Tax Tribunal’s Decision on Transfer Pricing Adjustments Upheld

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Case Name:

Principal Commissioner of Income Tax & Anr. Vs M/s. Eds Electronics Data Systems India Pvt. Ltd.[now merged with Mphasis Limited] (High Court of Karnataka)

ITA No. 680 of 2015

Date: 15th January 2021

Key Takeaways:

• The court upheld the Tribunal’s decision, which favored the assessee, indicating that the adjustment should be limited to the loss-making SKF contract.
• The decision emphasizes the importance of applying the Arms Length Price only to relevant transactions, avoiding unnecessary adjustments to profitable segments.
• The ruling reinforces the principle that factual findings by the Tribunal are generally upheld unless proven perverse.

Issue

Was the Tribunal correct in upholding the Commissioner’s decision to limit the transfer pricing adjustment to the SKF contract, rather than applying it to the entire technical consultancy segment?

Facts

• The respondent, EDS India, provided technical consultancy services and entered into a Master Service Agreement with SKF entities.
• The technical consultancy segment showed a loss of 14.76%, but the profitability varied between SKF and non-SKF contracts.
• The Transfer Pricing Officer (TPO) made an adjustment based on a 17.02% margin, which was contested by the assessee.
• The Commissioner of Income Tax (Appeals) reduced the adjustment, focusing only on the SKF contract.

Arguments

• Revenue’s Argument: The TPO’s method was correct, and the adjustment should apply to the entire segment, not just the SKF contract.
• Assessee’s Argument: The adjustment should only apply to the SKF contract, as other contracts were profitable, and applying it to the entire segment would be unjust.

Key Legal Precedents

• Section 92(1) (of Income Tax Act, 1961) and 92B(1) (of Income Tax Act, 1961): These sections deal with the computation of income from international transactions at Arms Length Price.
• Sudarshan Silks & Sarees vs. Commissioner of Income-Tax: Cited to support the principle that Tribunal’s factual findings are generally upheld unless shown to be perverse.

Judgement

The court dismissed the revenue’s appeal, affirming the Tribunal’s decision. It agreed with the Tribunal and the Commissioner of Income Tax (Appeals) that the adjustment should be limited to the SKF contract. The court found no substantial question of law, as the Tribunal’s findings were based on a meticulous appreciation of evidence.

FAQs

Q1: Why was the adjustment limited to the SKF contract?

A1: The adjustment was limited to the SKF contract because it was the only loss-making contract, and applying the adjustment to the entire segment would unfairly penalize profitable contracts.

Q2: What does this decision mean for other companies?

A2: This decision reinforces the principle that transfer pricing adjustments should be carefully applied to relevant transactions, avoiding unnecessary burdens on profitable segments.

Q3: Can the revenue appeal this decision?

A3: The revenue can potentially appeal, but the court’s decision was based on factual findings, which are typically upheld unless proven to be perverse.

This appeal under Section 260A (of Income Tax Act, 1961) (hereinafter referred to as the Act for short) has been preferred by the revenue. The subject matter of the appeal pertains to the Assessment year 2004-05.

The appeal was admitted by a bench of this Court vide order dated 24.08.2016 on the following substantial question of law:

"Whether the Tribunal is correct in law and facts in upholding the Commissioner of Income Tax (Appeals)'s order ignoring the basic mistake therein that having accepted Transaction Net Margin Method and the Profit Level Indicator as OP/TC when the application of the Profit Level Indicator on the total cost is proper and not on the payments made to the Associated enterprises?".

2. Facts leading to filing of this appeal briefly

stated are that the respondent provides its technical

consultancy services to third parties and operate as

entrepreneur. The business of providing technical

consultancy services is an independent business

segment. The parent company of the assessee is EDS

Sweden and another Swedish company i.e., SKF AB had

entered into a Master Service Agreement. As per the

aforesaid agreement, EDS entities across the globe had

to provide IT services to SKF entities in their respective

regions. In pursuance of the Master Service Agreement,

the assessee entered into a local / domestic contract

with SKF India for providing IT services. The assessee

bears all the entrepreneurial risks associated with the

contract with SKF India.

3. Apart from SKF India, the assessee also

entered into various other contracts with other third

parties for rendering technical services. The revenue

from the technical consultancy services segment of the

assessee is thus derived from a number of contracts

including SKF India, which have been entered by the

respondent globally and locally. Although, the technical

consultancy services segment made a loss of 14.76%,

the respondent was able to bifurcate the revenues and

costs on the basis of SKF and non SKF contracts and

profitability of the technical consultancy segment from

SKF contract and non SKF contract was -103% and 36%

respectively. Thus, the technical consultancy service

segment was profitable segment, whereas, SKF contract

was loss making contract. The respondent also availed

of certain assistance of its group entities across the

globe and one such entity was EDS Singapore, for which

assessee had paid cost plus 10% mark-up, which was

used by non Indian EDS entities globally. The aforesaid

payment was made by EDS India to EDS Singapore,

which includes the cost of services of all other segments

of EDS India as well and does not pertain to technical

consultancy segment alone.

4. The assessee claimed the benefit of deduction

under Section 10A (of Income Tax Act, 1961) in respect of profits derived

from export of software STP Units and claimed deduction

under Section 80HHE (of Income Tax Act, 1961) in respect of profits derived from

export of computer software available to any entity.

However, the Transfer Pricing Officer by order dated -

06.05.2006 considered the loss of 14.76% in the entire

technical consultancy services agreement and was of

the view that since, independent parties had an average

margin of 17.02% therefore, there ought to be an

adjustment. Thus, an adjustment of Rs.7,91,44,777/-

was made. Thereafter, the Assessing Officer by an order

dated 26.12.2006 under Section 143(3) (of Income Tax Act, 1961)

assessed the income at Rs.33,98,72,603/- after making

disallowances with regard to addition on account of

income from other sources, addition on account of

foreign exchange loss and addition on account of Arms

Length Price (ALP).

