Navigating the Honourable Supreme Court Judgments: Will the substantial question of Law travel the distance?

Harmonizing the Landmark April 2023 Rulings in SAP Labs and Travelport Inc.: Deciphering Whether Arm’s Length Price Determination and PE Profit Attribution Under FAR Analysis Constitute Substantial Questions of Law Under Section 260A

April 2023

Landmark Supreme Court Verdicts

Section 260A

Substantial Question of Law Gateway

Twin Test

Statutory Violation + Perversity

15% Threshold

Travelport PE Profit Attribution

In the month of April 2023, the Hon’ble Supreme Court of India delivered landmark judgments in the cases of SAP Labs India Pvt. Ltd. and Travelport Inc.—addressing Arm’s Length Price (ALP) determination in SAP Labs and Profit Attribution to a Permanent Establishment (PE) in Travelport. In SAP Labs, the Court held that ALP determination is a question of law, whereas in Travelport, it was held that the attribution of profits was a question of fact. Due to the ruling in Travelport, a majority of taxpayers and tax advisors concluded that if the attribution of profits is a question of fact, ALP determination too ought to be considered a question of fact, since Functions, Assets, and Risks (FAR) Analysis forms a vital part of both. However, in the author's view, the status quo has been maintained pre- and post-judgment—nothing has fundamentally changed, and even profit attribution can travel to the High Courts as a substantial question of law in certain circumstances.

Introduction: The Apparent Contradiction in April 2023

The month of April 2023 was quite a landmark and a period of ambiguity for tax practitioners in general, and Transfer Pricing and International Taxation practitioners in particular. This ambiguity arose because the Hon’ble Supreme Court of India delivered two judgments which, when viewed from the perspective of the existence of a "question of law," resulted in an inter-linkage that generated confusion across the profession.

In SAP Labs India Private Limited vs Income Tax Officer [TS-225-SC-2023-TP], the Supreme Court overruled the Karnataka High Court’s decisions in M/s SAP Labs India Pvt. Ltd. (ITA No. 340/2012) and PCIT vs Softbrands India (P.) Ltd. [2018] 406 ITR 513 (Kar). The Supreme Court held that it cannot be accepted as an absolute proposition that the Income Tax Appellate Tribunal (ITAT) is the final fact-finding authority when it comes to the determination of the Arm’s Length Price (ALP). The Court affirmed that it is always open to the High Courts to examine whether the statutory guidelines laid down under Chapter X of the Income-tax Act, 1961 ('the Act') and the Income-tax Rules, 1962 ('the Rules') were followed, and whether the findings recorded by the ITAT in determining the ALP are perverse.

Conversely, in Director of Income-tax vs Travelport Inc. [2023] 149 taxmann.com 470 (SC), the Supreme Court upheld the concurrent views of the Delhi ITAT and the Delhi High Court, dismissing the Revenue's appeal by holding that what proportion of profits arose or accrued in India (the question of attribution of profits to a Permanent Establishment) was purely a question of fact.

"Although FAR Analysis can be considered an important part of the process of the determination of the ALP, it is not the only part, and therefore, the question of determination of the ALP is one of law, and that of attribution of profits is one of fact."

Question of Law: When Can it be Considered 'Substantial'?

For an appeal to be maintainable before a High Court under Section 260A of the Act, the appeal must raise a substantial question of law, rather than a mere question of law. Section 260A is held to be in pari materia and in identical terms to Sections 100 and 103 of the Code of Civil Procedure, 1908 ('CPC'), as affirmed in PCIT vs Softbrands India (P.) Ltd. and Vijay Kumar Talwar vs CIT [2011] 330 ITR 1 (SC).

