High Court partially allows appeals for AY 2005-06 & 2007-08, emphasizes proper evaluation and natural justice principles.

The appeals for both assessment years were partly allowed for statistical purposes. The High Court's decision for AY 2005-06, determining the appellant was not engaged in core R&D, was crucial. Working capital adjustment was remanded for verification. For AY 2007-08, some grounds were not pressed, with similar issues as AY 2006-07, resulting in a comparable outcome. The order stressed proper evaluation of appellant's submissions and adherence to natural justice principles.

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Issues Involved:
1. Confirmation of draft order by DRP and AO.
2. Rejection of Cost Plus Method and application of TNMM.
3. Computation of net profit margin using TNMM.
4. Determination of Arm’s Length Price (ALP) using inappropriate comparables.
5. Steps followed by TPO in identifying comparable companies.
6. Lack of a speaking order by DRP.
7. Opportunity to contest selection of comparables.
8. Creation of Intellectual Property Rights (IPR) by market research and testing activities.
9. Risk profile assessment of the appellant.
10. Flawed analysis by TPO to determine ALP.
11. Miscalculation of operating margin of comparable companies.
12. Compliance with arm’s length standard after removing mistakes.
13. Consideration of information submitted by appellant.
14. Evaluation of TNMM method.
15. Consideration of new set of comparables.
16. Working capital adjustment and risk adjustment.
17. Application of 5% variation in determining ALP.
18. Denial of natural justice by not providing opportunity of being heard.

Detailed Analysis:

1. Confirmation of Draft Order by DRP and AO:
The appellant contested the confirmation of the draft order by the DRP and AO, which upheld the order issued under Section 92CA(3) by the TPO. The DRP’s decision to uphold the draft order without sufficient reasoning was challenged.

2. Rejection of Cost Plus Method and Application of TNMM:
The DRP/AO erred by not providing reasons for rejecting the Cost Plus Method identified by the appellant and instead applying the TNMM for market research and testing services. This issue was significant as it affected the determination of ALP.

3. Computation of Net Profit Margin Using TNMM:
The appellant argued that the DRP/AO erred in computing the net profit margin based on TNMM, which was not justified given the nature of the services provided.

4. Determination of ALP Using Inappropriate Comparables:
The DRP/AO used a set of companies engaged in different lines of business and misconstrued the actual nature of the services provided by the appellant, leading to an incorrect determination of ALP.

5. Steps Followed by TPO in Identifying Comparable Companies:
The appellant contended that the TPO did not follow the required steps in identifying comparable companies, including visiting the public database, using appropriate filters, and conducting a proper Functions, Assets & Risks (FAR) analysis.

6. Lack of a Speaking Order by DRP:
The DRP failed to pass a speaking order, which is necessary to justify the decisions made regarding the ALP and the methods used.

7. Opportunity to Contest Selection of Comparables:
The appellant was not given an opportunity to contest the selection of comparables during the transfer pricing assessment proceedings, which is a violation of natural justice.

8. Creation of IPR by Market Research and Testing Activities:
The DRP/AO incorrectly stated that the appellant’s market research and testing activities led to the creation of IPR, patents, copyrights, and trademarks, which was not the case.

9. Risk Profile Assessment of the Appellant:
The DRP/AO assumed that the appellant undertook substantial risk while rendering services, contrary to the fact that all expenses were reimbursed with a markup, indicating a "No Risk" status.

10. Flawed Analysis by TPO to Determine ALP:
The TPO’s analysis to determine the ALP was flawed as it compared the appellant to companies with insignificant research and development revenues.

11. Miscalculation of Operating Margin of Comparable Companies:
The appellant highlighted that the TPO grossly miscalculated the operating margin of comparable companies, affecting the determination of ALP.

12. Compliance with Arm’s Length Standard After Removing Mistakes:
The appellant argued that after correcting the mistakes in the margin computation, the international transactions would comply with the arm’s length standard.

13. Consideration of Information Submitted by Appellant:
The DRP did not give due cognizance to the information submitted by the appellant regarding the FAR analysis, which was crucial for the assessment.

14. Evaluation of TNMM Method:
The DRP failed to evaluate the rejection or acceptance of the TNMM method used by the appellant as a secondary choice for establishing the arm’s length nature of the services.

15. Consideration of New Set of Comparables:
The DRP did not consider the new set of appropriate comparable companies submitted by the appellant, which could have affected the determination of ALP.

16. Working Capital Adjustment and Risk Adjustment:
The DRP/AO did not allow any adjustment for working capital and risk, which was necessary for establishing the arm’s length nature of the international transaction.

17. Application of 5% Variation in Determining ALP:
The DRP erred by not directing the TPO to allow a 5% variation in determining the ALP, as the amended proviso to Section 92C was not applicable to the assessment year in question.

18. Denial of Natural Justice:
The appellant was denied natural justice as the DRP/AO did not provide an opportunity of being heard on critical matters, leading to an adverse conclusion against the appellant.

Conclusion:
The appeals for both assessment years were partly allowed for statistical purposes. The Hon’ble High Court’s decision for AY 2005-06, which concluded that the appellant was not involved in core R&D activity, was pivotal in the judgment. The issue of working capital adjustment was remanded back to the TPO/AO for verification. For AY 2007-08, certain grounds were not pressed, and the remaining issues were similar to AY 2006-07, leading to a similar outcome. The order emphasized the need for proper evaluation and consideration of the appellant’s submissions and adherence to natural justice principles.

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