2025 (6) TMI 1934 - AT - Income Tax

TP Adjustment - arm s length price (ALP) with regard to research and development fees (R D Fees) and management services fees - HELD THAT -We find that TPO suggested upward adjustment of management fee and R D payments to its AEs by taking view that assessee has not provided adequate documentation with regard to management fees and R D expenses. The ld DRP confirmed the action of TPO/AO. We find that before DRP the assessee filed additional submissions and also filed copy of agreements with its AEs for availing management fee. The assessee also furnished various evidences in the form of correspondence with its AEs to substantiated the proof of availing such services. On filing such additional evidence the DRP called remand report of AO/ TPO. No such remand report was furnished by AO/ TPO as recorded in order of DRP. We find that in CIT Vs Lever India Exports Limited 2017 (2) TMI 120 - BOMBAY HIGH COURT held that TPO has no jurisdiction to consider whether or not expenditure incurred has passed the test of section 37 of the Act. As decided in CIT Vs Lever India Exports Limited 2017 (2) TMI 120 - BOMBAY HIGH COURT held that TPO has no jurisdiction to consider whether or not expenditure incurred has passed the test of section 37 of the Act. We find that assessee has filed sufficient evidence on record which prima facie substantiate the payment of management fees as well as R D expenses are arm s length price though such evidences has not been examined by TPO nor the TPO computed the adjustment as per prescribed method simply holding that sufficient evidence is not filed before him. No remand report was furnished by AO / TPO on the direction of DRP. The DRP also made a general observation regarding various additional evidences furnished by assessee. Therefore the order of TPO / AO and DRP is set aside and the matter is restored back to the file of AO/ TPO to recompute the adjustment afresh in accordance with law. The assessee is also directed to provide requisite details and evidences before AO / TPO. In the result the grounds of appeal raised by assessee are allowed for statistical purposes

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this appeal relate primarily to the determination of arm's-length price (ALP) for international transactions involving payment of Research & Development (R&D) fees and management fees to associated enterprises (AEs). The issues include:

• Whether the additions made by the Assessing Officer (AO) and Transfer Pricing Officer (TPO) regarding upward transfer pricing adjustments on R&D fees and management fees are justified.
• Whether the methodology adopted by the assessee in its transfer pricing documentation complies with the requirements under section 92D of the Income Tax Act and Rule 10D of the Income Tax Rules.
• Whether the payments for R&D and management fees to AEs were at arm's length, considering the evidence of service rendition and benefit derived by the assessee.
• Whether the AO, TPO, and Dispute Resolution Panel (DRP) erred in concluding non-arm's length pricing based on assumptions of non-service rendition and lack of business nexus.
• Whether the cost allocation methodology adopted by the assessee for R&D and management fees is scientifically sound and consistent with global group practices.
• Whether the disallowance of expenses under section 37(1) of the Act was justified, considering the commercial expediency and business purpose of the expenditure.
• Whether the TPO and DRP complied with the mandatory provisions of section 92C regarding the application of prescribed methods for determination of ALP.
• Whether the initiation of penalty proceedings under section 270A was valid, given the absence of recorded satisfaction for underreporting or misreporting.
• Whether the DRP violated procedural requirements under section 144C(8) by issuing directions without proper consideration of additional evidence and remand reports.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of Transfer Pricing Adjustments on R&D and Management Fees

Legal Framework and Precedents: The determination of ALP for international transactions is governed by Chapter X of the Income Tax Act, specifically sections 92 to 92F, read with Rule 10D. The prescribed methods under section 92C must be mandatorily applied to benchmark transactions. The Hon'ble Jurisdictional High Court in CIT Vs Lever India Exports Limited and CIT Vs Johnson & Johnson Limited emphasized the mandatory nature of applying prescribed methods and held that adjustments made without following these methods are not sustainable.