Significantly, the term "substantial question of law" has neither been defined in the Income-tax Act nor in the CPC. Its precise contours have been established through a rich lineage of Supreme Court precedents, notably Sir Chunilal V. Mehta & Sons Ltd. vs Century Spinning & Mfg. Co. Ltd. (AIR 1962 SC 1314), Santosh Hazari vs Purushottam Tiwari [2001] 3 SCC 179, and Hero Vinoth (Minor) vs Seshammal [2006] 5 SCC 545. The governing principles may be summarized as follows:

Debatable Issue Affecting Rights: A question of law having a material bearing on the decision of the case (i.e., directly affecting the rights of the parties) is substantial if it is not settled by express statutory provisions or binding precedents, thereby involving a debatable legal controversy.
Substance vs. Technicality: The word "substantial" qualifies the question as having substance, essential value, and real worth—in contradistinction to something technical, of no consequence, or merely academic.
No Requirement of Public Importance: The legislature deliberately refrained from qualifying the term with the phrase "of general importance" (which appears in Section 109 CPC and Article 133(1)(a) of the Constitution). Thus, a substantial question of law need only be substantial between the litigating parties.
Disregard of Settled Precedent: A substantial question arises where the legal position is clear, but the lower courts or tribunals have decided the matter by ignoring or acting contrary to settled principles.
Application of Settled Law is Excluded: A mere question of law requiring the routine application of settled legal principles does not give rise to a substantial question of law.

When Does a Finding of Fact Become a Substantial Question of Law?

While the ITAT is universally recognized as the final fact-finding authority, a finding of fact can be challenged as a substantial question of law if it suffers from the vice of perversity. As established in Madan Lal vs Mst. Gopi (AIR 1980 SC 1754) and Narendra Gopal Vidyarthi vs Rajat Vidyarthi (Civil Appeal No. 7011 of 2008), perversity arises in five distinct evidentiary circumstances:

1. Findings Not Based on Evidence

Where the conclusions recorded by the ITAT are completely unsupported by any cogent evidence on record.

2. Ignoring Admissible Evidence

Where relevant, admissible, and material evidence submitted by the assessee or Revenue was arbitrarily ignored.

3. Relying on Inadmissible Material

Where the Tribunal based its decision on inadmissible evidence or unverified secret third-party information.

4. Misapplication of Legal Principles

Where established legal standards and statutory interpretation rules were not applied in appreciating the evidence.

5. Misreading of Evidence

Where documentary evidence, contracts, or audited financials were patently misread, distorted, or misconstrued.

In Vijay Kumar Talwar, the Supreme Court explicitly reaffirmed that: "the Tribunal being a final fact-finding authority, in the absence of demonstrated perversity in its finding, interference therewith by this Court is not warranted."

The Legal Battle: Softbrands vs. SAP Labs

The Karnataka High Court’s Stance in Softbrands (2018)

In PCIT vs Softbrands India (P.) Ltd., the Karnataka High Court ruled that:

The High Court cannot undertake the exercise of comparing comparables, which is essentially an exhaustive fact-finding exercise.
Under Section 260A, findings of fact cannot be disturbed unless they are ex-facie perverse, unsustainable, and exhibit a total non-application of mind.
Perversity is the sole "key to the lock" for entering High Court jurisdiction under Section 260A. Inconsistent Tribunal views alone do not create a substantial question of law.
Questions regarding whether comparables were rightly selected or whether comparability filters were properly applied do not give rise to a substantial question of law, making the ITAT’s ALP determination final.

The Supreme Court’s Overruling in SAP Labs (April 2023)

Setting aside the Softbrands doctrine, the Supreme Court held:

Any determination of the ALP under Chapter X of the Act de hors (outside of) the relevant statutory provisions and Rules can be considered perverse, and perversity itself is a substantial question of law.
There is no absolute proposition of law that the ITAT's determination of ALP is final and immune from scrutiny by High Courts under Section 260A.
High Courts are fully empowered to examine whether the statutory transfer pricing guidelines laid down in the Act and Rules were complied with, and whether the ITAT's findings are perverse.

Has Anything Changed Post-SAP Labs? The Author’s Analysis

Although critics argue that SAP Labs will overwhelm High Courts with protracted Transfer Pricing litigation over comparables, the author submits that the fundamental legal position remains unchanged. The Supreme Court did not adjudicate the individual factual merits of the case; it merely reiterated settled appellate principles through a mandatory Twin Test:

"For the determination of the ALP to be a substantial question of law, the twin test required to be fulfilled is: (1) ALP not being determined by following the guidelines mentioned in the Act and Rules; and (2) findings of the ITAT were perverse and have been established and demonstrated."

