Brief of the case
In the case of Venture Infogain India Pvt. Ltd vs. Dy.Commissioner of Income Tax ITAT has held that 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. Moreover, it is an admitted fact that in the preceding years as well as in the succeeding year i.e. assessment year 2011-12, the same method i.e. Profit Split Method has been accepted by the department. Therefore, we are of the view that the TPO/AO was not justified in applying the TNMM method instead of Profit Split Method adopted by the assessee.
Facts of the case
1. The assessee was engaged in the business of software development and filed the return of income on 30.03.2010 declaring income of Rs. 1,41,28,871/- which was processed u/s 143(1) of the IT Act, 1961. Later on the case was selected for scrutiny.
2. 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.
3. It was stated before the DRP that the entire pricing decision based on project costing estimates, resource requirements, time ommitments has entirely shifted to Infogain India (the assessee). The TP study undertaken has, on the basis of fuctions/responsibilities and based on interviews with the key management personnel of the Infogain US and Infogain India, identified the functions in the value chain of software services provided by Infogain US and Infogain India to customers based in US and assigned weightages to the functions.
4. The DRP after considering the submissions of the assessee rejected the objection of the assessee by holding that We have nowhere in the submissions, or during the course of discussion seen that the assessee has made any attempt by evaluating the contribution made by Infogain India and Infogain US on the basis of FAR of each one of them and have reliably employed any external market data which may be indicative of how such contribution would be evaluated by unrelated enterprises performing comparable functions in similar circumstances. The moot issue here is to reasonably and reliably identify a basic return appropriate for the type of international transaction in which the parties 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.
5. Accordingly, the DRP directed the TPO/AO u/s 144C of the Act to complete the assessment. On the directions of the DRP the AO completed the assessment vide order dated 01.10.2012 and made the adjustment.
Aggrieved against the said decision, the assessee has filed an appeal before ITAT
Whether The AO/DRP has erred on the facts and circumstances of the case and in law in rejecting/disregarding the profit split method in the Transfer Pricing and follow TNMM method 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. parentcompany. And thereby made addition of Rs 145289630/- on a/c of transfer pricing adjustment.
1. in the relevant assessment year there was a significant change in the functional matrix of the Infogain Group, with Infogain India assuming critical delivery functions and the corresponding. There was a process shift with the formation of Global Delivery Organization (GDO) in Infogain India and Client Service Organization (CSO) in Infogain US. during the initial years of the formation of Infogain Group, the execution and delivery of the software services as well as the marketing of these services was handled from Infogain US. To support such a structure, consequently all the key personnel/decision makers were stationed in Infogain US. However, gradually the fulcrum of the entire business witnessed a shift towards India. Therefore, the organizational structure was aligned by client services and delivery function and currently the team at Infogain US has been reduced to one-fourth since the conversion year.
2. 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.
3. That the Infogain India is responsible for program and project execution, customer satisfaction and technical support. The said work is undertaken through coordinated efforts of various teams including Global Resource Management, Global Process Management, Delivery Practices, Strategic Delivery Practice and Local Delivery Management. It was further stated that during the initial years of the formation of the Infogain Group, the execution and delivery of the software services as well as the marketing of these services was handled from Infogain US. However, gradually the fulcrum of the entire business witnessed a shift towards India.
4. That in the pre-restructuring phase, Infogain US was solely responsible for determining the key terms and conditions of the contract with the customers, including pricing. However, with the introduction of an online costing tool in August 2006, Infogain India also began to provide important inputs in the entire pricing decision based on project costing estimates, resource requirements, time commitments etc. as the entire delivery responsibility had migrated to Infogain India.
5. That the 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.
6. That the Rules provide that, under the TNMM, the net profit margin realized by the enterprise from a comparable uncontrolled transaction is taken into account to arrive at an Arm’s length in relation to the international transaction. However, from the functional analysis of the assessee, it is clear that the operations of Infogain India and Infogain US are inextricably linked, involving fungibility of human resources, making it difficult to evaluate either entity separately as both the entities were vested with critical functions and risks for providing software services to the end-customers. Therefore, the TNMM method was not considered as most appropriate method for determining the Arm’s length basis.
7. That in the assessment year 2011-12 also the Profit Split Method has been accepted while framing the assessment u/s 92CA(3) of the Act vide order dated 16.12.2014 (copy of the said order was furnished, which is placed on record). It was stated that the assessee’s case is also covered by the decision of the ITAT Delhi Bench ‘I’, New 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 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.
8. that the applicability of the method is based on interrelated transactions. He referred to page no. 243 of the assessee’s paper book and submitted that the grouping of function has been done and weight has been assigned to each function for which neither the TPO nor the DRP raised any objection. It was further stated that in the succeeding assessment year 2009-10, no such adjustment has been made by the department, even when the facts in the said year were similar as were involved in the year under consideration. It was submitted that even on the principle of consistency, the department ought to have accepted the PSM method adopted by the assessee.
