TaxTMI 
TaxTMI 
2008 (9) TMI 466
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....ee 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. 20,84,81,378. While passing her order and reaching her conclusi....
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.... 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 per cent variance as per proviso to s. 92C(2) of the Act. The CIT(A) erred in not commenting on the issue on exclusion of foreign currency expenditure and high speed link charges from the 'exp....
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....: (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 significant business and operational risks. (b) The assessee is insulated from the following business and operational risks: (i) Market risk; (ii) Product risk; (iii) Warranty risk; (iv) Technology risk; (v) R&D risk; (vi) Intellectual property risk; (vii) Credit and collection risk. (c) The only t....
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....t 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 listed on major stock exchanges like BSE/NSE plus other big unlisted companies. Based on the broad economic activity of the assessee, the 'computer software industry' was selected, wherein a set of 402 companies was generated. On this set of 402 companies, the assessee applied various quantitative (i.e. system based automatic elimination) and qualitative (i.e. manual elimination) filters as below: Filters applied Type of screening No. of....
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...., 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 percentage of operating costs). In line with the provisions of r. 10B(1)(e)(iii), the assessee, while computing the GP and net profit margins of the comparables, made an adjustment to the depreciation charge of the comparable companies. The adjustment was made as the assessee charges depreciation on its assets at a much higher rate as compared to the comparable companies which survived the search process. In other words, the comparable companies charged depreciation on their assets at rates which were much lower than the rates followed by the assessee. As su....
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....e 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 process included comparable companies having their turnover in the range of Rs. 100 crores and Rs. 250 crores. This search process generated a set of 20 companies, out of which, the TPO himself rejected six companies as not comparable to the assessee. Finally, the TPO arrived at a set of 14 companies and compared their average net profit margin on cost with that of the assessee. (d) Most appropriate method: The TPO selected the TNMM over the CPM, without providing any reasoning for doing so. (e) TPO's methodology not known: The TPO did not provide the assessee with any reasons for (i) using the prowess database; (ii) disregarding the most appropriate method as selected by the assessee, and (iii) disregarding the comparability anal....
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....re 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 diversified activities 4.96 Software segment accounts for approx. 43% of the total revenue. 2. Birlasoft Ltd. Rejected Company is having substantial related party transactions 12.05 Data not available. 3. Mascon Global Ltd. Rejected Financial data available related to a period exceeding 12 months. (-) 2.47 The financial Data available relates to 15 month period. 4. Mastek Ltd. Rejected Company is having substantial related party transactions. 34.47 Related party transactions account for more than 90% of the revenue. 5. Pentasoft Technologies Ltd. Rejected Company is having substantial related party transactions. 12.99 Related party transactions account for more than 54% of the revenue. 6. Sasken Communication Technologies Ltd. Rejected Company is having diversified activities. (-) 0.74 T....
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....g 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 return (in the instant case 30th Nov., 2003). However, the TPO conducted a fresh comparability analysis during January-February, 2006, using the data which was not available after the specified date. (e) In the search process conducted afresh by the TPO, he has applied a turnover filter of Rs. 100 crores to Rs. 250 crores without providing sufficient reasons for applying such filters. Though the TPO has not changed the upper end of the filter as applied by the assessee, he has not explained why he considered Rs. 100 crores as an appropriate lower end of the filter. The lower end of the filter applied by him is less than the turnover of the assessee by approx. Rs. 50 crores, whereas the upper end of the filter as applied by him exceeds the turnover of the assessee by approximately Rs. 100 crores. The TPO has indicated that the turnover filter is a very important criteria for selecting or rejecting comparables, showing complete disregard to the functional aspects of a comparable company. The TPO also ap....
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....lar company is enjoying tax exemptions in India, there would be no motive on the part of such a company to shift its profit out of India and hence TP provisions need not be applied to the international transactions undertaken by such a company. It was also argued by the taxpayer before the Tribunal that in the case of the taxpayer the average rate of tax is much lower in India than the tax rate applicable to the AE in Netherlands. The issue has been dealt with by the CIT(A) in her order at para 7.1. The Tribunal Special Bench has also decided this issue in the favour of the Revenue in the case of Aztec Software & Technology Services Ltd. vs. Asstt. CIT (2007) 109 TTJ (Bang)(SB) 892 : (2007) 294 ITR 32 (Bang)(SB)(AT). It is admitted that the TP provisions were introduced primarily to check shifting out of profits from India. But, the incidence of profit shifting has to be determined as per the procedure laid down in the Act. As per the TP provisions, if an international transaction is not at arm's length, an adjustment is required. Thus, shifting of profits outside India has to be determined with reference to the ALP of the transactions. There is no need for the tax authorities ....
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....e in view of the specific provisions contained in the first proviso to s. 92C(4) wherein it has been clearly stated that no deduction under s. 10A/10AA or s. 10B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this section. The Hon'ble Tribunal's conclusion is reproduced below: "It is abundantly clear that the legislature while introducing the enactment did comprehend a situation requiring investigation and addition on account of computation of ALP in cases of the assessee entitled to benefit under ss. 10A/10AA or s. 10B of the Act. In the light of specific provision, it is difficult to contend that ALPs cannot be determined under s. 92C or 92CA where assessee is entitled to benefit of above sections." It was also argued by the taxpayer in the present case before the Tribunal that the above observations in the Aztec case hold good only upto the stage of reference to the TPO. The TPO should independently establish tax avoidance motive before initiating proceedings. This argument is correct neither in law nor on facts. The Tribunal's above mentioned observa....
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.... assets employed in business can be compared. 4.5 The issue of use of contemporaneous data under r. 10B(4) and existence of the data by the specified date under r. 10D(4) are discussed below separately. The taxpayer has only reproduced the provisions of the Act. However, the issue of the role of the TPO versus the AO is as below. 4.6 The learned counsel has argued that the captive service providers-the offshore software development centers of the multinational companies operate in a risk insulated environment. This is not entirely correct; though it is true that the risks undertaken by a captive service provider are different from those undertaken by an independent entrepreneur. The captive service providers have to bear the risks relating to dependence on a single customer. The concept of dealing with a single customer and the inherent risks involved have been discussed by M/s Infosys in its audit report for the year 2004-05 as under: "Client concentration We rely on repeat business based on the strength of our client relationships and a major portion of our revenues come from existing key clients. As the size of a client increases, it limits our pricing flexibility, strengt....
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....t AE's prior written consent. This type of non-compete clauses puts heavy burden on an entrepreneur and normally warrant an extra compensation. No independent entrepreneur would agree to such a restrictive clause without being adequately remunerated. 4.11 The taxpayer's contract with the AE does not guarantee fixed volume of business for any fixed period. As per the agreement dt. 9th Jan., 2003 between the taxpayer and Philips Industrial Activities Belgium, the validity of the agreement is only for a period of 3 months. The cl. 4 of the agreement reads as under: "The commercial agreement covers the period from 1st Jan., 2003 to 31st March, 2003." (Copy of agreement is filed on page 152-155 of Assessee's paper book). 4.12 As per the taxpayer the captive service providers work on a cost plus model of pricing which insulated them from up and down of the market rates. The claim is true only technically. In reality, the AE is exposed to the market fluctuations and the terms of contract between the AE and the taxpayer are determined by the AE according to the market conditions. Further, the volume of business for the captive service provider depends on the AE's....
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....ovider with minimum risk. However, many studies have been conducted on MNCs setting their shops across the globe which have revealed that by multinationalising their operations, these MNCs are in fact decreasing their own risk, if the business risks pertaining to the captive service provider subsidiaries. Moreover, there should be increase in risk level for the MNC parent. However, many studies have been conducted to see how the degree of multinationality produces additional benefits in terms of excess returns or reduced risk and it is found that the degree of multinationality did not a significant influence on the risk and return performance of the MNCs (Degree of Multinationality and Financial Performance: A Study of US-Based Multinational Corporations by Khursheed Omer, David Durr and Philip Siegel). 4.17 The taxpayer has also argued that the independent enterprises earn higher margins because they bear more risk. Thus, according to the taxpayer there is a risk return trade off higher the risk higher the margins. But this hypothesis does not appear to be true. It is already shown above that many of the captive service providers are earning margins better than the industry avera....
