2012 (6) TMI 60 - AT - Income Tax

Transfer pricing - arm s length price - master software development agreement - Selection of comparable - held that - When the assessee was mainly engaged in software development services, though in a different vertical, having regard to the overall circumstances of the case, such comparable companies selected by the TPO should be considered as comparables in this case. As regards those four companies referred to by the assessee are concerned, after discussing the factual position in respect of those companies and applying those filters adopted by him, in para 13 at page 93-94 of his order, he has clearly held that the same cannot be considered as comparables in this case. In fact, having regard to the factual findings given by the TPO in that para, his decision in rejecting those four companies as comparables, is justified. Accordingly, we reject the plea of the assessee. Regarding ALP - held that - Other enterprises have claimed depreciation at much lower amounts. Size of the assets besides the age of the assets of comparables was leading to difference in the profit margins and in mean margin. On the contrary, claim of depreciation is eating up large chunk of profit in the case of the taxpayer. - The CIT(A) has not said a word on asset employed and risks suffered by the tested party and the comparables. Thus, material differences needing suitable adjustment were ignored and a flawed analysis was carried even in appellate proceedings. Without considering obvious material differences, the contention of the assessee to take profit without depreciation was rejected. This rejection is not sound in law. This ground is allowed.

Issues Involved:
1. Rejection of the Comparable Uncontrolled Price (CUP) Method for benchmarking Arm's Length Price (ALP) in international transactions.
2. Adoption of Transactional Net Margin Method (TNMM) by the Transfer Pricing Officer (TPO).
3. Selection of comparables by the TPO.
4. Negative working capital adjustment.
5. High depreciation adjustment.

Issue-wise Detailed Analysis:

1. Rejection of the Comparable Uncontrolled Price (CUP) Method:
The assessee contended that the CUP method was the most appropriate for benchmarking the ALP of international transactions. The CIT(A) and TPO rejected this method, noting that the services rendered to third parties were not similar to those rendered to the Associated Enterprise (AE). The CIT(A) emphasized that for the CUP method, similarity of transactions is crucial, and in this case, the services provided to third parties differed significantly from those provided to the AE. Agreements with various companies like Avedis Microsystems Pvt. Ltd., Agere Systems India Pvt. Ltd., Texas Instruments (India) Pvt. Ltd., Future Techno Designs Pvt. Ltd., and Beceem Communications Pvt. Ltd. were analyzed, and it was concluded that the services were not comparable. Consequently, the CUP method was deemed inapplicable.

2. Adoption of Transactional Net Margin Method (TNMM):
The TPO adopted TNMM as the most appropriate method for determining the ALP, which was upheld by the CIT(A). The CIT(A) noted that the TPO had applied TNMM in the preceding assessment years, and the same had been accepted. The TPO selected 17 companies as comparables, and the CIT(A) found this selection justified, rejecting the assessee's plea to use the four companies considered in previous years.

3. Selection of Comparables:
The assessee argued that only the four companies considered as comparables in the preceding two assessment years should be used. The CIT(A) rejected this, stating that the TPO had selected comparables based on filters and functional similarities. The TPO's selection of 16 companies (excluding Satyam Computer Services Limited) was upheld, and the average profit margin was computed at 26.41%.

4. Negative Working Capital Adjustment:
The TPO made a negative working capital adjustment of 5.12%, which the CIT(A) upheld. The assessee did not provide any working for this adjustment, and the TPO followed OECD guidelines and an approved formula for the computation. The CIT(A) found no error in the TPO's calculation and upheld the adjustment.

5. High Depreciation Adjustment:
The assessee argued for an adjustment due to high depreciation costs, which was 28.60% of the total cost, compared to 10-11% for other Indian companies. The CIT(A) and TPO rejected this plea, stating that under TNMM, all expenditures, including depreciation, should be considered. The ITAT, however, found merit in the assessee's argument, noting that depreciation could vary significantly and should not always be deducted. It directed the Assessing Officer to recompute the ALP, considering the high depreciation.

Conclusion:
The appeal was partly allowed, with the ITAT directing a recomputation of the ALP considering the high depreciation. The rejection of the CUP method and the adoption of TNMM, along with the selection of comparables and the negative working capital adjustment, were upheld.

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