Per hour billing rate published by NASSCOM for a specific business segment as an external CUP in determining the arm’s length price

Facts :-The Mumbai bench of the Income Tax Appellate Tribunal (ITAT) has recently pronounced its ruling on an appeal originating from a transfer pricing adjustment imposed on 3 Global Services Private Limited (“assessee”). The assessee operates in the voice based customer care segment within the IT-enabled services (ITeS) industry. During financial year 2003-04, the assessee rendered services to its associated enterprises (“AEs”). The Comparable Uncontrolled Price (CUP) method was selected as the most appropriate method to justify the arm’s length result of transactions with its AE. In order to apply the CUP method, the assessee relied on hourly rates of “Customer Care” segment as published by NASSCOM and a report prepared by M/s Batliwala & Karani Securities Pvt. Ltd.

During the course of assessment proceedings, the transfer pricing officer (TPO) rejected the CUP method selected by the assessee and chose the Transactional Net Margin Method (TNMM) as the most appropriate method for evaluating the international transaction. The TPO selected five companies for comparability purposes which operate in various segments, viz, KPO, content development, data conversion, software etc. These segments differ in essence from the voice based customer care segment to which the assessee belongs. The TPO computed the average margin of five companies at 6.28% resulting in an upward adjustment of Rs 6.73 crore to the income of the assessee. The AO passed the final order in conformity with the order of the TPO.

Proceedings before CIT(A)

Aggrieved by the order of the TPO/AO, the assessee preferred an appeal before CIT (A). The assessee contended that per hour rate relied upon by it relates specifically to voice-based ITeS services hence are comparable. Further, third-party transactions are priced on the basis of hourly rates and not as a percentage of costs. On the technicalities of the transfer pricing analysis, the assessee appealed that the usage of TNMM as the most appropriate method is not justifiable in view of availability of CUP which has not been rebutted by TPO. Further, the set of companies considered by the TPO/AO for arriving at the at arm’s length price under TNMM are not comparable given functional differences and erroneous margin computation by the TPO.

Ruling of CIT (Appeals)

The CIT (A) upheld the conclusions reached by the assessee and observed:

Per hour rate of customer care segment as reported by NASSCOM is based on actual billing rates offered by a member of independent enterprise and therefore the rate represent the arithmetic average of comparable uncontrolled rates.

Per hour rate of specific companies engaged in voice based services sector, as per Batliwala Karani Securities (I) Pvt. Ltd., ranges between $10 to $13 whereas appellant’s per hour rate is $13.09 which is within the arm’s length rage. Therefore, CUP method is justified in this case

The companies selected by the TPO are functionally different from assessee as these are not from voice?

based BPO services segment. Hence such companies are not comparable while applying the TNMM;

Even if the CUP is not applied, the appellant has generated reasonable amount of profit.

Ruling of the ITAT

Aggrieved by the decision, the revenue appealed before the ITAT, Mumbai Bench. The ITAT passed its order in conformity with the order of the CIT(A) and observed that:

The specific rates provided by the NASSCOM report, are specific to voice-based ITeS services segment under which the assessee falls;

Billing rate per hour of the assessee is in line with the man hour rate prevalent in the industry;

The companies selected by the TPO are not comparable as they operate in a segment different from that of the assessee; and

Computation of the average margin of companies selected by the TPO are incorrect and hence cannot be relied upon

In these circumstances, the CUP method as followed by the assessee is the most appropriate method.

Conclusion

The ruling emphasizes that per hour rate of a specific sub segment of ITeS industry may be considered as CUP provided the assessee applying such rate belongs to the specific sub segment. Further, companies which operate in a different segment of the industry cannot be selected as comparables for application of TNMM.

It is important to bear in mind that in an earlier ruling by Bangalore ITAT in case of Aztec Software & Technology Service Ltd its was held that average per hour rate given by NASSCOM cannot be considered as it is an average of transactions quite different in nature and content than the taxpayer. OECD’s transfer pricing guidelines also asserts that unadjusted industry average rate should not be considered as CUP.

