ITAT Mumbai Orders Fresh TP Benchmarking Using Foreign AE as Tested Party — Tech Mahindra Pvt. Ltd. vs. DCIT

Case Overview

The Mumbai Bench "J" of the Income Tax Appellate Tribunal adjudicated cross appeals for Assessment Year 2008-09 arising from the order dated 14.02.2014 passed under Section 250 of the Income-tax Act, 1961 by the CIT(A)-IV, Bangalore. The case involved Tech Mahindra Pvt. Ltd. — formerly operating as Tech Mahindra R&D Services Ltd. — and the Revenue, with both parties raising grievances against the appellate order of the Commissioner of Income Tax (Appeals).

The proceedings covered four principal disputes: a transfer pricing adjustment of Rs. 9,95,09,950, a disallowance of custom duty amounting to Rs. 11,78,884, a disallowance under Section 14A of Rs. 8,78,823, and a disallowance of foreign exchange loss of Rs. 47,97,489. On its part, the Revenue contested the CIT(A)'s approach toward excluding high-turnover comparable companies from the benchmarking set.

Issue 1: Transfer Pricing Adjustment — Selection of Tested Party

Background and Assessee's Position

The assessee was engaged in telecom software development services and hardware solutions for telecom equipment manufacturers, carriers and service providers. During the relevant financial year, the assessee made payment of Rs. 25,80,52,805 to its wholly owned subsidiary in the USA — its associated enterprise — for on-site software development and offshore support services.

For benchmarking this international transaction, the assessee applied the Transactional Net Margin Method (TNMM) with net cost plus markup as the Profit Level Indicator (PLI). Crucially, the assessee designated its US-based associated enterprise as the tested party, reasoning that the AE was functionally less complex than the assessee itself. A search on international databases identified 11 US-based comparable companies, which reflected a three-year weighted average margin of 7.13%. Since the associated enterprise computed its own PLI at 6.16%, the assessee claimed the international transaction was priced at arm's length.

TPO's Rejection and Adjustment

The Transfer Pricing Officer, vide order dated 31/10/2011 under Section 92CA(3) of the Income-tax Act, 1961, rejected the assessee's benchmarking methodology entirely. The TPO:

• Substituted the assessee itself as the tested party in place of the foreign AE
• Searched for and selected 20 Indian comparable companies with an average margin of 23.65%
• Granted a working capital adjustment, arriving at an arm's length mean margin of 17.97%
• Made a transfer pricing adjustment of Rs. 9,95,09,950

The Assessing Officer passed the assessment order under Section 143(3) read with Section 144C. In appeal, the CIT(A) upheld the TPO's approach primarily on the ground that the COMPUSTAT database used by the assessee was unavailable to the TPO in India, making it impracticable to verify the assessee's benchmarking. The CIT(A) also noted that the assessee had used multi-year data without demonstrating its relevance to the current year.

Functional, Asset and Risk Analysis by the Tribunal

The Tribunal undertook a detailed examination of the functions performed, assets employed, and risks assumed by each of the two entities.

**Functions of the assessee (TMRDS India)😗*

• Development of toll tandem switching system software supporting Class IV services
• Access product software development, customer support, verification and validation
• Cellular switch software development
• Wide Band Digital Cross Connect (Transmission) Switch development
• Adjunct Element Software Development for Telecom Network Elements
• Signal Transfer Point (STP) development for Telecom Signaling Network