2020 (9) TMI 325 - AT - Income Tax

TP Adjustment - 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 - As decided in own case 2018 (4) TMI 636 - ITAT HYDERABAD 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) 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 for statistical purposes.

Summary

Issues Involved:
1. Characterization of the assessee's distribution activity as an international transaction.
2. Applicability of Transfer Pricing (TP) provisions and determination of Arm's Length Price (ALP).
3. Application of Section 92(3) of the Income Tax Act, 1961.

Issue-wise Detailed Analysis:

1. Characterization of the assessee's distribution activity as an international transaction:

The assessee, engaged in software development services, software support services, and distribution of products, did not report its distribution activity as an international transaction. The Transfer Pricing Officer (TPO) held that the assessee was rendering services to its Associate Enterprise (AE) and computed the ALP, proposing an adjustment. The assessee argued that the distribution activity was not an international transaction as the products were supplied free of cost by the AE. The Tribunal, referring to a similar case from the previous year, held that the activity was indeed a distribution activity and not a service agreement.

2. Applicability of Transfer Pricing (TP) provisions and determination of Arm's Length Price (ALP):

The TPO re-characterized the distribution activity as a service agreement, requiring a markup on operational costs. The assessee contended that the agreement with the AE specified that no payment was required if the operating costs exceeded revenue. The Tribunal noted that the assessee had not made any payment to the AE and that the TPO could not re-characterize the transaction. The Tribunal directed the TPO to conduct a fresh TP analysis, treating the transaction as a distribution agreement and determining the most appropriate method, allowing necessary adjustments.

3. Application of Section 92(3) of the Income Tax Act, 1961:

The assessee argued that if the TP analysis increased the loss, no TP adjustment could be made under Section 92(3), which states that TP provisions do not apply if they reduce taxable income or increase loss. The Tribunal agreed, referencing the Delhi High Court's ruling in the case of Sony Ericson Mobile Communications India (P) Ltd., and held that the TP analysis should not reduce the income chargeable to tax or increase the loss. The Tribunal directed the AO/TPO to conduct a fresh TP analysis and apply Section 92(3) if the loss increased.

Conclusion:

The Tribunal allowed the assessee’s appeal for statistical purposes, directing the AO/TPO to conduct a fresh TP analysis by treating the transaction as a distribution agreement and determining the most appropriate method. If the TP study increased the loss, no TP adjustment could be made as per Section 92(3) of the Act. The decision was based on the precedent set by the Coordinate Bench in the previous year and the Delhi High Court's interpretation of Section 92(3).