TPO cannot determine arm's length price at nil for head office services without proper benchmarking methods

ITAT Ahmedabad partially allowed the assessee's appeal on TP adjustments. For global and regional head office services, the tribunal ruled that TPO erred in determining ALP at "Nil" without applying prescribed benchmarking methods, noting that once service receipt is demonstrated, TP adjustment without proper benchmarking is unsustainable. However, regarding contract R&D services to overseas entity, the tribunal confirmed the addition as assessee charged lower margin than 29% specified in the contract agreement.

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Issues Presented and Considered

The core legal questions considered in this appeal pertain to transfer pricing adjustments and procedural validity of the assessment order under the Income Tax Act, 1961 (the Act) for the Assessment Year 2018-19. The issues include:

• Whether the Transfer Pricing Officer (TPO), Assessing Officer (AO), and Dispute Resolution Panel (DRP) erred in making arbitrary, adhoc, and inconsistent transfer pricing adjustments aggregating INR 28,70,16,704 concerning intra-group services (Global Head Office (GHO) and Regional Head Office (RHO) charges) and rendition of Contract Research & Development (R&D) services.
• Whether the principle of natural justice was violated due to late issuance of show cause notice by the TPO without providing reasonable time to the assessee to respond.
• Validity of the reference made to the TPO under section 92CA(1) of the Act and whether such reference was legally sustainable.
• Whether the final assessment order was barred by limitation under section 153 of the Act.
• Whether the AO erred in issuing the draft and final assessment orders through the National Faceless Assessment Centre (NFAC) and jurisdictional AO, respectively.
• Whether the TPO/AO/DRP erred in making transfer pricing adjustments without applying prescribed methods under section 92C read with Rules 10AB/10B(1) and disregarding the detailed benchmarking and functional analysis submitted by the assessee.
• Whether the TPO/AO/DRP erred in rejecting voluminous evidence submitted by the assessee substantiating receipt and benefit of intra-group services.
• Whether the adjustments made on rendition of contract R&D services were justified, including the correctness of the arm's length margin applied.
• Whether the AO erred in computation of demand, levy of interest under sections 234B and 234C, and initiation of penalty proceedings under section 270A read with section 274 of the Act.

Issue-wise Detailed Analysis

1. Transfer Pricing Adjustments on Intra-group Services (GHO and RHO Charges)

Legal Framework and Precedents: Transfer pricing adjustments are governed by sections 92C and 92CA of the Act, which require determination of arm's length price (ALP) using prescribed methods under Rule 10B and related rules. The burden lies on the assessee to demonstrate receipt of services and their arm's length valuation. The TPO must apply one of the statutory methods and cannot arbitrarily fix ALP at nil without benchmarking or comparable uncontrolled transactions.

Court's Interpretation and Reasoning: The Tribunal referred to its own precedent in the immediately preceding Assessment Year 2017-18 involving identical facts, where it held that the TPO erred in adopting a restrictive view that no India-specific services were rendered by the global and regional head offices. The Tribunal observed that the assessee had submitted voluminous evidence, including emails and service descriptions, demonstrating India-specific benefits received. The TPO's approach of valuing such services at nil without applying any prescribed transfer pricing method or conducting a search for comparable uncontrolled transactions was held to be unsustainable.

Key Evidence and Findings: The assessee produced detailed documentation evidencing services such as treasury, controlling, IT, finance support, CFO functions, and regional management support provided by overseas offices. The Tribunal noted that the TPO and DRP failed to adequately appreciate or rebut this evidence, instead dismissing it summarily.

Application of Law to Facts: The Tribunal applied the statutory framework mandating use of prescribed transfer pricing methods and rejected the TPO's arbitrary valuation at nil. It emphasized that the existence of India-specific services was sufficiently demonstrated, and the TPO was required to benchmark these services rather than deny their value outright.

Treatment of Competing Arguments: The Department argued that the services were general and not India-specific, justifying valuation at nil. The Tribunal rejected this, holding that the evidence showed India-specific benefits and that the TPO's failure to apply any method was contrary to law.

Conclusion: The Tribunal allowed the appeal on this issue, setting aside the transfer pricing adjustments related to GHO and RHO services.

2. Transfer Pricing Adjustment on Rendition of Contract R&D Services

Legal Framework and Precedents: The ALP determination for contract R&D services also falls under section 92C and related rules. The parties' agreement and benchmarking analysis are relevant to determine the appropriate markup on cost.

