Bangalore Tribunal explains approach for domestic transfer pricing in case of profit-linked tax holiday qualifying units

 

 

This Tax Alert summarizes a decision of the Bangalore Income Tax Appellate Tribunal (Tribunal), dated 5 October 2020, in the case of Wipro Limited (Taxpayer) on the issue of application of domestic transfer pricing (TP) provisions while computing profits of eligible units qualifying for profit-linked tax holiday under the Income Tax Act, 1961 (ITA).

While the ruling comprehensively deals with several issues involved in the Taxpayer’s case for tax years 2008-09 to 2013-14, this Tax Alert discusses the Tribunal’s ruling on application of domestic TP while computing profit-linked tax holiday deduction for tax year 2013-14. The key principles laid down by the Tribunal are as follows:

·         With a view to curb the tendency of taxpayers to artificially shift profits from non-eligible units to eligible units, either by way of over-invoicing of income or under-invoicing of expenses by eligible units in inter-unit transactions between eligible units and non-eligible units, Section (s.) 80IA(8) of the ITA provides that such transactions should be at “market value”. 

·         In order to reduce the disputes on computation of such market value”, domestic TP provisions were introduced that require the taxpayer to compute such “market value” at arms’ length price (ALP) by applying TP methods which, hitherto, were applied in transactions with non-resident associated enterprises (AE). 

·         The application of domestic TP is merely to recompute the profits eligible for deduction from the total income of the taxpayer. The application of domestic TP to S.80IA(8) cannot lead to enhancement of the taxpayer’s total income since the transactions are between two units of the same taxpayer and, hence, reduction in income of the eligible unit leads to enhancement of income of the non-eligible unit. 

·         Also, application of domestic TP is not warranted where the inter-unit transactions are between two eligible units, since there is no “tax arbitrage” in such transactions i.e., increase in income of one eligible unit leads to decrease in income of another eligible unit, which has no impact on the aggregate profits eligible for deduction from the total income. 

·         It is true that TP provisions contain a provision to avoid base erosion, in terms of which the Tax Authority is precluded from: (a.) Making TP adjustments which can lead to reduction in the total income or increase in loss; or (b.) Allowing higher profit-linked deduction on the total income enhanced by TP adjustment. However, these provisions are not applicable in the context of application of domestic TP to inter-unit transactions since such adjustments do not lead to variation in the total income of the taxpayer. 

·         The domestic TP adjustment with reference to inter-unit transactions can merely lead to reduction in the quantum of profit-linked deduction from the gross total income.  

·         There is a possibility of “tax arbitrage” in inter-unit transactions between two eligible units, where one unit qualifies for higher deduction (100%) than the other unit (50%). However, this ”tax arbitrage” is not addressed by S.80IA(8) which applies only to inter-unit transactions between eligible units and non-eligible units and, hence, domestic TP cannot be applied to such inter-unit transactions.