TaxTMI 
TaxTMI 
2008 (9) TMI 466
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....sactions were at arm's length. The assessee filed its return of income for asst. yr. 2003-04 on 28th Nov., 2003 disclosing a total taxable income of Rs. 2,97,86,420. Subsequently, assessment proceedings were initiated under s. 143(3)/143(2) of the IT Act, 1961 and the case of the assessee was also referred to the Addl. Director of IT (Transfer Pricing)-II (the TPO). The TPO passed an order under s. 92CA of the Act, on 15th March, 2006, proposing a transfer pricing adjustment of Rs. 2,21,80,792 after arriving at a mean margin of the comparable companies @ 21.14 per cent. The assessment order under s. 143(3) of the Act was passed on 31st March, 2006 with the following primary adjustments: (a) Reduction in the claim for deduction under s. 10A of the Act to the extent of Rs. 1,31,26,943 and (b) Transfer pricing adjustment of Rs. 22,10,80,792 (as proposed by the TPO in his order dt. 15th March, 2006). Being aggrieved by the assessment order, the assessee appealed before the CIT(A). The CIT(A), vide her order, dt. 25th Jan., 2008, has recomputed the mean margin of the comparable companies at 20.47 per cent and has revised the transfer pricing adjustment to Rs. 20....
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....ort 'the Rules'). The TPO erred in not sharing the fresh comparability analysis conducted by him at the time of assessment and the CIT(A) erred in not commenting on the same in the impugned order. The CIT(A) erred in facts in confirming the rejection of comparable companies selected by the appellant, without proving that the comparable companies were deficient or insufficient. The CIT(A) erred in facts in confirming the comparability analysis conducted by the TPO, without having regard to the functions performed, assets employed and the risks assumed. The CIT(A) erred in law and facts in disregarding the decision by the Hon'ble Delhi Tribunal in case of Mentor Graphics (Noida) (P) Ltd. vs. Dy. CIT (2007) 112 TTJ (Del) 408 : (2007) 109 ITD 101 (Del). The CIT(A) erred in law and facts in not granting the suitable adjustments to the net profit margins of the appellant vis-a-vis the comparable companies, in terms of r. 10B of the Rules. The CIT(A) erred in facts in normalizing super profit margins of comparable companies on an inappropriate basis. The CIT(A) erred in law in not granting the benefit of +/(-) 5 pe....
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....nsumer Electronics; (b) Philips Semiconductors; (c) Philips Research; (d) Philips Centre for Industrial Technology; (e) Philips Components; and (f) Philips Intellectual Property and Standards. Agreement and compensation: (a) The commercial terms and conditions of services between Philips Software and its AEs are specified in 'commercial agreements'. (b) Two sample commercial agreements are available at pp. 152 and 155 of the paper book. (c) During the relevant previous year, the assessee was remunerated on the following basis: (i) From 1st April, 2002 to 31st Dec., 2002 on a cost plus 5 per cent mark up basis. (ii) From 1st Jan., 2003 to 31st March, 2003 on a cost plus 10 per cent mark up basis. For the above purpose, 'cost' has been defined as all costs incurred by the assessee including personnel cost, travel cost, infrastructure cost and depreciation. (a) The assessee is a captive contract service provider, rendering software development services to its overseas affiliates. While rendering services to its overseas affiliates, the assessee does not bear s....
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....ovider and adding an appropriate GP margin to the same. The GP margin is usually established with reference to comparable uncontrolled transactions. Further, to corroborate the results of the CPM, the assessee also used the transactional net margin method (TNMM) in the TP study as a supplementary analysis. 3.3 Generally, the TNMM is used when direct comparables are not available, because TNMM is an indirect method. Under this method, the net profit margin realised by an enterprise is computed in relation to some key factor such as sales, costs, assets, etc., and the ratio so computed is compared to the net margin realised by unrelated enterprises from comparable transactions. As the margins earned by the assessee were higher than those of the comparable companies, the international transactions of the assessee were at arm's length. 3.4 Once having selected the CPM as the most appropriate method, the assessee conducted a search process on the 'Capitaline 2000' database ('Capitaline'). The said database is compiled by Capital Market Publishers India Ltd. and is a comprehensive interactive database of around 7,000 Indian companies, covering all companies l....
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....operating at a nascent/start-up stage. On the other hand, companies having turnover of more than Rs. 250 crores were screened out on the basis that such companies would enjoy economies of scale on the basis of their size of operations. After the application of the filters, a set of 9 comparable companies remained. The remaining companies were not 'selected' by the assessee, but were those which survived a process of elimination. 3.6 The search process was conducted by the assessee during October, 2003, wherein the database as updated on 30th Sept., 2003 was used. Accordingly, the data used for computing the profit margins of the comparable companies was the latest data which was available as on 30th Sept., 2003. The due date for filing the IT return for asst. yr. 2003-04 was 30th Nov., 2003. Accordingly, the data used by the assessee was clearly complied with the requirement of r. 10D(4), which requires the data to exist by the specified date. For applying the CPM, the assessee computed the 'GP margins' (i.e., GP as a percentage of costs) of the comparables. For applying the TNMM, the assessee computed the 'net profit margins' (i.e. operating profit as a ....
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.... a) Sample copies of softex forms for F.Y. 2002-03. Filed vide letter dt. 22.9.2005. 158-220 b) Details of the man-hours worked during F.Y. 2002-03; and c) Updated margins of the comparable companies selected in the transfer pricing study Information relating to variation in contractual terms of business, turnover fitters applied in the TP Study, details relating to on-site visits of the employees and effort sheets maintained by the employees. Filed vide letter dt.10.1.2006. 222-224 Details relating to ratio of wage cost over total cost, selection of comparables. Filed vide letter dt. 23.1.2006 225-230 The TPO issued a show-cause notice on 3rd Feb., 2006, the highlights of the show-cause notice are as below: (a) Depreciation adjustment: The TPO did not agree with the depreciation adjustment made by the assessee in the TP study. (b) New search for comparables: Without rejecting the choice of database, comparability analysis or the most appropriate method selected by the assessee, the TPO conducted a fresh search. (c) Methodology of the TPO: The TPO's search was conducted on a different database, viz. prowess. The search....
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.... computed a net profit margin on costs of 21.14 per cent for these companies (i.e. the TPO applied TNMM in the order). Since the said margin of 21.14 per cent was higher than the corresponding profit margin of the assessee of 5.70 per cent, the TPO recomputed the ALP for software development services at Rs. 1,73,56,31,438. On this basis, the TPO proposed an adjustment of Rs. 22,10,80,792. The eight comparables rejected by the TPO were screened out for the following reasons: Reason No. of companies rejected Companies having diversified activities (i.e., where the revenue from software development services is less than 50 per cent of the total revenue) 2 Companies having 'substantial' related party transactions (no quantitative limit was indicated in the order). 4 Where the financial data available related to a period exceeding 12 months 1 The 14 companies identified vide the TPO's search and their final acceptance/rejection matrix is summarized as under: Sl. No. Company Accepted/ Rejected by TPO Reason for rejectio n TPO Net profit margin on cost (%) Remarks 1. 3i Infotech Ltd. Rejected Company is having diver....
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....the assessee in the TP study. (b) The assessee had used Capita line database for conducting a comparability analysis. The TPO used another database (i.e. Prowess) without giving any reasons. (c) The assessee had followed a methodical search process in the TP study, and arrived at a set of comparable companies which were functionally comparable to the assessee. However, without highlighting any deficiency or insufficiency in the comparables, functionally or otherwise, selected in the TP study, or the search process followed for arriving at those comparables, the TPO has rejected the comparables. In the above context, it would be relevant to note that even in the show-cause notice issued, the TPO had proposed to recompute the ALP on the basis of the comparables in the TP study. However, in the order, the TPO has used a set of comparable companies selected by him, the search process for which has not been shared with the assessee. (d) Rule 10D(4) clearly specifies that the informating relating to the international transactions, including the comparability analysis, has to be kept and maintained latest by the specified date, i.e. the date of filing of the IT ....
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....) has observed that before the AO the assessee had merely reiterated the submissions made before the TPO and no additional evidence was placed on record and accordingly, the AO had no alternative but to complete the assessment based on the TPO's order. The CIT(A) further stated that the 'lacuna' in the Act has been 'set right' vide the Finance Act, 2007, by replacing the words 'having regard to' with 'in conformity with' in s. 92CA(4) of the Act. 4. The learned Departmental Representative made submissions summarized as follows: 4.1 The taxpayer has quoted two of the CBDT's circulars explaining the rationale for introducing the TP provisions. The taxpayer has highlighted the part which says that "the basic intention underlying the new transfer pricing regulations (TP regulation) is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country's tax base". The taxpayer has emphasized the above part to develop an argument that if a particular company is enjoying tax exemptions in India, there would be no motive on the part of such a company to shift its profit....
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....ze tax. Thus, a tax adjustment under the arm's length principle would not affect the underlying contractual obligations for non-tax purposes between the AE and may be appropriate even when there is no intent to minimize or avoid tax. The consideration of transfer pricing should not be confused with the consideration of problems of tax fraud or tax avoidance, even though transfer pricing policies may be used for such purposes." To sum up, there does not necessarily have to be any pre-conditionality of an intention to minimize or avoid tax in order to make an adjustment to the ALP and even though transfer pricing policies may be used for purposes of tax fraud or tax avoidance, there are other factors that need to be taken into consideration in dealing with transfer pricing. 4.2 With regard to the taxpayer's argument that when its income is exempt under s. 10A, overpricing or under pricing of an international transaction would not affect the computation of its income, the Hon'ble Tribunal held in the case of Aztec Software that this argument is without force in view of the specific provisions contained in the first proviso to s. 92C(4) wherein it has been clearly sta....
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....turing textile and operate in the same business segment. Thus, the nature and quality of assets employed are very basic in determining functional comparability. In the case of Ranbaxy Laboratories Ltd. vs. Addl. CIT (2008) 114 TTJ (Del) 1 : (2008) 299 ITR 175 (Del)(AT), the Delhi Bench of the Tribunal held that, "the analysis of comparison should consider total assets employed and assets used to earn profit". 4.4 The learned counsel argued that there is no reference to 'value' of assets in the r. 10B(2)(a) which again shows taxpayer's tendency to raise an argument for arguments sake. The comparability analysis under the TP provisions is databased. It is not based on physical inspection of the units to be compared. Apparently, when rule prescribes that assets employed in any business are to be considered, one has to go by the assets shown in the balance sheet. All the assets, whether tangible or intangible, are given a certain value in the balance sheet. This value may be cost or depreciated value etc. The comparison will be based on such value. There is no other way the assets employed in business can be compared. 4.5 The issue of use of contemporaneous data under....
