TaxTMI 
TaxTMI 
2014 (10) TMI 358
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....torola Group are broadly structured around Wireless, Broadband and Automotive Solutions. Motorola is operationally structured in the following segments: a) Connected Home Solution; Motorola's Connected Home Solutions (CHS) business is focused around broadband solutions for the delivery of voice, video and data over HFC Networks. CHS core business revolves around the delivery of digital audio and video interactive applications, internet access and high speed data. b) Government & Enterprise Mobility Solutions; This segment is a provider of integrated radio communications and information solutions, with a focus on Government and enterprise customers worldwide. It also designs, manufactures and sells automotive and industrial electronics systems and telematics systems that enable automated roadside assistance, navigations and advance safety features for automobiles. c) Mobile Devices; This segment designs, manufactures, sells and services wireless subscription and server equipment for cellular systems and iDRN integrated digital and enhanced networks, advanced messaging devices, personal two way radios and a broad range of mobile data services, servers and software solutions, po....
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....romotion 179,31,42,647 179,31,42,647 Administrative Support Services 837,490,784 7,78,44,993 Total 294,24,29,967 4. The assessee filed objections before Dispute Resolution Panel, which, vide its order dated 20th September, 2011, gave various directions u/s 144C(5). The AO, in consequence to these directions, made a total adjustment to the declared prices of international transactions of Rs. 289,70,16,463/-, as under: Segment Adjustment u/s 92CA (Original) Adjustment u/s 92CA (Revised) AMP Segment 179,31,42,647 176,26,38,353 Software Development Services 1,071,442,327 105,57,45,127 Market Support Service Segment 7,78,44,993 7,86,32,983 Total 2,94,24,29,967 289,70,16,463 5. Being aggrieved with the order of AO, the assessee is in appeal before us and has taken various grounds of appeal: 1. "That on the facts and circumstances of the case, the assessment order passed by the ld. Assessing Officer is bad in law; 2. That on the facts and circumstances of the case and in law, the ld. AO/Transfer Pricing Officer and ld. DRP erred in holding that the 'excessive' Advertising, Marketing and Promotion ("AMP") expenses incurred by th....
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....ppellant; and (ii) are wholly dissimilar to the appellant in respect of the brands promoted by them; 2.9 holding that the alleged 'excessive' AMP expense incurred by the appellant constitutes 'AMP service' provided to the overseas AEs and thereby adding a mark-up over and above the expense amount on arm's length basis; and 2.10 determining the arm's length price of the alleged 'AMP service' by applying a mark-up of 11.11% on the alleged 'excessive' AMP expense computed on the basis of inappropriate comparables which are operating in business functions different from that of the appellant; 3. That the ld. AO and ld. TPO, on the facts and circumstances of the case and in law have erred in not following the binding direction issued by the ld. DRP regarding the inclusion of M/s Spice Mobility Ltd. and M/s General Sales Ltd. as comparables of the appellant for the purpose of computing the arm's length price of the alleged international transaction of "excessive" AMP expenses; 5. That on the facts and circumstances of the case and in law, the ld. AO/TPO and ld. DRP erred in enhancing the income of the appellant by Rs. 7,86,32,983/- by recomputing the ALP of the international transact....
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....ention of making an addition to the returned income of the assessee; 5.5 including certain companies that are not comparable to the assessee in terms of functions performed, assets employed and risk assumed; 5.6 resorting to arbitrary rejection of low-profit/loss making companies based on erroneous and inconsistent reasons; 5.7 excluding certain companies on arbitrary/frivolous grounds even though they are comparable to the assessee in terms of the functions performed, assets employed and risk assumed; 5.8 ignoring the business/commercial reality since the assessee is remunerated on an arm's length basis, i.e. it is compensated for all its operating costs plus a pre-agreed mark-up based on a benchmarking analysis, the assessee undertakes minimal business risks as against comparable companies that are fully fledged risk taking entrepreneurs, and by not allowing a risk adjustment to the assessee on account of this fact; and 5.9 committing a number of factual errors in accept-reject of comparables and/or in the computation of the operating profit margins of the comparables; 6. That on the facts and circumstances of the case and in law, the ld.TPO and ld. AO erred in not followin....
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....at the ld. AO erred in facts and in law in levying interest u/s 234D and sec. 244A(3) amounting to Rs. 58,59,630/- and Rs. 17,03,000/-. 12. The ld. AO has erred on the facts and the circumstances of the case and in law in arbitrarily intiating a penalty proceedings u/s 271(1)(c) against the appellant for furnishing inaccurate particulars of income." 5.1 Ground No.1 is general and does not require any adjudication. Ground No.2 :- Issue Relating To AMP Expenses 6. Brief facts apropos ground no. 2 are that while examining the distribution segmental profitability chart submitted by the assessee, TPO noticed that the assessee had debited following expenses under the head "advertisement and market promotion activities" (in short AMP Expenses) to the Profit & Loss Account: 1) Advertisement and sales promotion 1469952312/- 2) Business meetings and conferences 182405029/- 3) Dealer commission 8,71,07,635/- Total 173,95,24,976/-. The TPO pointed out that this was around 7.385% of the total sales (2355.44 crores) made by the assessee. He, accordingly, issued show cause notice to assessee which has been reproduced at pages 192 to 194 of his order. In this notice ....
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....al Transfer Policy, during FY 2006-07,theassessee received an amount of Rs. 1,506,756,362 from its AEs as a cost credit/purchase price adjustment." 6.2 The TPO disposed off the assessee's objections as under: 1) As regards the first objection raised by the assessee that TPO is to determine the ALP of the international transactions on reference being made by the AO to the TPO, the TPO pointed out that the AO had sent separate reference for AMP expenses vide his letter dated 19th October, 2010. 2) The TPO further pointed out that it was a matter of record that the AE of the assessee and its parent company Motorola Inc. had acknowledged an increase in its sale due to the marketing efforts of the assessee in India and, therefore, since the benefit had been received by the parent company from the effort of assessee, for which assessee had not been compensated, therefore, under the transfer pricing regulations, the arm's length price of such compensation had to be determined. He further pointed out that the assessee had not bench marked the international transaction of receipt of reimbursement and, therefore, the international transaction of receipt of reimbursement had t....
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....ion for AMP activities undertaken by the assessee. Therefore, the contention of the assessee in this regard is without any basis and is therefore rejected." 6.3 The assessee's objections as regards comparables selected by TPO, in regard to AMP Expenses, were disposed of as under: a. "As regards Cyber Media Online, the objection of the assessee was that the company has high Related Party Transaction. The data on Prowess shows that the company has 100% of its revenue from Advertisement activities. The RPT in the case of this company is less than 25% hence this objection is also rejected. This company was itself taken by the assessee as comparables in its Transfer Pricing Report in class III category of transactions. There is no effect of shared expenses on the operating results of the assessee, as objected by the assessee and, hence, this company is accepted as a comparable. b. As regards M/s Rockman Advertisement and Marketing India Limited, the assessee has submitted that the company is also actively involved in other related activities such as film and documentary production. The assessee has relied on the part information taken from the website. I have examined the data availa....
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....,382 Markup on above @ 13.04% (B) 20,68,52,265 Total of (A) & (B) above 179,31,42,647 7.4 The assessee filed objections before DRP after considering which, DRP directed the TPO to examine the assessee's objection in regard to exclusion of comparables by TPO, as under:- "As regards exclusion of Spice Mobility Ltd. by TPO on the grounds that it is promoting its own brands, we have considered the submissions of assessee. According to assessee, Spice brand is owned not by Spice Mobility (company proposed by assessee) but by Spiceorp Entertainment Ltd. Similarly, Lexus brand is not owned by General Sales Ltd. (Co. Proposed by assessee) but by Usha Sriram Entrprises. In view of the above explanation, Spice Mobility and General Sales Ltd. being functionally similar must be taken as a comparables. TPO is directed to include both after verification regarding ownership of brand." 7.5 As regards, Rockmen Advertisement & Marketing India Limited, the assessee, with reference to website of company, pointed out that this company was engaged in carrying out activities relating to film and, documentary production and, therefore, could not be included as a comparable to determine the ....
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....lant wishes to reiterate its facts with additional evidence in the form of summary of credit notes received, sample copies of the credit notes and sample copies of the Foreign Inward Remittance Certificates. This additional evidence goes into the root of the matter and may by admitted in the interest of justice. 2. Additional Evidence The appellant would like to bring to your notice that Rs. 3,465,141,270. of credit notes were received by the appellant in AY 2008-09 in its trading operations. A summary of credit notes received in this regard are enclosed as Annexure 1. Sample copies of the credit notes are enclosed as Annexure 2. Sample copies of the Foreign Inward Remittance Certificates issued by the bank on receipt of the money are enclosed as Annexure 3. Prayer The appellant humbly prays before your Honour to kindly take the additional evidences on record. Thanking you, Yours Faithfully Sd/- For Motorola Solutions India Private Limited (Ramadorai Raghupathy Meyoor) (Director) Dated: April 5, 2013. 17.1 Ld. Counsel submitted that the Spl. Bench in LG's decision has, inter-alia, ruled that subsidy given by the foreign AE in any form including in the form of subsidiary....
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.... From the comparable ranges which are generated,prices are established by the factory legal entity that aim to return to the Related Party distribution operations a net margin for the current year that falls at the midpoint of the Multi-Year Net Margin Range. However, if the Related Party distribution operation has an average net margin for the current year plus the two preceding years (the "3year average"), which is outside the Multi year Net Margin Range, then the current year's transfer price will be set to move the 3 year average closer to the Multi Year Net Margin Range, while still keeping the current year within the Net Margin Range." 9.2 Ld. Counsel submitted that this plea was taken before TPO also. In this regard he referred to page 293 of paper book containing the submissions made before lower revenue authorities wherein it was, inter-alia, submitted as under: "Thus, given the facts of the present case, the assessee already has a favourable pricing policy with its overseas group companies. Accordingly, since the pricing model of the Company already takes into account the AMP expenses incurred by the Indian entity, the question of recovery of the same again from the ove....
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....Bench "I" comprising of Hon'ble Members Mrs. S.V. Mehrotra and Ms. Diva Singh and the order has been reserved in the case. The order is still awaited in this matter. In the meantime, "I" Bench has delivered its judgment in the case of BMW India Pvt. Ltd. vs. Addl. CIT (ITA No. 5354/Del/2012) which has a direct bearing on one of the main grounds of appeal in the above-captioned appeal. The Appellant, is accordingly, filing an application along with the copy of the BMW India judgment for the kind consideration of the Hon'ble Members who have heard our case. The application and copy of the said judgment are attached herewith. Your are requested to kindly place the application along with the judgment before the Hon'ble Members so that the same may be considered by them while deciding the grounds which stand covered by the said judgment." Additional Written Submission and Application to consider the judgment of BMW India P. Ltd. vs. Addl. CIT (ITA No. 5354/D/2012): 1) That the hearing in appeal no. ITA 5637/Del/2011 for A.Y. 2007-08 were concluded on July 18, 2013 and the order was reserved on that date. The matter is now awaiting pronouncement of the decision by Your Honours. 2)....
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....ne limit of AMP expenditure @ 3% of sales. 60 C Actual AMP Expenditure by Indian entity. 100 D Excess AMP Expenditure [Rs. 100 less Rs. 60] 40 E ALP mark up on Service of Brand Building @ 10% on excess AMP expenditure i.e. 10% of Rs. 40 4 F Total Recovery to be made by Indian entity [Rs. 40 + Rs. 4] 44 G Taxable Income on a/c service of Brand Building for foreign AE, by incurring excess AMP expenditure over Bright Line ALP 4 Situation 2 Excess AMP Spend [D] Rs. 40 Amount actually reimbursed on a/c of Subsidy Received [H] Rs. 30 Remaining Amt. to be received [I] Rs. 10 ALP markup on brand building @ 10% of excess AMP spend has to be 10% of Rs. 40 which is Rs. 4. [G]. However, according to assessee, a mark up on brand building has to be on the sum of Rs. 10 which @ 10% of excess amount spent has to be Rs. 1 - [J]. Thus, by the non-specification of purpose of subsidy the assessee has reduced the income by Rs. 3." 12.2 Ld. CIT( DR) further submitted that determination of arm's length price in regard to AMP Expenses in case of Distributors is squarely covered by the decision of LG Electronics para 21 page 99 - 100. He submitted that each ....
