2016 (7) TMI 1689 - AT - Income Tax

Foreign company's IT service charges for software licenses and internet services require no transfer pricing adjustment

The ITAT PUNE held that no transfer pricing adjustment was required for IT service charges received by a foreign company from Indian entities for ... Royalty - Fees for Included Services - Arm's length price - Transfer Pricing adjustment - Cost allocation based on estimates versus actual costs - Base erosion principle - Application of a declaration under section 158A(1) to apply a pending higher authority decision - Applicability of Indian Transfer Pricing Regulations to international transactions liable to Indian taxRoyalty - Fees for Included Services - Application of a declaration under section 158A(1) to apply a pending higher authority decision - Taxability in India of consideration received for facilitating grant of user rights in off-the-shelf software and provision of related support services - HELD THAT: - Both the Assessing Officer and CIT(A) treated the receipts as taxable as Royalty under the India-US tax treaty and under the Act. Identical issues in the assessee's own earlier years were decided against the assessee by the Tribunal and a substantial question of law arising from that Tribunal decision was admitted by the Hon'ble Bombay High Court. The assessee filed a declaration in Form No. 8 under section 158A(1) asking that the final decision in the pending higher authority proceedings in its own earlier assessments be applied to the present year and undertaking not to raise further questions of law in this assessment year. The Assessing Officer acknowledged that the question of law was pending before the Bombay High Court. In view of the Tribunal's prior decision and the pending higher court adjudication, the appeal on this point is decided against the assessee following the Tribunal's decision, with a direction that the Assessing Officer shall apply the decision of the Hon'ble Bombay High Court and/or Hon'ble Supreme Court when finally pronounced pursuant to the assessee's declaration under section 158A(1). [Paras 4, 5, 6, 7]Addition held taxable as Royalty; ground dismissed following the Tribunal's earlier decision, subject to application of the final decision of the Hon'ble Bombay High Court/Supreme Court pursuant to the assessee's Form No. 8 declaration.Arm's length price - Transfer Pricing adjustment - Cost allocation based on estimates versus actual costs - Base erosion principle - Applicability of Indian Transfer Pricing Regulations to international transactions liable to Indian tax - Validity of transfer pricing adjustment of Rs. 22,67,333 to the international transaction for providing user rights in software and related services - HELD THAT: - The TPO rejected the assessee's use of cost estimate allocation and adopted actual calendar year costs to determine arm's length price, proposing an upward adjustment. The assessee argued (a) cost estimate allocation is an accepted method under OECD guidance where actual allocation is not possible, (b) percentage variation was under 5%, (c) application of an adjustment here would cause base erosion of India's tax base because higher charges in favour of the foreign assessee reduce Indian taxable income, and (d) transfer pricing rules apply only where the international transaction is liable to Indian tax. The Tribunal examined that DRP/TPO in other years had not made such adjustments for identical transactions and found, on the totality of facts, that the adjustment should not stand. Applying these factual and legal considerations, the Tribunal reversed the CIT(A)'s confirmation of the adjustment and directed deletion of the addition. [Paras 9, 10, 11, 12, 16]Transfer pricing adjustment of Rs. 22,67,333 deleted and grounds relating to this adjustment allowed.Non speaking order - Complaint that the CIT(A) adjudicated the transfer pricing ground by passing a non speaking order - HELD THAT: - The ground complaining of a non speaking order was not pressed by the assessee before the Tribunal. [Paras 8]Ground not pressed and dismissed as not pressed.Initiation of penalty proceedings premature - Challenge to initiation of penalty proceedings under section 271(1)(c) as premature - HELD THAT: - The Tribunal found that the challenge to initiation of penalty proceedings was premature at this stage and did not call for interference. [Paras 17]Ground dismissed as premature.Final Conclusion: The appeal is partly allowed: the addition treated as Royalty is sustained following the Tribunal's earlier decision but the Assessing Officer is directed to apply any final decision of the Hon'ble Bombay High Court/Supreme Court pursuant to the assessee's Form No. 8 declaration; the transfer pricing adjustment is deleted; the non pressed ground is dismissed as not pressed and the challenge to initiation of penalty proceedings is dismissed as premature. Issues Involved:1. Taxability of consideration for facilitating grant of user rights in off-the-shelf software and related support services.2. Transfer pricing adjustment of Rs. 22,67,333/- to the arm's length price of the international transaction.3. Adjudication of the transfer pricing ground by a non-speaking order.4. Transfer pricing adjustment when the adjustment variation is less than 5% of the total transaction value.5. Ignoring the base erosion principle.6. Exclusion of internet mail in cost allocation.7. Initiation of penalty proceedings under section 271(1)(c) of the Income-tax Act.Detailed Analysis:1. Taxability of Consideration for Facilitating Grant of User Rights in Off-the-Shelf Software and Related Support Services:The assessee contested the addition of Rs. 5,16,20,766/- as 'royalty' under Article 12 of the India-US Tax Treaty. The Tribunal noted that similar issues in previous assessment years (2004-05, 2006-07, and 2007-08) were decided against the assessee. The Bombay High Court admitted substantial questions of law on this matter but had not altered the Tribunal's decision. Following the Tribunal's earlier decisions and the assessee's declaration under section 158A(1) of the Act, the Tribunal directed the Assessing Officer to apply the final decision of the higher courts. Consequently, this ground of appeal was dismissed.2. Transfer Pricing Adjustment of Rs. 22,67,333/- to the Arm's Length Price:The assessee argued that cost allocation based on estimates was an accepted method for determining arm's length price and that actual cost allocation should not result in tax erosion in India. The TPO and CIT(A) rejected these arguments, leading to an addition of Rs. 22,67,333/-. The Tribunal found merit in the assessee's argument that the Indian Transfer Pricing provisions should not apply if they result in a reduction of India's overall tax base. The Tribunal also noted that no adjustments were made in subsequent years on similar transactions. Therefore, the Tribunal reversed the CIT(A)'s order and directed the deletion of the addition of Rs. 22,67,333/-.3. Adjudication of the Transfer Pricing Ground by a Non-Speaking Order:This ground was not pressed by the assessee and was dismissed as not pressed.4. Transfer Pricing Adjustment When the Adjustment Variation is Less than 5% of the Total Transaction Value:The Tribunal's decision on the second issue (transfer pricing adjustment) inherently addressed this ground. Since the addition of Rs. 22,67,333/- was deleted, this issue was resolved in favor of the assessee.5. Ignoring the Base Erosion Principle:The Tribunal accepted the assessee's argument that if the arm's length price results in a reduction of India's overall tax base, no adjustment should be made. This principle was upheld in the Tribunal's decision to delete the transfer pricing adjustment.6. Exclusion of Internet Mail in Cost Allocation:Given the Tribunal's decision on the second issue, which included considerations of cost allocation, this ground was not separately adjudicated.7. Initiation of Penalty Proceedings Under Section 271(1)(c) of the Income-tax Act:The Tribunal found this issue to be premature and dismissed it accordingly.Conclusion:The appeal was partly allowed. The Tribunal dismissed the grounds related to the taxability of software user rights and the initiation of penalty proceedings. However, it allowed the grounds related to transfer pricing adjustments, directing the deletion of the addition of Rs. 22,67,333/-. The other grounds were either not pressed or inherently resolved through the Tribunal's decisions on the main issues.