2012 (5) TMI 206 - AT - Income Tax

Transfer pricing - Arm s Length price (ALP) - associated enterprises - Software Development Activity - selling agent (or markteing office) versus distributor - held that - there was no direct evidence in the hands of the TPO to say that the assessee was simply a selling agent and that it appears that the TPO had proceeded on a presumption that the MUK has acted as a selling agent for the year under consideration. - His presumption is primarily based upon one fact that there was a fixed percentage of award given by MIL to MUK; which in his opinion is prevalent in selling agent s case. - considering the FAR analysis risk factor and the business model as well as the terms and conditions of the Master Agreement incorporated in the light of the changed circumstances of UK the AE i.e. MUK has functioned as a distributor in UK. - it was not appropriate to characterize MUK as a marketing services provider instead of a distributor . Selection of comparable transactions - held that - the selection of comparables and selection of similar transactions is not easy to find out and a difficult task to pick up exactly identical business model. Only an endeavour should be made so that the comparables should match with the assessee as close/near as possible. Applicability of cases decided u/s 40A(2)(a) - held that - though presently not the subject matter of dispute that the case laws which are already in public domain in respect of deciding the disallowances made u/s. 40A(2)(a) of the Act can be helpful. We have expressed this opinion because in a difficult Transfer Pricing case primarily because of the complexity of the facts even the best intentioned tax-payer can make an honest mistake and like-wise the best intentioned tax-examiner may genuinely draw wrong conclusion. OECD TP guidelines thus suggest first tax examiners are to be flexible because precision may be unrealistic and second commercial judgment or business expediency or trade realities do play a vital role in the application of arm s length principle. Human Resource Management ( HRM ) s Services / Secondment services between AEs- for enabling the AEs to provide onsite service the assessee has seconded its employees to those AEs. - held that - The assessee has made out a case that by such an arrangement of sending the employees to AEs in return assessee has also been benefited. Employees after returning are with upgraded skills better experience update knowledge and with a better delivery skills. This is one part of the advantage and the other part of the advantage happened to be procurement of offshore business in high volume. - The comparability analysis as carried out by the TPO do not match with the facts of the case. - The assessee was not functioning as an external recruitment agency. Interest on account of excess credit period to AE s - held that - Once it is an admitted fact that the MIL is a debt free company and that there was no interest burden on the assessee then it cannot be justifiable to presume that the borrowed funds have been utilized to pass on that facility to AEs. - There is no rationale to inflict upon the assessee merely on presumption that he ought to have charged the interest from it s AEs. Non deduction of Tax (TDS) - fees for technical services (FTS) - section 9(1)(vii)(b) - held that - Explanation has been inserted by Finance Act 2007 and later on substituted by Finance Act 2010. Due to this reason at the relevant point of time i.e. during the relevant Financial Year it was not possible on the part of the assessee to comply with the said Statute. We therefore hold since the services in question were neither availed nor rendered and even not utilized in India therefore no tax was required to be deducted at source. Rest of the issues about the nature of the FTS and whether it was made available to the assessee are alternate plea of the assessee and need not to be addressed because on the preliminary question of chargeability the issue stands decided in favour of the assessee. Disallowance of 20% of recruitment and training expenses - held that - where the requisite detail in respect of training of employees and the genuineness of the expenditure was very much before the AO and in respect of these two reasons no disallowance was suggested then it was unjustifiable on the part of the AO to say that a 20% recruitment and training expenses would be disallowed on mere presumption that it was not wholly beneficial to the assessee. Setting off losses of other units while computing deduction under section 10A of the Act from the profits of eligible units - held that - AO erred in not appreciating the fact that each eligible undertaking is an independent and distinctive business that required deduction to be computed specific to eligible undertaking instead of considering net profits of the assessee. Ld. AO ought to have granted deduction u/s 10A of the Act without setting off losses of eligible and non - eligible undertakings against profits of eligible undertaking while computing deduction u/s 10A of the Act.