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....rately bench marked, ld. DR has filed written submissions which are reproduced hereunder: "This is for the reason that law mandates that each international transaction has to be separately bench marked. (Please refer to para 15.1 of the order in the case of M/s LG Electronics India P. Ltd. A.Y. 2007-08, ITA No. 5140/D/11). The whole para is relevant, and the first 5 lines are indicative of the discussion in this paragraph,- "15.1 At this stage, we feel it productive to have a macro view of the transfer pricing provisions. Section 92 provides that the income from an international transaction shall be computed having regard to ALP. What is an international transaction and who is an associated enterprise has been defined in sections 92B and 92A respectively." The need for specific attribution of subsidy towards a specific international transaction can be understood by the following example- S.No Natures of Transaction Book Price (Rs.) Arms Length Price (Rs.), as Determin ed by TPO Remarks 1 Import of TV Tubes (Price paid) 1,00,000 60,000 The Assessee has paid excess price to the extent of Rs. 40,000/- 2 AMP Expenditure towards Brand Building (that s....
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....ed from the Indian AE, necessitating no separate further addition on the alleged presumption of the assessee having incurred any AMP expenses towards brand building. The ld. AR relied on the case of the Hon'ble Supreme Court in CIT vs. Calcutta Discount Co. Ltd. (1973) 91 ITR 8 (SC), to canvass the view that the assessee cannot be expected to earn maximum profit. It was submitted that the action of the Revenue in firstly taxing higher rate of net profit on sales and thereafter further increasing the income by making addition on account of AMP expenses, runs contrary to the cardinal principle laid down in that case. He explain that in that case the Revenue opined that the assessee should have transferred its goods at a higher price than that declared. Rejecting this contention, the Hon'ble Supreme Court came to hold that once a transaction is bona fide, the profit cannot be computed by taking market price, ignoring the real price fetched. In the light of this judgment it was contended that the action of the Revenue in firstly benchmarking the net profit by applying TNMM on the international transaction of imports and then making separate addition for AMP expenses is akin to the stan....
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....s singular when the transactions are closely linked to each other or are identical. These closely linked transactions can be processed as one transaction under any of the prescribed methods. If an Indian enterprise has made sale of similar goods to its foreign AE through several invoices and has also incurred some expenses or paid interest to it, it would mean that all the transactions of sales are closely linked and these can be processed as one unit. However, the transactions of payment of interest or incurring of any other expense would be required to be separately scrutinized under Chapter-X because these are of a different nature vis-à-vis the transactions of sales. 21.5 It is undisputed that under the TNMM, it is always the operating profit from the concerned international transaction that is viewed in relation to the total cost, sales or capital employed etc. of that international transaction. It is not as if the percentage of the margin is to be determined by considering the net profit of the entity in relation to the total sales of the entity. When we consider operating profit to total costs of an international transactions, all the items of non-operating exp....
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....pproach. Notwithstanding that, we deem it expedient to deal with the argument of the ld. AR that if rate of net profit of the assessee is better than other comparables, then no adjustment can be done under Chapter-X. 21.7. On a specific query from the Bench, it was admitted by the ld. AR that no addition was made by the TPO on account ofapplication of the TNMM on the imports made by the assessee from its foreign AE. In our considered opinion, there is a noteworthy difference between two situations, viz., one where the TNMM is wrongly applied on entity level and some addition is made to the overall net profit of the Indian AE while testing the international transaction of imports of raw material and also some further addition is made by applying the TP provision on AMP expenses; and the situation in which no addition is made to the overall profit on account of application of the TNMM but an addition is made by applying the TP provisions on the transaction of AMP expenses incurred towards brand building for the foreign AE. 21.8. We find no bar on the power of the TPO in processing all international transactions under the TP provisions when the overall net profit earned by the asses....
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.... note that presently we are dealing with a case in which the majority of the assessee's sales is to Indian customers. Naturally the TP provisions cannot be applied in respect of sales to Indian customers because these are not international transactions. In such a case, there can be no benchmarking of the profits realized from such Indian customers so as to form a platform for contending that the TNMM has been applied on the overall profits and hence the AMP expenses should not be subjected to the TP provisions. In fact, the assessee is a manufacturer and only raw materials are imported from its foreign AE. The transaction of import of raw-material is a separate international transaction liable to be subjected to the TP provisions. Apart from such purchase of raw material, the assessee, as a manufacturer is also required to incur several other expenses on manufacturing, financing and selling which constitute part of the total cost of product along with the cost of raw materials. Subjecting the international transaction of purchase of raw material to the TP provisions would only show that purchase price of raw-material is not unnecessarily inflated. It is self evident that net profit....
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....mpensation for its incurring AMP expenses towards the promotion of their brand. 21.11. At this stage, it is relevant to note sub-section (1) of section 92, which provides that : Rs.Any income arising from an international transaction shall be computed having regard to the arm's length price.' Similarly it is pertinent to take stock of sub-section (3) of section 92, which provides that : Rs.The provisions of this section shall not apply in a case where the computation of income under subsection (1) or the determination of the allowance for any expense or interest under that sub-section, or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction was entered into. On a careful perusal of sub-section (3) in combination with subsection (1), it transpires that if the computation of income having regard to ALP of an international transaction has the effect of reducing the income chargeable ....
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....ome redundant to some extent. 21.13. There is one more way of fortifying our above conclusion. TNMM is one of the five recognized methods for determining the ALP of an international transaction. Such ALP can be determined inter alia by comparable uncontrolled price (CUP) method or Cost Plus method or even by the TNMM. All the five methods, as prescribed under section 92(1) and rule 10B, aim at determining the ALP of an international transaction in one way or the other. First is the CUP method, by which the price charged or paid for property transferred etc. in a comparable uncontrolled transaction is identified. Such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transaction. The adjusted price arrived at is taken as ALP in respect of the property transferred etc. in the international transaction. In the like manner all the methods including TNMM provide for determining the ALP of an international transaction. The main focus of the ld. AR was on restricting the application of the provisions of Chapter-X to other international transactions when one transaction has been processed under the TNMM. It has been....
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....ets reduced to Nil. The balance subsidy remaining after the set-off would be available for set-off/adjustment against the other international transaction/s that have to be separately benchmarked. This is shown in the table below: S.No Nature of Transaction Book Price Arm's LengthPrice ALP) Subsidy adjusted Adjustment to the ALP 1 Import of TV tubes 1,00,000 60,000 10,000 30,000 2 AMP expenditure incurred on brand building Nil 20,000 20,000 Nil Total adjustment 30,000 It can be seen from above, that as per LG decision, out of subsidy of Rs. 30,000 received from the Group companies, Rs. 20,000 would be adjusted towards excess AMP expenditure. Accordingly, the value of 'excess' AMP expenditure would be Nil and no adjustment in respect of AMP expenditure would be warranted. Balance subsidy of Rs. 10,000 will be adjusted towards import price, resulting in an import price of Rs. 90,000. Accordingly, adjustment in respect of import transaction would be Rs. 30,000 (i.e. Rs. 90,000 less ALP of Rs. 60,000). Alternatively, in case the entire subsidy of Rs. 30,000 is off-set against import transaction, then adjustment in respect ....
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..... During the year under consideration in the order, under the Transactional Net Margin method ("TNMM") applied by BMW India its operating profit margin was higher than the operating profit margin of the comparable companies. During the transfer pricing assessment proceedings, the Ld. Transfer pricing Officer ("TPO"), had alleged that BMW India had incurred excessive AMP expenses vis a vis the comparable companies and therefore, should have been reimbursed by the BMW Group for the excessive AMP spend based on the bright line analysis along with a mark-Up. The Hon'ble Dispute Resolution panel ("DRP") confirmed the additions made by the Ld. TPO. On appeal by BMW India to the Hon'ble Tribunal, the Hon'ble Tribunal pronounced its decision on various issues related to AMP. As already mentioned above, BMW India was a distributor during the year considered in the order. On these facts, the Hon'ble Tribunal held that this case is distinguishable from the decision of the Special Bench in L.G. Electronics case ("Special Bench") as the fact under consideration in BMW India is the remuneration model of a distributor and not that of a licensed manufacturer. The relevant text of ....
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....ost of AMP with mark up. It held that the tax department cannot insist that the mode of compensation received by BMW India from its AE necessarily had to be direct compensation and that pricing adjustment was not acceptable. The relevant text of the Hon'ble Tribunal ruling in case of BMW India is provided here below(Para 6.27, page 56 of BMW India order): Quote The claim of the assessee has merit as the assessee with the AE can agree to be rewarded/ remunerated by price adjustments to earn profits which include the cost of rendering services with profit. The department cannot insist in the absence of any provision under the Act that the mode of compensation to the assessee by the foreign AE necessarily has to be directed compensation and pricing adjustment is not accepted. Unquote The Hon'ble Tribunal further held that (Para 6.26, page 55 of BMW India order): Quote In support of the remuneration model of the assessee who is a distributor rewarded by way of price adjustments to ensure profitability upto mutually accepted terms is a wellrecognized and well-accepted method for compensating a distributor. Unquote Further, on the issue of the mark up the Hon'ble Tri....
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....ributor. Hence, what is relevant for consideration is the remuneration model of a distributor in both the cases. 2.BMW India's operating margin was higher than that of the comparables. Similarly, MSIPL also operated at a higher net operating margin than that of the comparables. This is demonstrative of the fact that the compensation for the alleged higher services was embedded in the pricing arrangement of the contract goods itself and that no additional remuneration was required from the AEs. In other words, like it has been held in the BMW India order, the compensation for the alleged excess AMP expenses was received through premium pricing which can also be demonstrated through its higher profit margins. In the BMW India order, the Hon'ble Tribunal has held that the department cannot insist that pricing adjustment cannot be accepted as mode of compensation. Herein, it may be reiterated, that MSIPL has already received the said pricing adjustment through credit notes as a cost credit! purchase price adjustment from its AEs. This has been mentioned in para no 18 of page 11 of the written submission filed with Your Honours on May 20, 2013 and in para 8(1) of page 134 of t....
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....W Group has global operations in 3 segments namely Automobiles, Motorcycles and Financial Services. The parent company of the group is BMW AG i.e. the associated enterprise (hereinafter referred to as the "AE") which is headquartered in Munich, Germany and is primarily engaged in the manufacturing of automobiles and motorcycles. The major car brands manufactured by BMW AG are stated to be BMW, Mini and Rolls-Royce. The TPO takes note of the fact that the assessee had undertaken the following international transactions: S.No Description of transaction Value (in Rs.) Method 1. Purchase of raw material 167,051,934 TNMM 2. Purchase of traded vehicle 535,438,461 RPM 3. Purchase of spare parts 18,057,016 RPM 4. Purchase of fixed assets 175,346,819 CUP 5. Purchase of software 78,880,000 CUP 6. Receipt of technical support service 29,449,506 CUP 7. Receipt of IT support services 2,739,917 CUP 8. Market survey expenses 11,711,690 CUP 9. Reimbursement of personal cost 17,252,074 CUP 10. Reimbursement of expenses 12,270,724 CUP 11. Interest of loan 12,9773,291 CUP 2.5 Referring to the Transfer Pricing Study of the assessee, the TPO obs....
