2013 (3) TMI 415 - AT - Income Tax

s.10A benefits remanded for factual verification; satellite charges included in export turnover; transfer pricing comparable limits clarified

ITAT MUMBAI held that the issue of consolidation of units for s.10A benefits required factual verification and remanded the matter to the AO to examine ... Deduction u/s 10A - Technical Fees and Satellite Link Charges from Export Turnover - non computation of deduction u/s 10A in accordance with the provisions of sub-section (4) of section 10A - Held that:- In the case of the assessee, the CIT(A) has pointed out a new aspect to the issue for the first time during the AY under consideration that the assessee has formed a consolidated unit by restructuring of two existing units. But this fact is not clear from the record whether this new development had occurred during the year under consideration or it was already in existence right from the first year of assessment. Since it is not clear whether the non-eligible unit at Andheri was still in existence or closed by the assessee to bring into existence the alleged consolidated unit as held by the CIT(A) therefore, this fact is required to be examined by considering inter alia the number of employees working in the two units when the new unit was established by the assessee at vikroli only after comparing the number of employees and machinery installed in both the units, it can be determined whether the two existing units were merged and consolidated to bring into existence a new unit and thereby a new unit has been set up by restructuring of the existing unit during the year under consideration - the matter is remanded to the records of the AO for examination, verification and then decide the issue as per law. Technical fee and satellite link charges excluded from export turnover - Held that:- After considering the facts of the case and the principles established by the Coordinate bench in the case of Patni Telecommunication (P) Ltd. v. ITO [2008 (1) TMI 452 - ITAT HYDERABAD-A], it is held that the expenses on satellite link charges does not come within the scope of 'telecommunication charges' as provided in clause (iv) of Explanation 2 to section 10A and accordingly, the A.O. is directed not to exclude the same from export turnover A.O. is directed to recalculate the deduction under section 10A -in favour of assessee. Selection of comparables – TP Adjustment - Assessee company was providing Information Technology Enabled Services (ITES) to overseas affiliates/Associated Enterprises aggrieved by transfer pricing adjustments made by TPO who had accepted 8 out of the 11 comparables of assessee & concluded that the number of comparables was insufficient thus conducted a fresh search and added 22 comparables to the list of 8 – Held that:- As per the provisions of section 92CA(3), the TPO has jurisdiction/power to gather and consider all relevant material and information apart from the evidence, information and documents produced by the assessee to determine the ALP in relation to the international transaction. TPO for the purpose of determining the ALP to exercise any of the powers specified in clause (a) to (d) of sub-section (1) of section 132 or sub-section (6) of section 133 or 133A. Thus, under the TP regulations, there is no limitation on the powers of the TPO in carrying out fresh search for gathering more relevant information, documents etc., while determining the ALP in relation to international transactions. TPO is not justified in carrying out fresh search and adding 22 more comparables cannot be accepted as there cannot be a fixed number of comparables to be considered as sufficient or appropriate number for determination of the ALP as a general parameter. There is no fixed criteria or parameter for number of comparables, which can be universally applied to each and every case for determination of the ALP. Thus there is no upper limit prescribed under section 92C of the IT Act. One of the comparables selected by TPO had undergone merger/dermerger - Held that:- If merger and de-merger or amalgamation took place during the financial year and because of that the company became functionally different then the said company should be excluded from the comparables. However, if the merger of the two functionally similar companies took place then the event of merger itself cannot be taken a factor for exclusion of the said comparable - Matter remanded to TPO to verify this aspect that whether the merger or demerger is between two functionally similar companies or not. Some of the comparables selected had more than 15% related party transactions – Held that:- The related party transaction ranging from 10 to 25% of the total revenue can be considered having regard to the facts and circumstances of the given cases, 10% is the lowest limit and can be taken in the case where abundance number of comparables are available. Therefore, when there is no difficulty in searching the comparables, then the entity having more than 10% of the related party transaction should be excluded because the comparable should be an uncontrolled transaction and therefore, so far as it is possible, its result should not be influenced by related party transaction. In the normal circumstances, where a good number of comparables are available, then the limit of related party transactions should be 15% of the total revenue. In a extreme case where only one or few comparables are available, then an entity having related party transactions not exceeding 25% of the total revenue can be considered so that the ALP should be determined having comparison broad based, though this extreme limit of 25% can be considered only in exceptional cases. Where the comparable is operating in two or more segments, the above tolerable percentages to be applied to transactions in relevant segment (assessee's segment-ITES segment in this case). TPO has found sufficient number of comparables and finally took 30 companies as comparables; therefore, this case does not fall under the category of exceptional cases where criteria of related party transactions can be relaxed more than 15% of the total revenue of the entity. Hence, when there is no shortage of comparables, an entity can be considered as uncontrolled, if the related party transaction do not exceed 15% of the total revenue. Having applied this criteria, the company Allsec Technologies Ltd having related party transactions constituting 17.77% of the total revenue would be excluded from the comparables on this ground alone. Some of the comparables selected by TPO had much higher turnover than assessee-company while some were loss-making/high profit-making companies – Held that:- The factors for determining inclusion or exclusion of any case in the list of comparables are specifically provided under Rule 10B(2). Thus unless and until there are specific reasons and factors as provided