Territorial nexus and transfer pricing consistency govern taxation of split contract receipts and TNMM cost base computation.

A non-resident contract with separately identifiable consideration for offshore supply, onshore supply, onshore services, and design and engineering was not treated as a single composite receipt for Indian tax purposes. Offshore supply, where title and payment passed outside India, was not taxable in India by itself; however, the embedded consideration for services rendered in India was taxable on an apportionment basis under territorial nexus and PE attribution principles. Design and engineering receipts were characterised as fees for technical services, and onshore items were taxable only to the extent of actual taxable events in the relevant year. For transfer pricing, TNMM had to be applied on a consistent total operating cost base for both the tested party and comparables, so a fractured cost base was impermissible.

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Issues: (i) Whether the contract receipts relating to offshore supply, onshore supply, onshore services, and design and engineering were taxable in India and, if so, to what extent during the relevant year; (ii) Whether the transfer pricing adjustment was validly computed by applying the selected profit level indicator on a fractured cost base.

Issue (i): Whether the contract receipts relating to offshore supply, onshore supply, onshore services, and design and engineering were taxable in India and, if so, to what extent during the relevant year.

Analysis: The contract price was separately identifiable for the major components, and the arrangement was not to be treated as an inseparable composite receipt for tax purposes. Offshore supply of equipment, where title passed outside India and payment was received outside India, did not by itself give rise to taxable income in India. However, the sale consideration for offshore supply also embedded consideration for certain services to be rendered in India, and that part was taxable on an apportionment basis under the territorial nexus principle and the PE attribution rule. Onshore supply and foreign supervision charges were taxable in principle, but only to the extent actual taxable events or services occurred in the relevant year. Design and engineering receipts were not royalty, but were fees for technical services, and the retrospective amendment to the deeming provision negatived the plea that non-rendering of services in India excluded taxability.

Conclusion: Offshore supply simplicitor was not taxable in India, but the embedded consideration for services rendered in India and the design and engineering receipts were taxable in principle, subject to verification of the actual services and year of accrual; the matter on quantification was restored for fresh examination.

Issue (ii): Whether the transfer pricing adjustment was validly computed by applying the selected profit level indicator on a fractured cost base.

Analysis: Under the prescribed transfer pricing method, the net operating profit margin must be examined against the total operating cost base, and the same base must be applied consistently to both the tested party and comparables. Excluding selected expense heads while retaining others distorted the method and was impermissible. Since the method, the profit level indicator, and the comparables themselves were not in dispute, the computation had to be redone by applying the rule in full and with proper opportunity to the assessee.

Conclusion: The transfer pricing adjustment was set aside for de novo computation in accordance with the prescribed method and full operating cost base.

Final Conclusion: The appeal succeeded in part. The taxability issues were largely restored for fresh quantification on the correct legal basis, and the transfer pricing adjustment was also remitted for recomputation in accordance with the prescribed rule.

Ratio Decidendi: Where a non-resident contract contains separately identifiable consideration for different components, only the part of the income that has a territorial nexus with India or is attributable to operations carried out in India or to a PE can be taxed in India, and transfer pricing under TNMM must be computed on a consistent total operating cost base for both the tested party and comparables.

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