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Income Tax Appellate Tribunal, “C”, BENCH KOLKATA
Before: SHRI A.T. VARKEY, JM &DR. A.L.SAINI, AM
आदेश / O R D E R Per Dr. A. L. Saini:
The captioned appeal filed by the Assessee, pertaining to assessment year 2011-12,is directed against the fair assessment order passed by the Assessing Officer u/s 144C read with section 143(3) of the Income Tax Act, 1961 (in short the ‘Act’) dated 27.01.2016 which incorporates the Directions of the Dispute Resolution Panel u/s 144C(5) of the Act, dated 21.12.2015.
2.However in this appeal, the assessee has raised a multiple ground of appeal but at the time of hearing the main grievance of the assessee has been confined to ground nos. 5 and 6 and other grounds were not pressed. Ground No.5 and 6 relate to rejection of Associate Enterprise (AE) by DRP not to be treated as tested party which read as follows:
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12
Grounds against rejection of AE as the tested party 5. Erred in characterizing the Appellant’s business as a ‘captive service provider’ and not accepting the associated enterprise as the least complex entity compared to the Appellant, thereby rejecting the AE as the tested party which is not in line with transfer pricing principles;
Erred in not giving due cognizance to the scientific search progress adopted by the appellant by selecting the AE as the tested party and arriving at comparable companies, being in complete disregard of transfer pricing principles.
Facts of the case which can be stated quite shortly are as follows: The assessee company ‘TCG Digital Solutions (P) Ltd’ (herein after referred to as “TCG Digital”) is a wholly owned subsidiary of TCG Digital Solutions LLC (hereinafter referred as "TCG LLC" or "associated enterprise" or "AE"). TCG Digital (i.e. assessee) is engaged in rendering software development and implementation services for the transportation industry with special emphasis on the airline industry to TCG LLC. It was formed to set up state of art technology center to provide technology development support and solutions to United Airlines Ind ('UAL') and other Airline customers. The Associate Enterprise, i.e. TCG LLC is engaged in the marketing of software services and provision of consulting services in USA & other countries. The assessee company, ‘TCG Digital”provides software services primarily to its AE namely TCG LLC at a fixed rate of USD 21.50 per hour vide article 4.1 of the agreement dated 21 April 1999 between the two parties ( page no. 427 of the Paper book)
TCG LLC (i.e. AE) provides software services to end customers. As per the agreement with the customer dated 18 March 1999,the AE is remunerated at an hourly rate of USD 23 per hour for services rendered by them to end customers, (Pb no. 438 and 456 agreement).The TCG LLC (i.e. AE) based on the agreement entered into on dated 21 April 1999, with the assessee company(TCG Digital), engages in the marketing of software development and support services of the Page | 2
TCG Digital Solutions (P) Ltd TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Year: Assessment Year:2011-12 company and tries to win contracts from customers for providing software company and tries to win contracts from customers for providing software company and tries to win contracts from customers for providing software development and support services. In the said marketing pitches, the customer is development and support services. In the said marketing pitches, the customer is development and support services. In the said marketing pitches, the customer is made aware of the availability of technical expertise, experience, resource pool etc. ability of technical expertise, experience, resource pool etc. ability of technical expertise, experience, resource pool etc. from the very initial stages of the proposal/ bidding stage. Once the customer is from the very initial stages of the proposal/ bidding stage. Once the customer is from the very initial stages of the proposal/ bidding stage. Once the customer is won, the agreed services are rendered by the won, the agreed services are rendered by the assessee assessee ( pb no. 425 agreement).Thereby, in relation to the such Thereby, in relation to the such services the AE retains USD 1.5 services the AE retains USD 1.5 (USD 23 - USD 21.50)per hour out of entire amount of USD 23 received from customer. per hour out of entire amount of USD 23 received from customer. per hour out of entire amount of USD 23 received from customer. This is equivalent to a gross profit margin of 6.5% (USD 1.50/ USD 23).The ab This is equivalent to a gross profit margin of 6.5% (USD 1.50/ USD 23).The ab This is equivalent to a gross profit margin of 6.5% (USD 1.50/ USD 23).The above business model for software services business model for software services is further explained below:
