2015 (6) TMI 418 - AT - Income Tax

Transfer pricing adjustment - whether the transactions between the head office in India and branch office in Canada can be considered as international transactions, even though the assessee inadvertently reported the same so as a matter of abundant caution? - Held that - It is not permissible to make transfer pricing adjustment by applying the average operating profit margin of the comparables on the assessee s universal transactions entered into with both the AE and non- AEs. As the entire exercise under Chapter-X is confined to computing total income of the assessee from international transactions having regard to the arm s length price, there is no scope for computing the income even from non-international transactions having regard to the ALP. As the TPO has computed the transfer pricing adjustment qua all the transactions carried out by the assessee with reference to the base of total costs , also inclusive of costs relevant for transactions with non- AEs, we vacate the impugned order on this issue and restore the matter to the file of AO/TPO for recalculating the amount of addition of transfer pricing adjustment by taking into consideration the international transactions only under this segment to the exclusion of transactions with Canada Office and non-AEs. - Decided in favour of assessee for statistical purposes. Depreciation on building let out to some third party - whether should be excluded from the total operating costs? - Held that - The direction given by the DRP for verifying and excluding the excess amount of depreciation has not been adhered to by the TPO/AO, which position is contrary to law. As such, we set aside the impugned order on this score and remit the matter to the file of the AO/TPO for passing an order in conformity with the direction given by the DRP. We want to make it explicit that we have not undertaken the exercise of examining any aspect of the actual amount of the excess depreciation liable for exclusion. The DRP has also simply directed the TPO to verify this aspect, and, then, exclude the excess amount of depreciation in determining the ALP of the international transaction. As such, the Officer is not only entitled but also duty bound to verify the correctness of the claim lodged by the assessee before excluding the excess amount of depreciation. Treatment of hypothetical interest on security deposits as income u/s 28(iv) - Held that - It is amply clear that the direction given by the DRP for deletion of this addition has not been taken into consideration by the AO while finalizing the assessment. We have noticed above that the direction given by the DRP is binding on the AO in terms of section 144C(13). Adopting the discussion made above, we hold that the addition of ₹ 11.58 lac is not warranted because of the direction given by the DRP for the deletion of the addition. Transfer pricing adjustment towards interest on interest free loan given by the assessee to its AE - Held that - Respectfully following the precedent for the AY 2002-03, we set aside the impugned order and remit this matter to the file of AO/TPO for a fresh determination of the transfer pricing adjustment, on the basis of the directions given by the Tribunal for such earlier years.

Summary

Issues Involved:
1. Transfer pricing adjustment on software development services.
2. Inclusion of depreciation on building let out as operating cost.
3. Treatment of hypothetical interest on security deposits as income under Section 28(iv).
4. Transfer pricing adjustment on interest-free loan to associated enterprises (AE).

Detailed Analysis:

1. Transfer Pricing Adjustment on Software Development Services:
The primary issue concerns the addition of Rs. 8,61,31,210/- made by the Assessing Officer (AO) on account of transfer pricing adjustment. The assessee, an Indian company with a branch office in Canada, reported seven international transactions. The Transfer Pricing Officer (TPO) altered some of the comparables chosen by the assessee and computed the arm's length margin at 23.56% of the operating cost, applying it to the total revenue of Rs. 36.63 crore, inclusive of revenues from non-AEs. The Tribunal observed that the TPO wrongly included transactions between the head office in India and the branch office in Canada as international transactions. The Tribunal held that such transactions do not qualify as international transactions under Section 92B(1) of the Income-tax Act, 1961, as they are not between two or more associated enterprises. Consequently, the Tribunal directed the AO/TPO to exclude transactions with the Canada branch and non-AEs while recalculating the transfer pricing adjustment.

2. Inclusion of Depreciation on Building Let Out as Operating Cost:
The second issue pertains to considering depreciation on a building let out as an operating cost. The Dispute Resolution Panel (DRP) directed the TPO to verify and exclude the excess amount of depreciation from the total operating costs. However, the TPO/AO did not adhere to this direction. The Tribunal emphasized that the directions given by the DRP are mandatory under Section 144C(13) and must be followed by the AO. Therefore, the Tribunal set aside the impugned order and remitted the matter to the AO/TPO for passing an order in conformity with the DRP's direction to exclude the excess amount of depreciation.

3. Treatment of Hypothetical Interest on Security Deposits as Income Under Section 28(iv):
The third issue involves the treatment of hypothetical interest on security deposits as income under Section 28(iv). The AO included a sum of Rs. 11,58,822/- as notional interest on an interest-free security deposit received by the assessee. The DRP directed the AO to delete this addition, stating that neither the annual letting value (ALV) of the property can be increased under Section 23 with the notional interest nor can Section 28(iv) be applied. However, the AO still made the addition in the final assessment order. The Tribunal reiterated that the DRP's directions are binding and held that the addition of Rs. 11.58 lakh was not warranted, thus allowing this ground in favor of the assessee.

4. Transfer Pricing Adjustment on Interest-Free Loan to Associated Enterprises (AE):
The final issue concerns the transfer pricing adjustment towards interest on an interest-free loan given by the assessee to its AE. The TPO applied an interest rate of 14% on the loan amount, resulting in a transfer pricing adjustment of Rs. 87,90,467/-. This issue is recurring from earlier years, and the Tribunal had previously remitted the matter for fresh consideration. The Tribunal directed the AO/TPO to re-examine the transfer pricing adjustment in light of the Tribunal's earlier directions and the recent judgment by the Hon'ble Delhi High Court in CIT vs. Cotton Naturals (I) Pvt. Ltd., which states that the currency in which the loan is to be repaid determines the rate of interest. The Tribunal instructed the TPO to compute the rate of interest accordingly.

Conclusion:
The appeal is partly allowed, with the Tribunal directing the AO/TPO to:
1. Recalculate the transfer pricing adjustment by excluding transactions with the Canada branch and non-AEs.
2. Exclude the excess amount of depreciation on the building let out from the operating costs.
3. Delete the addition of notional interest on security deposits.
4. Reassess the transfer pricing adjustment on the interest-free loan to the AE in accordance with the Tribunal's earlier directions and the Delhi High Court's judgment.