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....e arguments of the ld. CIT DR for a moment, the contemporaneous international jurisprudence is ignored even then the claim of the assessee has merit as the assessee with the AE can agree to be rewarded/remunerated by price adjustments to earn profits which include the cost of rendering services with profit. The department cannot insist in the absence of any provision under the Act that the mode of compensation to the assessee by the foreign AE necessarily has to be directed compensation and pricing adjustment is not accepted. In the absence of any such Rule or provision in the Act baring such mode, the assessee is free to adjust and apply any method which it finds most suitable to manage its affairs. Had it been specifically required by the Statute and the Rules thereunder that the remuneration/compensation for the performance of non-routine functions of a distributor has to necessarily be remitted/reimbursed separately with a cost plus the occasion to refer and rely on the terms of then Importation Agreement would have not arisen as the mandate of the Statute necessarily prevails on the terms of the Agreement entered into between the parties. Similarly reliance on OECD TP Guidelin....
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....omes more so far a new entrant where there is a declining trend seen in the automobile sale market coupled with nentrenched position of early entrants in the sector." 16.2 However, in the present case, we find that unlike BMW's case, the assessee has carried out apart from acting as a distributor, the function of software development services to the group companies and also provided marketing and administrative support services to its group company. Therefore, the decision in the case of BMW, in our humble opinion, is not applicable to the present set of facts. 17. In BMW's case the Tribunal has observed that assessee has performed the functions of sales promotion and advertisement in order to make a dent in the market while performing the functions of a distributor with greater intensity as opposed to a routine distributor. Therefore, this decision is not applicable to the facts of the present case. The Tribunal also took note of the fact that BMW as distributor performed higher functions and undertook to establish distributorship network, advertise, promote and market the brand remuneration/compensation/rewards of distributorship were also guaranteed. Thus, Tribunal primarily p....
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.... Counsel for the assessee. However, the assessee has to establish that in its global transfer pricing policy the AMP expenses had duly been taken into consideration. 18.1 Admittedly, the assessee did not treat the excess AMP expenditure as international transaction and, therefore, it did not form part of TP study submitted by assessee. We find that before TPO the assessee had taken a specific plea to this effect but did not produce any documentary evidence in support of its contention. It is further stated in the above application for admission of additional evidence that DRP never asked the assessee to furnish any supporting evidence in respect of credit notes. After considering the assessee's submissions and taking into consideration the decision of Spl. Bench in the case of LG Electronics India P. Ltd. particularly with reference to guidelines laid down therein with regard to subsidy on the goods sold to the Indian AE , as noted earlier , the benefit of which was not available to either side before TPO or ld.DRP, we are of the opinion that credit notes, now sought to be produced before us, a summary of which has been filed with the application along with sample credit notes, ne....
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....the Indian AE ? 10 . Where such subsidy is allowed by the foreign AE , whether the amount of subsidy is commensurate with the expenses incurred by the Indian entity on the promotion of brand for the foreign AE ? 11. Whether the foreign AE has its presence in India only in one field or different fields? Where it is involved in different fields, then is there only one Indian entity looking after all the fields or there are different Indian AEs for different fields ? If there are different entities in India, then what is the pattern of AMP expenses in the other Indian entities ? 12. Whether the year under consideration is the entry level of the foreign AE in India or is it a case of established brand in India ? 13. Whether any new products are launched in India during the relevant period or is it continuation of the business with the existing range of products ? 14. How the brand will be dealt with after the termination of agreement between AEs?" 18.2 The main point for our consideration at present is whether assessee is required to establish direct nexus between the AMP expenditure incurred by the assessee and credit notes received from AE. In our opinion, para 17.5 read ....
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....t is mandatory for the TPO to consider all facts and evidence, as may be submitted by the assessee to substantiate that it had received credit notes/subsidy for projects of goods as per factor 9 and the value of the subsidy so received was commensurate with the expenses incurred by the assessee on AMP as per factor 10. Further, as rightly submitted by ld. counsel, presence or lack of agreements between related parties do not matter much. What matters is the conduct of parties. In this regard it has to be demonstrated by assessee that the global transfer pricing policy of assessee takes into consideration the compensation/contribution towards excess AMP Expenses (brand promotion expenses) incurred by assessee. The OECD guidelines cannot take precedence over the decision of Spl. Bench and, therefore, once the Spl. Bench has held that one of the factors to be taken into consideration is that foreign AE is compensating the Indian entity for the promotion of its brand in any form such as subsidy on the goods sold, then, merely with reference to the overall operating margin of the administrative and marketing division segment, it cannot be held that nexus is not required to be establishe....
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..... 22. Apropos ground no. 2.3, we find that in para 21.3 to 21.8 in LG's case (SB), reproduced earlier, it has been held that consideration of individual elements of costs (like AMP expenditure) is not inconsistent with TNMM method being accepted at entity level. 22.1 Respectfully following the decision, this ground is dismissed. 23. Ground no. 2.6 is regarding only indirect or incidental benefit to AE and Ground no.2.9 is regarding addition of mark up on the excess AMP expenses. We find that in LG's case in para 23.4 it has been observed as under: "23.4. It is relevant to note that under second and third steps what is required to be determined is the rate of normal gross profit mark-up as arising to the enterprise from an uncontrolled transaction or to an unrelated enterprise in a similar situation. Here it is significant to note that a comparable uncontrolled transaction to be considered for benchmarking the normal gross profit mark-up has to be similar to the international transaction under consideration. Consequently, the profit mark-up under steps 2 and 3 should in the present case be the rate which an independent third party earns for creating marketing intangible for and ....
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....or the foreign AE, the reduction of expenses in connection with sales would prejudice the computation of the AMP expenses for the brand building. 18.3. Having heard the rival submissions on this issue, we find that the AMP expenses refer only to advertisement, marketing and publicity expenses. A divider needs to be placed between the expenses for the promotion of sales on one hand and expenses in connection with the sales on the other. Both these expenses are required to be kept in different compartments. While expenses for the promotion of sales directly lead to brand building, the expenses directly in connection with sales are only sales specific. 18.4. Sub-section (3A) of sec. 37, before its omission, provided that where the expenses incurred by the assessee on any one or more of the items specified in sec. 37(3B) exceed one lac of rupees, then twenty percent of such excess shall not be allowed as deduction in computing the income chargeable under the head Rs.Profits and gains of business or profession'. Clause (i) of sub-sec. (3B) referred to advertisement, publicity and sales promotion. The Hon'ble urisdictional High Court in the case of CIT Vs. Khetu Ram Bishambar Dass [(20....
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.... illustrated by a simple example. If there is no subsidy in a comparable case but the assessee has received some amount of subsidy from its foreign AE on imports or in any other manner, which fact otherwise needs to be specifically established by the assessee, then the initial amount so computed would require reduction to the extent of such subsidy or vice versa. As the TPO has neither properly considered the request of the assessee for inclusion of some other comparable cases nor examined the effect of the above discussed relevant factors on the question of determination of the cost/value of international transaction, in our considered opinion the ends of justice will meet adequately if the order of the TPO and that of the AO giving effect to such order is set aside and the matter is restored to the file of the TPO for determining the cost/value of the international transaction and the consequent ALP afresh as per law after allowing a reasonable opportunity of being heard to the assessee." 26.1 We, therefore, restore this issue also to the file of TPO for examining the same afresh in the light of LG's decision. In the result this ground is allowed for statistical purposes. 27. A....
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.... is in no manner engaged in the provision of brand building or marketing services. 29. Ld. Counsel referred to DRP's order and pointed out that though this fact was brought to the notice of DRP but the same has not been considered. 29.1 We have considered the submissions of ld. Counsel for the assessee. We find that at page 3 of DRP's order it has been, inter-alia, observed as under: "The other comparable objected to by assessee Rockman Advertisement is found to be comparable by the DRP" 29.2 Therefore, the plea of ld. counsel that ld. DRP has not considered the issue cannot be accepted. Further, we find that TPO at page 205 has referred to the data available on the prowess data base from where he has pointed out that 100% of its revenue was from advertisement activities. However, we find that assessee, while filing its objection before DRP at page 58, had reiterated that company was also engaged in carrying out activities related to film and documentary production, fabrication of holdings etc. It was further pointed out that the company has booked the sales revenue of Rs. 1.4 crore during the said year. As against this, the assessee's alleged excess AMP expenses on which a ma....
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....ustry. 682 Companies with the ratio of research and development expenses to sales less than or Equal to 3%,were selected. Such comparables do not have ownership of intangibles And are pure service providers. 669 Companies with the ratio of net fixed assets to sales less than or equal to 200%, were Selected. Such comparables do not undertake manufacturing or hold substantial Assets, which are not utilized for provision of service. 538 Companies with average sales of more than or equal to INR 1 Crore over the period Under consideration were selected. The companies with low levels of sales may indicate start-up operations or the same persons being both shareholders and key employees, diminishing the economic distinction between profits and salaries. 484 Companies with net worth more than or equal to zero were selected. Implying that the Companies are in operations. 447 Companies with the ratio of the sum of advertising, marketing and distribution expenses to sales less than or equal to 3%, were selected. Such comparables do not have ownership of marketing intangibles and are engaged in provision of service. 340 Qualitative (Companies engaged software dev....
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....olled transactions with an international transaction shall be the data relating to the financial year in which the international transaction has* been entered into. The word used is "shall", indicating that neither the tax payer nor the TPO has any choice but to use the data pertaining to the FY 2006-07. Earlier year data, in addition to current year's data, can be used only if the conditions mentioned in Proviso to Rule 10B(4) are fulfilled. As can be seen from the TP report that the tax payer has not used at all the data pertaining to the FY 2006-07 in all the 18 comparables. This issue is discussed in detail under the head "Use of Current Year Data". The TP study thus suffers from legal infirmity. This has led to the use of incorrect data. 2.The tax payer has not given any details regarding the application of controlled-party transaction filter. As the tax payer has not at all considered the data for the FY 2006-07 in all the comparable cases, the following companies have been considered as comparables, which otherwise do not pass the tax payer's own admitted filter of RPT less than 15% of revenues. Name of the Comparable Company Considered by the Tax Payer Related P....
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.... which the respective parties to theinternational transactions operate, including geographical location and size of the market, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition etc. The major attribute of economic circumstances in comparability was ignored by the taxpayer and thereby, the TPO has to apply additional quantitative criteria such as onsite revenue filter, diminishing revenues filter etc. to make the economic circumstances comparable. 7.Some companies were rejected by the tax payer on the functionality ground / business review in its TP study though they are into software development services or they have software development services segment and qualify all the filters applied by the tax payer based on the data pertaining to the FY 2006-07 and also to the earlier years, in some cases. 8.As discussed below, except two none of the taxpayer's comparable do not stand scrutiny of FAR analysis. The taxpayer itself accepted the rejection of some of the comparables on the ground of RPT, functionally different etc. This itself shows that the comparables were not properly selected and....
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....) SIP Technologies & Exports Ltd. 24) Tata Elxsi Ltd. (Seg.) 25) Thirdware Solutions Ltd. 26) Wipro Ltd. (Seg.) 35. Ld. DRP directed the TPO to exclude two comparable companies viz Persistent Systems Ltd. & Mega Soft Solutions Ltd. After receiving the directions of ld. DRP, the AO only excluded Persistent Systems Ltd. and computed the arm's length profit margin at 23.90 as under: 35.1 He, accordingly, made a transfer pricing adjustment of Rs. 1055745127/- as under: Particulars Amount in INR Operating cost of the assessee under CSD Segment (A) 6,350,000,000 Add: Mark-up @23.90% (as per Hon'ble DRP's directions) (B) = (A*23.90%) 1,51,78,27,800 ALP of CSD segment (C) = (A) + (B) 7,86,78,27,800 Price charged in the international Transactions Rs. 6,812,082,673 Shortfall Being adjustment u/s 92CA Rs. 1,05,57,45,127 35.2 In the backdrop of aforementioned facts, the assessee has assailed the assessment order on various grounds with reference to Software Development Service Segment noted earlier. Before we consider separate grounds, we reproduce the submissions of ld. CIT(DR) which would be relevant for different grounds Miscellaneous 1. The power of TPO....