Summary

Issues Involved:
1. Re-computation of the Arm's Length Price (ALP) of international transactions of software services.
2. Adjustment related to Human Resource Management (HRM) services/secondment services.
3. Interest on account of excess credit period to Associated Enterprises (AE).
4. Excluding exchange fluctuation gain while computing deduction under section 10A.
5. Disallowance of expenses incurred in relation to earning exempt income under section 14A.
6. Disallowance of expenses incurred by the appellant's UK branch under section 40(a)(i) for non-deduction of tax.
7. Disallowance of 20% of recruitment and training expenses.
8. Setting off losses of other units while computing deduction under section 10A.

Issue-wise Detailed Analysis:

1. Re-computation of the Arm's Length Price (ALP) of international transactions of software services:
The primary controversy was whether Mastek UK Ltd. (MUK) should be considered as a distributor or a marketing support service provider. The Tribunal concluded that MUK functioned as a distributor, not merely a marketing entity. The Tribunal rejected the TPO's adjustments based on US comparables, emphasizing that UK comparables should be used. The Tribunal held that the agreement between MIL and MUK was genuine and the fixed percentage of profit was justified. The Tribunal directed the deletion of the impugned addition.

2. Adjustment related to Human Resource Management (HRM) services/secondment services:
The Tribunal found that the HRM function was an integral part of the software business and not a separate service. The Tribunal noted that the CIT(A) had previously decided in favor of the assessee for earlier assessment years. The Tribunal held that the TPO's comparability analysis did not match the facts and that the secondment of employees brought back more offshore work to the assessee. The Tribunal deleted the upward adjustment made by the TPO.

3. Interest on account of excess credit period to Associated Enterprises (AE):
The Tribunal noted that MIL is a debt-free company and does not charge interest for late payments from any party. The Tribunal emphasized that commercial considerations and market practices should be taken into account. The Tribunal found no justification for presuming that the assessee should have charged interest from its AEs. The Tribunal allowed the ground in favor of the assessee.

4. Excluding exchange fluctuation gain while computing deduction under section 10A:
The Tribunal referred to its earlier decision in the assessee's own case, where it was held that exchange fluctuation gain is part of the export business. The Tribunal restored the issue to the file of the AO to be decided de novo as per the directions given in the earlier decision.

5. Disallowance of expenses incurred in relation to earning exempt income under section 14A:
The Tribunal referred to the decision of the Bombay High Court in the case of Godrej & Boyce Mfg. Co. Ltd., which held that Rule 8D is applicable prospectively from AY 2008-09. The Tribunal remanded the matter back to the AO for a fresh determination in light of the Bombay High Court's guidelines.

6. Disallowance of expenses incurred by the appellant's UK branch under section 40(a)(i) for non-deduction of tax:
The Tribunal held that the services were neither availed, rendered, nor utilized in India. The Tribunal found that the impugned income did not accrue or arise in India and that no tax was required to be deducted at source. The Tribunal allowed the ground in favor of the assessee.

7. Disallowance of 20% of recruitment and training expenses:
The Tribunal found that the recruitment and training expenses were general in nature and incurred at an organizational level. The Tribunal noted that the AO had no evidence to hold that the expenses were not business-related. The Tribunal deleted the disallowance and allowed the ground in favor of the assessee.

8. Setting off losses of other units while computing deduction under section 10A:
The Tribunal noted that the exact facts and figures were not produced before it. The Tribunal remitted the issue back to the AO to decide de novo, directing the AO to provide details and for the assessee to furnish the necessary information. The Tribunal allowed the ground for statistical purposes only.

Conclusion:
The Tribunal allowed the appeal of the assessee partly, providing relief on several grounds, including the characterization of MUK as a distributor, the integration of HRM functions with the core business, and the non-requirement of interest on delayed payments. The Tribunal remanded certain issues back to the AO for fresh determination, emphasizing the need for detailed examination and adherence to legal principles.