entered into with each associated enterprise, details of property transferred or services provided and the quantum and the value of each such transaction or class of such transaction (e) a description of the functions performed, risks assumed and assets employed or to be employed by the assessee and by the associated enterprises involved in the international transaction (f) a record of the economic and market analysis, forecasts, bud gets or any other financial estimates prepared by the assessee for the business as a whole and for each division or product separately, which may have a bearing on the international transactions entered into by the assessee (g) a record of uncontrolled transactions taken into account for analysing their comparability with the international transactions entered into, including a record of the nature, terms and conditions relating to any uncontrolled transaction with third parties which may be of relevance to the pricing of the international transactions; (h) a record of the analysis performed to evaluate comparability of uncontrolled transactions with the relevant international transaction; (i) a description of the methods c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ample power to determine the same and make suitable adjustments. In such a situation, as rightly admitted in the ground of appeal by the Revenue, this responsibility of determination of the ALP is shifted to the Revenue authorities who are to determine the same in accordance with the statutory regulations. 195 There is a criticism that the Legislature is not justified in placing onerous burden on the taxpayer to maintain detailed documents and to justify that transaction was carried at the ALP. It is contended/argued that this is like insisting upon production of self-incriminating evidence and is uncalled for. This criticism, in our opinion, is without any valid basis. It is to be remembered that international transactions carried by the taxpayer are cross-border transactions. The Departmental authorities in India are required to deal with and determine the ALP of transactions carried in Asia, Europe, America, Australia, other developed and underdeveloped countries in Africa, etc. It is very difficult, if not impossible for them to find relevant data of an exact or of a similar transaction or profit made not only by the taxpayer, but also by other similarly situated uncontrolled ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ose information relevant to the question of whether the arm's length principle has been violated. This information would include items such as prices and gross profit earned by the parent company when dealing with other group companies and with unrelated customers. Where this information is not disclosed, the court concludes that the burden of proof on the Danish tax authorities is reduced. France As a rule, the burden of proof lies with the tax authorities, unless the transfer of profits concerns a tax haven, in which case the burden of proof is transferred to the taxpayer. Recent developments mean that there is now a legal requirement for taxpayers to provide documentation supporting their transfer pricing policies. Though in theory the burden of proof lies with the tax administration, in practical terms the burden of proof has always fallen on the taxpayer where the tax authorities have deemed a profit shift to have taken place or inappropriate transfer pricing to exist. Indonesia Indonesia operates on a self-assessment system with companies setting their own transfer prices. The burden of proof lies with the taxpayer to prove that the original price has been set at arm's l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transfer pricing issues, the burden of proof usually lies with the tax authorities. On the other hand, the burden lies with the taxpayer to prove the deductibility of expenses. In transfer pricing cases the burden of proof transfers to the tax payer if the pricing arrangements are very unusual, for example if comparable uncontrolled prices (CUP) are available but not used, or goods or services are provided at cost or below cost. The burden of proof is also transferred to the taxpayer, and will be more onerous, if he/she refuses to provide information requested by the tax authorities where there is a legal obligation to provide that information, or if the requisite tax return is not filed. Finally, the court sometimes allocates the burden of proof to the party best able to provide the evidence. New Zealand In New Zealand, the burden of proof normally lies with the tax payer, not the Commissioner. However, section GD 13(9) places the burden of proof on the Commissioner where the taxpayer has deter mined its transfer prices in accordance with section 13(6) to 13(8) of the New Zealand Tax Act. Where the Commissioner substitutes an arm's length price for the actual price, then the C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adversarial relationship between the Government and the taxpayer. This additional compliance burden is not unique to the field of transfer pricing. 