No TP adjustment on imports at lesser value under predatory pricing policy to capture market.

Facts of the case

  • Merck Limited ("the Taxpayer") is in pharmaceuticals business;
  • During AY 2003-04, the Taxpayer imported certain pigments from AE and paid technical know/ consultancy fees to AE for availing certain services.

During the course of the assessment proceedings for AY 2003-04, the Transfer Pricing Officer ["TPO"] rejected the comparables selected by the Taxpayer in its TP study and applied internal TNMM by considering the margin earned by the Taxpayer from AEs and non-AEs irrespective of the fact that transactions with non-AEs were not related to pigments. Therefore, TPO considered margin of non-AE segment at 16% and proposed the adjustment.

Further, TPO disallowed part of technical fees paid by the Taxpayer on the grounds that the Taxpayer had actually availed services in respect of 3 areas instead of all the 12 different areas which were agreed upon by the Taxpayer with its AE via agreement. TPO considered NIL value of nine services which were not availed by the Taxpayer and accordingly, proposed the addition by rejecting part of technical fees paid.

Aggrieved by the findings of the TPO, the Taxpayer approached higher appellate authorities and found relief at ITAT. However, Revenue appealed against ITAT order and approached Bombay High Court ("HC") to adjudicate the matter.

HC's Adjudication – Import of Pigments

  • HC observed that the Taxpayer was deliberately following predatory pricing policy with a view to finish local competition; hence, import of pigments at a price lesser than ALP is a matter of consideration;
  • HC further observed that bringing the import transaction at ALP would result in TP adjustment of allowing higher purchase price to the Taxpayer and thereby reducing income taxable in India, which is not permissible.
  • HC therefore ruled in favor of the Taxpayer for international transaction pertaining to import of pigments.

HC's Adjudication - Payment of technical know-how/ Consultancy fees

  • HC upheld the findings of ITAT that AEs were obliged to provide services in 12 areas, however, there was no obligation upon the Taxpayer to avail all the services;
  • While approving ITAT ruling, HC equated Taxpayer's arrangement as that of a 'retainer arrangement' for services;
  • HC held that "the finding of the Tribunal that the agreement for technical know how/ consultancy was in respect of all the 12 services and the Taxpayer could avail of all or any one of these 12 areas listed out in the agreement as and when the need arose;
  • HC further noted that Revenue had not applied any of the prescribed method for benchmarking the transaction and also in respect of 3 areas wherein services were availed, no benchmarking exercise of similar comparable transactions was carried out by Revenue;
  • HC, concluding in favor of the Taxpayer, held that the finding of the TPO attributing NIL value to nine of the services listed in the agreement which were not availed of by the Taxpayer in the present case was not justified.

Nangia's Take

A clear principle emerging from the above judgment is that, if a taxpayer has a prior arrangement with its AEs for receipt of set of services and if one of these services was not received or benefit of such services was not realized or could not be established by the taxpayer during audit stage, then the revenue authorities cannot challenge the same and determine the ALP as nil. Also, the revenue authorities can neither question such a commercial / business decision nor can they carry out a benefit test to demonstrate the ALP. Thus, it's important that the Indian Revenue provide certain set of guidelines on documentation requirements for such class of transactions taking cognizance of what is practical and feasible, which will help the taxpayers to reduce the overall compliance burden and also reduce litigation significantly

[Source: Merck Limited; TS-608-HC-2016(BOM)-TP]

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