TMI Blog2014 (4) TMI 787X X X X Extracts X X X X X X X X Extracts X X X X ..... onclusions of the T.P.O have to be vacated - the "Profit Split Method" (PSM) is the "M.A.M" for the reason that the assessee generates revenue out of operations that are highly integrated - When one transaction, (example transmitting data from a destination in one country, to a destination in a different country in a secured manner) requires deployment of assets and functions of different entities, located in different Geographical locations, to ultimately deliver services and when such combined efforts generate revenues, the MAM for determining arm's length price is "Profit Split Method (PSM)." The Transfer Pricing Officer is wrong in rejecting PSM on the ground that it is not possible to determine the cost incurred by the Indian entity separately - The cost incurred by the assessee is available on record - The entity maintains books and the same are subject to audit - use of unique intangibles is not a must for adopting "PSM" - the assessee does possess unique intangibles in the field of data transfer and communications, and comparing the operations with a simple E Mail and as a plug in operator is not factually correct - If the assessee is held to be a simple Email opera ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nds. The assessee company is engaged in providing internet and related network services to the group's customers in India. The services offered by Globe One India include internet direct connections, installation/configuration of routers, etc., and fully managed support solutions developed around the basic network services. The parent company, EGN BV, is confirmed and registered under the laws of the Netherlands. The assessee company filed a transfer pricing report along with its return of income on 30.10.2007, declaring 'nil' income. Later, the assessee filed a revised return of income on 31.3.2009, declaring income of Rs.19,29,436/-. A reference was made u/s 92CA(1) to the TPO-I(2) for determination of arm's length price of the international transactions undertaken by the assessee. The TPO, in his order, rejected the profit split method adopted by the assessee company as the most appropriate method and adopted the TNMM method and determined an upward adjustment of Rs.9,46,20,328/- to be made to the arm's length price for the Assessment Year 2007-08 and a Rs. 13,47,02,724/- upward adjustment for the Assessment Year 2008-09. The assessee approached the DRP, with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Equant group is a recognized leader in telecom services and provides global, integrated and customized communication infrastructure solutions that enable the key business process of its customers; The group operates the world's largest seamless data net work in more than 220 countries and territories. Over the years, Equant has successfully integrated several different net works into one and has consolidated entities such that today, Equant conducts business in most countries vis a single, multi functional entity that provides a full range of solutions and services; Customers contracts of the group are for provision of integrated services on Equant's group's net work which is spread across the globe; Equant operates as a globally organized company with critical customer facing and revenue generating activities being undertaken by the group's various operating entities across the globe (including GOIPL in India). Accordingly, each of the operating entities (including GOIPL) that own or operate elements of the network, contribute to the global network; In many cases the Equant group deals directly with the one location of its customer to complete the sal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transfer pricing purposes, it was concluded that the transactions of GOIPL with its group companies are highly inter related and involve unique services and related intangibles. This functional profile is not disputed by the Revenue before us. 3. The assessee adopted the Profit Split Method (PSM) as the Most Appropriate Method (MAM) for determining the Arm's Length Price (ALP) of the international transactions, based on residual profit analysis referred to in the T.P. regulations. 3.1 The steps adopted by the assessee are as follows: Step-I: Determination of the consolidated global operating profits/loss of the Eq group from the global tele communication operations. Step-II: Allocating basic arm's length return to each of the operating entity for undertaking the routine support services. The return in question is calculated by bench marking the same with comparables which are routine support service providers in India. Step-III: Residual profits/loss is determined by deducting the routine arm's length return of all the group entities from the consolidated profits of the group. Step-IV: The residual profits/losses is allocated among the operati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch any service provider will undertake. The TPO further held that: i. It is possible to determine the cost incurred by the Indian entity separately, and hence, it should be bench marked on a standalone basis and not by using PSM. ii. Earlier year's TP orders cannot be relied upon as there is no res judicata in tax proceedings; iii. Acceptance of PSM in other jurisdictions is of no consequence since applicability of PSM is to be judged with reference to Indian TP regulations and not the TP regulations in other countries. iv. PSM cannot be applied in the absence of reliable external market data for bench marking international transactions; v. The assessee has not put forth any evidence of any intangible created by it based on which it can justify the application of PSM; vi. The assessee has not been able to