Case Law Details
M/s. CLSA India Private Limited Vs DCIT (ITAT Mumbai)
Facts of the case:
The assessee company, i.e. CLSA India Private Limited is a subsidiary of Credit Lyonnais Securities Asia (CLSA) incorporated in Netherlands. The assessee is primarily engaged in the business of equity broking. The assessee’s customers comprise of foreign institutional investors (FIIs) and domestic institutional investors (DIIs). As submitted by the assessee, it had no international sales presence or capability to maintain client relationship with FIIs on global basis or internal resources to undertake various activities like regional research or perform various back-office functions. Hence, the assessee entered into agreements with its AEs (CLSA Hong Kong and CLSA Singapore) for availing international equity sales support, sales trading support and regional research as well as a range of back-office support services.
The compensation for such intra-group services to its AEs was considered as international transactions and benchmarked by the assessee by selection and application of transactional net margin method (TNMM) as the most appropriate method.
During the transfer pricing assessment, to substantiate its claim, the assessee inter alia submitted copies of service level agreement entered into with its AEs, description of services and summary of benefits, supplementary benchmarking analysis, documentary evidence to prove services rendered by the intra group under the heads administration, broking management, client management, etc. The assessee also submitted description of the various services, head-wise breakup of the payments and cost allocation as per keys provided in agreement.
Action of TPO:
During the transfer pricing assessment, the transfer pricing officer (TPO) did not accept the entity level benchmarking. The TPO stated that the cost contribution constituted a small part of the total transactions, therefore, the profit margin at the entity level could not be the basis for determining the ALP and thus, the TNMM should not be considered as the most appropriate method. The TPO estimated certain man-hours for the services rendered by the AE to the assessee and determined the arm’s length compensation of the services. The Dispute Resolution Panel upheld the contentions of the TPO and aggrieved with the same, the assessee filed an appeal before the Hon’ble Income-Tax Appellate Tribunal (Hon’ble Tribunal).
Observations and conclusions of the Tribunal:
1. Application of CUP as the most appropriate method by the TPO:
a. The TPO has made the transfer pricing adjustment purely on an estimation basis without any supporting material. The TPO has mentioned that arm’s length price has determined by applying CUP method but in fact he has not come up with any comparable circumstances to substantiate the same.
b. So, in view of the above, there is no reason to reject the TNMM applied by the assessee.
c. The Hon’ble ITAT placed reliance on the decision of jurisdictional High Court in the case of Johnson & Johnson Ltd.to conclude that the law does not permit the TPO to determine the arm’s length price on estimation and application of a method is mandatory.
2. Application of CUP as the most appropriate method by the TPO:
a. The Hon’ble Tribunal observed that the intra-group services availed by the assessee are closely linked to the business of the assessee
b. Further, the Hon’ble Tribunal also noted that decision of the Delhi Tribunal in the case of Knorr Bremse, has held that payment of intra group services may be benchmarked using TNMM as the most appropriate method.
3. Based on the above, the Hon’ble Tribunal concluded that transfer pricing adjustment made by the TPO on an ad hoc basis is not sustainable in law and thus, the assessment order passed by the AO pursuant to the directions passed by the DRP under section 144C of the Income-tax Act, 1961, is also not sustainable in law.
4. Restoring the matter to the file of TPO:
a. The Hon’ble Tribunal relied on the Bombay High Court (Bombay HC) decision in the case of Kodak Indiawherein the HC had declined to restore to the file of TPO holding that the methods as prescribed by the legislature are mandatory and not directory. The Bombay HC held that when the mandatory provision is either superseded or ignored it affects the jurisdiction. Since, the TPO did not adhere to the prescribed methods consciously, another innings to rectify the mistake cannot be allowed.
b. The Hon’ble Tribunal relying on the decision of Bombay HC concluded that the issue cannot be restored to the file of the TPO to determine the arm’s length price by applying most appropriate method out of the prescribed methods under the provisions of law.
