TaxTMI 
TaxTMI 
2015 (4) TMI 949
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....n in their opinion on this; it is the subject matter of the present appeal. 2. The questions framed for decision in this appeal, under Section 260-A of the Act, arising from an order of the Income Tax Appellate Tribunal ("ITAT") dated 20.12.2013 in ITA No. 6183/Del/2012 for assessment year (AY) 2008-09, are as follows: 1) Whether the proviso to Rule 10B(4) of the Income Tax Rules, 1962 will be applicable in case of fluctuations in the operating profit margins of comparable companies during the relevant financial year under question as compared to earlier years? 2) Whether comparables can be rejected on the ground that they have exceptionally high profit margins as compared to the assessee in transfer pricing analysis? 3) Whether factors like differential functional and risk profile coupled with high degree of volatility in operating profit margins is sufficient ground to reject comparables for transfer pricing analysis? 4) Whether disallowances can be made under Section 36(1)(ii) when the bonus paid to shareholders is not in the exact proportion of their shareholding and there is no avoidance of taxes? 3. The assessee is a private limited company incorporated under the Compan....
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....nto: Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.‖ The assessee argued that using multiple year data is consistent with the OECD Guidelines as well as transfer pricing regulations of several developed jurisdictions. The Operating Margin of the assessee was stable in contrast to the comparable companies, described below: Financial Year Operating Margin 2005-06 24.15% 2006-07 21.14% 2007-08 27.05% Average 24.11% 5. On 30.09.2008, the assessee filed its return for AY 2008-09 declaring a total income of Rs. 12,41,83,160. Its case was scrutinized by the AO who referred the matter to the Transfer Pricing Officer ("TPO") under Section 92CA (3) of the Act. On 03.10.2011, the TPO passed an order recommending transfer pricing additions of Rs. 20,93,34,155/- to the income of the Assessee. The TPO computed the Operating Margins of the four comparables above using single year data i.e. for FY 2007-08 and ignoring the data for two prior financial year....
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.... been selected as a comparable by the assessee itself based on the multiple year data for the comparability analysis. However, the TPO substituted the same with the data for the concerned financial year, in which Khandwala had exceptionally high profit margins. The ITAT upheld these findings and held that current year data should be used in the absence of abnormal or exceptional facts/circumstances in existence which could have an influence on the results as well as the determination of the transfer prices for the year under consideration. Further, the ITAT held that Rule 10B does not provide any basis to exclude an entity or eliminate it from the list of companies solely on the basis of high profitability. The authorities - including ITAT, held that the decisive factors for determining inclusion or exclusion of any entity in/from the list of comparables are the specific characteristics of the services provided by the said entities, assets employed, risks assumed, the contractual terms and conditions prevailing including the geographical location and size of the market, cost of labour and capital in the markets, etc. and high or low profit margins could not be criteria for inclusio....
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....computed the ALP on the basis of single year data (data for the FY 2005-06 only) this company should not be included in the final set of comparable as it would lead to distortion of the ALP.' The assessee while determining the ALP considered data for three years which mitigated the high volatility in operating margins of this company. However on the basis of single year data the operating margins of this company will substantially inflate the operating margins. ―The volatility in the operating margin of this company is clearly evident from the three year profitability of the comparables submitted before you are the Ld. TPO vide submission dated May 18, 2009 (copy enclosed at page 139 of the paper book dated January 01, 2010 filed before the Hon'ble Panel). The operating margin of this company during the FY 2003-04 was negative 6.87% and which converted to positive 13.33. In the FY 2004-05, thereby exhibiting the this margin further increased to 94.06% showing an even higher volatility (80 percent points) vis-à-vis previous year.‖ Further we would also like to state that Keynote can also not be considered a comparable to the assessee (on the basis of single yea....
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....ould be allowed as tax deductible expenditure. 11. Learned counsel argued that the ALP of an international transaction has to be determined by applying one of the methods provided in section 92-C (3) of the Act; it should be the most appropriate method and should also take into account prescribed factors. This is, counsel stated, elaborated in Rule 10-B of the Rules, which contemplates adjustment on account of functional and other differences. He contended that adopting of any method ultimately envisages comparison of like functions, transactions and enterprises. Rule 10B(2)(a) provides that specific characteristic of services rendered by the two entities should be compared in order to treat the same as comparables for the purpose of transfer pricing analysis. Counsel also referred to the OECD guidelines and argued that accurate ALP determination is dependent on flexibility and sound exercise of discretion. Chapter III of the OECD guidelines was relied on to say that they recommend that where can it be determined that some uncontrolled transactions have a lesser degree of comparability than others, they should be eliminated. He also referred to Section A-5 of OECD guidelines on &#....
