The assessee in a recent case manufactured refrigerators, washing machines and compressors, and spares thereof. It also traded in all the aforementioned items, as well as in microwave ovens, dishwashers, cooking ranges, air conditioners and other spares. When considering the assessee's business activities, the transfer pricing officer accepted that all of the assessee's international transactions with its associated enterprises were at arm's length, except those for payment of a royalty/brand fee (as a percentage of net sales) for use of the brand name.

When disallowing the brand fee payment, the officer stated that, against the background of continuous losses, such payments were not justified, as no benefits (in the form of improved profitability from operations) were accrued by the assessee. The officer further held that the assessee could not demonstrate any actual benefits derived by using the brand name.

When both appeal forums - the commissioner of income tax (appeals) and subsequently the tribunal - ruled in the assessee's favour, the revenue authorities brought substantial questions of law before the jurisdictional high court regarding the appropriateness of the tribunal's deletion of the transfer pricing adjustments.


The Delhi High Court ruled in favour of the assessee, allowing the deduction for payment of royalty/brand fee.(1) Referring to Article 9 of the Organisation for Economic Cooperation and Development (OECD) Model Tax Convention, the Delhi High Court observed that the guidelines recommend that, barring exceptional cases:

"tax administrations should not disregard the actual transaction or substitute other transactions for them and the examination of a controlled transaction should ordinarily be based on the transaction as it has been actually undertaken and structured by the associated enterprises."

Further, using the OECD guidelines as valid inputs, the high court also categorically stated that:

"it is not for the revenue authorities to dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure the assessee can incur."

Relying on settled legal positions and rulings in other similar cases by the Supreme Court, the Delhi High Court emphasised that the assessee is not bound (only out of necessity) to demonstrate the legitimacy of any expenditure it incurs, provided that it is incurred "wholly and exclusively" for the purpose of business. The high court also stated that while the transfer pricing officer is within its rights to examine the quantum of expenditure, it was not open to the revenue authorities to step into the shoes of the businessperson and disallow the entire expense merely on account of continuous losses.


This case is typical of the tax authorities' habit of making transfer pricing adjustments by denying contractually valid payments against the background of continuous losses, without delving into the economic rationale, the business requirements or the reality of the situation on the ground. This frequently results in undue and avoidable hardship for taxpayers. In holding that it is not the tax authorities' duty to dictate the manner of conducting business or to tell the assessee what expenditure it can incur, the High Court relied on the Supreme Court cases of Eastern Investment Ltd v CIT,(2) CIT v Walchand & Co(3) and CIT v Rajendra Prasad Moody.(4)

Based on the principle that expenditure cannot be equated with profit generation alone and losses are a natural outcome of a business, this ruling is welcome, as it emphasises the necessity that transfer pricing authorities give due consideration to the economic and commercial arrangement between associated enterprises. It is also pertinent for the taxpayer to realise that the Delhi High Court has not dismissed the transfer pricing officer's right to question the quantum of expenditure - it is merely the act of disallowing the entire expense that has been curtailed. Thus, it is important that taxpayers undertake in-depth analysis to satisfy queries that may be raised during transfer pricing proceedings that require them to justify the quantum of expenditure incurred.

For further information on this topic please contact Ranjeet Mahtani at Economic Laws Practice by telephone (+91 22 6636 7000), fax (+91 22 6636 7172) or email ([email protected]).


(1) CIT v EKL Appliances Ltd, ITA 1068 & 1070/2011.

(2) (1951) 20 ITR 1.

(3) (1967) 65 ITR 381.

(4) (1978) 115 ITR 519.