TaxTMI 
TaxTMI 
2011 (6) TMI 682
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....he assessee in asstt. year 2006-07. This common ground in all the three years, relates to addition made on account of adjustment recommended by the TPO in the arms length price of the international transactions entered by the assessee with its associate enterprises. The facts and circumstances on this issue are common. Therefore, we deem it appropriate to dispose of all these appeals by this common order. 2. The basic facts are common in all the asstt. years. For the facility of reference, we are taking up the facts from the asstt. year 2003-04. However, if we find some variation in the facts which have any bearing in adjudicating the controversy, we would refer those facts at the appropriate stage of this order. 3. The dispute in brief is that assessee has disclosed international transaction with its associate enterprises in all these three asstt. years. In its transfer pricing report submitted in form No. 3CEB, it has provided the appropriate method as transactional net margin method (TMM) and computed the PLI by dividing operating profits with operating cost. In this procedure, assessee has shown profit level indicator at 9.87%. The Ld. TPO on the basis of comparables, rec....
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....ansaction with associate enterprises, as reported in the TP report submitted by the assessee along with form No. 3CEB, made a reference u/s 92CA(1) of the Act to the transfer pricing officer. Ld. TPO in order to verify whether assessee has disclosed the value of its international transaction according to the arms length price or not examined the transfer pricing report submitted by the assessee and thereafter pointed out the defects in preparation of such report. After hearing the assessee, he carried out a fresh search and then selected suitable comparables and then recommended the adjustment in the value of internal transaction disclosed by the assessee. In this exercise, Ld. TPO first noticed the business profile of the assessee. Thereafter, he noticed operating model etc. The object of analysing the report is that such report will throw light on the function performed by undertaking, what type of assets were employed and how much risk was assumed by the assessee. Keeping in view these factors it is to be seen how much return is disclosed by the assessee in the shape of profit whether it is consumerate with the function performed, assets used and risk assumed. The business profi....
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....ubsequent sub-paras. 4.5.2 Operating model: The operating model of the ST group in respect of software development services is briefly described below: * ST NV performs the long-term strategic management and planning function for overseas operations * The product conceptualisation, core design, research and development, marketing, distribution, sales and post-sales client support are all performed by ST Group * All major decisions relating to software development (in terms of extent, timing, sequence, etc.) are taken by ST Group. * ST Group follows a waterfall model of chip design/software development life cycle. * ST Group is engaged in core technology development, complex manufacturing, global sales and marketing, etc. * STML develops Integrated Circuit Designs, CAD Tools, Computer Software etc, for ST Group and undertakes these activities in accordance with the guidelines. * STML acts as a back office contract service provider to ST Group and does not need to perform software development for any external customers. * STML only performs the routine service function in the life cycle provided by the S....
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....ct lies with ST Group which is responsible for any claims on the products. * As ST Group provides the necessary core tools and know-how relating to the basic technology / platform, it also bears Technology risk and the same is not assumed by STML. * STML does not undertake any research and development on its own account, and accordingly, it is not exposed to this risk. * STML is protected from credit risk as it is compensated by ST Group irrespective or collections by the latter from the ultimate customer. * STML bears foreign currency risk during the period between involving and recovery. * STML is exposed to manpower risk. * As ST India bills ST Group on a cost plus basis, it does not bear the idle capacity risk. * STML has low exposure to price risk because it renders software development services exclusively for ST Group under a long term development arrangement. 6. Ld. TPO after analysing the TP report submitted by the assessee observed that assessee has identified a set of 14 comparable companies from prowess data base by adopting a formula based search strategy, thereafter it applied various quantitative and q....
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....ntangible creation activity. For arriving at this conclusion he has assigned a number of reasons and Ld. CIT(A) take cognigence of those reasons in a summarised way and they read as under :- (i) STML is one of the largest design centres of ST Group outside Europe. Seamlessly integrated into ST Group's research and development organisation. (ii) STML combines the power of an advanced worldwide communications network and the discipline of a global service oriented corporate culture with the skill and enthusiasm of the Indian Scientific engineering community. (iii) STML has established a Design Centre at Noida, which serves the group as one of the most important centre for IP creation. It develops libraries of reusable IPs based upon UNICAD and the CAD platform, especially in advanced System-on-Chip (SoC) solutions for digital consumers, computer, telecom and automotive applications. (iv) Among the custom chip designs that have been implemented at Noida are telephone ICs and a variety of high profile hard disk and computer peripherals. (v) The range of design activities carried out by STML reflects the multifunctional nature and its ability....