First time, the assessee company First time, the assessee company (TCG Digital) raised the issue before Hon`ble raised the issue before Hon`ble DRP to treat the foreign AE “ DRP to treat the foreign AE “TCG LLC”, as a tested party. The assessee he assessee submitted before the ld DRP that F that Function, Assets, Risks analysis of “TCG LLC”, TCG LLC”, is very less its own, therefore foreign AE (TCG LLC),should be taken as complex as compared to its own, therefore foreign AE should be taken as tested party. The assessee submitted before the ld DRP that the functions performed and The assessee submitted before the ld DRP that the functions performed and The assessee submitted before the ld DRP that the functions performed and risk assumed by the assessee company (TCG Digital) is substantially high an risk assumed by the assessee company (TCG Digital) is substantially high an risk assumed by the assessee company (TCG Digital) is substantially high and it is akin to a full-fledged service provider. fledged service provider. Whereas, in case of associated enterprises (TCG LL in case of associated enterprises (TCG LLC) which simply renders marketing services and does not do any activity. The TCG LL simply renders marketing services and does not do any activity. The TCG LL simply renders marketing services and does not do any activity. The TCG LLC (AE) can only provide market support services and does bare risk therefo (AE) can only provide market support services and does bare risk therefo (AE) can only provide market support services and does bare risk therefore the foreign AE, TCG LLC is a least complex entity and t is a least complex entity and therefore it should be considered as a tested it should be considered as a tested party. However, the ld. DRP has rejected the plea of the assessee and party. However, the ld. DRP has rejected the plea of the assessee and held that held that since the assessee company has mentioned in his TP study report that the has mentioned in his TP study report that the assessee assessee himself (TCG Digital) has taken as a tested party. has taken as a tested party. The ld. DRP therefore concluded that since therefore concluded that since the assessee is only ‘Software Development Service’ provider ‘Software Development Service’ provider therefore it therefore it is not a complex Page | 3
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 entity hence, the assessee himself (TCG Digital) should be a tested party. The findings of the ld DRP is given below: “6.0. Finding: 6.1. DRP has duly considered the submissions of the assessee. The mainstay of contention of the assessee is that FAR analysis of its AE is quite simpler than that of its own, therefore foreign AE should be taken as tested party. 6.2. It is pertinent to mention that in its TP study report, the assessee has taken itself as tested party. During course of proceedings before DRP, the AO was requested to furnish remand report in reference to additional ground taken by the assessee. The assessee has also furnished rejoinder to the remand report sent by the AO. It is seen that the assessee is a simplicitor ‘Software Development Service provider, which in itself is not a complex activity. Further, almost 93% of its revenue is from its AE and therefore it is practically a captive service provider. The assessee does not own any significant intangible and does not incur R&D expenses. In what sense the activities of the assessee are complex is not evident from relevant facts of the case. 6.3. The assessee has stated that it bears market risk to the same extent as that of its AE. It is not correct as it is only the AE which is finding the customers and the assessee is only a captive service provider. Further, product liability and technology risk of the AE should be more because AE is directly liable to its customers. Being practically a captive service provider, the assessee does not bear capacity utilization risk to an significant extent. Further, as per para 4.2 of TP study report of the assessee, entire credit risk and cost over-run risk lies with AE. Therefore, facts of case do not support argument of the assessee that the assessee is a complex entity. Provision of software development services is a simple function which is capable of being benchmarked using comparables from database of Indian companies. Appellate authorities in various decisions have laid down that foreign entity should be avoided to be taken as tested party as it is very difficult to get comparables from foreign jurisdiction. 6.4. After considering remand report of the AO, rejoinder of the assessee and TP study as furnished by the assessee, the panel is of the view that no prejudice shall be caused to the assessee if the assessee is taken a tested party because a simple function of provision of software development service can be reasonable benchmarked using comparables from Indian database. Therefore, the additional ground of objection is dismissed. 6.5. Also, additional ground of appeal can only be admitted if it pertains to pure question of law and no fact finding is involved. In present case, new fact finding in addition to those mentioned in TP study report of the assessee, is involved. In any case, the panel has also decided this ground on merit as above.”
Aggrieved by the order of the ld. DRP, the assessee is in appeal before us.
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 6. The ld. Counsel for the assessee simply reiterated the submission furnished before the ld. DRP and stated that the foreign entity TCG LLC is a simple and least complex entity therefore, it should be treated as a tested party.
