January 2009
(I) AO/TPO should establish that the taxpayer had manipulated prices to shift profits. (ii) After taxpayer discharges onus by conducting proper analysis, before determining ALP, AO/TPO should prove that one of four conditions in S. 92C(3) is satisfied. (
By Geeta Jani, Dhishat B. Mehta, Chartered Accountants
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Part C — International Tax Decisions
8 Philips Software Centre (P) Ltd. v.
ACIT (2008) 26 SOT 226 (Bang.)
A.Y. : 2003-2004
S. 92C, S. 92CA, Income-tax Act
Dated : 26-9-2008
Issues :
(i) AO/TPO should establish that the taxpayer had
manipulated prices to shift profits.
(ii) After the taxpayer discharges onus by conducting
proper analysis, before determining ALP, AO/TPO should prove that one of the
four conditions in S. 92C(3) is satisfied.
(iii) Data used for comparability and analysis should
relate to the relevant financial year and should also be available as on the
specified date (i.e., the due date of filing tax return).
(iv)
Margin of comparable companies
cannot be taken as a benchmark without a proper FAR analysis to eliminate
differences.
Facts :
IndCo was engaged in providing software development services
to its associated enterprises. The Company claimed tax holiday under the
Income-tax Act, 1961 relating to the A.Y. 2003-04. While preparing its transfer
pricing documentation under Indian transfer pricing Rules for the relevant tax
year (2002-03), the Taxpayer selected the Cost Plus Method (‘CPM’) as the most
appropriate method for determining the arm’s-length price and also undertook a
benchmarking analysis using Transaction Net Margin Method (‘TNMM’). Based on the
analysis, the Taxpayer conducted a search on the electronic database available
in public domain and used various qualitative and quantitative filters. Data
till October 2003 (i.e., available up to the date of filing return of
income) was used for comparable analysis. The Taxpayer had made adjustment on
account of depreciation for difference in the depreciation policy adopted by the
him vis-à-vis comparable companies.
The TPO rejected the transfer pricing analysis undertaken by
IndCo on several grounds and determined the arm’s-length margin at higher
amount. On the basis of the TPO’s order, the Assessing Officer (‘AO’) made
adjustment to the total income of the Taxpayer.
Before ITAT, the assessee claimed that the adjustment was not
warranted as :
(a) The AO/TPO did not establish that the Taxpayer had
manipulated prices to shift profits outside India.
(b) The AO/TPO did not satisfy and communicate to the
Taxpayer the relevant clause u/s.92C(3) of the Act which alone empowers the AO
to disregard the analysis conducted by the Taxpayer.
(c) The AO/TPO conducted the analysis using the data that
did not exist by the specified date of filing the return of income and thus
contravened statutory requirement of using contemporaneous method.
(d) The AO/TPO did not grant suitable adjustments to
account for differences in functions performed, assets employed and risks
assumed between the Taxpayer and the comparable companies to arrive at the
ALP.
(e) The TPO had not granted the benefit of ±5% of tolerance
adjustment as provided under the Act.
Held :
The ITAT accepted most of the contentions of the appellant
and held that :
(i) The intention of the transfer pricing provisions is to
curtail avoidance of taxes by shifting profits outside India. The AO/TPO is
duty bound to demonstrate that the Taxpayer has manipulated its prices to
shift profits outside India, before a transfer pricing adjustment can be made.
The Taxpayer had also highlighted that the average rate of tax was much lower
in India than the tax rate applicable to the associated enterprise (‘AE’) in
the Netherlands. Accordingly, there was no motive on the part of the taxpayer
to shift profits out of India.
(ii) The AO/TPO did not establish, either before initiating
the transfer pricing proceedings or even at the time of concluding the
proceedings that the taxpayer had manipulated prices to shift profits. Since
the Taxpayer was availing tax holiday benefit, it would be devoid of logic to
argue that the Taxpayer had manipulated prices and shifted profits to an
overseas jurisdiction for the purpose of avoiding tax in India.
(iii) At no stage of the assessment proceedings the AO/TPO
established that the transfer pricing analysis of the Taxpayer could have been
rejected in terms of provisions of S. 92C(3) of the Act. The Taxpayer had
discharged its onus by conducting proper analysis. The AO/TPO cannot reject
such analysis unless they find deficiency or insufficiency in the
documentation of the Taxpayer.
(iv) As per the transfer pricing rules, for the purpose of
conducting the comparability analysis, subject to certain exceptions, the data
to be used for the comparability analysis need to relate to the relevant
financial year in which the international transaction has been entered into
and should exist latest by the specified date (i.e., the due date of
filing tax return). The ITAT held that both the conditions are cumulative in
nature. If any one of the conditions is not satisfied, the relevant comparable
cannot to be included in the analysis.
(v) The ITAT held that for the purpose of the analysis, the
comparables should not have transactions with its associated enterprises. Any
company having even a single rupee of related-party transaction cannot be
considered for benchmarking purpose.
(vi) The ITAT held that the margin of the comparable
companies cannot be directly taken as a benchmark without doing a proper FAR
analysis to eliminate differences on account of functions performed, risk
assumed and assets employed. By relying on the earlier Tribunal decisions in
case of Mentor Graphics (Noida) Pvt. Ltd. v. CIT, [(2007) 109 ITD 101]
and E-gain Communication (P) Ltd. v ITO, [(2008) 23 SOT 385], the ITAT
emphasised that adjustment needs to be made to the margins of the comparables
to eliminate differences on account of functions, assets and risks.
