Global Tax Alert (News from Transfer Pricing) | 26 August 2013
Bangalore Tribunal rules on applicability of transfer pricing provisions to assignment of contract
The Bangalore Income-tax Appellate Tribunal (Tribunal) in the case of Tellabs India Private Ltd (Taxpayer) has ruled on the issue of whether assignment of a contract to the Taxpayer by an Associated Enterprise (AE) is an international transaction to which the transfer pricing provisions apply. The Taxpayer is a member of a US based group engaged in designing, manufacturing and selling telecom equipment and products. Tellabs Denmark, the Taxpayer’s Danish AE, entered into a turnkey contract with an Indian customer for supply and installation of telecom equipment. The onshore component of the contract was thereafter assigned by the AE to the Taxpayer. The Tax Authority treated the assignment as an international transaction and sought to determine whether the consideration received was arm’s length. The Tribunal upheld the order of the Tax Authority and held that the assignment of contract constituted an international transaction that needed to be evaluated for satisfaction of arm’s length principles. The Tribunal thereafter remanded the matter back to the Tax Authority for determining the arm’s length price.
Power Grid Corporation of India Limited (PGCIL), a Government of India enterprise, invited tenders for the supply, installation and commissioning of telecommunication equipment. The work was to be performed both outside India (offshore) and in India (onshore).
The tender was successfully awarded to Tellabs Denmark, which by virtue of a common parent was an AE of the Taxpayer. Tellabs Denmark entered into four agreements with PGCIL: two onshore and two offshore services contracts. Separate remuneration was agreed for onshore and offshore contracts.
After the award of the contract, the Tellabs group underwent corporate restructuring. As a result, Tellabs Denmark, sought permission of PGCIL to assign a portion of the onshore contract to the Taxpayer. PGCIL agreed to the request subject to the condition that Tellabs Denmark continue to be liable for due performance of all four contracts.
The transaction the Taxpayer undertook consequent to assignment of the onshore contract by Tellabs Denmark was not reported by the Taxpayer as an international transaction and accordingly no documentation supporting the arm’s length nature was maintained by the Taxpayer.
Tax Authority’s argument
The offshore and onshore contracts were not independent contracts and they were inseparable. Further, the contract between PGCIL and the Taxpayer was also not an independent contract. There was no novation of the contract between PGCIL and Tellabs Denmark since Tellabs Denmark continues to be liable despite assignment.
The assignment agreement and the so-called transaction between the Taxpayer and PGCIL were only subsequent events. The terms of the transaction were determined between the person (PGCIL) and the AE (Tellabs Denmark), and the Taxpayer had no say or control in this regard.
The Taxpayer merely carried out the contract with PGCIL in accordance with terms and conditions originally determined in sum and substance by its AE. As a result, the transaction between the Taxpayer and PGCIL is a deemed an international transaction.
The Taxpayer took the position that both the onshore and offshore contracts were independent. The Taxpayer was assigned the contract with the approval of PGCIL and thus the agreement was between the Taxpayer and PGCIL. Further, the agreement was independent of any other agreement between PGCIL and Tellabs Denmark.
The assignment of the onshore contract with prior permission, consent and concurrence of PGCIL was in fact and substance novation of the contract.
Both, Taxpayer and PGCIL are residents in India and with the Taxpayer directly billing PGCIL for its services, as a part of their agreement, transfer pricing provisions are not attracted.
Ruling of the Tribunal
The Tribunal distinguished between novation of a contract and assignment of a contract. It held that assignment involves transfer of an interest or benefit from one person to another. However, the “obligations”/“burden” under the contract cannot be transferred. On the other hand, under novation, the original contract is extinguished and is replaced by a new one in which a third party takes up the obligations.
On a perusal of the contract agreements, the Tribunal held that PGCIL had consented to the assignment of a portion of the onshore agreement by Tellabs Denmark to the Taxpayer with a specific condition that the assignment not amount to novation of the contract between PGCIL and Tellabs Denmark.
The assignment agreement between Tellabs Denmark and the Taxpayer had all the ingredients of an international transaction within the meaning of tax law. In other words, it was an agreement between two or more AEs where one of the parties to the transaction, Tellabs Denmark, is a nonresident. The transaction relates to provision of services or a transaction that had a bearing on profits, income, losses or assets. Therefore, the price paid for such transaction had to be determined in accordance with arm’s length principles.
Thus, the Tribunal upheld the orders of the Tax Authority holding that transfer pricing provisions were applicable to the assignment of the portion of the onshore contract by Tellabs Denmark to the Taxpayer.
However, for determination of arm’s length price, the Tribunal remanded the case back to the Tax Authority since a detailed transfer pricing analysis was not undertaken, and adequate opportunity was not provided to the Taxpayer to present its case.
The Indian tax law provides a fairly broad definition for the term “international transaction” subject to transfer pricing provisions. The ruling affirms that the broad definition covers even arrangements between AEs involving assignment of contracts or other similar rights. The ruling however does not address the more contentious issue of determination of arm’s length consideration for such international transactions. The Taxpayer argued that as the assignment was under similar terms and conditions as that were agreed with the uncontrolled customers, the same should be recognized as a comparable uncontrolled price (CUP). The Tribunal has however left the issue open for consideration by the Tax Authority.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (India), Bangalore
- • Rajendra Nayak
+91 80 4027 5454
Ernst & Young LLP (India), New Delhi
- • Vijay Iyer
+91 11 6623 324
EYG no. CM3759