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2016 (2) TMI 382 - ITAT AHMEDABAD

2016 (2) TMI 382 - ITAT AHMEDABAD - [2016] 47 ITR (Trib) 113 - Transfer pricing adjustment - Capacity underutilization - Held that:- Merely because the employee costs of the assessee are higher, it does, in our considered view, lead to the conclusion that there is an underutilization of capacity. It is also a matter of record, as noted by the assessee in the written submissions, that the underutilization is much more in the case of non AE transactions inasmuch as “the employee costs to turnover .....

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has not been carried out at all. There is not even whisper of a discussion, on this aspect of the matter, in the orders of the authorities below or in the submissions of the assessee.

In view of the above discussions, we are not inclined to uphold the assessee’s grievance with respect to denial of adjustment for capacity underutilization.

Inclusion of three comparables, namely (a) Crossdomain Solutions Ltd (b) Maple eSolutions, and (c) Vishal Information Tech Ltd. challenge .....

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s adopted by the assessee is ₹ 12,50,03,640, on the basis of comparables agreed to by the assessee, or is ₹ 13,46,20,929 as worked out by the TPO, on the basis of comparables adopted by him. In either of the situations, the ALP adjustment will be restricted to the difference between the transaction value (i.e. ₹ 10,39,29,814) and the revenue realized from the non AE (i.e. ₹ 12,13,50,108). The directions of the DRP having reached finality, so far as this approach adopted b .....

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3(3) r.w.s. 144C (1) of the Income Tax Act, 1961, for the assessment year 2008-09. 2. Grievance of the assessee, in short, is that the Assessing Officer, on the facts and in the circumstances of this case, erred in making an arm s length price adjustment of ₹ 1,74,20,294 to the value of international transactions that the assessee had entered into with its associated enterprises. 3. The arguments are in support of this grievance, however, are multi-fold. 4. On legal principles, the fundame .....

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ed which is reflected in the employee cost as percentage of revenues being substantially higher compared to the employee costs of comparable companies. Finally, so far as comparables selected by the TPO are concerned, the grievance of the assessee is that (a) Crossdomain Solutions Ltd (b) Maple eSolutions (c) Vishal Information Tech Ltd have been wrongly selected as comparables inasmuch as these comparables are functionally not comparable to the assessee. 6. We will take up the preliminary legal .....

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mounting to ₹ 10,39,29,814, with its associated enterprises- namely Fortune Infotech (USA) Inc (Fortune US, in short). The assessee also entered into international transactions, aggregating to ₹ 13,90,58,591, with Fidelity Information Services Inc, USA (Fidelity US, in short)- a company which was, so far as material point of time is concerned, not an associated enterprises. The assessee s contention was that since the margins earned by the assessee on its transactions with non-AE are .....

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non-AE transactions, which is enumerated in the TP report itself, (and) considering these differences in functions and risks, the benchmarking done through internal TNMM cannot be accepted . A detailed analysis of these differences was then set out by the TPO, though, for the reasons we will set out in a short while, it is not really necessary to go into those factual aspects. Suffice to say that differences were pointed out which were challenged, on merits, during the proceedings before the Dis .....

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herefore the continuing transactions with the same entity may not actually be considered as at arm s length . The assessee s objection before the DRP was thus rejected. 8. During the course of proceedings before the TPO, it was contended by the assessee that since the assessee group, as a whole, was incurring the loss, no arm s length price adjustment was required at all. It was pointed out that revenue earned from the third party was much less than overall operating costs incurred by the assess .....

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ciple. However, as regards the plea of the assessee that further, the learned TPO and the learned AO have erred in law and on facts by not considering the fact that adjustments, if any, should be restricted to the price received by Fortune USA from its ultimate customers , the DRP did direct the TPO to restrict the quantum of adjustment to the amount actually received by the AE from the third parties . Accordingly, even though the ALP determined by the TPO was ₹ 13,46,20,929 as against the .....

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lobal profit earned by the group as a whole which is against the basic fundamental of transfer pricing. On this issue also thus, not satisfied by the orders of the authorities below, the assessee is in appeal before us. 9. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position. 10. We have noted that during the course of the hearing before us, learned counsel vehemently contended that, on the facts o .....

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ons we will set out in a short while and in our considered view, it is not really necessary to go into that aspect of the matter. When we put it to the learned counsel that when only one comparable is available so far as internal TNMM is concerned, and the reliability of this comparable is also not free from doubt, would it really be appropriate to select this method as most appropriate method for determining arm s length price on the facts of this case, he quickly responded that there is no sta .....