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....ontention that data in respect of Keynote should have been excluded. It was also similarly argued that the ITAT fell into error in rejecting the assessee's objection with respect to Brescon whose total turnover was over Rs. 14 crores, of which the comparable business was only Rs. 2 crores; the absence of any sectional data with regard to this company, meant that its activities were not comparable, on a fair application of Rule 10-B (2) and (3). 14. Learned counsel relied on the decisions of the Special Bench in the case of Quark Systems Private Limited v. DCIT (2010 38 SOT 307- Chandigarh Bench) Adobe Systems India Pvt. Ltd. (Del) 2011-(TII)-13-ITAT-DEL); Teva India (P) Ltd v. DCIT, [2011] 44 SOT 105 (Mum); Sapient Corporation (P) Ltd. v. Deputy CIT, [2011] 11 Taxmann 69 (Delhi); Asst CIT vs. Maersk Global Services Centre (India) P. Ltd. (133 ITD 543)(Mum.); Symantec Software Solutions (P) Ltd. v. Assistant CIT [2012] 25 Taxmann 163 (Mum); and a Division Bench decision of this court, in Commissioner of Income Tax v Agnity India Technologies Pvt. Ltd. (2013) 219 Taxman 26 (Del), were relied on. In Agnity India (supra) it was held that huge turnover companies like Infosys ....
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....be removed from the list of comparables unless, such removal is statutorily permitted by Rule 10-B (2) or (3). Counsel also submitted that this is also evident from a reading of Rule 10-C. It was pointed out that Rule 10B (3) (ii) and Rule 10 C (2)(e) permitted adjustment to eliminate material defects of the difference between the assessee and comparables. Counsel argued that only those factors which result in material difference in the comparables of transactions as between the assessee and the unrelated transaction or the third party enterprise, have to be reasonably adjusted to avoid distortions under the said provisions. The step envisioned there had to be necessarily followed keeping in view the mandate "shall". 18. It was also argued that the decision in Commissioner Of Income Tax v Mentor Graphics (Noida) Pvt.Ltd (ITA 1114/2008, decided by this court on 04-04-2013) has held that OECD guidelines cannot be applied because there are specific provisions of Rule 10B (2) & (3) and the first proviso to Section 92C(2) which apply. There, it was held that having held that the comparables given by the assessee were to be accepted and those searched by the TPO were to be rejected, the....
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.... is not reliable or correct; or (d)the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine the arm's length price in relation to the said international transaction [or specified domestic transaction] in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him: Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm's length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer." 20. Section 92C(1) thus visualizes determination of the "arms-length price" (ALP) by any of five enumerated methods, ―being the most appropriate method‖, having regard to the ―nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the board may....
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.... and benefits are to be divided between the respective parties to the transactions ; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and the Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions; (f) the nature, extent and reliability of assumptions required to be made in application of a method." Rule 10B (3) stipulates the third step, and spells out when the TPO is obliged to hold an uncontrolled transaction as comparable with others. This provision reads as follows: ―(3) An uncontrolled transaction shall be comparable to an international transaction or a specified domestic transaction if- (i) none of the differences, if any....
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....[2014] 30 ITR (Trib) 39 (Mum). Such views are echoed in Trilogy E-Business Software India P. Ltd. v. Deputy CIT [2013] 23 ITR (Trib) 464 (Bang) and Stream International Services P. Ltd. v. Asst. DIT (International Taxation) [2013] 23 ITR (Trib) 70 (Mum) too. 24. Before analysing the relative strengths of the rival contentions, a tabular statement containing the reasoning which persuaded various Benches of the ITAT to conclude one way or the other is reproduced below: S. No. Judgment Finding Rationale 1. ITO v. Saunay Jewels (P) Ltd., [2010] 42 SOT 2 (Mum). 1. One of the four comparables chosen by the TPO (Sovereign Diamonds Ltd.) should be excluded. 2. Simple arithmetic average of gross profit margin cannot be adopted as there is a wide variation in the parameters. Weighted average should be taken. The excluded comparable had a gross profit margin of 53.81% which was abnormal profits. 2. Adobe Systems India (P) Ltd. v. Additional Commissioner of Income-tax, [2011] 44 SOT 49 (Delhi) 1. Directed the exclusion of three entities as comparables. The said entities had shown supernormal profits. By excluding these three companies, the arithmetic mean of OP/TC comes to 17.15%,....
