2014 (2) TMI 36 - AT - Income Tax

Entitlement for benefit of proviso to section 92C(2) of the Act - 5% safe harbor range - Determination of Arm s length nature of international transaction Transfer pricing adjustment - Benchmarking analysis and comparables disregarded Requirement to maintain Transfer pricing documents u/s 92D of the Act r.w. Rule 10D of the Rules Held that - The decision in IHG IT Services (India) (P.) Ltd. v. 2013 (5) TMI 309 - ITAT DELHI Followed - The benefit of 5% tolerance margin as prescribed under provisio to Section 92C(2) for the purposes of determining the arm s length price of an international transaction is allowable as a standard deduction in all cases, or is allowable only if the difference is less than 5% - the second proviso to Section 92C(2) was amended by the Finance Act, 2012 with retrospective effect from 1.4.2002 - even after the retrospective amendment by the Finance Act, 2012, it was entitled to the benefit of adjustment of 5% variation while computing the ALP - if the variation between the arm s length price and the price at which international transaction was actually undertaken does not exceed the specified percentage, then only the price at which the international transaction has actually been undertaken shall be deemed to be arm s length price - Thus, the benefit of tolerance margin would be available only if the variation is within the tolerance margin - Once the variation exceeded the tolerance margin, then there would be no benefit even up to tolerance margin - Then, the ALP as worked out under Section 92C(1) shall be taken as ALP without any benefit of tolerance margin. Adjustments carried out by the TPO were on purchases made from its associate enterprise It could not be point out as to which were those companies which were excluded and what were the margin levels indicated by such companies - Assessee has indeed filed before the DRP, margins of comparables adjusted for difference in working capital, but at no point of time it had given any reason why such adjustments were required - What were the debtor adjustment and creditor adjustment and how these were relevant have not been demonstrated by the assessee - the assessee has not been able to justify the adjustments that were required to be made on account of negative working capital. Adjustment for Customs duty Held that - The higher import content of raw material was a factor to be considered while doing the ALP analysis - higher import content of raw material itself did not warrant an adjustment in operating margins - For getting the benefit of any such adjustment, assessee should be able to demonstrate that higher import content was necessitated by any extraordinary circumstance beyond its control - Assessee had endeavoured to make a 5% adjustment to its total cost for off-setting the leverage derived on account of negative working capital and for taking care of underutilization of capacity - there was no empirical data ever provided by the assessee to support the figure of 5% arrived by it. Addition made inspite of invoices raised Held that - Irrespective of the method of treatment given in the books of accounts, unless and until the invoice is raised, a customer will not be legally bound to pay - Assessee will get a legal right to claim the sum only after raising the invoice Relying upon E.D. Sassoon & Co. Ltd. v. CIT 1954 (5) TMI 2 - SUPREME Court - the point of accrual of income has to be seen from the date on which a legal claim could have been legitimately made on such income the amount could have been considered as income only for the relevant previous year ending 31st March, 2008 - The addition, made for the relevant previous year thus, deleted. Disallowance u/s 40(a)(i) and 40(a)(ia) of the Act Non-deduction of TDS on payment made for acquiring software Held that - royalty mentioned in Section 40(a)(i) and 40(a)(ia) has to be assigned the meaning given in Explanation 2 to clause (vi) of sub- section (1) of Section 9 of the Act - None of the authorities below have verified this issue in the proper perspective - They were also not having the benefit of the elucidation of the law in this regard by higher authorities - The A.O. had held that the tax had to be deducted by the assessee for payment made to software purchase, but, was not done - Neither he, nor the DRP had looked into the aspect whether the payments made were in respect of Shrink-wrapped software or towards right to use software and whether Section 40(a)(i) and 40(a)(ia) stood attracted thus, the matter remitted back to the AO for fresh adjudication Decided partly in favour of Assessee.

Issues Involved:
1. Transfer Pricing Adjustments
2. Non-Transfer Pricing Adjustments
3. Safe Harbour Provisions
4. Customs Valuation as Comparable
5. Adjustment for Negative Working Capital
6. Adjustment for Idle Capacity
7. Disallowance under Section 40(a)(i) and 40(a)(ia) for Non-Deduction of Tax at Source

Detailed Analysis:

1. Transfer Pricing Adjustments:
The assessee challenged the directions of the Dispute Resolution Panel (DRP) and the adjustments made by the Assessing Officer (AO) based on the Transfer Pricing Officer's (TPO) order. The TPO rejected the assessee's transfer pricing (TP) study for not being contemporaneous and conducted a fresh analysis, selecting 14 comparables. The TPO did not accept adjustments for negative working capital and first-year operational disabilities, and determined an arm's length price (ALP) adjustment of Rs. 9,58,60,522/-. The DRP upheld the TPO's rejection of the TP study, but accepted an idle capacity adjustment of 30%. The Tribunal found that the TPO's selection of comparables with related party transactions exceeding 25% was incorrect and directed the AO to exclude such comparables and restrict the TP adjustment to the proportionate AE transactions.

2. Non-Transfer Pricing Adjustments:
The AO proposed additional adjustments for income from an invoice raised in the subsequent year, amortization of leasehold land, software license acquisition, and reimbursement of expenses for non-deduction of tax at source. The DRP upheld the AO's additions except for the excess depreciation claim. The Tribunal deleted the addition of Rs. 5.34 Crores for the invoice raised in the subsequent year, as the income accrued only upon raising the invoice.

3. Safe Harbour Provisions:
The assessee claimed the benefit of a 5% safe harbour range under proviso to Section 92C(2). The DRP denied this, citing the retrospective amendment by the Finance (No.2) Act, 2009. The Tribunal upheld the DRP's decision, referencing the Special Bench decision in IHG IT Services (India) (P.) Ltd. v. ITO.

4. Customs Valuation as Comparable:
The assessee argued that Customs valuations should be accepted as comparable for TP purposes. The DRP rejected this, stating that Customs rules differ from TP rules. The Tribunal agreed, noting that Customs valuations aim to prevent undervaluation, which is not comparable to TP analysis.

5. Adjustment for Negative Working Capital:
The assessee claimed an adjustment for negative working capital. The DRP rejected this, stating the assessee failed to demonstrate the impact. The Tribunal concurred, finding no empirical data justifying the adjustment.

6. Adjustment for Idle Capacity:
The DRP accepted the assessee's argument for an idle capacity adjustment of 30%. The Tribunal upheld this adjustment, noting the assessee's low capacity utilization of 5.47%.

7. Disallowance under Section 40(a)(i) and 40(a)(ia) for Non-Deduction of Tax at Source:
The AO disallowed payments for software licenses under Section 40(a)(i) and 40(a)(ia) for non-deduction of tax at source. The DRP upheld this. The Tribunal remitted the issue back to the AO to verify if the payments were for "Shrink-wrapped" software or for the right to use software, and whether the sections were applicable.

Conclusion:
The Tribunal directed the AO to rework the TP adjustments, excluding comparables with related party transactions exceeding 25% and restricting adjustments to the proportionate AE transactions. The addition for the subsequent year's invoice was deleted, and the disallowance for software license payments was remitted for fresh consideration. The appeal was partly allowed for statistical purposes.

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