2011 (6) TMI 682 - AT - Income Tax

Most Appropriate Method for determining ALP for International Transaction u/s 92C - Data Required to be used for selecting Comparables u/s 10(4) - Selection of Comparable Assessees - Selection of Comparable Companies - Assessee used multiple years' data whereas the TPO is of the opinion that current year data is to be used for selecting comparables HELD THAT - Most Appropriate Method - In the present years, on an analysis of international transactions with the associate parties and data of comparables, the assessee has selected transactional net margin method (TNMM), using net profit margin based on cost as profit level indicator. In these three years this method was not disputed by the learned Transfer Pricing Officer. We can say that both sides are in agreement on the method. For Selecting comparables - Section 10(4) is referred, the used the expression shall make it mandatory to first use the current year data. If certain other circumstances reveal an influence on the determination of transfer pricing in relation to the transaction being compared than other datas for period not more than two years prior to such financial year may be used. Thus, the view point of the Transfer Pricing Officer for using the current year data is upheld. For finding out comparable Assessees who have uncontrolled international transactions of similar nature - We are in view that product produced by the assessee in itself is of a complex nature, which required skilled work force. We find certain comparables which were found acceptable by the assessee in the financial year 2004-05 all of a sudden become incomparable in the financial year 2005 06. It suggests that efforts of the financial analyst was to prepare the documentation in such a fashion which would give the result near to the result disclosed by the assessee. The TPO has considered this aspect elaborately - Thus Assessee is high end service provider. Search Methodology for selecting Comparables - The approach of the TPO ought to be judicious. The comparability between a controlled transaction and uncontrolled transaction is a comparison of condition which is broader than a mere comparison of price or margin. Where it is found that the conditions imposed were differed from those which would be made between independent enterprises, transfer pricing adjustment are to be made. Thus, the TPO while evaluating the transfer pricing study made by the assessee arrived at a conclusion that the assessee has left over various angles in identifying the comparables - Decision Against Assessee. Comparability Adjustment under Rule 10B - Selection of Comparable Companies - Assessee has eliminated certain comparables on the ground that some companies have related party transaction because more than 26 percent shareholding of subsidiary was held by the company abroad - TPO said that there may be transactions with associate enterprises but the transactions should not be more than 30 percent HELD THAT - TPO has applied the filter, quantitatively as well as qualitatively in eliminating the factors which effect the result of the alleged comparables so that the difference between the operations of the assessee as well as such comparables who worked in uncontrolled transactions can be neutralised - Thus, method adopted by TPO upheld. Benefit of Proviso u/s 92C - Tolerance Band - Assessee contended that arithmetic mean of the comparable price should be reduced by 5 percent for determining the arm's length price HELD THAT - We are of the view that tolerance band provided in the proviso is not to be construed as a standard deduction. In the present case, TPO has adopted the arithmetic mean of several comparables for taking out a profit level indicator which would be tested with the profit level indicator of the assessee. If that arithmetic mean falls within the range of alleged tolerance band then there may not be any adjustment but if it exceeds then ultimate adjustment is not required to be computed after reducing the arithmetic mean by 5 percent The actual working is to be taken. The learned first appellate authority has considered this aspect elaborately, thus, we do not see any merit in the ground of appeal. Software Expenses - Capital or Revenue in Nature? - Expenditure was incurred for acquiring the time based licence to use of software for a period of one year or less than two years - HELD THAT - There is no such dispute regarding this matter in two years. It suggests that the learned Dispute Resolution Panel has considered this issue without making a proper analysis. On perusal of the assessment order, we find that the AO while considering the ratios laid down by the Special Bench of the Income-tax Appellate Tribunal has observed that the Special Bench was not correct in interpreting the law. In our opinion, it is not for the AO to comment upon the orders of the higher authorities rather she is bound to follow them. Following the decision in the case of AMWAY INDIA ENTERPRISES. VERSUS DEPUTY COMMISSIONER OF INCOME-TAX, CIRCLE - 1(1), NEW DELHI. 2008 (2) TMI 454 - ITAT DELHI-C we held that, the assessee has not acquired any ownership in the alleged licence and the licences shelf life is less than two years. The nature of the assessee's business is such that it required computer software. Therefore, the expenses incurred by the assessee for obtaining the licence to use the software is to be treated as revenue expenditure - Decision in favour of Assessee. Amount paid to Noida Development Authority - Capital or Revenue in Nature? - The name of the allottee has been got changed by the assessee - For which Assessee was directed to pay charges for change in ownership - HELD THAT - The learned representative failed to bring the revenue laws of the UP State authorising the Noida Authority for charging such an amount, therefore, we restore the matter back to AO for fresh examination.