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....ng and marketing and the profit margin earned. Companies like Visual Soft and Infotech earned better margins than R.S. Software and Prithivi though the latter had spent more on marketing. Companies like Softsol, Lanco, etc. have not incurred any such expenditure still their margin is much higher. Thus, it is clear that the profit margin of a company is not dependent on the marketing expenditure, etc. Rs. Cr. (F.Y.02-03) Sr No. Name Op. income Op. cost Margin on cost as % Employee. cost Emp. cost as % of total cost Dep. Dep. as % of total cost Selling & marketing exp. (as % of total cost) (Tax Payer's Comparables) 1. Lanco Global 2.78 2.37 17 106 47.6 0.51 21.5 - 2. Melstar 45.29 43.15 4.96 6.13 15.2 2.72 6.75 - 3. Orient 27.93 29.65 -5.8 22.35 75 3.78 12.7 0.17(.6) 4. RS Software 60.29 72.47 -16/3 35.17 48.5 6.92 9.6 16.36 (22.5) 5. Shipara 9.70 8.38 15.76 3.85 45.9 1.65 19.7 1.08(12) 6. SMR (Asia HR) 4.65 4.61 .01 0.18 3.90 2.46 53 0.15 (3-1) 7. Softsol 12.19 9.57 27.3 0.29 03 1.06 11.8 - 8. Visual Soft 122.97 91.47 31.5 71.47 78 10.3 11.3 2.18 (2.3) 9. Amex 11.38 8.68 31 7.52 86.6 ....
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.... * The taxpayer is totally dependent on the AE for business. Thus, the taxpayer takes the risks associated with heavy dependence on a single customer. In common business parlance it is known as 'single customer risk'. * The cost plus agreement with the AE does not guarantee sufficient volume of business for any definite period. The agreement can be terminated by any party at any time after giving a statutory period notice. Thus, the taxpayer is not free from the risk of losing business entirely or losing volume of business. * The AE is exposed to the market risk and any fluctuation in the business conditions of the AE affect the contractual terms between the AE and the taxpayer. * There are many captive service providers earning much better margins than independent risk bearings enterprises and vice versa. Thus, there is no direct correlation between the margins earned and risks taken. * Many business studies have shown that the MNCs are actually distributing their risks by opening captive offshore centres. * The independent entrepreneur has to incur expenditure on marketing, R&D, etc., the expenditure is debited to the P&L a/c. Thus, if undertaking the market r....
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.... IP risk, etc., basically there are two major differences in the risk profile of the com parables and the taxpayer. 4.24 The taxpayer does not have to indulge into marketing of its services. It can depend on the AE to provide it with business. This issue has already been discussed above that as against the market risk the taxpayer is exposed to single customer risk. The present taxpayer spends substantial amounts on advertisement and publicity (Rs. 62,77,152 in asst. yr. 2003-04 and Rs. 71,66,413 in asst. yr. 2002-03). This is inexplicable if the taxpayer is free from the market risk. 4.25 As regards the remuneration on cost plus basis it is pointed out that the taxpayer's agreement with the AE guarantees cost plus returns only with lot of strings attached. The agreement between the taxpayer and the AE as available on p. 156 of the assessee's paper book shows that the maximum, remuneration fixed was 57,000 Euro inclusive of 5 per cent margins for the work to be done from January to May, 2002. Similarly, the agreement between the taxpayer and the AE as available on p. 153 of the assessee's paper book shows that the maximum remuneration fixed was 25,000 Euro inclusive o....
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....this regard which is perfectly justified. 4.29 In the show cause letter the TPO had also clarified that looking to the availability of the data it was not possible to have a comparability analysis at GP level. Hence, the TPO adopted PBIT as the PLI. It is factually incorrect to say that the TPO did not give his reasons for rejecting comparability at GP level which is required under the CPM. 4.30 The TPO did not have to explain use of Prowess database in the same way as the taxpayer was not required to explain use of Capitaline database. The Act does not specify use of any particular database. The TPO was required in the interest of natural justice to disclose the data used by him. This was done. The taxpayer cannot have any grievance. In any case the taxpayer is not arguing that the Prowess database is not reliable or is not available in public. The TPO had very much disclosed the search process adopted by him. It is very clear from show cause letter that the TPO as a first step had considered the companies engaged in software development and having turnover between Rs. 100 crores to Rs. 250 crores the turnover limit was fixed considering the taxpayer's turnover. The taxpayer....
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.... in various ways viz., by search of the database, through company websites, publicly available annual reports of the companies, information available in industry surveys, etc. The Act does not prescribe anyone particular way of collecting the data or selecting the comparables. Ultimately, every selected comparable should stand the test of FAR analysis. The taxpayer has to be provided with an opportunity to give his comments on the new comparables proposed by the TPO along with sufficient supporting data. So far as this requirement of natural justice is fulfilled, the search process or the source of the data used by the TPO is immaterial. In the instant case, the taxpayer has been provided with all the material gathered regarding the comparables selected/rejected. The taxpayer's arguments have been taken into consideration and each comparable has been finally selected or rejected after due FAR analysis. 4.32 In the show cause letter the TPO had made different propositions to the taxpayer. The TPO had mentioned in para 1.4 that the taxpayer's own comparables had an average (PBIDT) profit margin @ 35.20 per cent as against the taxpayer's PBDIT margin of 18 per cent. Hence....
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....s), insurance (Rs. 0.52 crores), repairs (Rs. 5.09 crores), lease and hire charges (Rs. 1.8 crores) and professional charges (Rs. 3.54 crores) were not considered as part of the services. This obviously resulted into a higher GP margin for the taxpayer. 4.36. The TPO rejected the CPM for the following reasons mentioned in the show-cause notice dt. 3rd Feb., 2006 as under: "It may be mentioned here that for the purpose of computing gross margin, accurate data is required in respect of direct, indirect costs and other costs in respect of all the comparables chosen. Since such data is not available operating profit to operating cost/operating profit to operating sales is adopted considering all costs (except interest) i.e. PBIT as PLI." The stand taken by the TPO is correct in law because as per r. 10B(1)(c), the CPM is to be applied as under: "10B. (1) 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, in the following manner, namely: (a) ..... (b) ..... (c) cost plus method, by which, (i) the direct and indirect costs of production incurred....
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....for rendering the services". Still the before mentioned expenses have been excluded by the taxpayer while arriving at the cost. So, the TPO correctly rejected the CPM and applied TNMM as all the costs except interest go into providing services by the taxpayer. Even, the OECD Guidelines say as under in regarding the CPM: "Cost plus method A transfer pricing method using the costs incurred by the supplier of property (or services) in a controlled transaction. An appropriate cost plus mark up is added to this cost, to make an appropriate profit in the light of the functions performed (taking into account assets used and risks assumed) and the market conditions. What is arrived at after adding the cost plus mark up to the above costs may be regarded as an ALP of the original controlled transaction. 2.36 The CPM presents some difficulties in proper application, particularly in the determination of costs. Although it is true that an enterprise must cover its costs over a period of time to remain in business, those costs may not be the determinant of the appropriate profit in a specific case for anyone year. While in many cases companies are driven by competition to scale down price....
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.... recognised that because of the variations in practice among countries, it is difficult to draw any precise lines between the three categories described above. Thus, for example, an application of the CMP may in a particular case include the consideration of some expenses that might be considered operating expenses, as discussed in para 2.39. Nevertheless, the problems in delineating with mathematical precision the boundaries of the three categories described above do not alter the basic practical distinction between the gross and net margin approaches." From the above, the CPM cannot be applied to the taxpayer's case for the following reasons as mentioned in the above OECD Guidelines: "(a) The CPM presents some practical difficulties in identifying the costs incurred for the provision of services like whether an indirect cost is towards rendering services or it is an enterprise level expense. (b) There is no discernible link between the level of costs incurred and a market price in software services as the services are usually compensated on a man-hourly basis which may not vary much across the industry for same or similar type of service. So, CPM is not the appropriate m....
