TaxTMI 
TaxTMI 
2011 (6) TMI 385
X X X X Extracts X X X X
X X X X Extracts X X X X
....ion 92CA(1) for computation of Arm's Length Price (hereinafter for short "ALP") in relation to international transaction. The TPO, vide order dated 29-10-2009, arrived at a Transfer Pricing adjustment of Rs. 1,94,44,068. The assessee made submissions before the Assessing Officer against the proposed adjustment. The Assessing Officer rejected the same and issued a draft assessment order. The assessee filed objections against the proposed variation to the income before the Dispute Resolution Panel-1, Mumbai on 22-12-2009. The panel, vide its order dated 6-8-2010, has issued certain direction under section 144C(4) of the Act. The Assessing Officer passed the order under section 143(3) read with section 144C(13) of the Act on 20-9-2010. Aggrieved the assessee is in appeal before us. 3. The facts, as far as the company and the issues are concerned, have been brought out in the order dated 29-10-2009, passed by the Transfer Pricing Officer (hereinafter for short "TPO") under section 92CA(3) of the Act, which is extracted for ready reference :- "3. The assessee is a company of the Exxon Mobil Corp. Group of US and is responsible for information dissemination, maintaining customer re....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ct applications and undertake new applications development. 3. Such other technical services as and when require by EMCAP : All these activities are to be carried out at the Bangalore Research and Development Technology Centre (BRDTC), which has been set up for this purpose. For the services rendered the AE undertakes to reimburse the entire costs for running BRDTC. This includes the direct cost represented by compensation for employees for materials and supplies and other costs including travel, bonus etc., of employees. The indirect costs comprising of utilities, rentals, supervisory and administrative costs plus general overheads including apportionment of the supporting departments etc. The AE also compensates direct expenses of application technical developments managers and expenses on seminars and conferences etc. However, the assessee does not get any compensation in respect of the services rendered to the AEs. (ii) The second agreement is called Technical Representation Agreement entered into by the assessee with Exxon Mobil Research & Engg. Company. Under this agreement the assessee has to assist its AE in promotion of its various petroleum processes ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....le the same and for this purpose a detailed questionnaire was issued to him 23-3-2009, the salient issues are reproduced below :- 3. Provision of technical services 3.1 As per your TP report the Bangalore Research & Development Technology Centre (BRDTC), division of EMCIPL (the assessee) is one of the Exxon Mobil Chemical US research centres, others being in US and in Belgium. This centre offers technical services to its associated enterprises and it concentrates primarily on developing new customer centric applications for the Butyl Polymers and Ethylene Elastomers line of products. 3.2 .......... 3.3 .......... 3.4 The centre of Bangalore is being run pursuant to an agreement between Exxon Mobil Co. India (P.) Ltd. and Exxon Mobil Asia Pacific (P.) Ltd. A perusal of the agreement, dated 17-5-2004 shows that as per Article 2 the assessee (BRDTC) shall provide the following services : 2.1 Application technical development services to Butyl and Ethylene Elastomers customers of EMCAP in Asia Pacific and other regions. 2.2 Develop product applications and undertake new applications development. 2.3 Such other technical services as and when required by EMCAP BRD....
X X X X Extracts X X X X
X X X X Extracts X X X X
....2,86,447 from the application research head to the marketing services. 3.7.2 It is a matter of fact that the personnel at BRTDC had been employed for the purpose of research only and their cost is being entirely reimbursement by your associated entity. Just because they provided some assistance in marketing (if any), cannot lead to allocation of their cost for marketing. They were full time employees of BRTDC and any such activity would have been possible only in their spare time. This cannot result in allocation of their costs between the marketing & the application research segments. Further there is no evidence to substantiate claim the assessee, nor have you maintained any log book or carried out any time and motion study to explain the percentage of 1, 10 and 25 per cent. Moreover as a matter of fact out of total study 36 persons employed only 9 persons are stated to be employed in application research and they were stationed at Bangalore. Just because they happened to be with the marketing team for some clarifications cannot be any basis of allocated their cost towards marketing. It is also a fact that the assessee while claiming the reimbursements has claimed the entire e....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... confirmations from its Manager employees relating to the time spent by their research personnel for marketing. Assessee has furnished some correspondence from its own employees. One such letter furnished is by Shri B.B. Sharma, who estimates that the time spent on butile ATD and R&D lab would be 10 per cent and 1 per cent respectively. Similarly, there is another letter from Pradeep Patki, who has enumerated the activities which he has undertaken. 8.3 I have gone through the various correspondences which are addressed to the Taxation Department. The e-mail correspondence which has initiated from the head office itself mentions the percentage of allocation carried out and seeks instances of work being done for justifying this allocation. None of the executives have any basis to justify the percentages of 1, 10 and 25 as mentioned above. The correspondences are self-serving documents without any supporting log books or time and motion studies. Such self-serving documents do not carry any evidential value. The total staff strength of the employees is only about 36 persons as stated by the assessee. Out of these 9 persons are in the application research and technical team statio....