I-T tribunal sends back Microsoft transfer pricing case to tax officer

An income tax (I-T) tribunal has asked the assessing officer to again do the calculation for transfer pricing adjustments to the taxable income of Microsoft India (R&D) Ltd, which renders software development services to group companies.


The ruling will have a repercussion on entities set up by pharmaceutical and information technology (IT) companies in India for taking advantage of the large pool of skilled personnel in the country, experts say.


Explaining the case, Gopal Bohra, partner at N A Shah Associates, said the assessing officer had made an addition of over Rs 2 billion in the taxable income of Microsoft India, a subsidiary of Microsoft Ireland Research Ltd — the ultimate parent company is Microsoft Corporation of the US — for assessment year 2011-12.  The company's taxable income was reported at Rs 10.72 billion that year.


The addition was later reduced to Rs 1.97 billion, after the dispute resolution panel asked the officer to do so. The matter reached the I-T appellate tribunal (ITAT) in Delhi, via appeals from both the assesses and the revenue department.


Microsoft India contended its international transactions in software development services primarily comprised two things — contract services and internal IT support. It was, it said, engaged in writing and testing of codes under the direction of MS Corporation, USA, requiring comparatively low levels of expertise and skills. And, such services were rendered for only specific functions or modules within a product, not for the whole product, which activity was done by the US-based parent.


It further stated there were a couple of minor products, like BizTalk and Data Protection Manager, for which it provided significantly more product engineering and design work services. In doing so, the claim went, it did not deal with any other aspect of product development, such as market research. And, nor did it make any decision regarding which products were to be developed. In sum, said Bohra, it was a low-end software service provider, went the argument.


The company arrived at the total income by calculating value of services provided to group companies at cost plus 15 per cent.


The company adopted third-party comparables of 27 companies, including Infosysm which have an average margin of 9.5 per cent for similar services.


However, the tax official felt a 15 per cent margin mark-up for such services were not justified and Microsoft India should have been remunerated at a higher margin. The officer rejected all third-party comparables, except those given for Persistent Software, and added three others. Based on some such comparable companies engaged in high-end software development services, the I-T department made additions to the income of the assessee.


ITAT has rejected all the comparables suggested by the assessing officer. It said additions must be made on the basis of the margins of Mindree Ltd. The issue is that the margins are adjusted at the level of plus or minus three per cent if there are at least two comparables. If there is only one, the margin here has to be taken. If this comes to be less than 15 per cent, it would help Microsoft in its tax calculation but if not, it would help the revenue department, Shah explained.

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