TaxTMI 
TaxTMI 
2012 (6) TMI 60
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....nto between the appellant and third parties. 4. The Learned CIT (A) ought to have accepted CUP method adopted by the appellant as the most appropriate method and ought to have accepted the international transactions as complied with Arms Length principle. 5. The Learned CIT (A) ought to have accepted Cost Plus Method (CPM) as an alternative method since transactions made by the appellant with unrelated third parties and the international transactions with AE are functionally comparable. 6. The Learned CIT(A) erred in endorsing the TPO's action of rejecting the four comparables which were accepted in the earlier assessment years i.e., AY 2003-04 and AY 2004-05 for applying TNMM. 7. The Learned CIT (A) is not justified in law in considering the 16 companies selected by the Ld TPO as comparables and arriving at a PLI of 26.41% as a ratio of operating profit/Total cost. For applying TNMM the 16 companies selected as comparables are engaged in software development services and are in no way functionally similar to the business of the appellant. 8. The Learned CIT (A) is not justified in law in endorsing the observation of the Ld TPO by ma....
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....ade an addition of Rs. 5,77,93,011/- to the returned income of the assessee u/s. 92CA of the Act. 4. During the assessment, the Assessing Officer further noticed that the assessee has paid an amount of Rs. 1,44,000/- towards interior design to M/s. Expanse Design Solutions. According to him, such expenditure being covered under the provisions of 194C of the Act, the assessee was required to deduct tax at source on the same. But, in absence of any TDS made by the assessee, the Assessing Officer disallowed the same, applying the provisions of section 40(a)(ia) of the Act. Further, in absence of any TDS made on a sum of Rs. 26,140/-, incurred towards advertisement expenses, the Assessing Officer disallowed the same u/s. 40(a)(ia) of the Act. Similarly, in absence of TDS made on an amount of Rs. 52,435/-, paid to one M/s. Roshini Micro Systems, towards job work during the previous year, the Assessing Officer disallowed the same u/s. 40(a)(ia) of the Act. The Assessing Officer further noticed that the assessee has Incurred expenditure of Rs. 1,24,160/- towards guest house charges during the previous year. According to him, the assessee was required to deduct tax at source on such pay....
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....ty or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. Thus, as per both the above provisions, i.e., under IT Rules and under OECD guidelines, for application of CUP method, similarity of the transactions is of utmost importance. In other words, there should be existence of transactions relating to transfer of property/ services, which are similar, so as to enable comparison between them. However, in the instant case, after going through the agreement entered into by the assessee with its AE and those agreements entered into with the third parties, the CIT(A) observed that that the services rendered to those third parties, are not similar to that rendered to the AE. 7. As per the contract/agreement made with Avedis Microsystems Pvt. Ltd., the said company has requested the assessee to provide two design engineers with specified experience (as mentioned therein) on a monthly fee basis and the terms and conditions in that regard also indicated therein. From the copy of the said agreement filed before the CIT(A), the nature of services to be rendered to th....
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.... the circumstance, the said company which was in the business of developing, manufacturing and selling digital signal processing devices, cannot be considered as an internal comparable in this case. In other words the transactions made with that company cannot be considered for the purpose of comparability analysis under CUP method, in this case. In this context, it may be further mentioned that though the assessee has furnished copy of a letter dated 29.11.2004 written by that company and certain invoices issued by that company, in absence of the nature of services to be rendered by the assessee to that company, those documents, have no application in this case. 10. As regards, the case of Future Techno Designs Pvt. Ltd., is concerned, the assessee has merely furnished copies of purchase order issued by that company wherein for design service charges for multi-adaptor project, the rate is shown at US$ 63,000. But, in absence of the nature of services to be rendered indicated in that purchase order, it cannot be said that the services rendered to that company were similar to that rendered by the assessee to its AE. Further in absence of any agreement with that company, it cannot....
