I run a captive sourcing arm paid cost plus 5 per cent. The TPO has ignored my cost base and applied a mark-up to the FOB value of the goods my group company sources through me. Can he do that?
No. The Delhi High Court held that broad-basing the profit determining denominator to the entire free-on-board value of contracts entered into by the associated enterprise is contrary to the Act and the Rules. The exercise finds no mention in either. The Transfer Pricing Officer had not disturbed the comparables or the method, and had shown neither how the Indian company bore significant risk nor what locational advantage the associated enterprise enjoyed. Findings of "significant risk" and "functional risk" cannot rest on vague generalities. The addition of Rs.57.65 crore was deleted and the Tribunal's order set aside.
Decided by the High Court (High Court of Delhi - Justice S. Ravindra Bhat and Justice R.V. Easwar (judgment by S. Ravindra Bhat, J)) on 2013-12-16, reported as ITA 306/2012 (Delhi High Court), reserved 8 July 2013, pronounced 16 December 2013. It bears on section 92C, section 92CA, section 92CA(3), section 144C(1) of the Income Tax Act 1961, in Assessment & Scrutiny and How Tax Law Is Read matters.
This is the authority for the proposition that the tested party's cost base must match what the tested party actually does. Once a TPO accepts the method and the comparables, he cannot substitute a denominator - here the FOB value of goods sold by unrelated Indian manufacturers to unrelated overseas customers - that has no relation to the assessee's own functions. The four propositions in the Court's summary are what practitioners quote: adjust nothing without showing how and to what extent risk is borne; base conclusions on specific facts, not labels; where the assessee's transfer pricing report sets everything out, analyse it and give reasons before rejecting any part; and record reasons for discarding a method. The judgment is also useful on location savings, where the TPO's whole case was that India is cheap and somebody should be taxed on the difference, with nothing quantified.
Binding within that High Court's jurisdiction. Persuasive elsewhere.
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For assessment year 2006-07, Li & Fung India is a wholly owned subsidiary of a Mauritius company, set up as a captive offshore sourcing provider. Its Hong Kong group company contracts with overseas retail chains for sourcing support for high volume, time sensitive consumer goods, and by an agreement of 4 December 1997 subcontracted that work to the Indian company, remunerating it at cost plus a 5 per cent mark-up. The Indian company received buying support fees of Rs.47,69,83,904. It benchmarked the transaction on the Transactional Net Margin Method with operating profit over total cost as the profit level indicator, and showed an operating margin of 5.17 per cent against a weighted average of 4.07 per cent for twenty-six comparables. It described itself as a low risk captive service provider, the substantial functions and enterprise risks resting with the associated enterprise. By an order of 28 October 2009 under section 92CA(3) the Transfer Pricing Officer accepted the comparables but held the cost plus 5 per cent was not at arm's length, and instead applied a 5 per cent mark-up to the FOB value of Rs.1,202.96 crore of exports made by Indian manufacturers to overseas third party customers. His reasons were that the Indian company performed all critical functions, bore significant risks, had developed unique intangibles including supply chain management and human capital, and had not quantified or been attributed any share of India's location savings. The resulting adjustment of Rs.57,65,61,186 went into the draft assessment order under section 144C(1) and was upheld by the Tribunal.
The appeal was allowed, the Tribunal's order set aside, and both questions answered in favour of the assessee. The Court recorded five conclusions. Broad-basing the profit determining denominator to the entire FOB value of the contracts entered into by the associated enterprise, presented as an "adjustment", is contrary to the Act and the Rules. The order below had not shown how, or to what extent, the Indian company bore significant risks, or that the associated enterprise enjoyed locational advantages such as to justify rejecting the assessee's transfer pricing exercise. Tax authorities must base their conclusions on specific facts rather than vague generalities such as "significant risk", "functional risk" or "enterprise risk", and where such findings are warranted they must be supported by demonstrable reason on objective facts with the relative weight and significance evaluated. Where all the elements of a proper Transactional Net Margin Method exercise are detailed and disclosed in the assessee's reports, the authorities must analyse them in detail and record why any of them is unacceptable. The order upholding a 3 per cent margin over the FOB value of the associated enterprise's contracts was in error of law, and the addition was deleted.
