Transfer Pricing Alert: Foreign company liable to penalty for non-maintenance of Transfer Pricing documentation in India

Background:

Section 92D of the Income-tax Act, 1961 (‘IT Act’) provides that every person who has entered into a transaction with its non-resident Associated Enterprise (AE) or specified domestic transaction shall be required to keep and maintain Transfer Pricing (TP) documentation. Where a taxpayer fails to comply with this provision, without reasonable cause, it is exposed to penalty under section 271AA of the IT Act. This penalty is leviable at the rate of 2% of the international transaction value or SDT value. While the Indian Company maintains necessary TP documentation, the foreign AE does not maintain TP documentation in India but relies on the Indian Company’s TP documentation. A question generally arises as to whether the foreign AE, especially having a PE in India, is correct in law for non-maintenance of TP documentation and therefore safeguarded from the levy of penalty under section 271AA of the IT Act.

Recently, the Delhi Tax Tribunal¹ had an occasion to examine this issue. We, at BDO in India, have summarised the ruling of Delhi Tax Tribunal and provided our comments on the impact of this decision hereunder:

Facts of the case:

Taxpayer, a company incorporated and fiscally domiciled in the United States of America, is engaged in providing outsourced customer, employee and marketing support services as well as comprehensive Customer Management Services to its customers and also avails call centre/back office support services from its subsidiary in India, an AE. For the fiscal years 2005-06 and 2006-07, the taxpayer filed its tax return for its transactions with its AE in the nature of interest on external commercial borrowings and fee for technical services. In the quantum proceedings, the tax officer has, inter-alia, concluded that the taxpayer has a Fixed Place Permanent Establishment (PE) in India. Against this order, the taxpayer filed an appeal before the First Appellate Authority (‘CIT(A)') which granted part relief. The taxpayer further appealed before the Delhi Tax Tribunal which, inter-alia, held that the taxpayer has Fixed Place PE in India and provided methodology for attribution of profits to PE. Aggrieved by the same, the taxpayer has filed an appeal before Hon’ble High Court of Delhi.

While the proceedings before the Delhi HC are pending, the tax officer passed an order giving effect to Delhi Tax Tribunal’s order and levied penalty under section 271AA of the IT Act for non-maintenance of TP documentation, computed at 2% of the value of international transactions. While levying the penalty, the tax officer disregarded the taxpayer’s reliance on its AE’s TP Study report as a reasonable cause for non-maintenance of TP documentation. Aggrieved by this penalty order, the taxpayer filed an appeal before the CIT(A) which granted relief to the taxpayer by deleting the penalty. The tax authority filed an appeal before the Delhi Tax Tribunal against the CIT(A)’s order.

Tribunal ruling

After hearing the contentions of the taxpayer and the tax officer, the Delhi Tax Tribunal upheld penalty order and observed that:

• It is mandatory for all taxpayers, without exception, to obtain an independent accountant's report in respect of all international transactions or SDT with AEs.
• Even if there is no international transaction, at least independent accountant’s report for SDT needs to be obtained.
• Absence of international transaction and merely relying on the supporting documents of the AE, cannot be termed as reasonable cause for not maintaining the TP documents by the non-resident taxpayer.
• Mandatory provisions to obtain an independent accountant’s report and maintain documents in respect of SDT with AEs as per the IT Act cannot be diluted by showing a reasonable cause.

BDO comments:

The Delhi Tax Tribunal has made an important observation that the mandatory provision of maintaining TP documentation cannot be diluted by showing reasonable cause. Thus, it appears that where a taxpayer defaults in maintaining the TP documentation a penalty could be levied.

It is pertinent to note in this case that the taxpayer was ring-fenced from the tax authority first, the value of transaction with its AE in India exceeded INR 10 million and second, invoked PE implications. Therefore, with these two facts under the background, merely relying on AE’s TP documentation has not helped the tax payer to justify on the reasonableness to the tribunal for non-maintenance of its own TP documentation in India.

It further held that even SDT transactions with AEs needs maintenance of TP documentation.

The tribunal has also commented on maintenance of documentation for SDT for the years under consideration despite the fact that SDT provisions was effective from fiscal year 2012-13. While the taxpayer has preferred an appeal before Hon’ble High Court in the quantum proceeding, it would be interesting to see if it prefers to further appeal on penalty.