2013 (1) TMI 45 - AT - Income Tax

Upward Transfer Pricing Adjustment Upheld Under Rule 10B Using Current Year Data, Safe Harbour Margin Disallowed

The ITAT Bangalore upheld the TPO's upward transfer pricing adjustment against the Indian assessee providing call centre services to its AE in the USA. ... International transactions entered with A.Es (USA) - assessee an Indian Company providing call centre services exclusively to A.E.- case referred to TPO - upward Transfer Pricing adjustment - Applicability of Multiple Year Data - Held that:- The use of the word 'shall' in the main provision of the Rule makes it abundantly clear that the use of data of the current financial year (i.e. of the financial year in which the international transaction was actually entered into) is a mandatory requirement of law in the comparability analysis to be undertaken as as per Indian T.P. Regulations - thus the TPO rightly rejected the use of earlier year's data by the assessee, as the assessee failed to establish before the TPO, CIT (Appeals) or the Tribunal how such earlier year's data had an influence on the prices of the current financial years. Use of data by the TPO after the cut off date - Held that:- Rule 10B(4) provides that the information and documents as specified under Rule 10B(1) and 10B(2) should as far as possible be contemporaneous and should exist latest by the 'specified date' referred to in section 92F(4) which has the same meaning as 'due date' in Explanation 2 to section 139(1). In the assessee's case, this would be '30th day of September' as it is a company. It is clear, that the Act has not provided for any cutoff date up to which only the information in the public domain has to be taken into consideration by the TPO while arriving at the ALP - no infirmity in the action of the TPO in using contemporaneous data at the time of transfer pricing audit, though the same may not have been available to the assessee at the time of preparation of statutory transfer pricing study/documentation. Safe Harbour - sought the benefit of +/- 5% - Held that:- The new section 92C(2A) mandates that if the arithmetical mean price falls beyond + / - 5% from the price charged in the international transactions, then the assessee does not have any option referred to in section 92C(2). Thus the + / - 5% variation is allowed only to justify the price charged in the international transactions and not for adjustment purposes accordingly the 5% benefit is not allowable in the assessee's case. Rejection of T.P. Study - Held that:- The use of current year data is mandated by the relevant IT Rules, 1962 and by not adhering thereto, the assessee has rendered into T.P. Study unreliable. In this view of the matter, the opinion that the TPO was right in rejecting the T.P. Study submitted by the assessee. Related Party Transactions - Held that:- Respectfully following the decision in the case of Sony India (P) Ltd. v. Dy. CIT [2008 (9) TMI 420 - ITAT DELHI-H], AO/TPO are directed to exclude after due verification those comparables from the list with related party transactions or controlled transactions in excess of 15% of total revenues for the financial year 2003-04. Economies of Scale - Held that:- As decided in Genisys Integrating Systems (India) (P.) Ltd. [2011 (8) TMI 952 - ITAT BANGALORE] only companies within the turnover range of ₹ 1 Crore to ₹ 200 Crores should be taken into consideration for the T.P. Study. The cited case squarely applies to the assessee's case as the turnover of the assessee being approximately ₹ 66 Crores falls within the range of ₹ 1 Crore to ₹ 200 Crores. Direct the AO/TPO to consider only those companies having a turnover of ₹ 1 Crore to ₹ 200 Crores as comparables. Comparable Companies Owning Intangiables - Held that:- It is a well accepted principle that only those companies which are on similar standards need to be considered for comparability. Therefore, companies which possess their own unique software intangibles cannot be compared with the assessee, as the former would derive significant advantage from unique software compared with the assessee, which is performing call centre services for it's A.E. in the USA. Parent Company Losses - Held that:- As per a plain reading of the language of the provisions of section 92 it is clear that the income arising from an international transaction shall be computed having regard to the arms length price. Similar transactions carried on between unrelated parties were to be seen to come to a conclusion whether the profits earned by the assessee is justified. Thus, the arguments that the profits earned by the assessee is justified because the parent company is under losses is against the principle of arms length price. To sum up, the assessee's arguments that it has not shifted profits outside India based on the loss incurred by the parent company is not acceptable. the assessee mainly states that the T.P. regulations being anti avoidance legislation, the TPO has to prove that tax avoidances had in fact taken place before making any T.P. adjustment - Held that: - As decided in case of Aztec Software Technology Services Ltd v. Asstt. CIT [2007 (7) TMI 50 - ITAT BANGALORE] that it is not necessary to prove that profits are shifted out of India for making a transfer pricing adjustment. Thus it is not necessary for the TPO to demonstrate tax avoidance and diversion of tax/income before invoking the provisions of section 92C and 92CA of the Act. Individual Companies for Comparability - Vishal Information