2015 (5) TMI 352 - AT - Income Tax

Transfer pricing adjustment - international transaction of Provision of contract R&D services. - inclusion/exclusion of certain companies as comparables - Held that - Infosys Technologies Ltd. directed to be excluded from the list of comparables as the extant assessee is a captive service provider with a limited number of employees at its disposal and also not owning any branded products but, rendering only offshore services with no expenditure on R&D etc and giantness of Infosys Ltd., in terms of risk profile, nature of services, number of employees, ownership of branded products and brand related profits, etc. Bodhtree Consulting Ltd. do not represent fair profitability on year to year basis, this company loses its tag of an effective comparable. We, therefore, order for the exclusion of this company from the final list of comparables. Tutis Technologies Ltd. no logic in not placing it in the final set of comparables as TPO inadvertently omitted to include it in the final set. There is no discussion either in the TPO s order or the direction given by the DRP as to why this company was being considered as incomparable. It implies that the TPO though treated this company as comparable, but, erroneously omitted to include it in the final set of comparables. Goldstone Technologies Ltd. is not comparable with the assessee company and has been rightly excluded by the authorities below as company is also engaged in providing services comprising on-site and offshore operations. Apart from that, it added two more new divisions during the current year, being, Media Division and IPTB Division. By no standard this company on entity level can be considered as comparable with the assessee company. In so far as the export filter applied by the TPO for rejecting this company is concerned, we find that it fails on geographical factors. VJIL Consulting Ltd., Think e-global Services Ltd., and RS Software (India) Ltd. - There is no mention of the assessee s objections about these three companies in the direction given by the DRP. As such, we find that the assessee did urge the inclusion of these three companies in the list of comparables before the TPO as well as the DRP, but, both of them chose not to comment on their comparability. Under such circumstances, we direct the AO/TPO to determine the comparability or otherwise of the above three companies and then take steps for including them in the list of comparables, if found to be comparable. - Decided in favour of assessee for statistical purposes. ALP of the international transaction of Provision of software development serves , is about not allowing risk adjustment - As the assessee is wholly dependent on its AE for securing business, its entire existence also depends on the same AE. If such AE runs out of business or its business is reduced, the assessee is bound to bear severe jolts. Since the ld. AR has failed to objectively demonstrate the relatively higher risks undertaken by the comparables on an overall basis, we are disinclined to grant any risk adjustment. No other aspect of the computation of ALP of the international transaction of Provision of software development services has been challenged by the assessee in the present appeal. The impugned order is ergo set aside on the question of determination of the ALP of the Software development services segment and the matter is remitted to the file of AO/TPO for computing ALP of the international transaction of this segment afresh in consonance with our above directions. Needless to say, the assessee will be allowed a reasonable opportunity of being heard. - Decided in favour of assessee for statistical purposes. International transaction of Purchase of capital goods - Held that - It is illogical to compute the ALP of the transaction of purchase of fixed assets and consequently reduce or nullify the amount of depreciation allowance de hors the consideration of international transaction of the revenue from AE, which is equal to depreciation as claimed with mark-up. Both the transactions of claim of depreciation allowance and revenue of depreciation with mark-up have to be seen jointly. The TPO in the present case has simply reduced the amount of deprecation allowance to Nil without simultaneously considering the revenue side of this transaction. If we consider these closely linked transactions of deduction for depreciation allowance and revenue due to depreciation in unison, the position which follows is that no further addition can be made on account of transfer pricing adjustment due to one-sided consideration of depreciation allowance at Nil. Rather, the determination of ALP of the international transaction of purchase of fixed assets, in the facts and circumstances of the instant case, is tax neutral. As such, we order for the deletion of addition made by disallowing or reducing the amount of depreciation on the assets purchased from AE. This ground is allowed. - Decided in favour of assessee.

Summary

Issues Involved:
1. Transfer Pricing Adjustment for Provision of Contract R&D Services.
2. Inclusion/Exclusion of Comparable Companies.
3. Risk Adjustment in Transfer Pricing.
4. Arm's Length Price (ALP) of Purchase of Capital Goods.

Detailed Analysis:

1. Transfer Pricing Adjustment for Provision of Contract R&D Services:
The primary issue concerns the addition of Rs. 15,43,32,633/- due to transfer pricing adjustment for the international transaction of 'Provision of contract R&D services.' The assessee, a wholly-owned subsidiary of a US-based corporation, used the Transactional Net Margin Method (TNMM) with the Profit Level Indicator (PLI) of Operating Profit to Total Cost (OP/TC) to justify the arm's length nature of its transactions. The TPO rejected most of the comparables chosen by the assessee and included two new companies, leading to a higher average OP/TC margin of 27.11%, resulting in the disputed addition.

2. Inclusion/Exclusion of Comparable Companies:
The assessee contested the inclusion/exclusion of certain companies in/from the final list of comparables. The Tribunal examined the functional profile of the assessee and the comparables in detail:

- Infosys Technologies Ltd.: Excluded due to its giant size, brand-related profits, and different risk profile, following the precedent set by the Delhi High Court in CIT vs. Agnity India Technologies (P) Ltd.

- Bodhtree Consulting Ltd.: Excluded due to its revenue recognition model leading to distorted profit margins, making it incomparable.

- Tutis Technologies Ltd.: Included as the TPO initially found it suitable, but inadvertently omitted it from the final list.

- Goldstone Technologies Ltd.: Excluded due to functional dissimilarity and failing the export turnover filter.

- VJIL Consulting Ltd., Think e-global Services Ltd., and RS Software (India) Ltd.: The Tribunal directed the AO/TPO to determine their comparability afresh.

3. Risk Adjustment in Transfer Pricing:
The assessee's claim for risk adjustment was denied due to insufficient evidence. The Tribunal noted that risk adjustment depends on demonstrating that the comparables bore relatively more risk than the assessee. The assessee, being a captive unit, did not convincingly prove that it was a no-risk entity. The Tribunal emphasized that risks associated with dealing with a single customer and dependency on the AE for business were significant. Therefore, no risk adjustment was granted.

4. Arm's Length Price (ALP) of Purchase of Capital Goods:
The assessee reported an international transaction of 'Purchase of fixed assets' with a transacted value of Rs. 33,50,51,611/-. The TPO determined the ALP at Nil due to the assessee's failure to provide comparable instances. The Tribunal held that the ALP should be determined using the Comparable Uncontrolled Price (CUP) method, but both the assessee and the TPO failed in their responsibilities. The Tribunal clarified that the difference between the transacted value and the ALP does not directly lead to an adjustment; instead, it affects the depreciation allowance. The Tribunal found that in the assessee's cost-plus model, depreciation and the resultant revenue are closely linked transactions. Therefore, the determination of ALP for the purchase of fixed assets was deemed tax neutral, and the addition made by disallowing or reducing the depreciation was deleted.

Conclusion:
The appeal was partly allowed. The Tribunal directed the AO/TPO to recompute the ALP of the 'Provision of software development services' segment and reconsider the comparability of certain companies. The addition on account of purchase of fixed assets was deleted due to the tax-neutral nature of the transaction.