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....e are factors at work that actually place a captive service provider in a much higher risk zone. For example, a captive service provider is completely dependent on its AE and any downswing impact in the business of the AE could have a severely damaging impact on the captive service provider. Such is not the case with an entrepreneur who has multiple clients and this diversification actually mitigates risk since a downswing in the business of one client results in a lesser impact on its business as compared to a captive service provider. 4.9 The claim that the captive service providers would be compensated all costs regardless of any work being done or not is only being irresponsible. Every captive service provider normally has a contract with its AE to render the required services. The cost plus remuneration is assured only on rendering of the services to the satisfaction of the AE. No AE enters into a contract stipulating that the captive service provider would be compensated even if no services are rendered. 4.10 In many cases the captive service providers cannot seek business from any 3rd party without AE's prior written consent. This type of non-compete clauses puts h....
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....7. Wipro Ltd. - 28% 8. Tektronics Engg. Ltd. - 40% 9. Mphasis BFL Ltd. - 27% 10. Subex Systems Ltd. - 32% 11. Sanyo LSI Tech. Ltd. - 21% 12. Silver Software - 35% 13. Manhattan Associates Ltd. - 29% 14. Snecma Aerospace Ltd. - 35% 15. Think 3 Design India - 40% 16. Torry Haris Business Soln. - 31% 17. Tavant Tech. Ltd. - 41% 18. MeCreade Software Ltd. - 92% 19. Multitech Software Systems - 25% 20. Spike Infotech - 30% 21. Magnasoft Cons. - 23% 22. S.G. Software Asia - 41% 23. Realsoft Ltd. - 31% 24. Relq Software - 23% 25. Medicom Consultance Services - 83% 4.15 Similar cases are available for the financial year 2002-03 as well. This clearly shows that even a captive service provider can earn margins at par with the independently operated companies. The perceived risk premium is not really a hindrance in earning profits, particularly in the software sector. The software industry is not a capital intensive industry and does not involve a long gestation period, etc. 4.16 The taxpayer has argued that the bus....
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.... risk borne by that company. 4.19 The taxpayer had also selected independent enterprises like Visual Soft, Soft Cell, Lanco Global, Orient, etc. as comparables in the TP study. The risk profile of the comparable companies selected by the taxpayer is the same as that of the comparables selected by the TPO. In the TP study, the taxpayer neither claimed nor computed any risk adjustment. If the taxpayer's comparables can be accepted than the TPO's comparables should also be accepted because the risk profile of both the comparables set is the same. 4.20 The taxpayer has mentioned various risks such as market risk, product risk, credit risk, etc. However, the taxpayer has not explained whether each of 9 comparables selected by him, bore all the risks enumerated in his submissions. As the comparables selected by the taxpayer had different risk profiles, the taxpayer should have explained which comparable bore what type of risks and how did the same affect its margins. The following table shows the expenditure incurred on selling and advertisement (marketing), R&D, etc. by the comparables selected by the taxpayer. The table also shows the bad debts written off or provided for....
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....sfer pricing proceedings. If, according to the taxpayer no quantification of the claimed adjustments is possible, the claim should be ignored because no adjustment can be made without actual quantification. In the present case the taxpayer has not furnished any computation of the risk adjustments claimed. Hence, the claim should be rejected. If the taxpayer furnishes at this stage any computation of the adjustments based on well accepted principles, including the working capital adjustment, or if the Tribunal holds that some adjustment has to be allowed, the matter may kindly be restored to the file of the AO/TPO for exact quantification of the risk adjustments including the working capital adjustment. 4.22 In the context of risk adjustments, it may also be kept in mind that the Act presumes that different comparables from the independent enterprises may have varying profit margins depending upon the functions, assets and risk (FAR) profile of each comparable. The comparables selected by the taxpayer had margins ranging from -18.9 per cent (loss) on cost to 30.36 per cent profit on cost. To take care of such differences, the Act provides for adoption of arithmetical mean of vary....
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....onsibility of determination of the ALP primarily on the taxpayer. • Different comparables can have different risk profiles and different profit margins. The Act provides for adopting arithmetical mean of the different prices. This provision neutralizes the effect of difference in the risk profile and profit margins of various com parables. • Finally the taxpayer's argument that its low margins are linked to the low risk bearing nature of the enterprises is belied by the fact that the margins were changed during the year from 5 per cent to 10 per cent on cost. As per the agreement dt. 1st Jan., 2002 the taxpayer was allowed cost + 5 per cent mark up, for similar service the taxpayer was allowed cost + 10 per cent as per the agreement dt. 9th Jan., 2003. No special circumstances have been revealed by the taxpayer which warranted sudden increase in the margin from 5 per cent to 10 per cent despite the nature of the services to be rendered and the surrounding circumstances (FAR) remained the same as earlier. This is a very clear proof that the taxpayer had not fixed the price of international transactions at arm's length, but the same were fixed to sui....
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....ion. 4.26 The other difference is regarding credit risk. Normally speaking, the taxpayer does not have a risk of bad debts or late recoveries because it is dealing only with the AE. This risk is taken care of by allowing working capital adjustment. The bad debts incurred by the comparables are anyhow debited to their P&L a/c and thus the profit margin gets automatically adjusted. 4.27 The taxpayer claims to have selected cost plus method (CPM) primarily and TNMM as a supplementary. This issue is discussed below separately. The search process applied by the taxpayer was faulty because it chose a very arbitrary range of turnover for selection of the comparables. The filters applied by the taxpayer are discussed below in detail. The issue of use of contemporaneous data, application of CPM and the adjustment sought on account of depreciation are discussed below. No comments except that the comparables selected by the taxpayer were not suitable. No comments except that the conclusion drawn on the basis of a faulty transfer pricing analysis cannot be accepted. 4.28 The taxpayer's claim is wrong that the TPO carried out a fresh search without first rejecting the taxpayer&#....
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.... 2003 11.38 2. Lanco Global March 2003 2.78 3. Melstar Inf. March 2003 45.29 4. Orient Inf. March 2003 28.50 5. RS Software March 2003 60.61 6. Shipara Tech. June 2002 9.70 7. SMR Universal March 2003 4.65 8. Softsol March 2003 12.20 9. Visual Soft March 2003 122.97 (Taxpayer) Philips 151.75 TPO's selection 1. Visual Soft March 2003 122.97 2. Flextronics March 2003 220.76 3. Hinduja TMT March 2003 100.80 4. Infotech 120.89 5. Xansa India 178.14 6. Prithvi Inf. 190.80 7. Silveiine Tech 206.82 (Taxpayer) Philips 151.75 It is apparent that the comparables selected by the TPO are turnover-wise closer to the taxpayer than the taxpayer's comparables. 4.31 The taxpayer's contention that the TPO had carried out a fresh de novo search of the database is factually incorrect. In its reply dt. 21st Feb., 2006 the taxpayer stated that all the comparables selected by the TPO had been examined by the taxpayer and eliminated from the comparables set in the TP study for various reasons. The TPO found that the reaso....
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....hree scenarios. After considering the taxpayer's objections the TPO selected the final set of the comparables and worked out the ALP accordingly. The taxpayer cannot complain of lack of opportunity or violations of principles of natural justice. 4.33 The taxpayer has objected that the TPO having determined the ALP proceeded to propose the adjustment under s. 92CA, it is seen from the order that the TPO did not 'propose' any adjustment. He simply computed the amount of the adjustment consequent to the determination of the ALP. How the taxpayer is prejudiced by this is not clear. The computation of the adjustment is a simple mathematical function. The TPO simply mentioned the difference between the ALP determined by him and the price charged by the taxpayer as the adjustment amount. This was done to double check the figures mentioned in the final order. 4.34 On the issues arising out of the TPO's order, the learned Departmental Representative submitted that he had resorted to selection of TNMM without rejecting the method adopted by the taxpayer. The taxpayer had selected CPM in the TP study. The taxpayer had also used TNMM as an alternative. The TPO adopted onl....
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.... of such transactions, is determined; (iii) the normal gross profit mark up referred to in sub-cl. (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark up in the open market; (iv) the costs referred to in sub-cl. (i) are increased by the adjusted profit mark up arrived at under sub-cl. (iii); (v) the sum so arrived at is taken to be an ALP in relation to the supply of the property or provision of services by the enterprise." As mentioned in the above rule, all the direct and indirect costs incurred in providing services by the taxpayer should form part of the cost. However, the taxpayer has ignored expenditure such as professional charges, rent, repairs and other costs which are incurred in providing services by the taxpayer. Further, all the costs except interest are towards provision of services by the taxpayer is also clear from the following extract of the agreement entered between the taxpayer and its AE. Philips Industrial Activ....
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....2.39 Another important aspect of comparability is accounting consistency. Where the accounting practices differ in the controlled transaction and the uncontrolled transaction, appropriate adjustments should be made to the data used to ensure that the same types of costs are used in each case to ensure consistency. The GP mark ups must be measured consistently between the AE and the independent enterprise. In addition, there may be differences across enterprises in the treatment of costs that affect GP mark ups that would need to be accounted for in order to achieve reliable comparability. In some cases it may be necessary to take into account certain operating expenses in order to achieve consistency and comparability; in these circumstances, the CPM starts to approach a net rather than gross margin. To the extent that the analysis takes into account operating expenses, the reliability of the analysis may be adversely affected. for the reasons set forth in paras 3.29-3.32. Thus, the safeguards described in paras 3.34-3.40 may be relevant in assessing the reliability of such analyses. 2.40 While precise accounting standards and terms may vary, in general the costs and expen....
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.... mark up e.g. rent, insurance, repairs, lease/hire charges on equipment were not considered. Professional charges were also excluded without giving any reasons. In the case of comparable companies, the details of indirect costs incurred in rendering services were simply not available. Thus, it cannot be said that the GP worked out in the case of the comparables is after taking into account the same items of expenditure as in the case of the taxpayer. (d) As per the agreement, the taxpayer's cost of providing services includes all costs that have been incurred by the taxpayer except interest expenses. All these expenses are reimbursed on cost plus basis. The taxpayer is forgetting that it is also getting 5 or 10 per cent on other costs which have been excluded by the taxpayer in CPM like rent, repairs, insurance, lease and hire charges, etc. So, the gross margin shown by the taxpayer distorts the true picture of its financials for which TNMM is the most appropriate method as it captures all expenses except interest, coinciding the cost base of the taxpayer for reimbursement (as per the agreement and invoices raised by the taxpayer). (e) In the taxpayer's ca....
