2025 (5) TMI 1392 - AT - Income Tax

TP Adjustment - benchmarking based on the comparable set of companies engaged in providing administrative support services - treating Appellant s transaction as a highend service misapplying the law pertaining to TP and by adopting faulty processes/ methodologies to finalize the adjustment such as but not limited to applying filters functional analysis selection of comparable companies computation of profit margin of Appellant and comparable companies and undertaking economic adjustment Deputation of Personnel - HELD THAT - Employees deputed are operational level employees. These employees are involved in the execution of projects and providing operational assistance including support functions such as finance. These employees are not supposed to do the action or process of making important decisions. We also note that there is/was no adjustment made during the previous and subsequent Assessment Years. Therefore we direct the AO to follow the judicial consistency and accept the detailed benchmarking based on the comparable set of companies engaged in providing administrative support services as submitted by the assessee in appeals for AYs 2013-14 2014-15. Hence this ground of appeal is allowed for statistical purposes. Downward adjustment for payment of royalty to AEs for availing technical services - In the present case the TPO has compared the rate of FTS paid by the Appellant with assessee s own agreed price during a prior year which is not an uncontrolled transaction and cannot be used as a CUP. As held in the case of Cabot India Ltd 2011 (5) TMI 365 - ITAT MUMBAI that where no data was available in respect of uncontrolled transactions which were similar to transactions of assessee with its foreign associated enterprise CUP method could not be considered as most appropriate method to determine arm s length price (ALP) of royalty paid by assesse to its AE for technology collaboration . Similarly as held in the case of Flakt (India) Ltd. 2016 (6) TMI 557 - ITAT CHENNAI that Without identifying comparable uncontrolled transactions TPO could not simply come to conclusion that quality and volume of services received by assesse were not commensurate with payment made by assessee . Hence in the light of above discussion and orders of the Tribunal we are of the considered view that the reasoning given by the TPO is not sound. Commercial expediency of the assessee cannot be questioned by the TPO. Hence in the light of the above factual and legal matrix we direct the AO to adopt the transfer methodology adopted in its TP documentation and accept the FTS payment at arm s length. Hence this ground of appeal is allowed for statistical purposes. Disallowance in relation to provision for expected loss on contracts - AO has disallowed the provision for expected loss on contract u/s 37 while computing the total income of the assessee - HELD THAT - As decided in own case AY 2016-17 2024 (9) TMI 479 - ITAT CHENNAI that the provision is an ascertained liability that has been created based on the estimated cost and revenue has been recognised on percentage of Completion method. Further the co-ordinate bench of Tribunal also noted that the provision created has been reversed in subsequent years and ordered to tax in the future years. Thus we delete this addition. Hence this ground of appeal is allowed.

Summary

Issues Presented and Considered:

The core legal questions considered by the Tribunal in these appeals relate primarily to the following issues:

1. Whether the Assessing Officer (AO) and Transfer Pricing Officer (TPO) erred in making transfer pricing adjustments by misapplying the law and adopting faulty methodologies, including the selection and benchmarking of comparable companies, functional analysis, and economic adjustments for payments made for technical services and deputation of personnel.

2. Whether the payments made by the appellant for technical services to its associated enterprises (AEs) were at arm's length price (ALP), particularly concerning the additional 2% fee disallowed by the AO.

3. Whether the characterization of the appellant's deputation of personnel transaction as high-end service was appropriate and whether the mark-up charged was at arm's length.

4. Whether the AO was justified in disallowing reimbursement of expenses paid to group companies on account of non-deduction of tax at source under Section 40(a)(ia) of the Income Tax Act, 1961.

5. Whether the provision for expected loss on contracts made by the appellant was allowable as a deduction under Section 37 of the Act or rightly disallowed by the AO.

6. Whether the AO erred in not allowing set off of brought forward losses and unabsorbed depreciation for the relevant assessment year.

7. Whether the assessment orders suffer from legal infirmities such as violation of principles of natural justice and lack of jurisdiction due to inadequate inquiries.

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustments - Technical Services Payments

Legal Framework and Precedents: The transfer pricing provisions under the Income Tax Act and Rule 10B mandate that payments between associated enterprises be at arm's length price (ALP). The Comparable Uncontrolled Price (CUP) method requires comparison with prices paid in uncontrolled transactions for similar services. Judicial precedents emphasize that the TPO must identify comparable uncontrolled transactions to apply CUP method correctly.

Court's Interpretation and Reasoning: The Tribunal found that the appellant had entered into an agreement with its AE for technical services at a fee initially set at 3% of turnover, increased to 5% from July 2012 via an addendum. The appellant substantiated that the additional services provided were specific and specialized, including contractual assistance, ISO accreditation, and maintenance of quality and safety standards.

The TPO rejected the incremental 2% fee, characterizing the services as generic and disallowing the adjustment without proper benchmarking. The Tribunal held that the TPO's comparison of the current fee with the appellant's prior year agreement was improper, as such prior agreements with the AE do not constitute uncontrolled transactions under Rule 10B(1)(a)(i). This approach was inconsistent with judicial rulings from the Mumbai and Chennai Benches of the Tribunal, which require identification of comparable uncontrolled transactions before applying CUP.

The Tribunal further noted that the TPO's reliance on the appellant's losses to question the arm's length nature of the transaction was misplaced. The Punjab & Haryana High Court ruling clarified that ALP determination is independent of whether a transaction results in profit or loss. The Tribunal emphasized that commercial expediency is beyond the TPO's scope.

Application of Law to Facts: The Tribunal accepted the appellant's transfer pricing documentation and benchmarking analysis, concluding that the payments for technical services were at arm's length.

Treatment of Competing Arguments: The AO and TPO's arguments were rejected as lacking proper application of transfer pricing principles and ignoring relevant judicial precedents.