Important principles:
It has been laid down that the TPO is bound to determine the ALP by following one of the prescribed methods under section 92C. Any ad-hoc determination of arm’s length price by the TPO under section 92 de-hors section 92C(1) of the Act cannot be sustained. This contention is supported by the judgement of the Hon’ble Bombay High Court in the case of Merck Ltd, wherein the HC declined to interfere with the findings of the Mumbai Tribunal that the transfer pricing adjustment made by the TPO without following one of the prescribed methods makes the entire transfer pricing adjustment unsustainable in law.
It is interesting to note that in an earlier Tribunal decision in the case of Ascendas, for benchmarking the international transaction of sale of shares, the Tribunal had accepted the Discounted Cash Flow (DCF) method of valuation by application of CUP method. In the said case as well, neither the assessee nor the TPO had demonstrated any comparable uncontrolled transaction for benchmarking the international transaction. Even then, the Tribunal accepted the methodology of valuation stating that:
‘Though s. 92C(1) provides that the arm’s length price in relation to an international transaction “shall” be determined by any of the methods set out therein, the selection of the method cannot be done with a water-tight attitude as such an interpretation will defeat the very purpose of enactment of transfer pricing rules and regulations and also detrimentally affect the effective and fair administration of an international tax regime. There may be difficulties in ascertaining the fair market value, but such difficulties should not be a reason for not adapting the prescribed methods. Some subtle adjustments in the methodology prescribed for evaluation of an international transaction are required to be done;
….
To a transaction of sale of shares in a closely held company, none of the six methods prescribed in s. 92C & Rule 10B apply. Accordingly, while determining the most appropriate method, the modern valuation methods fitting the type of underlying service or commodities cannot be ignored. Fixing enterprise value based on discounted value of future profits or cash flow is a method used worldwide. The endeavor is only to arrive at a value which would give a comparable uncontrolled price for the shares sold. Viewed from this angle, the discounted cash flow method adopted by the TPO is in accordance with s. 92C(1)’
Similarly, in the case of Tally Solutions, the Tribunal accepted the ‘Excess Earning Method’ for evaluation of sale of intellectual property rights, stating that such a method supplements the CUP method and is used to arrive at the CUP price i.e. the price at which the assessee would have sold in an uncontrolled condition.
Thus, since the evolution of jurisprudence in India, the Tribunals have insisted on the application of most appropriate method to be selected and applied while benchmarking the international transaction. However, they have accepted the propositions that the said method need not be the one exactly prescribed under section 92C, but even any other method which satisfies the description of such methods given in Rule 10B(1) of the Income-Tax Rules, 1962.
Further, with respect to the rejection of the benchmarking analysis conducted by the assessee, it appears that the TPO has not given cogent reasons for the same. Section 92C(3) prescribes that the AO/ TPO must form an opinion with the material or information or document and after giving an opportunity to the assessee, reject the benchmarking analysis conducted by the assessee. However, after giving cogent reasons and providing fair opportunity of being heard to the assessee, the TPO may carry out fresh benchmarking analysis as per the provisions of section 92C r.w. section 92 of the Act. Thus, when assessee has undertaken its benchmarking analysis, it has discharged its onus, after which it is the TPO’s responsibility to disregard the same by following the due process of law. Any order made by the TPO without following of such procedure laid down by law cannot be regarded as an infirmity which can be cured by granting second innings to the AO.
Thus, it is of utmost importance for the assessee to garner its resources in efficiently determining functions, assets and risks analysis of the international transactions and documenting its detailed benchmarking analysis as it acts as a primary and a fundamental defense while dealing with income-tax assessments.
Notes:-
1. CIT v. Johnson & Johnson Ltd. [2017] 80 taxmann.com 337 (Bombay)
2. Knorr Bremse India P. Ltd. vs. AICT 77 taxmann.com 101 (Delhi Tribunal)
3. CIT v. Kodak India (P) Ltd. [2017] 79 taxmann.362 (Bombay)
4. Commissioner of Income Tax vs. Merck Ltd. 389 ITR 70 (Bombay)
5. Ascendas (India) P. Ltd. (ITA No. 1736/Mds/2011; Chennai Tribunal)
6. Tally Solutions Private Ltd. vs. DCIT (ITA No. 1235/Bang/2010) (Bangalore Tribunal)
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