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....ile choosing comparable for high end service provider like assessee. On the strength of Rule 10B2,10B3 and guidelines issued by the OECD Ld. TPO has pointed out the defects in the selection of comparables committed by the assessee. These reasons have been summarised by the Ld. CIT(A) in the impugned order which read as under :- (i) "Specific characteristics of the property transferred or services provided in either transaction (ii) Functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions (iii) Contractual terms whether or not such terms are formal or in writing, of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (iv) Conditions prevailing in the markets in which the respective parties to the transactions operate, including geographical locations and size of the markets, the laws and Government orders in force, costs of labor and capital in the markets, overall economic development and level of competition and whether the markets are wholes....
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....arables. An arithmetic mean of all these 23 comparables have been worked out at 17.86%. He recommended the adjustment by adopting this PLI. The AO accepted the recommendation made by the Ld. TPO and accordingly made an addition of Rs. 10,35,72,191/-. 10. Dissatisfied with the TPO's recommendation, assessee carried the matter in appeal before Ld. CIT(A). It submitted that Ld. AO was erred in making a mechanical reference to the TPO as well as acceptance of TPO's recommendation. It pointed out that Ld. TPO has erred in classifying the assessee's business as high end service provider. According to the assessee, there is no material on the record which suggest that assessee is a high end service provider. For buttressing his contention, assessee has drew the attention of Ld. First Appellate Authority about its operating model as well as business profile extracted supra. It also submitted that Ld. TPO has erred in rejecting the search methodology used by the assessee for selecting the comparables. According to the assessee, the TPO has erred in applying fresh search method without pointing out specific defects in the assessee's method. The assessee also contended that TPO has erred i....
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....ilter applied by the TPO is related party transaction i.e. if any comparables has an international transaction less than 30% with related party i.e. associate enterprises then that can be taken as a comparable. Ld. CIT(A) was of the view that there is no scientific reasoning for adopting this filter. If transactions less than 30% of the total transaction are with related party, the company can be selected as a comparable then why not 10% or 20% transactions could be applied. In the opinion of the Ld. CIT(A), its adoption of less than 30% transaction with related party as filter, is an arbitrary step and, therefore, any enterprise who has related party transaction that has to be excluded from the comparable. 13. The next filter applied by the Ld. TPO is employee cost to the total cost. In asstt. year 2003-04, he was of the opinion that employees cost to total cost of the assessee was 53.69%. The TPO has used a filter of 10% for selecting the comparables. Ld. CIT(A) was of the opinion that there is a huge margin between 10% and 53.69%. In his opinion, the companies who have employees cost ratio over total cost exceeding 25% can be considered as a comparable. After applying these t....
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....mination of arms length price (ALP) as provided in section 92C of Income Tax Act read with Rule 10B of the Income Tax Rules. The section 92C provides 5 main method i.e. a) comparable uncontrolled price method b) resale price method c) cost plus method d) Profit split method e) Transactional net margin method and f) one residuary method i.e. such other method as may be prescribed by the board. 18. In the present years, on an analysis of international transactions with the associate parties and data of comparables, assessee has selected transactional net margin (TNMM), using net profit margin based on cost as PLI. In these three years this method was not disputed by the Ld. TPO. We can say that both sides are in agreement on the method. The next dispute is use of current year data or multiple area data 19. After resolving the appropriate method for determining the ALP, the next step is to find out the data required to be used for selecting comparables. The assessee has used multiple area data whereas the TPO is of the opinion that current year data is to be used. The view of the Ld. TPO has been accepted by the Ld. CIT(A)....
