Transfer Pricing Officer must observe Natural Justice, Relief to MNEs

Sections 92 to 92F contained in Chapter X of the Income Tax Act, 1961 titled “Special Provisions Relating to Avoidance of Tax” were introduced by the Finance Act, 2001 w.e.f. 1.4.2002 with a view to provide an exhaustive legislative framework relating to the fair computation of income arising from international transactions between associated enterprises (“AEs”) having regard to the arms length price (“ALP”) [Central Board of Direct Taxes, Circular No. 14/2001, 2001 252 ITR 65]. Before this amendment in 2002, cross border transactions were regulated under section 92 of the Income Tax Act, 1961 (“the Act”). However, the said section was limited in its scope and application and also employed undefined terms viz. ‘close connection’, ‘adjustment of profits’ and ‘estimation of reasonable profits’ etc.

 Introduction of Chapter X in the Act has assumed significant importance for multinational corporations and their associated enterprises in meeting transfer pricing obligations while following business standards and practices. The chief legislative intention behind the introduction of the said sections was to preclude the assessee from escaping tax liability by parking income generated in India to non-residents in relation to international transactions.

For the purposes of computing income arising out of international transactions, certain expressions occurring in the said sections have been unambiguously defined. Section 92A(1) of the Act defines AEs as one, which is directly or indirectly, managed and controlled by another. On a joint reading of sections 92B(1) and 92F(v) of the Act, it emerges that an “international transaction” would necessarily be an arrangement, understanding or action between the AEs. The computation of the ALP must be determined by any of the five methods provided in section 92C(1) of the Act viz. comparable uncontrolled price method (“CUP”), resale price method, cost plus method, profit split method and transactional net margin method (“TNMM”).

It must be noted that the primary burden in determining the ALP is on the assessee himself using the most appropriate method taking into account the nature of transactions, class of associates, or any other relevant factor for that matter. However, if the assessing officer has concerns about the method employed by the assessee in the determination of the ALP, he may proceed to determine the ALP taking into consideration the provisions of section 92C(3). In any such occasion, the assessing officer is required under law to confront the assessee by issuing a show cause notice to that effect. Having said that, the determination of the ALP is a complex process and therefore, the assessing officer, if he considers it “necessary” or “expedient”, is empowered under section 92CA to make a reference to the Transfer Pricing Officer (“TPO”) for the determination of the ALP.

The role of the TPO comes into play only after a reference under section 92CA has been made by the assessing officer. The TPO is obliged under law to entertain any such evidence that the assessee may produce including but not limited to any information or documents as also the relevant materials that the TPO had gathered on his own. The TPO is then required to determine the ALP in relation to international transactions on the basis of the materials considered and send a copy of the order, in writing, both to the assessing officer and the assessee. The assessing officer, then, after the receipt of the order passed by the TPO is mandated to proceed the computation of the total income of the assessee in conformity with the ALP determined by the TPO. 

This change was brought into effect by virtue of Finance Act, 2007 w.e.f. 1.6.2007, before which the assessing officer would proceed to compute the total income having regard to the ALP determined by the TPO. The difference is significant in that after the amendment, the assessing officer is bound by the order of the TPO in relation to the determination of ALP and he is not obliged to give a final opportunity to the assessee (Sony India Pvt. Ltd. vs. CBDT; 2007). Section 92CA (2) essentially requires the TPO to serve a notice on the assessee so that the latter can produce on a specified date any evidence in support of the computation made by him. A close reading of this legal requirement would unambiguously reveal the recognition of the principles of natural justice in proceedings relating to the determination of ALPs.

[The author, Ashish Goel, is one of the contributors at Breaking the Code of Criminal Procedure, and can be reached at ashish.nujs@gmail.com]