Provision of software service and marketing support service as per order passed under section 92CA(3) read with section 144C(5) of the Act

IN THE INCOME TAX APPELLATE TRIBUNAL

DELHI BENCH “I” NEW DELHI

BEFORE SHRI R.P. TOLANI AND SHRI SHAMIM YAHYA

ITA No. 5420/Del/2011 & 6057/Del/2012

A.Yrs. 2007-08 & 2008-09

Hughes Systique India Pvt. Ltd.

1, Shivaji Marg, Westend Green,

NH-8, New Delhi-110038.

PAN: AACB 6600 N

(Appellant)

Vs.

ACIT, Circle 12(1),

New Delhi.

 (Respondent)

Appellant by: Shri Ajay Vohra Adv.

Shri Abhishek Agarwal CA

Shri Ramit Katyal CA

Respondent by: Shri Peeyush Jain CIT(DR) TP

O R D E R

PER R.P. TOLANI, J.M::

These are assessee’s appeals against assessment orders dated 31.10.2011 for A.Y. 2007-08 and dated 19.10.2012 for A.Y. 2008- 09.passed by the assessing officer u/s 143(3) after seeking directions from DRP u/s 144C(13) of the Income-tax Act, 1961 (“the Act”). Both the appeals are heard together and disposed of by this common order for the sake of convenience.

2. The principal grounds of appeal, common in both the years under consideration, raised by the appellant are as under; others being supplementary and argumentative grounds are not pressed hence dismissed.

2. That the assessing officer erred on facts and in law in making an addition of Rs. 129,356,670/- (A.Y. 2007-08) & Rs. 17,28,83,745/- (A.Y. 2008-09) on account of the alleged

difference in the arm’s length price of the ‘international transaction’ of (i) provision of software services, and (ii) marketing support services, on the basis of the order passed under section 92CA(3) read with section 144C(5) of the Act by the Transfer Pricing Officer (“the TPO”).

2.1. That the assessing officer / DRP erred on facts and in law in disregarding the internal benchmarking undertaken by the assessee for determining the arm’s length price of the international transactions applying TNMM on the ground that (i) the transactions undertaken with unrelated party at 20.60% of the total revenue, is lower than the quantum of transaction undertaken with associated enterprises, hence, it does not provide a robust measure of comparability, and (ii) internal benchmarking was adopted to gloss over the entity level loss.

2.2. That the assessing officer/DRP erred on facts and in law in evaluating the international transactions applying TNMM at entity level by comparing the net operating profit margin of the assessee with uncontrolled net operating profit margin of comparable uncontrolled enterprises.

3. That the assessing officer/DRP erred on facts and in law in holding the arms length price of the international transactions of payment of market support services fees (‘MSF’) of Rs. 9,12,80,860/- (A.Y. 2007-08) and Rs. 7,70,11,732/- (A.Y. 2008-09) at nil allegedly concluding that no such service has been received by the and therefore there is no rationale for paying this marketing support services fees to the AE.

4. That the assessing officer erred on facts and in law restricting depreciation on computer peripherals @ 15% as against 60% claimed by the assessee, without appreciating that UPS could not work without computers and such machines are a part of computer system and not plant and machinery.

5. That the assessing officer erred on facts and in law in levying interest under Section 234B and Section 234C of the Act.

3. Brief facts about grounds of appeals are:

The appellant has challenged before us Transfer Pricing adjustment made by the TPO and sustained by the Dispute Resolution Panel (“DRP”) on account of (I) international transaction of provision of software development services; and (II) international transaction of payment of fee for marketing support services to the associated enterprise.

(I) Transfer Pricing adjustment in respect of the international transactions of software development services:

3.1. The appellant, Hughes Systique India Pvt. Ltd., is as subsidiary company of Hughes Systique Mauritius Private Limited and is engage in the business of providing software engineering services in the telecom domain with areas of focus being broadband, satellite communications, wireless, multimedia applications, etc. During the previous year, relevant to assessment years 2007-08 and 2008-09 the appellant, in the course of its business, entered into international transaction of rendering of software development services with its associated enterprise, viz., Hughes Network Systems, USA.

3.2. This international transaction of rendering of software development services to the associated enterprise was reported to be at arm’s length in the following manner by the appellant:

(i) Benchmarking of international transaction of software development services applying TNMM considering internal comparables.

3.3. Besides undertaking software development for the associated enterprise, viz., Hughes Network Systems Inc., USA, the appellant also entered into direct contracts with other unrelated party customers during the relevant previous years. Since an internal comparables were available for benchmarking the international transactions of provision of software design and development services, the appellant applied Transactional Net Margin Method (“TNMM”) as the most appropriate method and considered internal comparables for applying TNMM. The result of the benchmarking analysis, as aforesaid, is tabulated as under:

Onsite software development services 7.55% -9.29%

Offshore software development services -50.81% -56.73%

3.4. In respect of the international transactions of rendering onsite software development services to the associated enterprise, the appellant earned operating profit margin (OP/TC) of 7.55%, the average operating profit margin of (-) 9.29% earned on similar transactions with unrelated parties, such international transactions were considered to be at arm’s length.

3.5. While rendering offshore software development services to the AE, the appellant earned operating profit margin (OP/TC) of (-) 50.81% as against average operating profit margin of (-) 56.37% on similar transactions with unrelated third parties. Accordingly, the international transaction of provision of software design and development services onsite and also offshore was considered to be at arm’s length price.

(ii) Benchmarking of international transaction of software development services applying TNMM with external comparables

3.6. For the purpose of applying TNMM, the appellant by written submissions filed with the TPO, external comparables and the operating profit margin (Operating Profit/Operating Cost ratio) of the appellant on international transactions entered into with AE (i.e. on controlled transaction) was alternatively benchmarked with the operating profit margin (Operating Profit/Operating Cost ratio) of the comparable companies. After considering the various selection criteria, comparable companies were identified as functionally comparable to the operations of the appellant.

3.7. The operating profit ratio of the appellant from controlled transactions, i.e., 13.26% (after considering adjustment on account of idle capacity) being higher than the average of operating profit margin of the comparable companies at 6.48%, the international transaction was even otherwise demonstrated to be at arm’s length and no adjustment was required to be made.

(iii) Benchmarking of international transaction of software development services applying internal CUP method.

3.8. The assessee also justified the international transaction of onsite software development services rendered to associated enterprise being at arm’s length, applying CUP. It was contended that while providing onsite services, the appellant has charged $11,000 per month from its associated enterprise, viz, Hughes Network Systems as against $8000 - $9,000 per month charged from unrelated party, namely, Nokia Siemens Networks, Oy. Since the price charged from associated enterprise for providing onsite software development services was higher than the price charged from unrelated party, such international transaction of rendering of onsite software development services were to be considered being at arms length price

TPO’s/DRP’s orders:

3.9. The TPO in his report disregarded the internal benchmarking analysis undertaken by the appellant applying Transactional Net Margin Method (“TNMM”), holding that transactions with unrelated party constituted minor share of 20.30% of the total transactions and, therefore, did not provide a robust measure of comparability and further, internal benchmarking was adopted by the appellant to gloss over entity level loss.

3.10. The Dispute Resolution Panel (DRP), affirming the conclusions of the TPO, held that “in view of DRP, internal comparables can be used

Please check the full judgment in the attached file.