By Sriram Vijayaraghavan
The question of applicability of Chapter X (“transfer pricing provisions”) of Income Tax Act, 1961 (“IT Act”) with respect to issue of shares had come up in the past and in the Vodafone judgment [See Endnote 1], it was held that transfer pricing provisions kick in only when an income is charged to tax under other provisions of the IT Act.
In this background, whether transfer pricing (“TP”) provisions apply when depreciable capital assets are purchased from associated enterprises (“AE”) is a question that has to be answered in a fact specific manner. Similarly, whether arm’s length price (“ALP”) needs to be computed for every purchase of depreciable capital assets between AEs also needs to be answered keeping the facts in consideration.
Why the question?
Suppose an Indian company (“I. Co.”) purchases depreciable capital assets from its AE being a foreign company (“F. Co.”) for ₹100,000/-, is I. Co. as an assessee obligated to compute ALP for this transaction?
It is a well settled law [See Endnote 2] that in its normal meaning ‘income’ will not include capital receipts unless it is so specified in Section 2(24) of the IT Act. Neither Section 2(24)(vi) read with Section 45 nor clauses (vii), (ix) and (x) of sub-section (2) of Section 56 define purchase of depreciable capital assets to be income. Hence such a question arises.
Case law dealing with such a situation
The ITAT judgment in the Honda Motorcycles & Scooters India (P) Ltd v. ACIT, Circle-1(1), Gurgaon [See Endnote 3] (“Honda Motorcycle case”) dealt with the above question. This judgment held that:
- According to the Explanation to sub-section (2) of Section 92B, a transaction of purchase of fixed asset is also an international transaction.
- Since Section 92 is not a charging section but a procedural provision for re-computing the income, there must be some existing income chargeable to tax before applying TP provisions.
- If there is an international transaction in the capital field not giving rise to any income in itself then, no adjustment can be made for the difference between the declared value and the ALP of such international transaction.
- Computation of ALP is necessary because of the impact of such a transaction on the revenue offshoots, i.e. depreciation charge which goes into the computation of income. In such cases, depreciation must be based on the ALP of such assets.
Does that mean all capital asset purchase transactions require ALP computation?
The jurisprudence on this question has not developed yet. The answer to this question is also very fact specific. In the case of block of assets, Section 32 allows deduction of depreciation on the written down value, which is defined in Section 43(6) with reference to the actual cost of assets as defined by Section 43(1).
An analysis of Section 43(1) will reveal that in specific instances, the explanations provide a deeming fiction to deem actual cost to be something other than the “actual cost”. Illustrations of such deemed cost, are explanations 3, 4A, 6, 7 and so on.
It is settled principle of law that a deeming fiction must be construed strictly. Therefore, where actual cost is determined based on a deeming fiction computation of ALP would have no relevance.
Computation of ALP becomes relevant only where the actual cost is determined based on real cost to the assessee. This leads us to few more questions.
When does ALP have to be computed?
In instances where ALP computation becomes relevant, further questions may arise as to whether ALP computation must be done in the same year in which international transaction is entered into even though the depreciation claim may arise only in later years.
It follows from a reading of Section 92 of the IT Act with the Vodafone judgment and Honda Motorcycle case that re-computation of income with reference to ALP arises only when there exists an income chargeable to tax under some other provision of the IT Act. Since this includes allowance for deductions, the obligation to determine ALP in the case of purchase of depreciable capital asset arises only when depreciation is claimed.
However, this will not relieve the person from his or her obligation to maintain information as stipulated in Section 92D and the relevant rules of the Income Tax Rules, 1962 because Section 92D obliges a person who enters into an international transaction to maintain information in respect of such international transaction.
Should the ALP be used to adjust the value of assets or should it be used to adjust the depreciation charge?
According to the Honda Motorcycle case, no adjustment can be made for the difference between the declared value and the ALP as international transaction in the capital field not giving rise to any income in itself. In light of this, it is clear that only the value of depreciation charge claimed needs to be adjusted based on the ALP i.e. TP adjustment is the difference between depreciation computed on the actual purchase price of the depreciable capital asset and its ALP.
In instances where ALP computation is not relevant (deemed cost scenarios), what happens if the depreciable capital asset so purchased in the international transaction is sold or transferred later?
For instance, when a depreciable asset is transferred between a holding company and its wholly owned subsidiary, the actual cost in the hands of the transferee company will be taken as the written down value of the transferor company immediately prior to the transfer in terms of Explanation 6 to Section 43(1).
As the depreciation claim of the transferee will not be based on the price at which these assets are purchased from the transferor (AE), the question of determining the ALP does not arise. Moreover, even at the time of subsequent sale or transfer of these assets by the transferee, capital gain will be computed based on the written down value and not based on the purchase price of the assets. Consequently, the requirement to compute ALP of the assets will not arise at that stage as well.
[The author is a Principal Associate, Direct Tax Team, Lakshmikumaran & Sridharan, Delhi]