(Source: DCIT Vs. M/s 3 Global Services Pvt. Ltd. ITA No 1812/Mum/09)

International Tax -MAT & Share Transfer

Minimum Alternate Tax (MAT) provisions not applicable to foreign companies if no physical presence in India

The applicant is a company incorporated in the United States and is a leading manufacturer of engineered bearings, alloys etc. The applicant has a significant shareholding in an Indian listed company, which was initially set up as joint venture with Tata Iron and Steel Company. As part of a global restructuring exercise, the applicant proposes to transfer its shareholding in the Indian company to a company incorporated in Mauritius. The proposed transfer would be undertaken on the Bombay Stock Exchange and subject to Security Transaction tax (STT). The shares are held by the applicant for more than 12 months.

Capital gain on transfer of long term equity shares is exempt from tax in India under the Income-tax Act, 1961 (ITA) if STT is paid on the same.

Issue before Authority for Advance Ruling (AAR)

The issue before the AAR is whether MAT provisions are applicable to a foreign company having no physical business presence in India?

Ruling of the AAR

• The AAR distinguished its earlier ruling in the case of P.NO 14 of 1997 (234 ITR 335) wherein it had held that a foreign company would be subject to MAT provisions. The critical factor for distinguishing was on the basis that in the earlier ruling the applicant had a project office in India, which constituted a Permanent Establishment and was preparing its financial statements as required under Indian Companies Act.

• In order to comply with the requirement of MAT provisions regarding preparing Profit & Loss Account in accordance with the provisions of the Indian Companies Act, it is essential that the foreign company should have a place of business within India.

• In the present case, the applicant does not have a place of business in India; hence compliance of preparation of Profit & Loss Account as per the Indian Companies Act could not be possible.

• The MAT provisions are applicable to a company. Under the ITA, Company has inter-alia been defined to include a body corporate incorporated outside India ie foreign company. As per the AAR, the context in which Company is used for MAT provisions should not include a foreign company for the following reasons:

- Income which does not have a source in India cannot be made part of the book profit

- The annual accounts including Profit & Loss Account cannot be prepared in the prescribed manner for the worldwide income and presented before the company in its General Meeting.

- The Finance Minister’s speech and the memorandum explaining the introduction of MAT provisions would become out of sync if the meaning of company for MAT provisions would include a foreign company.

Conclusion:-As per the provisions of the ITA, rulings pronounced by the AAR are applicable only with respect to the applicant. However, there are certain judicial precedents which have held that ruling pronounced by the AAR do have a persuasive value. Accordingly, the aforesaid ruling could potentially come as an aid for foreign companies having no presence in India and are earning passive income from India to argue that MAT provisions are not applicable. For example, this ruling could be beneficial for capital gains made by Foreign Institutional Investors or Private Equity Funds investing in the Indian stock markets or unlisted Indian companies.

Transfer of shares by a foreign company to its wholly owned Indian subsidiary not taxable in India

Praxair Pacific Limited (PPL ), a company incorporated in Mauritius, proposes to transfer its 74% equity stake in Jindal Praxair Oxygen Company Private Limited (JPOCPL) to its wholly owned subsidiary in India, Praxair India Private Limited (Praxair India). The consideration for the proposed transfer is stated to be determined on the basis of cost, unless a higher consideration is required under the pricing guidelines prescribed by the Reserve Bank of India as applicable for transfer of shares.

Issues before the AAR

• Whether the investment held by PPL in equity shares of JPOCPL would be considered as “capital asset” under section 2(14) of the Income-tax Act, 1961 (“ITA”)?

• Whether transfer of JPOCPL from PPL to its wholly owned subsidiary Praxair India would be liable to tax in India in view of the exemption under section 47(iv) of the ITA?

