Customer Care No.

91-1145562222

ALP determination without

a corresponding
adjustment - a Double
Edged Sword
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The transfer pricing provisions was introduced in the incometax act, 1961 ("The Act") with an intention to curb tax
avoidance by multinational group companies.
Section 92 provides that any income arising from an
international transaction entered into between two
associated enterprises has to be computed having regard to
the arm's length price. The legislature within its wisdom, had
visualized a scenario wherein the transfer pricing adjustment
would result in a detriment to the revenue. Considering the
same, the provisions of sub-section 3 of Section92was
introduced in the act to safeguard the interest of the
revenue. The relevant extracts of Section 92(3) areas under:
"(3) The provisions of this section shall not apply in a case
where the computation of income under sub-section (1).,
has the effect of reducing the income chargeable to tax or
increasing the loss, as the case may be, computed on the
basis of entries made in the books of account in respect of
the previous year in which the international transaction or
specified domestic
was entered into."
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Care No. transaction
91-11-

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The above provision restricts the tax authority from substituting the transaction value with the
arm's length price, in case where it has the effect of reducing income chargeable to tax or of
increasing the loss returned by the tax payer. The implication of the above provision is explained
in the following illustration.
Illustration 1: Entity A, a captive IT service provider and an Indian assessee, has rendered services to its
associated enterprise ("Entity B"). Entity A is compensated on a total costs plus a predetermined mark-up. The particulars of the international transaction and the arm's length value
of the international transactions are as under:
Value of international transactions (rendering of services to AE) as per books of account
1,200
Arm's length value of the international transaction (rendering of services)

1,000

The Act does not permit the substitution of INR 1,000 /- as the value of the transaction, as it
would have an impact of reducing the income chargeable to tax.
The above proposition had been subjected to evaluation by the Delhi Bench of the Income-tax
Appellate Tribunal ("ITAT") in the case of Mercer Consulting Private Limited. The facts of the case
are as under:
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The appellant entity was operating as a captive ITeS service provider and was compensated on
a total cost plus an arm's length mark-up. In the course of rendering the services, the
associated enterprise had rendered management support services to the appellant. The
revenue authorities, based on the directions from the Disputes Resolution Panel, had accepted
the arm's length nature of the mark-up earned by the appellant for rendering the ITeS services.
However they had disallowed the cost of the management support services availed from its AE.
The ITAT after a detailed review, concluded that the disallowance made by the authorities,
would result in base erosion, as the terms of rendering services by the appellant was on a
total operating cost plus a mark-up. The principle laid down by the ITAT is elaborated in the
below illustration:
Illustration 2: In continuation of illustration 1, in case Entity A has availed management support services
from Entity B at a cost of INR 50 and the same has been recharged to Entity A.
Whether the tax authority could disallow the payment of INR 50, stating that the amount
paid towards management support services availed from Entity B is not appropriate?
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In addition it would be pertinent to evaluate as to whether the restriction imposed by section
92(3) has to be analysed from the perspective of the assessee alone or whether the impact has
to be evaluated by considering the transaction as a whole, i.e., considering the tax impact
arising from the transaction for both the assessee as well as the AE on an aggregate basis. The
said issue was subjected to a detailed analysis by the Special Bench of the ITAT in the case of
Instrument arium Corporation Ltd, Finland.
The appellant, a non-resident entity had advanced interest free loan to its wholly owned
subsidiary in India. The tax authorities during the course of assessment had imputed interest on
the loan and subjected the same to income-tax in India.
However, the revenue authorities had considered the interest free loan to be in compliance with
the arm's length requirement, while completing the transfer pricing audit of the wholly owned
Indian subsidiary.
The revenue authorities, while completing the transfer pricing audit had imputed interest on the
loan provided by the non-resident entity "Entity B" to the Indian resident entity "Entity A" and
had recommended an adjustment.

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