TaxTMI 
TaxTMI 
2015 (5) TMI 932
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....me. Inviting attention to Ground No.-3.3 and 3.4 raised in the present appeal and relying on the judicial precedent cited, it was his submission that the other grounds would become academic. 1.2. Accordingly the issue was stated to be covered by the said decision. 1.3. For ready-reference the specific grounds addressed are reproduced hereunder:- 3.3. "disregarding Profit Split Method ('PSM') as the most appropriate method for benchmarking Appellant's international transactions based on erroneous reasons and instead, applying the Transactional Net Margin Method ('TNMM') as the most appropriate method; 3.4. disregarding the fact that the judicial precedent in the case of the Appellant's predecessor entity Global One India Private Limited (ITA nos. 5571/Delj2011 and ITA nos. 5896/Del/2012) on the application of PSM, adjudicated by the Hon'ble Delhi Income Tax Appellate Tribunal is squarely applicable in the case of the Appellant." 2. Before we proceed to address the issues, it is necessary to bring out the fact that the present appeal filed by the assessee came to be argued on three different dates by the assessee. The first addressal in the ....
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....iled for the benefit of the Revenue. On the completion of his submission, the Revenue was required to respond. Both the Ld. Standing Counsel as well as the Ld.CIT DR, Mr. A. K. Singh were present at that time to address the Departmental stand but neither responded to Ld. AR's submissions. Instead, the Ld. CIT DR sought time. Time was granted again for the benefit of hearing the Revenue's response and matter was adjourned to 25.03.2015. It is unfortunate to note that during the hearing in the subsequent matters on the said date, the ld. CIT DR also walked out from the Court when his objections to the Court's recording in the proceedings in regard to the mis-demeanor of the Standing Counsel was declined as recorded in the Court proceedings of the matters on the said date. In the facts of the present case however Ld. CIT DR had sought time which was granted. 2.2. The appeal accordingly came up for hearing on 25.03.2015 on the request of the Ld. CIT DR. However on the said date, Ld. CIT DR again sought time though in writing setting out the following reasons:- "In this connection, we respectfully submit that the CIT(DR) who is to appear before the Hon'ble Bench is not available i....
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....nding counsel and Ld. CIT DR (International Taxation) chose not to advance any arguments whatsoever in support of the impugned order. Thus, in the absence of any submission from the Revenue the appeal is being decided ex-parte qua the Revenue on the basis of material available on record. We can only observe with surprise the tolerance of indiscipline by the Appropriate authorities who appear to have chosen to give their tacit compliance to the behaviour by evidently not taking day to day Reports of their performance and have allowed such a situation to continue by not addressing the patent dereliction of official duties evident in the behaviour of their representatives which borders on contempt of the Court. 4. Reverting to the facts of the case, Ld. AR addressing Ground Nos.3.3 & 3.4, has submitted that in the facts of the present case the issue is covered in assessee's favour by virtue of the aforesaid order of the Tribunal in Global One India Private Limited (ITA nos. 5571/Del/2011 and ITA nos. 5896/Del/2012). The said order it has been stated had been cited before the DRP however the DRP's order is silent on the issue as a result of this the AO while passing the final order ....
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....ned duty, the present appeal is being decided ex-parte qua the Revenue as per the relevant Court proceedings of the various dates which have been summed up in the earlier part of this order. 5.1. The relevant facts of the case as borne out from the record are that the assessee declared an income of Rs. 6,95,61,820/- by way of electronically filing its return which was subjected to scrutiny assessment. A reference to the TPO was made by the AO to determine the Arm's Length Price u/s 92CA(3) of the Act in respect of the international transaction entered into by the assessee in the year under consideration. It is seen that the TPO proposed an adjustment u/s 92CA of Rs. 17.41 crore odd. The assessee availing of the statutory remedy filed objections before the DRP wherein reliance was placed on the order of the predecessor of the assessee. The DRP rejected the assessee's objections posed to the TPO's order and held that the TNMM is the most appropriate method as opposed to profit split method relied upon by the assessee. 5.2. Pursuant to this order, the appeal has been filed. 5.3. Considering the prayer of the assessee addressed vide Ground No.-3.3 to 3.4, wherein reliance has ....