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....ed by the TPO. The only fetter is that the data so obtained is to be shared with the assessee in case it is proposed to be used against the assessee. The power of TPO to make inquiries u/s 133(6) has been okayed in a plethora of cases. Even if the information gathered u/s 133(6) is at variance with published annual report, information obtained by TPO u/s 133(6) is to be considered more authentic. (Pl. see para 72 of the order of M/s Trilogy E-Business Software (I) (P) Ltd., ITA No. 1054/Bang/2011, A.Y. 2007-08, dtd. 23/11/2012. Para 47 of this order is at variance with para 72). Support is found from * M/s Wills Processing Mumbai Order, 8722/Mum/2010, dtd. 07/12/2012, para 26 thereof. * M/s Actis P. Ltd. 5277/D/11, para 37. * M/s Trilogy E Business Software India P. Ltd. ITA No. 1054/Bang/2011, para 21 and 22, and para 72. This is assessee's own case law. * In the case of M/s Headstrong Services India P. Ltd., ITA No. 5466/D/2011, dtd. 17/07/2012, para 40, the use of powers u/s 133(6) by TPO has been okayed. This case is only for purposes of mentioning, not being part of main submission. 13. Even abnormal circumstances need to be examined, whether they have the ability to im....
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....lysis. Ld. Counsel has very fairly conceded that this issue stands decided against the assessee in numerous cases (Mentor Graphics (Noida) Pvt. Ltd. 109 ITD 101 Delhi, Customer Services India Pvt. Ltd. v ACIT 30 SOT 486. 37.2 In view of above discussion, we do not find any reason to interfere with the order of AO/TPO on this count. 38. In the result, this ground is dismissed. 39. Vide ground no. 4.3 the assessee submits that since it was entitled to tax holiday u/s 10A/10B of the Act on part of its profit from CSD services and, therefore, had no motive of deriving a tax advantage by manipulating transfer prices of its international transactions. In this regard it may be pointed out that the computation of arm's length price is to be done as per the provisions contained under Chapter X of the I.T. Act dealing with special provisions relating to avoidance of tax. Merely because assessee was entitled to tax holiday u/s 10A/10B of the Act, it cannot be inferred that international transaction has been entered into as per arm's length price. There is nothing u/s 10A/10B which entitles an assessee to get deduction in respect of addition made under Chapter X. Ld. Counsel for the assesse....
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....panies along side profitable companies tends to even out the risk profile of comparable companies; * If loss making companies are to be eliminated on the ground of previous year losses, then for other profit making companies, previous year average financial data should also be taken into account rather than single year financial information; * The TPO should restrict the functional and financial data comparability only to the data of the relevant financial year. The TPO's approach by applying criteria favorable to the revenue would be prejudicial to the interest of the tax payer. 44. The TPO did not accept the assessee's contention for the following reasons: * A company whose performance is extremely divergent from the normal industry trend cannot be considered as a normal comparable. On the face of it, the contrary behavior of the particular company is indicative of some peculiar facts and circumstances of that company which lead to such divergent behavior. * The OECD guidelines say that except in start-up situation, loss companies generally will not be appropriate comparables for controlled companies, because they obviously have borne more risk than controlled companies norm....
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....ating in comparable (economic) circumstances. This issue has been dealt by ITAT, Delhi Bench in the case of Sony India (P) Limited vs. DCIT, (114 ITD 448) as under in favour of the revenue. "Godrej in the first place is making refrigerator and not TVs. Secondly, it has suffered huge losses over a period of several years. It has recorded negative growth as admitted at page 6 & 7 of its annual report for F.Y. 2000-01. It had huge unutilized capacity. It needs financial restructuring. It is carrying on disputes on account of demands raised by Punjab Small Scale Industries and Export Corpn. Ltd., apart from the disputes made by its employees for increased wages, reinstatement or termination and suspended employees. The joint venture of the company stands terminated. All this is admitted in the official report of Godrej. Besides, it is also carrying on related party transactions. Each of above factors which is considered and highlighted in the annual report, may not have a significant effect, if taken singly. However, when cummulative effect of all the factors is considered, one gets a totally different picture. It has therefore to beheld that Godrej was rightly excluded from the list....
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....able was incurring losses and confirmed the same with economic circumstance of the tested party, that is the assessee, therefore, the TPO had appropriately applied this filter. 46. Ld. Counsel for the assessee submitted that this filter is not an appropriate filter to be applied for the purpose of comparability analysis for the following reasons: 1. the company is judged as comparable or otherwise based on parameters relating to functions risks and assets. The comparability analysis as per law has to be in accordance with Rule 10B(2) of the Income Tax Rules. 2. Diminishing revenue does not mean that a company is functionally not comparable. Further reasons of diminishing revenue should be investigated and in case any abnormal factor is found to be present then the company should be excluded from the list of comparable company. 3. Ld. TPO has considered the data for previous three years to apply this filter of diminishing revenue. Thus, there is a complete contradiction in TPO's own approach of using only current year data as per Rule 10B(4). 4. The TPO has rejected the companies with diminishing revenue but accepted companies with abnormal revenue trend, such as Avani Cimcon T....
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.... 47. Ld. (CIT) DR submitted that persistent losses depicts existence of abnormal circumstances. Ld. DR further referred to page 321 of appeal set (page 53 of transfer pricing officer's order), wherein TPO has summarized his conclusion on this issue, noted earlier. 47.1 Ld. DR further clarified that data for last three years has not been used to work out the mean but to work out the trend. He submitted that only one year data has been used for computing arithmetic mean. Ld. DR further pointed out that in software industry there is no installed capacity but the activity is personal extrinsic. The persistent losses in such an industry is an indicator of assessee not utilizing its full capacity, which is an abnormal factor, making the company non-comparable. Ld. DR further clarified that loss making companies and persistent losses making companies are two different aspects and it is only the persistent loss making companies that have been excluded by TPO. 47.2 Ld. CIT(DR) submitted as under:- Exclusion of companies with diminishing revenues/persistent losses for last three years upto and including F.Y. 2006-07. Counter: It is submitted that only current year's data has been used f....
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....e justification of including a particular comparable Maple E-Solution which had wildly fluctuating margins ranging from loss of 100% to profits of 37.38%. The Hon'ble ITAT was not adjudicating the applicability of a filter of diminishing revenue or persistent losses at a general level but only in respect of a particular comparable. 51.Similarly, reliance on CRM Services India Pvt. Ltd. ITA No. 4068/0e1/2009 is also of no assistance to the Revenue as the issue in this case was inclusion/exclusion of a particular comparable whose capital base had been eroded due to persistent losses. (Please refer to Para 13.2 of the order). The question of suitability of the filter of persistent losses or diminishing revenue was not before the Hon'ble ITAT. 52.The industry is an average of both high and low profit earning companies. Further in the search process undertaken by the Ld. TPO 51 out of a total of 765 companies showed diminishing revenue which is approximately 7% of the industry selection made by the TPO. This means if he eliminates companies with diminishing revenue then he is eliminating 7% of the total population of the comparables 53.The sweeping generalization that persist....
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....rusal of Rule 108(4) makes it clear that the contention of the Ld. CIT DR, that earlier year data is used only for the purpose of computing mean, is not tenable. 57.Further the Appellant wishes to highlight that the business cycle for any company starts from a trough (lower point) and passes through a recovery phase followed by a period of expansion (upper turning point) and prosperity. After the peak point is reached there is a declining phase of recession followed by a depression. Again the business cycle continues similarly with ups and downs. 58.Thus, every company would be in a different phase of business cycle at a given point of time and thus elimination of a company based on the revenue/profit would not be correct. 59.On the issue of underutilization of capacity as pointed out by the Ld. CIT DR, the Appellant wishes to submit that a declining sales would not always mean an underutilization of capacity. Increase or decrease of sales can be because of increase or decrease of hourly rates charged by the software companies due to variation of demand and supply. Furthermore, in the software industry capacity can be increased or decreased quite quickly depending upon market ne....
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....tion to the Indian GDP had increased from 1.4% in 1998-99 to 5.4% in 2006-07 with growth rate of about 30% (Source Ness com); * The exports contributed around 66% of the total Indian IT Industry; * The key segments that have contributed significantly (about 98%) to the export growth are ITS & ITES. 49. All this statistical data clearly demonstrate that IT Industry was growing with rapid pace and, therefore, the argument advanced by TPO cannot be faulted. As far as assessee's contention regarding contradictory stand adopted by TPO in not considering the persistent loss making companies based on earlier year's data but taking into consideration the current years data for computing the mean is concerned, we do not find any merit in the submission of ld. Counsel for the assessee because, as rightly submitted by ld. CIT(DR), the TPO has not excluded loss making companies but only those companies which incurred persistent losses. It cannot be disputed that persistent loss making by a company in this sector is not in normal behavioral pattern of the industry as a whole. Therefore, it triggers the enquiry into the causes of losses. We are in agreement with ld. Counsel for the assessee t....
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....guiding the selection of comparables. We appreciate ld. Counsel's submissions that instan,ce of loss usually arises due to market forces/computation, emergence of new technologies or processes, increased costs, variation in demand and subject, and these are all normal economic factor which impact all industry player. However, this argument, when considered taking into account the holistic view of the IT Industry, cannot be accepted because all the factors enumerated by ld. Counsel, which results into loss, do occur in all comparables but still overall industry in this sector had shown considerable growth. We will consider each and every comparable separately and while undertaking that exercise take into consideration all the aspects emphasized by ld. Counsel for the assessee. However, in principle we are in agreement with TPO that given the trend of IT Industry growth persistent loss making companies cannot be taken as comparable because that in itself reflects existence of abnormal circumstances which. of course, needs to be identified. Therefore, the impugned comparable can be taken into consideration only if reasonably accurate adjustment can be made to eliminate the material ef....
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...., if sufficient comparables are not available then gradually the limit has to be increased. Ld. Counsel submitted that there is conflict of judicial opinion on this issue and, therefore, no standard figure can be taken. 55. Ld. CIT(DR) referred to para 8.1page 36 of TPO's order and pointed out that assessee in principle had no objection for applying this filter. He submitted that threshold limit of 25% was quite reasonable, as applied by TPO because otherwise sufficient number of comparables would not be available. In this regard ld. CIT(DR) referred to para 28, 29 & para 40 of Actis, wherein this threshold has been accepted. He submitted that if more than 25% related party transactions are there then only it is uncontrolled. Ld.CIT(DR) further pointed out that in the case of Global Logic India Pvt. Ltd. for A.Y. 2006-07 vide order dated 31/12/2012, it has been clarified in para 5.17 as to what should be included for determining related party transaction. In this case, the capital was of 50 crores and out of the total sale of 45 crores, sale to related parties were only 25 crores and the balance 20 crore sale was to the third party. Therefore, this was excluded applying RPT filter....
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....e fixed for this filter. Ld. DRP has also noted that neither there is any judicial consensus on the numerical limit nor the section so prescribes. However, there is consensus on the effect of RPT i.e. it should not materially affect the international transaction. Therefore, considering the submissions of both the sides, we are of the opinion that if by applying the threshold limit of 15% of related party transaction, sufficient comparables are available then there is no reason to further extend the limit to 25%. Therefore, we direct the TPO to take into consideration only those comparables where related party transactions are to the extent of 15% because it is not the case of revenue that by applying the threshold limit of 15%, it will not get sufficient number of comparables. 57. In the result, this ground is allowed. 58. Vide ground no. 4.5.5, the assessee has assailed the application of filter by TPO of adopting employee cost greater than 25% of their total revenues as a search criteria for short listing and evaluating comparables for software development services. The TPO noticed that the assessee is a software development services provider and incurs 64% of sales as salary e....
