Captive Service Provider Entitled to Risk Adjustment; Nil ALP for Proven Intra-Group Services Rejected: ITAT Delhi

Corning Technologies India Pvt. Ltd. Vs DCIT (ITAT Delhi)

The assessee appealed against the assessment order passed under sections 143(3) read with 144C of the Income-tax Act, 1961, challenging transfer pricing (TP) adjustments relating to market support services and administrative support services. The Assessing Officer (AO), following the Transfer Pricing Officer’s (TPO) order and the Dispute Resolution Panel (DRP)’s directions, made adjustments of ₹34.67 lakh in respect of market support services and ₹3.15 crore in respect of intra-group administrative support services. The assessee also challenged the selection of comparables, denial of working capital adjustment, and refusal to grant risk adjustment. The assessee had adopted the Transactional Net Margin Method (TNMM) as the most appropriate method for benchmarking its international transactions. The company was engaged in the purchase and sale of ophthalmic products and life science products in India, besides rendering marketing support services and administrative support services to its Associated Enterprises (AEs).

Market Support Services – Comparable Selection

The dispute regarding market support services primarily related to the inclusion of Just Dial Ltd. as a comparable. The TPO and DRP considered Just Dial functionally comparable on the ground that it provided information services and facilitated interaction between buyers and sellers.

The assessee contended that it was merely a captive marketing support and liaison service provider rendering services exclusively to its AE, whereas Just Dial operated an independent search platform through multiple media, owned significant brand value, and dealt with numerous products and customers.

The Tribunal examined the Functions, Assets and Risks (FAR) analysis and held that Just Dial Ltd. was not an appropriate comparable. It observed that Just Dial functioned as a multi-platform search engine dealing with diverse products and services, while the assessee merely rendered captive liaison and marketing support services to its AE. Accordingly, the Tribunal directed that Just Dial be excluded from the list of comparables.

Working Capital Adjustment

The Tribunal noted that the DRP had already allowed working capital adjustment, but while giving effect to the DRP’s directions, the AO failed to grant the adjustment. It therefore directed the AO to rectify the assessment order and allow the working capital adjustment accordingly.

Risk Adjustment

The TPO had rejected the assessee’s claim for risk adjustment on the ground that the assessee had failed to demonstrate that the comparable companies had actually undertaken higher risks.

The Tribunal observed that the assessee was a captive service provider rendering services only to its AE and was not exposed to market risk, service liability risk, collection risk or capacity utilisation risk. The TPO had attributed only a single-customer risk to the assessee. The Tribunal held that this was merely an anticipated risk, whereas the comparable companies operated independently in the open market and actually faced existing marketing and technical risks.

The Tribunal distinguished between an anticipated risk and an existing business risk and held that the risks faced by the comparables were materially different from those of the assessee. It therefore directed that appropriate risk adjustment be granted to the margins of the comparable companies to achieve comparability.

Administrative Support Services

The assessee had paid ₹3.15 crore towards administrative support services to its AEs for IT support and accounting services, with the services being charged on a cost-plus 5% markup basis. The TPO determined the arm’s length price of these services at Nil, holding that the assessee had failed to establish receipt of services, derived no benefit from the services, produced no supporting evidence, and had no business need for such services.

The assessee submitted that it had entered into formal agreements with its AEs, produced agreements, invoices, emails and cost allocation details, and explained the allocation methodology based on the number of users, transaction volumes and full-time equivalent resources. It also explained that the shared service centres provided specialised expertise, standardised processes, confidentiality, and operational efficiency across group entities.

The Tribunal examined the documentary evidence placed on record and found no dispute regarding the actual receipt of services. It noted that the assessee had produced agreements, invoices, emails and detailed cost allocation workings demonstrating that the services had in fact been rendered.

On the benchmarking analysis, the Tribunal accepted the assessee’s economic analysis but directed exclusion of Pay Cheques Inc. from the comparables because it had extraordinary profits. After excluding that company, the Tribunal found that the arithmetic mean of the remaining comparable companies exceeded the 5% markup charged by the AEs. Consequently, the Tribunal held that the 5% markup satisfied the arm’s length standard, and no transfer pricing adjustment was warranted in respect of the administrative support service fees.

