TaxTMI 
TaxTMI 
2015 (4) TMI 586
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....n international transaction with an associate enterprise, the income arising from such transaction in view of the provisions of section 92C has to be computed having regard to the arm's length price. Section 92CA prescribes various methods such as comparable uncontrolled pricing (CUP) method, resale pricing method, cost plus method, profit split method and transactional net margin method (TNMM), etc. The Assessing Officer during the assessment proceedings referred the issue of determination of the arm's length price to the Transfer Pricing Officer (TPO). The Transfer Pricing Officer, therefore, issued notice under section 92C to the assessee asking the assessee to give details of transfer pricing study conducted by it to compute the arm's length price of the international transaction. The assessee in the transfer pricing study selected transactional net margin method as the most appropriate method for benchmarking the international transaction with respect to uncontrolled transactions. The assessee selected 11 comparables which were engaged in similar line of business and provided services primarily to the U.S. or European market having sufficient public financial and b....
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....mpany which resulted in change in business dynamics. Similarly Sonata Software Solutions had diversified in the Europe through an acquisition of significant stake in a German company which had changed its functional profile. The results of Satyam Computers P. Ltd. could not be relied upon due to massive fraud which had been unearthed in case of the company. In case of VJIL, it was submitted that financial information was not available in the public domain. It was thus submitted that five companies were in fact not comparable. Excluding these five companies, the updated margin in respect of six companies for the financial year 2006-07 was given as under : Sr. No. Name of Company Margin in financial year 2006-07 1. CG-Vak 2.8 2. Infosys Technologies Ltd. 28.1 3. Mascon Global Ltd. 10.4 4. Mastek 12.7 5. Patni Computer Systems Ltd. 19.1 6. Wipro Technologies Ltd. 20.1 2.2. In the working of margin in the above cases, the assessee had used consolidated results of the comparables for the purpose of comparison. The assessee explained that consolidated financial statements had been adopted because in such statements, the ef....
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....cials of different companies also noted that CG-Vak Software & Exports, Mascon Global Limited, Mastek Ltd. and Patni Computer Systems Ltd. had substantial related party transactions exceeding 25 per cent. in each case. He, therefore, excluded these companies from the list of comparable cases. In relation to VJIL Consulting Ltd., the Transfer Pricing Officer noted that it had incurred heavy losses, i.e., 42.94 per cent. during the financial year 2006-07 and therefore held that it was not comparable to the assessee-company which was a cost plus entity. The Transfer Pricing Officer, therefore, found only two companies comparable, i.e., Infosys Technologies Ltd. and Wipro which had margin of 40.26 per cent. and 26 per cent. respectively on standalone basis. 2.4. The assessee during the proceedings before the Transfer Pricing Officer added three more comparables which had not been taken at the time of preparation of transfer pricing study report due to unavailability of financial information. These three companies were as under : (i) Datamatics Ltd. ; (ii) Mindtree Consulting Ltd. ; and (iii) Persistent Systems Private Ltd. 2.5. The Transfer Pricing Offi....
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....d as having exercised all the stock options in Kanbay International for consideration of USD 29 per share resulting in an accelerated exercise of options. The consideration was paid immediately for all options that had vested as on that date which resulted into an exceptional cost of Rs. 46,41,96,501 in the month of February 2007. The assessee treated the ESOP cost, as exceptional in nature arising out of acquisition. The assessee, therefore, in the transfer pricing study excluded these costs for the purpose of computation of margin in case of the assessee and this exceptional cost was amortised over a period of five years starting from the financial year 2007-08 in transactional net margin method analysis of subsequent years. 2.6.1. The Transfer Pricing Officer however did not accept the claim of the assessee of making adjustment while computing its margin on account of ESOP cost. It was observed by him that any adjustment in this regard had to be made in accordance with rules. He referred to rule 10B(1)(e)(iii) as per which adjustment on account of any difference between international transaction and comparable uncontrolled transaction or between enterprises entering into such....
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....es selected by the assessee itself. He referred to OECD guidelines as per which working capital adjustment should be considered only when the reliability of comparables could be improved and reasonable accurate adjustments could be made. The Transfer Pricing Officer further observed that the assessee had not been able to give details as to what was representative level of working capital in the hands of comparables. The comparability on the last date of the financial year would give skewed results. The Transfer Pricing Officer thus concluded that reasonable accurate adjustments could not be made on account of working capital and accordingly rejected the claim of the assessee. 2.8. The Transfer Pricing Officer finally computed the arm's length price of the international transaction relating to software programming services at Rs. 6,69,67,04,652 by applying the mean margin of 27.82 per cent. on the operating cost of Rs. 5,23,91,68,090. The transfer pricing adjustment was thus computed at Rs. 1,11,97,50,424 (Rs. 6,69,67,04,652 - Rs. 5,57,69,54,228). The assessee filed objections against the Transfer Pricing Officer's order before the Dispute Resolution Panel-I (DRP-I), Mumb....
