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

Date of the Judgment: 19 April 2023

Citation: 2023 INSC 394

Judges: M.R. Shah, J. and M.M. Sundresh, J.

Can the High Court intervene in decisions made by the Income Tax Appellate Tribunal (ITAT) regarding transfer pricing? The Supreme Court of India recently addressed this question, clarifying the extent of the High Court’s authority in such matters. This judgment is crucial for understanding the appellate process in transfer pricing disputes. The Supreme Court held that the High Court can examine whether the ITAT followed the guidelines while determining the arm’s length price. The bench comprised Justices M.R. Shah and M.M. Sundresh.

Case Background

This case involves a batch of civil appeals, primarily from the Revenue (Income Tax Department), challenging various High Court decisions. These High Courts, particularly the High Court of Karnataka, had dismissed appeals against the Income Tax Appellate Tribunal’s (ITAT) rulings on transfer pricing issues. The High Courts reasoned that the ITAT’s decisions were based on factual findings and did not raise any substantial questions of law that would warrant intervention under Section 260A of the Income Tax Act, 1961. The High Court of Karnataka relied on its previous judgment in PCIT v. Softbrands India (P) Ltd., (2018) 406 ITR 513 (Karnataka), which held that the ITAT is the final authority on factual matters related to transfer pricing.

Timeline

Course of Proceedings

The High Courts dismissed the appeals filed by the Revenue, stating that the issues decided by the ITAT were questions of fact. The High Courts found no perversity in the ITAT’s findings and concluded that no substantial question of law arose under Section 260A of the Income Tax Act, 1961. The High Court of Karnataka specifically relied on its earlier judgment in PCIT v. Softbrands India (P) Ltd., which held that the ITAT is the final fact-finding authority in transfer pricing matters. This led to the Revenue appealing to the Supreme Court, contesting the High Court’s interpretation of its appellate jurisdiction.

Legal Framework

The core of this case 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 states that an appeal can only be entertained if the High Court is satisfied that the case involves a substantial question of law. The Supreme Court also examined the transfer pricing provisions under Chapter X of the Income Tax Act, 1961, specifically Sections 92, 92A to 92CA, 92D, 92E, and 92F, along with Rules 10A to 10E of the Income Tax Rules, 1962. These provisions outline the methods for determining the arm’s length price (ALP) in international transactions. Section 92C(1) of the Income Tax Act, 1961, specifies various 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. The court also referred to Rule 10B of the Income Tax Rules, 1962, which prescribes the manner of determining the arm’s length price under Section 92C of the Income Tax Act, 1961.

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, provides:

“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 of Karnataka, in Softbrands India (P) Ltd., erred in holding that the ITAT is the final fact-finding authority on arm’s length price (ALP) and that its decisions are not subject to judicial review under Section 260A of the Income Tax Act, 1961.
• The Revenue contended that the determination of ALP must adhere to the guidelines stipulated under Chapter X of the Income Tax Act, 1961, and Rules 10A to 10E of the Income Tax Rules, 1962.
• It was submitted that if the ITAT determines the ALP without following these guidelines, such a determination can be considered perverse and subject to scrutiny by the High Court under Section 260A of the Income Tax Act, 1961.
• The Revenue argued that the High Court should examine whether the guidelines under the Act and Rules were followed by the ITAT while determining the ALP.

Assessees’ Arguments:

• The assessees argued that Section 260A of the Income Tax Act, 1961, allows appeals to the High Court only if a substantial question of law is involved.
• They contended that once the ITAT determines the ALP by considering the relevant guidelines, it should not be challenged unless there is a substantial question of law.
• The assessees submitted that a substantial question of law arises only when there is a fair argument and room for difference of opinion on a point of law.
• They argued that findings of fact can only be challenged if they are based on no evidence, inadmissible evidence, misreading of evidence, or if legal principles have not been applied.
• The assessees emphasized that the ITAT is a final fact-finding authority and its findings should not be interfered with unless there is demonstrated perversity.
• It was argued that issues like comparability of companies and selection of filters are questions of fact and unless perversity is demonstrated, the High Court should not intervene.
• The assessees also contended that transfer pricing analysis is a statistical exercise and valuation is a question of fact, citing G.L. Sutania and Anr v SEBI and Ors. (2007) 5 SCC 133.

Submissions Table

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. 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

The following table demonstrates as to how the Court decided the issues:

Authorities

The Supreme Court considered the following authorities:

Cases:

• PCIT v. Softbrands India (P) Ltd., (2018) 406 ITR 513 (Karnataka) – The High Court of Karnataka held that the ITAT is the final fact-finding authority on transfer pricing issues. The Supreme Court overruled this view.
• Vijay Kumar Talwar v. CIT, (2011) 1 SCC 673 – This case was cited by the assessees to support their argument that the ITAT is a final fact-finding authority, and its findings should not be interfered with unless there is demonstrated perversity.
• Sir Chunilal V. Mehta and Sons Ltd. v. Century Spinning and Manufacturing Co. Ltd., AIR 1962 SC 1314 – This case was cited by the assessees to support their argument that the ITAT is a final fact-finding authority, and its findings should not be interfered with unless there is demonstrated perversity.
• G.L. Sutania and Anr v SEBI and Ors., 2007 (5) SCC 133 – This case was cited by the assessees to support their argument that valuation is a question of fact.

