The key question in this case was whether Glaxo Smithkline Asia (P) LTD and it’s service provider [GSKCH] are related companies within the meaning of Section 40A(2) of the Income Tax Act? If the answer to the question is in the affirmative, then the next question on the merits which arose for determination was whether the allocation of cross-charges by Glaxo Smithkline Asia (P) LTD was the correct test applied by the assessee? In other words, whether the allocation of cross-charges should be allowed or disallowed by the tax authorities? Held by the Supreme Court The Court was of the view that as far as this case was concerned, there was no need to interfere as the entire exercise was revenue neutral. Therefore, the special leave petition filed by the tax authorities was dismissed. Excerpts – “The main issue which needs to be addressed is, whether Transfer Pricing Regulations should be limited to cross-border transactions or whether the Transfer Pricing Regulations be extended to domestic transactions? In the case of domestic transactions, the under-invoicing of sales and over-invoicing of expenses ordinarily will be revenue neutral in nature, except in two circumstances having tax arbitrage – [i] If one of the related Companies is loss making and the other is profit making and profit is shifted to the loss making concern; and [ii] If there are different rates for two related units [on account of different status, area based incentives, nature of activity, etc.] and if profit is diverted towards the unit on the lower side of tax arbitrage. For example, sale of goods or services from non-SEZ area [taxable division] to SEZ unit [non-taxable unit] at a price below the market price so that taxable division will have less profit taxable and non-taxable division will have a higher profit exemption. (…) We are informed that the matter has been examined by CBDT and it is of the view that amendments would be required to the provisions of the Act if such Transfer Pricing Regulations are required to be applied to domestic transactions between related parties under Section 40A(2) of the Act. (…) In order to reduce litigation, we are of the view that certain provisions of the Act, like Section 40A(2) and Section 80IA(10), need to be amended empowering the Assessing Officer to make adjustments to the income declared by the assessee having regard to the fair market value of the transactions between the related parties. The Assessing Officer may thereafter apply any of the generally accepted methods of determination of arm’s length price, including the methods provided under Transfer Pricing Regulations. (…) Normally, this Court does not make recommendations or suggestions. However, as stated above, in order to reduce litigation occurring in complicated matters, we are of the view that the question of amendment, as indicated above, may require consideration expeditiously by the Ministry of Finance.” Click here for translation ...