Recently, the Supreme Court in the case of Sap Labs India Private Ltd. v ITO1, held that in transfer pricing matters, a High Court cannot be precluded from examining the correctness of the determination of the arm’s length price by the Tribunal in an appeal on the ground that it does not raise a substantial question of law. The appeals before the Supreme Court were against the decision of the High Court of Karnataka, which dismissed the appeals preferred by the Revenue by relying upon its earlier judgment in the case of PCIT v. Softbrands India (P) Ltd2. Interestingly, the Supreme Court, a few days after the Sap Labs judgment in the case of DIT v. Travelport Inc.,3 has ruled that what proportion of profits arose or accrued in India is essentially one of facts and there is no question of law involved and hence, it doesn’t require any interference.
The Plot
Softbrands was an appeal filed by the Revenue against the order of the Income Tax Appellate Tribunal (“Tribunal”) before the High Court of Karnataka. The question of law that the Revenue wanted the High Court to answer was whether the Tribunal was correct in rejecting certain comparables that were used by the Transfer Pricing Officer (“TPO”) and whether the filter used by the Tribunal was justified.
The Tribunal in its order in the case of Softbrands had deep dived into the comparables that were added by the TPO and also the filters that were used and by way of a speaking order, rejected the comparables and applied the relevant filters. The High Court, after taking into account the order of the Tribunal in its prima facie opinion, held that transfer pricing adjustments or determination of arm’s length price is nothing but a matter of an estimate of a broad and fair guess-work of the authorities based on relevant material brought before the authorities, including the Tribunal. It further opined that unless the Court is satisfied that a substantial question of law is arising from the order of the Tribunal, an appeal to the High Court against the order of the Tribunal cannot be entertained and the exercise of fact finding or ‘Arm’s Length Price’ determination or ‘Transfer Pricing Adjustments’ should be allowed to become final with a quietus at the hands of the final fact finding body, i.e., the Tribunal.
The High Court of Karnataka further held that in an appeal, the matter of which pertains to whether the comparables have been rightly picked up or not, filters for arriving at the correct list of comparables have been rightly applied or not, etc., does not give rise to any substantial question of law and hence, does not meet the criteria laid down under Section 260-A of the Income-tax Act, 1961 (“Act”). However, before concluding that choice of comparables, etc., is a question of fact and no question of law is involved, the High Court goes into the details of what is meant by question of law. The speaking order of the High Court explains what is meant by substantial question of law and goes onto state that it is only when the findings of the Tribunal are ex-facie perverse, unsustainable and exhibit a total non-application of mind by the Tribunal to the relevant facts of the case and to the evidence before the Tribunal, can a finding of fact give rise to a substantial question of law. To arrive at this conclusion, the High Court analyses various judgments of the Supreme Court which discuss what is meant by substantial question of law.
Climax or anti-climax?
Simply put, a transfer pricing study consists of a Functions, Assets and Risk (“FAR”) analysis, applying the right filters to arrive at the correct choice of comparables which is as close as possible to the operations of the entity in question and then determining the Arm’s Length Price (“ALP”) by using the most appropriate method for the benchmarking analysis. Thus, it is essentially a fact finding operation which is governed by the provisions of the ITA read with the Income-tax Rules, 1962 (“Rules”). Consequently, it would have been appropriate for the Supreme Court to also have ruled similarly and stated what the High Court did in its judgment. However, the Supreme Court goes one step ahead and says that the High Court cannot be precluded from examining the correctness of the determination of the arm’s length price by the Tribunal in an appeal on the ground that it does not raise a substantial question of law. With all due respect, wasn’t that always the case? The High Court of Karnataka had only given a prima facie opinion that the determination of arm’s length price, transfer pricing adjustments, etc., should be allowed to become final at the Tribunal level. Even so, in our view, the essence of the Softbrands judgment was to say that only in cases of perversity in the Tribunal’s order there lies a challenge to the High Court where a question of fact would become a substantial question of law, which the court would then be bound to answer.
Nevertheless, and in an interesting turn of events, the Supreme Court in the case of Travelport, goes on to hold that what proportion of profits arose or accrued in India is essentially one of facts and therefore, the orders of the Tribunal and the High Court do not call for any interference. This begs the essential question – if what proportion of profits arose or accrued in India is one of facts, then isn’t which comparable to choose or reject, which filter to apply, etc., also a question of fact? How does one differentiate between the two to say that one is a question of fact but the other still requires adjudication? Or the other way to look at this is in SAP, the Supreme Court didn’t hold anything which wasn’t already the case and therefore, what is held in Travelport should pave the way for transfer pricing cases in which the issue is choice of comparables, filters, etc.
The End
While the judgment in Travelport is definitely welcomed, SAP does act as a bit of an anti-climax. In absolute terms, one could say that Travelport was restricted to proportion of profits and not on choice of comparables, filters, etc. and hence, the latter may be a question of law (or still a question of fact) and the High Court is bound to answer that question. The other issue that is going to come up is that the High Courts are going to be flooded with re-answering each case and preferably within a period of 9 months, which is only going to add to the already long list of cases that the High Court has to hear. It will be interesting to see how the High Court looks at this after the Supreme Court’s ruling in SAP and whether the judgment in Travelport is given any weightage to determine whether the question of choice of comparables, choice of filter, etc., is a question of fact or do they give rise to a substantial question of law.
– Ayushi Jhawar & Ashish Sodhani
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