prove that its operations are integrated to disprove the applicability of TNNM; vii. The key value drivers identified by the assessee are routine in nature and do not lead to creation of any unique intangible and marketing expenses are very low even though they constitute a key driver cost; viii. The assessee has not been able to demonstrate any unus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng RPSM, especially in a scenario wherein the functions performed or services rendered are unique in nature and comparables are not available easily for determining the manner in which profit has to be split, reliance has to be placed on some other indicia such as costs for determining how the residual profit must be allocated. This approach is supported by OECD Guidelines, UN's Practical Manual on Transfer Pricing for Developing Countries ('UN TP Manual') as well as US Treasury Regulations. For your Honours' reference, enclosed herewith as Appendices to this annexure are: (a) the relevant extracts of Chapter II (Part III: Transactional profit methods) on TP Methods of OECD Guidelines (b) the relevant extracts of Chapter VI (Section 6.3.13: Profit Split Method) on TP Methods of UN TP Manual (c) The relevant extracts of US Treasury Regulations Para 4.182-6 (c)(3)(i)(b) Moreover, each of the above costs that are relied upon to measure the contributions to key 'value drivers' are from financials and are fully based on the actual costs/ expenses borne by the various entities. They represent third party costs determined based on full-fledged negotiati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing new business opportunities. Thus, the field operation is also a significant value driver of the Group's business. The appellant is the joint entrepreneur in the business and not a low risk captive unit. Even if the costs incurred by an entrepreneur can be identified, the return attributable to it cannot be ascertained by applying TNNM and comparing it with other independent comparables/ entrepreneurs. Appellant's operations are highly integrated, it is also not possible to directly identify the revenue that is attributable to appellant's efforts in India. Appellant's business is integrated other parameters for applicability of PSM also have to be considered - not possible to identify revenue streams attributable to any specific operating entity which is why the total group revenue necessarily has to be apportioned between the different operating entities based on key value drivers as is done under PSM. Mere determination of the costs cannot imply that TNNM can be applied in the instant case. This does not any-how enable an identification of appellant's corresponding share in the Group revenue and/ or profit/ loss. In FY 2004-05 (i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd reviewed by OECD from time to time. Indian Courts/ Tribunal have in many cases referred to overseas TP legislations/ jurisprudence to seek guidance on various TP issues. The underlying basis for applicability of PSM is same/similar as per the OECD Guidelines, US regulations and the Indian TP regulations applicable in case of integrated transactions involving unique intangibles. To the extent the global policy of the Group based on PSM has been accepted in other countries as well even though such acceptance is based on their TP regulations, it raises a strong presumption of the conformity of the Equant Group policy (based on PSM) with the arm's length principle enshrined in the Indian TP regulations. Non-acceptance of PSM would imply that India is the only exception: Globally, wherever the Revenue authorities have audited/ tested the intercompany transaction pricing/ TP policy/method for the Equant group, PSM has been accepted and no adverse inference has been drawn either in relation to the application of the method or the transfer prices. appellant understands that Revenue Audits have been completed in countries including France, Belgium, Italy, Thailand, etc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ellant's operations as discussed in the submission filed in the DRP application. Further, on the contribution of key value drivers, in the detailed submission filed before the Ld TPO it was also clearly explained how each value driver contributes to the business/ creation of a unique intangibles i.e. the network, field operations, sales and marketing, etc. Further, as submitted before the Ld TPO, the total key driver cost constitutes as much as one-fourth (approx) of the total expenses for the appellant which is not an insignificant amount contrary to what has been contended by the Ld TPO. Hence, the assertions made by the Ld TPO that key value drivers identified by the appellant are completely routine and do not lead to creation of any unique intangibles completely baseless. The appellant had furnished before the TPO detailed reasons/ explanation for losses being made by the Equant Group at the global level. Hence, the observation of the Ld TPO on absence of any credible reasons for losses is completely incorrect. Commercial reasons for losses include: - (a) Prevalent market trends in the global telecommunications industry, the Equant group operates in a very dynamic, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e decision shall be binding on the parties. Moreover, the Arbitrator would also be appointed jointly by the administrator and the disputing party. (iii) The last point of the TPO on the power to have access to records is merely a procedural aspect in the administration of the agreement and not imply absence of any power/ say of the AEs in the administration of agreement/ allocation mechanism. Further, the appellant does access to the methodology/basis followed by the Administrator for carrying out the RPSM. Also, the