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....the TPO has the support of the highest Court of the land. 4.39 Selection of a different database by the TPO: as is already mentioned above the Act does not specify use of any particular database. It is not the taxpayer's case that the Prowess database used by the TPO is less reliable than the Capitaline database used by the taxpayer. Both the databases are publicly available and contain details about Indian companies the taxpayer has also not given any reasons for selection and use of Capitaline in place of Prowess database in the TP study. In any case, no new com parables were considered by the TPO. The comparables selected by the TPO had already been considered and rejected by the taxpayer in its TP study. 4.40 The taxpayer had selected comparables which were different from the taxpayer in size and asset base. The taxpayer cannot argue that turnover and size of a company is not an important factor in determining comparability. The taxpayer himself had selected companies having turnover between Rs. 5 crores to Rs. 250 crores, 116 companies were excluded by the taxpayer applying the turnover criterion. Companies like Infosys, Satyam, L&T Infotech were excluded by the taxp....
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.....]. In this case the taxpayer had a turnover of Rs. 10.25 crores the taxpayer had selected comparables having turnover between Rs. 8 crores to Rs. 18 crores, the TPO selected comparables having turnover between Rs. 8 crores to Rs. 364 crores and the CIT(A) applied a turnover range of Rs. 5 crores to Rs. 25 crores for selection of comparables. The Tribunal upheld the CIT(A)'s action. Applying the ratio of the Tribunal decision it can be said that the turnover range applied by the TPO in the present case gave better comparables. 4.44 The taxpayer's argument that the TPO did not examine the asset base of the comparables is also wrong and self-contradictory. The most important asset in software industry is the employees, the human capital. As the employee cost of the comparables companies was in the same range as that of the taxpayer, the asset base of the comparable companies was also comparable to that of the taxpayer. Moreover, the turnover in general is directly proportional to the number of employees as the billing in the software, industry in general is based on man-hourly basis. Therefore, turnover gives a close approximation to the number of employees as the data reg....
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....cts: (i) M/s Melstar Information had significant related party transactions. In the financial year 2002-03 the company had sold services worth Rs. 4.60 crores to its associate concerns. Similarly, the company's overseas subsidiaries had been paid service charges to the extent of Rs. 18.18 crores, both these transactions put together constitute 50.12 per cent of company's total turnover. The company had about 17 per cent related party transactions in the financial year 2001-02. (ii) M/s Melstar Information had a turnover of Rs. 45.29 crores in the financial year 2002-03. The total cost incurred by the company was Rs. 43.30 crores which included software development expenses incurred outside India of Rs. 25.91 crores. Thus, more than 50 per cent of total cost was incurred outside India. The company was not predominantly an offshore software development company is also clear from the fact that its total expenditure on employee cost was only Rs. 6.13 crores, about 13 per cent of the total sales. Melstar is thus not a pure offshore development center. More than 50 per cent of its turnover pertains to the job work got done abroad which is represented by the deve....
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....ch of Tribunal in the case of Aztec Software & Technology Services Ltd. (ITA No. 584 and 585/Bang/2006, order dt. 12th July, 2007); upholding the Revenue's objection against use of multiple year data by the taxpayer, the Hon'ble Tribunal held as under: "It cannot be said that this base data was relevant and sufficient to come to any findings about the ALP. The objection of the Revenue based on sub-r. 4 of r. 10B for not confining to data for the financial year 2001-02 is also justified as it is not shown that data for other years had any influence on the determination of ALP of the transactions involved." The Special Bench decision was followed by the Tribunal, Delhi Bench in the case of Mentor Graphics (Noida) (P) Ltd. The relevant part of the order is reproduced below: "The learned CIT(A) was of the view that taxpayer was not justified in taking into account data for the earlier two preceding years. In his view, only the data for the current year should have been taken into account. He has given detailed reasons in different paras. We are not recording all reasons/details as during the course of hearing before us, learned representative of the taxpaye....
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....tal disregard to functional comparability. Except for the turnover criterion the TPO had used the same filters as the taxpayer. Aberrations by the TPO in applying the related party filter have been corrected by the CIT(A). The comparables selected by the TPO were not lacking in functional comparability is clear from the detailed discussion in the CIT(A)'s order regarding FAR analysis of each of the TPO's comparable. 4.49 The learned Departmental Representative further submitted that normalisation of the margins was undertaken by the TPO in favour of the taxpayer. The original margins of the companies may be restored at the insistence of the taxpayer. The TPO's order does not get vitiated because the TPO adopted an approach beneficial to the taxpayer the normalization done by the TPO is actually a kind of adjustment provided for in r. 10B. Transfer pricing is still a new subject in our tax administration. It is quite possible that different persons dealing with the provisions may resort to certain practices in the interest of natural justice, though these practices may not find a place in the letter of the law. 4.50 The taxpayer has raised the issue that the TPO er....
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....uiring consideration of specific characteristics of the property, functions performed, assets employed, risk assumed and other conditions of comparability, the TPO in the computation did not adopt or attach any importance to special characteristics or conditions of contract, and wrongly relied upon art. 9 of the OECD Model Convention which had no application in the matter. ...... 169. Rule 10A(d) also provides that a transaction includes a number of closely linked transactions. But here it is nobody's case that all controlled transactions carried for different customers were closely linked transactions and similar was the position of comparable uncontrolled transaction. In fact, by taking average, services of a totally different person were taken into account. 170. In the light of above discussion, we set aside the impugned order of the CIT(A) and restore the matter to the file of the AO who may again refer the question of determination of ALP to the TPO. In our view, TPO should use his power and first call upon the taxpayer to furnish ALP and all material and information which he is obliged to maintain under r. 10D of the IT Rules." 4.53 Thus, it ....
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....text assumes some significance. An opinion must be formed strictly in terms of the factors enumerated therein. The expression indicates that in exercising the power regard must be had also to the factors enumerated therein together with all factors relevant for exercise of that power. Their Lordships further quoted the following extracts from two decisions of Supreme Court in the above report: (i) India Cement Ltd. vs. Union of India (1990) 4 SCC 356; The meaning of the expression 'having regard to' is well-settled. It indicates that in exercising the power, regard must be had also to the factors enumerated together with all factors relevant for exercise of that power.' (ii) Delhi Farming & Construction (P) Ltd. vs. CIT (2003) 181 CTR (SC) 12 : (2003) 260 ITR 561 (SC); 'The words 'having regard to' used in the section do not restrict the consideration only to two matters indicated in the section as it is impossible to arrive at a conclusion as to the reasonableness by considering only the two matters mentioned isolated from other relevant factors. It is neither possible nor advisable to lay down any decis....
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....quite reasonable and should be accepted. This question is decided accordingly." In the instant case, the AO after receiving the TPO's order allowed an opportunity of hearing to the taxpayer. The AO also considered the arguments filed by the taxpayer. The taxpayer had not raised any fresh objections before the AO. Naturally, the AO had no reason to disturb the ALP determined by the TPO. The AO's action cannot be held to be in violation of the principles of the natural justice or against the provisions of the Act. 4.55 The taxpayer has referred to CBDT Circular No. 14 of 2001 [(2002) 172 CTR (St) 13] and argued that ALP determined by the taxpayer should not be disturbed. The said circular actually does not put any such restrictions on the TPO. The circular in fact re-emphasizes the legal position that if based on the information or material furnished by the taxpayer or collected by him, the TPO is of the opinion that ALP has not been determined correctly, he can compute the ALP as per the provisions of the Act and the manner prescribed in the rules. The relevant portion of Circular No. 14 of 2001 is reproduced below: "Under the new provisions the primary onu....
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....ayer's approach on the issue of related party transactions. The TPO also applied a filter of substantial related party transactions. The following companies falling within the turnover range applied by the TPO were excluded on account of substantial related party transactions: Mphasis BFL Ltd. Mastek Ltd. Pentasoft Technology The taxpayer argued before the CIT(A) that the following out of the comparables selected by the TPO should be excluded on account of related party transactions: Flextronics Software Hinduja TMT Infotech Enterprises Silverline Technologies 4.57 The CIT(A) has held that companies having more than 25 per cent of their total operating income as related party transactions should only be excluded. Companies having related party transactions below this limit can be retained as comparables. The CIT(A)'s order has been accepted by the Department. The CIT(A) deleted only one company-Flextronics Software from the list of comparables. 4.58 The Act requires that the controlled transactions should be compared with uncontrolled transactions. In common parlance uncontrolled transactions mean....
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.... or selection of very few and very small companies which may not give sufficient base for comparison. 4.62 The taxpayer has also impliedly accepted that companies haying related party transactions above certain limit only should be excluded. The taxpayer had applied a filter of companies having 'predominant' related party transactions. Though the taxpayer did not specify any particular limit in percentage terms, it is apparent that the taxpayer is also against elimination of companies having insignificant or relatively few transactions with the related parties. The Tribunal Special Bench has held in the case of Aztec Software that an adequate number of comparable companies should be selected for analysis. To quote from the order: "The sample size of data taken by the taxpayer, to support the ALP, was too small to come to any general conclusion. The assessee had taken profitability figures of only ten US companies and even it was not established that activities of these ten companies were same and similar, i.e. to provide onsite and marketing services on cost plus mark up basis. It cannot be said that this base data was relevant and sufficient to come to any f....
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....ticular controlled transactions. Therefore, it would be inappropriate to apply the transactional net margin method on a company-wise basis if the company engages in a variety of different controlled transactions that cannot be appropriately compared on an aggregate basis with those of an independent enterprise. Similarly, when analysing the transactions between the independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled, transactions under examination should be excluded from the comparison. Finally, when profit margins of an independent enterprise are used, the profits attributable to the transactions of the independent enterprise must not be distorted by controlled transactions of that enterprise." The filter of 25 per cent related party transactions has been adopted because transactions with related parties exceeding 25 per cent of total turnover may distort the overall profit margins of that company. While calculating the 25 per cent, the transactions on account of sales as well as purchases have been combined and percentage on the overall sales of the comparable company worked out. The r. 10B(1)(e)....
