Notional Interest not to be considered while computing transfer price – ITAT
Commercial transactions between the different parts of the multinational groups may not be subject to the same market forces shaping relations between the two independent firms. One party transfers to another goods or services, for a price. That price is known as “transfer price”. This may be arbitrary and dictated, with no relation to cost and added value, diverge from the market forces.
Transfer price is, thus, a price which represents the value of goods or services between independently operating units of an organisation. But, the expression “transfer pricing” generally refers to prices of transactions between associated enterprises which may take place under conditions differing from those taking place between independent enterprises.
It refers to the value attached to transfers of goods, services and technology between related entities. It also refers to the value attached to transfers between unrelated parties which are controlled by a common entity.
“Arm’s length price” means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions. Let us refer to the case of Motherson Sumi Infotech & Designs Ltd. Vs DCIT (ITAT Delhi) whereappeal filed by assessee was against order of DCIT passed under section 143(3) of the Income-tax Act, 1961. The issue raised in the present appeal was against the transfer pricing adjustment made on account of international transaction of rendering Software Development Services to the AEs.
Facts of the Case
- The assessee was engaged in providing customized Software Development Services to the customer of its Associated Enterprises (AE) and was compensated at cost + 10% for rendering the said services.
- During the year under consideration, the assessee had undertaken few international transactions with its AE, which were reported in its TP study report.
- The assessee had selected Transactional Net Margin Method (TNMM) to benchmark its international transactions with Profit Level Indicator (PLI) at 10.01%.
- The assessee selected 16 companies as functionally comparable, whose mean margins worked to 13.08%. The assessee thus in the TP study report pointed out that its international transaction were at Arm’s Length Price.
- The Assessing Officer (AO) made reference under section 92CA(1) to the TPO to benchmark Arm’s Length Price of the international transaction of provision of Software Development Services by the assessee to its AE.
- The TPO noted certain defects in the transfer pricing study report and also the application of average margin of 3 years by the assessee.
- He also revised the filters to be applied and show caused assessee with a fresh list of comparables of 18 companies, whose mean margin worked out to 22.32%.
- The TPO in the order passed under section 92CA(3) also proposed an adjustment on account of interest on receivables from AE.
Proceedings of Dispute Resolution Panel (DRP)
- The assessee filed objection before the DRP, which in turn directed exclusion of two concerns i.e. Infosys Ltd. and eZest Solutions Ltd. and inclusion of Think Soft Global Services Ltd.
- The DRP also directed that working capital adjustment is to be allowed.
- The DRP directed application of LIBOR rates instead of SBI PLR lending rates for the adjustment to be made on account of interest on Receivable.
- Consequent to the directions of DRP, the AO/TPO drew up final list of comparable totaling 17, whose mean margins worked to 19.04%.
- The AO/TPO also reworked the adjustment to be made on account of interest on Receivables.
- The AO passed the consequent order making upward adjustment against which the assessee appealed before the Income Tax Appellate Tribunal (ITAT)
Observation of the ITAT on the issue of adjustment of international transaction of provisions of Software Development Services by the assessee to its AE
The assessee was engaged in provision of Software Development Services to its AE. For benchmarking the international transaction, TNMM was applied.
The assessee wanted to be exclude M/s. Acropetal Technologies Limited from the list of comparables.
- Assessee pointed out that the said concern failed employee cost/sale filter. The concern was providing the services onsite.
- Attention was brought to the fact that expenditure on onsite development incurred on technical sub-contractor was debited. The said technical sub-contractors could not be the employees of the concern.
- Revenue pointed out that the assessee was providing array of services, which included Software Development Services and Infra Management Services.
- He further stated that the assessee was delivering end to end solutions. The assessee was providing variety of services and there was whole range of services.
- His contention was that while applying TNMM method exact matching concerns would not be available and TPO selected companies keeping in mind comparability margin of 75%.
- ITAT was of the view that where TNMM method is applied, it took care of certain marginal differences between the functioning of the tested party and the finally selected comparables.
- However, if the module of working was different, then such a concern could not be held to be functionally comparable and cannot be selected in the final list of comparables.
- The assessee was engaged in provision of Software Development Services to its AE which it provided offsite.
- On the other hand M/s. Acropetal Technologies Limited was providing onsite services and had booked the expenditure on account of technical sub-contractors under the head onsite development.
- It failed the employee/sales filter applied for benchmarking. Accordingly, ITAT directed the AO/TPO to exclude the margins of M/s. Acropetal Technologies Limited from the final list of comparables.
The assessee wanted to be exclude E-Infochips Limited from the list of comparables.
- The objection against its inclusion by the assessee was that the said concern failed services revenue filter. He pointed out that the said filter was 75%.
