One of the most disputed areas in international taxation has been determining the appropriate transfer price for inter-company transactions. Typically, disputes arise over selecting the appropriate benchmarks (i.e., transactions or companies) to compare with inter-company transactions. In 2018, the Karnataka High Court, followed by several other high courts, held that comparability issues in transfer pricing were essentially a fact-finding exercise and the tax tribunals had the last word on these matters. This was also because comparability issues were not considered to be a ‘substantial question of law’ that the high court would typically hear on appeal unless the order of the tribunal was perverse. So, taxpayers thought that once the tax tribunals decided the matter it was final and settled, and transfer pricing issues could not be subjected to further judicial scrutiny by the high court.
The Supreme Court Verdict
The Supreme Court recently ruled that comparability issues in transfer pricing can give rise to a ‘substantial question of law’, overturning earlier rulings that such issues amounted to fact-finding. The apex court has clarified that the determination of arm’s length pricing (ALP) for inter-company transactions must follow the detailed guidelines stipulated in the Indian income tax law, and any departure from these guidelines can be considered as perverse giving rise to a ‘substantial question of law’. The Supreme Court has rejected the High Court’s blanket proposition that in all cases where the tribunal has determined ALP, the same is final and sacrosanct.
Put simply, the ruling suggests that high courts can examine whether the tax tribunals followed the right rules, and if not, it is a legal matter that can be litigated in the High Court. The apex court has also remanded all the appeals back to the high courts for examining the cases on merits and directed them to decide the matter preferably within nine months.
Impact of the Ruling
As a direct consequence of this ruling, the time involved in reaching finality on transfer pricing controversies under the Indian judicial system is likely to be a long-drawn process. This is because the cases remanded back to the high courts for fresh consideration on merits will add to the existing backlog of pending appeals. Further, the high courts may only examine the process followed by the tax tribunal to conclude on perversity in decision-making and would not practically get into choosing appropriate comparables for an inter-company transaction. This exercise may in turn be delegated to the tax tribunals resulting in a fresh loop of litigation.
Therefore, it would be important for taxpayers to re-evaluate their strategies for managing transfer pricing disputes in India. Taxpayers should evaluate merits and pros and cons, or traditional litigation route vis-à-vis alternative dispute prevention/resolution forums, such as Advance Pricing Agreement (APA) and Mutual Agreement Procedures (MAP).
APAs continue to remain the most effective forum for obtaining tax certainty in transfer pricing issues in a timely manner, of course, subject to the current backlog being managed more effectively. Taxpayers could also evaluate the alternative dispute resolution route under the tax treaties through the MAP.
Time to Redesign the Safe Harbour Rules
While taxpayers would need to evaluate alternative dispute prevention and resolution strategies, the government should also use this ruling as an impetus to redesign the transfer pricing safe harbour rules.
Safe harbour rules were introduced by the government to minimise transfer pricing disputes. However, there have not been many takers for safe harbours in view of high margins and low turnover thresholds. It is now an opportune time for the government to rationalise the safe harbour rules and widen the coverage. A well-designed safe harbour rule would substantially reduce transfer pricing litigation in India in one masterstroke. Learnings from the APA programme and the tribunal/court rulings can be leveraged to rationally design safe harbour rules that would provide a cost-effective and time-efficient process to minimise disputes.
The safe harbour channel could also be considered to settle the existing suite of transfer pricing disputes. Further, the government should consider providing a one-time window for taxpayers to move pending cases from the APA programme or tribunals/courts onto the safe harbour programme. It would unclog the APA programme, which has seen a rise in the number of pending applications in the last few years. It would also reduce the burden of the appellate/judicial process.
Eric Mehta is Partner and Jitendra Jain is Associate Partner at Price Waterhouse & Co LLP. Views are personal, and do not represent the stand of this publication.