In other words, the tribunal found that the concept of “arm’s length price” (pursuant to the transfer pricing chapter of the tax law) cannot be used to compute “ordinary profits” (under another chapter of the tax law).
Background
The taxpayer (a subsidiary of a U.S. company, and engaged in various “back office” operations) was eligible for and claimed certain “tax holiday” benefits under section 10A of the Income-tax Act, 1961.
The taxpayer had reported an operating profit margin of 33.24% for the year in respect of services it provided.
However, the Transfer Pricing Officer (based on a transfer pricing study furnished by the taxpayer) observed that the arithmetic mean of comparable companies under the Transaction Net Margin Method (TNMM)—using operating profit to cost ratio—was 21.92%.
Thus, the Transfer Pricing Officer—while accepting the taxpayer’s analysis and concluding that the transactions were at arm’s length—issued an order stating that the profit reported by the taxpayer exceeded the amount of arm’s length profit by INR 44.85 million.
The Assessing Officer, relying on the Transfer Pricing Officer’s order, determined that this amount of “excess profit” was not eligible for the tax holiday under section 10A, and approved an addition to tax. On administrative appeal by the taxpayer, the assessment order was upheld by the Dispute Resolution Panel.
The taxpayer then sought this review by the tribunal.
Tribunal’s judgment
The tribunal issued a generally taxpayer-favorable decision, finding among other items that:
- The transfer pricing rules are contained in a separate chapter (Chapter X) of India’s tax law—one that was enacted for the specific purpose of computing income from transactions under an arm’s length price determination—whereas the assessment procedures are governed by Chapter XIV. If the Transfer Pricing Officer does not recommend an adjustment, any adjustment proposed by the Assessing Officer must be made independently of the order of the Transfer Pricing Officer, and not based on India’s transfer pricing statutes.
- There is a distinction between the concepts of “arm’s length price” and “ordinary profits.” Arm’s length price cannot be used to determine what amount is “ordinary profit” for purposes of the tax holiday benefits under section 10A.
The judgment reinforces a concept that the transfer pricing provisions are a distinct code chapter and that the scope of these provisions cannot be extended beyond their express intent.
To read a May 2012 report on the case, prepared by the KPMG member firm in India: Chennai tribunal held that the concepts of “arm’s length price” and “ordinary profit” are different and any excess profit over arm’s length profit cannot be the basis for denial of tax holiday deduction under section 10A of the Income-tax Act (PDF 169 KB)
KPMG observation
The Hyderabad Bench of the Income-tax Appellate Tribunal has also reached a similar conclusion; see TaxNewsFlash-Transfer Pricing: India - “Ordinary profit” differs from “arm’s length price”