2014 (9) TMI 117 - AT - Income Tax

Transfer pricing Adjustment - determination of ALP u/s 92CA(6) - reduction of Project Management Cost discounting factors - Held that - The assessee had determined its ALP by reducing its gross margin ratio on cost of production from 69.65% to 6.97% by loading discounting factors with respect to long term contract 20.90%, technology transfer 10.45%, Project Management Cost 27.86% & Credit and Credit Risks 3.48% - TPO rejected these factors however, accepted the project management cost factor at 14.14% - In arriving at 14.14% discounting factors on project management cost, the TPO accepted the same method adopted by the assessee however, shifted the computation by adopting total value of sales of unrelated party with the related parties - This stand of the TPO with respect to the discounting factors on project management cost is reasonable, because when the discounting factors are considered for transactions with unrelated party, then the data with respect to unrelated party are to be taken into account for arriving at the discounting factors - TPO had further rejected the discounting factors with respect to credit risks because the same was considered for arriving at the discount factors with respect to project management cost - TPO had not duly considered the discounting factors with respect to long term contract and technology transfers, which was adopted by the assessee at 20.90% & 10.45% respectively. There was no merit in the order of the CIT (A), there were no discussions on the computation made by the appellant or by the TPO in his order - the discounting factors adopted considered by the assessee appears to be relevant, computations with respect to the aforesaid discounting factors are not explained and they also do not emerge from the orders of the Revenue or from the submissions and paper book submitted by the assessee - AO to adapt the discounting factor of 15% for long term contract, and 6% for technology transfer being 70% & 60% approximately as that was accepted by the assessee the AO is directed to arrive at the ALP based on the acceptable discount factors as given in the table the method of computation to be adopted for determining the ALP modified, and also uphold the inclusion of the salary paid to technical persons by the appellant in computing the direct cost Decided partly in favour of revenue.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) under Section 92CA(6) of the Income Tax Act, 1961.
2. Inclusion of salary for non-technical employees in direct cost.
3. Methodology and discounting factors for computing ALP.
4. Rejection of adjustments by the Transfer Pricing Officer (TPO).
5. Justification of ALP by the assessee using Comparable Uncontrolled Price (CUP) and Transactional Net Margin Method (TNMM).
6. Reasonable opportunity for the assessee to present its case.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP):
The core issue in the appeal by the Revenue is the deletion of the addition made towards adjustments on account of determination of ALP under Section 92CA(6). The assessee, a private limited company engaged in software development and export, had its ALP determined by the TPO, which resulted in an addition of Rs. 1,41,56,531.

2. Inclusion of Salary for Non-Technical Employees in Direct Cost:
The assessee argued that the salary of Rs. 73.27 lakhs paid to non-technical employees should not be classified under direct cost. The Ld. CIT(A) appreciated this distinction and included only the salaries of technical persons involved in software development as direct costs.

3. Methodology and Discounting Factors for Computing ALP:
The assessee adopted the cost-plus method for determining its ALP, considering various discounting factors such as long-term contracts, technology transfer, project management costs, and credit risks. The TPO rejected some of these factors but accepted the project management cost factor at 14.14%.

4. Rejection of Adjustments by the TPO:
The TPO rejected the discounting factors for long-term contracts and technology transfers, arguing that the relationships and contracts between the assessee and its AE were perpetual and mutually dependent, thus not justifying the claimed discounting factors.

5. Justification of ALP by the Assessee Using CUP and TNMM:
The Ld. CIT(A) observed that the TPO arbitrarily rejected the ALP determined by the assessee without showing how the pricing was incorrect. The assessee justified its prices using comparable uncontrolled prices and also adopted the TNMM method as an alternative.

6. Reasonable Opportunity for the Assessee to Present Its Case:
The Ld. CIT(A) noted that the assessee was not given reasonable opportunity to present its case and that the TPO's findings were based on mere surmises and conjectures.

Conclusion:
The Tribunal found that the TPO had not duly considered the discounting factors for long-term contracts and technology transfers. The Tribunal modified the computation method and directed the Assessing Officer to arrive at the ALP based on revised discount factors: 15% for long-term contracts and 6% for technology transfer, in addition to the accepted 14.14% for project management costs. Consequently, the Revenue's appeal was partly allowed, and the assessee's cross-objections were dismissed as infructuous.