TaxTMI 
TaxTMI 
2013 (1) TMI 672
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....natural justice; 3. making a reference to Transfer Pricing Officer for determining arms' length price; 4. passing the order without demonstrating that appellant had motive of tax evasion; 5. ignoring the fact that the members of Dispute Resolution Panel also being jurisdictional Commissioner/Directors of Income Tax of the appellant, the constitution of the Dispute Resolution Panel is bad in law; 6. not appreciating that the charging or computation provision relating to income under the head "Profits & Gains of Business or Profession" do not refer to or include the amounts computed under Chapter X and therefore addition under Chapter X is bad in law; 7. adopting a flawed process of issuing notices u/s 133(6) and relying on the same without providing complete information and an opportunity to cross examine the companies concerned; 8. rejecting the comparables selected by the appellant and rejecting transfer pricing analysis of the appellant; 9. performing fresh transfer pricing analysis and adopting inappropriate filters in doing fresh transfer pricing analysis; 10. ....
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....e assessee for comparability is annexed as Annexure-I to this order and the process by which the same was arrived at is detailed in the Annexure to the report in Form 3EB. The PLI of the assessee as arrived at in the said report is annexed as Annexure-II to this order. It can be seen from Annexure-I that the arithmetic mean of comparables was computed at 14.53%. The PLI of the assessee (as per Annexure-II) was computed at 9.98%. It was the claim of the assessee that exercising the option of determining the ALP between +/- 5% of the arithmetic mean of the comparable prices, the range of operating margin would be between 8.80% & 20.25% on operating costs. Since the assessee's operating margin on operating cost was within the arms' length range, the assessee claimed that its international transaction was at arms' length. 5. The filters or criteria adopted by the tax payer in its TP study and the remarks of the Transfer Pricing Officer ("TPO") to whom the AO referred determining of ALP on such approach were as follows:- "Filters or criteria adopted by the taxpayer in its TP study: Sl. No. Particulars Remark of the TPO 1 Companies for which suffi....
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....able and the segment qualifies this filter. * Companies who have more than 25% related party transactions (income as well as expenditure combined) of the operating revenues were excluded * Companies who have less than 25% of the operating revenues as export sales were excluded * Companies who have diminishing revenues/persistent losses for the period under consideration were excluded * Companies having different financial year ending (i.e. not March 31, 2006) or data of the company does not fall within 12 month period i.e. 01-04-2005 to 31-03-2006, were rejected * Companies whose employee cost to operating revenues is less than 25% of the revenues were excluded * Companies whose onsite revenue is more than 75% of the export revenues were excluded." 7. The TPO rejected 20 out of 28 comparables given by the assessee in its TP report (Annexure I to this order). The assessee before the TPO had also given some other additional comparables which was also rejected by the TPO. The TPO on his own, on a search carried on in Prowess Database arrived at a set o....
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....ns Rs. 47,46,66,638/- Shortfall being adjustment u/s 92CA Rs. 6,20,48,644/- The above shortfall of Rs. 6,20,48,644/- is treated as transfer pricing adjustment u/s 92CA." 9. Against the said adjustment proposed by the TPO which was incorporated in the draft assessment order by the AO, the assessee filed objections before the DRP. The DRP rejected those objections and confirmed the transfer pricing adjustment suggested by the TPO. The adjustment confirmed by the DRP was added to the total income of the assessee by the AO in the fair order of assessment. Against the said order of the Assessing Officer, the assessee has preferred the present appeal before the Tribunal. 10. The ld. counsel for the assessee as well as the ld. DR made rival submissions on various aspects of the adjustment made by the TPO. These objections will be dealt with under different heads. (1) Turnover Filter 11. The ld. counsel for the assessee submitted that the TPO has applied a lower turnover filter of Rs. 1 crore, but has not chosen to apply any upper turnover limit. In this regard, it was submitted by him that under rule 10B(3) to the Income-tax Rules, it was necessary for co....
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....s 1,000 crore company cannot be compared with the transaction entered into by a Rs 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate." 13. It was further submitted that the TPO's range (Rs. 1 crore to infinity) has resulted in selection of companies like Infosys which is 277 times bigger than the Assessee (turnover of Rs. 13,149 crores as compared to Rs. 47.47 crores of Assessee). It was submitted that an appropriate turnover range should be applied in selecting comparable uncontrolled companies. 14. Reference was made to the decision of the ITAT Bangalore Bench in the case of Genisys Integrating Systems (India) (P.) Ltd. v. Dy. CIT [2012] 53 SOT 159, wherein relying on Dun and Bradstreet's analysis, the turnover of Rs. 1 crore to Rs. 200 crores was held to be proper. The following relevant observations were brought to our notice:- "9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which are (sic) making losses as comparables. This shows that there is a l....