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.... immediate preceding years. Learned senior counsel also referred to monthly expenditure on account of ESOP placed at page 6 of the paper book which showed that expenditure varied during the year from nil in January 2007 to maximum of to Rs. 6.10 crores in December 2006. It was also pointed out that this extraordinary ESOP cost had been amortised by the assessee over the subsequent 5 year period starting from the assessment year 2008-09 which had been reduced from the profit while working out transfer pricing adjustments in the subsequent years as was clear from the details given at page 76 of the paper book which had been filed before the Transfer Pricing Officer vide letter dated October 28, 2010. It was further submitted that the exceptional ESOP cost had been claimed by the assessee in the profit and loss account as same had been incurred during the year and not to reduce any tax liability because the assessee was otherwise eligible for exemption under section 10A of the Act. It was also pointed out that ESOP cost had been treated as perquisite in the hands of the employees on which tax had been deducted at source. 3.1.1. It was thus argued that the assessee had rightly exclu....
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....-alone results could not be proper to adopt as the company's international transactions in many cases were carried out through branches and, therefore, the so called standalone result reflected the consolidated results in cases where the company operated in several jurisdiction through branches. It was therefore urged that the consolidated results should be adopted for the purpose of comparison and in case this was done, the margin of the assessee was within the 5 per cent. safe labour limit and, therefore, no adjustment was required. Learned senior counsel further submitted that the Transfer Pricing Officer had rejected the comparable, VJIL on the ground of losses. The assessee vide letter dated October 27, 2010 had pointed out to the Transfer Pricing Officer that VJIL was not a persistent loss making company and it was profitable in the assessment years 2005-06 and 2006-07. Therefore, it was submitted that exclusion of the said comparable was not justified as the Transfer Pricing Officer is not permitted to do cherry picking of comparables and that comparables could not be rejected only on the ground of loss without pointing out any specific features which make them non-compa....
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..... Wipro also had a very high margin. It was, therefore, urged that turnover filter should be applied to select comparables which had support of the following decisions of the Tribunal. (i) Deputy CIT v. Deloitte Consulting India P. Ltd. [2012] 15 ITR (Trib) 573 (Hyd) ; (ii) DHL Express (India) P. Ltd. v. Asst. CIT [2011] 12 ITR (Trib) 658 (Mum) ; [2011] 46 SOT 379 (Mum) ; (iii) I. T. A. No. 3856/Del/2010 in the case of Aginity India Techno logies v. ITO ; (iv) Genisys Integrating Systems (India) P. Ltd. v. Deputy CIT [2012] 15 ITR (Trib) 475 (Bang) in I. T. A. No. 1231/Bang/2010; (v) I. T. A. No. 1494/Hyd./2010 in the case of Brigade Global Services Pvt. Ltd. ; and (vi) Asst. CIT v. Frost and Sullivan India P. Ltd. [2012] 50 SOT 517 (Mum). 3.3.3. It was also argued that the assessee had submitted four new comparables before the Dispute Resolution Panel which had not been considered without giving any reasons. It was pointed out that the Transfer Pricing Officer in the show-cause notice for rejection of comparables had given only one week time and, therefore, the assessee did not have sufficient time to conduct further study a....
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....ts included operations in different jurisdictions which may not be comparable. He referred to rule 10B(2)(d) as per which comparability had to be decided after considering the prevailing market conditions including the geographical location and size of markets, cost of capital and labour, etc. Considering these factors, the consolidated results which included operations in different market conditions in different jurisdictions could not be considered as comparables. He referred to annual reports of the four comparables having related party transactions to point out that in case of Mascon Global Ltd., 75 per cent. of the revenue came from the U.S.A., Moscow and the UK and only about 25 per cent. from India. Similarly in case of CG-Vak Software and Exports, 75 per cent. of the revenue came from other jurisdictions. In case of Patni Computer Systems Ltd., 61 per cent. of revenue came from the U.S.A., the UK, Germany and Brazil whereas in case of Mastek Ltd., substantial part of the revenue came from other countries. It was therefore urged that it was not safe to consider the consolidated results. He placed reliance on the decision of the Tribunal in the case of American Express (India....