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the light of availability of necessary inputs for various alternative options and in the light of other relevant factors. If in one case the Tribunal has held that even one comparable is good enough for determining the arm s length price on the basis of one of the prescribed methods, and that method is most appropriate method in a given situation, it cannot be inferred that irrespective of the method employed and de-hors the peculiarities of a fact situation, a single comparable is good enough f .....

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r, the mandate of Section 92C(1), read with rule 10C, is unambiguous. A method selected for benchmarking must be a permissible method to be included in the consideration zone, but even it s presence in the consideration zone is not good enough to justify its application for benchmarking the international transactions on the facts of a particular case because such a method has to be not only a permissible method but also most appropriate method having regard to all the material factors, including .....

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erything permissible in law, as indeed in all walks of life, is not necessarily the most appropriate thing as well. It is important to bear in mind the fact that under section 92C(1), the arm s length price in relation to an international transaction shall be determined by one of the ...(prescribed)... methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other r .....

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gth price in relation to the international transaction (2) In selecting the most appropriate method as specified in sub-rule (1), the following factors shall be taken into account, namely:- (a) the nature and class of the international transaction; (b) the class or classes of associated enterprises entering into the transaction and the functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprises; (c) the availability, coverage and reliab .....

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nd reliability of assumptions required to be made in application of a method [Emphasis, by underlining, supplied by us] 11. The scheme of the transfer pricing legislation in India is thus unambiguous. There is no dispute that the selection of most appropriate method is not in the unfettered discretion of the assessee and it is something which can always be subject matter of adjudication at the assessment as well as appellate stage. The TPO has a right, as indeed duty, to examine whether a partic .....

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one of the crucial factors in deciding whether that particular method of determining the ALP is most appropriate method of determining ALP on the facts of that case, or not. When only one comparable is available for application of a particular method, this serious limitation on the availability of data, in our considered view, certainly relegates its appropriateness vis-a-vis other alternate methods available, such as external TNMM, in respect of which sufficient, and essentially reliable, data .....

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ing huge losses, as high as 21.75% on cost, and the fact that it is a single comparable, does raise serious apprehensions about its reliability. This fact situation, coupled with the admitted position that sufficient number of external comparables for TNMM are available, does leave the internal TNMM much lower in the hierarchy of methods, particularly vis-à-vis external TNMM, appropriate for determining the ALP on the facts of this case. We are of the considered view that the internal TNM .....

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to the AE, but, given our above conclusions, that aspect of the matter is wholly academic. 12. The second legal proposition advanced by the learned counsel is that the total adjustment made to the arm s length price of the appellant should be restricted to the overall income earned by the AE from third parties. As we deal with this contention, we must bear in mind the situation before us is that the AE has sold the service to the independent enterprise at a price lower than the ALP worked out by .....

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is not content with this. He contends that since the AE has incurred certain expenses to earn this revenue, the expenses so incurred by the AE should also be reduced from the revenue, so realized by the AE, to arrive at the correct arm s length price of the service. The underlying conceptual justification for this proposition is that the ALP adjustment should be restricted to the overall profits of the group as a whole. In support of this proposition, the written submissions filed by the assesse .....

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quantum of adjustment of the Appellant to the price received by the AE from its third party, the expenditure incurred by the AE should also be allowed as a reduction from the proposed TP adjustment if the contentions of the Appellant at grounds 2.2. to 2.7 are rejected. Consequently, the adjustment should be limited to the profits earned by the AE of the Appellant and not to the revenues earned by the AE from third party. The learned TPO has incorrectly interpreted the ruling of the Hon ble ITAT .....

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nt of revenue received by an entity (say entity A, is lower than the fair amount of revenue receivable by it is due to the other entity (say entity B) receiving a larger share. Such unfairness may be mitigated by requiring the entity B to retain only its fair share and give up the balance amount in favour of entity A. In the worst case, entity B may be required to give up its entire share of revenue which would result in entity A receiving 100 per cent of the revenue. However, it cannot be logic .....

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e to the object and scheme of transfer pricing regulation which govern the international transaction undertaken by an assessee with its associated enterprise and not when transactions take place between assessee and independent clients. It is further submitted by the Appellant that Fortune USA undertakes the business development and the marketing functions for and on behalf of the Appellant. It is also responsible for maintaining the relationship with the end customers in order to procure regula .....

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obtaining business; effectively, the AE will have to pay this amount of expenditure from its internal resources which is an absurd proposition envisaged in the decision of Global Vantedge (supra). An alternate way of looking at this is if the AE was not in picture and the Appellant was required to perform the marketing and business development function, the Appellant would have to incur this expenditure by itself. No doubt in such cases, all the revenues would have also accrued to the Appellant .....

