Circumstances in which the Profit Split Method (PSM) has to be preferred over the TNMM for determining the ALP and method of allocation of profits between the assessee and the AE under the PSM explained
Aug 27, 2015
The Tribunal had to consider whether the most appropriate method is the Profit Split Method (PSM) as claimed by the assessee or the TNMM as claimed by the AO, while working out the Arm’s length value in respect of international transactions between Infogain India i.e. assessee and Infogain US i.e. parent company. HELD by the Tribunal:
(i) Rule 10B(1)(d) of the Income Tax Rules, 1962, defines the Profit Split Method. From the provisions contained in the said Rule 10B(1)(d), it is clear that “PSM” may be applicable in case where transaction involved transfer of unique, intangibles or any multiple transactions interrelated international transactions which cannot be evaluated separately for determining the Arm’s Length Price of any one transaction. The Profit Split Method (PSM) first identifies the profit to be split for the associated enterprise from the controlled transactions in which the AEs are engaged. It then splits these profits between the AEs on an economically valid basis that approximates the division of the profit that would have been anticipated and reflected in an agreement, transaction or a residual profit intended to represent the profit that cannot readily be assigned to one of the parties. The contribution of each enterprise is based upon a functional analysis and valued to the extent possible by any available reliable standard market data. The functional analysis is an analysis of the functions performed (taking into account assets used and risk assumed) by each enterprise (Aztech Software and Technology Ltd. Vs ACIT 107 ITD 147 (SB) and Global One India Pvt. Ltd. Vs ACIT in ITA No. 5571/Del/2011 referred);
(ii) A perusal of the function of the assessee company reveals that the international transactions are highly integrated and interrelated and both the entities are contributing significantly to the value chain of provision of software services to the end customers. The Global Delivery Organization Group (GDO) in India is responsible for delivery of services to the customers globally. The primary objective of the group is to bring synergies amongst geographic groups and project, to make efficient use of the available resources, to broaden areas of service offerings, to improve opportunity fulfillment ration, and to maximize customer satisfaction with each project execution. However, the TPO had not considered the role of the GDO. The assessee assigned weights to each activity keeping in view the relative importance in the entire value chain, based on interviews with the key management personnel and the functions in the value chain of software services provided by the Infogain Group to the customers based in the US were identified and weights were assigned to the functions having regard to their relative importance in the value chain. Both the parties i.e. Infogain India (assessee) and Infogain US are making contribution. Therefore, the Profit Split Method is the most appropriate method for determination of ALP. The decision as what is the most appropriate method does not depend on the fact as to whether an assessee is having loss or has a profit.
(iii) On the question as how the allocation is to be done for residuary profits under the Profit Split Method, it is well settled that as per the Rule 10D, the benchmarking should be done with the external uncontrolled transactions, however, in the present case, it is not possible to get a comparable. Therefore, such allocation can be done on the basis that how much each independent enterprise might have contributed. Therefore, relative contribution has to be determined, based on key value drivers because benchmarking is not practicable. In the present case, as the comparables having similar transactions would be difficult to find out, therefore, in such a situation, a harmonious interpretation of the provisions is required to make the rule workable, so as to achieve the desired result of the determination of the ALP.
(iv) Both the OECD Transfer Pricing Guidelines as well as the UN draft method of transfer pricing for developing countries, suggest that an allocation of residual profits under PSM should be done, based on contributions by each entity. In the present case, since the department has accepted in the preceding year and the succeeding year 40:60 ratio between the Infogain India and Infogain US and if the facts are similar for the year under consideration then no deviation is to be done.