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....ered into: Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared." 22. A bare perusal of this rule would reveal that expression "shall" has been employed in this rule which make it abundantly clear that current year data of an uncontrolled transaction is to be used for the purpose of comparability, while examining the international transactions with associate enterprises. The proviso appended to the section carves out an exception that the data relating to the period of being more than two year prior to such financial year may also be considered, if such data reveals facts which could have an influence on the determination of transfer price in relation to transaction of comparison. Thus the main section used the expression "shall" which make it mandatory to first use the current year data. If certain other circumstances reveals an influence on the determination of transfer pricing in relation to the transaction being compared than other datas for period not more than two....
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....stomers needs. This has been carried out by ST Group Overseas, who identifies a customer's requirements for the ICs from the customers surveys, feedback and technological advancement in the industry. The second stage is where product is conceptualized and specifications are determined. This stage is also performed by ST Group and role of assessee in India, nowhere come in picture. The product is conceptualized with the help of input provided by the customers and technical know how process by ST Group Neitherland. Next stage is stage No.3 where design and development is finalized. According to him, this part of the value chain also involves research and development activities related to the product. The high design cost is incurred in France and Italy and are mainly on account of their focused activities on centralized development of technology platform. The role of the assessee is negligible in performance of this stage. He admitted that no doubt in India, certain designs works are also carried out but they are only a partial execution of the design and developments carried out by the ST Group. The assessee works only on the specification given to it by the ST Group. The next stage....
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....r the expected return. He pointed out that the Learned TPO has selected the companies which are full-fledged entrepreneurs, whose risk profile assumes much higher risk, as compared to the risk free nature of the assessee. They also submitted that risk adjustment factor ought to be applied by the Learned TPO. 27. Learned DR have relied upon the orders of the Revenue Authorities Below. Shri NK Chand has drew our attention towards page No.12 of the Learned CIT(Appeals)'s order in assessment year 2003-04 and pointed out what type of activities have been performed by the assessee. According to the Learned DR, the activity performed by the assessee within India may be not be at par with the activities carried out by it's A.E. but that cannot be a test to determine the nature of activity performed by the assessee. The work performed by the assessee within India has to be compared with other assessees who are performing such type of activities and where they stand in a value chain of software development. The crucial issue is to find out whether the activity performed by the assessee can generate the profit equivalent to the one shown by the assessee only or there is some hidden embedde....
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....he learned counsels for the assessee have demonstrated the low affairs of the assessee while making the comparison with ST group. They lost sight that comparables are to be compared and not the incomparable. Thus, the test which they are advocating is not at all relevant for deciding the character of the assessee, whether it is high end performer or a low end performer. The assessee could have produced the report of an expert indicating the work performed by it as negligible in comparison to other software development companies. Instead of carrying out that exercise, it is emphasizing that its role is only 2% or 3% in comparison to over all role performed by ST group. The crucial issue which ought to be explained by the assessee is what is the importance of this 2% role vis-à-vis the role performed by similarly situated companies in an uncontrolled business environments. On an analysis of the learned TPO's order in different three years, including the TP report submitted by the assessee, we find that assessee has tried to give a uniform PLI, certain comparables which were found acceptable by the assessee in financial year 2004-05 all of a sudden become incomparable in financ....
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.... year 2004-05. In a way, it has adopted a pick and chose policy. 30. The learned counsel for the assessee at the time of hearing pointed out that objections referred by the learned TPO are not sustainable. One of the objections referred in assessment year 2006-07 is that assessee is also earning income from market supports services (MMS). With regard to this objection, it was submitted that it constitutes 2.19% of the total revenue earned by the assessee. Similarly on the scale of operation, it was submitted that turnover of the company is Rs.283.83 crores. While applying bench marking analysis, it has eliminated companies having sales less than Rs.10 crores and eliminated companies having sales more than Rs.2500 cores. On the strength of ITAT's order in the case of Mento Graphic, it was submitted that learned TPO could have carried out fresh search only if the comparable drawn by the tax payers was insufficient or had other deficiencies. The learned counsel for the assessee also submitted that in the case of Philips Software, ITAT has held that learned TPO was supposed to satisfy and communicate to the taxpayers, about carrying out fresh search and not accepting the comparables....