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the global operating profits earned by the group from the international transaction (please refer para 9 and 10 on page 682 and 683 of the compilation of case laws). Similar view has also been expressed in the decision of Apollo Health Street included at serial no 38 of the compilation of legal case laws (please refer para 9 and 10 on page 692). Considering all the above, the Appellant respectfully submits that the TP adjustment should be limited to the net profits of the AE. Accordingly, since .....

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tive that the transfer pricing provisions are not applicable in view of the total incidence of tax remaining at the same leval due to losses incurred by AE offsetting the income of the assessee, does not merit acceptance. The intent and purpose of these provisions is not to ensure that there is no diminution in the tax liability of Indian enterprise as well as its AE on a total basis. Rather the logic is to make certain that the transactions between the AE should not be arranged in such a way th .....

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levant in the determination of correct tax liability in the hands of the Indian enterprise. What is material is that the rightful tax payable in India should not suffer due to the adjustment of price for goods or services between the related enterprises. The contention of the learned Authorised Representative that the entire exercise of determining ALP of the transactions between the two enterprises is useless as the price charged or paid by one enterprise to another AE is tax-neutral on totalit .....

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visions of ss. 92 to 92F would become redundant 14. Oblivious of this development, another coordinate bench, in the case of Global Vantedge Pvt Ltd Vs DCIT and vice versa [(2010) 37 SOT 1 (Del)] touched a different chord. That was a case in which, as it appears from the limited facts stated in the body of this decision, there was a linear relationship between the group entities in question, i.e. the assessee and its US based AE, and respective contribution, as held by the CIT(A) and on the basis .....

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expenses in the software industry were in the range of 1.4 per cent, accordingly, I am of the view that a share of 1.40 per cent, of the Revenue is adequate to compensate RCS (i.e. the US based AE) for its activities. Thus, as per this hypothesis, the arm's length price determined cannot exceed 98.60 per cent, of the Revenue earned by the Global Vantedge Group as a whole 15. When the matter travelled in appeal before a coordinate bench of this Tribunal, these findings of the CIT(A) were con .....

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ble Delhi High Court, by the Commissioner, but without any success. Hon ble Delhi High Court, in the judgment reported as Global Vantedge Pvt Ltd [(2013) 354 ITR 21 (Del)], observed that, In the present case, we find that the Tribunal had examined the findings of the Commissioner of Income Tax (Appeals) in detail and had given an opportunity to the departmental representative to controvert or rebut the findings and conclusions arrived at by the CIT (Appeals). However, despite that opportunity, i .....

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ration in these appeals. Hon ble Supreme Court, vide order dated 2nd January 2014, dismissed the special leave petition filed against this judgment of Hon ble Delhi High Court. The matter has thus reached finality. 16. These somewhat parallel developments, even as these developments have quite different approaches, do not lead to any conflict and both of these decisions deserve utmost respect from us. Clearly, there is a meeting ground. In our humble understanding, these two decisions are distin .....

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in a situation that the profits of the AEs taken together cannot exceed global profits of the group as a whole. In Global Vantedge s case (supra), it was an uncontroverted position that the contribution of the AE was just 1.4%, which was arrived at by taking into account average expenditure on selling in software industry, that normally the assessee had a right over the residual receipts from the end customer, and that, therefore, the ALP adjustments could only be made for the difference betwee .....

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made to the value of international transaction cannot be such so as the ALP and the transaction value put together exceed the overall revenues realized from the non AE. That is what the DRP has accepted and that aspect of the matter is not even in dispute before us. We donot, therefore, see any conflict in the decisions of the coordinate benches in the cases of Gharda Chemicals (supra) and Global Vantedge (supra). In any case, all intra AE relationships are not linear. There are complex structu .....

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tion that the profits of the AEs and the ALP adjustments, put together, exceed the global profits of the group as a whole. As regards the reliance placed by the learned counsel on certain observations in the CIT(A) s order, which have been extensively reproduced and approved by the coordinate bench, we can only say, to borrow the words of Hon ble Bombay High Court in the case of CIT vs. Sudhir Jayantilal Mulji [(1995) 214 ITR 154 (Bom)], a judicial precedent is only "an authority for what i .....

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held that we concur with the assessee on this issue that the adjustments, if any, cannot exceed the global profits earned by the group from those transactions . Taking note of these directions of the DRP, and the fact that the Assessing Officer has not giving proper effect to these directions, the coordinate bench remitted the matter to the file of the Assessing Officer. While doing so, the coordinate bench has also observed as follows: 10. On a plain reading of the aforesaid extracted portion .....