RPSM workings are also shared by administrator with the appellant and the same were also filed with the Ld TPO during the audit proceedings and the workings are shared the appellant. Hence, he argued that the observations made by the Ld TPO are incorrect. On facts he submitted that : Both the statements of the TPO in this regard are factually incorrect since neither has the PSM been applied in the TP study for the first time nor is it a device to camouflage the losses of the appellant. PSM based model is followed by the Equant Group globally for the setting of Transfer Prices. This model is clearly borne out from the intercompany agreement which was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... facts and circumstances of the case, to drive home the point that, it is not mandatory to follow PSM as the MAM adopted in the Previous Years, in this year also, even if the same is accepted by the T.P.O. He argued that it is well settled that the burden of proof is on the assessee to prove that its international transactions with its Associated Enterprise are at arm's length. He referred to the order of the TPO and submitted that the application of PSM by the assessee is not as per Rule 10B(1)(d). He referred to page 180 of the paper book and pointed out, to the details given therein, of the A.E. and all the international transactions, entered into by the assessee and pointed out that they are of (i) purchase of equipment, (ii) telecom charges, and (iii) reimbursement of expenses in two cases. He submitted that purchase of equipment is not service and hence PSM cannot be applied. He questioned whether PSM can be the most appropriate method for purchase of equipment. It is only in the case of Telecom charges, which is received by the assessee from Equant Ireland that PSM may possibly be applied and in that case the profits of both the enterprise have to be considered. He vehem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 4.2 Joining the , the Ld.D.R. Mr.Peeyush Jain submitted that the entire group has 100 entities and when the assessee has transactions only with two entities, how could the entire group profits be apportioned? He submitted that only such entities as are involved in the international transactions should be considered. He vehemently contended that PSM was not applied by the assessee as per the requirement of Rule 10(A)(A), as residual profits allocation are not bench marked. 4.3 The Ld.Counsel for the assessee admitted that PSM has not been applied as per the requirements of the Income Tax Act read with Rules to the extent that residual profits allocation was not bench marked. But he submitted that nowhere in the world, bench marking of residual profits for allocation is required. He relied on various commentaries in support of the same. He referred to the decision of the Chennai Bench of the Tribunal in the case of Asendas (India) Pvt.Ltd. v. DCIT in ITA no.1736/Madras/2011, order dated 02nd January,2013, and submitted that the Tribunal has adopted a valuation methodology not given in the rules, as a matter of exception. He relied on interpretation of statutes and submitted t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itted that the additional grounds may be rejected. 7. After hearing rival contentions, we find that both the grounds raised are legal grounds and that no fresh investigation into facts is required. When all facts are on record, in our view, these grounds have to be admitted, being legal grounds, by following the judgement of Hon'ble Supreme Court in the case of National Thermal Power Co.Ltd. v. CIT [1998] reported in 229 ITR 383 (SC). In the result we admit the additional grounds. 8. Ground no.5 to 9 are grounds connected with corporate tax issues. 9. The Ld.Counsel for the assessee submitted that the A.O. disallowed payments made for lease lines, as the assessee has not deducted tax at source u/s 40(A)(i)(a). The A.O. disallowed the same by holding that lease lines were, technically speaking, equipment and payment for taking these lines on lease, is covered u/s 194-I and that the assessee himself has described the payment has been made towards lease lines. The Ld.Counsel relied on the decision of the Delhi high court in the case of Asia Satellite Tele Communication Co. 332 ITR 340(Del)C and submitted that the issue is covered in his favour. He relied on the decision o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... we allow this ground of appeal of the assessee. In the result ground no.5 for the A.Y. 2007-08 is allowed. 12. Ground no.6 for A.Y. 2007-08 is on the issue of the Assessing Officer not granting the benefit of carry forward of business losses and unabsorbed depreciation, to the assessee. After hearing both the parties, as this is a factual matter and as the same is not adjudicated by the lower authorities, and as this is a legal claim, we set aside the same to the file of the A.O. for fresh adjudication in accordance with law. In the result this ground is allowed for statistical purposes. 13. Ground no.7 for the A.Y. 2007-08 and ground no.6 for the A.Y. 2008-09 are general in nature. Ground no.8 for the A.Y. 2007-08 and ground no.7 for the A.Y. 2008-09 are against the levy of interest u/s 234'B'. Levy of interest is mandatory and consequential. Hence, these grounds are dismissed. 14. Ground no.9 for the A.Y. 2007-08 and ground no.9 for the A.Y. 2008-09 are on the initiation of penalty u/s 271(1)(c) of the Act. The same is dismissed as premature. 