Background Transfer pricing provisions in section 92 of the Income-tax Act, 1961 (‘the Act’) prescribe that the arm’s length price (‘ALP’) of international/specified domestic transactions between associated enterprises (‘AEs’) needs to be determined having regard to the ALP, by applying any of the following methods:
– Price-based methods: Comparable Uncontrolled Price (‘CUP’) Method
– Profit-based methods: Resale Price Method (‘RPM’), Cost Plus Method (‘CPM’), Profit Split Method (‘PSM’) and Transactional Net Margin Method (‘TNMM’)
– A ny other prescribed methods
The provisions of the Act prescribe the choice of the most appropriate method having regard to the nature of the transaction, availability of relevant information, possibility of making reliable adjustments, etc., and do not prescribe a hierarchy or preference for any method. Given the concern that it is not possible to obtain reliable comparable financial data in the public domain, in the case of a number of transactions between associated enterprises (including inter-alia, unique transactions, where the determination of independent third party comparables is a major challenge), the OECD member countries as well as non-member OECD countries needed to have recourse to a more “flexible” method, which in essence establishes a better standard of arm’s length transfer prices between associated enterprises, given its purposive application.
Internationally, Para 2.9 of the OECD Guidelines permitted the use of the “other method” and states that the taxpayers retain the freedom to apply methods not described in the guidelines to establish prices provided those prices satisfy the arm’s length principle. Furthermore, it also states the following:
– Such other methods should however not be used in substitution for OECD-recognised methods where the latter are more appropriate to the facts and circumstances of the case.
– In cases where other methods are used, their selection should be supported by an explanation of why the other recognised methods were rejected and the reason why the other method was regarded as more appropriate.
– Taxpayers should maintain and be prepared to provide documentation regarding how their transfer prices were established
The US Regulations also approve the use of so-called unspecified methods and discuss some parameters and situations where the unspecified method could be applied. The same are listed below:
– The unspecified method should provide information on the prices or profits that the controlled taxpayer could have realised by choosing a realistic alternative to the controlled transaction
– The unspecified method will not be applied unless it provides the most reliable measure of an arm’s length result under the principles of the best method rule. Therefore, a method that relies on internal data rather than uncontrolled comparables will have reduced reliability.
Probably taking cue from the above, the Central Board of Direct taxes (CBDT) prescribed the use of the “sixth method”/“the other method” for the purposes of comparison under the Indian transfer pricing regulations, in notification no. 18/2012 issued on 23rd May 2012.
2. Deconstructing the statutory provisions – Rule 10AB
The CBDT prescribed the use of the “other method” by introducing Rule 10AB of the Income-tax Rules, 1962 which reads as under:
“ Other method of determination of arm’s length price:
10AB. For the purposes of clause (f) of sub-section (1) of section 92C, the other method for determination of the arm’s length price in relation to an international transaction or specified domestic transaction shall be any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transactions, with or between non-associated enterprises, under similar circumstances, considering all relevant facts.”
The authors have identified some frequently asked questions in respect of the various nuances considering the application of the “other method” and laid down points for consideration below:
3. Application of the Other Method
In view of the above analysis of Rule 10AB, the use of the sixth method in benchmarking certain unique transactions (especially considering the amendments to the definition of international transactions u/s. 92B of the Act and the introduction of specified domestic transactions u/s. 92BA of the Act) in a few illustrative cases can be considered as under:
Conclusion
The Other Method is undoubtedly a flexible recourse for taxpayers to consider and apply various plausible comparability indicators/alternatives other than the ones prescribed under the statute, in order to compare controlled transactions (whether or not unique) with associated enterprises. Furthermore, the intention of the Tribunals as regards the application of the Other Method with retrospective effect (given its curative intent) and supporting its “purposive interpretation” to cover the expanded definition of “price” is positively appreciated, however, there may be consequent challenges, by the Revenue Authorities, to the application of the other method, especially in cases where ad hoc attributions or allocations are made to the profits/incomes of Indian taxpayers. In the absence of uncontrolled comparables, the Revenue Authorities could argue that the application of the Other Method as the most appropriate method accords a flexibility to use their own “formula based mechanism” of allocation of prices/profits, as opposed to the transfer pricing methodology selected by taxpayers. Accordingly, taxpayers would be required to consider all these aspects and maintain the right level of documentation to substantiate their claims.
