TaxTMI 
TaxTMI 
2015 (12) TMI 1410
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....both in law and on facts by summarily rejecting the Appellant's objections to the draft order passed by the Ld. AO under section 143(3) read with section 144C(1) of the Act. The Hon'ble DRP while issuing directions under section 144C(5) of the Act did not consider the facts and merits of Appellant's objections to the proposed adjustments, and merely relied on the reasoning given by the Additional Commissioner of Income-tax, Transfer Pricing Officer - I (2) vide order under section 92CA(3) of the Act dated October 27, 2011 ("TP Order"). On the facts and in the circumstances of the case, the Ld. TPO and the Ld. AO have erred in proposing and the Hon'ble DRP has further erred in confirming the transfer pricing adjustment of Rs. 145,259,630/- without due application of mind and without affording a reasonable opportunity of being heard in the matter to the Appellant on the following grounds: 1.1. The DRP has erred on the facts and circumstances of the case and in law in rejecting/disregarding the comparability analysis (most appropriate method) without giving any cogent basis and without demonstrating the inadequacy or infirmity in the economic analysis conducted by the Assesse....
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.... of the case and in law by using data called pursuant to issuance of notice under Section 133(6) of the Act which was not available to the Assessee at the time of maintenance of Transfer Pricing Documentation. Further, the Ld. TPO also erred by not providing the complete information which was called pursuant to issuance of notice under Section 133(6) of the Act and by conducting the assessment based on unfair analysis. 1.9. The Ld. TPO erred by misconstruing the functional and risk profile of the Assessee and by not allowing risk adjustments. The Ld. TPO also erred in the facts and circumstances of the case and in law by selecting comparable having dissimilar functional profile vis-a-vis the Assessee. 1.10. The Ld. TPO has erred in the facts and circumstances of the case and in law by applying the wages-to-sales ratio based upon conjectures and surmises and further, applying an arbitrary filter of 25 percent without following a cogent economic basis and without establishing any statistical veracity of the presumption/ hypothesis framed. Further, the Ld. TPO has also erred by juxtaposed application of two or more methods to conclude a single benchmarking analysis a....
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.... the case was selected for scrutiny. 5. During the course of assessment proceedings it came to the notice of the AO that the assessee had international transactions for which the assessee had filed form no. 3 CEB as per the provisions of Section 92E of the Act relating to international Transactions in access of Rs. 5 crores. The AO as per the provisions of Sec. 92CA(3) referred the matter to the Transfer Pricing Officer (TPO) who proposed an addition of Rs. 16,86,58,151/-. The AO then proposed the draft assessment order u/s 144C(5) of the Act which was forwarded to the assessee who filed objections in Form no. 35A to the Dispute Resolution Penal (DRP) on 27.01.2012 and highlighted the following events which contributed to shift in its functional matrix: (i) Formation of Global Delivery Organization in India in September, 2005. (ii) Relocation of key Personnel to India in July 2006. (iii) Establishment of Chief Technology Officer in December 2006. (iv) Appointment of General Manager Sales in October 2007. 6. It was stated before the DRP that the entire pricing decision based on project costing estimates, resource requirements, time commitmen....
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.... shows that there is no shift as far as the contract with end customer and AE and further sub contract to Infogain India is concerned, there is no marked shift. However, the delivery models have been different. Infogain US develops onshore in addition to sales and marketing services and Infogain India after the development process is over delivers directly to clients. The flow charts are only representative of functions and not funds. We however see that the assessee has, by virtue of this diagram carried out a contractual obligation no doubt but has not provided these services to the overseas AE as it was earlier, rather than it has delivered the Software on behalf of its overseas AE. Another issue that has not been sufficiently documented at all is that whether the software developed in totality is partially developed onsite and partially in India. If we were to go strictly by the economic analysis carried out in the TP report, Conceptualization and scoping, System Requirement and design, Coding, Documentation and Testing is done majorly in India. We however have no project wise data to prove this. No specific contracts to support this. Also going by the TP Report it is evident t....
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....es at test are engaged, with reference to market returns achieved for similar types of transactions by independent enterprises. In none of the methods employed for determination of ALP, the issue of comparability is dispensed with. The foremost requirement of determination of ALP is to identify a comparable transaction. In the case of Profit Split Method, the way that has to be done is also mentioned. We do not find that the assessee has demonstrated this comparability anywhere. The TP Report is subjective and completely inadequate to support its conclusions. We are constrained to reject the same for the reasons given above and agree with the action of the TPO. We are of the opinion that Profit Split Method is not the most appropriate method in this case for this year as the same was not demonstrated by the assessee and the TPO was right in proceeding with the analysis on the basis of TNMM. The objection is rejected." 8. As regards to the objection of the assessee that the TPO collected selective information of companies by exercising power u/s 133(6) of the Act that was not available to the assessee in public domain and relying on the same for comparability purposes, the DRP ob....
