Contact us   Feedback   Annual Subscription   New User   Login      
Tax Management India .com
TMI - Tax Management India. Com
Extracts
Home List
← Previous Next →

2015 (5) TMI 932 - ITAT DELHI

2015 (5) TMI 932 - ITAT DELHI - TMI - TP Adjustments - Disregarding Profit Split Method ('PSM') as the most appropriate method for benchmarking Appellant's international transactions - held that:- The claim of the assessee that the issue is covered by the order of the Co-ordinate Bench in GOIPL [2014 (4) TMI 787 - ITAT DELHI] wherein held that when a transaction is integrated and interrelated and when costs are incurred by multiple entities and the revenues are to be apportioned to multiple enti .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

s and when such combined efforts generate revenues, the MAM for determining arm's length price is "Profit Split Method (PSM)", thus being the predecessor to the assessee is found to be correct. Relative contribution has to be determined, based on key value drivers - there is a general consensus on the principles of allocation of residual surplus - as per rule 10B(l)(d) of the IT Rules, a contribution or residual PSM would need to be supplemented by a comparable PSM - the TPO, should determine th .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

e case of GOIPL, the issue needs to be restored back to the TPO with identical directions. Decided in favour of assesse for statistical purposes - I.T.A. No. 1201/Del/2015 & SA-169/Del/2015 - Dated:- 8-5-2015 - Smt. Diva Singh And Sh. N. K. Saini,JJ. For the Appellant : Kanchun Kaushal, CA & Oindrila Bala, CA For the Respondent : None ORDER Per Diva Singh, JM By the present appeal the assessee assails the correctness of the order dated 30.01.2015 passed by the AO in pursuance to the directio .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ces, it was submitted, continue to remain the same. Inviting attention to Ground No.-3.3 and 3.4 raised in the present appeal and relying on the judicial precedent cited, it was his submission that the other grounds would become academic. 1.2. Accordingly the issue was stated to be covered by the said decision. 1.3. For ready-reference the specific grounds addressed are reproduced hereunder:- 3.3. disregarding Profit Split Method ('PSM') as the most appropriate method for benchmarking Ap .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

the Appellant. 2. Before we proceed to address the issues, it is necessary to bring out the fact that the present appeal filed by the assessee came to be argued on three different dates by the assessee. The first addressal in the afore-mentioned line as brought out in the first para was made on 16th March 2015. The Ld. Standing counsel for the Revenue appeared not to have the benefit of the aforesaid decision. Accordingly, in order to afford time to the Revenue to go through the same, the heari .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

d not have the authority to represent the Revenue in the two batches of interconnected 7/8 appeals each. However the oral request for adjournment was found to be factually incorrect as the two separate batch of appeals contrary to the submissions of the Ld. Standing Counsel were infact unconnected with each other. Accordingly after informing this fact to the Ld. Standing Counsel his oral request for adjournment on incorrect facts was declined and a pass over was instead given till CIT DR, Mr. A. .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

l shockingly on being so questioned walked out of the Court while shouting that he cannot argue. 2.1.2. Hence, considering that the Revenue was left unrepresented in the Court, the Court proceedings were directed to be stopped in the interest of the Revenue. The Court re-assembled only on the arrival of Ld. CIT DR (Transfer Pricing), Mr. A.K.Singh. However, some time after the re-commencement of the hearing, the Ld. Standing Counsel had walked back in the Court for a few minutes and again walked .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

he Revenue s response and matter was adjourned to 25.03.2015. It is unfortunate to note that during the hearing in the subsequent matters on the said date, the ld. CIT DR also walked out from the Court when his objections to the Court s recording in the proceedings in regard to the mis-demeanor of the Standing Counsel was declined as recorded in the Court proceedings of the matters on the said date. In the facts of the present case however Ld. CIT DR had sought time which was granted. 2.2. The a .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

his earlier request for adjournment which was specifically sought in order to afford him opportunity to put the Revenue s position on record. It is further seen that till the date of passing this order, no request has been made by the department seeking time to address the issues. It therefore becomes evident that instead of gainfully utilising the time granted in good faith to the Ld. Standing Counsel/CIT DR so that they can address the issues, the time so sought was not utilised for the stated .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

