In its recent judgment dated June 17, 2011 in case of ACIT vs. Birla Soft Ltd. [IT Appeal No. 4001 (Delhi) 2009] Hon’ble Delhi Bench of the Income-tax Appellate Tribunal (‘Delhi ITAT’) observed that it would be wrong to consider different STP units of the taxpayer on a standalone basis, for the purpose of transfer pricing analysis, wherein the services provided by the units are same/similar and to same Associated Enterprises (‘AEs’). Further, Delhi ITAT also observed that current year data of an uncontrolled transaction is to be used for the purpose of comparability, while examining the international transactions with AEs.
Facts
Birla Soft Ltd. (‘Taxpayer’) is the wholly owned subsidiary of Birla Soft Enterprises, which is further owned by Birla Soft Inc. US. It is engaged in the business of software development and related services. The software related business was being carried out from Software Technology Park (‘STP’). For the purpose of computation of arm’s length price, the taxpayer selected transactional net margin method (‘TNMM’) as the most appropriate method and justified the net margin earned on an operating cost (‘NCP’) on a company wide basis vis-à-vis margin earned by 24 comparable companies.
During the course of assessment, the assessing officer referred the case to the transfer pricing officer (‘TPO’) for computation of arm’s length price. The TPO;
· rejected the company wide approach of the taxpayer and in-turn compared the profitability of each STP units on a standalone basis with the mean margin of comparable companies.
· Out of 24 comparable companies selected by the taxpayer, the TPO rejected 9 companies.
· Further, instead of multiple/ prior years data used by the taxpayer of comparable companies, the TPO only used current year data.
As out of 3, 2 STP Units were having lower NCP than the mean NCP of comparable companies, the TPO suggested transfer pricing addition.
The case travelled to Commissioner of Income-tax (Appeals) (‘CIT(A)’) and it disapproved the STP units on a standalone approach of the TPO. [The judgment is silent on stand of CIT(A) on comparable companies and usage of multiple/ prior years data].
Against the order of CIT(A), the Tax Department/ TPO filed an appeal before Delhi ITAT. The couple of transfer pricing issues which were raised before Hon’ble Delhi ITAT in this case were;
· Whether the multiple year data used by the tax payer precedes the current year data used by the tax authorities?
· Should each STP unit be considered as the standalone unit for computing ALP or the result of all the STP units has to be considered in totality?
Observation of Delhi ITAT – STP Units on a standalone basis
Hon’ble Delhi ITAT observed that there is no significant functional difference in the software development and maintenance services to related and unrelated parties. The services rendered by the STP Unit were rendered to the same AEs of, namely, Birla Soft Inc. US and Birla Soft UK on continuing basis. The terms and conditions for rendering such services by each of the STP Unit was governed by one single agreement entered into between Birla Soft India and Birla Soft Inc. US. The learned TPO assumed that functions, assets and risks (‘FAR’) undertaken by each of the STP Unit are distinct from each other and is comparable with the functions, assets and risks undertaken by existing comparables. In other words, learned TPO totally ignored the unity of the business, administrative control and unity of funds etc. The independent FAR analysis of each unit with existing comparables is practically not possible because there is a common management, interlacing of the funds etc.
Based on the above findings, Delhi ITAT held that the different STP Unites should not be benchmarked on a standalone basis.
Observation of Delhi ITAT – Usage of Multiple / Prior years data
Hon’ble Delhi ITAT observed that the usage of word ‘shall’ in the Rule 10B(4) makes it mandatory to first use the current year data and the proviso appended to the main section carves out an exception that the data relating to maximum two years prior to the current year may be considered, if the circumstances reveal an influence on the determination of transfer prices in the current year.
Rule 10B(4) of the Income-tax Rules
“(4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into :
Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.”
In this case, as the taxpayer was not able to demonstrate the influence of multiple/ prior year’s data on the determination of transfer prices in the current year, the view of the TPO was upheld.
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