However, the ld. DR for the revenue vehemently submitted that the assessee all along has been maintaining that he himself (TCG Digital) was treated a tested party. In TP study report the assessee has mentioned that assessee (TCG Digital) is a tested party. During the TPO proceedings assessee did not object and assessee (TCG Digital) was treated as a tested party. However, in order to avoid payment of taxes the assessee took a fresh stand before the ld. DRP that its AE (TCG LLC) should be a tested party. This is nothing but to enter into tax evasion practices and not to pay the legitimate taxes to the Government. Therefore, ld DR submitted that at a later stage the assessee cannot raise new stand or additional ground. The ld DR also submitted that the financial year ending in case of foreign AE is December ending whereas in case of Indian entity, the financial year ending is 31st March each year therefore it is difficult to compare the accounts of foreign AE with Indian entity and hence, the foreign AE should not be treated as a tested party even if it is a least complex entity.
We heard both the parties and carefully gone through the submission put forth on behalf of the assessee along with the documents furnished and the case laws relied upon, and perused the fact of the case including the findings of the ld CIT(A) and other materials available on record. We note that the solitary grievance of the assessee in this appeal is that the Foreign Associate Enterprise, “TCG LLC” should be the tested party. In order to adjudicate this issue, let us, first of all, we should examine the Function, Assets and Risks, that is, FAR analysis. The ld Counsel submitted, before us, FAR analysis of TCG Digital (assessee Co.) and TCG LLC (AE) as follows:
The assessee submitted that comparative analysis of FAR of AE and that of the assessee shows that AE is least complex entity as under:
TCG Digital Solutions (P) Ltd TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Year: Assessment Year:2011-12
TCG Digital Solutions (P) Ltd TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Year: Assessment Year:2011-12 We have gone through the above FAR analysis and through the above FAR analysis and noticed that in case of assessee in case of assessee company product/service liability risk is high, whereas in case of AE it is company product/service liability risk is high, whereas in case of AE it is company product/service liability risk is high, whereas in case of AE it is moderate. Assessee bears high technology risk whereas AE does not bear moderate. Assessee bears high technology risk whereas AE does not bear moderate. Assessee bears high technology risk whereas AE does not bear technology risk. Assessee bears high ma technology risk. Assessee bears high manpower risk whereas in case of AE it is npower risk whereas in case of AE it is moderate. The currency risk and capacity utilization risk is moderate. The currency risk and capacity utilization risk is high in case of high in case of Assessee whereas AE does not bear these risks. This clearly demonstrates that Assessee whereas AE does not bear these risks. This clearly demonstrates that Assessee whereas AE does not bear these risks. This clearly demonstrates that assessee (TCG Digital) is more complex entity and TCG LLC TCG Digital) is more complex entity and TCG LLC TCG Digital) is more complex entity and TCG LLC (AE) is least complex entity. Therefore TCG LLC (AE) should be the tested party. complex entity. Therefore TCG LLC (AE) should be the tested party. complex entity. Therefore TCG LLC (AE) should be the tested party.
Now, we shall address the grievance of ld. D.R. for the revenue. Now, we shall address the grievance of ld. D.R. for the revenue. Now, we shall address the grievance of ld. D.R. for the revenue. Before us ld DR for the Revenue submits that DR for the Revenue submits that assessee`s (TCG Digital) accounting year end accounting year ends as on 31st March every year, whereas in case of AE March every year, whereas in case of AE (TCG LLC) the (TCG LLC) the accounting year ends as on 31st December every year therefore it is difficult to compare the December every year therefore it is difficult to compare the December every year therefore it is difficult to compare the financial data of these two entities of these two entities, and hence AE should not be treated as treated as a tested party. We are of the view that in order to determine the tested party only FAR iew that in order to determine the tested party only FAR iew that in order to determine the tested party only FAR analysis is required. That is, That is, Functions, assets and Risks remain same irrespective Functions, assets and Risks remain same irrespective of the fact that accounting year of both the entities are different. of the fact that accounting year of both the entities are different. I It does not make any difference because funct because functions, assets and risks are being compared and not the are being compared and not the financial data. The Functions, assets and Risks remain same whether accounting . The Functions, assets and Risks remain same whether accounting . The Functions, assets and Risks remain same whether accounting year is ending on March or December. March or December. Thus for determination of tested party the Thus for determination of tested party the Page | 7
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 concept of different accounting year does not play any role therefore, we do not agree with ld DR that different accounting year disturb the determination of tested party.