under the Rule 10B, an entity cannot be excluded or eliminated from the list of comparables solely on the basis of high profit making unit or loss making unit because no such factor finds place either in Rule 10B(2) or 10B(3) of IT Rule. One of the comparables selected by TPO was engaged in software services and IT consultancy not functionally similar to assessee-company – Held that:- As from the annual report of this comparable company it can be concluded that is engaged in the business of GIS activity. As per the notification no. SO 890(E), dated 26-9-2000 of CBDT, GIS is one of the ITES notified by the Board. Thus when GIS is notified ITES/product, then undisputedly, this comparable and the assessee both are engaged in the ITES services therefore, there is no substance or merit in the contention of the assessee that this company is functional different and cannot be considered as a comparable. Issues: (i) Whether the assessee is eligible for deduction under section 10A for AY 2007-08 and whether the method of apportionment/computation (head-count method) is permissible or requires reworking; (ii) Whether satellite link charges and technical fees must be excluded from export turnover for computing deduction under section 10A; (iii) Whether the transfer-pricing adjustment of Rs.7,52,20,419 made by the TPO (inclusion of additional comparables, benchmarking, and related adjustments including risk and working capital adjustments) is sustainable; (iv) Whether payments to Equant Network Services Ltd. are taxable as royalty/fees for technical services attracting section 40(a)(ia) disallowance.Issue (i): Eligibility for deduction under section 10A and correctness of apportionment/computation method.Analysis: The Tribunal noted prior findings in the assessee's own case for AY 2006-07 where the head-count method had been accepted and the AO had not examined apportionment of export turnover and common expenses. The Bench held that where a deduction/method has been consistently accepted in earlier years, it should not be disturbed mid-stream unless the earlier relief has been withdrawn or new facts arise. The CIT(A) raised a new factual aspect that a consolidated unit may have been formed by restructuring, but records did not make clear whether consolidation was a new development or pre-existing; factual verification (employees, machinery, books) is required.Conclusion: The Tribunal partly allowed the assessee's ground: it held that the claim of deduction under section 10A cannot be summarily rejected and remanded the matter to the AO for examination and quantification of eligible profit and verification whether consolidation/restructuring creating a new unit occurred. The AO is directed to examine apportionment and give the assessee opportunity to be heard.Issue (ii): Exclusion of satellite link charges and technical fees from export turnover for section 10A computation.Analysis: The Tribunal followed its earlier decisions and relevant authorities distinguishing telecommunication charges attributable to delivery on FOB basis and expenditures incurred for providing technical services outside India. Examining invoices and agreements, it found satellite link charges were fixed service charges for data processing and not telecommunication charges attributable to delivery of software outside India; technical fees were factually not for services provided outside India.Conclusion: Ground No.2 is allowed in favour of the assessee: the AO is directed not to exclude the satellite link charges and technical fees from export turnover for computing deduction under section 10A (subject to AO's recalculation as directed).Issue (iii): Legitimacy of transfer-pricing adjustments TPO's fresh search, inclusion/exclusion of comparables, benchmarking, and risk/working capital adjustments.Analysis: The Tribunal held that the TPO has statutory powers under section 92CA and related provisions to carry out fresh searches and gather relevant material; there is no fixed numeric minimum of comparables. The Bench examined objections to individual comparables, applied Rule 10B(2)/(3) tests and earlier precedents, and made specific determinations: several comparables were to be excluded (e.g., where related-party transactions exceed the adopted threshold in these facts), others required verification (e.g., alleged mergers, outsourcing, availability of segmental data or public domain information). The Tribunal observed that risk adjustments must be quantified with objective data and not made ad hoc; working capital adjustments and risk adjustments require factual/quantitative verification.Conclusion: The Tribunal did not wholly uphold or reverse the TPO's adjustment; it remanded multiple comparability issues and the risk/working capital quantifications to the AO/TPO for verification, reassessment and application of Rule 10B factors (i.e., directed re-examination of selected comparables, margins and adjustments). Overall transfer-pricing relief is not finally allowed; further adjudication on remitted points is required.Issue (iv): Characterisation of payments to Equant Network Services Ltd. as royalty/fees for technical services attracting section 40(a)(ia).Analysis: The Tribunal followed its earlier decision in the assessee's own case for AY 2006-07 which analysed the nature of satellite link charges and connectivity services, finding lack of possession, control or right to use equipment and reliance on AAR/precedents distinguishing such service charges from royalty/FTS.Conclusion: This ground is decided in favour of the assessee: the payments to Equant are not royalty or fees for technical services for the purpose of section 40(a)(ia); the related disallowance is deleted.Final Conclusion: The appeals are partly allowed: the Tribunal sustained the assessee's entitlement to make a section 10A claim in substance (requiring AO to examine apportionment and quantify eligible profit), directed that satellite link charges and technical fees not be excluded from export turnover, remanded multiple transfer-pricing comparability and adjustment issues (including risk and working capital) to the AO/TPO for factual verification and fresh computation, and held that Equant payments are not royalty/FTS. The result is a mixed outcome requiring further proceedings at assessment/TPO level.Ratio Decidendi: Where a tax benefit or method (e.g., head-count apportionment) has been consistently accepted in earlier assessments, the revenue cannot disturb it in later years absent withdrawal of the earlier relief or clear new facts; TPOs have statutory power to conduct fresh searches and add comparables, but comparability, related-party filters and adjustments must be determined by applying Rule 10B(2)/(3) and supported by contemporaneous, verifiable data; payments for standard connectivity services without transfer of right to use or control of equipment are not royalty/FTS.