2013 (8) TMI 812 - AT - Income Tax

Difference in the arm's length price of the 'international transaction' - TPO evaluated the international transactions applying TNMM at entity level by comparing the net operating profit margin of the assessee with uncontrolled net operating profit margin of comparable uncontrolled enterprises - DRP confirmed additon made by TPO - Held that - The most direct comparison has been provided by way of comparable uncontrolled transactions entered into by the associated enterprise with unrelated parties, in India, for rendering similar software development services. The internal comparison undisputedly provides the most reliable and direct benchmark for establishing the arm's length price of such international transactions of rendering software development services entered into by the appellant - CUP could appropriately be applied considering internal comparable uncontrolled transactions entered into by the appellant with unrelated parties - The TPO was not justified in ignoring the aforesaid comparable uncontrolled transactions placed on record and instead embarking upon a less direct benchmarking exercise by resorting to comparison of profits of external comparables - The internal comparables available in case of an assessee are to be preferred for the purpose of benchmarking of international transactions even in the case where TNMM is applied, instead of relying on external comparables - Decided in favour of assessee. The revenue derived from unrelated party transactions at 20.30% of the aggregate revenue of the appellant, cannot be the reason for disregarding internal comparability analysis undertaken by the appellant. It would be appreciated that the appellant in the course of its business enters into several software development contracts of small volume. TPO in his order, while conducting fresh search has selected companies with turnover in excess of 1 crore. However, the TPO himself has rejected the internal comparable with a turnover of 2.97 crores used by the appellant for benchmarking analysis, holding is to be very small as against the sales made to associated enterprise. Since the TPO himself has accepted companies with turnover more than 1 crore, this argument of the TPO seems inconsistent with his own approach. The internal benchmarking analysis undertaken by the appellant, therefore, has wrongly been rejected by the TPO and the Transfer Pricing adjustment made in respect of the international transaction of software development services rendered to the associated enterprise, calls for being deleted. Transfer Pricing adjustment in respect of international transactions of payment of marketing and management support services - Held that - Assessee does not have any sales or marketing office outside India and therefore the entire third party business of the appellant is generated as a result of the market support services provided by HSC, USA. The increase in revenue of more than 3 times of the revenue of immediately preceding year is pursuant to the significant marketing activity undertaken by HSC, USA - The associated enterprise, HSC USA, does not undertake any business activity of its own and was created solely for the purpose of rendering marketing and aforesaid management support services to the appellant. The operating costs incurred by the HSC USA relate entirely to the operations of the appellant in India and there is no other revenue reflected in the profit and loss account of the associated enterprise. Nature of costs being incurred by HSC USA for the aforesaid services, are, payroll, insurance, general office running expenses, etc. - The international transactions of rendering of marketing and management support services by the associated enterprise has independently been demonstrated to be at arm's length applying TNMM, taking associated enterprise as the tested party. Such international transactions undertaken in the Transfer Pricing study, has otherwise not been disputed by the TPO - Transfer Pricing adjustment made by the TPO in respect of international transactions of payment of marketing and management support services is not sustainable and is liable to be deleted - Decided in favour of assessee.

Summary

Issues Involved:
1. Transfer Pricing Adjustment for Software Development Services
2. Transfer Pricing Adjustment for Marketing Support Services
3. Depreciation on Computer Peripherals
4. Levying of Interest under Sections 234B and 234C

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment for Software Development Services:

Facts:
The appellant, a subsidiary of a Mauritius-based company, engaged in software engineering services, entered into international transactions with its associated enterprise in the USA. The transactions were benchmarked using the Transactional Net Margin Method (TNMM) and internal comparables.

Appellant's Argument:
The appellant justified the arm's length price (ALP) using internal comparables, showing higher profit margins from transactions with associated enterprises compared to unrelated parties. The appellant also provided external comparables and justified the ALP using the Comparable Uncontrolled Price (CUP) method, showing higher prices charged to associated enterprises than unrelated parties.

TPO/DRP's Orders:
The TPO disregarded the internal benchmarking, considering it unreliable due to the minor share of unrelated transactions and entity-level losses. The DRP affirmed this, emphasizing the inadequacy of internal comparables. The TPO used external comparables, resulting in an adjustment of Rs. 3,80,75,810.

Tribunal's Decision:
The Tribunal admitted additional evidence, emphasizing the need for a proper assessment of the CUP method. The issue was remanded back to the TPO for reconsideration, allowing the appellant to present additional evidence.

2. Transfer Pricing Adjustment for Marketing Support Services:

Facts:
The appellant paid marketing support service fees to its associated enterprise in the USA, which was benchmarked using TNMM, showing the transaction at arm's length.

Appellant's Argument:
The appellant argued that the associated enterprise provided significant marketing support services, which were crucial for its business operations. The appellant provided affidavits from key personnel to substantiate the services rendered.

TPO/DRP's Orders:
The TPO determined the ALP of the marketing support services as NIL, citing a lack of evidence for the services rendered. The DRP concurred, questioning the necessity and effectiveness of the services provided by the associated enterprise.

Tribunal's Decision:
The Tribunal admitted additional evidence, including affidavits from key personnel, and remanded the issue back to the TPO for reconsideration, allowing the appellant to present additional evidence.

3. Depreciation on Computer Peripherals:

Facts:
The appellant claimed depreciation at 60% on computer peripherals, which the assessing officer restricted to 15%, treating them as plant and machinery.

Appellant's Argument:
The appellant argued that computer peripherals should be considered part of the computer system, citing relevant case laws and decisions.

Tribunal's Decision:
The Tribunal allowed the appellant's claim, following the Delhi High Court judgment in the case of BSES Rajdhani Powers Ltd., granting depreciation at 60% on computer peripherals.

4. Levying of Interest under Sections 234B and 234C:

Tribunal's Decision:
The Tribunal held that the issue of interest under Sections 234B and 234C is consequential and will depend on the final outcome of the adjustments.

Conclusion:
The appeals were partly allowed for statistical purposes, with the main issues regarding transfer pricing adjustments remanded back to the TPO for fresh consideration, and the claim for higher depreciation on computer peripherals allowed.