The next grievance of the ld DR is that the assessee company cannot change its stand at a later stage for selection of tested party as per its wish and the Transfer Pricing regulation does not permit to change the tested party at a later stage because it leads to tax evasion, hence as per Ld DR , the assessee company should be treated as a tested party and not the associate enterprise (AE). We note that purpose of the Transfer Pricing law is to compute the correct arm`s length price by selecting most appropriate method and by selecting correct tested party. We have already noted in our earlier para No.8 of this order that assessee`s function, asset and risk profile (FAR analysis) are complex. The summery of functions, assets and risk profile of the assessee company is given in para 8 of our order. Because of these reasons, the assessee company is more complex and hence it should not be accepted as a tested party, whereas AE (TCG LLC) is least complex entity, hence based on this factual aspect the AE(TCG LLC) should be a tested party.
We are of the view that such a contention of ld DR cannot be upheld because it is found on the facts of the case that assessee company is a more complex entity and hence taking the assessee company as a tested party will not result into proper determination of ALP. The TPO / DRP or the Appellate Authorities can very well hold that why assessee company cannot be tested party for getting proper determination of ALP, or the assessee can demonstrate that its AE can be tested party to justify its ALP. Thus, even after the assessee has selected himself as a tested party, then also assesssee is not precluded from raising the contention before the DRP or appellate court that it`s AE can be a tested party, as it is least complex entity. The ultimate aim of the TPO/DRP is to examine whether the price or the margin arising from an international transaction with a related party is at arm’s length price (ALP) or not. The determination of the ALP is the key factor for which the least complex tested party is to be selected. Therefore, the TPO as well as the DRP should take into consideration such plea of the assessee which was raised by assessee before them, provided, it is demonstrated by assessee that as to Page | 8
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 why the change in the tested party will produce better or more appropriate arm’s length price (ALP) on facts of the case. Therefore, we reject the contention of the ld. DR and also the observation of the DRP that the AE cannot be a tested party. Based on the FAR analysis produced by the ld Counsel before us, which is noted by us in para 8 of this order, we conclude the AE (TCG LLC) should be a tested party.
Our view is also fortified by the judgment of the Co-ordinate Bench of ITAT Kolkata in the case of Almatis Alumina Pvt. Ltd. in & 2361/Kol/2017 for A.Y. 2012-13 & 2013-14 dated 16/04/2019, wherein based on the similar facts and circumstances, the AE was treated as a tested party. The findings of the bench is given below: “15. We have heard both the parties and perused the material available on record. We have gone through the function, asset and risk profile (FAR analysis) of the assessee company. The ld Counsel submitted before us that assessee company is more complex and the same can be ascertained from the FAR profile of the assessee company, which is given below in brief: (i). The summery of functions, assets and risk profile of the assessee is given in paper book page 642 to 656. (ii).Detailed evidences about FAR analysis which are mentioned at page nos. 708 to 797 of paper book. (iii). The functions performed by the assessee company is more complex than its associate enterprise (AE). (iv). Assets employed by the assessee company is more than its associate enterprise (AE). (v).The risk profile of the assessee company is more than its associate enterprise (AE). (vi).The assessee company is engaged in the function of negotiation with customers and fix the price with customers. The negotiation and price fixation is done by the assessee company with the following customers ( for the sake of example): (a)IFGL Ltd, paper book page 528-536. (b) Tata Refractory Ltd. paper book page538 to 547. (c ) TRL Crosaki Ltd. paper book page548 to 555. (d).The credit risks are borne by the assessee company (vide paper book page nos. 556 to 577). (e). The assessee company bears warranty risk and product liability risk. (f)The assessee company handles the complaints from the customers, vide paper book page 578 to 593. (g) The assessee company bears the foreign exchange risk. (i) The assessee company also bears the inventory risk. Having gone through the functions, assets and risks profile (FAR analysis) of the assessee company and other risks borne by the assessee company, as mentioned Page | 9 TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 above, the ld Counsel claimed that the assessee company is a more complex entity therefore it should not be considered as a tested party. However, we have gone through the FAR profile of associated enterprises (AE), and we find that the associated enterprises (AE) is not so complex as the assessee company, hence based on the factual position narrated above, the associate enterprise (AE) can be treated as least complex entity and therefore it should be selected as a tested party.
