2025 (1) TMI 646 - AT - Income Tax

TPO cannot levy tax on notional income from non-existent international transactions after business shutdown

Motricity India Private Limited Versus DCIT, Circle 2, Gurgaon.

The ITAT DELHI ruled in favor of the assessee regarding TP adjustment on deemed international transactions. The TPO had deemed revenue for a 3-month ... TP adjustment - International Transaction to be deemed - as submitted that there is no provision in the Act or in the relevant rules to deem an international transaction in the manner in which the TPO has deemed the revenue for the 3 month’s period after cessation/expiry of the service agreement between the AE and assessee - TPO observed that the assessee has booked more expenditure post service agreement i.e. 01.01.2012 to 31.03.2012 and has not booked any income. Accordingly, he rejected the TP study submitted by the assessee and he selected 18 comparables and computed the average comparable price of 20.92% and he proceeded to determine the ALP for whole assessment year. HELD THAT:- The assessee has actually provided software services only during the period April 2011 to December 2011 and subsequent to that period, it has carried out effectively operations to shut down the business. In this case, assessee has effectively carried on the international transaction only during period of service agreement. TPO has to determine only the ALP for such international transactions carried on by the assessee. TPO selected various comparables for which various financial statements of comparable comparison were prepared on the basis of going concern whereas financial statements of the assessee are prepared not on the basis of going concern. This was disclosed in appropriate places in the audited Balance Sheet itself. TP study has to be carried on comparable basis on equal terms. This itself makes all the comparables selected by the TPO are liable to be rejected. TPO has determined the ALP on the basis of presumption. No tax can be levied on notional income which was determined on the basis of transactions which are not technically international transaction. All funds remitted to India will not fall under services or under international transaction having economic impact. No doubt holding company has set up infrastructure in India to do business in order to receive services, no doubt for captive services still the ALP has to be on the basis of services provided by the Indian entity and as per the agreement it can charge mark-up only on the services provided by the assessee not for the negative services for which the holding company already by investing in India eroded the capital by such decision to create facility in India and on the top of it Revenue authorities cannot presume and impose further mark-up on the expenses which are incurred technically to shut down the business. On similar ground, the Hon’ble Supreme Court held in the case of Excel Industries Ltd. [2013 (10) TMI 324 - SUPREME COURT] and in the case of Ravi Kumar Sinha [2024 (8) TMI 939 - DELHI HIGH COURT] expressed similar view that the tax levied on actual income that has accrued or received and not on the notional or hypothetical income. Accordingly, we are inclined to delete the ALP adjustment made by the TPO in the present case and accordingly, grounds raised by the assessee are allowed. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered in this judgment include:Whether the Transfer Pricing Officer (TPO) correctly determined the Arm's Length Price (ALP) for the entire fiscal year, including the period after the service agreement had expired.Whether the expenses incurred by the assessee after the termination of the service agreement should be considered as operating expenses for the purpose of ALP determination.Whether the TPO was justified in including notional income for the period after the expiration of the service agreement in the ALP calculation.Whether the assessee was entitled to a markup on expenses incurred after the termination of the service agreement.2. ISSUE-WISE DETAILED ANALYSISIssue 1: Determination of ALP for Entire Fiscal YearLegal Framework and Precedents: The determination of ALP is governed by Section 92CA of the Income Tax Act, 1961. The ALP should reflect the price that would be charged in a comparable uncontrolled transaction.Court's Interpretation and Reasoning: The court found that the TPO's determination of ALP for the entire fiscal year was inappropriate as the service agreement was only valid until December 31, 2011. The court emphasized that the ALP should only pertain to the period during which services were actually rendered.Key Evidence and Findings: The court noted that the service agreement was not renewed after December 31, 2011, and the assessee had not provided any services post this date.Application of Law to Facts: The court applied the principle that ALP should be determined based on actual transactions during the operative period of the agreement.Treatment of Competing Arguments: The court rejected the TPO's argument that expenses incurred post-agreement should be included in ALP determination.Conclusions: The ALP should be determined only for the period during which the service agreement was in effect.Issue 2: Consideration of Post-Termination Expenses as Operating ExpensesLegal Framework and Precedents: Operating expenses are defined under Rule 10TA of the Income Tax Rules, which excludes costs not related to international transactions.Court's Interpretation and Reasoning: The court held that expenses incurred after the termination of the service agreement were not related to international transactions and thus should not be considered as operating expenses.Key Evidence and Findings: The assessee had not claimed these expenses as deductible under Section 37 of the Income Tax Act, 1961.Application of Law to Facts: The court found that the expenses were related to winding up the business and not to the provision of services.Treatment of Competing Arguments: The court dismissed the Revenue's argument that these expenses should be included in the ALP calculation.Conclusions: Post-termination expenses should not be included as operating expenses for ALP determination.Issue 3: Inclusion of Notional Income in ALP CalculationLegal Framework and Precedents: The concept of notional income is not recognized under Indian tax law unless explicitly provided for.Court's Interpretation and Reasoning: The court referred to the Supreme Court's ruling in CIT v Shoorji Vallabhdas & Co, which held that only real income, not hypothetical or notional income, can be taxed.Key Evidence and Findings: The court found that no services were rendered during the post-agreement period, and thus no real income accrued.Application of Law to Facts: The court applied the principle that tax liability arises only on actual income, not on notional figures.Treatment of Competing Arguments: The court rejected the TPO's inclusion of notional income for the period after the service agreement expired.Conclusions: Notional income for the post-agreement period should not be included in the ALP calculation.Issue 4: Entitlement to Markup on Post-Termination ExpensesLegal Framework and Precedents: The service agreement specified a markup on costs incurred during the provision of services.Court's Interpretation and Reasoning: The court concluded that the assessee was not entitled to a markup on expenses incurred after the termination of the service agreement.Key Evidence and Findings: The court noted that the expenses were related to the winding up of operations and not to the provision of services.Application of Law to Facts: The court applied the terms of the service agreement, which did not provide for a markup on post-termination expenses.Treatment of Competing Arguments: The court dismissed the Revenue's argument that a markup should be applied to all costs.Conclusions: The assessee was not entitled to a markup on post-termination expenses.3. SIGNIFICANT HOLDINGSThe court held that 'no tax can be levied on notional income which was determined on the basis of transactions which are not technically international transactions.'The court established that the ALP should be determined based on actual transactions during the operative period of the agreement, not on hypothetical scenarios.The court concluded that expenses incurred after the termination of the service agreement should not be considered as operating expenses for ALP determination.The final determination was to delete the ALP adjustment made by the TPO, allowing the appeal filed by the assessee.