15. Ground no.8 for the A.Y. 2008-09 is against the A.O. not allowing credit of TDS and charge of interest. As this is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ofit Split Method (PSM) Rule 10B (1) (d) prescribes PSM as follows: (i) The combined net profit of the associated enterprises arising from the international transaction in which they are engaged, is determined; (ii) The relative contribution made by each of the associated enterprises to the earning of such combines net profit, is then 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 indicates how such contribution would be evaluated by unrelated enterprises performing comparable functions in the similar circumstances; (iii) the combined net profit is then split amongst the enterprises in proportion to their relative contributions, as evaluated under sub clause(ii); (iv) the profit thus apportioned to the assessee is taken into account to arrive at an arm's length price in relation to the international transaction; 181. This method may be applicable in case where transactions involved transfer of unique, intangible or any multiple interrelated international transactions, which cannot be evaluated separately for determining the ALP of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es, it is stated as follows: C.3.2.2 Residual analyses 2.121 A residual analysis divides the combined profits from the controlled transactions under examination in two stages. In the first stage, each participant is allocated an arm's length remuneration for its non-unique contributions in relation to the controlled transactions in which it is engaged. Ordinarily this initial remuneration would be determined by applying one of the traditional transaction methods or a transactional net margin method, by reference to the remuneration of comparable transactions between independent enterprises. Thus, it would generally not account for the return that would be generated by any unique and valuable contribution by the participants. In the second stage, any residual profit (or loss) remaining after the first stage division would be allocated among the parties based on an analysis of the facts and circumstances, following the guidance as described at paragraphs 2.132-2.145 for splitting the combined profits. 2.122 An alternative approach to how to apply a residual analysis could seek to replicate the outcome of bargaining between independent enterprises in the free market. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to aggregate) by determining the division of profits that independent enterprises would have expected to realize from engaging in the transaction or transactions. Figure 5 illustrate this. 6.3.13.3 The Profit Split Method starts by identifying the profits to be divided between the associated enterprises from the controlled transactions. Subsequently, these profits are divided between the associated enterprises based on the relative value of each enterprise's contribution, which should reflect the functions performed, risks incurred and assets used by each enterprise in the controlled transactions. External market date (e.g. profit split percentages among independent enterprises performing comparable functions) should be used to value each enterprise's contribution, if possible, so that the division of combined profits between the associated enterprises is in accordance with that between independent enterprises performing functions comparable to the functions performed by the associated enterprises. The Profit Split Method is applicable to transfer pricing issues involving tangible property, intangible property, intangible property, trading activities or financial servic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to be commensurate with the income attributable to the intangible. It is also consistent with the result that would obtain at arm's length under a hypothetical joint venture agreement between the different parties contributing their respective investments of functional and entrepreneurial capital. 17.9 Residual Profit Split Method is stated as follows: 10.04 Residual Profit Split Method As illustrated in Figure 10-2, RPSM proceeds in two steps: Step 1: Functional capital is provided a return derived from data for functional comparables, i.e. independent companies performing similar routine manufacturing or distribution functions; and Step 2: The remaining residual operating profit or loss is allocated based on residual, entrepreneurial capital so as to equalize the rate of return on such capital, adjusted for market differences in the cost of capital. In actual practice, implementation of the RPSM concept outlined above involves the determination of a number of interrelated valuations of functional and entrepreneurial activities in different countries and economic circumstances. The existing IRS regulations provide relatively little specific guidance conc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... NMM is similar to RPM and CPM to the extent that it involves comparison of margin earned in a controlled situation with margins earned from comparable uncontrolled situation. The only difference is that, in the RPM and CPM methods, comparison is of margins of gross profits and whereas in TNMM the comparison is on margins of net profit. TNMM requires comparison between net margins derived from the operations of the uncontrolled parties and net margins derived by an AE from similar operations. Net margin is indicated by the rate of return on sales or cost or operating assets, and this forms the basis for TNMM. A functional analysis of the tested party or the independent actions are comparable and the adjustments that are required to be made to obtain reliable results. The tested party would have to consider other factors, like cost of assets of comparable companies, etc. while applying the return on assets measure. Ordinarily, the tested party, has to be the party provided services because it is on the basis of rate of return on sales or cost or operating assets that transactional margin is computed. These parameters generally available in the case of party providing service. 