Decision

The Tribunal held that:

• Just Dial Ltd. was not a valid comparable for benchmarking the assessee’s market support services.
• Working capital adjustment already directed by the DRP should be granted by the AO.
• Risk adjustment should be allowed as the assessee, being a captive service provider, did not bear the same business risks as independent comparable companies.
• Administrative support services had actually been received, the documentary evidence substantiated the services, and the 5% markup was at arm’s length after excluding the extraordinary profit-making comparable.

Accordingly, the appeal of the assessee was allowed.

FULL TEXT OF THE ORDER OF ITAT DELHI

The present appeal has been filed by the assessee against the order dated 30.01.2017 passed by the AO u/s 143(3)/144C of the Income Tax Act, 1961.

2. Following grounds have been raised by the assessee:

“1. That the assessing officer (‘AO’) erred on facts and in law in completing the assessment under section 144C read with section 143(3) of the Income-tax Act, 1961 (‘the Act’) at a loss of Rs. 3,29,43,540 as against the loss of Rs. 6,79,40,379 returned by the appellant.

2. That the AO erred on facts and in law in making an adjustment of Rs.3,49,96,839 allegedly on account of the difference in the arm’s length price of the international transactions undertaken by the appellant on the basis of the order passed under section 92CA(3) of the Act by the Transfer Pricing Officer (‘TPO’).

3. That the AO/TPO erred on facts and in law in making adjustment of Rs. 34,67,344 to the income of the appellant on account of difference in the arm’s length price of the international transaction of provision of market support services to the associated enterprise.

3.1 That the AO/TPO erred on facts and in law in considering Just Dial Ltd. as comparable not appreciating that the audited financial statement of the company for the financial year 2011-12 is not available in public domain and also do not satisfy the comparability criteria laid down in rule 10B(2) of the Income Tax Rules, 1962 (‘the Rules’).

3.2 That the AO/TPO erred on facts and in law in rejecting the following comparable companies considered by the appellant in the Transfer Pricing Documentation not appreciating that these companies are functionally comparable to the appellant:

3.3 That the AO/TPO erred on facts and in law in rejecting comparability adjustment on account of working capital employed by the appellant vis-a-vis comparable companies.

3.4 That the AO/TPO erred on facts and in law in not allowing appropriate risk adjustment to establish comparability on account of the appellant being a low-risk-bearing captive service provider as opposed to the comparable companies who were independent comparable companies.

3.5 That on the facts and in the circumstances of the case and in law, the AO/TPO erred in rejecting the contention of the appellant regarding risk adjustment, allegedly holding that no evidence has been provided by the appellant to prove that risk has actually been undertaken by the comparable companies.

4. That the AO/TPO erred on facts and in law in making an adjustment of Rs. 3,15,29,495 on account of arm’s length price of the international transaction of receipt of administration support services on the basis of the order passed under section 92CA(3) of the Act by the TPO.

4.1 That the AO/TPO erred on facts and in law in determining the arm’s length price of the international transaction of payment of administration support services fees at NIL allegedly concluding that no such service/ benefit has been received by the appellant and therefore, there is no rationale for paying this support services fees to the associated enterprise.

4.2 That the AO/TPO erred on facts and in law in allegedly holding that the appellant failed to place on record any documentary evidence substantiating receipt of administrative support services from the associated enterprises.

4.3 That the AO/TPO erred on facts and in law in computing adjustment on account of international transaction of payment of administration support service fee without reasonably applying any prescribed methods, thereby, violating the basic principles of TP regulations.”

3. Corning Technologies India Pvt. Ltd. (CTIPL) was incorporated on 02.06.2009. The company is engaged in the business of purchase and sale of ophthalmic glass products, ophthalmic plastic lenses and life science products in the Indian market and rendering marketing services and support services to its Group companies. CTIPL has taken over the entire business of Corning India, on a slump sale basis w.e.f. 01.02.2012, pursuant to the approval of the Reserve Bank of India for a purchase consideration of Rs.19,44,70,482/-.