Court's Interpretation and Reasoning: The Tribunal noted that the TPO treated the payments for R&D and management fees as nil without applying any prescribed method under section 92C, basing the adjustment solely on the absence of evidence of service rendition or benefit. The DRP confirmed the TPO's view despite the assessee submitting detailed documentation, including agreements, correspondence, invoices, and evidence of payments and tax deductions at source (TDS).

Key Evidence and Findings: The assessee furnished extensive evidence to demonstrate the nature of services rendered by AEs, including technical support, software licenses, and management assistance. The assessee also provided benchmarking analysis using the Transactional Net Margin Method (TNMM), showing that the operating profit to operating income (OP/OI) margin of the assessee fell within the arm's-length range of comparable independent enterprises.

Application of Law to Facts: The Tribunal found that the TPO and DRP failed to apply the prescribed methods and disregarded the benchmarking reports and evidences filed by the assessee. The absence of a remand report from the AO/TPO, despite directions from the DRP, further weakened the case for the adjustments made.

Treatment of Competing Arguments: The revenue argued that the assessee failed to prove receipt of services or benefit, justifying the adjustment and disallowance under section 37. The assessee countered with documentary evidence and case law asserting that TPO has no jurisdiction to assess the allowability of expenditure under section 37 and that the ALP must be determined by applying prescribed methods.

Conclusion: The Tribunal held that the TPO and DRP erred in making adjustments without applying prescribed methods, and in disregarding substantial evidence of service rendition and benchmarking. The matter was remanded for fresh determination of ALP in accordance with law.

Issue 2: Application of Prescribed Methods under Section 92C

Legal Framework and Precedents: Section 92C mandates the use of one of the prescribed methods for determining ALP. The Hon'ble Bombay High Court in CIT Vs Lever India Exports Limited and CIT Vs Johnson & Johnson Limited underscored that failure to apply these methods renders the transfer pricing adjustment invalid.

Court's Interpretation and Reasoning: The Tribunal observed that neither the TPO nor the DRP applied any prescribed method for benchmarking the payments in question. The TPO's determination of ALP as nil was based on assumptions and lack of evidence rather than on any methodically applied transfer pricing method.

Key Evidence and Findings: The assessee's benchmarking report using TNMM was not disputed by the TPO. The assessee also provided additional evidence to corroborate the arm's-length nature of the transactions.

Application of Law to Facts: The Tribunal emphasized the mandatory nature of applying prescribed methods and found the TPO's approach contrary to statutory requirements.

Treatment of Competing Arguments: The revenue relied on the absence of evidence of service and benefit, while the assessee relied on legal precedents and detailed transfer pricing documentation.

Conclusion: The Tribunal concluded that the TPO's failure to apply prescribed methods vitiated the transfer pricing adjustment, necessitating a fresh determination.

Issue 3: Evidence of Service Rendition and Business Nexus

Legal Framework and Precedents: The burden of proof lies on the assessee to demonstrate that international transactions with AEs are at arm's length and that services were rendered and received. However, the TPO cannot disregard credible evidence without proper examination. The Bangalore Tribunal in AXA Technologies Shared Services (P) Ltd. vs. DCIT held that where services are rendered under agreement and expenditure is booked, treating payment as nil is not acceptable.

Court's Interpretation and Reasoning: The Tribunal noted that the assessee submitted detailed agreements, correspondence, software usage details, employee lists, and payment proofs. The DRP's rejection of these evidences as "general in nature" was considered a generalized observation lacking substantive basis.

Key Evidence and Findings: The assessee demonstrated usage of proprietary software, detailed R&D activities, management support services, and payment of withholding taxes on these transactions.

Application of Law to Facts: The Tribunal found that the AO, TPO, and DRP failed to properly examine or appreciate the evidence, instead relying on presumptions and general observations.

Treatment of Competing Arguments: The revenue's contention of no benefit or service was rebutted by the assessee's documentary evidence and benchmarking analysis.