5. The assessee thereupon filed an appeal

before the Commissioner of Income Tax (Appeals) who

by an order dated 21.01.2009 inter alia held that

respondent has earned a profit in technical service

segment in contracts other than contracts with SKF

India, the Transfer Pricing Officer (TPO) should not have

loaded the mark-up on the costs / expenses in meeting

the obligations other than the contracts with SKF India,

on which the assessee had earned 36% profits.

Accordingly, the Commissioner of Income Tax (Appeals)

reduced the Transfer Pricing Adjustment from

Rs.7,91,44,777/- to Rs.1,29,43,376/- by meeting the

adjustment to SKF contract. Being aggrieved, the

assessee as well as the revenue filed appeals before the

Income Tax Appellate Tribunal (hereinafter referred to

as 'the tribunal' for short). In order to bring the quietus

to the controversy, the assessee did not prosecute its

appeal, whereas, the tribunal by an order dated

23.06.2015 dismissed the appeal preferred by the

revenue. In the aforesaid factual background, this

appeal has been filed.

6. Learned counsel for the revenue submitted

that the Transfer Pricing Officer/ has adopted

transaction net method or bench marking cost as the

profit level indicator and the Commissioner of Income

Tax (Appeals) has confirmed the aforesaid finding of the

Transfer Pricing Officer. It is submitted that having

concurred with the finding recorded by the Transfer

Pricing Officer on the method adopted by him, the

Commissioner of Income Tax (Appeals) ought to have

held that the adjustment has to be restricted to SKF

contracts, which has made losses and by adopting

transaction net margin method, the profit margin of

17.02% ought to have been applied on the total cost of

Rs.17,11,64,696/- and therefore, mistake in

computation of the adjustment in the order of the

Commissioner of Income Tax needs to be corrected. It is

also submitted that the Transfer Pricing Officer had

adopted a method in accordance with Section 92 (of Income Tax Act, 1961) read

with Rule 10B of the Income Tax Rules, 1962 and therefore, re-computation

of Arms Length Price made by Commissioner of Income

Tax (Appeals) and the tribunal is not correct. It is

further submitted that the tribunal has failed to assign

any reasons for disturbing the findings of Transfer

Pricing Officer that arithmetic mean of 17.02% of the

comparables determined for Arms Length Price

computation is erroneous.

7. On the other hand, learned counsel for the

assessee submitted that only the revenues from the

contract entered into between the assessee and SKF

India if at all could be subjected to Arms Length Price

test which has been held by the Commissioner of

Income Tax (Appeals) as well as by the tribunal. It is

further submitted that making an adjustment to the

entire segment merely because transactional net margin

method is applied would lead to unintended

consequences which would give rise to unnecessary load

being created on a segment which is otherwise

profitable. It is further submitted that where there are

no international transactions or where the price of

international transaction is already at arms length no

adjustment can be made. It is further submitted that the

revenue has neither challenged the findings of the

tribunal as being perverse nor has brought any material

on record to demonstrate perversity. Therefore, in view

of concurrent findings of fact recorded by the tribunal no

substantial question of law arises for consideration. In

support of aforesaid submissions, reliance has been

placed on decisions of the Supreme Court in

'SUDARSHAN SILKS & SAREES VS. COMMISSIONER

OF INCOME-TAX', (2008) 169 TAXMAN 321 (SC)

and a decision of this court in PCIT AND ANOTHER

VS. SAMSUNG R & D INSTITUTE BANGALORE PVT.

LTD. I.T.A.NO.622/2017 DATED 30.11.2020.

8. We have considered the submissions made

by learned counsel for the parties and have perused the

record. Section 92(1) (of Income Tax Act, 1961) provides that any

income arising from an international transaction shall be

computed having regard to Arms Length Price. Section

92B(1) deals with meaning of international transaction,

which means a transaction between two or more

associated enterprises either or both of whom are non

residents in the nature of purchase, sale or lease of

tangible or intangible property or provisions of services

or rendering or borrowing money. Section 92C (of Income Tax Act, 1961)

deals with computation of Arms Length Price. The

Commissioner of Income Tax (Appeals) has recorded a

finding that since the assessee had earned profit in a

technical service segment in contracts other than

contracts with SKF and therefore, the Transfer Pricing

Officer should not have loaded the mark-up on the costs

/ expenses incurred in meeting the obligations under

contracts other than the contracts with SKF on which the

assessee had earned a profit of 36% on operating cost.

The aforesaid finding of fact has been affirmed in appeal

by the tribunal. The aforesaid findings are findings of

fact, which have been arrived at by the Commissioner of

Income Tax (Appeals) as well as the tribunal on the

basis of meticulous appreciation of evidence on record.

9. It is the cardinal principle of law that tribunal

is fact finding authority and a decision on facts on the

tribunal can be gone into by the High Court only if a

question has been referred to it, which says the finding

of the tribunal is perverse. [SEE: ‘SUDARSHAN SILKS

& SAREES VS. CIT’, 300 ITR 205 SCC @ 211 and

‘MANGALORE GANESH BEEDI WORKS VS. CIT’, 378

ITR 640 (SC) @ 648]. It is pertinent to note that even

in the substantial question of law, no element of

perversity is either pleaded or demonstrated before this

court.

In view of preceding analysis, the substantial

question of law framed by a bench of this court is

answered against the revenue and in favour of the

assessee. In the result, we do not find any merit in this

appeal, the same fails and is hereby dismissed.

Sd/-

JUDGE

Sd/-

JUDGE