Transfer pricing Limitations
Bottleneck in TP
In a transfer pricing matter more often than not we get to read an observation or a remark by the Courts and Tribunal/DRP that ‘we are unable to treat this company fit for comparability analysis for determining the arm’s length price for the assessee in the absence of segmental details’. Also benches of the Tribunal in more than one instance have held that ‘segmental results does not give a true picture and may not be always be correct and precise because it is almost impossible to distribute certain common expenses. The Delhi bench of the ITAT in DHL Express ( India) Pvt Ltd v Asstt CIT (2012) 12ITR(Trib)658 held that the assessee’s objection for rejecting the Transport Corporation of India as comparable is also devoid of any merits, because when pro per comparable companies are available, there is no requirement for making comparison with segmental results which does not give a true picture. Later it also remarked that it is a known fact that segmental results may not be always correct and precise because it is almost impossible to distribute certain common expenses.
However, till date there is no law or section that bars a comparable being chosen on segmental results basis. Transfer pricing is a subjective phenomenon where the assessee has all the right to substantiate its price on whatever material is available with him which may even be in the form of segmental results of an enterprise. Rule 10D proviso says it all on such right given to the assessee. The words ‘on the basis of material available with him’ in the proviso are sheer pointer to this fact. Hence the view held by the Income Tax Appellate Tribunal to hold that segmental results are untrue and unreliable is not in accordance with the law.
Inclusion or exclusion of a comparable make a vital difference in the determination of arms length price because of which a transfer pricing study could actually fail.
It is therefore important that the proviso to rule 10D must also be read as sufficient a provision that enables production of segmental results as a material relevant in the exercise of determination of arm’s length price.
It is an irony that on one hand we complain that segmental results are not available and right on the other side we hold stand that the segmental results are not true. These disconnects have to go somehow from the judicial interface.
In the prime most it is desirable to have the segmental details for revenue/sales of varieties of product and service dealt by an enterprise. At the same time the financials must also provide for segmental details of operating income of respective variety of product and services. These two are essentials for assessing the comparability for carrying out study and determination of arms length price with a testing party. Accounting Standard 17 further states that an enterprise should comply with the requirements of this Standard fully and not selectively. However often we find that there is unallocated sums that are adjusted against the total income for one reason or the other. This kind of reporting goes adverse to the accounting standard and must also be reported as a qualification by the auditor in their report.
Now the proviso to rule 10D of the Income tax Rules, 1962 require upon an assessee to substantiate on the basis of material available with him that the income arising from international transactions entered into by him has been computed in accordance with section 92. One is expected to maintain prescribed documents for this purpose if the value of international transactions exceeds Rs. 1 crore. To substantiate one’s price one is required to have matching results of operation of a comparable company. Often there is a difficulty to make such an assessment in the absence of similar comparable hence one employ software with various kind of filters to arrive at one lot of comparables. And out of these some fails for one reason or the other as we go up in the ladder before dispute resolution process, Tribunal and Courts.
If we have segmental accounting in its proper form and substance the entire exercise of transfer pricing could be made more simpler and accurate.
Segmental accounting standard
AS 17 Filters and Limitations
Para 27 of AS 17 provide for certain filters in the disclosure of segmental results viz. –
A business segment or geographical segment should be identified as a reportable segment if:
(a) its revenue from sales to external customers and from transactions with other segments is 10 per cent or more of the total revenue, external and internal, of all segments; or
(b) its segment result, whether profit or loss, is 10 per cent or more of –
(i) the combined result of all segments in profit, or
(ii) the combined result of all segments in loss, whichever is greater in absolute amount; or
(c) its segment assets are 10 per cent or more of the total assets of all segments.
Further AS 17 is not mandatory for Small and Medium Sized Companies. The Companies (Accounting Standards) Rules, 2006 vide rule 2 (f) define a “Small and Medium Sized Company” (SMC) as a company-
(i) whose equity or debt securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India;
(ii) which is not a bank, financial institution or an insurance company;
(iii) whose turnover (excluding other income) does not exceed rupees fifty crore in the immediately preceding accounting year;
(iv) which does not have borrowings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding accounting year; and
(v) which is not a holding or subsidiary company of a company which is not a small and medium-sized company.
Explanation: For the purposes of clause (f), a company shall qualify as a Small and Medium Sized Company, if the conditions mentioned therein are satisfied as at the end of the relevant accounting period.
Importantly it is out of place to have filters in an accounting standard set with an object to provide segmental accounting. The 10% revenue/profit/loss/ or assets filter in the context of large company may size down the segment information which information may otherwise be of relevance in carrying a comparable study in case of small and medium sized company.
Also in the determination of arm’s length price in the case of small and medium company the software may filter-in a large company as a comparable. As a result often the dispute arises on the inclusion or exclusion in the course of extended litigation.
To overcome the limitation of comparables it is desirable to bring an amendment in AS 17 for application of segment accounting for all companies including small and medium companies. Further the 10% filters in AS 17 are not understandable given that this 10% value may have significance in the search for a testing comparable for a small and medium enterprise. At the same time sub-rule (3) of rule 10D may be suitably amended to include segmental results as one form of information that can be kept and maintained under section 92D.
Ca Gopal Nathani