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....ourt held as under: "The taxpayer is required to compute the ALP for a transaction using one of the five methods stipulated in the IT Rules. Rule 10C(1) of the IT Rules defines the most appropriate method as the method which is most suited to the facts and circumstances of each particular international transaction. As per r. 10C(2), the most appropriate method has to be selected having regard to a number of factors which are enumerated therein." 4.38 The apex Court has clearly given primacy to r. 10C(2) for purposes of selecting the most appropriate method, which is wider in scope than r. 10B(2) and has been sought to be relied on by the taxpayer in favour of its arguments against the application of a turnover criteria by the TPO. The Hon'ble Court further observed as under: "... the methods quoted above, namely, CUP, RPM, CPM, PSM and TNMM 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 facts and circumstances of each particular international transaction..." The Supreme Court has also held TNMM to be the most appropriate method in the case of service PE-"in our view apart from the orders pass....
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.... turnover less than Rs. 50 crores the smallest comparable had turnover of only Rs. 7.41 crores. The TPO found that the taxpayer's selection of the comparables was skewed. 4.42 The TPO therefore applied a minimum turnover limit of Rs. 100 crores and maximum turnover limit of Rs. 250 crores as a criterion. The taxpayer had taken upper side turnover limit of 160 per cent of the taxpayer's turnover of Rs. 151.75 crores. The TPO therefore applied the same limit on the upper and lower both sides Le. companies having less than 60 per cent of the taxpayer's turnover, rounded off to Rs. 100 crores, were also excluded. The taxpayer has also argued that the TPO accepted the higher side limit of Rs. 250 crores, i.e., Rs. 100 crores more than that of the taxpayer whereas on the lower side, the limit is only Rs. 100 crores i.e. Rs. 50 crores less than that of the taxpayer. This interpretation of the taxpayer is misleading. The argument is unsustainable because in percentage terms, the limit applied by the TPO on higher side as well as on lower side is more or less identical to 60 per cent less or 60 per cent more than the turnover of the taxpayer. Further, the upper limit is the sam....
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....xcept for M/s Visual Soft all other comparables did not have even half of the taxpayer's turnover. Thus, the selected companies were not comparable in size and turnover to the taxpayer. (c) The taxpayer excluded 36 companies as they were carrying out diversified activities. But, nowhere it is clarified as to what constitutes diversified activities. Companies such as Geometric Software, Infotech Enterprises, etc. were eliminated though these companies are mainly into software development. (d) The taxpayer excluded 8 companies as they were rendering predominant services to their AEs. However, the taxpayer has not clarified the meaning of predominant. Melstar Information selected by the taxpayer had 50.12 per cent related party transaction in financial year 2002-03 and 17 per cent related party transactions in financial year 2001-02. Similarly, M/s Softsol had almost 100 per cent transactions with the related parties in the financial year 2002-03 as well as financial year 2001-02. The taxpayer should not have selected these companies as comparables as per its own filter. (e) The taxpayer excluded companies incurring loss at the gross level because they do not represent the i....
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.... clients place i.e. outside India. The employees have to be paid in line with salary structure of that country. This practically wipes out the margins resulting from the low salary structure prevailing in India. Thus, an onsite service provider company works at relative disadvantageous position. M/s Orient should not have been selected as a comparable. (v) M/s SMR Universal had total revenue of Rs. 4.65 crores in financial year 2002-03 and employee cost of only Rs. 0.18 crore i.e. less than 5 per cent of the revenue. No software company can work without employees. The employee strength is reflected in the employee cost. The taxpayer had 46 per cent of its revenue spent on employee cost. Apparently, SMR did not have enough employees to indulge in software development. The major expenditure in the case of SMR is other operating expenses, though full details of such expenses are not available in the database. The company deserves to be excluded from the comparable set. These issues were not examined and discussed in detail by the TPO in his order as most of the taxpayer's com parables failed the turnover filter itself. Contemporaneous data-The issue has been discussed in detai....
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.... data available. (ii) The second stage is when the taxpayer undertakes the transfer pricing analysis as required by the Act and files the 3CEB report. This is a post facto exercise. The taxpayer has to use the contemporaneous data as available to him at the time. The provisions of r. 10D(4) are applicable at this stage. But, at this stage the taxpayer is not permitted to use earlier year's data unless the conditions mentioned in the proviso to r. 10B(4) are satisfied. (iii) The third stage in the transfer pricing analysis is when the TPO takes up the transfer pricing audit. The TPO is also bound to use the contemporaneous data. However, there is no restriction in the Act or the Rules that the TPO should confine himself to those data which was available to the taxpayer at the time of 3CEB audit. The TPO is expected to use all the material and facts available to him at the time of transfer pricing audit. (iv) To sum up, the TPO was correct in law and facts in using the current year's data for comparability analysis. 4.48 The issue of the turnover filter has already been discussed above. Apparently, the turnover range adopted by the TPO gave closer comparables than the ....
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....ve related party transactions in one year, but may have them in the next year. The companies may change their business or may get acquired by different companies, etc. All these changed facts would have a bearing on selection of comparables. Therefore, it is quite likely that some of the comparables chosen in the earlier year may not qualify the test of uncontrolled transaction in the succeeding year. Thus, in transfer pricing proceedings it is not possible to apply res judicata. 4.52 Besides, the original order for the asst. yr. 2002-03 has been set aside by the CIT as the same was found erroneous. The taxpayer cannot argue that an erroneous order is also to be followed. As is discussed by the CIT(A) in her order and also in the order passed by the CIT under s. 263 for the asst. yr. 2002-03, the CUP is not a proper method to be applied in the taxpayer's case. This view is also upheld in the case of Aztec by Hon'ble Tribunal, Bangalore, wherein the TPO has used CUP method and adopted the average billing rate shown by Nasscom. The matter is restored to the AO by the Tribunal as under: "161. Having noted that hourly rate of billing would vary depending upon qualification a....
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....termined by the TPO unless there are very good grounds to modify or alter the transfer pricing ordered by the TPO. Only after recording reasons, as above, the AO can take the transfer price other than one determined by the TPO. There may be cases in which the assessee, after ALP is determined by the TPO and before his order is made the basis of assessment, may get such authentic material to show that transfer pricing determined by the TPO is not correct or should not be blindly adopted without modifying it. However, in the cases before us, the AO adopted the orders of the TPO and computed assessments accordingly. We see no illegality in the procedure followed by the AO and therefore do not approve of the contrary observations of the learned CIT(A) in the impugned order." The Tribunal had also considered meaning of the words 'having regard to' and the amendment to s. 92C(4) in its order at paras 52, 53 and 54 as under: "52. As far as decision of the Supreme Court in the case of Rajesh Kumar & Ors. vs. Dy. CIT & Ors. (2006) 206 CTR (SC) 175 : (2006) 287 ITR 91 (SC) is concerned on which strong reliance was placed, their Lordships, as already noted, have observed that the e....
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....rds 'having regard to' have been replaced by words 'in conformity with'. So, now, AO after introduction of sub-s. (4) above is required to pass assessment order in conformity with the order of the TPO determining ALP. Now the order of the TPO has been expressly made binding on the AO. From the above it is clear that there was a lacuna in the Act as appropriate language was not used earlier. This has been modified and w.e.f. 1st June, 2007, the order of TPO is binding on the AO who now has no choice but to pass an order in conformity with the order of the TPO. The word 'having regard to' did not convey the same meaning. For all the aforesaid reasons, we hold that prior to substitution of sub-s. (4) by a new section, the order of the TPO was not binding on the AO. 54. .... Ordinarily, without strong reasons, the AO should not challenge the transfer pricing determined by the TPO and bring to naught his efforts after receipt of the reference. Our observations that it was not binding on the AO, prior to 1st June, 2007 are meant to convey that the assessee even before the AO could file evidence and show that ALP shown by the assessee is quite reasonable and shoul....