4. In accordance with the provisions of Section 92C r.w. Rule 10B & 10C, the assessee has choosen TNMM as the most appropriate method vide order u/s 92CA(3) dated 29.01.2016. The TPO determined ALP of the transactions and proposed an adjustment of Rs.3,49,96,839/- vide order dated 11.03.2016. The AO pursuant to the directions of the ld. DRP made adjustments of Rs.3,15,29,495/- on account of Intra Group Services and Rs.34,67,344/- on account of market support services.

5. The assessee mainly involved in three different activities namely ophthalmic support, marketing support and provision of Intra Group services.

6. With reference to the marketing research, the assessee appraises the AE of current market trends and developments in India by monitoring the industry, capital prices, political factors, supply and demand of the relevant Indian market in addition to identifying the potential customers in India. It is also involved in providing support and liason between the customers and Corning France (AE).

Comparables:  

7. With regard to the comparables selected by the AO in his TP study, the assessee objected to the inclusion of “Just Dial Ltd.” The TPO held that it is functionally comparable to the assessee, as the comparable also provides information to the users and connects the buyers to the sellers, the same way “Just Dial” operates. The ld. DRP confirmed the inclusion holding that since the comparable is effectively involved in marketing the information pertaining to different categories of SMEs across multiple platforms and is facilitating trade transactions.

8. Before us, it was argued by the ld. AR that “Just Dial” is having a website and the search service is available to users across multiple platforms such as internet, mobile, voice and text. It was argued that the assessee is a captive service provider providing services only to its AE, and is devoid of any excess remuneration attributable to “brand ownership”.

9. The ld. DR argued that what needs to be seen is the functional commonality but not any other issues or functional dissimilarities. It was argued that both the assessee and the comparable in question (Just Dial) are involved in getting new clients, customers to the principle. It is the common functionality that both entities are involved in client procurement and liason work.

10. Having gone through the facts on record and the FAR analysis, we find that while “Just Dial” is a search engine for multifarious activities and is a search engine using different platforms, dealing with multiple products whereas the assessee is a captive liason and marketing service provider for its AE. Hence, we hold that “Just Dial” cannot held to be a right comparable.

Working Capital Adjustment:

11. With regard to capital adjustment, we find that the ld. DRP allowed the working capital adjustment, however the AO failed to take the cognizance of the same while giving effect to the ld. DRP directions. Hence, the AO is directed to rectify the orderto that extent.

Risk Adjustment:

12. With regard to the risk adjustment, the TPO denied risk adjustment on the grounds that the assessee has not clearly shown that the comparables had actually undertaken risks.

13. The ld. DRP held that in cross border transactions, the tested party will typically always be a captive while comparables will always be entrepreneurs for ALP determination. It held that risks can be adjusted only if there is complete and reliable data available otherwise the entire exercise will be tainted by the inaccuracies.

14. Hence, the question before us would be whether the risk of having a single customer is equivalent to the marketing and technical risks attached to the comparable. A single customer risk is an anticipated risk ab initio. The anticipated risk may happen or it may not happen. Whereas the risk attributed to the comparables is an existing risk. At the same time, we find that the assessee is not exposed to any of the risks such as market risk or service liability risk, collection risk, capacity utilization risk for the AE being the sole customer. The question before us is as to whether the risk of having a single customer is equivalent to the marketing and technical risk attached to the comparables. According to the TPO, the assessee has the ‘single customer risk’ meaning, if the single customer refuses to have any dealings with the assessee, the assessee would lose all of its business and there would be no profit at all. But, as we see it, the risk of having a single customer is anticipated risk which may or may not happen. What we have to see is the position in the relevant period whether the appellant had encountered such a risk during the relevant period or not .

15. In the instant case, it can be seen that the assessee has not encountered the risk of having a single customer, whereas the same cannot be said as regards the comparables. The comparables were dealing in open market and therefore, they were prone to the marketing and technical risks. They would invariably incur certain expenditure on marketing services and also to safeguard the technical inputs used by them. In such a case, the risk encountered by the assessee cannot be said to be the equivalent risks attached to the comparables. The risk attributed to the assessee by the TPO is an anticipated risk whereas the risk attributed by the assessee to the comparables is an existing risk. In such situation, we direct that the risk adjustment be accorded to the net margin of the comparables for bringing them on par with the assessee company.