s was found to be misplaced and abused. Hence in the facts of the case, on the completion of the Ld. AR s arguments, the adjournment request was rejected as the Court functioning cannot be allowed to be obstructed ad-infinitum by the whims & fancies of persons who are reluctant to work where admittedly more than reasonable time had already been given to the Revenue who still chose to remain unrepresented. The application was rejected holding as under:- Rejected in view of the fact that the L .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

mentioned background, the present appeal came up to be argued three times by the Ld. AR where despite opportunities provided in good faith repeatedly to the Revenue the Revenue, through its standing counsel and Ld. CIT DR (International Taxation) chose not to advance any arguments whatsoever in support of the impugned order. Thus, in the absence of any submission from the Revenue the appeal is being decided ex-parte qua the Revenue on the basis of material available on record. We can only observ .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

bmitted that in the facts of the present case the issue is covered in assessee s favour by virtue of the aforesaid order of the Tribunal in Global One India Private Limited (ITA nos. 5571/Del/2011 and ITA nos. 5896/Del/2012). The said order it has been stated had been cited before the DRP however the DRP s order is silent on the issue as a result of this the AO while passing the final order did not address it. 4.1. For ready-reference, attention has been invited to the internal page 11 of the DR .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

vt. Ltd. as has been taken note of by the AO in his order dated 11.03.2014 u/s 143(3)/144C was the successor entity of Global One India Private Limited (hereinafter referred to as GOIPL ) wherein the order of the Tribunal is available. 4.3. The assessee it was submitted had taken over the business operation of GOIPL post the GOIPL s Board decision of ceasing GOIPL operations in FY 2008-09. 4.4. The assessee it was submitted has all along claimed that it follows the same business model, undertake .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

rgin method (hereinafter referred to as TNMM ) as the most appropriate method (hereinafter referred to as MAM ) on similar reasoning as in the facts of the present case. 4.6. Accordingly it was his prayer that in the facts of the present case also following the decision of the Co-ordinate Bench in similar facts and circumstances in the case of the predecessor of the assessee, PSM may be directed to be held as the most appropriate method. 5. We have heard the submissions advanced on behalf of the .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

orne out from the record are that the assessee declared an income of ₹ 6,95,61,820/- by way of electronically filing its return which was subjected to scrutiny assessment. A reference to the TPO was made by the AO to determine the Arm s Length Price u/s 92CA(3) of the Act in respect of the international transaction entered into by the assessee in the year under consideration. It is seen that the TPO proposed an adjustment u/s 92CA of ₹ 17.41 crore odd. The assessee availing of the st .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

Co-ordinate Bench in the case of GOIPL, stated to be predecessor of the assessee, we find that the Ld. AR has specifically invited our attention to the objections filed before the DRP (copy at pages 1 to 52), Annexure-I of the same at page 48 reads as under:- Annexure 1 - Note on transfer of business operations to Equant Networks India Private Limited Global One India Pvt. Ltd. ( GOIPL'), incorporated under the laws of India, was a 100% subsidiary of Equant BV. GOIPL was engaged in providing .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

operations of GOIPL were decided by the Board of Directors to be transited under the new FDI and regulatory regime and hence to be continued in newly incorporated entity compliant with required licenses and shareholding pattern. A new company, Equant Networks Services India Private Limited ('ENSIPL' or 'Assessee' or 'the Company') was incorporated in 2007 as a Foreign Investment Promotion Board approved Joint Venture Company between EGN B.V., Equant Pte, Limited and Emery .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

national Long Distance ( ILD') service categories, in India. The Company became operational from August 2008 and is engaged in providing data services including IP voice services and related network services to the Group's customers in India. The services offered by ENSIPL under its NLD & ILD license are layer 2 and layer 3 data services which mainly cover IPVPN, MPLS, ATM, Frame Relay, X.25, X.28 Protocol etc, as was provided by GOIPL. During FY 2008-09, both GOIPL and ENSIPL had IS .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ons completely in GOIPL w.e.f. March 31, 2009. Post FY 2008-09, there was no business in GOIPL at all and ENSIPL had taken over servicing the customers of the Equant Group. ENSIPL, though a distinct entity, took over the business operations of GOIPL post the GOIPL's Board decision of ceasing GOIPL's operations in FY 2008-09. ENSIPL follows the same business model, undertakes the same operations, services the same Equant Group clients and employs the same management personnel and employee .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

