Supreme Court clarifies High Court’s powers in Transfer Pricing Appeals: SAP Labs India vs. Income Tax Officer (2023)

Date of the Judgment: April 19, 2023
Citation: Civil Appeal No. 8463 of 2022 (Arising from S.L.P.(Civil) No.28652/2018) [and batch of other appeals]
Judges: M.R. Shah, J., M.M. Sundresh, J.
Can High Courts intervene in transfer pricing cases where the Income Tax Appellate Tribunal (ITAT) has already determined the arm’s length price? The Supreme Court of India recently addressed this critical question, clarifying the scope of the High Court’s powers under Section 260A of the Income Tax Act, 1961. This judgment is significant because it clarifies the extent to which High Courts can review the ITAT’s decisions on transfer pricing issues, particularly concerning the determination of arm’s length price (ALP). The bench, comprising Justices M.R. Shah and M.M. Sundresh, delivered the judgment.

Case Background

This batch of civil appeals primarily involves appeals by the Revenue (Income Tax Department) and some by assessees (taxpayers), challenging decisions made by various High Courts, particularly the High Court of Karnataka. These High Courts dismissed appeals against the Income Tax Appellate Tribunal’s (ITAT) findings on “Transfer Pricing” issues. The High Courts, relying on the judgment in PCIT v. Softbrands India (P) Ltd., (2018) 406 ITR 513 (Karnataka), held that the ITAT’s decisions on arm’s length price (ALP) are findings of fact and not subject to review under Section 260A of the Income Tax Act, 1961, unless perversity is demonstrated. The Revenue contended that the High Court’s view in Softbrands India (P) Ltd. was incorrect, arguing that the High Court should examine whether the ITAT followed the guidelines stipulated in the Income Tax Act and Rules while determining the ALP.

Timeline

Course of Proceedings

The High Court of Karnataka dismissed the appeals preferred by the Revenue, challenging the findings of the Income Tax Appellate Tribunal (ITAT) on ‘Transfer Pricing’ issues. The High Court held that the issues decided by the Tribunal were questions of fact and since perversity was neither pleaded nor argued, no substantial question of law arose for consideration under Section 260A of the Income Tax Act, 1961. The High Court relied on its earlier judgment in the case of PCIT v. Softbrands India (P) Ltd., (2018) 406 ITR 513 (Karnataka). The Revenue then appealed to the Supreme Court, contending that the High Court had erred in holding that the Tribunal was the final fact-finding authority on determining the arm’s length price.

Legal Framework

The core legal issue revolves around the interpretation of Section 260A of the Income Tax Act, 1961, which governs appeals to the High Court from orders of the Income Tax Appellate Tribunal (ITAT). This section stipulates that an appeal lies to the High Court only if it involves a substantial question of law. The determination of arm’s length price (ALP) is governed by Chapter X of the Income Tax Act, 1961, particularly:

• Section 92C of the Income Tax Act, 1961, which outlines the methods for determining the arm’s length price, including the comparable uncontrolled price method, resale price method, cost plus method, profit split method, and transactional net margin method.
• Sections 92, 92A to 92CA, 92D, 92E and 92F of the Income Tax Act, 1961, which provide the framework for transfer pricing regulations.
• Rules 10A to 10E of the Income Tax Rules, 1962, which provide detailed guidelines for applying the methods prescribed in Section 92C.

Section 92C(1) of the Income Tax Act, 1961 states:

“The arm’s length price in relation to an international transaction [or specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely : –
(a) comparable uncontrolled price method;
(b) resale price method;
(c) cost plus method;
(d) profit split method;
(e) transactional net margin method;
(f) such other method as may be prescribed by the Board.”

Rule 10B(1)(e)(i) of the Income Tax Rules, 1962, defines the transactional net margin method (TNMM):

“10B. (1) Determination of arm’s length price under section 92C:— . .
************* *********
(e) transactional net margin method, by which,—
(i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base.”

Arguments

Revenue’s Arguments:

• The Revenue argued that the High Court in Softbrands India (P) Ltd. erred in holding that the ITAT is the final fact-finding authority on ALP.
• It submitted that the High Court should examine whether the ITAT followed the guidelines under the Income Tax Act and Rules while determining the ALP.
• The Revenue contended that if the ALP is determined by the Tribunal without following these guidelines, it is a perverse finding, which is subject to scrutiny by the High Court under Section 260A of the Income Tax Act, 1961.