198 Similar provisions are available in the laws of other countries. It would be seen that even a most advanced country like the United Kingdom has provisions placing on the taxpayer the burden of proving that international transaction is carried at the ALP. 199 A dispassionate study of provisions of various countries on burden of proof, would show, the following fundamental features: (i) That the burden to establish that international transaction is carried out at the ALP, is on the taxpayer who is to disclose all the relevant information and documents relating to prices charged and profit earned with related and unrelated customer. (ii) If the Assessing Officer has determined the ALP, other than the price declared by the assessee, the Assessing Officer has to prove that the price determined by him is reliable and reasonable and confirms the statutory requirement unless the case is covered by situation No. (iii) below. (iii) In the case of failure on the part of the taxpayer to comply with the statutory provisions, the tax author ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1 There would be cases, where taxpayer does not co-operate and fails to furnish the ALP or disclose the full information, relevant for the determination of the ALP when called upon to do so by tax authorities. The taxpayer fails to discharge burden placed on the taxpayer. In similar enactments of other countries, it is provided that burden on the Revenue authorities in such a case would be reduced. We have not come across similar provision in Chapter X of the Act. The tax authorities therefore, have to resort to the provision of section 144 of the Income-tax Act and determine the ALP on the basis of the material collected or available on record. In such circumstances, the ALP determined would be on the parity with a best judgment assessment. Such assessment (determination of the ALP) would have some approximations and estimations. But even such approximations and estimations must satisfy dictates of justice and fair play and look reasonable. It cannot be arbitrary and capricious. The order of the TPO is appealable and therefore, it must be objective, contain detailed reasons, conform to regulations and should be seen as just and fair. 202 On consideration of the relevant provision ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed by the assessee and accepted by the learned Commissioner of Income-tax (Appeals) in the impugned order. It is further to be noted that in the audit report filed by the taxpayer in Form 3CEB it was stated that the taxpayer had paid Rs. 28,32,20,103 to Aztec US towards onsite software services. Likewise, the sum paid for marketing services was also stated. Taking above details from the audit report, a reference was made by the Assessing Officer to the TPO to determine the arm's length price of international transactions. The taxpayer and the TPO had fully and clearly understood what international transactions were referred for the determination of the ALP. In the light of Instruction No. 3 of 2003, approval was rightly given by the Commissioner of Income-tax as aggregate value' of transactions exceeded Rs. 5 crores. The circular being binding was required to be followed. The taxpayer filed all conceivable objections before the TPO. Although each transaction should be separately mentioned, but no prejudice is shown to have been caused to the taxpayer on account of non-mention of each transaction separately. Therefore, in our opinion, this contention is to be rejected. 204 Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stand of the taxpayer was clear that it has compensated/paid its associated enterprise, Aztec US, cost + 5 per cent. mark-up for providing "onsite software development services", and cost + 10 per cent. mark-up for the marketing services. The case pleaded by the assessee, right from the very beginning, was that payments to associated concern were made as per agreements. We do not see any change in the pleading's. The agreements were produced before the TPO and were thoroughly examined. Same case based upon agreements was set up before the learned Commissioner of Income-tax (Appeals). as is evident from the impugned order. Whether it is called "compensation of cost" or "reimbursement of expenditure" or is given some other name, could not make any difference. There was no doubt on the nature of international transactions. The question required to be determined was whether international transactions were the arm's length transactions. That was the question considered by the TPO and his assessment challenged in appeal. Having rejected the method employed by the taxpayer, the TPO chose comparables and selected methods, and ultimately determined the ALP. This has been struck down by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he net profit margin any relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realises from a controlled transaction (or transactions that it is appropriate to aggregate under the principles of Chapter I)" (OECD Guidelines, Glossary) 212 The following OECD Guidelines on transactional net margin method has also been relied upon and brought to our notice: "The transactional net margin method examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realises from a controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter I). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the by net margin of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter 1) should ideally be established by reference to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons. This comparison of operational profit of companies was considered without establishing that other companies were also involved in operation of onsite software operation and marketing services at "cost" + markup. International transactions involved here cannot be taken at the arm's length price as the taxpayer had paid more to its AE than it has realised from its customers and admitted, suffered a loss in transactions. 