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 5,78,63,688 out of this the expenses towards Banaglore Research Centre are Rs. 4,98,14,572. This leaves the remaining amount of Rs. 80,49,116 against the representation and ATD services of Rs. 1,30,57,361 giving a mark up of 62.22 per cent on costs. The adjustment in respect of the compensation for BRTDC is being worked out as under. 8.6 Selection of comparables and their operating margins : The assessee had undertaken a detailed search in its transfer pricing report and selected following 7 comparable companies for working out arithmetic mean of 18.47 per cent: Sr. No. Name of the company Average adjusted OP/TC 1. Alphageo (India) Ltd. 24.74% 2. Dolphin Medical Services Ltd. 11.46% 3. N.G. Industries Ltd. 29.60% 4. Vimta Labs Ltd. 69.49% 5. Neeman Medical International (Asia) Ltd. -0.89% 6. ADS Diagnostic Ltd. - seg. -9.20% 7. Pfizer Ltd. - service seg. 4.07% Arithmetic mean 18.47% As discussed above, on his own segmental analysis it has worked out its PLI of 13.13 per cent and considered its pricin....
X X X X Extracts X X X X
X X X X Extracts X X X X
....stic segment cannot be worked out accurately. Alternatively, this activity is only subservient and dedicated to the main activity in the field of pharmaceuticals. This company is therefore, also rejected. The operating margins were reworked on the basis of annual reports and final comparable after considering the submissions are given below : Sr. No. Name of the Company Return on total costs 1. Alphageo (India) Ltd. 47.79 2. Dolphin Medical Services Ltd. 14.52 3. N.G. Industries Ltd. 31.26 4. Vimta Labs Ltd. 57.68 5. Choksi Laboratory Ltd. 32.22 6. Transgene Biotech Lt. - segmental 8.16 7. Medinova Diagnostics Services Ltd. 7.26 Arithmetic mean 28.41% The assessee has further sought working capital adjustments of 0.47 per cent in respect of the working capital being employed by the comparables and the assessee. The assessee has further sought risk adjustments by following the capital asset pricing model. The issue of risk adjustments and the short comings of CAPM model adopted by the assessee are discuss....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... that the persons concerned dealing with the matter had left the company, but this cannot be accepted as a basis for non-explanation of the variation which is apparent. 4.3 The non-explanation of the precise reasons for variation will lead to a conclusion that the segmental financial information furnished by you is not reliable. This could be on account of incorrect allocation of headcount or some different basis of allocation at the time of budgeting. 4.4 The essence remains that you have agreed for the being remunerated at only 10 per cent markup to cost. You have requested to show cause why the segmental results not to rejected and your total receipts on account of BPO be bench marked at the comparable PLI considering your PLI to be 10 per cent instead of 21.3 per cent as shown by you in your TP Report. 9.1 In his explanation the assessee has stated that the billings are made on budgeted costs while the books of account show the actual cost incurred and there is likely to be variation. Further, the accounts of the AEs are maintained on calendar year basis while the accounts of the assessee are on financial year basis. This generally results in variations. The assessee h....
X X X X Extracts X X X X
X X X X Extracts X X X X
....xplanation the assessee has not been able to explain the head-wise variation and the specific reasons on account of which those variations have arisen. It therefore appears that the allocation of expense by the assessee is not as per the actual budget exercise but only with a basis to work out better margins for the lower priced segments. The explanation/the segmental allocation of the assessee therefore, is rejected." 4. The TPO observed that the assessee has aggregated various technical services rendered into one category (total amount of Rs. 6,28,71,633). He observed that the assessee mentioned that a mark up of 10 per cent has been charged on ATD activities of Rs. 1,13,04,961 and in relation to technical representation Rs. 17,52,400, the mark-up is around 80 per cent. He also observed that the assessee has not denied the fact that, it has not been separately compensated for services rendered at Bangalore Research and Development Technology Centre (for short "BRDTC") (Rs. 4,98,14,572). The assessee allocated a part of cost of the application and research technical segment, towards marketing services as follows :- (a) 1 per cent R&D testing Rs. 4,45,507; ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ricing report and selected following 7 comparable companies for working out arithmetic mean of 18.47 per cent. Sr. No. Name of the company Average adjusted OP/TC 1. Alphageo (India) Ltd. 24.74% 2. Dolphin Medical Services Ltd. 11.46% 3. N.G. Industries Ltd. 29.60% 4. Vimta Labs Ltd. 69.49% 5. Neeman Medical International (Asia) Ltd. -0.89% 6. ADS Diagnostic Ltd. - seg. -9.20% 7. Pfizer Ltd.- service seg. 4.07% Arithmetic mean 18.47% As discussed above, on his own segmental analysis it has worked out its PLI of 13.13 per cent and considered its pricing to be at arm's length. A perusal of the comparable shown that the assessee had adopted multiple year data for working out the PLI of the comparables and further some of the companies so selected could not be considered as comparable companies. Accordingly, the assessee was issued a show cause notice dated 17th July, 2009 confronting the above facts and also the reasons for rejection of a few office comparable companies. The correct operating margin was also....
