TaxTMI 
TaxTMI 
2012 (5) TMI 206
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.....s. 143(3) dated 26.10.2010 by ACIT, Range-4, Ahmedabad. (A) Facts 2. The appellant is a Domestic Limited Company incorporated in India on 14th May-1982. As informed the appellant is a Software Development Company and worked as a global information Technology Services Provider. The services were "off-shore" as well as "on site" services; hence operated through its subsidiaries at other countries, viz. USA, UK, Germany, Singapore, Malaysia. It is informed that the assessee-company provides composite deliverables to the clients One of its Associate Enterprise (in short A.E.) is Mastek U.K. Ltd. (in short MUK) is a 100% subsidiary; established in the year 1992. This said A.E. is contributing substantial revenue and for the year under consideration stated to be 60% of the total Revenue of the Mastek group. 2.1. The assessee-company has filed the return for A.Y. 2006-07 on 31.10.2006 declaring total income at Rs. 61,28,140/-, however the assessment was made u/s. 144C r.w.s. 143(3) vide an order dated 26.10.2010 on assessed income of Rs. 22,46,55,290/-; hence challenged in this appeal. It was found by the Revenue Department that International Transaction was involved with an Ass....
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.... Management Services With Mastek UK - adjustment required Rs. 2,92,22,683/- (c) Excess Credit period granted to the A.E. 11,22,281/- Total adjustment suggested by T.P.O. Rs. 21,65,90,064 All the three adjustments and other additions made in the impugned assessment order are now under appeal, therefore, the ground-wise adjudication is as under:- On the facts and circumstances of the case and in law, the Additional Commissioner of Income-tax Range-4, Ahmedabad ('Ld. AO') erred in concluding the assessment under section 143(3) of the Income tax Act, 1961 ('the Act') read with section 144C of the Act on the basis of directions issued under section 144C(5) of the Act by the Hon'ble Dispute Resolution Panel, as follows: 1. GROUND NO. 1 - Re-computation of the Arm's Length Price ('ALP') of the international transactions of software services distributed by Mastek (UK) Limited ('MUK') i. The Ld. AO has erred in law and on facts in relation to the re-computation of the ALP of the international transactions of software services distributed by MUK (associated enterprise) by making an....
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....fit on cost at 26.02% in the immediate preceding assessment year. An enquiry was raised to explain the reason of fall in operating profit. In this regard, the preliminary explanation of the assessee was that there was a new profit sharing agreement with MUK. That agreement has been referred to as "Master Agreement" dated 30/03/2005. From the side of the assessee, FAR analysis was furnished. That analysis shall be discussed in the later part of this order. Meanwhile it is worth to mention that on the basis of the said FAR analysis the contention of the assessee before the TPO was that the MUK has functioned as a "distributor". The distribution activities of MUK were, such as, identifying the customers, establishing contacts, soliciting enquiries, managing of relationship. All these activities were performed in UK and MUK was appointing advertising agencies for advertisement of software services in newspaper journals, etc. It was informed that the MUK has entered into contracts and negotiated with the customers in UK. On signing of the contract, MUK has provided all requisite details, time limit of completion, warranty period and other specific commitments. The assessee has also furn....
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....aration of bill and noted that the bills raised by the assessee-company to MUK were based upon the Revenue collected from the clients and after reducing the front office cost of MUK, a net profit of 5.5% was given. As per TPO the assessee( MIL) was raising bills on the basis of the third party receipts after considering MUK as a front office. Lastly, according to him, expenses would have been borne by the MUK, had it functioned as an independent distributor. 3.5. Thereafter, the TPO has discussed one of the clause of the agreement with MUK through which it was agreed upon that MUK shall be entitled to retain an arm's length return on the revenues received from customers in UK. At the end of each month, Mastek India used to determine the total transfer price due from MUK for services rendered during that month and then issue an invoice in Great Britain Pounds. On the basis of information, the TPO has cited an example of the compensation for MUK and the related transfer price of Mastek India in the following manner:- GBP Revenue from UK Client 1000 Less: Front office cost of MUK 200 Arm's le....
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....ng as under:- "(a) The assessee has stated that MUK is assuming market risk and credit risk with regard to key functions of selling. In fact exposure to these risks is more to the assessee company as compared to MUK as any reduction in revenue will hurt huge set up and infrastructure created by the assessee company as compared to MUK which is merely customer facing entity and marketing assessee's business using goodwill and name of the assessee company. It is the assessee company which is more involved in getting a contract in fixing competitive pricing and taking profit risk. It can be seen from the financial statement of the assessee company that it is receiving fluctuating margins on each contract whereas MUK has been assured of a fixed return irrespective of the fact whether the assessee is earning profit or incurring losses on a particular contract. In addition to the above, it is the assessee company which bears product/service liability risk, technology risk, manpower risk and foreign exchange risk. Further Assessee Company assumes all credit risk of the MUK even credit risk lies with Assessee Company. Under the circumstances, MUK cannot be said to be an entity havi....
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....nnot be any distributor which is to be paid for all its expenses and risk and in addition above, volume related commission as same would promote inefficiencies in expenses and further remuneration to the distributor on intangibles of the principal. (d) The assessee has further stated that it has employed highly qualified full fledged strategy business team which was not only selling and promoting items but also taking strategic decision in respect of the sales. The assessee has not submitted what strategic decisions or whether all strategic decisions required in respect of sale was being taken by that team only. Providing a very highly qualified team is merely a marketing exercise which provides comfort to third party clients and presence of the assessee company in the UK. Any marketing strategy requires providing comfort to the clients and showing to others including clients that the assessee company is competent in carrying out all technical projects and has support services near to it. Signing of contract in UK and presence of competent team is clearly marketing exercise for software service business. (e) The assessee has further relied on Transfer Pricing Guid....
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.... in short are as follows. DRP was of the view that the said AE, i.e. MUK situated in UK has performed the functions, such as, identification of customers, establishment of contacts, solicitation of enquiries, maintenance of customer relationship, appointment of advertisement agencies, etc. were the functions in the nature of "marketing activities". Even the signing of contracts, agreement on price, scope of deliverables or the time schedule were the functions though undertaken by the MUK but only with reference to the feedback received by the Mastek India Ltd. They have endorsed the view of the TPO that the MUK had functioned as a front office of the assessee. According to DRP, only a fixed profit was settled as per the terms of the agreement between the assessee-company and MUK. The MUK was admittedly remunerated at 5.5% of the revenue received as a third party sale price. According to DRP if MUK was working as a distributor, then there should not be a fixed profit but the profit should kept on changing. They have stated that the selling price could not be fixed by MUK and, therefore, MUK could not be considered as an independent entrepreneur. The assessee had made contentions in ....