he same Equant Group clients and employs the same management personnel and employees as was done by GOIPL. The claim has also been put forth that as a consequence, the employees of GOIPL were transferred and the network equipments of GOIPL were sold (following a valuation undertaken by a third party valuer) to ENSIPL during the year. The said claim put forth before the DRP, it is seen, has not been addressed by the said authority. The said claim it is seen has been made even before us on three d .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

OBSINPL i.e the assessee) is a company incorporated under the laws of India. It is a joint venture company between EGN B.V, Equant Pte. Ltd. and Emery Technologies Private Limited wherein EGN B.V. and Equant Pte. Ltd. are the foreign investors in the joint venture and are part of the FT Group. ENSIPL was incorporated in the year 2007 and during the F.Y. 2008-09 and as per the TPO obtained licenses from Department of Telecommunications to provide services under the NLD and ILD service categories .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

:- 5.1. Functions Performed by ENSIPL (Taxpayer) ENSIPL is one of the operating entities of the group in India. ENSIPL is primarily engaged in providing data services and related network services to group's customers located in India. The data services offered by ENSIPL under the NLD and ILD service categories include provision of IP Voice services and related network services and services relating to installation/configuration of routers etc. The services offered by ENSIPL under its NLD &am .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

nd that undertaking filed operations viz installation/configuration of routers etc and fully managed support solutions developed around the basic network services. Further, ENSIPL also owns and deploys necessary network equipments. 5.7. In the facts of the present case, we find that repeatedly the assessee vide reply dated 17.01.2014 before the TPO and before the DRP has advanced the arguments that PSM was the most appropriate method as its correct application, satisfies the conditions. Namely, .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

telecom services and provides global, integrated and customized communication infrastructure solutions that enable the key business processes of its customers; Customers contracts of the Group are for provision of integrated services on Equant Group's network which is spread across the globe; in many cases the customers of Equant Group have one decision maker, the head office, which is usually located in one country and Equant Group deals directly with one location to complete the sales con .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

services to be billed between more than one location, but not necessarily all the locations where the services are provided- this again results in a mismatch between where the revenues are recorded and where the services are provided; each of the entities in the Equant Group is reliant upon the other functions to generate global profits or losses for Equant Group, the services and investments made by each of these entities are of a non-routine nature; the Key Industry Success Factors for the bus .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

The TPO in the present proceedings also considered the fact that similar facts were there in the preceding years as the company had barely started its operations in August, 2008 and started realizing revenue from December, 2008 onwards and infact value to Network depreciation was given only in the month of March 2009 and it is for this reason the TPO holds that despite application of PSM by the assessee, no adverse inference was drawn by the Revenue in the earlier year as the revenues earned dur .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

res-judicata does not apply in transfer pricing proceedings. 5.9.1. A perusal of the order of the Co-ordinate Bench shows that identical reasoning and fact has been considered by the Co-ordinate Bench and the departmental stand taken has not been accepted. 5.9.2. For ready-reference, we extract the relevant finding:- The Transfer Pricing Officer, had after a detail enquiry in the earlier assessment years, accepted PSM as the MAM . This being so, in our view, rejection of this method on the grou .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

