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2016 (11) TMI 205 - AT - Income TaxDetermination of arm s length price (ALP) in respect of transactions of the assessee with its Branch Office in Canada - Held that - Not only the income but, also the expenses and all the items of balance sheet of branch office, Canada have also been merged with the figures of head office. It is the total income as also including the total revenue earned by branch office Canada, which has been offered for taxation. Under such circumstances and in the backdrop of the foregoing discussion, the transfer pricing provisions cannot apply in respect of transactions between the Indian head office and branch office in Canada. The impugned order is set aside pro tanto. Addition due to transfer pricing adjustment - filters for selecting the comparable companies - Companies whose software development service revenue less than ₹ 1 crore were excluded - Held that - We are not convinced with the argument advanced on behalf of the assessee in this regard. When functionally similar companies are chosen and then average of the profit rate of such similarly functional companies is taken into account for determining the ALP of the international transaction undertaken by the assessee, the size of some of the companies in the whole lot of comparable companies, becomes meaningless. Averaging of the profit rates of the whole lot of functionally similar companies of different sizes, viz., some having higher while some others having lower turnover vis- -vis the assessee, irons out the effect of such differences. The Hon ble jurisdictional High Court in the case of ChrysVapital Investment Advisors (India) Pvt. Ltd. vs. DCIT (2015 (4) TMI 949 - DELHI HIGH COURT ) has held that high profit/turnover cannot be a criteria to exclude an otherwise comparable company. This issue being no more res integra, does not deserve the acceptance by us of the argument advanced on behalf of the assessee. We, therefore, hold that the TPO was justified in applying this filter. Companies who have less than 25% of the revenues as export sales were excluded - Held that - the assessee s export revenue is roughly 21% of total revenue. If we apply the filter of excluding the companies having less than 25% of the revenue s from export sales, it would tend to eliminate the companies which are similarly placed as the assessee. - Both the sides agreed that if, in the given circumstances, the filter of excluding the companies with export sales of more than 30% of the total revenue is applied, that would serve the purpose. In our considered opinion, this proposition put forth by the ld. AR and as accepted by the ld. DR, is in order. Companies who have more than 25% related party transactions (sales as well as expenditure combined) of the operating revenues were excluded - Held that - The decision as to whether a company should be included in the list of comparables by applying the filter of more than 25% RPTs, would depend on the outcome of two such percentages of RPTs. If either of the two breaches the 25% threshold, then the company will cease to be comparable. The impugned order, combining sales and expenses, for calculating the percentage of the RPTs is set aside to this extent and the TPO is, accordingly, directed to apply this filter in the manner discussed above. Companies who have diminishing revenues/persistent losses for the period under consideration were excluded - Held that - if we exclude the companies having diminishing profits, it would mean that the companies whose profit pattern is also similar to that of the assessee would face the axe. Doing so would mean excluding the comparable companies from the final tally, which is not appropriate. However, the companies having persistent losses, obviously, cannot be compared with the assessee because it has earned positive income not only in this year, but, in the preceding year as well. We, therefore, hold that the companies having diminishing revenue should not be excluded, but, only the companies having persistent losses should be expelled from the final tally of comparables. Companies whose onsite income is more than 75% of the export revenues were excluded - Held that - the companies whose onsite income is more than 75% of the export limit should be rather included. Since the necessary complete information is not available with the ld. AR for verifying the veracity of the contention of the foreign branch earning 100% onsite services, we consider it expedient to direct the TPO/AO to examine the break-up of the revenues earned by branch office, Canada, for seeing if the same is from onsite/offsite services. The application of the filter will be then decided accordingly by the TPO. Disallowance of adjustment on account of idle capacity - Held that - The effect of differences between the international transaction and comparable uncontrolled transactions is always given in the net operating profit margin of the comparable uncontrolled transactions. There is no mandate for adjusting the assessee s profit margin under the provisions of Rule 10B(1)(e). The assessee s contention that its operating costs should be reduced to the extent its employees remained idle is, ergo, incapable of acceptance. The adjustment, if any, could have been allowed, if the assessee had demonstrated that the comparable companies had more under-utilization of their labour force vis- -vis the assessee. The onus to prove such under-utilization of employees of the comparables, for claiming adjustment, squarely lies on the assessee. On a specific query, the ld. AR could not point out that the utilization of employees by the comparable companies was less than the assessee. Under such circumstances, we are of the considered opinion that no such adjustment can be granted. We, therefore, approve the view taken by the authorities on this issue.
