2017 (9) TMI 300 - AT - Income Tax

Adjustment u/s 92CA - strictly relying on TNMM OR considered CUP as MAM - providing telecommunication net working services - adjustment on account of capacity under-utilisation of capacity - Held that - entity level results comprising of international transactions and domestic transactions cannot be considered for the purpose of testing the price of the international transactions with comparable price being ALP. It is also pertinent to note that while selecting the comparable entity for the purpose of determining the ALP of international transactions an appropriate filter of not less than 75% of the revenue from exports is applied. - the appropriate method in our view would be CUP and particularly when the AE of the assessee was receiving the same services from Tata Communications just prior to the incorporation of the assessee. The assessee is using the same network bandwidth hired from Tata Communications and also claimed that during the year under consideration the assessee is in the testing phase and was not able to provide proper services as manifest from the agreement with the client. Thus it is apparent that the services of the assessee were not better than the earlier provided by Tata Communications to the AE of the assessee and therefore, the contention of the ld. AR is devoid of any substance or merit. Further in case CUP is adopted as a MAM the question of non-utilisation of network and corresponding adjustment on account of lease, charges would not arise. Accordingly, in the facts and circumstances of the case, when direct CUP between the AE and Tata Communications from whom the assessee has taken the network on lease is available then the ALP has to be computed under CUP. We further note that it is the stand of the assessee that the assessee as well as the TPO has accepted the TNMM as MAM. However when the assessee has expressed its helplessness to compute the margins separately in respect of the international transactions then the direct CUP available in case of the assessee would be an appropriate method of determination of ALP. Also the assessee claimed to have taken the network on lease from Tata Communications however the agreement filed before us by the assessee is with Tata Teleservices Ltd. (TTL)/Tata Teleservices (Maharashtra) Limited (TTML) and not Tata Communications Limited. Therefore this aspect is required to be verified properly. Hence when the assessee has substituted the Tata Communications Ltd. in providing the services to the AE then the CUP would be the MAM. Accordingly, we set aside the matter to the record of the TPO for determination of the ALP on the basis of CUP. Appeals of assessee are allowed for statistical purpose

Summary

Issues Involved:
1. Violation of principles of natural justice and arbitrariness.
2. Error in directing the TPO to verify prior arrangements and excluding certain transactions.
3. Denial of start-up cost adjustment.
4. Error in adjusting start-up costs only for comparables and not for the appellant.
5. Deeming unutilized capacity cost as an international transaction.
6. Restriction of adjustment value to the value of international transactions.
7. Non-adjudication on functionally different comparables.
8. Jurisdictional error in reference under section 92CA(1).
9. Denial of 5% adjustment benefit under section 92C.
10. Error in levying consequential interest under section 234B.
11. Error in initiating penalty proceedings under section 271(1)(c).

Detailed Analysis:

1. Violation of Principles of Natural Justice and Arbitrariness:
The assessee contended that the CIT(A) confirmed the addition made by the AO and TPO without adhering to the principles of natural justice, rendering the order arbitrary and void ab initio. The Tribunal noted the procedural aspects but did not find a direct violation of natural justice principles, focusing instead on the substantive issues raised.

2. Error in Directing the TPO to Verify Prior Arrangements:
The CIT(A) directed the TPO to verify the existence of prior arrangements between the AE and third parties in India. The Tribunal found this direction ultra vires, as the CIT(A) can only confirm, reduce, enhance, or annul the assessment but cannot restore the matter for fresh determination. The Tribunal emphasized the limitations of the CIT(A)’s powers under section 251 of the Act.

3. Denial of Start-up Cost Adjustment:
The CIT(A) denied the start-up cost adjustment claimed by the assessee, arguing that such adjustments could only be made to the financials of comparable companies, not to the appellant’s operating margin. The Tribunal noted that the assessee was a start-up in its first operational year and required an adjustment for under-utilization of leased network capacity. The Tribunal found merit in the assessee's argument but emphasized the need for proper verification of the claimed adjustments.

4. Error in Adjusting Start-up Costs Only for Comparables:
The Tribunal highlighted the CIT(A)’s error in not appreciating the start-up adjustment workings submitted by the assessee. It pointed out that the CIT(A)’s approach was flawed as it did not consider the appellant's specific circumstances and the nature of its start-up phase.

5. Deeming Unutilized Capacity Cost as an International Transaction:
The CIT(A) concluded that the unutilized capacity cost incurred by the assessee was a deemed international transaction under Section 92B(2). The Tribunal disagreed, noting that both the appellant and third-party telecom operators were Indian companies, making Section 92B(2) inapplicable. The Tribunal emphasized that the provision requires third-party companies to be non-resident entities.

6. Restriction of Adjustment Value to the Value of International Transactions:
The Tribunal noted the CIT(A)’s error in not adjudicating the plea that the adjustment value should be restricted to the value of the international transaction. The Tribunal found that the CIT(A) failed to address this critical aspect, requiring further examination.

7. Non-adjudication on Functionally Different Comparables:
The Tribunal observed that the CIT(A) did not adjudicate on the issue of comparables that were functionally different from the appellant's business. The Tribunal emphasized the need for a thorough analysis of comparables to ensure accurate benchmarking of international transactions.

8. Jurisdictional Error in Reference Under Section 92CA(1):
The assessee argued that the AO’s reference to the TPO under section 92CA(1) suffered from a jurisdictional error, as no reasons were recorded for the necessity or expediency of the reference. The Tribunal did not find substantial grounds to support this claim, focusing instead on the substantive issues of transfer pricing adjustments.

9. Denial of 5% Adjustment Benefit Under Section 92C:
The Tribunal noted the CIT(A)’s error in not allowing the benefit of a 5% adjustment as provided in the proviso to section 92C. The Tribunal emphasized the statutory entitlement to this adjustment, requiring reconsideration by the lower authorities.

10. Error in Levying Consequential Interest Under Section 234B:
The Tribunal acknowledged the assessee’s contention regarding the erroneous levy of consequential interest under section 234B. It directed the AO to recompute the interest based on the final determination of the transfer pricing adjustments.

11. Error in Initiating Penalty Proceedings Under Section 271(1)(c):
The Tribunal noted the assessee’s objection to the initiation of penalty proceedings under section 271(1)(c). It directed that the penalty proceedings be reconsidered in light of the final outcome of the transfer pricing adjustments.

Conclusion:
The Tribunal set aside the matter to the TPO for determination of the ALP on the basis of CUP, emphasizing the need for proper verification of agreements and transactions. For Assessment Years 2010-11 and 2011-12, the Tribunal noted that the issue of set-off of brought forward losses was consequential to the TP adjustment for AY 2009-10 and directed the AO to take consequential action based on the outcome of the remanded issue for AY 2009-10. The appeals were allowed for statistical purposes.