Ipolicy Network (P) Ltd. vs Income Tax Officer

Introduction

The Delhi Bench of the Income Tax Appellate Tribunal (ITAT), in the case of iPolicy Network (P) Ltd. vs. Income Tax Officer (ITA No. 5504/Del/2010, Asst. Yr. 2006-07, decided on 17th June 2011), delivered a significant ruling on the application of the safe harbour provision under Section 92C(2) of the Income Tax Act, 1961. This case commentary analyzes the Tribunal’s decision, which favored the assessee by applying the pre-amendment proviso to the transfer pricing adjustment. The core issue revolved around whether the +/- 5% safe harbour should be computed based on the arithmetical mean determined by the Transfer Pricing Officer (TPO) or the transaction price declared by the assessee, and whether the post-2009 amendment to the proviso could be applied retrospectively. The ruling provides critical clarity for multinational enterprises (MNEs) regarding transfer pricing adjustments for assessment years prior to the 2009 amendment.

Facts of the Case

The assessee, iPolicy Network (P) Ltd., was a 99.96% subsidiary of iPolicy Networks Inc., USA, functioning as an offshore development centre for software exports. For the Assessment Year 2006-07, the assessee entered into international transactions with its associated enterprises (AEs) aggregating Rs. 14,33,33,713. The assessee adopted the Transactional Net Margin Method (TNMM) to determine the Arm’s Length Price (ALP), selecting 101 comparable companies and arriving at an average operating profit to total cost (OP/TC) margin of (-)0.33%. The assessee’s own OP/TC was 10.06%, leading it to conclude that its international transactions were at ALP.

The TPO, however, applied additional filters and rejected all but three comparables: SoftPro Systems (18.03%), Fortune Informatics Ltd. (8.05%), and Sankhya Infotech (20.84%). The TPO computed the average OP/TC of these three companies at 15.64%, resulting in an ALP of Rs. 15,08,43,128. This created a difference of Rs. 75,09,415 compared to the assessee’s declared revenue, which the TPO added to the assessee’s income as a transfer pricing adjustment. The assessee challenged this addition on multiple grounds, including the erroneous rejection of comparables and, critically, the applicability of the safe harbour provision under the proviso to Section 92C(2).

Reasoning of the ITAT

The ITAT’s reasoning focused on the legislative history and proper interpretation of the proviso to Section 92C(2). The Tribunal meticulously compared the pre-amendment and post-amendment versions of the proviso.

1. Pre-Amendment vs. Post-Amendment Proviso:
The pre-amendment proviso (applicable to AY 2006-07) stated: “Provided that where more than one price is determined by the most appropriate method, the ALP shall be taken to be the arithmetical mean of such prices or at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding 5 per cent of such arithmetical mean.” This gave the assessee an option to accept a price within 5% of the TPO-determined arithmetical mean.

The post-amendment proviso (inserted by the Finance (No. 2) Act, 2009, effective from 1st October 2009) changed the calculation base: “Provided further that if the variation between the ALP so determined and price at which the international transaction has actually been undertaken does not exceed 5 per cent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the ALP.” This shifted the benchmark from the TPO’s arithmetical mean to the transaction price declared by the assessee.

2. Rejection of Retrospective Application:
The Revenue argued that the amendment was clarificatory and should apply retrospectively, relying on CBDT Circular No. F. 142/13/2010-SO (TPL) dated 30th September 2010, which stated the amendment applies to proceedings pending before the TPO on or after 1st October 2009. The Revenue also cited Supreme Court judgments in K. Govindan & Sons vs. CIT and Allied Motors (P) Ltd. vs. CIT to support retrospective application.

The ITAT rejected this argument, holding that the amendment was substantive, not clarificatory. The Tribunal noted that the pre-amendment proviso gave the assessee an option to vary the ALP by 5% of the arithmetical mean, while the post-amendment proviso made the safe harbour mandatory but changed the base to the transaction price. This change altered the taxpayer’s liability and was therefore a substantive provision. The Tribunal relied on the Special Bench decisions in ITO vs. Ekta Promoters (P) Ltd. and Kuber Tobacco Products (P) Ltd. vs. Dy. CIT, which established that fiscal impositions cannot be applied retrospectively without express legislative intent. Since the TPO’s order was dated 8th October 2009 (before the corrigendum) and the assessment year was 2006-07, the pre-amendment proviso applied.

3. Computation of Safe Harbour:
Applying the pre-amendment proviso, the ITAT computed 5% of the TPO-determined ALP (Rs. 15,08,43,128), which equaled Rs. 75,42,156. The difference between the ALP and the assessee’s declared revenue was Rs. 75,09,415. Since this difference (Rs. 75,09,415) was less than 5% of the arithmetical mean (Rs. 75,42,156), the Tribunal held that the assessee fell within the safe harbour. Consequently, the addition of Rs. 75,09,415 was deleted.

4. Rejection of Revenue’s Alternative Argument:
The Revenue contended that the safe harbour should be computed on the revenue shown by the assessee (Rs. 14,33,33,713), not the TPO’s ALP. The ITAT dismissed this, noting that the pre-amendment proviso explicitly referred to “5 per cent of such arithmetical mean” (i.e., the TPO-determined ALP). The Tribunal also cited several precedents, including Development Consultants (P) Ltd. vs. Dy. CIT, Philips Software Centre (P) Ltd. vs. Asstt. CIT, and Haworth (India) (P) Ltd., which consistently held that the safe harbour benefit is available when the ALP is determined using multiple comparables.

Conclusion

The Delhi ITAT’s decision in iPolicy Network (P) Ltd. is a landmark ruling that reinforces the principle of prospective application of substantive tax amendments. By applying the pre-amendment proviso to Section 92C(2), the Tribunal protected the taxpayer from a transfer pricing adjustment that fell within the +/- 5% safe harbour. The ruling provides critical guidance for MNEs and tax practitioners: for assessment years prior to the 2009 amendment, the safe harbour is computed based on the TPO’s arithmetical mean, not the transaction price. The decision also underscores that the CBDT’s circular cannot override clear statutory language or impose retrospective liability without express legislative mandate. This case remains a vital precedent for transfer pricing disputes involving safe harbour provisions.

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