The Income Tax Appellate Tribunal (ITAT), New Delhi, ruled that where the taxpayer, a limited risk distributor, had conducted distribution and after-sales customer services that were inextricably linked, then segmenting trading and service activities with revenue-based allocation for arm’s length price (ALP) was impermissible.
The Tribunal referred to the identification of the performance obligations in the contract, which says that the ”Product performance obligations include hardware and software licenses, and service performance obligations include maintenance, software post-contract, training and professional services. Certain software licenses and related post-contract support are combined into a single performance obligation when the maintenance updates are critical to the continued functionality of the software”.
The Tribunal found that just because the appellant is involved in the trading of the products supplied by the AEs and also has a service facility, the tax authorities divided its business into two segments and reworked the segmental results by allocation based on the revenue factor. They have completely overlooked the fact that the core business is trading and the customer services are interconnected to it.
The Tribunal explained that the trading results have to be benchmarked when the trading is complete, as soon as the products are sold to the Indian customers, whereas it is interconnected with the after-sales customer services as defined in the mutual agreement. Merely because the appellant has the facility to provide customer services, it cannot be segregated without analysing the key functions that are interdependent on each other.
The Division Bench comprising Yogesh Kumar U.S. (Judicial Member) and S. Rifaur Rahman (Accountant Member) observed that the core business of the appellant was trading and customer services, which were interconnected to it and most of the customer services were provided with the assistance of Associated Enterprises (AEs) abroad.
Thus, simply because the appellant had the facility to provide customer services, it could not be segregated without analysing key functions which were interdependent on each other, as the sole existence of the appellant depended upon trading activities, without which there was no business for the service segment.
The Bench therefore concluded that since trading and customer service activities of the appellant were closely linked, the benchmarking should be undertaken under the TNMM at the entity level and, thus, TPO/DRP’s segregation of trading and service segments and revenue-based allocation of costs for ALP determination was impermissible.
Briefly, the appellant, a limited risk distributor for its Associated Enterprise (AE), was engaged in distribution, sales, marketing and customer support services of networking equipment and software embedded therein. It imported equipment and spares from its AE for onward sale in India and also undertook merchant trading transactions. In the course of the transfer pricing assessment, the TPO recorded that the appellant had carried on trading and, in a second limb, maintenance/warranty services in India. He therefore opined these functions to be different, carved out a trading segment, and allocated employee and other common expenses based on revenue share. Finally, he proposed an Arms’ Length Price (ALP) adjustment of about Rs. 16.87 crores.
Appearances:
Senior Advocate Sachit Jolly, Advocate Sandeep Bhalla, and CA Anurag Singhal, for the Appellant/ Taxpayer
CIT S.K. Jadhav, for the Respondent/ Revenue
