Philips Software vs. ACIT (ITAT Bangalore) (4 MB)

Where the assessee was rendering captive contract software development services to its’ associated enterprises on a “cost plus” basis and its profits enjoyed exemption u/s 10A and the question arose whether the AO/TPO were justified in rejecting the assessee’s transfer pricing study and substituting it with their own, HELD allowing the appeal that:

(i) While the motive of tax avoidance need not be shown at the time of initiating transfer pricing provisions, the same is required to be shown at the stage of making the assessment. The AO has to show that the assessee manipulated prices to shift profits outside India. In view of the fact that the assessee enjoyed exemption u/s 10A, the transfer pricing provisions ought not to have been applied;

(ii) The AO/TPO have to satisfy and communicate to the taxpayer which one of the four conditions prescribed in s. 92C (3) are satisfied before applying the transfer pricing provisions and the failure to demonstrate this to the assessee renders the transfer pricing order void;

(iii) The assessee’s selection of the Cost Plus Method (CPM) using the Capitaline database as the most appropriate method could not be substituted by the AO/TPO with the Transactional Net Margin Method (TNMM) using the Prowess database without showing how the assessee’s method was erroneous;

(iv) For purposes of making a comparability analysis it is essential that (a) the data should relate to the financial year and (b) be contemporaneous i.e. exist on the specified date. If one of the conditions is not fulfilled, the data should not be included for comparison;

(v) In view of the definition of “uncontrolled transaction” in Rule 10A (a), for purposes of comparability analysis, the comparables should not have any transactions with its associated enterprises. A company having even a single rupee of related party transaction cannot be considered as a comparable transaction;

(vi) Adjustment needs to be made to the margins of the comparables to eliminate differences on account of different functions, assets and risks and in particular for (a) differences in risk profile (b) difference in working capital position and (c) differences in accounting policies;

(vii) The profits of super profit companies should not be “normalized”; instead they should be excluded from the list of comparables;

(viii) The proviso to section 92 C (2) provides a standard deduction of 5% to the taxpayers at their option.

See Also: Sony India vs. DCIT (ITAT Delhi), E-Gain Communication vs. ITO (ITAT Pune) and Development Consultants vs. DCIT (ITAT Kol)