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.... 319 (Pune), wherein one of us, i.e. JM is the co-author. The difference in quantum of imports was held as difference in business model and, therefore, it was suggested that the requisite adjustment is required to be carried out for such functional difference. But the DRP was of the view where there is no difference in the functions performed, then there could not be any need for any change in PLI in those circumstances. 3.12. DRP has further referred that the assessee has followed TNMM method for bench-marking its transactions. It was observed that TNMM method emphasizes the adoption of net margin from various transactions. The profit level indicator adopted should indicate the real and not notional profit. Any indicator which may either indicate increase profit or reduce loss due to non-consideration of certain factors, according to DRP, do not represent the actual state of affairs. According to them, bench-marking done, therefore have no meaning. They also ruled out that as per Rule 10B(10)(e)(iii) the items of expenses which were proportionately higher should also not be allowed. Ld. DRP has rather commented that the assessee had not given any kind of working as to how and a....
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....vision of services A selling entity is rewarded on a cost plus basis by a connected party. You should scrutinize carefully any claims that the company has no risk and is merely introducing the customer, or helping to maintain existing customer relations - that the company is providing a service to the principal who is actually selling the goods. Between independents selling is usually a critical, entrepreneurial part of any trade rather than a low level service type activity. Such cases may range from a small representational office with a few employees, to a large presence involving hundreds of staff. In the selling world, even a relatively small concern would expect some form of reward related to the sales made. The larger the presence, the more unlikely it is that the company is just providing a service. It is of course possible to think of services that might be provided to someone carrying on the business of selling, for example the selling company will very likely pay someone to advertise their goods. However, the act of soliciting and securing a sale goes beyond the provision of services to the selling activity; instead it is a fundamental aspect of the selling a....
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....to pay taxes at a rate as high as 30% in UK. In this regard, the Ld. Counsel relied upon the decision of the High Court of Delhi in case of Moser Baer India Ltd. v. Addl. CIT [2009] 176 Taxman 473/316 ITR 1 (Delhi), which brings out the reasons for introducing Chapter X in the Act, which is to prevent an assessee from avoiding payment of tax by transferring income yielding assets to non-residents even while retaining the power to enjoy the fruits of such transactions i.e. the income so generated. In the instant case, the entire income even if brought back to India in the first place would have never suffered a single rupee of tax. (e) In addition to above, the Ld. Counsel relied upon the following to support the fact that there was no reason for shifting of tax base by MIL, which is enjoying Section 10A benefits: * Circular No. 12 dated August 12, 2001 [251 ITR(St.) 15]; * Circular No. 14 dated November 09, 2001 [252 ITR(St) 65] - Para 55, which brings the objective of introducing TP regulations. The same has also been discussed in the case of Moser Baer as discussed above; * Asstt. CIT v. Dufon Laboratories....
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.... qualified Managerial and Technical personnel with skills as well as the experience to understand the software offerings, create proposals, negotiate and conclude contracts independently. The break-up of the employees were discussed by the Ld. Counsel. He identified apart from 1 Country head, there were 28 employees of MUK who were involved in Sales Solutions & Strategy, 13 employees were involved in Sales operations and support and 8 employees were part of legal and finance. ix. After a sale contract is concluded, MUK informs MIL of the specifications and the terms of the contract. Accordingly, MIL'S role would start only after MUK has concluded the customer contract. The customer contracts may be discussed at times with MIL before concluding. However this is from the perspective of only aligning with the group's business policies and goals. This is in accordance with any third party distributors who would need to consult with the manufacturers to find out as to when the required goods would be made available. The contracts between MUK and the UK customer were independent and not entered into on behalf of MIL. MIL was providing the software services as per the contract te....
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....bove mere cost plus. The Ld. Counsel further emphasized that UK HMRC's website provides that cost plus method is unlikely to be appropriate only for selling activity. (h). In relation to the tangible / intangible assets owned by MUK, the Ld. Counsel pointed out that MUK owns tangible assets. MUK owns marketing intangibles also in the form of customer relationship and contracts. In this regard, the Ld. Counsel pointed out that if MUK were to sell its business to a third party, would it not claim adequate compensation towards marketing intangibles owned by it. (i). The Ld. Counsel then pointed out that after considering the selling functions performed, MUK should be characterised as a distributor and not a mere marketing services provider. The said characterization was adopted by the assessee and documented in the TP Study Report. In this regard, the Ld. Counsel relied upon the following case laws: * Bechtel India (P.) Ltd. v. Dy. CIT [2011] 46 SOT 427/12 taxmann.com 299 (Delhi) Para 12, wherein it was held that entity characterisation should be done after proper FAR analysis of the assessee and only thereafter, the comparables should be select....
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.... well argued reasons. He relied upon Abhishek Auto Industries Ltd. v. Dy. CIT IT Appeal No. 1433 (Delhi) of 2009, dated 12-11-2010. The said ruling in turn relied upon the following judicial precedents: ♦ Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706/132 Taxman 373 (SC); ♦ CIT v. Gillette Diversified Operations (P.) Ltd. [2011] 324 ITR 226/198 Taxman 154 Delhi (Mag); ♦ CIT v. Walfort Share & Stock Brokers (P.) Ltd. [2010] 192 Taxman 211 326 ITR 1 (SC) ♦ Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448 (Delhi). In this regard, Ld. Counsel questioned that would the Revenue department agree to give fluctuating returns to MUK and would that be treated arm's length ? * Comfort letter to third parties: The Ld. Counsel argued that even in a third party scenario the manufacturer of goods would always give guarantee about the products manufactured. In the instant case, if MIL has given comfort letter to third parties, it is for its own performance and this by no way dilutes the role of MUK as a distributor of services. * Case studies depicting ....