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Net Margin Method is discussed at para 2.1. Transactional Net Margin method 2.1. Definition and choice of tested party The transactional net margin method ('TNMM') is a profit based method that can be used to apply the arm's length principle. The TNMM can be applied on either the related party manufacturer or the related party distributor as the tested party for transfer pricing purposes. The TNMM examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a tax payer realizes from a controlled transaction (or transactions that are appropriate to be aggregated). The profit margin indicators are discussed in paragraph 2.3 below. The TNMM compares the net profit margin (relative to an appropriate base) that the tested party earns in the controlled transactions to the same net profit margins earned by the tested party in comparable uncontrolled transactions or alternatively, by independent comparable companies. As such, the TNMM is a more indirect method than the cost plus/resale price method that compares gross margins. It is also a much more indirect method than the CUP method that compares prices, because it uses net p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansaction is integrated and interrelated and when costs are incurred by multiple entities and the revenues are to be apportioned to multiple entities, then the factual conclusions of the T.P.O have to be vacated. 18.5 Transaction Net Margin method compares the profit margin of tax payer arising from a non arm's length transaction, or a group of such similar transactions, with the profit margin realized by the assessee with its A.E. on a similar transaction whereas the PSM allocates operating profits or losses from controlled transactions, on the principle of relative contributions made by each party in creating the combined revenues. 18.6 The objection of the assessee is that the TNMM does not take into account commercial/business reasons for losses. The TPO rejected this argument. He held that the assessee has not been able to identify, the reasons that has lead to incurrance of loss. He concluded as follows: the administrator can examine the records of the operating entity but not vice versa in any dispute the decision of the administrator shall be binding. No independent entity would have agreed to such terms, nor would it have agreed to be tied down by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se. 19. In the case at hand, we are of the considered opinion that the Profit Split Method (PSM) is the M.A.M for the reason that the assessee generates revenue out of operations that are highly integrated. When one transaction, (example transmitting data from a destination in one country, to a destination in a different country in a secured manner) requires deployment of assets and functions of different entities, located in different Geographical locations, to ultimately deliver services and when such combined efforts generate revenues, the MAM for determining arm's length price is Profit Split Method (PSM). 19.1 In our considered opinion, the Transfer Pricing Officer is wrong in rejecting PSM on the ground that it is not possible to determine the cost incurred by the Indian entity separately. The cost incurred by the assessee is available on record. The entity maintains books and the same are subject to audit. What is to be seen is the contribution of the entities' resources to a transaction, or to a series of similar transactions. In our view, this finding is not correct. Hence, this ground of the T.P.O. taken for rejecting application of PSM as the MAM ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l transactions, which cannot be evaluated separately for determining ALP of any one transaction. When the transaction involves contributions of multiple entities and are integrated and interrelated and they cannot be separately evaluated for the purpose of determining ALP of any one transaction, the PSMP is the MAM . Hence, in our view, use of unique intangibles is not a must for adopting PSM . In any event, we have considered the facts of this case and we have, elsewhere in this order, given a finding that the assessee does possess unique intangibles in the field of data transfer and communications, and comparing the operations with a simple E Mail and as a plug in operator is not factually correct. If the assessee is held to be a simple Email operator, then it is to be explained as to why reputed global enteprises would pay them for data transmission, when E Mail is free. The assessee does offer unique services as compared to an ordinary Email service and it is these unique services which are its intangibles. 20.1 We also hold that the factum of the assessee having a loss is no ground to reject PSM as the MAM . The decision as to what is the MAM does not depend on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which he feels it should have been applied. 20.5 The assessee in this case has adopted 'residuary profit split method'. As explained in various commentaries, residual PSM involves: (i) Determination of routine return (ii) Allocation of residuary profits. At the stage of determination of routine profits, as already stated, bench marking has to be done by the assessee, with reliable external market data from uncontrolled transactions. 