2021 (7) TMI 1308 - AT - Income Tax

TP Adjustment - benchmarking the international transactions - segments bifurcation - Software development services /ITES services - As per taxpayer he is engaged in two distinct activities i.e. CSDS and ITES services - HELD THAT - All the facts substantiate the claim of the taxpayer that it has a full-fledged team of software development engineers to carry out its software development activities and they are carrying out software development activities independently. The taxpayer has also brought on record list of employees working in contracts of contract software development services /ITES services along with the monthly cost of each employee available of the convenience compilation. When we examine this evidence in the light of the order passed by the AO/TPO in AYs 2010-11 2011-12, there is no change in the functional profile of the taxpayer company and likewise, there is no change in the international transactions as well as functions performed by the taxpayer. The TPO/DRP/Tribunal have reached the conclusion that because of paucity of evidence the taxpayer has failed to substantiate that it is carrying out activities in two segments viz. CSDS and ITES. When Revenue has been accepting and benchmarking such international transactions in segregated manner in earlier years in taxpayer s own case and there is no change in the nature of international transactions as well as functional profile of the taxpayer during the year under assessment vis- -vis earlier assessment years, following the rule of consistency as has been held by Hon ble Supreme Court in Radhaswami Satsang 1991 (11) TMI 2 - SUPREME COURT we are of the considered view that both the segments viz. CSDS and ITES are required to be benchmarked independently/in segregated manner. How to allocate certain common expenses incurred by the taxpayer in various segments for the purpose of calculation of the gross profit margin? - Keeping in view the evidence brought on record by the taxpayer and following the reasons rendered by Hon ble High Court of Delhi in case of Fujitsu India Private Ltd. 2019 (2) TMI 1993 - DELHI HIGH COURT we are of the considered view that ld. TPO should allocate common expenditure incurred by the taxpayer in two segments i.e. ITES IT segment for the purpose of benchmarking the two separate transactions for calculation of the gross profit margin by applying the head count method. In the first round of litigation, ld. TPO in this case had proceeded to benchmark international transactions qua CSDS and ITES segment by adopting aggregated approach. Now, as per our findings returned in the preceding paras, both the segments i.e. CSDS and ITES are required to be benchmarked independently. Ld. AR for the taxpayer as well as ld. DR for the Revenue have contended in one voice that the issue of benchmarking both the segments independently is required to be remanded back to the ld. TPO as the entire exercise of benchmarking international transactions are to be redone. Since the issue of benchmarking the international transactions is required to be examined qua both the segments i.e. CSDS and ITES separately and independently for factual analysis of taxpayer s TP study, the case is remanded back to ld. TPO who shall determine the ALP of international transactions of both the segments independently afresh after providing an opportunity of being heard to the parties. Consequently, the appeal filed by the taxpayer is allowed for statistical purposes.

Summary

Issues Involved:
1. Characterization of the taxpayer as either an ITES provider or as engaged in both ITES and software development services.
2. Benchmarking of international transactions and the method of allocation of common expenses.

Issue-Wise Detailed Analysis:

1. Characterization of the Taxpayer:
The primary issue was whether the taxpayer was engaged solely in ITES or also in software development services. The Transfer Pricing Officer (TPO) and the Dispute Resolution Panel (DRP) had characterized the taxpayer as an ITES provider, rejecting its claim of providing software development services. This characterization was upheld by the Tribunal in its initial order. However, the Hon’ble High Court remanded the case back to the Tribunal to re-examine this issue, considering additional evidence (Annexures A-6 to A-13) and any other evidence produced after hearing both parties.

The Tribunal noted that the taxpayer had been recognized as engaged in both IT services and ITES by the Assessing Officer (AO) and TPO in previous assessment years (AYs 2010-11 and 2011-12). There was no evidence of a change in the business model for AY 2013-14. The taxpayer provided additional evidence to substantiate its claim of engaging in software development, including details of highly qualified employees, job descriptions, and examples of software developed. The Tribunal concluded that the taxpayer was indeed engaged in two distinct segments: Contract Software Development Services (CSDS) and ITES.

2. Benchmarking of International Transactions and Allocation of Common Expenses:
The taxpayer had benchmarked its international transactions using the Transactional Net Margin Method (TNMM) with Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI). The TPO, however, merged the CSDS and ITES segments and used comparables from the ITES segment alone, leading to a proposed adjustment of ?13,67,86,810.

The Tribunal emphasized the need to benchmark the CSDS and ITES segments independently, following the "rule of consistency" as there was no change in the taxpayer's functional profile or international transactions compared to previous years. The Tribunal also addressed the allocation of common expenses, endorsing the "head count" method for this purpose, as upheld by the Hon’ble High Court of Delhi in the case of Fujitsu India Private Ltd. vs. DCIT.

The Tribunal remanded the case back to the TPO to re-benchmark the international transactions of both segments independently, using the head count method for allocating common expenses and determining the Arm's Length Price (ALP) afresh.

Conclusion:
The appeal was allowed for statistical purposes, and the case was remanded to the TPO for re-examination and fresh determination of the ALP of international transactions for both CSDS and ITES segments, providing an opportunity for both parties to be heard.