X X X X Extracts X X X X
X X X X Extracts X X X X
....d, hence, they could achieve a higher mark. He observed that if the A.E. closed its accounts on 31st December each year, the actual costs incurred by the assessee from January to December each year after due adjustment would have been considered. He also observed that if budgeted billing was lower than the actual cost in a particular quarter, the same would be adjusted in next quarter. He held that such differences, if any, would have definitely been taken into account by the AEs while finalizing the accounts. At Page 8, the TPO observed as follows :- "Every AE is an independent Company and a separate profit centre. None would like to provide a higher expenditure than warranted. The AEs have allowed a mark up of 10 per cent only and if they were finding that the AE is actually making profit of 21 per cent they would have reduced their mark up in the first quarters of 2006 so as to make an overall mark up of 10 per cent for the year. The assessee is not an independent company which can be fool the various group companies by charging a mark up of 21.3 per cent against agreed margins of 10 per cent. In fact, the assessee has reported that in the next years the mark up has been incr....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ns Ltd. Rejected No financial data available 13. Ace Software Exports Ltd. Accepted - - 14. BT Tech Net Ltd. Rejected No financial data available 15. Tulsyan Technologies Ltd. (Formerly known as Cosmic Global Ltd.) Accepted - - 16. Goldstone Teleservices Ltd. BPO segment Accepted - - 17. Hypersoft Technologies Ltd. BPO segment Rejected Consistent loss 18. CMC Ltd. - ITES segment Rejected It failed in export filter. Its export is only 9% 19. Indus Networks Ltd. Rejected Consistent loss 20. Mapro Industries Ltd. Rejected Consistent loss 9.3.1 the department has conducted the separate search for selection of comparables in the IT industry. The search strategy and the comparables are reproduced below. This was confronted to the assessee vide questionnaire dated 17th July, 2009. The search for suitable comparables is conducted based on the data available in Prowess and capital databases. These two databases were searched and the filters are applied on these data. The information on related party transacti....
X X X X Extracts X X X X
X X X X Extracts X X X X
....s search has thrown 41 companies. In some of these 41 companies, the annual reports, related party transactions information, segmental information etc., is not available. Thus, these companies were issued notices under section 133(6) to submit this information. 3 Companies have been selected as comparables from the Prowess segment search. Step Description No. of Companies Resulted No. of Companies eliminated 1. Number of companies resulted by the segment search 41 2. Number of companies not already covered under the key word search as above 36 5 3. ITES revenue/segment available for the F.Y. 2005-06 29 7 4. Replies u/s. 133(6) in respect of segmental data 22 7 5. Number of companies with less than 25% RPT 14 8 6. Number of companies with turnover more than Rs. 1 cr. 12 2 7. Number of companies with export revenue more than 25 per cent of the revenues 4 8 8. Reliability of data (Satyam Computer Services Eliminated) 3 1 Balance 3 9.3.5 Capitaline Plus Da....