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....h mainly cover IPVPN, MPLS, ATM, Frame Relay, X.25, X.28 Protocol etc, as was provided by GOIPL. During FY 2008-09, both GOIPL and ENSIPL had ISP license. However, during the year GOIPL's Board of Directors decided to transit the network operations from GOIPL to ENSIPL. As a consequence, both the employees of GOIPL were transferred and network equipments were sold (following a valuation undertaken by a third party valuer) to ENSIPL during the year. Further, the operations in GOIPL were discontinued w.e.f. August 8, 2008 and customer were gradually started to be served through ENSIPL and a Board resolution was passed to cease operations completely in GOIPL w.e.f. March 31, 2009. Post FY 2008-09, there was no business in GOIPL at all and ENSIPL had taken over servicing the customers of the Equant Group. ENSIPL, though a distinct entity, took over the business operations of GOIPL post the GOIPL's Board decision of ceasing GOIPL's operations in FY 2008-09. ENSIPL follows the same business model, undertakes the same operations, services the same Equant Group clients and employs the same management personnel and employees as was done by GOIPL." (emphasis provided) ....
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....merated the following functions of the assessee in para 5.1 :- 5.1. "Functions Performed by ENSIPL (Taxpayer) ENSIPL is one of the operating entities of the group in India. ENSIPL is primarily engaged in providing data services and related network services to group's customers located in India. The data services offered by ENSIPL under the NLD and ILD service categories include provision of IP Voice services and related network services and services relating to installation/configuration of routers etc. The services offered by ENSIPL under its NLD & ILD license are layer 2 and layer 3 data services which mainly cover IPVPN, MPLS, ATM, Frame Relay X25, X28 Protocol etc. For the provision of these services, ENSIPL utilizes the global network footprint for connecting the customers outside the Indian territory. ENSIPL also provides Equant's fully managed support solutions developed around the basic internet services offered by the Company. ENSIPL has separate teams in India that are engaged in undertaking sales and marketing activities and that undertaking filed operations viz installation/configuration of routers etc and fully managed support solutions developed aroun....
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....re stated to be : a) Price Competition; b) network capability; c) global footprint/ span; d) performance reliability; e) Service Quality; and f) Value added services/ solutions offered. The various operating entities of the Equant Group own/ deploy the necessary leg of the network footprint in their respective country/ jurisdiction. 5.9. A perusal of the facts as considered by the Co-ordinate Bench in GOIPL show that the facts in the case of GOIPL were also identical. The TPO in the present proceedings also considered the fact that similar facts were there in the preceding years as the company had barely started its operations in August, 2008 and started realizing revenue from December, 2008 onwards and infact value to Network depreciation was given only in the month of March 2009 and it is for this reason the TPO holds that despite application of PSM by the assessee, no adverse inference was drawn by the Revenue in the earlier year as the revenues earned during the 1st 4 months of its operations were considered to be not significant. The TPO on facts in the present case has also concluded that merely because revenues were insignificant accordingly interference in the method was....
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.... transfer Pricing Regulation recognize this aspect, as evident from the introduction of Rule 10 AB, which allows the use of any other method which is generally accepted, for determining ALP." 5.11. It is further seen that the assessee in support of its justification for PSM as the most appropriate method even before the TPO as per the afore-said letter dated 17.01.2014 (which has been extracted in the TPO's order also) relying on its T.P. Study has submitted that each 'Key value driver' is measured as: (i) Network Operations: The value of the contribution made to network operations by each entity is determined as a sum of the following four items. * Network deprecation: Based on the financials of each entity. * Network personnel cost: Staff costs relating to personnel engaged in network related activities. * Historical investment in the network: Historical investment in the network is measured by the accumulated unabsorbed investments in the network made by Equant Network Systems Ltd. ("ENSYS") an Equant Group Company in Ireland. * Foregone performance payments: Prior to the execution of a Memorandum of Understanding ("MOU") on September 10, 2004 effective....
