2016 (8) TMI 950 - AT - Income Tax

Assessee wins appeal on consultancy charges, Transfer Pricing methods scrutinized

The Tribunal partially allowed the Assessee's appeal, ruling in favor of the Assessee on various issues. It deleted the additions made by the TPO and AO ... Addition on account of professional consultancy charges and management fees - adjustment in Arm’s Length Price pertaining to the international transaction ‘SAP consultancy charges and other expenses’- MAM - Held that:- The employee of the AE provided on job training to the staff of the assessee and they were also engaged in knowledge sharing with the existing employees during the meetings, minutes of which were furnished by the assessee before the authorities below. The AE charged the actual cost of services rendered by the specific employee and to substantiate the same, the assessee furnished invoices as documentary evidences. In the instant case the TPO placed his reliance on para 7.24 of the OECD Guidelines which states that “to satisfy the arm’s length principal, the allocation method chosen must lead to a result i.e. consistent with what comparable independent enterprises would have been prepared to accept”. In the present case, the TPO was unable to provide any cogent reason for the determination of arm’s length value of professional consultancy at Nil. On the contrary, the assessee explained the benefits received by it on account of the services received from AE. As regards to the application of method for determining the Arm’s Length Price, we are of the view that the method to be used to determine arm’s length price for intra-group services should be in accordance with the guidelines in Chapter-I, II & III of the “OECD Transfer Pricing Guidelines” which provides the various methods to be applied and the CUP method is likely to be a most appropriate method where there is a comparable service provided between independent enterprises in the recipient’s market or by the AEs providing the services to an independent enterprise in comparable circumstances. In the present case, the TPO although applied the CUP method but nothing was brought on record to substantiate that the AE provided the similar services to an independent enterprise in comparable circumstances. He also did not bring on record any instance where comparable services were provided to an independent enterprise in the recipient market. Therefore, in our opinion, in the assessee’s case the CUP method was not the most appropriate method. On the contrary, the assessee rightly applied the TNMM method as most appropriate method because it was difficult to apply the CUP method or the cost plus method. Therefore, the TNMM was the most appropriate method in the absence of a CUP which is applicable where the nature of the activities involved, assets used, and risk assumed are comparable to those undertaken by an independent enterprise. In the present case, the assessee divided its operation in the manufacturing and distribution segment. In the manufacturing segment, the net profit margin (OP/Sales) was disclosed at 9.26%, assessee has selected 5 comparable companies and using three years financial data margin of comparables had been computed at 8.40%. In the distribution segment, the assessee has selected TNMM as most appropriate method and the tested party margin had been computed at 15.21% as compared to average margin of 6 comparables using 3 years financial data at 3.96% and the international transactions were claimed at arm’s length. We, therefore, keeping in view the aforesaid discussion are of the view that the impugned addition made by the AO on account of the adjustment made in the receipt of professional consultancy services and management support services rendered by the employees of the AE, was not justified. In that view of the matter we delete the impugned addition. Issues Involved:1. Assessment of total income.2. Adjustment of professional consultancy charges and management fees.3. Determination of arm's length price (ALP) for SAP consultancy charges.4. Segregation of closely linked transactions and rejection of the Transactional Net Margin Method (TNMM).5. Adoption of Comparable Uncontrolled Price (CUP) method.6. Transfer pricing adjustment based on incorrect assumptions.7. Commercial rationale of business expenses.8. Benefit of +/-5% under Section 92C.Detailed Analysis:1. Assessment of Total Income:The Assessee challenged the assessment of total income at Rs. 153,342,630/- against the computed income of Rs. 124,680,920/-. The primary contention was the adjustments made by the AO based on the TPO’s order.2. Adjustment of Professional Consultancy Charges and Management Fees:The AO, based on the TPO’s order, made an adjustment of Rs. 34,967,980/- to the total income of the Assessee. This adjustment was related to the arm's length price of international transactions involving receipt of professional consultancy services and management services. The TPO determined the ALP of these transactions as NIL, which was contested by the Assessee. The Assessee argued that the services received led to substantial business benefits, including increases in exports and gross margins. The Tribunal noted that the Assessee had demonstrated financial and commercial benefits from these services, leading to the deletion of the impugned addition.3. Determination of ALP for SAP Consultancy Charges:The TPO made an adjustment of Rs. 3,539,236/- by determining the ALP of SAP consultancy charges as NIL. The Assessee contended that no such transaction occurred during the year and that the TPO had a pre-occupied mind in making similar adjustments as in the previous year. The Tribunal found that the TPO's approach was not justified and set aside the issue for fresh adjudication, noting that the Assessee had not incurred such expenditure during the relevant year.4. Segregation of Closely Linked Transactions and Rejection of TNMM:The TPO rejected the TNMM, which the Assessee used to benchmark closely linked transactions, and instead segregated the transactions for determining the ALP. The Tribunal found that the TNMM was the most appropriate method in the absence of a comparable uncontrolled transaction and held that the TPO's segregation approach was incorrect.5. Adoption of CUP Method:The TPO adopted the CUP method without identifying any comparable uncontrolled transactions for computing the ALP. The Tribunal noted that the TPO did not bring any instances of comparable services provided to independent enterprises and thus held that the CUP method was not the most appropriate method in this case.6. Transfer Pricing Adjustment Based on Incorrect Assumptions:The Assessee argued that the TPO ignored relevant submissions and documents, reaching an inappropriate conclusion that the ALP of the impugned transactions should be NIL. The Tribunal observed that the TPO failed to provide cogent reasons for determining the ALP as NIL and that the Assessee had substantiated the receipt of services and their benefits.7. Commercial Rationale of Business Expenses:The TPO questioned the commercial rationale of the business expenses incurred by the Assessee. The Tribunal, referencing the Punjab & Haryana High Court's decision, stated that the profitability of a transaction is not the sole determinant of its arm's length nature. The Tribunal held that the Assessee had demonstrated the benefits of the services received, thus justifying the expenses.8. Benefit of +/-5% under Section 92C:The Assessee contended that the benefit of +/-5% under the proviso to Section 92C was not provided. The Tribunal did not specifically address this issue in detail, focusing instead on the broader adjustments and methodologies used.Conclusion:The Tribunal found merit in the Assessee's arguments regarding the adjustments made by the TPO and AO. It deleted the additions related to professional consultancy charges and management fees, and set aside the issue of SAP consultancy charges for fresh adjudication. The Tribunal emphasized the importance of demonstrating financial and commercial benefits from transactions and the appropriate application of transfer pricing methods. The appeal was partly allowed for statistical purposes.