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.... v. Deputy CIT in I. T. A. No. 3858/M/2006 [2013] 22 ITR (Trib) 424 (Mum) in which case also the assessee wanted to exclude certain comparables selected by it as per the transfer pricing study but the same was not allowed by the Tribunal. 4.3. Coming to the arguments of learned senior counsel that Infosys and Wipro had exceptionally high profit and turnover and therefore should be excluded, it was submitted that the comparable could not be excluded only on the ground of turnover. It was pointed out that the argument based on economy of scale was not relevant in case of a service company. It was relevant only in case of manufacturing concern where the cost per unit product increased with rise in turnover, and therefore, profitability rises with rise in turnover which is not a case in service providing companies where fixed costs are nominal. He referred to decision of the Tribunal in case of Symantec Software Solutions P. Ltd. v. Asst. CIT in I. T. A. No. 7894/M/2010 [2012] 15 ITR (Trib) 323 (Mum) in which the Tribunal did not accept the plea of exclusion on the ground of difference in turnover. The Tribunal observed that in a competitive market, high turnover was associated with....
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....ny working capital adjustment in transfer pricing study made by it. The plea was taken only when the Transfer Pricing Officer rejected the comparables and therefore, there was no merit in the plea and it was only an afterthought to reduce the margin. It was also submitted that as per OECD guidelines, such adjustment should be made only if it is expected to increase the reliability of the comparable and it can be made accurately. It was pointed out that there was no material to show that accurate adjustment could be made which will increase reliability. 5. We have perused the records and considered the rival contentions carefully. The dispute raised in this appeal is regarding transfer pricing adjustment made by the Assessing Officer in relation to international transaction entered into by the assessee with the associated enterprise, i.e., the parent company in the US. In view of the provisions of section 92C, the income arising from international transactions with associated enterprises has to be computed having regard to the arm's length price. Section 92C prescribes various methods such as comparable uncontrolled price (CUP) method, resale price method, cost plus method, p....
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....d be excluded from the profit and loss account for the purpose of computation of margin. The authorities below have not accepted the request of the assessee on the ground that, under the provisions of rule 10B(1)(e)(iii), an adjustment could be made only in case of comparables and not in case of the assessee. No dispute has been raised by the authorities below or the learned Commissioner of Income-tax-Departmental representative that this was a one-time cost incurred by the assessee due to acquisition. We also note from the monthly expenditure on ESOP cost for the relevant year that normal ESOP cost fluctuated between nil cost in January 2007 to the maximum of Rs. 6.1 crores in December 2006. We further note that total ESOP cost in the immediate preceding year was only Rs. 10.25 crores and only because of exceptional item this year, ESOP cost had gone up to Rs. 70.25 crores. There cannot be any dispute that comparison of margin between assessee and comparables has to be made under identical conditions. No case has been made by the Revenue before us that any of the comparables, have claimed, any extraordinary item of expenditure on account of ESOP cost. Therefore, in our view, for t....
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.... ESOP cost over the subsequent five year period which was reduced from the profit of the assessee for the purpose of computation of transfer pricing adjustment. We, therefore, do not agree with the action of the authorities below in not excluding the one time ESOP cost and accordingly direct the Assessing Officer to exclude the one time ESOP cost while computing margin in the case of the assessee. The margin after excluding ESOP cost is stated to be 16.6 per cent. which may be verified by the Assessing Officer. 5.3. The next issue on which dispute has arisen is selection of comparables and method of computation of margin in their cases. The assessee in terms of transfer pricing study conducted by it selected eleven comparables which were engaged in similar line of business, providing services primarily to the US or European markets, having sufficient public financial and business information and excluding the cases which were subsidiaries of another company. The study gave eleven comparables details of which have been given in para 2 earlier. However, subsequently during the proceedings before the Transfer Pricing Officer, the assessee submitted that five of the eleven comparabl....
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....ransfer Pricing Officer had given notice for rejection of comparables only one week before passing of the order. Therefore, the assessee did not have enough time for selecting more comparables. It has therefore been requested that these comparables may also be considered. In addition, it has also been argued that Infosys Technology and Wipro though these were the assessee's own comparables, should be excluded as these were extreme cases of high turnover and profit and thus not comparable to the case of the assessee. Reliance has been placed on several decisions of the Tribunal as mentioned earlier in which turnover filter has been applied for selection of comparables. In addition, it has also been argued that in case high profit cases were selected the case of VJIL which was initially excluded by the assessee before Transfer Pricing Officer on the ground that financial information was not available in public domain and was rejected by the Transfer Pricing Officer on ground of losses, should also be included. It has been further argued that consolidated results of the companies should be considered for the purpose of computation of margin as consolidated results neutralise resul....