Technologies Ltd. (VIT) - Held that:- An in the case of this comparable the Mumbai Tribunal in the case of Asstt. CIT v. Maersk Global Service Center (India) (P.) Ltd. [2011 (11) TMI 465 - ITAT MUMBAI] has held that since Vishal Information Technologies Ltd is outsourcing most of its work it has to be excluded from the list whereas the assessee in the cited case was carrying out the work by itself. In the instant case of the assessee also the assessee was carrying out its work by itself exclusion of Vishal Information Technologies Ltd. from the list of comparables warranted. Wipro BPO Ltd. - Held that:- the turnover/Revenue of Wipro BPO Ltd. in the period relevant to Assessment Year 2004-05 is ₹ 322 Crores. Further, this company having the influence of 'Wipro' brand may be seen as having its unique intangibles. Tricom India Ltd. & Fortune Infotech Ltd. - Held that: - Has registered an abnormal growth of 33% increase in PAT in the relevant period due to the fact that it has developed its unique software to provide BPO services to its customers. Spanco Telesystems & Solutions Ltd. - Held that:- this company has a clearly demarcated call centre segment and segmental results are available in the audited financial statements of the company and therefore see no reason why this company should not be considered as a comparable - grounds seeking its exclusion is rejected. M/s. Ultra Marine Pigments Ltd. - Held that:- The assessee has not been able to demonstrate with any evidence to support that the profit of the comparable company was abnormally high. It must not be overlooked that high profits reflect better business sense and practices also - grounds seeking its exclusion is rejected. Apollo Health Street Ltd. - Held that:- Perusal of its annual report for F.Y. 2003-04 though it does not appear to have any related party transactions, it is seen that out of its total revenues of ₹ 12.2 Crores, only ₹ 6.50 Crores i.e. about 54% of its revenue was received from ITES. This shows that significant Revenue earning of about 46% is not from IT enabled services which will render it functionally different and not comparable. MCS Ltd & Tata Share Registry - Held that:- The assessee caters to the export market, whereas these two companies cater to the domestic market - rejection warranted. Depreciation adjustment - Additional ground of appeal - Held that:- Mere claim for an adjustment will serve no purpose unless it is backed by proper details - remit the issue to the file of the AO/TPO to consider it. 1. ISSUES PRESENTED and CONSIDERED 1.1 Whether the adjustments made by the Transfer Pricing Officer (TPO) and upheld by the Commissioner of Income Tax (Appeals) (CIT(A)) to the arm's length margin in respect of call centre services rendered to the Associated Enterprise (AE) are justified. 1.2 Whether the comparable companies selected by the TPO, which include entities with related party transactions exceeding prescribed thresholds, economies of scale, and ownership of intangibles, are appropriate comparables. 1.3 Whether the assessee's use of non-contemporaneous data and multiple year data for benchmarking is permissible under the Transfer Pricing Regulations. 1.4 Whether the benefit of safe harbour provisions (+/- 5% variation) under the proviso to section 92C(2) of the Income Tax Act, 1961, is applicable to the assessee. 1.5 Whether the loss incurred by the parent company impacts the arm's length price determination for the assessee. 1.6 Whether the Transfer Pricing Study (TPS) submitted by the assessee is reliable and acceptable. 1.7 Whether the depreciation adjustment sought by the assessee as an additional ground should be admitted and allowed for comparability purposes. 1.8 Whether individual comparable companies selected or rejected by the TPO are correctly included or excluded based on functional comparability, related party transactions, export orientation, and other relevant criteria. 2. ISSUE-WISE DETAILED ANALYSIS 2.1 Adjustments to Arm's Length Margin - Legal Framework: Transfer Pricing provisions under sections 92C and 92CA of the Income Tax Act, 1961; Rule 10B of the Income Tax Rules, 1962. - Court Reasoning: The assessee initially challenged the CIT(A)'s upholding of the TPO's upward adjustment to the arm's length margin on call centre services. However, the ground challenging rejection of non-contemporaneous data was not pressed and dismissed as infructuous. - Conclusion: The adjustment to the arm's length margin as upheld by the CIT(A) stands, except for issues related to specific comparables discussed separately. 2.2 Use of Non-Contemporaneous and Multiple Year Data - Legal Framework: Rule 10B(4) mandates use of data relating to the financial year in which the international transaction occurred; data not more than two years prior may be considered only if it influences transfer price determination. - Court Reasoning: The mandatory use of contemporaneous data is emphasized. Non-availability of current year data in public databases does not excuse the assessee from this requirement. The TPO is empowered and duty-bound to use contemporaneous data, even if unavailable to the assessee at the time of TPS preparation. - Competing Arguments: Assessee argued for acceptance of earlier years' data and multiple year averaging due to non-availability of current year data. These grounds were not pressed or rejected. - Conclusion: Use of non-contemporaneous and multiple year data by the assessee is not permissible; the TPO's rejection of such data is upheld. 