It is most appropriate to compare the intra- group transactions for a particular year against independent com parables having data for the same year, if available, where such com parables have already been accepted by the Department for a subsequent year
The Mumbai Bench ‘L’ of the Income Tax Appellate Tribunal (the “Tribunal”), on 23 February 2011, pronounced its ruling in the case ACIT Vs. M/s. NGC Network (India) Pvt. Ltd., Mumbai, ITA No. 5307/M/2008. The Taxpayer’s position under appeal filed by the Department with the Tribunal related to the use of independent comparables under TNMM for justifying the arm’s length nature since the same was accepted by the AO for a subsequent year. The AO argued that the comparables were not acceptable since they were different from functional and operational point of view. The Tribunal, ruled that the most appropriate comparison, under the facts and circumstances of the case, would be between the results achieved by the Taxpayer for the relevant assessment year and those earned by comparable uncontrolled entities during the corresponding period (provided such data is available for comparables), particularly where the set of comparable companies as well as the methodology have already been agreed to by the Department in the subsequent years.
The AO’s had rejected the comparables selected by the taxpayer and instead made transfer pricing adjustment using the license fee paid by the Taxpayer to its AE in the previous year as the basis for determining the arm’s length price. The CIT (A) had negated the adjustment made by the AO on the grounds that arm’s length price cannot be determined by relying on a controlled transaction. The Tribunal however held that merely because a transaction is with an associated enterprise cannot be the ground for rejection of such transaction as an internal comparable, especially where the said transaction closely resembles the one being reviewed, and has already been accepted to be at arm’s length. The Tribunal further held that where the working can rely on previous year’s figures then the controlled transaction undertaken by the Taxpayer in the previous year which has been found to be at arm’s length will give better results since the business is the same.
In light of its observations, the Tribunal set aside the order of the CIT (A) in this case, and restored the matter to the file of the Assessing Officer (“AO”) for reworking the transfer pricing adjustments based on the facts and figures available for the relevant assessment year with respect to the set of comparables selected by the Taxpayer and already agreed to by the Department for a subsequent assessment year.
Facts of the case
The Taxpayer is primarily engaged in the distribution and marketing of National Geographic Channel and the Adventure One Channel, and renders post production services to media companies. During the assessment year 2003-04, the Taxpayer had international transactions totalling INR 137,527,281 with its associated enterprise M/s. NGC Asia LLC (“NGC-Asia”).
The AO, with the approval of the concerned CIT, had referred the matter to the Transfer Pricing Officer (“TPO”) for determination of arm’s length price, but the reference was not accepted by the TPO due to paucity of time. Therefore, the AO asked the Taxpayer to furnish details relating to the computation of arm’s length price with regard to its international transactions with NGC-Asia.
The Taxpayer had performed a transactional net margin method (“TNMM”) analysis to demonstrate the arm’s length nature of its international transactions with NGC-Asia. Specifically, the Taxpayer had identified eight comparable companies (primarily software distributors) and compared their net margins from software segments for the assessment year 2002-03, against the net margin achieved by the Taxpayer for the assessment year 2003-04.
Upon examination, the AO rejected the comparables selected by the Taxpayer and used a set of eleven comparables collected by himself, for the purpose of transfer pricing adjustment for the assessment year 2003-04. The Taxpayer argued that it had carried out due diligence in selection of comparables and the latest data available on the date of due diligence had been applied to demonstrate the arm’s length nature of its international transactions with NGC-Asia. The Taxpayer also argued that the comparables selected by the AO were engaged in broadcasting in television channels which was different from the business of distribution of channels in which the Taxpayer was engaged. The Taxpayer explained that, given the facts and circumstances, companies trading in software were the only companies which could be considered as engaging in activities comparable to the business of distribution of channels, since both involved distribution of an intangible product.
After considering the Taxpayer’s argument, the AO concluded that the comparables selected by neither the Taxpayer nor the AO were suitable for comparison due to differences in the nature of business. Therefore, the AO considered the payments made by the Taxpayer to NGC-Asia during the immediately preceding assessment year 2002-03, for the purpose of comparison based on the premise that such payment had already been found to be at arm’s length. The Taxpayer had paid license fees to NGC-Asia to the tune USD 100,000 per month for the assessment year 2002-03. Thereafter, vide an agreement dated 27 January 2003, the license fees were revised to USD 183,333 per month with retrospective effect from 1 April 2002. When asked by the AO to explain the reason for hike in license fees, the Taxpayer responded that the enhanced license fees were the result of increase in the subscriber base between 2001 and 2003. According to the Taxpayer, the license fee of USD 100,000 per month was decided in cognisance of the fact that National Geographic Channel was a new and novel channel and would take time to establish subscriber base. According to the taxpayer, the subscriber base during this period had doubled and the negotiation regarding increase in license fees was in progress for quite some time before the agreement was reached in January, 2003. Therefore, the Taxpayer contended that the increase in the license fees as well as the retrospective effect of such increase is justified under the facts and circumstances of the case. The AO held that such steep increase in license fees by 84.66 percent was not justified, since the increase in the revenue over the corresponding period was only 32.26 percent. The AO, therefore, made a transfer pricing adjustment on the basis of license fees paid in the immediately preceding assessment year (2002- 03). However, the AO agreed to the increased license fees for the last two months of the previous year 2002-03, and made an adjustment with respect to the license fees paid for the remaining 10 months (i.e. April 2002 to January 2003).
In appeal before the CIT (A), the Taxpayer made the following contentions:
Ruling of the Tribunal
Being aggrieved with the order of the CIT (A), the Department filed an appeal before the Tribunal. Judging the relative merit of the arguments made by the Department and the Taxpayer, the Tribunal held the following:
In light of its observations, the Tribunal set aside the order of the CIT (A), and restored the case to the file of AO for re-working the transfer pricing adjustment using the TNMM, on the basis of facts and figures available for assessment year 2003-04 in respect of the com parables selected by the Taxpayer and already agreed to by the TPO for the subsequent assessment year 2004-05.
The ruling of the Tribunal affirms that in order to demonstrate the arm’s length nature of an assessee’s intra- group transactions for a particular assessment year, it is most appropriate to compare such transactions with data available for the same year in respect of comparables that have already been accepted by the Department. Also, where prior year data is being used for the purpose of a transfer pricing analysis and the nature of the business has remained the same, an assessee’s international transactions with associated enterprises during such prior years, can be used as internal comparables for application of the CUP method, provided such prior year’s transactions have already been accepted by the Department to be at arm’s length.