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....a comparable was not incorrect. Wipro cannot be a comparable. Assessee derived its income from software development and IT enabled services. Assessee itself argued before the TPO that VTIL is a comparable company offering IT enabled services. The intangibles will not Previous year data can be used for comparables only under exceptional circumstances. materially affect the price or profit-earning [within the meaning of Rule 10B(3)]. No two comparable companies can be replicas of each other. Rule 10B should be applied on a broader perspective and not with technical rigour. Wipro cannot be a comparable as its turnover is 20 times that of the assessee. 8. Symantec Software Solutions (P) Ltd. v. Assistant CIT, [2012] 25 Taxmann 163 (Mum). Two entities (ICC International Agricultural Ltd. and TSR Darashaw Ltd.) were directed to be excluded as comparables. These entities were required to be excluded on account of significantly higher operating margins (82.92% and 78.29%) whereas the next highest was 26.67%. Thus, unless it was demonstrated that these super normal profits were earned in the normal routine of activities, they could not be included. 9. Sony India (P) Ltd. v. Deput....
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....ion is necessary in the circumstances of the case. 14. Maersk Global Centres (India) (P) Ltd. v. ACIT, [2014] 43 Taxmann 100 (Mumbai Special Bench). Entities with abnormally high profit margins cannot be rejected outright as comparables. In the given facts of the case, two comparables sought to be included indicated unusual features for the year, which qualified for their exclusion. The inclusion of entities with supernormal profits would depend upon the facts and circumstances of each case. It should trigger further investigation to establish whether it can be taken as a comparable or not - this would depend upon whether the high profits reflect a normal business condition or whether they are a result of some abnormal conditions prevailing in the relevant year. The profit margin earned by such entity in the immediately preceding year may also be taken into account to determine this issue. If the high profit margin does not reflect normal business condition, it should be rejected. An entity cannot be rejected solely on the basis of abnormally high profit margin. 15. Goldman Sachs (India) Securities Pvt. Ltd. v. ACIT, ITA No. 7724/Mum/2011, dated 23.01.2013 Directed the ex....
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....ight away be rejected as comparables unless abnormal loss is projected. 21. Google India (P) Ltd. v. DCIT, [2013] 29 Taxmann 412. Exclusion of two companies making supernormal profits. The Tribunal has consistently held that super profit making companies have to excluded from the list of comparables before making transfer pricing adjustment. 25. Maersk Global Centres (India) (P) Ltd (supra) was a Special Bench (3 Member) decision of ITAT which had to address the precise question which arises for consideration in this case, i.e whether in the facts of that case ―companies earning abnormally high profit margin should be included in the list of comparable cases for the purpose of determining the arm's length price of international transactions‖. Although the ITAT did not specifically answer the question, in view of its findings that two comparables, i.e eClerx Services Ltd and Mold Tech Technologies Ltd, on account of unusual or peculiar features which were apparent from the materials on record, the Bench did indicate the general approach appropriate in this regard: ―the comparability of an international transaction with an uncontrolled transaction for the ....
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....g unit. Similarly, a higher profit making unit cannot also be automatically eliminated just because the comparable company earned higher profits than the average. The reason for rejecting the two loss making units is not just because they were loss making units but for the reasons which are already stated in the preceding paragraphs. If similar reasons existed in the higher profit making unit, then, it is for the assessee to bring out those reasons and seek exclusion of the same. A general argument that you have to exclude units which have high profit range, in case you exclude units which have made loss is a general submission which cannot be accepted. In other words, as a general principle, both loss making unit and high profit making unit cannot be eliminated from the comparables unless there are specific reasons for eliminating the same which is other than the general reason that a comparable has incurred loss or has made abnormal profits.‖ This court notices that American Express Services India Ltd v Deputy Commissioner Of Income-Tax, 2013 (57) SOT 22 (ITAT-Del) said, similarly, that: ― If the comparables are performing the same functions then merely on the groun....
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....61 where contentions such as these were accepted: ".....The wide difference in the ratio of operating margins in the final selection of comparable ... is a clear pointer to the fact that the selection made was faulty...The OECD guideline on this point is as under '1.47 Where the application of one or more methods produces a range of figures, a substantial deviation among points in that range may indicate that the data used in establishing the some of the points may not be as reliable as the data used to establish the other points in the range or that the deviation may result from features of the comparable data that require adjustments.' Inferring from the above ruling, we requests your goodself to not consider companies displaying abnormal profits since they deviate from the normal trend displayed by the data set." Many decisions of different benches of the ITAT indicate a rote repetition (in the words of Felix Frankfurter J, quoted in the beginning of this judgment a "lazy repetition") of this reasoning, without an independent analysis of the provisions of the Act and the rules. (Ref. IQ Information Systems India P. Ltd. [2013] 25 ITR (Trib) 185 (Hyderabad Bench) Symphony Mar....
