2016 (4) TMI 157 - AT - Income Tax

Transfer pricing adjustment - rejecting the CUP / RPA methods adopted by the assessee in respect of royalty and other international transactions - Held that - TPO travelled in the wrong presumption that the assessee used TNMM method for benchmarking the transactions as evident from the language used in the order of the TPO. It is undisputedly wrong as the TP study indicates the application of different methods for different transactions by the assessee, which are already extracted and placed in the above paras of this order. The aggregation approach of benchmarking the international transactions by the TPO is not sustainable as per the today‟s legal position. It is a trait law that the transactions have to be independently benchmarked applying the appropriate method in benchmarking of the transactions. We also perused the submissions of the assessee before the TPO wherein it was categorically submitted by the assessee that the reasons for rejection of the CUP and RPA methods should be given to the assessee and the same is part of the submissions. But, either the AO or the TPO / DRP is bothered to furnish the same. In fact, as seen from para 7.3 of the DRP order, the onus is kept on the assessee by mentioning that the assessee agreed for substituting the TNMM method as an appropriate method, which is not proper. Considering the above deficiencies, inaccuracies and incompleteness, we are of the opinion the matter should be set aside to the file of the TPO / AO for fresh adjudication. AO / TPO shall grant a reasonable opportunity of being heard to the assessee as per the set principles of natural justice.

Summary

Issues Involved:
1. Application of TNMM method for determining Arm's Length Price (ALP) in the software licensing segment.
2. Consideration of extraordinary factors affecting the software licensing segment.
3. Selection of comparables for benchmarking the software licensing segment.
4. Restriction of transfer pricing adjustment to transactions with Associated Enterprises (AEs) only.
5. Limitation of transfer pricing adjustment under Chapter X of the Act.

Detailed Analysis:

Issue 1: Application of TNMM Method for Determining ALP
The appellant contended that the lower authorities erred in applying the Transactional Net Margin Method (TNMM) for determining the Arm's Length Price (ALP) in the software licensing segment. The appellant argued that the Comparable Uncontrolled Price (CUP) method was more appropriate for the international transactions in question. The Tribunal noted that the Transfer Pricing Officer (TPO) rejected the CUP method without providing justification, which was deemed improper. The Tribunal directed the TPO to reconsider and provide reasons for the rejection of the CUP method and the adoption of the TNMM method.

Issue 2: Consideration of Extraordinary Factors
The appellant highlighted that the software licensing segment incurred losses due to extraordinary factors such as reduced turnover, increased employee costs, and lease rent, which were unrelated to international transactions with AEs. The Tribunal acknowledged these factors and emphasized the need for the TPO to consider these extraordinary circumstances while determining the ALP.

Issue 3: Selection of Comparables for Benchmarking
The appellant challenged the selection of three comparables by the TPO for benchmarking the software licensing segment, arguing that these comparables were functionally dissimilar to the appellant's business. The Tribunal observed that the TPO shortlisted three out of six comparables without adequate justification and directed the TPO to re-evaluate the comparables, ensuring they are functionally similar to the appellant's business activities.

Issue 4: Restriction of Transfer Pricing Adjustment to Transactions with AEs
The appellant argued that the transfer pricing adjustment should be restricted to transactions with AEs only, as per the jurisdictional High Court's ruling in Thyssen Krupp Industries India Pvt Ltd vs. CIT. The Tribunal agreed with this contention, referencing the High Court's decision that the adjustment should be limited to transactions with AEs and not the total turnover of the software licensing segment.

Issue 5: Limitation of Transfer Pricing Adjustment
The appellant contended that the transfer pricing adjustment under Chapter X of the Act should not exceed the net value of the international transaction. The Tribunal concurred, directing the TPO to ensure that the adjustment does not surpass the net value of the international transactions.

Conclusion:
The Tribunal partially allowed the appeal for statistical purposes, setting aside the TPO's order and directing a fresh adjudication on the issues. The TPO was instructed to provide a reasoned order addressing the appropriateness of the CUP method, the selection of comparables, and the restriction of transfer pricing adjustments to transactions with AEs. The Tribunal also upheld the appellant's contention regarding the limitation of transfer pricing adjustments under Chapter X of the Act. The appeal was partly allowed, with specific directions for re-evaluation and adherence to legal precedents.