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....). 4.65 The CIT(A) has done a detailed FAR analysis of the comparables selected by the taxpayer. The taxpayer's objections regarding the following comparable companies were considered by the CIT(A) and she found that the companies are functionally similar to the taxpayer: (i) Prithvi Information Solution Ltd. (ii) Xansa India Ltd. (iii) Infotech Enterprises (iv) Hinduja TMT Ltd. The taxpayer's objection that the company's export turnover was less than 75 per cent of the total turnover was rejected by the TPO because in the relevant year the company's exports constituted more than 75 per cent of its turnover. The details are reproduced below from the Prowess database: Hinduja TMT Ltd. Mar. 2002 Mar. 2003 Mar. 2004 Mar. 2005 Mar. 2006 Mar. 2007 Rs. crore (Non- Annualised) 12 mths. 12 mths. 12 mths. 12 mths. 12 mths. 12 mths. - Foreign exchange earnings 50.22 92.7 141.22 118.38 200.17 382.09 Export of goods 0 0 0 0 0 0 (FOB) &nb....
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....¢ eBusiness Applications • Customer Relationship Management • Business Intelligence • Dataware house • Implementations • Application Development • Upgrade & Migration • Application Management Services • Infrastructure Support Services • Testing & QA • Business Process Outsourcing M/s Melstar has following to say about its functions: Melstar Technology An application management company Everyday Melstar is helping customers across the globe in building and managing their business applications by virtue of its domain knowledge in banking, insurance and information technology as well as its technical expertise in IBM, Microsoft and Sun Technologies. • Services • MelSupport • MelSupport, our application support service, offers services that can be undertaken onsite, offsite, offshore, or any combination thereof. Ongoing application maintenance and support and integration, enhancement and support of third party applications. • MelSotutions • MelSotutions, our flexi....
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....r the TNMM these type of adjustments are not required. OECD Guidelines describe the strength and weakness of TNMM as under: "One strength of the TNMM is that net margins (e.g. return on assets, operating income to sales, and possibly other measures of net profit) are less affected by transactional differences than is the case with price, as used in the CUP method. The net margins also may be more tolerant to some functional differences between the controlled and uncontrolled transactions than GP margins. Differences in the functions performed between enterprises are often reflected in variations in operating expenses. Consequently, enterprises may have a wide range of GP margins but still earn broadly similar levels of net profits. The taxpayer has also given the same reason while selecting TNMM as an alternative method at p. 62 of the TP study. 4.6.6 The taxpayer has asked for an adjustment based on the average rate of depreciation. The average rate has been worked out by dividing the total depreciation claim by the total WDV of all the fixed assets. In the case of the taxpayer the opening WDV of the assets as on 1st April, 2002 was Rs. 20,15,47,185 duri....
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....hereas in the case of other companies who are following lower depreciation rates, the decrease in the value of assets each year is also less to that extent and consequently, the closing WDV of assets remain relatively higher. In other words, though the taxpayer had applied depreciation at higher rate, the base (opening WDV of assets) is much lower, whereas in the case of comparable companies depreciation though applied at a lower rate, is applied on a higher base. Thus, the effect of higher depreciation rate is considerably reduced. If any adjustment/normalization of depreciation has to be worked out, it must be worked out minimum for the last three years, so that the base effect can be neutralized. (D) One way to tackle the problem of differences in depreciation rates is to take PBDIT (profit before depreciation, interest and tax) as the PLI. The profit before depreciation will rule out any effect on the margins on account of difference in the rate of depreciation. The TPO had done this exercise and found that the taxpayer was earning PBDIT @ 18 per cent on cost whereas the average PBDIT of comparables selected by the taxpayer's comparables was at 23.98 per cent on co....
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....o parties own and/or use comparable intangibles, but one has acquired them and amortised them overtime, while the other has developed them and expensed them upfront. 139. For this reason, some commentators suggest that depreciation and amortisation ought to be excluded from the determination of the net profit margin indicator. On the other hand, in asset intensive industries where assets are key value drivers, excluding depreciation and amortisation might not lead to a meaningful outcome, and depreciation and amortisation would not be excluded if it can be reasonably assumed that they do not create material comparability issues. Where uncertainties of that type are material, the third party comparable concerned might have to be rejected. Where no or insufficient satisfactory comparables are available to apply the considered net margin indicator, another net margin indicator that is less sensitive to depreciation and amortisation costs might need to be considered." Rule 10B(1) provides for adjustments only if the alleged difference between the taxpayer and the comparables affects the margins. In the instant case the result of the comparability analysis remains the same w....
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....f. 28.62779 30.39658 Thus, even if depreciation is ignored and PBDIT is taken as the PLI, even then the taxpayer's transactions are not at arm's length and a transfer pricing adjustment is justified. 4.67 As per r. 10B(1)(e)(i), the net profit margin earned by the tested party from an international transaction is computed in relation to the costs incurred or sales effected or assets employed or having regard to any other base. The provisions of r. 10B(1)(c)(i) also allow selection of any appropriate base for comparing the margins. Thus, in the taxpayer's case PBDIT can be adopted as PLI, if the taxpayer still feels that the depreciation is making a significant effect on the margins. 4.68 The taxpayer has referred to the decision of Pune Tribunal in the case of E-Gain Communication (P) Ltd. In the said decision, the Tribunal had not actually approved the computation of the adjustment. The Tribunal merely held that such an adjustment may be granted in the facts of the case. The Tribunal however did not say that average rate of depreciation should be applied to the comparable companies. On the contrary, the Tribunal held that th....
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.... the software sector. In such circumstances, no parallel can be drawn between the alleged risk premium charged by the banks and the risk premium which should be available to a captive service provider in the software sector in India. 4.71 Working capital adjustment: The taxpayer did not compute the same during the transfer pricing proceedings. If the Hon'ble Tribunal decides that the same has to be allowed the matter may be remanded to the AO/TPO for actual computation. 4.72 The CIT(A) has discussed the applicability of Mentor Graphics decision in her order in detail. In brief, (a) The Tribunal upheld the use of contemporaneous data. The para 19 of the order dealing with contemporaneous data is reproduced below: "The learned CIT(A) was of the view that taxpayer was not justified in taking into account data for the earlier two preceding years. In his view, only the data for the current year should have been taken into account. He has given detailed reasons in different paras. We are not recording all reasons/details as during the course of hearing before us, learned representative of the taxpayer agreed that arm's length pricing has to be determined b....
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....panies are a very pertinent criterion of comparability analysis. The TPO selected comparables which are closer in size and turnover to the taxpayer than the comparables selected by the TPO. (e) The Tribunal held that assets owned and employed by the comparable companies should also be considered in comparability analysis. The assets of the comparables selected by the taxpayer were grossly dissimilar to the taxpayer. Hence, TPO rejected the same. (f) The Tribunal held that companies having related party transactions should not be taken as comparables. The TPO tried to follow this and excluded such companies as per the data available at the time. (g) The Tribunal held that suitable adjustments should be allowed to the taxpayer for differences in risk, etc. It must be pointed out that in the present case the plea for making adjustments on account of risk and working capital was not made at any time during the assessment proceedings and the claim was made before the CIT(A) for the first time. The taxpayer's claim of 5 per cent risk adjustment was without any proper basis. This has already been discussed above. (h) The Tribunal also gave some dire....
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....ied by him. Project profile and other factors were, therefore, not erroneously considered. As noted earlier, the case of Integrate Hitech has been specifically accepted as comparable by both the parties. On other four cases noted above, the TPO or other Revenue authorities have not made any adverse comment at any stage of proceeding. It was open to them in proceedings before the learned CIT(A) or the Tribunal to show that PIL figures of Integrated Hitech or other four companies were wrong or on account of their FAR analysis, these entities could not be taken as "reliable" comparables for computation of the ALP. But, no material was brought on record, no arguments advanced to reject the above transaction. Therefore, having regard to facts of the case and material on record, we accept them as comparable and accept the price disclosed by the taxpayer as ALP. Consequently, the addition of Rs. 1,45,73,857 is directed to be deleted. The view taken by us finds support from para 1.4 of OECD Guidelines which we quote below: '1.48 If the relevant conditions of the controlled transactions (e.g. price or margin) are within the arm's length range, no adjustment should be made. ....
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.... the ALP shall be taken to be the arithmetical mean of such prices, or, at the option of the taxpayer, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean].' It is note worthy that there can be only one most appropriate method because the section uses the term in singular. Rule 10B(1) reproduced below also shows that there can only be one most appropriate method: 'For the purposes of sub-s. (2) of s. 92C, the ALP in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method,......' Similarly, heading of r. 10C is 'most appropriate method' not methods. The rule also refers to most appropriate method in singular only. Rule 10(D)(1)(i) also mentions only one most appropriate method selected by the taxpayer as under: 'a description of the methods considered for determining the ALP in relation to each international transaction or class of transaction, the method selected as the most appropriate method along with explanations as to why such method was so selected, and how such method was applied in each....
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....ent is required as per the law. The Tribunal's view that no adjustment is required if the taxpayer's PLI is comparable with any of the comparable company's PLI, which with due respect, does not find support in the provisions of the Act. The Tribunal is correct in observing that the ALP does not mean maximum price or maximum profit in the range. But, the Tribunal's finding that the ALP implies minimum price or profit in the range is not supported by the provisions of the Act. As per the provisions of the Act, the arithmetical mean of the different prices has to be taken as ALP. The Tribunal's observations are therefore contrary to the explicit provisions of the Act. It also appears that there was no controversy regarding adoption of arithmetical mean in the present case. This was not one of the grounds of appeal to be decided by the Tribunal. Before concluding it is also clarified that the Tribunal decision in the case of Mentor Graphics was essentially based on the peculiar facts of the case. The Hon'ble Tribunal allowed the taxpayer's appeal because of certain omissions and mistakes on the part of the TPO. This aspect is discussed at paras 34 to 41 of t....
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....between. ALP of international transaction has to be determined in every case." 4.81 In the Mentor's case, the Tribunal accepted the PLI determined by the taxpayer irrespective of the fact that the transfer pricing done by the taxpayer suffered from similar lacuna. The taxpayer's comparables also had huge variation in margins, the FAR analysis done by the taxpayer was faulty because it included even trading companies, the comparables selected by the taxpayer were also engaged in diversified activities and different verticals of software development, the taxpayer had also not looked into the related party transactions of the selected comparables and the taxpayer had also used earlier year data. Following the Aztec order, with due respect, the Tribunal should not have accepted the taxpayer's TP study but should have redetermined ALP afresh or should have directed the TPO to determine ALP afresh. It appears from the Tribunal's order that the Tribunal did not undertake a fresh transfer pricing analysis because the Tribunal was convinced that as one of the com parables had a PLI which was lower than the taxpayer's PLI hence there was no need for any adjustment or f....