Assessees’ Arguments:

• The assessees argued that once the ITAT determines the ALP by considering the relevant guidelines, it cannot be challenged as a substantial question of law under Section 260A of the Income Tax Act, 1961.
• They contended that a substantial question of law arises only when a question of law is fairly arguable, with room for differing opinions.
• The assessees submitted that a finding of fact can only give rise to a substantial question of law if it is based on no evidence, if relevant admissible evidence is not considered, or if legal principles are not applied.
• They argued that the ITAT is a final fact-finding authority, and its findings should not be interfered with by the High Court unless perversity is demonstrated.
• The assessees asserted that the issues raised by the Revenue, such as the inclusion or exclusion of comparables and the selection of filters, are primarily questions of fact.
• They also argued that the High Court should not suo moto explore facts not presented before it, and that the Transfer Pricing analysis is largely a statistical exercise.
• The assessees relied on the decisions of the Supreme Court in Vijay Kumar Talwar v. CIT, (2011) 1 SCC 673 and Sir Chunilal V. Mehta and Sons Ltd. v. Century Spinning and Manufacturing Co. Ltd., AIR 1962 SC 1314.

The assessees also highlighted that the Transfer Pricing provisions are essentially a valuation exercise, and valuation is a question of fact, citing G.L. Sutania and Anr v SEBI and Ors. reported in 2007 (5) SCC 133.

Submissions Table

Issues Framed by the Supreme Court

The primary issue before the Supreme Court was:

Whether in every case where the Tribunal determines the arm’s length price, the same shall attain finality and the High Court is precluded from considering the determination of the arm’s length price determined by the Tribunal, in exercise of powers under Section 260A of the Act?

Treatment of the Issue by the Court

Authorities

Cases Relied Upon:

• PCIT v. Softbrands India (P) Ltd., (2018) 406 ITR 513 (Karnataka) – High Court of Karnataka.
• Vijay Kumar Talwar v. CIT, (2011) 1 SCC 673 – Supreme Court of India.
• Sir Chunilal V. Mehta and Sons Ltd. v. Century Spinning and Manufacturing Co. Ltd., AIR 1962 SC 1314 – Supreme Court of India.
• G.L. Sutania and Anr v SEBI and Ors. reported in 2007 (5) SCC 133 – Supreme Court of India.

Legal Provisions Considered:

• Section 260A of the Income Tax Act, 1961 – Deals with appeals to the High Court from the ITAT.
• Section 92C of the Income Tax Act, 1961 – Specifies methods for determining arm’s length price.
• Sections 92, 92A to 92CA, 92D, 92E and 92F of the Income Tax Act, 1961 – Provide the framework for transfer pricing regulations.
• Rules 10A to 10E of the Income Tax Rules, 1962 – Provide detailed guidelines for applying the methods prescribed in Section 92C.

Authority Analysis Table

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

The Supreme Court overruled the Karnataka High Court’s decision in PCIT v. Softbrands India (P) Ltd., (2018) 406 ITR 513, stating that the High Court’s view that the ITAT’s decision on ALP is final and not subject to review under Section 260A was incorrect. The Supreme Court clarified that High Courts can review ITAT decisions on ALP to ensure that the guidelines under the Income Tax Act and Rules are followed and that the findings are not perverse.

The Supreme Court acknowledged the assessees’ reliance on Vijay Kumar Talwar v. CIT, (2011) 1 SCC 673 and Sir Chunilal V. Mehta and Sons Ltd. v. Century Spinning and Manufacturing Co. Ltd., AIR 1962 SC 1314, which support the principle that the ITAT is a final fact-finding authority. However, the Court clarified that this does not preclude the High Court from reviewing ITAT decisions where there is perversity or a failure to follow the guidelines.

The Supreme Court also acknowledged the assessees’ reliance on G.L. Sutania and Anr v SEBI and Ors. reported in 2007 (5) SCC 133, which supports the principle that valuation is a question of fact. However, the Court clarified that this does not preclude the High Court from reviewing ITAT decisions where there is perversity or a failure to follow the guidelines.

The Supreme Court stated that the High Court should examine whether the guidelines laid down in the Act and Rules are followed while determining the arm’s length price. It clarified that the High Court is not precluded from examining the correctness of the determination of the arm’s length price by the Tribunal under Section 260A of the Income Tax Act, 1961, if it raises a substantial question of law.

The Court held that any determination of the arm’s length price under Chapter X of the Income Tax Act, 1961, de hors the relevant provisions of the guidelines can be considered as perverse.

The Court stated that it is always open for the High Court to consider and examine whether the arm’s length price has been determined while taking into consideration the relevant guidelines under the Act and the Rules.

The Court also stated that the High Court can examine the question of comparability of two companies or selection of filters and examine whether the same is done judiciously and on the basis of the relevant material/evidence on record.

The Court also stated that the High Court can also examine whether the comparable transactions have been taken into consideration properly or not, i.e., to the extent non-comparable transactions are considered as comparable transactions or not.

The Supreme Court emphasized that the High Court should examine whether the ITAT followed the guidelines under the Income Tax Act and Rules, and whether the findings are perverse.

