Transfer pricing on pre-incorporation reimbursements excluded, while post-incorporation management services remained subject to mark-up and adjustment.

Expenditure incurred before a foreign subsidiary came into existence, where the activity was undertaken only in the capacity of a shareholder, was treated as outside transfer pricing and no mark-up was permitted on its reimbursement. By contrast, post-incorporation managerial services to the subsidiary were regarded as a separate international transaction and the adjustment on that reimbursement was sustained. The employee stock option plan expenditure issue was not finally decided on merits and was remitted to the Assessing Officer for verification and fresh adjudication in light of the applicable precedent.

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Issues: (i) Whether expenses incurred before incorporation of the foreign subsidiary and reimbursed by it could be treated as an international transaction subject to transfer pricing adjustment and mark-up; (ii) Whether the disallowance of employee stock option plan expenditure required fresh adjudication.

Issue (i): Whether expenses incurred before incorporation of the foreign subsidiary and reimbursed by it could be treated as an international transaction subject to transfer pricing adjustment and mark-up.

Analysis: The reimbursement relating to activities undertaken before the subsidiary came into existence was treated as shareholder activity performed solely because of ownership interest. Such pre-incorporation expenditure was held to be different from post-incorporation managerial services. Since the foreign associated enterprise was not in existence when those costs were incurred, they could not be treated as an international transaction for transfer pricing purposes. However, the post-incorporation management services rendered to the subsidiary were held to be a separate transaction, and the assessee's own benchmarking did not displace the adjustment made on those services. The Tribunal therefore accepted that no mark-up could be charged on pre-incorporation reimbursement, but upheld the mark-up on reimbursement for management services after incorporation.

Conclusion: The issue was answered partly in favour of the assessee and partly in favour of the Revenue.

Issue (ii): Whether the disallowance of employee stock option plan expenditure required fresh adjudication.

Analysis: The Tribunal noted the binding Special Bench view on employee stock option expenditure and also took account of the assessee's own later-year treatment. In view of those circumstances, the matter was not finally determined on merits in this year and was sent back to the Assessing Officer for verification and fresh decision in accordance with the applicable precedent.

Conclusion: The issue was restored to the Assessing Officer for fresh adjudication.

Final Conclusion: The transfer pricing addition survived only to the extent of post-incorporation management services, while the pre-incorporation shareholder activity reimbursement was kept outside transfer pricing; the employee stock option issue was remitted for reconsideration.

Ratio Decidendi: Expenditure incurred before the existence of an associated enterprise, solely in the capacity of a shareholder, is not an international transaction under transfer pricing law, whereas post-incorporation managerial services rendered to that enterprise may be benchmarked and subjected to mark-up.

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