Administrative Support Services:

16. During the financial year 2011-12, the assessee received “Administrative Support Services” from its associated enterprises for assisting it in carrying its business operations in India. For the aforesaid services, the assessee paid administrative and support service fees amounting to Rs.3,15,29,495/- to the following associated enterprises:

17. In the Transfer Pricing Documentation, for the purpose of benchmarking, the assessee applied TNMM as the most appropriate method considering itself to be the tested party. The assessee conducted two separate searches on Onesource Database for determination of the arms length price of the international transactions undertaken with Corning Inc. and Corning China. The results of the benchmarking analysis is summarized as under:

18. It was submitted that since the mark up earned by Corning China and Corning Inc. at 5% for rendering of support services to the assessee is lower than the average operating profit margin of the comparable companies, therefore, the international transaction of receipt of administrative support services can be considered to be at arm’s length.

19. The TPO determined the value of such “expenditure” at ‘NIL’ holding that:

a. No services were actually received by the assessee

b. No benefit was derived by the assessee by making payment for Administrative Support Services

c. No evidence was furnished substantiating the receipt of administrative services

d. The services were not actually needed by the assessee

20. The ld. AR argued that during the relevant financial year, the assessee paid administrative and support fees of Rs.3,15,29,495/- to the associated enterprises which are remunerated at a cost plus 5 percent markup, wherein, cost includes all direct and indirect cost incurred in the provision of aforesaid services. This entails payment of all fixed costs, recognized on the basis of time spent by the service provider, and the same is allocated to the service recipient on the basis of the volume of usage, plus a mark-up of 5 percent.

21. For provision of administrative support services, the assessee entered into the following agreements with its associated enterprise namely Corning China (Shanghai) Regional Headquarter for the purpose of Accounting services and with Corning Inc., United States for the purpose of IT Support.

22. Cost allocation keys applied by respective associated enterprises for the purpose of allocating expenses to group entities alongwith the invoices raised by the associated enterprises are as under:

23. Similarly, accounting services provided by Corning Shanghai in the nature of processing of accounting vouchers, sanctioning of payments, undertaking monthly closings, and various other accounting processes to other group entities, rather than each entity maintaining its own department to undertake such functions, and incurring costs in this regard.

24. It was argued that the shared service centers offer the advantage of economical, specialized services, expertise in terms of knowledge of Corning products, adherence to Corning culture, Corning rules and procedures and most importantly confidentiality. Apart from that, the shared service centers cater to all Corning entities based out of Asia and the volumes of transactions of the assessee are very less compared to the volume of other Corning Asian entities.

25. It was argued that outsourcing the same, work to third party vendors would not only involve training them in Corning group’s procedures and infrastructure but also involve a compromise on data confidentiality as well as on the stability of the services. Further, if each group entity is expected to contract with local vendors themselves, the group’s operations as a whole will not only become far more expensive but also inefficient since each group entity will be replicating the same work and multiple third party vendors shall be involved in processing the same transactions. Arguing thus, the ld. AR canvassed that the mark-up of 5% on the services is to be allowed.

26. The entire grounds consists of two issues, whether in fact the services were rendered and availed by the assesse and if so, whether the mark-up of 5% can be considered as comparable with the market averages. Culling from the details filed and arguments of both the parties, we find that there is no dispute about availing of the services. The evidences include the e-mails, invoices, agreements submitted at page nos. 294 to 397 of the paper book. The assessee has also provided details of cost allocation at page nos. 285 to 288 of the paper book. Hence, it cannot be said that the services have not been provided to the assessee. With regard to the mark-up of 5% paid by the assessee, we find that the economical analysis submitted by the assessee at page nos. 121 to 128 of the paper book is acceptable at the same time, the comparable namely, Pay Cheques.Inc. showing the OP/OC of 56.12% is being excluded owing to the extraordinary profits. Taking into consideration, the remaining comparables, we find that the arithmetic mean is more than the 5% mark-up charged from the company. Hence, we hold that no adjustment is called for while determining the ALP on account of payment for Intra Group Services.

27. In the result, the appeal of the assessee is allowed. Order Pronounced in the Open Court on 17/09/2021.