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....large turnover. Learned representatives have not pointed out any specific defect in the rejection of the TP report for assessment years 2003-04 and 2004-05. His main emphasis was how the learned TPO has erred in selecting the comparables. A general argument was taken that TP report ought not to be rejected by the learned TPO and he should not proceed for selecting the fresh comparables. According to the learned counsel for the assessee before rejecting the TP study made by the assessee, learned TPO has to point out specific defects in the transfer pricing analysis made by the assessee as well as the documentation maintained by it. He referred the decision of ITAT in the case of Sony India reported in 114 ITD 448 and in the case of Philips Software reported in 26 SOT 226. To some extent, we concur with the proposition raised by the learned counsel for the assessee but in our opinion such circumstances are to be decided by the learned TPO on a touchstone basis. He is not supposed to record specific finding before proceeding to select fresh comparables. The idea is to arrive at a reasonable conclusion for identification of comparables which can goad any authority to determine the ALP ....
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....ns assigned by the learned TPO, we are of the view that the very beginning in identifying comparables by the assessee as well as by the learned TPO did not match. Learned TPO termed the assessee as a high end services provider, whereas assessee is treating itself as a low end service provider. We have considered this aspect in the foregoing paragraph and observed that assessee is involved in manufacturing a highly complex technical product and its activity cannot be considered as a low end service provider. This disparity in the approach would automatically lead to a diagonally opposite path for selecting the comparables. Apart from this one aspect, the learned TPO has pointed out other aspects also. As observed earlier, he has to appreciate the TP study submitted by the assessee on reasonable basis as well as prima facie. Therefore, we do not see any error in the procedure adopted by the learned TPO for carrying out the fresh search in identifying the new comparables. We have seen TP report submitted by the assessee for these three years and the order of the PTO in assessment year 2007-08 also, we find that in every year by adjusting the financial calculation depending on differen....
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.... S. No. Company Name Functional Profile RPT % Standalone Turnover Employee cost/Total cost % Fixed asset turnover ratio NCP (%) 17 Maars Software International Ltd. Engaged provision of software development and consultancy services Nil 33.84 69.95 1.10 5.52 34 Visu Consultants Ltd. Engaged in the business of software development Nil 14.92 43.7 4.89 13.31 35 Visualsoft Technology Ltd. Company is a focused IT company operating in Software Dev. Services and Products. Nil 155.56 67.93 1.74 30.17 Arithmetic Mean 60.53 2.58 16.33 35. In assessment year 2006-07, learned TPO has identified 12 comparables. They are as under: S. No. Company Name FY OP/TC% 1 Bodhtree Consulting Ltd 16.52 2 Lanco Global Systems Ltd. 5.88 3 Exensys software solutions Ltd. 26.18 4 Sankhya Infotech Ltd. 25.27 5 Visualsoft Technologies Ltd. 13.05 6 Sasken Communications Tech. Ltd. 2.59 7 L & T Infotech Ltd. 12.42 8 Infosys 41.99 9 Flextronics Ltd. 28.55 ....
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....to a sunshine sector. He further submitted that Learned CIT(Appeals) has finalized six comparables but then excluded two in assessment year 2003-04 for non-availability of data. Now, the data are available and if they are included then NCP margin will be within the range of plus/minus 5% contemplated in the proviso to section 92C(2) and no adjustment would require. 38. In assessment year 2006-07, learned counsel for the assessee raised multifold submissions for pointing defect in the ultimate selection of comparables. Firstly, he contended that learned TPO did not grant proper opportunity of hearing for rebutting the selection of 19 companies out of which 12 has been selected by him. He further contended that application of fresh benchmarking analysis is contrary to the provisions of law. For buttressing his contentions, he pointed out that the determination of ALP, has to be in accordance with sub-section(1)(2) of sec. 92C of the Act. The expression "in accordance" means "inconformity" or "as provided". If the assessee has determined ALP of international transaction according to this mandate then Assessing Officer cannot determine the price according to the method which is appr....