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.... the seven companies are taken into consideration or all eight companies are taken into consideration, be less than 6.99 per cent which is the PLI of the respondent/assessee for the relevant year, that is, financial year ending 31st March, 2002. We may also make it clear that the reference to the OECD Guidelines by the Tribunal in the impugned order are in the context of the reliance placed by the TPO on the very same guidelines, in particular, to para 3.27 thereof. In the present case, there are specific provisions of sub-rr. (2) and (3) of r. 10B of the said rules as also of the first proviso to s. 92C(2) of the said Act which apply. Therefore, the question of applying OECD Guidelines does not arise at all.‖ It is therefore, evident that the Special Bench and this Court stressed that mere distortion cannot be the basis of exclusion, given the mandate of Section 92C. The assessee had during the hearing, heavily relied on OECD guidelines and another Division Bench ruling in Agnity (supra). This court proposes to take up the latter decision first for discussion. In Agnity (supra), the revenue had questioned, inter alia, the ITAT decision to exclude the data relating to Infosy....
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.... the assessee. Details of these companies are mentioned in para 5 of the impugned order. 9. In view of the aforesaid position, we do not think that any substantial question of law arises for consideration. The appeal is dismissed.‖ 28. Quite evidently, the Court accepted the assessee‟s contentions with respect to dissimilarity of comparables; given the facts, equally, there was sufficient material to favour that view, in the facts of the case. The Court, unlike in Mentor Graphics (supra) did not undertake an analysis of the provisions involved- it was not also necessary, given the admitted state of facts. 29. Considerable inspiration was drawn from OECD guidelines to say that extraordinary facts in relation to a comparable should lead to its rejection in the TP analysis. The relevant provisions of the 2010 OECD Transfer Pricing Guidelines are extracted below: ―A.7.3 - Extreme Results: Comparability Considerations 3.63: Extreme results might consist of losses or unusually high profits. Extreme results can affect the financial indicators that are looked at in the chosen method (e.g. the gross margin when applying a resale price, or a net profit indicator ....
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....year data is often useful in a comparability analysis, but it is not a systematic requirement. Multiple year data should be used where they add value to the transfer pricing analysis. It would not be appropriate to set prescriptive guidance as to the number of years to be covered by multiple year analyses. 3.76: In order to obtain a complete understanding of the facts and circumstances surrounding the uncontrolled transaction, it generally might be useful to examine data from both the year under examination and prior years. The analysis of such information might disclose facts that may have influenced (or should have influenced) the determination of the transfer price. For example, the use of the data from past years will show whether a taxpayer's reported loss on a transaction is part of a history of losses on similar transactions, the result of particular economic conditions in a prior year that increased costs in the subsequent year, or a reflection of the fact that a product is at the end of its life cycle. Such an analysis may be particularly useful where a transaction profit method is applied. See paragraph 1.72 on the usefulness of multiple year data in examining loss situa....
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.... Rules 10-A to 10-E. 31. Arm's length price determination, in respect of an international transaction has necessarily to confirm to the mandate of Rule 10B. In this case, the method followed for determining the arm's length price of the international transaction adopted by the assessee and the revenue is the TNMM. The comparability of an international transaction with an uncontrolled transaction has, in such cases, to be seen with reference to the functions performed, taking into account the assets employed or to be employed and the risks assumed by the respective parties to the transaction as per rule 10B(2)(b). The specific characteristics of the property transferred or services provided (contemplated by Rule 10B(2)(a)) in either transactions may be secondary, for judging comparability of an international transaction in the TNMM, because the price charged or paid for property transferred or services provided and the direct and indirect cost of production incurred by the enterprise in respect of property transferred or services provided go into reckoning comparability analysis in the transaction methods, i.e the comparable uncontrolled price, resale price and cost p....
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....Rule 10B (3) on the other hand, indicates the approach to be adopted where differences and dissimilarities are apparent. Therefore, the mere circumstance of a company - otherwise conforming to the stipulations in Rule 10B (2) in all details, presenting a peculiar feature - such as a huge profit or a huge turnover, ipso facto does not lead to its exclusion. The TPO, first, has to be satisfied that such differences do not ―materially affect the price...or cost‖; secondly, an attempt to make reasonable adjustment to eliminate the material effect of such differences has to be made. 34. The Court is also aware of the factors mentioned in Rule 10B (2), i.e characteristics of the service provided, functions performed taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; contractual terms of the transactions indicating how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and the Gov....
