Captive service provider cannot be compared with Infosys

Court : Delhi bench of the Income-tax Appellate Tribunal

Brief : ITAT Delhi held that a captive service provider assuming minimal risks, cannot be compared to a large company like Infosys Technologies Limited which assumes all risks leading to greater rewards.

Citation : Agnity India Technologies Private Limited Vs. ITO (ITA No. 3856(Del)/ 2010)

Facts of the case

The taxpayer is a wholly owned subsidiary of BayPackets Inc., USA and is engaged in the business of software development in the field of telecommunication for its parent company. The taxpayer also enjoys a tax holiday.

The taxpayer operating at a net profit margin of 17 percent over costs, identified 23 comparables in the TP documentation resulting in arm’s length net profit margin of 10 percent over costs.

The Transfer Pricing Officer (TPO) rejected few comparables identified by the taxpayer on the basis of functional dissimilarity and wages/ sales ratio. The TPO also included Infosys Technologies Limited (Infosys) and Satyam Computers Services Ltd. (Satyam) as comparables and thereby determined the arms length net profit margin at 27.08 percent over costs.

On objections raised by the taxpayer before the Dispute Resolution Panel (DRP), Satyam was excluded by the DRP since the data available was not reliable. However, Infosys was retained, leading to an arm’s length net profit margin of 25.6 percent over costs.

Against the order of the assessing officer, an appeal was filed by the taxpayer to the Income Tax Appellate Tribunal (the Tribunal).

Tribunal’s Ruling

The Tribunal ruled in favor of the taxpayer. The key aspects of Tribunal’s order are summarised below:

The Tribunal held that the taxpayer was not comparable to Infosys Technologies Limited since Infosys is a giant in the area of development of software and assumes all risks, leading to higher profit as compared to the taxpayer which is a captive unit and assumes only limited currency risks.

The Tribunal also referred to other reasons given by the taxpayer for establishing that Infosys was not comparable to the taxpayer, including:

Infosys renders diversified services as compared to the taxpayer which is only rendering software development services

Vast difference in turnover/capital of Infosys and of the taxpayer

Infosys owns proprietary products as compared to none owned by the taxpayer

Infosys renders onshore and offshore services equally as

compared to taxpayer which only renders offshore services

Infosys incurs a substantial expenditure on advertising/ sales promotion and research & development which are not incurred by the taxpayer

After exclusion of Infosys, the arms length net profit margin based on rest of the comparable companies was found to be consistent with the net profit margin of the taxpayer.

The Ruling emphasises that a pigmy enterprise cannot be compared with a giant company and that functions, assets and risks analysis is critical to comparability.