.10. It is also seen that the stand taken by the TPO in the facts of the present case to justify his action that TP proceedings shall be conducted based on the provisions of the Indian Transfer pricing regulations and the judicial guidance provided by the Indian judiciary rejecting the supporting argument of the assessee that as a method PSM has been accepted in other tax jurisdictions has also not been approved of by the Co-ordinate Bench. 5.10.1. Similar reasoning was considered by the Co-ordi .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

arriving at conclusions. One such case is, Azadi Bachao Andolan, 184 CTR SC 450. Even the Indian transfer Pricing Regulation recognize this aspect, as evident from the introduction of Rule 10 AB, which allows the use of any other method which is generally accepted, for determining ALP. 5.11. It is further seen that the assessee in support of its justification for PSM as the most appropriate method even before the TPO as per the afore-said letter dated 17.01.2014 (which has been extracted in the .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

n the network is measured by the accumulated unabsorbed investments in the network made by Equant Network Systems Ltd. ( ENSYS") an Equant Group Company in Ireland. • Foregone performance payments: Prior to the execution of a Memorandum of Understanding ( MOU") on September 10, 2004 effective January 1, 2004 amongst all Equant entities, a prior intercompany transfer pricing agreement with ENSYS required ENSYS to compensate each entity within the Group for the network cost incurred .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

work operations. (ii) Sales and Marketing Operations: The sales and marketing operations undertaken by each entity within the Group are measured by the staff costs of the personnel engaged in sales and marketing related activities. (ii) Field Operations: The field operations undertaken by each entity within the Group are measured by the staff costs of the personnel working in the relevant field operation functions." 5.11.1. A perusal of the GOIPL s order passed by the Co-ordinate Bench show .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ke to continue in business. Moreover, no patents/copyrights were found to be held in these intangibles. As in GOIPL s case herein also the TPO took the position that a unique intangible is one that adds value to the existing set up. In the facts of the present case as in GOIPL s case the TPO held that no evidence of any new business practice, a new marketing strategy, a new technological development or anything of this kind that can be stated to have been developed by it that can be said to have .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ed the Point of Supply; (ii) From there it travels to a 'landing station' where the distance between the point of supply and the landing station may be maintained by the assessee or it may be outsourced; and (iii) The last part where from the landing station to the terminal of the customer is called 'last mile connectivity'. The TPO considering the claim held that this is almost always outsourced to another service provider and infact the assessee depended upon other unrelated en .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

e domestic TP Regulations even in cases involving multiple interrelated international transactions, which cannot be evaluated separately for determining ALP of any one transaction. The Coordinate Bench further held that when the transaction involved 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 . 5.12.2.The Co-ordinate Bench also held that use of unique .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

to why reputed global enterprises 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. 5.13. Thus, it is seen that the above finding also deals with the objections of the TPO in the present proceedings that the assessee's business does not have any integration with the other group entities. The objection of the TPO in the present proceeding in par .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

irements in India as a justification for applying TNMM has also been considered by the Coordinate Bench in para 18.3 and for the following reasons set out in para 18.4 it was disagreed with:- 18.4. In our view, the TPO has erred on facts. The revenues in the case of the assessee are generated in a transaction where there is contribution from multiple entities. It is true that the assessee runs its business independently in India. This leads to a conclusion that the assessee is an independent ent .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

eliberate business strategy; Economic downturn; Business cycle stage; Excessive financial risk; Effect of government intervention according to the TPO did not address the losses made. Similarly the explanation of the assessee not accepted by the TPO that there is no loyalty to any particular service provider as far as customers are concerned and the argument that there is continuous erosion of margins for telecommunication industry rejected by the TPO as facts common to all entities operating in .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ity would have agreed to such terms nor would it have agreed to be tied down by the financial performance of another entity/entities over which/whom it has little or no control have also been considered by the Co-ordinate Bench and disagreed with. 5.15.1. These issues have been considered by the Co-ordinate Bench in para 20.1 & 20.2 in the following manner:- 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 .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

In our view, this cannot be a ground for rejection of PSM. The conclusion of the T.P.O. that the PSM is adopted only to camouflage the loss at the net level, is merely an allegation which, in our view, is not substantiated or demonstrated by the T.P.O. and hence is devoid of merit. 20.2. When determining as to which is the MAM, the TPO is required to primarily examine the functional profile of the assessee and the nature of the international transaction and having undertaken such an exercise, we .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

multiple entities. It is true that the assessee runs its business independently in India. This leads to a conclusion that the assessee is an independent entrepreneur. But when a transaction 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 .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