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....cting assessee's stand for using PSM as MAM and the Co-ordinate Bench also rejected the TPO's justification for using TNMM. 5.12. Similarly the argument of the assessee that the provision of network services is a three stage process wherein (i) the network signal first reaches a point in India called the Point of Supply; (ii) From there it travels to a 'landing station' where the distance between the point of supply and the landing station may be maintained by the assessee or it may be outsourced; and (iii) The last part where from the landing station to the terminal of the customer is called 'last mile connectivity'. The TPO considering the claim held that this is almost always outsourced to another service provider and infact the assessee depended upon other unrelated entities to complete its business activity which facts accordingly to him led to the conclusion that no unique intangible was provided by the assessee to the business. 5.12.1.These objections of the TPO it is seen were also there in GOIPL's case and they have not found favour by the Co-ordinate Bench who at internal page 40 of the order considering the TPO's objection that the assessee has not ....
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....ssee are generated in a transaction where there is contribution from multiple entities. It is true that the assessee runs its business independently in India. This leads to a conclusion that the assessee is an independent entrepreneur . But when a transaction is integrated and interrelated and when costs are incurred by multiple entities and the revenues are to be apportioned to multiple entities, then the factual conclusions of the T.P.O have to be vacated." 5.14. It is also seen that similar reason of the TPO has been considered by the Co-ordinate Bench as justification for resorting to TNMM namely that the general reason advanced by the assessee that business losses are due to Business start up; Poor management; Deliberate business strategy; Economic downturn; Business cycle stage; Excessive financial risk; Effect of government intervention according to the TPO did not address the losses made. Similarly the explanation of the assessee not accepted by the TPO that there is no loyalty to any particular service provider as far as customers are concerned and the argument that there is continuous erosion of margins for telecommunication industry rejected by the TPO as facts common....
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.... 18.4. "In our view, the TPO has erred on facts. The revenues in the case of the assessee are generated in a transaction where there is contribution from multiple entities. It is true that the assessee runs its business independently in India. This leads to a conclusion that the assessee is an independent entrepreneur. But when a transaction is integrated and interrelated and when costs are incurred by multiple entities and the revenues are to be apportioned to multiple entities, then the factual conclusions of the T.P.O have to be vacated. 18.5. Transaction Net Margin method compares the profit margin of tax payer arising from a non arm's length transaction, or a group of such similar transactions, with the profit margin realized by the assessee with its A.E. on a similar transaction whereas the PSM allocates operating profits or losses from controlled transactions, on the principle of relative contributions made by each party in creating the combined revenues. 18.7. In our view the argument of the assessee, that in cases where there are commercial losses, TNMM cannot be applied, cannot be accepted as a general rule. To this extent, we agree with the conclusions of the T.....
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....s of the functions performed, assets employed or to be employed and risks assumed by each enterprise and on the basis of reliable external market data which indicates how such contribution would be evaluated by unrelated enterprises performing comparable functions in the similar circumstances; (iii) the combined net profit is then split amongst the enterprises in proportion to their relative contributions, as evaluated under sub clause(ii); (iv) the profit thus apportioned to the assessee is taken into account to arrive at an arm's length price in relation to the international transaction; 181. This method may be applicable in case where transactions involved transfer of unique, intangible or any multiple interrelated international transactions, which cannot be evaluated separately for determining the ALP of any one transaction. 182. The profit split method first identifies the profit to be split for the associated enterprise from the controlled transactions in which the associated enterprises are engaged. It then splits those profits between the associated enterprises on an economically valid basis that approximates the divisions of profits that would have been anticip....
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....this initial remuneration would be determined by applying one of the traditional transaction methods or a transactional net margin method, by reference to the remuneration of comparable transactions between independent enterprises. Thus, it would generally not account for the return that would be generated by any unique and valuable contribution by the participants. In the second stage, any residual profit (or loss) remaining after the first stage division would be allocated among the parties based on an analysis of the facts and circumstances, following the guidance as described at paragraphs 2.132-2.145 for splitting the combined profits. 2.122. An alternative approach to how to apply a residual analysis could seek to replicate the outcome of bargaining between independent enterprises in the free market. In this context, in the first stage, the initial remuneration provided to each participant would correspond to the lowest price an independent seller reasonably would accept in the circumstances and the highest price that the buyer would be reasonably willing to pay. Any discrepancy between these two figures could result in the residual profit over which independent enterprise....
