2016 (11) TMI 1403 - AT - Income Tax

Allocation of expenses on the basis of gross margin in the agency segment - Held that - We direct the TPO to allocate the expenses on the basis of gross margin in the agency segment and not in the ratio of sales for the purpose of computing the ALP of the international transactions as the TPO/DRP/AO have erred in making adjustment by clubbing commission income with market support services in allocating expenses to the agency segment in the ratio of sales. So, ground is determined in favour of the assessee. Selection of 10 comparables for benchmarking the international transactions having average OP/OC at 22.12% - Held that - Assessee s own case of AY 2002-03 that allocation of expenses to the agency segment in the ratio of sales cannot be made, as has been held by the Bench in the preceding paras, sought to exclude three comparables, namely, Aptico Ltd., Choksi Laboratories Ltd. and Wapcos Ltd. and also sought to include three comparables, namely, Educational Consultants India Limited, India Tourism Development Corporation Limited and In House Productions Limited for benchmarking the international transaction and considered its international transactions at arm s length. Since in view of the findings returned by the Tribunal on ground no.2.2 the basis for allocating the expenses to the agency segment is ordered to be changed, it would be futile to go into the validity of the comparables considered by the TPO for benchmarking international transactions as it would change the entire scenario and fresh TP study analysis is required to be done by the TPO. So, we hereby direct the TPO to make fresh TP study analysis after providing adequate opportunity of being heard to the assessee company to benchmark the international transactions undertaken by the assessee company. So, we decide grounds no.2.2 to 2.7 accordingly.

Summary

Issues Involved:
1. Completion of assessment under section 144C/143(3) of the Income-tax Act, 1961.
2. Addition of ?1,40,30,553 due to alleged difference in arm's length price of international transactions.
3. Aggregation of international transactions for provision of agency services with market support services.
4. Allocation of expenses to the agency segment based on sales ratio.
5. Use of inappropriate quantitative filters.
6. Rejection of comparable companies selected by the appellant.
7. Selection of specific companies (APITCO Ltd, Choksi Laboratories Ltd, WAPCOS) for benchmarking.
8. Inclusion of super normal profit-making companies as comparables.
9. Risk adjustment for the assessee operating as a low-risk-bearing contract service provider.

Issue-wise Detailed Analysis:

1. Completion of Assessment:
The assessing officer completed the assessment under section 144C read with section 143(3) of the Income-tax Act, 1961, at an income of ?3,74,88,920, against the income of ?2,34,58,367 returned by the appellant.

2. Addition of ?1,40,30,553:
The assessing officer made an addition of ?1,40,30,553 due to the alleged difference in the arm's length price of international transactions undertaken by the appellant.

3. Aggregation of International Transactions:
The assessing officer/TPO aggregated the international transaction of provision of agency services with market support services. The appellant argued that such services should have been aggregated with the distribution segment, being closely linked with such segment. The Tribunal noted that the TPO disagreed with the appellant and segregated agency activities from distribution, clubbing it with marketing activities for computation of ALP.

4. Allocation of Expenses:
The TPO allocated expenses to the agency segment in the ratio of sales. The appellant contended that such allocation should be based on the functions performed, assets employed, and risks assumed in the agency segment. The Tribunal referenced a previous decision in the appellant's own case for AY 2003-04, where it was held that allocation should be based on gross margin rather than sales ratio. The Tribunal directed the TPO to allocate expenses on the basis of gross margin in the agency segment.

5. Use of Inappropriate Quantitative Filters:
The TPO used various filters for TP study, including excluding comparables whose data was not available for FY 2007-08, companies with business support service revenue less than ?1 crore, companies with less than 75% of total operating revenues from business support service, companies with more than 25% related party transactions, companies with different financial year endings, and functionally different companies. The Tribunal did not specifically address the appropriateness of these filters but implied that a fresh TP study analysis would be required.

6. Rejection of Comparable Companies:
The TPO rejected the comparable companies selected by the appellant. The Tribunal noted that the appellant had chosen 12 comparables with an average margin of 8.86%. The Tribunal directed a fresh TP study analysis, implying that the selection of comparables would need to be revisited.

7. Selection of Specific Companies:
The TPO selected APITCO Ltd, Choksi Laboratories Ltd, and WAPCOS for benchmarking the international transactions. The appellant argued against their inclusion. The Tribunal directed a fresh TP study analysis, which would include reconsideration of the selected comparables.

8. Inclusion of Super Normal Profit-making Companies:
The appellant contended that the TPO erred in selecting super normal profit-making companies, namely APITCO and WAPCOS, as comparables. The Tribunal's direction for a fresh TP study analysis would address this issue.

9. Risk Adjustment:
The appellant argued that as a low-risk-bearing contract service provider, a risk adjustment of 5% over the cost should be provided. The Tribunal did not specifically address this issue but directed a fresh TP study analysis, which would consider risk adjustments.

Conclusion:
The Tribunal partly allowed the appeal for statistical purposes. It directed the TPO to conduct a fresh TP study analysis, providing the appellant adequate opportunity to be heard, and to allocate expenses based on gross margin rather than sales ratio. The Tribunal's decision implied that the selection of comparables and other related issues would be reconsidered in the fresh analysis.