2022 (12) TMI 526 - AT - Income Tax

TP adjustment - International Transaction of provision of contract research and development (R D) services - Functional profile of assessee company - whether the assessee is providing contract research and development activities or merely providing contract software development services of bug fixing? - HELD THAT - As the TPO and the DRP without verifying, the actual functions performed by the assessee were guided only by the title of the agreement, characterizes assessee as research and development service provider. Lower authorities also without looking into the functional profile claimed by the assessee in form no. 3CEB have changed the characterization of assessee. As the functions performed by assessee is not verified and merely based on agreement, lower authorities have upheld the benchmarking of International Transactions. Decision of coordinate benches in assessee's own case for earlier years on this issue has also set aside benchmarking back to the AO/ TPO. We set aside the whole of issue back to the file of the Transfer Pricing Officer with a direction to the assessee to substantiate that it is not a research and development service provider but a contract software development service provider. The assessee is at liberty to produce such documents as well as cost incurred in provision of the services, work force employed, certificate of work, and various other material such as contract papers, engagement letters etc to substantiate the same. Assessee is also directed to show benchmarking analysis of these transactions. AO/ TPO are directed to examine nature of services provided by the assessee and then, determine its arm‟s length price in accordance with the law.

Issues Involved:
1. Determination of total taxable income.
2. Addition in respect of international transactions.
3. Validity of reference to Transfer Pricing Officer (TPO).
4. Rejection of economic analysis and use of single-year data.
5. Re-characterization of the appellant's functional profile.
6. Determination of the appellant as the economic owner of Intangible Property (IP).
7. Rejection of comparable companies and cherry-picking of comparables.
8. Risk and working capital adjustments.
9. Levy of interest under sections 234A, 234B, and 234C.
10. Initiation of penalty proceedings.

Detailed Analysis:

1. Determination of Total Taxable Income:
The learned Assessing Officer (AO) erred in determining the total taxable income of the appellant at INR 6,49,49,092 for A.Y. 2012-13 and INR 16,61,59,297 for A.Y. 2014-15, against the reported income of INR 1,09,25,800 and INR 4,43,99,441 respectively.

2. Addition in Respect of International Transactions:
The AO made an addition of INR 5,40,23,292 for A.Y. 2012-13 and INR 12,17,59,856 for A.Y. 2014-15 in respect of international transactions pertaining to the provision of contract software development services by the appellant to its associated enterprise (AE).

3. Validity of Reference to TPO:
The AO erred in making a reference to the TPO under section 92CA of the Act for determining the arm's length price (ALP) of the international transactions in a mechanical manner, without demonstrating the necessity or expediency of doing so as mandated under sub-section (1) of the Act.

4. Rejection of Economic Analysis and Use of Single-Year Data:
The TPO rejected the economic analysis undertaken by the appellant and used data pertaining only to the financial year 2011-12, rejecting the use of multiple-year data by the appellant.

5. Re-characterization of the Appellant's Functional Profile:
The TPO characterized the appellant as a contract R&D service provider instead of a contract software development service provider, relying on the nomenclature in the inter-company agreement and financial statements. The appellant argued that it is engaged in contract software development services, not R&D services. The Tribunal set aside this issue back to the TPO for a detailed examination of the appellant's functional profile.

6. Determination of the Appellant as the Economic Owner of IP:
The TPO erred in determining the appellant as the economic owner of the Intangible Property (IP) resulting from the R&D services provided to its AE.

7. Rejection of Comparable Companies and Cherry-Picking of Comparables:
The TPO erroneously rejected the comparable companies selected by the appellant and cherry-picked comparables like Acropetal Technologies Limited and Eclerx Services Limited. The Tribunal directed the TPO to re-examine the comparability analysis.

8. Risk and Working Capital Adjustments:
The TPO did not make suitable adjustments to account for differences in working capital and risk profiles between the appellant and the comparable companies.

9. Levy of Interest under Sections 234A, 234B, and 234C:
The AO erred in levying interest under sections 234A, 234B, and 234C of the Act.

10. Initiation of Penalty Proceedings:
The AO erred in initiating penalty proceedings under sections 271(1)(c), 271B, 271BA, and 271F of the Act.

Conclusion:
The Tribunal set aside the issues related to the characterization of the appellant's functional profile and the determination of the arm's length price back to the TPO for a detailed examination. The appeals for A.Y. 2012-13 and A.Y. 2014-15 were partly allowed for statistical purposes. The Tribunal directed the TPO to verify the actual functions performed by the appellant, the cost incurred, and the nature of services provided, and to determine the arm's length price in accordance with the law.

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