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.... sentence, in that para, he has further mentioned that, but while selecting CUP method, one more important aspect ignored by the taxpayer is whether the data used by the taxpayer is reliable and verifiable by the TPO. From such observations of the TPO, it may be seen that he has pointed out that, the data used by the assessee are not reliable and not verifiable and for the same he has rejected such method adopted by the assessee. In any case, since after detailed discussions made above, the CIT(A) held that CUP method cannot be adopted in this case, such decision of the TPO in rejecting such method adopted by the assessee, is justified and hence, the same is upheld. Further, for the reasons stated by him in his said order, adoption of TNMM by the TPO as the most appropriate method for determining ALP of such international transactions made by the assessee during the F.Y 2004-05 with its AE, is held to be justified. It may also be mentioned here that in the preceding two assessment years, TNMM has also been applied by the TPO and the same has been accepted. Under such circumstances, application of the said method i.e., TNMM by the TPO for computing ALP of the international transacti....
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.... for selecting each such company as comparable are discussed by him in that order. Though the assessee has not made any submission with reference to those companies, after excluding only Satyam Computer Services Limited, whose financial statements, in the wake of the recent media reports regarding manipulation in their accounts, are not reliable, as already held by him in the case of Intergraph Consulting Pvt. Ltd., vide his order In ITA. No. 0210/CIT(A)-III/OB-09 dated 31.03.2010, the other 16 companies, for the reasons stated in that order, should be considered as comparables for the purpose of determining ALP of the international transactions in this case. The workings relating to ratio of operating profit to total cost in case of each company, i.e., the profit margin are given by the TPO in Annexure B to his said order. After excluding Satyam Computer Services Limited; on the basis of such data given by the TPO, in respect of the remaining 16 companies, the average profit margin i.e., arithmetic mean PU, comes to 26.41%. 15. With regard to the working capital adjustment allowed by the TPO from the average profit margin, determined In respect of the comparable companies, it i....
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....payments made and procurement costs incurred 5,11,588 18. The assessee-company adopted the Internal Comparable Uncontrolled Price (CUP) method for determining the arm's length price for sale of software services to its Associated Enterprise. The assessee-company submitted the following information, in addition to Form No. 3CEB and Company Audit Report, to the Transfer Pricing Officer, during the proceedings. (a) Details of sales made during the year, which included amount charged, no. of engineers employed, total number of man months, the rate in INR and USD per man month to unrelated parties, (b) Justification for the methods adopted. (c) Details of ownership structure, broad description of business, nature and terms of international transactions and functional analysis, assets employed and risks undertaken of the assessee-company. 19. The learned AR submitted that Comparable Uncontrolled Price (CUP) Method adopted for benchmarking of export sales to QualCore Logic Inc. USA was the Most Appropriate Method in view of other internal comparables being available in the form of sales made to other unrelated parties. Such submissions made by the a....
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.... 23. He submitted that The Transfer Pricing officer, after perusal of information and evidence submitted by assessee-company completed the reference by passing the order u/s 92CA(3) as under: (a) The CUP method adopted by assessee-company for export transactions with the associated enterprise was rejected. (b) In place of CUP, the Transfer Pricing Officer, adopted the Transactional Net Margin Method ( TNMM ) for the export transactions mentioned above and revised the arm's length price in accordance with TNMM.The Learned TPO selected 17 companies for the purpose of benchmarking. The 17 companies selected as comparables by the Learned TPO are engaged in software development services and are in no way functionally similar to the business of the assessee. (c) Revised sales figure as per TNMM came to Rs. 12,74,96,713 as against actual sales of Rs. 6,01,83,326 made by the assessee-company. (d) The above difference lead to a transfer pricing adjustment to the tune of Rs. 5,77,93,011. 24. The Assessing Officer on the basis of order u/s 92CA(3) mentioned above, made an addition of Rs. 5,77,93,011 in the assessment u/s 143(3). The addition result....
