Supreme Court Orders Fresh Review of Transfer Pricing Cases: Karnataka High Court Ruling Set Aside

The Supreme Court of India has overturned the Karnataka High Court’s ruling that had dismissed multiple appeals concerning Transfer Pricing (TP) adjustments under the Income Tax Act, 1961. In the case titled SAP Labs India Private Limited vs. Income Tax Officer, Circle 6, Bangalore, the Court ruled that High Courts must examine whether the guidelines prescribed in the Income Tax Act and Income Tax Rules were followed while determining the Arm’s Length Price (ALP). The judgment holds significant implications for Transfer Pricing litigation and clarifies that the Tribunal’s decision is not always final.

Background of the Case

The case involved a batch of civil appeals, most of which were filed by the Income Tax Department challenging decisions of the Income Tax Appellate Tribunal (ITAT). A few appeals were also filed by the assessees. The Karnataka High Court had dismissed these appeals on the ground that the Tribunal’s findings were based on facts and did not involve any substantial question of law.

The primary issue was whether the Tribunal’s determination of Arm’s Length Price (ALP) in Transfer Pricing cases should be considered final or whether the High Courts could review it under Section 260A of the Income Tax Act.

Key Legal Issues

The Supreme Court examined the following critical questions:

Can the High Courts refuse to entertain Transfer Pricing appeals solely on the ground that the Tribunal is the final fact-finding authority?
Should High Courts examine whether the ITAT followed the prescribed guidelines under the Income Tax Act while determining ALP?
Was the Karnataka High Court’s reliance on the Softbrands India (P) Ltd. judgment correct?

Arguments by the Appellants (Income Tax Department)

The Revenue contended:

High Courts Must Scrutinize ALP Determination: The Karnataka High Court erred in holding that Transfer Pricing disputes do not involve substantial questions of law.
Tribunal’s Findings Are Not Absolute: The Tribunal’s determination of ALP must be reviewed for compliance with statutory guidelines.
Softbrands India (P) Ltd. Case Misapplied: The High Court’s reliance on this precedent was misplaced because it barred judicial review of ALP determinations.
Errors in Selection of Comparables: Many cases involved wrongful exclusion or inclusion of comparables, which required judicial scrutiny.

Arguments by the Respondents (Assessees)

The assessees, represented by senior advocates, argued:

Tribunal’s Findings Are Primarily Factual: Once the ITAT determines ALP based on statutory methods, the High Court should not intervene.
Burden on Revenue to Prove Perversity: The Department failed to demonstrate that the Tribunal’s findings were perverse.
Scope of Section 260A Limited: Only substantial questions of law should be reviewed, and Transfer Pricing adjustments largely involve factual determinations.
Consistency in Approach: The Tribunal had followed established guidelines, and mere disagreements over comparables should not warrant High Court interference.

Supreme Court’s Ruling

1. High Courts Must Scrutinize ALP Determination

The Supreme Court held that the Karnataka High Court’s blanket refusal to examine ALP determinations was incorrect. It clarified:

“There cannot be any absolute proposition of law that in all cases where the Tribunal has determined the arm’s length price, the same shall be final and cannot be the subject matter of scrutiny under Section 260A of the IT Act.”

2. Tribunal’s Findings Not Always Binding

The Court ruled that High Courts must examine whether the ITAT followed the Income Tax Act and Rules 10A to 10E in determining ALP:

“If the determination of ALP is challenged before the High Court, it is always open for the High Court to examine in each case whether the guidelines under the Act and Rules were followed or not.”

3. Karnataka High Court’s Misinterpretation of Softbrands Case

The Supreme Court explicitly rejected the Karnataka High Court’s reliance on Softbrands India (P) Ltd., which had held that Tribunal decisions on Transfer Pricing are beyond judicial review:

“The view taken by the Karnataka High Court in the case of Softbrands India (P) Ltd. that ALP determinations by the Tribunal cannot be the subject matter of scrutiny under Section 260A is incorrect.”

4. High Courts Must Re-Examine the Appeals

The Court remitted all cases back to the respective High Courts for fresh consideration, directing them to:

Ensure that ITAT followed statutory guidelines.
Determine whether the Tribunal’s findings were perverse.
Complete the review process within nine months.

Key Excerpt from the Judgment

The Supreme Court concluded:

“In view of the above, the impugned judgments and orders passed by the High Court dismissing the Revenue’s appeals are quashed and set aside. The matters are remitted back to the respective High Courts to decide and dispose of the appeals afresh in light of the observations made hereinabove.”

Conclusion

The Supreme Court’s ruling sets an important precedent for Transfer Pricing litigation in India. It reinforces the principle that judicial review is permissible in ALP determinations and clarifies that the Tribunal’s findings are not beyond scrutiny.

This decision ensures that tax authorities and High Courts can examine whether Transfer Pricing assessments follow prescribed legal procedures, thereby promoting consistency and fairness in tax disputes.

Petitioner Name: SAP Labs India Private Limited.
Respondent Name: Income Tax Officer, Circle 6, Bangalore.
Judgment By: Justice M.R. Shah, Justice M.M. Sundresh.
Place Of Incident: Bangalore, Karnataka.
Judgment Date: 19-04-2023.

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