The High Court of Bombay issued its decision in the case of: CIT v. Garware Polyester Ltd [ITA 1434 of 2013] on 23 June 2015. The decision concerns a situation where the scope of work accepted by the associated enterprise (AE) agent is wider than that of a comparable third party. In this case the arm’s length price (ALP) for the agency commission must be at a higher rate.

The taxpayer had paid a commission to its foreign AE for the agency services obtained. The taxpayer had claimed a deductible expense for 12.5% commission as the arm’s length price (ALP). The transfer pricing officer (TPO) reduced the claim to 5% based on the average rate of commission paid by the taxpayer to the third party agents in other countries. On appeal, the Commissioner (Appeals) determined the ALP of the commission payment at 8% plus 2% for the additional risk undertaken by the AE agent i.e. 10%. The Income Tax Appellate Tribunal (ITAT) upheld the order of the Commissioner (Appeals). The tax authorities appealed to the High Court.

The High Court ruled in favor of the taxpayer by upholding the ITAT’s order. The High Court, while reviewing the order of the ITAT, observed that the Commissioner (Appeals) had performed an in-depth examination of the relationship of the AE and the non-AE agents with the taxpayer before arriving at the ALP. It was observed that the agency arrangement entered into by the taxpayer with the AE agent and the non-AE agents differed significantly in their business model.

However, the High Court also observed that the Commissioner (Appeals), on the above analysis, had noted that the non-AE agents had limited risk and had not incurred any expenditure towards the development of the market for the taxpayer’s products. The market for the products was developed by the AE Agents and the AE agent therefore carried risk which a non-AE did not. Thus the scope of the work of the AE agent was wider than that of the non-AE agents. The High Court further observed that in these circumstances the Commissioner (Appeals) had determined the transfer pricing adjustment on account of commission paid at 8% with 2% on account of additional risk i.e. 10% as the ALP commission payable to the AE Agents.