2.3 Use of Data Beyond Specified Cut-Off Date - Legal Framework: Section 92D and Rule 10B(4) require contemporaneous documentation by the specified date (due date of filing return). - Court Reasoning: No statutory cutoff limits the TPO to data available by the specified date for ALP determination. The TPO may use contemporaneous data available at the time of audit. - Conclusion: The TPO's use of contemporaneous data beyond the assessee's documentation date is valid. 2.4 Safe Harbour Provisions - Legal Framework: Proviso to section 92C(2) prior to amendment allowed ALP to vary by +/- 5% of the arithmetical mean; section 92C(2A) (introduced retrospectively) restricts this option if variation exceeds 5%. - Court Reasoning: The retrospective amendment disallows the assessee's option to accept a price within +/- 5% variation if the actual price differs by more than 5%. Judicial decisions cited by the assessee predate this amendment and are not applicable. - Conclusion: The assessee is not entitled to safe harbour benefit of +/- 5%; ground dismissed. 2.5 Reliability and Rejection of Transfer Pricing Study (TPS) - Legal Framework: Transfer Pricing documentation requirements under section 92D and Rules 10B and 10D; comparability analysis principles. - Court Reasoning: The TPO rejected the assessee's TPS due to use of non-contemporaneous data, inadequate search of comparables, and inclusion of domestic sector companies instead of export-oriented ones. The Court upheld the TPO's rejection as the assessee failed to comply with mandatory requirements. - Conclusion: TPS submitted by the assessee is unreliable and rightly rejected. 2.6 Selection and Exclusion of Comparable Companies - Related Party Transactions: -- Legal Framework: No explicit threshold in Transfer Pricing Regulations; however, transactions exceeding 15% of total revenue are considered significant to distort comparability. -- Court Reasoning: Following precedent, companies with related party transactions exceeding 15% of revenue are to be excluded from comparables. -- Conclusion: TPO/Assessing Officer directed to exclude comparables exceeding 15% related party transactions. - Economies of Scale and Turnover Range: -- Legal Framework: OECD Guidelines and Tribunal precedents recognize size as a key comparability factor. -- Court Reasoning: Only companies with turnover between Rs. 1 Crore to Rs. 200 Crores are appropriate comparables for the assessee (turnover approx. Rs. 66 Crores). Wipro BPO Ltd. with turnover Rs. 322 Crores is excluded. -- Conclusion: Companies outside the turnover range to be excluded. - Ownership of Intangibles: -- Legal Framework: Comparables must be functionally similar; ownership of unique intangibles confers competitive advantage affecting profitability. -- Court Reasoning: Companies owning unique software intangibles (e.g., Tricom India Ltd., Fortune Infotech Ltd.) derive advantages not possessed by the assessee and must be excluded. -- Conclusion: Comparables with unique intangibles excluded. - Individual Comparable Companies: -- Vishal Information Technologies Ltd. excluded due to outsourcing significant work, making it functionally dissimilar. -- Spanco Telesystems & Solutions Ltd. retained as comparable due to clear call centre segment and related party transactions below 15% threshold. -- Ultramarine Pigments Ltd. retained despite high profit margin, as Indian TP Rules require inclusion of all companies in arithmetic mean method; no specific evidence of abnormality. -- Ace Software Ltd. excluded as it is an Associated Enterprise (100% services to single AE). -- Apollo Health Street Ltd. to be verified for related party transactions and functional comparability due to mixed revenue sources. -- MCS Ltd. and Tata Share Registry excluded due to functional dissimilarity and domestic market orientation failing export filter. -- Allsec Technologies Ltd. accepted as comparable; however, TPO to reconsider adjustments to abnormal expenses (connectivity and database costs) based on assessee's submissions. 2.7 Parent Company Losses and Impact on ALP - Legal Framework: Section 92 mandates ALP determination based on comparable uncontrolled transactions; parent company profitability irrelevant. - Court Reasoning: Profit or loss of the parent company is irrelevant to ALP determination for the assessee. The focus is on the tested party's transactions at arm's length, independent of group results. Precedents confirm no need to prove profit shifting or tax avoidance to make TP adjustments. - Conclusion: Parent company losses do not justify deviation from ALP; ground rejected. 2.8 Depreciation Adjustment (Additional Ground) - Legal Framework: Adjustments for differences in accounting treatment affecting comparability are permissible if justified by operational facts. - Court Reasoning: The assessee raised this ground belatedly without prior notice to authorities below and without detailed evidence explaining the difference in depreciation percentages or operational reasons. The difference in depreciation as a percentage of gross block alone is insufficient to justify adjustment. The issue involves both fact and principle. - Court Direction: The additional ground is admitted but remitted to the Assessing Officer/TPO for examination and decision after affording opportunity to the assessee, considering operational reasons, accounting methods, and impact on comparability. - Conclusion: Depreciation adjustment issue remitted for fresh consideration; no immediate relief granted.