Determining the ALP is an intricate composite exercise involving FAR analysis, tested party selection, choice of the Most Appropriate Method (MAM—such as TNMM), selection of the Profit Level Indicator (PLI), and the application of quantitative and qualitative filters. The ITAT must evaluate all these factors in totality under statutory guidelines. If the Tribunal properly investigates and applies the statutory provisions, its factual findings on comparability cannot be disturbed unless perversity is established and demonstrated.

The Travelport Inc. Judgment & Profit Attribution to PE

Shortly after SAP Labs, the Supreme Court in Director of Income-tax vs Travelport Inc. dismissed the Revenue’s appeal, ruling that the quantum of income attributable to operations carried out in India is fundamentally a question of fact.

Facts of the Travelport Case: The assessee provided electronic global distribution services to airlines via Computerized Reservation Systems (CRS). Its mainframe servers were situated outside India (USA and Europe). To market and distribute services in India, the assessee contracted Indian distribution agents, paying them between USD/EUR 1 to 1.8 out of its total booking fee of USD/EUR 3.

The ITAT held that the distributors constituted a Fixed Place PE and a Dependent Agent PE (DAPE) in India. However, based on an exhaustive FAR analysis, the ITAT determined that because the lion's share of complex technical activities occurred on overseas servers, only 15% of Travelport's global profits (approx. 0.45 cents per booking) could be attributed to Indian operations. Crucially, because the commission paid to Indian distributors (USD/EUR 1 to 1.8) far exceeded the 15% threshold, the ITAT concluded that no further profit attribution to the PE was warranted. The High Court and Supreme Court upheld this factual finding.

Harmonizing SAP Labs and Travelport: The Ultimate Conclusion

Many tax advisors perceived an irreconcilable contradiction: if profit attribution to a PE based on FAR analysis is a question of fact, shouldn't ALP determination (which also hinges on FAR analysis) also be a question of fact?

The author demonstrates that there is no contradiction. While FAR analysis forms a critical common foundation, ALP determination incorporates extensive statutory methodologies, rules, and mathematical formulas under Chapter X that are absent in general PE profit attribution.

More importantly, the ratio in SAP Labs is completely intact: even in profit attribution cases, if the ITAT conducts an arbitrary, irrational, or perverse FAR analysis, that finding of fact can be challenged as a substantial question of law before the High Court.

"Therefore, to conclude, the question of determination of the ALP as well as the attribution of profits to PE may travel the distance to the High Courts if the findings of the ITAT are perverse."

About the Author

CA. Raj Maniyar

Member of the Institute of Chartered Accountants of India

CA. Raj Maniyar is a Chartered Accountant with extensive specialization in International Taxation, Transfer Pricing dispute resolution, and appellate litigation. His professional research examines Chapter X benchmarking, Permanent Establishment profit attribution under Article 7 of DTAAs, and the jurisprudential boundaries of Section 260A before the High Courts and the Supreme Court of India.

Table of Cited Authorities & Precedents

[1] SAP Labs India Private Limited vs Income Tax Officer, [TS-225-SC-2023-TP] (Supreme Court of India).
[2] Commissioner of Income Tax-III vs M/s SAP Labs India Pvt. Ltd., (2018) I.T.A. No. 340/2012 (Karnataka High Court).
[3] PCIT vs Softbrands India (P.) Ltd., [2018] 406 ITR 513 (Karnataka High Court).
[4] Director of Income-tax vs Travelport Inc., [2023] 149 taxmann.com 470 (Supreme Court of India).
[5] Vijay Kumar Talwar vs Commissioner of Income-tax, New Delhi, [2011] 330 ITR 1 (Supreme Court of India).
[6] Sir Chunilal V. Mehta & Sons Ltd. vs Century Spinning & Mfg. Co. Ltd., AIR 1962 SC 1314 (Supreme Court of India).
[7] Santosh Hazari vs Purushottam Tiwari, [2001] 3 SCC 179 (Supreme Court of India).
[8] Hero Vinoth (Minor) vs Seshammal, [2006] 5 SCC 545 (Supreme Court of India).
[9] Madan Lal vs Mst. Gopi & Anr., [AIR 1980 SC 1754] (Supreme Court of India).
[10] Narendra Gopal Vidyarthi vs Rajat Vidyarthi, [Civil Appeal No. 7011 of 2008] (Supreme Court of India).