2017 (1) TMI 1815 - AT - Income Tax

TP Adjustment - sub-contracting cost paid to A.Es - whether should form part of the operating cost of the assessee for determining the arm's length price? - HELD THAT - DRP in case of assessee s A.E. (TOIVL) for assessment year 2011-12 and Transfer Pricing Officer s order in assessee s case for assessment year 2012- 13, there cannot be any manner of doubt in coming to the conclusion that the sub-contract payment made by the assessee to its A.E. was merely in the nature of pass through cost as the assessee has passed on the work of off-shore drilling operation to its A.Es on back-to-back basis and it has acted merely as an intermediary in obtaining the contract and passing on the same to the A.E. and for which it has been remunerated on cost plus mark-up basis by the A.E. We hold that sub-contract payment cannot be considered as part of the operating cost of the assessee for determining the arm's length price. Accordingly, we direct the AO to determine the arm's length price of the international transaction relating to the provision of Support service by the assessee to its A.E. after excluding the sub-contracting cost paid to A.E. from its cost base. In the course of hearing as well as in the written submission, it was submitted by the learned Authorised Representative if the sub-contract cost paid to the A.E. is not included in the cost base, the margin of the assessee would be higher than the margin of comparables considered by the Transfer Pricing Officer himself. Hence, the issue relating to comparables need not be gone into. As we have accepted assessee s claim in relation to non-inclusion of sub-contract cost paid to the A.E. in the cost base of the assessee, the other issues relating to comparability analysis having become academic in nature, we do not intend to adjudicate them.

Summary

Issues Involved:
1. Addition on account of Transfer Pricing adjustment.
2. Determination of arm's length price for international transactions.
3. Inclusion of sub-contracting costs in the operating cost of the assessee.
4. Comparability analysis and selection of comparables.

Detailed Analysis:

1. Addition on Account of Transfer Pricing Adjustment:
The primary issue revolves around the addition of Rs. 4,47,88,71,298 due to Transfer Pricing adjustment. The assessee, a subsidiary of the Transocean Group, was awarded a contract by ONGC for offshore drilling services. The assessee did not possess the necessary assets or expertise and relied on its parent company and other group entities for execution. The Transfer Pricing Officer (TPO) questioned the arm's length nature of the transactions and included sub-contracting costs in the operating cost, leading to the adjustment.

2. Determination of Arm's Length Price for International Transactions:
The TPO examined the international transactions reported by the assessee, including support services and reimbursement of expenses. The assessee categorized itself as a low-risk entity and used the Transactional Net Margin Method (TNMM) with Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI). The TPO, however, found that the assessee performed broader functions and undertook certain risks, leading to the conclusion that the assessee should share in the profit on the entire contract value.

3. Inclusion of Sub-Contracting Costs in the Operating Cost of the Assessee:
The TPO included the sub-contracting costs paid to the Associated Enterprises (AEs) in the operating cost of the assessee, arguing that the assessee was not merely providing liaison services but also undertook significant risks. The assessee contended that these costs were pass-through and should not be included. The Dispute Resolution Panel (DRP) upheld the TPO's view. However, the Tribunal found that the assessee acted merely as an intermediary, with the actual drilling operations performed by the AEs. The Tribunal concluded that the sub-contracting costs should be excluded from the operating cost for determining the arm's length price.

4. Comparability Analysis and Selection of Comparables:
The assessee selected five comparables with an average updated margin of 5.13%, while the TPO selected two comparables with an average margin of 13.11%. The TPO rejected the comparables selected by the assessee and included the sub-contracting costs in the operating cost, leading to a lower PLI for the assessee. The Tribunal, however, noted that once the sub-contracting costs are excluded, the margin of the assessee would be higher than the comparables selected by the TPO, rendering the comparability analysis moot.

Conclusion:
The Tribunal directed the Assessing Officer to exclude the sub-contracting costs from the cost base of the assessee and determine the arm's length price accordingly. The other issues relating to comparability analysis were deemed academic and not adjudicated. The appeal was partly allowed in favor of the assessee.