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.... that even if it is ultimately held that the TPO's order suffers from some infirmities, it would not automatically establish that the taxpayer's transactions are at arm's length. The TP study done by the taxpayer has to stand on its own merits. Otherwise, the appellate authorities are required to determine the ALP of the impugned international transactions. In this regard the following observations made by the Special Bench of the Tribunal in the case of Aztec Software are reproduced below: "133. Having regard to the statutory provisions, particularly the mandate of ss. 92(1) and 92D read with relevant rules, we hold that it is obligatory on the part of the taxpayer to furnish information relating to controlled international transactions, select a suitable method for determination and furnish ALP of such international transactions carried by it and give basis and supporting authentic evidence of ALP and adjustments made. The taxpayer has further to co-operate in the determination of the ALP by the tax authorities by furnishing all relevant information. The tax authorities in cases where they are of the opinion that ALP has not been correctly determined by the t....
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....actions or the matter may be restored to the AO/TPO. It will not be out place here to bring to the notice of the Tribunal, certain inconsistencies in the approach and arguments of the taxpayer. • The taxpayer has not commented on the issue of the turnover filter applied by the TPO. It is admitted fact that but for M/s Visual Soft, all other comparables selected by the taxpayer were very small in size when compared with the taxpayer. No specific arguments have been made by the taxpayer on this issue. If it is held that the lower limit of turnover (Rs. 100 crores) applied by the TPO was not justified, then the higher limit of the turnover applied by the TPO and the taxpayer (Rs. 250 crores) would also have to be relaxed. The entire search criterion would change and the TPO as well as the taxpayer should be allowed to search for the comparables within the new turnover limits if any determined by the Tribunal. • During the course of hearing before the Hon'ble Tribunal, it was argued by the taxpayer that the turnover range of Rs. 100 crores to Rs. 250 crores would throw up more than 200 software companies. This appears to be factually incorrect. Even tod....
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....t has incurred expenditure on R&D more than 3 per cent, it is not a comparable. In this regard, it is submitted that R&D expenditure was not used as a filter either by the taxpayer in its transfer pricing or by the TPO. The taxpayer did not raise this objection either before the TPO or before the CIT(A). The taxpayer should not be allowed to contradict its own TP study at this stage. It is also worth mentioning here that the taxpayer (PSCPL) himself has a full-fledged R&D division known as Philips Research as mentioned on p. 14 of the TP study. The relevant portions of the transfer pricing report are reproduced below to show that the taxpayer's main business is product related R&D: "The professionals working at PSCPL use state-of-the-art software engineering paradigms and platforms including real-time systems, components based software engineering, multithreaded architecture and ASIC design methodologies in deep sub-micron technologies to drive the creation of tomorrow's products and services. PSCPL is an ISO 9001/Tick IT, SEI CMM SM Level 5 company and has emerged as a critical partner in the development of a range of Philips products ..... PSCPL has built up exte....
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....The taxpayer has argued that the R&D filter was upheld in the cases of Mentor Graphics, E-Gain Communication (P) Ltd. and Development Consultants (P) Ltd. In tills regard, it is submitted that in none of the above decisions, the Tribunal had actually decided the issue of suitability of R&D filter. The filter finds a mention in the Tribunal orders simply because many taxpayers use this filter in search of the comparables. • As held by the Special Bench of Tribunal, Ahemdabad, in the case of Asstt. CIT vs. Goldmine Shares & Finance (P) Ltd. (2008) 116 TTJ (Ahd)(SB) 705 : (2008) 302 ITR 208 (Ahd)(SB)(AT), if an issue is not discussed and directly decided in a particular order, mere mention of the issue does not have any precedent value. Expenditure on R&D is not a suitable filter in the facts and circumstances of the case, as the taxpayer himself engaged in software R&D services. Thus, the taxpayer's case is clearly distinguishable on facts on the abovementioned Tribunal decisions relied by the taxpayer. • The taxpayer has argued it should be allowed benefit of +/(-) 5 per cent range as per the proviso to s. 92C(2). It is submitted that the issue has been....
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.... 23. The learned Departmental Representative could not refute the arguments and facts discussed by Shri Rahul Mitra. He only reiterated that the CIT(A) during the course of appellate proceedings had argued against the analysis that DCIL was the main company and that the assessee was only a paper company and not a company of substance. Based on his findings from the internet the CIT(A) had understood the assessee to be the main company of the group and DCIL, he argued was a paper company created only to evade taxes. Hence, in his order he stated that there is no justification for allowing 28 per cent margins to DCIL and entire profits should come to DCPL. 24 ........ 25. We have examined all the facts and record and after the due consideration of arguments placed by both the sides, we can see that DCIL has longstanding banking relationship with banks like, Bank of India and Indian Overseas Bank. Further, it enjoys substantial credit limits provided by these banks for the purpose of its business operations. No paper company would be having such substantial business operations and have excellent customer relationship with its bankers and no nationalized banks woul....
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....e cannot take a simplistic view on the matter of tax avoidance. In this connection the learned Departmental Representative has drawn reference to the proviso to s. 92C(4). Relying on OECD Guidelines, the Departmental Representative has mentioned that the consideration of transfer pricing should not be confused with the consideration of problems of tax avoidance, even though transfer pricing policies may be used for such purposes. In this connection, it was pointed out that by not declaring proper profits in India, the assessee is indirectly reducing its liability to DDT. The Special Bench of the Tribunal, in the case of Aztec Software, has concluded that the AO/TPO need not prove the motive of shifting of profits outside India for making a transfer pricing adjustment. The assessee had generally argued that one of the factors driving any motive for shifting profits would be the difference in the tax rate in India and the tax rate applicable to the AE in the overseas jurisdiction. In the instant case, since the assessee was availing the benefit under s. 10A of the Act, it would be devoid of logic to argue that the assessee had manipulated prices (and shifted profits) to an overseas j....
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..... 52 or decision of the Hon'ble Supreme Court in the case of K.P. Varghese vs. ITO & Anr. (1981) 24 CTR (SC) 358 : (1981) 131 ITR 597 (SC) wherein profit on account of understatement of consideration was held to be essential special requirement of the provision. There is no such requirement of establishment of 'tax evasion' before initiation of proceedings for determination of ALP as discussed above. Contrary view held by the learned CIT(A) is accordingly held to be unsustainable." 5.3 Further, the Departmental Representative's argument on this point is also not consistent with the provisions of s. 92C(3) of the Act and the Circular No. 14 of 2001 which provide that before the ALP is determined by the AO, he has to prove that at least one of the four conditions laid down in sub-s. (3) above has been satisfied. In the instant case, the AO did not prove to the assessee that the above conditions were satisfied, either before initiating the transfer pricing assessment or during the course of the proceedings. 5.4 Circular No. 14 of 2001 reported in (2002) 172 CTR (St) 13 : (2001) 252 ITR (St) 65 issued by the CBDT spells out the intention of inserting the provision....
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....ruction No.3, dt. 20th May, 2003 issued by the CBDT is consistent with the statutory objective underlying s. 92CA(1) and acts as a guidance to the AO in the exercise of discretion in referring an international transaction to the TPO for determination of its ALP. It is neither arbitrary nor unreasonable, and is not ultra virus the Act." This view has also been taken by the Tribunal, Bangalore Bench in the case of Aztec Software. At paras 44 and 45 of the order, the Tribunal has observed as below: "44. Therefore, when provisions of s. 92CA(1) are read with circular of CBDT, Instruction No. 3, dt. 20th May, 2003, it becomes 'necessary' for the AO to refer the question of determination of transfer pricing of international transactions to the TPO. He has no discretion in the matter in the light of limit fixed by the Board. The AO has only to look at the aggregate value of international transactions disclosed by the assessee in the audit report and then follow directions of CBDT. The AO therefore, is left with a very limited role under s. 92CA(1). Likewise, while granting approval to the action of the AO the CIT has only to see whether aggregate value of international....
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....he AO, he has to prove that at least one of the four conditions laid down in sub-s. (3) above has been satisfied. However, in the instant case, the AO has not proved that the above conditions were satisfied, either before initiating the transfer pricing assessment or before the completion of the assessment proceedings. The learned counsel submitted that in the case of the assessee, the AO has failed to establish that any of these four conditions has been satisfied. In fact, there is not even a finding to this effect that any of the four conditions has been satisfied. Further, s. 92CA(3) provides that even a TPO should determine the ALP in accordance with the provisions of s. 92C(3). Accordingly, the conditions of s. 92C(3) would also be relevant to the TPO. The learned counsel drew reference to Circular No. 12 of 2001, dt. 23rd Aug., 2001 [(2001) 169 CTR (St) 45) issued by the CBDT, wherein the following has been mentioned: "(iii) It should be made clear to the concerned AOs that where an international transaction has been put to a scrutiny, the AO can have recourse to sub-s. (3) of s. 92C only under the circumstances enumerated in cls. (a) to (d) of that sub-section and i....
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....orest Co. vs. CIT 1975 CTR (J&K) 88 : (1975) 101 ITR 721 (J&K). In the instant case, the TPO/AO has at no stage of the assessment proceedings established that the transfer pricing record of the assessee should be rejected. The TPO/AO simply conducted his analysis and applied the same to the assessee's case. Once the assessee has discharged its onus by conducting a proper comparability analysis it would be open for the AO to make a fresh analysis only if the case of the assessee falls under s. 92C(3)(c). There is nothing in the order of the TPO or the AO to suggest that cl. (c) of s. 92C(3) is satisfied. In this connection, reference is also drawn to Circular No. 14 of 2001 issued by the CBDT, which also provides that only if such deficiency or insufficiency is found in the documentation of the assessee, the TPO/AO can conduct a scrutiny. The relevant extract of the circular has been reproduced below: "Where such onus is discharged by the assessee and the data used for determining the ALP is reliable and correct, there can be no intervention by the AO. This is made clear by sub-s. (3) of s. 92C which provides that the AO may intervene only if he is, on the basis of m....