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ies, in the light of the directions given by the DRP, we remit the issue back to the file of the Assessing Officer for deciding it afresh in conformity with the direction given by the DRP… 18. In the case of Apollo Health Street Vs DCIT [(2014) 151 ITD 248 (Hyd)] also, the situation was materially the same. In this case also, as noted by the coordinate bench, the DRP considered the assessee s objection and has given a direction that the upper limit for any TP adjustment in transactions be .....

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ity for the proposition that the TP adjustments of an assessee cannot result in a situation that these are in excess of the global profits. These decisions were dealing with a situation in which the DRP had given certain direction and the limited question before the Tribunal was whether these directions have been given proper effect or not. 20. In view of the above discussions, in our considered view, the right course of action will be to remit the matter to the Assessing Officer with a directio .....

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tivity, are less than the transaction value, or within 5% range of the same, the same will have to be accepted as an arm s length price by the Assessing Officer. The functional profile of the AE, as also other related factors such as weightage to this functional profile in terms of the revenue allocation, will also have to be examined. As the matter is being remitted to the file of the Assessing Officer for fresh adjudication de novo in the above light, we also consider it appropriate to leave i .....

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h the two factual grievances of the assessee. Coming back to the factual aspects, the assessee s twin grievances are with respect to the selection of comparables and with respect to adjustment for underutilization. So far as comparables selected by the TPO are concerned, the assessee seeks exclusion of (a) Crossdomain Solutions Ltd (b) Maple eSolutions, and (c) Vishal Information Tech Ltd. On comparability adjustments, the assessee seeks adjustment in respect of the higher employee costs as the .....

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ment in any of the replies submitted to the show cause notices issued. Since there is no underutilization of capacity in the case of AE transactions, there is no basis for any adjustment in the AE transactions. 23. The assessee did raise an objection before the DRP, against the above findings, inasmuch as, vide ground no. 1.6, it was contended that based on the facts and circumstances of the case, the learned AO and the learned TPO have erred in law and on facts, by attributing the reasons for l .....

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pproximately and that as there are material differences between employee costs of Fortune India (AE segment) and that of comparable companies, an adjustment for substantial difference in employee cost is required to be carried out before computing the ALP . In the DRP order, there is no mention about the specific submissions on this issue. There is no specific mention about the underutilization of capacity either. The grievance of the assessee did not find any favour with the DRP either. The ass .....

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lization is much more in the case of non AE transactions inasmuch as the employee costs to turnover ratio in AE segment is 76% whereas in non-AE segment it is 97% . There is no specific submission and quantification on the fact, if at all, of the underutilization of capacity. The factual elements embedded in the submissions are not at all established. There is no room for vague generalities and over simplifications, as the impact of underutilized capacity is to be, with reasonable precision, qua .....

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ilization of capacity and the limited issue before the Tribunal was an advertent error in grant of adjustment which was, with the consent of the parties, settled. There was no decision on merits, as suggested by the learned counsel, that the capacity underutilization adjustment was warranted when employee cost was higher than that in the comparables. This aspect of the matter will be clear from the following observations in the Tribunal s order: 6. At the outset, the learned counsel for the asse .....

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stment. 7. The learned DR also agreed that an error has been committed while making the adjustment under utilization of capacity of the comparables As this is only a mistake apparent from record, we deem it fit and proper to direct the assessing authority to rectify the mistake by computing the correct adjustment in under utilizing capacity by taking the capacity utilization of the comparable companies at 80 percent instead of 65 percent mentioned in the order of the DRP. 27. As for the case of .....

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n market because lower capacity utilization results in higher per unit costs, which, in turn, results in lower profits. Of course, the fundamental issue, so far as acceptability of such adjustments is concerted, is reasonable accuracy embedded in the mechanism for such adjustments, and as long as such an adjustment mechanism can be found, no objection can be taken to the adjustment . There is no, and cannot be any, quarrel with this proposition but that does not advance the case of the assessee .....

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e. 28. In view of the above discussions, we are not inclined to uphold the assessee s grievance with respect to denial of adjustment for capacity underutilization. 29. That leaves us with the assessee s grievance against the inclusion of three comparables, namely (a) Crossdomain Solutions Ltd (b) Maple eSolutions, and (c) Vishal Information Tech Ltd. However, in our considered view, this grievance is absolutely academic because even if we do so, the ALP adjustment computed on the basis of revise .....

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