Transfer Pricing – Applicability to third party transactions
11 June, 2015
To come within the ambit of transfer pricing, there has to be an international transaction. The two requirements of international transaction are that there must be a transaction between associated enterprises and either or both parties should be non-residents (prior to the amendment by Finance Act, 2014). In an interesting decision [Novo Nordisk India v. DCIT, IT (TP)No.122/Bang/2014, ITAT Bangalore, 8-5-2015] involving two resident non-related entities and one (related) non-resident entity indirectly, the ITAT examined whether the transaction of purchase, manufacture and sale between two resident non-related entities could be an international transaction.
It opined that amendment to Section 92B (2) of the Act deeming transactions between non-AEs as international transaction when there is a prior agreement, has been inserted by Finance Act 2014 only by way of abundant caution. Thus, an entity entering into a series of transactions with third parties who are not associated enterprises cannot claim to be immune from TP regulation if in substance the transaction is between related parties, one or both of who are non-resident.
The transaction in dispute
The resident unrelated enterprise (third party) purchased raw material, namely insulin crystals from the overseas entity (Novo Nordisk Denmark) related to the assessee (Novo Nordisk India) and after manufacturing insulin formulations as per specification and knowhow supplied by the overseas entity, sold them to the assessee at rates fixed by the overseas entity. The assessee claimed that purchase and sale of insulin formulation in the market was a separate transaction in nature of trading and did not report it as an international transaction. The department, however, contended that the transaction of purchase of insulin was deemed to be a transaction between two associated enterprises and therefore required to be benchmarked.
The Tribunal’s reasoning
The assessee argued that Section 92B (2) controls only the definition of ‘Associated Enterprise’ and cannot be read to understand what is an international transaction. It does not dispense with the condition that either or both parties to a transaction should be non-resident for the transaction to be termed an international transaction.
The department emphasised on reading the agreements between the third party manufacturer and the overseas entity, those between the assessee and the manufacturer and those between the AEs, together. It argued that since one non-resident entity was involved the ingredients for international transactions were satisfied. Further it pointed out that transaction includes arrangement or action in concert.
The Tribunal held that the sum and substance of all agreements was to enable supply of raw material by the overseas AE, manufacture the formulation and sell it in India and it had been so arranged so that provisions of Section 92B of the Act were not attracted. Since the overseas AE was part of the arrangement, the requirement of one party being a non-resident was satisfied. Therefore the transaction of supply of raw material was an international transaction.
Erosion of tax base - Transaction between the third party and assessee
Though the department contended that the entire chain of purchase of raw material, and manufacture and sale fell within the ambit of international transaction, the Tribunal, reasoning that the transactions of manufacture and subsequent sale are duly subject to taxation and there is no erosion of tax base, held that this was not an international transaction.