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.... considered the rival submissions. The provisions of the Act and the Rules that are relevant for deciding the issue have to be first seen. Sec.92. of the Act provides that any income arising from an international transaction shall be computed having regard to the arm's length price. Sec.92-B provides that "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Sec.92-A defines what is an Associated Enterprise. In the present case there is no dispute that the transaction between the Assessee and its AE was an international transaction attracting the provis....
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....y proceed to determine the arm's length price in relation to the said international transaction in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him: 18. Rule 10B of the IT Rules, 1962 prescribes rules for Determination of arm's length price under section 92C:- "10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a) to (d)** ** ** (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by th....
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....rate adjustments can be made to eliminate the material effects of such differences. (4) The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into : Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared." 19. A reading of the provisions of Rule 10B(2) of the Rules shows that uncontrolled transaction has to be compared with international transaction having regard to the factors set out therein. Before us there is no dispute that the TNMM is the most appropriate method for determining the ALP of the international transaction. The disputes are with regard to the comparability of the comparable relied upon by the TPO. 20. In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay ....
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....er, taking into consideration the assessee's objections, if any, only then can the TPO proceed to take a decision. If the assessee seeks an opportunity to cross examine the party, the assessee shall be provided such an opportunity. It is only during a cross examination that the assessee can rebut the stand of that particular company." Besides the above, several other decisions were also referred to for identical proposition. In the final analysis, it was submitted that the information obtain u/s. 133(6) in so far as it is contrary to the information available in the public domain should be rejected. 22. The ld. DR however submitted that the power u/s. 133(6) of the Act is absolute and cannot be questioned by the assessee, unless the assessee is able to establish that the same is incorrect. 23. We will deal with this aspect after considering the other submissions made by the assessee on the transfer pricing adjustments, if necessary and required. If on other parameters on which the ALP has to be determined, it is found that the price charged by the Assessee is at Arm's Length, we need not decide this aspect in this case. (3) Improper selection of comparables (a) Megas....
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.... product segment of Megasoft is substantially different from its software service segment. The product segment has employee cost of 27.65% whereas the software service segment has employee cost of 50%. Similarly, the profit margin on cost in product segment is 117.95% and in case of software service segment it is 23.11%. Both the segments are substantially different and therefore comparison at entity level is without basis and would vitiate the comparability (submissions on page 381 to 383 of the PB-I). It was further submitted that Megasoft Limited has provided segmental break-up between the software services segment and software product segment (page 68 of PB-II), which was also adopted by the TPO in his show cause notice (Page 84 of PB-I). The segmental results i.e., results pertaining to software services segment of this company was: Segmental Operating Revenues Rs. 63,71,32,544 Segmental Operating Expenses Rs. 51,75,13,211 Operating Profit Rs. 11,96,19,333 OP/TC (PLI) 23.11% 26. It was reiterated that in the given circumstances only PLI of software service segment viz., 23.11% ought to have been selected for comparison. 27. It was further submi....
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....ot be taken as a comparable. In this regard, reliance was placed on the decision of the Mumbai Bench of the ITAT in the case of Emersons Process Management India (P.) Ltd. v. Addl. CIT [2011] 47 SOT 157. 31. The learned DR relied on the order of the TPO and the DRP on this aspect. 32. We have considered the rival submissions. First we will consider the submission of the Assessee that companies with abnormal margins should not be regarded as comparable. In the case of Quark Systems (P.) Ltd. (supra), the Special Bench had to deal with cases where the results were abnormal. The special Bench observed as follows: "Even if the taxpayer or its counsel had taken Datamatics as comparable in its T.P. audit, the taxpayer is entitled to point out to the Tribunal that above enterprise has wrongly been taken as comparable. In fact there are vast differences between tested party and the Datamatics. The case of Datamatics is like that of "Imercius Technologies" representing extreme positions. If Imercius Technologies has suffered heavy losses and, therefore, it is not treated as comparable by the tax authorities, they also have to consider that the Datamatics has earned extraordinary pr....
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....ount assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. 35. There is therefore no bar to considering companies with either abnormal profits or abnormal losses as comparable to the tested party, as long as they are functionally comparable. The OECD guidelines and in US TP regulations, this question may not arise at all because those regulations advocate the quartile method for determining ALP. Indian regulations specifically deviate from OECD guidelines and provide Arithmetic Mean method for determining ALP. In the q....