agree with the conclusions of the T.P.O. T.N.M.M. can be applied even in cases where there are commercial or other losses. At best, suitable adjustments may be asked for. On the role of the administrator we will be discussing the same separately. 18.8. The next objection of the assessee is that TNMM cannot be used for bench marking returns earned by the number of complex entities/entrepreneur, where each make valuable unique contributions. The TPO has not specifically dealt with this objection .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ansactional profit split method will generally be the Most Appropriate Method. 5.17. A reading of the order in GOIPL s case further shows that the view so take was only after considering the judicial precedent laid down by the Special Bench in the case of Aztech Software and Technology Services Ltd. vs ACIT 107 ITD in para 17.3; and the OECD in Transfer Pricing Guidelines for multinational enterprises and tax administration; and United Nations practical Manual on Transfer Pricing for developing .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

eported in 107 ITD, at page , states as follows: Profit 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 e .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

tion; 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 any one transaction. 182. The profit split method first identifies the profit to be split for the associated enterprise from the controlled transactions in which the associated enterprises are engaged. It then splits those profits between the associated enterprises on an .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

al analysis is an analysis of the functions performed (taking into account assets used and risks assumed) by each enterprise. The external market criteria may include, for example, profit split percentages or returns observed among independent enterprises with comparable functions. 17.4. The OECD transfer pricing guideline for multinational enterprises and tax administration in Chapter 2 on transfer pricing methods, at page 93, para C.1 states as follows: C.1 In general 2.108 The transactional p .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

the controlled transactions in which the associated enterprises are engaged (the combined profits ). References to profits should be taken as applying equally to losses. See paragraphs 2.124-2.131 for a discussion of how to measure the profits to be split. It then splits those combined profits between the associated enterprises on an economically valid basis that approximates the division of profits that would have been anticipated and reflected in an agreement made at arm s length. See paragrap .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

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 .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ice that the buyer would be reasonably willing to pay. Any discrepancy between these two figures could result in the residual profit over which independent enterprises would bargain. In the second stage, the residual analysis therefore could divide this pool of profit based on an analysis of any factors relevant to the associated enterprises that would indicate how independent enterprises might have split the difference between the seller s minimum price and the buyer s maximum price. 2.123 In s .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

could be estimated with a reasonable degree of certainty. However, the reliability of such an approach will depend on the use of an appropriate discount rate, which should be based on market benchmarks. In this regard, it should be noted that industry wide risk premiums used to calculate the discount do not distinguish between particular companies let alone segments of business, and estimates of the relative timing of receipts can be problematic. Such an approach, therefore, would require consid .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

it Method seeks to eliminate the effect on profits of special conditions made or imposed in a controlled transaction(or in controlled transactions that it is appropriate 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 trans .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

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 services. 17.7. Residual analysis is stated as follows: 6.314.7 The Residual Profit Split Method is used more in practice than the contribution appr .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

amount of profit that is to be split in the potentially more controversial second step. 6.3.17.3. In step 1 of the residual analysis, a basic return for the manufacturing function is determined for Company A and Company B. Specially a benchmarking analysis is performed to search for comparable independent manufactures which do not own valuable intangible property. The residual profit, which is the combined profits of company A and company B after deducting the basis (arm s length ) return for t .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

follows: Thus, to summarize, RPSM provides a test of arm s length transfer pricing between value- added stages of an integrated enterprise that is consistent with the separate enterprise standard under conditions of resource mobility and competitive capital and product markets. By valuing functional activities and capital in terms of the competitive norms of the market place, RPSM attributes extra- normal profit or loss in proportion to the relative investment cost (or other valuation) of the n .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

onal and entrepreneurial capital. 17.9. Residual Profit Split Method in the book U.S.Transfer Pricing by HARLOW N.HIGINBOTAM at Chapter 10, it 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 o .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

tions, and thus leave open the question of how best to determine the relative value of each controlled taxpayer s contribution to the success of the relevant business activity in a manner that reflects the functions performed, risks assumed, and resources employed by each participant in the relevant business activity, consistent with the comparability provisions of 1.482- 1(d) (3). 18. We now consider TNMM. In Aztek Software and Technology Services (supra) the TNMM is stated as follows. Transact .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ber of such transactions is computed having regard to the same base; (iii) The net profit margin referred to in sub clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) The net profit margin realized by t .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

r operation. Under this method, the net profit margin realized by an AE from an international transaction is computed in relation to a particular factor such as costs incurred, sales, assets utilized etc. The net profit margin realized by an AE is compared with net profit margin of the uncontrolled transactions to arrive at the ALP. The TNMM 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 uncontrol .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