Legal Provisions:

• Section 260A of the Income Tax Act, 1961 – This section governs appeals to the High Court from orders of the ITAT, stating that an appeal can only be entertained if the case involves a substantial question of law.
• Sections 92, 92A to 92CA, 92D, 92E, and 92F of the Income Tax Act, 1961 – These sections outline the transfer pricing provisions and the methods for determining the arm’s length price (ALP).
• Rule 10A to 10E of the Income Tax Rules, 1962 – These rules provide guidelines for the determination of the arm’s length price.
• Section 92C(1) of the Income Tax Act, 1961 – Specifies various methods for determining the arm’s length price.
• Rule 10B of the Income Tax Rules, 1962 – Prescribes the manner of determining the arm’s length price under Section 92C of the Income Tax Act, 1961.

Authorities Table

Judgment

The Supreme Court held that the High Court is not precluded from examining the correctness of the ITAT’s determination of the arm’s length price (ALP) under Section 260A of the Income Tax Act, 1961. The Court clarified that the High Court can examine whether the ITAT followed the guidelines laid down in the Income Tax Act, 1961 and the Income Tax Rules, 1962 while determining the ALP. The Court stated that if the ITAT’s determination is found to be perverse, it can be considered a substantial question of law, allowing the High Court to intervene.

The Supreme Court observed that the High Court should examine whether the ITAT considered the relevant guidelines under the Act and Rules, including the comparability of companies and selection of filters. The Court emphasized that the High Court can examine whether the ITAT has considered comparable transactions properly.

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

How each authority was viewed by the Court?

The Supreme Court specifically overruled the Karnataka High Court’s decision in PCIT v. Softbrands India (P) Ltd., (2018) 406 ITR 513 (Karnataka)* which had held that the ITAT’s determination of ALP is final. The Supreme Court clarified that the High Court can examine the ITAT’s decisions for perversity within the parameters of Section 260A of the Income Tax Act, 1961. The other cases cited by the assessees were considered in the context of the legal principles, but the Supreme Court clarified that perversity in the ITAT’s findings can be a substantial question of law.

The Supreme Court quoted the following from the judgment:

“Therefore, while determining the arm’s length price, the Tribunal has to follow the guidelines stipulated under Chapter X of the IT Act, namely, Sections 92, 92A to 92CA, 92D, 92E and 92F of the Act and Rules 10A to 10E of the Rules.”

“Any determination of the arm’s length price under Chapter X de hors the relevant provisions of the guidelines, referred to hereinabove, can be considered as perverse and it may be considered as a substantial question of law as perversity itself can be said to be a substantial question of law.”

“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.”

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 statutory guidelines provided under the Income Tax Act, 1961 and the Income Tax Rules, 1962. The Court emphasized that the High Court has a crucial role in reviewing whether the ITAT followed these guidelines and whether its findings are perverse. The Court was also concerned that the High Court of Karnataka’s view in Softbrands India (P) Ltd., which treated the ITAT’s decision as final, could lead to a lack of judicial oversight in transfer pricing matters. The Supreme Court’s reasoning also reflects a balance between respecting the ITAT’s role as a fact-finding authority and ensuring that its decisions are not arbitrary or inconsistent with the law.

Fact:Law Ratio

Logical Reasoning:

Key Takeaways

• The High Court is not barred from examining the ITAT’s decisions on transfer pricing under Section 260A of the Income Tax Act, 1961.
• The High Court can review whether the ITAT followed the guidelines under the Income Tax Act, 1961 and Income Tax Rules, 1962 while determining the arm’s length price.
• Perversity in the ITAT’s findings can be considered a substantial question of law, allowing the High Court to intervene.
• The High Court can examine the comparability of companies, selection of filters, and whether comparable transactions have been properly considered by the ITAT.
• The judgment clarifies that the ITAT is not the final authority on transfer pricing matters, and its decisions are subject to judicial review by the High Court.

Directions

The Supreme Court quashed and set aside the impugned judgments and orders passed by the High Courts. The matters were remitted back to the concerned High Courts to decide and dispose of the respective appeals afresh in light of the observations made in the judgment. The High Courts were directed to examine in each case whether the guidelines laid down under the Act and the Rules were followed while determining the arm’s length price by the Tribunal and whether the findings recorded by the Tribunal were perverse or not. The High Courts were directed to complete this exercise preferably within nine months from the date of receipt of the order.

Development of Law

The ratio decidendi of this case is that the High Court has the power to review the Income Tax Appellate Tribunal’s (ITAT) decisions on transfer pricing, specifically on the determination of the arm’s length price (ALP), under Section 260A of the Income Tax Act, 1961. This is a change from the previous position of law established by the Karnataka High Court in Softbrands India (P) Ltd., which had held that ITAT’s determination of ALP was final and not subject to judicial review by the High Court. The Supreme Court clarified that the High Court can examine whether the ITAT followed the statutory guidelines and if the findings are perverse, which constitutes a substantial question of law.

Conclusion

In conclusion, the Supreme Court’s judgment in SAP Labs India Private Limited vs. Income Tax Officer clarifies the High Court’s role in transfer pricing appeals. The High Court is not precluded from examining the ITAT’s decisions, particularly on the determination of the arm’s length price. The High Court can review whether the ITAT followed the statutory guidelines and if the findings are perverse. This judgment ensures a balance between respecting the ITAT’s authority and ensuring judicial oversight in transfer pricing matters. The Supreme Court remitted the cases back to the respective High Courts for fresh consideration in light of these observations.