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KPMG IN INDIA
Delhi High Court rules that transfer pricing reference does not curtail test of
deductibility of expenses under Section 37 of the Income-tax Act, 1961.
Holds that cost-to-cost reimbursement transactions should also be
benchmarked from an arm’s length perspective
2 June 2014
B
Background
Recently, the Delhi High Court (High Court) in the
1
case of Cushman and Wakefield (India) Pvt. Ltd. (the
taxpayer) rejected the taxpayer's contention that
since the associated enterprise (AE) has charged
only cost incurred without any mark-up, further
benchmarking is not necessary in view of Section
92(3) of the Income Tax Act, 1961 (the Act). The
High Court also held that the Assessing Officer’s
(AO's) reference to the Transfer Pricing Officer (TPO)
is for limited purpose of determining the arm’s length
price (ALP) and does not curtail powers of the AO
under Section 37 of the Act to check if expenditure is
wholly and exclusively incurred for the purposes of
the business.
Facts of the case

The taxpayer is engaged in the business of
rendering services connected to acquisition, sales
and lease of real estate. These services are
provided to several clients within and outside India.
______________
1
CIT v. Cushman and Wakefield (India) Pvt. Ltd. v. (ITA 475/2012/Del)
The taxpayer reported several international
transactions including – (i) payment of referral fees
to AEs; and (ii) reimbursement to AEs for the costs
incurred by them for certain coordination and liaison
services provided to the taxpayer.

The TPO disallowed reimbursement of expenses
transaction by determining its ALP as nil. The TPO
held that no intra-group services existed in this case
as the taxpayer was unable to file any evidence to
support the specific need for such services and the
benefits that were actually accrued from them.
While the taxpayer claimed that the reimbursement
of cost related to certain coordination, liaison, and
client solution services rendered by the AEs, no
benchmarking or transfer pricing analysis was
conducted to substantiate the arm’s length nature of
such transactions. The TPO also noted that the
taxpayer may have received only incidental benefit
from the global relationship between the AEs and
clients. Further, given that the taxpayer itself had
many offices in India which conducted market
research, the services rendered by the AEs were
merely a duplication of services.
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
As regards the payment of the referral fees, the TPO
concluded it to be at arm’s length. However, the AO
disallowed the same under Section 37 of the Act,
stating that the taxpayer failed to demonstrate the
genuineness of the transaction, the receipt of any such
services, and the business purpose of the same.

The Dispute Resolution Panel (DRP) upheld the
adjustments made by the AO. The taxpayer preferred
an appeal with the Income-tax Appellate Tribunal (the
Tribunal) against the DRP order. The Tribunal reversed
the findings of the AO/TPO on both of the abovementioned transactions. On the transaction related to
the reimbursement of expenses, the Tribunal, while
rejecting the TPO’s contention of ‘incidental benefits’,
held that the services were rendered by the AEs. On
the transaction of payment of the referral fee, the
Tribunal upheld the taxpayer’s contention that the AO,
after having referred the matter to the TPO, could not
reopen or re-examine the transaction. The Tribunal also
held that the taxpayer has submitted ample evidence to
support the expenditure and it was shown that such
expenditure is incurred with respect to revenue earned
by the taxpayer.
present case have only recovered their costs of
providing the services, which means that the ALP
for such a transaction would, at a minimum, be
above or equal to the costs claimed as
reimbursement. The ALP if determined would
necessarily be greater as the cost would be
supplemented with a profit mark-up for the AE. In
such event, Section 92(3) clearly mandates that
ALP is not to be considered, since the effect would
be a total reduction in the tax incidence in India.

High Court’s ruling

The High Court observed that whether a third
party, in an uncontrolled transaction with the
taxpayer, would have charged amounts lower,
equal to or greater than the amounts claimed by
the AEs, has to be tested under the various
methods prescribed in Section 92C of the Act.
The argument of the taxpayer that it only
reimbursed the cost incurred, while an
uncontrolled transaction would involve an
additional element of profit, is not tenable. This
being a transaction between related parties,
whether the cost itself is inflated or not is a matter
to be tested under a comprehensive transfer
pricing analysis. The High Court also noted that
the application of Section 92(3) is not a logical
inference from the fact that the AEs have only
asked for reimbursement of costs.