Now, we address the main grievance of the ld DR for the Revenue that the assessee company can not change its stand at a later stage for selection of tested party as per its wish and the Transfer Pricing regulation does not permit to change the tested party at a later stage because it leads to tax evasion, hence as per Ld DR for the Revenue, the assessee company should be treated as a tested party and not the associate enterprise (AE). We note that during the TPO proceedings, the assessee himself was selected as a tested party. The method to compute the ALP which has been chosen by the assessee as the tested party himself and therefore the assessee cannot resort to change his selection of tested party at the DRP proceedings/appellate stage, is not acceptable for the reasons given above in para No.15 of this order. We have already noted in our earlier para No.15 of this order that assessee`sfunction, asset and risk profile (FAR analysis) are complex. The summery of functions, assets and risk profile of the assessee company is furnished by ld Counsel before us, which is given in paper book page 642 to 656. The ld Counsel also submitted detailed evidences about FAR analysis which are mentioned at page nos. 708 to 797 of paper book. Because of these reasons, the assessee company is more complex and hence it should not be accepted as a tested party. We are of the view that such a contention of ld DR cannot be upheld because it is found on the facts of the case that assessee company is a more complex entity and hence taking the assessee company as a tested party will not result into proper determination of ALP. The TPO or the Appellate Authorities can very well hold that why assessee company cannot be tested party for getting proper determination of ALP, or the assessee can demonstrate that its AE can be tested party to justify its ALP. Thus, even after the assessee has selected himself as a tested party, then also assesssee is not precluded from raising the contention before the DRP or appellate court that it`s AE can be a tested party, as it is least complex entity. The ultimate aim of the TPO/DRP is to examine whether the price or the margin arising from an international transaction with a related party is at ALP or not. The determination of the ALP is the key factor for which the least complex tested party is to be selected. Therefore, the TPO as well as the DRP should take into consideration such a plea before them, provided, it is demonstrated as to why the change in the tested party will produce better or more appropriate ALP on facts of the case. Therefore, we reject the contention of the ld. DR and also the observation of the TPO that the AE cannot be a tested party. We note that the associate enterprise (AE) has the following characteristics: (i).Performs simpler functions; (ii).Assumes minimal risks; (iii). Does not own valuable intangibles / unique assets; and (iv). Reliable data regarding uncontrolled comparable companies is available. Therefore, the assessee pleaded before the Ld. Panel to consider the functional analysis provided above, to select the AEs as the tested party being the least Page | 10
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 complex entities. The assessee urged, the Ld. Panel to rely on the information presented above which is due to some information coming to the knowledge of the assessee tax payer which reflects facts contrary to the facts captured in the TP study. In this context, we rely on the case of Deputy Commissioner of Income- tax v. Quark Systems (P.) Ltd. [2010] 38 SOT 307 (CHD)) wherein it was held as follows: '37 When substantial justice and technical considerations are pitted against each other, the cause of substantial justice deserves to be preferred. For the other side cannot claim to have a vested right in injustice being done due to some mistakes on its part. Accordingly, on facts and circumstances of the case, we hold that taxpayer is not estopped from pointing out that Datamatics has wrongly been taken as comparable. While admitting additional ground of appeal raised by the assessee to require us to consider whether or not Datamatics should be included in the comparable, we make no comments on merit except observing that assessee from record has shown its prima facie case. Further claim may be examined by the Assessing Officer, we are inclined to take a rather liberal approach by giving assessee an opportunity to make out its case properly and place all the relevant facts before the tax authorities so that proper arm's length price can be determined in accordance with the law the proceedings before the tax authorities are not adversarial proceedings and the assessee should not, therefore, be placed at under advantage because of his inadvertent and bona fide mistakes. (emphasis added) It is therefore pleaded before the Ld. Panel, in order to test the transactions under analysis from a transfer pricing perspective, it is essential to appreciate the modus operandi of the operations of Almatis India which undertakes entrepreneurial function and assumes significant risks in course of manufacturing operation. To summarise, the business profile of both the assessee and AE are re- summarised below: • The assessee is engaged in buy, manufacture and sale operation with the objective of creating and retaining a wide customer base in the competitive market • In doing so, the assessee assumes market risk, price risk, credit risk and forex risk • AE is primarily engaged in manufacture and supply of goods to Almatis India based on Almatis India's specific requirement • AE primarily assume manufacturing (quality risk) and is absolved of all other risk Selection of tested party Based on the above, it is apparent that the AE assumes lesser complex functions and bears lower level of risks as compared to that of Almatis India. It may kindly be noted that sub-rules (2) and (3) of Rule 10B of the Rules do not restrict taking an overseas entity/AE of an enterprise as the tested party. The two sub-rules provide the yardsticks for comparability of an international transaction with an uncontrolled transaction. It may kindly be noted that in order to establish the ALP, determination of the 'tested party' plays a very important and key role since one needs to identify comparables and compare the same with tested party.