20.6 Coming to the allocation of residuary profits, in our view, though the Rules do suggest that benchmarking should be done with external uncontrolled transactions, we find that this is an impossibility in this case, as it is not possible to get a comparable. On a perusal of the various commentaries, we are of the view that such allocation can be done, based on how much each independent enterprise might have contributed. Relative contribution has to be determined, based on key value drivers. Bench marking at this stage is not practicable as comparables having similar, multiple, interrelated and integrated transactions, would be difficult to find. Thus, in our view, in such a situation, a harmonious interpretation of the provi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comparable uncontrolled transactions 2.133 One possible approach is to split the combined profits based on the division of profits that actually results from comparable uncontrolled transactions. Examples of possible sources of information on uncontrolled transactions that might usefully assist the determination of criteria to split the profits, depending on the facts and circumstances of the case, include joint- venture arrangements between independent parties under which profits are shared, such as development projects in the oil and gas industry; pharmaceutical collaborations, co-marketing or co-promotion agreements; arrangements between independent music record labels and music artists; uncontrolled arrangements in the financial services sector; etc. C.3.4.3 Allocation keys 2.134 In practice, the division of the combined profits under a transactional profit split method is generally achieved using one or more allocation keys. Depending on the facts and circumstances of the case, the allocation key can be a figure (e.g. a 30%-70% split based on evidence of a similar split achieved between independent parties in comparable transactions), or a variable (e.g. relative valu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erprise to the controlled transaction and their relative value. Guidance on intangible property is found at Chapter VI of these Guidelines. See also the examples in the Annex to Chapter VI Examples to illustrate the Transfer Pricing Guidelines on intangible property and highly uncertain valuation . Cost-based allocation keys 2.138 An allocation key based on expenses may be appropriate where it is possible to identify a strong correlation between relative expenses incurred and relative value added. For example, marketing expenses may be an appropriate key for distributors-marketers if advertising generates material marketing intangibles, e.g. in consumer goods where the value of marketing intangibles is affected by advertising. Research and development expenses may be suitable for manufacturers if they relate to the development of significant trade intangibles such as patents. However, if, for instance, each party contributes different valuable intangibles, then it is not appropriate to use a cost-based allocation key unless cost is a reliable measure of the relative value of those intangibles. Remuneration is frequently used in situations where people functions are the prima ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 17 and 2.132. They will frequently be extracted from the taxpayers' cost accounting or financial accounting. 2.142 For instance, where an asset-based allocation key is used, it may be based on data extracted from the balance sheets of the parties to the transaction. It will often be the case that not all the assets of the taxpayers relate to the transaction at hand and that accordingly some analytical work is needed for the taxpayer to draw a transactional balance sheet that will be used for the application of the transactional profit split method. Similarly, where cost-based allocation keys are used that are based on data extracted from the taxpayers' profit and loss accounts, it may be necessary to draw transactional accounts that identify those expenses that are related to the controlled transaction at hand and those that should be excluded from the determination of the allocation key. The type of expenditure that is taken into account (e.g. salaries, depreciation, etc.) as well as the criteria used to determine whether a given expense is related to the transaction at hand or is rather related to other transactions of the taxpayer (e.g. to other lines of products no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6.3.14 - Step 2: Allocation of Residual Profit (i.e. profit remaining after step 1) between the associated enterprises based on the facts and circumstances. If the residual profit is attributable to intangible property then the allocation of this profit should be based on the relative value of each enterprise's contributions of intangible property. 20.9 In the UN Transfer Pricing Manual, Chapter VI, at para 6.3.17.4, it is stated as follows. The PSM involves the determination of the factors that bring about the combined profit, setting a relative weight to each factor and calculating the allocation of profits between the associated enterprises. The contribution analysis is difficult to apply, because external market data that reflect how independent enterprises would allocate the profits in similar circumstances is usually not available. The first step of the residual analysis often involves the use of the TNMM to calculate a return and is not, in itself, more complicated than the typical application of TNMM. The second step is, however, an additional step and often raises difficult additional issues relating to the valuation of intangibles. 20.10 In the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or b. a residual PSM, namely where each of the AEs, who are parties to the transactions in question, are first assigned routine/ basic returns for the routine functions performed by them; and thereafter, the residual profits are split amongst the AEs, however, in a manner that whether or not an assessee adopts a contribution PSM or a residual PSM, the profits, would need to be split amongst the various AEs, who are parties to the transactions in question, on the basis of reliable external market data, which indicates how unrelated parties would have split such profits in similar circumstances. 