2023 (9) TMI 1615 - AT - Income Tax

BPO service provider wins partial relief as tribunal excludes notional share-based compensation from transfer pricing analysis

ITAT Bangalore ruled on transfer pricing adjustments for a BPO service provider. The tribunal excluded notional share-based compensation costs from ... Transfer pricing - share-based compensation (SBC) inclusion in cost base - arm's length price and comparables selection - TNMM (transactional net margin method) - working capital adjustment - deduction under section 80G - depreciation and capital/revenue distinction - double taxation/double addition - remand for fresh consideration - interest consequentialShare-based compensation (SBC) inclusion in cost base - Transfer pricing - Notional SBC costs added by TPO excluded from the assessee's operating cost base for computing TP margins - HELD THAT: - The Tribunal applied its earlier reasoning in Radisys India Ltd. to the facts: SBC/book entry recognition pursuant to accounting standards, where no cost is charged to the assessee and no liability to reimburse the AE exists, cannot be treated as operating expense of the tested party for TNMM benchmarking. The Tribunal found that the ESOP/RSU cost was incurred by the Associated Enterprise and not charged to the assessee, and hence inclusion of such notional cost in the assessee's operating cost to compute margins is erroneous. On that basis the grounds challenging the inclusion of SBC were allowed.SBC not included in operating cost; grounds 4-7 allowedArm's length price and comparables selection - remand for fresh consideration - Selection, inclusion and exclusion of comparables and related filters remitted to TPO/AO for fresh consideration with opportunity to be heard - HELD THAT: - The Tribunal declined to adjudicate fully on multiple contentions concerning inclusion/exclusion of numerous comparable entities and the application of various filters (including RPT, employee cost, export revenue, functional dissimilarity, extraordinary events, outsourcing/subcontracting, intangibles, segmental information and search-matrix issues). Where the DRP's directions led to inclusion/exclusion without adequate opportunity or where material factual/functional differences required further examination, the Tribunal set aside those elements and remitted the matters to the TPO/AO to examine afresh, give the assessee opportunity of hearing, and decide on comparability and admissible set of comparables. Specific companies/sets of comparables and related grounds were identified for remand in the order.Comparables-related issues (grounds 12-19 and related sub-grounds) remitted to TPO/AO for fresh consideration and hearingArm's length price and comparables selection - computation of comparable margins - Re-computation of operating mark-up/margins of specified comparable companies remitted for correction - HELD THAT: - The Tribunal directed the TPO/AO to recompute correct margins where specific comparables' mark-ups were challenged and to take correct margins while passing consequential orders. The Tribunal did not itself rework those margins but ordered fresh computation by the TPO/AO.Margins of listed comparables to be recomputed by TPO/AO (remitted)TNMM (transactional net margin method) - MSS segment - TPO/AO directed to respect assessee's TNMM-based benchmarking for MSS segment; ad hoc revenue split methodology rejected - HELD THAT: - On review of the record and submissions about the assessee's functional profile in MSS (marketing/support services), the Tribunal accepted that the assessee follows a cost plus/TNMM approach for MSS and found the TPO's ad hoc revenue split and recharacterisation, which allocated distribution profits to the assessee, unsustainable. The Tribunal directed the AO/TPO to follow the same TNMM method used by the assessee to benchmark ALP for MSS.TPO/AO to apply TNMM as used by the assessee for MSS; ad hoc revenue split set asideWorking capital adjustment - Transfer pricing - Actual working capital adjustment to be granted while determining ALP - HELD THAT: - The Tribunal directed the TPO/AO to allow the assessee's actual working capital adjustment when determining arm's length price, indicating that such adjustment was to be factored into the benchmarking exercise.Working capital adjustment to be granted by TPO/AODeduction under section 80G - double taxation/double addition - Claim for deduction under section 80G remitted to AO/TPO for consideration in accordance with law - HELD THAT: - The Tribunal accepted the assessee's submission that CSR payments may be eligible under section 80G subject to the statutory conditions and that restriction under section 37 should not be read into section 80G. Rather than decide on merits, the Tribunal remitted the matter to AO/TPO to grant deduction under section 80G where appropriate and in accordance with law.Issue remitted to AO/TPO to examine and grant 80G deduction if legally permissibleDepreciation and capital/revenue distinction - Computer peripherals treated as revenue in nature for depreciation; depreciation to be allowed at higher rate - HELD THAT: - The Tribunal found the assessee's claim justified that certain computer peripherals/accessories do not confer enduring benefit and are integrally used with computers. It directed the AO/TPO to grant depreciation at the applicable higher rate (60% where applicable) instead of treating the purchases as capital expenditure not deductible, thereby allowing the assessee relief on these items.Depreciation on computer peripherals to be allowed at 60% or applicable rateDepreciation and capital/revenue distinction - Explanation 5 to section 32 - Depreciation to be allowed on items earlier disallowed as capital in prior years - HELD THAT: - The Tribunal directed the AO/TPO to grant depreciation at applicable rates on expenditures earlier disallowed as capital in prior assessment years, observing that the earlier appellate outcomes require giving effect to depreciation entitlement.Depreciation on amounts disallowed in earlier years to be allowed by AO/TPODouble taxation/double addition - remand for fresh consideration - Various procedural and verification items remitted to AO/TPO for fresh consideration (double disallowance under section 36(1)(va), sub lease rental income, section 40(a)(ia), consolidated revised return, advance tax and TDS credits) - HELD