The Court's reasoning as it survives in the harvested text runs along two lines. The first is the statutory scheme and the Board's own understanding of it. Under section 92C the primary onus is on the taxpayer to determine an arm's length price under the Rules and to substantiate it with the prescribed documentation; where that onus is discharged and the data used are reliable and correct, the Assessing Officer may not intervene. Section 92C(3) permits intervention only where he has material or information or a document on the basis of which he can form an opinion that one of the specified circumstances exists - the price was not determined in accordance with sub-sections (1) and (2), the documentation under section 92D was not kept, the data used are not reliable or correct, or information called for was not furnished. In all other cases the value of the international transaction is to be accepted without further scrutiny. The Board's circulars, which the Court set out, add that the regime exists to prevent profits being shifted out by manipulating prices, and is not intended to be applied where adopting an arm's length price would reduce the overall Indian tax incidence. The second line is the quality of the order under challenge. The Transfer Pricing Officer must determine the arm's length price on all relevant facts and data and pass a speaking order, containing the data used, the reasons for the price arrived at and the applicability of the methods, subject to judicial scrutiny. Here he gave no substantive reason for disregarding the method the assessee had applied, and his adjustment of a 5 per cent mark-up on the FOB value of exports finds no mention in the Act or the Rules.
Tax authorities should base their conclusions on specific facts, and not on vague generalities, such as "significant risk", "functional risk", "enterprise risk" etc. without any material on record to establish such findings.
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Handle my notice → Ask a CA on WhatsAppNo. The Delhi High Court held that broad-basing the profit determining denominator to the entire free-on-board value of contracts entered into by the associated enterprise is contrary to the Act and the Rules. The exercise finds no mention in either. The Transfer Pricing Officer had not disturbed the comparables or the method, and had shown neither how the Indian company bore significant risk nor what locational advantage the associated enterprise enjoyed. Findings of "significant risk" and "functional risk" cannot rest on vague generalities. The addition of Rs.57.65 crore was deleted and the Tribunal's order set aside. This was decided by the High Court (High Court of Delhi - Justice S. Ravindra Bhat and Justice R.V. Easwar (judgment by S. Ravindra Bhat, J)) and bears on section 92C, section 92CA, section 92CA(3), section 144C(1) of the Income Tax Act 1961. It is reported as ITA 306/2012 (Delhi High Court), reserved 8 July 2013, pronounced 16 December 2013. This is the authority for the proposition that the tested party's cost base must match what the tested party actually does. Once a TPO accepts the method and the comparables, he cannot substitute a denominator - here the FOB value of goods sold by unrelated Indian manufacturers to unrelated overseas customers - that has no relation to the assessee's own functions. The four propositions in the Court's summary are what practitioners quote: adjust nothing without showing how and to what extent risk is borne; base conclusions on specific facts, not labels; where the assessee's transfer pricing report sets everything out, analyse it and give reasons before rejecting any part; and record reasons for discarding a method. The judgment is also useful on location savings, where the TPO's whole case was that India is cheap and somebody should be taxed on the difference, with nothing quantified. If it applies to you, the first step is this: Make the transfer pricing report set out every element of the method in detail; the Court held that where it does, the authorities must analyse it and give reasons before rejecting any part of it.