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....p the job of customizing the packaged software. The company also explained that 30 to 40% of the product software (software developed) would constitute packaged product and around 50% to 60% would constitute customized capabilities and expenses related to travelling, boarding and lodging expense. Based on the above reply, the TPO proceeded to hold that the comparable company was mainly into customization of software products developed (which was akin to software development) internally and that the portion of the revenue from development of software sold and used for customization was less than 25% of the overall revenues. The TPO therefore held that less than 25% of the revenues of the comparable are from software products and therefore the comparable satisfied TPO's filter of more than 75% of revenues from software development services. Having drawn the above conclusion, the TPO did not bother to quantify the revenues which can be attributed to software product development and software development service but adopted the margin of this company at the entity level. In terms of Rule 10B(3)(b) of the Rules, an uncontrolled transaction shall be comparable to an international transact....
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....atio of this company can be taken into consideration for comparing the case that of assessee. In absence of any kind of details provided by the TPO, we are unable to persuade ourselves to include it as comparable party. Learned CIT DR has provided a copy of profit loss account which shows that mainly its earning is from software exports, however, the details of percentage of export of products or services have not been given. We, therefore, reject this company also from taking into consideration for comparability analysis." It was also highlighted that the margin of this company at 52.59% which represents abnormal circumstances and profits. The following figures were placed before us:- Particulars FYs 05-06 06-07 07-08 08-09 Operating Revenue 21761611 35477523 29342809 28039851 Operating Expns. 16417661 23249646 23359186 31108949 Operating Profit 5343950 12227877 5983623 (3069098) Operating Margin 32.55% 52.59% 25.62% - 9.87% 40. It was submitted that this company has made unusually high profit during the financial year 06-07. The operating revenues increased 63.03% which indicates that it was an extra....
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....act from the Directors report which reads as follows: 'The Company has developed a de novo drug design tool "CELSUITE" to drug discovery in, finding the lead molecules for drug discovery and protected the IPR by filing under the copy if sic (of) right/patent act. (Apprised and funded by Department of Science and Technology New Delhi) based on our insilico expertise (applying bio-informatics tools). The Company has developed a molecule to treat Leucoderma and multiple cancer and protected the IPR by filing the patent. The patent details have been discussed with Patent officials and the response is very favorable. The cloning and purification under wet lab procedures are under progress with our collaborative Institute, Department of Microbiology, Osmania University, Hyderabad. In the industrial biotechnology area, the company has signed the Technology transfer agreement with IMTECH CHANDIGARH (a very reputed CSIR organization) to manufacture and market initially two Enzymes, Alpha Amylase and Alkaline Protease in India and overseas. The company is planning to set up a biotechnology facility to manufacture industrial enzymes. This facility would also include the research laboratori....
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....iding software development services. The Assessee in reply to the proposal of the AO to treat this as a comparable has pointed out that this company provides software products/services as well as bioinformatics services and that the segmental data for each activity is not available and therefore this company should not be treated as comparable. Besides the above, the Assessee has point out to several references in the annual report for 31.3.2007 highlighting the fact that this company was develops biotechnology products and provides related software development services. The TPO called for segmental data at the entity level from this company. The TPO also called for description of software development process. In response to the request of the TPO this company in its reply dated 29.3.2010 has given details of employees working in software development but it is not clear as to whether any segmental data was given or not. Besides the above there is no other detail in the TPO's order as to the nature of software development services performed by the Assessee. Celestial labs had come out with a public issue of shares and in that connection issued Draft Red Herring Prospectus (DRHP) in ....
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....of software products and services and is not comparable to software development services provided by the assessee. The appellant has submitted an extract on pages 185-186 of the Paper Book from the website of the company to establish that it is engaged in providing of I T enabled services and that the said company is into development of software products, etc. All these aspects have not been factually rebutted and, in our view, the said concern is liable to be excluded from the final set of comparables, and thus on this aspect, assessee succeeds." Based on all the above, it was submitted on behalf of the assessee that KALS Information Systems Limited should be rejected as a comparable. 47. We have given a careful consideration to the submission made on behalf of the Assessee. We find that the TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that in the decision referred to by the l....
