FEBRUARY 19, 2020

By Subhashree R

FOR any tax to be levied, the taxable event must occur. In case of income tax, the pre-condition is that there must be some income and such income must accrue or arise. Section 92 of the Income Tax Act, 1961, ('the Act') provides that 'Any income arising from an international transaction shall be computed having regard to the arm's length price'. Thus, the essential elements to trigger the exercise of transfer pricing are (a) existence of an international transaction and (b) income arising from the same. International transaction is defined in a wide manner and any transaction having a bearing on profits could be covered. The terms 'arising' and 'accruing of income' are not defined in the Income Tax and have to be understood with the help of jurisprudence in this regard. Thus, a line of argument commonly advanced against a transfer pricing adjustment is either that no international transaction exists or that no income arises from it. As such, arguments of capital receipt ¹, incurring of advertising, marketing and promotion expenses not being an international transaction ², etc., have been used by assessees successfully. However, a debit entry in the P&L ³ has been held to satisfy the clause of 'having a bearing on profits' and hence, being an international transaction.

In a recent order of ITAT, Delhi in Aricent Holdings Technologies v. DCIT, ITA No. 1308/Del/2015, it was held that where no income could arise in the first place, i.e. where there was no possibility of any income arising to the assessee, transfer pricing provisions would not apply. The facts of the case were that the assessee in India provided a loan to its AE in China, which was repayable after three years. At the end of three years, the Chinese AE had applied to the relevant authorities in China to remit money towards repayment of the loan. Chinese law prohibited payment of interest on loan from the date on which such application for repayment is made to the authorities, till the time such permission is granted by the authorities. The question before the ITAT was whether the TPO was justified in making an addition on account of interest on loan for the said period during which application was pending before Chinese authorities.

The ITAT decided the issue in favour of the assessee primarily on the ground that for taxability, income must arise, accrue or be received by the assessee and since income could not accrue at all to the assessee, it was not taxable. The validity of addition under Indian tax law has been decided taking into account the legal framework in China. Since the Chinese law prohibited payment of interest on loan from the date on which application was made to the authorities for such remittance, no income could arise to the assessee. As per Section 5 (c) of the Act, a resident is taxed on the income which accrues or arises to him outside India during such year. Thus, if income did not accrue to him, the assessee cannot be subjected to tax on the same.

On a literal reading of section 92 of the Act, there should be income arising from an international transaction for which the ALP will be computed. Thus, when it was not possible for any interest to be paid or payable, it was held that no analysis is required under the TP provisions to impute certain income.

The assessee had also drawn support of Rule 10B(2)(d) to state that the comparability would be judged with reference to conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force. As per the OECD Transfer Pricing Guidelines, government policies and intervention through price controls etc., are to be treated as market conditions and hence, if such conditions apply equally on independent as well as associated enterprises then it will not be a major concern. However, the enterprises must resolve the issue of whether independent enterprises would enter into transaction where the action of the foreign government is not favourable to them.

The ITAT also referred to the India-China DTAA to conclude that India would get the right to tax income only if it arises in either State and since no income arose in China, India cannot tax any income which would be a notional income.

An interesting question would be - what if the interest payable instead of being nil was fixed as per Chinese law at say 0.5%? Since there is some income arising to the resident, transfer pricing provisions would apply. However, would the bar on paying higher rate which would be market rate or the ALP rate be read as income which cannot accrue and hence no transfer pricing adjustment is warranted?

[The author is an Advocate and the views expressed are personal.]

¹Vodafone India Services P Ltd v. UOI, 2014 (10) TMI 278 -Bombay High Court = 2014-TII-21-HC-MUM-TP

² [2015] 64 taxmann.com 150 (Delhi) = 2015-TII-58-HC-DEL-TP

³Vodafone India Services P Ltd v. DCIT, ITAT 565/Ahd/17, AHD ITAT order dated 23-1-2018 = 2018-TII-55-ITAT-AHM-TP