2. In other words, as per rule 10B(l)(d) of the IT Rules, a contribution or residual PSM would need to be supplemented by a comparable PSM. 3. The terminologies, namely contribution PSM , residual PSM and comparable PSM , have not been used in the IT Act or Rules, however, they can be found in the TP guidelines of OECD [paragraphs 2.108 to 2.1491 and UN [paragraphs 6.3.13.1 to 6.3.181, by referring to the similarity of the manner of application of the said methods, as contained in the OECD and UN TP guidelines; and also in the IT Rules. 4. Having said that, PSM prescribed by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the Group is the proprietary network, without which the services cannot be rendered; and thus existence of joint venture arrangements between third parties is not conceivable, the application of comparable PSM would be an impossibility. 9. The OECD further acknowledges that where comparable uncontrolled transactions of sufficient reliability are lacking to support the division of the combined profits, consideration should be given to internal data, which may provide a reliable means of establishing or testing the arm's length nature of the division of profits, meaning that resort to either contribution or residual PSM may be made, without the same having to pass through the compulsory rigors of comparable PSM [paragraph 2.141 of the OECD TP guidelines]. 10. Further, many of the global TP specialists have commented on the lack of reliable third party data, which often renders comparable PSM impossible to apply for splitting profits amongst related parties, except for in the limited cases of joint venture arrangements and determination of royalty, where again, the split of profits between the licensor and the licensee can be discernible on the face of accounts. Extracts f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ribution PSM, residual P'SM and comparable PSM, without requiring the contribution and residual PSMs to mandatorily pass through the sanity of comparable PSM, being a mandate given under the Indian TP regulations, in the form of rule10OB(I)(d) of the IT Rules. Thus, such compulsory mandate would render the entire mechanism PSM unworkable in India, even in the most deserving of cases. 12. It is a golden and accepted rule of jurisprudence that an interpretation, which makes a statute or rule unworkable or impossible to be complied with, should be avoided; and recourse need to have to the interpretation, which would make the statute or rule workable and also subserve the purpose for which it has been enacted. In this connection, reference is invited to the ruling of the Hon'ble Supreme Court in the case of Superintendent of Taxes v. Onkarmal Nathumal Trust [AIR 1975 SC 2065], where it has been held that The law in its most positive and peremptory injunctions, is understood to disclaim, as it does in its general aphorisms, all intention of compelling performance of that which is impossible ... where the law creates a duty or charge, and the party is disabled to perform it, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Tribunal perceives that the requirement contained in rule 10B(1)(d) of the IT Rules of mandatory adoption of comparable PSM in all cases of PSM actually renders the entire scheme or mechanism of PSM virtually redundant, otiose and impossible to comply with, even in the most deserving of cases, namely where there can be no doubt that the AEs, who are parties to the transactions in question, contribute and exploit non routine or unique intangibles, or the transactions are so inter related that they cannot be evaluated separately for the purpose of determining the ALP thereof, however where reliable external data to gauge third party behavior is impossible to be obtained, then the requirement for adoption of comparable PSM should be dispensed with, and the assessee should be given an option to adopt a residual or contribution PSM, when such sub-methods of PSM are otherwise accepted globally, both under the OECD and UN TP guidelines, and also in rule 10B(1)(d) itself. 17. It is submitted that applying such an interpretation would not tantamount to altering the overall mechanism of PSM under the Indian TP regulations, but would merely supplement life and force into rule 10B(1)(d) o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e much as to the purpose, it can be seen that the purpose and objective of introduction of this rule is to determine the arm's length price , whenever the methods suggested result in practical difficulties by adopting generally accepted methods which are not specifically listed. It is a procedural provision aimed at arriving at the ALP . Thus, in our , it is retroactive. ALP , ideally, should be the same, in the previous years, as in the subsequent years when the facts and circumstances are the same, irrespective of the method adopted for arriving at the same. One cannot be heard saying that the ALP arrived by one methord cannot be acceptable for the earlier year as that method was not notified by the CBDT. In our view, Arms Length Price should be the same, with minor variations. When a new method is allowed, with the objective of enabling determination of the proper ALP, in our comprehension, such a provision operates retroactively, and can be used to determine the ALP in the earlier assessment years also. When the aim and object of introducing a Rule allowing the assessee to adopt any other method for determining the ALP, by introducing S.10AB, is to remove unintended ..... X X X X Extracts X X X X X X X X Extracts X X X X
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