RHYTHM AND HUES STUDIOS INDIA P.LTD,MUMBAI vs. ITO 11(1)(2), MUMBAI

Briefly stated, the assessee company which is a wholly owned subsidiary of Rhythm and Hues Studios Inc., USA is engaged in the business of providing graphics and animation services to motion picture and television industry. The assesee had e-filed its return of income for A.Y. 2011-12 on 30.11.2011, declaring its total income at Rs.50,91,847/- under Sec.115JB of the Act. Subsequently, the case of the assessee was selected for scrutiny assessment under Sec.143(2) of the Act.

In the course of the assessment proceedings the A.O observing that the assessee had entered into international transactions with its Associate Enterprise (for short „AEs‟) exceeding an amount of Rs.15 crores, thus made a reference under Sec.92CA(1) of the Act to the Transfer Pricing Officer-II (3), Mumbai (for short „TPO‟) for computing the Arm‟s Length Price (for short „ALP‟) of the said transactions.

Evoke Technologies Pvt.ltd .

Kireeti Soft Technologies Ltd.

Sankhya Infotech Limited 16. Sasken Communication Technologies Ltd.

Tata Elxsi Ltd. (Segment) 18. Thirdware Solutions 19. Wipro Technologies ltd.

ZylogStystems Ltd. Objections filed by the assessee as regards applying of TNMM were rejected by the TPO. In fact, it was observed by the TPO that in A.Y. 2009-10 also TNMM was applied in the case of the assessee after rejecting the CUP method. The TPO justified the adoption of TNMM as the most appropriate method for multiple reasons, viz. (i) that, the TNMM was applied in the case of the assessee for A.Y. 2009-10; (ii) that, as the third party transactions in the case of the assessee were only to a minimal extent of 1.2% of the total transactions, therefore, in the backdrop of the limited volume of such transactions the CUP method could not be applied; and (iii) that, as the activities of the assessee were akin to providing software services and no two softwares can be similar as the nature of visual effects would be different for both the assessee and the third party, therefore, due to difference in the nature of work also the CUP method could not be applied for benchmarking purposes. On the basis of his aforesaid deliberations, the TPO after applying the TNMM worked out the mean PLI i.e OP/OC of the 20 comparables at 23.64%. As the PLI of the assessee (OP/OC) was worked out at -0.40%, therefore, the TPO by applying the mean PLI of the comparables worked out a TP adjustment of Rs.7,18,01,446/-.

The A.O after receiving the order passed by the TPO under Sec.92CA(3) of the Act, dated 29.01.2015, therein passed a draft assessment order under Sec. 144C r.w.s 143(3), dated nil. On the basis of the draft assessment order, the A.O worked out the income of the assessee under the normal provisions at Rs.7,91,22,944/- and „book profit‟ under Sec. 115JB at Rs.50,91,847/-.

Aggrieved, the assessee filed objections with the Dispute Resolution Panel-2, Mumbai (for short „DRP‟). The DRP was not persuaded to subscribe to the claim of the assessee that the TPO was in error in rejecting the CUP method and substituting the same by TNMM. It was observed by the DRP, that the CUP method adopted by the assessee company was not broad based as it did not involve multiple parties. It was noticed by the DRP, that the third party transactions of the assessee formed only 1.2% of the total transactions, which thus did not P a g e | 6 IT(TP) A. No.1849/Mum/2016 A.Y. 2011-12 Rhythm And Hues Studios India pvt.Ltd.Vs. Income-tax Officer-11(1)(2) justify the application of CUP method. Also, it was observed by the DRP, that the services provided by the assessee to the third parties were distinguishable as against those rendered to its AE. Further, it was observed by the DRP, that the assessee had provided animation services to the third party viz. Q.E.D films for three small advertisements only, which were for a short span of 50 second and 10 second only. On the contrary, the assessee company had provided services to its AE viz. M/s Rhythm & Hues Inc., USA for feature films and television. It was also noticed by the DRP that the claim of the assessee that it had charged its AE @ USA 893 per man week and USD 808 per man week to third parties also could not be verified in the absence of the relevant data on record. Apart there from, it was observed by the DRP that while for the sample bills raised by the assessee on its AE revealed that the invoices were raised on the basis of USD per man week along with detailed calculations, however, the invoices raised on the single third party namely Q.E.D films were on a lump sum basis and there was no calculation of rupees per man week available in respect of the same. Also, it was observed by the DRP, that a perusal of the MOU, dated 01.11.2010 between the assessee and its AE i.e Rhythm and Hues Inc., USA, revealed that the assessee company was to provide to the AE not only offshore computer graphics and animation services, but also software development services. In the backdrop of the aforesaid facts, the DRP was of the view that as no software development services were to be provided by the assessee to the third party viz. Q.E.D films, therefore, it could safely be concluded that the functions performed by the assessee company in relation to the AE vis-a-vis third party were entirely different. It was also observed by the DRP, that while for the third party was based in India, the AE viz. Rhythm & Hues Inc. was stationed in USA. Accordingly, the DRP was of the view that there was a considerable difference in the two markets because of the geographical location. The DRP also noted that the assessee company had provided customised software to the AE and the features of these software products varied considerably for each contract. On the basis of his aforesaid deliberations, it was concluded by the DRP that as the assessee had failed to place on record the details of the AE and the non-AE contracts, therefore, it could safely be concluded that the CUP method could not have been applied as the most appropriate method. Accordingly, the DRP upheld the rejection of CUP method and application of the TNMM by the TPO as the most appropriate method. As regards the contention advanced by the assessee that the TPO had erred in concluding that the assessee was providing software development services to its AE, it P a g e | 7 IT(TP) A. No.1849/Mum/2016 A.Y. 2011-12 Rhythm And Hues Studios India pvt.Ltd.Vs. Income-tax Officer-11(1)(2) was observed by the DRP, that a perusal of the functional analysis of the assessee in the TP study report, and also the various clauses of the MOU and the other material available on record revealed that the assessee company was mainly providing software development services. In fact, it was observed by the DRP, that even the offshore computer graphics and animation services were being provided by the assessee with the help of software only. On the basis of its aforesaid observations, it was concluded by the DRP that no infirmity did emerge from the action of the TPO insofar the selection of the comparables which were providing software development services was concerned. At the same time, the DRP observed that two comparables viz. (i) Infosys Ltd.; and (ii) Wipro Technologies Ltd, both of which were software giants having substantial brand value could not have been selected as comparables to the assessee company. Accordingly, the DRP directed the AO/TPO to remove the aforesaid two companies from the final list of comparables and therein rework out the TP adjustment.