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....1.96%. Further, the benefit of (+/-)5% as provided in proviso to Section 92C(2) should also be provided to the assessee. After granting the benefit of (+/-)5%, the assessee would have well complied with the transfer pricing regulations of India and the question of adjustment would not arise. Further, the Ld. Counsel also highlighted the error on part of the TPO by adopting the financials of MUK for the period July 2005-June 2006 instead of April 2005-March 2006. At this juncture it is worth to mention that Ld. CIT DR has not objected and accepted the said fallacy. About DRP's observation Ld. Counsel has briefly mentioned that the said order is nothing but a copy-paste of the TPO's order as also the submissions of the assessee, hence the points discussed therein has already been attended by him. (m) Basis of Study : About search strategy for uncontrolled comparables it is informed that renowned external data- bases were consulted namely FAME ( by Bureau Van Dijk), Standard & Poor's Research Insight, Compustat Global Data, Primark's disclosure Worldscope and on the basis of the study filtered out the non-comparables. He has thus pleaded that the primary onus as casted upon b....
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.... the time of delivery; and for that has to necessarily consult MIL. Delivery of the software has always taken place from MIL to the customer. vii. MUK has no brand / technical expertise to distribute. They use MIL'S India brand. As per Ld. DR how would a customer in UK give a contract to MUK without MIL's back-up. The requisite technical capabilities are with MIL and therefore MUK cannot enter into contract on its own. viii. The Ld. DR took us through the relevant portion of the TP Study Report, where the asset analysis was carried out by the assessee and re-emphasized that without MIL's name, MUK will not be able to sell the contracts to third parties in UK. ix. Further, MIL has also given performance guarantee to the customers in UK, which further strengthens the point that MUK acts like a marketing support service provider. x. As per the conclusion of the Functions, Assets and Risks analysis, it is MIL which is primarily responsible to the customer and acts like an entrepreneur. xi. Further, the rate of the compensation for MUK is also fixed at 5.52% every month. xii. Then, the Ld. DR put up his contentions against the ....
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....e customers. f. Commission to employees of MUK:- The Ld. DR vehemently argued that this plea was taken for the first time by the assessee before the Tribunal. The assessee has never produced any evidence as regards the staff of MUK being paid salary and commission. These details now given should not influence the Tribunal and should be disregarded. g. Use of US comparables:- In this regard, the Ld. DR stated that in the show cause notice he requested the assessee to state why UK/US comparables should not be used. According to the Ld. DR, the assessee never submitted the details of UK comparable until the TPO placed his order for DIT's approval. He pointed out that the assessee gave his replies but never gave any replies in relation to the UK comparables. The details given by the assessee were submitted late and not within the time given in the show cause. As per the Ld. DR, the procedure is to send the draft order for DIT's approval, which would take a gap of around 5 to 6 working days. The Ld. DR further stated that the TPO used the same report of the assessee, which was prepared in relation to another subsidiary in USA having similar business model....
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.... services after sales. The Ld. DR highlighted that as regards the functions of MUK, which have been submitted by the assessee, the functions relating to after sales services have not been discussed. The team of MUK though technical are not from the software services perspective but merely commercial perspective. xv. Based on the above, the Ld. DR concluded that the TPO has rightly treated MUK as a marketing support service provider/performing front office activities and should be therefore compensated only on a cost plus basis. (E) Rejoinder: 6. In the Rejoinder, the Ld. Counsel for the Assessee responded to the aforesaid arguments and the same are summarized below: a. Shifting of tax base:- The Ld. Counsel clarified that the point raised by him was not to challenge the jurisdiction of the TP Regulations but was more from a commercial perspective and in his view it is an important point to be considered as to why would a businessman not bring all the profits in India, when the same were exempt and continue to pay taxes at a rate of 30% in UK by parking these profits there. He further emphasized that the Delhi High Court's ruling need to be respected. .....
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....r issuing any letter to MUK supporting / rejecting the terms of the agreement between MUK and third parties, which proves that MIL does not interfere in the process when MUK signs the contracts with the customers in UK. e. Employees of MUK:- MUK sells based on the software capabilities of MIL. It does not have technical people to perform the software services. However, it does all that is required to distribute a complex software solution to a customer and the same have been well demonstrated through the business case studies. f. Deliveries to the customer by MIL:- The software solutions developed by Mastek are customised software solutions and will always have to be put up at the customer's site by MIL. This does not give any right to MIL to raise any invoices on customers directly. Deliveries directly to the customers will have no bearing on the case as to whether MUK acts as a distributor or a mere marketing services provider. g. Commission to the employees:- It was incorrect on the part of the Ld. DR to state that this was never discussed before the TPO. This aspect has been very much discussed with the TPO and placed on record. Page....
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....td., an Indian Corporation (referred as "Mastek" in short MIL ), Ahmedabad and Mastek UK Ltd. (MUK), A United Kingdom Corporation, UK. The said Agreement was effective from 01/01/2005. In the preamble, it is stated that from 01/01/2005, "Mastek" has changed its business model for UK operations. Consequently, "Mastek" has started providing on-site software services to customers in UK through Mastek UK- Branch . The Agreement says that earlier those services were provided by MUK. An another opening remark in the preamble was that the Mastek has engaged as also retained MUK to perform the distribution activities for the software development and information technology services. On-site and off-shore services to be performed by "Mastek". MUK has accepted to perform such distribution activities but for consideration as recorded therein below in the said Agreement. Relevant portion is reproduced below. "Whereas with effect from January 1, 2005, Mastek has changed its business model for the UK operations. Consequently, Mastek has started providing onsite software services to MUK's customers in the UK, through Mastek Ltd., -UK Branch, which were earlier provided by MUK. Whereas hencef....
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....ot genuine or it was sham/fake. It is a settled proposition that commercial transactions are in the domain of the business-man and the Revenue Department cannot intervene in the realm of intricacies of commercial expediencies involved, hence it is improper to ignore the terms & conditions incorporated therein without assigning some strong reason. 7.5 On the basis of the above Master Agreement a vehement argument from the side of the assessee was that the activities performed by the MUK was distribution of software services. A question was raised that why at all business model was required to be changed and why the impugned Master Agreement date 30.3.2005 was executed and that what was the necessity to substitute the existing business pattern. In this regard, ld.AR has referred Her Majesty of Revenue and Customs ('HMRC'). 8. Relevant portion of HMRC is reproduced below:- "It is of course possible to think of services that might be provided to someone carrying on the business of selling for example the selling company will very likely pay someone to advertise their goods. However, the act of soliciting and securing a sale goes beyond the provision of services to the selling ....