215 It is further stated that taxpayer did not provide bills of rates charged by AE for which total payment. of Rs. 28,32,20,103 for total 69509 man hours was made. The average per man-hour has been worked out at 85USD. The learned Commissioner of Income-tax (Appeals) has not accepted this rate as the Transfer Pricing Officer did not take into consideration the man hour, unutilised on account of idle time, leaves and overtime. The finding is claimed to be untenable. It is emphasised that the taxpayer as service provider to its customer was not expected to pay for unbilled hours. In the like manner, taxpayer cannot be exp to pay for unbillable hours of the service provider. As per business practice, the rate of payment billing, could be calculated only with refer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d Commissioner of Income-tax (Appeals) is that international transactions have been accepted to have been carried at the arm's length price although on record no such finding has been recorded by any authority. On the basis of arguments before us and material to which our attention was drawn, even we are unable to record such a finding. In not appreciating the mandate of statutory provisions that the income of every international transaction is to be determined at the arm's length price, the learned Commissioner of Income-tax (Appeals) left his task incomplete and was wrong in deleting the addition. For this glaring error, the order of the learned Commissioner of Income-tax (Appeals) can not be sustained and is liable to be set aside. We order accordingly. 217 Besides the above, the learned Commissioner of Income-tax (Appeals) committed several factual errors and to highlight few we may refer to his wrong findings at pages 173 and 174. It has been observed as under: "Transfer Pricing Officer has tried to demonstrate as to how the appellant has charged from its customers the revenue for the services rendered to them for different activities at lower than the accepted market rate ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r, the learned Commissioner of Income-tax (Appeals) did not consider the back ground of the dispute and agreement between the taxpayer and its associated enterprises (AE) Aztec US. The agreement clearly provided that AE was to be paid cost + markup profit. It is difficult to hold that the Transfer Pricing Officer was not aware of the nature of international transaction and did not carry the exercise to determine transfer price of cost + markup keeping in mind the background of the transactions. But to say that the Transfer Pricing Officer was duty bound to take into account only reimbursement transactions in same situation and not revenue generating transactions is to stretch the matter beyond the logical limits when no relevant information was made available by the taxpayer. Therefore, we are unable to agree with the above observation of the Commissioner of Income-tax (Appeals) as correct and in accordance with law. Besides, the learned Commissioner of Income-tax (Appeals) failed to take note of the nature of services, which AE was to provide, and actually provided on behalf of the taxpayer (company). Some important features of agreement between the taxpayer and AE (service provid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nly ten US companies and even it was not established that activities of these ten companies were same and similar, i.e., to provide onsite and marketing services on cost plus markup basis. It cannot be said that this base data was relevant and sufficient to come to any findings about the arm's length price. The objection of the Revenue based on sub-rule (4) of rule 10B for not confining to data for the financial year 2001-02 is also justified as it is not shown that data for other years had any influence on the determination of the ALP of the transactions involved. 224 Now, we come to the crucial question of the ALP determined by the TPO. The Revenue has justified method of transfer pricing and its figure determined by the Transfer Pricing Officer. It is contended that the Transfer Pricing Officer has rightly determined the arm's length price by using CUP method and two separate analysis; one based on external comparable and other on internal comparable. Supplementary analysis of TNMM was also carried. However, the learned Commissioner of Income-tax (Appeals) has struck down CUP analysis based on external comparable. The impugned order, however, is silent on CUP analysis based on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tions. It is urged that NASSCOM average of onsite billing rates is nothing but average or rates actually charged of a number of enterprises for onsite services. So, instead of a single specified transaction, number of transactions were considered. The fact that these individual transactions are not specifically named does not alter their character as transaction. Further justification for taking US$58 for man hour as the arm's length price is given as under: "Having identified comparable uncontrolled price or prices, the next step is to make adjustments towards transactional differences. There are transactional differences. The NASSCOM average rates of USD 58-65 per man-hour is wide enough to account for a variety of functional differences. Still, these represent the charge out rates of independent entrepreneurs with a full risk profile. As such, they require a downward adjustment to serve as the arm's length rate that can be commanded by a no-risk sub-contractor. Here again, the quantification becomes a difficult issue. Therefore, the rate of USD 58/ manhour is taken as the arm's length rate. This gives an advantage to the taxpayer as the rate is definitely higher than the arm's ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... us associated enterprises towards a single -product or service or the ultimate profit made from transfer of this product or service to a third party customer as these enterprises are scattered over different tax territories, many having no relationship with the Indian taxpayer". On the basis of this analysis, the Transfer Pricing Officer concluded that "CUP method is selected as most appropriate method" and that "it is supported by a supplementary analysis using TNMM". In the