Summary

Issues Involved:
1. Adjustment recommended by the TPO in the arms length price of international transactions.
2. Use of current year data versus multiple year data for selecting comparables.
3. Characterization of the assessee's business as high-end service provider.
4. Rejection of the search methodology and comparables selected by the assessee.
5. Selection of comparable companies for benchmarking analysis.
6. Application of the proviso to section 92C regarding the tolerance band of +/-5%.
7. Treatment of software expenses as capital or revenue expenditure.
8. Treatment of charges paid to NOIDA Development Authority as capital expenditure.

Detailed Analysis:

1. Adjustment recommended by the TPO in the arms length price of international transactions:
The assessee disclosed international transactions with its associate enterprises for the assessment years 2003-04, 2004-05, and 2006-07. The TPO recommended adjustments based on comparables, leading to disputes between the assessee and the revenue. The TPO used the Transactional Net Margin Method (TNMM) and computed the Profit Level Indicator (PLI) using operating profit divided by operating cost. The TPO's adjustments were based on the average operating profit on total cost ratio, which was higher than what the assessee reported. The CIT(A) marginally reduced the percentages recommended by the TPO, leading to cross-appeals by both parties.

2. Use of current year data versus multiple year data for selecting comparables:
The assessee used multiple year data for selecting comparables, while the TPO insisted on using current year data, as mandated by Rule 10B(4) of the Income Tax Rules. The CIT(A) and DRP upheld the TPO's view that current year data should be used, as the rule specifies that data relating to the financial year in which the international transaction occurred should be used unless it reveals facts influencing the determination of transfer prices.

3. Characterization of the assessee's business as high-end service provider:
The TPO characterized the assessee as a high-end service provider, performing high-value functions in the software development life cycle. The assessee contended that it was a low-end, risk-free captive service provider. The CIT(A) and the tribunal upheld the TPO's characterization, noting the complex nature of the products and services provided by the assessee, the skilled workforce employed, and the significant role played by the assessee in the value chain of the software industry.

4. Rejection of the search methodology and comparables selected by the assessee:
The TPO rejected the search methodology and comparables selected by the assessee, citing defects such as the use of multiple year data, improper characterization of the assessee's business, and inappropriate filters. The tribunal upheld the TPO's rejection, noting that the TPO had provided specific reasons for rejecting the assessee's comparables and had conducted a fresh search for suitable comparables.

5. Selection of comparable companies for benchmarking analysis:
The TPO selected comparables based on specific filters, including related party transactions and employee cost to total cost ratios. The CIT(A) modified some of these filters and identified a smaller set of comparables. The tribunal upheld the CIT(A)'s approach, noting that the selection of comparables should be based on a judicious and reasonable basis, considering the functions performed, assets employed, and risks assumed by the assessee.

6. Application of the proviso to section 92C regarding the tolerance band of +/-5%:
The assessee contended that the arithmetic mean of the comparable prices should be reduced by 5% for determining the ALP. The CIT(A) and the tribunal rejected this contention, clarifying that the tolerance band is not a standard deduction but a range within which no TP adjustment is required if the transfer price falls within this band.

7. Treatment of software expenses as capital or revenue expenditure:
The assessee claimed software expenses as revenue expenditure, arguing that the expenses were for acquiring licenses to use software for a limited period. The DRP upheld the AO's treatment of these expenses as capital expenditure. The tribunal, following the ITAT's decision in the case of AM WAY India Enterprises, held that the expenses should be treated as revenue expenditure, as the licenses did not provide enduring benefits and the ownership of the software remained with the vendor.

8. Treatment of charges paid to NOIDA Development Authority as capital expenditure:
The assessee paid charges to NOIDA Development Authority for changing the name of the owner in the revenue records. The DRP and AO treated these charges as capital expenditure. The tribunal set aside the orders of the DRP and AO, directing the AO to ascertain the exact nature of the charges and then decide whether they should be included in the cost of land for capital gains purposes.