Once TPO has accepted ALP, AO cannot say that assessee has earned more than ordinary profits for disallowance u/s 10A(7) – Hyd ITAT


Zavata India Pvt Ltd v ITO [IT APPEAL NO. 628 (HYD.) OF 2008 dtd 31-01-2013] Hyd ITAT

Background:

Assessee is in the business of rendering back office processing services in the field of health-care administration. Its services are not akin to call centre services, wherein tele-communication expenses constitute more than 24%. The assessee’s service centre is registered under the Software Technology Parks of India and provides services exclusively to Samsung Data Corporation USA (SDC US), its Associate Enterprise (AE). The SDC US markets services in USA. The revenue sharing policy was determined at the ratio of 85:15 on the gross receipts received from third parties. For the financial year 2003-04, i.e. AY 2004-05, the assessee filed return of income and claimed deduction under S.10A to the extent of Rs. 3,15,69,530.

The assessee made TP study and based on the functional analysis chose the Comparable Uncontrolled Price (CUP) method as the most appropriate method for determination of ALP.  It justified its allocation of profits on the basis of the price paid by third party for services at US$10, wherein proper BPO services/call centre services are placed, and since the assessee is not having that much telecommunication services, was paid at US$8.50, and justified the price by the CUP method.

Pursuant to detailed scrutiny of the TP documentation, the TPO concluded that the pricing of the assessee is within the Arm’s Length Standard and no adjustment is required to be made to the value of the international transactions between the assessee and its AE. However, the AO invoked the provisions of S.10A(7) read with S.80IA(10) to consider that the assessee has earned more than the ordinary profit and considering the same TP study submitted by the assessee under TNMM method, determined the excess profit at Rs.2,99,34,750 and denied deduction under S.10A while completing the assessment.

Tax Authority’s arguments:

  • The provisions of section 10A(7) r.w.s. 80IA(10) are primarily meant to check the tendency of the assessees to show higher profits of the undertakings which are eligible for tax concession.
  • The transfer pricing study indicates average mean prices at 8-9% whereas the assessee earned profits at 151 %, which is more than the normal profits.
  • It is noted that all market risks with respect to services including business development and customer acceptance are borne by the AE. The other risks like the service liability risk, credit and collection risk, foreign exchange risk, idle capacity risk, contractual risks, etc. was also on the AE. The assessee company had absolutely no responsibility in this regard.
  • As per the additional supplementary analysis under TNMM, it is noted that the arithmetical mean of operating profit margin of comparable cases was 3.77% whereas it was 8.96% even in the cases figuring in the upper range.

Assessee’s contentions:

  • On a reading of Section 10A(7), CBDT Circular No 308 dated June 29, 1981 (wherein the reasons for applying Section 80IA(8) and (10) to an undertaking have been explained) and judicial precedents on the subject, the legislative intention for introduction of 80-IA(I)(10) was to apply provisions in following two situations, both of which do not apply to the facts of the case.
    (a) Where both the closely connected persons are taxable in India:
    The intention with reference to this situation is to cover two distinct taxable entities belonging to the same business group, in a situation, where the group may abuse such tax incentives by transferring profits of non-eligible assessees (which would be subject to tax in India) to eligible assessees (which would not be taxable). The AO’s contentions that the assessee could abuse the deduction claimed by routing back of funds to the AE is not correct, since the AE is not subject to tax in India. Assessee has to pay more taxes in the form of dividend distribution tax owing to the increase in the amount of dividends available for distribution.
    (b) Business transaction are so arranged to produce more than ordinary profits:
    The word “arranged” has been interpreted to suggest a motive to avoid tax by manipulating the profits of the Company. Avoidance of tax must be the main motive for provisions to apply and a mere incidental benefit is not sufficient.
  • The issue is no more RES INTEGRA and has been decided by the following benches of the Tribunals which are squarely applicable to facts of the present case of the assessee:
    – Visual Graphics Computing Services (India) (P.) Ltd. v. Asstt. CIT [2012] 52 SOT 172 (Chennai)
    Tweezerman (India) (P.) Ltd. v. Addl. CIT [2010] 133 TTJ 308 (Chennai)
    CIT v. Schmetz India (P.) Ltd. [2012] 211 Taxman 59 (Bom.) (Mag.)
    Weston Knowledge Systems & Solutions (India) (P.) Ltd. v. ITO [2012] 52 SOT 120 (Hyd.)
    Digital Equipment India Ltd. v. Dy. CIT [2006] 103 TTJ 329 (Bang.)
  • Assessee has operational advantages as it has less cost on telecommunications and other operational advantage in staff salaries etc. whereas the comparable cases selected are not exactly in BPO business like assessee and they also have software development and other activities.
  • The adjustments made by the TPO is deemed to be the amount determined under S.80IA(10) with effect from assessment year 2013-14, and this indicates subjective approach being adopted by the Transfer Pricing authority.

HELD:

  • As far as the TP study is concerned and justification made by the assessee both under the CUP method and TNMM method the matter should end there itself, and the AO should have fresh evidence or details to invoke the provisions of S.10A(7) read with S.80IA(10).
  • TNMM study itself shows the profit range varying from ‘- 94.26 % to + 48.32%’.
  • As seen from the comparable companies, most of the companies are in software development, outsourcing and call centre activities as per annexure-3 placed in the TP study. Even though these are selected by the assessee as comparable companies, since the TPO has not made any adjustments to the Arm’s Length transactions, the issue of profit of comparable companies has lost its relevance.
  • The AO considered the arithmetic mean at 8% to be the profit margin of the comparable companies, ignoring various TP studies made by other TP officers in the BPO service sector to an extent of 39%.
  • Operational cost being less was also justified by the nature of the BPO services undertaken by the assessee in the TP study.
  • While determining the ‘arms’ length price’ during the financial year 2003-04, SDC US has sub-contracted voice based BPO services to Swift Response Inc USA(SWIFT), an unrelated entity at a rate of USD 10 per hour. Hence, the price paid by SDC US to SWIFT US has been identified as price paid/charged in a comparable uncontrolled transaction. Similarly, it was stated that based on the provisions of Rule 10B regarding application of CUP method, where differences exist between the controlled and uncontrolled transactions, reasonably accurate adjustments would be required.
  • In view of the decisions of the Coordinate Benches of the Tribunal, the exercise undertaken by the Assessing Officer under S.10A(7) is neither sustainable on facts nor under the provisions of law.
  • The receipts are fixed at US$ 8.5 per hour and the margin of profit became higher only because the operation costs were less being in the non voice based BPO services. Even though the authorities relied on “arranged” transaction between the assessee and AE, we do not see any such arrangement on the facts of the case.
  • Nor there is any passing of profits directly or indirectly. In view of this, since the assessee’s operations are efficient enough to obtain more profits and since the receipts are at arms length and there is no passing of excess profits by the parent company (AE) to the assessee, we are of the opinion that Assessing Officer’s action in restricting the profits is not correct.

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