Exemption under section 47(iv) of the ITA is available if the capital asset is transferred by a holding company to its wholly owned Indian subsidiary.

• Whether PPL would be entitled to the benefits of the India – Mauritius Tax Treaty (“Treaty”) and whether the gain arising to PPL would be liable to tax in India having regard to the provisions of Article 13 of the Treaty?

• Whether the gains arising to PPL from the sale of equity shares of JPOCPL would be taxable in India in the absence of Permanent Establishment (“PE”) of PPL in India in light of the provisions of Article 7 read with Article 5 of the Treaty?

• Whether PPL would be liable to Minimum Alternate tax under the ITA?

• Where the gains arising to PPL on account of the proposed transfer is not taxable in India under the Act or the Treaty, whether Praxair India, the transferee company, is required to withhold tax in accordance with the provisions of section 195 of the ITA?

• If the gains are not taxable in India, whether PPL is required to file any return of income of income under section 139 of the ITA? This question was not pressed by PPL.

• Whether the proposed transfer of equity shares by PPL to Praxair India attracts the transfer pricing provisions of section 92 to 92F of the ITA?

Contention of the applicant

• The shares held by PPL in JPOCPL are not held as stock-in-trade but represent investments and thus should be classified as a capital asset.

• As PPL proposes to transfer its equity shareholding in JPOCPL to Praxair India, its wholly owned subsidiary in India, the provisions of section 47(iv) of the ITA are fulfilled. Gains, if any, on the transfer of equity shares in JPOCPL would not be taxable in India.

• PPL would not be liable to tax book profits or Minimum Alternate tax under the ITA as the provisions of section 11 5JB would be applicable only to domestic companies and not to foreign companies.

• The gains from the proposed transfer of shares in JPOCPL by the Applicant would not be taxable in India as capital gains or business income in the light of the treaty.

• In case the proposed gains are not considered as capital gains but as business income, such business income will not be taxable in India since PPL does not have a PE in India.

Observations / Rulings of the AAR

• The shares in JPOCPL have been held as “Non-current assets – investment in subsidiaries” since 1995 and were never a subject matter of any transaction till date. As the shares were not held as stock in trade, the nature of the investment in these shares is held to be a “capital asset” as defined in section 2(14) of the ITA.

• As PPL proposes to transfer its equity share holding in JPOCPL to Praxair India which is its wholly owned subsidiary in India, the conditions under section 47(iv) of the ITA are fulfilled and hence the gains if any arising on transfer would not be taxable in India.

• As PPL is tax resident of Mauritius and has been issued Tax Residency Certificate by the Mauritius Revenue Authority, it would not be subjected to tax in India on the capital gains arising from the proposed transaction in India under the Treaty.

• The annual accounts of the applicant cannot be prepared in accordance with Schedule VI of the Companies Act 1956. The provision under the ITA relating to Book Profits Tax is not designed to be applicable to a foreign company which has no presence or PE in India. The AAR relied on its ruling in the case of Timken USA (AAR 836 of 2009) where it was held that under the Companies Act 1956 only such foreign companies who have established a place of business within India are required to make out a Balance Sheet and Profit and Loss account as required under the said Act.

• Sections 11 5JB of the ITA is not attracted in the case of PPL.

• The transfer pricing provisions of section 92 to 92F of the ITA would not be attracted in the absence of liability to pay tax on the capital gain.

Conclusion:-Gains from the transfer of shares by a Mauritius company to its wholly owned subsidiary in India would not be taxable in India either under the ITA. The AAR has also reiterated the benefit of the India- Mauritius tax treaty would be available to PPL as it had adequate tax residency certificate issued by the Mauritius Revenue Authority. Further, the gains from such transfer would not be subject to Minimum Alternate Tax as the provisions under the ITA governing such tax do not apply to a foreign company that has no presence or PE in India

Source: M/s. Praxair Pacific Limited (A.A.R. No. 855/2009 dated 23 July 2010)