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....or the purposes of sub-rule(2), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely: a) the specific characteristics of the property transferred or services provided in either transaction; b) the functions performed, taking into account asserts employed or to be employed and the risks assumed, by the respective parties to the transactions; c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail". 40. A bare perusal of this rule indicates that various aspects of the international transaction vis-à-vis uncontrolled tr....
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....worked in uncontrolled transactions can be neutralized. The arguments raised by the assessee in assessment year 2006-07 are touching only peripheral aspects. Learned TPO has started investigation quite well in time and has provided sufficient opportunity for giving comments. We have already held that learned TPO has rightly rejected the TP study made by the assessee and proceed to make fresh search. All other arguments made by the assessee in the written submissions as well as addressed before us were in the background of putting the assessee as a low end performer. At every stage, their emphasis was that it is a risk free captive service provider, it cannot be compared with other software development. We do not find force in this contention of the assessee in the discussion made in the foregoing paragraphs of the order. As far as the contentions of the assessee regarding exclusion of Infosys from comparables is concerned, learned TPO has considered this aspect and was conscious of the fact that in a quantitative filter, this concern deserves to be excluded but then he observed that in this year assessee in its TP study report included certain concerns who has a huge turnover of 14....
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....y. Learned CIT(Appeals) in assessment year 2003-04 has examined this issue in detail. He observed that in order to avoid hardships to the assessees in the initial years of implementation of the TP provisions, the Government of India, through a prices note issued by the Ministry of Finance on 22nd August 2001 expressed its intention that no adjustment could be made if the transfer price adopted by the assessee was within the band of +/- 5% of the ALP determined by the Assessing Officer. CBDT had issued Circular No.12 on 23.8.2001 specifying that Assessing Officer shall not make any adjustment to the price shown by the assessee if it is within the +/- 5% band, the effect of the Circular was that transfer price shown by the assessee was not to be disturbed if it was up to 5% less in case of receipt and up to 5% more in case of outgoing. The relaxation extended by this Circular was in substance brought on to the statute by the Finance Act 2002 by amending the proviso to sec. 92C(2) with retrospective effect from 1.4.2002. It provides a tolerance band. It also suggests that there will be no TP adjustment in cases of marginal variation up to +/- 5% but substantial variation would result ....
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....hmetic mean of the comparable price should be reduced by 5% for determining the ALP. He pointed out that in 2009, the proviso appended to section 92C has been amended but this amendment would be applicable prospectively, because the basis of determination of ALP in respect of international transaction get changed. This amendment effects imposing a new liability by taking the option away from the taxpayers. Thus, according to the learned counsel for the assessee, the amended proviso is not applicable. On the other hand, Learned DR has submitted that under the proviso no standard deduction has been provided to the assessee. 46. On due consideration of the facts and circumstances and perusal of the proviso introduced in 2002 as well as in 2009, we are of the view that this tolerance band provided in the proviso is not to be construed as a standard deduction. In the present appeals, learned TPO has adopted the arithmetic mean of several comparables for taking out a PLI which would be tested with the PLI of the assessee. If that arithmetic mean falls within the range of alleged tolerance band then there may not be any adjustment but if it exceeds then ultimate adjustment is not requi....
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.... for the adjudicating authority to decide whether expense incurred by the assessee is of capital nature or of revenue nature. According to the assessee, the ITAT has basically laid down three tests which are ownership tests, test of enduring benefit and functional tests. If all the three tests are applied on the facts of the assessee then it would reveal that it is a revenue expenditure. The learned counsel for the assessee further relied upon the order of the ITAT rendered in the case of DCIT vs. Mohindra Reality & Info. Developers reported in 2011 TIOL 115. On the other hand, Learned DR relied upon the order of the Assessing Officer. 49. We have duly considered the rival contentions and gone through the record carefully. We find that learned DRP has not applied its mind to the dispute raised by the assessee. According to the learned counsel for the assessee, reference to assessment years 2003-04 and 2004-05 is misplaced. There is no such dispute in those two years. We have disposed of the appeals of both the parties for these two years along with the present appeal. We also do not find any such dispute in those years. It suggests that learned DRP has considered this issue with....