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 In this regard, the Ld. Panel's kind attention is also drawn to para 3.18 and para 3.19 of the TP Guidelines issued by Organization for Economic Cooperation and Development ('OECD TP Guidelines') that also highlight the above point. Para 3.18 states that: When applying a cost plus, resale price or transactional net margin method as described in Chapter 11, it is necessary to choose the party to the transaction for which a financial indicator (mark-up on costs, gross margin, or net profit indicator) is tested. The choice of the tested party should be consistent with the functional analysis of the transaction. As a general rule, the tested party is the one to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables can be found, i.e. it will most often be the one that has the less complex functional analysis (emphasis added) Para 3. 19 states that; This can be illustrated as follows. Assume that company A manufactures two types of products, P1 and P2 that it sells to company B, an associated enterprise in another country. Assume that A is found to manufacture P1 products using valuable, unique intangibles that belong to B and following technical specifications set by B. Assume that in this P1 transaction, A only performs simple functions and does not make any valuable, unique contribution in relation to the transaction. The tested party for this P1transaction would most often be A. Assume now that A is also manufacturing P2 products for which it owns and uses valuable unique intangibles such as valuable patents and trademarks, and for which B acts as a distributor. Assume that in this P2 transaction, B only performs simple functions and does not make any valuable, unique contribution in relation to the transaction. The tested party for the P2 transaction would most often be B." (emphasis added) 17. Further, the US TP Regulations discussing the concept of tested party at 1.482-5(b) is produced below: " the tested party will be the participant in the controlled transaction whose operating profit attributable to the controlled transactions can be verified using the most reliable data and requiring the fewest and most reliable adjustments, and for which reliable data regarding uncontrolled comparables can be located. Consequently, in most cases the tested party will be the least complex of the controlled taxpayers and will not own valuable intangible property or unique assets that distinguish it from potential uncontrolled comparables." (emphasis added) 18. By virtue of the above guidance, it can be reasonably concluded that the tested party should be the one, which has the following characteristics: • Performs simpler functions; • Assumes minimal risks; • Does not own valuable intangibles / unique assets; and • In respect of which, reliable data regarding uncontrolled comparable companies is available. Page | 12
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 19. Almatis India would also place strong reliance on the United Nation's Practical Manual on Transfer Pricing for Developing Countries, 2013, India Chapter wherein it was stated as follows: "10.4.1.3. The regulations prescribe mandatory annual filing requirements as well as maintenance of contemporaneous documentation by the taxpayer in case international transactions between associated enterprises cross a threshold and contain stringent penalty implications in case of non- compliance. The primary onus of proving the arm's length price of the transaction lies with the taxpayer. The Indian transfer pricing administration prefers Indian comparables in most cases and also accepts foreign comparables in cases where the foreign associated enterprise is the less or least complex entity and requisite information is available about the tested party and comparables." (emphasis added) 20. We note that the landmark ruling by the Coordinate Bench, Kolkata Tribunal, in the case of Landis + Gyr Limited (ITA Nos Assessment Year: 2007-08, & I.TA No. 1623/Ko1/2012, Assessment Year: 2008-09) spoke about overseas party as a tested party. Relevant findings are given below: 5.2.11. We find that the concept of overseas tested party and foreign comparable companies is well recognized and acknowledged by Indian Revenue as could be seen from India's commentary in United Nations Practical Manual on Transfer Pricing for Developing Countries which were placed on record by the Id AR, wherein, the following has been stated:- 10.4.1. Transfer Pricing Regulations in India 10.4.1.3. The Indian Transfer Pricing administration prefers Indian comparables in most cases and also accepts foreign comparables in cases where the foreign associated enterprise is the less or least complex entity and requisite information is available about the tested party and comparables. In the instant case, all the recuisne information was available for undertaking overseas benchmarking study and the same was also made available to the Id TPO and Id DRP's perusal. We find that the reliance placed by the Id AR on the decision of the Co-ordinate Bench of Delhi Tribunal in the case of Ranbaxy Laboratories Ltd vs ACIT reported in (2016) 68 taxmann.com 322 (Delhi Trib.) is very well founded wherein the concept of overseas tested party and foreign comparable companies for determination of Arm's Length Price has been accepted. In View of the above discussions, in order to meet the ends of justice in the facts and circumstances of the case, we deem it fit and appropriate, to set aside this issue to the file of the Id TPO / Id AO for determination of Arm's Length Price based on transaction to transaction approach submitted by the assessee taking the AE as a tested party using CPM as the Most Appropriate Method (emphasis added) Page | 13