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....tunity has to be given to the assessee before determining such price. Thereafter, as provided in sub-s. (4) of s. 92C, the AO may compute the total income on the basis of the ALP so determined by him." The Board's circular referred to by the taxpayer also states that the taxpayer's ALP can be accepted only if the data used is reliable and correct. In this case, it has been demonstrated by the TPO as well as by the CIT(A) that the data used by the payer was not correct. The circular did not grant an amnesty to the taxpayers. 4.56 The taxpayer had eliminated 8 companies from the comparables set on account of their having controlled transactions. The taxpayer had applied a filter of eliminating companies with predominant related party transactions. However, in the TP study, the taxpayer did not elaborate further on this filter. As mentioned above one of the comparables selected by the taxpayer, Melstar Ltd. had related party transactions amounting to 50 per cent of the company's turnover and another of taxpayer's comparable Softsol had almost all its sales to the related party only. Thus, there was no consistency in the taxpayer's approach on the issue of related....
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....e to case. If such transactions with the related parties are significantly affecting the overall enterprise level profits of that company, then certainly that company would have to be excluded from the list of comparables. On the other hand if the related party transactions constitute a minor and insignificant part of the overall turnover, then the same may not affect the overall margins of the company and hence that company may still be retained as a comparable subject to functional similarity. 4.60 To overcome the difficulty of eliminating companies with significant controlled transactions but at the same time retaining an adequate number of comparables, it was thought proper to exclude all those companies who had related party transactions in excess of 25 per cent of their operating revenue. 4.61 Though it may be ideal to select only those companies which have nil related party transactions, it would not be a practical approach because almost all the companies have related party transactions to some extent. Nil criteria would result into elimination of all the companies or selection of very few and very small companies which may not give sufficient base for comparison. 4.62 T....
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....ny. Thus, it is seen that 20 per cent or 26 per cent interest is considered as substantial interest. As the provisions of s. 92A(2)(a) are from the transfer pricing chapter itself, a limit of 25 per cent may be considered more reasonable to be applied as the threshold limit for the related party transactions. If the limit is reduced further it would only result in eliminating more and more companies. On the other hand, if the limit is relaxed then companies with predominantly related party transactions would get included which would not represent uncontrolled transactions. Therefore, on balance 25 per cent appears a proper threshold limit for related party transactions. The companies having more than 25 per cent related party transactions should only be rejected as comparables. The OECD Guidelines regarding adoption of enterprise level profits in TNMM and treatment of partial controlled transactions are reproduced below: "3.42 An analysis under the transactional net margin method should consider only the profits of the AE that are attributable to particular controlled transactions. Therefore, it would be inappropriate to apply the transactional net margin method on a company-wis....
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....ment that companies with higher margins should have been excluded is not in accordance with the TP provisions. The TPO had resorted to normalization of the profits of some of the comparables only in order to take a liberal view in the whole matter. To some extent the normalization of profits compensated for various risk adjustments was asked for by the taxpayer. The taxpayer should not have any grievance. There was a substantial difference between the employee cost to sales ratio in the case of the taxpayer and in the case of the two companies whose profits were normalized. The taxpayer has a sales to employee cost ratio of 45.5 per cent (employee cost/sales) as against the same in the case of Hinduja TMT @ 20 per cent and in the case of Infotech Enterprises @ 34.10 per cent. The process of normalization was therefore required. Moreover, it is also mentioned here that M/s Infotech had only 31.78 per cent margin on cost which is only slightly higher than the normalized margin @ 28.61 per cent (the margin in the case of Visual Soft). 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 com....
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....Here, we may see that the companies selected by the taxpayer were also engaged in diversified activities and different verticals of software. Hence, verticals of software were never a criterion of comparability either in the taxpayer's selection or the TPO's selection. Thus, the TPO's comparables cannot be found fault with on this account. The comparables selected by the taxpayer were engaged in diversified activities as mentioned below. Lanco Global renders services in the following sectors: Solutions * IT Governance, Compliance & Security Services * Enterprise Resource Planning * SAP * Oracle * 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, ins....
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....on, the issue had been discussed by the CIT(A) at para 8.7 of her order. 4.66 The taxpayer asked for adjustment on account of depreciation on the ground that the taxpayer had charged depreciation at higher rate than the comparables. This is not acceptable for the following reasons: (A) Under 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 adjustm....
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....er on the basis of average rate of depreciation is thus not acceptable. (C) The taxpayer has consistently applied depreciation @ 43 per cent on a straightline method. Consequently, the closing WDV of assets in the case of the taxpayer is reduced to that extent, whereas 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 acc....
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....as such book intangible assets are typically the result of acquisitions, and do not include internally developed intangibles. 138. Depreciation and amortisation can pose difficult comparability issues, for instance, if two 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 considere....
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....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 the taxpayer's (tested party) margin may be reworked out by applying lower depreciation rates as per....
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....rged 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 by taking only the data of the current year. He fairly conceded that the Special Bench in the case of Aztec has also taken th....
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.... 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 directions on functional comparability but the same are not very specific. In the Mentor's case the Tribunal finally accepted the taxpayer's comparables which included a trading company. Thus the Tribunal....
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....ases 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. If the relevant conditions of the controlled transaction (e.g. price or margin) fall outside the arm's length range asserted by the tax administration, the taxpayer should have the opportunity to present arguments that the....
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.... 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 case.' In the statutory 3CEB Form also, the term used is 'most appropriate method' and not methods. The aspect of the most appropriate method and average mark up of comparable companies was discussed by the Hon'ble Supreme Court in its order in the case of Director of IT (International Taxation) vs. Morgan....
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..... 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 the Tribunal order. 4.78 In brief the Tribunal found that: (a) The TPO erred in considering the data for the financial year 2003-04 while determining the related party transactions in the case of comparables of the financial year 2001-02. (b) The TPO had adopted contradictory approaches by rejecting the taxpayer comparable for being not based on conte....
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....rading 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 fresh transfer pricing analysis. It has already been discussed above at para 17.5 that the Tribunal's approach on the issue is not in line with the provisions of the Act. Had the Tribunal not followed this approach, it is apparent that the Tribunal would have undertaken a fresh transfer pricing analysis to determine the ALP. 4.82 The taxpayer is a part of the software industry in India. It is worth mentioni....
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....y 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 taxpayer, can substitute their own ALP on the basis of material or information furnished by the assessee or collected by them. However, such ALP has to be determined having in mind provisions of ss. 92 and 92C and other rules and regulations. While determining ALP, tax authorities are bound to follow principles of natural justice and be fair and reasonable to the taxpayer. Any material collected to be used against the taxpay....
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.... 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 today, the databases do not show more than 20 to 30 software companies in this turnover range. However, if the taxpayer is correct, then the Hon'ble Tribunal may direct the taxpayer to produce the list of the 200 software companies having turnover between Rs. 100 crores to Rs. 250 cores so that suitable comparables may be searched from these companies. * The taxpayer has argued against the 'significant' related party transactions filter, ....
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....rch 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 extensive know-how and expertise in the software engineering and technology domains relevant to its business. PSCPL's software expertise is primarily in the areas of embedded and information system engineering, architecture design, programming and testing. PSCPL's IC design expertise is in the areas of logic and circuit design. In addition, competencies in the areas of project management, requirement engineering and quality assurance have been established to offer customers, products and services of the hi....
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....08 (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 dealt with in detail by the CIT(A) in her order. The taxpayer's reliance on the Tribunal's decision in the case of Development Consultants (P) Ltd. is of no avail, because in that case no arguments were relied on this issue either by the Department or by the taxpayer. The computation of the ALP as submitted by the taxpayer before the Tribunal was not refuted by the Departmental Representative and hence was approved by the Tribunal as under 22. The learned AR Submitted that in case of AY 2003-04, the arm's length GP/Sales of the comparable companies is 28.22% which is lower than the GP/Sales of ....