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.... outsourcing their work in India, generally have better pay scales than certain Indian Companies performing similar or more complex activities. He referred to the decision of Hyderabad Bench in Hello Soft India Pvt. Ltd. vide ITA No. 645/Hyd./09 and pointed out that ITAT rejected this filter as the relevant data in this regard was not available and many companies include employee cost data under different heads. Ld. Counsel pointed out that TPO had obtained information u/s 133(6) for applying this filter. He submitted that data used should be available in public domain. 59.1 Ld.CIT(DR) submitted that in software companies major cost is salary cost. Software development involves using man power or brain power. Therefore, there has to be a cut off for finding out whether the company is in software development sector or only a trading company. Therefore, the threshold of 25% of employee cost being considered as minimum employee cost for selecting comparables is quite reasonable. 59.2 Ld. CIT(DR) relied on the order of TPO in this regard and submitted that his filter has been approved in following cases: * M/s Bitharis Technologies (para 5.3) (ITA No. 4372/Del/09) * M/s Asia ....
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....o FAR analysis while applying this filter. This is a functional filter and if a company fails this filter, it indicates that either it is outsourcing major part of the work; a predominantly on-site company (as it does not show the payments made to on-site consultant under the employee cost); a software product company or trading company or a company with peculiar economic circumstances. The submissions of ld. Counsel, therefore, cannot be accepted. This filter has been applied on the ground that companies which are engaged in software development require a minimum level of expenditure on personnel expenses. In our opinion, in order to consider the functional similarity of two comparables, it is necessary that such quantitative filters are applied to reach a reasonable conclusion regarding functional similarity. However, we find considerable force in the submission of ld. Counsel for the assessee that while fixing the range for applying this filter, regard should first be to the employee cost to sales ratio of tested party viz. assessee. He has rightly pointed out that in Asia India Pvt. Limited (supra) since the employee cost to sales was 46%, therefore, the range of employee cost ....
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.... assessee's objections and pointed out that the business dynamics of on-site and offshore varies a lot. He summarized his findings based on "Industry overview of software services sector," as under: * The Indian Software Sector provides both on-site and offshore services; * The Indian vendors have succeeded in raising the share of offshore revenue from 44% in 2000-01 to 64% in 2003-04 and to 71% in 2004-05; * There is a substantial rate difference between the on-site and offshore projects/contracts; 64.2 He pointed out that as per the industry reports (source-annual report of emphasis BFL F.Y. 2004-05), in the year 2004-05 average rate per man hour in the case of Offshore projects was US-18 dollars, whereas the same was considerably higher in the case of on-site project at about 66US dollars per man hour. He, therefore, pointed out that the profit margin also accordingly vary significantly; the offshore projects have much higher margins. The reasons for the same lie in the fact that while in the case of offshore projects most of the costs are incurred in India, an on-site project has to be carried out abroad significantly increasing the employee cost and other cost. The I....
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....n-site then offshore work; o The pricing structure is different on the inside work; o The assets are negligible in the operating on-site companies as they utilise the assets of their customer; o The margins for on-site are lower when compared to offshore work; o The labour markets are different for offshore and on-site work as the people who are working from on-site get competitive salaries of the countries where the work is actually performed; o Cost arbitrage is not available for the on site work; o The companies whose revenues are generated mainly from on-site work almost mimic a company which is resident in that company. He further pointed out that the companies who were also operating through their branches for their on-site work were also subjected to this filter. 66. As regards the assessee's argument that offshore and on-site revenues may individually yield diferring profit margins and , therefore, needs to be considered on a holistic basis, the TPO pointed out that comparables margins were considered at the enterprise/segmental level. The offshore margins neither were calculated for the comparables nor obtained from the companies u/s 133(6). 66.1 In view of above f....
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....lter observing that relevant data in this respect is not available in the data base. All the on-site information had been obtained by the TPO u/s 133(6) which is un-audited. 70. Ld. CIT(DR) submitted that this filter has been approved in the case of Trilogy E-business Software India Pvt. Ltd., ITA No. 1054/Bang./2011 dated 23/11/2012 A.Y. 2007-08 (paras 52 till 67 of the order). As regards the decision relied upon by ld. Counsel for the assessee, ld. CIT(DR) pointed out that this decision has just made a passing and cryptic reference, as opposed to detailed discussion in M/s Trilogy E-Business India Software Ltd. (supra). He further pointed out that assessee had relied upon this decision for different proposition. 70.1 Ld. DR explained that on-site and off site distinction has to be taken into consideration in order to select comparables. In this regard ld. DR explained that medical company may be earning export revenues from X-ray digitally transferred and also from specialist going abroad. He submitted that in case of first viz. x-ray digitally transferred, the same is offshore revenue though export earning but the other one viz. specialist going abroad is on-site revenue becaus....
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....w as compared to offshore work. The TPO has clearly demonstrated with facts and figures that there is considerable difference between the average rate per hour in the case of offshore projects vis-a-vis on-site projects. The reasons given by TPO are well founded. As the on-site project is altogether a different segment of the business and, therefore, the factors which influence the profitability of that segment have to be considered before considering the same for comparability study. In on-site projects the assessee utilizes the assets of the client whereas in offshore project the assessee utilizes its own asseets. This itself brings considerable difference in the comparability of the two segments by affecting the profitability. The salary structure in case of on-site project is governed by the economic conditions prevailing in the resident country where work is actually performed, whereas in offshore projects, Indian conditions govern the salary structure which is much lower as compared to the country where associated enterprise is located. We, therefore, do not find any reason for not accepting the TPO's contention in this regard. 72. Ld. Counsel has submitted that the threshol....
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....ems, Wipro Ltd., Tata Elxsi Ltd., Sasken Communication Technologies Ltd., Sab Lab Ltd., all these companies are Software Product Development Companies and have their own proprietary products and patents. It is not a coincidence that companies that incur substantial R&D expenditure are product companies and own intellectual property rights. 74. The TPO did not accept the assessee's contention observing that for creating intellectual property rights, R&D is required but the converse is not true i.e. each company is spending on R&D automatically is not towards creating an IPR. The R&D activity in a software development company is to improve the processes in delivering the software development services and not in creating intangible. TPO further pointed out that even bigger companies like Infosys spend on R&D but not in creating intangible (other than relating to products). TPO has reproduced at page 25 extracts from an annual report of Infosys for the F.Y. 2006-07, wherein it has been, inter-alia, observed as under: "R&D of new services, designs, frameworks, processes and methodology continue to be an importance of us. This allows us to enhance quality, productivity and customer sati....
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....anies with products though the assessee is mainly software development company. Therefore, the comparables had to be pre-dominantly engaged in software development services. However, by applying this filter, the assessee could not eliminate software product companies. Further, some of such companies were rejected by the assessee company being product companies though they qualified the R&D filter as under: 1. Aftek Ltd. 2. Essel Software & Services Ltd. 3. Iflex Solutions Ltd. 4. Intense Technologies Ltd. 5. Maars Software International Ltd. 6. Mirco Technologies (India) Ltd. 7. Teledata Informatics Ltd. 8. Transworld Infotech Ltd. 9. Tutis Technologies Ltd. 10. Vakrangee Softwares Ltd. 11. Zenith Infotech Ltd. 12. Take Solutions Ltd. 13. ABM Knowledgeware Ltd. 14. Asian Cerc Information Technologies Ltd. 15. Shyam Telecom Ltd. 16. KALS Information Systems Ltd. 74.2 Thus, the aforementioned companies though passed the R&D filter applied by assessee but had to be rejected by assessee on the ground that they were product intensive companies. Therefore, it is evident that the expenditure debited in the profit and loss account under the head "R&D" is not conclusive pro....
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....logy intangibles, intellectual property etc., even though such companies were not developing software products. Ld. TPO further pointed out that assessee had not explained any rationale for putting the limit of 3%. 77. Accordingly, ld. TPO concluded that there is no reason to exclude comparable companies engaged in R&D if they are software service providers. He observed that the criteria may be a trigger to examine further whether the company has any sales by way of products or created any intangible which was exploited commercially for sale. But it cannot be applied as a filter because this filter also eliminates software development companies. Ld. TPO demonstrated that R&D expenses of the company and the margin earned by the comparable had no correlation by considering following comparable selected by him: 77.1 He pointed out that three companies viz. Tata Elxsi, Celestial Labs & Wipro Ltd. had a ratio of marketing expenses to sales of more than 3% but still they remain software development companies. 78. Ld. DRP accepted the ld. TPO's contention that rejection of this filter had no material impact in the case of assessee. Ld. DRP, inter-alia, pointed out that spending on R&D ....
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....ngaged in software development activities broadly similar to those carried out by assessee then only 11 comparables were left. Therefore, by applying this filter sufficient number of comparables which were functionally similar got excluded. Ld. DR further submitted that para 19 to para 24 of Actis covers this issue. Ld. CIT(DR) pointed out that how does R&D expenditure influences profits and FAR analysis, needs to be established. He submitted that research activity does not change the functional profile of an entity and thus, does not make the same as not comparable to the assessee. Research activity has no direct correlation to profits or margin. 81. In the rejoinder, ld. Counsel for the assessee submitted that the decision of Deloite Consulting India P. Ltd. (supra) is of no assistance to revenue as the issue discussed in para 36 is not in relation to the filter in question i.e. R&D expenditure being 3% or more of the sales. In this case, the suitability of one particular comparable was discussed based on peculiar facts of the comparable. He submitted that it is pertinent to note that Deloite Consulting India P. Ltd. and the comparable in question were not software development c....
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....ord of the case. We are in agreement with ld. TPO's observations that for creating intellectual property rights, R&D is required but the converse is not true i.e. each company spending on R&D automatically is not towards creating an IPR. We are also in agreement with the observation of ld. TPO that R&D activity in a software development company is to improve the processes in delivering the software development services and not for creating an intanglible. But at the same time the submissions of ld. Counsel for the assessee that profitability of companies having intangibles is more cannot be lost sight off. If a company is having brand then it is definitely in a better position to command higher profits. Ld. Counsel in his submissions has pointed out that companies having patent had incurred substantial sums on R&D to develop its own products. Thus, both sides have their logical view point. Under such circumstances, the balance has to be drawn keeping in view the primary object of transfer pricing study. The object of selection of comparables is to find out companies which are performing similar functions as assessee with almost similar asset base and similar risks. These comparable....
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....ies result in creation of marketing intangibles and thereby demand a return of such investment made in creation of such intangible. The assessee pointed out that Infosys Technologies Ltd., Wipro Ltd., Tata Elecsis Ltd., Flextronics have created a brand name for itself in the market and have made significant investment in creating such intangibles. The assessee further pointed out that along with application of this quantitative filter, qualitative analysis was also carried out for determining whether any marketing intangible existed or not. Ld. TPO, however, did not accept the assesee's contention, inter-alia, observing that assessee did not give the basis on which it concluded that Infosys Technology Ltd. etc., noted earlier, had created marketing intangible. He observed that in the case of manufacturing or distribution companies, expenses over a period of time may create marketing intangible. However, the same may not be true for service industry like software development services. Ld.TPO further demonstrated that it is not always true that marketing expenses result in better profitability. He pointed out that in the case of Infosys 95% of its revenue for F.Y. 2006-07 was derived....
