Brief of the case:- The Hyderabad bench of the Income Tax Appellate Tribunal (Tribunal) recently pronounced its ruling in the case of ADP Private Limited Vs. DCIT (Hyderabad Bench), ITA No: 155/Hyd/2009 , on transfer pricing issues arising from provision of software services by the Taxpayer to its Associated enterprise (AE). The Tribunal ruled in favor of the Revenue upholding the adjustment proposed by the Transfer Pricing Officer (TPO).
Facts of the case
The Taxpayer is engaged in rendering software development services to its AE. During the AY 2004-05, the Taxpayer has provided software services to its AE at Cost plus markup of 10% and received a sum of Rs 39,04,34,858. The Transfer Pricing Officer (TPO) rejected 10 com parables from 14 com parables selected by the Taxpayer on the ground that they had substantially related party transactions or the companies were functionally different. The TPO computed the arithmetic mean of operating profit/cost of remaining 4 com parables at 17.66% and calculated the adjustment.
Being aggrieved by the said transfer pricing order, the Taxpayer filed an appeal before the Commissioner of Income Tax – Appeals i.e. the CIT (A). The CIT (A) upheld the action of TPO but accepted the contention of Taxpayer to provide marginal benefit of 5% margin to the Taxpayer. Hence CIT(A) reduced the adjustment to only Rs 42,82,338.
Aggrieved by the order of the CIT(A), Taxpayer as well as Revenue preferred appeals before the Tribunal.
Ruling of the Tribunal
The salient aspects of the Tribunal s order are as follows:-
1. The Tribunal rejected the contention of the Taxpayer for providing Working Capital and other risk adjustments in accordance with Rule 10B(1)(e) on account of differences in the risk profile of the taxpayer and independent companies selected as com parables. The reasoning given by Tribunal were:
─ At the time of compilation of Transfer Pricing Documentation (TP Study), the Taxpayer has not quantified or identified any differences, while undertaking the FAR analysis and no adjustment was made on account of differences if any.
─ Risk Adjustments can be given only on company to company basis, considering the peculiar facts and circumstances of the case. Further there is no thumb rule for allowing such risk adjustment.
2. The Taxpayer has agreed with the rejection of eight of the ten comparables rejected by the TPO. However with regards to the remaining two disputed comparables, namely Aztec Software & Technology Services Ltd and Quintegra Solutions Ltd, the Tribunal upheld the decision of CIT(A) wherein it was decided to reject them on the basis of substantial related party transactions of more than 25% of the total sales and financial results of one company are for different year ending as compared to Taxpayer’s Financia year end.
3. The Tribunal upheld the decision of the lower tax authorities of rejecting the use of contemporaneous data (data existing by the due date of filing of return of income) and multiple year data (latest data of last 2 years preceding the current year) by the Taxpayer of comparable companies in determination of ALP as the same was not in accordance with Rule 10B(4) of Income Tax Rules.
4. The Tribunal accepted the Revenue’s appeal of non-allowance of adjustment of 5% as per section 92C(1) of the Act by giving following reasons:
─ Where the ALP has been determined by applying only one out of the several methods specified under section 92C(1) of the Act, the Taxpayer is not entitled for deduction of 5% adjustment from the ALP as stipulated under section 92C (2) of the Act. The Tribunal relied on decision of Delhi Bench of the Tribunal in the case of Perot Systems TSI [India] Ltd. [ 5 ITR 106]
─ The Tribunal decided that decisions relied on by the Taxpayer including that of Sony [India] Pvt. Ltd. (supra) do not apply to the facts of the instant case. Further Tribunal decided that even the Circular No.12 dated 23-08.2001 issued by the CBDT does not apply to the case of Taxpayer as the price variation is more than 5% and said Circular No. 12 is applicable only if the variation in price with the AE vis-â-vis the unrelated party is within [+] or [–] 5%.
The ruling is significant since it deals with many contentious transfer pricing issues faced by Taxpayers especially in the IT/ITES industry. The Tribunal did not allow the working capital and risk adjustments to the Taxpayer on the basis that the same were not quantified or identified in the TP study. The Tribunal has not provided any substantive reasons on why such adjustments were not relevant under the comparability standards prescribed in the Indian rules. Therefore whether non-inclusion of risk and other adjustments in the TP study can by itself prevent the taxpayer from claiming these adjustments during the appellate proceedings remains debatable until further jurisprudence develops on the matter.
The ruling also highlights the need for selecting robust com parables in the bench marking analysis in the TP study to avoid mass rejection by the TPO during the audit proceedings.