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 .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

iples of paragraphs 3.9 - 3.12). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net profit indicator of the tax payer from the controlled transaction ( or transactions that are appropriate to .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

for comparability, and in particular those of paragraphs 2.69-2.75, must be applied. 2.59. A transactional net margin method is unlikely to be reliable if each party to a transaction makes valuable, unique contributions, see paragraph 2.4. In such a case, a transactional profit split method will generally be the most appropriate method, see paragraph 2.109. However, a one-sided method (traditional transaction method or transactional net margin method) may be applicable in cases where one of the .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ition 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 t .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

more indirect method than the CUP method that compares prices, because it uses net profit margins to determine (arm s length) prices. One should bear in mind that many factors may affect net profit margins, but may have nothing to do with transfer pricing. The TNMM is used to analyse transfer pricing issues involving tangible property, intangible property or services. When the TNMM is applied on controlled transactions involving tangible property, the tested party in the analysis can either be .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ested party should not own valuable intangible property. This, by the way, is also the reason why it is recommended to select the least complex entity for the application of the cost plus method or resale price method. 18.3. The Transfer Pricing , in the case at hand, has applied the TNMM method. While doing so, at para 3.7, he considered the objection of the assessee to the use of TNMM as the MAM. He observed as follows: that the assessee s business does not has any integration with the other g .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

operational requirements in India. Therefore, there is no case to say that TNMM does not qualify to be the MAM for its reason. 5.18. It is only after the above marathon discussion that the afore-quoted conclusion in para 18.4 to 18.8 reproduced in the earlier part of this order have been arrived at leading to finally holding in para 19 and 19.1 that the TPO s rejection of PSM as the MAM on facts was incorrect. 5.19. It is also seen that considering the facts, the Co-ordinate Bench has held that .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

of the view that PSM has not been correctly applied then this conclusion did not justify rejection of the method. The Co-ordinate Bench on the facts which in the facts of the present case continued to remain the same had infact concluded that the assessee has applied Residency Profit Split Method. Considering the legal position thereon the Co-ordinate Bench remitted the matter back to the TPO with speaking directions and it is this direction which is sought to be repeated by the assessee herein .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

rolled transactions. 5.20. It is further seen that in paras 20.6 to para 20.10 the Co-ordinate Bench after discussing the facts vis-à-vis the rules in the absence of a direct reference to the issue of allocation of residuary profits in the Rules under the Statute the Co-ordinate Bench in para 20.11 and para 2.12 directed the TPO to determine ALP by adopting Residual PSM as MAM by allocating residual profits based on the relative value of each enterprise s contribution, as suggested by var .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ty 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 har .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

provided in the statute. Nevertheless, to make the provisions workable, a harmonious interpretation is the requirement, as held by the Supreme Court in CIT vs. J.H.Gotla, reported in 156 ITR 985. Such harmonious interpretation, in our view, does not tantamount to misreading the provisions, or to the reading down of a provision. Both the OECD Transfer Pricing Guidelines as well as the UN Draft Method of Transfer Pricing for Developing Countries, suggest that an allocation of residual profits und .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