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....ive at a prefixed conclusion. Revenue finds support from the cases of i. M/s Actis Advisers P. Ltd. ITA No. 5277/Del/2011, para 19, 20and 26 thereof. (Directly on this issue). ii. M/s Deloiette Consulting India (P) Ltd. ITA No. 1082/1084/Hyd./2010, paras 36 & 40. 84.1 We have considered the rival submissions and have perused the record of the case. Admittedly the reasons for rejection of this filter by Ld. TPO were similar to that for rejection of R&D filter applied by assessee. Ld. Counsel's submissions with respect of market intangibles in the form of brand being created by incurring heavy expenditure on advertising and marketing are well founded. If a comparable is having brand then its profitability is definitely better. We are in agreement with ld. Counsel for the assessee that for economic concepts evidence is not required but if the very objective of TP Study viz. finding out suitable number of comparable fails then the proposed filter can be applied subject to necessary adjustment. In such circumstances a holistic view has to be taken. It is true that by incurring heavy expenditure on advertisement marketing and distribution the companies carrying on manufacturing activ....
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....bility is required. In fact, this is the reason that then benefit of +-5% safe Harbour limit has been provided. Also, in a situation of mean, differences get evened out. Support is found from the following case laws: i. M/s Symantec Software Solutions P. Ltd. ITA No. 7894/Mum./2010, para 16. ii. M/s Actis Advisors P. Ltd. ITA No. 5277/Del/2011, para 35. iii. M/s Deloitte Consulting Hyderabad. ITA No. 1082- 84/Hyd./2010, para 36 and 40. iv. M/s ST Microelectronics (P) Ltd. ITA No. 1806-1807/Del/2008, para 40. v. M/s CRM Services I (P) Ltd. ITA No. 4068/Del/2009, para 8.1. vi. M/s Quark Systems (P) Ltd. SB Chd. 41 ITR 606, para 25. (For the proposition that in a mean situation, differences get evened out). vii. M/s Bayer Material Sciences P. Ltd. 134 ITD 582, paras 23 and 24. viii. M/s Capgemini (ITA No. 7861/Mum./2011), para 4.3.6, for the proposition that size matters in manufacturing industry only, and not in service including such as software. It is also to be noted that Brand/Intangible does not (Per se) make any difference i. M/s Deloiette Consulting (I) P. Ltd. ITA No. 1082/Hyd./2010, para 36. ii. M/s Actis Advisors P. Ltd. ITA No. 5277/Del/2011, para 25. iii. M/s ....
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....1054/BANG/2011 b. M/s Bearing Point Business Consulting Pvt. Ltd. v. DCIT, Bangalore (ITA No. 1124/BANG/2011 c. M/s CSR India Pvt. Ltd. v. ITO, Bangalore (ITA No. 1119/BANG/2011 d. M/s L.G. Soft India Pvt. Ltd. v. DCIT, Bangalore (ITA No. 1121/BANG/2011 e. M/s Transwitch India Pvt. Ltd. v. DCIT, Bangalore (ITA No. 948/BANG/2011 f. M/s HCL EAI services Ltd. v. DCIT, Bangalore (ITA No. 1348/BANG/2011 g. M/s Logica Pvt. Ltd. v Asstt.CIT, Bangalore (ITA No. 1129/BANG/2011 h. M/s Mercedez Benz Research & Development India Pvt. Ltd. DCIT, Bangalore (ITA No. 1369/BANG/2011 87.1 Ld. Counsel submitted that Accel Transmatic has been specifically rejected on the ground that a software development company cannot be compared with the software product company: 88. Ld. CIT(DR) submitted that in TNMM Method only broad functionality is to be considered. He pointed out that ld. TPO has considered the software service segment only and, therefore, this comparable is not to be excluded. 88.1 We have considered the rival submissions and have perused the record of the case. 89. Ld. TPO has reproduced at page 99 of his order the segmental details from the annual report which separately contains....
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....Software Development and as such in services sector. He, therefore, submitted that this comparable was rightly selected by ld. TPO. 90.1 We have considered the rival submissions and have perused the record of the case. The company has specifically confirmed in response to information sought u/s 133(6) that it is a pure software development service provider and, therefore, the contention of assessee that it is software product company cannot be accepted particularly when it does not have any revenues from sale of products. Further, as per the information received u/s 133(6) it is clearly stated that this company is in providing software development and consulting IT services to its international clients. It is further stated that it utilized prudent technologies to enable customer's business systems. When this information is read along with the contents of annual report on the web site of this company, we do not find any contradiction Inasmuch as it is also stated that the company is involved in provision of software development and IT services. Ld. counsel's contention that it is a product company is primarily based on the details given on web site that it owns product like Dxchan....
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.... comparable on the ground that as per information provided by Celestial Labs under section 133(6), the company is primarily Into development of Software tools as products for application in the field of bio technology, pharmaceuticals & healthcare Industry. It was further pointed out that the software tools developed by celestial lab were proprietary in nature and protected using patent. Thus, it was submitted that this company is product company owning intangible property. The assessee also referred to the annual report wherein it is, inter-alia, stated that the company has developed a de novo drug design tool 'CELSUITE' to drug discovery and protected the IPR by filing under the Copyright / patent Act. It was further pointed out that based on its silico expertise (applying bio-informatics tools), it had developed a molecule to treat leucoderma and multiple cancer and protected the IPR by filing the patent. The company also outlined its future plans in the field of biotechnology. Thus, in sum and substance, the assessee submitted that the company was functionally dissimilar to the assessee as the company was engaged in the biopharma & biotech manufacturing with customized IT Solut....
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....vices Through inhouse Developed products. 50,75,100 20,21,12,145 Revenue from third Party Products Nil Nil Total 50,75,100 20,21,12,145 From this information, the ld. TPO pointed out that the revenue from in house developed products was only to the extent of Rs. 50,75,100/- for FY 2006-07 i.e. only 3.6% of its operating revenues of Rs. 14,12,75,776/-. Thus, more than 75% of revenues were from software development only. He further submitted that as regards assessee's contention that the software products mentioned by the tax payer were used for rendering software development services, Ld. TPO has clarified many software development companies use in house developed libraries/framework for rendering software development services and the presence of these in house developed software tools in no way changes the characteristic of the services as these tools are not sold as a product. 93. As regards the submission of ld. Counsel that in AY 2008-09 this comparable was not taken into consideration as it did not meet the employee cost, Ld. DR pointed out that the TPO also studied the prospectus filed by the company before SEBI and based on its examination issued notice u....
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....lter has not been controverted by department.. 93.3 In view of above discussion, we direct exclusion of this comparable from the list of comparables selected by the ld. TPO. D. KALS Information Systems: Ld. Counsel pointed out that as per the Annual Report, KALS is engaged in the business of software services and software products. Further, at page 17 of the Annual Report it also shows that there is "consumption of software inventory" as expenditure which implies that the company is into trading of software. The assessee relied on same decisions as for Accel Transmatic, noted earlier, and also on following decisions in support of its contention that KALS Info Systems Ltd. has been rejected as a comparable: Trilogy E business India Software Private Limited, ITA No. 1054/Bang/2011 para 35, Exxon Mobil Company India Private Limited, ITA No. 8311/Mum./2010 para 33 (xi), Quark Systems Private Limited, 32 TTJ 1 (SB) (Chd.), para 25 94. Ld.CIT(DR) referred to page 127 of ld. TPO's order (page 395 of appeal set) and pointed out that in the TP document this company was rejected by observing "Business Review". However, no reasons were given. Ld. DR pointed out that as per the information ....
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....which it transpired that the company was engaged in software development services and qualified all the filters applied by the TPO including RPT filters. Ld. TPO, therefore, proposed to include this company as a comparable to the assesse and accordingly, issued show cause notice to assessee. He has pointed out that assessee did not offer any comments and, therefore, this company was considered as comparable. Ld. Counsel referred to page 386& 387 of paper book, wherein the reply dated 14th September, 2010 contained from pages 317 to 408 is contained to demonstrate that assessee had given specific reply in this regard but the same had not been considered. 95.1 Having heard both the parties, we restore the matter back to the file of ld. TPO to examine the assessee's reply and then decide the inclusion/exclusion of this comparable. a. Flextronics Software Systems Ltd.: Ld. TPO noticed that this company was finding place in the accept/reject matrix of the tax payer and was rejected in the TP document saying that it failed R&D filter. He observed that based on the information submitted by the company, it qualified all the filters applied by the TPO. From the details of the produc....
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.... has not been provided. He pointed out that in following three cases this company has been excluded by ITAT as the segmental breakup was not available: Trilogy E business India Software Private Limited, ITA No. 1054/Bang/2011 para 35, Exxon Mobil Company India Private Limited, ITA No. 8311/Mum./2010 para 33 (xi), Quark Systems Private Limited, 32 TTJ 1 (SB) (Chd.), para 25 96. Ld. Counsel further submitted that the details provided by the Flextronics u/s 133(6) were unreliable and contradictory as on one hand it states that it does not own any IPR for products and on the other its financial details show that it has earned around Rs. 100 crores as software product revenue. Ld. Counsel further submitted that information u/s 133(6) can be an elaboration of the annual report but cannot replace the annual report. 97. Ld.CIT(DR) submitted that the information u/s 133(6) will prevail over the information contained in the annual report. He submitted that the product revenue is around 10% of the total revenue as per the information obtained u/s 133(6). 97.1 We have considered the submission of both the parties and have perused the record of the case. 97.2 For a company to be included i....
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....hed the company from the assessee and, therefore, the company cannot be considered as a comparable. Ld. TPO, however, did not accept the assessee's contention and pointed out that as per the assessee's contention the competitive strength of Infosys was due to on account of following factors: a. Innovation and leadership b. Provess Global Mobile c. Comprehensive and sophisticated solution d. Long standing of the relationships e. States as an employer or choice f. Ability to scale. 97.3 Ld. TPO pointed out that all the above factors are there in the services being rendered by the tax payer to the associated enterprise. If the margins earned by a comparable company are affected by the factors like brand value etc. appropriate adjustments can be made. He pointed out that assessee had not given any cogent evidence or data to support the presumption that the margins earned by Infosys or any other company in the software industry were affected by the so called brand value. He submitted that the ultimate profits earned by any company including Infosys dependent upon the over all market conditions and the services rendered. He demonstrated with reference to final comparable selected ....
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....119 crores had been spent in R&D in software development services mainly to improve the processes in delivering software development services. As regards assessee's contention that Infosys had software products, ld. TPO pointed out that the revenue's from software products were only 538 crores out of total operating revenues of Rs. 13149 crores. Therefore, the revenue from software product constituted only 4.1% of operating revenues. Hence it qualified the filter of more than 75% revenues from software development services. He, accordingly, included this in the list of comparables. 98. Ld. Counsel for the assessee reiterated the submissions made before ld. TPO and pointed out that the Spl. Bench of LG case clearly brings out the importance of brand and marketing intangible in the ramp on transfer pricing. He submitted that this case clearly lays down that risk bearing activities that compete in the market place need to incur AMP Expenditure to establish and maintain their brand. 99. Ld. CIT(DR) relied on following decisions in support of his contention that brand/intangible does not per se make any difference: 1. M/s Deloite Consulting India Pvt. Ltd., 108/Hyd./2010 (para 36); ....
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....e of Actis Advisors Pvt. Ltd. to hold that marketing expenditure was not a factor that impacts profitability of software and IT Enabled Services. He pointed out that assessee is not contending that Infosys should be excluded because it incurred high level of marketing expenditure but because it had significant brand which itself had value at more than Rs. 20,000/- crore. Further as per annual report also large profits were derived because of brand. 100.1 We have considered the rival submissions and have perused the record of the case. 101. The earning of profit i.e. that profit margin of an entity depends on several factors such as geographical location of entity, operational efficiency, prevailing market conditions, goodwill of the company, intangibles in the form of brand value of entity , economies of scales, etc.. However, while selecting a comparable for determining the arm's length price of an international transaction, the pre dominant aspect which has to be taken into consideration is the functional profile of the comparable. If a comparable is performing the same functions as the assessee then a further exercise is to be taken regarding assets utilized and risk assumed i....