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....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 would give such credit limits to a paper company. DCIL has been established after proper permission obtained from the RBI. Hence, based on the facts and our findings we can conclude that DCIL is a company of substance and is performing fullfledged distribution activities. It is not a paper company established to evade taxes as argued by the CIT(A) in his order. Hence, we do not find any justification in the arguments of the CIT(A) that entire profits should come to the assessee and DCIL should not retain profits. Further, the benchmarking exercise and analysis conducted by the assessee has been examined by the CIT(A) and the TPO, but they have not been able to controvert the analysis of the assessee. Therefore, we conclude DC....
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.... 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 jurisdiction for the purpose of avoiding tax in India. The reference by the Departmental Representative to the proviso to s. 92C(4) is completely out of context and irrelevant. The Departmental Representative ought to have appreciated that the proviso comes into play only once a transfer pricing adjustment is made. By quoting OECD Guidelines, the learned Departmental Representative does not get much help. The learned Departmental Representative ought to have appreciated that what is relevant in the Indian context is the specific provisions of the Circular No. 14 of 2001. As submitted above, at para 55.5 of the said circular, the CBDT has clearly mentioned that the intention of the TP provisions is to curtail avoidance of taxes by s....
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....hat 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 provisions of transfer pricing in the Act, vide Finance Act, 2001. Relevant extract of the CBDT circular is reproduced as under: "55.5 The new provision is intended to ensure that profits taxable in India are not understated (or losses are not overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country's tax base." 5.5 As per the above-mentioned circular, the TP provisions ought to be applied to cas....
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....retion 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 transaction is more than Rs. 5 crores or not. If it is more, he has also to grant approval in the light of directions of CBDT. These directions are mandatory and binding on the AO and the CIT(A). The fact that directions are not binding on the assessee or Courts is immaterial. The relevant question to be answered is whether circulars are binding on the Departmental authorities. The question has an obvious answer. The issue of legality and validity of above directions was raised before Hon'ble Delhi High Court in the case of Sony India (P) Ltd. Their Lordships have also upheld validity of directions of CBDT. 45. In the light of above discussions, we do not find any illegality in the directions issued by the CBDT." Since the circulars issued by the CBDT have a binding ....
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....1 [(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 in the event of material information or document in his possession on the basis of which an opinion can be formed that any such circumstance exists. In all other cases, the value of the international transaction should be accepted without further scrutiny." Based on the above mentioned para, it is clear that the intention of s. 92C(3) has always been that scrutiny of the international transactions of an assessee can only be done if the AO/TPO can prove that the circumstances enumerated in cls. (a) to (d) are satisfied. Even where any infirmity is identified by the AO/TPO, the action of the AO/TPO would be restricted to taking remedial action commensurate with the infirmity identified by him, and not beyond. For instance, if there is a finding, based on evidence, for satisfaction of the condition of s. 92C(3)(d), the AO/TPO could, at best, use h....
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....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 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 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 order have observed as follows: "The TPO could have carried fresh search only if the comparables drawn by the taxpayer were insufficient or had other deficiency." The Act and the Rules provide that while conducting the comparability analysis, the data to be used should be contemporaneous. In this r....
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....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, the book written in 2008 would not satisfy the test as it would not be contemporaneous, and also would not exist by the specified date. 5.7 In the context of the argument of the assessee, the CIT(A) in her order has observed that the provisions of r. 10D(4) do not override the provisions of r. 10B(4). Thus, inter alia, the data for financial year 2002-03 shall be used, even though the same was not available by the specified date. For the reasons as discussed above, the assessee submitted that the above observation of the CIT(A) is clearly contrary to the provisions of rr. 10B(4) and 10D(4). The assessee therefore submitted that the TPO/CIT(A) is not justified in: (a) conducting a fresh comparability analysis during the course of the assessment; and (b) using non-contemporaneous data, i.e., data which was not available* as on the specified date. It would not be out of place to quote the following observation of ....
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....us 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 satisfy the conditions of r. 10B (4) and the other that would satisfy the conditions of r. 10D(4). 5.8 Rule 10B has been framed under s. 92C and r. 10D has been framed under s. 92D. Sec. 92C expressly refers to the documentation referred to in s. 92D. Sec. 92D provides as follows: "(1) Every person who has entered into an international transaction shall keep and maintain such information and documentation, in respect thereof, as may be prescribed...." Further, the operative portion of r. 10B reads as follows: "(1) Every person who has entered into an international transaction, shall keep and maintain the following information and documents, namely,....." On a combined reading of ss. 92C and 92D, and rr. 10B and 10D, it is clear that the data used for the purpose of conducting a comparability analysis should relate to the relevant financial year [if the proviso to r. 10B (4) is not attracted]; and be available as on the specified date. It should be noted t....
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....the international transaction." The guidance issued by the ICAI clearly specifies that selection of the most appropriate method should be based on a meticulous appraisal of facts and circumstances. In the TP study, the assessee had carefully evaluated the five prescribed methods, and based on the facts, the assessee selected CPM as the most appropriate method. The analysis of the assessee is documented in pp. 85 and 86 of the paper book. To support the results achieved by applying the CPM, the assessee had also selected the Transactional Net Margin Method (in short TNMM) in its TP study. However, while conducting his comparability analysis and passing the order, the TPO did not provide any reasons for rejecting the CPM, which was selected as the most appropriate method by the assessee. Further, the TPO selected the TNMM as the most appropriate method, without sharing with the assessee any analysis, basis or reasons which led him to: (a) select the TNMM as the most appropriate method; and (b) reject CPM, as selected by the assessee, as the most appropriate method. Secs. 92D and 92E cast a responsibility on the assessee to prove that the requisite transfer pricing documentation....
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....documentation; and * the data used by the assessee was reliable and correct. Very clearly, in the instant case, the TPO/AO has not discharged the onus of proving that the methodology followed by the assessee is erroneous in any manner, before rejecting the same. The learned counsel submitted that TPO is not justified in considering another method as the most appropriate method, even though there is no shortcoming in the method adopted by the assessee in the TP study. Reference in this connection can also be made to the decision of the Delhi Tribunal in the case of Mentor Graphics. At para 39.4 of the said order, the Tribunal has observed as follows: "The TPO could have carried fresh search only of the comparables drawn by the taxpayer was insufficient or had other deficiency." Further, reference in this connection could also be made to the decision of the Madras High Court in the case of CIT vs. K. Sankarapandia Asari & Sons (1980) 19 CTR (Mad) 264 : (1981) 130 ITR 541 (Mad). 5.11 A look at the show-cause notice referred to by the Departmental Representative clearly shows that the argument of the Departmental Representative is erroneous as in the said notice, no reasons were....
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....ose of concluding the transfer pricing assessment, the TPO used another database (i.e., Prowess). The TPO did not: (a) question the database used by the assessee; (b) question the data which emanated from such database; (c) specifically reject the database used by the assessee; and (d) provide any reason for using the new database. 5.13 The learned counsel therefore submitted that since the TPO has not rejected the basis (including the database used) of conducting the comparability analysis by the assessee, using a completely different basis is an erroneous approach followed by the TPO. In other words: (a) where the assessee has followed a methodical process while conducting the TP study, with a recognized database and a correct approach. (b) the approach followed by the assessee is in consonance and in conformity with the requirements of the law; and (c) there is no shortcoming or deficiency in the approach of the assessee. There is no reason as to why the TPO/AO should conduct a fresh transfer pricing analysis, completely disregarding the approach of the assessee which is acceptable in law. The assessee submits that the approach followed by the TPO/CIT(A) to rejec....
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....e parties to the transactions; (c) the contractual terms of the transactions, dividing the risks, responsibilities and benefits between the parties to the transactions; (d) conditions prevailing in the market of the respective parties to the transactions, including the laws, economic development, level of competition, etc. It would also be relevant to note that the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations issued by the OECD, at pp. 1-9 to 1-15, lays down the following five factors which should be considered for conducting a comparability analysis. The said five factors, which are very similar to the provisions of r. 10B(2), are as under: (i) Characteristics of property or services; (ii) Functional analysis; (iii) Contractual terms; (iv) Economic circumstances; and (v) Business strategies. From the above, it is clear that the focus is on the functions performed and the reference to other economic criterion is only in the context of the functions. It would also be relevant to note that in the order, the TPO has admitted that the comparables are functionally similar. The relevant extract is reproduced below: "Even though the c....
