AKAMAI TECHNOLOGIES SOLUTIONS (INDIA) PRIVATE LIMITED,BANGALORE vs. DCIT, BANGALORE

These cross appeals are filed by the Deputy Commissioner of Income Tax, Circle 1(1)(1), Bangalore (“learned Assessing Officer”) and Akamai Technologies Solutions India Private Limited (“assessee”) for assessment year 2010–11 against the assessment order dated 31 December 2014 passed under section 143(3) read with section 144C of the Income-tax Act, 1961 (“the Act”). In that order, the learned Assessing Officer determined the assessee’s total income at ₹54,414,546, as against the returned income of ₹20,071,870 declared in the return filed on 15 October 2010. The assessment incorporated the order dated 30 January 2014 passed by the Deputy Commissioner of Income Tax (Transfer Pricing)-IV, Bangalore (“learned Transfer Pricing Officer/TPO”) under section 92CA (3) of the Act, proposing a transfer pricing adjustment of ₹34,342,675 in the draft assessment order. The assessee objected to the draft assessment order before the Dispute Resolution Panel-1, Bangalore (“learned DRP”), which issued its directions on 28 November 2014. 2. The Assessee and ld. AO has raised the following grounds of appeal:

That the order of the learned Deputy Commissioner of Income Tax, Circle 1(1)(1), Bangalore ("Assessing Officer" or "AO") to the extent prejudicial to the Appellant, is bad in law and liable to be quashed.

That on the facts and in the circumstances of the case, the learned AO and the learned Dispute Resolution Panel ("Panel") erred in upholding the adjustment made by the learned Transfer Pricing Officer (TPO) to the transfer price of the international transactions of Akamai Technologies Solutions (India) Private Limited (‘Akamai Solutions' or 'the Company' or 'the Appellant') amounting to INR 34,342,675 contending that the same is not at arm's length in terms of the provisions of sections 92C(1) and 92C(2) of the Income-tax Act, 1961 read with Rule 10D of the Income-tax Rules, 1962.

That the learned AO and the learned TPO erred in passing the order giving effect to the learned Panel directions without giving opportunity to the Appellant of being heard, as directed by the learned Panel. The Appellant has also filed a rectification petition dated January 20, 2015, requesting the learned AO and the learned TPO to pass a rectified order under section 154 of the Act

That the learned AO/ learned TPO/ learned Panel have grossly erred, in law and in facts, in not appreciating properly the facts and circumstances of the case and in concluding that

That the learned AO / learned TPO/ learned Panel erred, in law and in facts, by rejecting the comparable companies engaged in the distribution of software and hardware products identified by the Appellant and accepting comparable companies engaged in the provision of ITeS/ sales and marketing services.

The learned AO/ learned TPO/ learned Panel erred, in law and in facts, by determining the arm's length margin/ price using the following filters in the economic analysis for identifying services companies:

The learned AO/learned TPO erred, in law and in facts, in computing the operating margin of the Appellant by treating the gain on account of foreign exchange fluctuation as non-operating in nature and while doing so grossly neglected the direction given by the learned Panel in this regard.

That the learned AO/ learned TPO/ learned Panel erred in upholding the interest charged under section 234D of the Act.