The A.O after receiving the order passed by the DRP under Sec. 144C(5) of the Act, dated 14.12.2015, therein passed the final assessment order under Sec. 143(3) r.w.s 144C(13), dated 29.01.2016, as per which the income of the assessee under the normal provisions was assessed at Rs.7,05,29,585/- and its „book profit‟ under Sec. 115JB was determined at Rs.50,91,847/-.

The assessee being aggrieved with the order passed by the A.O under Sec. 143(3) r.w.s 144C(13), dated 29.01.2016 has carried the matter in appeal before us. The ld. Authorized Representative (for short „A.R‟) for the assessee at the very outset of the hearing of the appeal submitted, that as instructed, the grounds of appeal

Per contra, the ld. Departmental Representative (for short „D.R‟) relied on the orders of the lower authorities. It was submitted by the ld. D.R that as the CUP method adopted by the P a g e | 10 IT(TP) A. No.1849/Mum/2016 A.Y. 2011-12 Rhythm And Hues Studios India pvt.Ltd.Vs. Income-tax Officer-11(1)(2) assessee company was not broad based as it did not involved multiple parties, therefore, the TPO/DRP had rightly rejected the internal CUP method that was adopted by the assessee. Also, it was submitted by the ld. D.R, that unlike the services for feature films and television which were provided by the assessee to its AE viz. Rhythm & Hues Inc., USA, services which were provided to the solitary third party/non-AE i.e Q.E.D films was only in respect of three small advertisements, which too were for a short time span of 50 seconds and 10 seconds only. As such, it was submitted by the ld. D.R, that as even the services provided by the assessee to its AE and the non-AE were substantially at variance, therefore, the CUP method adopted by the assessee had rightly been rejected by the lower authorities.

We have heard the authorized representatives for both the parties, perused the orders of the lower authorities and the material available on record, as well as considered the judicial pronouncements relied upon by them. The assessee company is engaged in the business of providing graphics and animation to motion pictures and television industry. As observed by us hereinabove, the assessee during the year had provided services to its AE viz. M/s Rhythm and Hues Inc., USA, and also to a third party i.e Q.E.D films. The assessee for the purpose of benchmarking its international transactions had adopted internal CUP method as the most appropriate method („MAM‟). However, the TPO holding a conviction that internal CUP method could not be safely applied for benchmarking analysis in the case of the assessee company, had thus rejected the same for multiple reasons, viz. (i) that, in A.Y. 2009-10 also TNMM was applied by the TPO as against CUP method adopted by the assessee; (ii) that, the third party transactions formed just 1.2% of the total transactions; and (iii) that, as the assessee was providing software services to its AE, therefore, for the reason that no two softwares can be similar as the nature of visual effects would be different for both the assessee and the third party, thus, CUP method could not be accepted as the appropriate method for benchmarking the international transactions of the assessee. As observed by us hereinabove, the TPO after substituting TNMM as the MAM, had therein selected 20 parties which were into software development services, and on the said basis had worked out an upward TP adjustment of Rs.7,18,01,446/-. On objections filed by the assessee, the DRP had excluded two comparables viz. (i) Wipro Technologies Ltd, and (ii) Infosys Ltd., for the reason, that the said software giants could not feasibly be selected as comparable to the assessee company. At the same time, the P a g e | 11 IT(TP) A. No.1849/Mum/2016 A.Y. 2011-12 Rhythm And Hues Studios India pvt.Ltd.Vs. Income-tax Officer-11(1)(2) DRP upheld the substitution of internal CUP method by TNMM as the most appropriate method for benchmarking the international transactions of the assessee by the TPO. Also, it was observed by the DRP, that as the assessee was into software development services, therefore, no infirmity did emerge from the order of the TPO as regards selection of remaining 18 comparables for benchmarking the ALP of the international transactions of the assessee.

