2012 (10) TMI 177 - AT - Income Tax

Arms Lenth Price - Allocation of 80% of unbilled hours to the Associated Enterprise - assessee submission that he suffered losses in the aftermath of bomb attack on World Trade Centre on 9/11 in US - Held that - CIT (A) even though accepts the fact that the difference in man hours paid to the AE and billed to the clients is due to recession and slump in software industry after the 9/11 incident, he nevertheless making his own interpretation of the agreement came to a conclusion that assessee can be allowed benefit at 20% out of the loss arising from payment made for extra 3500 man hours as the AE had four times risk in the transactions.The aforesaid conclusion of the CIT (A) is without a reasonable basis. When the assessee has paid to the AE for a minimum of 25 persons as per the terms of the agreement whereas it could bill its client for 10 persons the CIT (A) was not justified in coming to the conclusion that the assessee could be given benefit of 20% out of the loss arising on account of excess payment made for 3500 man hours. It is a fact that assessee s business suffered due to recession as result of 9/11 incident and assessee ultimately had to close down its operations. The CIT (A) also does not dispute this fact. Thus finding force in assessee s contention that assessee s income being exempt there was no need on its part to transfer its income to its AE whose profit was taxable. The assessee has demonstrated before us the ALP at Rs.12,99,42,172/- after deducting cost of 1370 man hours @61.39USD and the payment made by it to the AE to be within /-5% of the ALP range which are inclined to accept. Thus the order of CIT (A)is set aside and AO is directed to verify the invoices raised by the assessee on its clients and invoices raised by the AE on the assessee to find out the actual unbilled hours lost in November, 2001. If the assessee s claim will be found to be correct, then no addition can be made under the Transfer Pricing Regulations - in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Allocation of unbilled hours to the Associated Enterprise (AE).
2. Determination of Arm's Length Price (ALP) in the aftermath of the 9/11 incident.
3. Attribution of business loss due to unbilled hours of the AE.

Detailed Analysis:

1. Allocation of Unbilled Hours to the Associated Enterprise (AE):

The primary contention of the assessee was that the CIT (A) erred in allocating 80% of unbilled hours to the AE, leading to an erroneous determination of the ALP. The CIT (A) found that the agreement between the assessee and its AE, which stipulated payment for a minimum of 25 employees per month regardless of utilization, was unduly advantageous to the AE. This clause was deemed contrary to accepted contractual norms between unrelated parties, as it placed the entire burden of non-utilization on the assessee. The CIT (A) concluded that the agreement was not at arm's length and that the payment for unutilized manpower was excessive.

2. Determination of Arm's Length Price (ALP) in the Aftermath of the 9/11 Incident:

The TPO determined the ALP by identifying a discrepancy of 3741 man hours between what the assessee paid to the AE and what it billed to its clients. After accounting for 241 man hours for demo purposes, the TPO concluded that the assessee had paid for 3500 excess man hours. The CIT (A) further reduced this by 750 man hours, attributing the remaining 2800 man hours as excessive payment. The CIT (A) recalculated the ALP at Rs.12,57,28,362, which was not within the +/- 5% range of the payment made by the assessee to its AE. Consequently, an addition of Rs.82,50,816 was made to the assessee's income.

3. Attribution of Business Loss Due to Unbilled Hours of the AE:

The assessee argued that the loss incurred due to unbilled hours was a direct result of the 9/11 attacks, which led to a recession in the software industry. The assessee had to pay for 25 personnel per month as per the agreement with its AE, but could only deploy 10 personnel, resulting in a significant number of unbilled hours. The CIT (A) acknowledged the impact of the 9/11 incident but attributed only 20% of the loss to the assessee, considering that the AE had four times greater risk. The remaining 80% of the loss was treated as excessive payment by the assessee to its AE.

Conclusion:

The appellate tribunal found that the CIT (A)'s conclusion lacked a reasonable basis. The tribunal noted that the CIT (A) accepted the recession in the software industry post-9/11 but still made an arbitrary allocation of loss. The tribunal was convinced by the assessee's argument that the payment to the AE was based on the number of personnel rather than man hours, and that the unbilled hours were a result of the inability to deploy personnel due to the 9/11 incident. The tribunal directed the AO to verify the invoices and determine the actual unbilled hours. If the assessee's claim was found correct, no addition would be made under Transfer Pricing Regulations. The appeal was allowed for statistical purposes.