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Supreme Court tax ruling may add to litigation

Wednesday’s Supreme Court ruling that “arm’s length price” determined by the income tax appellate tribunal (ITAT) cannot be treated as “final” in disputes related to alleged income suppression by multinational companies will give more currency to 224 cases pending at higher forums like high courts and the apex court itself, besides potentially increasing fresh litigation, tax experts said. The tax department will be the immediate gainer, as among the pending appeals against tribunal orders, 219 were initiated by it, with only five appeals filed by taxpayers.

The SC decision could also increase the utility of conciliatory mechanisms like advance pricing agreements (APAs), which have gained traction in the last few years, as taxpayers would resort to these, with more vigour, given the delays and uncertainties associated with litigation.

As a result of apex court’s ruling, the pending appeals will be restored to the respective high courts for adjudication, said Tarun Arora, partner, Deloitte India, adding that the ruling would also affect a large number of appeals which are pending before various courts on “similar matters.”

“The Supreme Court ruling can lead to increase in uncertainty and more litigation as the revenue authority can go to the high court for an appeal on the transfer pricing decision by the tribunal. However, revenue will have to prove to the high court that there was substantial deviation in following the law and rules by the tribunal before the case is admitted by the high court,” he noted.

India’s tax authorities were seen to be very aggressive in seeking transfer pricing adjustments in related party transactions. While tens of thousands of crores were demanded by the tax authorities from MNCs which resort to cross-border related party transactions for many years through FY15, such additional tax demands have come down in recent years, thanks to the APA mechanism, safe harbour rules and mutual agreement procedure.

The applications filed under the APAs mechanism are for pre-determination of arm’s length prices for certain periods in MNCs’ transactions with related parties abroad. The APAs, introduced in 2012 and bolstered in 2014, saw a decline in its efficacy during the pandemic period, but gained momentum again in FY23.

Amit Maheshwari, tax partner, AKM Global also said the SC ruling is likely to have a significant impact on litigation around transfer pricing issues as a large chunk of controversy in this area lies on the issues pertaining to inclusion and exclusion of comparables, selection of filters, computation of tested party margin, which used to attain finality at the tribunal stage after Softbrands ruling by the Karnataka high court in June, 2018, which said determination of arm’s length price by the Income Tax Appellate Tribunal is final and cannot be the subject matter of scrutiny by the high court

The apex court ruling came in a batch of matters led by Softbrands/SAP Labs on the issue of comparables selection in transfer pricing cases and whether it constituted a ‘substantial question of law’.

“…within the parameters of Section 260A of the IT Act in an appeal challenging the determination of the arm’s length price, it is always open for the high court to examine in each case whether while determining the arm’s length price, the guidelines laid down under the Act and the rules… are followed or not and whether the determination of the arm’s length price and the findings recorded by the tribunal while determining the arm’s length price are perverse or not,” said the Supreme Court. The apex court also said that high courts should complete the exercise within a nine-month period.

The basis of transfer pricing is the arm’s length principle, which is that the price agreed in a transaction between two related parties must be the same as the price in a comparable transaction between two unrelated parties.

S Vasudevan, executive partner, Lakshmikumaran & Sridharan Attorneys, noted that the SC judgment opens avenue for further challenge by both tax department as well as taxpayers and will definitely have the effect of further straining of the limited bandwidth of the higher judiciary.

“This would also substantially increase the time taken for transfer pricing disputes to attain finality,” he said, adding that as most of these issues are recurring in nature, taxpayers may be more motivated to explore alternate dispute resolution mechanisms, like APA and MAP, going forward.

MAP is a dispute resolution method under which tax authorities of countries having a DTAA between them may consult each other and reach an understanding to avoid double taxation. An APA is a mechanism to resolve transfer pricing issues in advance, i.e., before the cross-border related party transaction actually takes place or, at least, before a dispute arises in respect of such cross-border transaction.

The safe harbour rules restrain the taxman from questioning the pricing of certain transactions between multinational companies and their subsidiaries and this is especially useful for software, pharmaceutical and automobile firms.

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