On a perusal of the records, it stands revealed that the assessee during the year under consideration viz. A.Y. 2011-12 had carried out third party transactions of Rs.39,24,600/- as against its total transactions of Rs.30,14,04,799/-. As such, the third party transactions of the assessee works out to the tune of 1.20 % of its total transactions. Admittedly, as claimed by the ld. A.R, the fact situation in the immediately preceding year viz. A.Y. 2010-11 was also not much different. In the said preceding year the assessee had provided third party transactions of Rs.46,50,000/- as against its total transactions of Rs.25,52,82,998/-, which thus worked out to 1.84% of the total value of transactions. Also, in the immediately preceding year viz. A.Y. 2010- 11 the assessee had adopted CUP method for benchmarking its international transactions. The aforesaid facts can safely be gathered from a perusal of “Form No. 3CEB” filed by the assessee under Sec. 92E of the Act (Page 190-194 of APB). It is also a fact borne from the records that CUP method that was adopted by the assessee as MAM for benchmarking its international transactions was accepted by the TPO, vide his order passed under Sec.92CA(3), dated 24.01.2014 in A.Y. 2010-11. Also, it is the claim of the ld. A.R that the CUP method which was applied in A.Y. 2006-07 for benchmarking the international transactions was accepted by the department. In fact, we find that the said fact finds a clear mention in the order passed by the TPO under Sec. 92CA(3), dated 29.01.2015 for the year under consideration. As for the A.Y. 2007-08 and A.Y. 2008-09, it was claimed by the ld. A.R that no TP reference was made by the A.O during the said respective years. As regards A.Y. 2009-10, it was submitted by the ld. A.R that as no contemporaneous transactions of the assessee in the domestic market for the said year were available, therefore, it was for the said reason that the CUP method that was adopted by the assessee was rejected by the TPO. In sum and substance, it was the claim of the ld. A.R that the adoption of CUP method by the assessee for A.Y.2009-10 was not rejected on the ground that the same was not the most appropriate method, but for the reason, that no contemporaneous transactions for the said year in order to facilitate such comparison was P a g e | 12 IT(TP) A. No.1849/Mum/2016 A.Y. 2011-12 Rhythm And Hues Studios India pvt.Ltd.Vs. Income-tax Officer-11(1)(2) available. In the backdrop of the aforesaid facts, it was the claim of the ld. A.R that CUP method that was being followed by the assessee for benchmarking its international transactions right from its inception in A.Y. 2006-07 till A.Y. 2010-11 was consistently accepted by the revenue as the most appropriate method. Ld. A.R drawing support from the judgment of the Hon‟ble Supreme Court in the case of Radha Soami Satsang Vs. CIT (1992) 193 ITR 321 (SC), had submitted, that as the CUP method that was consistently adopted by the assessee as MAM in the preceding years was throughout accepted by the revenue, therefore, it was not correct on the part of the lower authorities to have adopted an inconsistent approach and rejected the said method during the year under consideration. Apart there from, the ld. A.R in order to drive home his aforesaid contention had also relied on the order of the ITAT, Ahmedabad, „I‟ Bench, Ahmedabad in case of Schniedre Electric India Pvt. Ltd. Vs. Dy. CIT, Central-1(2), Vadodara (ITA No. 209/Ahd/2015, dated 31.05.2017). On the basis of his aforesaid submissions, it was the case of the ld. A.R, that the revenue without any cogent reason could not have rejected the method of benchmarking the ALP of the international transactions of the assessee, which till date had consistently been accepted in the past.

