Transfer Pricing: ITAT Pune Bench doubts Philips Software

In a recent decision, ACIT v. MSS India, ITA No. 393/PN/07, the Pune Bench of the Income Tax Appellate Tribunal had to consider an interesting issue pertaining to the application of transfer pricing provisions. On an appeal after a transfer pricing assessment, the CIT (Appeals) had held in favour of the assessee; deciding that as the assessee was a 100% export oriented undertaking exempt from income tax, it could not be said to have a tax avoidance motive. In the absence of such a motive, transfer pricing provisions could not be resorted to. The CIT (Appeals) went ahead to comment on the merits of the arms length price adjustments made by the Transfer Pricing Officer as well; again deciding in favour of the assessee.

The Revenue preferred an appeal before the Tribunal. The two issues which came up for the consideration of the Tribunal related to whether transfer pricing provisions for calculation of arms length price could be resorted to in the case of an assessee exempt from income tax (therefore, presumably, there being no tax avoidance motive); and if they could be so resorted to, what would be the appropriate method to be used for calculating arms length price.

On the question of whether a tax avoidance motive is necessary before invoking transfer pricing provisions, the Philips Software v. ACIT (2008 TIOL 471 ITAT Bangalore) decision had suggested that motive was a requirement. In that case, the Bangalore Bench had distinguished an earlier five-member Bench in Aztec Software and Technology Services v. ACIT (294 ITR AT 32).

ITAT Online had summarized an important portion of the Philips judgment as holding, “While the motive of tax avoidance need not be shown at the time of initiating transfer pricing provisions, the same is required to be shown at the stage of making the assessment. The AO has to show that the assessee manipulated prices to shift profits outside India. In view of the fact that the assessee enjoyed exemption u/s 10A, the transfer pricing provisions ought not to have been applied…”

The Pune Bench in MSS India however took a different view and held that the decision in Philips Software was in reality conflicting with the decision of the 5-member Special Bench in Aztec Software. Further, it was held that there is no meeting ground between the two conflicting decisions. As such, the decision in Philips Software (being of a smaller Bench) could not be followed; and Aztec cannot be said to have been watered down by Philips. Therefore, the conclusion of the CIT (Appeals) that transfer pricing provisions could not be invoked at all could not be sustained.

On the merits of the adjustment, the Bench provided relief to the assessee. It was held (taking into consideration Rule 10C of the Income Tax Rules, 1962) that in a case where the Revenue sought determine the arms length price by a method different from that which had been adopted by the assessee, it was for the Revenue to demonstrate that its proposed method would be more appropriate than the assessee’s method. Also, it was held that the transaction profit methods of determination of arms length price should be used only when other standard or traditional methods are incapable of being properly applied to the facts of the case. On the facts of the case, the Revenue’s burden was held to be not discharged.

Thus, while the final result was that the Revenue’s appeal was dismissed, the case will be of use to the Revenue authorities in invoking transfer pricing provisions.

Strict Scrutiny in Indian constitutional adjudication: Part I

In an earlier post, I had stated that I disagreed with a few conclusions drawn by Mr. Vikram Raghavan in his series of posts on Law and Other Things, where he argues that the decision of the Delhi High Court in the Naz Foundation case misapplies strict scrutiny.

Mr. Raghavan states:

I have serious reservations about its wisdom in needlessly importing the American doctrine of strict scrutiny to invalidate Section 377. As the bench admits in paragraph 110, the use of strict scrutiny has been decisively rejected by the Supreme Court in Ashok Kumar Thakur. Yet, Naz Foundation insisted that it could still use strict scrutiny based on the Supreme Court’s decision in Anuj Garg. The bench reasoned that, upon a “harmonious construction” of the two Supreme Court judgments, strict scrutiny would not apply to affirmative action, while it would to apply to disadvantaging measures targeting a vulnerable group based on personal characteristics.

I’m afraid I find the high court’s reasoning on this issue to be rather disingenuous for several reasons.

Further:

Strict scrutiny was invented to scrutinize classifications because the U.S. Constitution does not contain anti-discrimination provisions, such Articles 15 and 16, of our Constitution, and it requires a showing of a compelling state interest in order for a suspect classification to be upheld.

Mr. Raghavan’s argument thus appears to proceed at two levels – on the basis of case law (Thakur and Garg cannot really be reconciled) and on the basis of first principles (structural dissimilarities in the provisions of the US and Indian Constitutions militate against incorporating American principles of strict scrutiny into Indian constitutional interpretation). By way of clarification, it must be stated that I agree with Mr. Raghavan on the former level. The reasoning of Thakur does not leave scope for application of strict scrutiny even outside affirmative action cases. However, I disagree with him at the latter level – I believe that Indian courts should adopt strict scrutiny, and, with respect, Thakur is to that extent incorrectly decided.

In Part II, I will take Mr. Raghavan’s argument further and provide additional reasons as to why Thakur may perhaps not lend itself to an interpretation which restricts its application only to affirmative action cases. In the Part III, I will argue why Thakur is incorrectly decided on the point; and why strict scrutiny should be used in Indian constitutional adjudication. In particular, I will focus on the aspect of the dissimilarities in the two Constitutions.