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....ny was finding place in the accept/reject matrix of the assessee but was rejected in the TP document on the ground that it failed business review. However, no reasons were given for rejection on functional grounds or qualitative criteria. On the basis of information received u/s 133(6), he observed that the company is into software development services and qualified employee cost filter and all other filters applied by the TPO. Therefore, it was considered as comparable. The assessee was show caused. However, assessee did not offer any comments except saying that the computation of PLI was wrong as dividend income and other income was considered by the TPO. The ld. TPO accordingly, corrected the PLI and included the company as comparable. Ld. Counsel pointed out that the company was engaged in providing services such as application management services, business and technology consultant ITES & BPO services, Maritime practice, etc. Ld. Counsel referred to page 388 of paper book and pointed out following objections were raised by assessee in this regard: 1. This company failed the employee cost/sales filter of more than 25% applied by ld. TPO. However, the company was selected on th....
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....ftware is contained. Further in A.Y. 2008-09 TPO himself has excluded this company as a comparable. In this regard ld. Counsel referred to page 425 of the main appeal set for A.Y. 2008-09 and page 60 of the TP order for AY 2008-09. 107. Ld. DR relied on the order of TPO and submitted that as per the information received u/s 133(6), the Lucid Software is a pure Software Development Service Provider and does not have any revenue by way of sale of product/licenses. 107.1 We have considered the submissions of both the parties and have perused the record of the case. Since this comparable has been excluded by TPO himself in AY 2008-09, we do not find any justification for inclusion of this comparable for AY 2007-08 under the same set of facts and circumstances. No distinguishing feature has been brought on record in regard to this company between A.Y. 2007-08 and 2008-09. 107.2 Accordingly, we direct Ld. TPO to exclude this comparable from the list of comparables. 11. Third Ware Solutions Ltd.: 108. At the time of hearing, ld. Counsel for the assessee did not press exclusion for this comparable from the list of comparables. 12. Siskin Communication Technologies Ltd.: 109. Ld TPO ....
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....O noticed that the company was rejected in the TP document saying that the company failed its filter of business review and R&D to sales more than 3%. However, no reasons were given for the business review. From the annual report, ld. TPO noticed that this company has two segments one software development and services segment and second systems integration and support segment. Segmental details were available and the company satisfies all the filters. The TPO, accordingly, considered software development and services segment as a comparable. The assessee, inter-alia, pointed out that as per the information received u/s 133(6), it has been specifically provided that the company is into production of specialized embedded software development services to its customers. Further, the company has termed the services provided by it as unique and non-repetitive in nature involving development of embedded software for use by the customer, whereas in the case of assessee the software development service provided were of routine nature and involved low level coding, testing and documentation services. The assessee further pointed out that in the information obtained u/s 133(6), the company it....
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....ost of the processes had to be standardized to have a control, which becomes difficult in bigger companies. Thus, incurring R&D is a natural process of evolution of a small company into a bigger company, without which the company may not survive. It may fail to deliver the projects in time and also to the satisfaction of the clients. So, in bigger companies many processes are streamlined based on the past experience and converting the same in standardizing in the form of readymade tools. Thus, the presence of R&D expenses is a minor functional difference and does not have material impact on profitability. Thus, as the software development and services segment does not contain any revenue by way of sale of software products/IPRs/license fees, the same is considered as a comparable." 113.1 The submission of ld. Counsel for the assessee that NASSCOM, which is the premium body of IT/ITES Companies in India, has classified hardware and software designing activity as functionally different to software development activities cannot be ignored. However, since segmental details were available, the objection raised by ld. Counsel cannot be accepted. As far as asseessee's objection with rega....
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.... and recognized research institution across the world has also not been shown. The manner in which the risk adjustment is computed by the taxpayer is not followed by any country or organization of international repute like OECD. In fact, even the OECD is reluctant to take the risk adjustment as part of the guidelines as there are divergent views on this issue among the member countries of OECD and many countries feel that there is no straight jacket formula for risk adjustment as it depends entirely on the facts and circumstances of the case. Thus risk adjustment is case specific, function specific and also depends on the nature of functions (including risks) carried out by the comparable companies. 2. The tax payer had not given any evidence or argument regarding how the assumptions of CAPM model are true in the case of the AE when it is doing business with the taxpayer. 3. The CAPM model has some weakness, the main being that the model does not recognize the presence of human capital, which is the main driving source for revenues in the software service industry. 4. The taxpayer considered only listed companies. But, there is a method of computationof similar nature in the ind....
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....considered in the case of taxpayer while computing the risk adjustment. 11. The taxpayer considered total assets including current assets and current liabilities, but the CAPM hinges upon return on equity or capital employed. The operating assets are the major indictor of capital employed rather than total assets. Operating assets includes fixed assets, trade receivables net of trade payables. 12. The tax payer has assumed that operating expenses of the comparables would not change after risk adjustment. But, after giving effect to risk adjustment, the financial statements of the comparables should look like that of the tax payer i.e., stripping the risk component. So, the expenses pertaining to the risk like sales and marketing expenses, bad debts etc. should be removed from operating expenses and corresponding risk premium adjusted amount has to be reduced from the operating revenues. Hence, as per the above detailed discussion, the computation of risk adjustment by the taxpayer is not acceptable. There is no scientific basis for working out the taxpayer company's beta or beta of the unlisted comparable companies. The taxpayer altogether forgotten that the risk adjustment, if a....
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....al has held that there is difference in risk profile of a captive service provider and full-fledged entrepreneur software development companies that are selected as comparables: 117.3 He further pointed out that in Sony India Pvt. Ltd. 114 ITD 448, Tribunal has approved an ad-hoc adjustment for difference in risk on account of R&D and working capital. Further, in Philips Software Centre (supra), Tribunal approved computation of adjustment on account of difference in risk by looking at the difference between the bank rate (rate at which RBI lends to the bank) and the Prime Lending Rate (PLR) which is the rate at which banks lend to customers. He submitted that matter may go back to ld. TPO before whom assessee will file computation as per CAPM Model duly supported by expert opinion and TPO could rebut the same with an expert opinion. 118. Ld. CIT(DR) submitted as under:- Ground 4.7 and 4.10 Including certain companies that had extraordinarily high profit margins and hence were not comparable to a low risk captive unit such as the appellant: Ignoring the business/commercial reality since the assessee is remunerated on an arm's length basis, i.e. it is compensated for all its opera....
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....and not by resorting to complicated methods. Ld. CIT(DR) relied on the decision of ITAT, Delhi Benches in the case of M/s Premier Exploration Services Pvt. Ltd. v ITO 2013-TII-134-ITAT-DEL-TP for the proposition that risk adjustment can be considered when it is demonstrated that comparables had actually undertaken such risks and these materially affected their margin. 118.1 We have considered the submissions of both the parties and have perused the record of the case. We have perused the record of the case. We have also gone through the detailed written submissions filed by assessee from pages 92 to 104 of the written submissions The main contention of assessee is in regard to adjustment on account of market risk by applying CAPM Model. In this regard ld. TPO has observed that the services rendered by the assessee forms a component within the products developed by the assessee. Thus, the associated enterprise incurs marketing for its products and not on the services rendered by the assessee as they are considered in the product sold by the associated enterprise. The relationship between the tax payer and its parent company is exactly the same as that of the independent company and....
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....e for material differences in risk profile. Therefore, risk adjustment has statutory recognition. Ld. TPO carried out alternative analysis after risk adjustment on the basis of CAPM model and worked out the risk adjustment at .73% from the mean PLI of 25% (before working capital adjustment) as against 5.32% computed by assessee in respect of 22 comparables considered by it and 8.99% in respect of comparables proposed by TPO. Ld. TPO observed that .73% difference caused by risk to near PLI was not much so as to require any adjustment. Ld. TPO summarized the risk analysis as under: 15.1.3 "Summary of analysis of risk The discussion on the risk analysis is summarized as under: * The taxpayer is totally dependent on the AE for business. Thus, the taxpayer takes the risks associated with heavy dependence on a single customer. In common business parlance it is known as 'single customer risk'. * The cost plus agreement with the AE does not guarantee sufficient volume of business nor period as the agreement is for a period of one year and renewed one year at a time unless terminated otherwise. The agreement can be terminated by any party at any time after giving a stipulated period not....
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....bserved as under: "Inclusion of comparables by TPO in CDS sector has been considered by DRP. We find Megasoft should be excluded as it has different financial year end and went under restructuring hence has extraordinary business circumstances. Persistent Systems Ltd. also underwent restructuring. So both are to be excluded as comparables. In case of R Systems assessee has pointed out that the correct margin is 10.09% instead of 15.07%. TPO to verify and adopt correct margin." 124. Ld. Counsel has also pointed out that an application under Section 154 was filed by ld. TPO before ld. DRP which has been rejected. Accordingly, ld. TPO is directed to carry out the directions of ld. DRP. 125. In the result, this ground is allowed for statistical purposes. 126. Now, we will take up grounds relating to Administrative and Marketing Support Services segment of the assessee. 127. The brief description on functions of the company in this segment as under: "The corporate segment ('CS') is the administrative arm of MIPL. It comprises various teams rendering services that are essentially administrative in nature. Apart from rendering these services to other segment/business units of MIPL t....
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....his ground is dismissed. 131. Ground no. 5.3.1, 5.3.3, 5.3.4 and 5.3.5 were not pressed by assessee at the time of hearing. 132. As far as ground no. 5.3.2 is concerned, this issue has been decided by us while considering ground no. 4.5.3 in regard to software development service segment. Therefore, this ground is partly allowed in terms of observations made therein. 133. As far as ground no. 5.3.6 relating to rejection of assessee's filter of excluding companies having research and development cost to sales being more than 3% is concerned, the said issue has been decided while considering the ground no. 4.5.9 in software development service segment and, therefore, for the reasons stated therein this ground is dismissed. 134. As far as ground no. 5.3.7 is concerned the same relates to advertisement marketing and distribution cost more than 3% filter which was applied by the assessee. This ground has been considered while deciding ground no. 4.5.10 of software development segment and, therefore, for the reasons stated therein this ground is dismissed. 135. As far as ground no. 5.4 is concerned, the same relates to challenge by assessee to TPO's action in including high profit m....
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....venue and consistent losses were eliminated; 2) companies which had more than 25% related party transactions (income as well as expenditure combined) of the operating revenues were excluded; 3) companies with research and development expenditure in excess of 3% of sales were included. 138.2 Ld. Counsel submitted that comparables selected by applying these filters could not be considered. He has assailed various comparables selected by TPO on different grounds which we will consider now. We have already discussed the scope of applicability of above three filters while considering the software development segment. We, therefore, proceed to consider each comparable separately: 1) Genins India TPA Ltd.: 138.3 Ld. Counsel submitted that this company is a third party administrator in health insurance and, therefore, cannot be considered to be in the provision of market support services. 139. Ld. TPO has not established the functional similarity. 139.1 Having heard both the parties, we find that ld. TPO has pointed out from the details provided by the assessee that this company handles customer related queries, pocesses of claims, cashless authorization etc. Therefore, we agree wit....
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....re also very different. 145.1 Ld. Counsel further pointed out that during 2006-07 ICRA demerged its consulting services subsidiary ICRA Management Consulting Services. Therefore, this was an extraordinary event which had the effect on profitability but was not ascertainable. 145.2 Having heard both the parties, we are not in agreement with ld. Counsel for the assessee that this company is to be excluded on the ground of functional profile because admittedly it was imparting consulting and advisory services. Further, we find considerable force in the argument of ld. Counsel for the assessee that the fact of demerger being an extraordinary event had impact on profitability but this aspect had not been considered by ld. TPO. Ld. Counsel has also challenged the inclusion of this comparable on the ground of expenditure on R&D. In this regard ld. Counsel referred to extracts from annual report to demonstrate that company continuously invests in creating new products and services. Most of the product/service offerings of company involve innovation and original thinking. Further, company also takes steps to register its right over the intellectual property. Therefore, in the the light of....