- Referring to the order of the TPO, the assessee pointed out that TPO himself had applied the filter of 75% and if a concern fails the said filter, then the same had to be excluded.
- Assessee referred to the order of TPO and pointed out that the TPO had wrongly observed that services filter in case of the said concern was 74%.
- Revenue objected to the submissions of the assessee and pointed out that the same came to 84.93%. He pointed out that 74% was wrongly mentioned.
- The issue raised before ITAT was whether a concern which failed service revenue filter applied by the TPO, can be excluded from final list of comparable?
- In view of the dis-similarity in the figures proposed by the AO / TPO, the assessee and the Revenue, ITAT remitted this issue to the file of AO / TPO to verify the stand of the assessee and in case it failed to service revenue filter, which was proposed by the TPO himself then the said concern would be excluded from the final list of comparable.
The next concern which the assessee wanted to exclude was Persistent Systems Limited.
- The assessee pointed out that the said concern was functionally dis-similar to the assessee by referring to the nature of services provided by the concern and also stated that the segmental were unavailable and even it owned IPFs.
- Revenue however referred to the order of the ITAT in assessee’s own case, relating to assessment year 2007-08 and pointed out that the said concern was held to be functionally similar to the assessee.
- Assessee pointed out that the issue was decided against the assessee by the Tribunal. ITAT found no merit in the plea of the assessee and Persistent Systems Limited was included in the final list of comparable.
The next concern which the assessee wanted to be excluded was Wipro Technology Services Limited
- Assessee pointed out that it was a concern with huge brand value and also failed RPT filter.
- ITAT found merit in the plea of the assessee that the concern having such huge brand value and owning intangibles cannot be compared with the concern providing BPO services.
The assessee was also aggrieved by the inclusion of Sasken Communication Technologies Limited
- The claim of the assessee was that the said concern was functionally dis-similar as it is developing mobile enterprise applications etc.
- The said concern was rendering variety of services; however, the segmental details were not available. Revenue said that the assessee was also providing whole range of services and the product revenue was 10%. Further TPO had applied filter of 75%.
- ITAT was of the view that first step which had to be seen was functional comparability. The concerns were providing variety of services and application of service filter of 75% would come in the next point of comparability.
- M/s Sasken Communication Technologies Limited was developing mobile enterprise applications and solutions across various mobile platforms which was clearly mentioned in the annual report of the said concern.
- The assessee on the other hand was only providing Software Development Services to its AE.
- Hence the concern Sasken Communication Technologies Limited was not functionally comparables to the assessee and same needs to be excluded from the final list of comparable.
The last concern which the assessee wanted to exclude from the list of comparables was Thirdware Solutions Limited
- The TPO had compared the margins of the assessee with segmental details of the said concern.
- The objection of the assessee was that the said concern was functionally different and it was engaged in various activities.
- Revenue on the other hand stressed that the segmental details of the said concern were being applied and hence there was no merit in the plea of the assessee.
- ITAT noted that the assessee was engaged in the provisions of Software Development Services to its AE and hence the concern engaged in similar activity should be picked up for comparable.
- ITAT found that the said concern was engaged in implementation and consulting services of software and business intelligence.
- It had also declared Revenue from sale of license, Software Services, export from SEZ and STPI. However, the segmental details were not available and the same was to be excluded from the final list of comparable.
The next issue raised was against the transfer pricing adjustment made on account of interest due on receivables outstanding
- The case of the Revenue was that as the assessee had not received the amount due from the AEs, within the stipulated period then interest adjustment needed to be made on account of interest due on Receivables, as this was an International Transaction.
- The case of the assessee on the other hand was that on such outstandings from both AE and non AEs, no interest was charged by the assessee and this was not an international transaction and hence no adjustment was to be made.
- The said issue stood covered in favour of the assessee by the decision of the Tribunal in M/s. Global Logic India Ltd. The Tribunal relied on the decision of Delhi High Court in Pr. CIT-V vs Kusum Health Care Pvt. Ltd. and held that no adjustment was to be made on account of notional interest on receivables by relying upon section 92B by treating the continued debt balance as an international transaction.
- Moreover when the taxpayer is debt free company, there was no question of charging any interest on Receivables.
- The assessee during the year under consideration had not availed any loan from AEs or unrelated third parties and was not incurring any interest cost.
- Further, there was similar delay in receipt of receivables from others and the assessee was not charging any interest on delay in receipt of receivables against services rendered to unrelated third parties.
- ITAT found no merit in making any adjustment on account of interest due on receivables from its AE.
Basically, if any assessee does not avail any loan from AEs or unrelated third parties and is not incurring any interest cost and as is not charging any interest on delay in receipt of receivables against services rendered to unrelated third parties, no adjustment is to be made on account of interest due on receivables