For assessment year 2006-07, Li & Fung India is a wholly owned subsidiary of a Mauritius company, set up as a captive offshore sourcing provider. Its Hong Kong group company contracts with overseas retail chains for sourcing support for high volume, time sensitive consumer goods, and by an agreement of 4 December 1997 subcontracted that work to the Indian company, remunerating it at cost plus a 5 per cent mark-up. The Indian company received buying support fees of Rs.47,69,83,904. It benchmarked the transaction on the Transactional Net Margin Method with operating profit over total cost as the profit level indicator, and showed an operating margin of 5.17 per cent against a weighted average of 4.07 per cent for twenty-six comparables. It described itself as a low risk captive service provider, the substantial functions and enterprise risks resting with the associated enterprise. By an order of 28 October 2009 under section 92CA(3) the Transfer Pricing Officer accepted the comparables but held the cost plus 5 per cent was not at arm's length, and instead applied a 5 per cent mark-up to the FOB value of Rs.1,202.96 crore of exports made by Indian manufacturers to overseas third party customers. His reasons were that the Indian company performed all critical functions, bore significant risks, had developed unique intangibles including supply chain management and human capital, and had not quantified or been attributed any share of India's location savings. The resulting adjustment of Rs.57,65,61,186 went into the draft assessment order under section 144C(1) and was upheld by the Tribunal. The matter was decided on 2013-12-16 by the High Court (High Court of Delhi - Justice S. Ravindra Bhat and Justice R.V. Easwar (judgment by S. Ravindra Bhat, J)). On those facts the High Court held as follows. The appeal was allowed, the Tribunal's order set aside, and both questions answered in favour of the assessee. The Court recorded five conclusions. Broad-basing the profit determining denominator to the entire FOB value of the contracts entered into by the associated enterprise, presented as an "adjustment", is contrary to the Act and the Rules. The order below had not shown how, or to what extent, the Indian company bore significant risks, or that the associated enterprise enjoyed locational advantages such as to justify rejecting the assessee's transfer pricing exercise. Tax authorities must base their conclusions on specific facts rather than vague generalities such as "significant risk", "functional risk" or "enterprise risk", and where such findings are warranted they must be supported by demonstrable reason on objective facts with the relative weight and significance evaluated. Where all the elements of a proper Transactional Net Margin Method exercise are detailed and disclosed in the assessee's reports, the authorities must analyse them in detail and record why any of them is unacceptable. The order upholding a 3 per cent margin over the FOB value of the associated enterprise's contracts was in error of law, and the addition was deleted.
The Court's reasoning as it survives in the harvested text runs along two lines. The first is the statutory scheme and the Board's own understanding of it. Under section 92C the primary onus is on the taxpayer to determine an arm's length price under the Rules and to substantiate it with the prescribed documentation; where that onus is discharged and the data used are reliable and correct, the Assessing Officer may not intervene. Section 92C(3) permits intervention only where he has material or information or a document on the basis of which he can form an opinion that one of the specified circumstances exists - the price was not determined in accordance with sub-sections (1) and (2), the documentation under section 92D was not kept, the data used are not reliable or correct, or information called for was not furnished. In all other cases the value of the international transaction is to be accepted without further scrutiny. The Board's circulars, which the Court set out, add that the regime exists to prevent profits being shifted out by manipulating prices, and is not intended to be applied where adopting an arm's length price would reduce the overall Indian tax incidence. The second line is the quality of the order under challenge. The Transfer Pricing Officer must determine the arm's length price on all relevant facts and data and pass a speaking order, containing the data used, the reasons for the price arrived at and the applicability of the methods, subject to judicial scrutiny. Here he gave no substantive reason for disregarding the method the assessee had applied, and his adjustment of a 5 per cent mark-up on the FOB value of exports finds no mention in the Act or the Rules. In the words reproduced by the source cited on this page: "Tax authorities should base their conclusions on specific facts, and not on vague generalities, such as "significant risk", "functional risk", "enterprise risk" etc. without any material on record to establish such findings."
It was decided by the High Court on 2013-12-16 and is reported as ITA 306/2012 (Delhi High Court), reserved 8 July 2013, pronounced 16 December 2013. Binding within that High Court's jurisdiction. Persuasive elsewhere. A High Court decision binds the assessing officer, the Commissioner (Appeals) and the Income Tax Appellate Tribunal within that state, and is persuasive elsewhere. If your assessment is in a different jurisdiction, check whether your own High Court has taken the same view before relying on it. On section 92C, section 92CA, section 92CA(3), section 144C(1), the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The appeal was allowed, the Tribunal's order set aside, and both questions answered in favour of the assessee. The Court recorded five conclusions. Broad-basing the profit determining denominator to the entire FOB value of the contracts entered into by the associated enterprise, presented as an "adjustment", is contrary to the Act and the Rules. The order below had not shown how, or to what extent, the Indian company bore significant risks, or that the associated enterprise enjoyed locational advantages such as to justify rejecting the assessee's transfer pricing exercise. Tax authorities must base their conclusions on specific facts rather than vague generalities such as "significant risk", "functional risk" or "enterprise risk", and where such findings are warranted they must be supported by demonstrable reason on objective facts with the relative weight and significance evaluated. Where all the elements of a proper Transactional Net Margin Method exercise are detailed and disclosed in the assessee's reports, the authorities must analyse them in detail and record why any of them is unacceptable. The order upholding a 3 per cent margin over the FOB value of the associated enterprise's contracts was in error of law, and the addition was deleted. It arises in Assessment & Scrutiny and How Tax Law Is Read matters, on section 92C, section 92CA, section 92CA(3), section 144C(1) of the Income Tax Act 1961, and was decided by High Court of Delhi - Justice S. Ravindra Bhat and Justice R.V. Easwar (judgment by S. Ravindra Bhat, J). Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Where the TPO accepts the comparables and the profit level indicator but changes the cost base, take that as the point of attack - the substituted base must correspond to the tested party's own functions and risks. Ask the TPO to state, with material, how and to what extent your client bears each risk he asserts; labels such as "significant risk" or "enterprise risk" without facts were held insufficient. On location savings, require the department to quantify the saving and identify who bears the cost of creating it, rather than inferring an entitlement to extra profit from low Indian costs.