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 21. The concept of tested party was also dealt in detail by Coordinate Bench of ITAT Ahmedabad, in the case of General Motors India Private Limited, in I. T.A. Nos. 3096/Ahd/2010 and 3308/ Ahd/2011, wherein the tribunal has concluded that the foreign AE should be considered as the tested party being the least complex of the transacting entities and has relied on the UN TP Manual and various judicial precedents on this issue. The relevant extract of the order has been given below: "Taking all the above facts and circumstances of the issue as discussed in the foregoing paragraphs, in consonance with the case laws quoted (supra) and also the United Nation's Practical Manual on transfer pricing, we direct the TPO to adopt GMDAT as the 'tested party' for analysing the inter-company transactions of the assessee for both the AYs under consideration. To facilitate the TPO to analyse the inter-company transactions in the case of the assessee by selecting GMDAT as 'tested party' as directed above, this issue is restored on the files of the TPO. It is ordered accordingly. (emphasis added) 22.Further, the Coordinate Bench of Kolkata Tribunal in the case of Development Consultants Private Limited [2008-TII-03-ITAT-KOL-TP] affirmed that in order to select the most appropriate method for determining the arm's length price, it is first necessary to select the tested party, which will be least complex of the controlled tax payers engaged in the transaction and will not own valuable intangible property or unique assets that distinguish it from potential uncontrolled comparables. The relevant extract has been given below: "5 However, in order to determine the most appropriate method for determining the arm's length price, it is first necessary to select the tested party'. The transfer pricing legislation in India does not provide any discussion or mention of the concept of 'tested party'. In order to understand the concept of tested party we need to refer to the transfer pricing legislations of developed countries where the principles of transfer pricing have been in use for a long time and act as a guiding force for all the developing economies. The transfer pricing guidelines issued by the US Internal Revenue Services under section 482 provide and discuss the concept of transfer pricing. Section 1.482-5 of the US transfer pricing regulations state that "the tested party will be the participant in the controlled transaction whose operating profit attributable to the controlled transactions can be verified using the most reliable data and requiring the fewest and most reliable data and requiring (he fewest and most reliable adjustments, and for which reliable data regarding uncontrolled comparables can be located. Consequently, in most cases the tested party will be the least complex of the controlled taxpayers and will not own valuable intangible property or unique assets that distinguish it from potential uncontrolled comparables. Thus, in a sense, the tested party would have lesser risk as compared to the other transacting party or the real entrepreneur. " (emphasis added)
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 23. The above concept of "tested party" has also been confirmed by Coordinate Bench of Delhi Tribunal, in the case of Ranbaxy Laboratories Ltd. v. Additional Commissioner of Income-tax (110 ITD 428) wherein, it was held as follows: "58 The tested party normally should be the party in respect of which reliable data for comparison is easy and readily available and fewest adjustments in computations are needed. It may be local or foreign entity, i. e., one party to the transaction. The object of transfer pricing exercise is to gather reliable data, which can be considered without difficulty by both the parties, i.e., taxpayer and the revenue. It is also true that generally least of the complex controlled taxpayer should be taken as a tested party" (emphasis added) 24. We would also make a passing reference to the judgment of the Coordinate Bench of Ahmedabad Tribunal, in the case of Mastek Limited v. Addl. CIT (ITA NO.3120/Ahd/2010), wherein the selection of overseas AE as tested party was not disputed by the Bench and it was held as follows: "we are of the view that in order to determine the most appropriate method for determining the arm's length price, first it is necessary to select the 'tested party' and such a selected party should be least complex and should not be unique, so that prima facie cannot be distinguished from potential uncontrolled comparables " (emphasis added) Typically, the "tested party" would be the least complex of the transacting entities, i.e. the simpler entity in terms of intensity of functions performed and risks assumed; and would also not own valuable or non-routine intangibles. Accordingly, this entity would also typically earn routine but steady returns. As a general rule, entrepreneurs should not be considered as "tested parties" and accordingly benchmarked, since, by virtue of their complex functional and risk profiles, their margins fluctuate heavily with the vagaries of the economy, thus making comparability analysis extremely difficult and unreliable. Further, the financial results of the entrepreneur, being the ultimate fallout of third party businesses, often depend on external economic factors in the market; and not on the internal pricing policies of the MNC group. This concept of "tested party" is fundamental to transfer pricing. Based on the above analysis of the functions and risks assumed by both the parties, it can be reasonably concluded that Almatis India is engaged in operation that entails entrepreneurial function and related risks. The AE, on the other hand, based on the functional and risk profile, can be characterized as a manufacturer engaged in manufacturing and supply of the products based on orders from Almatis India. Considering the above functional and risk profile and the resulting characterization, we should appreciate and give due cognizance to the assessee's business profile for the relevant year under consideration. Arm's length analysis and conclusion derived without appreciating the business profile would defeat the cardinal principles of transfer pricing.
