Forex

Transfer pricing rules have come up for interpretation before the Supreme Court in DIT (International Taxation) vs. Morgan Stanley and Co. Inc. [2007] 292 ITR 416 (SC) in the case of a nonresident company with an office set up by the company in India to support main office functions in equity and fixed income research, account reconciliation and in providing IT enabled services such as back office operations, data processing and support centre, what can be compendiously described as stewardship activities. Authority for Advance Rulings (AAR) had held that the assessee did not have a fixed base or permanent establishment (PE) in India, as it was not concluding any business in India, a finding that was not palatable to revenue, which argued that there was an agency PE, so that it cannot avoid liability for income attributable to the operations in India. The only further point in its view was ascertainment of an arm’s length price (ALP) for determining income attributable to its PE in India. The Supreme Court accepted this argument. Out of the methods prescribed for the purposes, the Supreme Court found that the Transactional Net Margin Method (TNMM) would be the most suitable method, since under this method, total operating profits from the transactions in India and abroad are allocated between the nonresident’s main office and the office in India on the basis of sales, costs, assets etc. In response to the assessee’s argument, that the local office did not take any risk, it was pointed out that this factor can be taken into consideration in fixing the ratio of profits. The Supreme Court directed that the matter to be further examined by the department as to whether service charges payable fully represents the value of the service for a decision as to applicability of transfer pricing rules. As for the economic nexus, it was pointed out, that it was an important aspect of the attribution principle. The same issue has been dealt with by the Special Bench of the Tribunal (Delhi Bench) in Mentor Graphics (Noida) Ltd. vs. Dy. CIT [ITA No. 1969/D/2006 dated 2nd November, 2007] in respect of determination of arm’s length price and denial of deduction under section 10A of the Act. The appellant company is a software development support service provider for its parent company in U.S. The assessee justified its accounts by a working under TNMM method further supported by Cost Plus Method. But revenue (Transfer Pricing Officer, [TPO]) sought to apply Comparable Uncontrolled Price (CUP) method. Assessee selected ten cases as comparable cases, but ultimately 5 cases were relied upon by TPO to arrive at an addition of about 1.46 crores. The addition was confirmed in appeal. Deduction under section 10A was found inadmissible as it was an old unit, while relief under section 80HHE could not be given for lack of audit certificate. In appeal to the Tribunal, assessee challenged selection of comparable cases. The Tribunal found three of the cases selected could be treated as comparable, since two of them having dealing with related parties could not be taken as comparable. It found that application of TNMM method did not arise because the arguments before the lower authorities were on CUP method. Taking into consideration that the parent company bore the risk except for exchange risk borne by the assessee. Intellectual Property Rights were with non-resident principal. Though the Tribunal referred to the Supreme Court decision in TNMM method, it found that even under this method in Rule 10(B)(1)(e)(ii), net profit margin arrived at would require adjustment arising out of comparable uncontrolled transactions. Cases chosen by assessee as comparable could not have been rejected, so that the addition was not justified. As for claim for deduction under section 10A, it was remitted to the Assessing Officer as was done for an earlier year. It could have been added that even if 10A is not admissible, assessee should be permitted to file tax audit certificate for relief under section 80HHE on the basis of assessee’s alternative plea and matter considered on merits.