X X X X Extracts X X X X
X X X X Extracts X X X X
....n, segmental information etc. is not available. Thus these companies were issued notices under section 133(6) to submit this information. Out of these, none of the companies has been selected as a comparable based on the information received from the companies under section 133(6). Additional Comparables While doing the search process for suitable comparables in the software sector, some of the companies though categorized as software service provider are in fact either in the IT enabled services sector or have IT enabled services as one of the business segment. The search criteria for the software sector are summarized as under :- Database Description of the Search Keywords used Prowess Keyword Search Computer Software Prowess Segment Search Computer Software, Software Services & Consultancy Capitaline Keyword Search Computer - Software - Converts, Computer - Software - Large and Computer - Software - medium/small Capitaline Segment Search 1. Software 2. Software & BPO 3. Software & Proc....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ormation submitted by the company in response to notice under section 133(6), the company has an ITES segment and this segment qualifies all the filters applied by the TPO. 6. Wipro Ltd. The company's annual report for the F.Y. 2005-06 did not have segmental results for BPO segment on stand alone basis. The company was asked under section 133(6) to submit segmental information pertaining to BPO segment. But the company said that it is not able to submit segmental information on stand alone basis. Therefore rejected. 7. Syntle (India) Ltd. Annual report is not available for the F.Y. 2005-06. As per the information and annual report submitted by the company, in response to section 133(6) notice, the company has stated that it is into software services and ITES segment 92 per cent of IT enabled services are rendered to its AEs. Thus it fails RPT filter and is not considered as a comparable. 8. Mold Tek Technologies Ltd. As per the information submitted by the company, the company is into IT enabled services segment. The company earned a profit of Rs. 1,60,28,000 on an operating cost of Rs. 2,14,77,839. As the company's operating....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Vishal Information Technologies Ltd. 25.64 48.03 Arithmetic mean 24.00% Note : 1. All the figures are taken from the annual reports; 2. Costs taken for the computation of margins are the costs before interest charges; 3. Forex gain/loss is not taken as part of the operating expenses as forex gain is categorized as other income; and 4. Loss of sale of assets, etc., are not taken as expenditure." 21. The assessee gave its objections. The Assessing Officer, after considering various contentions, held that the assessee had worked out the adjusted average PLI of the comparables at the rate of 24.43 per cent and this would be used for bench marking the back office support services. Thereafter, the TPO considered the submissions of the assessee, in respect of adjustments of risk being a captive unit. He came to a conclusion that there is no difference between the assessee and the comparable companies. He computed ALP of service would be Rs. 4,76,49,682, as against the actual receipt of Rs. 4,21,23,805, and arrived at an adjustment of Rs. 55,25,877. On t....
X X X X Extracts X X X X
X X X X Extracts X X X X
....Assessing Officer passed in pursuance of the directions issued by the DRP is a vitiated order, as the DRP erred both on facts and in law in partially confirming the addition made by the Dy. CIT, to the appellant's income. 2. The Assessing Officer erred in facts and in law in concluding the assessment under section 143(3) reed with section 144C(13) of the Act in - 2.1 making an adjustment to your appellant's international transactions of provisions of technical services and back office support services at Rs. 1,24,03,828 and Rs. 55,25,877 respectively. 2.2 disregarding the arm's length price (ALP) and the methodical bench marking process carried out by the appellant in the Transfer Pricing (TP) documentation maintained by it in terms of section 92D r/w Rule 10D of the I.T. Rules, 1962. 2.3 not allowing the use of multiple year data as prescribed under Rule 10B(4) of the Rules r/w the OECD TP guidelines, and determining the arm's length price on the basis of financial information of the comparables for the year ended March 31, 2006 identified pursuant to a fresh search for comparables performed during the assessment proceedings. The AO/TPO/DRP erred in rejecting the conte....
X X X X Extracts X X X X
X X X X Extracts X X X X
....taken average of two years' data for comparison but the TPO has taken only one year. He submits that for various reasons, the assessee does not want to press this issue. In view of the above submissions, we dismiss this argument of the assessee. 24. On the second issue of rejection of loss making comparables, the learned Counsel drew the attention of the Bench to Page-226 of the paper book and submits that it is clear from the director's report of the comparable company, ADS Diagnostic Ltd. that the decrease in scanning income is due to stiff competition from the existing and new diagnostic centres that are coming up in and around Delhi. He pointed out that the loss after depreciation has, in fact, decreased from Rs. 21,76,000 to Rs. 14,32,000. His case is that, the company should be accepted as functionally comparable. 25. On the rejection of comparable Neeman Medical International (Asia) Ltd., he points out that gross revenue has increased during the year. He points out that company's clinical trial income has reduced as compared to last year. He submits that this company was wrongly treated as a consistent loss maker as it had a loss of Rs. 28,00,000 in financial year 2003....
X X X X Extracts X X X X
X X X X Extracts X X X X
....vices (ALP) 4,32,11,194 Application of the Range-ALP x 0.95 4,10,50,635 The revised ALP (after applying 5 per cent margin) is Rs. 4,10,50,635. As the actual income is Rs. 4,21,23,805, no adjustment would be required." 29. On the issue of ground No. 3, the learned Counsel submits that he is not pressing the same. Thus, this ground is dismissed as "not pressed". 30. Learned Departmental Representative, Mr. D. Songate, on the other hand, controverted the submissions made by the assessee's counsel. On the first issue of adopting multiple year data or single year data, the learned Departmental Representative noted that assessee's counsel has not pressed the same and, hence, made no submissions. 31. On the issue of elimination of loss making units from the list of comparables, the learned Departmental Representative relied on the order of the DRP as well as that of the TPO and submits that consistent loss making companies cannot be treated as proper comparables. He basically relied on the order of the TPO and submits that the assessee has not been receiving any mark-up on technical services provided to it's A.Es in the form of research and development at BR....