We note that the assessee had prepared and submitted a transfer pricing study report in accordance with the Indian transfer pricing provisions contained in sections 92 and 92A to 92F of the Act, read with Rules 10A to 10E of the Rules. In Page | 15 TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 the said transfer pricing study report, the assessee has used the transactional net margin method and tested the margins of Almatis India. We note that the assessee adopted an incorrect approach of considering Almatis India as the tested party for analysis without appreciating the business profile of both Almatis India and its AE based on the functional and risk profile, and it has been clearly demonstrated that the AEs are the least complex entities vis-a-vis the assessee company.
To conclude, we note that the ld counsel for the assessee pleaded before us to accept the AE as the tested party, as the initial approach adopted by the assessee and consequently the TPO, was a bona fide mistake. In the interest of natural justice, we note that the facts placed before us shows that AE should be tested party. The AE to be the tested party, and the said approach has been made considering all relevant facts and circumstances and is well supported by judicial precedents cited above and transfer pricing regulations mentioned above. Therefore, the overseas AEs, being the least complex transacting entities be selected as the tested party and the margin earned by them should be tested from arm's length perspective, as the AE performed simpler functions and do not assume any significant risks contrary to the assessee. Having gone through the functions, assets and risks profile (FAR analysis) of the assessee company and other risks borne by the assessee company, as mentioned above, we noticed that the assessee company is a more complex entity therefore it should not be considered as a tested party. However, we have gone through the foreign associated enterprises and its profile and we find that the foreign associated enterprises can be treated as a tested party because it is the least complex party. For that our views are fortified by the following judgments of the Co-ordinate Benches of Kolkata and Delhi which are already discussed above in detail: i) Landys + Gyr (Kolkata) (supra) page 21 para 5.2.11 ii) Ranbaxy Laboratories Ltd. vs. ACIT (supra) (110 ITD 28) (ITAT Delhi) We note that Indian Transfer Pricing guidelines issued by the Institute of Chartered Accountant of India vide guidance noted on report u/s 92E by ICAI and transfer pricing guidelines issued by the OECD and considering the united nation practical manual of transfer pricing for developing country, we note that in the assessee`s case under consideration, the Associate Enterprise(AE) can be selected as a tested party. Therefore, we direct the ld. TPO / Assessing Officer to treat the foreign associated enterprises as a tested party and compute the arms’ length price adjustment accordingly.”
We note that assessee`s issue is covered by the judgment of the Coordinate Bench in the case of Almatis Alumina Pvt. Ltd(supra), therefore, we conclude that the functions performed and the risks assumed by the assessee company (TCG Digital) is substantially high and is akin to a full-fledged service provider, whereas the AE(TCG LLC) simply renders marketing services only therefore it is a least Page | 16
TCG Digital Solutions (P) Ltd Solutions (P) Ltd. Assessment Year:2011-12 complex entity therefore we direct the AO/TPO to compute the arm`s length price (ALP) taking into account the AE(TCG LLC) as a tested party.
In the result, Ground No. 5 and 6 raised by the assessee are allowed.
Order pronounced in the Court on 13.12.2019