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....ion is prevalent in selling agent's case. We have examined this thought of the TPO in depth. Even in the case of a distributor, it is expected from a distributor to consult with the manufacturer or the main concern while finalizing a contract so that the negotiation should be in line with the requirement of the main manufacturer. Though the parties i.e. MIL and MUK are associated to each other but simultaneously two separate legal entities having separate tax structure hence settled the terms of payment on sales basis, considering their respective advantages, though can be a fixed amount, so that there should be enviable incentive to generate more revenue. 11. One must not overlook a basic fact that the MIL had changed its business model in respect of UK operations. Before us, the percentage of award/ compensation paid to other Associate Enterprises is informed. The geographical revenue was compared and it was found that out of the other Associate Enterprises the revenue generated by MUK from UK was highest at 60%. Because of the substantial growth in business in UK and substantial increase in revenue, it was a business decision to change the business pattern. Therefore with eff....
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....change in the business model, there was also a change in the profitability. According to ld. AR, there was an overall increase in profit due to increase in turnover and that the said change has resulted into excess profit of MIL group. Due to the change in the business model, the entire 'on-site' revenue, approximately it was stated to be Rs.150 crores, was accounted in the books of MIL. And that on account of the UK operations, the profits have been increased in Indian Rupees from 45 crores to Rs.51 crores. The percentage of profitability was low simply because of increase in denominator, but there was no shifting of profit from MIL to MUK. Otherwise also it is a general market phenomenon that whenever there is high turn over there is decline in profit ratio so as to sustain the market competition as also to garner more business. This universal realty thus supports the stand of the appellant. 14. An another argument has also been raised that there was no advantage in shifting of profit from India to UK. A vehement contention was raised that once the entire income of MIL is subject to special benefit as prescribed u/s.10A and there was NIL incidence of tax, then there was no jus....
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....efitted by charging 5% mark up as against 17.14% fixed by the TPO and that the profits of the AEs being subject to tax out of country's jurisdiction, therefore there was no necessity for the assessee to transfer the profits in any overseas jurisdiction. We have also noticed that in an unequivocal terms it is pronounced, quote "that since the profits by the AEs have been subjected to tax in the respective overseas jurisdiction, there was no necessity for the assessee to transfer the profits in any overseas jurisdiction" unquote. 15. An another question is that merely because in terms of the Master Agreement the MUK has received a fixed compensation at 5.5%, whether it could lead to a conclusion that the said entity was a marketing or front office entity. Though undisputedly a legally binding agreement must not be disregarded but that agreement has to be understood and taken into account as a whole and not in piece-meal. A decision of Abhishek Auto Industries Ltd. (supra) has been referred. It is also worth to refer Azadi Bachavo Andolan & Anr. (supra). An another fact has also been brought that the MUK had prescribed commission to its employees on sales. The employees who have ea....
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.... the comparables between UK and US bench-marks, then in the present case only UK bench-mark can be said to be most appropriate and most suitable comparable. We, therefore, do not endorse the bench-marking of TPO being based upon US comparables. 16.1. It is clear that arm's length price is to be determined by taking result of comparable transactions and those transactions must be in comparable circumstances. It is therefore required to have a proper study of specific characteristics of controlled transaction. It is also required that there should be proper study of functions performed so as to match the identical situations under which functions have been performed. Then risk profile is also required to be compared. We may like to add that there are so many perspectives which are required to be compared and in this connection the Hon'ble Courts have also suggested so, such as, comparison of functional profile, similarity in respect of assets employed and a thorough screening of the comparables etc. Hence, in the present case, it is necessary to consider an analysis that whether the comparables selected by the TPO had analogous functional profile to that of functional profile of t....
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....the revenue was 4,98,26,033 and the Mastek billing was 3,82,63,673. The expenses, such as, administrative cost, selling, travelling, communication, etc. were 88,13,223. The total of the billing and the expenses was thus 4,70,76,896. This amount was deducted from the Revenue of 4,98,26,033 and the balance was the Operating Profit (OP) came to 27,49,137. This figure of OP is in fact 5.52% of the total revenue. The calculation of transaction has been further explained and in this connection paper book-II is referred wherein on page 306 there was a list of invoices raised on MUK. For example, for the month of July 2005 as per Mastek Invoice No.(MH-1030001) the invoice amount was 2450.82. However, the total revenue of MUK was 3333.78. The front office cost of MUK was 699.60. Thereafter, the Operative Profit of MUK was calculated as 183.36. This amount of OP is 5.5%. For the entire period, the MUK's operating margin was uniform at 5.5%. In this regard, invoices have been placed before us. On the basis of the said figures it was certified; after economic analysis; that "the most appropriate method" for the assessee was TNMM method. It has also been certified that the application of TNMM r....
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....ic Mean of the comparable companies 4.62% Median 2.11% Upper Quartile 3.59% Lower Quartile 0.68% We have been informed that in respect of the software services distributed by MUK, after the amounts received by Mastek, the MUK was left with an OM operative margin of 4.62% or less for such transaction. But in the instant case, MUK was left with an OM of 5.52%. Since it was better, therefore the impugned international transaction between Mastek and MUK can be held an Arm's Length transaction. If on examination of facts and figures the situation is that the comparisons do not give a clear picture rather they skew the result, then such results cannot be considered as the representative of the industry. Rather, we may like to comment that the DRP being a high-power and highly qualified consortium of high-ranking Revenue Officers, therefore their order should be precise on the issues raised and must not be lacking in reasoning. Though the present order of the DRP cannot be said to be a laconic order or a cursory order but devoid of precisely handling the issues raised by the TPO and confronted by the assessee. 17.2. We are aware that the selection of comparables....
