Economic double taxation – Domestic Transfer Pricing

    Non-compliance with ALP would result in disallowance of expenditure in the hands of assessee incurring the same under sec. 40A(2)(b). However there is no mechanism to make corresponding downward adjustment of income in the hands of related party. This would obviously result in economic double taxation. Circular 6-P dated 6th July, 1968 dealt with the issue of disallowance under sec. 40A(2)(b) had clarified that there should not be any disallowance when there is no attempt to evade taxes. Para 74 of said circular reads as under:

    "It may be noted that the new provision is applicable to all categories of expenditure incurred in businesses and professions, including expenditure on purchase of raw materials, stores or goods, salaries to employees and also other expenditure on professional services, or by way of brokerage, commission, interest, etc. Where payment for any expenditure is found to have been made to a relative or associate concern falling within the specified categories, it will be necessary for the Income-tax Officer to scrutinise the reasonableness of the expenditure with reference to the criteria mentioned in the section. The Income-tax Officer is expected to exercise his judgment in a reasonable and fair manner. It should be borne in mind that the provision is meant to check evasion of tax through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases."

    The import of the circular is intact and the benevolent portion of the same would be available for the assessees. In this context we need to address the issue of economic double taxation which is never the objective of domestic transfer pricing. In other words unless corresponding downward adjustments of income are allowed in the hands of recipients who are related parties, on the event of upward adjustment of income in the hands of assessee incurring the same, there is no legal justification as it would result in economic double taxation. In international Transfer Pricing we have the concept of corresponding adjustments as per Article 9(2) of OECD MC/UN MC and the same analogy should be brought in the context of domestic transfer pricing also.