It was submitted that as in the present case, although the DRP had jurisdiction under section 144C of the Act, its directions travelled beyond the statutory framework. For this proposition, she relied on the decision of the coordinate bench in Swiber Offshore Constructions Pte. Ltd. v. Additional Director of Income-tax (2014) 34 ITR (T) 522 (Mumbai). She also submitted that, in similar cases, coordinate benches of the Tribunal have remanded the matter to the Assessing Officer for passing a fresh assessment order. In this regard, she referred to IBM India Private Limited v. Joint Commissioner of Income-tax (2014) 49 ITD 191 (Bangalore), L H Sugar Factories Ltd. v. Assistant Commissioner of Income-tax (2024) 165 taxmann.com 573, Swiber Offshore Constructions Private Limited v. Additional Director of Income-tax (2014) 34 ITR (T) 522 (Mumbai), and PGS Geophysical v. Additional Director of Income- tax (2014) 50 taxmann.com 392 (Delhi Tribunal). 11. As regards the decision of the Hon’ble Karnataka High Court in Principal Commissioner of Income-tax v. Flextronics Technologies India Private Limited (2023) 459 ITR 493 (Karnataka), it was submitted that the said decision is distinguishable on the peculiar facts of the present case. 12. According to the learned Departmental Representative, this is not a case where the Assessing Officer failed to consider the directions issued by the learned Dispute Resolution Panel; rather, it is a case where the directions themselves created an irreconcilable statutory conflict. It was therefore submitted that the assessee’s ground seeking quashing of the assessment order is devoid of merit. 13. We have carefully considered the rival submissions and perused the orders of the lower authorities. The issue before us is whether the learned Assessing Officer was required to follow the directions of the learned Dispute Resolution Panel, and whether failure to do so would render the assessment order liable to be quashed. 14. The learned Dispute Resolution Panel considered objection No. 2, in which the assessee contended that the learned Assessing Officer and the learned Transfer Pricing Officer had committed error n holding that assessee is an Ites Service provider. The assessee submitted that its international transaction was in the nature of purchase of services for resale, and not provision of ITeS, and that its economic analysis had been prepared in accordance with the Act and the Rules. In its transfer pricing documentation, the assessee had characterized itself as a distributor/reseller of Akamai services, and this functional analysis and entity characterization were also explained before the learned Transfer Pricing Officer during the hearing. 15. However, relying on the reasons recorded in the order passed under section 92CA of the Act, the learned Transfer Pricing Officer held that the assessee’s international transaction was in the nature of provision of ITeS and not distribution of services. Accordingly, the TPO rejected the transfer pricing study report and treated the assessee as an ITeS service provider to its associated enterprises. 16. After hearing the assessee and examining the service reseller agreement dated 7 January 2010, the learned Dispute Resolution Panel observed that employee cost in ITeS services generally ranges between 30% and 40%, whereas the assessee’s employee cost was only ₹2.24 crores against sales of ₹32.74 crores, representing 7.33% of sales. The Panel also noted that, out of the other operating expenses, excluding provision for doubtful debts and bad debts written off, ₹1.17 crores were incurred on rent, ₹43.68 lakhs on travelling, ₹71.74 lakhs on travelling, and ₹14.36 lakhs on legal and professional services. These facts, according to the Panel, showed that the assessee had not rendered IT-enabled services. The Panel further noted from page 26 of the annual report that the assessee was engaged in providing marketing, sales, and customer support services in India, and from Schedule 15 to the notes to accounts that it had been set up to provide marketing, sales, and customer support services to its parent company. The reseller agreement also permitted the assessee to market, resell, and support the services, and the assessee in fact carried out activities relating to marketing, resale, and support. The Panel therefore held that the learned Transfer Pricing Officer was not justified in treating the services as ITeS for determining the arm’s length price. At the same time, the Panel noted that the assessee had selected comparables relating to distribution of software products, including hardware. Since, in the Panel’s view, the services were in the nature of sales and marketing services, it directed the Assessing Officer to determine the arm’s length price under the transactional net margin method by selecting appropriate comparables after giving the assessee an opportunity of being heard. These directions are contained in pages 4 to 17 of the DRP’s directions. 17. From these directions, it is evident that the assessee characterized its functions as those of a distributor/reseller of Akamai services. The learned Transfer Pricing Officer, however, treated the services as ITeS, while the learned Dispute Resolution Panel characterized them as sales and marketing services. Thus, there was a clear divergence among the assessee, the TPO, and the DRP on the proper characterization of the assessee’s activities. 