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....cting assessee should not be taken for comparables either." 11. As regards to the objection of the assessee for considering the multiple year data instead of single year data while working out the Arm's Length Price, the DRP observed as under: "This issue has been examined in detail in TPO's order. Briefly summarized, the arguments put forth by TPO are based on the law as it exists. Persuasive value of OECD guidelines have also been considered and the relevant case laws. The TPO has articulated the relationship between Rule 10B(4) and 10D(4). Rule 10D(4) refers to maintenance of documentation, while Rule 10B(4) is very clear that for the purposes of benchmarking an international transaction, data of the comparables used should be of the year in which the transaction took place. The proviso can be invoked only if it is established that earlier years circumstances do have a bearing in the performance of the year under audit. The Delhi High Court in Schefenacker Motherson Ltd. Vs ITO 2009-TIOL-376-ITAT Delhi has upheld the use of current year data. ITAT Hyderabad in M/s Deloitte Consulting India Pvt. Ltd. ITA No. 1082 and 1084 of 2010 in order dated 22.07.2011 has again re....
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.... adopted Profit Split Method (PSM) as the most appropriate method for the financial year 2007-08 relevant to the assessment year under consideration, in view of the fact that it transitioned from a back end software services company of its AE to being fully responsible for the execution and delivery of software services to the end customers. It was submitted that under the offshore service delivery model, the entire project is developed and managed offsite (i.e. in India) by Infogain India while an employee of the AE acts as the onsite coordinators for managing client expectations and acting as an interface/communication channel between the client/customer and Infogain India. It was explained that under the dual shore model, Infogain US outsources only part of the software project to Infogain India, while the other part is executed by it onsite team requirement analysis, design and implementation support. However, the software engineers engaged in providing onsite services to the client/customers work under the direction of the Practice Directors ("PDs") stationed in India. It was further stated that the Infogain India is responsible for program and project execution, customer sati....
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.... India. The marketing department was responsible to perform marketing and selling activities to target customers/clients in regions where Infogain US/Infogain UK are not operating. Infogain India also performs the marketing fuctions which include the following activities: * Infogain India receives markeing leads through its website, which is operated, maintained and updated from India. Leads in relation to regions where its AEs operate are forwarded to respective AEs, while those from rest of the world are handled and harnessed by Infogain India; * Infogain India also engages in outreach campaigns which are carried out from India. These campaigns include advertising through newsletters, information collection on potential clients and through e-mails and tele-marketing; and * Infogain India also conducts and participates in seminars, exhibitions and conferences by various IT associations, etc. to increase its visibility and market presence. However, the aforesaid marketing functions performed by Infogain India are ancillary to the marketing functions performed by Infogain US. Additionally, Infogain India also provides support in marketing....
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....s, develop, formalize, packaging and adoption of best practices, such as, assessment offerings, managed services offerings; and - Implement center of excellence laboratories in each verticals, publish technology white-papers, review technical design in bids/proposals, etc. The following table depicts the split in the functional responsibilities of Infogain and its AEs: Table 5: Functional Responsibilities of Infogain and its AEs Functions Performed Entity Identifying Clients /Maintaining client relationship/Client contracts Function * Identification of clients *Contract formulation, negotiation, commitment Infogain US/Infogain India (to limited extent) * Lead Generation, Soliciting orders and initiating sales Infogain US/Infogain India (leads generated by a website that is operated and maintained by Infogain India are passed to Infogain US) * Client r elationship management Infogain US * Formulating sales strategy Infogain US * Engagement management Infogain US/Infogain India (to limited extent) Project Management including Defining of Functional Specifications Functions * Ov....
