Delhi High Court: AO Cannot Deviate From TPO Order When Calculating Income

Delhi High Court: AO Cannot Deviate From TPO Order When Calculating Income

In a recent decision, the Delhi High Court has clipped the wings of Assessment Officers (AOs) when it comes to transfer pricing. The court, presided over by Justices Yashwant Varma and Purushaindra Kumar Kaurav, declared that AOs lack the authority to determine the Arm's Length Price (ALP) for any international transaction. This applies even to transactions chosen for scrutiny based on transfer pricing risk parameters.

Furthermore, the court emphasised that Section 92CA(4) of the Income Tax Act restricts AOs from deviating from the Transfer Pricing Officer's (TPO) order. This ensures that the total income of the assessee (taxpayer) is calculated based on the TPO's assessment, not the AO's independent evaluation of the ALP.

The company involved in this case (referred to as the "assessee" or "appellant") provides software and information technology-enabled services. Notably, a segment of their business focused on mobile security was demerged and became a wholly-owned subsidiary named Giesecke & Devrient MS India. Both companies are ultimately owned by a German parent company, Giesecke & Devrient MS GmbH.

For the assessment year 2017-18, the assessee filed their Income Tax Return, declaring an income of ₹18,15,98,120. However, their case was selected for scrutiny, leading to the issuance of notices under Sections 143(2) and 142(1). Since the assessee had international transactions during this period, reflected in the duly filed Form 3CEB as mandated by Section 92E, the Assessment Officer (AO) referred the case to the Transfer Pricing Officer (TPO) for determining the arm's length price (ALP) of those transactions.

Following the assessee's response, the TPO issued an order under Section 92CA(3) on January 31, 2021, determining a transfer pricing adjustment. However, the TPO identified an error and issued a rectified order on the same date, adjusting the arm's length price (ALP). Significantly, the rectified order included a suggestion for the Assessment Officer (AO) to examine the tax implications of the value associated with the assessee's "demerged business."

Based on the TPO's orders, the AO issued a draft assessment order under Section 144C. This draft order included a substantial total adjustment of ₹25,58,68,79,196. This figure comprised two key elements: the adjusted ALP of ₹16,84,51,531 and a much larger amount of ₹25,41,84,27,665.

The company (assessee) did not take the assessment order lying down and instead contested it in court through a writ petition. Their primary argument centred on the Assessment Officer's overreach of authority. The assessee believed the AO made critical errors in their approach:

Firstly, the AO disregarded the expertise of the TPO entirely. Instead of considering the TPO's order, the AO proceeded to make transfer pricing adjustments independently. In essence, the assessee argued, that the AO assumed the role of the TPO, which they were not authorised to do.

Secondly, the assessee contended that the AO misinterpreted the concept of arm's length price (ALP) in relation to international transactions. The rectified TPO order, according to the assessee, never determined the ALP by incorporating the demerger of their mobile security division. Despite this clear directive, the AO included the value of the demerged business in their calculation of the ALP.

The crux of the assessee's argument hinges on the AO's jurisdictional error. By determining the ALP for international transactions without following the TPO order, the assessee maintains that the AO made a significant legal misstep.

The department vigorously defended the order, arguing that it was legally sound and did not overstep jurisdictional boundaries. They asserted that the AO strictly followed the guidelines outlined in Section 92CA of the Act. As mandated, the AO referred the matter to the TPO for determining the arm's length price of international transactions. According to the department, the TPO did indeed examine the international transaction related to the demerger process. Having received the TPO's findings, the AO then computed the total income of the assessee based on the established ALP. In their view, the entire process adhered to the proper legal channels.

The bench, however, found significant discrepancies in the AO's assessment. The TPO order, as the court pointed out, solely addressed a transfer pricing adjustment of ₹16,84,51,531. Crucially, the AO included an additional amount of ₹25,41,84,27,665 in the assessee's total income. This hefty sum was not determined or directed by the TPO, and there was no mention of it as part of the ALP for the international transaction related to the demerger. The court found this inclusion to be a clear overreach of authority by the AO. Furthermore, the AO added this amount without providing the assessee with an opportunity to be heard, further compounding the legal error.

In light of these issues, the Delhi High Court ruled that the AO's order demonstrably violated the legislative mandate outlined in Section 92CA of the Income Tax Act. This section restricts AOs from deviating from the TPO's findings when calculating the assessee's total income. By exceeding their authority and failing to follow proper procedures, the court concluded that the AO's order was legally flawed.