Court's Interpretation and Reasoning: The DRP confirmed the addition on the ground that although the contract stipulated a 29% markup, the assessee charged a lower markup of 20.73% in the year under consideration. The DRP held that the rule of consistency did not apply to preclude reassessment, as each year is a separate unit and prior acceptance does not bind subsequent years. The Tribunal agreed with the DRP/AO, noting that the assessee failed to justify deviation from the contractually agreed markup and that the Department had not rejected the comparables but objected to the lower margin charged.

Key Evidence and Findings: The assessee submitted a detailed FAR (functions, assets, risks) analysis and benchmarking study indicating that the 20.73% margin was within acceptable arm's length range. However, the contract specifically provided for a 29% margin, which was not adhered to.

Application of Law to Facts: The Tribunal applied the principle that contractual terms are relevant and that the Department is entitled to adjust income where the actual margin charged is below the agreed rate without sufficient justification. The rule of consistency was held inapplicable to bind the Department in this case.

Treatment of Competing Arguments: The assessee argued for acceptance of the 20.73% margin based on benchmarking and prior acceptance. The Department relied on the contract and the DRP's reasoning to uphold the adjustment.

Conclusion: The Tribunal dismissed the appeal on this issue, confirming the transfer pricing adjustment on contract R&D services.

3. Procedural and Jurisdictional Issues

Natural Justice: The assessee contended that the TPO issued the show cause notice late in the assessment proceedings without reasonable time to respond, violating the principle of natural justice. The Tribunal did not specifically dwell on this ground in the final order, implying no relief was granted on this procedural ground.

Reference to TPO under Section 92CA(1): The assessee challenged the validity of the reference to the TPO, alleging violation of the statutory provisions. The Tribunal did not find merit in this contention, as no specific findings were recorded to quash the reference.

Limitation under Section 153: The assessee alleged that the final assessment order was time-barred. The Tribunal did not interfere on this ground, indicating that the assessment was held within the prescribed time limits.

Issuance of Draft and Final Assessment Orders: The challenges to the NFAC's issuance of draft assessment and jurisdictional AO's final assessment were not upheld, as no infirmity was found in the procedural conduct.

4. Other Issues: Computation of Demand, Interest, and Penalty

The assessee raised objections to the computation of demand under section 156, levy of interest under sections 234B and 234C, and initiation of penalty proceedings under section 270A read with 274. The Tribunal did not grant relief on these grounds, implying that the AO's actions were found to be in accordance with law.

Significant Holdings

On the issue of intra-group services, the Tribunal held:

"The Ld. Transfer Pricing Officer in view has taken a rather restrictive view in coming to the conclusion that no services were rendered for which any independent third party would pay and hence it was not possible to determine arm's length price in the instant set of facts. As held in various decisions, the TPO cannot stand in judgment on what benefits the assessee has derived from the services and assessee's obligation lies to the extent of demonstrating receipt of services. Once, the assessee has been able to demonstrate receipt of services, in our view, Transfer Pricing adjustment without applying any prescribed benchmarking method is unsustainable and Ld. TPO cannot determine ALP at "Nil" and has to determine ALP under any one of the methods prescribed under the Income Tax Act read with the IT Rules."

This established the core principle that the TPO must apply one of the prescribed transfer pricing methods and cannot arbitrarily value intra-group services at nil without benchmarking, once receipt of services is demonstrated.

On the rendition of contract R&D services, the Tribunal upheld the Department's adjustment, emphasizing the contractual terms and rejecting the rule of consistency as a bar to reassessment:

"There can be no finding on any particular issue in a particular year. But, that cannot be perceived as a silent acceptance of the same and a considered view so as to qualify as a departmental stand. A scrutiny assessment is after all a verification done on sample basis and the same should not be upgraded to the level of a certificate. We also know that every year is also different and a unit in itself."

Thus, the Tribunal confirmed the adjustment increasing the markup from 20.73% to 29% as per contract.

On procedural and limitation grounds, the Tribunal did not find merit in the assessee's contentions and upheld the validity of the assessment proceedings and orders.

Final Determinations

• The appeal was allowed in part by setting aside the transfer pricing adjustments related to Global Head Office and Regional Head Office services, directing that the ALP determination must be made using prescribed methods after considering the evidence of India-specific services.
• The appeal was dismissed with respect to the transfer pricing adjustment on rendition of contract R&D services, confirming the addition based on the contractual markup of 29% and rejecting the lower margin charged by the assessee.
• The procedural and jurisdictional challenges raised by the assessee, including violation of natural justice, invalid reference to TPO, limitation, and issuance of draft and final assessment orders, were rejected.
• The objections regarding computation of demand, levy of interest, and penalty proceedings were not upheld.

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