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....at in the facts of the present case, the assessee was incorrect, both in its reliance placed upon previous years‟ data as well as the manner of such reliance. First, the assessee‟s justification for relying on such data is the volatility in the comparables‟ profit margins and the consequent inability to transact at a consistent ALP. However, this is not warranted herein. Whilst there may be a wide fluctuation in the profit margins of comparables from year-to-year, this by itself does not justify the need to take into account previous years‟ profit margins. The transfer pricing mechanism provided in the Act and the Rules prescribes that while determining the ALP, the arithmetic mean of all comparables is to be adopted. This is to offset the consequence of any extreme margins that comparables may have and arrive at a balanced price. Similarly, the wide fluctuations in profit margins of the same entity on a year-to-year basis would be offset by taking the arithmetic mean of all comparables for the assessment year in question. In any case, in the event that the volatility is on account of a materially different aspect incapable of being accounted for, the analys....
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...., in the area of human rights -particularly in personal liberty, been emphasizing that to the extent the provision of any treaty is in consonance with provision of the Constitution (such as Article 21) it would be read along with such provision or right (Jolly George Varghese and Anr. v. The Bank of Cochin, AIR 1980 SC 470, Apparel Export Promotion Council v. A.K. Chopra, AIR 1999 SC 625; Kubic Dariusz v Union of India AIR 1990 SC 605). Thus, the Courts are primarily bound by the law on the subject in India; if the law is clear and unambiguous, there is no question of resorting to extrinsic sources. The only rider is that if the terms of such conventions or treaties are similar to the law applicable in India, courts may consider precedents in that regard; however those are only of persuasive value. 38. The aforesaid conclusion is fortified by the Division Bench decision of this Court in Mentor Graphics (supra), where the Court noted: ― We may also make it clear that the reference to the OECD guidelines by the Tribunal in the impugned order are in the context of the reliance placed by the Transfer Pricing Officer on the very same guidelines, in particular, to paragraph 3.27 ....
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....proposed ‗comparables'‖ and that "further examination would be needed to understand the reasons for such extreme results‖. Similarly, para 3.65 states that "loss-making comparables that satisfy the comparability analysis should not however be rejected on the sole basis that they suffer losses‖. Further, para 3.64 states that "it is the facts and circumstances surrounding the company in question that should determine its status as a comparable, not its financial result‖. The same approach is prescribed in para 3.66 for entities making supernormal profits. Therefore, both the OECD Guidelines as well as Rule 10B (2) and 10B (3) do not, in any manner, prescribe automatic exclusion of entities with extreme financial results. Similarly, insofar as the use of multiple year data is concerned, Para 3.75 of the OECD Guidelines states that "[m]ultiple year data should be used where they add value to the transfer pricing analysis.‖ This is akin to the proviso to Rule 10B(4) which provides for "data relating to a period not being more than two years prior to such financial year [to] be considered if such data reveals facts which could have an influence on th....
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....ver, this Court holds that such a contention cannot be raised for the first time at this stage. Therefore, Brescon and Khandwala Securities are held to be functionally similar, and the matter is remitted to the DRP for the purposes of examination under Rule 10B(3) of the Rules. In the event that the material differences arising out of the extremely high profits cannot be eliminated as per Rule 10B(3), these two entities will have to be discarded as comparables. 42. As far as Keynote is concerned, this Court notices that the assessee had challenged its inclusion as a comparable on two grounds: a) differences in the activities of Keynote and the assessee; and b) exceptionally high profit margins. The TPO rejected the first ground relying on the fact that the assessee had used it as a comparable for previous years and in the subject assessment year as well, it qualified as a comparable based on the assessee‟s search process. Further, the TPO held that Keynote was engaged in financial consultancy and would therefore be considered as a comparable. The ITAT, for reasons unknown, did not examine this issue. This Court notes that the assessee is engaged in the business of rendering ....
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....assessee itself had included that dividend income in its return for the year in question but there is no estoppel in the Income tax Act and the assessee having itself challenged the validity of taxing the dividend during the year of assessment in question, it must be taken that it had resiled from the position which it had wrongly taken while filing the return. Quite apart from it, it is incumbent on the income-tax department to find out whether a particular income was assessable in the particular year or not. Merely because the assessee wrongly included the income in its return for a particular year, it cannot confer jurisdiction on the department to tax that income in that year even though legally such income did not pertain to that year.‖ For the sake of completion, this Court would also deal with the assessee‟s reliance on the DRP‟s order dated 04.03.2013 (for AY 2006-07) for the exclusion of Keynote as a comparable. The DRP directed such exclusion on two grounds: a) the fact that Keynote was making exceptionally high profits; and b) only single year data could be considered for determining ALP in the present case and the volatility in profit margins of Keynot....