Incentive paid to the employees by the employer’s parent company pursuant to takeover does not require any mark-up

Income Tax Appellate Tribunal (“The Tribunal”), Delhi Bench recently pronounced its ruling in the case of M/s Ari cent Technologies (Holding) Limited Vs. DCIT (Appeal No. ITA No. 4699 /Del. /2010) for AY 2006- 07, on the amount paid as incentive to employees of the Taxpayer by its parent company pursuant to transaction of takeover for the employees’ retention. The Tribunal held in favor of the Taxpayer observing that transaction does not have any element of income for the purpose of making an adjustment to the price of the said international transaction and is merely in the nature of reimbursement of incentive paid by Taxpayer to its employees.

Facts

The Taxpayer is engaged in business of designing packaged software and providing software consultancy services and was taken over by Flextronics International Singapore Pte Ltd being an Associated Enterprise (AE). AE is original equipment manufacturers and did not have any previous experience in the software business. It was anticipated that some of the employees may leave the organization. Accordingly, to retain the employees of the Taxpayer, the AE paid them incentive over a period of three years. Since AE couldn’t pay the amount directly to the employees of the Taxpayer, the transaction was routed through the books of Taxpayer.

The Transfer Pricing Officer (“TPO”) held that the Taxpayer had received payment towards technical services rendered to its AE and showing it as an incentive was just a colorable device to avoid paying a mark-up on these receipts. The operating profit margin on costs (OP/TC) margin of the Taxpayer was 27.95%, excluding the international transaction. TPO observed that since the payment by AE has been made without any mark-up, such payment is not at arm’s length. TPO applied the mark-up of 27.95% on the international transaction and accordingly made an upward adjustment.

Dispute Resolution Panel (“DRP”) also upheld and confirmed the order of TPO.

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