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....even with some differences between international Transactions and Comparable Uncontrolled Transactions subject to proper adjustments for removing the differences. It is strongly recommended that the CUP method should not be denied on the basis of differences. In this regards the relevant portion of the text of Para 2.16 is reproduced. Where differences exist between the controlled and uncontrolled transactions or between the enterprises undertaking those transactions, it may be difficult to determine reasonably accurate adjustments to eliminate the effect on price. 'The difficulties that arise in attempting to make reasonably accurate adjustments should not routinely preclude the possible application of the CUP method. 28. According to the AR, the assessee company applied CUP method as the Most Appropriate Method (MAM) by considering internal comparables as explained above. As the service rendered to AE and unrelated parties are similar it is permitted to make the comparison of man hour / man month rate between both such services. In the chip designing industry, it is common practice to quote for the services in terms of man-hour / man-month basis. The invoices with unrelate....
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....terprises (AEs), on price at which transactions have been entered into by such AEs - (c) In Clear Plus India (P.) Ltd. v Deputy Commissioner of Income-tax, Circle-3(1), Delhi (10 Taxman 249) the Delhi Tribunal observed that CUP method was most suitable method for determining ALP (d) In DCIT v. 3 Global Services Pvt. Ltd (11 Taxman 136) (Mum) the Tribunal held that the Comparable Uncontrolled Method (CUP) followed by the assessee company is the most appropriate method. 30. The AR submitted that the Arms Length Price be benchmarked by using the CUP Method for which transactions with unrelated parties were submitted. 31. The AR submitted that the assessee's case would be further strengthened by application of Cost Plus Method (CPM) as an extension to CUP method. Rule 108(1)(c) reads as under:- (i) The direct and indirect costs of production incurred by the enterprise in respect of properly transferred or services provided to an associated enterprise, are determined; (ii) The amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar p....
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....any engaged in development of software in its own and selling it in the open market ". Subsequently for the years AY 2003-04 and AY 2004-05 the TPO accepted the following four companies as appropriate comparables for benchmarking the assessee's results under TNM method: 1. M/s. SPEL Semiconductor Ltd. 2. M/s. MRO-Tek Ltd. 3. M/s. Solectron Centum Electronics Ltd. 4. M/s. Tera Software Ltd. 35. The same four companies are appropriate for benchmarking under TNM method even for the year under consideration. The assessee submitted before the learned CIT(A) that the same comparables which were accepted earlier may be considered for the current year also. This submission was rejected by the CIT(A) and 17 comparables which are functionally different and were selected by the learned TPO were confirmed by the CIT(A). The AR submitted that the said four comparables which were earlier accepted as appropriate may be considered for the current year also under the TNM method. 36. In respect of the companies selected as comparables and confirmed by the CIT(A), the learned AR has expressed strong objections. 37. The learned AR submitted that none of....
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....that company is ascertainable. Under the circumstance, even though in that document there is mention that, the said company shall pay the assessee an amount of US$ 3000 per man month, the said company cannot be considered as a comparable (internal comparable) in this case. 41. The software development agreement made by Agere Systems India Pvt. Ltd., with the assessee, the said company desires to engage QCL i.e., the assessee company, to carry out certain software development work and the assessee agrees to carry out such work, in accordance with the terms and conditions of that agreement and any attachment referenced therein. Thus, the work to be performed/services to be rendered by the assessee, are referred to in concerned attachment. In the entire narrative of the said agreement, there is no reference to the nature of work/services to be rendered by the assessee i.e., QCL. Further, in Annexure-A (scope and statement of work), it is mentioned that the same shall be to support the design verification activities of SoCs, being designed by Agere. Thus, the assessee was required to carry out certain design verification of some activities that were assigned by that company. From th....
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....lar to those rendered to the AE. Hence, the said company cannot be considered as an internal comparable in this case. In other words, the transactions made with that company, cannot be considered for comparability analysis under CUP method. 44. The agreement with Beceem Communications Pvt. Ltd., as per the purchase order dated 05.10.2004 issued by that company, a copy of which was filed before him, the said company, for the purpose of VLSI design consultancy, has requisitioned two persons from the assessee at a price of Rs. 1,57,650/- (extended price Rs. 3,15,300). As per the same, the said company needed two persons from the assessee, in the context of some design consultancy. The same pertains to mere consultation. Under the circumstance, it cannot be said the assessee has rendered the same services to that company as it rendered to the AE. In other words, the services rendered to that company cannot be treated as similar to that rendered to the AE. Hence, the transaction made with the above company, cannot be considered for comparability analysis under CUP method in this case. 45. It is clear that the service rendered by the assessee to those third parties, were different ....