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.... in a similar situation had not allowed the same on the ground that substantial revenue came from other markets which were not comparable. We, therefore, uphold the view taken by the authorities below to adopt standalone results for the purpose of comparison of margins. Consequently we also uphold the order of the Transfer Pricing Officer for rejecting the abovementioned four comparables which have substantial related party transactions because the transactions in these cases could not be considered as fully uncontrolled. 5.3.4. We now take up the arguments advanced on behalf of the assessee that extreme profit and loss cases should be excluded or in case extreme profit cases are included, the case of losses should also be included. This argument is particularly relevant in relation to VJIL which has margin of -42.94 per cent. on turnover of Rs. 13.02 crores and also Infosys Technologies and Wipro which are extreme profit cases. Learned senior counsel has argued that VJIL had been initially excluded by the assessee on the ground of lack of financial information in the public domain and since information was now available, this should be considered. It has also been pointed out t....
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....bunal decisions cited, no detailed examinations have been made as to how these factors increase the profitability with rising turnover. The concept of economy of scale is relevant to manufacturing concerns, which have high fixed assets and, therefore, with the rise in volume, cost per unit of the product decreases, which is the reason of increase in margin as scale of operations goes up because with the same fixed cost there is more output when the turnover is high. The same is not true in case of service companies, which do not require high fixed assets. In these cases employees are the main assets, who in the case of the assessee are software engineers, who are recruited from project to project depending upon the requirement. The revenue in these cases is directly related to manpower utilised. With rise in volume cost goes up proportionately. Therefore, as rightly pointed out by the learned Commissioner of Incometax-Departmental representative the concept of economy of scale could not be applied to service oriented companies. The learned Commissioner of Income-tax-Departmental representative has also placed a graph plotted between margin and turnover in case of the comparables se....
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....he turnover range of Rs. 1 crores-Rs. 200 crores ; Rs. 200 crores-Rs. 2,000 crores and greater than Rs. 2,000 crores for the purpose of comparison of margin. The said classification made by the Tribunal was on the basis of classification made by Dun and Bradstreet. We, however, find that Dun and Bradstreet had made the classification according to size of the company, i.e., large, medium and small. The classification was not made on the basis of margin as there is no empharical evidence to suggest that margin is directly related to turnover. We, therefore, reject the argument advanced by learned senior counsel for applying turnover filter for selection of comparables for the purpose of comparison of their margins with that of the assessee. 5.3.7. However, we may make it clear that for the purpose of comparison, the turnover would be relevant only from the limited purpose to ensure that the comparable selected is an established player capable of executing all types of work relating to software development as the assessee is also an established company in the field. In other words, it must have a certain critical mass to compete successfully in the market, which can be decided by t....
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....ld earlier, are not found convincing. The assessee, therefore, cannot be permitted to exclude Infosys and Wipro which were its own comparables. This issue is also supported by the decision of the Tribunal in the case of Kansai Nerolac Paints Ltd. [2013] 22 ITR (Trib) 424 (Mum), which has been relied upon by the learned Commissioner of Income-tax-Departmental representative in which it has been held that the assessee itself having selected the comparables, it cannot turnback and say that they are not comparables without giving any cogent and convincing reasons. 5.3.9. Reverting back to the new comparables submitted by the assessee at the level of the Dispute Resolution Panel, we find substance in the submissions by learned senior counsel that the Transfer Pricing Officer had not given sufficient opportunity for study and selection of new comparables as order was passed within a week of issue of show-cause notice. Therefore, the new comparables selected at the level of the Dispute Resolution Panel should have been considered. The Dispute Resolution Panel has not considered the new comparables without giving any reason. In our view, it would be appropriate to take as many comparabl....
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....d Wipro, these shall be eliminated while taking the mean margin as the margin of the other two comparables is much lower than the above two comparables. The assessee has, however, disputed the computation of margin in the case of Mindtree and Persistent by the Assessing Officer/Transfer Pricing Officer. The Assessing Officer is therefore, directed to verify the margin of these comparables after hearing the assessee. 6. The assessee has also requested for working capital adjustment. The case of the assessee is that working capital does have an impact on the profitability of the company and more accounts receivable in case of a company would mean relatively lower profit. Therefore, the companies could be considered as fully comparable if they hold the same level of account receivable and account payable. The Transfer Pricing Officer has, however, rejected the claim of working capital adjustment which has been upheld by the Dispute Resolution Panel. The reason given by the authorities below is that the assessee had not made any claim for working capital adjustment in its the transfer pricing study and that it is not possible to make accurate adjustment on this account as it is diff....