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....between the associated enterprises based on the relative value of each enterprise's contribution, which should reflect the functions performed, risks incurred and assets used by each enterprise in the controlled transactions. External market date (e.g. profit split percentages among independent enterprises performing comparable functions) should be used to value each enterprise's contribution, if possible, so that the division of combined profits between the associated enterprises is in accordance with that between independent enterprises performing functions comparable to the functions performed by the associated enterprises. The Profit Split Method is applicable to transfer pricing issues involving tangible property, intangible property, intangible property, trading activities or financial services. 17.7. Residual analysis is stated as follows: 6.314.7 The Residual Profit Split Method is used more in practice than the contribution approach for two reasons. Firstly, the residual approach breaks up a complicated transfer pricing problem into two manageable steps. The first step determines a basic return for routine functions based on comparables. The second step analysis retu....
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....pter 10, it is stated as follows: 10.04 Residual Profit Split Method As illustrated in Figure 10-2, RPSM proceeds in two steps: Step 1: Functional capital is provided a return derived from data for functional comparables, i.e. independent companies performing similar routine manufacturing or distribution functions; and Step 2:The remaining "residual" operating profit or loss is allocated based on residual, "entrepreneurial" capital so as to equalize the rate of return on such capital, adjusted for market differences in the cost of capital. In actual practice, implementation of the RPSM concept outlined above involves the determination of a number of interrelated valuations of functional and entrepreneurial activities in different countries and economic circumstances. The existing IRS regulations provide relatively little specific guidance concerning these valuations, and thus leave open the question of how best to determine the "relative value of each controlled taxpayer's contribution to the success of the relevant business activity in a manner that reflects the functions performed, risks assumed, and resources employed by each participant in the relevant business activity, ....
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....mparison between net margins derived from the operations of the uncontrolled parties and net margins derived by an AE from similar operations. Net margin is indicated by the rate of return on sales or cost or operating assets, and this forms the basis for TNMM. A functional analysis of the tested party or the independent actions are comparable and the adjustments that are required to be made to obtain reliable results. The tested party would have to consider other factors, like cost of assets of comparable companies, etc. while applying the return on assets measure. Ordinarily, the tested party, has to be the party provided services because it is on the basis of rate of return on sales or cost or operating assets that transactional margin is computed. These parameters generally available in the case of party providing service. 18.1. The, in its review of comparability and methods, dt. 22nd July,2010 in Part III B Transactional Net Margin Method, B I, page 33, paras 2.58 to 2.59, held as under. "B. Transactional net margin method B.1. In general 2.58 The transactional net margin method examines the net profit relative to an appropriate base (e.g. costs, sales, assets) th....
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....tested party for transfer pricing purposes. The TNMM examines the net profit margin relative to an appropriate base (e.g.costs, sales, assets) that a tax payer realizes from a controlled transaction (or transactions that are appropriate to be aggregated). The profit margin indicators are discussed in paragraph 2.3 below. The TNMM compares the net profit margin (relative to an appropriate base) that the tested party earns in the controlled transactions to the same net profit margins earned by the tested party in comparable uncontrolled transactions or alternatively, by independent comparable companies. As such, the TNMM is a more indirect method than the cost plus/resale price method that compares gross margins. It is also a much more indirect method than the CUP method that compares prices, because it uses net profit margins to determine (arm's length) prices. One should bear in mind that many factors may affect net profit margins, but may have nothing to do with transfer pricing. The TNMM is used to analyse transfer pricing issues involving tangible property, intangible property or services. When the TNMM is applied on controlled transactions involving tangible property, the....
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....e said exercise has been done by them and thereafter they have arrived at the conclusion that "PSM" is the "MAM". The Co-ordinate Bench's finding that if the TPO was of the view that PSM has not been correctly applied then this conclusion did not justify rejection of the method. The Co-ordinate Bench on the facts which in the facts of the present case continued to remain the same had infact concluded that the assessee has applied Residency Profit Split Method. Considering the legal position thereon the Co-ordinate Bench remitted the matter back to the TPO with speaking directions and it is this direction which is sought to be repeated by the assessee herein also in the facts of the present case. For ready-reference we first extract the relevant deliberation by the Co-ordinate Bench:- 20.5. "The assessee in this case has adopted 'residuary profit split method'. As explained in various commentaries, residual PSM involves: i) Determination of routine return ii) Allocation of residuary profits. At the stage of determination of routine profits, as already stated, bench marking has to be done by the assessee, with reliable external market data from uncontrolled transactions."....
