2011 (2) TMI 50 - AT - Income Tax

Ruling clarifies TNMM comparables, Rule 10B(4) data use, section 10A turnover, denies 5% section 92C(2) cushion

ITAT upheld the CIT(A)'s rejection of additional comparables proposed by the assessee, agreeing that companies with related party transactions exceeding ... Adjustments made u/s 92CA - Arm's Length Price (ALP) of its international transactions with Associated Enterprises - data link charges - related party transactions or the companies were functionally different - Transactional Net Margin Method without making appropriate adjustments for difference in accounting policies and risks between the controlled transactions and comparable uncontrolled transactions in accordance with provisions of Rule 10B(1)(e) - HELD THAT:- We agree with the CIT(A) that there is no thumb rule for allowing such risk adjustment. The other contention of the assessee is with regard to the rejection of the comparable companies satisfying all the filters adopted by the TPO. On this issue, the CIT(A) clearly observed in his order that out of fourteen comparable companies selected by the assessee, only four companies were selected by the TPO. The assessee agreed with the TPO for rejection of eight companies, and the other companies available were only two companies. That is one Aztec Software and the other one is Quintegra Solutions Ltd. These companies were rejected by the TPO for the reason that it had substantial related party transactions, which work out to more than 25% of the total sales. Hence, the findings given by the CIT(A) in rejecting these two companies as not comparable, in our considered opinion, are in order. One other contention of the assessee relates to use of multiple year and contemporaneous data available by the prescribed data. As per Rule 10B(4), data to be used in analyzing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into, with the only exception being that data of earlier two years may also be considered, if such data reveals facts which could have an influence on the determination of the transfer prices in relation to the transactions being compared. In view of the above, the CIT(A) is right in holding that the data of the subsequent period cannot be considered for comparison. Accordingly, assessee's grounds on these aspects of the matter are rejected. Grievance of the assessee in its appeal is that the CIT(A) was not justified in confirming that the data link charges are completely attributable to the delivery of computer software outside India for the purpose of computation of deduction under section 10A of the Act. In the recent decision of the Special Bench (Chennai) of the Tribunal in the case of Sak Soft Ltd. [2009 (3) TMI 243 - ITAT MADRAS-D], it has been held that if data link charges are reduced from export turnover, then the same should also be reduced from total turnover. Respectfully following the said decision of the Special Bench of the Tribunal, we find no infirmity in the order of the CIT(A) on this issue. Entitlement to the adjustment of 5% as stipulated u/s 92C(1) - TNMM was applied to find out the ALP price - In our considered opinion, where the ALP has been determined by applying only one out of the several methods specified under section 92C(1) of the Act, the assessee is not entitled for deduction of 5% adjustment from the ALP as stipulated under section 92C(2) of the Act. In other words, section 92C(2) of the Act specifies that the adjustment of 5% is not applicable if a single price is determined by the assessee. Thus, we hold that the CIT(A) is not justified in allowing 5% adjustment in terms of section 92C (1) of the Act. We accordingly set aside the order of the CIT(A) on this aspect, allowing the ground raised by the Revenue. Both the appeals of the assessee as well as revenue are partly allowed. Issues Involved:1. Adjustments made under Section 92CA of the Income Tax Act.2. Rejection of certain comparable cases by the Transfer Pricing Officer (TPO).3. Use of multiple year data for determining Arm's Length Price (ALP).4. Working capital adjustments and risk adjustments.5. Data link charges and their impact on the computation of deduction under Section 10A.6. Entitlement to the 5% adjustment under Section 92C(2) of the Act.Detailed Analysis:1. Adjustments made under Section 92CA of the Income Tax Act:The main issue in these cross appeals pertains to adjustments made under Section 92CA. The assessee, engaged in software development services, received Rs. 39,04,34,858 from its Associated Enterprises (AEs) and determined the ALP using a transfer pricing study. The TPO rejected ten out of fourteen comparable cases due to substantial related party transactions or functional differences, accepting only four and computing an arithmetic mean of operating profit/cost at 17.66% against 10.56% shown by the assessee. This resulted in an addition of Rs. 2,50,56,927. The CIT(A) upheld the rejection of the ten comparables but allowed a 5% margin benefit under Section 92C(2), reducing the differential adjustment to Rs. 42,82,338.2. Rejection of certain comparable cases by the Transfer Pricing Officer (TPO):The TPO rejected ten out of fourteen comparable cases selected by the assessee, which was upheld by the CIT(A). The assessee agreed to the rejection of eight companies, disputing only Aztec Software & Technology Services Ltd. and Quintegra Solutions Ltd. The TPO rejected Aztec due to substantial related party transactions and Quintegra because its financial results were for a different fiscal year. The Tribunal found the CIT(A)'s rejection of these companies justified.3. Use of multiple year data for determining Arm's Length Price (ALP):The assessee argued for the use of multiple year data and contemporaneous data available by the due date of filing the return. However, the Tribunal upheld the CIT(A)'s decision, stating that under Rule 10B(4), data should relate to the financial year of the international transaction, with earlier data considered only if it influences the determination of transfer prices.4. Working capital adjustments and risk adjustments:The assessee contended that adjustments for working capital and risk differences were necessary. The Tribunal noted that the assessee did not quantify or identify these differences in its transfer pricing documentation and thus could not claim them at this stage. The CIT(A)'s decision to deny these adjustments was upheld, as risk adjustments depend on specific case facts and no thumb rule applies.5. Data link charges and their impact on the computation of deduction under Section 10A:The CIT(A) directed the exclusion of data link charges from total turnover, having excluded them from export turnover, based on the Tribunal's decision in the assessee's case for the previous year and the Special Bench decision in Sak Soft Ltd. The Tribunal upheld this view, rejecting the Revenue's contention that Sections 10A and 80HHC are independent and should not be merged.6. Entitlement to the 5% adjustment under Section 92C(2) of the Act:The Tribunal concluded that the assessee is not entitled to the 5% adjustment under Section 92C(2) when only one method (TNMM) is applied to determine the ALP. The Tribunal cited the Delhi Bench decision in Perot Systems TSI (India) Ltd. and noted that the CBDT Circular No.12/2001 does not apply as the price variation exceeds 5%. The CIT(A)'s allowance of the 5% adjustment was set aside.Conclusion:Both the appeals of the assessee and the Revenue were partly allowed. The Tribunal upheld the CIT(A)'s decisions on rejecting comparable cases, use of single-year data, and exclusion of data link charges from total turnover. However, it set aside the CIT(A)'s allowance of the 5% margin adjustment under Section 92C(2).