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Meaning of Tested Party
Tested party means the entity whose profit margin is taken up for comparison. Therefore, tested party would be the entity on which most appropriate method out of the methods as specified under section 92C of the Income Tax Act, 1961 would be applied.
In other words, tested party is the one on which various provisions relating to transfer pricing would be made applicable.
Selection of Tested Party
Determination of tested party is very crucial and such selection has always been a matter of dispute as Indian Income Tax Law is silent on determination of tested party.
However, Organisation for Economic Co-Operation and Development (OECD) Guidelines and UN Manual provide detailed analysis on selection of tested party. As per OECD guidelines and UN manual, tested party shall be one having following attributes :-
On the analysis of above mentioned attributes regarding tested party, it can be concluded that tested party can either be Indian entity or Associated entity outside India depending upon the case. Therefore, there is no specific condition that tested party shall always be an Indian entity.
In support of the above drawn conclusion, following judgements has been provided :-
In the case of General Motors India (P.) Ltd. v. Dy. CIT/Asstt. CIT  37 taxmann.com 403/ 146 ITD 559 (Ahd. - Trib.), the ITAT bench of Ahmedabad has held that tested party should be the least complex entity for which reliable data in respect of itself and in respect of comparables is available. The Tribunal accepted that tested party could be the local entity or a foreign associated enterprise (AE), and upheld selection of foreign AE as tested party in the instant case. It also implicitly held that tested party should be determined based on the international transaction rather than the entities as a whole. Further, it re-emphasizes the importance of detailed FAR (functions, assets and risks) analysis to determine the least complex entity.
The brief facts of the case are as under :
The Ahemdabad ITAT pronounced its judgment in favor of GMILPL by concluding that,
Another decision of Tribunal which affirms that foreign entity can be treated as tested party. The decision is delivered by the Chandigarh bench of the ITAT in the case of IDS Infotech Ltd. v. Dy.CIT  69 taxmann.com 393.
In the facts of the case, while the assessee chose its foreign counterpart as a tested party, the only reason for rejecting the foreign AE as the tested party by the department was that no reliable data in respect of foreign comparables was available. The arguments on behalf of the assessee were three fold.
Firstly, the act of the assessee having taken foreign AE as the tested party in the preceding year was accepted by the TPO.
Secondly, it was submitted that while the assessee was engaged in full-fledged product development and marketing/product selling covering a wide range of activities and other commercial or marketing intangibles and is the developer, owner and licensor of virtually all valuable intellectual property rights including proprietary products and processes, whereas it bears all significant business and entrepreneurial risks, product development, performance and financial risks and develops and sells products and services to unrelated parties across the globe, on the other hand the foreign entity, indulged only in the activity of providing marketing support services to the assessee for the American market and took only routine risks associated with undertaking such activities without owning any intellectual property. Thus it was the least complex of the two entities in the transactions.
Thirdly, the entire process of selecting the comparables in relation to the foreign tested party and the data base used was duly disclosed in transfer pricing report and all information pertaining to the comparables was also furnished in the report.
After analyzing the rival submissions and giving a specific finding of fact that the data picked up by the assessee was available in the public domain and detailed search mechanism was explained to the TPO, the Hon'ble Bench rejected the contention of the department that the foreign AE cannot be a tested party.