Transfer Pricing Dispute: Assessments, Comparables, & Characterization Upheld

ST Microelectronics P. Ltd. Versus Commissioner of Income-tax (Appeals) and Addl. CIT Range-9, New Delhi & DCIT, Cir. 9 (1) Versus ST Microelectronics P. Ltd.

ST Microelectronics P. Ltd. Versus Commissioner of Income-tax (Appeals) and Addl. CIT Range-9, New Delhi & DCIT, Cir. 9 (1) Versus ST Microelectronics P. ... Issues Involved:
1. Adjustment recommended by the TPO in the arms length price of international transactions.
2. Use of current year data versus multiple year data for selecting comparables.
3. Characterization of the assessee's business as high-end service provider.
4. Rejection of the search methodology and comparables selected by the assessee.
5. Selection of comparable companies for benchmarking analysis.
6. Application of the proviso to section 92C regarding the tolerance band of +/-5%.
7. Treatment of software expenses as capital or revenue expenditure.
8. Treatment of charges paid to NOIDA Development Authority as capital expenditure.

Detailed Analysis:

1. Adjustment recommended by the TPO in the arms length price of international transactions:
The assessee disclosed international transactions with its associate enterprises for the assessment years 2003-04, 2004-05, and 2006-07. The TPO recommended adjustments based on comparables, leading to disputes between the assessee and the revenue. The TPO used the Transactional Net Margin Method (TNMM) and computed the Profit Level Indicator (PLI) using operating profit divided by operating cost. The TPO's adjustments were based on the average operating profit on total cost ratio, which was higher than what the assessee reported. The CIT(A) marginally reduced the percentages recommended by the TPO, leading to cross-appeals by both parties.

2. Use of current year data versus multiple year data for selecting comparables:
The assessee used multiple year data for selecting comparables, while the TPO insisted on using current year data, as mandated by Rule 10B(4) of the Income Tax Rules. The CIT(A) and DRP upheld the TPO's view that current year data should be used, as the rule specifies that data relating to the financial year in which the international transaction occurred should be used unless it reveals facts influencing the determination of transfer prices.

3. Characterization of the assessee's business as high-end service provider:
The TPO characterized the assessee as a high-end service provider, performing high-value functions in the software development life cycle. The assessee contended that it was a low-end, risk-free captive service provider. The CIT(A) and the tribunal upheld the TPO's characterization, noting the complex nature of the products and services provided by the assessee, the skilled workforce employed, and the significant role played by the assessee in the value chain of the software industry.

4. Rejection of the search methodology and comparables selected by the assessee:
The TPO rejected the search methodology and comparables selected by the assessee, citing defects such as the use of multiple year data, improper characterization of the assessee's business, and inappropriate filters. The tribunal upheld the TPO's rejection, noting that the TPO had provided specific reasons for rejecting the assessee's comparables and had conducted a fresh search for suitable comparables.

5. Selection of comparable companies for benchmarking analysis:
The TPO selected comparables based on specific filters, including related party transactions and employee cost to total cost ratios. The CIT(A) modified some of these filters and identified a smaller set of comparables. The tribunal upheld the CIT(A)'s approach, noting that the selection of comparables should be based on a judicious and reasonable basis, considering the functions performed, assets employed, and risks assumed by the assessee.

6. Application of the proviso to section 92C regarding the tolerance band of +/-5%:
The assessee contended that the arithmetic mean of the comparable prices should be reduced by 5% for determining the ALP. The CIT(A) and the tribunal rejected this contention, clarifying that the tolerance band is not a standard deduction but a range within which no TP adjustment is required if the transfer price falls within this band.

7. Treatment of software expenses as capital or revenue expenditure:
The assessee claimed software expenses as revenue expenditure, arguing that the expenses were for acquiring licenses to use software for a limited period. The DRP upheld the AO's treatment of these expenses as capital expenditure. The tribunal, following the ITAT's decision in the case of AM WAY India Enterprises, held that the expenses should be treated as revenue expenditure, as the licenses did not provide enduring benefits and the ownership of the software remained with the vendor.

8. Treatment of charges paid to NOIDA Development Authority as capital expenditure:
The assessee paid charges to NOIDA Development Authority for changing the name of the owner in the revenue records. The DRP and AO treated these charges as capital expenditure. The tribunal set aside the orders of the DRP and AO, directing the AO to ascertain the exact nature of the charges and then decide whether they should be included in the cost of land for capital gains purposes.