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.... The ld. DR, on the other hand, relied on the order of the TPO. 50. We have considered the submissions and are of the view that the plea of the assessee that the aforesaid company should not be treated as comparables was considered by the Tribunal in Capgemini India (P.) Ltd (supra) where the assessee was software developer. The Tribunal, in the said decision referred to by the ld. counsel for the assessee, has accepted that this company was not comparable in the case of the assessees engaged in software development services business. Accepting the argument of the ld. counsel for the assessee, we hold that the aforesaid company should be excluded as comparables. Assessee's comparables 51. It is the grievance of the Assessee that the lower authorities have rejected certain comparables selected and proposed by the assessee on the ground that they have predominant onsite revenues and are functionally different. The justification for retaining the comparables selected by the assessee are available on pages 318 to 331 and pages 394 to 402 of PB-I. The comparables that have been rejected by the TPO, but do not deserve to be so rejected, according to the Assessee are: Sl. No ....
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.... performance. It is not that a company performs altogether different functions under onsite assignments. The margins in offshore or onsite operations are not greatly dissimilar although the rate per hour may substantially differ. Similarity of functions performed and absence of dissimilarities in margins should lead to the acceptance of onsite work and its data for comparison purposes. Accordingly, the assessee submits that this reason of the TPO is without basis. 54. On the reasoning of the TPO that the pricing structure is different in onsite work, it is the submission of the assessee this aspect was irrelevant. The method selected is TNNM. What is tested is margin and not price. If pricing structure were to be considered as criteria, then it will have to be seen as to what is the pricing structure of all the comparable for various projects. The pricing would differ from project to project, domain to domain and on various other parameters. Such exercise has not been done. Further as admitted by the TPO, once functional similarity is accepted, companies can be compared. The attempt to separate onsite activity for comparison purposes is thus without basis. 55. On the reasonin....
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.... the assessee. Two companies may have similar margins although their gross margins may differ. When net margins are being compared, difference in gross margins cannot be a factor for rejection of companies as a comparable. Similarly for software companies when net margins are being compared, price/rate differential should not be criteria for acceptance or rejection of a company as a comparable. It was pointed out that though it is true that a professional sent on onsite projects are paid higher salaries, however the billing rates are also higher. It is on the basis of the cost structure that revenues are agreed upon. In case of onsite operations both income and cost would go up. There cannot be a presumption that margins have been sacrificed to secure revenues. Such an indication of the learned TPO is without any basis. 59. The learned TPO has further stated that companies whose revenues are generated mainly from onsite work mimic a company which is a resident in that country. This again is a conclusion without basis. It is again a conclusion whose relevance to the case on hand has not been established. The same is therefore to be ignored. Further, the TP Regulations or OECD Gui....
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.... of such differences. 62. The Indian software sector provides both on-site and offshore services. The Assessee in the present case is mainly offshore service provider and it generates income only from offshore software development service. Most of the uncontrolled enterprises follow hybrid model with revenue mix both from onsite and offshore. It is true that in terms of the functions performed both in the case of offshore service provider and onsite service provider, it is development of computer software. But having regard to Rule 10B(2)(b) it is necessary to have regard to the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions. 63. The first objection of the Assessee is that the TPO has observed that "market conditions" are different for on-site and offshore work, but he has not substantiated how market conditions differ. We fail to see any substance in such objection. The fact is that in onsite development of computer software, the Assessee does not employ assets nor does the Assessee assume many risks which the offshore software developer assumes. Even the Assessee accepts that th....
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....he TPO has referred to the margins. 67. The companies who generate more than 75% of the export revenues from onsite operations outside India are effectively companies working outside India having their own geographical markets, cost of labour etc., and also return commensurate with the economic conditions in those countries. Thus assets and risk profile, pricing as well as prevailing market conditions are different in predominantly onsite companies from predominantly offshore companies like the taxpayer. Since, the entire operations of the tax payer are taking place offshore i.e. in India; it is but natural that it should be compared with companies with major operations offshore, due to the reason that the economics and profitability of onsite operations are different from that of offshore business model. As already stated the Assessee has limited its analysis only to functions but not to the assets, risks as well as prevailing market conditions in which both the buyer and seller of services located. Hence, the companies in which more than 75% of their export revenues come from onsite operations are to be excluded from the comparability study as they are not functioning in simil....
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....e 98 of the TPO's order, the objection of the Assessee for selecting Ishir InfoTech Ltd. as comparable is for the reason that this company was outsourcing software development and that the company does not satisfy 25% employee cost filter. Both these objections have been found to be not sustainable by the TPO. The question therefore would be as to whether software testing services would be equivalent to software development services. Software testing is only part of software development life cycle. It cannot be equated with software development services. The TPO in our view rightly excluded this company for comparability purposes. 72. With regard to Goldstone Technology Ltd., the same was rejected as a comparable by the TPO for the reason that it was engaged in I.T. enabled services. It is the claim of the Assessee that in the company's annual report, flow of revenue in this company is from software development both, onsite and offshore operations. On the above, we find that this company has clarified in response to notice of the AO u/s.133(6) of the Act that it is not in the business of software development but in ITES. The alternative plea of the Assessee is that it should be ....
