2018 (4) TMI 636 - AT - Income Tax

TPA - determination of the ALP of the international transactions - computation of mark up - Re-characterizing the Distribution activities of Appellant to a Service Provider - Held that - In the case before us, there is no difference between the form and substance of the transaction of distribution to recharacterise the transaction as a service agreement. As per the agreement, the AE is entitled to a specified percentage of the distributor s sales revenue less operating costs/expenses of the distributor. Since the assessee had no revenue left after reducing the operating cost/expenses, the AE was not paid any percentage. The revenue generated by selling the goods is retained by the assessee. The TPO has instead computed the mark up on the operating cost of the assessee to determine the ALP and brought the notional income to tax which is not justified. Therefore, the additional grounds of appeal are allowed. As regards the applicability of the provisions of section 92(3) is the contention of the assessee that if the transaction is taken as distribution as agreed to between the parties, then the TP analysis would go to increase the loss. If the provisions of section 92(3) would apply, then the provisions of sub-sections (1) and (2A) of section 92 would not be attracted. Since, we have already held that the transaction is a distribution transaction and not service agreement, then the TP analysis has to be done afresh and then it has to be seen if the provisions of section 92(3) would apply. Additional grounds of appeal raised by the assessee are allowed and AO/TPO is directed to conduct fresh TP analysis by treating the assessee s transaction as a distribution agreement and by determining the most appropriate method afresh and after allowing the necessary adjustments. If the loss declared by the assessee is increased by such TP study, then no TP adjustment can be made as provided in section 92(3) of the Act. - Decided partly in favour of assessee

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) for international transactions.
2. Applicability of Transfer Pricing regulations to distribution activities.
3. Selection of comparables and appropriate method for ALP determination.
4. Use of multiple year data.
5. Adjustments for differences in risks and working capital.
6. Levy of interest and penalties under various sections.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for International Transactions:
The assessee, engaged in software development and distribution of products, reported a loss and had international transactions with its Associated Enterprises (AE). The Transfer Pricing Officer (TPO) accepted the ALP for software development and maintenance services but questioned the distribution activity where products were supplied free of cost. The TPO proposed an adjustment based on comparables, leading to an ALP adjustment of ?1,54,47,842, which was upheld by the Dispute Resolution Panel (DRP).

2. Applicability of Transfer Pricing Regulations to Distribution Activities:
The assessee argued that the Transfer Pricing regulations should not apply as no payments were made to the AE for the software. The TPO recharacterized the distribution agreement as a service agreement requiring a markup. The Tribunal found that the distribution agreement explicitly stated that payments to the AE were only due if the assessee made a profit, and since no payment was made, the provisions of section 92 did not apply.

3. Selection of Comparables and Appropriate Method for ALP Determination:
The TPO rejected the assessee's comparables and selected four companies, leading to an average margin of 1.26% against the assessee’s -81.54%. The Tribunal held that the TPO could not recharacterize the transaction and should conduct a fresh TP analysis treating the transaction as a distribution agreement. The Tribunal instructed the TPO to determine the most appropriate method afresh and allow necessary adjustments.

4. Use of Multiple Year Data:
The TPO used data for FY 2010-11 only, rejecting the use of multiple-year data. The Tribunal did not specifically address this issue in the final decision but implied that a fresh TP analysis should consider all relevant data.

5. Adjustments for Differences in Risks and Working Capital:
The assessee argued for adjustments for functional, risk, and working capital differences as per rule 10B(1)(e). The Tribunal's directive for a fresh TP analysis implies that these adjustments should be considered in the new determination.

6. Levy of Interest and Penalties under Various Sections:
The assessee contested the imposition of interest under section 234D and penalties under sections 271(1)(C), 272BA, and 271AA. The Tribunal's decision to conduct a fresh TP analysis would affect these levies, depending on the new findings.

Conclusion:
The Tribunal allowed the additional grounds of appeal, directing a fresh TP analysis treating the transaction as a distribution agreement. It emphasized that if the TP analysis increased the loss, no TP adjustment could be made as per section 92(3). The original grounds of appeal were allowed for statistical purposes, and the assessee's appeal was partly allowed. The order was pronounced on 11th April, 2018.