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....terprises, one has to look for the differences and whether such differences are likely to affect the price, cost charged or paid or profit arising from the transaction in the open market. It has further to be examined whether a reasonably accurate adjustment can be made to eliminate the material effect of the differences between the transactions or entities. If a reasonably accurate adjustment for the difference to eliminate material effect of the differences cannot possibly be made, then such comparables (uncontrolled) are to be rejected" unquote. While deciding the case of Mentor Graphics (Noida) (P.) Ltd. v. Dy. CIT [2007] 18 SOT 76 (Delhi), the guidelines given were as under:- "The first step in the determination of arm's length price is to analyse the specific characteristics of the controlled transaction whether it relates to transfer of goods, services or intangibles. Without proper study of specific characteristics of controlled transaction, no meaningful comparison or location of comparable is possible. For example, a mere consideration that controlled transaction relates to "software supply" is not sufficient as there are hundreds of softwares with different characteri....
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....and operating profit but functions performed and risk profile are 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 comparison 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 risk not only due to human resources, infrastructure and quality which are normally taken into account yet more significant risks like market risk, contract risk, credit and collection risk and risk of infringement of intellectual property are being ignored here. If there are differences which can be adjusted, then adjustments are required to be made. If the differences between the companies are so material that adjustment is not possible, then comparables are required to be rejected. Further in the analysis numerous ratio are applied, depending on the specific of the comparables. The search may include the following....
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....sactions are to be eliminated for the purposes of comparison. 18. In the light of the above discussion and the case laws cited, we are tempted to make certain observations in respect of the scheme of transfer pricing as it was enumerated in Circular No. 12/2001 dated 23/08/2001(251 ITR 15 (St.). The provisions of Section 92 & 92A upto Section 92F have been enacted with a view to provide a Statutory framework which can lead to computation of a reasonable, fair and equitable profit and tax in India, so that the profits which are chargeable to tax in India do not get diverted elsewhere. These provisions have therefore laid down certain rules to arrive at a ALP through the most justifiable method. Generally the allegation is that by ordering the prices charged and paid in intra-group transaction the modes operandi leads to erosion of tax revenue in India. Naturally, for the purpose of determination of arm's length price of an international transaction a very fair method has to be adopted and that our tax-payers must not be put to avoidable hardship in the implementation of these regulations. We have to keep in mind the preliminary objective as it was propounded vide a Circular No. 1....
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....pose that TPO has to communicate to the taxpayer which one of the four conditions prescribed in this section are satisfied which render the Transfer Pricing as void or not at an Arm's length. Rather CBDT Circular No. 12 dated 23 Aug. 2001 (252 ITR 15 St.) made clear to the A.O. vide it's clause (vi) that when an International Transaction has been put to a scrutiny, the recourse is to follow the four conditions as prescribed in Sec.92C(3) based upon the material information or document in possession, otherwise the value of the international transaction be accepted. Therefore in the case of Philips Software Centre (P.) Ltd. (supra) the observation is as follows:- "5.1 We have heard the rival contentions and we proceed to adjudicate on the issues in the sequence which has been argued by the rival parties before us. The learned counsel for the assessee has argued that the tax payable by it in India is lower than the tax rate applicable to its AE in the Netherlands. Since the assessee is availing the benefit under s. 10A of the Act, one cannot take a simplistic view on the matter of tax avoidance. In this connection the learned Departmental Representative has drawn reference to the p....
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....or comparing the uncontrolled transaction. These Rules also prescribe that while comparing the international transaction, then conditions prevailing in the markets, functions performed, contractual terms, etc. etc. are the factors to analysis the comparability. Therefore, we express an opinion, though presently not the subject matter of dispute, that the case laws which are already in public domain in respect of deciding the disallowances made u/s. 40A(2)(a) of the Act can be helpful. We have expressed this opinion because in a difficult Transfer Pricing case, primarily because of the complexity of the facts, even the best intentioned tax-payer can make an honest mistake and like-wise the best intentioned tax-examiner, may genuinely draw wrong conclusion. OECD TP guidelines thus suggest, first, tax examiners are to be flexible because precision may be unrealistic and, second, commercial judgment or business expediency or trade realities do play a vital role in the application of arm's length principle. 18.2. Under the totality of the facts and circumstances of the case, first we hereby hold that considering the FAR analysis, risk factor and the business model as well as the term....
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....19.1. The observation of the AO was that the services rendered by the assessee were for the benefit of its Associate Enterprises by seconding employees. The seconding of employees has involved recruitment, training, re-allocation of personnel, re-absorption on return. According to TPO, Human Resource Services were different from software development services. Therefore, the TPO has decided to examine the quantum of services rendered and to determine the arm's length price of such services. As per the Function Asset Risk (FAR) analysis, the performance included recruitment and selection. The HRD carried out an analysis to determine the vacancies at various levels. Thereafter, re'sume of suitable candidates was obtained. After evaluating those candidates, they have been given general as well as technical training. According to TPO, the assessee was responsible for maintaining a pool of skilled manpower. The TPO has taken a view that it was clear from the functions performed that the assessee has performed human resource function. Therefore, according to TPO, it was essential to bench-mark the Human Resource Services separately. He has observed that the direct quantitative indicator o....
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....ty to absorb them with adequate work. 20.1. The assessee's contention was that the said HRM function was not a separate function and it was a part of the software services. The assessee has explained that there were two different types of transactions, first one, providing software services to the clients through AEs. For this services, charges are to be made by the clients through AEs for the software services. The second one is, providing man-power including technical man-power to AEs for carrying out their work as an independent entity. For this purpose, assessee-company provides the man-power out of its own pool of man-power. Seconding of these employees from existing assessee's business thus effects its Bench-strength and the assessee is in turn is required to recruit further manpower to fill up the gap. It is also common that those seconded-personnel may return, after the agreed time, back to assessee-company, however at the time of return those employees become the employees of the assessee-company. It has also been explained that during the period of secondment the assessee had to perform certain administrative functions regarding those employees. On the other hand, thos....
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....eparate from its core business activity of providing software services. According to DRP secondment services are used by the AEs and therefore those services should be compensated to the assessee as per arm's length principle. It was therefore held that the TPO was justified for the said adjustment. Now the assessee has challenged the observation of the Revenue Authorities. (B) Arguments : 22. At the outset, ld. AR Mr. S.N. Soparkar has drawn our attention on an Additional Ground; reproduced below:- 1. The Learned Transfer Pricing Officer, and consequently the D.R.P. and the Assessing Officer, have no jurisdiction to make any adjustment in relation to any item other than covered under Ground 1 of the appeal memo in as much as the same were not subject matter of Reference made to the Transfer Pricing Officer under section 92CA(1) of the Income Tax Act, 1961." 23. From the side of the Revenue, ld. DRs Mr. V.K. Gupta and Mr. Kartar Singh have vehemently objected that, while seeking approval, the said transaction has duly been communicated and it is incorrect on the part of the assessee to raise an objection in this regard. Ld. DRs have referred a letter dated 31/08/2009 in....