We have given a thoughtful consideration to the contentions advanced by the ld. A.R in the backdrop of the orders of the lower authorities and the material available on record. Admittedly, where a fundamental aspect permeating through the different assessment years has been found as a fact one way or the other and parties have allowed that position to be sustained by not challenging the order, it would not be at all appropriate to allow the position to be changed in a subsequent year. But then, the adherence to the aforesaid principle requires that there is no change in the factual position in the aforementioned years. We are afraid the aforesaid principle of consistency cannot be applied to the facts of the case of the assessee before us. In fact, it is not the case of the assessee that it had entered into similar transactions with the aforesaid third party i.e Q.E.D films in either of the preceding years and the same were accepted as a comparable by the revenue. Rather, on the contrary, we find that the nature of services rendered by the assessee to the third party i.e Q.E.D Films during the year are clearly distinguishable as against those rendered to its AE. As observed by us hereinabove, while for the assessee was providing VFX services to its AE viz. M/s Rhythm & Hues Inc., USA for feature films and television, on the contrary it had provided animation services to the third party P a g e | 13 IT(TP) A. No.1849/Mum/2016 A.Y. 2011-12 Rhythm And Hues Studios India pvt.Ltd.Vs. Income-tax Officer-11(1)(2) viz. Q.E.D films for three small advertisements which were spread over a short span ranging between 10 seconds to 50 seconds only. Apart there from, we find that a perusal of the invoices raised by the assessee on its AE are for Visual effects/computer graphics done on feature films, while for those raised on the third party viz. Q.E.D films are absolutely silent about the nature of services and only make a mention of the respective commercials viz. “Chocoliebe Commercial”, “Iodex” etc. In fact, as observed by the DRP, the assessee had provided animation services to the third party viz. Q.E.D films. Also, we are in agreement with the view taken by the lower authorities that the CUP method adopted by the assessee company was not broad based as it did not involve multiple parties. As is discernible from the records, the assessee for benchmarking its international transactions worth Rs. 29,74,80,199/- by adopting CUP method has used its transaction with a local vendor i.e Q.E.D films, which were worth Rs, 39,24,600/- only. As observed by us hereinabove, the said third party transaction of the assessee forms just 1.2% of the total transactions. As the volume of such third party transactions are so thin that the same in our considered view would not justify application of CUP method. Also, we are in agreement with the view taken by the DRP that in the absence of the relevant data on record, including the „agreements‟ relating to the various services rendered by the assessee to the third party and the contract-wise services rendered to its AE, the veracity of the rates charged to its AE and that charged to the third party could not be ascertained. In fact, we find that a perusal of the invoices raised by the assessee on its AE though reveals a detailed calculation, but the invoices raised on Q.E.D films are on lump sum basis. As regards the reliance placed by the ld. A.R on the principle of consistency, in order to drive home his contention that the revenue authorities were not justified in rejecting the CUP method that was consistently accepted in the preceding years as the MAM for benchmarking its international transactions, we are of the view, that now when the facts involved in the case for the year under consideration are not in parity with those for the preceding years, therefore, the aforesaid claim of the assessee cannot be accepted. Alternatively, we find that even otherwise as held by the Hon‟ble High Court of Delhi in the case of CWT Vs. Meatles Pvt. Ltd. (1984) 156 ITR 569 (Del) the revenue authorities cannot be stopped from taking a correct view of the statutory provisions in a later year. On a similar footing, the ITAT, Mumbai in the case of Onward Technologies Limited Vs. DCIT (2014) 147 ITD 534 (Mum), had observed, that application of a wrong method for P a g e | 14 IT(TP) A. No.1849/Mum/2016 A.Y. 2011-12 Rhythm And Hues Studios India pvt.Ltd.Vs. Income-tax Officer-11(1)(2) benchmarking the ALP of the international transactions of the assessee cannot be granted a seal of approval on the basis of acceptance by the TPO in a preceding year.

Admittedly, CUP method is a traditional transaction method and the most direct and reliable way of determining whether prices and conditions between the assessee and its AEs are at arms‟s length, or not. But then, we also cannot remain oblivious of the fact, that for applying CUP method there has to be access to reliable comparables data for the uncontrolled transactions. Accordingly, in the backdrop of the aforesaid facts, we are of the considered view that in the absence of an internal or external comparable uncontrolled transaction as in comparison to the controlled transaction i.e between the assessee and its AE viz. M/s Rhythm & Hues Inc., USA, the CUP method could not have been adopted as the MAM for benchmarking the ALP of its international transactions. After deliberating at length on the issue under consideration and also considering the observations of the lower authorities, we are in agreement with the view taken by them that CUP could not have been adopted as MAM for benchmarking the international transactions of the assessee. As a matter of fact, we find that in A.Y. 2009-10 also the assessee had adopted CUP method, which however was rejected by the TPO, for the reason, that no contemporaneous transactions of the assessee in the domestic market for the said year were available. We find that during the year under consideration also, in absence of any internal or external comparable uncontrolled transaction as in comparison to the controlled transaction i.e between the assessee and its AE viz. M/s Rhythm & Hues Inc., USA, the CUP method adopted by the assessee had rightly been rejected by the lower authorities. Accordingly, finding no infirmity in the rejection of the CUP method that was adopted by the assessee for benchmarking its international transactions, we uphold the order of the A.O/DRP to the said extent .