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....tancy services and, therefore, these are not comparable to the assessee's routine administrative and marketing support services. Further, the inclusion of this company is also not warranted on the ground of earning abnormal margin and un-comparable sales turnover. He further submitted that this company has incurred expenditure on advertisement and marketing which exceeds 3% of sales. He further submitted that ld. TPO's observation that assessee had incurred only 2.54% of sales on advertising is incorrect as the assessee is a captive service provider and it does not need to spend on advertising and marketing. Ld. TPO, however, has not accepted the assessee's contentions for the following reasons: 1) the assessee is also imparting consultancy service like the comparable selected by him; 2) expenditure on advertisement and marketing does not make the company functionally dissimilar; 3) assessee has not pointed out any fact that would lead one to believe that there is some factor in the accounts of the company that makes the profit margin of 38.46% as extraordinary. 148.1 Ld. Counsel pointed out that in the case of M/s Mcicom India Pvt. Limited and M/s Varison India Pvt. Ltd. (ITA ....
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....onally comparable. 151.1 We have considered the submissions of both the parties and have perused the record of the case. We find that in the case of Mcicom India Pvt. Limited and others (supra) it has been held as under: "Marketing support services cannot be compared with turnkey Engineering Services. We agree with the view of the First Appellate Authority that EIL, Rites, Wapsos and TCE are engineering companies and provide end-to-end solutions and whereas the assessee company provides marketing support services to the parent company, which is in the nature of support service and hence not functionally comparable. She rightly concluded that the risk profile is vastly different and hence on this count also they are not comparable." We are in agreement with ld. CIT(DR) that merely because of shares being held by the Government of India, the company cannot be excluded, unless it is established that the company is not functionally comparable. However, we find that assessee was imparting only marketing support services but Rites Ltd. admittedly was primarily imparting turnkey engineering services. Therefore, in view of the observations in the case of M/s MCI com India P. ltd. and oth....
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.... parties, we do not find ourselves in agreement with ld. Counsel for the assessee for exclusion of this company from the list of comparables. In our opinion, unless it is demonstrated with robust data that because of shares being held by the Government of India, there is impact on profitability of company, the same cannot be excluded merely on the ground of general perception. Further, we find clear cut contradiction in the argument of ld. Counsel for the assessee because the effect of undertaking social obligation by Government Company at best results in reduction of profit and not in increasing the profits. As far as, the decision relied upon by ld. Counsel is concerned, the same has been rendered having regard to related party transactions but no data has been provided in the present case. We, therefore, uphold the ld. TPO's contention in this regard. 10) Consulting Engineering Services (India) Pvt. Ltd.: 156. Ld. Counsel submitted that this company is engaged in the business of rendering services in diversified areas such as agricultural and rural development, architecture, bridges and structure, roads and highways etc. He pointed out that ld. TPO has not controverted the con....
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.... operating profit margins of the comparables chosen for administrative and marketing support service segment to account for the differences in the working capital levels of the assessee and the comparables. The other two sub-grounds viz. (b) and (c) were not pressed by assessee. In regard to this, ld. Counsel submitted that the binding direction of the ld. DRP in respect of allowing adjustment on account of working capital differences in the operating margins of the comparables should be directed to be followed by ld. TPO. 162.1 Having heard both the parties, we find that while considering ground no. 4.9 relating to working capital adjustment, ld. DRP has directed AO/TPO to grant working capital adjustment based on the OECD formula and by taking 10.25% as the PLR. We, therefore, direct the ld. TPO/AO to carry out the directions given by ld. DRP. 163. In the result, this ground is allowed for statistical purposes. Corporate Issues: 164. Vide ground no.7, the assessee has assailed the order of ld. AO as per the directions of ld. DRP in disallowing provision for liquidity damages amounting to Rs. 201537175/- on the ground that the claim for liquidated damages is a liability of fut....
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....dmitted fact that the provisions are made and also written back when no longer required. This indicates that no generalization can be made about liquidated damages. There is a great deal of contingency and it cannot be accurately predicted. Therefore, it would be in the fitness of things to uphold this disallowance. But at the same time the entire reversal of the said provision of Rs. 306779345/- should have been reduced in computing taxable income". 167.2 Ld. Counsel submitted that the assessee is engaged, inter-alia, in the business of installation and commissioning of telecommunication and equipment network and provides technical support services in relation to the same for various telecom operators in India. All the projects executed by the assessee company are done under contracts which contain the clause for liquidated damages in accordance with the normal industry practice. In this regard, ld. Counsel referred to a sample agreement for supply of services between Tata Teleservices (Maharashtra) Ltd. & Motorola India Pvt. Ltd. dated 10/10/2003 contained from pages 798 to 838 of paper book and specifically referred to page 818, wherein the clause relating to delays and liquida....
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....ccount. In case where the customer agrees to waive the liquidated damages either, partly or fully, the provision is reversed to that extent. This amount is offered to tax as income in the year in which this reversal is done. He further pointed out that this year, the amount of reversal is more than the amount added to the provision, i.e., taxable income of the assessee has gone up on account of the reversal. Ld. Counsel relied on following case laws in support of his contention that provision for liquidated damages is an allowable deduction: 1. Bharat Earth Movers vs. CIT, 245 ITR 428; 2. Delhi High Court in the case of Ericson Communication, 318 ITR 340; 3. KCP Limited, 34 ITD 50 (Hyd.) ITAT Spl. Bench; 4. Madras ITAT in the case of Kaveri Engineering Services, 43 ITD 527; 5. FFE Minerals India Pvt. Ltd. vs. JCIT, 84 TTJ 907 (Chen.) ITAT; 6. Pune ITAT in Thermax Babcock and Willcox Ltd. vs. Addl. CIT, 304 ITR 130; 7. Delhi ITAT in Addl. CIT vs. Ericson India Pvt. Ltd., ITA No. 516/Del/2005. 168. Ld. DR submitted that provision for liquidated damages is actually provision for unliquidated damages because liability has not crystallized. He submitted that unless the damages a....
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....in the supply of raw cashew nuts and consequent high in prices. Due to the failure to supply the chashew nuts as per the terms of the contract, there was breach of contract and the assessee, therefore, claimed a deduction of Rs. 1251625/- towards damages payable to the foreign companies. The claim was rejected by Tribunal against which assessee preferred appeal which was dismissed as the assessee failed to establish its claim. The Hon'ble High Court, inter-alia, observed that the details regarding the period of contracts, the manner of their performance, quantification of damages etc. were not specifically brought to their notice. Only the fact regarding arbitration proceedings was brought to the Hon'ble Court's notice. Under these facts, it was held that the damages had not crystallized particularly because there was no stipulation in contract and assessee had denied its liability. In the present, case, however, as noticed earlier, the provision had been made on the basis of specific terms of contract in regard to liquidated damages. Therefore, this decision is of no assistance to the revenue. 171. The next decision relied upon by ld. DR is in the case of Navjeevan Rollar and Flo....
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....he claim by the foreign party was for unliquidated damages." 170.1 Thus, in this case also the provision was not made on the basis of some contractual obligations but on account of Arbitrator's Award which had not become final. 171. From the analysis of the two decisions relied upon by ld. DR, it is evident that both are not applicable to the facts of the case. 172. On the other hand, we find that the case laws relied upon by ld. Counsel for the assessee clearly support the assessee's case particularly because terms and conditions of agreement with customers contained delayed delivery clause whereunder specified penalty was to be paid by assessee for delay in delivery. We find that Hyderabad ITAT Spl. Bench in the case of KCP Limited, 34 ITD 50 in para 8, inter-alia, observed as under: 8. "As we have noted above, it is not in dispute that in terms of the agreements of the assessee for the supply of goods, time was the essence of the contract and any delay in the delivery of the goods would result in the liability to pay damages. That the parties mean it seriously is proved by the fact of provision for bank guarantee up to the maximum value of liquidated damages. It is als....
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....ated as the essence of the contract ; nonetheless it would have served no purpose if the purchaser had cancelled the contract when the work on the manufacture of the machinery had progressed perhaps a very large extent and payments were made in the mean time as per the terms of contract. That was the reason why penalties have been provided in the agreement itself depending on the period of delay which is intended to act as a deterrent against delays in deliveries and this is to avoid future litigation as to the quantum of damages. Under section 74 of the Indian Contract Act, even if there is a stipulation by way of penalty, the party complaining is entitled to receive only reasonable compensation not exceeding the amount named. Section 74 reads as follows: "When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as th....
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....cock and Wilcox Ltd. (supra) 304 ITR 130 in para 24.5 to para 25, has observed as under: 33. "Having regard to the facts and circumstances of the case and submissions of both the parties, there is no dispute as to the fact that the stipulation providing the payment of liquidated damages to the other party for delay in completing the work, is a part of the contract agreement entered into by both the parties for executing and completing the work. In other words, the condition for payment of liquidated damages for delay in work is in-built in the contract agreement itself. Therefore, there exists an undertaking given by the parties to execute the work within the specified time, the defaulter has agreed to pay damages on account thereof. This undertaking is not found to be conditional. Thus, this undertaking imported a definite liability on the assessee which accrued as soon as the delay in executing the works had first occurred and continued till the work was fully completed, though that liability was to be quantified precisely and discharged at a future date. On this aspect, we may again usefully6 refer to a decision of the Hon'ble Supreme Court in the case of Calcutta Co. Ltd. [195....
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.... certain act or event of not completing the work within stipulated time has imported a definite and absolute liability on the assessee and merely because of the fact that liability would be discharged at a future date and, there is a difficulty in estimating the correct amount thereof would not convert this definite and absolute liability into conditional one as has been held by the Hon'ble Supreme Court in the case of Calcutta Co. Ltd. vs. CIT [1959] 37 ITR 1 (SC), Metal Box Company of India Ltd. vs. Their Workmen [1969] 37 ITR 53 (SC) and Bharat Earth Movers vs. CIT [2000] 245 ITR 428 (SC). In this view of the matter, we may, therefore, say that the reasons given by the AO as well as by the CIT(Appeals) for rejecting the assessee's claim is not in consonance with the principle laid down by the Hon'ble Supreme Court in the case of Calcutta Co. Ltd. vs. CIT [1959] 37 ITR 1 and Bharat Earth Movers vs. CIT [2000] 245 ITR 428 (SC). The very principles laid down by the Hon'ble SC in the case of Calcutta Co. Ltd. vs. CIT [1959] 37 ITR 1 were also followed by the Kerala High Court in the case of CIT vs. Indian Transformers Ltd. [2004] 270 ITR 259 and the Hon'ble Delhi High Court in CIT v....
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....works have been executed after the expiry of the stipulated period. The stipulation as to the payment of liquidated damages towards delay in executing the contract work is related to the contract work, revenue thereof has been accounted for in the year under consideration. Although exact quantification of the claim of liquidated damages may be made at a future date, the assessee payer was, in obligation to pay liquidated damages for the delay in work did accrue on the date when the delay was first occurred and continued upto the date of completion of the work, and thus, in computing the profit and gains derived by the taxpayer from such contract works in the present year, the assessee tax payer is entitled to deduct from the profits from the aforesaid contract works a provision, for the cost of the anticipated liquidated damages in so far as the same is related to the period of delay falling within the year under consideration." 174.1 It has also allowed the assessee's claim of liquidated damages following the decision of Hon'ble Supreme Court in the case of Calcutta Company Ltd. vs. CIT (1959) 37 ITR 1 and Bharat Earth Movers vs. CIT,245 ITR 428 (SC). 175. In view of above discu....