BIG QUESTIONS

Should companies which are having income from other sources, either be ignored or appropriate adjustments for such differences be made?

Did the TPO erroneously consider non-operative income in computing weighted average NCP of the comparable companies?

Was it right on the part of the TPO not to make adjustment for the differences in comparable transactions? Should the fact that the taxpayer was a captive company be given importance?

Is it correct to include comparable companies, which are not engaged in software development activities, as peers?

THE JUDGMENT

The Tribunal, after considering both sets of contentions, agreed with the taxpayer. Following are its observations on the different facets of the case.

Differences sorted: It held that while comparing the controlled and uncontrolled transactions under the TNMM, those differences having material effect on price, costs or profit must be taken into consideration with an idea to make reasonable and accurate adjustment to eliminate such differences.

Relying on the Mentor Graphics (P) Ltd (2007 18 SOT 76 Del) case, the authority observed that while applying TNMM, necessary adjustments for differences on account of FAR analysis must be made. (In FAR, arm’s length price or ALP is determined based on functions performed, assets used and risks taken.)

OECD guidelines: The Tribunal also relied on relevant OECD (Organisation for Economic Co-operation and Development) Transfer Pricing Guidelines as well as transfer pricing regulations in the US. These stated that the TNMM may afford a practical solution to otherwise insoluble transfer pricing problems, if it is used sensibly and with appropriate adjustments to account for differences having effect on price, costs, or profit.

Peer selection: What was emphasised was the similarities (and dissimilarities) of the transactions under comparison need to be examined to see differences of situations, circumstances, and environment. To enable this, parameters such as the nature or line of business, product or market size, assets composition employed, size and scope of operation, stage of business or product cycle must be considered while comparing the tested party and uncontrolled comparables.

Error: The Tribunal observed that the comparable companies and the taxpayer were not scrutinised by the tax authorities to find and note those differences which needed to be adjusted. It concluded that there was no justification for considering “oversized companies” in calculating the average industry profit for transfer pricing purposes.

With respect to certain specific comparable companies, the Tribunal held that these companies must be excluded from the comparison because (i) their line of business was different from the taxpayer’s business, and (ii) they had income from other sources.

Depreciation: Tribunal accepted the taxpayer’s contention that the depreciation must be determined under the provisions of the Companies Act, 1956; therefore, the taxpayer was correct in adjusting its NCP.

EXPERT SPEAK

Business Line engaged Mr Rohan K. Phatarphekar, Executive Director & National Head, Global Transfer Pricing Services, KPMG India Pvt Ltd, Mumbai, in a brief discussion on the whole issue. Here’s what he had to say. “Observers believe that the decision by the Pune Tribunal is a step in the right direction because it focuses and reaffirms the importance of comprehensive FAR analysis for identifying and selecting comparable companies.”

The decision also clarifies that depending on the facts and circumstances of the case, appropriate adjustments must be made in the operating profit of the tested party and the comparable companies, he adds.

The recent decision by the Pune Tribunal as well as those in other recent cases reinforce certain basic transfer pricing principles — which if followed would resolve and address a number of ’grey’ issues, Mr Phatarphekar hopes.