final computation of arm's length price, only the CUP method working is taken into account. It is interesting to note that there is no specific rejection of TNMM as the most appropriate method, and yet, contrary to the scheme of section 92F(2), arithmetic mean of the arm's length arrived at by these two methods is not taken into account by the TPO. She did not feel any need to even make adjustment in the external comparables on the ground that "The rate of US$18 to US$25 (for offshore) or US$ 58-65 (for onsite) is wide enough to take care of enterprise level or transaction level differences such as differences in terms of the nature of software developed or the bargaining capacity of the developer or purchaser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rm's length price will be most appropriate method on the facts of this case. The nature and class of international transactions, and other relevant factors, were required to be looked into. None of these important aspects of the matter have been dealt by the Commissioner of Income-tax (Appeals) at all. That certainly is not judicious way of dealing with the issue as to what should be the correct arm's length price on the facts of this case, more so when one of the specific grounds of appeal before the Commissioner of Income-tax (Appeals) was that "The Transfer Pricing Officer/the Assessing Officer erred in ignoring the method (of determining the ALP) followed by the appellant. The Transfer Pricing Officer/Assessing Officer ought to have adduced cogent reasons for rejecting the method followed by the appellant before substituting and prescribing a new method". Once a particular method is found to be suitable, the next thing that the Commissioner of Income-tax (Appeals) was required to examine was whether input variables required for the ALP determination have been properly gathered; if not, then the onus of gathering those inputs arises, which we have discussed above in detail. In c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ded purely on a subjective satisfaction as done in the present case, then the appellate authorities are faced with a difficult task while examining the correctness of such action. Without details, how could taxpayer effectively object that controlled and uncontrolled transactions are not comparable ? Differences are not known and adjustments imaginary. Evaluation of transactions is the most important part of transfer pricing and the TPO. In this case failed to carry the same in accordance with law. It has vitiated determination of the ALP. The Commissioner of Income-tax (Appeals) also adopted a similar approach enamoured with the erroneous impression that tax avoidance motive of the assessee is required to be established by the Revenue authorities before initiation of action for determination of the arm's length price. He did not examine the merits of the case from the right perspective, as discussed above. 231 The Revenue has justified consideration of industrial average as comparable uncontrolled transaction. Before the Transfer Pricing Officer as also in proceedings before the Commissioner of Income-tax (Appeals), the tax payer had objected to adoption of average and objection ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... states that, if it can be used, the CUP method is preferable over all other methods. In practice, this method is often very difficult to apply as it is unusual for multinationals to have the details on appropriately comparable transactions. In response to this, the OECD report suggests that multinationals and tax authorities should take a more adaptable approach to the use of this method, possibly working with data prepared for CUP purposes supplemented by other appropriate methods. The extent of the OECD's support for the CUP method can be seen from the comment that 'every effort should be made to adjust the data so that it may be used appropriately in a CUP method'." 235 In the same publication and with reference to the OECD reports, the various difficulties which are felt while making adjustment or adjustments are made impossible are stated to be on account of the following differences * differences in the quality of the products; * differences in the geographic markets; .differences in the level of the market ; and .differences in the amount and type of intangible property involved in the sale. 236 It is reasonable to infer that a specialist like TPO was well aware of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e taxpayer. However, as we have discussed above, any changes in the most appropriate method of computing the arm's length price is to be dealt with by way of a speaking order. The TPO is also at liberty to collect independent relevant information of. comparable uncontrolled transactions. Let the Revenue authorities determine the fresh arm's length price in the light of the above observation and in accordance with the regulations. Be that as it may, a fair and reasonable arm's length price should be determined as enjoined by the directions of the Board to its officer. With the above hopeful observation, we remand the matter back to the file of the Assessing Officer. 239 The assessee has also challenged disallowance of payment of Rs. 1 crore on termination of lease as a "capital expenditure". It is claimed that payment was made for the purposes of running business and was, therefore, of "revenue nature". The contention advanced before the learned Commissioner of Income-tax (Appeals) was reiterated before us. 240 We have given careful thought to the submissions of the parties on this point. We have also seen orders of the Revenue authorities on this issue. There is no dispute that t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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