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....said matter is covered in favour of the assessee by the orders of Ld. CIT(A) for the AY 2005-06, AY 2004-05, AY 2003-04 and AY 2002-03. For all these assessment years, the Hon'ble CIT(A) have deleted the disallowance as regards human resource management function. Ld. AR has concluded that it was not appropriate on the part of the TPO to regard HRM function as "recruitment services". The assessee has not acted as an external recruitment agency. He has argued that the TPO has considered the third party rate paid by MIL during the financial year 2004-05 (viz. 8.33% of the annual salary paid by the associated enterprises to its employees) to other recruitment agencies as the benchmark and on a presumptive basis used 9% determining the arm's length compensation on the ground that assessee incurs certain administrative costs in relation to providing HRM services. This would mean that the TPO has regarded Comparable Uncontrolled Price Method ('CUP') as the most appropriate method. Application of CUP method requires stricter comparability between the controlled and uncontrolled transactions. In order to draw the comparability, the provisions of the Rules 10B(2) and 10B(3) need to be consid....
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....compensation computed; ld. DR has mentioned that the direct quantitative indicator of the HRM services rendered by MIL is the number of persons deputed by MIL on yearly basis. He has also vehemently pleaded that the 'offshore' activity and 'onsite' activity cannot be segregated and both the activities go hand in hand. According to him, the AEs have derived valuable benefit of availability of technical persons as and when required, hence for providing this facility the assessee-company should recover the compensation at arm's length price. (C) Findings : 26. We have heard both the sides at length. We have perused the orders of the Revenue Authorities in the light of the voluminous compilation filed. It is true that the assessee is engaged in providing 'offshore' software development. The Associate Enterprises are also in the business of providing related services for software development 'onsite'. Facts have revealed that for enabling the AEs to provide 'onsite' service, the assessee has seconded its employees to those AEs. 26.1 To deal with this problem it is better to first examine the correct meaning of this notion i.e. " Secondment" and have found that a 'secondment' ta....
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....her it was justifiable on the part of the TPO to hair-split these two activities? As far as our common understanding of the business model of this assessee is concerned, as also the prevailing business pattern all over the world is concerned, the deployment of Human Resources is inter-linked with the business activity of the assessee, then such HRM activity can be said to be the intricately linked activity with the main business activity of an entrepreneur. Reason being, in the present case, software development services cannot be performed independently or in isolation with the deployment of technical persons. In such business model, there is an established existence of AEs abroad. Those AEs generally demand for supply of technical employees/engineers so as to accomplish the software development project 'onsite'. Such facility is provided by the Head Office, i.e. MIL. In return, MIL has also heaped the prize i.e. high revenue generation. By displaying different FAR, the TPO had made an attempt to distinguish the two activities. Nevertheless, the law prescribes that FAR should be appropriately documented, so that the correct figures is in the knowledge of the Revenue Department. ....
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....experience, update knowledge and with a better delivery skills. This is one part of the advantage and the other part of the advantage happened to be procurement of "offshore" business in high volume. We are therefore of the view that the comparability analysis as carried out by the TPO do not match with the facts of the case. It is not appropriate to hold that HRM function as carried out by this assessee is to be taken as recruitment services. We therefore hold that the assessee was not functioning as an external recruitment agency. At the cost of repetition, while arguing before us, the ld. DR has supported the action of the TPO primarily on the ground that by the deployment of skilled engineers at the services of AEs, those AEs have been benefited, hence, in return, the assessee should have recovered some compensation on secondments. It is not a correct approach because one has to examine the business strategies and the business model of an Enterprise and if it is found that other benefits are much higher than the small amount of compensation, then naturally applying a common business acumenship, no compensation or mark-ups should be asked for. In the present case as well, facts ....
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....thout prejudice to the above the Ld. AO/the Additional Commissioner of Income-tax, Transfer Pricing-l, Ahmedabad. ('Ld. TPO') has erred in law and on facts by disregarding the appellant's counter claim for recoveries made before the credit period of 60 days. 28.1 The TPO had observed that the assessee had granted excessive credit period to its AEs. According to him, normal credit period is 60 days, however, it was noticed that the assessee had granted credit period above 60 days. The TPO was of the view that the assessee should have charged interest @ 6.65% on account of excess credit period granted to AEs. A working was called for from the assessee and on that basis the TPO has asked the AO to make an adjustment of Rs. 11,22,281/-. 28.2 When the matter was discussed before DRP, the action of the TPO was affirmed with the finding that the AE had retained the sale consideration beyond a stipulated time, hence, the assessee was entitled for compensation in the form of interest. 28.3 Ld. AR Mr. S.N. Soparkar stated that though a working was provided to TPO but that was made only to comply with the directions but there was no concession or acceptance was offered. As far as cha....
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.... Naturally, even as per the OECD(TP) guidelines, now worth mentioning, it has been subscribed that to ensure a healthy relationship and to maintain a long business transaction, such compensation or charging of interest are being ignored commonly by business man. We cannot ignore this fact as well that in past few Asst. Years, such an adjustment was overruled by ld. CIT(A). It was a correct decision that a business and commercial consideration have to be looked into and one cannot apply arm's length method to say that the assessee ought to have earned the compensation from the AE. Rather, during the course of proceeding, it was enquired by us whether it would be relevant to see if the AEs have received the funds from the third parties within reasonable credit period and whether the transaction as a whole need reconsideration. If the AEs have not charged interest to third parties for late recoveries, would it be reasonable to expect MIL to recover the interest from the AEs. Likewise if MIL is not paying interest on advance/preponment of payment to AE then was it justifiable to levy interest on few days delay? In response to this, the Ld. DR has stated that since MIL and its AEs were ....