Still good law. The framing of the questions, the facts, the Court's summarised conclusions and the operative order allowing the appeal were read, so the holding is secure, although most of the intervening reasoning is missing from the harvested text. On later treatment, Indian Kanoon's citator carries 37 documents citing this judgment. The Delhi Bench of the Tribunal applied it in Gap International Sourcing (India) Pvt Ltd v DCIT, ITA No. 577/Del/2015, 1 October 2015, at paras 11-12: para 11 reproduces the High Court's numbered conclusions (a) to (e) and para 12 is where the Bench decides in its own voice, deleting the mark-up on the FOB value of exports and holding the assessee entitled to cost-plus remuneration on its own cost base. It continues to be treated as governing: the Delhi High Court in PCIT-7 v Sabic India Pvt Ltd, 14 October 2024, upheld a Tribunal order which had proceeded on it at para 21, and the Delhi High Court referred to it again in McKinsey Knowledge Centre India Pvt Ltd v PCIT, 9 August 2018, at para 25. Nothing overruling or doubting it was found among the citator results examined. Two qualifications: only the first ten of the 37 citing documents were reviewed, and no search was made for a Supreme Court appeal by the Revenue. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The harvested page is heavily clipped: the source marks that about 34,526 characters of the middle - the bulk of a forty-one page judgment - are not reproduced. What survives is the framing of the two questions of law, paragraphs 1 to roughly 8 setting out the facts and the Transfer Pricing Officer's reasons, a fragment on the OECD guidelines, and paragraphs from about 29 to 50, containing the discussion of section 92C and the Board's circulars, the Court's criticism of the order, its five numbered conclusions and the operative order. The Court's detailed treatment of the functional analysis, the intangibles, the location savings argument and the authorities it relied on is absent, so the reasoning above is necessarily partial. The batch line listed Rule 10B of the Income Tax Rules; the surviving text refers to the Act and the Rules generally without a discussion of Rule 10B that I can see. The judgment's paragraph 50 describes the Tribunal's order as dated 25 November 2011 while paragraph 1 gives 30 September 2011; I could not resolve that. The source page carried no reporter citations, so the case number is given instead. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The appeal was allowed, the Tribunal's order set aside, and both questions answered in favour of the assessee. The Court recorded five conclusions. Broad-basing the profit determining denominator to the entire FOB value of the contracts entered into by the associated enterprise, presented as an "adjustment", is contrary to the Act and the Rules. The order below had not shown how, or to what extent, the Indian company bore significant risks, or that the associated enterprise enjoyed locational advantages such as to justify rejecting the assessee's transfer pricing exercise. Tax authorities must base their conclusions on specific facts rather than vague generalities such as "significant risk", "functional risk" or "enterprise risk", and where such findings are warranted they must be supported by demonstrable reason on objective facts with the relative weight and significance evaluated. Where all the elements of a proper Transactional Net Margin Method exercise are detailed and disclosed in the assessee's reports, the authorities must analyse them in detail and record why any of them is unacceptable. The order upholding a 3 per cent margin over the FOB value of the associated enterprise's contracts was in error of law, and the addition was deleted.
TaxSphere, “Li & Fung India Pvt Ltd v CIT”, https://taxnotice.vittsphere.com/caselaw/case/li-fung-india-p-ltd-v-cit/ (validity last checked 2026-09-16)
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