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.... Profit Split Method (PSM) is normally used in multiple international transactions, which are so closely interrelated that they cannot be evaluated separately for determining the Arm's length price or in situations involving transfer of unique intangibles. The ld. Counsel for the assessee further explained that based on the functions, asset and risk analysis ("FAR analysis"), as detailed in Chapter 3 of the documentation, it was determined that Infogain India is responsible for the significant delivery functions while Infogain US is responsible for the marketing, client identification and customer relationship management functions. It was pointed out that the functional analysis revealed that the activities performed by Infogain India and Infogain US are inextricably linkage and collaborative functions performed by Infogain India and Infogain US. Therefore, the Profit Split Method (PSM) has been selected as most appropriate method for the determination of Arm's length price in respect of International transactions between Infogain India and Infogain US. It was further stated that none of the direct methods (CUP, RPM and CPLM) can be applied to establish Arm's length value of the as....
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....Delhi in the case of Global One India Pvt. Ltd. Vs ACIT in ITA No. 5571/Del/2011 for the assessment year 2007-08 order dated 15.04.2014. It was further stated that the said order was also followed in the case of M/s Orange Business Services India Networks Pvt. Ltd. Vs DCIT in ITA No. 1201/Del/2015 for the assessment year 2010-11 order dated 08.05.2015. The ld. Counsel for the assessee stated that the assessee's case falls in category 1 mentioned in Circular No. 6/2013 dated 29.06.2013 issued by the Income Tax Department. Therefore, the TNMM method adopted by the TPO/AO was not the correct method and the PSM adopted by the assessee was the most appropriate method. The reliance was placed on the decision of the ITAT Delhi Bench 'G', New Delhi in the case of ITO, Ward 7(1), New Delhi Vs Net Freight (India) P. Ltd., New Delhi in ITA No. 4670/Del/2009 for the assessment year 2004-05, order dated 31.12.2013. 17. In his rival submissions the ld. DR strongly supported the order of the TPO/AO and further submitted that each assessment year is an independent, therefore, the findings given in the assessment year referred by the ld. Counsel for the assessee i.e. assessment year 2011-12 are ....
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.... method adopted by the assessee. Reliance was placed on the following case laws: • CIT Vs Neo Poly Pack (P) Ltd. (2000) 245 ITR 492 (Del) • RADHASOAMI SATSANG Vs CIT (1992) 193 ITR 321 (SC) • Azitech Software and Technology Ltd. Vs ACIT 107 ITD 147 20. We have considered the submissions of both the parties and carefully gone through the material available on the record. In the present case, the controversy revolves around the most appropriate method, the claim of the assessee is that the Profit Split Method (PSM) is the most appropriate method while the AO is of the view that the TNMM is the most appropriate method, while working out the Arm's length value in respect of international transactions between Infogain India i.e. assessee and Infogain US i.e. parent company. Rule 10B(1)(d) of the Income Tax Rules, 1962, defines the Profit Split Method as follows: "Profit Split Method, which may be applicable mainly in international transactions involving transfer of unique intangibles or in multiple international transactions which are so inter related that they cannot be evaluated separately for the purpose of determining the arm's leng....
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....e AEs on an economically valid basis that approximates the division of the profit that would have been anticipated and reflected in an agreement, transaction or a residual profit intended to represent the profit that cannot readily be assigned to one of the parties. The contribution of each enterprise is based upon a functional analysis and valued to the extent possible by any available reliable standard market data. The functional analysis is an analysis of the functions performed (taking into account assets used and risk assumed) by each enterprise. 22. Before us there are two methods for consideration i.e. PSM and TNMM. A perusal of the function of the assessee company reveals that the international transactions are highly integrated and interrelated. The ITAT Special Bench in the case of Aztech Software and Technology Ltd. Vs ACIT reported at 107 ITD 147 discussed the various methods of determination of ALP as well as the OECD in Transfer Pricing Guidelines for multinational enterprise. The Coordinate Bench in the case of Global One India Pvt. Ltd. Vs ACIT in ITA No. 5571/Del/2011 for the assessment year 2007-08 after taking note of the decision of the Special Bench in the c....
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....of the parties, such as the profit arising from high value, sometimes unique, intangibles. 183. The contribution of each enterprise is based upon a functional analysis and valued to the extent possible by any available reliable external market data. The functional analysis is an analysis of the functions performed (taking into account assets used and risks assumed) by each enterprise. The external market criteria may include, for example, profit split percentages or returns observed among independent enterprises with comparable functions." 17.4. The OECD transfer pricing guideline for multinational enterprises and tax administration in Chapter 2 on transfer pricing methods, at page 93, para C.1 states as follows: "C.1 In general 2.108 The transactional profit split method seeks to eliminate the effect on profits of special conditions made or imposed in a controlled transaction (or in controlled transactions that are appropriate to aggregate under the principles of paragraphs 3.9-3.12) by determining the division of profits that independent enterprises would have expected to realize from engaging in the transaction or transactions. The transaction....