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....nancial year 2002-03 was not available as on 30th Nov., 2003 (i.e., the specified date for financial year 2002-03), the same cannot be used for conducting the comparability analysis. The transfer pricing analysis was conducted by the assessee in October, 2003 using Capitaline Plus database updated as on 30th Sept., 2003, which is a period reasonably close to the specified date of 30th Nov., 2003. However, the TPO conducted a fresh comparability analysis in the show-cause notice issued on 3rd Feb., 2006. The fact that the TPO conducted the comparability analysis after the 'specified date', clearly proves that such comparability analysis did not use data which was 'contemporaneous' and hence is not in compliance with the provisions of r. 10D(4). 5.6 If the provisions of rr. 10B(4) and 10D(4) were to be applied to a book. e.g., written in 1857 would satisfy all the conditions as-(a) it relates to the war of independence; (b) it is contemporaneous; and (c) it exists by the specified date (i.e., 31 Dec., 1860). For that matter, even the book written in 1860 would satisfy the test as it would exist by the specified date and relates to the war of independence. However, ....
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....study, the learned counsel had clearly mentioned that data relating to the year ended March, 2003 has been used and in case such data is not available, the previous year's data has been used. The process adopted in the TP study is clearly in conformity with the provisions of rr. 10B(4) and 10D(4) which provide as follows: (i) Rule 10B(4)-data relating to the relevant financial year shall be used. (ii) Rule 10D(4)-data used should be as far as possible be contemporaneous and such data should exist as on the specified date. The learned Departmental Representative has made an argument that rr. 10B(4) and 10D(4) have to be read independently and in isolation, and both the rules are for different purposes-r. 10B (4) is relevant for the purpose of comparability, while r. 10D(4) is relevant for avoiding penal provisions. The learned counsel submitted that such an interpretation of the learned Departmental Representative is completely erroneous and without any legal basis. If one were to take the argument of the learned Departmental Representative to a logical conclusion, a taxpayer would be required to maintain two separate sets of documentation-one that would sat....
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....of the five prescribed methods, being the most appropriate method. In connection with the above, while conducting the TP study, the learned counsel had selected the CPM as the most appropriate method, after evaluating the criterion laid down in r. 10C(2), which are summarized as under: (a) Functions performed, taking into account the risks assumed and the assets employed by the assessee; (b) Availability and reliability of data; (c) Degree of comparability; and (d) Extent of reliable and accurate adjustments that can be made to account for differences. Further, the guidance issued by the ICAI, relating to issue of Form 3CEB by chartered accountants, explains the use of the most appropriate method as under: "13.5 The conditions referred to above are cumulative. The reference therein to the terms 'best suited' and 'most reliable measure' indicates that the most appropriate method will have to be selected after a meticulous appraisal of the facts and circumstances of the international transaction." The guidance issued by the ICAI clearly specifies that selection of the most appropriate method should be based on a metic....
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....ote that Instruction No. 3, dt. 20th May, 2003, also provides as under: "(ii) Role of TPO ... The transfer price has to be determined by the TPO in terms of s. 92C. The price has to be determined by anyone of the methods stipulated in sub-s. (1) of s. 92C and by applying the most appropriate method referred to in sub-s. (2) thereof." As can be seen from the above, the CBDT has held that where: • -the onus is discharged by the assessee; and • -the data used by the assessee is reliable and correct, there can be no intervention by the AO. In the instant case, the assessee discharged its liability, inter alia, of: (a) preparing a transfer pricing documentation; (b) conducting a comparability analysis; and (c) furnishing the same to the TPO. However, during the transfer pricing assessment proceedings, the TPO, without providing any reasons, followed a different methodology and selected a different method, completely disregarding the statutory provisions and the fact that: • the assessee had discharged the onus of maintaining the prescribed documentation; and • the data used by the a....
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....tative has not done. On the other hand, the assessee has carefully evaluated all the five methods and selected the CPM as the most appropriate method. • The Departmental Representative's argument of applying TNMM in all cases would mean that all the four other methods would be left redundant. Accordingly, the said observation cannot be applied as such in the instant case. It would not be out of place here to mention that at para 27 of the said order, the Supreme Court has itself observed that: "27. The methods, quoted above, namely, CUPM, RPM, CPM, PSM, TNMM, etc. are mentioned in s. 92C r/w r. 10B. The most appropriate method has to be applied for computation of the ALP. It will depend on the facts and circumstances of each particular international transaction." In the TP study conducted by the assessee, the database used for conducting the comparability analysis was Capitaline 2000 ('Capitaline'). The said database is compiled by Capital Market Publishers India Ltd. and is a comprehensive interactive database of around 7,000 Indian companies, covering all companies listed on major stock exchanges like BSE/NSE plus other big unlisted compani....
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....nating non-comparable companies to leave a final set of comparables, consistent with the criteria used for elimination. The assessee has conducted a TP study using the second approach as discussed above. The TPO has resorted to pick and choose. 5.16 In the TP study conducted by the assessee, comparable companies were arrived at after using a methodical search process on the Capitaline database. For the purpose of conducting the comparability analysis on Capitaline, the assessee selected all companies in the computer software industry, as the first step. The said search process was followed by applying a number of pre-defined filters, both quantitative (i.e., system based) and qualitative (i.e., manual based) filters/eliminations. Thus, the final comparable companies were those which survived the elimination process and not the companies which were selected by the assessee. The final set of comparable companies were in accordance with the criterion mentioned in r. 10B(2). Rule 10B(2), provides that the following factors need to be considered for the purpose of comparability analysis: (a) the specific characteristics of the property transferred or services provided in ....
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....l manufacturing company. If the steel manufactured by the controlled party is the same in all respects as steel manufactured by a comparable uncontrolled party. The controlled party would not be able to justify a materially different price for the same goods merely because its steel mill is much larger or much smaller. Admittedly, for a profitability comparison, the size of the enterprise could be one of the relevant factors, but given the modular nature of software development units, a company which has a higher turnover might simply have more software units, and these would not necessarily bring significant economies of scale. 5.19 The onus was on the TPO/AO to state and to show that the range of turnover sizes chosen by the assessee was wrong, and the TPO/AO have neither given a finding to that effect, nor have they discharged that onus. Further, while conducting the benchmarking process, the TPO has applied a turnover filter of Rs. 100 crores to Rs. 250 crores without providing sufficient reasons for applying such filters. Further, the TPO has not changed the upper end of the filter as applied by the assessee, but has not explained why he considered Rs. 100 crores as an appr....
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....t should be noted that this test of 'R&D expense' has also been approved by the Kolkata Bench of the Tribunal in the case of Development Consultants (P) Ltd. vs. Dy. CIT (2008) 115 TTJ (Kol) 577 wherein the Tribunal has approved the rejection of companies having R&D expenses of more than 3 per cent of sales. 5.22 With regard to the above, the assessee would like to further place reliance on the decision of the Delhi Bench of the Tribunal in the case of Mentor Graphics, wherein it was held that depending on the facts of the case, the final set of comparables may need to eliminate differences by making adjustments, including an adjustment for R&D expenses. Accordingly, for a proper comparability, the TPO ought to have excluded M/s Visualsoft as a comparable company. 5.23 The learned counsel had submitted for comparability under r. 10B, the focus is on the functions performed, and reference to other economic criterion are only in the context of the functions. This is clear from the provisions of r. 10B(2), the relevant extracts of which are reproduced below: "(2) For the purposes of sub-r. (1), the comparability of an international transaction with an uncontroll....
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....ase of Ranbaxy Laboratories Ltd., but a reproduction of the observation made by the Tribunal in the case of Mentor Graphics at para No. 27, wherein the Tribunal has discussed various aspects relating to comparability analysis. Even in the said decision, the comment was made by the Tribunal in the context of the functions performed. This assertion of the Departmental Representative contradicts the argument made by him that there was no search conducted by the TPO. The learned counsel submitted that the Departmental Representative has not given any reasons for rejecting the comparables in the TP study. Further, there is no such observation in the show cause notice issued by the TPO. In fact, the show-cause notice and the order of the TPO are totally in different directions and are clearly independent of one another. In the show-cause notice, the TPO had proposed to compute the ALP by adopting a net profit margin of 16.82 per cent (based on an updated net margin working of the comparables on the TP study). However, in the order, the TPO proceeded to pass the order based on fresh comparables as selected by him, and arrived at a net margin of 21.14 per cent. Neither the TPO nor the AO h....
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.... "24. It is true that 'transfer pricing' is not an exact science, evaluation of transactions through which the process of determination is carried is an art where mathematical certainty is indeed not possible and some approximation cannot be ruled out, yet it has to be shown that analysis carried out was 'judicial' and was done after taking into account all the relevant facts and circumstances of the case." Further, the OECD, with its vast knowledge and experience in the area of transfer pricing has also observed that: "It should also be recalled at this point that transfer pricing is not an exact science but does require the exercise of judgment on the part of both the tax administration and taxpayer." 5.27 Considering the above background that transfer pricing is not an exact science and the fact that the assessee's turnover during the relevant year was Rs. 153 crores, it is grossly erroneous on the part of the Departmental Representative to argue that the turnover filter applied by the company was arbitrary. Moreover, the TPO ought not to have brought in a new turnover filter of Rs. 100 to Rs. 250 crores, especially considering that there....
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....ores but he was in error in considering turnover as the only relevant factor needed to be considered for a proper analysis. What about a large number of other factors which materially affect the profit? The functions performed, assets employed, risk taken (FAR) analysis was also required to be undertaken as per the TP regulation and other guidelines. This was not done, which renders the comparison as unsound and unreliable." The Departmental Representative's arguments on human assets are without any basis, and are full of contradictions. One such example of contradiction is at p. 18 of the written submissions of the Departmental Representative, which has been extracted below: "Moreover, the turnover in general is directly proportional to the number of employees as the billing in the software industry in general is based on man-hourly basis. Therefore, turnover gives a close approximation to the number of employees as the data regarding the number of employees is not available in respect of all comparable companies selected by the TPO threw up closer comparables and hence, should be accepted as correct." In the above comment, at one hand, the Departmental Represen....
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....ng: (a) working capital. (b) adjustment for risk and growth. (c) adjustment of R&D expenses." 5.28 The learned counsel submitted that the request for recomputing the margins of M/s Silverline cannot be accepted, inter alia, for the following reasons: (i) The Departmental Representative cannot request for increasing the margin and improving his position in an appeal which has been filed by tire assessee. In fact, it would be relevant to note that even the CIT(A) has considered the margin of M/s Silverline at (-) 11.37 per cent. It should be noted that no cross-objection by the Revenue on this matter. (ii) Without prejudice to the above, the financials attached by the Departmental Representative to the written submissions are not for the year ended 31st March, 2003, and relate to 15 months period ended 30th June, 2002. (iii) Any such computation would not be in conformity with r. 10B(4) and r. 10D(4). (iv) There are no provisions by which the margins can now be recomputed by the TPO. While conducting the comparability analysis, the TPO rejected companies having substantial related party transactions. This view of th....