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....in is incorrect then we will be persuaded to afford opportunity to the Assessee but not on a claim which lacks substance and is based on surmises. 76. The comparable now accepted as comparable and their operating margins before and after working capital adjustment are detailed in the table given below:- Table 1 - Turnover Range 1 To 200 Crores and After Considering Comparables Selected By The Assessee Sl. No. Name of the Company Operating Revenues Operating Margin on Cost Adjusted Margin on Cost 1. Datamatics Ltd. 545,088,027 1.38% 0.58% 2. E-Zest Solutions Ltd. 62,594,544 36.12% 37.23% 3. Geometic Ltd. (seg) 1,583,797,773 10.71% 10.81% 4. Helios & Matheson Information Technology Ltd. 1,786,380,304 36.63% 35.62% 5. Ishir Infotech Ltd. 74,209,887 30.12% 31.60% 6. LGS Global Ltd. (Lanco Global Solutions Ltd.) 453,893,898 15.75% 16.36% 7. Lucid Software Ltd. 16,992,078 19.37% 18.24% 8. Mediasoft Solutions Pvt. Ltd. 18,508,785 3.66% 2.77% 9. Megasoft Ltd (Seg.) 637,132,545 23.11% 17.85% 10. Quintegra Solutions Ltd. 627,216,....
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.... Fluctuation gains are required to be added to operating revenue. Following the same, the AO is directed to accept the claim of the Assessee in this regard. As far as provision for bad debts are concerned, the TPO has accepted that the same would be part of operating expenses provided the same is incurred every year for at least three years and the manner in which provision is made is consistent. The Assessee in reply to the query of the TPO on the above aspect has not furnished any details. We are of the view that the Assessee should be afforded opportunity to explain its position on the above and the AO is directed to consider the same in accordance with law. As far as Fringe Benefit Tax (FBT) is concerned, the same was not considered by the TPO as part of operating cost in the case of comparables and therefore the same should also not be considered as part of operating cost of the Assessee. We hold accordingly and direct the AO to compute the operating cost of the Assessee. (C) Not making proper adjustment for enterprise level and transactional level differences between the Assessee and comparable companies. (D) Adjustment for differential in risk to be given. ....
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.... charges, bank charges, insurance etc., which are basically revenue expenses in nature. The plea of the Assessee was that it was in the business of rendering software development services and as a continuous process to develop and improvise new products in domestic market, it has to indulge in research and development. The expenses were for exploring the possibility of domestic market through pilot projects. The expenses were wholly and exclusively for the purpose of existing business carried on by the Assessee. The expenses were revenue in nature and did not result in any advantage/benefit of enduring nature to the Assessee. It was the plea of the Assessee that the information technology industry is fast changing and there is a great degree of obsolescence and therefore expenses of this nature cannot be said to result in any enduring benefit to the Assessee. Among other decisions the Assessee relied on the decision of the Hon'ble Supreme Court in the case of Alembic Chemicals Works Co. Ltd. v. CIT [1989] 177 ITR 377. 84. In the assessment order, the learned AO has disallowed a sum of Rs. 1,76,98,160/- being research and development expenses under section 37 of the Act stating t....
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....on afresh by the AO after affording opportunity of being heard to the Assessee. 87. Grounds No.19 & 20 raised by the Assessee reads as follows: "19. disallowing a sum of Rs. 12,50,000 being provision for building registration charges without appreciating that same has been written back in the later assessment year and therefore is deductible expenditure; and 20. disallowing a sum of Rs. 28,25,890 being provision towards foreign travel expenses on the ground that these are liabilities on provisional basis." 88. During the previous year, the assessee had made provision of Rs.12,50,000/- towards building registration charges. The AO has disallowed the same on the ground that it is a provision. The assessee submitted that the provision has been reversed and offered to tax during the AY 2009-10 and therefore same should not be taxed in the year under consideration. The limited plea of the Assessee before us is that if the sum is disallowed in this year the same should not be taxed in AY 09-10. We are of the view that it would be appropriate to direct the AO not to tax the same sum in AY 09-10 as the sum has already suffered tax by disallowance in the present AY. With the abo....