2016 (5) TMI 862 - AT - Income Tax

Rejection of CUP as most appropriate method for determining ALP - Held that - We find that while adjudicating the appeals for the assessment years 2002-03 and 2003 -04, the Tribunal had rejected the cup method adopted by the TPO, that he had not proposed adjustment in the subsequent years i. e. assessment years 2010-11 to 2012-13. - Decided against revenue Adjustment on account of allocation of e-connectivity cost - TPA - Held that - The assessee had entered into agreement with its AE for econnectivity, dt. 1. 1. 2004, to received SAP services, e-connectivity services and people soft services, that in the TP study the cost incurred by the AE in providing services by the AE. s to the assessee on the basis of number of users, that the Operating margin of the assessee from all other transaction was higher than of the comparables, that the assessee claimed that transaction was at Arm s Length because of the cost allocation methodology adopted by AE, that the TPO made an adjustment of ₹ 4. 73 crores by determining the ALP as Nil, that he held that the assessee did not furnish copy of the agreement or any proof of requesting for such services, that he further held that assessee did not demonstrate as to how the cost benefited it, that it did not provide any proof of any exact number of users and their allocation, that the DRP called for a remand report from the TPO after admitting additional evidence, that DRP directed the TPO/AO to delete the proposed adjustment. We are of the opinion that TPO is not empowered to determine the ALP of an IT at NIL, that in the case under consideration he had made adjustment without adopting any of the prescribed methods. It is a fact that the assessee had satisfied all the necessary tests for the purpose of availing services from its AE. In these circumstances, we hold that the approach of the assessee in benchmarking the transaction under the head availing e-connectivity services under combined transaction approach was at arm s length. Considering the above, we confirm the order of the DRP and decide ground against the revenue. Treatment to expenditure incurred for e-connectivity - Revenue or capital expenditure - Held that - The expenditure incurred by the assessee on econnectivity is incurred for day-to-day running of its business without creating any asset and therefore same is allowable as revenue expenditure. - Decided in favour of assessee

Summary

Issues Involved:
1. Rejection of Comparable Uncontrolled Price (CUP) method for determining Arm's Length Price (ALP) of import transactions.
2. Adjustment on account of allocation of e-connectivity cost.
3. Treatment of e-connectivity expenditure as capital expenditure.

Detailed Analysis:

1. Rejection of Comparable Uncontrolled Price (CUP) Method:
The first issue pertains to the rejection of the CUP method for determining the ALP of the import of Active Pharmaceutical Ingredient (API). The Transfer Pricing Officer (TPO) adopted the CUP method, comparing the prices with those paid by competitors, leading to a significant adjustment. The Dispute Resolution Panel (DRP) found that the TPO did not provide sufficient information about the uncontrolled transactions and failed to establish the close similarity required for a valid CUP comparison. The DRP directed the TPO to verify the segmental analysis under the Transactional Net Margin Method (TNMM) and quantify the TP adjustment accordingly. The Tribunal upheld the DRP's decision, noting that the TPO did not prove the comparability of Micro Lab Ltd. (MLL) with the assessee and ignored the internal CUP provided by the assessee. The Tribunal emphasized that the CUP method requires perfect or realistic comparability and reasonable adjustments, citing the Aztec Software and Technology case.

2. Adjustment on Account of Allocation of E-Connectivity Cost:
The second issue involves the adjustment on account of e-connectivity cost allocation. The TPO questioned the nature of the e-connectivity expenses and treated them as capital in nature. The DRP, after considering additional evidence and a remand report, held that the services were necessary for the assessee's business efficiency and were allocated based on usage. The DRP directed the AO to delete the TP adjustment, confirming that the cost allocation methodology adopted by the AE was at arm's length. The Tribunal upheld the DRP's decision, stating that the TPO is not empowered to determine the ALP of an international transaction at NIL and that the assessee satisfied all necessary tests for availing services from its AE.

3. Treatment of E-Connectivity Expenditure as Capital Expenditure:
The third issue concerns the treatment of e-connectivity expenditure as capital expenditure. The AO treated the expenditure as capital in nature, allowing depreciation at 60%. The DRP upheld this view, following the decision for the earlier assessment year. The Tribunal, however, found that the assessee did not acquire any ownership rights to software or capital assets but merely received services related to software. The Tribunal referred to the Asahi Safety Glass Ltd. case, emphasizing that the expenditure enabled the profit-making structure to work more efficiently without creating any capital asset. The Tribunal concluded that the e-connectivity expenditure was for day-to-day business operations and should be treated as revenue expenditure.

Conclusion:
The Tribunal dismissed the appeal filed by the AO and allowed the appeal of the assessee, thereby confirming the DRP's decisions on all issues. The CUP method was rejected in favor of TNMM for determining ALP, the e-connectivity cost allocation was deemed at arm's length, and the e-connectivity expenditure was treated as revenue expenditure. The order was pronounced in the open court on 18th May 2016.