18. Thus, while passing the final assessment order, the learned Assessing Officer was faced with the Transfer Pricing Officer’s communication stating that the TPO’s order could not be modified considering the DRP’s directions. Consequently, the learned Assessing Officer retained the same transfer pricing adjustment of ₹34,342,675 as proposed by the learned TPO. The core issue, therefore, is that the DRP’s direction to determine the arm’s length price under the transactional net margin method, by selecting appropriate comparables after giving the assessee an opportunity of being heard and by characterizing the assessee as a provider of sales and marketing services, was not complied with. 19. The Hon’ble Karnataka High Court, in Principal Commissioner of Income-tax v. Flextronics Technologies (India) Private Limited (2023) 459 ITR 493 (Karnataka), by order dated 9 January 2023, affirmed the decision of the coordinate bench in Flextronics Technologies India Private Limited v. Assistant Commissioner of Income-tax, ITA No. 832/Bang/2017, dated 31 December 2018. In that case, a transfer pricing adjustment of ₹401,177,583 was made to the assessee’s returned income and incorporated in the draft assessment order. The assessee challenged the draft order before the Dispute Resolution Panel, which granted relief in respect of the transfer pricing adjustment. The Assessing Officer then requested the Transfer Pricing Officer to recompute the adjustment in accordance with the DRP’s directions. Since the recomputation was not received before the statutory time limit for passing the final assessment order, the Assessing Officer passed the final order on the basis of the adjustment contained in the draft assessment order, stating that any subsequent increase or reduction pursuant to the TPO’s order giving effect to the DRP’s directions would be dealt with under section 154 of the Act. The coordinate bench held that, as the Assessing Officer had not computed the arm’s length price adjustment in accordance with the DRP’s directions, there was a failure to comply with a mandatory requirement of section 144C of the Act. It therefore quashed the final assessment order. The Revenue carried the matter before the Hon’ble Karnataka High Court, which dismissed the appeal, holding that under section 144C the Assessing Officer is bound by the DRP’s directions and must pass the assessment order in conformity with those directions within one month from the end of the month in which they are issued. Accordingly, where the final order is not passed in conformity with section 144C, it is liable to be quashed. 20. Section 144C (10) of the Act mandates that every direction issued by the Dispute Resolution Panel is binding on the Assessing Officer. In the present case, the DRP directed that the assessee be characterized as a provider of sales and marketing services. The Assessing Officer did not give effect to that direction. Therefore, in view of the decision of the Hon’ble Karnataka High Court, the impugned assessment order cannot be sustained. We are dutybound to follow the decision of Honourable Jurisdictional high court so, other decision relied by the ld. CIT DR does not carry any weight. Respectfully following that decision, we quash the assessment order passed by the learned Assessing Officer for failure to comply with the directions of the learned Dispute Resolution Panel. 21. However, the DRP’s approach is difficult to sustain. After rejecting both the assessee’s characterization as a distributor/reseller of services in its transfer pricing study and the TPO’s characterization of the assessee as an ITeS service provider, the DRP concluded that the assessee was providing sales and marketing services. Having reached that conclusion, the DRP, without adequate reasoning, adopted the transactional net margin method as the appropriate method and directed the Assessing Officer to select suitable comparables, give the assessee an opportunity of hearing, and then determine the arm’s length price. In effect, the DRP set aside the proposed variation and directed the Assessing Officer to conduct further enquiry before passing the assessment order, which is contrary to section 144C (8) of the Act. Further, section 144C (13) requires the Assessing Officer to pass the final order within one month from the end of the month in which the DRP’s directions are received and prohibits any further opportunity of hearing to the assessee. The proper course would have been for the DRP itself to call for the relevant comparable-search matrix and comparable set, define the applicable filters, and determine the comparable margins and resultant adjustment. Had that exercise been undertaken, the directions would have remained within the framework of section 144C. Instead, the DRP issued directions contrary to section 144C, resulting in the transfer pricing adjustment of ₹34,342,675 being set aside and placing the Assessing Officer and the TPO in a position not contemplated by law. 22. In the result, respectfully following the decision of the Hon’ble Karnataka High Court in Flextronics Technologies India Private Limited (supra), we quash the assessment order dated 31 December 2014 passed by the learned Assessing Officer. Accordingly, the assessee’s appeal is allowed and the appeal filed by the learned Assessing Officer is dismissed.