Revenue appeal on transfer pricing markup and s.14A dismissed; no substantial law question, low tax effect

The HC dismissed the Revenue's appeal at the admission stage, holding that no substantial question of law arose regarding the transfer pricing adjustment on mark-up for out-of-pocket expenses, as the Revenue had conceded before the ITAT that prescribed methods were not followed and merely sought a fresh opportunity, which could not be raised for the first time before the HC. On the disallowance under s.14A, the HC declined to adjudicate the substantive issues in view of the low tax effect, disposing of the appeal solely on this ground and expressly keeping all questions of law open for future consideration by either side.

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1. ISSUES PRESENTED AND CONSIDERED

(1) Whether any substantial question of law arises in an appeal against the Tribunal's order deleting transfer pricing adjustment where the Transfer Pricing Officer failed to apply any of the statutorily prescribed methods for determining the arm's length price and this failure was not disputed by the Revenue.

(2) How "tax effect" is to be computed under the CBDT Circular dated 15 March 2024 for purposes of filing or prosecuting appeals, and whether an appeal is maintainable where the tax effect relatable to the disputed issues in that appeal is below the monetary limit, notwithstanding a higher aggregate tax effect for the assessment year.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Substantial question of law in transfer pricing appeal where no prescribed method applied

Interpretation and reasoning

(a) The Tribunal recorded a categorical finding that, in determining the arm's length price for the impugned international transaction, the Transfer Pricing Officer had not followed any of the methods prescribed under the Income-tax Act.

(b) The Tribunal further recorded that this factual position was not controverted by the Departmental Representative before it.

(c) Relying on prior decisions, the Tribunal held that it is incumbent upon the Transfer Pricing Officer to follow one of the methods prescribed in law for benchmarking; failure to do so renders the transfer pricing adjustment vulnerable and unsustainable.

(d) It was also noted that precedent holds that where the prescribed method is not followed, the Transfer Pricing Officer cannot be afforded a "second innings" to cure the defect by redoing the exercise.

(e) Before the Court, the Revenue sought to argue that, in the peculiar facts, there was no question of following any other method than what the Transfer Pricing Officer had adopted; however, this contention had not been raised before the Tribunal, and the Revenue had, in fact, effectively conceded that the prescribed methods were not followed and only sought a fresh opportunity.

(f) The Court observed that the new argument was neither raised nor involved before the Tribunal and did not even find reflection in the questions formulated in the appeal memo.

Conclusions

(g) In view of the undisputed factual finding that no prescribed transfer pricing method was followed, and the application of binding precedent by the Tribunal, no substantial question of law arose for consideration.

(h) The appeal was dismissed at the admission stage, with the clarification that questions on the broader legal position are left open for determination in an appropriate future case where they properly arise.

Issue 2: Computation of "tax effect" under CBDT Circular dated 15 March 2024 and maintainability of appeal

Legal framework

(a) The Court referred to paragraph 5.1 of the CBDT Circular dated 15 March 2024 defining "tax effect" as the difference between the tax on the total income assessed and the tax that would have been chargeable had such total income been reduced by the amount of income in respect of the issues against which the appeal is intended to be filed ("disputed issues"), inclusive of surcharge and cess, with specific rules for loss cases and penalty orders.

Interpretation and reasoning

(b) The Revenue contended that for the relevant assessment year, since there were multiple appeals and the aggregate tax effect exceeded Rs. 2 crores, the monetary limit in the CBDT Circular would not bar the present appeal.

(c) The assessee contended, by placing reliance on paragraph 5.1, that "tax effect" must be confined to the income pertaining to the specific disputed issues forming the subject matter of the particular appeal, and on that basis, the tax effect in the instant appeal was only Rs. 10,18,145/-, well below the Rs. 2 crores threshold.

(d) The Court noted that the connected appeal for the same assessment year, in which the larger tax effect had been computed, stood dismissed. Consequently, the outstanding tax effect relatable to the present appeal alone was Rs. 10,18,145/-.

(e) The Court emphasised that paragraph 5.1 lays stress on the phrase "the issues against which the Appeal is intended to be filed", and this expression cannot be ignored while determining the tax effect. Even if the concept of "aggregate tax effect" for the year is invoked, it must still be read in the context of this definition.

(f) The Court observed that, even assuming the substantial questions of law regarding disallowance under Section 14A read with Rule 8D were to be answered in favour of the Revenue, the recoverable amount in this appeal would remain restricted to Rs. 10,18,145/- plus interest; effectively, therefore, the tax effect for the purposes of the Circular was only Rs. 10,18,145/-.

(g) The Court was referred to decisions suggesting that where no exempt income is earned, disallowance under Section 14A is not warranted, and also to a decision indicating that disallowance under Section 14A cannot exceed the exempt income. The Court found that these decisions prima facie supported the assessee's case but, given the low tax effect, chose not to adjudicate these substantive issues.

Conclusions

(h) The Court held that the tax effect, as understood under paragraph 5.1 of the CBDT Circular dated 15 March 2024, in relation to the disputed issues in the present appeal, was far below the monetary ceiling of Rs. 2 crores.

(i) The appeal was disposed of on the ground of low tax effect, with all questions of law raised in the appeal kept open for consideration in an appropriate future case.

(j) It was clarified that, in any such future proceedings, the assessee would be entitled to rely on the cited decisions in its favour, and the Revenue would be at liberty to contend that those decisions do not govern the issue.

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