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....view that the approach to be taken should be one where comparables should be found where the extent of the related party transaction is not of such an order of magnitude as to distort the results and therefore made comparison less than meaningful. Such, I believe, is the approach that I have taken and the approach the assessing authorities have taken as well." In view of the above submissions and based on the provisions of the law, the learned counsel had argued that the TPO and the CIT(A) have erred, in including companies having any related party transactions. Without prejudice to the above contention, even if companies having related party transactions were to be included in the set of the final comparables, the filter of 25 per cent over sales is ad hoc, and without any basis. Further, even if it were be assumed that companies with related party transactions could be included on the basis of the 25 per cent filter, the learned counsel submitted that the TPO/CIT(A) should have then also rejected two more companies, namely, Hinduja TMT Ltd. [margin computed by the CIT(A) at 111.87 per cent, normalized to 32.71 per cent] and Xansa India Ltd. [margin computed by the CIT(A) at 25....
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....anies need to be adjusted to take into account the functional and other differences which could materially effect such margins in the open market. During the course of the proceedings, the assessee had requested the CIT(A) to grant an adjustment to the margin of the comparable companies on account of the difference in the risk profile of the comparable companies. However, the CIT(A) has not approved the claim of the assessee on the basis that: (a) the assessee is bearing a significant risk in the form of a single customer risk; and (b) the method for claiming the adjustment of 5.25 per cent is ad hoc and without basis. In connection with the above issue, the learned counsel submitted that its claim is squarely within the provisions of the law (i.e., r. 10B) and the CIT(A) has not given any legal basis for the rejection of the claim. Further, the CIT(A) has grossly erred in reaching a conclusion that the assessee bears a significant risk in the form of a single customer risk. The CIT(A) ought to have appreciated that the assessee is working on a cost plus basis, and accordingly, is insulated from all kinds of business and operational risks. The claim of the asse....
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....h. (c) adjustment of R&D expenses. 27.1 The risk not only due to human resources, infrastructure and quality which are normally taken into account yet more significant risks like market risk, contract risk, credit and collection risk and risk of infringement of intellectual property are being ignored here. 33. Most of the business risk such as contract risk, market risk, credit risk, warranty risk, price risk etc. were essentially borne by parent AE....." This matter has also been considered by the Pune Bench of the Tribunal in the case of E-Gain Communication. Attention is drawn to the comments of the Tribunal at para 40 of the order, which is reproduced below: "40. We further agree with the contention of the learned counsel for the taxpayer that the benefit of adjustment was required to be given in working the margin of profit of the taxpayer for not undertaking any risk in the transactions involved with its parent company. However, evaluation of above risk in the present case is not necessary as even otherwise the margin of profit shown by the taxpayer has fully satisfied the ALP benchmark." The contention of the Departmental Representat....
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....r services to a single customer, he would charge a premium for his services. In fact, the assertion made by the Departmental Representative is not in line with any theory of economics. This fact is also emphasized in the written submissions made by the Departmental Representative in the context of 'single customer' risk. The assessee bears very nominal/nil business risks. The Departmental Representative has drawn reference to the commercial agreement at p. 152 of the paper book. Clause 5 of the very same agreement clearly provides that all risks are of the customer. The relevant extract has been reproduced below: "5.1 The ownership and copyright of all deliverables will be held by Philips Industrial Activities, N.V., at the end of the assignment. All risks are to the account of Philips Industrial Activities, N.V." In the first instance, it should be noted that there has been a consistent growth in the quantum of business of the assessee. The revenue from software development services in the financial year 2001102 was Rs. 137 crores which increased to Rs. 207 crores in the financial year 2003-04. Since the assessee is operating on a cost plus model, the margin re....
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.... that on a realistic estimate, the fee to be charged for the assignment would be Euro 25,000. The said clause nowhere restricts the fee that can be charged by the assessee under cl. 1 (a) of the said agreement. The purpose of cl. 2(a) of the agreement is only to provide a framework to both the parties for the assignments. (c) In any case, the agreement represents only two of the various agreements entered into by the assessee with its AE of asst. yr. 2003-04. (d) The Departmental Representative can also consider the derived man-hour billing rate for comparison purpose. The derived man-hour billing rate of the assessee works out USD 29.24. Further, the TPO in the assessment made for asst. yr. 2002-03 has herself used an industry benchmark of USD 18-25 per hour. If the industry rates are considered as a potential comparable uncontrolled price (CUP), the man-hour rate of the assessee and the consequent value of the international transactions of the assessee with its AE would be at arm's length. 5.33 The learned Departmental Representative's act of giving a new list of 25 supposedly captive companies is an example of making irresponsible and incorrect as....
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....l is for financial year 2002-03. 5.34 The learned counsel submitted that the assessee understood that there are a significant number of other captive companies who have earned margins in the region of 5 to 10 per cent. The Departmental Representative has purposefully not highlighted such companies, which clearly brings out the anomalies in the process of cherry choosing. Even if one were to now do a broad search for a universal set of companies for 'computer software services and consultancy services', the average net margin would be in the region of 6.34 per cent (293 companies from Prowess database as updated on 15th Feb., 2008). Margin of entrepreneurial companies cannot be compared with the assessee, who is a captive service provider bearing minimal/no risks, without any adjustments. The approach of the Departmental Representative seems to be bias as there are many other companies whose margins are in the range of 5 to 10 per cent. The Departmental Representative has ignored such companies while making his argument. The margins of these companies cannot be directly taken as a benchmark without doing a proper FAR analysis to eliminate differences on account of functio....
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....p's convenience." It should also be noted that the margins of the assessees in the case of Mentor Graphics and E-Gain Communication were also in the range of 5 per cent to 7 per cent, which was approved as being at arm's length by the Tribunals. 5.37 The reference of the Departmental Representative to various studies is out of context. The learned Departmental Representative had made a sweeping statement which is based on his conjecture and surmise. MNCs recognize the fact that international operations are subject to various risks, such as, political, economic, different legal systems, etc. which could also adversely affect their operations and increase their overall risk of doing business. The Departmental Representative seems to have incorrectly assumed that by setting shops across the globe, the MNC has transferred some of its risk to the new legal entity in the foreign jurisdiction. The Departmental Representative has failed to prove as to how by multinationalising their own operations, the reduction of external/market risks to the MNC groups on an overall basis would actually result in increasing the risk of the captive service provider in the foreign jurisdiction. ....
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....ompany in the given industry earns, under ordinary circumstances. 5.41 Rule 10B(3) provides that an uncontrolled transaction shall be considered as a comparable if: (a) none of the differences between the comparable company and the controlled transaction is likely to materially affect the profit arising from such transactions in the open market; or (b) reasonably accurate adjustments can be made to eliminate the material effect of such differences. In the instant case, it was acknowledged by the CIT(A) that two companies in the set of comparables as approved by the CIT(A) are making super profits. The super profits of these companies would materially affect the comparability analysis. The learned counsel had submitted that in the absence of any specific provision for making the necessary/appropriate adjustment to the margins of the super profit making companies and the ability to accurately identify and quantify the adjustments to eliminate the differences, the two profit making companies should not be considered as 'comparables'. Therefore, given the fact that a company is making super profits, such a company cannot be taken as a comparable company.....
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....in of the comparable companies. This method, in no way, can be said to be liberal. The assessee cannot be dependent upon a charitable whim of the TPO. The comparability analysis should be made on the basis of the provisions of law and not on an ad hoc basis. The argument of the Departmental Representative that the act of normalization offsetting for the need for risk adjustment is devoid of any merits and logic. The Departmental Representative's comment of normalizing using the margin of Visualsoft as 28.61 per cent is erroneous. In fact, the normalization has been done by using a margin of 32.71 per cent. It would be out of place to mention here that in the pretext of normalization of super profits, the TPO has actually increased the margin of Infotech from 31.78 per cent to 32.71 per cent. There cannot be a more glaring example of a deliberate action by the TPO to arrive at disproportionately higher arithmetical mean with the objective of making a transfer pricing adjustment. Independent of the above, by a parity of reasoning, even M/s Visualsoft which has made a margin of 32.71 per. cent should be considered as a company making super profits and accordingly not to be include....
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....resentative has acknowledged the need for making an adjustment, but has not agreed to the methodology adopted by the assessee. 5.46 During the appellate proceedings before the CIT(A), considering the financial position of the assessee and the comparable companies, a request was made to the CIT(A) to allow making an adjustment on account of the difference in the working capital position. The learned counsel for the assessee also submitted that a similar working capital adjustment was also granted by the TPO in the succeeding assessment year, in the assessee's own case. However, the CIT(A) did not allow an adjustment for working capital citing that the same cannot be granted merely because such an adjustment has been allowed by the TPO for the succeeding assessment year. The CIT(A) has not addressed the merits of the case of the assessee, it should be noted that the assessee is a captive contract service provider, rendering software development services to its AE. The payment cycle in the case of the assessee is shorter as against a considerable time lag in case of a third party service provider. In case of the com parables as approved by the CIT(A), the holding period for wor....
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....verage holding period of com parables) - (Holding period of the assessee) Step 3 The net holding period is applied to the prima lending rate (PLR) to compute to the working capital adjustment. [Net holding period (in days)) x PLR360 days Actual workings are as under: Step 1 Holding period for comparables [all comparables approved by the CIT(A)) = 265.98 days. Holding period for the assessee = 80.42 days. (Note : None of the comparable companies have a holding period which is less than that of the assessee) STEP 2 Net holding period is (265.98 days - 80.42 days) = 185.56 days. STEP 3 Working capital adjustment on PLR =185.56 days x 11.50 per cent 360 days= 5.93 per cent For computing the working capital adjustment, instead of using the PLR, the following other returns on capital can also be considered: Particulars Percentage of return Corresponding working capital adjustment ROCE (Return on Capital Employed) of the assessee for financial year 2002-03 24.99% 12.88% Interest rates charged by credit card companies (current rate annualized) 35.40% 18.25% The working capit....
