2023 (1) TMI 1076 - AT - Income Tax

TP Adjustment - functions performed by the assessee and the comparables selected - whether the assessee is in distribution support services or is doing marketing support services as held by the TPO - HELD THAT - As perused the Reseller agreement between the assessee and its AE and in this agreement the very term the assessee is referred to as Reseller . In the recital part clause (B), it states Company wishes to appoint reseller to market and sell the products in the territory (as defined herein) and reseller desires to accept such appointment. Here, the reseller is MSC Software Corporation India Pvt. Ltd. i.e. the assessee and this clearly signifies that the assessee has to do the marketing activities and sell the products. Assessee being the reseller is doing only marketing support services. That MSC India is actually performing routine marketing activities in India attracting customers of software products in the Indian market. The marketing material is provided by company to the assessee at no cost and even when assessee prepares localized products, the copyrights are always with the company. The routine marketing activity primarily includes attending conferences, exhibitions, seminars to showcase the product to the targeted customers. When an order is received from the customer by MSC India that would be submitted to AE with specific type quantity of the product name and e-mail address of the customer and the requisite delivery date. However, the AE has the discretion either to accept or reject that order. If accepted, the delivery of the product is the responsibility of AE. The company will deliver the product directly to the customer and company will provide the assessee just a notification of such delivery. The customer makes payment to the assessee, the assessee retains 3.5% of revenue from the receipts from customers and the remaining amount is passed on to the company i.e. AE. The copy of agreement with customer is done in a format which also to be approved by the AE. AE has right to call for periodic report regarding the activities of the assessee and verify the books of account of assessee as evident from clauses 3.8 and 3.9 of the agreement. Assessee's main activity is nothing but marketing activity, whereas all the ownership of the product, the power to determine whether to accept / reject the order and the pricing is with the AE. The assessee is only getting 3.5% of the revenue from the receipts of the customers for the marketing function that it is doing. We, therefore, set aside the findings of ld. CIT(A) and restore the order of ld. TPO - grounds of appeal of Revenue are allowed. Treat foreign exchange gain as non-operating in nature for the purpose of computation of the PLI of the appellant as well as that of the comparable companies - We find that Pune Bench of Tribunal in several decisions have held that forex gain is operating in nature. See TRANSPERFECT SOLUTIONS INDIA PVT. LTD. VERSUS ACIT, CIRCLE-7 PUNE 2022 (8) TMI 521 - ITAT PUNE - Thus we hold that forex gain is operating in nature and accordingly, ground of objection No.2 is allowed.

Summary

Issues Involved:
1. Whether the assessee is engaged in distribution activity or marketing support services.
2. The functional comparability of selected companies.
3. The treatment of foreign exchange gain in the Profit Level Indicator (PLI).
4. The correctness of the Transfer Pricing Officer (TPO)'s functional analysis and benchmarking.

Detailed Analysis:

Issue 1: Distribution Activity vs. Marketing Support Services
The primary issue for adjudication was whether the assessee was involved in distribution support services or marketing support services. The TPO's analysis of the agreement between the assessee and the Associated Enterprise (AE) concluded that the assessee was performing routine marketing activities. The TPO noted that the assessee's main activities included attending conferences, exhibitions, and seminars to attract customers, with the AE retaining ownership of the product and control over order acceptance and pricing. The assessee was remunerated with a fixed mark-up of 3.5% of net revenue. Consequently, the TPO held that the assessee's main activity was marketing support services. The CIT(A) had earlier allowed the assessee's appeal, holding that the assessee was involved in distribution support services based on a precedent from A.Y. 2013-14. However, the Tribunal set aside the CIT(A)'s findings, restoring the TPO's order and concluding that the assessee's primary function was marketing support services.

Issue 2: Functional Comparability
The TPO analyzed the functional profiles of comparables selected by the assessee, including Integra Telecommunications, Dynacons Technologies Limited, and JMD Telefilms. The TPO found that these companies were functionally different as they were engaged in trading activities involving computer hardware and software, whereas the assessee was involved in marketing support services without holding inventory or ownership of the products. Therefore, the TPO rejected these comparables. The Tribunal upheld the TPO's analysis, agreeing that the selected comparables were not functionally similar to the assessee.

Issue 3: Treatment of Foreign Exchange Gain
The assessee contested the CIT(A)'s decision to treat foreign exchange gain as non-operating in nature for the purpose of computing the PLI. The Tribunal referenced its own precedent and other judicial decisions, including the Delhi High Court's ruling in Pr.CIT Vs. BC Management Services Pvt. Ltd., which held that foreign exchange gain should be considered as operating revenue. Accordingly, the Tribunal allowed the assessee's ground of objection, ruling that foreign exchange gain is operating in nature.

Issue 4: Correctness of TPO's Functional Analysis and Benchmarking
The assessee raised several grounds of objection regarding the TPO's benchmarking analysis, including the selection/rejection of filters, the profitability comparison, and the selection of functionally non-comparable companies. The CIT(A) had dismissed these grounds as academic without a detailed analysis. The Tribunal found that the CIT(A) had not adequately addressed the TPO's specific findings on the functional profile of the assessee and had not provided a detailed order regarding the transfer pricing study report. Consequently, the Tribunal remanded these grounds back to the CIT(A) for re-adjudication, emphasizing the need for a detailed and specific finding in compliance with the principles of natural justice.

Conclusion:
The Tribunal allowed the Revenue's appeal, restoring the TPO's findings that the assessee was engaged in marketing support services. The Tribunal also partly allowed the assessee's cross-objection for statistical purposes, directing the CIT(A) to re-adjudicate specific grounds related to the benchmarking analysis. The order was pronounced on January 16, 2023.