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.... after the gap of sometime. The gain in exchange rate is therefore recorded on the date of realization. The said difference is duly accounted for in the books of accounts as "exchange rate difference". Few case laws have also been cited as follows:- "1. Decision of the Hon'ble Chennai ITAT in the case of Changepond Technologies P Ltd v. Assistant Commissioner of Income Tax Circle 1(3) (2007) (22 SOT 220) 2. Decision of Hon'ble Ahmedabad ITAT in the case of Gami Exports vs. Assistant Commissioner of Income Tax (2005) (94 TTJ 557) 3. Decision of the Hon'ble Gujarat High Court in case of Hindustan Trading Corp. 160 ITR 15 4. Decision of the Hon'ble Mumbai ITAT in the case of K. Uttamlal Exports v. DCIT [2004] (133 Taxmann 196) 5. Decision of the Hon'ble Delhi ITAT in the case of Smt. Sujata Grover v. Deputy Commissioner of Income Tax (2001) (74 TTJ 347) 6. Decision of the Hon'ble Mumbai ITAT in the case of CMC Limited, Mumbai v. The DCIT, Spl. Range - 36, Mumbai (ITA No. 4811/Mum/1998)." 31.2 The AO was not convinced and held that on perusal of computation of deduction u/s.10A, it was noticed that t....
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....TA Nos. 1688 and 4352/Ahd/2003 tiled as Mastek Ltd. v. Asst. CIT for AYs 2000-01 & 1999-2000, dated 17/06/2008 and finally held as under:- "16.4 As regards income on account of exchange rate fluctuation, Hon'ble Gujarat High Court in the case of CIT v. Amba Impex 282 ITR 1445(Guj) held that merely because an amount is received in a year subsequent to the year of export by way of exchange rate difference, it does not necessarily always follow that the same is not relatable to the exports made. The ITAT in the case of Renaissance Jewellery (P.) Limited v. Income-tax Officer, Ward 8(3)(3), Mumbai 289 ITR SP 65 (Mum.) held that the profit on account of foreign exchange gain is directly referable to the articles and things exported by the assessee. Such profits are, therefore, of the same nature as the sale proceeds and there is no reason as to why deduction under section 10A should not be allowed in respect of such exchange gain. No contrary decision has been brought to our notice. However, in the case under consideration, it is not evident from the order of lower authorities as to whether or not gain due to difference in exchange rate is on account of exports or otherwise. In these....
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....ng Rule 8D of IT Rules. The assessee has submitted that no part of the investment was made out of borrowed funds. It was explained that the company had sufficient funds in hand. The entire investment was made out of its own funds. The position of the reserves and surplus was narrated to the AO to explain that there were sufficient share capital and reserve and surplus funds in comparison to the investment amount. However, the AO was not convinced and according to him, the assessee has not furnished details of exact source of investment in shares. According to AO, the assessee has not explained whether separate accounts were maintained to demonstrate that non-interest bearing funds were utilized for the said investment. According to AO, apart from the above, certain administrative expenses would have also been incurred for managing the said investment. Applying the Rule 8D, which according to him was applicable for the year under consideration, he has computed expenditure in relation to the income which did not form part of the total income and a proportionate computation was made. Finally a disallowance u/s.14A of Rs. 20,39,041/- was taxed. The DRP has referred Daga Capital Managem....
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....herefore, the Tribunal was justified in remanding the matter. (b) Section 14A was introduced by the Finance Act 2001 with retrospective effect from 1 April 1962. However, in view of the proviso to that Section, the disallowance thereunder could be effectively made from assessment year 2001-2002 onwards. The fact that the Tribunal failed to consider the applicability of Section 14A in its proper perspective, for assessment year 2001-2002 would not bar the Tribunal from considering disallowance under Section 14A in assessment year 2002-2003. (c) The decisions reported in Sridev Enterprises (supra), Munjal Sales Corporation (supra) and Radhasoami Satsang (supra) holding that there must be consistency and definiteness in the approach of the revenue would not apply to the facts of the present case, because of the material change introduced by Section 14A by way of statutory disallowance in certain cases. There, the decisions of the Tribunal in the earlier years would have no relevance in considering disallowance in assessment year 2002-2003 in the light of Section 14A of the Act. 73. For the reasons which we have indicated, we have come to the conclusion that under ....
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....8 shall apply with effect from Assessment Year 2008-09; (vi) Even prior to Assessment Year 2008-09, when Rule 8D was not applicable, the Assessing Officer has to enforce the provisions of sub section (1) of Section 14A. For that purpose, the Assessing Officer is duty bound to determine the expenditure which has been incurred in relation to income which does not form part of the total income under the Act. The Assessing Officer must adopt a reasonable basis or method consistent with all the relevant facts and circumstances after furnishing a reasonable opportunity to the assessee to place all germane material on the record; (vii) The proceedings for Assessment Year 2002-03 shall stand remanded back to the Assessing Officer. The Assessing Officer shall determine as to whether the assessee has incurred any expenditure (direct or indirect) in relation to dividend income/income from mutual funds which does not form part of the total income as contemplated under Section 14A. The Assessing Officer can adopt a reasonable basis for effecting the apportionment. While making that determination, the Assessing Officer shall provide a reasonable opportunity to the assessee of p....
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....es that in order to treat the services as FTS, the same should make available technical knowledge, experience, skill know-how or processes, or consist of the development and transfer of a technical plan or technical design. The services provided by the non-residents to the UK branch neither make available any technical knowledge, skill, know-how nor is in the nature of transfer of technical plan or technical design and as such, not liable to tax in India. iv. When the income of non-resident is not liable to tax in India, then the provisions of section 195 is not applicable and as such, the appellant has no liability to deduct tax on such payments and accordingly, no disallowance can be made under section 40(a)(i) of the Act. v. The aforesaid issue has been decided in favour by the Hon'ble CIT(A) in appellant's own case for earlier AY 2005-06. (A) Facts: 35.1 It was noted by the AO that the assessee has made payment to 19 parties, listed in the assessment order, for software consultation and recruitment services. The payment to the extent of Rs. 12,26,18,416/- was made without deduction of tax. A show cause was issued as to why the disallowance u....