In sum, I will try to argue that while strict scrutiny should be applied in Indian constitutional adjudication (particularly, equality-related adjudication); given the binding law laid down in Thakur it cannot be so applied at present.

Bombay High Court on the 90:10 quota

Earlier this week, the Bombay High Court struck down a 90% quota put in place by the State of Maharashtra in favour of SSC (Maharashtra State Board) students in 11^th standard admissions. The Government had put in place a 90 : 10 quota for SSC : non-SSC students. The non-SSC students, for whom 10% of the seats were left, included students from national boards such as the CBSE and ICSE. The state government sought to justify this reservation as a reasonable classification under Article 14. It was argued that the disparities in the marking structures among SSC and non-SSC boards had resulted in the latter set of students getting higher percentages in the respective 10^th standard board examinations. This meant that the two categories – SSC and non-SSC – were separate classes. There was a need to protect the interests of SSC students because of the disparity in marking schemes. Further, the reservation was sought to be justified as among the total number of students who sought admission to 11^th, more than 90% were from the SSC board – thus the reservation was not excessive but was proportionate.

Among the legal issues which the Court had to decide included (i) whether there was a reasonable classification; and (ii) whether the so-called proportionate reservation of seats was permissible under Articles 14, 19 and 21. The Court, in an order available here, answered these issues against the government. The order indicates that detailed reasons will be provided later; but among the major grounds which the Court relied on were the following:

• The Government Resolution dated 18th June 2009 violated the principles stated by majority view of the Bombay High Court in the case of Francis D Luis v State of Maharashtra.
• The rule of merit-cum-preference which is the only logical and legally acceptable principle for allotment of seats had been violated in its spirit and substance.
• The State had created an artificial classification when in reality, there was no distinction between the students coming from different streams of the Boards.
• In any event, the 90% reservation for one section of students is entirely excessive and impermissible. Ordinarily there can be no reservation above 50%.
• Insofar as private unaided institutions are concerned, the quota must fall on the principles settled by the Supreme Court in T.M.A. Pai and Inamdar

It is likely that the detailed judgment will be of interest in its reconciliation/interpretation of a few Supreme Court judgments on reservations as per stream of entry/source of entry. One recent case pertaining to streams of entry in the AIIMS case, which is linked here. The interpretation of AIIMS and the cases cited in it (Duraisamy, Chanchala etc.) was heavily contested in the arguments before the Bombay High Court. At first glance, the case-law seems to have resulted in some confusion over whether quotas based on streams of entry would be ‘reservations’; and over what principles would apply in testing the constitutionality of stream-based quotas.

Income Tax: Digest of cases - June 2009

The Mumbai ITAT Bar Association digest of recent cases, updated till the beginning of June 2009, is available here on the ITAT Bar website. The consolidated digest can be downloaded from the same link.

Scrutinising Naz Foundation

Vikram Raghavan has analysed the Naz Foundation judgment in three admirable posts on Law and Other Things. While I do not agree with a few of his arguments, the posts provide an excellent discussion of the legal aspects of the case. They can be read here, here and here. Meanwhile, Gautam Bhatia analyses the judgment here; defending the judgment from a legal philosophy perspective.

Among the few points where I would disagree with Mr. Raghavan is his analysis of strict scrutiny and compelling state interest; doctrines which originally evolved in the United States. He seems to argue on principle that strict scrutiny has no clear place in Indian constitutional interpretation because of structural dissimilarities in the Constitutions of India and the United States. I will try to elaborate on my reasons for this disagreement in a subsequent post.

Duty of Care of Non-executive Directors

Earlier discussions on corporate governance norms have raised questions about the role of independent non-executive directors in maintaining appropriate standards of governance. In this context, a recent Australian judgment, Australian Securities and Investment Commission v. MacDonald, indicates the nature of duties which a non-executive director may be required to discharge. I have posted on the judgment on the Indian Corporate Law blog here.

Significant High Court decisions expected shortly

Two significant pronouncements are expected from the High Courts in the coming few days. Law and Other Things reports that the Delhi High Court will deliver its judgment in the Naz foundation case tomorrow. Meanwhile, a Division Bench of the Bombay High Court is hearing arguments in the challenge to the 90% reservation introduced by the Maharashtra government in favour of SSC (state board) students in Standard 11 admissions, leaving only 10% for non-SSC (eg ICSE/CBSE) students. The petitioners’ arguments were heard over the past couple of days, and the challenge is focused on Articles 14, 19 and 21. The judgments in T.M.A. Pai, Inamdar, and AIIMS are strongly relied upon by the petitioners. The arguments on behalf of the State are likely to go on till Friday, and it seems that the judgment will be delivered on Friday or on Monday.


UPDATE: The Delhi High Court has held that Section 377 of the Indian Penal Code is to an extent unconstitutional. It held, "S. 377 of IPC in so far as it criminalises consensual sexual acts of adults in private is violative of Articles 14, 21... the provision of section 377 IPC will continue to govern non-consensual (acts)..."

A detailed post will follow shortly.