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....based on an analysis of any factors relevant to the associated enterprises that would indicate how independent enterprises might have split the difference between the seller's minimum price and the buyer's maximum price. 2.123 In some cases an analysis could be performed, perhaps as part of a residual profit split or as a method of splitting profits in its own right, by taking into account the discounted cash flow to the parties to the controlled transactions over the anticipated life of the business. One of the situation in which this may be an effective method could be where a start-up is involved, cash flow projections were carried out as part of assessing the viability of the project, and capital investment and sales could be estimated with a reasonable degree of certainty. However, the reliability of such an approach will depend on the use of an appropriate discount rate, which should be based on market benchmarks. In this regard, it should be noted that industry wide risk premiums used to calculate the discount do not distinguish between particular companies let alone segments of business, and estimates of the relative timing of receipts can be problematic. Such an a....
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....ue which is, in many cases, a practical solution. Secondly, potential conflict with the tax authorities is reduced by using the tow step residual approach since it reduces the amount of profit that is to be split in the potentially more controversial second step. 6.3.17.3. In step 1 of the residual analysis, a basic return for the manufacturing function is determined for Company A and Company B. Specially a benchmarking analysis is performed to search for comparable independent manufactures which do not own valuable intangible property. The residual profit, which is the combined profits of company A and company B after deducting the basis (arm's length ) return for the manufacturing function, is then divided between Company A and Company B. This allocation is based on relative R & D expense which are assumed to be a reliable key to measure the relative value of each company's intangible property. Subsequently, the net profits of Company A and Company B are calculated in order to work back to a transfer price." 17.8. In "Practical Guide to U.S. Transfer Pricing by Robert T Cole, Chapter 10, PSM authored by Arlow N. Higinbotham, pg nos.10-52, it is stated as follows....
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....er TNMM. In Aztek Software and Technology Services (supra) the TNMM is stated as follows: "Transactional Net Margin Method (TNMM) : Rule 10(B)(1)(e) describes TNMM as under: (i) The net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) The net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii)The net profit margin referred to in sub clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv)The net profit margin realized by the enterprise and referred to in sub clause (i) i....
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....s) that a taxpayer realizes from a controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9 - 3.12). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net profit indicator of the tax payer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of paragraphs 3.9-3.12) should ideally be established by reference to the net profit indicator that the same tax payer earns in comparable uncontrolled transactions, i.e. by reference to "internal comparables" (see paragraphs 3.27- 3.35). A functional analysis of the controlled and uncontrolled transactions is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results. Further, the other requirements for comparability, and in particular those of paragraphs 2.69-2.75, must b....
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....controlled transactions involving tangible property, the tested party in the analysis can either be the related party manufacturer or the related party distributor. The choice of the tested party depends on the availability of comparable data. This usually implies that the TNMM is applied to the least complex of the related parties involved in the controlled transaction, because generally more comparable data will then be in existence and fewer adjustments will be required to account for differences in functions and risks between the controlled and uncontrolled transactions. In addition, the tested party should not own valuable intangible property. This, by the way, is also the reason why it is recommended to select the least complex entity for the application of the cost plus method or resale price method." 23. Now by keeping in view the findings given by the Coordinate Bench in the aforesaid referred to case of Global One India P. Ltd. Vs ACIT, 12(1) in ITA Nos. 5571/Del/2011 and 5896/Del/2012 order dated 15.04.2014. In the present case, we have to see as to whether the PSM is the appropriate method as adopted by the assessee or TNMM method as adopted by the AO. In the present....
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.... the TPO has not demonstrated or substantiated how the change in method was dependent upon the loss incurred. Therefore, we are of the view that the conclusion of the TPO that the PSM is adopted by the assessee only to camouflage loss at the net level is merely an allegation and hence devoid of merit. In the present case, the assessee adopted Profit Split Method, for application of the said method, the provisions are contained in Rule 10B(1)(d) of the Income Tax Rules, 1962. According to the said provisions the Profit Split Method is applicable mainly in international transactions which are so interrelated that they cannot be evaluated separately, for the purpose of determining the arms' length price. The combined net profit is then split amongst the enterprises in proportion to relative contribution as evaluated on the basis 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 indicated how such contribution would be evaluated by unrelated enterprise performing comparable functions in similar circumstances. In the present case, Infogain India i.e the assessee is responsible for th....