Judicial Affirmation of Regulated SEB Rates over IEX Rates in Transfer Pricing Adjustments: Delhi High Court

Introduction

In the case of PR. COMMISSIONER OF INCOME TAX v. DCM SHRIRAM LTD, decided by the Delhi High Court on January 21, 2025, the court was required to assess key questions regarding the determination of market value and the arm’s length price (ALP) for transactions in the electricity sector. The dispute centered on whether the rates derived from the Indian Energy Exchange (IEX) could serve as an appropriate external Comparable Uncontrolled Price (CUP) for adjusting transfer pricing in relation to electricity transactions between eligible captive power plants and non-eligible units.

The case involved the Principal Commissioner of Income Tax (Appellant) and DCM Shriram Limited (Respondent), the latter being engaged in diverse business activities including power generation and supply. The litigation emerged from an earlier order of the Income Tax Appellate Tribunal (ITAT) concerning the assessment year 2014-15, particularly addressing the deductions claimed under Section 80IA of the Income Tax Act, 1961.

Summary of the Judgment

The Delhi High Court reviewed the questions posed regarding the appropriateness of applying IEX rates for benchmarking transfer pricing adjustments and the deletion of certain adjustments made by the Transfer Pricing Officer (TPO) on domestic transactions. The court held that:

The IEX rates, due to their volatility and the nature of the transactions on the IEX platform, could not be considered comparable to the regulated rates offered by State Electricity Boards (SEB) or power distribution companies.
The regulated rates quoted by the SEBs, used as the internal CUP for assessing the market value of electricity, are more reflective of an “open market” scenario for power consumption by industrial units.
In upholding the decision of the ITAT, the court agreed that the deletion of adjustments based on the IEX rates was proper, thereby supporting the principle that electricity transactions executed through regulated channels should be benchmarked using internal CUP rates rather than short-term, volatile IEX benchmarks.

The judgment, therefore, confirmed that for purposes of computing the deduction available under Section 80IA, the ALP and market value of power must be determined by considering the rates that would ordinarily fetch in the regulated, competitive environment of SEBs rather than IEX.

Analysis

Precedents Cited

The Court extensively reviewed previous judicial pronouncements and guidelines, including references to:

The OECD Transfer Pricing Guidelines – which outline the principles underlying the Comparable Uncontrolled Price (CUP) method, emphasizing the necessity for a high degree of similarity between controlled and uncontrolled transactions.
Decisions from lower forums such as Sumitomo Corporation India Pvt. Ltd. v. CIT and other notable ITAT decisions, which reassert the importance of using internal CUP rates in situations where the subject matter is closely regulated and the contrasting transaction types (such as those on IEX) lack comparability.
The Supreme Court decision in Commissioner of Income Tax v. Jindal Steel and Power Limited, which clearly distinguished between contracted prices fixed by dominant State Electricity Boards and open market prices. This precedent was critical in reinforcing the principle that prices determined under statutory control should be the benchmark for market value in the context of transfer pricing adjustments.

These precedents buttressed the Court’s reasoning by demonstrating that the adoption of IEX rates, characterized by sporadic bidding and short-term volatility, was highly inappropriate compared to the consistent and regulated pricing provided by SEBs.

Legal Reasoning

The crux of the Court’s legal reasoning revolved around the application of the CUP method as mandated by Rule 10B(1)(a) of the Income Tax Rules and its suitability in the context of electricity transactions:

The Court meticulously explained that the regulated rates at which power is traded or sold by SEBs—despite the degree of governmental oversight and limited negotiation—accurately reflect the “market value” as envisioned by Section 80IA. This is in sharp contrast to the IEX rates which are influenced by immediate availability, volatility, and short-term bidding dynamics.
It was noted that, for the CUP method to function effectively, the transactions rely on a very high degree of comparability. In this case, the intragroup transactions of supplying electricity between captive units and non-eligible units were fundamentally different from spot trading transactions on IEX, thereby rendering any adjustment based on IEX rates unsuitable.
The Court pointed out that the determination of the ALP in this instance necessitated adhering to the dual parameters provided by the Explanation to Section 80IA and Section 92F; namely, that the rate should either reflect the open market price or the arm’s length price derived from comparably controlled transactions. The evidence demonstrated that the rates provided by SEBs—given their regulated and stable nature—were indeed representative of this open market.

Impact on Future Cases and Legal Practice

This judgment is poised to have significant implications for transfer pricing disputes in the electricity sector and similar regulated industries. Key impacts include:

A reinforced judicial and administrative preference for using internally consistent, regulated pricing data (such as those from SEBs) over volatile market indices from commodity exchanges or spot markets like IEX.
Guidance for tax practitioners and adjudicators in examining the comparability of transactions. Future cases may lean more heavily on pre-determined regulated rates to compute market value, particularly under Section 80IA and related provisions.
Encouragement for businesses operating in sectors with statutory price determination to robustly maintain records and agreements that validate the application of internal CUP methodologies.

Complex Concepts Simplified

The judgment involves several technical legal and economic concepts. Here are simple explanations for key terms:

Comparable Uncontrolled Price (CUP) Method: A transfer pricing method in which the price charged in a controlled transaction is compared to the price charged in a comparable transaction between independent parties.
Arm’s Length Price (ALP): The price which would have been agreed upon between independent enterprises in similar circumstances; this forms the basis for ensuring that intra-group transactions are conducted as if they were between unrelated parties.
Internal CUP versus External CUP: Internal CUP refers to using pricing data from controlled, related party transactions (often regulated or stable), while external CUP utilizes pricing from transactions among independent entities in the open market. The judgment emphasizes that for electricity supplies by regulated SEBs, internal CUP is more reliable.
IEX Rates: Prices quoted on the Indian Energy Exchange, which are determined through a bidding process and can be subject to rapid fluctuations. The court held that these rates are not suitable for benchmarking regulated power transactions.

Conclusion

In conclusion, the Delhi High Court’s decision in PR. COMMISSIONER OF INCOME TAX v. DCM SHRIRAM LTD catalyzes a reaffirmation of the principle that, in sectors characterized by heavy regulation and stable, internally determined pricing, the use of regulated SEB rates is the appropriate benchmark for determining market value and the arm’s length price of power transactions.

The comprehensive analysis presented in the judgment—backed by established precedents and international guidelines—clarifies that volatile market rates such as those from the IEX cannot adequately substitute the pricing obtained from purchases or sales under statutory control. This ruling is set to influence future transfer pricing assessments in the energy sector and beyond, ensuring enhanced consistency and fairness in tax computations under Section 80IA of the Income Tax Act.

The key takeaway is a judicial endorsement for relying on rates that characterize genuine market competition within a regulated framework, thereby cementing an important interpretative precedent in the realm of transfer pricing.

Judicial Affirmation of Regulated SEB Rates over IEX Rates in Transfer Pricing Adjustments