2016 (10) TMI 1135 - AT - Income Tax

Tribunal voids reassessment proceedings, allows assessee's appeal for 2009-10. Adjustments made to software services pricing.

The Tribunal held that the reassessment proceedings initiated based on the Transfer Pricing Officer's order were void ab initio and bad in law. The ... Illegality of reference to Transfer Pricing Officer when no scrutiny assessment is pending - Use of a TPO order obtained from an invalid reference as a basis for reopening under section 147 - Validity of reassessment initiated on the basis of TPO s order - Comparability analysis in transfer pricing and acceptability/exclusion of comparables - Determination of arm s length price for royalty payments and the benefit test - Application of CBDT Circular No. 21/2015 on low tax effect appealsIllegality of reference to Transfer Pricing Officer when no scrutiny assessment is pending - Use of a TPO order obtained from an invalid reference as a basis for reopening under section 147 - Validity of reassessment initiated on the basis of TPO s order - Whether reassessment proceedings (AY 2009-10) initiated and framed on the basis of a TPO order passed pursuant to a reference made when no scrutiny assessment was pending were valid. - HELD THAT: - The Tribunal examined the statutory scheme for references to the Transfer Pricing Officer and the binding CBDT Instruction (No.3/2003) which contemplates reference to the TPO only when the case is selected for scrutiny. Following the coordinate-bench decision in Bucyrus India Pvt. Ltd. and relevant High Court authority, the Tribunal held that where no valid scrutiny proceedings were pending at the time of reference, the reference to the TPO was illegal. An order passed by the TPO pursuant to such an invalid reference is a nullity and cannot be used as material to form the belief under section 147 that income has escaped assessment. The AO s use of the earlier TPO order (made from an illegal reference) to reopen the assessment and make additions was therefore held to be unsustainable. Once the primary addition based on that TPO order is struck down, the foundation of the reassessment proceedings falls away and the entire reassessment was quashed. The Tribunal declined to adjudicate other grounds as infructuous in view of this conclusion. [Paras 2]Reassessment for AY 2009-10 initiated and concluded on the basis of the TPO s order made pursuant to an invalid reference is void ab initio; the reassessment order is quashed and the addition based on that TPO order is deleted.Application of CBDT Circular No. 21/2015 on low tax effect appeals - Whether the revenue s appeal (AY 2010-11) was maintainable in view of CBDT Circular No.21/2015 lowering monetary limits for filing appeals before the Tribunal. - HELD THAT: - The Tribunal considered the tax effect computations placed on record and the CBDT Circular No.21/2015 which prescribes monetary thresholds for filing appeals (including before the Tribunal). The revenue conceded, and the material established, that the tax effect fell below the threshold applicable before the Tribunal. The Circular was held binding on the tax authorities and to apply retrospectively to pending appeals. No exception to the Circular was shown to apply. Accordingly, the appeal was treated as a low tax effect case and dismissed in limine as unadmitted without adjudication on merits. [Paras 3]Revenue s appeal for AY 2010-11 dismissed in limine as a low tax effect case under CBDT Circular No.21/2015.Comparability analysis in transfer pricing and acceptability/exclusion of comparables - Determination of arm s length price for royalty payments and the benefit test - Whether (for AY 2010-11) certain comparables selected by the TPO should be excluded and one comparable of the assessee included, and whether the TPO s determination of ALP of royalty at Nil was correct. - HELD THAT: - On the comparables challenge, the Tribunal examined the functional profiles and contemporaneous disclosures (including annual reports and segmental information) of the disputed comparables. It found force in the assessee s contentions that (i) E-Infochips Bangalore Ltd was engaged in both software and ITES with no reliable segmental break-up and had been treated as non-comparable by coordinate benches, (ii) Infinite Data Systems Pvt Ltd (merged) operated under a distinct BOT/contractual business model with abnormal margins and extraordinary events making it functionally distinct, and (iii) Spry Resources India Pvt Ltd was engaged in software consultancy rather than the assessee s development activities; accordingly these three comparables were directed to be excluded. The Tribunal also directed inclusion of Akshay Software Technologies Ltd as a comparable, on review of its annual report and precedents. The matter was remitted to the TPO/AO to rework the comparable set (excluding the three and including Akshay) and determine the ALP in accordance with law. On the royalty issue, the Tribunal applied the benefit test and relevant authorities to hold that the assessee had demonstrated commercial benefit from the royalty arrangement (including benchmarking showing a mean royalty rate in the comparables and the assessee s payment of 40%). The TPO s conclusion of ALP at Nil was rejected and the royalty payment was held to be at arm s length; deduction for the royalty was directed to be allowed. Consequent issues rendered academic were not decided. [Paras 8, 9, 11]Directed the TPO/AO to exclude E-Infochips Bangalore Ltd, Infinite Data Systems Pvt Ltd (merged) and