THAT: - The Tribunal identified instances where CPC/Assessing Officer computations resulted in apparent double disallowances or where additions were made without prior proposal; it remitted these matters to the AO/TPO for verification, correction and fresh decision after hearing the assessee, including: alleged double disallowance under section 36(1)(va), sub lease rental income (claimed and offered to tax but added again), alleged double disallowance under section 40(a)(ia), non consideration of consolidated revised return, and short/incorrect credit for advance tax and TDS.Issues remitted to AO/TPO for verification, correction and decision with opportunity to assesseeInterest consequential - Interest and penalty grounds treated as consequential and to be charged/adjusted accordingly - HELD THAT: - The Tribunal held that challenges to interest under Sections 234B, 234C and 234D are consequential on the assessment outcome; accordingly interest computation will follow the ultimate assessment adjustments and be applied as required.Interest/penalty to be computed consequentially after final adjustmentsFinal Conclusion: The appeal is partly allowed: the Tribunal excluded notional SBC from the assessee's operating cost; directed the AO/TPO to apply the assessee's TNMM for MSS, allow working capital adjustment, grant depreciation at applicable rates (including on earlier disallowed items), and treat interest as consequential. Multiple transfer pricing issues-selection and computation of comparables, recomputation of margins, several factual verifications, and certain statutory deductions/credits-were remitted to the TPO/AO for fresh consideration and decision after giving the assessee an opportunity of hearing. Issues Involved:1. Transfer Pricing Adjustment2. Treatment of Notional Costs Related to Share-Based Compensation (SBC)3. Inclusion and Exclusion of Comparable Companies4. Methodology for Marketing Support Services (MSS) Segment5. Working Capital Adjustment6. Disallowance of Deduction Under Section 80G7. Disallowance of Expenditure Under Section 378. Non-Grant of Depreciation on Disallowances from Previous Years9. Disallowance of Expenses Under Section 36(1)(va)10. Addition of Income Towards Sub-Lease Rental Income11. Disallowance Under Section 40(a)(ia)12. Non-Consideration of Consolidated Revised Return of Income13. Short Grant of Credit for Advance Tax and TDS14. Levy of Interest Under Sections 234B, 234C, and 234DIssue-Wise Detailed Analysis:1. Transfer Pricing Adjustment:- The Tribunal addressed the adjustments made by the Transfer Pricing Officer (TPO) to the international transactions of the assessee. The TPO had recomputed the profit margin by adding notional expenses related to the employee stock option plan. The Tribunal examined the comparables selected by both the assessee and the TPO, and the directions issued by the Dispute Resolution Panel (DRP). The Tribunal directed the TPO to re-evaluate the comparables and the methodology used for determining the arm's length price.2. Treatment of Notional Costs Related to Share-Based Compensation (SBC):- The Tribunal held that the notional SBC costs, which were not incurred by the assessee but by the Associated Enterprise, should not be included in the operating cost base. The Tribunal relied on previous decisions to conclude that only actual expenses incurred should be considered as operating expenses, and not notional expenses.3. Inclusion and Exclusion of Comparable Companies:- The Tribunal addressed the inclusion and exclusion of various companies as comparables for the purpose of transfer pricing analysis. It remitted the issue back to the TPO/AO for fresh consideration, emphasizing the need to grant an opportunity for the assessee to comment on the inclusion of additional comparables.4. Methodology for Marketing Support Services (MSS) Segment:- The Tribunal found that the TPO's ad-hoc methodology of revenue split was not in accordance with the prescribed methods under the Act. It directed the TPO/AO to follow the Transactional Net Margin Method (TNMM) to benchmark the arm's length price for the MSS segment, as the assessee was a contract service provider and not a distributor.5. Working Capital Adjustment:- The Tribunal directed the TPO/AO to grant an actual working capital adjustment while determining the arm's length price of the international transactions.6. Disallowance of Deduction Under Section 80G:- The Tribunal remitted the issue to the TPO/AO to grant deduction under Section 80G in accordance with the law, as the CSR expenditure was eligible for deduction under other sections subject to fulfillment of conditions.7. Disallowance of Expenditure Under Section 37:- The Tribunal accepted the assessee's claim that the expenditure on computer peripherals was revenue in nature and directed the TPO/AO to grant depreciation at 60% or applicable rates.8. Non-Grant of Depreciation on Disallowances from Previous Years:- The Tribunal directed the TPO/AO to grant depreciation on the expenditure disallowed in earlier years as capital expenditure, in accordance with the applicable rates.9. Disallowance of Expenses Under Section 36(1)(va):- The Tribunal remitted the issue to the TPO/AO for fresh consideration, directing them to give effect to the DRP's directions by deleting the disallowance.10. Addition of Income Towards Sub-Lease Rental Income:- The Tribunal remitted the issue to the TPO/AO for verification, as the assessee had already offered the income to tax, which resulted in a double addition.11. Disallowance Under Section 40(a)(ia):- The Tribunal remitted the issue to the TPO/AO to verify whether there was a double disallowance and decide accordingly.12. Non-Consideration of Consolidated Revised Return of Income:- The Tribunal remitted this issue to the TPO/AO to consider the revised return of income in accordance with the law.13. Short Grant of Credit for Advance Tax and TDS:- The Tribunal directed the TPO/AO to give the correct credit for advance tax and TDS as claimed by the assessee.14. Levy of Interest Under Sections 234B, 234C, and 234D:- The Tribunal noted that these grounds are consequential and mandatory, and interest is to be charged accordingly.In conclusion, the Tribunal allowed the appeal of the assessee partly for statistical purposes, providing directions for several issues to be reconsidered or verified by the TPO/AO.