1. 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 not conclusive for the assessment year under consideration i.e. assessment year 2008-09. It was further submitted that in the assessee’s case there was no international transaction, therefore, the PSM was not the most appropriate method. It was stated that for applying the PSM, risks is to be quantified in scientific manner on creditable objectives information which had not been done in the present case.
2. that in assessee’s case no external data was available for uncontrolled transaction to substantiate the relative contribution by each entity, therefore, the split was not evenly placed. It was further stated that few of the functions were not listed and that the commitments, contract formation, engagement management function were not mentioned.
3. That there was no sales strategy for soliciting the orders and there was only subjective estimation without any objective data and there was no basis for giving the weightage. that Circular No. 6 issued by the CBDT has no relevancy for the functional profile of developer in R&D sector. Therefore, the PSM was not applicable in assessee’s case and the TPO/AO rightly applied the TNMM method as most appropriate method. The reliance was placed on the following case laws: Haworth (India) (P) Ltd. Vs DCIT(OSD) (2011) 131 ITD 215 (Del) and Sony India (P) Ltd. Vs DCIT (2008) 114 ITD 448 (Del)
4. The Ld D.R submitted that the Ld CIT(A) has upheld the disallowance, in principle, but set aside the matter to correct the clerical mistakes.
Tribunal decision / observations
1. 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 case of Aztech Software and Technology Ltd. Vs ACIT (supra), OECD in transfer pricing guidelines for multinational enterprise and tax administration, the United Nations-Practical manual on Transfer Pricing for developing countries and then after deliberating on the methodology and precedence available thereon arrived at a conclusion in para 17.3 to 18.2.
2. 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 case, the different activities performed by the Infogain India i.e. assessee and Infogain US are inextricably linked and both the entities are contributing significantly to the value chain of provision of software services to the end customers. In the instant case Global Delivery Organization Group (GDO) in India is responsible for delivery of services to the customers globally. The primary objective of the group is to bring synergies amongst geographic groups and project, to make efficient use of the available resources, to broaden areas of service offerings, to improve opportunity fulfillment ration, and to maximize customer satisfaction with each project execution.
3. The explanation of the assessee was that though the transition process started from September 2005 which was very gradual and led to the complete shift in the functional matrix of Infogain Group over a period of 2-3 years, therefore, the pricing model was changed w.e.f April 2007, the said explanation appears to be a plausible. In the instant case, the assessee assigned weights to each activity keeping in view the relative importance in the entire value chain, based on interviews with the key management personnel and the functions in the value chain of software services provided by the Infogain Group to the customers based in the US were identified and weights were assigned to the functions having regard to their relative importance in the value chain
4. In the present case, both the parties i.e. Infogain India (assessee) and Infogain US are making contribution. Therefore, the Profit Split Method is the most appropriate method for determination of ALP. In the instant case, it is noticed that the TPO in the show cause notice has pointed out that the assessee changed the method due to loss incurred, in our opinion, the conclusion drawn by the TPO was not justified because the decision as what is the most appropriate method does not depend on the fact as to whether an assessee is having loss or has a profit.
5. In the present case, Infogain India i.e the assessee is responsible for the significant delivery functions while Infogain US is responsible for the marketing client identification and customers relation management functions. However, the activities performed by the Infogain India and Infogain US are inextricably linked with both entities contributing significantly to the value chain of provision of software services to the end customers.
6. Therefore, by keeping in view the aforesaid discussion and considering the totality of the facts we are of the view that Profit Split Method was rightly applied by the assessee for determining the arm’s length price. Moreover, in the instant case, it is an admitted fact that in the preceding years as well as in the succeeding year i.e. assessment year 2011-12, the same method i.e. Profit Split Method has been accepted by the department. Therefore, we are of the view that the TPO/AO was not justified in applying the TNMM method instead of Profit Split Method adopted by the assessee.
7. For the aforesaid view we are fortified by the following decisions of the Coordinate Bench:
8. now question arises that how the allocation is to be done for residuary profits. It is well settled that as per the Rule 10D, the benchmarking should be done with the external uncontrolled transactions, however, in the present case, it is not possible to get a comparable. Therefore, such allocation can be done on the basis that how much each independent enterprise might have contributed. Therefore, relative contribution has to be determined, based on key value drivers because benchmarking is not practicable.
9. Both the OECD Transfer Pricing Guidelines as well as the N draft method of transfer pricing for developing countries, suggest that an allocation of residual profits under PSM should be done, based on contributions by each entity. In the present case, since the department has accepted in the preceding year and the succeeding year 40:60 ratio between the Infogain India and Infogain US and if the facts are similar for the year under consideration then no deviation is to be done.
10. We, therefore, set aside the issue to file of the AO/TPO to decide the issue following the clear directions given in former part of this order as well as by the Coordinate Bench in the aforesaid referred to orders.
Analysed by CA Rahul Sureka