The Supreme Court quoted the following from the judgment:

“Therefore, there cannot be any absolute proposition of law that in all cases where the Tribunal has determined the arm’s length price the same is final and cannot be the subject matter of scrutiny by the High Court in an appeal under Section 260A of the IT Act.”

The Court further stated:

“When the determination of the arm’s length price is challenged before the High Court, it is always open for the High Court to consider and examine whether the arm’s length price has been determined while taking into consideration the relevant guidelines under the Act and the Rules.”

The Court also held:

“Even the High Court can also examine the question of comparability of two companies or selection of filters and examine whether the same is done judiciously and on the basis of the relevant material/evidence on record.”

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to ensure that the determination of arm’s length price (ALP) by the Income Tax Appellate Tribunal (ITAT) adheres to the guidelines and provisions of the Income Tax Act, 1961, and the Income Tax Rules, 1962. The Court emphasized that the High Court should not be precluded from reviewing ITAT decisions, especially when there is a possibility of perversity or a failure to follow the prescribed guidelines. The Court’s reasoning was driven by the following key points:

• Adherence to Guidelines: The Court stressed that the ALP determination must follow the guidelines stipulated under Chapter X of the Income Tax Act, 1961, and the relevant rules. Any deviation from these guidelines could lead to a perverse finding, which should be subject to judicial scrutiny.
• Judicial Review: The Court clarified that the High Court’s power of review under Section 260A of the Income Tax Act, 1961, should not be curtailed in transfer pricing matters. The High Court has the authority to examine whether the ITAT has correctly applied the law and the rules.
• Perversity: The Court highlighted that perversity in the ITAT’s findings is a substantial question of law that warrants judicial review. This includes situations where the ITAT has not considered relevant evidence or has misapplied legal principles.
• Comparability and Filters: The Court acknowledged that issues of comparability and selection of filters are primarily questions of fact. However, it clarified that the High Court can examine whether these issues have been addressed judiciously and based on relevant evidence.

The Court’s sentiment was geared towards ensuring a balanced approach where the ITAT’s role as a fact-finding authority is respected, but also ensuring that there is sufficient judicial oversight to correct any errors or perversities in the decision-making process.

Sentiment Analysis Table

Fact:Law Ratio

Logical Reasoning:

The Court rejected the absolute proposition that the ITAT’s determination of ALP is final. It held that the High Court can examine whether the ITAT followed the guidelines under the Act and Rules. If the guidelines are not followed or if the findings are perverse, the High Court can intervene under Section 260A of the Income Tax Act, 1961.

Key Takeaways

• High Courts’ Review Power: High Courts have the power to review ITAT decisions on transfer pricing, particularly the determination of arm’s length price (ALP).
• Adherence to Guidelines: The ITAT must follow the guidelines under the Income Tax Act and Rules while determining ALP. Failure to do so can be grounds for High Court intervention.
• Perversity as a Ground: Perversity in the ITAT’s findings is a valid ground for appeal to the High Court. This includes cases where relevant evidence is not considered or legal principles are misapplied.
• Comparability and Filters: While these are questions of fact, the High Court can examine if the ITAT’s decisions are judicious and based on relevant material.
• Remand to High Courts: The cases have been remanded back to the respective High Courts to re-examine the issues based on the Supreme Court’s observations.

Directions

The Supreme Court directed the respective High Courts to re-examine the appeals in light of the observations made in this judgment. The High Courts are to determine whether the ITAT followed the guidelines under the Income Tax Act and Rules while determining the arm’s length price and whether the findings of the ITAT are perverse. The Supreme Court also directed that the High Courts should complete this exercise within nine months from the date of receipt of the order.

Specific Amendments Analysis

(Omitted as not discussed in the source)

Development of Law

The ratio decidendi of this case is that the High Court’s power to review decisions of the Income Tax Appellate Tribunal (ITAT) on transfer pricing is not limited to cases where there is a substantial question of law. The High Court can review the ITAT’s decision to ensure that the guidelines under the Income Tax Act and Rules are followed and that the findings are not perverse. This decision changes the previous position of law that ITAT’s decision on ALP is final and not subject to review under Section 260A of the Income Tax Act, 1961, as held in PCIT v. Softbrands India (P) Ltd..

Conclusion

The Supreme Court’s judgment in SAP Labs India Private Limited vs. Income Tax Officer clarifies the scope of the High Court’s review powers in transfer pricing cases. The Court held that the High Court can examine whether the Income Tax Appellate Tribunal (ITAT) followed the guidelines under the Income Tax Act and Rules while determining the arm’s length price (ALP). The Court overruled the Karnataka High Court’s view that the ITAT’s decision on ALP is final and not subject to review under Section 260A of the Income Tax Act, 1961. The cases were remanded to the respective High Courts for fresh consideration. This judgment ensures that there is judicial oversight in transfer pricing matters and that the ITAT’s decisions are in compliance with the law.