Issues Involved:
1. Determination of Arm’s Length Price (ALP) for transactions between the Indian head office and its branch office in Canada. 2. Transfer pricing adjustment for 'Software development services' provided to an associated enterprise in the USA. 3. Application of specific filters by the Transfer Pricing Officer (TPO) in selecting comparable companies. 4. Adjustment on account of idle capacity. Issue-wise Detailed Analysis: 1. Determination of Arm’s Length Price (ALP) for transactions between the Indian head office and its branch office in Canada: The primary issue in this appeal is whether transactions between an Indian head office and its branch office in Canada should be subject to transfer pricing adjustments. The tribunal noted that transactions between a head office and its branch office do not constitute 'international transactions' as per Section 92B(1) of the Income-tax Act, 1961 because a branch office is not a separate enterprise. The principle of mutuality, supported by several judgments, including Sir Kikabhai Prem Chand VS CIT (1953) and Betts Hartley Huett & Co. Ltd. VS CIT (1979), implies that no profit or loss can arise from transactions with oneself. Furthermore, the tribunal explained that any profit earned by the head office from the branch office would be offset by the corresponding expense in the branch office, making such transactions tax neutral. Consequently, the tribunal concluded that transfer pricing provisions do not apply to transactions between the Indian head office and its branch office in Canada. 2. Transfer pricing adjustment for 'Software development services' provided to an associated enterprise in the USA: The assessee contested a transfer pricing adjustment of ?2,59,26,400/- for software development services provided to its associated enterprise, Aithent Inc., USA. The TPO had used the Transactional Net Margin Method (TNMM) and selected comparables after applying specific filters. The tribunal agreed with the filters applied by the TPO but remitted the matter back to the TPO/AO for reconsideration of the comparability of companies based on the tribunal's observations. 3. Application of specific filters by the Transfer Pricing Officer (TPO) in selecting comparable companies: The tribunal addressed several filters applied by the TPO in selecting comparable companies: - Revenue Filter: The tribunal upheld the TPO's exclusion of companies with software development service revenue less than ?1 crore, rejecting the assessee's argument for an upper limit on turnover. - Export Sales Filter: The tribunal found the TPO's filter of excluding companies with less than 25% export sales inappropriate since it would exclude companies similarly placed as the assessee. Both parties agreed to apply a filter excluding companies with export sales of more than 30% of total revenue. - Related Party Transactions (RPT) Filter: The tribunal directed the TPO to segregate RPTs of purchases and sales separately instead of combining them, ensuring the percentage of RPTs is correctly calculated. - Diminishing Revenues/Persistent Losses Filter: The tribunal held that companies with diminishing revenues should not be excluded, but companies with persistent losses should be. - Onsite Income Filter: The tribunal directed the TPO/AO to verify the revenue break-up of the branch office in Canada to determine if the filter excluding companies with more than 75% onsite income should be applied. 4. Adjustment on account of idle capacity: The assessee sought a reduction in operating costs due to 42% idle capacity of its employees. The tribunal rejected this request, stating that the TNMM method does not provide for adjusting the assessee’s profit margin. Adjustments could only be considered if the assessee demonstrated that comparable companies had more under-utilization of labor, which the assessee failed to do. Consequently, the tribunal upheld the authorities' decision on this issue. Conclusion: The appeal was allowed for statistical purposes, with the tribunal remitting the matter back to the TPO/AO for reconsideration of comparables based on the tribunal's observations and directions. The order was pronounced in the open court on 21.09.2016.
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