Spry Resources India Pvt Ltd from the comparable set, include Akshay Software Technologies Ltd, and re-determine the ALP for software development transactions; held that the royalty payment at 40% is at arm s length and the TPO s finding of ALP at Nil is rejected.Final Conclusion: The assessee s appeal for AY 2009-10 is allowed by quashing the reassessment initiated on the basis of a TPO order obtained from an invalid reference. The revenue s appeal for AY 2010-11 is dismissed as a low tax effect case under CBDT Circular No.21/2015. The assessee s appeal for AY 2010-11 is partly allowed: the Tribunal directed exclusion of three TPO comparables, inclusion of one assessee comparable and remitted the matter for redetermination of ALP accordingly, and held the royalty payment at 40% to be at arm s length. Issues Involved:1. Validity of reassessment proceedings.2. Adjustment to Arm's Length Price (ALP) for software development services.3. Disallowance of royalty payments.4. Inclusion and exclusion of comparables for Transfer Pricing analysis.5. Low tax effect on the revenue's appeal.Detailed Analysis:1. Validity of Reassessment Proceedings:The primary issue was whether the reassessment proceedings were validly initiated. The assessee filed its return of income on 29.09.2009 and received an intimation under section 143(1) on 13.10.2010. No notice under section 143(2) was issued for scrutiny, but the Assessing Officer (AO) made a reference to the Transfer Pricing Officer (TPO) for determining the ALP, which resulted in an adjustment of Rs. 2,43,53,752. The AO reopened the assessment by issuing a notice under section 148 to give effect to the TPO's order. The reassessment was completed by making the same addition towards ALP and a disallowance under section 40(a)(ia) of Rs. 27,575. The Dispute Resolution Panel (DRP) stated that the assessee was not an eligible assessee under section 144C(15)(b), and the jurisdiction of the DRP could not be invoked. The Tribunal held that the reassessment proceedings initiated based on the TPO's order were void ab initio and bad in law, as no valid assessment proceedings were pending when the reference to the TPO was made. The reassessment proceedings were quashed, and the appeal of the assessee for the Asst Year 2009-10 was allowed.2. Adjustment to ALP for Software Development Services:The assessee used the Transactional Net Margin Method (TNMM) with a Profit Level Indicator (PLI) of Net Cost Plus Margin (NCP) and selected 15 comparables with an average NCP margin of 14.79%. The TPO revised the NCP margin to 30.94% and selected 9 comparables with an average NCP margin of 40.34%, resulting in a TP adjustment of Rs. 1,57,27,755. The DRP allowed adjustments for working capital and recalculated the ALP at 39.25%, making an upward adjustment of Rs. 74,92,375. The Tribunal directed the exclusion of three comparables (E-Infochips Bangalore Ltd, Infinite Data Systems Pvt Ltd, and Spry Resources India Pvt Ltd) and the inclusion of one comparable (Akshay Software Technologies Ltd). The Tribunal instructed the TPO to redetermine the ALP and decide on any necessary adjustments.3. Disallowance of Royalty Payments:The assessee paid royalty of Rs. 72,84,012 to its AE for license sales and maintenance revenue from third-party customers. The TPO determined the ALP for royalty at Rs.Nil, which the Tribunal found erroneous. The Tribunal held that the payment of royalty was integral to the assessee's operations and justified by increased revenues and profitability. The Tribunal relied on the decisions of the Delhi High Court in CIT vs EKL Appliances Ltd and CIT vs Cushman and Wakefield (India) (P) Ltd, which held that the TPO cannot determine the ALP of payments at Nil without considering the benefits derived by the assessee. The Tribunal directed the TPO to allow the deduction for royalty payment, stating that the royalty rate of 40% was at arm's length.4. Inclusion and Exclusion of Comparables:The Tribunal addressed the inclusion and exclusion of certain comparables for Transfer Pricing analysis:- Exclusion of E-Infochips Bangalore Ltd: The Tribunal found that this company was engaged in both IT and IT-enabled services without segmental income break-up, making it functionally not comparable.- Exclusion of Infinite Data Systems Pvt Ltd: The Tribunal noted that this company had a different business model and provided services primarily to a single customer under a Build, Operate, and Transfer (BOT) model, leading to abnormal profit margins.- Exclusion of Spry Resources India Pvt Ltd: The Tribunal found that this company was engaged in software consultancy services, not similar to the assessee's software development services.- Inclusion of Akshay Software Technologies Ltd: The Tribunal found that this company was engaged in software development activities, making it functionally comparable to the assessee.5. Low Tax Effect on Revenue's Appeal:The revenue's appeal for the Asst Year 2010-11 was dismissed due to low tax effect, as the disputed addition was less than Rs. 10 lakhs. The Tribunal relied on CBDT Circular No. 21/2015, which states that appeals should not be filed where the tax effect does not exceed the specified monetary limits.Conclusion:- The appeal of the assessee for the Asst Year 2009-10 was allowed.- The appeal of the assessee for the Asst Year 2010-11 was partly allowed for statistical purposes.- The appeal of the revenue for the Asst Year 2010-11 was dismissed due to low tax effect.Order Pronounced:The order was pronounced in the open court on 19.10.2016.