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.... in the TP study of the taxpayer only if the comparables are insufficient or deficient. A mere variation in the turnover of the comparables does not alone qualify as a reason sufficient to reject functionally comparable companies. The above view is also supported by the decision of the Delhi Tribunal in Mentor Graphics. At para 39.4 of the order, the Tribunal has observed as follows: "The TPO could have carried fresh search only if the comparables drawn by the taxpayer was insufficient or had other deficiency." 5.21 As indicated earlier, the TPO has not given any reason as to why the comparables in the TP study were insufficient/deficient and liable to be rejected. At this juncture, it would also be relevant to take note of the following observations of the Pune Bench of Tribunal in the case of E-Gain Communication (P) Ltd. vs. ITO (ITA No. l685/Pn/2007) [reported at (2008) 118 TTJ (Pn) 354 : (2008) 13 DTR (Pn) 65-Ed.] at para 36. p. 34 of the order: "The learned CIT(A) was justified in taking entities having turnover between Rs. 5 crores to Rs. 25 crores but he was in error in considering turnover as the only relevant factor needed to be considered for a proper analysis. What....
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....ons; (c) ....." A mere reference to assets employed or the turnover, disregarding the functions performed would be an erroneous approach. In this connection, the learned counsel also drew reference to the decision of the Pune Bench of the Tribunal in the case of E-Gain Communication. At para 36, p. 34 of the order, the Tribunal has observed as follows: "The learned CIT(A) was justified in taking entities having turnover between Rs. 5 crores to Rs. 25 crores 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." Further, the example of a automated vis-a-vis manual manufacturing unit as given by the Departmental Representative is not supported by logic. The products from a handloom would be commercially different from those produced through a powerloom. For example, a hand made Sari would typically cost more as com....
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....d that unlike the tax Department, it has not selected comparables. 5.25 The assessee had identified the appropriate category in the database of companies and had used filters for eliminating companies that are not comparable to it. The filters used for eliminating companies are system based (quantitative filters) and manual eliminations (qualitative filters). The final comparables are those companies that have survived all the elimination filters. On the other hand, the tax Department has resorted to cherry picking comparables (typically those companies which are making huge profit margins) without explaining the basis and rationale thereof. This is also clear from the way the Department has 'normalised' the profits of super profit making companies. 5.26 The learned counsel submitted that the turnover range selected by it is not 'arbitrary'. Further, the Departmental Representative has not defined what is 'arbitrary' for him. A turnover filter (system based filter) of Rs. 100-250 crores (that the Departmental Representative claims to be relevant in the instant case) if used now will give an initial set of around 20 companies only. At the time of doing the ....
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....y the taxpayer, to support the ALP, was too small to come to any general conclusion." It is quite evident that the sample size data selected by the TPO (i.e., 20 companies) was very small and not sufficient to apply any meaningful elimination filters for arriving at the final set of comparables. Even if one were to now do a broad search for a universal set of companies for 'computer software/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). The turnover filter applied by the TPO is without any basis. Further, the Departmental Representative's computation argument of a range of +/(-) 60 per cent from the turnover of the assessee is not factually correct. At the lower end, the TPO has reduced 33 per cent and at the higher end, the TPO has increased 66 per cent for arriving at his filters. This itself shows the arbitrariness in the procedure of the TPO. Without prejudice to the submission that there should be no variation in the turnover filter applied by the assessee, even based on the upper turnover filter of 66 per cent applied by the TPO, if th....
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....tified and included in the balance sheet. There is no basis for concluding that employee cost being in the same range of turnover would mean that asset bases are comparable. 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 to USD 29.24, as computed below: Particulars Amount Remarks Total Revenue (A) Rs. 1517550646 Source : statement. As per financial Billable hours (B) Rs. 1075077 This detail was filed before the TPO; please see pages 216-217 of the paper book. Rate per man hour (A/B) Rs. 1412 Rate per man hour (In USD) USD 29.24 Using the exchange rate of USD 1 = Rs. 48.27, which is the average of rates as on 1st April, 2002 and 31st March, 2003 (source: www.oanda.com) 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. The Departmental Representative has completely missed th....
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....referred to the transfer pricing assessments made in other cases. In connection with the above, the assessee draws attention to r. 10A(a) which defines the term 'uncontrolled transaction' to mean: "a transaction between enterprises other than AE, whether resident or non-resident." As is clear from the above definition, for the purpose of the comparability analysis, the comparables should not having transactions with its AE. In other words, a company having any related party transaction (i.e., even a single rupee of related party transaction) should not be considered as a comparable company. This view is also supported by the decision of the Delhi Tribunal in the case of Mentor Graphics. At para 35 of the said order, the Tribunal has observed that: "In the first place, while screening and filtering of comparables, he took into account companies which were dealing with their related companies either as subsidiaries or as parent companies. Thus, controlled transactions were taken into account which is against the very basics of the transfer pricing guidelines." The above view is also supported by the OECD. In the draft notes on comparability issued by the OECD, it has be....
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.... be excluded from the set of comparable companies. As submitted above, the above matter is clearly covered by the provisions of r. 10A(a), and the decision of the Tribunal in the case of Mentor Graphics, both of which establish that for the purpose of the comparability analysts, the comparables should not be having any transactions with its AE. At one end, the Department has thought it fit to relax the conditions of r. 10A relating to controlled transactions, for getting a larger number of comparables. On the other hand, the TPO has altered the range of turnover filter applied by the taxpayer, which has resulted in a reduction of the sample size of comparables. In other words, when it suits the Departmental Representative/TPO, they seek shelter under practical reasons for tweaking the law to suit their convenience. Further, the reference drawn by the Departmental Representative to various other sections [such as s. 40A(2)(b) and s. 92A(2)(a)] to justify the selection of 25 per cent as the cut-off is misplaced. In fact, as submitted above, the provisions of r. 10A(a) clearly prove that where the legislature intended to give a cut-off they had provided the same in the relevant sectio....
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....stics of the controlled transaction. This is necessary to find whether comparable selected are really comparable and reliable. Comparison based on functional analysis include economically significant activities and responsibilities undertaken or to be undertaken by the independent and AE. The structure and organisation of the group, and more particularly the judicial relationship between different entities of same group are to be seen. The function that needs to be identified while carrying comparison as per GECD Guidelines include design, manufacturing, assembling, R&D, servicing, purchasing, distribution, marketing, advertising, transportation, functional and management activities. It is also necessary to examine as to what is the principal function of the entities. The analysis of comparison should consider total assets employed and assets used to earn profit. The risk assumed by respective parties is a very important consideration. It is a simple principle of economics that the greater the risk, the greater the expected return (compensation). If there are material and significant differences in the risk involved then the comparable identified are not correct as appropriated adj....
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....n risk profile. The Departmental Representative also ignored the following: (i) the assessee is working on a cost plus model and is earning constant/consistent profit in the current and past years, and is also likely to make consistent profit in the foreseeable future; (ii) the assessee's quantum of business has increased considerably. The revenue from software development services in the financial year 2001-02 was Rs. 137 crores which increased to Rs. 207 crores in the financial year 2003-04. (iii) the levels of risk would be significantly different as between service provider who has a single third party customer and another service provider who has a single (or for that matter, even multiple) captive customer(s). To explain the above by way of an example, if two manufacturing companies are considered (i) ABC Ltd. which is a captive contract manufacturer supplying corrugated boxes only to its parent company in USA, namely ABC Inc. and (ii) XYZ Ltd. which is an independent company supplying identical corrugated boxes only to ABC Inc. (i.e., ABC Inc. is an independent client for XYZ Ltd.). Apart from this difference, both ABC Ltd. and XYZ Ltd. operate identically with re....