Conclusion: The Tribunal held that the presumption of non-service rendition was not justified and the evidence prima facie substantiated the transactions.

Issue 4: Disallowance under Section 37(1) of the Act

Legal Framework and Precedents: Section 37(1) allows deduction of expenditure incurred wholly and exclusively for business purposes. The Hon'ble High Court in CIT Vs Lever India Exports Limited held that the TPO has no jurisdiction to decide allowability under section 37.

Court's Interpretation and Reasoning: The DRP issued a show cause notice proposing disallowance of payments under section 37, which the assessee contested with justifications and evidence. The Tribunal noted that such disallowance is beyond the remit of TPO and DRP under transfer pricing proceedings.

Key Evidence and Findings: The assessee provided explanations and documentation supporting the commercial expediency and business purpose of the payments.

Application of Law to Facts: The Tribunal found that the disallowance under section 37 was not warranted in the transfer pricing proceedings and that the issue should be adjudicated separately.

Treatment of Competing Arguments: Revenue relied on absence of service rendition to justify disallowance, while the assessee relied on legal precedents and evidence of business purpose.

Conclusion: The Tribunal held that the disallowance under section 37 was not sustainable in the present transfer pricing context.

Issue 5: Procedural Compliance and Validity of DRP Directions

Legal Framework and Precedents: Section 144C(8) mandates that the DRP consider all evidence and remand reports before issuing directions. Failure to do so may render directions bad in law.

Court's Interpretation and Reasoning: The Tribunal observed that the DRP directed the AO/TPO to make adjustments without considering the additional evidence filed by the assessee and despite non-furnishing of remand report by AO/TPO. The DRP also issued show cause notices beyond its jurisdiction.

Key Evidence and Findings: The assessee submitted voluminous additional evidence, which was not adequately considered by the DRP.

Application of Law to Facts: The Tribunal found procedural lapses in the DRP's handling of the matter, including ignoring mandatory provisions of section 144C(8).

Treatment of Competing Arguments: The revenue supported the DRP's directions based on non-submission of evidence before TPO, while the assessee emphasized procedural violations and incomplete consideration.

Conclusion: The Tribunal held that the DRP's directions were flawed and required reconsideration after proper examination of evidence and remand reports.

Issue 6: Initiation of Penalty Proceedings under Section 270A

Legal Framework and Precedents: Section 270A requires recording of satisfaction by the AO before initiating penalty for underreporting or misreporting.

Court's Interpretation and Reasoning: The assessee contended that the penalty proceedings were initiated mechanically without recording adequate satisfaction.

Key Evidence and Findings: The record did not reflect any satisfaction note or reasoned order for penalty initiation.

Application of Law to Facts: The Tribunal found the initiation of penalty proceedings without proper recording to be erroneous.

Treatment of Competing Arguments: The revenue did not provide contrary evidence on the record of satisfaction.

Conclusion: The penalty proceedings were held to be invalid for lack of proper satisfaction.

3. SIGNIFICANT HOLDINGS

"The TPO and DRP erred in making transfer pricing adjustments without applying any of the prescribed methods under section 92C of the Income Tax Act, which is mandatory for determination of arm's-length price."

"The assessee furnished sufficient evidence, including agreements, correspondence, benchmarking reports, and payment proofs, to prima facie substantiate the arm's-length nature of payments for R&D and management fees to associated enterprises."

"The jurisdictional High Court has held that the TPO has no jurisdiction to examine the allowability of expenditure under section 37 of the Act; such issues are beyond the scope of transfer pricing proceedings."

"The DRP's directions are bad in law for ignoring mandatory provisions under section 144C(8) by failing to consider additional evidence and remand reports before issuing directions."

"The initiation of penalty proceedings under section 270A without recording adequate satisfaction is invalid."

"The matter is remanded to the AO/TPO for fresh determination of arm's-length price in accordance with law and after considering all relevant evidence and applying prescribed methods."