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.... applying cost plus method (CPM) is concerned, since the transactions made by it with those domestic parties are not similar to those rendered to the AE, the said method cannot be applied in this case. Accordingly, we reject the plea of the assessee. 46. Coming to the plea of the assessee that only those four companies, which were considered as comparables in the preceding two assessment years i.e., A.Ys. 2003-04 and 2004-05, should be considered in this case, the CIT(A) observed that there is no merit in such contention. As admitted by the assessee in its written submissions made vide letter dated 02.01.2010, the company in its case, is engaged in the business of software development services in the field of application of ASIC and VLSI. Thus, it was in the business of software development, though pertaining to a different field. Since, such fields come under purview of a vertical, under software development services, the different comparable companies referred to by the TPO at page 106, for the reasons stated by him against each such company, should be considered as comparables for the purpose of determining ALP of the international transactions in this case. The TPO has selec....
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.... upheld by the CIT(A). This ground is rejected. 50. The next ground is Ground No. 9. This ground is in correlation to Ground Nos. 7 and 8. Being so, this ground does not require any adjudication and is rejected. 51. The last ground for adjudication is with regard to not giving adjustment on account of high depreciation to the total cost in the case of the assessee. 52. Brief facts of the issue are that the total cost including depreciation and excluding interest is Rs. 9.69 crores and depreciation is Rs. 2.78 crores. Depreciation/total cost works out to 28.69%. This abnormal depreciation cost should be adjusted while computing margin of comparable companies under TNMM. Hence the PBDIT/expenditure of the company works out to 5.23% whereas the PBDIT/expenditure of comparable companies is 0.80%. The AR requested to consider PBDIT/expenditure as the profit level indicator. 53. The AR relied on the decision of Delhi Bench of the Tribunal in the case of Schefenacker Motherson Ltd. v. ITO (123 TTJ 509) for AY 2003-04 and Schefenacker Motherson Ltd. v. DCIT in ITA No. 4460/Del/07 for AY 2004-05 has agreed that where depreciation component varies significantly between the tested....
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....eement, under section 3.03, it is mentioned that the fees and/or commissions to be charged by distributor shall be determined by mutual agreement of distributor and company on a case by case basis with respect to each other. From such terms of the said agreement, it is seen that the company i.e., assessee company in this case, has full right to fix the price to be charged in respect of intellectual properties and design services, developed by it and it shall provide the said distributor i.e., the AE in this case, a pricelist in this regard. From the same, it shows, when the assessee was fixing the price, it has taken into account all costs incurred by it, both direct cost and indirect cost, in development of such intellectual property/design services. Under this circumstance, i.e., when the assessee, as per the said agreement, was to get the price, covering all costs incurred by it, in respect of such intellectual properties, etc., developed by it, the assessee cannot claim exclusion of depreciation in respect of the assets, for the purpose of computing operating profit. Further, when inthis case, the matter relates to determination of arm's length price of such international t....
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....or as per policy of the company. In the case in hand, Revenue authorities went wrong in disregarding the context and purpose for which the "net profit" was to be computed. Depreciation, which can have varied basis and is allowed at different rates, is not such an expenditure which must be deducted in all situations. It has no direct connection or bearing on price, cost or profit margin of the international transactions. Object and purpose of the transfer pricing to compare like with the like, and to eliminate differences, if any, by suitable adjustment is to be seen. Therefore, there was justification on the part of the assessee in pleading that profits be taken without deduction of depreciation as depreciation was leading to large differences in margins for various reasons. Contention that depreciation would depend upon type of technology employed, age and nature of machinery used, is quite well-founded. Above, along with size of enterprise and investment in plant/machinery were important factors to be taken into account for comparison and for computing profit. There is considerable support for the contention raised on behalf of the assessee in the OECD Guidelines on Transfer Pric....