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.... Transfer Pricing for Developing Countries, suggest that an allocation of residual profits under PSM should be done, based on contributions by each entity. 20.8. We have already extracted the OECD Transfer Pricing Guidelines at para 17.4. At para 2.121, it is stated as follows: "In the second stage, any residual profit (or loss) remaining after the first stage division would be allocated among the parties based on an analysis of the facts and circumstances, following the guidance as described at paragraphs 2.32 to 2.145 for splitting the combined profits. The paragraphs read as follows. "C.3.4. How to split the combined profits C.3.4.1. In general 2.132 : The relevance of comparable uncontrolled transactions or internal data and the criteria used to achieve an ;arm's length division of the profits depend on the facts and circumstances of the case. It is therefore not desirable to establish a prescriptive list of criteria or allocation keys. See paragraphs 2.115-2.117 for general guidance on the consistency of the determination of the splitting factors. In addition, the criteria or allocation keys used to split the profit should: * Be reasonably independent of tran....
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....ts, number of servers, data storage, floor area of retail points, etc. may be appropriate depending on the facts and circumstances of the transactions. Asset-based allocation keys 2.136 Asset-based or capital-based allocation keys can be used where there is a strong correlation between tangible or intangible assets or capital employed and creation of value in the context of the controlled transaction. See paragraph 2.145 for a brief discussion of splitting the combined profits by reference to capital employed. In order for an allocation key to be meaningful, it should be applied consistently to all the parties to the transaction. See paragraph 2.98 for a discussion of comparability issues in relation to asset valuation in the context of the transactional net margin method, which is also valid in the context of the transactional profit split method. 2.137 One particular circumstance where the transactional profit split method may be found to be the most appropriate method is the case where each party to the transaction contributes valuable, unique intangibles. Intangible assets pose difficult issues in relation both to their identification and to their valuation. Identifica....
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....the time when expenses are incurred and the time when value is created, and it is sometimes difficult to decide which period's expenses should be used. For example, in the case of a cost-based allocation key, using the expenditure on a single-year basis may be suitable for some cases, while in some other cases it may be more suitable to use accumulated expenditure (net of depreciation or amortization, where appropriate in the circumstances) incurred in the previous as well as the current years. Depending on the facts and circumstances of the case, this determination may have a significant effect on the allocation of profits amongst the parties. As noted at paragraphs 2.116-2.117 above, the selection of the allocation key should be appropriate to the particular circumstances of the case and provide a reliable approximation of the division of profits that would have been agreed between independent parties. C.3.4.4 Reliance on data from the taxpayer's own operations ("internal data") 2.141 Where comparable uncontrolled transactions of sufficient reliability are lacking to support the division of the combined profits, consideration should be given to internal data, whi....
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....ues should rely on a functional analysis that takes into account all the economically significant functions, assets and risks contributed by the parties to the controlled transaction. In those cases where the profit is split on the basis of an evaluation of the relative importance of the functions, assets and risks to the value added to the controlled transaction, such evaluation should be supported by reliable objective data in order to limit arbitrariness. Particular attention should be given to the identification of the relevant contributions of valuable intangibles and the assumption of significant risks and the importance, relevance and measurement of the factors which gave rise to these valuable intangibles and significant risks. 2.145 One possible approach not discussed above is to split the combined profits so that each of the associated enterprises participating in the controlled transactions earns the same rate of return on the capital it employs in that transaction. This method assumes that each participant's capital investment in the transaction is subject to a similar level of risk, so that one might expect the participants to earn similar rates of return if the....