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...., no doubt, the flow of business to the captive service provider could also come down. However, the AE would still continue to compensate the captive service provider for such reduced work at full cost plus a reasonable mark up. 5.31 Compare this situation with the AE giving work to a third party service provider during a slow down. The AE might bargain hard on the price and the third party service provider might even agree a lower price just to keep his business going during the slow down. The fact that a captive service provider (a separate and distinct legal entity in India) is assured of business from an AE (another legal entity outside India) and is compensated at a consistent reasonable mark up over costs incurred by it (i.e., the captive service provider) is sufficient to demonstrate that the captive service provider is effectively insulated from all business risks and, as such, any mark up ought to be only commensurate with the captive service provider's risk taking ability, and not beyond. During the course of the hearing, the Departmental Representative referred to the commercial agreements to demonstrate that the assessee also carries on pricing risk as there is an ....
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....n of transfer pricing is consistent with the arm's length principle." Page 26: "18. In addition, if the selection process is not transparent to the taxpayer, it cannot verify whether or not the process is subjective/objective, reliable/unreliable, therefore, whether the result is right or not. Because the identity of the comparable is not disclosed to the taxpayer, the taxpayer cannot evaluate the objectivity/reliability of the selection process from the result." Based on the above, the learned counsel submitted that the data provided by the Departmental Representative in his submissions is clearly 'secret comparables' and cannot be considered during the course of these proceedings. The final comparables that were accepted by the Tribunal in the Mentor Graphics and E-Gain Communication clearly demonstrate that there are many other companies that are making net profit margins in the range of 5 to 10 per cent. In fact, the margins of the assessees in both these cases were in the range of 5 per cent to 7 per cent. The list of 25 companies is new material produced for the first time before the Tribunal. No such argument was raised during the course of assessment proceedi....
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....tional contributions and advertisement for recruitment. The above expenditure has been incurred to create awareness with a view to attract potential employees and has nothing to do with market risks. Independent of the above, since all of the services of the assessee are rendered to its AE, there is no marketing risk borne by the assessee. This has also been established in the TP study of the assessee. It should also be noted that the assessee does not have any marketing department. In any case, the assessee operates on a cost plus model, and all costs are included in the cost base for recovering from the service recipients. 5.36 The learned counsel submitted that the 'risk return trade off is not a hypothesis, but a simple and well accepted principle of economics. The Tribunal in case of Mentor Graphics has also confirmed this proposition. Relevant extracts of the said decision are reproduced as under: "27.....It is a simple principle of economics that the greater the risk, the greater the expected return (compensation)." With regard to objection raised by the Departmental Representative relating to increase of mark up from 5 per cent to 10 per cent, the learned counsel ha....
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....y for earning profit, and but for such marketing being vigorously undertaken, the profit would not accrue. Further, the Departmental Representative has not appreciated the purpose of arithmetical mean [proviso to s. 92C(2)] and the adjustments to be made to the margins (r. 10B). The proviso to s. 92C(2) provides an option to the taxpayer to consider the arithmetic mean of the prices determined. On the other hand, r. 10B(1)(c)(iii)/(e)(iii) provides that the margins of the comparable companies needs to be adjusted to take into account the functional and other differences which could materially effect such margins in the open market. Accordingly, in addition to the adjustment for arithmetic mean, adjustments on account of risk are clearly envisaged in the Rules, and both co-exist. 5.39 Out of the final set of comparable companies [as approved by the CIT(A)], the CIT(A) has identified two companies as being companies earning super profits. The CIT(A) has 'normalised' the margins of such companies, by replacing their profit margins with the profit margins of the next highest profit making company from the set of final comparables. 5.40 Rule 10B(1)(c)(iii)/10B(1)(e)(iii) allow....
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.... or the arithmetical mean margin of the comparable companies. Without prejudice to the above, at one extreme, the assessee can also counter-argue that the CIT(A) ought to have normalized the margins of these two companies using the margin of the lowest profit making company in the set of comparables as approved by the CIT(A). 5.43 The issue of exclusion of high profit making companies has been addressed by the Tribunal in the case of Mentor Graphics as well as E-Gain Communication. In the case of Mentor Graphics, the Tribunal has observed as follows: "46.1 We are not taking into account high profit or high loss making companies as comparables." Further, in the case of E-Gain Communication, the Tribunal has, at para 37 of the order, commented as below: "A cursory look at the chart in the assessment order of 20 comparables would reveal that the margin of profit shown by Thirdware Solutions Ltd. and WTI Advanced Technology is extraordinary at 67.65 per cent and 54.72 per cent respectively." 5.44 The Departmental Representative has mentioned that the TPO has taken a liberal view by way of normalizing the margins of the companies accepted to be making 'super profits.' Th....
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....e acceptable in principle. However, she has rejected the claim of the assessee for an adjustment for the different depreciation policy followed on the basis that the method adopted by the assessee for making the adjustment was too 'simplistic.' In relation to the above, the learned counsel submitted that the CIT(A) is of the opinion that making an adjustment based on rates of depreciation is too simplistic, a more systematic basis of making the said adjustment needs to be done. The CIT(A) has not expressly rejected the need for making such adjustment in the instant case. In such a scenario, if the CIT(A) believed that the methodology of the assessee was too simplistic, the CIT(A) ought to have computed the adjustment using a method which she found appropriate. At this point, the assessee would also like to highlight that the TPO had normalized the margins of super profit making companies by simply using the profit margin of the next highest profit making company. The approach of the TPO was also approved by the CIT(A). Neither the Act nor the Rules prescribe any method for normalizing super profit margins of companies. At one end, the CIT(A) has termed the depreciation adj....
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....d, then the comparables identified are not correct as appropriated adjustments for differences in such cases are not possible. Therefore, while performing searches for potential comparable companies, not only turnover and operating profit but functions performed and risk profile are also to be considered. However, it can always be shown on the given facts of the case that comparables found are similar or almost similar to the controlled transaction and no adjustments are needed. It is useful to see the level of intangible assets in comparable to an appropriate base. Depending on facts of the case, final set of comparables may need to eliminate differences by making adjustments for the following: (a) working capital (b) adjustment for risk and growth (c) adjustment of R&D expenses." The OECD in "a public invitation to comment on a series of draft issues notes," has clearly recommended a need for making a working capital adjustment if the working capital position of the taxpayer is favourable as compared to the comparable companies. A brief computation of the working capital adjustment, as applicable to the present case and based on the comparables as approved by the CIT(A) is....
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....g all business and operational risks). In this regard, the economic theory of higher the risk higher the returns would apply. (b) Thus, where a risk insulated captive service provider would earn lower returns, a full-fledged entrepreneur would earn higher returns. The difference between the two returns would be the risk premium or the additional return which one would earn by bearing higher risks. (c) Drawing the above theory to the financial markets, a normal risk bearing rate of return could be the rate as notified by the RBI being the prime lending rate (PLR). This rate is primarily the base rate at which all commercial banks in India would ideally lend money to independent customers. During the previous year relevant to asst. yr. 2003-04, the PLR as notified by the RBI was around 11.50 per cent. (d) In comparison to the PLR, the RBI also notifies a bank rate which can be considered as a risk free rate of return. During the previous year relevant to asst. yr. 2003-04, the bank rate as notified by the RBI was around 6.25 per cent. (e) Based on the above, the PLR can be considered as a normal risk bearing rate of return whereas the bank rate can be considered as the risk f....
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....f such arithmetical mean." In this regard, relevant extracts from the Explanatory Memorandum and Notes to Clauses of the Finance Bill, 2002, which explained the 6 per cent variation, are produced hereunder: Extract from Explanatory Memorandum to Finance Bill 2002 "Under the existing provision contained in the proviso to sub-s. (2) of s. 92C of the IT Act, if the application of the most appropriate method leads to determination of more than one price, the arithmetical mean of such prices shall be taken to be the ALP in relation to the international transaction. With a view to allow a degree of flexibility in adopting an ALP, it is proposed to amend the proviso to sub-s. (2) of the said section to provide that where the most appropriate method results in more than one price, 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, at the option of the assessee." Extract from Notes on Clauses to Finance Bill, 2002 "Under the existing provisions contained in sub-s. (2) of the said s. 92C, the most appropriate method shall be applied for determination of ALP in the manner prescribed. The proviso to sub-s.....