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....nder obligation to deduct TDS. The AO was not convinced and after analyzing section 195 of IT Act and the provisions of section 9(1)(i) and section 9(1)(vii) held that the payment was in the nature of "Fees for Technical Services" ('FTS'). He has mentioned that in section 9(1)(vii) the word used is the services "utilized in India" as against "services rendered in India". He has explained that the effect of the word "utilized" in place of "rendered" is that the non-resident need not to come physically to India or the transaction need not to take place in India. According to AO, it is enough if the services or the end result of the services are utilized in India. He was of the view that irrespective of the source and place of delivery, the FTS deemed to accrue or arise in India, if the services are utilized in India for which FTS is paid. The AO has also referred Explanation to section- 9(1) of IT Act. The intention of this Explanation is to bring certain income of non-residents to tax in India if the source is in India. According to AO, the source is MIL, an Indian Company. From the side of the Assessee, CBDT Circular 740 was cited for the argument that the branch of a foreign compa....
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.... to hold that the profit is charged to tax attributable to branch operations in UK. In his view, the UK branch is a separate legal entity formed under UK regulations. In his opinion, after the combined reading of exception laid down in section 9(1)(vii)(b) along with India-UK DTAA the consultancy charges paid by the UK branch not to be held as income accrue or arising in India. A decision of Hon'ble Supreme Court in the case of Ishikawajma-Harima Heavy Industries Ltd. v. DIT [2007] 288 ITR 408/158 Taxman 259 (SC) was cited. Further, a decision of Hon'ble Madras High Court in the case of Skycell Communications Ltd. v. Dy. CIT [2001] 251 ITR 53/119 Taxman 496 was also cited. 35.4 From the side of the Revenue, ld. DR has placed reliance on the order of the AO and the order of the DRP. (C) Conclusion ; 36. We have heard both the sides and noticed the basic facts that the impugned payment was made without deduction of tax. It is also not in dispute that the payment was made to 19 (Nineteen) parties and all of them are not Indian Residents. It is also not in dispute that the nature of expenses were, namely, "Recruitment Services", "Training Services" and "Software Consulting". B....
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....se of export. An issue has therefore been raised that the professional charges paid by the UK Branch of the assessee to various entities which are non-resident, then whether it can be held that an income has deemingly accrued in India. As far as the assessee's vehement contention is that the AO should not have decided against the order of CIT(A) pronounced in A.Y. 2005-06, wherein vide an order dated 30/09/2009, the CIT(A)-VIII Ahmedabad has considered this aspect at length and thereupon held as under:- "8.12. It may be further pointed out that Article 7 of the DTAA between India and UK states that business income of the UK enterprise shall not be taxable in India unless the UK enterprise has a Permanent Establishment ('PE') in India. The Ld. A.R. pointed out that the entities from whom UK branch availed services does not have PE in India. From the invoices submitted before me, it was observed that these entities are based in the United Kingdom with no business presence in India. The A.O. while drawing adverse conclusion has not brought any fact on record to controvert the claim of the app in this regard. I am of the view that the professional fees payable to should be considere....
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....s from the foreign consultants were neither rendered in India nor utilized in India. Our attention has been drawn on an insertion of an Explanation below Section 9(2) of IT Act and for ready reference, reproduce below:- "Explanation - For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not- (i) The non-resident has a residence or place of business or business connection in India; or (ii) The non-resident has rendered services in India." This Explanation has been inserted by Finance Act, 2007 and later on substituted by Finance Act, 2010. Due to this reason, at the relevant point of time, i.e. during the relevant Financial Year, it was not possible on the part of the assessee to comply with the said Statute. We therefore hold since the services in question were neither "availed" nor "rendered" and even not "utilized" in India, therefore no tax was required to be deducted at source. Rest of the issues abou....
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....ployees only for the purpose of deputation to its subsidiaries. The expenditure has been incurred at organizational level. The HR Department of the Company on a continuous basis is indulged in recruitment programmes, training programmes, so as to retain the talent of technical persons. The assessee has explained the business rationale behind such expenditure that the Company derives double benefits, one, increase in offshore revenue, second, employees with upgraded skill has enhanced solution delivery skills. It has also been informed that there is "continuity of employment" even if sent abroad to AEs. Such employees remain on the pay-roll of the assessee-company. A detailed explanation was furnished, however the AO was not convinced and expressed that the Company had seconded as many as 148 persons to its AEs. The assessee is, therefore, in the opinion of the AO, is a supplier of man-power to its offshore subsidiaries. But those persons were recruited and trained at the expense of the Company. In his opinion, such persons deployed outside India may or may not come back and may be absorbed by AE. In such a situation, the benefits of recruitment and training have been enjoyed by AEs....
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....ated. In fact, the argument of the assessee appears to be logical that considering the nature of the services provided a training of the technical staff is always a business necessity and because of the trained staff the assessee's revenue has substantially gone up. In the absence of any adverse material, we are not inclined to approve such an adhocism. This disallowance is hereby deleted and Ground is allowed. 39. Ground No.8 reads as under:- 8. Ground No. 8 - Setting off losses of other units while computing deduction under section 10A of the Act from the profits of eligible units The Ld. AO has erred in law and on facts in computing deduction under section 10A of the Act considering the net profits of business of all units taken together i.e. after setting off losses of eligible and non-eligible units with profits of eligible units thereby restricting deduction under section 10A of the Act. The Ld. AO ought to have appreciated the following: i. Each eligible undertaking is an independent and distinctive business unit and deduction under section 10A should be computed specific to eligible undertaking instead of computing such deduction after considering n....
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....ower amount and the AO has held that the eligible amount was higher. If it was so, then there should not be any grievance of the assessee. The only information before us in respect of the claim of deduction u/s.10A is as under:- Particulars Amount (Rs.) Mahape unit 59,63,47,583 Pune Unit 1,75,61,530 Total 61,39,09,113 The AO has made the computation of the total taxable income wherein the deduction u/s.10A was mentioned as eligible for Rs. 72,98,75,578/-, however, the same was allowed to the extent of the income computed at Rs. 63,14,08,049/-. As far as the law is concerned, Section 10A prescribes a deduction of profits and gains derived by an Undertaking from the export of articles or things or computer software. After the substitution of word "deduction" the intention of the Legislature was to give only deduction and not the exclusion from total income. Section 10A has further been amended and sub-section (6) was introduced which prescribes that in computing the total income of the assessee, no loss referred to in Section 72(1) or Section 74(1) or Section 4(3) shall be carried forward or set off so far as such loss relates to the business undertaking an....