A recent ruling by the Delhi High Court in Commissioner of Income Tax vs. Benetton India Pvt. Ltd. (Assessee)-ITA 472/2018 delivered on 06.02.2025 has clarified a crucial aspect of transfer pricing: the Arm’s Length Price (ALP) of related-party transactions should not be determined based on the profitability or losses of the Assessee. This judgment provides much-needed clarity for multinational companies engaged in cross-border transactions.

The Case and the Core Issue

The Assessee was under scrutiny for royalty payments to an associated enterprise (AE) for IT support services and reimbursements for seconded employees. The Transfer Pricing Officer (TPO) determined the ALP for both transactions as nil, arguing that because Assessee incurred losses, the services and know-how received had no value. The Delhi High Court, however, strongly disagreed.

The court emphasized that the TPO’s role is to determine the ALP based on comparable market prices, not to evaluate the commercial success or failure of the transactions. Simply because a company experiences losses does not automatically invalidate the value of the goods or services it receives from related parties. The court reiterated that transfer pricing assessments must be grounded in recognized valuation methods, not assumptions about profitability.

Key Observations from the Court

The High Court made several fundamental observations:

• ALP is independent of commercial outcomes: The court explicitly stated that ALP determination should not be contingent on profitability. A company’s business decisions, even if resulting in losses, do not invalidate the value of inputs like technology or services received from AEs. The TPO cannot penalize a company for business decisions that ultimately don’t yield profit.
• Losses do not equate to zero value: The court highlighted the fallacy of equating losses with zero value for resources used. Using the analogy of office rent, the court explained that even a loss-making business still incurs rent expenses. Similarly, the value of technical know-how or employee services is independent of the company’s overall financial performance.
• Focus on the transaction itself: The court stressed that ALP analysis must focus on the transaction itself. The question should always be: what would independent, unrelated parties pay for the same goods or services under similar circumstances? The Assessee’s overall financial performance is not the deciding factor. This principle applies equally to royalty payments and employee expense reimbursements. The TPO’s approach of assigning a zero value simply because of losses was deemed incorrect.

Implications for Assessee’

While the ruling protects companies from arbitrary assessments based solely on losses, it doesn’t give them free rein. Related-party transactions remain subject to scrutiny. Therefore, it is crucial for Assessee’ to:

• • Maintain robust documentation: Meticulous and comprehensive documentation is paramount. This should substantiate the arm’s length nature of every related-party transaction. Strong documentation, including details of comparable transactions, functional analysis, risk assessment, and the chosen methodology, is the best defense against potential disputes with tax authorities. It proactively demonstrates compliance and helps avoid protracted and costly litigation.

The Delhi High Court’s ruling provides welcome clarity on the principles of transfer pricing. By emphasizing an objective, transaction-focused approach, it prevents the TPO from overstepping its jurisdiction and ensures fairer and more methodical ALP assessments. This is a significant win for multinational companies operating in India, providing greater certainty and predictability in their cross-border transactions.