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.... the ALP as determined by the CIT(A) (which is a risk bearing rate of return) would have to be adjusted by the risk premium of 5.25 per cent. As an alternative to the above, if one were to consider the rate at which banks charge credit card holders (35.40 per cent) as the risk bearing rate, the risk adjustment required would workout to 29.15 per cent. 5.48 At the first instance, the learned counsel submitted that the need for a risk adjustment has been approved by the Tribunals in the case of Mentor Graphics and E-Gain Communication. Independent of the above, the Departmental Representative ought to appreciate the conceptual difference between the PLR and the bank rate. While the bank rate is the rate at which the RBI lends money to various banks, the PLR represents a base rate for loans disbursed by banks to its customers. During the course of the hearing, the Departmental Representative has himself pointed out that the banks typically give loans at a rate which is higher than the PLR, and this additional difference is based on the bank's assessment of the risk profile of the borrower. 5.49 Considering the above, the assessee has been fair in requesting for an adjustment....
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....ion to the international transaction. It is proposed to substitute the aforesaid proviso to sub-s. (2) so as to provide that where the most appropriate method results in more than one price, the arithmetical mean of such prices or, at the option of the assessee, a price which differs from the arithmetical mean by an amount not exceeding five per cent, of such mean may be taken to be the ALP in relation to the international transaction." It was submitted that the language of proviso to s. 92C(2) is clear and even without reference to extracts from "Explanatory Memorandum to Finance Bill, 2002" and 'Notes on Clauses to Finance Bill, 2002', no different view can be formed. The only criterion for availing itself of the 5 per cent variation is that the same is available at the option of the assessee. Based on the above, one can reasonably conclude that a 5 per cent variance is allowed as a standard deduction which should be allowed while making an adjustment to the ALP. as declared by the assessee. Vide Circular No. 12 of 2001 dt. 23rd Aug., 2001 [(2001) 169 CTR (St) 45], the CBDT had instructed its officers to not make any adjustment to the ALP as determined by the taxpay....
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.... counsel had submitted that his arguments are squarely covered by the decision of the Tribunal in the case of Development Consultants. In the said case, the Tribunal, after considering all the facts and issues of that case had approved the methodology of the assessee in that case. The discussion on this matter is covered under paras 22 and 23 of the said order, which has been reproduced below: "22 The learned Authorised Representative submitted that in case of asst. yr. 2003-04, the arm's length GP/sales of the comparable companies is 28.22 per cent, which is lower than the GP/sales of DCIL for the year ended 31st March, 2003 of 61.10 per cent, indicating that DCIL has retained more than the arm's length margin at the gross level. He stated that transfer pricing legislation as provided in the IT Act allows a taxpayer to have an option to compute the ALP which may vary from arithmetic mean by an amount not exceeding 5 per cent of such arithmetic mean. For this, he quoted proviso to s. 92C(2) of the IT Act which states that "where more than one price is determined by the most appropriate method, the ALP shall be taken to be the arithmetical mean of such prices or at ....
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.... of s. 92C having regard to the ALP determined under sub-s. (3) by the TPO." As discussed above, upon receipt of the order of the TPO, the AO would compute the total income of the assessee under sub-s. (4) of s. 92C. Relevant extract of the said sub-section is reproduced as under: "(4) Where an ALP is determined by the AO under sub-s. (3), the AO may compute the total income of the assessee having regard to the ALP so determined." Based on the above, the learned counsel submitted that s. 92CA(4) requires that the total income of the assessee is to be computed 'having regard to' the ALP and not only either, based on, or in conformity with, the order passed by the TPO. Where the words 'having regard to' are used, the authorities should not mechanically consider only the factor which the statute had drawn their attention to, but consider all other reasonable aspects which could have a bearing on the matter. In this regard, as the expression 'having regard to' has not been defined in the Act, the counsel has drawn reference to the definition as provided in Law Lexicon. The definition of the expression 'having regard to' is as under: ....
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....being the date on which the AO passed the assessment order). Accordingly, it is a remote possibility that the AO would have perused the submissions, filed by the assessee and the income to a conclusion that the submissions were a repetition of the submissions filed with the TPO. 5.56 In relation to the second part of the question, the learned counsel submitted that the s. 92C(3) provides that the AO may proceed to determine the ALP if he is of the opinion that certain conditions have been satisfied. Relevant extracts of the said sub-section are reproduced as under: "(3) Where during the course of any proceeding for the assessment of income, the AO is, on the basis of material or information or document in his possession, of the opinion that- (a) the price charged or paid in an international transaction has not been determined in accordance with sub-ss. (1) and (2); or (b) any information and document relating to an international transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-s. (1) of s. 92D and the rules made in this behalf; or (c) the information or data used in computation of....
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....TPO/AO clearly demonstrates bias. In this connection, reference is also drawn to Circular No. 14 of 2001 issued by the CBDT, which also provides that only if such deficiency or insufficiency is found in the documentation of the assessee, the TPO/AO can conduct a scrutiny. The relevant extract of the circular has been reproduced below: "Where such onus is discharged by the assessee and the data used for determining the ALP is reliable and correct, there can be no intervention by the AO. This is made clear by sub-s. (3) of s. 92C which provides that the AO may intervene only if he is, on the basis of material or information or document in his possession, of the opinion that the price charged in the international transaction has not been determined in accordance with sub-ss. (1) and (2), or information and documents relating to the international transactions have not been kept and maintained by the assessee in accordance with the provisions contained in sub-s. (1) of s. 92D and the rules made thereunder, or the information or data used in computation of the ALP is not reliable or correct..." Further, even in the case of Mentor Graphics, the Tribunal, at para 39.4 of the or....
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....ee, billable man-hours during the financial year 2002-03 and IN/USD rate of 48.27 (which is the average of the rate on 1st April, 2002 and 31st March, 2003). Further, the TPO in the assessment made for asst. yr. 2002-03 has herself used an industry benchmark of USD 18-25 per hour. If the industry rates are considered as a potential CUP, the man-hour rate of the assessee and the consequent value of the international transactions of the assessee with its AE would be at arm's length. Based on the above three additional analysis/workings, the learned counsel submitted that the international transactions of the assessee with its AE during asst. yr. 2003-04 are at arm's length. 5.60 In case of a reference being made to the TPO, the TPO passed his order under s. 92CA(3), a copy of which is forwarded to the AO. Sec. 92CA(4) (as it stood prior to the amendment made by the Finance Act, 2007) provides that upon receipt of the order of the TPO, the AO shall compute the total income of the assessee 'having regard' to the ALP determined by the TPO. "(4) On receipt of the order under sub-s. (3), the AO shall proceed to compute the total income of the assessee under sub....
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....assessment considering the TNMM as the most appropriate method, disregarding the use of the CUP method as used during the transfer pricing assessment for asst. yr. 2002-03. 5.63 In this regard, the learned counsel submitted that the principles of res judicata, under which, amongst other reasons, unless new facts are brought on record, the conclusion arrived at during the assessment in respect of one year, cannot differ from the assessment in respect of the subsequent year. Further, various High Courts have held that when a question of law or fact is decided in the assessee's own case for an earlier year, the Tribunal will be justified in placing reliance on the earlier decision to base its conclusion, in the absence of any new material or change in circumstances or a fresh look necessitated on existing facts on a closer and more intelligent analysis. Reliance in this regard is placed by the learned counsel on the following decisions: (a) CIT vs. Velimalai Rubber Co. Ltd. (1990) 181 ITR 299 (Ker) (b) Annamalai Reddiar vs. CIT (1964) 53 ITR 601 (Ker) The learned counsel further submitted that in the context of transfer pricing, there is normally a presumpt....
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....sis, the AO/TPO reached at a conclusion in asst. yr. 2002-03 that the pricing of the assessee was at arm's length. Further, all the facts pertaining to asst. yr. 2002-03 were similar to the facts relating to asst. yr. 2003-04, such as: • Nature of services i.e., provision of software development services; • Contractual terms; and • Method of receiving remuneration. Accordingly, the learned counsel submitted that the principles of res judicata should apply in its case, and it is completely inappropriate on the part of the AO/TPO to have reached a different conclusion in asst. yr. 2003-04. 5.67 The arguments of the learned Departmental Representative are therefore factually incorrect. The order for asst. yr. 2003-04 was passed by the TPO and AO in March, 2006. It was only based on the conclusions reached in the proceedings of this year that the CIT subsequently revised the order passed for asst. yr. 2002-03. The revision order for asst. yr. 2002-03 was passed in March, 2007. 5.68 The decision of the Tribunal, Delhi, in Mentor Graphics is the only decision which specifically deals with a captive software development service provider.....
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....e companies having related party transactions are against the basics of transfer pricing and therefore ought not to be considered for the purpose of benchmarking. (d) Adjustment for normal open market risks which the taxpayer was insulated from, being a captive service provider should be made. Some adjustments are adjustments for working capital, risk and growth and R&D expenses, etc. 5.69 The learned counsel submitted that the CIT(A) ought to have followed the guidelines issued by the Delhi Tribunal and provided appropriate relief to the assessee, as the said decision is squarely applicable in the case of the assessee. The following table shown some of the similarities between the assessee and E-Gain Communication being the assessee in the case of E-Gain Communication: S. No. E-gain Communication Philips Software (assessee) 1. E-gain Communication is a captive company rendering software development services to its associated enterprises. (Para 31 on page 23 of the order) Engaged in rendering captive contract software development services to its associated enterprises. 2. E-gain was insulated from all business and operational risks (Para 18....
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....here was no infirmity in the TP study conducted by the assessee, and the TPO erred in disregarding the same for the purpose of computing framing the assessment and making the transfer pricing adjustment. (iv) The TPO or the AO needs to satisfy and communicate to the taxpayer the relevant clause under s. 92C(3) which has been triggered by the assessee, which has necessitated the application of the TP provisions. In the instant case, since this was not demonstrated to the assessee, the transfer pricing order is void. (v) The TPO erred in conducting a fresh study for the purpose of passing his order. The study conducted by the TPO is not in conformity with the provisions of rr. 10B(4) and 10D(4). (vi) The TPO erred in disregarding the most appropriate method adopted by the assessee in the TP study, and also in using the Prowess database. The TPO did not provide any reason for deviating from the TP study in respect of these matters. (vii) The TP study cannot be ignored by the TPO, in the absence of any deficiency or insufficiency. Further, the order passed by the TPO appears to have been passed with the intention of making a higher transfer pricing a....