ITAT Delhi Rejects Segmentation of Trading and Service Activities in Transfer Pricing Case

ITAT: Rejects Revenue’s segregation approach, notes trading & service segments are interconnected

Summary: The case of Juniper Networks Solution India Pvt. Ltd. v. Assessment Unit (NFAC), addresses the central transfer pricing issue of functional segmentation concerning Juniper Networks Solution India Pvt. Ltd. (JNSIPL), a Limited Risk Distributor. JNSIPL aggregated its product distribution (trading) and after-sales support (service) for benchmarking under the Transactional Net Margin Method (TNMM). However, the Transfer Pricing Officer (TPO) and Dispute Resolution Panel (DRP) insisted on segregating these functions, applying TNMM separately to the trading segment and allocating common costs mechanically based on the revenue ratio. The Income Tax Appellate Tribunal (ITAT) rejected the Revenue’s approach, observing that JNSIPL’s after-sales services—such as warranty support and software updates—were ancillary to and functionally interdependent with the core trading activity. The services were found to be a “natural extension” of the sales function, existing only to facilitate product sales and ensure brand reliability. Finding that both segments shared the same organizational structure and systems, the ITAT concluded that the Revenue’s mechanical segregation lacked proper Functional, Asset, and Risk (FAR) analysis and distorted profitability. Consequently, the Tribunal directed that the trading and service activities, being economically inseparable and forming a single, cohesive business model, must be aggregated, and TNMM should be applied at the entity level.

Facts:

• The assessee, Juniper Networks Solution India Pvt. Ltd. (JNSIPL), is a wholly owned subsidiary of Juniper Networks International BV (JNIBV), Netherlands, a global leader in networking and cybersecurity solutions. The Indian entity was incorporated in December 2017 to carry out distribution, marketing, sales, and customer support activities for Juniper’s networking products and software solutions in India.
• JNSIPL functions as a Limited Risk Distributor (LRD) for its Associated Enterprise (AE), JNIBV. In this capacity, it imports networking equipment, software, and related components from its AE and resells them to customers in India. It also engages in merchant trading transactions (MTT), wherein goods are shipped between two foreign countries without physically entering India. Apart from trading operations, the assessee provides after-sales and maintenance support services, including annual maintenance contracts (AMC), software updates, hardware repair, and technical assistance to customers purchasing Juniper products.
• For the Assessment Year (AY) 2020–21, the assessee filed its income tax return on 12 January 2021, declaring a loss of Rs.49.78 crore and book profit under section 115JB at nil. The case was selected for scrutiny under the Computer Assisted Scrutiny Selection (CASS) mechanism for examination of specific issues such as claims of deductions, imports, and international transactions.
• In view of the assessee’s cross-border dealings, the Assessing Officer (AO) referred the matter to the Transfer Pricing Officer (TPO) under section 92CA(1) to verify the arm’s length nature of its international transactions. The assessee had adopted the Transactional Net Margin Method (TNMM) as the most appropriate method, applying it at the entity level by aggregating both trading and service activities on the ground that they were functionally interdependent and formed part of a single, integrated business model.
• The TPO, however, disagreed with the assessee’s approach. He held that the trading and service functions were distinct in nature, involving separate functions, assets, and risks, and therefore could not be benchmarked together. The TPO consequently segregated the financial results of the two segments and applied TNMM only to the trading segment, resulting in a transfer pricing adjustment of Rs.16.86 crore.
• Aggrieved, the assessee filed objections before the Dispute Resolution Panel (DRP). The DRP upheld the TPO’s approach in treating trading and service activities as separate segments but granted relief in respect of working capital adjustment. Upon giving effect to the DRP’s directions, the TPO found that the assessee’s margins fell within the arm’s length range, thereby reducing the TP adjustment to nil. However, the core issue of functional segmentation was sustained. The assessee, still contesting the segregation of trading and service operations, carried the matter in appeal before the Income Tax Appellate Tribunal (ITAT), Delhi Bench.

Issues:

• Whether the trading and service activities of the assessee could be segregated for transfer pricing purposes.
• Whether the Transactional Net Margin Method (TNMM) should be applied at the entity level or segment level.
• Whether the authorities were justified in allocating costs between trading and service segments merely on the basis of revenue ratio.

Observations:

• The Tribunal observed that Juniper Networks Solution India Pvt. Ltd. was primarily engaged in trading of networking equipment and software imported from its Associated Enterprise, Juniper Networks International BV, Netherlands. The after-sales and maintenance services provided by the assessee, such as warranty support, repairs, and software updates, were found to be closely linked to the trading activity. These services were not independent or stand-alone operations but formed part of the overall distribution and sales function. The Tribunal observed that the services were ancillary to the trading business, intended to facilitate product sales, ensure customer satisfaction, and maintain brand reliability.
• It was further observed that the TPO and DRP had erred in treating the trading and service segments as independent business lines without conducting a proper functional, asset, and risk (FAR) analysis. The authorities had simply allocated common expenses such as employee and administrative costs on a revenue ratio basis and benchmarked the two segments separately. This approach, in the Tribunal’s view, was mechanical and not supported by the functional realities of the assessee’s business. The services could not exist without the trading activity; they were dependent on the sale of products imported from the AE. The Tribunal remarked that the services segment was a natural extension of the trading business, much like the “chicken and egg story,” where the two activities are mutually dependent.
• The Bench referred to the agreement between the assessee and its AE, which explicitly provided that Juniper Networks Solution India Pvt. Ltd. would market, distribute, and provide customer support for Juniper products in India. The definition of “Customer Services” in the agreement included product maintenance, software updates, technical assistance, and professional training—all of which were integral to the distribution activity. The Tribunal also examined the assessee’s revenue recognition policy, which reflected that hardware, software, and post-sale maintenance formed part of a single performance obligation under customer contracts. This clearly established that the trading and service revenues were functionally and economically integrated.
• The Tribunal found that both segments shared the same organizational structure, personnel, and management oversight. The financial and operational systems were common for both functions, and costs could not be accurately or reasonably divided without distorting profitability. Therefore, benchmarking the trading activity in isolation from the service function would not represent the true profit level of the assessee. The functional overlap and economic interdependence demonstrated that both activities together constituted one cohesive business model.
• The Tribunal emphasized that transfer pricing rules permit aggregation of transactions where they are closely linked and continuous in nature. Citing this principle, it held that in Juniper’s case, the trading and after-sales service activities were interdependent and had to be evaluated together under the Transactional Net Margin Method (TNMM) at the entity level. The authorities’ failure to recognize this integration had led to an artificial segmentation and incorrect analysis of the assessee’s profitability.
• In conclusion, the Tribunal held that the Revenue’s approach of separating the trading and service functions was unsustainable. The trading and service segments were found to be functionally interlinked and economically inseparable, forming part of one unified business operation. Accordingly, the Tribunal directed that TNMM be applied at the entity level for transfer pricing purposes and allowed the assessee’s appeal on this issue.