Conclusion: The Tribunal allowed the ground of appeal relating to the disallowance of 2% technical service fees and directed the AO to accept the appellant's transfer pricing methodology.

2. Transfer Pricing Adjustments - Deputation of Personnel

Legal Framework and Precedents: Transfer pricing principles require benchmarking of inter-company transactions based on functional and risk analyses to select appropriate comparable companies and determine ALP.

Court's Interpretation and Reasoning: The appellant deputed operational-level employees with basic engineering qualifications to its AEs, charging a cost-plus mark-up of 12%. The TPO characterized these services as high-end and applied a higher arm's length margin based on unrelated companies engaged in engineering and design services, some of which were functionally dissimilar (e.g., wind power generation, optical fiber infrastructure).

The Tribunal accepted the appellant's submission that the deputed employees provided only support services without decision-making authority and that the mark-up charged was consistent with benchmarking of companies engaged in administrative support services. The Tribunal also noted the principle of consistency, as no adjustment was made in previous or subsequent years for this transaction.

Application of Law to Facts: The Tribunal directed the AO to accept the appellant's benchmarking based on comparable companies providing administrative support services and disallowed the TPO's arbitrary selection of comparables.

Treatment of Competing Arguments: The Tribunal rejected the TPO's approach of selecting functionally dissimilar companies and applying higher margins without proper justification.

Conclusion: The Tribunal allowed the appeal on this issue for statistical purposes and directed the AO to adopt the appellant's benchmarking.

3. Disallowance of Provision for Expected Loss on Contracts (AY 2014-15)

Legal Framework and Precedents: Accounting Standard (AS) 7 mandates that expected losses on long-term contracts be recognized immediately on a prudent basis. Judicial precedents, including decisions of the Supreme Court and various High Courts, have held that such provisions are allowable deductions under Section 37, provided they are based on sound accounting principles and are not contingent liabilities.

Court's Interpretation and Reasoning: The appellant had provided for expected loss on a dredging contract based on the Percentage of Completion Method (POCM). The AO disallowed the provision without providing reasons. The Tribunal relied on a coordinate bench's ruling in the appellant's own case for AY 2016-17, which held that the provision represented an ascertained liability based on estimated costs and revenues recognized on POCM. The provision was reversed and offered to tax in the subsequent year, avoiding double taxation.

Application of Law to Facts: The Tribunal found that the appellant's provision was consistent with AS-7 and supported by detailed computations. The disallowance would result in double taxation since the reversal was taxed later.

Treatment of Competing Arguments: The AO's disallowance was rejected as lacking basis and ignoring accounting standards and judicial precedents. The revenue's reliance on a Madras High Court ruling was found distinguishable on facts.

Conclusion: The Tribunal deleted the disallowance and allowed this ground of appeal.

4. Disallowance of Reimbursement of Expenses under Section 40(a)(ia)

The appellant initially challenged the disallowance of cost-to-cost reimbursement of expenses paid to group companies without tax withholding. However, during hearing, the appellant did not press this ground. Consequently, this issue was dismissed as not pressed.

5. Relief for Brought Forward Losses and Unabsorbed Depreciation

The appellant contended that the AO erred in not allowing set off of brought forward losses and unabsorbed depreciation against the income for AY 2014-15. The Tribunal noted the appellant's submissions and directed the lower authorities to consider the same while computing taxable income.

6. Procedural and Jurisdictional Grounds

The appellant alleged violation of principles of natural justice and lack of jurisdiction by the AO and lower authorities in framing assessments without adequate inquiries. The Tribunal, after hearing submissions and perusing records, did not find merit in these contentions sufficient to quash the assessments entirely but allowed certain grounds on merits as detailed above.

Significant Holdings:

"The TPO dehors the TP documentation referred supra cannot arbitrarily and erroneously conclude that services are generic in nature."

"While applying CUP method, TPO has to follow the rule 10B(1)(a)(i) which speaks of 'price paid for similar services received by parties in an uncontrolled transaction.' However, in the present case the TPO has compared the rate of FTS paid by the Appellant with assessee's own agreed price during a prior year, which is not an uncontrolled transaction and cannot be used as a CUP."

"Whether a transaction is at an ALP or not is not dependent on whether transaction results in an increase in assessee's profit. Mere failure to establish that transactions resulted in a profit does not indicate they were not at an ALP and even if profit is established, it does not necessarily follow that transaction was at an ALP."

"The employees deputed are operational level employees involved in the execution of projects and providing operational assistance including support functions such as finance. These employees are not supposed to do the action or process of making important decisions."

"The provision for expected loss on contract is an ascertained liability based on estimated cost and revenue recognized on Percentage of Completion Method as mandated by AS-7. Disallowance of such provision would result in double taxation as the reversal of provision is offered to tax in subsequent years."

"Commercial expediency of the assessee cannot be questioned by the TPO."

Final Determinations:

The Tribunal partly allowed the appeals of the appellant for AYs 2013-14, 2014-15, and 2015-16, directing the AO to:

• Accept the appellant's transfer pricing methodology and arm's length pricing for payments made for technical services to AEs, including the additional 2% fee.
• Accept the benchmarking of deputation of personnel transactions based on comparable companies providing administrative support services rather than high-end engineering services.
• Delete the disallowance of provision for expected loss on contracts for AY 2014-15 following the accounting standards and coordinate bench rulings.
• Consider brought forward losses and unabsorbed depreciation while computing taxable income for AY 2014-15.
• Dismiss the issue relating to disallowance under Section 40(a)(ia) as not pressed.

The Tribunal emphasized adherence to transfer pricing principles, consistency in approach, proper application of accounting standards, and respect for judicial precedents in determining the arm's length nature of transactions and allowable deductions.