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....y contributed by each taxpayer may be measured by external market benchmarks that reflect the fair market value of such intangible property. Alternatively, the relative value of intangible contributions may be estimated by the capitalized cost of developing the intangibles and all related improvements and updates, less an appropriate amount of amortization based on the useful life of each intangible. Finally, if the intangible development expenditures of the parties are relatively constant over time and the useful life of the intangible property of all parties is approximately the same, the amount of actual expenditures in recent years may be used to estimate the relative value of intangible contributions. If the intangible property contributed by one of the controlled taxpayers is also used in other business activities(such as transactions with other controlled taxpayers), an appropriate allocation of the value of the intangibles must be made among all the business activities in which it is used." 20.11. A perusal of the above demonstrates that there is a general consensus on the principles of allocation of residual surplus. Hence, we are inclined to accept the following submis....
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....ransaction or where such transactions are extremely interrelated, of the types as in the case of the appellant, where knowledge of third party behavior is impossible to possess, but where the case otherwise deserves the treatment of PSM, then the prescription to mandatorily use a comparable PSM would render the whole machinery of PSM under the Indian TP regulations a nullity & impossible to be implemented. 6. This is exactly what the UN has provided in its TP guidelines relating to comparable PSM, namely that such method is seldom used, since reliable external market date on third party behavior in the matter of splitting profits are often not available [paragraph 6.3.15 of UN TP guidelines]. 7. Describing the comparable PSM, the OECD held in its guidelines that external data for comparable PSM can be available in cases of joint venture agreements between independent parties under which profits are shared, such as development projects in the oil and gas industry; pharmaceutical collaborations; co-marketing or co-promotion agreements; arrangements between independent music record labels and music artists; uncontrolled arrangements in the financial services sector; etc [paragra....
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....enting information on comparable independent transactions as potentially insurmountable obstacle to the practical realization of CPSM. This pessimistic viewpoint overlooks a relatively voluminous body of evidence and experience in the intellectual property area where such calculations are routinely, if somewhat roughly, applied in valuing license transactions". d. Transfer Pricing Rules and Compliance Handbook - Page number 33 - 0.2 Comparable Profit Split Method - Authored by Marc M. Levey, C. Wrappe Steven and Steven C. Wrappe - " .... The use of comparable profit split method will be limited because it will typically be difficult to find comparable companies engaged in transactions that are similar to those of both the buyer and the seller, and data delineating how the independent parties shared the combined profits from a comparable transaction rarely exists. Finding a comparable transaction is made more difficult because the regulations provide that the comparability degree of similarity not only of the function, risk, but also of contractual terms." 11. In view of the above discussions emanating from the OECD and UN TP guidelines; and also commentaries of several transf....
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.... the ALP thereof. 14. Now, it is submitted that such lacuna is curable even by maintaining, and without disturbing the overall spirit and concept of PSM, as enshrined in rule 10B(1)(d) of IT Rules, and as also understood in the OECD and UN TP guidelines, through interpreting rule 10B(1)(d) in a manner that the same provides an option and not compulsory mandate to apply a comparable PSM in a case where reliable external data to gauge third party behavior is impossible to be obtained. 15. In this connection, reference is invited to the ruling of the Hon'ble SC rendered in the case of M.Pentiah and others vs. Muddala Veeramallappa and others (1961 AIR 1107), where the Hon'ble Court quoted with approval, the famous words on interpretation of statutes said by Lord Denning in the case of Seaford Court Estates Ltd. Vs. Asher(1), namely : "When a defect appears a Judge cannot simply fold his hands and blame the draftsman. He must set to work on the constructive task of finding the intention of Parliament.............. and then he must supplement the written word so as to give "force and life" to the intention of the legislature. ..........A judge should ask himself the question ho....
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....unt the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts." While introducing the Amendment the CBDT Circular is referred to below. "The Central Board of Direct Taxes, vide Notification No.18/2012 (F.No.142/5/2012-TLP) dt. 25th May,2012 introduced the sixth method in TP, referred to as the "Other Method," with effect from 1st April,2012, i.e. on and from the Assessment Year 2012-13, through inserting rule 10AB, read with clause (f) of rule 10B(1) of the IT Rules. The said "Other Method" is like an omnibus or residual one, in the sense that it refers to any method, which takes into account the price charged or paid or which would have been charged or paid, for similar uncontrolled transactions, with or between non-AEs, would have been charged or paid, for similar uncontrolled transactions, with or between non AEs, under similar circumstances, considering all the relevant facts. Thus, the said "Other Method" would ideally operate where none of the methods specified under the IT Act and Rules would a....