.3.4. How to split the combined profits C.3.4.1. In general 2.132 : The relevance of comparable uncontrolled transactions or internal data and the criteria used to achieve an ;arm s length division of the profits depend on the facts and circumstances of the case. It is therefore not desirable to establish a prescriptive list of criteria or allocation keys. See paragraphs 2.115-2.117 for general guidance on the consistency of the determination of the splitting factors. In addition, the criteria o .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

d 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 .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

it achieved between independent parties in comparable transactions), or a variable (e.g. relative value of participant's marketing expenditure or other possible keys as discussed below). Where more than one allocation key is used, it will also be necessary to weight the allocation keys used to determine the relative contribution that each allocation key represents to the earning of the combined profits. 2.135 In practice, allocation keys based on assets/capital (operating assets, fixed asset .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

data storage, floor area of retail points, etc. may be appropriate depending on the facts and circumstances of the transactions. Asset-based allocation keys 2.136 Asset-based or capital-based allocation keys can be used where there is a strong correlation between tangible or intangible assets or capital employed and creation of value in the context of the controlled transaction. See paragraph 2.145 for a brief discussion of splitting the combined profits by reference to capital employed. In ord .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

transaction contributes valuable, unique intangibles. Intangible assets pose difficult issues in relation both to their identification and to their valuation. Identification of intangibles can be difficult because not all valuable intangible assets are legally protected and registered and not all valuable intangible assets are recorded in the accounts. An essential part of a transactional profit split analysis is to identify what intangible assets are contributed by each associated enterprise to .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ed. 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 t .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ys is that they can be very sensitive to accounting classification of costs. It is therefore necessary to clearly identify in advance what costs will be taken into account in the determination of the allocation key and to determine the allocation key consistently among the parties. Timing issues 2.140 Another important issue is the determination of the relevant period of time from which the elements of determination of the allocation key (e.g. assets, costs, or others) should be taken into accou .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

rcumstances) incurred in the previous as well as the current years. Depending on the facts and circumstances of the case, this determination may have a significant effect on the allocation of profits amongst the parties. As noted at paragraphs 2.116-2.117 above, the selection of the allocation key should be appropriate to the particular circumstances of the case and provide a reliable approximation of the division of profits that would have been agreed between independent parties. C.3.4.4 Relian .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

sfy the conditions outlined in this Section and in particular at paragraphs 2.116-2.117 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 i .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

n 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 not subject to this profit split determination) should be applied consistently to all the parties to the transaction. See also paragraph 2.98 for a discussion of valuation of assets in the context of the transa .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

tc. 2.144 Internal data are essential to assess the values of the respective contributions of the parties to the controlled transaction. The determination of such values should rely on a functional analysis that takes into account all the economically significant functions, assets and risks contributed by the parties to the controlled transaction. In those cases where the profit is split on the basis of an evaluation of the relative importance of the functions, assets and risks to the value adde .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

each of the associated enterprises participating in the controlled transactions earns the same rate of return on the capital it employs in that transaction. This method assumes that each participant's capital investment in the transaction is subject to a similar level of risk, so that one might expect the participants to earn similar rates of return if they were operating in the open market. However, this assumption may not be realistic. For example, it would not account for conditions in ; .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

utions 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 circumsta .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

d taxpayers' routine contributions will not reflect profits attributable to the controlled group's valuable intangible property where similar property is not owned by the uncontrolled taxpayers from which the market returns are derived. Thus, in cases where such intangibles are present there normally will be an unallocated residual profit after the allocation of income described in paragraph(c)(3)(i)(A) of this section. Under this second step, the residual profit generally should be divi .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

the intangibles and all related improvements and updates, less an appropriate amount of amortization based on the useful life of each intangible. Finally, if the intangible development expenditures of the parties are relatively constant over time and the useful life of the intangible property of all parties is approximately the same, the amount of actual expenditures in recent years may be used to estimate the relative value of intangible contributions. If the intangible property contributed by .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

rule 10B(1)(d) of the IT Rules, India prescribes that an assessee can adopt - a. either a contribution PSM, namely where the entire systems profits are split amongst the various AEs, who are parties to the transactions in question; 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 ma .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

y "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 the IT Rules of India is quite unique, as compared .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

the PSM virtually redundant in most cases, since, it is not possible to obtain reliable market data on third party behavior in the matter of splitting profits, except for in some rare cases of joint venture arrangements. However, in cases of transactions involving either ITA contribution or exploitation of intangibles by all the parties to the transaction or where such transactions are extremely interrelated, of the types as in the case of the appellant, where knowledge of third party behavior i .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ot available [paragraph 6.3.15 of UN TP guidelines]. 7. Describing the comparable PSM, the OECD held in its guidelines that external data for comparable PSM can be available in cases of joint venture agreements 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 i .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