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....LP determined varies by more than 5 per cent; and (b) The circular was issued by the CBDT in August, 2001, whereas the proviso to s. 92C was amended vide Finance Act, 2002, to introduce the concept of 5 per cent deduction to the ALP. Thus, the abovenoted circular is not relevant in the context of the issue raised. In summary- The proviso to s. 92C(2) provides that in the event that more than one ALP is determined, the ALP would be: * the mean of such prices; or * at the option of the assessee, a price which varies by 5 per cent of such mean. The above clearly establishes that the only condition for substituting the mean by a price which varies by 5 per cent of such mean is that the same is at the option of the assessee. Accordingly, if any transfer pricing adjustment is to be made, if the assessee opts the adjustment can be computed with reference to the 95 per cent of the mean price. At this juncture, it would be relevant to note that this view has in principle been approved by the Kolkata Bench of the Tribunal in the case of Development Consultants. In the instant case, the TPO/CIT(A) has not applied the proviso to s. 92C(2) i.e., they have not allowed a standard deducti....
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....04 of 25.26 per cent indicating that DCIL has not retained more than the arm's length margin. 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 it 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." Sec. 92CA(4) 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. Relevant extracts of sub-s. (4) of s. 92CA are reproduced as under: "(4) On receipt of the order under sub-s. (3), the AO shall proceed to compute the total income of the assessee under sub-s. (3), the AO shall proceed to compute the total income of the assessee ....
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....y went ahead and issued a notice to the assessee. This is further substantiated by the fact that the AO issued a notice to the assessee within one day of receiving the TP order. It appears as though the AO, being an Asstt. CIT, felt himself bound by the direction of the TPO, being an Addl. Director of IT (i.e., an officer of a higher rank). 5.54 The learned counsel further submitted that the AO neither took into consideration the submission filed by the assessee nor did the AO grant an opportunity to the assessee of being heard. It is clear that the AO simply went ahead and confirmed the adjustment proposed by the TPO, without 'having regard' to any facts or submissions made by the assessee. Accordingly, the learned counsel submitted that the process followed by the AO for concluding the transfer pricing assessment was flawed. 5.55 In this regard, the CIT(A), in her order, has stated that the assessee made no additional submissions and simply reiterated the submissions made before the TPO. In this connection, it should be noted that on receipt of the show-cause notice from the AO on 29th March, 2006, the assessee filed submissions on 31st March, 2006 at 5 PM (being the da....
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....ii) 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 in the event of material information or document in his possession on the basis of which an opinion can be formed that any such circumstance exists. In all other cases, the value of "the international transaction should be accepted without further scrutiny." Based on the above-mentioned para, it is clear that the intention of s. 92C(3) has always been that scrutiny of the international transactions of an assessee can only be done if the AO can prove that the circumstances enumerated in cls. (a) to (d) are satisfied. In the instant case, the TPO/AO has at no stage of the assessment proceedings, provided any information or documentation which could establish that the procedure followed by the assessee or the computation of the ALP by the assessee was erroneous. The TPO/AO simply conducted his analysis and applied the same to the assessee's case. This approach of the TPO/AO clearly demonstrates bias. In this connection, reference is al....
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....as at the beginning of the reporting period. The above table clearly demonstrates that the international transactions of the assessee satisfy the arm's length test on the basis of comparison of return on assets. If one were to run a fresh search for comparable companies for the relevant period the results would be as under: Basis No. of companies PBIT/Operating cost of the comparables PBIT/Operating cost of the assessee. Universal set 293 6.34% 5.91% Companies having turnover between Rs. 0 to Rs. 250 crores 275 4.47% 5.91% The above search was conducted using Prowess database (i.e., the same database used by the TPO), as updated on 15th Feb., 2008, using the following economic activities: (a) Computer software; and (b) Software services and consultancy. No additional quantitative/qualitative filters were applied. The derived man-hour billing rate of the assessee works out to USD 29.24. This rate has been computed after taking into account the turnover of the assessee, 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....
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....of sub-s. (4) above is required to pass assessment order in conformity with the order of the TPO determining ALP. Now, the order of the TPO has been expressly made binding on the AO." 5.62 In the transfer pricing assessment made on the assessee for asst. yr. 2002-03, after doing a detailed scrutiny, the TPO had upheld the international transactions of the assessee with its AE to be at arm's length. For this purpose, the TPO had compared the derived offshore billing rates of the assessee with the comparable offshore rates (as comparable uncontrolled price or CUP) as available on the website of NASSCOM. The order of the TPO, holding that the international transactions of the assessee were at arm's length, was also acknowledged by the AO. Accordingly, the AO did not make any transfer pricing adjustment in asst. yr. 2002-03. However, during the transfer pricing assessment for asst. yr. 2003-04, the TPO has taken a completely different view and has concluded the 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 subm....
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....pplicable to the decision of tax authorities, has certain clear limitations. 5.65 If a given case falls within the parameters of the following limitations explained in H.A. Shah & Co. vs. CIT (1956) 30 ITR 618 (Bom) and numerous other decisions, the tax authority would not be entitled to unsettle the earlier findings: (i) where the earlier finding was not arbitrary or perverse; (ii) where the earlier finding was arrived at after making due inquiries; (iii) where no fresh facts were placed before the authority giving the later decision; (iv) where the authority giving the earlier decision had taken into consideration all material evidence; or (v) where unsettling the earlier decision leads to injustice to the assessee. 5.66 The learned counsel had submitted that its case falls within each of the limitations enumerated above. Based on a detailed inquiry/analysis, 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; * Co....
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....nal business and operational risks. 6. Mentor Graphics used to develop software as instructed by its parent company. (Para 2.1 on page 116 ITD) Philips Software is continuously provided services to its associated enterprises. 7. Net profit margin of Mentor Graphics was 6.99% (Para 6 on page 118 ITD) Net profit margin of Philips Software is 5.91% The Tribunal, in the said case, has inter alia, laid down the following guiding principles: (a) A TPO can reject comparables in the TP study of the taxpayer only if the comparables were insufficient or deficient. (b) Methodology of selection appropriate comparable companies is dependent on the principle of FAR analysis (i.e., functions performed, assets employed and risks assumed). (c) Comparable 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 tha....
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....s contexts, and the note is another desperate attempt by the Departmental Representative to confuse the matter at hand. In any case, the assessee has appropriately addressed the relevant arguments made by the Departmental Representative at the appropriate places in this note. 5.71 We, therefore, summarise our conclusion as follows: (i) Since the basic intention behind introducing the TP provisions in the Act is to prevent shifting of profits outside India, and the assessee is claiming benefit under s. 10A of the Act, the TP provisions ought not to be applied to the assessee. (ii) Circular No. 14 of 2001 issued by the CBDT is binding upon the TPO. (iii) There 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) Th....
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....rises in the software components and hardware manufactured outside India. (Para 2.1 on page 116 ITD) The software developed by Philips Software is integrated by the associated enterprises in the software components and hardware manufactured outside India. 4. The complete package of the hardware and software manufactured was sold in the open market by the associated enterprises (Para 2.1 on page 116 ITD) The complete package of the hardware and software manufactured is sold in the open market by the associated enterprises 5. Mentor Graphics was insulated from all business and operational risks. (Para 33 and 46.1 on pages 133 and 143, respectively ITD) Philips Software bears nominal business and operational risks. 6. Mentor Graphics used to develop software as instructed by its parent company. (Para 2.1 on page 116 ITD) Philips Software is continuously provided services to its associated enterprises 7. Net profit margin of Mentor Graphics was 6.99% (Para 6 on page 118 ITD) Net profit margin Philips Software is 5.91% of Sl No. E-gain Communication Philips Software (assessee) 1. E-gain Communication is a captive company rendering software....