In relation to both of the transactions under
dispute, the High Court noted that the jurisdiction
of the AO under Section 37, and that of the TPO
under Section 92CA of the Act, are distinct. The
High Court noted that the authority of the TPO is
to conduct a TP analysis to determine the ALP,
and not to determine whether there is a service or
not from which the taxpayer benefits. That aspect
of the exercise is left to the AO under Section 37
of the Act. The High Court referred to the Rulings
by the Mumbai Tribunal in Dresser-Rand India Pvt.
2
Ltd. v. ACIT and Deloitte Consulting India Pvt.
3
Ltd. v. DCIT as the ones supporting such
distinction between the TPO’s and AO’s
jurisdictions.
Issue before the High Court

Is the Tribunal correct in holding that benchmarking
was not necessary in respect of the cost reimbursement
reported by the assessee that was later subject to
disallowance by the AO, since the TPO held that ALP in
respect of this component was nil?
Tax department’s contentions

The taxpayer did not conduct any benchmarking of the
costs claimed as reimbursement. The costs so
reimbursed to the AEs must be compared to costs paid
on other similar transactions, on the basis of one of the
methods of calculating the ALP prescribed in Indian TP
Regulations. The Tribunal’s finding is incorrect as the
same concerns only with whether the services were
rendered. The transaction cannot be allowed without
determination of the ALP, otherwise the same would
amount to a by-pass of the provisions of Section 92 of
the Act.
Taxpayer’s contentions

On payment of the referral fee - the AO, after
having referred the matter to the TPO under the
provisions of Section 92 of the Act, could not
reopen or re-examine the transaction under
Section 37 of the Act.
On the reimbursement transaction, the Tribunal’s
approach is statutorily sanctioned under Section 92(3)
of the Act, which states that the provisions of Section
92 will not apply if the result of the ALP determination is
a reduction of the overall tax incidence. The AEs in the
___________________
2
Dresser-Rand India Pvt. Ltd. v. ACIT (ITA No. 8753/Mum/2010)
Deloitte Consulting India Pvt. Ltd. v. DCIT (ITA No. 579, 1272,
1273/Mum/2011 and ITA No. 3910/3911/Mum/2009)
3
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Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

In reference to the referral fee transaction, the High
Court noted the TPO determines whether the
transaction value represents the ALP or not (including
whether the ALP is nil), while the AO makes the
decision as to the validity of the deduction under
Section 37. This would include the decision as to
whether the expenditure was ‘laid out or expended
wholly and exclusively for the purposes of the business’
as the same is a fact determination or verification to be
undertaken by the AO. The authority of the AO under
Section 37 is not curtailed in any manner by a reference
under Section 92C. Based thereon, the High Court held
the finding of the Tribunal that - the AO could not have
gone into the matter of whether the referral actually
took place after referring the matter to the TPO, to be
incorrect.

The High Court did bring in an important observation
that neither the Revenue, nor this Court, must question
the commercial wisdom of the taxpayer, or replace its
own assessment of the commercial viability of the
transaction. Whether it is commercially prudent or not to
employ outsiders to conduct this activity is a matter that
lies within the taxpayer's exclusive domain.

The finding of the Tribunal on both the transactions
were set aside, and the matter was remanded to the file
of the AO, for an ALP assessment by the TPO, followed
by the AO’s assessment order in accordance with law.
The Ruling also advocates the importance of
analysing and preparing the relevant documentation
surrounding transactions even in the nature of cost-tocost reimbursements. Evaluating aspects such as
authenticity of the cost itself, whether such costs are
incurred for the purpose of the business, undertaking
the correct benchmarking analysis in accordance with
the provisions of India TP regulations, etc. for the
reimbursement transactions are as important as for
any other inter-company transactions.
Our comments
Intragroup services transactions have already been one of
the most litigated subject matter in transfer pricing in India.
The revenue authorities in India typically consider that the
very basis of determining the ALP for such transaction is by
evaluating the business need for such services, benefits
accrued therefrom and the actual receipt of such services.
This High Court ruling may add greater complexity as the
need/benefit aspects of such transactions, which typically
pose burdensome documentation onus on the taxpayers,
may be independently examined by the AO for the purpose
of Section 37 of the Act. That said, Section 37 of the Act
requires the assessee to demonstrate that expenditure is
‘laid out or expended wholly and exclusively for the
purposes of the business’. Therefore, whether any actual
benefits have been accrued from such services or not may
be outside the purview.
The High Court’s observation that the Revenue cannot
question the commercial wisdom of the assessee and that it
is entirely for the taxpayer to take decisions that favour the
advancement of its business, is welcome.
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Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International
Cooperative (“KPMG International”), a Swiss entity. All rights reserved.