es 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 th .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ble on the face of accounts. Extracts from a few of the said articles/ books are reproduced below for ease of reference - a. J.P. Warner and H.B. McCawley, Transfer Pricing: The Code and the Regulations, note 70, at A-144; and T. Horst. Profit Split Methods 0,60 Tax Notes (1993), at 335 - "The comparable profit split method is rarely applied, as information on comparable reference transactions will not normally be available." b. Transfer Pricing and Corporate Taxation: Problems, Practi .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

ons as potentially insurmountable obstacle to the practical realization of CPSM. This pessimistic viewpoint overlooks a relatively voluminous body of evidence and experience in the intellectual property area where such calculations are routinely, if somewhat roughly, applied in valuing license transactions". d. Transfer Pricing Rules and Compliance Handbook - Page number 33 - 0.2 Comparable Profit Split Method - Authored by Marc M. Levey, C. Wrappe Steven and Steven C. Wrappe - " .... .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

also of contractual terms." 11. In view of the above discussions emanating from the OECD and UN TP guidelines; and also commentaries of several transfer pricing experts, it is evident that comparable PSM is rarely used internationally in view of lack of reliable external data with respect to third party behavior to split profits; and OECD and UN clearly give taxpayers an option to adopt anyone of the three sub- methods under the overall PSM, namely contribution PSM, residual P'SM and co .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

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 vs. 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 .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

excuse. 13. The requirement contained in rule 10B(1)(d) of the IT Rules of mandatory adoption of comparable PSM in all cases of PSM is a lacuna, which 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 nonroutine or unique intangibles, or the transactions are so interrelated that they can .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

d party behavior is impossible to be obtained. 15. In this connection, reference is invited to the ruling of the Hon ble SC rendered in the case of M.Pentiah and others vs. Muddala Veeramallappa and others (1961 AIR 1107), where the Hon ble Court quoted with approval, the famous words on interpretation of statutes said by Lord Denning in the case of Seaford Court Estates Ltd. Vs. Asher(1), namely : When a defect appears a Judge cannot simply fold his hands and blame the draftsman. He must set to .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

is woven, but he can and should iron out the creases. 16. In other words, in case the Hon ble 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 an .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

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) of the IT Rules, in order to make the mechanism of PSM actually workable in India, and not rendered otiose on the ground of impossibility of performance. 20.12. In view of the above discussion, we are of the cons .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

of section 92C, the other method for determination of the arm s length price in relation to an international transaction shall be any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts. While introducing the Amendment the CBDT Circular is referred to below. The Central Board of Dire .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

, for similar uncontrolled transactions, with or between non-AEs, would have been charged or paid, for similar uncontrolled transactions, with or between non AEs, under similar circumstances, considering all the relevant facts. Thus, the said Other Method would ideally operate where none of the methods specified under the IT Act and Rules would apply, with reference to the descriptions/definitions provided in rule 10B(1) of the IT Rules, yet there is a compelling need to arrive at the ALP of any .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

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 method 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 determina .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

d. Counsel for the assessee has relied on the decision of I.T.A.T. Chennai Bench in the case of Acendas India P.Ltd. vs. DCIT in ITA 1736/Mds/2011 and the decision of the Bangalore Bench of the Tribunal in the case of Tally Solutions P.Ltd. vs. DCIT in ITA 1235/Bng/2010, for the proposition that suitable adjustments and methodology prescribed for evaluation of an international transaction are permissible and that the prescribed methods may not be rigidly followed, as was done in those cases.. He .....

X X X X X X X

Extract - Part text only
Click here to Access Full Contents

X X X X X X X

 

 

 

 

 



|| Home || Acts and Rules || Notifications || Circulars || Schedules || Tariff || Forms || Case Laws || Manuals ||

|| About us || Contact us || Disclaimer || Terms of Use || Privacy Policy || TMI Database || Members || Site Map ||

© Taxmanagementindia.com [A unit of MS Knowledge Processing Pvt. Ltd.] All rights reserved.

Go to Mobile Version