X X X X Extracts X X X X
X X X X Extracts X X X X
....g service segment. The disputes pertains to technical service segment and back office support service. (iii) In the technical service segment, there are three activities i.e., (a) application research at BRDTC; (b) application of technical development services; and (c) promoting the licensing of technology. (iv) For application research carried out at BRDTC, no mark-up is paid by the A.E. As far as the application research is concerned, the A.E. reimbursed cost plus 10 per cent. For the activity of promotion of licensing of technology, US$ 40,000 is annually reimbursed by the A.E. The assessee seeks to club all these three activities and, thereafter, determined the ALP. It is a case of the assessee that all these operations put together generated 13.13 per cent. The TPO rejected the aggregation approach on the ground already stated in the preceding paragraph. We fully agree with the findings of the TPO. We do not understand as to how carrying on application research at BRDTC can be clubbed with, the activity of promoting the licensing of technology owned by the overseas group entity. We note that the A.E. reimbursed only the cost incurred by BRDTC on researc....
X X X X Extracts X X X X
X X X X Extracts X X X X
....'s accounts of ADS Diagnostics Ltd. for assessment year 2005-06, the income from scanning services has reduced due to stiff competition from existing and new diagnostic centres that were coming up in and around Delhi and the loss is attributable to stiff competition. The assessee also points out that the statutory auditor has not mentioned that the company has been facing any going concern issues. In our opinion, the TPO has rightly rejected this comparable for the following reasons:- The directors' report of ADS Diagnostic Ltd., reads as follows:- "The operational income of the company has increased from Rs. 248.44 lacs to Rs. 271.69 lacs in the current year registering a growth of 9.36 per cent for the year under review. However, income from scanning business has decreased from Rs. 174.34 lacs to Rs. 165.02 lacs during the year under review. The income from trading and servicing has been increased from Rs. 61.51 lacs to Rs. 82.26 lacs and Rs. 7.24 lacs to Rs. 23.24 lacs respectively. Overall income increased by Rs. 23.25 lacs. The decrease in scanning income is due to stiff competition from the existing and new diagnostic centres that are coming up every year in and around ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....any to access a larger segment of customers and offer them a bouquet of clinical trial service under one roof. Here also, they rely on the statutory auditor's report and pointed out that no going concern issues are not raised by the statutory audit. (x) In our opinion, statutory audit not mentioning that they are going concern issue, does not help the case of the assessee. It cannot be said that the loss making units, which are only having going concern issues, are to be eliminated. In the case on hand, the gross revenue of the company has reduced from Rs. 4,45,60,000 to Rs. 2,85,68,000. In the previous year, the company earned net profit of Rs. 18,36,000, whereas in the current year, the loss is Rs. 1,28,53,000. The above figures demonstrate that there is more than a normal change in the profitability of the company. There is a fall in the profit by Rs. 1.47 crores (approx.), when there is a fall in turnover of about Rs. 1.60 crores (approx.). These figures are abnormal and without explaining a huge fall in profits as compared to the fall in turnover, the assessee cannot, in our opinion, argue for inclusion of this comparable. Thus, we uphold the findings of the TP....
X X X X Extracts X X X X
X X X X Extracts X X X X
....and, hence, we dismiss the argument. (xiii)The next contention is that the Assessing Officer has wrongly taken the margin of Pfizer Ltd. as 4.07 per cent as per transfer pricing study instead of one year up/margin of 7.41 per cent. It is also submitted that the revised ALP is within the range of +/- 5 per cent if the figures are correctly taken and calculations made. Detailed table and working are submitted before us. The learned Departmental Representative was not able to controvert these submissions of the assessee. Under these circumstances, we are of the opinion that the issue of computation has to be set aside to the file of Assessing Officer, for limited purpose of quantification of the transfer pricing adjustment. In case the ALP determined by the Assessing Officer is within the range of 5 per cent of the actual income, then no adjustment need to be made. With these observations, we set aside the matter to the file of Assessing Officer. (xiv) This brings us to the second issue which relates to determination of ALP of back office support services - whether the Assessing Officer is bound by the directions of the DRP. The DRP directed as follows:- "The next TP ground r....